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Whats Inside: Bajaj Finance (BUY); IT Services; Reliance Infra (ADD); Maruti Suzuki (REDUCE); Events
The government expects to complete the ONGC and IOC divestments in this financial year and raise up to Rs190bn from the process. (BS) Dr Reddy's plans to spend Rs16bn for capacity expansion over the next two years. (BS) HCL Tech bags 3-year IT infra deal from New Zealand government. (ET) PowerGrid Corporations Rs80bn FPO is set to be launched in the second week of November 2010. (ET) Infosys BPO stated that it would increase the total headcount of its Poland operations to 1,500 in the next one year. (BS) Reliance Industries agrees to sign a gas supply contract with Essar Oil. (BS) Reliance Industries completes its deal to acquire a 60% stake in the Marcellus Shale gas asset in the US for US$392mn. (BL) Gujarat NRE Mineral Resources is set to offer 25% of its equity to the public. The company is the controlling stake holder in Gujarat NRE Coke. (BS) IOC plans to rope in a strategic investor for its proposed Rs100bn project at Ennore, Tamil Nadu. (BS) IVR Hotels & Resorts, a SPV formed by IVRCL Assets & Holdings plans to promote a Rs50bn township project at Sriperumbudur. (BS) DLF plans to invest Rs9bn in a luxury residential project in Chennai. (BS) Atlas Copco stated that plans to invest Rs1bn in the next 2 years for capacity expansion purposes. (BL) Natco Pharma does not rule out a settlement over the patent issue with Celgene, which has said it would file a complaint against the former for alleged infringement of its cancer drug Revlimid. (ET) Cholamandalam Investment & Finance Co. is in plans to make a pref. issue of equity shares for Rs 1.5bn. (BL) Crompton Greaves has entered into an agreement with the Spain-based ZIV Aplicaciones y Tecnologia to set up a JV in India to manufacture substation automation systems. (BS)
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Sensex price volume trend 140 120 100 80 60 40 Volumes (Rs bn) Sensex 22,000 19,500 17,000 14,500 12,000
Lanco Infratech is setting up a combined 720MW combined cycle gasbased power plant for an investment of Rs25bn at Humnabad in Bidar district. (BS) Shipping Corporation of India plans to invest up to US$4bn in the next four years to double its total cargo carrying capacity to 10m dead weight tonnage. (BS) IFGL Inc, wholly owned US subsidiary of IFGL Refractories acquires two US companies engaged in manufacturing and ancillary services in alumina graphite continuous casting refractories for US$13mn. (BL) The Company Law Board allows Zenotech Laboratories founder and managing director to sell a part of his 25% stake in Daiichi Sankyos open offer to shareholders. (ET)
V olume spurts
Company KSK Energy Ventures Ltd IDBI Ba nk Ltd Ada ni Enterprises Ltd Bank of India Aditya Birla Nuvo Ltd MAX India Ltd HDFC Bank Ltd Chambal Fer tilize rs & Che m Hindustan Oil Explora tion C Ide a Cellular Ltd CMP 176.4 139.8 661.1 489.5 871.4 171.7 2,244.9 75.9 245.0 76.8 M.Cap (US$ m) 1,411 2,176 8,687 5,521 1,928 857 22,238 678 687 5,441 Vol. (in '000) 3,342 18,108 2,562 2,621 688 3,345 1,483 9,612 2,604 14,579 10D A.Vol (in '000) 548 4,992 768 876 238 1,216 602 3,922 1,113 6,517 % Chg 510 263 233 199 189 175 147 145 134 124
Insider Trading
Company Anuh Pharma Ltd Dr Reddys Lab Dr Reddys Lab Educomp Solution HDFC Bank Ltd HDFC Bank Ltd ITC Kotak Mahindra Bank Ltd Kotak Mahindra Bank Ltd Kotak Mahindra Bank Ltd Kotak Mahindra Bank Ltd Name of Acquirer / Seller Bharat Nemchand Shah HUF Dr K Anji Reddy Dr Cartikeya Chennuru Reddy Gopal Jain Nitin Rao Paresh Sukthanakar S B Mathur Raghunath T V Vikram Sud Paul Parambi Paul Parambi Transaction Date -06/09/2010 30/08/2010 07/09/2010 - 08/09/2010 18/08/2010 18/08/2010 03/09/2010 04/08/2010 05/08/2010 05/08/2010 06/08/2010 19/08/2010 Buy /Sale Sell Sell Buy Sell Sell Sell Buy Sell Sell Sell Sell Sell Quantity 16,000 50,000 11,150 55,000 4,000 4,000 54,000 13,000 10,000 8,000 7,000 13,809 Price (Rs) 595.0 1,427.0 1,346.0 570.0 2,189.0 2,189.0 164.3 810.0 813.0 813.0 813.0 2,099.0 Deal Size (Rs m) 10 71 15 31 9 9 9 11 8 7 6 29 Shares Transaction (%) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Holding after Transaction (%) 1.4 0.0 0.4 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Deal size worth more than Rs5m considered. The exchange does not report transaction prices, so we have assumed them to be closing prices for the respective days. Hence, actual deal sizes may vary from the figures above.
