Cement dispatches for February 2012 continued to be impressive: As per the data released by the Cement Manufacturers of India (CMA), the all-India cement dispatches for February 2012 increased by 9.8% on a year-on-year (Y-o-Y) basis to 16.25 million tonne. The cement demand in the domestic industry has revived since November 2011 primarily on account of increased cement consumption in the rural house building activity. On a year-till-date (YTD) basis (April-February 2012), the cement dispatches grew by 6.1% and for FY2012 we believe the all-India cement dispatches would grow at over 6.5% (as compared with the earlier growth of 4.5-5.0% expected by the Street). Going ahead, the cement demand for FY2013 would grow at about 8.0-8.5% and support the revenue growth of the cement companies.
Positive impact of budget: In the Union Budget 2012-13, though the excise duty rate has increased from 10 to 12% (as anticipated by the Street), the net impact of the move has been neutral as the finance minister has allowed 30% abatement. Further, the exemption in the import duty on coal has benefited the companies that have higher dependency on imported coal, like India Cements, Madras Cement, Dalmia Cement and UltraTech Cement. Hence the changes announced in the budget have had a positive impact on the sector as against the neutral to negative impact anticipated by the Street.
Railway freight hike results in cost increase of Rs8-9/bag: Recently the railways have effected major changes in the freight slabs which would result in a 20-25% rate increase over the same distance. For cement, there has been a hike of around 20%. The new railway freight scheme will increase the cost of freight by around Rs3-4 per bag of 50kg. Cement companies also transport domestic coal via the railways which would have an additional cost burden of around Rs4 per bag of cement. Hence the overall impact of the changes in freight slabs is an increase in the production cost of cement by around Rs8-9 per bag. However, we believe the incremental cost burden will be passed on to the end user.
Price hike more than the incremental cost burden, hence EBITDA/tonne in Q4 likely to be better sequentially: In order to pass on the incremental cost burden in terms of the increase in the railway freight the cement manufacturers have increased the prices by around Rs15-20 per bag across major cities of the country. As per our analysis, the cost burden on account of the railway freight is around Rs8-9 per bag. Hence the price hike is much higher than the cost burden which will improve the EBITDA per tonne of the cement players in Q4FY2012 on a sequential basis.
Outlook With the recovery in the cement consumption by the rural housing segment the all-India cement volume for FY2012 is likely to grow by over 6.5%. However, the failure to adhere to the supply discipline could be a key risk to the cement prices. Another cause for concern remains the cost pressure in terms of higher coal prices and freight cost. Hence, we maintain our neutral stand on the sector. However, selectively we are positive and our top pick in the sector is Grasim Industries in the large-cap space and in the mid-cap space we prefer Orient Paper & Industries.
Change in price target and recommendation
On account of the revival in the cement demand in the past couple of months and the higher than expected price hike implemented by the cement players we believe few cement companies under our coverage could see earnings upgrades for FY2013.
Further, looking at the sluggish volume growth in H1FY2012 we had downgraded the valuation multiple to arrive at the price target. However an improvement in the demand outlook and the benefit allowed in the budget have led us to revise our valuation multiple. Hence, we are upgrading our price target for India Cements to Rs125, for Madras Cement to Rs160 and for Shree Cement to Rs3,100.
Looking at the reasonable upside from its current market price we are also upgrading our recommendation on India Cements from Hold to Buy. However, we are keeping our recommendation on Madras Cement and Shree Cement unchanged at Hold on account of the limited upside in their stock prices from the current levels.
VIEWPOINT
Bharat Forge
Robust business; wait for better entry point
Key points
Stand-alone revenue growth likely to moderate: Bharat Forge Ltd (BFL)'s stand-alone revenues are expected to grow by 13.5% compounded annual growth rate (CAGR) between FY2012 and FY2014 as against the growth of 40% CAGR achieved in FY2010-12. The automotive segment, which contributes roughly 62% to the stand-alone revenues, is expected to grow by 9.5% and 12.6% in FY2013 and FY2014 respectively against the 33.4% CAGR recorded between FY2010 and FY2012. Similarly, the non-automotive revenue growth is expected to moderate to 18% CAGR between FY2012 and FY2014 as against the 56.8% CAGR achieved in FY2010-12. The share of the non-automotive business in the stand-alone revenues has gone up from 30% in FY2010 to 35% in M9FY2012. BFL aims to equate the non-automotive revenues with the automotive revenues over the next ten years.
