Top movers Change, % Best performers 4-Aug 1-day 1-mo 3-mo BHFC IN Equity 749.7 3.6 11.6 84.9 RCAPT IN Equity 582.2 0.6 (11.2) 70.8 UT IN Equity 25.9 3.2 (21.3) 62.9 SSLT IN Equity 289.6 2.7 (5.1) 60.5 AL IN Equity 35.1 3.4 (2.8) 56.3 Worst performers UNSP IN Equity 2393.4 2.7 (2.5) (13.4) CAIR IN Equity 319.3 2.1 (12.2) (4.7) UBBL IN Equity 736.3 3.5 3.2 (4.6) MMFS IN Equity 248.7 2.9 (8.7) 0.8 ACEM IN Equity 204.4 0.5 (8.6) 0.9
Contents Special Reports Strategy Strategy: Smart beta using eXtractor - growth and profitability overshadow other styles Daily Alerts Results Power Grid: Steady on the growth path Cummins India: Poised to outperform peers Marico: 1QFY15 ahead, outlook positive; valuations full. REDUCE Mphasis: Revenue growth challenges mount Oriental Bank of Commerce: Lower provisions cushion a weak performance Bajaj Corp.: 1QFY15 ahead of expectations; raise estimates a tad. ADD Carborundum Universal: Margins to improve further; order flow is encouraging Results, Change in Reco Petronet LNG: Weak results and full valuations Company Crompton Greaves: Annual report - broad demand recovery uncertain; expects overseas demand in some pockets
For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL. Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 eXtractor, KIEs proprietary data analytics tool KIEs proprietary data-analytics tool, eXtractor, mines a universe of Indian stocks based on nine factors: value, relative value, growth, profitability, momentum, leverage, size, sentiment and our proprietary factor iQ, or investment quotient. The data-mining is comprehensive in nature with iQ deriving higher concepts from basic financial parameters by unifying various traditional investment parameters under a single factor. This bridges the gap between data and inference. eXtractor is part of our Quantools offerings and is available on our website (http://kie.kotak.com). Here, clients can screen and test various investment styles, using their own parameters for universe, investment horizons, churn periods, portfolio size and more. Investment style guidegrowth and profitability outperform in July Growth (+5.3%) and profitability (+3.7%) emerged as the best-performing investment styles in July (see Exhibit 1). Value (-6.3%) and low leverage (-5.3%) were the worst-performing factors even as sentiments (-2.2%) lagged the broader markets. Investment trends have been mixed since May with growth and profitability experiencing mixed fortunes in CYTD14 (see Exhibit 2). While SUNP and TCS assisted the growth portfolio over the month, consumer staples like HUVR and ITC were the biggest boost to the profitability basket (see Exhibit 3). The value portfolio was affected by corporate governance concerns in CAIR (-13.6%). Exhibit 4 showcases the August 2014 portfolios based on various investment styles. AXSB was added to the iQ portfolio for the month on the back of growth, value and sentiments. AXSB, HUVR and APNT make up the sentiment- based portfolio for August, having witnessed consensus target price upgrades of 10-12% over the month. Smart betaoptimized CNX Nifty 50 portfolio underperforms by 50 bps in July We extend eXtractors framework to optimize the weights of the CNX Nifty 50 constituents by exposing the broader portfolio to selected factors (see Exhibit 5). The strategy has consistently outperformed the benchmark since CY2006 (see Exhibit 6) based on a set of assumptions (see Exhibit 7). In July, the optimized portfolio underperformed the CNX Nifty 50 by 50 bps for the first time since January 2014 (see Exhibit 8). While the overweight positions in materials like NMDC and JSPL weighed upon portfolio performance, underweight positions in LT and SBIN assisted overall portfolio returns (see Exhibit 9). Exhibit 10 showcases the optimized CNX Nifty 50 portfolio performance for July. August 2014 optimized CNX Nifty 50 portfolioprefers financials over healthcare and industrials The optimized CNX Nifty 50 portfolio for August prefers financials, information technology, materials and consumer discretionary over consumer staples, healthcare and information technology (see Exhibit 11). PNB, CAIR, IIB and SBIN saw the highest additions in weight on a mom basis while HMCL, ONGC and ITC were placed at the opposite end of the spectrum (see Exhibit 12). Exhibit 13 showcases the optimized CNX Nifty 50 portfolio for August.
Strategy.dot
Strategy India Quantitative Smart beta using eXtractorgrowth and profitability overshadow other styles. Growth and profitability were the best-performing investment styles in July despite their mixed fortunes in CYTD14. The optimized CNX Nifty 50 portfolio for August prefers financials, information technology and materials over consumer staples, healthcare and industrials. PNB, CAIR and IIB are the biggest additions to the August portfolio.
INDIA AUGUST 05, 2014 UPDATE BSE-30: 25,723
QUICK NUMBERS Growth and profitability supersede other investment styles in July 2014 AXSB gets added to the iQ portfolio Optimized portfolio prefers financials, information technology and materials PNB, CAIR, IIB and SBIN were the biggest mom addition
Saifullah Rais saifullah.rais@kotak.com Mumbai: +91-22-4336-0895
Strategy India KOTAK INSTITUTIONAL EQUITIES RESEARCH 3 Exhibit 1: Growth and profitability are the only investment styles to outperform the CNX Nifty 50 in July Performance of the portfolios based on different investment styles, July 2014 Portfolio returns Minimum Maximum Average Investment style Company Returns (%) Company Returns (%) (%) iQ ONGC (6.9) Tata Consultancy Services 6.4 (0.0) Growth IndusInd Bank (2.1) Sun Pharmaceuticals 15.0 5.3 Value Cairn India (13.6) Bank of Baroda (0.5) (6.3) Relative value Jindal Steel & Power (14.8) ITC 9.5 (2.3) Profitability NMDC (6.8) Hindustan Unilever 10.7 3.7 Size State Bank of India (9.2) Tata Consultancy Services 6.4 (1.4) Momentum Larsen & Toubro (11.7) Tata Steel 4.7 (3.4) Sentiments BHEL (8.8) Maruti Suzuki India 3.5 (2.2) Leverage Bajaj Auto (10.4) Infosys 9.5 (5.3)
India Strategy 6 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 5: Strategy showcases consistent outperformance Optimized portfolio performance and factor exposure Security-wise constraints Upper bound stock ownership (%) 8 Stockwise deviation (%) 5 Composite factor style exposure (%) Growth 15 Value 15 Relative value 25 Profitability 15 Size 0 Mometum 10 Sentiments 20 Leverage 0 Performance statistics Average returns (%) 0.6 Avg. +ve returns (%) 1.8 Avg. -ve returns (%) (1.1) Annualized outperformance (%) 7.1 Hit ratio (%) 59 Maximum drawdown (%) 11 Profit factor (X) 1.6 Avg. number of securities owned 26
Source: eXtractor, Kotak Institutional Equities
Exhibit 6: The optimized portfolio strategy has consistently outperformed since CY2008 Annual optimized CNX Nifty 50 portfolio outperformance over the CNX Nifty 50 (%) (8) (4) 0 4 8 12 16 CY2007 CY2008 CY2009 CY2010 CY2011 CY2012 CY2013 CYTD14 Annual outperformance over the CNX Nifty 50 (%)
Source: eXtractor, Kotak Institutional Equities
Strategy India KOTAK INSTITUTIONAL EQUITIES RESEARCH 7 Exhibit 7: Maximum allowable deviation from benchmark weight is 5% Key assumptions to consider liquidity and implementation constraints Assumptions AUM (US$ mn) - 100 Participation aggression - 25% Days to set up position - 2 days Security-wise maximum deviation from Nifty Index = 5% Upper bound on ownership = 8% No shorting allowed.
Source: eXtractor, Kotak Institutional Equities
Exhibit 8: Optimized portfolio underperforms benchmark in July Mom performance of the optimized CNX Nifty 50 portfolio based on eXtractor's scoring model (%) (6) (4) (2) 0 2 4 6 8 10 12 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 CNX Nifty 50 (%) Optimized CNX Nifty 50 portfolio (%)
Source: eXtractor, Kotak Institutional Equities
Exhibit 9: Portfolio performance negatively affected by excess exposure to materials like JSPL and NMDC Positive and negative contributors to portfolio alpha, July 2014 Weight (+/-) Performance Weight (+/-) Performance Company (%) (%) Company (%) (%) Case VII (c ) 0.9 Lupin 6.0 12.8 Jindal Steel & Power 5.5 (14.8) Larsen & Toubro 0.4 (11.7) HDFC 1.0 7.6 State Bank of India 0.0 (9.2) NMDC 5.6 (6.8) HCL Technologies 6.6 3.7 Sun Pharmaceuticals (0.0) 15.0 Tata Motors 8.0 3.6 Oil & Natural Gas Corp. 6.2 (6.9) Positive contributors Negative contributors
Source: eXtractor, KIE Quantools
India Strategy 8 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 10: The optimized portfolio underperformed the CNX Nifty 50 by ~0.5% in July Optimized CNX Nifty 50 portfolio performance for July 2014 CNX Nifty 50 Optimized Difference Performance Company GICS Sectors (%) (%) (+/-) (%) Infosys Information Technology 6.2 8.0 1.8 3 Tata Motors Consumer Discretionary 3.1 8.0 4.9 4 Axis Bank Financials 2.5 7.5 5.0 2 ITC Consumer Staples 7.0 7.0 0.0 10 HCL Technologies Information Technology 1.6 6.6 5.0 4 ICICI Bank Financials 6.3 6.3 0.0 4 Hero MotoCorp Consumer Discretionary 1.2 6.2 5.0 (1) Power Grid Corp of India Utilities 1.2 6.2 5.0 (4) Oil & Natural Gas Corp Energy 2.9 6.2 3.2 (7) Lupin Health Care 1.0 6.0 5.0 13 Bank of Baroda Financials 0.6 5.6 5.0 (1) NMDC Materials 0.6 5.6 5.0 (7) Jindal Steel & Power Materials 0.5 5.5 5.0 (15) Tata Consultancy Services Information Technology 4.9 4.9 (0.0) 6 HDFC Bank Financials 6.0 4.6 (1.4) 2 Reliance Industries Energy 6.6 1.6 (5.0) (1) Wipro Information Technology 1.4 1.4 (0.0) (0) HDFC Financials 6.0 1.0 (5.0) 8 IndusInd Bank Financials 1.0 1.0 (0.0) (2) Cairn India Energy 0.8 0.4 (0.4) (14) Larsen & Toubro Industrials 5.4 0.4 (5.0) (12) Performance (%) 1.44 0.94 eXtractor-based
Source: eXtractor, Kotak Institutional Equities
Exhibit 11: eXtractor recommends a high exposure to financials; allocations to healthcare drops Portfolio sector-wise comparison of exposure as compared to previous month (%) CNX Nifty 50 Weights Difference Weights Difference GICS Sectors Original Optimized (+/-) Optimized (+/-) Consumer Discretionary 9 11 2.3 14 5.3 Consumer Staples 10 3 (7.6) 7 (2.5) Energy 12 10 (1.5) 8 (3.7) Financials 29 43 14.3 26 (2.5) Health Care 5 (5.6) 6 0.9 Industrials 6 (5.5) 0 (5.9) Information Technology 15 20 4.2 21 5.6 Materials 9 12 3.7 11 2.2 Telecommunication Services 2 (1.7) (1.6) Utilities 4 1 (2.6) 6 2.2 Performance (%) (0.49) 0.4 0.9 Alpha (%) 0.90 (0.5) Portfolio 22 21 Current month Previous month
Source: eXtractor, Kotak Institutional Equities
Strategy India KOTAK INSTITUTIONAL EQUITIES RESEARCH 9 Exhibit 12: PNB, CAIR and IIB saw the highest mom increase in weights Optimized CNX Nifty 50 portfolio mom change in weights, August 2014 Optimized CNX Nifty 50 weights MoM change Company GICS Sectors (%) (%) (%) MoM weight increase (%) Punjab National Bank Financials 0.6 5.6 5.6 Cairn India Energy 0.7 5.7 5.3 IndusInd Bank Financials 0.9 5.9 5.0 State Bank of India Financials 2.9 2.9 2.9 MoM weight reduction (%) Lupin Health Care 1.1 (6.0) Power Grid Corp of India Utilities 1.1 1.1 (5.1) ITC Consumer Staples 7.6 2.6 (4.4) Oil & Natural Gas Corp. Energy 2.7 2.7 (3.4) Hero MotoCorp Consumer Discretionary 1.2 3.1 (3.2)
Source: eXtractor, Kotak Institutional Equities
Exhibit 13: TTMT, INFO, ICICI and AXSB have the biggest allocations in the portfolio Optimized CNX Nifty 50 portfolio constituents and weights, August 2014 CNX Nifty 50 Optimized Difference Company GICS Sectors (%) (%) (+/-) Tata Motors Consumer Discretionary 3.1 8.0 4.9 Infosys Information Technology 6.2 8.0 1.8 ICICI Bank Financials 6.6 8.0 1.4 Axis Bank Financials 2.5 7.5 5.0 HCL Technologies Information Technology 1.6 6.6 5.0 HDFC Bank Financials 6.0 6.0 (0.0) IndusInd Bank Financials 0.9 5.9 5.0 Cairn India Energy 0.7 5.7 5.0 Bank of Baroda Financials 0.6 5.6 5.0 Punjab National Bank Financials 0.6 5.6 5.0 NMDC Materials 0.5 5.5 5.0 Jindal Steel & Power Materials 0.4 5.4 5.0 Tata Consultancy Services Information Technology 5.1 5.1 (0.0) Hero MotoCorp Consumer Discretionary 1.2 3.1 1.9 State Bank of India Financials 2.9 2.9 Oil & Natural Gas Corp Energy 2.7 2.7 ITC Consumer Staples 7.6 2.6 (5.0) HDFC Financials 6.5 1.5 (5.0) Tata Steel Materials 1.4 1.4 (0.0) Reliance Industries Energy 6.3 1.3 (5.0) Power Grid Corp of India Utilities 1.1 1.1 IDFC Financials 0.7 0.4 (0.3) Performance (%) (0.49) 0.41 Portfolio 22 eXtractor-based
Source: eXtractor, Kotak Institutional Equities
For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.
Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 Earnings lower than estimates owing to lower transmission revenues as well as other income PWGR reported net sales of `39 bn (11% yoy, 0% qoq), operating profit of `34 bn (11% yoy, 2% qoq) and net income of `11.6 bn (13% yoy, -2% qoq) against our estimates of `41 bn, `35 bn and `12.3 bn, respectively. The lower net income was (1) primarily on account of lower transmission revenues of `38 bn against our estimates of `39 bn, (2) sequential decline in consultancy revenues at `610 mn in 1QFY15 compared to `1.6 bn in 4QFY14 and `965 mn in 1QFY14 and (3) lower other income of `1.3 bn against our estimates of `2.3 bn. Capitalization picks up in 1QFY15, investment approval of `73 bn given during the quarter Asset capitalization for 1QFY15 was ~`49 bn (66% yoy), which adds up to `194 bn asset capitalization in the trailing four quarters. PWGR achieved capitalization of `159 bn, which makes our estimate of `287 bn for the current fiscal an uphill task, though comes with a promising start. Investment approval during the quarter at `73 bn is the highest in the last three years, giving visibility to sustenance of growth beyond the immediate capex plans. The last such chunky investment approvals were seen in FY2012, the benefits of which were accrued over the past three years. Ordering activity at `27 bn, although unexciting, is the highest in the trailing four quarters. In our view, ordering activity will likely gain momentum owing to the recently accorded investment approvals. Maintain BUY on strong earnings momentum and reasonable valuations We maintain our BUY rating on PWGR with a target price of `145. At 1.5X P/B and 10X P/E of FY2016E, PWGR trades at reasonable multiples not fully taking cognizance of the step-up in earnings as over `400 bn of CWIP will likely be capitalized over the next two years. We have currently maintained our earning estimate for FY2015E at `9.5/share and for FY2016E at `13/share and will review the same post the analyst meet.
Power Grid (PWGR) Utilities Steady on the growth path. Powergrid continues to report strong earnings13% yoy growth in net income in 1QFY15, with asset capitalization of `49 bn for the quarter. The performance gains significance owing to (1) tightening of operating parameters by CERC and (2) absence of short-term open access earnings that were part of the base quarter. Valuations may seem pricey at 1.5X P/B, but underlying growth trajectory places PWGR among the preferred stocks in the utility space. Maintain BUY with TP of `145.
Exhibit 2: Asset capitalization of Rs49 bn in 1QFY15 Quarterly capex and capitalization for PGCIL, March fiscal year-ends, 1QFY11-1QFY15 (Rs bn) 10 30 50 70 1 Q
F Y 1 1 2 Q
F Y 1 1 3 Q
F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5 (Rs bn) Capex Capitalisation
Source: Company, Kotak Institutional Equities
Utilities Power Grid 12 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 3: Revival in approvals as Rs73 bn investments approved during 1QFY15 Quarterly approvals and ordering for PGCIL, March fiscal year-ends, 1QFY11-1QFY15 (Rs bn) 10 50 90 130 170 1 Q
F Y 1 1 2 Q
F Y 1 1 3 Q
F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5 (Rs bn) Approvals Ordering
Source: Company, Kotak Institutional Equities
Exhibit 4: At 1.5X P/B and 10X P/E 2016E earnings trades reasonable owing to strong growth profile Key valuation metrics for PGCIL, March fiscal year-ends, 2012-16E 2012 2013 2014E 2015E 2016 Valuations (at CMP) 130 Book value (Rs) 54 61 71 78 89 Net worth 250,887 281,986 369,026 410,517 464,306 P/B (X) 2.4 2.1 1.8 1.7 1.5 EPS 7.1 9.1 8.6 9.5 13.0 P/E (X) 18 14 15 14 10 RoE (%) 13.7 15.9 13.8 12.7 15.6 RoCE (%) 6.3 6.7 6.1 6.1 7.2 Net debt 508,130 659,637 746,940 825,885 813,178 EV 1,109,995 1,261,502 1,427,048 1,505,993 1,493,286 EV/EBITDA (X) 11.1 9.9 9.4 8.0 6.4
Power Grid Utilities KOTAK INSTITUTIONAL EQUITIES RESEARCH 13 Exhibit 6: Profit model, balance sheet, cash model of PGCIL, March fiscal year-ends, 2011-17E (Rs mn)
2011 2012 2013 2014E 2015E 2016E 2017E Profit model Net revenues 83,887 100,353 127,095 151,527 189,011 232,152 273,960 EBITDA 70,513 83,824 108,880 128,788 167,557 207,700 247,308 Other income 6,709 7,497 6,193 5,687 6,887 7,313 8,536 Interest expense (17,339) (19,433) (25,352) (31,675) (43,331) (45,966) (52,799) Depreciation (21,994) (25,725) (33,519) (39,957) (57,672) (72,113) (84,546) Pretax profits 37,889 46,163 56,202 62,843 73,441 96,935 118,499 Tax (6,846) (8,911) (10,521) (12,741) (14,591) (19,280) (23,316) Deferred taxation (4,432) (4,541) (3,583) (4,922) (9,230) (9,430) (12,851) Net income 26,611 32,710 42,098 45,179 49,620 68,225 82,332 Extraordinary items 359 (161) 247 (205) Reported profit 26,969 32,550 42,345 44,974 49,620 68,225 82,332 Earnings per share (Rs) 5.7 7.1 9.1 8.6 9.5 13.0 15.7 Balance sheet Paid-up common stock 42,088 46,297 46,297 46,297 52,316 52,316 52,316 Total shareholders' equity 213,670 234,878 262,395 344,596 376,858 421,217 474,748 Deferred taxation liability 11,467 16,009 19,592 24,430 33,659 43,089 55,939 Income received on account of AAD 23,474 22,831 37,176 45,175 45,175 45,175 45,175 Total borrowings 408,828 538,950 681,876 794,902 907,265 920,754 911,557 Total liabilities and equity 657,439 812,668 1,001,038 1,209,103 1,362,957 1,430,235 1,487,420 Net fixed assets 372,240 476,623 614,006 776,892 970,438 1,136,288 1,390,714 Capital work-in progress 266,246 281,835 348,235 449,416 353,868 235,094 666 Investments 13,651 12,845 11,476 9,987 5,981 4,080 4,054 Miscellaneous expenses not w/o 24 Cash 36,801 23,369 16,620 44,175 79,426 107,521 152,088 Net current assets (excl. cash) (31,522) 17,997 10,701 (71,367) (46,754) (52,749) (60,102) Net current assets (incl. cash) 5,279 41,366 27,320 (27,192) 32,671 54,772 91,986 Total assets 657,439 812,668 1,001,038 1,209,103 1,362,957 1,430,235 1,487,420 Free cash flow Operating cash flow, excl. working capital 46,192 62,174 93,792 97,852 116,521 149,768 179,728 Working capital changes (5,910) (49,519) 7,296 82,068 (24,613) 5,995 7,353 Capital expenditure (134,204) (145,945) (237,784) (304,023) (155,669) (119,190) (104,544) Free cash flow (93,922) (133,290) (136,695) (124,104) (63,761) 36,573 82,538 Ratios Net debt/equity (%) 168 214 249 215 218 192 159 Return on equity (%) 13.5 13.7 15.9 13.8 12.7 15.6 16.5 Book value per share (Rs) 49 54 61 71 78 89 101 ROCE (%) 6.5 6.3 6.7 6.1 6.1 7.2 8.2
For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.
Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 Exportsscale-up in low hp and recovery of high-hp sales drive very strong growth Cummins reported the second straight quarter of strength with 41% yoy growth in revenues. This was driven by exports in (1) low-hp (`1.2 bn, up 128% yoy), (2) high-hp (`1.7 bn, up 20% yoy) and (3) mid-range (`460 mn, 55% yoy) segments. Low and mid-hp exports continued to benefit from a good response in seeded markets (Latin America) and high hp exports grew after bottoming out in 1QFY14. For FY2015 Cummins expects exports to grow 30% yoy, driven by low hp exports. We build in 30-35% growth for exports over FY2015-17. Domesticsees demand bottoming out across sectors; guidance indicates recovery from 2HFY15 Cummins anticipates broad-based recovery in demand from 2HFY15, though 1QFY15 revenues were sedatedown 16% yoy, led by industrials. Higher powergen realizations, on pass-through of costs to comply with revised emission norms, will support revenues. The company raised its revenue growth guidance to 0-5% from flattish guidance earlier and said its outlook was positive for the follo0wing businesses(1) powergen (investment-led demand), (2) industrials (construction, mining, railways and marine segments) and (3) distribution (increased customer reach; higher demand in the revised emission regime). Marginsexpects to overcome the impact of new emission norms and maintain margins EBITDA margin of 17.2% included costs related to (1) higher-than-average corporate charges (~40 bps impact), which are expected to normalize and (2) higher CSR spends (-40 bps impact), which are expected to continue. The company said benefits of higher operational efficiencies and a favorable product mix (higher low-hp exports) helped it to sustain margins in an otherwise weak demand scenario. For FY2015 it aims to maintain margins, factoring in the negative near-term impact of revised emission norms being offset by lower incremental corporate charges. Estimateswe build in strong recovery in scale-up of new businesses; retain our REDUCE rating We revise estimates marginally to `27.0 and `30.5 from `25.3 and `30.0 for FY2015 and FY2016 on higher export growth. We revise our target price to `615 from `570 on roll-forward (19X June 2016E earnings). We build in 22% revenue CAGR and 100 bps margin expansion over FY2014-17.
Cummins India (KKC) Industrials Poised to outperform peers. After having added significant capacities and protecting margins through the down-cycle, Cummins is well placed to outperform the market on (1) an impending recovery in the domestic business, (2) growth in high-hp exports (bottomed out a year ago) and (3) scale-up in its low-hp business (domestic and exports). We build strong estimates of 22% sales CAGR, 100 bps margin expansion, though find it hard to reconcile with market expectations (21X FY2016E EPS). We retain REDUCE and revise target price to `615 from `570 on roll forward to June 2016E earnings.