(Rs) 1000 (31%) 600 781/200 37 2 1.5 49.5 50.5 16.6 8.6 24.3 1Y 248.2 232.0 49.8 182.6
Financial Summary
3.0 2.7 3.2
Y/e 31 Mar Pre prov. operating inc. (Rs m) Net profit (Rs m) EPS (Rs) Growth (%) PER (x) Book value (Rs) PB (x) CAR (%) ROA (%) ROE (%) Dividend yield (%)
FY09A 2,146 339 9.3 68.6 82.2 297 2.6 38.4 1.0 3.2 0.3
FY10A 3,949 894 24.4 163.6 31.2 315 2.4 26.0 2.3 8.0 0.8
FY11ii 4,828 1,650 45.1 84.5 16.9 347 2.2 17.8 2.7 13.6 1.5
FY12ii 6,642 2,660 72.7 61.2 10.5 398 1.9 14.8 3.0 19.5 2.4
FY13ii 8,829 3,785 103.4 42.3 7.4 471 1.6 13.4 3.2 23.8 3.4
Sampath Kumar sampath.kumar@iiflcap.com 91 22 4646 4665 Prabodh Agarwal prabodh@iiflcap.com 65 6511 6161 Sumeet Singh sumeet.singh@iiflcap.com 91 22 4646 4673
Company snapshot
Background Bajaj Finance Ltd (BFL) was incorporated in March 1987. BFL was promoted by the erstwhile Bajaj Auto Limited and Bajaj Auto Holdings Limited. BFL was subsequently listed in 1994. As per the scheme of demerger of the erstwhile Bajaj Auto Limited, the shareholding of Bajaj Auto Limited in BFL was transferred to Bajaj FinServ Limited. As of September 2010, the company was renamed from Bajaj Auto Finance Ltd to Bajaj Finance Ltd. BFL is engaged primarily in the business of financing two-wheelers, consumer durables, personal loans, small business loans, loan against property, mortgages, and loan against securities. The company has also recently begun financing construction equipment and plans to gradually scale up this business. BFL is present across 375 Bajaj Auto dealerships and over 2,000 consumer-durable outlets spread across the country. Small business lending is carried out through 63 branches spread across the top 16 cities.
Disbursement trend Shareholding pattern as of June 2010
Rahul Bajaj
Chairman
Sanjiv Bajaj
Director
Rajeev Jain
CEO
Pankaj Thadani
CFO
50 40 30 20
(Rs bn) 46
FIIs (17%)
DIIs (9%)
Consumer finance 12%
30 26 20 14 10 25
10 0
FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10
Others (24%)
sampath.ku mar@iiflcap. c om
(Rs)
0.5
0.0 Sep-05 Mar-06 Sep-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10
Source: IIFL Research
sampath.ku mar@iiflcap. c om
100.0 (x) 80.0 60.0 40.0 5-year average forw ard PE 25.3x 20.0 0.0 Sep-05 Mar-06 Sep-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10
Key risks to our recommendation, target price and earnings include an unfavourable lending environment, rapid increase in interest rates, less proven track record in the new business segments and increase in risk weights. We believe asset quality outlook would likely remain benign, given our favourable outlook for the economy. The management, though less proven in the current set-up, brings a wealth of experience in the chosen business segments from various multi-national organisations. We believe this should hold in good stead even during periods of distress. We attach less probability to a rapid increase in interest rates, and hence, on its adverse effects on NIM and earnings at this juncture. But, interest rates will likely remain a concern. Increase in risk weight on loans could be a key risk if the Reserve Bank of India (RBI) sees rapid credit growth in the entire system as a key risk. Increase in risk weight could constrain the growth rate of BFL, but this could be mitigated through capital augmentation. Higher capitalisation will likely depress RoE, which could be partially offset by higher RoA.
0.0 Sep-05 Mar-06 Sep-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10
Source: IIFL Research
sampath.ku mar@iiflcap. c om
Figure 7: Banking sector loans to small business have been growing at below the system growth rate
3000 (Rs bn) 2,643 2000 1,840 1000 1,419 2,367 2,655 (%) 35 30 25 20 15 10 5 0 FY05 FY06 Loans outstanding FY07 FY08 FY09 YoY grow th (RHS) 0
Figure 8: Banking sector loans for consumer-durable purchases have remained stagnant over the years
100 (Rs bn) 80 60 40 20 0 FY05 FY06 Loans outstanding FY07 FY08 FY09 YoY grow th (RHS) 67 96 71 74 63 (%) 50 40 30 20 10 0 (10) (20) (30)
sampath.ku mar@iiflcap. c om
Well-timed entry by BFL into new niches: BFLs investment in new initiatives could not have had a more opportune time. Lenders including well-established NBFCs such as CitiFinancial Consumer Finance and GE Money and banks such as HDFC Bank, Kotak Mahindra Bank and Standard Chartered Bank were withdrawing from small business and consumer lending, owing to rising delinquencies and a worsening lending environment in FY08. In our view, competitive intensity had ebbed completely by FY10, leaving the opportunity entirely to fewer players. This allowed BFL the time to invest in processes and systems for credit management. BFL made a beginning in small business loans and consumer financing in FY09 and began scaling up in FY10, while at the same time withdrawing from its legacy businesses. Unique customer proposition in consumer durables: BFL finances only high-value items such as LCD, refrigerators, and air conditioners in the consumer-durable segment, where BFL effectively competes with credit cards. BFL has invested considerable resources to bring down the turnaround time for loan applications, from a few hours to 15mins, thus allowing it to compete with credit cards in this segment. This reduction in the turnaround time has also been made possible largely due to better data availability with the Credit Information Bureau (India) Limited (CIBIL). A customer taking a consumer durable loan from BFL pays 0% interest on the loan, which has a duration of 8 months and is required to make 30% down-payment for the product. This is in contrast to a credit card purchase, where the consumer would end up paying 2535% for the same purchase, but with no down-payment. BFL on its part earns its entire spread from the manufacturer, who sub-vents the consumers purchase. Competitive intensity is low, but likely to rise over the medium term: With many key players withdrawing from small business lending and consumer financing, competitive intensity remains very low. Given BFLs head start, it is likely to derive significant pricing power and ability to cherry pick assets. However, competition would likely intensify, as risk appetite of banks return. There is some evidence of new entrants,
particularly, new generation private-sector banks such as IndusInd Bank and Yes Bank. Much of the focus remains on secured lending products. Given the gap in financing needs, new competition may not pose a threat to the pricing power that BFL enjoys. As the risk appetite increases and expands into unsecured products too, we believe pricing power would likely wane. Recognising the threat to pricing power, BFL continues to invest in process improvements to drive down costs.