Non automotive business-the game changer: The company charted a major diversification path after the slump in its automotive business in FY2009. While the non-automotive business is primarily focused on forgings, the company is targeting to increase the proportion of machining components from 30% currently to 100%. The company receives 47% contribution from exports in the non-automotive business and the rest from the domestic markets.
Capital allocation critical to boost valuation in long run: The company has allocated over Rs900 crore or 25% of its balance sheet into various investments and joint ventures (JVs) to enhance the growth but has met with limited success. While the subsidiaries on a consolidated basis are expected to report a 25% revenue growth in FY2012, they are still operating at less than 1% profit before tax (PBT) margin.
Other business will take time to take off and add substantially to valuations: The BFL-Alstom JV is executing as per plan. Recently, the court ruling has gone in favour of NTPC. The JV is expected to receive the order worth Rs3,300 crore from NTPC being the lowest bidder (L1). The execution time is of four years starting from FY2014. The other JVs with NTPC and KPIT are also in investment phase.
Valuations For FY2013, we are factoring in a lower than consensus revenue growth of 12.1% for the stand-alone operations due to the reduced guidance for non-automotive growth as well as the reduced guidance for India. We estimate the standalone earnings per share (EPS) would grow by 19% CAGR, higher than the revenue growth of 13.5% CAGR between FY2012 and FY2014. The company is expected to boost its earnings in FY2014 as new investments/capital expenditure (capex) start contributing to revenues. We also expect a reduction in debt during FY2014 as the capital expenditure reaches its tail end.
The company can trade at 13x FY2014 earnings and the valuations can also incorporate the book value of its investments in subsidiaries and JVs. In spite of having the positive long-term view, the sharp run-up in the stock has now got limited upside in store.
ITC Cluster: Apple Green Recommendation: Buy Price target: Rs250 Current market price: Rs221
Price target revised to Rs250
Key points
Excise duty increased by ~15%: The Government of India has imposed a 10% ad valorem duty on 50% of the minimum retail price (MRP) of cigarettes (exceeding the length of 65mm) in the Union Budget 2012-13. This is an additional charge on the existing specified excise duty on different slabs of cigarettes (of above 65mm in length). The move has resulted in an excise duty hike of around 15% for ITC (ahead of our expectation of 8-12% but in line with the Street's expectation of a 15% hike).
Price increase of 7-9% needed to neutralise the impact: We believe ITC needs to take an additional price increase in the range of 7-9% in its cigarette portfolio (around 2% price hike already implemented prior to the Union Budget 2013) to mitigate the impact of the excise duty hike. A price increase of around 10% in the cigarette portfolio would help the margins to sustain at the current level.
\Volume growth expectation for FY2013 downgraded: A price increase of additional 7-9% in the cigarette portfolio will have an impact on the sales volume of ITC's cigarette business, resulting in flattish sales for a quarter or two. However, once the prices are absorbed in the market, we expect the volume growth to improve in the subsequent quarters. Hence, we have reduced our cigarette business' volume growth expectation for FY2013 to 3.5% from 6% earlier.
Marginal downward revision in earnings estimates for FY2013: The downward revision in the sales volume growth estimate of the cigarette business (which contributes around 60% to the overall revenues) has resulted in a downward revision of about 2% in our earnings estimate for FY2013. We have also introduced our FY2014 earnings estimate in this note.
Likely launch of cigarette in below 65mm category: The government has introduced a new slab of cigarettes of up to 65mm (with excise duty of Rs509 per 1,000 cigarettes) in the Union Budget 2012-13. There is a possibility of the company launching new cigarettes below the 65mm length (priced at around Rs2 per cigarette) under some of its existing brands, which will help it in offsetting the impact of the excise duty hike in the other slabs of cigarettes. Also, the government has increased the excise duty on both hand-made and machine-made bidis by Rs2 per thousand, which will make bidis costlier in the market. Thus, we might see the lower strata of population upgrading themselves from bidis to lower-priced filter cigarettes.