Industrials Cummins India 16 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 2: Quarterly trajectory of Cummins' segment sales (` bn) Power generation 3.5 3.3 2.7 3.2 4.3 3.7 4.0 4.4 3.2 2.4 3.0 2.7 2.9 0.0 1.0 2.0 3.0 4.0 5.0 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5 (Rs bn)
Industrials 1.4 1.2 1.6 1.3 1.1 1.1 1.5 1.5 1.4 1.2 1.5 1.1 1.0 0.0 0.5 1.0 1.5 2.0 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5 (Rs bn)
Export 2.7 3.1 2.6 3.3 4.2 3.0 2.5 3.0 2.7 3.0 2.8 3.4 3.9 0.0 1.0 2.0 3.0 4.0 5.0 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5 (Rs bn)
Distribution 2.3 2.0 1.7 2.2 2.5 2.4 2.3 2.0 2.6 2.3 2.4 2.0 2.2 0.0 0.5 1.0 1.5 2.0 2.5 3.0 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5 (Rs bn)
Source: Company, Kotak Institutional Equities
Exhibit 3: Sharp growth in low-hp sales in 1QFY15; high-hp sales also grow Exports break-up for Cummins India, March fiscal year-ends (` mn) Export sales breakup in 1QFY14 (Rs2.8 bn) Mid range, 296 Heavy duty, 357 HHP, 1,429 LHP, 522 Spares, 156 Export sales breakup in 1QFY15 (Rs3.9 bn) Mid range, 460 Heavy duty, 400 HHP, 1,720 Spares, 120 LHP, 1,190
Source: Company, Kotak Institutional Equities
Cummins India Industrials KOTAK INSTITUTIONAL EQUITIES RESEARCH 17 Exhibit 4: Domestic high-hp sales possibly grew yoy in 1QFY15 Segmental break-up of sales for Cummins, March fiscal year-ends, 2013-1QFY15 (` mn) Rating Yoy growth Segment (kva) 2013 2014 (%) 1QFY15 2015 (annualized) Low HP <160 4,611 4,150 (10.0) 1,480 5,920 Mid Range HP 160-380 8,046 7,000 (13.0) 1,840 7,360 Heavy Duty 450-625 4,019 4,300 7.0 880 3,520 High HP >750 18,243 13,500 (26.0) 3,710 14,840 Exports 7,119 1,720 6,880 Domestic 6,381 1,990 7,960 Distribution NA 9,250 9,250 0.0000 2,180 8,720 Total 44,169 38,200 (13.5) 10,090 40,360
Source: Company, Kotak Institutional Equities
Exhibit 5: Trends in raw material costs and currency, not supportive of margins Impact of raw material cost and currency on margin, March fiscal year-ends, 2008-1QFY15 50 70 90 110 130 150 170 Q 3
F Y 0 8 Q 1
F Y 0 9 Q 3
F Y 0 9 Q 1
F Y 1 0 Q 3
F Y 1 0 Q 1
F Y 1 1 Q 3
F Y 1 1 Q 1
F Y 1 2 Q 3
F Y 1 2 Q 1
F Y 1 3 Q 3
F Y 1 3 Q 1 F Y 1 4 Q 3 F Y 1 4 Q 1 F Y 1 5 (X) 56 60 64 68 72 (%) Raw material cost to sales [RHS] Pig iron India wholesale price index [LHS] Inverse USD INR index [LHS]
Source: Company, Kotak Institutional Equities Concall takeawaysraises FY2015 guidance; operates at 50-60% utilization Exportsguidance indicates 30% revenue growth, led by scale-up in the low-hp segment. Cummins reported the second straight quarter of strength with sequential improvement in revenues. On a yoy basis, sales grew by 41%. Growth was driven by (1) low hp (`1.2 bn, up 128% yoy), (2) high hp (`1.7 bn, up 20% yoy) and (3) mid-range segments (`460 mn, 55% yoy). High-hp sales reported good sequential growth for the second consecutive quarter in 1QFY15, growing 20% yoy. For the full year, the company expects exports to grow 30% yoy driven by low-hp exports (can grow 70% in FY2015 but maintaining the 1QFY15 run rate) and sustained recovery in high-hp sales.
Industrials Cummins India 18 KOTAK INSTITUTIONAL EQUITIES RESEARCH Domesticexpects recovery from 2HFY15; guidance indicates 0-5% sales growth. Domestic sales declined 15-16% yoy with weakness seen across verticals (powergen, industrials, and distribution). Lack of pre-buying demand for gensets made results look weaker (would also have limited negative impact in coming quarters). While highlighting weak on-ground demand, the company believes demand to have bottomed out: (1) M&HCV operators now thinking of replenishing capacities as they see recent increase in freight cost getting absorbed by market, (2) improving demand for mining equipment and (3) government focus on railways and marine investments. For FY2015, it anticipates a 0-5% growth in domestic sales (with flattish volumes). Marginguidance indicates maintaining current margins. EBITDA margin of 17.2% was impacted by higher than average corporate charges (~40 bps impact), which should normalize going forward. The company also cited higher spending on donations as it aims to comply with new Companies Acts target of higher CSR spend (2% of PBT). This charge would sustain at `40-50 mn. For FY2015, company aims to maintain its margin at current levels, factoring in the negative near-term impact of CPCB-II norms to get compensated by lower corporate charges. Company said benefits from higher efficiencies and favorable product mix (higher LHP exports) have helped it sustain reasonable margin in an otherwise weak demand scenario. Operates at capacity utilization of 50-60%. Cummins facilities are utilized to the extent of 50-60%. Incremental capex focus on office building and technical center. Cummins aims to invest `5-6 bn in FY2015 (similar spend in FY2016). A large share of this spend would go towards the setting up of an office complex. Out of the three towers, one is complete and another is 60% complete. Each tower would cost about `3 bn. Domestic low-hp business now significant. Cummins said material 1QFY15 domestic powergen sales in the 7-40 kVA category were `700 mn (a third of overall domestic powergen sales). It believes that there is strong potential to grow this segment. We retain REDUCE on full valuations We revise estimates marginally to `27.0 and `30.5 from `25.3 and `30.0 for FY2015 and FY2016 on higher exports growth. We revise our target price to `615 from `570 on roll- forward (19X June 2016E earnings). We build strong 22% revenue CAGR and 100 bps margin expansion over FY2014-17E.
Cummins India Industrials KOTAK INSTITUTIONAL EQUITIES RESEARCH 19 Exhibit 6: Key estimates for Cummins India, March fiscal year ends, 2014-17E (` mn)
Industrials Cummins India 20 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 7: Standalone balance sheet, profit model and cash flow statement of Cummins, March fiscal year-ends, 2010-17E (` mn)
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Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 1QFY15 another quarter of strong earnings beat Marico beat our expectations handsomely for the second quarter in a row. Reported consol revenues (`16.2 bn, +25% yoy), EBITDA (`2.63 bn, +19% yoy) and recurring PAT (`1.85 bn, +19% yoy) were 3%, 14%, and 23% ahead of our expectations, respectively. Earnings beat was driven by better-than-expected EBITDA margin performance for both domestic as well as international businesses. Higher-than-expected pricing component of growth was the primary driver of margin outperformance as volume growth was broadly in line with our expectations. We believe that the company also benefitted from lower-than-expected consumption cost average for copra. ETR at 26.3% also came in lower than our expectation of 30%; the company has lowered its ETR guidance for FY2015E to 28-29% from 30% earlier. Impressive volume growth across the portfolio Barring non-rigid Parachute CNO SKUs, Marico delivered solid volume growth across its brand portfolio Parachute CNO rigid volume growth of 6% came in despite weighted-average price hike of 35%; we are surprised with the resilient response to the price hikes from the consumers this reflects the deeply ingrained habit of hair oil usage in India as also the strength of the Parachute brand. We note that Maricos reported market share number do not suggest any MS gains for the company; one typically expects Parachute to gain share in inflationary copra price environment. The management did indicate that they believe there are problems with Nielsens retain audit data and market growth may not be as weak as Nielsens numbers suggest. Value-added hair oil portfolio rebounded and delivered 11% volume growth for the quarter. We note that the company has taken meaningful price hikes (15%+) in this portfolio as well. Saffola volume growth was 10% for the quarter.
Marico (MRCO) Consumer Products 1QFY15 ahead, outlook positive; valuations full. REDUCE. Marico delivered a solid quarter despite challenges from a soft growth environment and material inflation in copra prices. Parachute volume growth despite sharp price hikes was impressive and so was the double-digit volume growth in Saffola and VAHO portfolio. The companys medium-term guidance (2X revenues in the next four years) reflects managements confidence on growth. Stock at 25X FY2016E EPS, however, bakes in the impressive facets of performance as well as the confident outlook. We retain REDUCE with a revised target price of `250 (`235 earlier). Implied target PE is 24X FY2016E.
Anand Shah anand.shah@kotak.com Mumbai: +91-22-4336-0882
Consumer Products Marico 22 KOTAK INSTITUTIONAL EQUITIES RESEARCH Factor in the beat and raise our EPS estimates by 7-11% for FY2015/16E; retain REDUCE as we find the stock fully valued at 25X FY2016E EPS We have revised our revenue estimates by ~3% for both FY2015E and FY2016E as we model in higher quantum of price-led growth in Parachute CNO (rigids) and VAHO portfolio on account of fresh hikes initiated in June 2014. We have also revised our EPS estimates by 10.8% and 7.2% for FY2015E and FY2016E, respectively led by 40-60 bps upwards revision in our EBITDA margin assumptions on account of better-than-expected gross margins and higher operating leverage led by sustained price hikes across portfolio. The stock at 25X FY2016E EPS, however, bakes in the impressive facets of performance as well as the confident outlook. We retain REDUCE with a revised target price of `250 (`235 earlier) based on target PE of 24X FY2016E. Exhibit 1: Key changes to consolidated earnings model, Marico, March fiscal year-ends, 2015-16E
Source: Company, Kotak Institutional Equities estimates Category-wise highlights Parachute CNO. Rigid packs posted a robust 41% value growth led by ~35% price hikes and a modest volume growth of 6%, marginally below our estimate of 8% volume growth. Marico maintained its market share in CNO category at 56%however, management did highlight that Nielsen audit numbers have been lagging behind and not reflective of true picture of current hair oil growth environment. We note copra remains inflationaryup 120% yoy in July and 7% mom. Consequently, Marico initiated another round of price hikes in 1QFY15 taking cumulative price hike to 33% yoy. The company expects Parachute volume growth to be maintained at 6-8% levels in the near term. Saffola. Saffola posted a robust 10% volume growth, in line with our estimate, and 14% value growth aided by several initiatives undertaken over the last few quarters(1) restaged an existing variant as Saffola Total, which is priced at ~30% premium to Saffola Gold and is pitched as an alternative to olive oil, (2) sustained investment in brand communicationDil ka high science campaign launched a few quarters ago and (3) focus on expanding rural distribution. Surprisingly, Marico indicated that Saffolas marketshare declined by 200 bps yoy/stable qoq. Value-added hair oils. Maricos VAHO portfolio registered a robust 11% volume growth, ahead of our estimate of 8% growtha commendable performance given challenging market context. Management highlighted that growth in VAHO portfolio has been broad- based and it now has 4 strong brands with a turnover of `2 bn+. Maricos market share remained stable sequentially at 28%, up 100 bps yoy, while Nihar Shanti Amla maintained its market share at 30% in Amla hair oils categoryup 300 bps yoy. Value growth in Maricos VAHO portfolio stood at 28% yoy driven by price hikes as the company initiated another round of fresh price hikes to the tune of 6% during the quarter.
Marico Consumer Products KOTAK INSTITUTIONAL EQUITIES RESEARCH 23 Youth brands. Maricos acquired youth brands portfolio of Set Wet, Zatak and Livon posted `550 mn revenue, a flattish growth yoy due to high basewe note Marico had re-launched its deodorants portfolio under Zatak brand in the base quarter. Maricos market share in hair gels, post-wash leave-on conditioner and deodorants stood at 42%, 82% and 5%, respectively both hair gels and serums registered modest market share gains during the quarter. Management is confident of sustaining 15-20%+ growth rates in the youth brands portfolio in the near term. Other key brands. Saffola oats continues to do well, led by Saffola savory oats. Marico has emerged as the No2 player in the category with 17% value market share overall and 51% share in flavoured oats market. Marico launched two new sweet variants during the quarter and its oats offerings are now available in eight different flavours. Management highlighted its ambition of making Saffola foods business `0.75 bn size product segment in FY2015E and `1 bn portfolio in FY2016E. Parachute Advansed Body Lotion also witnessed healthy growth during the quarter and now enjoys 6% market share in the body lotion category. International business. Maricos international business posted revenue of `3.4 bn, a reported growth of 16.3% yoy aided by 6.7% translation gains, 4.6% price-led growth and a 5% volume growth. Geography-wise highlights Bangladesh Bangladesh reported a topline growth of 14% (constant currency) led by 5% volume growth and market share gains across categories. Management highlighted that it plans to invest significant marketing spends to diversify its portfolio beyond coconut oils and expects more than 80% of incremental growth from FY2016E onwards from non-CNO portfolio. We note Marico had launched several new products in Bangladesh market in last several quarters, including Saffola Active, Set Wet deodorants, Livon hair serum and HairCode Keshkala. MENA MENA region sustained its recovery delivering 18% growth on constant currency basis driven by strong recovery in Middle East business. Management highlighted that post several initiatives like distribution transition, restructuring of business model and SKU rationalisation, business in MENA is stabilizing and is poised for full recovery in FY2015E. South Africa Reported a modest 9% topline growth (constant currency) in a challenging macro environment. South East Asia South East Asia, predominantly Vietnam revenues were flat yoy impacted by high base and sluggish economy. Management highlighted that it maintains its leadership position in shampoos in Vietnam and expects growth to recover in 2HFY15, albeit at slower rates versus historical growth rates witnessed over last few years. Other key highlights Comments on medium-term strategic plan. Marico shared its medium-term strategic plan (1) it plans to double its revenues over the next four years driven by a mix of organic and inorganic growth, (2) it plans to become an emerging market MNC with focus on Asia and Africa in key categories of hair care, skin nourishment and male grooming and (3) it has identified give key areas of transformationinnovation, GTM, Talent Value Proposition, IT & Analytics and Cost Management. Near-term guidance. Management has guided for 7-8% volume growth and 14.5-15% EBITDA margin band for FY2015E though it expects next two quarters to witness margin pressure on account of sustained copra inflation.