Figure 9: Key product features and competition landscape for consumer loans
Consumer loans Consumer durable loan 7,500 50,000 37,000 24 500,000 20,000 8
Products offered Minimum loan size (Rs) Maximum loan size (Rs) Average loan size (Rs) Maximum duration of loan (months)
Key competitors
Source: IIFL Research
All banks
Figure 10: Key product features and competition landscape for small business loans
Business loans Loan against property 2,000,000 125,000,000 14,000,000 180 All banks, India Bulls Financials, SCUF Loan against shares 5,000,000 100,000,000 24 Some banks, India Bulls Financials Construction equipment financing 500,000,000 48 All Banks, SREI Finance
Products offered Minimum loan size (Rs) Maximum loan size (Rs) Average loan size (Rs) Maximum duration of loan (months)
Key competitors
Source: IIFL Research
sampath.ku mar@iiflcap. c om
Credit behaviour remains pro-cyclical: Small businesses and consumer lending are more vulnerable to downturn/distress in the economy. BFLs entry into small business and consumer finance coincided with the trough levels in economic activity in FY09. With the economy on the upswing since then and outlook remaining robust, we believe asset quality outlook would remain benign for BFL. Focus on secured assets would cushion against sharp rise in credit cost: The key thrust product for BFL would be secured loans for small businesses, which will help in lengthening the duration of assets and at the same time provide protection against significant increase in credit costs. BFL would not have the leverage of using foreclosure as a disincentive against default; nevertheless, secured loans would provide significant downside protection.
Figure 11: Trend in deployments auto finance share has declined since FY08
100 90 80 70 60 50 40 30 20 10 0 3 46 5 40 4 36 2 39
Devang Mody
Sales Finance
Deepak Reddy
Amit Gainda
5 46
13 23
26 21
32 51 56 60 59 49
Sanjeev Vij
24
32
30 FY10
Vivek R. Likhite Loan against securities
FY06
FY09
Advantage for BFL includes experienced team and sophistication in processes: As part of organisational restructuring in FY08, BFL inducted several management personnel who were well-experienced in small business lending and consumer finance. We believe BFL gained significant expertise through these new hires.
Investments in loan origination and underwriting processes should give competitive edge over peers: For consumer finance, it employs analytics (score card system) for risk assessment of borrowers and fully integrated processes to enable quick response to customers. This unique selling proposition is likely to give BFL an edge over its competitors.
sampath.ku mar@iiflcap. c om
Figure 13: Standardised and technologically advanced processes allow BFL to approve/reject a consumer-durable loan within 15mins
Yes Customer inquires about a CD loan BFL personnel at the shop logs onto salesforce.com and fills out the online form Is an existing customer? No Yes Has a pan card/credit card?
does not provide an edge against higher competitive intensity in the future. Deployments likely to grow at a rapid clip: Deployments (loan disbursements) grew 87% in FY10, driven by a focus on new niches. We believe BFL would scale up business volumes in existing locations and expand selectively into new markets mainly for small business lending. For consumer finance, BFLs focus is on tapping opportunities in major urban markets, with a specific emphasis on large retail chains/outlets. With a presence already in 71 cities, BFL would likely push for rationalisation of distribution set-up and look to increase its wallet share with large retailers. Personal loans are originated through cross-sell from the customer base of durable finance. The origination process would be largely technology driven, as the company is likely to rely on its customer relationship management tools. Small business lending would likely see expansion into new markets to sustain volume growth apart from scaling up volume in the existing locations. Currently, BFL operates from 16 cities. Our discussion with BFL suggests that the company would likely expand its operation to 25/27 cities over the medium term to sustain volume growth. We forecast deployments to show 35% CAGR during FY10-13ii, driven by expanding wallet share in existing locations and through a selective push into new geographies. Construction equipment financing would likely be added as a new product. BFL is weighing the opportunity and risks in lending to this segment. As such, the outlook for growth is less clear to us at this juncture. We expect receivables under finance to show 44% CAGR during FY1013ii, led by loan against property for small business and consumer durable financing. Growth rate and share of 2-wheeler financing in receivables under financing is expected to decline, as the prospects for volume are linked to the prospect of Bajaj Auto. Our Auto analyst forecasts double-digit volume growth and higher realisation. This along
Yes
Check CIBIL
No
For small business lending, it employs a traditional approach of field verification and due diligence on borrowers. The key differentiators are: a) BFL generates significant volume of new loans through its own sales force; and b) makes its sales team accountable for collection as well. The differentiated approach for origination and collection would likely make the credit selection and administration process more robust, but it
sampath.ku mar@iiflcap. c om
with an increase in penetration of financing to Bajaj Auto products would likely drive a CAGR of 24% in receivables from this segment.
Figure 14: Expected deployment mix
100 (%) 80 60 40 20 0 FY10 2 w heelers FY11ii FY12ii Consumer durables FY13ii 26 21 23 30 25 20 29 26 19 30 27 18 31
25 13 26 FY11ii
24 14 22 FY13ii
25
25
24
FY10 2 w heelers
(%)
80
60
60 40 20
100000
40
90,108
65,570
20
20000
FY11ii
FY12ii
FY13ii
sampath.ku mar@iiflcap. c om
Robust earnings growth, significant ROE uplift likely from improving cost efficiency and falling provisions
NIM to moderate going forward: We expect NIM to moderate from 18.6% in FY10 to 12.1% by FY13ii, as incremental growth would largely come from LAP and small business loans, thus putting pressure on overall NIM. Furthermore, BFL benefited from a relatively benign interest rate environment over the past year, which aided the company in keeping the cost of funds low, despite the rapid growth in borrowings. Going ahead, we expect the change in loan mix along with an increase in cost of funds to put pressure on the NIM. However, owing to its rapid growth, we believe BFL would be in a position to deliver stellar earnings growth.