Valuation and outlook: In view of the strong pricing power and price inelastic nature of the category, we expect ITC to hike the prices in the portfolio in the coming quarters to safeguard its margins. Nevertheless, any significant hike in the value-added tax (VAT) rate in the key states would be risk to the margins of ITC's cigarette business. Though we expect the cigarette business to record a sales volume growth of around 3.5% in FY2013 but we expect it to improve to 6-7% in FY2014 (unless there is no substantial increase in the Union Budget 2013-14). Overall, we expect the top line and bottom line to grow at compounded annual growth rates (CAGRs) of 16% and 19% respectively over FY2011-14. We have rolled over our price target to the FY2014 earnings estimate. Hence our revised price target stands at Rs250 (based on 23x its FY2014E earnings per share [EPS] of Rs10.9). In view of the strong balance sheet, better earnings visibility and about 15% upside from the current level, we maintain our penchant for ITC in the large-cap FMCG space. At the current market price the stock trades at 24.0x its FY2013E EPS of Rs9.2. We maintain our Buy recommendation on the stock.
SECTOR UPDATE
Pharmaceuticals
Budget 2013 is net negative for pharma players
Key points
Negatives outweighs positives in Union Budget 2013 for pharma: The proposal of the Union Budget 2013 to increase the basic excise duty and extend the applicability of alternate minimum tax (AMT) to units controlled by partnerships under certain conditions are some of the key provisions which would materially impact the performance of a few players in the pharmaceutical (pharma) sector. The provisions related to weighted deduction of 200% for in-house research and development (R&D) expenditure have been extended for another five years. A higher allocation of funds for building infrastructure in rural areas and concession in customs duty on import of medical devices including raw materials for medical devices are some of the key bounty for the sector. The net impact we feel remains negative for key players in the short to medium term.
Sun Pharma and Cadila Healthcare to take steeper impact among peers: These proposals are set to increase the tax burden for companies like Sun Pharmaceutical Industries (Sun Pharma; 59% contribution of profits from partnership-based undertakings), Cadila Healthcare (58% of profits being contributed by partnered undertakings) and Torrent Pharmaceuticals (Torrent Pharma; undisclosed profit from partnership based undertakings), as they have manufacturing units in Sikkim which are being controlled by partnership firms floated to by-pass taxation meant for only companies.
We revise earnings estimates, target price: We revise our earnings estimates for Sun Pharma, Cadila Healthcare and Torrent Pharma to factor the new provisions proposed in the budget, which would lead to an incurrence of a higher effective tax rate for the mentioned companies. Accordingly, we have revised downwards our earnings estimate for Sun Pharma by 10% and 9% for FY2013 and FY2014 respectively while Cadila Healthcare's earnings estimates have been reduced by 5% and 6% for FY2013 and FY2014 respectively. Torrent Pharma, which started its partnership based manufacturing units in FY2011 is likely to have a marginal impact of 2-3% in FY2013 and FY2014 assuming a 25% contribution to consolidated profits from its partnership firm based in Sikkim. We have reduced our target price proportionately for these companies.
Kalpataru Power Transmission Cluster: Emerging Star Recommendation: Buy Price target: Rs151 Current market price: Rs112
Concerns priced in, growth ahead
Key points
Better times ahead: Competition in the domestic T&D EPC space intensified in the last few years, adversely affecting the market share, margins and valuations of the established players including Kalpataru Power Transmission Ltd (KPTL). However, the stringent norms adopted by PGCIL recently could ease the competition to some extent in future. Meanwhile, KPTL has gained a strong foothold in some high-growth international geographies. Also, opportunity in the T&D space is huge and growing impressively. The domestic opportunity is pegged at Rs150,000 crore in the 12th Five-Year Plan and the global opportunity is around $1.5-2.0 trillion between FY2011 and FY2030.
Strong order book provides growth visibility: After the muted performance of the past two years, we expect an improvement in the revenue growth of KPTL from FY2012. This will be backed by a strong order book of Rs5,500 crore (stand-alone), ie 1.8x its FY2012E revenues. In JMC Projects (a 67% subsidiary) the strong revenue traction is likely to continue in FY2013 and FY2014, thanks to an order book of over Rs5,000 crore. The consolidated revenue is estimated to grow at 17% CAGR during FY2012-14. Moreover, the renewed focus of the government on the power sector could improve the generation-linked transmission infrastructure demand.
Concerns on margin and cash flows priced in: On account of a competitive bidding environment and the extended execution time line of projects (primarily ROW issues), the EBITDA margin of KPTL (stand-alone) is likely to remain subdued in the near term which is already priced in the stock. Further, on account of the tightened payment norms adopted by PGCIL, KPTL could witness strain in its working capital requirements and cash flows. Nevertheless, KPTL's balance sheet position is better than that of its peers with relatively less leverage (a consolidated debt-equity ratio of 0.6x). Further, the peaking of the interest rate in the near future could be beneficial, as for KPTL the interest cost is the highest cost component below the EBITDA line.
