Slowdown fails to deter investments as VAT incentives lure
Ashok Leyland conference call
ALL highlights investment plan in Tamil Nadu
Ashok Leyland Ltd (ALL) highlighted a Rs4,000 crore investment plan in Tamil Nadu. This comprises of investment towards medium and heavy commercial vehicles (MHCVs), which the company has been considering to undertake since 2008, and another investment under its joint venture (JV) with Nissan towards light commercial vehicles (LCVs).
Until March 2012, the company has undertaken Rs950 crore of capital expenditure (capex), primarily towards the MHCV business in Tamil Nadu. Some part of this Rs950 crore investment has also been directed towards the LCV segment where ALL manufactures engines for the ALL-Nissan JV.
The ALL- Nissan JV has spent around Rs200 crore towards the LCV project. Further investments to the tune of Rs1,800 crore would be made in the greenfield LCV JV that would have a capacity of 1.9 lakh units in Tamil Nadu. The JV would raise Rs800 crore as debt and the rest would be made up by equity contribution by both the JV partners. ALL's equity contribution in the LCV JV is pegged at Rs500 crore. During FY2013, the company would spend around Rs300 crore while the balance would be spent in FY2014.
The balance capex would be spent in remaining years with January 2017 as a deadline for the completion of the Rs4,000 crore investment.
Company justifies attractive VAT incentives as investment rationale
For the LCV JV; the value added tax (VAT) incentive for every vehicle produced and sold in Tamil Nadu is pegged at Rs50,000. The benefit would be availed in the form of an interest free loan for 14 years as a grant. The company expects 25-30% of the LCV sales to come from Tamil Nadu. On an initial assumption of 15,000 units to be sold in Tamil Nadu, the interest free loan translates into a benefit of Rs75 crore per year for the JV. With a 1.9 lakh units / annum capacity coming on-stream and overall volumes improving over the next few years, the VAT benefits can increase considerably for the JV.
For MHCVs the company indicated of VAT benefits that could be availed on incremental volumes whereby the company needs to produce 68,000 vehicles within Tamil Nadu to claim the benefits. The company needs to sell at least 14,000 vehicles in Tamil Nadu and thereafter would receive VAT benefits on incremental volumes sold in Tamil Nadu to the tune of Rs1.5-1.9 lakh/per unit. The company sold 17,000 units in Tamil Nadu during FY2012. At this run-rate the VAT benefits amount to Rs45 crore per year.
These VAT benefits would not attract any income tax charge as they would be termed as a 14-year interest free loan.
ALL leveraging to increase but debt equity to remain under control
The company has passed an enabling resolution to raise funds by way of equity issuance and debt. In FY2013, the company would raise around Rs1,200 crore by way of debt. Any equity issuance would primarily go towards reducing debt. The debt: equity has been guided at 1:1 and incremental debt raising for FY2013 is guided at Rs500 crore. Recently, the company raised $80 million to retire an old external commercial borrowing (ECB) debt at a 150 basis points higher interest rate with weighted average cost below 6%.
Valuation
The investment in Tamil Nadu, given the attractive VAT incentives augurs well for the company and is a positive from a long-term perspective. However, we are cautious on the management's commentary on poor volume growth in H1FY2013, rising discounts, as well as possible slippages in margin to the lower end of the FY2013 guidance.
We are presenting our expectations for Q1FY2013 earnings where we estimate earnings to remain flat Y-o-Y. We would revise our FY2013 estimates post the quarterly results if required as our volume and margin expectations are conservative than the street's. We continue with our Hold recommendation with short term caution on the stock.
Key points
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Q1FY2013 would bring no respite to the capital goods companies as most of our coverage companies are expected to report a sluggish revenue growth in single digits led by low order booking in the previous quarters and an unfavourable base effect.