Figure 18: NIM to moderate, owing to change in asset mix and rising cost of funds
30 25 20 15 10 5 0 FY05 NIM
Source: Company, IIFL Research
and staff for sourcing loans is broadly in-line with the fees charged to the customer for loan processing, which effectively provides for the variable payouts. Thus, in our view, BFL will be able to keep cost growth under check, even though the company is set to witness robust growth in disbursements. We expect operating costs to register a 23% CAGR over FY10-13ii, while we expect total income to register a CAGR of 28% over the same period. Thus, we expect the cost/income ratio to be steady in FY11ii and improve by 100bps by FY13ii to 39.6%.
Figure 19: Trend in cost/income ratio operating leverage likely
65.0 (%) 56.7
(%)
25.0 FY05 FY06 FY07 FY08 FY09 FY10 FY11ii FY12ii FY13ii
Source: Company, IIFL Research
FY06
FY07
FY08
FY09
FY10
FY11ii
FY12ii
FY13ii
Yield on advances
Cost of funds
Cost/income to moderate: BFL has aggressively been investing in building its presence across consumer retailing chains for consumer durables financing and across the top-16 cities for small business lending. As such, the company will see only limited geographical expansion from hereon, primarily in small business lending. Furthermore, the commission paid out to direct marketing agents (DMA)
Provision charges set to normalise: BFLs asset quality woes over the past two years resulted in provision charges as a % of average loans rising to 815bps in FY10. Provision charges are likely to stay high in FY11ii, as BFL would have to write-off more legacy loans to bring down gross NPAs. However, with the peak in gross NPAs having already passed in FY09, we expect provision charges to drop to 450bps in FY11ii before normalising between 250-300bps. This would provide a substantial kicker to earnings, as provision charges on legacy issues made up 66% of PPoP in FY10. We estimate this to effectively fall to 3035% of PPoP by FY13ii.
sampath.ku mar@iiflcap. c om
10
Figure 20: Fall in provision charges, due to declining risk profile of assets to aid earnings growth
10.0 8.0 6.3 6.0 3.9 4.0 1.8 2.0 3.5 2.6 4.5 3.4 3.0 (%) 8.1
Figure 21: RoA to improve, owing to operating leverage and falling provision charges
5.0 4.0 3.0 2.1 2.0 1.0 0.0 1.6 0.5 1.0 (%) 2.7 2.3 3.0 3.2 4.7
0.0 FY05 FY06 FY07 FY08 FY09 FY10 FY11ii FY12ii FY13ii
Source: Company, IIFL Research
FY05
FY06
FY07
FY08
FY09
FY10
FY11ii
FY12ii
FY13ii
Significant improvement in return ratios likely: We expect BFLs RoA to rise by 120bps to 3.2% during FY10-13ii mainly driven by improving cost efficiency and falling provisions. We believe BFL would likely sustain above average RoA, as we believe credit costs are likely to undershoot during the early phase of growth in secured loans, i.e. loan against property. Consequently, we expect RoE to show substantial improvement in FY11ii and rise to 13.6%, from 8% in FY10. We expect RoE to improve further to 20% by end-FY12ii, on the back of increase in leverage. However, higher leverage may not be sustainable, requiring BFL to raise additional capital in FY12ii. We believe BFLs sustainable RoE will be 21-22%. Normalisation of credit costs would likely drive RoA closer to 3%; regulatory and other market-driven discipline would likely require BFL to maintain a leverage of 7x and hence, we expect a sustainable RoE of 21-22%.
(%) 23.8 21.9 13.6 9.9 6.4 2.0 3.2 8.0 19.5
sampath.ku mar@iiflcap. c om
11
Financial summary
Income statement summary (Rs m)
Y/e 31 Mar Net interest income Others Non-interest income Total operating income Total operating expenses Pre provision operating profit Provisions for loan losses Profit before tax Taxes Net profit FY09A 4,139 212 212 4,350 2,204 2,146 1,636 510 171 339 FY10A 6,545 600 600 7,145 3,196 3,949 2,606 1,343 449 894 FY11ii 7,923 901 901 8,823 3,995 4,828 2,366 2,462 813 1,650 FY12ii 10,307 1,261 1,261 11,568 4,926 6,642 2,672 3,970 1,310 2,660 FY13ii 13,071 1,765 1,765 14,836 6,007 8,829 3,179 5,649 1,864 3,785
Ratio Analysis - I
Y/e 31 Mar Balance Sheet Structure Ratios (%) Loan Growth Growth in Total Assets (%) Profitability Ratios Net Interest Margin Return on Average Assets Return on Average Equity Non-Interest Income as % of Total Income Net Profit Growth FDEPS Growth Efficiency Ratios (%) FY09A 26,075 418 2,739 29,456 202 506 30,164 16,114 16,114 3,162 19,276 10,887 30,164 FY10A 43,539 225 3,018 47,029 505 692 48,226 32,268 32,268 4,433 36,700 11,525 48,226 FY11ii 69,833 414 1,660 72,228 732 692 73,652 55,016 55,016 5,943 60,960 12,693 73,652 FY12ii 97,178 533 1,826 99,955 988 692 101,634 79,333 79,333 7,726 87,060 14,574 101,634 FY13ii 127,529 476 2,009 130,557 1,284 692 132,533 105,236 105,236 10,044 115,280 17,252 132,533 Cost to Income Ratio Salaries as % of Non-Interest costs 50.7 33.1 44.7 31.1 45.3 32.3 42.6 31.5 40.5 31.0 13.7 1.0 3.2 4.9 68.6 68.6 18.6 2.3 8.0 8.4 163.6 163.6 14.3 2.7 13.6 10.2 84.5 84.5 12.8 3.0 19.5 10.9 61.2 61.2 12.1 3.2 23.8 11.9 42.3 42.3 -19.9 -21.6 67.0 59.9 60.4 52.7 39.2 38.0 31.2 30.4 FY09A FY10A FY11ii FY12ii FY13ii
Ratio Analysis - II
Y/e 31 Mar Credit Quality Ratios (%) Gross NPLs as % of loans NPL coverage ratio Total provision charges as % avg loans Net NPLs as % of net loans Capital Adequacy Ratios (%) Total CAR Tier I capital ratio
Source: Company data, IIFL Research
sampath.ku mar@iiflcap. c om
12
IT Services
Visibility improves for FY12! Demand is becoming diversified at Indian IT vendors. Growth rates in 1HFY11 were helped by pentup demand and BFSI M&A integration work. As these projects intensity subsides, work related to application migration, regulatory compliance and many discretionary services is picking up. Also, commentary on the pricing environment is increasingly sanguine. In the meantime, visibility on volume growth for FY11 remains high, with a possible upside surprise from the ongoing pick-up in discretionary services. While worries over attrition have not fully abated, we see minimal risk of further cost escalation associated with high attrition. We remain positive on the larger Indian IT vendors. Infosys and HCL Tech are our top picks. From a surge to a sustained high: Lack of IT spending since mid-2008 and the consequent surge due to pent-up demand formed a considerable part of the robust revenue growth since 2QFY10 (US$: ~5.5% CQGR). This demand will gradually ease off, but industry participants tell us that demand is picking up for a diverse range of IT servicesboth near-term discretionary (testing, high-tech R&D, etc) and medium-term strategic/essential spending (migration of applications to cloud computing, modernisation of legacy systems, ERP implementation, etc). Minimal risks of further cost escalation from attrition: Our recent interactions indicate that after the robust salary hikes, employee attrition at leading IT vendors is waning. We dont see attrition returning to comfortable levels (17% to 20%) before the current batch of freshers is absorbed (by 3QFY11), but risks of cost escalation due to attrition at larger vendors have abated. Protectionism not a worry, but cant be dismissed: Given the high unemployment and the increasingly populist nature of protectionist rhetoric, the threat is real. But, rather than it affecting the viability of the offshore business model, we see the damage being limited to a minor margin headwind (increase in local recruitments onsite), as vendors hire more locals in their overseas markets.