Consumer Products Marico 24 KOTAK INSTITUTIONAL EQUITIES RESEARCH Current quarter international margins unsustainable. Management highlighted that current quarter EBITDA margin of 18.2% in international business (improvement of 490 bps yoy, 60 bps qoq) reflects a structural shift in international margins achieved through a series of cost management projects undertaken last year. However, it has guided for a threshold level of 14-15% band in medium term as it expects to plough back gains from cost-savings measures to drive volume growth and create multiple pillars of growth across core international markets. Focus on distribution expansion continues. Marico has initiated on a go to market (GTM) distribution strategy to expand its direct distribution reach in urban market beyond general trade to other channels like MT, chemists stores and cosmetic stores in order to support its youth brands portfolio and new launches in foods and skin care. It has also initiated a new initiative called Project One aimed at expanding direct coverage in top 6 metros over the last 6 months the project has expanded direct coverage in these cities by ~60%. Overall, Marico expects to yield ~3% revenue benefits in medium term from better assortment segmentation, optimized spends based on analytics and its GTM initiatives. Exhibit 2: Interim consolidated results of Marico, March fiscal year-ends (Rs mn)
10 7 4 3 6 10 15 14 17 16 16 14 15 10 10 12 16 2 5 8 11 14 17 20 1 Q F Y 1 1 2 Q F Y 1 1 3 Q F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Consumer Products Marico 26 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 5: Parachute volume growth was 6% yoy Parachute (rigid) volume growth (%) 14 10 5 5 10 10 13 11 18 9 6 5 4 10 6 2 1 - 2 4 6 8 10 12 14 16 18 20 1 Q F Y 1 1 2 Q F Y 1 1 3 Q F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Exhibit 6: Parachute market share flattish Parachute CNO market share trends (%) 52 53 54 55 56 57 58 59 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Exhibit 7: Saffola posts volume growth of a healthy 10% Saffola volume growth trends (in %) 18 18 13 12 15 11 15 3 12 6 4 5 10 7 9 11 10 - 4 8 12 16 20 1 Q F Y 1 1 2 Q F Y 1 1 3 Q F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Exhibit 8: Saffola market share flattish qoq, down yoy Saffola market share trends (in %) 53 55 57 58 58 59 58 58 57 57 57 55 55 52 53 54 55 56 57 58 59 60 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Marico Consumer Products KOTAK INSTITUTIONAL EQUITIES RESEARCH 27 Exhibit 9: Value-added hair oils volume at 11% yoy Value-added hair oils volume growth trends (in %) 27 15 31 21 32 26 20 18 25 20 30 24 16 15 8 5 11 - 5 10 15 20 25 30 35 1 Q F Y 1 1 2 Q F Y 1 1 3 Q F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Exhibit 10: Value-added hair oils market share up yoy, flat qoq Value-added hair oils market share trends (in %) 23 23 24 24 24 25 26 27 27 28 28 28 28 22 23 24 25 26 27 28 29 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Consumer Products Marico 28 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 11: Consolidated profit model, balance sheet of Marico, March fiscal year-ends, 2011-17E
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Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 Revenue growth outlook challenging Revenue growth outlook for Mphasis appears challenging across its business segments. HP channel revenues have declined 53% in the past 12 quarters and the decline shows no sign of easing up. The management indicated that it expects HP channel to continue declining at this rate in the immediate future. DR declined a sharp 16% in 1QFY15 due to weakness in the US mortgage market, where mortgage originations are down ~40%, according to the management. In a rising interest rate environment, this is unlikely to change in the near future. Mphasis reported US$45 mn TCV of deal wins in the organic direct business. It is a start, but deal wins need to be larger and more consistent to even offset the drag from other segments. We expect 0.8% revenue decline in FY2015E and 3.5% revenue growth in FY2016E. Margin pressure imminent Mphasis has stepped up its S&M spending in the last few quarters in a bid to revive its growth in the direct channel. This has had some early results in terms of deal wins. But more investments in broadening service capability and market reach are essential for Mphasis growth engine to revive. The company will have to trade margins for growth. Also, near-term margin headwinds include (1) wage hikes to be given effective 3QFY15, which will have a 150-170 bps impact and (2) DR weakness, which will push its EBITDA margin into high single digits from the low double- digit levels it operated at previously. With limited operational levers to offset these pressures, we expect Mphasis EBITDA margin to decline 100 bps in FY2015E and 60 bps in FY2016E. Cut revenue and earnings estimates. SELL with a TP of `370 We cut our revenue estimates for Mphasis by ~3% for the next two years. Cut in margins assumptions drives ~5% cut in earnings estimates for FY2015E-16E. We retain our SELL rating with a target price of `370 (`390 earlier), valuing Mphasis at 11X FY2016E earnings. The stock currently trades at 13.3X FY2016E earnings, expensive in our view. The current stock price is driven by expectations of an eventHP stake sale rather than business fundamentals, which are clearly challenged.
Mphasis (MPHL) Technology Revenue growth challenges mount. With the sharp decline in Digital Risk (DR) in 1QFY15, Mphasis revenue growth challenges have become steeper. The HP channel decline shows no sign of letting off while growth in the direct organic business is not strong enough to offset the drag from HP and DR. We cut revenue estimates by ~3% for FY2015E-16E. Margin impact from DR decline and S&M investments drive ~5% cut in EPS estimates. Retain SELL with a TP of `370 (`390 earlier).
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Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 A few one-offs support earnings Oriental Bank of Commerce (OBC) posted muted 1QFY15 earnings growth of 3% yoy despite one- off (1) reversal in staff expenses, (2) gains on loans sold to ARCs and (3) write-back in investment depreciation, as provisions for NPLs were high. Fresh impairments remained highunchanged qoq at 6.6%. High slippages hurt NIM as they declined ~15 bps qoq to 2.6%. Focus on impairments slowed loan growth, which was 8% yoy, primarily in the large-corporate segment. Fresh impairments remain high at ~6% of loans 1QFY15 was a weak quarter on the impairments front with gross NPLs increasing 30 bps qoq to 4.3% of loans and restructured loans increasing 20 bps qoq to 7.8% of loans (30% of the restructured loans are in the discom and aviation segments). Slippages in the quarter were 4% of loans and fresh restructuring was 2.5% of loans (power and construction sectors). Nearly 40% of fresh slippages came from priority-sector loans and slippages in other segments were driven by a few large accounts in the iron and steel and construction segments. About 20% of the slippages were from restructured loans. Loan-loss provisions were 1.4% of loans. NIM moderates, led by higher interest reversals NIM moderated by ~15 bps qoq to 2.6% of loans, primarily as high slippages led to reversal of interest while costs showed a marginal sequential increase. Given the softness in interest rates as well as better current trends on impairment, we are optimistic about the NIM outlook. Maintain ADD as valuation expansion is expected to be driven by macro-economic improvement After our upgrade about a year ago, we have made no material change to our estimates and are comfortable retaining our positive rating. With the economy showing signs of possible revival, we expect credit costscurrently 1.5X our earnings estimatesto materially decline, which is expected to support earnings and RoE improvement. Also, a possible decline in interest rates is expected to give headroom for NIM expansion. We value the bank at `330 (`350 earlier), which implies 0.8X book and 6X FY2016E EPS for RoEs of 11-12%.
Oriental Bank of Commerce (OBC) Banks/Financial Institutions Lower provisions cushion a weak performance. 1QFY15 was a weak quarter with one-off reversal of staff provisions and write-back from investments supporting flat earnings. Fresh impairments were high at 6.6% of loans. Apart from inexpensive valuations and better tier-1 ratios than peers, which are driving our positive rating, we derive comfort from the fact that OBC is one of the few banks with greater focus on NPLs than growth. We maintain ADD with a target price of `330 (`350 earlier).
Oriental Bank of Commerce Stock data Forecasts/Valuations 2014 2015E 2016E 52-week range (Rs) (high,low) EPS (Rs) 38.0 48.9 56.4 Market Cap. (Rs bn) 84.6 EPS growth (%) (16.5) 28.7 15.3 Shareholding pattern (%) P/E (X) 7.4 5.8 5.0 Promoters 59.1 NII (Rs bn) 51.3 53.8 61.7 FIIs 9.9 Net profits (Rs bn) 11.4 14.7 16.9 MFs 9.4 BVPS 341.6 368.4 407.1 Price performance (%) 1M 3M 12M P/B (X) 0.8 0.8 0.7 Absolute (12.5) 11.4 105.2 ROE (%) 8.7 10.5 11.2 Rel. to BSE-30 (11.7) (3.0) 52.9 Div. Yield (%) 2.7 3.5 4.0 Company data and valuation summary 378-121
ADD AUGUST 05, 2014 RESULT Coverage view: Neutral Price (`): 282 Target price (`): 330 BSE-30: 25,723
Oriental Bank of Commerce Banks/Financial Institutions KOTAK INSTITUTIONAL EQUITIES RESEARCH 33 Other highlights of the quarter Non-interest income increased 9% yoy, driven by income from sale of written-off NPLs to asset reconstruction companies (ARCs). Income from recovery of written-off accounts increased 120% yoy to `1.8 bn, of which `1.4 bn was from sale to ARCs. Forex income declined 9% yoy. Fee income declined 3% yoy. Treasury contribution remained weak, declining 40% yoy. Tier-1 is at 8.9% and overall capital adequacy at 11%. The bank has made a negligible contribution for unhedged foreign exposure at `34 mn and has estimated the full impact at `140 mn. Exhibit 1: Gross NPLs increased 30 bps qoq to 4.3% NPLs and provision coverage, March fiscal year-ends, 1QFY12-1QFY15 (%) - 0.9 1.8 2.7 3.6 4.5 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5 - 20 40 60 80 100 Gross NPL (LHS) Net NPL (LHS) Provision coverage (RHS)
Banks/Financial Institutions Oriental Bank of Commerce 34 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 4: OBC - rolling PBR and PER One-year forward rolling PER and PBR, 2007-14 (X) - 2.4 4.8 7.2 9.6 12.0 A u g - 0 7 F e b - 0 8 A u g - 0 8 F e b - 0 9 A u g - 0 9 F e b - 1 0 A u g - 1 0 F e b - 1 1 A u g - 1 1 F e b - 1 2 A u g - 1 2 F e b - 1 3 A u g - 1 3 F e b - 1 4 A u g - 1 4 0.0 0.3 0.6 1.0 1.3 1.6 Rolling PER (X) (LHS) Rolling PBR (X) (RHS)
Exhibit 5: OBC is trading at a discount to its long-term discount to peers OBC trading premium to public banks, 2007-14 (X) 0.3 0.5 0.7 0.9 1.1 A u g - 0 7 A u g - 0 8 A u g - 0 9 A u g - 1 0 A u g - 1 1 A u g - 1 2 A u g - 1 3 A u g - 1 4
Exhibit 6: NIM declined 15 bps qoq to 2.6% NIM and cost of deposits, March fiscal year-ends, 1QFY11-1QFY15 (%) 4.0 5.0 6.0 7.0 8.0 9.0 1 Q F Y 1 1 2 Q F Y 1 1 3 Q F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5 2.0 2.4 2.8 3.2 3.6 4.0 Cost of deposits (LHS) NIM (RHS)
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Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 Slightly ahead on all parameters; volume decline in ADHO arrested to 1% yoy Bajaj Corp beat expectations on all parametersrevenue at `1.91 bn (+12%; KIE: `1.83 bn), EBITDA at `534 mn (up 11% yoy; KIE: `497 mn) and recurring PAT at `514 mn (up 9% yoy; KIE: `486 mn). Adjusted for NOMARKs (registered a revenue of `141 mn, up 40% qoq), organic revenues grew 4% yoy. Reported PAT declined 16% yoy to `396 mn due to extraordinary expenses of `117 mn on account of NOMARKs brand amortization charge. ADHO volume decline was arrested to just 1% yoy, ahead of our estimate of 5% volume decline, as this quarter did not witness any inventory correction at distributor and retail level, a trend that was visible for the past few quarters. Management also highlighted that adjusted for a large institutional sales order in the base quarter, ADHO volumes grew ~4% yoydecent performance in a challenging market environment. Overall hair oil volumes declined 1.5% yoy while price/mix- led growth in ADHO improved to 6.1% yoy driven by price hikes and better mix. Margins maintained despite jump in LLP aided by lower advertising spends EBITDA margin contracted 30 bps yoy to 28% impacted by 80 bps drop in gross margins and 120 bps jump in other expenditure. However, 190 bps cut in advertising spends helped arrest EBITDA margin contraction. GMs were impacted due to higher LLP prices (up 17% yoy, 9% qoq). We note Bajaj Corp has cut its combined A&SP expenditure (as % of sales) to 16% versus ~16- 18% spent over last several quarters, a response to weak market conditions, in our view. Expect volumes to stabilize; retain ADD with revised TP of `255 (`230 earlier) We have raised our revenue estimates by ~2% for both FY2015E and FY2016E, respectively as we bake in marginally higher volume growth in ADHO and better traction in NOMARKS. We now bake in 5.5% volume growth (5% earlier) and `580 mn revenues for NOMARKS (`500 mn earlier) in FY2015E. We have also raised our EPS estimates by ~3-4% as we increase EBITDA margin forecast by 40 bps aided by lower A&SP spends. We retain our ADD rating on the stock with revised target price of `255 (`230 earlier) based on 16X March FY2016E EPS. We believe reasonable valuations at 14.5X FY2016E EPS amply bake in any challenges on volume frontwe believe volumes have stabilized and expect them to inch up in ensuing quarters.
