Fw: Investor's Eye: Thematic Report (Closure of switch call from HUL to ITC with nearly 12% gains); Update - CESC (Stepping efforts to pull back retail), Fertilisers (Demand shifts to cheap fertilisers)

 

 

Investor's Eye [July 10, 2012]  Sharekhan www.sharekhan.com

Summary of Contents THEMATIC REPORT Closure of switch call from HUL to ITC with nearly 12% gains We close call with around 12% absolute return and 6% outperformance to Nifty: Our Switch Idea to shift from Hindustan Unilever Ltd (HUL) to ITC, released on December 2, 2011, has given a positive return of ~12.0% so far while the broader market has moved up by 5.8% over the same period. ITC has outperformed despite the sharp increase in the excise duty on cigarettes in this year's Union Budget (which is likely to affect the sales volume growth of its core cigarette business in FY2013) and HUL's better than expected financial performance in the past two quarters. We now close the switch call.   Rationale for closing the call HUL's premium over ITC has narrowed to 11% from 38% at time of initiating the call Historically HUL traded at a premium valuation to ITC. The valuation gap had widened to 38% from an average of 24% in December 2011, thereby prompting us to initiate the switch call. However, the valuation gap has narrowed down to 13.6% now, making the risk-reward ratio unfavourable. The premium of HUL over ITC has declined for two reasons: (1) a sharp appreciation of 25% in ITC's stock price and (2) a relatively better upgrade in the earnings estimates for HUL.   Remain bullish on ITC from a long-term perspective; HUL susceptible to weak monsoon-led potential slack in rural demand The aberration in the relative valuations of ITC and HUL has played out well; the risk-reward ratio in the switch trade is no longer favourable now. However, we continue to remain bullish on ITC and prefer the stock as our top pick in the fast moving consumer goods space for the long-term investors. ITC's core cigarette business is a lot more inelastic to the changing demand environment and the investments in the non-cigarette business will begin to yield better returns in the coming years.  On the other hand, HUL could face some margin pressures (due to the volatility in commodity prices and foreign exchange fluctuations) and also get adversely affected by a potential weak monsoon-led dampening of rural demand (the rural markets contribute 50% of its revenues). STOCK UPDATE CESC Cluster: Ugly Duckling Recommendation: Buy Price target: Rs405 Current market price: Rs307 Stepping efforts to pull back retail  Consolidated PAT hit by discontinuation of deferred tax: CESC's utility business (standalone) reported a PBT growth of 13% YoY. However the consolidated PBT grew by 19% YoY on a low base of the corresponding period of the previous year. The retail subsidiary reported a loss of Rs300 crore in FY2012. Moreover, in FY2012, the company stopped taking deferred tax in consultation with its auditors. Hence, the consolidated PAT declined by 11.5% YoY; ie lower than the PBT growth. Retail losses contained in spite of sales growth: The loss from the retail business dropped from Rs253 crore in FY2011 to Rs220 crore in FY2012, despite a 20% jump in sales growth. Besides that, a significant improvement has been witnessed in working capital. We view prudent cash flow as the game changer for the retail business.  Cash generation improved in standalone business; status quo maintained at the consolidated level: While inventory days and creditors' days are broadly in line with the previous trend, debtors' days jumped from 46 days to 72 days in FY2012 on account of prior period receivable accrued from tariff revision. Broadly, cash from operations (before capex) improved significantly in FY2012 to above Rs600 crore at the standalone level. On a consolidated basis, cash from operations remained positive and managed to gain a flattish growth YoY. An additional loan of around Rs1,300 crore was sourced to fund subsidiaries (largely new businesses), thereby increasing the consolidated debt even as standalone debt remained unchanged.  New power projects on track but property got delayed by a quarter: Currently, two generation capacities at Haldia (600mw) and Chandrapur (600mw) are in an advanced stage of execution. The management expects to commission Unit I in April 2013 and Unit II in July 2013 of Chandrapur. Further, the Haldia project is expected to get commissioned during September 2014. However, the Kolkata shopping mall is expected to complete by Q4FY2013 with a delay of a quarter.  Valuation and view: During FY2012, the PBIT level loss as % of sales declined to 18% from 24% in FY2011, as losses grew by 13% YoY; ie at a slower pace against sales growth of 20% in FY2012. The company aims to bring its retail business into EBITDA positive by FY2015 implementing a three pronged strategy. We believe the hangover of retail losses is over played in the stock currently but fundamentally, the company is witnessing early signs of transformation after it contained losses at the PBT level in spite of top line growth. We continue to rate CESC as a long term buy and expect benefits to accrue once the retail business turns around over the next few years. We maintain our target price of Rs405 on the stock.  SECTOR UPDATE Fertilisers Demand shifts to cheap fertilisers Key points Overall sales volume declined in June 2012: In June 2012, the aggregate sales of the domestically manufactured fertilisers (by 15 leading manufacturers) declined by 21% as compared with that in the same period of the last year. In the same period the import of fertilisers (DAP, MOP and complex fertilisers) also declined from 10.25 lakh tonne to 7.15 lakh tonne on account of lower imports of urea, DAP and MOP. The import of complex fertilisers increased by 62% during June 2012 mainly on the back of higher imports of lower graded complex fertilisers by Indian Potash, Zuari Industries and Nagarjuna Fertilizers. The import of urea, DAP and MOP decreased by 89%, 25% and 34% respectively during June 2012.  Sales of indigenous complex fertilisers declined in Q1FY2013: The sales of fertilisers declined by 13% in Q1FY2013 as compared to the same period of the last year. The sales volume of the fertilisers declined mainly due to the lower volume of urea and non-urea fertilisers. The indigenous sales of the DAP and complex fertilisers were lower in the first three months of the financial year mainly due to a lower demand, the shifting of demand towards urea and the high price of non-urea fertilisers as compared with the last year. The sales of DAP, MOP and complex fertilisers were lower by 20%, 25% and 27% respectively whereas the sales of urea declined by 5% during Q1FY2013. The sales of urea were also lower during the quarter mainly due to the lower imports by the government-owned trading agencies. Outlook: We believe that the sales of fertilisers in the coming months will remain low as compared to the last year. The demand for overall fertilisers will be lower mainly on the back of the lower sales of non-urea fertilisers during the current fiscal. The demand for urea will be higher as compared with the last year because of the shift in demand from non-urea fertilisers to urea fertilisers. The demand shifted to urea fertilisers mainly due to the high price of the non-urea fertilisers and the inflationary pressure on the farmer due to the rising cost of the other farm inputs and labour. So going ahead, the margin of the complex fertiliser manufacturers will remain under pressure. We, therefore, prefer pure urea manufacturers like Chambal Fertilisers along with single super phosphate (SSP) manufacturers like Rama Phosphate and Liberty Phosphate. Click here to read report: Investor's Eye   Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a postition in the companies mentioned in the article.