Centrum wealth india investment strategy - 24 august 2013


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Centrum wealth india investment strategy - 24 august 2013

  1. 1. o Editorial o Equity Strategy & Tactical Asset Allocation o Rupee Crash – A tactical opportunity in 5 MNC stocks o Rupee Crash: Net exporters & producers of import substitutes to benefit o Sector strategy during turbulent time o Five high conviction large cap stocks o New Banking Licenses: Benefit to old private sector banks o High dividend yield stocks with diversified business models o Beaten Down Value Stocks o Silver: Set to shine o Gold: A defensive bet against falling Rupee o Fixed Income Outlook and Strategy: Currency defense pushes up bond yields August 2013 Emerging $ squeeze & General Election: Uncertainty in markets to continue
  2. 2. I nd i a I nv e s tm en t S tr a t eg y2 Table of Contents 1 Editorial 3 2 Equity Strategy & Tactical Asset Allocation 4 3 Rupee Crash – A tactical opportunity in 5 MNC stocks 11 4 Rupee Crash: Net exporters & producers of import substitutes to benefit 17 5 Sector strategy during turbulent time 23 6 Five high conviction large cap stocks 30 7 New Banking Licenses: Benefit to old private sector banks 34 8 High dividend yield stocks with diversified business models 39 9 Beaten Down Value Stocks 43 10 Silver: Set to shine 49 11 Gold: A defensive bet against falling Rupee 52 12 Fixed Income outlook & strategy: Currency defense pushes up bond yields 55
  3. 3. I nd i a I nv e s tm en t S tr a t eg y3 Dear Clients / Colleagues, 24 August 2013 Emerging $ squeeze & General Election: Uncertainty in markets to continue The domestic equity market has faced severe stress since the beginning of the current calendar year, going through an unprecedented turbulent time. The Sensex is down 6.5%, BSE500 down 13.3% and INR has fallen 15.2% YTD in 2013. However, the trend in both Sensex and BSE500 indices does not truly reflect the pain in the equity markets. In the BSE500 index, while as many as 81% of the stocks are in negative territory, nearly 1/5th of the stocks have lost anywhere from 50% to as high as 97% of their market cap and 52% of stocks have lost more than 25% of their market cap on a YTD basis. What went wrong? In our view, there are two set of factors which have adversely impacted macroeconomic scenario – severe industry slowdown and loss of confidence in INR - leading to this state of affairs in the domestic markets: While the global slowdown also contributed to domestic economic slowdown, the high interest rate regime has taken a toll on industrial growth in India. While most economies in the world were worried about either avoiding or escaping the recession, perhaps we were alone sitting in an “island of inflation”. Despite WPI inflation falling from an average of 9.5% in CY2011 to 5.8% in July 2013 and core manufacturing inflation falling below 3%, India did not allow interest rates to fall substantially and in the process, we saw significant de-growth in the industrial economy. A lot of importance was given to CPI inflation, which is highly influenced by fuel and crop prices, both of which are exogenously determined to a large extent; Loss of confidence in INR is partly due to severe slowdown in global trade and hence, in India’s exports. However, the steep spurt in import of gold has made a severe dent in $ reserves. Despite the country resorting to withdrawal of $12 billion from forex reserves for balancing BOP in FY2012, it allowed import of gold to the extent of over $110 billion in the last 30 months alone – had even half of this been controlled India would have been in a very comfortable position to tackle the INR exchange rate crisis it faces today. Export of foreign capital towards importing gold, the most unproductive asset, has also impacted the investible liquidity available in the domestic economy. The opportunity of holding back at least $50 billion was lost to this. The RBI, which had bought $78 billion (a record level, at an average price of just about Rs.40/$) from the open market in FY2008) has already exhausted $60.45 billion (as of June end 2013) since the Lehman crisis. Owing to this swift depletion in $, RBI has little headroom left to sell $ in the spot market to support the INR. Catch 22 situation: The Central Bank is in the midst of a perfect storm, with lack of resources to support INR and facing adverse macroeconomic situation along with the possible risk of a ratings downgrade. Unfortunately RBI having been late in taking steps to prevent the Rupee depreciation, has recently tried to tighten INR liquidity in the short term to create an artificial liquidity squeeze for INR and pulling down $ value! This has delivered a massive blow to both equity and debt markets, as the action is tantamount to raising rates in the economy, further increasing losses in both the debt and equity segments. While broad indices are trading at attractive valuation, they are not representing the grim picture of domestic equity markets. About 80% of individual listed stocks are trading anywhere 10% to 90% below their price levels existed and INR is down about 45% as compared to levels existed two years ago. In our view, India does not deserve such punishment for its currency and equity markets though it has been a major failure in containing the damage. Volatility with negative bias is expected to continue till General Elections are over in next 8 to 9 months. However, the excellent monsoon we are experiencing, coupled with lower inflation and significant fall in trade deficit will help the markets to recover substantially post elections. Hence, we suggest our clients to expose note more than 30% for average profile and for highly conservative investors not more than 20%, of total wealth in equity over next 3 to 6 months. We suggest keeping at least 40% in liquid cash or cash equivalent instruments. Within the equity asset class keep around 15% cash for further bargain buys in next 3 months and also play on defensive equity bets. Sincerely yours, G Chokkalingam, Chief Investment Officer, Centrum Wealth (chokka@centrum.co.in)
  4. 4. I nd i a I nv e s tm en t S tr a t eg y4 Equity Strategy & Tactical Asset Allocation
  5. 5. I nd i a I nv e s tm en t S tr a t eg y5 Equity Strategy & Tactical Asset Allocation What you see is NOT what you get The domestic equity market has faced severe stress since the beginning of the current calendar year, going through an unprecedented turbulent time. The Sensex is down 5.5%, BSE500 down 12.6% and INR has fallen 15.8% YTD in 2013. However, the trend in both Sensex and BSE500 indices does not truly reflect the pain in the broader equity markets. In the BSE500 index, while as many as 81% of the stocks are in negative territory, nearly 1/5 th of the stocks have lost anywhere from 50% to as high as 97% of their market cap and 52% of stocks have lost more than 25% of their market cap on a YTD basis! The top contributors to BSE 500 movement were a handful of large stocks largely in the consumer, IT and pharma sectors. The proportion of stocks in BSE 500 index which are near their 52 week low is close to the ratios that we saw during the Lehman crisis and even post the dot- com bust. Moreover, today there are close to half of the total listed companies which are below the lows seen post the Lehman crisis, although the Nifty has moved up by approximately 125% since then! This clearly shows how skewed the performance of the indices have been, with only a handful of stocks leading to the rise in the Index that we see in headline numbers. What caused the mayhem in the markets? We see primarily two set of factors viz., steep fall in GDP growth and crash in the exchange rate of Indian Rupee (INR), being responsible for causing the pain in the domestic equity markets: Vicious cycle of growth slowdown and poor corporate performance RBI raised interest rates by 175bps during FY2012 and maintained a hawkish view on rates despite significant slowdown in the economy. Even though the headline inflation fell by almost 600bps from the peak to below 6% and core-inflation (non-food manufactured product inflation) fell below 3%, the central bank reduced benchmark rates only by 125bps from the peak. The focus on inflation management hit the growth of the economy, leading to a vicious cycle of low GDP growth, severe deceleration in the industrial economy, severe deterioration in banks’ asset quality and steep fall in corporate earnings; India’s GDP growth fell to 4.99% for FY2013, the lowest level in the last decade; The Index of Industrial Production (IIP) de-grew at 2.2% for the month of June 2013 mainly on account of decline in capital goods (down 6.6%) and consumer durables (down 10.5%). On a cumulative basis, the IIP declined by 1.1% for the period Q1FY2013; Corporate earnings data for Q1FY14 was one of the weakest in the last 15 quarters with the sales being flattish and net profit posting low single digit growth for Q1FY14. The auto sales numbers have been weak posting de-growth of 2.09% during the period April-July 2013 and cement dispatch numbers have also posted de-growth reflecting an overall decline in the investment and production activity. Indirect tax collections have been weak for the period April-July 2013 growing by just 2.9% on a YoY basis as against the Budget target of 19% for FY2014. Among indirect taxes, the excise duty collections during this period de-grew at 11% - it is really worrisome since excise duty collections reflect the status of aggregate demand in the country and show pain for the corporate world in terms of poor sales revenues; In the first quarter of current fiscal itself the fiscal deficit in Q1FY14 has already reached close to 50% of the budgeted estimates for the whole of FY2014 – hence, there is a high possibility that the government may overshoot their fiscal deficit target considering the higher subsidy burden from recent INR crash. Exhibit 1: Core-inflation versus Repo rates Exhibit 2: IIP versus GDP (and its components) -4% -2% 0% 2% 4% 6% 8% 10% May-05 Oct-05 Mar-06 Aug-06 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Core Inflation% Repo Rate % -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 IIP% Manufacturing GDP % GDP% Services GDP% Source: RBI, Centrum Wealth Research Source: Bloomberg, Centrum Wealth Research
  6. 6. I nd i a I nv e s tm en t S tr a t eg y6 Structural issues and failure on gold imports lead to rupee crash Failure to address structural issues impact rupee We have failed to address structural issues over the years - the import of gold, crude oil, edible oil and fertilizers have gone up from 6 fold to as high as 21 fold in the last 10 years. For instance, coal imports were up by 52% in the month of June 2013. During the last 10 years, our overall exports have gone up only 6 fold, hence our trade deficit zoomed 22 fold in $ term in the last 10 years. Exhibit 3: Increase in India’s imports, exports and trade balance in the last 10 years Year India's Import Data ($ Billion) Exports ($ bn) Trade Balance ($ bn)Crude GOLD Coal Edible Oil Fertilizer All Imports FY2003 17.6 3.8 1.2 1.8 0.4 61.4 52.7 -8.7 FY2013 169.0 53.7 15.4 11.2 7.4 490.3 300.2 -190.1 Increase in 10 years 10x 14x 12x 6x 21x 8x 6x 22x Source: Bloomberg, Centrum Wealth Research Booming gold imports leads to limited intervention capability by RBI Gold import (US$53.7 bn) accounted for almost 58% of the current account deficit in FY2013. The government acted on gold imports only after it got out of hand and we imported US$ 15bn worth of gold in just the first two months of FY2014. We have made a major blunder in allowing easy import of around $110 billion in gold in the last 30 months. Had we contained this to even $50 billion, the current situation would not have come about at all. In Rupee terms, the gold imports took up Rs.5 lakh crore. We not only lost precious forex but also simply exported domestic liquidity when we bought the most unproductive asset viz. gold. In FY2012, we had to drawdown USD 12bn from the reserves to balance our BOP (Balance of Payments). Still we delayed stringent measures on gold import till June 2013. In FY2008 alone, RBI had purchased 78.2bn worth of US Dollars at the rate of below Rs.40 which it has used intermittently to support the currency, but the RBI has almost depleted its reserves in selling off close to USD 60bn worth of these dollars by June 2013 and hence has limited head room to support the currency any more. Moreover the services exports which helped meet the trade deficit numbers have also come down by 3.5% in the month of June 2013 at USD 6.22bn. Further, during April-June 2013, NRIs put $5.50 billion into Indian banks' deposits, down by 16.11% YoY. The total NRI bank deposits as on June 30, 2013 stood at $71.07 billion, marginally lower than $71.69 billion in May 2013. Continued instability in INR may lead to continued de-growth in NRI deposits; this would impact the financing options for the current account deficit. Exhibit 4: Sale (-) and Purchase (+) of USD by RBI 78.2 -34.9 -2.6 1.7 -20.1 -2.6 -1.8 -60.0 -40.0 -20.0 0.0 20.0 40.0 60.0 80.0 100.0 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 (USD bn) Source: RBI, Centrum Wealth Research Global meltdown and fear of “taper” impacts flows The emerging market currencies have all seen sharp depreciation owing to fears of the US Fed tapering in its quantitative easing program in September 2013. In the recently released FOMC meeting minutes the members agreed to a reduction in quantitative easing on the back of economic recovery, although the timing or quantum of the roll back seemed uncertain. The fear of sharp outflow of funds from both the equity as well as the debt market has led to rise in yields and further depreciation of currency. Another casualty of slow growth in the developed world has been the slow export growth which has also impacted the current account deficit. Owing to the above reasons INR has depreciated by almost 45% in the last two years and has caused instability in the macro environment as it has impacted imported inflation and fiscal deficit of the country. The instability in INR has raised some uncertainty among the FIIs as well, though they pulled out less than $3 billion from the equity markets since June 2013. Their pull out from the equity market so far in the last 3 months is insignificant as compared to their overall cumulative investment of over $216 billion till date, or over $35 billion in the last 18 months. However, as the appetite to absorb the equity supply is so poor among domestic investors, even this marginal selling by the FIIs has led to chaos in both currency and equity markets.
