Fw: Investor's Eye: Update - Apollo Tyres (Drive with caution; price target under review), Bharat Electronics (Annual report review)

 

Investor's Eye [August 27, 2012]  Sharekhan www.sharekhan.com

Summary of Contents STOCK UPDATE Apollo Tyres Cluster: Apple Green Recommendation: Hold Price target: Under review Current market price: Rs95 Drive with caution; price target under review  Key points The crucial Bandung conference aiming to restrict fall in natural rubber prices Thailand, Malaysia and Indonesia (accounting for 70% of world's rubber production) are expected to meet in Bandung, Indonesia in the first week of September 2012 to discuss ways to stabilise natural rubber prices. The chairman of the Malaysian rubber board has hinted that natural rubber prices can increase by 33% after the crucial Bandung conference.  We believe that the outcome of the Bangdung conference would have a significant influence on natural rubber prices (in either direction) and a direct bearing on the margins of the tyre manufacturers. International natural rubber prices dropped 30% from their highs; failed to recover International natural rubber prices failed to recover significantly from the lows of Rs151/kg even after the announcement of the crucial tripartite conference. In Thailand the prices of RSS-4 grade rubber touched the high of Rs240/kg and have been sliding over the last three quarters.  Some media reports indicate that the tripartite rubber producers are planning to cut down aging trees across 1 lakh hectares. These countries may also cut exports by 3 lakh tonne to contain the global prices. Valuation: Sharp run-up in stock pricing in the positives; Hold We believe that the sharp run-up in the stock price has priced in the positives of the lower natural rubber prices. Of late, too many uncertainties have cropped up over the price of natural rubber due to cartelisation by the key rubber producing countries. Also, the strength in crude-linked raw materials together with the weakness in the local currency may negate the benefit of the weak natural rubber prices. In the current context, we await greater clarity on the fall-out of the Bandung conference. We change our recommendation to Hold and have kept our price target under review.   Bharat Electronics Cluster: Apple Green Recommendation: Buy Price target: Rs1,685 Current market price: Rs1,228 Annual report review  Key points Falls short of its revenue target: Bharat Electronics Ltd (BEL) reported a growth of 3.1% in its gross revenues to Rs5,703.6 crore in FY2012 as against a revenue target of Rs6,200 crore. The key reasons for the revenue miss were the delay in receiving the bulk production clearance for new products and the partial receipt of items from the consortium partners. The export revenues for FY2012 were down to $38.45 million against $41.53 million in FY2011. Going ahead, the management has set a revenue target of Rs6,300 crore for FY2013, expecting a growth of 10.5%. On the back of a strong order book of Rs25,748 crore, the company has already orders worth Rs5,650 crore available for dispatch in FY2013. Margin falters: The operating profit margin (OPM) crashed by 680 basis points to 9.2% in FY2012. The drop was mainly on account of the lower than expected revenues and a higher contribution from the low-margin civilian sector. The civilian sector contributed 27% of the total revenues, up from 20% in the previous year. The orders executed in FY2012 were mainly asset heavy and with lower value-addition which led to the lower margin. Going ahead, the management expects the contribution from the defence sector to rise to 80% leading to a margin improvement. The other income surged by 81% to Rs703.1 crore on the back of a strong cash reserve in the books. On a reported basis, the net profit was down 3.7% to Rs829.9 crore.  Working capital remains negative: The working capital for the company remained negative at Rs1,999 crore (129 days) on the back of the high customer advances received by the company. The customer advances increased to Rs7178.1 crore, up from Rs6441.1 crore in FY2011. The debtor days improved to 174 days from 194 days in the previous year whereas the loans and advances deteriorated to 113 days from 37 days mainly on account of the advances to the suppliers. Soft performance and high cash reserve affecting return ratios: BEL continues to have a strong cash balance with the cash reserves standing at Rs6,772.5 crore at the end of FY2012, ie 120% of the Rs5,637 crore capital employed by the company as at the end of FY2012. The higher cash reserve along with a poor operating performance led to the lower return ratios. The return on capital employed (RoCE) decreased to 19.6% from 22.8% in FY2011. The return on equity (RoE) also decreased to 14.7% from 17.2% in the previous year with the net profit margin (NPM) declining to 14.7% from 15.7% in the previous year.  Valuation and view: BEL is one of the strongest plays on the Indian defence sector. The financial year 2012 saw a soft performance mainly due to a delay in obtaining production clearance. However, going ahead we remain assured of a stronger FY2013 on the back of a strong order book of Rs25,829 crore and the management's commitment of a better FY2013 with a revenue target of Rs6,300 crore. The company is sitting on a huge cash reserve of Rs6,772.5 crore which translates into cash of Rs847 per share. This would cushion the downside. We remain positive on BEL with a 12-month perspective. We maintain our Buy rating and price target of Rs1,685 for BEL. At the current market price, the stock trades at 11.6x FY2013E and 10.5x FY2014E earnings. 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