Valuation summary
Company TCS Infosys Wipro HCLT Patni Hexaware Tech M KPIT Mindtree Infotech Infoedge
Source: Bloomberg, IIFL Research
13 September 2010
We see the demand surge leading to better revenue growth for the remainder of FY11 and demand remaining at a sustained high in FY12
Revenuecqgr (US$m)
7% 6% 5% 4% 3% 2% 1% 0% 1% 2% 3% 5.6%5.9% 4.8% 5.5%5.6% 4.3%
1.3% Infosys
1.7% TCS
1.6% Wipro
TCSRevenuescqgr (US$m)
15.8% 8.2% 4.0% 4.6% 1.6% 1.1%
2QFY09to2QFY10 2QFY101QFY11
5.5% 4.9%
6.5%
0.3% 3.1%
Testing BPO ERP Other diversified Infra.
8.0%
Price (Rs) 879 2,879 411 406 452 75 710 168 517 163 1,142
Mcap (US$m) 36,727 35,242 21,384 5,805 1,309 230 1,846 282 422 385 666
EPS FY11ii 43.8 124.9 22.7 26.3 41.8 4.9 70.7 10.1 27.9 12.8 25.4
FY12ii 49.2 160.0 26.7 33.7 37.1 7.1 70.2 15.1 41.2 15.8 34.8
PEX FY11ii 20.1 23.1 18.1 15.4 10.8 15.3 10.0 16.6 18.5 12.7 40.1
FY12ii 17.9 18.0 15.4 12.0 12.2 10.5 10.1 11.1 12.5 10.3 29.3
FY10-12 EPS CAGR 18.4% 21.2% 19.2% 36.9% -9.6% -12.7% -3.2% 18.0% -12.0% 1.0% 35.1%
IT Services
term IT services projects such as modernisation of legacy systems and ADM work for regulatory compliance, is already underway.
Figure 2: Demand generators for a diversified range of IT services
Regulatory compliance-related demand for IT services from BFSI. Modernisation of legacy core systems in US BFSI. Migration of existing applications as movement of peripheral processes into the cloud picks up pace. Consolidation of vendors and processes. ERP and business intelligence-related spending continue to accelerate. US healthcare reforms related to data reporting and standardisation are driving demand for IT services. For technology and other consumer related clients, the rapid consumerisation of high-tech (iPhone, Android devices, etc), is leading to standardisation of processes and normalisation of spikes in R&D spending for faster feature deployment.
Source: IIFL Research
ADM
ERP
Infra.
BPO
Products
Diversified
Ro bust gro wth in A DM - M igratio n, Co mpliance and Feature deplo yment B uo yant demand fo r ERP - To tal o utso urcing, B I implementatio ns, fo cus o n analytics increases B P O gro wth to accelerate To tal Outso urcing, P latfo rm B P O and analytics M o vement o f peripheral services into the 'clo ud' intensifies M o dernizatio n o f legacy systems
2QFY09to2QFY10 1QFY11to4QFY11ii
5.6%
2QFY101QFY11 FY12ii
5.3% 4.5% 4.2%
High visiblity o n ro bust vo lume gro wth. Likely upside as the pickup in discretio nary services is stro ng.
65% of revs.
Revenue gro wth in so me services like testing is accelerating. Ro bust demand fo r pro ducts High fo cus o n infra. and B P O. A ro bust gro wth will likely be lagged.
Our recent interactions indicate that demand is picking up for a diversified range of IT services. Demand for some services, such as migration into cloud, are likely to pick up in FY12, but many medium-
2QFY10 - 1QFY11
2HFY11ii
FY12ii
IT Services
Visibility of volume growth for FY11 remains high, based on our recent interactions with company managements and Infosyss upward revision after 1QFY11 of its revenue growth guidance for FY11 (from 20% YoY to 25% YoY). Also, demand for discretionary services has been picking up stronglywhich would not only help increase realisations, but also accelerate volume growth through the rest of FY11.
Figure 4: Demand for discretionary services is picking up strongly
20%
Net, we see a benign environment for realisations toward 2HFY11, and expect realisations to start rising as early as 3QFY11.