  7. 7. I nd i a I nv e s tm en t S tr a t eg y7 Exhibit 5: INR movement against USD Exhibit 6: YTD 2013 movement of emerging currencies 52 54 56 58 60 62 64 66 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Announcement of possible taper -20% -15% -10% -5% 0% 5% SOUTH AFRICA BRAZIL INDIA INDONESIA RUSSIA MALAYSIA PHILIPPINES THAILAND TAIWAN POLAND MEXICO CHINA Source: RBI, Centrum Wealth Research Source: Bloomberg, Centrum Wealth Research Exhibit 7: FII/DII flows versus Sensex, USD-INR Month DII (Rs.Cr) FII (Rs.Cr.) FII Debt Investment (Rs.Cr.) Sensex INR / USD Jan-13 (17,542) 22,230 3,274 19,895 54.3 Feb-13 (8,819) 22,123 4,074 18,862 53.8 Mar-13 (7,872) 10,399 5,031 18,836 54.4 Apr-13 (2,701) 6,407 6,936 19,504 54.4 May-13 (12,052) 20,678 2,575 19,760 55.1 Jun-13 8,427 (10,530) (31,342) 19,396 58.4 Jul-13 (1,541) (5,909) (12,651) 19,346 59.7 Aug-13 2,936 (1,097) (7,176) 18,312 64.7 Source: Bloomberg, Centrum Wealth Research FIIs have sold in the debt market to the extent of Rs.27,000 crore YTD, post the announcement by Fed on possible tapering of its stimulus program. This has further added to the rise of debt yields and further fall in the equity markets especially in banking stocks as the potential losses from investments in government securities increased substantially. Other factors that aggravated the crisis in domestic equity markets Repayment of debt: India has over $170 billion in various foreign currency liabilities which need to be repaid before March 31, 2014. This could put pressure on the economics of the capital account owing to the current USD-INR levels and also lead to pressure on government finances; Governance issues among many midsized, highly leveraged companies – nearly 100 stocks have lost market cap to the extent of 70% to 90% and in many cases, the promoters have offloaded their stake in the companies. Such governance issues have also led to soaring NPAs, especially for the PSU banks; Sovereign downgrade could be last nail in the coffin: With deteriorating finances of the government and growth not picking up, a final blow to the market could come in terms of a rating downgrade by international rating agencies. This could lead to a flight of capital from the country and further pressure on the INR. However, some green shoots visible The FIIs have remained net buyers in the domestic equity markets - on a YTD basis, their net buying stands at Rs.42,144 crore and the Domestic Institutional Investors (DIIs) who have been largely net sellers since the beginning of 2012 have turned net buyers in June and August 2013. We believe that any large scale selling of equities by the FIIs is most unlikely – the Rupee has already crashed over 45% in the last 2 years and about 80% of equities are negative on YOY basis. Over 2/3 rd of cumulative investments of the FIIs into the country flew in over 2 years ago. Therefore, any large scale selling by the FIIs would involve huge losses for them. India’s GDP is still growing in nominal terms at about 11%, so we believe that there is no need for any panic for FIIs who hold Indian equities and assets. Other comforting factors are: Steep fall in trade deficit: For July 2013 trade deficit declined by 30% YoY to $12.3 billion on the back of steep fall in gold and silver imports – their imports fell sharply by 34% YoY to $2.97 billion during July 2013 following the increase in import duty and other curbs imposed recently by the government. On a cumulative basis, for April-July 2013 the trade deficit was down 4.6% to $62.4 billion. Exports grew by 11.6% YoY to $25.8 billion during July 2013 – the 1st double digit growth in 2 years. Back of the envelope calculations suggest that the government may even meet its target of US$70 billion current account deficit (CAD) for FY2014. Surplus rainfall: For the period from June 1, 2013 to August 18, 2013 India as a whole received 14% surplus rainfall with 86% (31 subdivisions) out of total 36 subdivisions receiving normal to excess rainfall, which is one of the best in a decade. We can hope for a record level of food grain production in current year. With the recent crash in INR, there exist opportunities for foreign investors to opt for bargain buying of Indian equities from the markets and assets through FDI route. Already the FDI inflows in Q1FY2014 have shown 22% YoY growth.
  8. 8. I nd i a I nv e s tm en t S tr a t eg y8 What is in store for next 6 months? The passing of the “populist” food security bill by an ordinance, events in Telengana (awarded status of a separate state) and increased activity by major parties on various social media platforms allude to undercurrents of preparation for elections. The election announcement and the run up to the elections would be marked with bouts of volatility as investors, especially the FIIs, would prefer to wait and watch before they take a fresh call on the markets. There would be greater uncertainty on core macroeconomic issues as the focus would shift from economic policies to politics. Rating agencies may announce more adverse downgrades among the PSU banks as there would not be any let up in the NPA levels for many of them. The list of candidates for possible downgrades would only increase. Interest rate cycle reversal may be a long protracted journey: The RBI, in the month of July 2013 has taken a series of steps to create an INR squeeze and raise short term rates to support the INR. The RBI increased the MSF rates from 8.25% to 10.25% and also reduced the LAF borrowing window to Rs.75,000 crore. Moreover, the RBI has also proposed to further suck out liquidity from the banking system by issuing cash bills to the tune of Rs.22,000 crore each week. This has caused the short term rates to rise and led to some banks increasing their deposit rates and base rates for lending. Thus, the reversal of interest rates in the economy has come to a halt for some period. Considering there are no strong triggers for INR to appreciate in the short term, the interest rate reversal could get delayed in spite of core inflation coming down to 2.4% levels. This would in effect delay our earlier assumption on reversal of interest rates in CY2013. While the expectations from the new RBI Governor would be very high, we believe that he has limited ammunition to tide over the current macroeconomic situation. Considering the current state of INR any sharp reversal of interest rate could lead to further withdrawal of debt by the FIIs. INR to trend close to Rs.60 level: We believe that the government and RBI have little ammunition left to address short term movement of Rupee unless some of the long term structural problems are taken care of. The government has been a bit late in implementing higher import duty on gold and the steps take by RBI to stem short term liquidity has also failed to avert instability in INR. Moreover, the risk of downgrade from rating agencies has increased as the fiscal deficit pressure and dependence on external flows to maintain balance of payment has caused a sharp depreciation in INR. This has led to a vicious cycle of higher imported inflation, higher subsidy payments and rising long term yields putting further pressure on the economy and corporate sector. The FIIs may remain on the sidelines till the elections, creating a potential funding gap in the balance of payment account. The government has continued to make desirable moves on the path of reforms creating the right environment for increased FDI investment into the country. We expect INR to stabilize around Rs.60 against the USD by end of 2013 and would wait for election results for further recovery. Corporate earnings to be weak and risk of defaults increase: The corporate earnings for Q1FY14 have been quite weak with low single digit growth in earnings among the Sensex companies. This would be the lowest growth seen over the last few quarters. Moreover, the asset quality of banks is deteriorating and possibility of large scale defaults is increasing. As per a Crisil report, there have been 42,819 cases involving close to Rs.1.43 lakh crore pending with the debt recovery tribunals across the country. Net non-performing assets for banks went up 51% in FY13 to Rs.92,825 crore. Gross NPAs of banks are expected to increase to 4% in FY14 from 3.3% in March 2013. The unanticipated rise in interest rates by the central bank could further put pressure on the asset quality of banks. The rise in asset quality pressure could further risk a downgrade for the country, leading to further INR depreciation and could lead to a vicious cycle of high interest rates and weak INR. Risk of tapering of the quantitative easing: The global markets are under pressure owing to possible reduction in the stimulus measures by the Fed in its meeting in September. We expect soft landing of monetary expansion in the US from the last quarter of 2013 – this would cause further temporary uncertainty on foreign investment inflows into the country. While INR has crashed by 45%, the international crude oil prices almost remain quite firm over the last one year – this would aggravate the government’s burden on oil subsidy. High interest regime is also likely to keep India’s GDP growth below 5% during the first half of FY2014. Hence, Unlucky (20)13 for most investors Owing to uncertainties anticipated during the next 6 months, we expect the year 2013 to be a lost year for investors. We expect the index to remain in the range of 18,000-19,000 (Sensex) for the rest of 2013, with only a handful of stocks participating in any possible marginal recovery in the broader indices. Although post election we could see Sensex creating a new high We maintain our target in the range of 25,000 to 27,000 (Sensex) for the December end 2014 as we expect one of the national parties to win and get a majority in Parliament. This would enable the formation of a stable government and implementation of pending reform measures. This is also expected to give a sentimental boost to the markets. Forces of economic equilibrium on account of the INR crash would also start working – we have already seen major fall in gold imports, improvement in profitability of textile exports and overall exports growth improving in double digits in July 2013 for the first time in the recent past. Hence, the long term investors who have appetite to take another 5% to 10% risk to their portfolio in next 6 months and whose equity exposure is less than 30% of total wealth may remain invested in quality stocks. We believe that there is a convergence of many positives in 2014 which could help in expansion of corporate earnings and lead to re-rating of the Indian markets. With good progress of monsoon we expect the food inflation to come down, which should further pull down the WPI inflation. Current monsoon performance is one of the best in recent times – there are reports of kharif crop planting area going up by 9% leading to cooling off in food inflation and therefore significant fall in overall inflation; The interest rate reversal may continue in 2014 as we expect the currency to stabilize once the elections are over. With reversal of interest rates the corporate earnings should expand, owing to margin expansion leading to re-rating of the Indian equity markets; We will also see significant fall in imports of goods and also dip in export of $ capital going forward. We can also expect further aggressive purchase of Indian assets by foreign companies as it is about 45% cheaper as compared to 2 years earlier. FDI investments in multi brand retail and airline sector would fructify. FDI in insurance and pension sectors is likely to be relaxed.