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Operating margins are largely expected to be stable on a yearly basis as we feel that the adverse effect of competitive margin pressure and low operating leverage would be partially offset by cooling of metal prices in the last three to four months. Conventionally, Q1 forms 16-22% of the yearly sales, making it the lowest revenue contributing quarter for capital goods companies. On this account, operating margins are also the lowest in this quarter.
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The order inflow announcements in the capital goods space marginally picked up (by 17% quarter on quarter [QoQ] and 12% year on year [YoY]) with companies bagging orders worth Rs35,977 crore in Q1FY2013. Larsen and Toubro (L&T) was the highest contributor (34% of the total orders announced). Some NTPC orders for the super-critical equipment that were expected to be awarded during the quarter, however, are yet to be announced. The book-to-bill ratio for most companies has now started falling, thereby aggravating concerns of growth in future. Also, the fierce competition from the overseas players, mainly the Chinese, has created additional pricing and margin pressure in the power equipment space.
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Margin sustenance along with revenue offtake and order inflow would be the key monitorables in the Q1 report card. In terms of the anticipated Q1 results, L&T is expected to outperform in the large-cap space while V-Guard Industries (V-Guard) would lead the show in the mid-cap space.
Outlook
We expect the sluggish order inflow, margin pressure and subdued future guidance in the face of a slow demand environment and sluggish industry capex cycle to be the recurring tune in Q1FY2013 for most capital goods companies. Hence, the management commentary of these companies on the future growth would be closely watched and could lead to significant downgrades in earnings estimates.
The cabinet is to soon decide on imposition of import duty to curb overseas competition, but the same is likely to be dragged/ diluted because of the strong lobby of power developers like Reliance Power, Adani Power etc. On the positive side, the expected awarding of NTPC's super-critical orders, a cut in interest rates and a pick-up in industrial capex activities remain the key positive triggers for the sector. Our top picks in this space are L&T and V-Guard, and we recommend a Buy on these companies from a long-term perspective.
SECTOR UPDATE
Time for selective buying in utilities
Key points
Power utilities-a steep correction driven by structural issues
In the past two years, the valuations of power utilities have corrected sharply on the back of some concerns including a lack of fuel security (unavailability of the required amount of coal at a reasonable price and a sharp deterioration in the health of the state electricity boards [SEBs]; the key customer of the power generation companies). The inability to secure fuel supply and the concerns related to the offtake of the power generated have clouded the growth visibility of the power generation companies in a scenario where most private players are in an expansion mode with highly leveraged balance sheets.
Time for selective buying post sharp correction and improving policy actions
The good news is that the things have finally started moving on the policy front in the form of the fuel supply agreements (FSAs) being signed by Coal India Ltd (CIL) for committed fuel supply and the tariffs being hiked by the SEBs among others. The corrective steps taken by the government are rather feeble, given the complexity of the issues, and a lot more needs to be done. However, the valuations of the power utilities have turned quite supportive now and there is an opportunity to selectively nibble on certain power generation companies. We have done a risk analysis of the power utilities and believe that some of the companies have relatively much lower risk and have also corrected substantially along with the other stocks in the sector. Companies like CESC, Gujarat Industries Power Company Ltd (GIPCL) and Torrent Power have a relatively higher proportion of operational assets with fuel security and a captive client base (ie a distribution set-up).
Weak monsoon pushes up spot rates; trading opportunity in JSPL
Merchant power rates moved up during June 2012 (peaking at Rs7 per unit) and are likely to remain high for some time, given the weak monsoon outlook for this year. The monsoon is 31% in deficit now leading to a fall in the water level in the reservoirs and power shortage. In case the monsoon gets delayed further, the demand for power will rise and keep the spot prices high for a longer period. Unlike for the hydro power generators, a weak monsoon would be favourable for the thermal power plants as their fuel gets wet and coal mining gets affected during the monsoon rains. Therefore, the current situation offers a trading opportunity in companies like Jindal Steel Power Ltd (JSPL), which has captive coal supply and sells power on a merchant basis.
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