Figure 5: Better realisations in 2HFY11
Better realizations
TCSRevenuescqgr(US$m)
15.8%
2QFY09to2QFY10
2QFY101QFY11
15%
1
8.2% 4.0% 4.6% 1.6% 1.1% 4.9% 5.5% 6.5%
High value resources as discretionary demand remains buoyant
2
Discontinuation of some temporary price cuts + Resumption of COLA adjustments
10%
5%
10%
IT Services
Infosys
Wipro*
25%
20%
15%
10%
5% 1QFY07 2QFY07 3QFY07 4QFY07 1QFY08 2QFY08 3QFY08 4QFY08 1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11
Given the acceleration in demand growth and the consequent need for lateral resources, we see attrition levels remaining higher than the comfortable level till the 2010 batch of freshers is absorbed (in 2QFY11 and 3QFY11). That said, we think risks of further cost escalation have reduced considerably.
Favourable risk-reward
The Maharashtra Electricity Regulatory Commission (MERC) has lifted its stay order (imposed in June 2009) on Reliance Infrastructures (RELI) Mumbai discom tariff plan, as the regulatory audit found no irregularities in the books. Hence, RELI will earn the prescribed 16% RoE, and also recover Rs17bn in unrecovered costs. Separately, RELI will commence operations of the Delhi Metro shortly (3QFY11), which should lay to rest concerns on the companys execution abilities. RELI trades at 1.1x FY11 consolidated BV; and given its portfolio of quality infrastructure projects we do not expect valuations to further deteriorate. The risk-reward is favourable, in our view; upgrade the stock to ADD. MERC lifts stay on tariffs - a big positive: ASCI (Administrative Staff College of India), appointed by MERC to conduct a cost audit on RELIs Mumbai distribution business, found no irregularities in RELIs books. Hence, MERC has lifted the stay order imposed in June 2009 on tariff increases. As a result of the tariff cap, RELI has been incurring under-recoveries over the past 15 months; they added up to an estimated Rs17bn as at end-1QFY11. Withdrawal of the stay will allow RELI to recover these dues along with carrying costs, and earn the prescribed 16% RoE on its Mumbai distribution business. RELI is required to submit a plan to MERC for recovery of dues. Key infra projects approaching completion: Separately, RELI is executing 25 infra projects11 roads, three metros, five transmission lines, one sea-link and five airportsentailing a capex of Rs400bn. While its Mumbai metro phase-I is facing delays, the Delhi metro project is set to commence operations with the Commonwealth Games in October 2010. In addition, RELI is well-poised to commence operations of five road projects in FY11. Completion of key projects will improve RELIs operating cash flows in FY12. Favourable risk-reward; upgrade to ADD: After underperforming the broader market over the past year, we think RELIs valuations are attractive, at 1.1x consolidated BV on FY11ii. Completion of the key projects and visible improvement in the Mumbai discoms finances are key triggers for the stocks outperformance. We believe the risk-reward is favourable, and upgrade the stock to ADD.
RELI has 25 key projects at various stages of construction
Projects Roads Metro Transmission Line Sea Link Airports
Source: Company
(Rs) 1150 (14%) 4,973 1405/950 245 40 1.8 57.3 42.7 15.0 26.5 15.8 1Y -15.2 -31.4 -1.2 -2.8 10.5
0.0
Financial Summary
Y/e 31 Mar Revenues (Rs m) EBITDA Margins (%) Pre-Exceptional PAT (Rs m) Reported PAT (Rs m) EPS (Rs) Growth (%) PER (x) ROE (%) Debt/Equity (x) Price/Book (x) Consol Price/Book (x) FY09 96,965 7% 4,389 10,461 19.4 -36.1 52.1 8.6 0.6 1.9 1.4 FY10ii 96,285 12% 11,517 11,517 47.0 142.2 21.5 8.8 0.5 1.9 1.3 FY11ii 1,19,043 10% 12,487 12,487 46.6 -1.0 21.7 7.7 0.3 1.7 1.1 FY12ii 1,43,982 11% 14,940 14,940 55.7 19.6 18.1 8.5 0.2 1.5 1.1 FY13ii 1,70,175 11% 18,001 18,001 67.1 20.5 15.1 9.5 0.2 1.4 1.0
Mar-10
11 3 5 1 5
120 160 66 51 3
Harshvardhan Dole harsh.dole@iiflcap.com 91 22 4646 4660 Devesh Agarwal devesh.agarwal@iiflcap.com 91 22 4646 4647
May-10
Jun-10
Apr-10
No.
MERC vacates stay on RELIs Mumbai discom tariffs RELI distributes around 1,200MW of power to around 2.5m consumers in the western suburbs of Mumbai. According to regulations, this business is entitled to earn an assured post-tax RoE of 16% and its tariffs are set by the MERC. MERC had set RELIs tariffs for FY10 through its tariff plan issued in 1QFY10.
Figure 1: RELI sells around 9BU units annually in its Mumbai distribution business
Industrial 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 FY05 FY06 FY07 FY08 FY09 (MU) Commercial Residential
Further, MERC also reversed its own tariff order and capped RELIs tariffs at FY09 levels, till completion of such business cost audit. ASCI has recently submitted its final report to MERC, stating that it has found RELIs business practices in-line with the provisions of the Electricity Act. Hence, MERC has vacated stay on RELIs tariffs. Meanwhile, RELI has been buying power from external sources, as its own generation is well short of the total demand (500MW from Dahanu, as against demand of 1,200MW). Since its tariff was capped at FY09 levels, it was unable to pass through even the actual power purchase costs and incurred under-recoveries of Rs17bn through 1QFY101QFY11. Such under-recovery of costs has been dragging down RELIs RoE from the Mumbai business. For instance, in 1QFY11, RELIs standalone profits declined 25% YoY, as it could not pass through Rs1.1bn of additional costs that it incurred as a result of the cap on its tariffs.