  9. 9. I nd i a I nv e s tm en t S tr a t eg y9 Risk to our Views Remaining period of 2013: In case the US postpones proposal to cut down monetary expansion to 2014 – this would provide sentimental boost to both currency and equity markets; In case a predominant portion of the foreign investors believe that 45% crash in INR is a rare opportunity which may not be available post elections and therefore decide to rush in, instead of sitting on sidelines, to buy out Indian equities and assets – this development can lead to robust recovery in the Indian equities. For CY2014: In case the developed world especially the US and Euro zone fall back to low growth or recession, then the Indian economy would suffer from decelerating exports and poor inflow of foreign capital, leading to GDP growth remaining below 5% for one more year. General Election results: We bank on our hypothesis that one of the two dominant national parties would succeed in forging successful alliances with regional parties and improve their own tally, on standalone basis, close to 250 seats. This would strengthen the hold of the major ruling party over its alliance partners. However, in case both major national political parties secure only around 150 seats on a standalone basis (while simple majority requires 273 seats), there would be major setback to both the markets (currency & equity) and economy. We would remain alerted on these risk factors over the next 9 months. Conclusion: Equity Strategy & TAA Equity strategy – Portfolio allocation Considering substantial volatility over the next 6 months period, we prefer a defensive strategy. Hence, suggest we 15% cash within equity asset class for another 3 months or till individual stocks are further beaten down badly. Investment strategy Suggest large cap and fairly large mid cap for investments; Avoid companies with high promoters share pledging; Avoid highly leveraged companies, as high interest rates are impacting bottom line growth; Sectoral Bias Export oriented sectors: Prefer sectors which have a major portion of their earnings which are dollar denominated and hence prefer stocks in the IT Sector; Domestic demand themes: Sectors which do not depend on government intervention or regulatory overhang or major capital expenditure in the country. Hence, prefer FMCG and Pharma; High Dividend Yield: Companies which have a strong track record of dividend payments and also have some visibility on the earning potential. They would provide a good downside protection in the current volatile environment; Import substitutes: companies which compete with importers of goods would stand to benefit from the current Rupee crash as the competitiveness of their products would increase; Deep value: Stocks which offer deep value and still hold the potential to become multi-baggers in the long term; Market cap bias In terms of market cap segments, we suggest restructuring the portfolios and recommend investing only 20% of the equity allocation into small caps (below Rs.1000 crore market cap) and rest in large and large midcap stocks. The recovery – as and when it happens, may start with large and large midcap stocks. On the other hand, if risk emanates from the election results, exit from larger stocks would be much easier. Exhibit 8: Equity Allocation Allocation by Market Cap Allocation (%) Large Cap 30 Large Mid Cap 35 Small Cap 20 Cash 15 Total 100 Source: Centrum Wealth Research
  10. 10. I nd i a I nv e s tm en t S tr a t eg y10 Tactical Asset Allocation (TAA) Considering our expectation of huge volatility in the equity markets till elections are over and possible major risks associated with the election results for CY2014, we have cautiously developed following conservative TAA strategy. For an average investor, we would suggest not having more than 30% of wealth in the equity market due to high volatility in the next 3-6months. For a very conservative investor, not more than 20% of wealth till elections are over or till further possible beating down of individual stocks; Suggest additionally 5% allocation to silver while maintaining 5% in gold; Exhibit 9: Tactical Asset Allocation Asset Class Current TAA (%) Previous TAA (%) Equity 30% 50% Other than Equity 70% 50% Fixed income/ Structured products 55% 40% Gold/ Silver 10% 5% Real Estate Investment 5% 5% Total 100% 100% Source: Centrum Wealth Research G Chokkalingam, CIO (chokka@centrum.co.in) Ankit Agarwal, Fund Manager (ankit.agarwal@centrum.co.in)
  11. 11. I nd i a I nv e s tm en t S tr a t eg y11 Rupee Crash – A great attraction for foreigners to buy Indian Assets; a tactical opportunity in 5 MNC stocks
  12. 12. I nd i a I nv e s tm en t S tr a t eg y12 Rupee Crash – A great attraction for foreigners to buy Indian Assets; a tactical opportunity in 5 MNC stocks INR has depreciated by 45% in the past 2 years, from Rs.43.86 in July 2011 to Rs.63.4 at present. In the last 2 years, though Sensex rose 13%, over 80% of individual stocks, including MNC stocks, fell anywhere from 10% to as high as 90%. This provides a historically rare opportunity for MNCs to either increase their stake in Indian subsidiaries up to 75% or 100% (and then delist them) at the cheapest possible valuations. Other factors which could make Indian assets attractive to the foreign investors are: o In nominal terms, India is still growing over 11% and in the past India’s GDP growth has rarely stayed at very low levels for more than 2 years in a row. India has probably crossed Japan to occupy 3rd largest position in terms of GDP size (Source: OECD); o INR is unlikely to fall further significantly as it has already crashed close to 50%. Considering the steep fall in gold imports and other remedial measures taken by government, we can expect the INR to stabilize soon and in fact, it can appreciate 10% to 20% in the next one to 2 years; In the last 2 years most of the MNC stocks, barring those in the FMCG space have fallen substantially. We have shortlisted 6 MNC stocks based on their fundamentals, strength of parents’ balance sheets and correction in their stock prices. These 6 stocks except GSK Pharma have fallen in the range of 3% to 48%. However, the price fall has been in the range of 23% to 63% in USD term. Hence, we believe that the current market conditions in India provide a historically rare opportunity for MNCs to consider open offers to increase their stakes. Even if they offer 40-50% premium to the current valuations, the benefit for the MNCs would be far greater in the long run. Exhibit 10: % Fall in stock prices of Indian subsidiaries in last two years -48% -33% -24% -8% 9% -63% -52% -46% -34% -23% -75.0% -60.0% -45.0% -30.0% -15.0% 0.0% 15.0% Siemens StyrolutionABS Clariant BASFIndia GSKPharma Price chg in INR terms Price chg in USD terms Source: Bloomberg, Centrum Wealth Research Exhibit 11: Most of the companies are trading near 52 week low Open offer candidates Parent Company Indian Subsidiaries (%) of total subsidiaries wholly owned Revenue (In EUR bn) Net Cash (In EUR bn) CMP (Rs.) Chg from 52 Week 1 year forward P/EHigh Low BASF India 87 72.1 1.6 521 -32.3% 6.3% 14.5* Clariant Chemicals (India) 91 5.0 1.4 481 -28.6% 29.6% 18.9 Glaxosmithkline Pharma 89 32.6 5.3 2,282 -21.3% 18.2% 25.1 Siemens 73 78.3 11.4 451 -39.9% 7.6% 28.1** Styrolution ABS (India) 94 6.0 0.2 350 -56.3% 3.2% 8.7 Note: * March ending; ** September ending; Rest December ending Source: Bloomberg, Centrum Wealth Research
  13. 13. I nd i a I nv e s tm en t S tr a t eg y13 Exhibit 12: A tactical opportunity for 5 MNC stocks Open offer Candidates Rational for possible open offers / Stock Attraction BASF India In 2011, its parent merged 4 of its local unlisted subsidiaries with BASF India, which was followed by merger of the Indian operations of Cognis, which was globally acquired by BASF SE in December 2010; Parent company made public its intention of converting BASF India the “Single Legal Entity” for all its India based operations; The parent has already increased its holding in the company from 52.7% in FY2008 to the present 73.3% through an open offer in FY2009 and the merger of unlisted entities (2.1%); Clariant Chemicals (India) Clariant International, the parent company has been restructuring its businesses across geographies – it is exiting non-core segments in order to concentrate on value added segments like specialty chemicals. In the past the company has sold its land and other assets & distributed one third of the sale proceeds as dividend. Expect another special dividend payout as last year it sold low focus businesses for Rs.209 crore; Glaxosmithkline Pharmaceuticals Recently, the GSK Pte announced increasing its stake in its GlaxoSmithKline Consumer subsidiary from 43.2% to 75%, in a deal worth ₤591m at a 28% premium to the unit’s closing share price of the previous week; The logical possibility of increasing the stake is higher for its pharma venture, as the extent of involvement of parent’s technology is more for this business; Siemens Siemens AG had earlier increased its stake in Siemens by 19.8% from 55.2% to 75% through an open offer in 2011; Siemens AG has charted a new strategy to design and develop about 60 products especially for India, targeting $1.3 billion in annual revenues from them alone by 2020; Reversal of interest rate cycle along with revival of economy would lead to the company outperforming its peers; Styrolution ABS (India) The parent had tried to acquire 100% stake in its Indian subsidiary in the past but had not been successful; Styrolution ABS has been on a steady growth path. Over CY2008-2012, its revenue and net profit has been consistently growing at 13.1% CAGR and 36.7% CAGR respectively; Due to OFS to meet the SEBI norms, the stock has witnessed correction and the current market price offers a good opportunity for MNC to consider delisting of the Indian subsidiary; Source: Company, Centrum Wealth Research Abhishek Anand, VP - Research (a.anand@centrum.co.in; +91 22 4215 9853) Dhaval Sangoi - Research Analyst (dhaval.sangoi@centrum.co.in; +91 22 4215 9980)
  14. 14. I nd i a I nv e s tm en t S tr a t eg y14 BASF India Ltd. BASF India, a subsidiary of €72 billion chemical engineering major BASF, Germany (73.3% equity stake) is engaged across virtually the entire chemicals sector including agri chemicals, performance products, plastics, functional solutions, etc. In FY2012, BASF consolidated its businesses by merging four of its unlisted entities belonging to the parent company (BASF Polyurethanes, BASF Coatings, BASF Construction Chemicals and Cognis Specialty Chemicals) with itself. Subsequently, the management announced that BASF India would be the “Single Legal Entity” for all its India operations. This provides us some conviction of its eventual delisting, as the MNC already holds more than 73% stake in this company; Post consolidation, BASF has proposed aggressive capacity expansions. It is setting up a new chemical plant in Gujarat at a cost of over Rs.1,000 crore and the plant is expected to be operational in 2014. BASF is looking to fund this expansion through a mix of internal accruals and ECB from group companies which would be on beneficial terms. The plant is likely to add at least Rs.700 crore of revenue in its 1st year of operations. Further, the company is looking to set up a Global Research Centre for crop protection solutions in India as it shifts its R&D work to Asia, supporting its major expansion into the region; BASF is expected to add a production line for precious metal-based fine chemical catalysts at its Mangalore plant. These catalysts find applications in the manufacturing of active pharmaceutical ingredients (API). This is the first chemical catalyst facility in the Asia-Pacific region and will not only cater to the increasing pharma market in India but also the growing market across the Asia-Pacific region; BASF for Q1FY2014 reported 21% YoY growth in net profit to Rs.87 crore led by improvement in margin from