Bajaj Corp. (BJCOR) Consumer Products 1QFY15 ahead of expectations; raise estimates a tad. ADD. Bajaj Corps 1QFY15 results beat our expectations on the back of better volumes and lower-than-expected A&SP intensity. Our EPS estimates for FY2015/16E go up 3-4% on the back of this beat and we raise our target price to `255 (`230 earlier; now end-FY2016 target versus Sep 2015 earlier). Challenging operating environment (subdued volume growth and inflationary LLP) is factored into the CMP, in our view. We retain ADD.
Source: Company, Kotak Institutional Equities estimates Key highlights from management concall Overall hair oil market growth continues to witness deceleration. Management highlighted that overall hair oils growth, as per Nielsen, continues to witness deceleration across segments with 1QFY15 registering 4.9% decline in overall hair oil volumes and 5.3% decline in LHO volumes. However, we note several managements in their recent commentary have indicated that Nielsens retail audit is not accurately reflecting the pick- up in volume growth, which companies have reported in their quarterly results (i.e. primary sales) and expect same to correct with a lag. Rural growth ahead of urban growth. Management highlighted that ADHO posted 4.4% growth in rural markets while urban and rural growth combined stood at negative 2.7%, indicating sharp decline in urban markets. Rural sales now account for ~40% of total sales for ADHO. Rural growth has picked up due to higher growth in sachets, indicative of downtrading management highlighted that sachets now contribute 19% of ADHO volumes. No inventory correction witnessed in current quarter. Management highlighted that it did not witness any inventory correction (i.e. down stocking at distributor level) over last 2 months and expects same to stabilize in ensuing quarters. Number of stock days at distributor level has reduced from peak of 40-45 days to 30-32 days, at similar levels to 4QFY14. Update on NOMARKS. Management highlighted that both creams and face washes under NOMARKS brand have witnessed good offtake post re-launch and initial signs of trade acceptance, especially from wholesalers, are very positive. Key monitorables in medium term are (1) retailer stocking, (2) stock at each level (i.e. retail, wholesale and distributor) and (3) volume of sales and mix. NOMARKS brand is currently available in 350,000 outlets from initial 150,000 outlets and near-term target is to reach 500,000 outlets.
Consumer Products Bajaj Corp. 40 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 2: Interim standalone results of Bajaj Corp, March fiscal year-ends (Rs mn)
13 21 25 17 23 20 19 24 19 23 21 19 16 (1) (10) (1) 12 (15) (10) (5) 0 5 10 15 20 25 30 1 Q F Y 1 1 2 Q F Y 1 1 3 Q F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Bajaj Corp. Consumer Products KOTAK INSTITUTIONAL EQUITIES RESEARCH 41 Exhibit 4: Gross margins dip 80 bps yoy due to spike in LLP prices
57.6 56.3 53.7 52.9 53.7 54.2 53.0 55.6 57.7 57.9 58.3 60.0 60.5 60.5 58.9 59.2 60.6 50 53 56 59 62 1 Q F Y 1 1 2 Q F Y 1 1 3 Q F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Exhibit 5: A&SP moderated to 16% (as % of sales)
12.8 10.9 11.5 11.8 12.5 12.6 16.8 12.6 13.8 14.5 16.5 16.8 17.6 17.9 16.0 15.5 10.0 8 10 12 14 16 18 20 1 Q F Y 1 1 2 Q F Y 1 1 3 Q F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities
Consumer Products Bajaj Corp. 42 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 6: Consolidated profit model, balance sheet, cash model of Bajaj Corp, March fiscal year-ends, 2011-17E (Rs mn)
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Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 Resultsa tad below estimates; however, underlying trends are encouraging CUMI reported 1QFY15 consolidated sales at `5.2 bn (+3% yoy; -3% qoq), which were a tad below our estimates. Underperformance on the sales front flowed through to the EBITDA level; the company reported 1QFY15 consol EBITDA at `744 mn (+16% yoy; +10% qoq). However, 1QFY15 EBITDA margins at 14.3% were 170 bps higher yoy, indicating continuing improvement in operations driven by rising sales volumes. Even as 1QFY15 is a seasonally weaker quarter versus 4QFY14, margins improved (qoq) by 160 bps, pointing towards strong underlying trend of improving volumes/mix. The company reported consol 1QFY15 PAT at `274 mn. Order inflow/mix is improving; should reflect in better margins going forward As per the management, order inflow is improving across business segments, which should reflect in better sales/margin trajectory in the coming quarters. 1QFY15 results reflect improvement in operations of subsidiaries with the standalone entity reporting subdued growth in sales and a decline in EBITDA (margins as well) yoy, implying that the recovery in operations led by the India- centric business is yet to play out. As per the management, apart from positive trend in volumes, which are helping margins in all business segments, margins in abrasive and ceramic segments should also benefit on improving mix. In the abrasive segment, order inflow of higher margin products, used by industries that require value-added services and hence avoid cheap imports (for example, auto/auto-ancillary industry), is increasing. Similar trend is playing out in the ceramics segment also; order inflow of wear-and-tear-resistant tiles (partly through Australian subsidiary) is improving on normalizing maintenance spends. Positive mix trends in order inflow should reflect in better margins in the respective businesses going forward. Maintain BUY with unchanged target price of `200 (16X FY2016E EPS) In our view, CUMI is well-positioned to ride the trends of (1) recovery in manufacturing activity in India and (2) recovery in global capex/maintenance spends, specifically in power/coal/ferrous and non-ferrous metals space. During the downturn, the company has made significant efforts towards rationalizing costs, winning approvals for new products and repositioning unused capacities to cater to changing market conditions. Also, capacities are available (~75% utilization in most of the businesses) to scale up volumes with small incremental capex spends.
Carborundum Universal (CU) Others Margins to improve further; order flow is encouraging. CUMIs results were a tad below estimates led by lower (~5%) sales. However, improvement (yoy) in EBITDA margins was encouraging. As per the management, the improvement reflects rising volumes across businesses; the trend can accelerate further. Also, order flow implies better mix going forward, specifically in abrasives. Better mix and operating leverage should be a tailwind for margins going forward. BUY with an unchanged TP of `200.
Others Carborundum Universal 44 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 1: Margin improvement was led by higher volumes and better mix Interim results of CUMI, consolidated, March fiscal year-ends (Rs mn) 1QFY15 1QFY15E 1QFY14 4QFY14 KIE est yoy qoq Total Income 5,219 5,481 5,077 5,364 (4.8) 2.8 (2.7) Total Expenditure (4,475) (4,690) (4,436) (4,685) (4.6) 0.9 (4.5) Raw materials (1,676) (1,711) (1,942) Employee expense (718) (670) (814) Power and fuel (892) (782) (816) Other expenditure (1,189) (1,272) (1,112) EBITDA 744 791 642 679 (6.0) 15.9 9.5 EBITDA (%) 14.3 14.3 12.6 12.7 Depreciation (259) (280) (203) (270) Interest (66) (75) (64) (75) PBT (excl. other income) 419 436 375 334 (3.8) 11.8 25.5 PBT (%) 8.0 8.0 7.4 6.2 Other income 32 20 82 46 PBT 451 451 457 380 0.0 (1.2) 18.6 Exceptional items (27) 16 15 Tax expense (135) (150) (184) (134) PAT 289 306 288 262 Add: Share of profits from associate Less: Minority interest (15) (10) (11) (12) PAT 274 296 276 249 (7.4) (1.0) 9.7 Margins (%) RM/sales 32.1 33.7 36.2 Employee cost/sales 13.8 13.2 15.2 Power and fuel/sales 17.1 15.4 15.2 Other expenditure 22.8 25.1 20.7 Change (%)
Source: Company, Kotak Institutional Equities
Exhibit 2: Margins have been improving with each passing quarter Trend in quarterly EBITDA margins for CUMI, consolidated, March fiscal year-ends (%) 19.6 18.5 17.1 10.7 12.9 16.7 17.6 12.6 14.7 14.6 20.8 18.0 14.3 12.7 8.3 22.3 9.1 5 8 11 14 17 20 23 26 Q 1 F Y 1 1 Q 2 F Y 1 1 Q 3 F Y 1 1 4 Q F Y 1 1 1 Q F Y 1 2 2 Q F Y 1 2 3 Q F Y 1 2 4 Q F Y 1 2 4 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 4 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 1 Q F Y 1 5
Source: Company, Kotak Institutional Equities Some disappointments versus earlier expectations Even as overall trend in growth in sales and margins is encouraging, there have been a few disappointments versus some of our earlier expectations: At Foskor (51% sub), the company is finding it difficult to scale up the new bubble zirconia plant (~5,000 tons capacity per annum) on account of technical challenges. As per earlier guidance of the management, the plant was estimated to produce close to 3,000 tons in the first year (FY2015) and would have gradually scaled up to near-full utilization levels in the subsequent years. However, now on account of some technical difficulties, the company is not able to scale up production levels to more than 200 tons per month. As per the management, the new plant cannot be profitable at current levels of production and it expects the situation to remain unchanged at least for the next two quarters. However, on account of a general pick-up in the economy, the erstwhile capacity of 5,000 tons has started producing at optimum utilization levels and hence is offsetting subdued performance of the new capacity. At Thukela (100% sub), the company is finding it difficult to scale up fusion volumes (capacity is close to 22,000 tons). As per the management, most of the fused material manufactured by this facility hitherto used to service the refractory industry, which is not doing well as of now. Hence, capacity utilization has been hovering in the range of 30- 40%. As per the management, scaling up volumes has proved to be much harder versus earlier expectations and the company will have to reposition/re-engineer the product slate to cater to other industries to increase off-take.