Figure 2: In 1QFY11, RELIs power sales declined 14% YoY
Rs m Sale of Electricity Energy EPC and Contracts Gross Turnover
Source: Company, IIFL Research
However, the Government of Maharashtra (GoM) issued a directive to MERC after this tariff order. MERC was to investigate whether RELI had discharged its duties as envisaged in the Act in the most economical and efficient manner, so as to avoid unnecessary burden on the consumers of its area. MERC submitted a detailed report to GoM, where it pointed out a need for an independent investigation into power purchase transactions, accuracy of the electronic meters installed and a steep increase in capital expenditure being undertaken. It appointed the Administrative Staff College of India (ASCI) to investigate three broad areas of RELIs Mumbai business: 1. power purchase cost; 2. capital investment; and 3. expenses of regulated business vis--vis other business.
Figure 3: ... and EBIT declined by 43%, on account of the tariff cap imposed by MERC
Rs m Sale of Electricity Energy EPC and Contracts Total EBIT
Source: Company, IIFL Research
Now, with vacation of the stay from MERC, RELI would be able to recover the amount from consumers, along with interest. RELI will submit a proposal to MERC, detailing a plan to recover arrears. We reckon such regulatory intervention will have a positive effect on RELI.
Separately, RELIs Delhi power distribution business, run by its subsidiaries BSES Rajdhani and BSES Yamuna, is doing well. As per management, these subsidiaries have seen significant improvement in the AT&C losses and from FY11 onwards would earn incentives. Approaching completion of key infra projects RELI currently has 25 infrastructure projects, comprising roads (11), metros (3), transmission lines (5), sea link (1) and airport management contracts (5). These projects are at various stages of completion, and RELI is estimated to spend Rs400bn. In FY10, RELI commenced operations of two toll road projects in Tamil Nadu, and the management expects to complete five additional projects in FY11. Thus, by FY11, RELI will have seven operational road projects.
Figure 4: RELI Road portfolio
Connaught Place, has begun trial runs. The management expects commercialisation of this project in time for the Commonwealth Games scheduled to start in October 2010. RELI has also made good progress in the Western Grid Strengthening projects, and expects to complete two lines in FY11.
Figure 5: Delhi Airport Metro to commence operation by the end of Sept 2010
While its flagship Mumbai Metro (phase 1) has seen some time overruns, the Delhi Metro, which connects Delhi International Airport to
Thus, over the next 12 months, RELI is well-poised to emerge as one of the key infrastructure players in India, with a well-diversified project portfolio. Moreover, completion of large projects should allay investors concerns on the companys execution abilities, and improve visibility on other large projects that are underway. At the end of FY11, there would be 11 revenue-generating projects with a total capital outlay of Rs192bn. 3
The management has plans to separate each of its businesses into separate SPVs, and is working on a re-organisation scheme. Such reorganisation would not only allow effective monitoring of the ongoing projects, but would also allow value unlocking through a partial stake sale in the future. The scheme is pending approval from various stakeholders, and is to be applicable retrospectively from April 2009.
Figure 6: Proposed re-organisation would allow RELI to unlock value in each SPV
Favourable risk-reward; upgrade to ADD RELIs stock has underperformed the markets by 30% over the past 12 months. Such underperformance was largely due to the challenges faced by the company in each of its business verticals (under recovery in Mumbai discom, delays in metro project, etc). At CMP, the stock trades at 1.1x consolidated BV on FY11ii. As such, given the infrastructure project portfolio, we do not expect the stock to trade below its book value. However, the positive regulatory verdict and completion of key projects are key triggers for the stocks outperformance hereon. We therefore think the risk-reward is favourable and upgrade the stock to ADD. In the 1QFY11 conference call, RELI disclosed that it had gross cash (and equivalents) of Rs81bn (net of Rs40bn). Of this, around Rs53bn is invested in preference shares and inter-corporate deposits of the various group companies. The management said that there has not been any material change QoQ as well as YoY in this number, and is likely to remain at current levels in the next couple of years. The investors would look forward to reduction in such inter-corporate deposits extended to the unlisted group companies.
Quick Take
Maruti Suzuki - REDUCE Discounts higher in spite of robust demand
Maruti has recently announced its discounts for the Ganesh festival in Mumbai. The Ganesh festival marks the start of the festive season and discounts tend to be similar for the main festival period of Diwali. Surprisingly, in spite of robust demand, discounts are similar or higher on most models compared to last year. Most surprising is the discount of the recently launched WagonR. It also highlights the fact that even though demand has surprised on the upside, competitive intensity in the space would keep margins muted. Hence, though volumes may surprise positively in the near term, we retain REDUCE. Autos 13 September 2010
CMP 12-mth Target price (Rs) Market cap (US$ m) Bloomberg 52Wk High/Low (Rs) Diluted o/s shares (m) Daily volume (US$ m) Dividend yield FY11ii (%) Free float (%) Shareholding pattern (%) Promoters FIIs Domestic MFs Public
Rs1,308 1,200 8,099 MSIL IN 1,740/1,127 289 21 0.5 45.8 54.2 20.1 17.0 8.7
Price performance (%) 1M Maruti 7.0 Rel. to Sensex 4.2 Mah & Mah -2.1 Tata Motors 15.6 Ashok Leyland Stock Performance
Shares (000') 10,000 8,000 6,000 4,000 2,000 0
3.9
Jun-10
May-10
Sep-09
Nov-09
Dec-09
Financial Summary Y/e 31 Mar Revenues (Rs m) EBITDA Margins (%) Pre-Exceptional PAT (Rs m) Reported PAT (Rs m) EPS (Rs) Growth (%) PER (x) ROE (%) Debt/Equity (x) EV/EBITDA (x) Price/Book (x) FY09A 204,553 7.0 12,187 12,187 42.2 -29.0 31.0 13.7 0.1 24.4 4.0 FY10A 290,989 11.8 24,977 24,977 86.5 104.9 15.1 23.6 0.1 9.6 3.2 FY11ii 360,292 8.8 23,783 23,783 82.3 -4.8 15.9 18.4 0.1 10.2 2.7 FY12ii 398,232 8.9 25,208 25,208 87.3 6.0 15.0 16.7 0.1 9.4 2.3 FY13ii 439,439 9.2 27,529 27,529 95.3 9.2 13.7 15.7 0.0 8.0 2.0
Even with a lower price tag and the same engine as the Swift, the Ritz has struggled against both Maruti's own Swift and new competition. No benefit No benefit Still enjoys a three-month waiting period. 13,000 13,000 NA 20,000 15,000 17,000 Gradually being phased out.