agri- solution business. Revenue for the quarter grew by 5.2% YoY to Rs.1,360 crore. The company’s operating profit grew by 22% YoY to Rs.151 crore with margin improving by 151 bps to 11.1%. On segmental basis, Agri-solution business outperformed with its EBIT growing by 61% YoY to Rs.111.4 crore and revenue increasing 16% YoY to Rs.586 crore. EBIT margin of the segment improved 527 bps to 19%. BASF reported an EPS of Rs.20 for Q1FY2014; The company is setting up precious metal catalyst plant at its existing manufacturing site at Mangalore at an approximate cost of Rs.10 crore (Euro 1.5 million) and the same will be financed through internal accruals. Production is likely to commence in Q3FY2013. Further, it is targeting annual sales of Rs.820 crore from innovative lifestyle solutions for affordable mass housing, food fortification, solar and wind energy and water purification. Also, the parent company is targeting sales revenue of €25 billion (~Rs.2.12 lakh crore) by 2020 in the Asia-Pacific region in which India is likely to play a major role. We believe this would be positive for BASF; INR has depreciated by almost 44% since July 2011 from Rs.43.9 to Rs.63.4 at present. We believe this offers a good opportunity for the parent to delist BASF which if implemented would make the stock a multi bagger. Even if delisting does not materialize, the stock can provide significant returns post the business restructuring and aggressive expansion plans which would boost both its top line and bottom line in the next 2 years. Hence we recommend Buy with a fair value of Rs.773. Financial Summary (Rs. Cr.) CMP: Rs. 521 52 week H/L Rs. 770/490 Y/E Mar Revenue Adj. PAT Growth % EPS P/E 2012A 3,516 101 -14.4 23.3 22.3 2013A 3,941 121 19.5 27.8 18.7 2014E 4,532 155 28.6 35.8 14.5 2015E 5,235 159 2.8 36.8 14.1 Source: Company; Centrum Wealth Research Estimates Clariant Chemicals (India) Ltd (CCIL) Clariant Chemicals (India) Ltd. (CCIL), a 63.4% subsidiary of Clariant AG Switzerland, is a leading manufacturer of specialty chemicals in India catering to various sectors including automobiles, paints, personal care, food & beverage and among others. It has four manufacturing plants across the country. We expect significant export opportunity for CCIL from its parent as some plants in EU and South Korea are not likely to be operative. CCIL is a debt-free cash rich company, with cash on books at Rs.181 crore as on June 2013 (~14% of its current market cap). The company had restructured its business in 2011 and sold land & infrastructure worth Rs.240 crore of which it distributed a third as special dividend to shareholders. It had paid a total dividend of Rs.60 per share for CY2011 (including a special dividend of Rs.30). For CY2012, CCIL paid a total dividend of Rs.27.5/share translating to a yield of 5.7% at the current market price; CCIL’s board in March 2013 approved the sale of 3 out of the total 9 business units - Textile Chemicals, Paper Specialties and Emulsions to SK Capital (US based PE Investor) for a consideration of Rs.209 crore. The divestment of the company's business includes a textile chemical plant situated at Roha. The total cash after considering the divestment (post tax) would increase to about Rs.389 crore (Rs.145 per share) or 30% of its current market cap; Further, the company has recently decided to sell its land at Kolshet, Thane and move its plant to a new location. Based on media reports, the company has around 88 acre of land in Thane and is looking to raise about Rs.1,500-Rs.1,600 core. Even if we consider realisation of Rs.1,200 core for the land, post tax the cash would increase by about Rs.840 crore (Rs.311 per share). Considering its history with regards to being investors friendly, we believe there is likely case for a special dividend by the company in future as the total cash post the sale of 3 business units and land at Thane would increase to Rs.1,229 crore (Rs.456 per share); For Q2CY2013 on CCIL’s net profit declined by 21.6% YoY to Rs. 24 crore. While Revenue grew by 14% YoY to Rs. 327 crore, EBITDA declined by 17% YoY to Rs. 38 crore with margin contracting by 420 bps to 11.5%. This was mainly due to raw material and employee cost, which as a percentage of sales increased by 194bps YoY and 305 bps YoY to 63.3% and 10% respectively. For H1CY2013, while the revenue grew by 15% YoY to Rs.612 crore, the company’s net profit declined by 13% YoY to Rs.49 crore. Operating profit declined by 3.7% YoY with margin contracting 233 bps to 12.1%. CCIL reported EPS of Rs.9 and Rs.18.3 for Q2CY2013 and H1CY2013 respectively. CCIL has declared an interim dividend of Rs. 10 per share; CCIL’s core business (after the sale of 3 units) would continue to growth with focus on high margin businesses. We expect CCIL to report an EPS of Rs.25.40 in CY2013. We value the core business at Rs.254, 10x its CY2013E EPS, which we believe is conservative given the MNC parentage. Further the company would have cash per share of Rs.456 per share (Rs.145 existing + Rs.311 from land sale), giving a total fair value of Rs.710 per share over a one year period and recommend Buy. Financial Summary (Rs. Cr.) CMP: Rs.481 52 week H/L Rs. 674/371 Y/E Dec Revenue Adj. PAT Growth % EPS P/E 2011A 979 118 0.9 44.4 10.8 2012A 1,096 95 -20.0 35.5 13.5 2013E 663 68 -28.6 25.4 18.9 2014E 759 77 14.4 29.0 16.5 Source: Company; Centrum Wealth Research Estimates
  15. 15. I nd i a I nv e s tm en t S tr a t eg y15 Glaxosmithkline Pharmaceuticals Ltd. (GSKP) GlaxoSmithKline Pharma (GSKP) is a leading player in the Indian pharma market with products across therapeutic areas such as anti-infectives, dermatology, gynecology, diabetes, oncology, cardiovascular disease and respiratory diseases. The domestic pharmaceutical market is expected to reach $20 billion by 2015, making it one of the world's top 10 pharma markets. Domestic formulations industry is expected to grow at a CAGR of ~15% over the next decade. GSKP has a robust product pipeline aided by the strong backing of its parent company, GlaxoSmithkline Plc, UK. GSKP is the market leader in the dermatology, vaccines and hospital segments. Its sales have grown nearly 2.2 fold over the last 10 years and net profit has grown more than 3.8 times to Rs.662 crore during the last 10 years. GSKP enjoys EBITDA margins of over 30% which is among the highest in the industry. GSKP has excellent return ratios and margin. It achieved ROCE of over 28% and ROE of over 30% over the last few years. Hence, GSKP commands a premium valuation over its peers; GSKP and Biological E have agreed to set up a 50:50 joint venture (JV) to develop a six-in-one vaccine for polio and other infectious diseases. The transaction is expected to complete in 2013 subject to several conditions including regulatory approval of the JV; For Q2CY2013, reported net profit declined by 30% YoY to Rs.115 crore, while revenue declined by 2.5% YoY to Rs.645 crore. EBITDA declined by 42.6% YoY to Rs.122 crore while EBITDA margins stood at 18.9% as compared to 32.1% in CY2012. Company’s performance suffered due to supply constraints and trade related issues. Going forward, GSK revenues would be impacted by ~5% of annualised sales due to price reduction under new pharma pricing policy (NPPP); As per AIOCD AWCS data for the month of July 2013, GSK sales declined by 5.6% as against the industry’s 9.2%; Recently, the GSK Pte. announced its intension to increase its stake in its pivotal Indian division, GlaxoSmithKline Consumer Healthcare from 43.2% to 75%, in a deal worth ₤591m and representing about 28% premium to the unit’s closing share price then. The parent has also announced its plans to increase its stake in GlaxoSmithKline Consumer Nigeria from 46.4% to 80% with a tender at N48 a share, a premium of approximately 28%; GSKP is a cash rich company, with cash and current investments as of June 2013, stood at Rs.1,829 crore, which is Rs.216 per share. GSKP has declared a dividend of Rs.50/share for CY2012 giving a yield of 2.2% at the current price. We expect GSKP’s performance to improve from 2HCY2013 onwards due to new product launches and growth in existing products. At CMP of Rs.2,282, the stock is trading at 25.1x CY2013E EPS of Rs.91. We recommend BUY on GSKP. Moreover, there could be possibility of open offer even in GSK Pharma like the one witnessed in case of GSK Consumer. Financial Summary (Rs. Cr.) CMP: Rs. 2,282 52 week H/L Rs. 2,899/1,931 Y/E Dec Revenue Adj. PAT Growth % EPS P/E 2011A 2,378 648 12.1 76.5 29.8 2012A 2,621 663 2.3 78.2 29.2 2013E 3,014 770 16.1 90.9 25.1 2014E 3,458 899 16.9 106.2 21.5 Source: Company; Centrum Wealth Research Estimates Siemens Ltd., (India) (SL) Siemens Ltd., India (SL), a 75% subsidiary of Siemens AG, Germany (a €78.3 billion company as on Sept,2012) is a zero- debt & cash-rich company (cash of €11.4 billion as on Sept,2012). The parent earlier had increased its shareholding by 19.8% in SL from 55.2% to 75% through an open offer in March 2011 and had diluted its stake by 1.2% to 73.8%. The consolidation of operations and the open offer to increase its stake gives us enough confidence of an eventual possibility of delisting SL. SL is emerging as a key beneficiary of the parent group’s growing global presence and it would become a key sourcing destination for value-added products offered by it. Two recent moves by Siemens, AG are expected to be positive for the SL: o Siemens group has started an NBFC, which will focus on sectors like healthcare, infrastructure, energy and industry, with an initial investment of $50 million from the parent. This initiative will increase the demand for capital goods from SL by facilitating capital available to the customers; o Siemens AG has charted a new strategy to design and develop some 60 products especially for India, targeting $1.3 billion in annual revenues from them alone by 2020; For Q3SY2013 (September year ending), SL reported a net loss of Rs.48.8 crore as against a profit of Rs.36.2 crore. Revenue for the quarter declined by 12.5% YoY to Rs.2,643 crore. SL reported a loss of Rs.6.2 crore at the operational level as against a profit of Rs.130 crore last year. Pursuant to the significant developments in certain projects, the company has revised estimated revenue, costs and project related provisions and has charged a net amount of Rs.135.4 crore for the same in Q3SY2013 as against NIL last year. Order inflow during the quarter stood at Rs.2,620 crore, a 3% YoY decline; During FY2012 (September year end), the amalgamated Winergy Drive Systems Pvt. Ltd. with SL. It has also merged another parent owned company - Siemens Power Engineering (SPEL) with itself. This was after the company had already merged Siemens Rolling Stock Pvt. Ltd in May 2011, Siemens VAI Metal Technologies Pvt. Ltd. and Morgan Construction Company India Pvt. Ltd. in October, 2011; SL has cash of Rs.344 crore and debt of Rs.320 crore on books as on 31 March, 2013. Growing opportunities in India and outsourcing from the parent is expected to lead to strong earnings growth for SL over FY2013-14. Going forward, we expect a reversal in the interest rate cycle and also a revival in the capital goods segment, which will be positive for SL; SL, with comfortable order book, is poised to benefit from its NBFC foray & designing of over 60 new products and thereby improve its growth prospects going forward and holds an attractive delisting opportunity. Hence, we recommend BUY on the stock with a target price of Rs.700. Financial Summary (Rs. Cr.) CMP: Rs. 451 52 week H/L Rs. 750/419 Y/E Sept Revenue Adj. PAT Growth % EPS P/E 2011A 12,920 422 -50.1 11.8 38.0 2012A 12,145 430 1.9 12.1 37.3 2013E 13,068 571 32.8 16.0 28.1 2014E 14,205 665 16.5 18.7 24.1 Source: Company; Centrum Wealth Research Estimates