Others Carborundum Universal 46 KOTAK INSTITUTIONAL EQUITIES RESEARCH At VAW Russia, ongoing issue involving Ukraine has halted the mix improvement, which was underway at this facility. In the last few quarters, proportion of crystalline silicon carbide (Sic) was increasing (versus metallurgical grade) in the sales mix on account of pick-up in user industries of abrasive/ceramics, which in turn were benefitting out of improving global economy. Most of the incremental demand of crystalline grade has been originating from Europe. As per the management, on account of the current turmoil involving Ukraine and Russia, the company will not be able to further increase sales of crystalline Sic to Europe. Most of the consumers of crystalline Sic in Europe are small manufacturers of abrasives/ceramics, who are now reluctant to buy incremental supplies from a Russian company. To solve the problem, CUMI will have to create a front-end presence in Europe, which will take time. Hence, at least for the next one year, mix of Russian operation would remain static (60% sales of metallurgical grade) and margin benefits, which we were expecting on improving mix, wont materialize in FY2015. Exhibit 4: Standalone business should also start contributing to improvement in operations in the coming quarters Interim results of CUMI, standalone, March fiscal year-ends (Rs mn) 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 % chg yoy % chg qoq Total Income 2,736 3,040 2,699 3,011 2,723 0% -10% Total Expenditure (2,364) (2,599) (2,437) (2,636) (2,396) 1% -9% Raw materials (1,214) (1,406) (1,172) (1,339) (1,183) -3% -12% Employee cost (300) (325) (310) (324) (315) 5% -3% Power and fuel (281) (269) (311) (320) (307) 9% -4% Other expenditure (569) (599) (643) (653) (591) 4% -9% EBITDA 372 441 262 375 327 -12% -13% EBITDA (%) 13.6 14.5 9.7 12.5 12.0 Depreciation (121) (122) (123) (126) (141) Interest (30) (31) (32) (37) (24) EBIT 222 288 108 212 162 EBIT (%) 8.1 9.5 4.0 7.0 5.9 Other income 77 15 4 76 61 PBT 299 303 112 288 223 -26% -23% Exceptional items 19 9 1 (7) (5) Tax expense (92) (100) (40) (65) (63) PAT 226 212 73 217 155 -32% -29% Margins (% of net sales) RM 44.4 46.2 43.4 44.5 43.4 Employee cost 10.9 10.7 11.5 10.8 11.6 Power and fuel 10.3 8.9 11.5 10.6 11.3 Other expenditure 20.8 19.7 23.8 21.7 21.7
Source: Company, Kotak Institutional Equities Other highlights The company has spent `190 mn on capex in 1QFY15, 50% of which has been incurred in the standalone business (remaining mostly in Russia). The company has maintained its capex guidance at `700-800 mn for FY2015. As per the management, order inflow (ceramics) has improved for the Australian subsidiary (51%) led by pick-up in maintenance spends in power plants and mining industries. Also, the Australian subsidiary of the company has won a couple of project orders in Middle East and South East Asia. The company is hopeful of scaling up refractory volumes in VAW, Russia. As per the management, VAWs refractory material has been approved by the largest aluminum producer in Russia (RUSAL) and a couple of large aluminum smelters in Middle East. In the standalone business, EM segment margins were lower yoy, as power generation from the companys Maniyar hydropower plant (power is consumed by the EM business) declined versus last year on account of much lower quantum of rains. Gross debt has declined from `4.6 bn in 4QFY14 to `4.4 bn in 1QFY15. After restructuring of Russian abrasive business in 2HFY14, it is no longer losing money. In the consolidated abrasive operations, only the Chinese abrasive operation is still making losses. The company is trying to position the Chinese abrasive capacity to cater to local market rather than for exports to India. Initial results from this strategy are positive and losses have been coming down gradually. Uttarakhand abrasive (thin wheels) plant, which was commissioned last year, is running at 60% utilization. Thin wheels are used extensively in the construction industry (for cutting purposes) and since construction activity has not picked up in India as of now, the utilization remains at suboptimal levels.
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Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 Dismal marketing margins take the sheen off moderate volume growth PLNG reported 1QFY15 EBITDA at `3.58 bn (-7.5% qoq, -10.1% yoy) and net income at `1.57 bn (-7.5% qoq, -30.5% yoy), lower than our estimates of `4.4 bn and `1.8 bn, respectively despite higher-than-expected LNG volumes, reflecting a sharp decline in marketing margins on short- term/spot LNG cargoes. Overall re-gasification volumes across two LNG terminals increased 18% qoq and 7% yoy to 138.7 tn BTUs. However, implied tariff on LNG volumes declined 21% qoq and 11% yoy to `33.3/mn BTU, reflecting a sharp decline in marketing margins to a modest US$0.2/mn BTU versus US$1/mn BTU in FY2014. We were expecting margins to decline, but not so fast and so soon We were skeptical of high marketing margins earned by the company over the past few years and were expecting it to decline, albeit more gradually in 2-3 years, led by an increase in LNG availability in the country. However, a sharp decline in marketing margins during the quarter reflects either an enhanced competition from the tolling contracts of GAIL and GSPC or a negative impact from pricing risk (lack of back to back contracts for some spot cargoes) borne by the company in light of declining spot prices; we note that the management has categorically denied the latter in the conference call, which implies that the margins are likely to remain subdued on a sustainable basis henceforth. Downgrade to REDUCE on full valuations We revise our rating on PLNG stock to REDUCE from ADD previously as the stock is trading above our DCF-based target price of `175 (`165 previously), post 24% rally over the past three months. Our assumptions of stable long-term tariffs, post 5% annual escalation for three years and low marketing margins of US$0.3/mn BTU yield a reasonable 19% CROCI for the company in the long term, which factors in potential regulatory/competitive risks to domestic LNG business. Cut EPS estimates to factor in lower marketing margins We cut our EPS estimates for PLNG to `8.9, `11.3 and `15.6 for FY2015E, FY2016E and FY2017E from `10, `12.4 and `15.9 previously to reflect (1) lower marketing margins on short-term/spot volumes, (2) modestly lower volumes and (3) other minor changes.
Petronet LNG (PLNG) Energy Weak results and full valuations. PLNG reported lower-than-expected EBITDA and net income in 1QFY15 despite a moderate volume growth, reflecting a sharp decline in marketing margins. We downgrade the stock to REDUCE from ADD previously with a revised DCF-based target price of `175 (`165 previously) noting weaker earnings outlook in FY2015-16 given subdued volumes and margins, full valuations with the stock trading near our fair value and lack of positive triggers to justify further rerating.
Energy Petronet LNG 50 KOTAK INSTITUTIONAL EQUITIES RESEARCH Key highlights from 1QFY15 results Exhibit 1 gives the details of PLNGs 1QFY15 results and compares the same with 4QFY14 and 1QFY14 results. Exhibit 1: Interim results of Petronet LNG, March fiscal year-ends (` mn)
Source: Company, Kotak Institutional Equities estimates Strong growth in re-gasification volumes. PLNG reported higher re-gasification volumes at 138.7 tn BTU versus 117.2 tn BTU in 4QFY14 and 129.5 tn BTU in 1QFY14. Long-term contracted LNG volumes increased to 96.4 tn BTU versus 92 tn BTU in 4QFY14 and 92.3 tn BTU in 1QFY14. The company reported (1) higher tolling volumes at 24.9 tn BTU versus 4.5 tn BTU in 4QFY14 and 18.3 tn BTU in 1QFY14 and (2) lower spot volumes at 17.4 tn BTU in 1QFY15 versus 20.8 tn BTU in 4QFY14 and 19 tn BTU in 1QFY14. Sharply lower implied tariffs led by weak marketing margins. We compute sharply lower implied tariffs at `33.3/mn BTU in 1QFY15 versus `42.1/mn BTU in 4QFY14 and `37.4/mn BTU in 1QFY14. We highlight that estimated marketing margins on PLNGs short-term/spot LNG volumes declined sharply to US$0.2/mn BTU from US$1.1/mn BTU in 4QFY14 and US$0.8/mn BTU in 1QFY14 (see Exhibit 2). Decline in depreciation expense; stable interest cost. PLNG reported lower depreciation expense at `771 mn (-23% qoq), led by change in rates of depreciation as per provisions of the Companies Act 2013. Interest cost remained stable at `784 mn (- 0.3% qoq). The sharp yoy increase in depreciation and interest cost reflects capitalization of Kochi terminal from September 2013. 1QFY15 operating loss of ~`150 mn from Kochi terminal. The management indicated that the company incurred an operating loss of `150 mn on Kochi terminal in 1QFY15. The company highlighted that it is likely to incur a PBT loss of ~`5 bn at Kochi, if the terminal continues to operate at the current utilization. The company has received necessary approvals from the Board to utilize Kochi terminal as a temporary storage facility for global players and it expects to initiate activity in the current quarter.
Source: Company, Kotak Institutional Equities estimates Other updates from conference call Second jetty at Dahej. PLNG has commissioned the second jetty at Dahej terminal on April 10 and has started servicing the long-term tolling contract of 1.25 mtpa with GSPC. The company has accounted a depreciation expense of ~`65 mn for the second jetty in 1QFY15. Gangavaram terminal. The company has received necessary approvals from the Andhra Pradesh government for its LNG import terminal at Gangavaram. The management indicated that it will tie up LNG sources and consumers before going ahead on the project. The company expects to commission the terminal within three years from the award of EPC contracts. Expansion of Dahej terminal. The management highlighted that the expansion of Dahej terminal to 15 mtpa capacity remains on track for completion by end-CY2016. Key assumptions behind our earnings model We discuss the key assumptions underlying our earnings model below (see Exhibit 3).
Source: Company, Kotak Institutional Equities estimates LNG volumes. We model gradual ramp-up in LNG volumes to 17.4 mn tons in FY2018E versus 9.7 mn tons in FY2014 and 10.3 mn tons in FY2013 led by (1) completion of ongoing expansion project at Dahej terminal by end-CY2016, (2) recent commissioning of second jetty at Dahej terminal and (3) gradual increase in utilization of Kochi terminal. Dahej. We have assumed LNG import volumes at 10.8 mtpa, 11.2 mtpa and 12.2 mtpa in FY2015E, FY2016E and FY2017E for Dahej terminal. We have assumed further ramp-up in volumes to 15.5 mtpa by FY2020E following completion of ongoing expansion project at Dahej terminal by end-CY2016. Kochi. We have assumed LNG import volumes at 0.2 mtpa, 0.5 mtpa and 1.4 mtpa in FY2015E, FY2016E and FY2017E for Kochi terminal. We have assumed a gradual ramp-up to 5 mtpa (full capacity utilization) at Kochi terminal by FY2022E. Re-gasification tariffs. We model re-gasification tariff for Dahej terminal to increase by 5% annually in CY2015-17E to `44.7/mn BTU and expect it to remain flat until FY2024E, the terminal year of our DCF model (see Exhibit 4). We model re-gasification tariff for Kochi terminal to increase by 5% annually in CY2015-17E to `75.4/mn BTU and expect it to remain flat thereafter. Higher re-gasification tariffs may sustain in the near term in the absence of regulations for open access of LNG terminals. Marketing margins. We have assumed lower marketing margins on short-term/spot LNG volumes at US$0.3/mn BTU from FY2015 onwards versus implied margins of US$1.1/mn BTU in FY2014. Exchange rate. We have assumed Rupee-Dollar exchange rate for FY2015E, FY2016E and FY2017E at `59.5/US$, `58/US$ and `58/US$.
Petronet LNG Energy KOTAK INSTITUTIONAL EQUITIES RESEARCH 53 Exhibit 4: Our DCF-based fair value for PLNG is `175 Calculation of equity value of PLNG using discounted cash flow (` mn) 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E EBITDA 14,603 17,219 21,941 29,934 33,283 35,603 37,088 37,882 37,060 36,187 36,187 36,187 Adjusted tax expense (2,372) (2,895) (3,812) (6,116) (8,786) (9,914) (10,685) (11,165) (11,049) (10,878) Change in working capital (1,217) (721) (1,557) 122 (317) (1,409) (1,278) (962) (986) (1,146) Operating cash flow 11,014 13,602 16,572 23,939 24,180 24,280 25,125 25,755 25,024 24,162 Capital expenditure (10,254) (9,400) (9,032) (1,250) (1,250) (1,250) (1,250) (1,250) (1,250) (5,429) Free cash flow 760 4,202 7,540 22,689 22,930 23,030 23,875 24,505 23,774 18,733 18,733 18,733 Discounted cash flow-now 704 3,458 5,516 14,753 13,252 11,827 10,899 9,944 8,575 6,004 Discounted cash flow-1 year forward 3,892 6,205 16,597 14,909 13,310 12,261 11,187 9,647 6,757 6,004 Discounted cash flow-2 year forward 6,983 18,671 16,772 14,974 13,799 12,585 10,853 7,602 6,757 6,004 Now + 1-year + 2-years Discount rate (%) 12.5% 12.5% 12.5% Total PV of free cash flow 84,933 100,769 115,000 Terminal value assumption Growth in perpetuity 0.0% 0.0% 0.0% FCF in 2024E 18,733 18,733 18,733 Exit FCF multiple (X) 8.0 8.0 8.0 174 -1.0% -0.5% 0.0% 1.0% 1.5% Exit EV/EBITDA multiple (X) 4.1 4.1 4.1 11.5% 186 189 193 201 205 Terminal value 149,864 149,864 149,864 12.0% 177 180 183 190 194 PV of terminal value 48,034 48,034 48,034 12.5% 169 172 174 181 184 Total company value 132,967 148,804 163,035 13.0% 162 164 166 172 175 13.5% 155 157 159 164 167 Net debt 22,139 24,858 24,839 Equity value 110,829 123,946 138,196 Shares outstanding (mn) 750 750 750 Equity value of regasification business (Rs) 148 165 184 Equity value of 26% stake in Dahej Port (Rs) 8 9 10 Fair value of PLNG (Rs) 156 174 195 Fiscal Year end (March 31, XXXX) March-15 March-16 March-17 March-18 March-19 March-20 March-21 March-22 March-23 March-24 Today 5-Aug-14 5-Aug-14 5-Aug-14 5-Aug-14 5-Aug-14 5-Aug-14 5-Aug-14 5-Aug-14 5-Aug-14 5-Aug-14 Days left 238 604 969 1,334 1,699 2,065 2,430 2,795 3,160 3,526 Years left 0.65 1.65 2.65 3.65 4.65 5.66 6.66 7.66 8.66 9.66 Discount factor at WACC 0.93 0.82 0.73 0.65 0.58 0.51 0.46 0.41 0.36 0.32 Sensitivity of 12-month fair value to WACC and perpetual growth Perpetual growth (%) W A C C
( % )
Source: Kotak Institutional Equities estimates
Energy Petronet LNG 54 KOTAK INSTITUTIONAL EQUITIES RESEARCH Exhibit 5: Petronet LNG: Profit model, balance sheet, cash model March fiscal year-ends, 2010-18E (` mn)
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Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 Powernon-committal on market recovery; banking on internal improvements for growth FY2014 was another challenging year for Crompton, marred by (1) sedate market conditions and (2) production losses continuing in Canada and Hungary. It is cautious about broad demand recovery expectations and aims to grow business by leveraging (1) internal improvements (stabilization of overseas power transformer facilities, qualifications for its switchgears), (2) improving demand for distribution automation (European opportunity, entry-level orders in emerging markets, opening of India facility) and (3) build-up of references from recently commissioned systems orders. Looks beyond mainstay domestic business in industrials; outpaces market in consumer business The company expects growth in industrials to be driven by (1) the export of motors (new capacities commissioned, approvals received from GE and other global OEMs), (2) domestic demand for low- voltage drives (commissioned a new unit using Emotron technology) and (3) strong growth prospects in the traction motors business. Cromptons consumer business has grown ahead of the market in key segments (fans, lightings and pumps). It aims to leverage increasing reach, product launches and growing customer reach to grow its consumer business. Belgium, Hungary, US, UK and Canada losses continue; ZIV business scale-up partly compensates We note sustained losses in the Belgian (`1.2 bn), Hungarian (`0.8 bn), US (possibly `0.6 bn), UK (`0.4 bn) and Canadian (`0.7 bn) facilities. Commissioning of the Saudi Arabian facility added `0.5 bn of losses. The losses were partly compensated by (1) business scale-up in ZIV (sales doubled yoy, `0.5 bn PAT) and (2) strong growth in PT Indonesia (~30% growth in sales and PBT). Sells investments to fund subsidiary losses; increasing low-cost share of business Crompton sold its standalone investments to invest `4 bn in its subsidiaries (investments`2.5 bn; L&A`1.5 bn). Exports in key markets (Asia, Africa, Europe) recovered in FY2014. The share of sourcing from low-cost countries increased to 32% in FY2014 from 12% in FY2012. Crompton also plans to hire/select senior managers for the next decade of growth. CRG (consolidated) reported a modest decline in operating cash to `3.2 bn.