Ripe for re-rating: Given the tough business environment, the valuation multiples of the T&D EPC companies have contracted significantly in the past few years. The current valuation multiple of 7-8x one-year forward earnings (as against the average of 15-16x earlier) does not factor in the potential revival in the overall business outlook. The estimated earnings growth of 17% (CAGR; during FY2012-14) implies a PEG of 0.4x. Based on the SOTP method, we value the stock (KPTL at 9x, JMC Projects at 6x of FY2014E earnings and SPV at 1x equity invested) at Rs151, which is 1x FY2014E book value and 5x EV/EBIDTA FY2014E. We initiate coverage on KPTL with a Buy recommendation.
Singapore Complex GRM corrects sharply: The gross refining margin (GRM) of the Singapore Complex has fallen sharply to around $2.4 per barrel from $5.6 per barrel at the end of Q3FY2012. The correction in the Singapore GRM was on account of contraction in the gasoil crack. Looking at the severe drop in the Singapore Complex' GRM we believe RIL may post a sequential drop in the GRM in its Q4FY2012 report card. We have factored GRMs of $7.5 and $8 par barrel for FY2012 and FY2013 respectively. With a drop of every $1 per barrel in the GRM, our earnings estimates for FY2012 and FY2013 carry a downside risk of 3-4% for RIL.
Gas output at KG basin falling continuously; likely to reach 27mmscmd by FY2013: The gas output at the Krishna Godavari (KG) D6 oil field has been declining for more than a year now and the field is currently producing 34.5 million standard cubic metre of gas per day (mmscmd) compared to 53-54mmscmd a year ago. According to the management guidance in the media reports, the gas output at the KG basin is further expected to slide to an all-time low of 27mmscmd by April-May this year due to issues with the reservoir and to about 22mmscmd by FY2014. In our estimates for FY2012 and FY2013 we have factored in gas output of around 40mmscmd. Hence with the likely drop in the gas output to around 27mmscmd in FY2013 there is a downside risk of around 3% to our FY2013 earnings estimate.
Petchem margin under pressure with increase in naphtha price: The petrochemical (petchem) business, which accounts for 20% of the revenue and over 35% of the EBIT, is facing severe margin pressure. For M9FY2012 the company has posted over 360-basis-point contraction in its EBIT margin from the petrochemical division. Further, with the increase in the naphtha price (up 18% in the past two months the margin pressure of the petrochemical division is likely to increase.
We maintain our earnings estimates and would revise them after Q4FY2012 results of RIL: A few negative developments like the fall in the GRM, the lower than expected output from the KG basin and the margin pressure in the petrochemical division could be downside risk to our earnings estimate for FY2012 and FY2013. However, we maintain our earnings estimates for FY2012 and FY2013 and would revise them after the announcement of the Q4FY2012 results of the company. Further, in this note we are also introducing our FY2014 estimates with the earnings per share (EPS) estimate at Rs71.4.
Outlooks In order to factor in the recent negative developments of falling GRM, lower than expected output from the KG basin and margin pressure in the petrochemical division, we are downgrading our valuation multiple in case of its refining and petrochemical businesses. We thus arrive at a revised price target of Rs890. However, we believe the ongoing buy-back programme to provide support to the stock price and any positive development in terms of an improvement in the GRM and the petrochemical margin could be positive triggers for the company. Currently, the RIL stock is trading at 12.8x and 11.6x of FY2012 and FY2013 estimated earnings respectively. We maintain our Buy rating on RIL with a revised price target of Rs890 (based on the sum-of-the-parts valuation method).
VIEWPOINT
Liberty Phosphate
Subsidy reduction not to hurt volume growth
We have interacted with the management of Liberty Phosphate to understand the impact of reduction in subsidy payout rates on non urea fertilisers and its fallout on the demand environment.