  16. 16. I nd i a I nv e s tm en t S tr a t eg y16 Styrolution ABS (India) Ltd. (SAL) Styrolution ABS (India) Ltd. (SAL) is a 75% subsidiary of Styrolution Group GmbH, Germany. Styrolution Germany, a $10 billion company is a leading manufacturer of an engineering plastic namely styrene monomer, polystyrene and ABS and is a 50:50 joint venture between global chemical giants BASF SE (about $100 billion company) and INEOS ABS ($42 billion company). The parent had tried to acquire 100% stake in SAL in the past but has not been successful. SAL is the market leader in the engineering plastics industry in India with ~60% market share in ABS resins segment and ~68% in SAN resins segment. Absolac (ABS) is plastic resin produced from Acrylonitrile, Butadiene & Styrene. Its application ranges from home appliances to automobile, consumer durables, business machines; There is a huge demand supply gap for ABS in India which is being met through imports over the years. CRISIL Research estimates that the supply of ABS would grow at 17% CAGR to meet the demand during CY2010-15E. SAL has expanded its SAN capacity from 36,000 tpa to 65,000 tpa, which has helped increasing its capacity of ABS from 60,000 tpa to 1,00,000 tpa. This expansion has been funded through internal accruals. We expect the demand growth to continue and provide steady revenue stream to SAL; SAL has been on a steady growth path. Over CY2008- 2012, its revenue and net profit has been consistently growing at 13.1% CAGR and 36.7% CAGR respectively. For Q2CY2013 SAL reported 16.5% YoY decline in net profit to Rs.8.3 crore. Revenue for the quarter declined by 2.5% YoY to Rs.230 crore. Operating profit declined 1.1% YoY to Rs.14.5 crore with margin remaining flat at 6.3%. For H1CY2013, while the revenue remained flat at Rs.472 crore, SAL’s net profit declined by 10.1% YoY to Rs.23.4 crore. Operating profit and margin stood flat at Rs.38 crore and 8% respectively. SAL reported EPS of Rs.4.7 and Rs.13.3 for Q2CY2013 and H1CY2013 respectively; The company has proposed internal re-structuring within its businesses in India. The parent which has another private company named Styrolution India private Ltd. is now evaluating methods to combine the two companies under one umbrella which would streamline management operations and functions. We believe this is a likelihood of merging the unlisted entity with SAL which would be very positive as this would further improve the business through better synergies of the combined entity; We believe the impact of OFS has already been factored in the price and the current valuation of 8.7x CY2013E EPS of Rs.40.4 offers a great opportunity to accumulate. We value the stock at 14.1x CY2014E EPS estimates to arrive at a fair price of Rs.660 from a long term perspective. Financial Summary (Rs. Cr.) CMP: Rs. 350 52 week H/L Rs. 800/339 Y/E Dec Revenue Adj. PAT Growth % EPS P/E 2011A 825 54 -22.9 30.7 11.4 2012A 989 63 15.9 35.6 9.8 2013E 1,116 71 13.5 40.4 8.7 2014E 1,273 83 16.2 46.9 7.5 Source: Company; Centrum Wealth Research Estimates
  17. 17. I nd i a I nv e s tm en t S tr a t eg y17 Rupee Crash: Net exporters & producers of import substitutes to benefit
  18. 18. I nd i a I nv e s tm en t S tr a t eg y18 Rupee Crash: Net exporters & producers of import substitutes to benefit In the three to four decades prior to Lehman crisis, the exchange rate of Indian Rupee (INR) against the US$ had been depreciating in the range of 4-5% per annum. However, in the last 5 years, INR has witnessed huge volatility and fell more than 15% on four occasions. The first of these was post the Lehman crisis in 2008 and then thrice every year from 2011. INR has depreciated by about 13% YTD in 2013 and by over 45% in last two years. Exhibit 13: Sharp movement in INR-USD in the last 5 years Sl. No From Date INR / USD To Date INR / USD % Change Duration 1 Aug 2008 42.35 Mar 2009 51.30 21% 8 Months 2 Aug 2011 44.08 Dec 2011 53.65 22% 5 Months 3 Mar 2012 49.22 Jun 2012 57.14 16% 4 Months 4 May 2013 53.82 Aug 2013 63.35 18% 4 Months Source: Bloomberg, Centrum Wealth Research In our view, two set of reasons have led to such crash in INR. There has been a structural change in the Indian economy with the ever increasing demand for imports of 5 major commodities – Crude oil, Gold, Coal, Edible oil and Fertilizer. In the last 10 years, the imports of these commodities have gone up from anywhere between 6 to 22 times. However, India’s exports have not kept pace with its increasing imports leading to a huge negative trade balance, which has gone up 22 fold! On the back of these structural changes, the pressure on INR compounded by the recent fear over the US Federal Reserve tapering its Quantitative Easing (QE) and subsequent withdrawal of money from the domestic debt markets by the FIIs. Exhibit 14: INR movement against USD 35 40 45 50 55 60 65 70 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Source: Bloomberg, Centrum Wealth Research The way forward and how to benefit Going ahead, unless the structural changes are addressed, the pressure on INR is unlikely to ease substantially in the short term. It is likely to take one to two years for INR to appreciate by 10% to 20%. Meanwhile we believe the companies which are net exporters or engaged in producing import substitutes would be the major beneficiaries. Hence, we present 6 stocks which were also filtered in terms of valuations, growth prospects, tactical (like possible de-listing, stake sale, etc), dividend yields, etc. Exhibit 15: Net Exporters and import substitutes (FY2013 standalone numbers) Company Revenue (Rs. crore) Net Exports (Rs. crore) Net Exports as % of Revenue Other positive highlights Cairn India 9,201 8,708 95% Largest and cheapest crude oil producer in the country Oracle Fin Serv. 2,938 1,956 67% De-listing possibility; Cash rich Polaris Fin Tech 1,854 839 45% Cheapest valuation and Impressive dividend yield; Management committed to enhance shareholders’ value through restructuring JB Chemicals 816 357 44% Growing fastest in the domestic pharma space; Cash rich and Cheapest valuation in the pharma space Tata Coffee* 598 216 36% Seen steep correction in stock price; Subsidiary in the US engaged in coffee retailing doing extremely well, posted close to 100% YoY profit growth in Q1FY2014 Hindustan Zinc 12,700 681 5% Tactical opportunity from divestment of government stake through auction route; Cash rich; Major producer of silver whose prices are expected to rise significantly; Producer of Zinc, which is a major import substitute Source: Company, Centrum Wealth Research
  19. 19. I nd i a I nv e s tm en t S tr a t eg y19 Exhibit 16: Valuation Table Company Name CMP (Rs.) Market Cap (Rs. Cr.) Target Price (Rs.) Upside (%) 52 Week High (Rs.) 52 Week Low (Rs.) EPS (Rs.) P/E (x) FY2014E FY2015E FY2014E FY2015E Cairn India 311 59,224 375 21.0 367 268 51.5 46.2 6.0 6.7 Oracle Fin. Serv. 2,876 24,181 3,300 15.0 3,415 2,350 143.3 167.8 20.1 17.1 Polaris Fin. Tech 105 1,045 145 38.1 148 96 24.1 27.2 4.4 3.9 JB Chemicals 82 695 120 46.3 96 64 12.9 15.8 6.4 5.2 Tata Coffee* 958 1,789 - - 1,680 880 72.3 84.1 13.3 11.4 Hindustan Zinc 116 49,014 144 24.1 147 94 15.9 16.8 7.3 6.9 * Note: Tata Coffee is not under our coverage. We have started buying this stock for our clients under fund management over the last few months; Source: Bloomberg, Company, Centrum Wealth Research Siddhartha Khemka, VP - Research (siddhartha.khemka@centrum.co.in; +91 22 4215 9857) Rijul Gandhi - Research Analyst (rijul.gandhi@centrum.co.in; +91 22 4215 9415)
  20. 20. I nd i a I nv e s tm en t S tr a t eg y20 Cairn India Ltd. (CIL) Cairn India Ltd. (CIL) is one of the largest independent oil and gas exploration and production companies in India producing more than 20% of India’s domestic crude oil production. It operates the largest onshore oil field in India, the MBA (Mangala, Bhagyam and Aishwariya) fields in Rajasthan, having gross recoverable oil reserves of ~1 billion barrels and has made over 40 oil & gas discoveries. The production at Rajasthan fields grew by 32% YoY to 169,390 bpd in FY2013. The average overall daily gross operated production grew by 19% YoY to 205,323 barrels per day (bpd) in FY2013. The CIL-ONGC JV has started commercial sale of 5 million standard cubic feet per day of natural gas initially from its Barmer fields in March 2013, to be sold at around $5/mBtu. Also, CIL has commenced production at its Aishwariya field, the 3rd largest discovery in the Rajasthan block. The field will be ramped up to its plateau of 10,000bpd in FY2014E. CIL has recovery and basin production potential of 300,000 bpd from the Rajasthan block. The JV expects product made its 26th discovery in India so far in the RJ-ON-90/1 block and has commenced drilling of 1st exploration well in Barmer after a gap of over 4 years which will help realise the estimated 0.5 billion barrels of oil equivalent (boe) of risked recoverable prospective resource, amounting to ~1/3rd of the Estimated Ultimate ion rate of 200,000- 215,000 bpd from the block by end FY2014. CIL has also acquired 600 sq. km of 3D seismic in Block SL 2007-01-001 in early 2012 and spud its 4th exploration well in the block on February 2, 2013; CIL is planning to invest more than Rs.16,000 crore ($3 billion) for new exploration till FY2016 including Rs.13,000 crore ($2.4 billion) to drill more than 450 wells in its Rajasthan block. With these new explorations CIL is targeting to add 530 million barrels of oil to its reserves. CIL indicated delayed ramp up of Bhagyam field (in H2FY2014E) with drilling of 15 additional wells. However, it is accelerating its plans to drill 30 wells in FY2014 and FY2015 each. So far CIL has invested a total of Rs.18,000 crore in Rajasthan fields and plans to invest Rs.6,000 crore in FY2014; For Q1FY2014, CIL reported a 8.3% YoY decline in consolidated net profit to Rs.3,127 crore against Rs.3,826 crore in Q1FY2013, mainly led by decline of about 16% YoY in EBITDA and a 19% YoY increase in depreciation. The revenue declined by 8.5% YoY to Rs.4,063 crore. CIL has achieved highest ever gross operated production of 212,442 bpd in Q1FY2014. It plans to increase crude production in the Rajasthan block from the current 180,000 bpd to 210-215,000 bpd by FY2014. The block also witnessed a full quarter of gas sales from the Rageshwari Deep gas field which commenced in March 2013; Crude Oil (Brent) prices have remained steady with a marginal fall of 0.8% since the start of 2013 as against the average decline of about 7% in the international prices of other non – agri commodities during the same period. This is positive for CIL. The company has net cash reserve of Rs.16,000 crore as on March 31, 2013 and is expected to generate about Rs.10,000 crore each year for next few years. With most of the regulatory issues being addressed, CIL is poised to focus on ramping up its production. Considering capacity expansion, firm oil prices and substantial cash flow we maintain our ‘BUY’ on CIL which trades at 6.7x FY2015E EPS of Rs.46.2/share with a price target of Rs.375. Financial Summary (Rs. Cr.) CMP: Rs. 310 52 week H/L Rs.366/268 Y/E Mar Revenue Adj. PAT Growth % EPS P/E 2012A 11,861 7,938 25.3 41.6 7.5 2013A 17,524 11,920 50.2 62.4 5.0 2014E 16,582 9,847 -17.4 51.5 6.0 2015E 17,076 8,827 -10.4 46.2 6.7 Source: Company; Centrum Wealth Research Estimates J.B. Chemicals & Pharmaceuticals Ltd. (JBC) JB Chemicals (JBC), a mid-sized pharmaceutical company, had sold off its OTC business in Russia/CIS in FY2012 for Rs.1,155 crore. It is one of few companies to share the cash proceeds with the shareholders which indicates a good management - it gave out a special dividend of Rs.40/share (a total dividend –including dividend tax - of around Rs.400 crore). JBC has posted an impressive result for Q1FY2014 with its standalone net profit growing by 4.7 times (372% YoY) backed by a 24% YoY growth in operating income and EBIDTA growing by 102% YoY. The formulation exports business, which accounts for almost 50% of revenue, grew by 28% during the quarter. The overall sales in domestic formulations business grew by 19% YoY with API revenue