Crompton Greaves (CRG) Industrials Annual report broad demand recovery uncertain; expects overseas demand in some pockets. Crompton was non-committal about its expectations of a broad recovery in demand; but it aims to grow through (1) stabilization of the overseas power business, (2) bets on pockets of overseas demand (systems business, distribution sub- station) and (3) new domestic capacity additions (motor exports, AC drives, fans). Bleeding overseas units (Belgium, Hungary) and a stagnating domestic non-consumer business are concerns.
Industrials Crompton Greaves 56 KOTAK INSTITUTIONAL EQUITIES RESEARCH Consumer segment drives standalone sales growth Break-up of standalone sales suggests a flattish trajectory for the key transformer/reactor and motors/drives segments over the past four years. Switchgear sales have been flattish over 2011-13 with double-digit growth in FY2014. Growth was driven by the consumer segment. Exhibit 1: Broad-based growth in consumer categories; power and industrial sales are flattish yoy Product-wise break-up of Crompton Greaves standalone sales, March fiscal year-ends, 2011-14 (%) Yoy change CAGR 2011 2012 2013 2014 (%) (%) Transformers/reactors 17,360 18,031 18,154 18,262 1 1 Motors, Alternators, Drives Panels 13,200 13,898 13,331 12,982 (3) (0) Switchgears 7,059 7,317 7,431 8,574 15 5 Fans, Ventilation and Pollution Control Systems 9,097 9,122 11,138 12,848 15 9 Electric Lamps 5,703 6,667 7,689 9,010 17 12 Power driven pumps 5,217 5,019 5,869 5,790 (1) 3 Appliances 967 1,211 2,120 1,817 (14) 17 Traction Electronic,Drives and SCADA 569 1,209 1,480 1,897 28 35 Others 3,168 5,666 8,130 7,530 (7) 24 Total 62,339 68,140 75,342 78,710 4 6
Source: Company, Kotak Institutional Equities Powermarket challenging; company banks on internal improvements The global power business continued to be impacted by a combination of market-related issues. Demand situation has continued to be sedate across key geographies of Europe and North America. Against this, competitive intensity has remained high (began in FY2011, intensified in FY2012 and has sustained in FY2013 and FY2014), especially in the US and Europe. In addition, many customers are delaying taking physical deliveries across key regions (Europe, Middle East, North Africa and India). For this, customers have used several means, including (1) invocation of storage clause, (2) demanding short-circuit testing and (3) insistence on extended series of tests for each transformer of a series. Apart from market factors, company has also been impacted by production-related issues at its Canadian and Hungarian plants (had impacted in FY2013 as well). Aims to leverage internal improvements and business references While remaining cautious in market demand, company is still positive on growth led by internal improvements. It mentioned (1) stabilization of overseas power transformer facilities (Belgium, Hungary), (2) new qualifications (extra-high voltage switchgears, 765 kV circuit breaker, new design for 765 kV GIS) and (3) scale-up in automation business (European opportunity, entry-level orders in EMs, opening of India facility). Crompton is also aiming to leverage prior work in the domain of integrated power systems. It has now commissioned 4-5 large wind-offshore projects over the past few years and mentioned new large systems orders (EUR52 mn). Power transformers overseas plants stabilizing; Canada a concern. The annual report carries positive takeaways in terms of (1) improvement in gross margin in new orders for Belgium plant, (2) capacity expansion for Hungarian plant (to 10,000 MVA) and (3) cost- savings/stabilization at the Belgian plant. The key challenge remains the Canadian plant. Here, the company has made management changes and reorganized workforce. The order book for the plant remains healthy and so do sales (delivered 7,000 MVA in FY2014 versus 4,200 MVA in FY2013).
Crompton Greaves Industrials KOTAK INSTITUTIONAL EQUITIES RESEARCH 57 Distribution transformer subdued business. Distribution transformer business has remained sedate across geographies barring US. Essentially business has been impacted by weak demand in Europe and severe margin pressures in India. Company has a capacity of close to 25,000 MVA for this business. Switchgears new qualifications enthuse. On the extra-high voltage side, CRG has full-fledged plants in India and Hungary and manufactures medium-voltage switchgear from India. The company has cited positive developments including (1) introduction of new design for 765 kV GIS in India, (2) on-site qualification for 765 kV circuit breaker for PGCIL and (2) development of 245 kV gas-insulated switchgear at Hungarian plant (plant has also received full-type test certification from Korea Electro-technology Research Institute for the 245 kV GIS). Power systems aims to expand presence by leverage demand and references. The power systems business fared well in Belgium and Indonesia while reported reduced business in UK and losses in India (cost overruns). At a global level, company aims to expand its systems business by leveraging recently completed large wind-farm projects (Belwind, Northwind, Butendiek, Amrumbank, Humber Gateway). It cited receiving a large EUR52 mn order from Netherlands (includes off-shore wind park, onshore substation and electrical grid substation). Automation business wins key entry orders; starts India plant. Crompton has won automation orders in key markets of (1) Iraq, (2) Saudi Arabia and (3) India (PGCIL). It has also commissioned its Bengaluru facility, which is capable of producing 10,000 smart devices per annum (`80 mn investment). The facility would bid for tenders in India, South Asia and the SEAP (South East Asia and Pacific). The automation group has also secured product approvals from PGCIL, Federal Grid in Russia, Mexico, Philippines and Energy Networks Association in UK. Belgian, Hungarian, Canadian losses continue; ZIV scale-up partly compensates The overseas subsidiaries have contributed a total implied PBT loss of about `2 bn for FY2014. Our analysis of the individual subsidiaries yields a combined PBT loss of about `1.5 bn. Key loss-making units were the ones in Belgium (power systems), Canada (power systems), Ganz (electric systems), United Kingdom (power solutions) and Middle East (power systems). This accumulated to a loss of `3.6 bn and was partly compensated by profits of about `2.1 bn from facilities in Indonesia (power systems), Sweden (power automation) and ZIV (distribution automation). CG Power Systems Belgium (loss `1.2 bn) sales decline on contracted base. CG Power Systems Belgium reported a marginal yoy decline in sales to `12.5 bn despite a low FY2013 base (had productivity-related losses. Losses at `1.2 bn have declined by about `2 bn yoy, reflecting the one-off restructuring charge of `1.2 bn in FY2013 and `0.8 bn of potential benefit from lower employee cost. CG Power Systems Canada (loss - `0.7 bn) large losses despite bounce-back in sales. CG Power Systems Canada reported a sharp pull-back in sales to `3.8 bn (versus `2.7 bn in FY2013). Despite the recovery in sales, PBT losses remained significant at `0.7 bn or 19% of sales. CG Electric Systems Hungary (loss - `0.8 bn) sales and losses scale-up. The Hungary unit has increased reported third-year of large losses (double-digit negative PBT margin). This is despite a strong 30%+ growth in sales. Essentially the plant is still in stabilization phase. Its capacity has further increased to 10,000 MVA (from 8,000 MVA earlier).
Industrials Crompton Greaves 58 KOTAK INSTITUTIONAL EQUITIES RESEARCH CG Middle East FZE (loss - `0.5 bn) - initial start-up losses. This unit manufactures power transformers for supply to the key Middle East region. In its initial year, it reported sales of `2 bn and loss of `535 mn. The facility for power transformers is now fully operational and has set up sales and marketing forces in Belelux (Belgium, Netherlands, Luxumberg), France, UK and Algeria. ZIV Spain (profit - `0.5 bn) positive surprise on sales-scale-up. ZIV Spain reported scale-up in sales to about `8 bn (more than 2X of FY2013 value). PBT at `533 mn in FY2014 improved significantly (had reported losses in FY2013). CG Power Systems Indonesia (profit - `0.6 bn) sales and profits increase. Indonesian entity reported a strong ~28% growth in sales and a similar growth in PAT. CG Power USA (includes US$10 mn losses of Power Solutions). CG has likely combined three of its key US subsidiaries (Power Solutions, Power Systems and Automation Solutions) into one subsidiary by the name CG Power USA. The subsidiary reported revenues of `11.2 bn (marginal yoy decline) and PAT of `310 mn (`410 mn last year). Key loss-making business is CG Power Solutions (has incurred US$10 losses in each of the past two years).
Source: Kotak Institutional Equities Industrialsexpects benefit from new capacity additions and approvals While FY2014 carried the negative impact of slowdown in order inflows, higher material costs and severe pricing pressures, company is optimistic about business incrementally. Its optimism is based on addition of capacities at Mandideep, which it intends to use for supplying motors and drives for exports. Its aim to expand exports has received a further boost as it has received approvals from ten global OEMs and four large end-users. The low voltage and medium voltage motors plant at Mandideep has been approved by GE Oil and Gas for global sourcing. It has also commissioned another facility at Mandideep for low voltage AC drives in July 2013. This facility uses Emotrons technology and has capacity to produce 6,000 drives per annum per shift. The company is also optimistic on in its transportation business. During FY2014, it developed its integrated power supply system for railway signaling systems.
Industrials Crompton Greaves 60 KOTAK INSTITUTIONAL EQUITIES RESEARCH Consumer segmentproduct launches help Crompton to outpace market Key segments of fans and lighting have continued to grow at strong 15-17% rates in FY2014, supported by new product launches. Pumps business has remained flat (in a declining market) and appliances business has declined in double digits. Exhibit 3: Fans and lighting sustain strong growth trajectory Product-wise break-up of CG's consumer sales, March fiscal year-ends, 2011-14 (` mn) Yoy change 2011 2012 2013 2014 (%) Fans, Ventilation and Pollution Control Systems 9,097 9,122 11,138 12,848 15 Electric Lamps 5,703 6,667 7,689 9,010 17 Power driven pumps 5,217 5,019 5,869 5,790 (1) Appliances 967 1,211 2,120 1,817 (14) Total 20,984 22,018 26,816 29,465 10
Source: Company, Kotak Institutional Equities We note that fans and lighting are the key segments in Cromptons consumer business. These account for about 75% of total sales. These also drive the profitability for the business as Crompton has low value add content in other products (pumps and appliances). Exhibit 4: Fans and lighting account for dominant share of portfolio Sales break-up of Crompton's consumer business for year-ending March 2014 FY2014 revenues (Rs28 bn) Fans, Ventilation and Pollution Control Systems 43% Electric Lamps 31% Power driven pumps 20% Appliances 6%
Source: Company, Kotak Institutional Equities Fans. CGs net sales have grown ahead of the market at 15% for FY2014 (versus 10% growth for the market). This has led to a 3.3% increase in CGs market share to 26.6%. The second plant at Baddi is now operational and has a capacity of 1 mn fans per annum. Company said 30% of its business in FY2014 is being contributed by new product launches. Lighting (#3 player). CGs net sales grew ahead of the market at 17% versus 12% growth for the market. CG is the number three player in the segment with a portfolio of about 180 SKUs. New products accounted for 17% of the total segment sales and 24% for luminaries. Key segments in LED and CFL have done well. In LED, companys growth was 4X that of the market (driven by product launches). In CFL too, it grow 24% versus market growth of 15-16%.