Volumes have not been cannibalised by the Eeco, which continues to do well. No benefit Has done very well since its launch in April 2010. No benefit Very low volumes; negligible impact
Jatin Chawla
jatin.chawla@iiflcap.com
91 22 4646 4654
Aug-10
Jan-10
Oct-09
Mar-10
Apr-10
Feb-10
Jul-10
Figure 2: In 2009, with the market just recovering, manufacturers were still not confident on the demand environment and hence, discounts were higher
Figure 3: In 2010, in spite of a very robust demand environment, discounts remain high. Our concern is that discounts could go up once demand moderates.
2009 2010
jatin.chawla@iiflcap.com
Monday
Tuesday
Wednesday
Thursday
Friday
Saturday
SEPTEMBER2010 6 7 8 9 10 11
Jul IIP-
13.80%
13
14
15
16
17
18
Aug WPI-
20
21
22
23
24
25
Aug CPI-
AL/RL
27
28
29
30
HDFC 18 Oct
Aug CPI-
AL/RL
Jul-Sep 10
Economics / Politics
Oct-Dec 10
Jan-Mar 11
RBIs Monetary Policy meeting (end Jan) 3QFY11 Quarterly GDP
RBIs Monetary Policy meeting on 27th July, RBIs Monetary Policy meeting (end Oct) 2010 2QFY11 Quarterly GDP 1QFY11 Quarterly GDP India Cements 1.5mtpa plant in Rajasthan to start (Sep)
Cement
Bharathi Cement 2mtpa (2nd unit) in Chettinad Cement 2mtpa expansion at Cuddapah to start (Dec) Karikali, TN (Mar) Ambuja Cements 1.5mtpa unit in Bhatapara Jaiprakash Associates 3.5mtpa to start (Dec) expansion at Nalgonda, AP (Mar) Shree cements 1.5mtpa plant in Ras to start Jaiprakash Associates 3mtpa expansion (Nov) at Dalla, UP (Mar) ACC Wadi clinker unit to support 3mtpa cement to start (Oct) Prism Cements 3mtpa plant to start (Dec) JP Associates 2nd phase addition in Gujarat to start (Nov)
Media Metals
Sun TV To release its high budget movie Indhiran Sterlite: 1st phase of 2400MW will commence operation JSWs Chilean iron ore mine to commence shipments Sterlite: 100ktpa lead smelter is expected to commence operation FPO of IOC (Dec) Sun Pharma: Israeli Supreme court decision on Taro acquisition agreement Dr Reddys: Potential USFDA approval for fondaparinux Lupin: launch of Allernaze in US Ranbaxy: Launch of generic Aricept in US Sun Pharma: resolution of Caraco manufacturing quality issues in US Opto Circuits: Launch of Dior drug eluting balloon in Europe Dr Reddys: court review decision on Allegra D24 preliminary injunction Piramal Healthcare: Closure of sale of domestic formulations business to Abbott Labs Sterlite: 2nd phase of 2400MW will commence operation
Jul-Sep 10
Real Estate Peninsula land QIP fund raising Anantraj - QIP fund raising IPO of Oberoi constructions DoT to revert on TRAI 2G recommendations BWA spectrum allocation expected
Oct-Dec 10
Listing of Unitech Infrastructure on completion of restructuring of Unitechs non-core assets.
Jan-Mar 11
Telecom
MNP to be implemented Indus to complete court process for tower transfer RCOM GTLI tower deal to be implemented 3G spectrum allocation expected
Utilities
JSPL - Second 135 MW unit of 540MW plant at Chhattisgarh (Jul / Aug) KSK Unit III & IV (135MW each) at Wardha Warora EGoM meeting on July 27 to decide on gas allocation to Reliance Power from RILs KG-D6 field
Key to our recommendation structure BUY - Absolute - Stock expected to give a positive return of over 20% over a 1-year horizon. SELL - Absolute - Stock expected to fall by more than 10% over a 1-year horizon. In addition, Add and Reduce recommendations are based on expected returns relative to a hurdle rate. Investment horizon for Add and Reduce recommendations is up to a year. We assume the current hurdle rate at 10%, this being the average return on a debt instrument available for investment. Add - Stock expected to give a return of 0-10% over the hurdle rate, ie a positive return of 10%+. Reduce - Stock expected to return less than the hurdle rate, ie return of less than 10%.
Published in 2010. India Infoline Ltd 2010 This report is published by IIFLs Institutional Equities Research desk. IIFL has other business units with independent research teams separated by Chinese walls, and therefore may, at times, have different or contrary views on stocks and markets. This report is for the personal information of the authorised recipient and is not for public distribution. This should not be reproduced or redistributed to any other person or in any form. This report is for the general information of the clients of IIFL, a division of India Infoline, and should not be construed as an offer or solicitation of an offer to buy/sell any securities. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, so far as it relates to current and historical information, but do not guarantee its accuracy or completeness. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. India Infoline or any persons connected with it do not accept any liability arising from the use of this document. The recipients of this material should rely on their own judgment and take their own professional advice before acting on this information. India Infoline or any of its connected persons including its directors or subsidiaries or associates or employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained, views and opinions expressed in this publication. India Infoline and/or its affiliate companies may deal in the securities mentioned herein as a broker or for any other transaction as a Market Maker, Investment Advisor, etc. to the issuer company or its connected persons. India Infoline generally prohibits its analysts from having financial interest in the securities of any of the companies that the analysts cover. In addition, the company prohibits its employees from conducting F&O transactions or holding any shares for a period of less than 30 days.