witnessing a growth of 62% YoY. The total sales under the supply agreement with Cilag GmBH International, a Johnson & Johnson affiliate, registered a growth of 15.5% YoY and this is expected to grow further over the coming quarters; JBC has been consistently outperforming industry growth rate since July 2012. We expect this outperformance to continue going forward. The focus of the company is on the contract manufacturing opportunities and on niche branded generics; On a consolidated basis, the company’s net cash for FY2014, after accounting for the Rs.64.5 crore to be transferred to Cilag GmBH Intl., is expected at Rs.442 crore (cash & current investments of Rs.506.4 crore minus debt of Rs.44.5 crore), which is 64% of current market cap of Rs.695 crore. Its book value stood at Rs.120/share as on March 31, 2013; Considering revenue growth and current margin, the company can achieve Rs.12.90 EPS in FY2014E, implying a P/E of 6.4x at current market price. Further, we estimate net cash and equivalents (net of debt) of Rs.52/per share as on June 2013 – at current stock price, its net Enterprise value is just about 25% of its sales which is extremely attractive when we consider anywhere 3 to 6x valuations given to recent acquisitions in the pharma space. We reiterate BUY with a fair value of Rs.120/share – in case JBC joins consolidation process, then it can provide a multi-bagger opportunity in the medium to long term; We consider JBC as the most defensive stock – operating in defensive pharma business, growing faster than the domestic industry since July 2012, investor friendly management (rewarded with special dividend), sitting on huge cash and also debt free, and on our expectation of a dividend of Rs.4 per share for FY2014, also offers 4.9% dividend yield. Hence, we suggest all our clients continue to accumulate the stock. Consolidated Financial Summary (Rs. Cr.) CMP: Rs. 82 52 week H/L Rs. 96/64 Y/E Mar Revenue Adj. PAT Growth % EPS P/E 2012A 802 68 -51.3 8.0 10.2 2013A 866 79 17.2 9.4 8.7 2014E 1,017 109 37.2 12.9 6.4 2015E 1,220 134 23.2 15.8 5.2 Source: Company; Centrum Wealth Research Estimates
  21. 21. I nd i a I nv e s tm en t S tr a t eg y21 Oracle Financial Services Software Ltd. (OFSS) Oracle Financial Services Software (OFSS), a subsidiary of Oracle Corp. USA, the global leader in providing software platforms to Banking and Financial Services Industry (BFSI) and enterprise solutions. The company witnessed revenue growth of 10% in FY2013 after a slower growth of an average 2% over FY2010-12. For FY2013, the product revenue (which contributes 75% to the total revenue), grew by 14% and helped the overall growth momentum; For Q1FY2014 on a consolidated basis, OFSS reported a growth in net profit by 30.2% QoQ (declined by 0.5% YoY) to Rs.366 crore. The company’s revenue grew by 2% QoQ (declined by 5% YoY) to Rs.899 crore. EBIT grew by 1.7% QoQ (declined by 14% YoY) to Rs. 320 crore. The EBIT margins stood at 35.5% for the quarter. The company signed new licenses worth $18 million and 10 new customers for the product portfolio in Q1FY2014. The EPS for the quarter stood at Rs.43.6 as against Rs.43.7 in Q1FY2013. On a segmental basis, the revenue from the Product business grew marginally by 0.8% QoQ (declined by 3.4% YoY) to Rs. 687 crore. The services business grew by 8.2% QoQ (declined by 10.7%YoY) to Rs.191 crore. On a geographical basis, North America grew by 23% QoQ (declined 7.6% YoY) to Rs. 315 crore. Asia Pacific declined by 14.1% QoQ and 5% YoY to Rs. 288 crore. Europe, Middle East and Africa (EMEA) grew by 2% QoQ (declined 2% YoY )to Rs. 297 crore; Over the last 5 quarters, OFSS has added 51 new clients set across various geographies thereby increasing its market share. It signed license agreements worth $80.3 million over the last 5 quarters. It diversified its hold in to new geographies by signing licenses in nations such as Ethopia, Kenya, Nigeria, Zambia, Oman and Myanmar which have high growth prospective. Going forward, we expect the revenue to grow at 13-14% over FY2013-15E, in- line with the expected industry growth of 12-14% for FY2014 by NASSCOM; As on June 2013, the company was sitting on a cash of Rs.5,792 crore which is about 24% of the current market capitalization. Oracle Corp has a history of not declaring dividends and the investors had to wait for 23 years when it first declared a dividend in 2009. Since then both Oracle Corp (US) and Oracle Japan have been declaring regular dividends. OFSS last declared a dividend of Rs.5 per share in 2006. Going forward, considering the improvement in profitability and the significant cash in books, we believe OFSS might follow its parent and start declaring regular dividends; OFSS enjoys one of the highest net profit margins in the industry at 31%. The company’s return on capital employed (RoCE) has historically remained above 20% despite the high level of cash in balance sheet; At the current price, the stock is trading at 20.1x FY2014E and 17.1x FY2015E earnings estimate which is in line with large IT services companies. We believe that the stock is attractive considering 1) expected improvement in financial performance going forward; 2) strong balance sheet with cash of Rs.653 per share (23% of the CMP); and 3) strong balance sheet of parent (net cash of close to $14 billion) and INR depreciation of close to 39% in the last two years can lead to buy back or de-listing would offer tactical opportunity. Consolidated Financial Summary (Rs. Cr.) CMP: Rs. 2,876 52 week H/L Rs. 3,414/2,350 Y/E Mar Revenue Adj. PAT Growth % EPS P/E 2012A 3,147 909 -18.0 108.2 26.6 2013A 3,474 1,075 18.2 128.0 22.5 2014E 3,891 1,204 12.0 143.3 20.1 2015E 4,475 1,409 17.1 167.8 17.1 Source: Company; Centrum Wealth Research Estimates Polaris Financial Technology Ltd. (Polaris) Polaris Financial Technology Limited (Polaris) a leading global player in Specialty Application Development for the BFSI sector. Over the years, the company has strengthened its product and services profile with the help of global acquisitions. Polaris has a strong base of more than 200 customers with 80 of them as strategic accounts. It gets around 58% of revenues from its top 10 clients with Citigroup forming a bulk of it, with whom it has been dealing since last 15 years. Recently, Polaris approved of an organizational restructuring. Polaris currently operates in three verticals - software services, products and cloud computing. Polaris has planned five chief executive officers for different verticals to improve focus and client success ratio; With acquisition of Patni by iGate, we believe there can be further consolidation in the mid and small sized IT companies and the average PE multiple of companies like Polaris, which are witnessing strong operating performance, should shift vertically. The company is exploring options including appropriate restructuring, that would provide an impetus for the next stage of its growth, in order to maximize shareholder value; For Q1FY2014, Polaris reported a decline in PAT by 1.4% QoQ and 29.4% YoY to Rs.43 crore. The decline was on account of forex loss and higher software development expenses. Revenue grew by 5% QoQ and 0.4% YoY to Rs.584 crore. The operating profit grew by 8.9% QoQ, however the same declined 8.5% YoY to Rs.101.4 crore. The EBITDA margins stood at 17.3% in Q1FY2014. The company acquired 11 new clients during Q1FY2014. The debtor collection period improved to 107 days as compared to 118 days in Q1FY2013. The cash and cash equivalents as on June 30, 2013 stood at Rs.571 crore which is 54% of the current market cap; The company is looking at divesting its stake in IdenTrust Inc due to security reasons raised by the US government. Polaris acquired 85% stake in the company for US$19 million. The management do not expect any significant losses from this sale; Polaris has been improving its dividend payout over the years and had paid Rs.4.50 and Rs.5 in FY2011 and FY2012 respectively. The Board paid a final dividend of Rs.5 for FY2013 which translates into a yield of 4.8%; At the current price of Rs.105, the stock is available at an attractive valuation of 4.4x FY2014E EPS of Rs.24.1 and 3.9x FY2015E EPS of Rs.27.2. While the result subdued, we believe that consolidation story would play out within IT sector and Polaris would be one such company to benefit from this theme. Considering business restructuring plan and mandate to enhance shareholder value indicated by the management, we recommend investors to Buy Polaris for a target of Rs.145, giving an upside of 38% from current levels. Consolidated Financial Summary (Rs. Cr.) CMP: Rs. 105 52 week H/L Rs. 147/96 Y/E Mar Revenue Adj. PAT Growth % EPS P/E 2012A 2,049 221 13.8 22.2 4.7 2013A 2,308 201 -8.9 20.2 5.2 2014E 2,597 239 19.1 24.1 4.4 2015E 2,909 271 13.1 27.2 3.9 Source: Company; Centrum Wealth Research Estimates
  22. 22. I nd i a I nv e s tm en t S tr a t eg y22 Tata Coffee Ltd. (TCL) Tata Coffee Ltd (TCL) is the largest integrated coffee plantation company in the world with business ranges from growing and curing of coffee & tea to manufacture and marketing of value added coffee products. TCL has a huge plantation area of 25,447 acres or 10,303 hectares, as of FY2013. Around 77% of standalone revenue comes from the coffee segment while Tea, Pepper and Estate supplies contribute 12%, 5% and 6% respectively. Acquisition of Eight O’clock coffee (EOC), helped TCL to transform from being just a commodity player into a significant branded player. EOC contributes around 65% of the consolidated top-line of TCL numbers. EOC registered sales CAGR of 10.2% to Rs.1,099 crore over FY2008-2013. Furthermore EOC, re-launched its brand and introduced new products in US and Canadian market which would drive growth growing forward; Instant coffee share in the standalone revenue is consistently increasing, from 38% in FY2010 to 54% in FY2013 and is expected to be around 75% going ahead. The segment has higher margins and is helping the overall PAT margins to improve (from 9.8% in FY2010 to 16.8% in FY2013). Company is planning to invest more than Rs.300 crore over the next 3 years to increase its instant coffee production capacity, which may partly be achieved via acquisitions outside India; TCL’s has made an agreement to supply coffee beans to JV “Tata Starbucks” in India and also to Starbucks operations in South East Asia. Tata Starbucks currently operates around 17 outlets and it plans to have 50 outlets in the country by 2013. Further, Starbucks (Global) approximately has 700 retails (licensed and company operated) chains in South East Asia. Supplying coffee beans to these chains would boost TCL standalone revenue going ahead; TCL is a net exporter and as of March 2013, its net forex earnings stood at Rs.216 crore, 36% of the company’s standalone revenue and hence INR depreciation is beneficial for TCL; During Q1FY2014, Average Arabica coffee prices are down by 21.9% YoY to 132.4 cents/lb while Robusta prices are down 7.4% YoY to $1,916 tonne. EOC uses Arabica and Robusta green beans as its raw material and hence fall in their prices would be margins accretive for the company. On a consolidated basis, for Q1FY2014, net profit grew by 43% to Rs 40.4 crore while total income was up 1% YoY to Rs.418 crore. EBITDA grew by 49.3% YoY to Rs.103 crore while margins stood at 24.5% as compared to 16.6% in Q1FY2013; TCL stock has corrected by 42.8% from its 52-week high of Rs.1,675. The stock is currently trading at attractive valuation of 11.4x its consensus FY2015E EPS of Rs 84.1 per share. We believe that TCL is strong play on branded coffee retail (EOC) and growing demand for coffee & tea. Hence we are positive on the company. Financial Summary (Rs. Cr.) CMP: Rs. 958 52 week H/L Rs. 1,675/880 Y/E Mar Revenue Adj. PAT Growth % EPS P/E 2012A 1,549 81 11.9 43.5 22.0 2013A 1,697 116 43.2 62.2 15.4 Source: Company; Centrum Wealth Research
  23. 23. I nd i a I nv e s tm en t S tr a t eg y23 Sector strategy during turbulent time