Crompton Greaves Industrials KOTAK INSTITUTIONAL EQUITIES RESEARCH 61 Pumps (#2 player). The pumps business was negatively impacted by good monsoons last year, which raised water levels. Company still did better than the market and reported flattish sales (industry declined by 10%). CG now has a 27% market share. Business earns healthy margin. Appliances. This is a relatively small business for Crompton where its value addition is also low (comprises mostly traded goods). The business unit achieved sales of `1.8 bn in FY2014. Other takeaways from the annual report Working capital remains steady on an adjusted basis. Companys working capital (at a standalone level) has increased to 63 days of sales at end-FY2014 versus 48 days as of end-FY2013. Adjusted for the `5.5 bn loan given by the standalone entity to subsidiaries, working capital marginally increased on a yoy basis. At a consolidated level, working capital has remained steady at 30 days of sales. Exhibit 5: Modest increase in working capital on an adjusted basis Standalone working capital for CG, March fiscal year-ends, 2005-14 39 27 24 18 7 5 31 37 48 63 - 15 30 45 60 75 2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 (Days of sales Rs 4 bn new loan given in FY2013 to CG International B.V. and increased to 5.5 bn in FY2014
Company still generates strong operating cash at consolidated level. Crompton has reported strong adjusted cash flows of `3.6 bn at a standalone level and `3.2 bn on a consolidated level. Note that we have adjusted the standalone cash flows for `1.5 bn of additional loans and advances given to subsidiaries.
Notes: (a) FY2013 data is adjusted for Rs4 bn increase in loans and advances to subsidiaries and associates. (b) (b) FY2014 data is adjusted for Rs1.5 bn increase in loans and advances to subsidiaries and associates Source: Company, Kotak Institutional Equities
Sells standalone current investments to fund `4 bn to subsidiaries. We note related party investments amounting to `4 bn into Cromptons subsidiaries. Essentially company has increased its funding to (1) CG International BV (combination of `2.5 bn of new investment and `0.5 bn of additional loans and advances) and to (2) CG Power Solutions (`0.8 bn of additions loans and advances). Exhibit 9: Crompton provided Rs4 bn of additional funding to subsidiaries in FY2014 Consolidated and standalone balance sheet of Crompton, March fiscal year-ends, 2011-2014 (` mn) 2011 2012 2013 2014 2010 2011 2012 2013 2014 Shareholders funds 32,747 36,109 35,615 36,446 17,647 23,041 27,009 30,569 33,561 Share capital 1,283 1,283 1,283 1,254 1,283 1,283 1,283 1,283 1,254 Reserves & surplus 31,464 34,826 34,332 35,192 16,364 21,758 25,726 29,286 32,307 Minority interest 157 157 95 118 Loan funds 4,703 10,400 20,336 21,930 268 134 73 141 305 Secured loans 4,554 9,793 20,215 21,930 138 82 73 141 305 Unsecured loans 149 607 121 130 52 Deferred tax liabilities (net) 160 (513) (1,681) (1,532) 834 735 432 498 736 Total sources of funds 37,767 46,153 54,365 56,962 18,749 23,910 27,514 31,207 34,602 Fixed assets 19,417 22,575 30,664 34,591 5,668 9,230 6,755 7,753 8,226 Investments 6,747 7,864 7,908 2,989 6,881 7,816 10,525 10,549 8,263 Current 5,005 206 Non-current 5,546 8,057 Cash & bank balance 2,984 4,976 5,834 8,150 5,485 1,509 3,211 2,888 4,428 Current assets 42,512 50,368 53,974 61,019 16,717 22,341 25,214 31,505 34,947 Inventories 11,893 12,233 16,367 16,714 3,035 4,057 4,496 5,485 5,578 Sundry debtors 25,427 32,913 33,789 35,913 12,128 15,102 17,845 18,904 19,750 Other current assets Loans & advances 5,192 5,222 3,818 8,392 1,554 3,182 2,873 7,117 9,619 CG International B.V. 922 923 833 4,699 5,287 CG Power Solutions 319 1,104 Current liabilities & provision 33,892 39,630 44,014 49,787 16,002 16,986 18,191 21,489 21,263 Current liabilities 29,595 35,843 39,792 45,723 14,466 15,293 16,688 19,629 19,541 Provisions 4,298 3,787 4,222 4,064 1,536 1,693 1,503 1,860 1,722 Net current assets (excl. cash) 8,619 10,738 9,960 11,232 715 5,355 7,023 10,017 13,684 Total application of funds 37,767 46,153 54,365 56,962 18,749 23,910 27,514 31,207 34,602 Consolidated Standalone Rs2.5 bn increase in investments in CG International B.V., more than compensated by sale of financial investments Rs1.5 bn increase in L&A to subsidiaries Sells current investments to fund subsidiaries
Source: Company, Kotak Institutional Equities
Crompton Greaves Industrials KOTAK INSTITUTIONAL EQUITIES RESEARCH 63 Exports: Asia, Africa and Europe bounce back; rest remains steady. Exports for the company (overseas sales from the standalone entity) have recovered in FY2014 on contracted base. Essentially business from Asia, Africa and Europe have bounced back and from Americas has remained steady. Exhibit 10: Exports pick up to FY2011 levels Exports of CG standalone, March fiscal year-ends, 2005-14 (Rs bn) 10.9 10.4 9.1 7.8 7.6 9.1 - 2 4 6 8 10 12 2009 2010 2011 2012 2013 2014 (Rs bn)
Source: Company, Kotak Institutional Equities
Exhibit 11: Asia and Africa bounce back; rest remains steady Exports for CG standalone, March fiscal year-ends, 2009-14 (Rs bn) - 1 2 3 4 5 6 Asia - ex India Africa Americas Europe Australia (Rs bn) 2009 2010 2011 2012 2013 2014 Source: Company, Kotak Institutional Equities
We note sharp recovery in exports from a quarterly perspective. Exhibit 12: Exports have scaled up for CRG after bottoming out in 1QFY14 Power exports for Crompton, March fiscal year-ends (` bn) Power exports 1.6 2.5 2.0 1.5 1.0 2.4 2.9 3.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 1 Q F Y 1 3 2 Q F Y 1 3 3 Q F Y 1 3 4 Q F Y 1 3 1 Q F Y 1 4 2 Q F Y 1 4 3 Q F Y 1 4 4 Q F Y 1 4 (Rs bn)
Source: Company, Kotak Institutional Equities
Industrials Crompton Greaves 64 KOTAK INSTITUTIONAL EQUITIES RESEARCH Geographical break-up of sales. Domestic sales accounted for 50% of the consolidated sales in FY2014 with Europe being the next largest region (contributed 20% of consolidated sales). Exhibit 13: Europe - 45% of subsidiary revenues, 20% of consol. Geographical break-up of Crompton's revenues (consolidated, standalone and private), March fiscal year-end, 2013 (` mn) Consolidated revenues (Rs121 bn) India 50% Africa 3% North America 11% South America 3% Europe 20% Australia 1% Asia - ex India 12% Standalone revenues (Rs71 bn) South America 3% India 88% Asia - ex India 5% Africa 3% North America 0% Europe 1% Australia 0% Subsidiary revenues (Rs49.6 bn) India 0% Asia - ex India 22% Africa 3% North America 24% South America 3% Europe 45% Australia 3%
Source: Company, Kotak Institutional Equities Majority of Europe revenues booked are from local sales. We note that majority of the sales from the European facility service local demand. A small 24% share of production goes as exports to Africa, Asia and possibly South America. Exhibit 14: 76% of revenues booked in European subsidiaries is from actual sales within Europe Likely geographical break-up of revenues and sales of Crompton subsidiaries for year-ending March 2014 North America Production: Rs15bn Sales: Rs15 bn 100% of production Europe Production: Rs35 bn Sales: Rs27bn 76% of production Asia Production: Rs9 bn Sales: Rs13 bn 20% of production to Australia 6% of production to Africa and South America South America Production: Rs1 bn Sales: Rs2 bn Africa Production: NIL Sales: Rs1.8 bn Australia Production: NIL Sales: Rs1.3bn 15% of production - to Asia (Middle East) 80% of production 3% of production to South America
R E S E A R C H June 2014: Results calendar 4-Aug 5-Aug 6-Aug 7-Aug 8-Aug 9-Aug 10-Aug AIA Engineering Ajanta Pharma Adani Ports Aurobindo Phar Birla Corp Adani Enter DFL Infra Bata India ADANI POWER Balrampur Chini Chambal Fert Dena Bank Indraprastha Gas Crompton Greav Amara Raja Bombay Dyeing Corporation Bank Godrej Inds Kalpataru Power EIH Apollo Tyres Gujarat State Pet Gujarat state Sudarshan Chem Marico Gateway Distr City Union Bank IL&FS Invest Mgrs J indal Stainless Oriental Bank Hero MotoCorp Glaxosmithkl Cons India Cements Mahindra & Mahindra Petronet LNG J ubilant IDBI Bank J UBL FOOD PC J eweller Power Grid Mahindra Ugine J indal Steel Nestle India Power Finance Punj Lloyd NHPC J ubilant Inds Neyveli Lignite SBI Tata Comm Tata Chemicals Maharashtra Seam Puravankara Proj Sobha Dev TBZ Tata Invest Tube Invest ZEE MEDIA Sun TV Network 11-Aug 12-Aug 13-Aug 14-Aug 15-Aug 16-Aug 17-Aug Eicher Motors Aditya Birla Nuv GMR Infra Hindalco Gail India Apollo Hosp GVK Power Page Inds J et Air India BPCL J yothy Lab National Alum Britannia Inds Siemens SAIL Coal India SundaramClayton Glaxosmithkl Phar Tata Steel HPCL Motherson Sumi NMDC REC Sun Pharma Tata Power
73 KOTAK INSTITUTIONAL EQUITIES RESEARCH Disclosures
"Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Kawaljeet Saluja, Rohit Chordia, Murtuza Arsiwalla, M.B. Mahesh, Jasdeep Walia, Tarun Lakhotia, Saifullah Rais, Aditya Mongia."
Kotak Institutional Equities Research coverage universe Distribution of ratings/investment banking relationships Source: Kotak Institutional Equities As of June 30, 2014 Percentage of companies covered by Kotak Institutional Equities, within the specified category. Percentage of companies within each category for which Kotak Institutional Equities and or its affiliates has provided investment banking services within the previous 12 months. * The above categories are defined as follows: Buy = We expect this stock to deliver more than 15% returns over the next 12 months; Add = We expect this stock to deliver 5-15% returns over the next 12 months; Reduce = We expect this stock to deliver -5-+5% returns over the next 12 months; Sell = We expect this stock to deliver less than - 5% returns over the next 12 months. Our target prices are also on a 12-month horizon basis. These ratings are used illustratively to comply with applicable regulations. As of 30/06/2014 Kotak Institutional Equities Investment Research had investment ratings on 149 equity securities. 15.4% 23.5% 35.6% 25.5% 2.0% 0.7% 2.0% 0.7% 0% 10% 20% 30% 40% 50% 60% 70% BUY ADD REDUCE SELL
Ratings and other definitions/identifiers Definitions of ratings BUY. We expect this stock to deliver more than 15% returns over the next 12 months. ADD. We expect this stock to deliver 5-15% returns over the next 12 months. REDUCE. We expect this stock to deliver -5-+5% returns over the next 12 months. SELL. We expect this stock to deliver <-5% returns over the next 12 months. Our target prices are also on a 12-month horizon basis. Other definitions Coverage view. The coverage view represents each analysts overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious. Other ratings/identifiers NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. CS = Coverage Suspended. Kotak Securities has suspended coverage of this company. NC = Not Covered. Kotak Securities does not cover this company. RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA = Not Available or Not Applicable. The information is not available for display or is not applicable. NM = Not Meaningful. The information is not meaningful and is therefore excluded.
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List of Key Financial Ratios: Formulas and Calculation Examples Defined for Different Types of Profitability Ratios and the Other Most Important Financial Ratios