Subsidy cut may lead to increase in price of SSP: The government has decided to reduce subsidy payout on nutrients in complex fertilisers on the back of a decrease in the prices of raw materials in international markets. The government has decreased the subsidy on phosphorous by 32.6% to Rs21.8 while that on sulphur remains unchanged. Single Sulphur Phosphate (SSP) contains 16% phosphorous and 12% sulphur. So a decline in the subsidy on phosphorous will reduce the subsidy payout on SSP by 31.4% to Rs3,690 per tonne. A decrease in subsidy on SSP will restrict the company from decreasing the maximum retail price (MRP) from the current level of Rs5,000 per tonne. As per our interaction with the management, the price of SSP can be increased by Rs1,000 per tonne to Rs6,000 per tonne if the government reduces subsidy in the forthcoming budget.
Demand to remain intact for SSP even if price increases: We expect the demand for SSP to remain strong in spite of a likely price hike as it will find preference as a substitute to diammonium phosphate (DAP). The price of DAP has run up sharply in the last one year from Rs9,400 to Rs19,000 per tonne. Farmers, as a result, have been forced to look for a substitute. A special initiative taken by the government to use more of indigenously manufactured fertilisers in order to restrict subsidy will provide support to SSP manufacturing as a substitute to DAP in the long term. As stated earlier, the use of SSP in place of DAP may provide an additional growth opportunity to the company.
Margin may remain at current levels in spite of decrease in raw material prices: The prices of key raw materials have seen a declining trend on the back of lower demand in the international markets. The price of rock phosphate, after reaching a peak level of Rs10,000 per tonne during the current fiscal, has corrected to Rs8,000 per tonne. The same may further decline to Rs7,000 per tonne. In addition to this, the price of sulphuric acid has also corrected down and is presently quoting at Rs2,500 per tonne. The same may stabilise at the current levels. However the positive impact of decrease in the prices of raw materials will be offset by a decrease in subsidies and hence the margin is likely to remain at the current level.
Outlook and valuation: Liberty Phosphate is one of the largest SSP manufacturers which can grow by capitalising on its brand name and distribution network. Given the aggressive expansion of its manufacturing capacities the company can potentially grow at a compounded annual growth rate (CAGR) of around 28.6% over the next two years. In terms of valuation, the stock trades at around 1.7x FY2013 rough estimates. This makes it one of the cheapest stocks in the complex fertiliser space. Liberty Phosphate has appreciated by over 22% since we introduced the stock with a positive bias in the "viewpoint" section of our daily online publication "Investor's Eye" on September 7, 2011. We maintain our positive bias on the stock.
In January 2012, the Index of Industrial Production (IIP) grew by 6.8%, which was significantly higher than the market's expectations. The higher than expected performance was led by a strong growth in the manufacturing sector (up 8.5% year on year [YoY]) and a sharp jump in the non-durable consumer goods sector. On a year-till-date (YTD) basis, the IIP growth stands at 3.9% as against 7.8% in YTD FY2011. The December number has been revised upwards to 2.5% (against 1.8% provisional) mainly contributed by the manufacturing and electricity segments.
Outlook The IIP numbers have been quite volatile but the recent jump (from 2.5% in December 2011 to 6.8% in January 2012) shows some uptrend in the industrial activity. We continue to track the three-month moving average (3-MMA) as well as the YTD growth as these give a better picture. The 3-MMA grew to 5.1% whereas the YTD growth stood at 3.9%. Since the RBI has already reduced the cash reserve ratio (CRR) by 75 basis points to 4.75% to ease the liquidity, the probability of repo rate cuts has reduced in the March 15th mid-quarter policy review.
VIEWPOINT
TD Power Systems
A niche play but macro concerns cloud near term outlook
Company background
TD Power Systems is India's leading manufacturer of AC generators in the range of 1MW to 52MW for steam turbines, gas turbines, hydro turbines, wind turbines and for diesel and gas engines. The company operates basically in three segments -
1. Manufacture of AC generators up to 52MW (formed 39% of FY2011's sales). 2. Projects business- Turbine Generator projects up to 52MW (19% of sales). 3. EPC business -Boiler Turbine Generator projects of 52-150MW (42% of sales) executed by a subsidiary - DF Power Systems.
We interacted with the company's management recently to understand the business and future outlook.
View
The company has a strong niche in the captive power space. But the slowdown in captive power investment amid rising interest rates and tough business environment has led to a slowdown in the company's order booking. Hence, the growth for the next few quarters is expected to be muted, however an uptick in the capex cycle post elections and budget could give a positive thrust to the company's order book. Its increasing focus on the overseas market could also result in a breakthrough with respect to procuring a few big orders. At the current level, the stock is trading at 13.2x our FY2013E rough earnings.