  24. 24. I nd i a I nv e s tm en t S tr a t eg y24 Sector strategy during turbulent time We expect the domestic economic growth to remain subdued for another 3 to 6 months and GDP growth to continue to remain below 5% till 3rd quarter of FY2014. This low growth scenario for next 3 to 6 months would be characterized by high borrowing costs, deterioration in quality of banking assets, subdued capital expenditure, lower level of job opportunities and income generation especially in the urban economy and continued stress on both exchange rate of Rupee and the fiscal balance. Considering this environment, we suggest the following sector strategy for the period till elections. Exhibit 17: Sector Strategy Sector Recommenda tion High conviction Stocks Remarks Banking & Financials Neutral Karur Vysya, City Union, HDFC Bank, J&K Bank, YES Bank Asset quality would continue to deteriorate especially for the PSU banks; Credit growth to remain subdued due to high interest regime maintained over last 2 years and with further tightening of liquidity by RBI. Information Technology Overweight Oracle FinServe, Polaris, CMC# Over 45% fall in exchange rate in the last 2 years of INR is positive; It would be very difficult for INR to recover beyond 10% in next 6 months. In case of any rating downgrade INR can fall further, significantly. The IT sector would remain a safe bet in this environment; Further revival of US economy would also be positive for Indian IT industry. Energy Neutral RIL, Cairn India While INR fell 13% YoY, oil prices remain quite firm leading to more stress on oil under-recovery. Difficult for the government to shift the entire burden on people during the election time, hence PSU upstream and oil marketing companies would share larger burden; Prefer private operators as they are likely to benefit from INR depreciation, volume growth and increase in gas prices. FMCG Overweight ITC, Tata Coffee# , Britannia# , Akzo Long term growth prospects still remain better, compared to other sectors; FMCG would remain the best defensive and can mitigate any possible risk arising from further domestic shocks Automobiles & Components Neutral M&M, MRF, Bosch, JK Tyre Low GDP growth and high interest regime would lead to continued deceleration in automobile sales for at least next 3 months; Competition cutting across segments (car producers getting into SUVs, high-end car producers getting into small cars, etc) would provide further pressure to automobile producers; While M&M set to gain in tractor segment due to successful monsoon, ancillaries would gain from recent boom in automobile population and consequent robust demand from replacement markets. Capital Goods Underweight SIEMENS, BHEL, L&T Sector would continue to suffer poor order inflows, slow execution and high interest costs; While long term investments can be made in L&T and BHEL, investors can bank on Siemens for tactical reasons (possible delisting). Metals/Mining Underweight on Metals; Overweight on resource producers HZL, NMDC, MOIL Growth slowdown to be negative for metal companies; However, competition among resource companies is less intense and some are debt-free, cash rich and make extra-ordinary profit margins – hence, better positioned to change their fortunes in a big way as and when economic conditions turnaround. Telecommuni cation Services Neutral None Reliance Jio launch can increase the competitive intensity again in the data business; Balance sheets still under pressures for most players; Sector would start witnessing renewal of spectrum and licenses at circle level which would increase balance sheet pressure. Healthcare Neutral J B Chemicals, Indoco Remedies, Wockhardt* Prefer domestic pharma players as they continue to get benefit from off-patent blockbuster drugs and are relatively least impacted from pharma pricing policy ; Sector is expected to grow ~18% over the next 2-3 years. Real Estate/ Infra Underweight NESCO Sector is facing challenge from slowdown in the economy and hence, poor demand, and high interest rate regime; Recommend BUY on NESCO alone at this juncture as its revenue model is based on rental income from exhibition centre & IT Parks. Note: *Recommended exclusively for risk-taking investors – while investors may lose about 20% in the worst case scenario, if company successfully comes out from the US FDA Alert, then stock can be a multi-bagger. # Not under our coverage, however, we have started buying these stocks for our clients under fund management over the last few months; Source: Centrum Wealth Research
  25. 25. I nd i a I nv e s tm en t S tr a t eg y25 Portfolio Allocation and Investment Suggestion Considering the substantial volatility expected in equity markets during the next 6 months, we prefer a defensive strategy. Hence, we suggest having minimum 15% cash within equity asset class for another 3 months or till individual stocks are further beaten down badly. Within the equity asset class, we would prefer large cap and fairly large mid cap companies for investments. Within this framework, we prefer export oriented sectors, import substitutes, domestic demand themes, high dividend yield stocks and beaten down value stocks. Investors should avoid highly leveraged companies and stocks with high promoter pledging. Exhibit 18: Sectoral Allocation and preferred stocks Allocation by Sector / Theme Allocation Stock Picks in the sector FMCG 15% ITC, Tata Coffee# , Britannia# , Akzo IT 10% Oracle, CMC# , Polaris, Infosys - Hold Pharma/ Healthcare 10% Biocon, JB Chemical, Indoco Dividend Yield 20% KCP Sugar, Surya Roshni, HIL, Indraprastra Medical, BLIL Banking (Value picks) 15% HDFC Bank, KVB, CUB Beaten Down Value stocks 15% Balmer Lawrie, Andhra Sugar, BASF, Linde*, NMDC, MOIL, JK Tyre, Nesco, BBTC, Wockhardt* Cash 15% Total 100% Note: *Recommended exclusively for risk-taking investors – while investors may lose about 20% in the worst case scenario, if company successfully comes out from the US FDA Alert, then stock can be a multi-bagger. # Not under our coverage, however, we have started buying these stocks for our clients under fund management over the last few months; Source: Centrum Wealth Research Abhishek Anand, VP - Research (a.anand@centrum.co.in; +91 22 4215 9853) Siddhartha Khemka, VP - Research (siddhartha.khemka@centrum.co.in; +91 22 4215 9857)
  26. 26. I nd i a I nv e s tm en t S tr a t eg y26 FMCG Akzo Nobel India Ltd. (Akzo) Akzo (previously known as ICI India) is a strong player in paints and chemicals business with over 100 years of presence in India. In 2008, Akzo Nobel NV, Netherlands took equity ownership of Imperial Chemical Industries, UK and currently has 72.96% equity stake in the Indian subsidiary. During FY2012, Akzo commissioned two new plants – one in Hyderabad for decorative paints and another in Bangalore for coil coatings increasing its total facilities to 5 plants. Further the greenfield expansion at the Gwalior plant (mainly for its decorative segment) is expected to get commissioned in 2 phases of 50 milllion litres per annum each, of which 1st phase would be commissioned in next few months. This facility would help address growing demand from the North and East India. The company is currently focusing on decorative segment which contributes around 57% of its total sales. We believe this would improve the overall profitability of the company, as this segment enjoys higher margins; During Q1FY2013, Akzo merged three parent owned unlisted entities in India with itself, which led to increase in promoter holding to 68.9% from 59.6%. The company believes that the merger has created an integrated coatings and chemicals company, with significant synergies in several segments, namely, premium decorative, industrial and automotive coatings; In July 2012, the company completed buyback of 13 lakh equity shares at Rs.920 per share which increased the promoter stake to 70.8%. The promoters further acquired 10 lakh shares in the company in August 2012 increasing their holding to current 72.96%. We believe that consolidation in the business and increasing promoter stake signals a strong case for de-listing. Akzo has cash and investments of Rs.1,033 crore or Rs.221 per share as on March 31, 2013 which is 18.9% of current market capital. We believe that the company may go for another round of buyback before eventually going for de-listing; For Q1FY2014, net profit declined by 43% YoY to Rs.35 crore mainly on the back of decline in other income, even as revenue grew 2% YoY to Rs.574 crore. EBITDA declined by 8% YoY to Rs.49 crore, with margins contracting by 93 bps YoY to 8.5%. Other income fell by 71% YoY to Rs.10 crore. For FY2013, while the net income rose 12.3% to Rs.2,232 crore, the company's net profit increased 8.45% YoY to Rs.218.8 crore; Akzo at the current price is trading at 16.1x FY2014E EPS of Rs.51.5 and is the most attractive as compared to other listed paint companies. We believe the company is well placed to benefit from the improved outlook for the paints industry combined with the expected higher dividend and a possibility of de-listing. Hence we recommend BUY on the stock with a target price of Rs.1,300 per share. Financial Summary (Rs. Cr.) CMP: Rs.828 52 week H/L Rs. 1,196/820 Y/E Mar Revenue Growth % EBIDTA EBIDTA (%) Adj. PAT Growth % EPS (Rs.) P/E 2012A 1,988 81.2 175 8.8 202 14.1 43.3 19.1 2013A 2,232 12.3 189 8.5 219 8.4 47.0 17.6 2014E 2,510 12.5 210 8.4 240 9.6 51.5 16.1 2015E 2,875 14.5 245 8.5 303 26.3 65.0 12.7 Source: Company, Centrum Wealth Research Britannia Industries Ltd. Britannia is the largest player in the fast growing biscuits category with a market share of over 30% with a strong portfolio of brands like Tiger, 50:50, MarieGold, Good Day, Milk Bikis, Treat and NutriChoice. Britannia is focusing on premiumisation of its product portfolio. We believe it will help the company achieve better margins in the long term. The recent management change in Britannia appears more likely to be related to building its snack food franchise. Dairy is also a large opportunity and Britannia offers a great proposition in the segment given the quality of its product portfolio. Britannia is setting up plants in different geographic locations (two new units at Patna and Odisha, new bakery plant in Gujarat at a cost of Rs.50 crore) to reduce freight cost. This will help reduce lead distance by 100-150kms. The company has also implemented initiatives like alternative fuels to keep costs as low as possible; Britannia has come out with strong Q1FY2014 results. On a consolidated basis, Britannia’s net profit grew by 93% YoY to Rs.89.5 crore while revenue increased by 15% YoY to Rs.1,552 crore. EBITDA increased by 73% YoY to Rs.138 crore, while EBITDA margins expanded by 300bps YoY to 8.9%. EPS for the Q1FY2014 stood at Rs.7.48 as compared to Rs.3.89 per share in Q1FY2013; At the current market price of Rs.715, the stock is trading at 28.6x FY2014E consensus EPS of Rs.25 and at 24.0x its consensus FY2015E EPS of Rs.29.80. The stock is one of the cheapest in the FMCG space with market cap to sales of 1.4x on FY2013 compared to other domestic firms which are trading at anywhere between 3-5x market cap to sales; We believe that it is one the preferred branded plays in the biscuits space and is a possible acquisition target of firm like ITC which is scouting for inorganic ways to grow its business. Considering its size and cheap valuations it could be one of the preferred companies for any acquisition. Hence, we recommend accumulating the stock considering medium to long term investment horizon. Consolidated Financial Summary (Rs. Cr.) CMP: Rs. 715 52 week H/L Rs. 775/400 Y/E Mar Revenue Growth % EBIDTA EBIDTA (%) Adj. PAT Growth % EPS (Rs.) P/E (x) 2012A 5,485 19.0 311 5.7 200 48.9 16.7 42.9 2013A 6,185 12.8 421 6.8 260 30.0 21.7 33.0 Source: Company, Centrum Wealth Research
  27. 27. I nd i a I nv e s tm en t S tr a t eg y27 Information Technology CMC Ltd. CMC’s unique solutions approach in the System Integration space along with focus in the hi-tech space has enabled it to post robust growth in an uncertain environment and also ensures revenue stickiness for the future. The company has been working for the last several years with TRW, a large automotive electronic player, primarily due to its unique domain capabilities and hi-tech approach. We believe that like other successful mid cap focused players, CMC’s expertise has been the hi-tech space where competition has been limited, which has enabled significant revenue and client stickiness. The solutions and technology approach, along with TCS parentage provides it with all advantages of a large player (in spite of being a small player), right from capabilities to offer services across geographies to a large balance sheet required to participate in huge projects like the Indian passport project; For Q1FY2014 on a consolidated basis, CMC reported a net profit decline of 13.4% QoQ and 9.1% YoY to Rs.53.1 crore. Revenue declined 7.1% QoQ (grew by 7.6% YoY) to Rs.486.6 crore. EBITDA declined by 5.8% QoQ (grew by 2.4% YoY) to Rs.77 crore and the EBITDA margins stood at 15.8% for the quarter. On a segmental basis, system integration (SI) segment which contributes around 58% of the total revenue grew by 7.8% QoQ and 10.8% YoY to Rs.293 crore. CMC added 16 new clients (14 domestic and 2 international) in the quarter. The management has planned for a capex of Rs.230 crore for FY2014 and has incurred a capex of Rs.38 crore in Q1FY2014; We expect CMC to continue its endeavor to enhance revenue contribution of high margin SI and ITES segments. Further, with its focus on higher off-shoring in the SI segment we expect the overall margins to improve over the next two years. At the current price of Rs.1,262 the stock is trading at P/E of 13.7x its FY2014E consensus EPS of Rs.92.11 and at 11.1x its consensus FY15E EPS Rs.114.16 respectively. Consolidated Financial Summary (Rs. Cr.) CMP: Rs.1,262 52 week H/L Rs. 1,523/951 Y/E Mar Revenue Growth % EBIDTA EBIDTA (%) Adj. PAT Growth % EPS (Rs.) P/E 2012A 1,463 35.5 224 15.3 152 45.5 50.0 25.2 2013A 1,928 31.2 317 16.4 230 51.7 76.0 16.6 Source: Company, Centrum Wealth Research Infosys Ltd. Infosys is the second-largest IT services company in India with revenue of ~$7.4b (FY2013) and employing over 157,000 people. It offers IT and IT-enabled business solutions to its clients across more than 30 countries. Infosys has 87 global development centers and 69 sales offices. Its wide service offerings include business and technology consulting, ADM, SI, product engineering, IT infrastructure services and BPO. According to NASSCOM, Indian IT exports are expected to grow by 12-14% to $87 billion in FY2014 as against growth of 10% in FY2013 at $75.8 billion. Moreover, the expectation of economic revival in US can further improve demand for Indian IT sector. Post Q1FY2014 results, Infosys management maintained its revenue growth guidance of 6-10% in dollar terms and 13%-17% in INR terms for FY2014; For Q1FY2014, on a consolidated basis, revenues grew by 7.8% QoQ (17.2% YoY basis) to Rs.11,267 crore aided by volume growth of 4.1% QoQ (5.8% onsite and 3.3% offsite). Net profit declined by 0.8% QoQ (3.7% growth on YoY basis) to Rs.2,374 crore. EBIT grew by 8.2% QoQ to Rs.2,664,crore, maintaining the margins at 23.6%; Lodestone Holdings AG (contributing ~6% of the consolidated revenue in FY2013) which was acquired by Infosys in October 2012 saw a turnaround in the current quarter. Lodestone posted a net profit of $1.88 million as compared to a loss of $3.44 million in Q4FY2013. Its revenue grew by 29% QoQ to $90.67 million; Infosys won 7 large deal wins with total contract value of $600 million in 1QFY2014, of which 6 are in the US. Over the past three quarters, Infosys has bagged large deals worth around $1.6b, largely in outsourcing, which could drive growth in Business IT Service (BITS) going forward. The company has scope to improve operating margin going forward by way of increased utilization and revenue proportion from offshore; The company has cash and equivalents of Rs.24,078 crore as on June 30, 2013, which translates to Rs.421 per share (14% of the current market price). In terms of cash utilization, we believe the company may opt for any of the following : 1) Acquisition outside India which could further help achieve growth apart from hedging the risk of the proposed new US Visa Bill; 2) Buy-back of shares or special dividend; 3) Invest in products, platforms and solutions ideas in line with Infosys 3.0 strategy (the company has already set aside up to Rs.550 crore for this); At CMP, the stock is trading at 16.2x FY2015E EPS of Rs.185 per share. We believe that the stock is fairly priced considering valuation and the fact that Q2FY2014 may face margin pressure due to impact of wage hike. We advise Hold on the stock only for the long term investors as IT sector becomes a defensive in case of further Rupee depreciation. Consolidated Financial Summary (Rs. Cr.) CMP: Rs.2,999 52 week H/L Rs. 3,098/2,190 Y/E Mar Revenue Growth % EBIDTA EBIDTA (%) Adj. PAT Growth % EPS (Rs.) P/E 2012A 33,734 22.7 10,749 31.9 8,332 6.3 146 20.6 2013A 40,352 19.6 11,569 28.7 9,421 13.1 165 18.2 2014E 43,958 8.9 12,033 27.4 9,602 1.9 168 17.8 2015E 48,410 10.1 13,190 27.2 10,545 9.8 185 16.2 Source: Company, Centrum Wealth Research
  28. 28. I nd i a I nv e s tm en t S tr a t eg y28 Pharma Biocon Ltd. Biocon is present across the entire biogenerics space and has strong technological skill-sets to develop complex biotechnology products on its own. In the next 5 years nearly $33 billion ($17 billion in US alone) worth of biotechnology products are likely to lose patent protection globally. Biocon is likely to benefit from this as its plans to file 20 ANDAs in the US market post FY2015. Biocon has identified 5 growth verticals – API business, Bio-simillars, formulations business, novel programme vertical and research services. With low leverage and as a net exporter (about 10% of total revenues), Biocon is better placed than a lot of its domestic peers. Recently, Biocon has hired the services of global consulting giant McKinsey to create a new structure to help the company achieve its ambitious target of $700 million revenue in 2015 and $1-billion revenue target by 2018; Biocon is the leading supplier of Orlistat API (anti-obesity drug) to the developed markets and generated sales of over Rs.100 crore per annum. It has entered into collaboration with Abbott Labs, US for neutraceutical research. Biocon is likely to spend Rs.200 crore on its new R&D centre and aims to build its Rs.300 crore healthcare business to Rs.1,000 crore in 5 years; Biocon has launched ALZUMAb, a new biologic for treatment of psoriasis at about 50% cheaper than other psoriasis drugs for which the domestic market size is around Rs.200 crore. If successful, Biocon plans to market the drug in international market which is expected to be about $8 billion by 2016; Biocon has entered into an option agreement with Bristol-Myers Squibb (BMS) for IN-105, an oral insulin drug candidate. If BMS exercises its option to license IN-105 following the successful completion of Phase II trial, it will assume full responsibility for the programme including development and commercialization outside India. Biocon will receive a license fee in addition to potential regulatory and commercial milestone payments, and royalties on sales outside India; On a consolidated basis, for Q1FY2014, Biocon’s net profit grew by 21.3% YoY to Rs.97 crore backed by a 24.6% YoY growth in EBIDTA. Sales grew by 21.5% YoY backed by a 21% YoY growth in the biopharma segment, 17% YoY in branded formulations and 26% in research services. The company incurred R&D expenses of Rs.43 crore which were 10% of the Biopharma revenue. Biocon paid a dividend of Rs.5/share along with a special dividend of Rs.2.50/share for FY2013; Biocon is a net debt-free company with borrowings of Rs.374 crore as against cash and cash equivalents of Rs.652 crore and current investments of Rs.633 crore as on June 30, 2013. The stock is currently trading at an attractive valuation of 14x its FY2015E earnings of Rs.24.3/share. We recommend a BUY on the stock with a fair value of Rs.390/share. Financial Summary (Rs. Cr.) CMP: Rs.341 52 week H/L Rs. 352/243 Y/E Mar Revenue Growth % EBIDTA EBIDTA (%) Adj. PAT Growth % EPS (Rs.) P/E 2012A 2,087 -24.7 517 24.8 338 -0.8 16.9 20.2 2013A 2,428 16.4 486 20.0 307 -9.3 15.4 22.2 2014E 2,938 21.0 595 20.3 380 23.8 19.0 17.9 2015E 3,672 25.0 727 19.8 486 28.0 24.3 14.0 Source: Company, Centrum Wealth Research Indoco Remdies Ltd. (IRL) Indoco Remedies Ltd (IRL) has a strong brand portfolio of 120 products across various therapeutic segments with its top 10 brands contributing about 60% to its domestic sales and has 5 brands in top 500 brands globally. IRL is looking to expand its presence in other regulated markets like US and emerging nations. It is targeting exports business to grow at 25-30% CAGR over the next 2-3 years and to contribute close to 45% of the revenues by FY2015E. IRL is planning to file 9 ANDAs in FY2014 of which 3 will be with Watson Pharma, US. IRL has also entered into an alliance with Aspen Pharma (a South African MNC) for emerging markets and with DSM, a €9 billion Dutch company, for marketing & distribution in Australia. The total number of patent applications filed as on June 30, 2013 are 55, out of which 37 pertain to API processes and 18 pertain to finished dosages; IRL has posted muted results in Q1FY2014 with net profit declining by 11% YoY and net sales declining by 2% YoY mainly on the back of decline in international sales of formulations (lower tender business in Germany). However, the management has re-iterated its revenue guidance of over Rs.700 crore and Rs.1,000 crore, with EBITDA margins (ex-R&D) at 18% and 20% for FY2014 and FY2015, respectively. This would be on the back of ramp up in the Watson Pharma and Aspen Pharma businesses and revival of growth in domestic business with chronics contributing close to 20% of the revenues, from 10% currently. IRL’s Goa I facility has got USFDA approval and the company is likely to launch one drug from this facility in September 2013. The Goa II facility is awaiting ANDA approvals for the Watson alliance which are expected post the USFDA’s routine re-inspection expected in August 2013 end; IRL expects spurt in international business with commencement and ramp up of sales of sterile formulations in US. The strategy to partially replace contract manufacturing business with supplies against own dossiers/ marketing authorizations in European markets would help to improve margins and sustainability. The API business is expected to grow at faster pace due to its low base and is also likely to contribute to the growth of the formulation business through backward integration in select APIs. Moreover, on the new pharma pricing policy, IRL does not expect any major negatives as the potential impact could be only to the tune of Rs.4-5 crore; We believe that the firm is well poised to grow its revenue at 20% plus over FY2013-15E and with expected improvement in margins we believe that the PAT CAGR would be in excess of 25%. Improved traction in the domestic business coupled with growth driver in international business coming from new tie ups would help IRL to re-rate closer to the large-cap pharma companies which are trading at an average of 18x one year forward earnings. We recommend BUY on IRL with a fair value of Rs.73 per share. Financial Summary (Rs. Cr.) CMP: Rs.64 52 week H/L Rs. 83/55 Y/E Mar Revenue Growth % EBIDTA EBIDTA (%) Adj. PAT Growth % EPS (Rs.) P/E 2012A 569 18.2 85 14.9 46.3 -9.4 5.0 12.7 2013A 630 10.8 94 14.9 43.0 -7.2 4.7 13.7 2014E 782 24.0 141 18.0 53.3 24.0 5.8 11.1 2015E 977 25.0 195 20.0 66.7 25.0 7.2 8.8 Source: Company, Centrum Wealth Research