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AMBIT INSIGHTS 30 September 2016

DAILY

Updates

Automobile

Sept volume estimates healthy; dealers upbeat

Metals & Mining

Steel - Lacks pricing power despite protection

Technology

Accenture’s guidance muted, but better than feared

Strategy

Ten interesting things that we read this week

Analyst Notes: BFSI: Auto NBFCs - Improving outlook for tractor loans Aadesh Mehta, CFA, +91 22 3043 3239

Trends in tractor financing are improving as indicated by: (i) improving growth over the past 3 quarters and (ii) rating agencies indicating improvement in collections (click here). MMFS and MGMA stand to benefit the most given high share of tractors in their AUM (17-19%). Whilst MMFS would be a beneficiary of these trends, we expect RoE improvement to be lower than consensus expectations due to pressure on operating profitability (driven by increasing competitive intensity and structural increase in its cost of funds) and lower-than-expected improvement in credit cost (click here). Current valuations of 2.7x 1-year forward P/B for TTM RoEs of 12% factor in more than warranted earnings recovery. Instead, Magma, with identical AUM mix and much lower valuations despite similar RoEs (1x 1-yr forward P/B for 12% TTM RoEs), is a better bet to play the recovery in tractor loans. Source: Ambit Capital research

Please refer to our website for complete coverage universe

http://research.ambitcapital.com

http://research.ambitcapital.com

http://reports.ambitcapital.com/reports/Ambit_BFSI_AutoNBFCs_Improvingoutlookfortractorloans_28Sept2016.pdf

http://reports.ambitcapital.com/reports/Ambit_M&MFinancialServices_CompanyInsight_Thistimeitsdifferent_06Jun2016.pdf

AMBIT INSIGHTS

Ambit Capital Pvt Ltd 30 September 2016

Automobile Sept volume estimates healthy; dealers upbeat Our interaction with dealers indicates healthy growth in retail demand for two-wheelers and passenger vehicles. Enquiries/bookings for festival season (Navratra) appear stronger than last year. With both Navratra and Diwali being in October this year (vs spread over Oct-Nov 2015), dealers expect 20-25% retail sales growth in Oct 2016. This is responsible for inventory build-up in September-end. In 2Ws, TVS would record highest domestic dispatch volume growth in September (28% YoY) followed by Honda (15%), Bajaj (12%) and Hero (9%). In PVs, demand for Maruti remains strong, but inventory build-up has been affected by capacity constraints. In MHCVs, Ashok Leyland would see 32% YoY volume decline (ex Dost) due to continued weakness in demand and a high base last year.

Background

We recently interacted with the dealers of 2Ws, PVs and CVs across various regions to get an update on the latest demand trends and also derive a sense of September 2016 volumes. The key takeaways from the dealer interactions are as below.

2Ws: September dispatch volumes to remain healthy; festival season expected to be strong

Current retail demand trends

The retail sales volume in the first 15 days of September has been good mainly supported by Ganesh Chaturthi and Onam festivals. However, the sales volumes were muted in the second half due to the onset of Shradh season which is considered inauspicious for new purchases. Overall, there has been no significant change in MoM retail volumes between August and September.

Based on initial trends, bookings for the festival season appear to be stronger than last year. Dealers indicated that this year both the major festivals, i.e. Navratra/Dussehra and Diwali, are in the month of October vs. having been spread over October and November last year. Dealers expect 20%-25% YoY retail growth in the month of October 2016.

Volume growth in southern India is better than that in western and northern India.

Company-wise feedback

Honda: After the recent commissioning of the Gujarat plant, the availability of its flagship scooter Activa has improved and the product is now available off the shelf. Unlike last year, when Activa was short in supply, this time Honda started building up inventory from the month of August itself. Driven by continuing strong demand for Activa and build-up of inventory, Honda dealers appear to be optimistic about the upcoming festival season.

Hero: Hero’s scooter volumes continue to decline due to increased availability of Activa and lower-than-expected customer response to Hero’s Maestro Edge (Duet is faring better). The recently launched Achiever 150 will be initially launched only in Eastern India.

TVS: Dealers indicated that Victor sales have been as per expectations; however, it is cannibalising Star City volumes to some extent. Initial customer responses/enquiries about Apache 200 have been good. Jupiter volumes seem to be stabilising at the current levels. Unlike Hero’s scooters (Maestro and Duet) Jupiter has been less impacted by better availability of Activa.

Bajaj: Dealers are witnessing healthy demand driven by low YoY base and successful customer response to new models, particularly Avenger and V-15.

POSITIVE Quick Insight Analysis Meeting Note News Impact

Research Analysts

Ashvin Shetty, CFA [email protected] Tel: +91 22 30433285

Gaurav Khandelwal, CFA [email protected] Tel: +91 22 30433132

Ritu Modi [email protected] Tel: +91 22 30433292

mailto:[email protected]



AMBIT INSIGHTS


Expect healthy growth in September wholesales; but lower than August growth due to high YoY base

Wholesale volume has been higher than the retail volume as the dealers continue to build up inventory in expectation of a good festival season demand. As per our discussion with dealers, while Honda and Hero started building up inventory from August itself, TVS built up inventory mainly in the month of September. However, it lost 2 days of production in September due to Cauvery River dispute (between Karnataka where TVS’s main factory is situated and Tamil Nadu) and hence wholesale volumes could have been impacted to that extent. On the other hand, Bajaj has been the most conservative and will build most of its inventory in the month of October.

We expect TVS (28% YoY) to report highest growth in ‘domestic’ wholesale dispatches followed by Honda (15% YoY). Bajaj and Hero (both 9%) are expected to lag industry volume trends.

Export volumes for all the players are expected to be weak due to continuing macro-economic challenges in their end-user markets.

Overall, we expect the top four 2W players to report 14% YoY growth in wholesale volume in the month of September 2016.

Exhibit 1: TVS to lead 2W industry dispatch volume growth in September 2016

Volumes in '000 Sep-16E Sep-15 YoY Aug-16 MoM Apr- Sep 16

Apr- Sep 15 YoY Oct-Mar

17 Oct-Mar

16 YoY FY17 FY16 YoY

Hero MotoCorp

Domestic Motorcycle 562 527 7% 520 8% 3,026 2,811 8% 3,024 2,792 8% 6,050 5,603 8%

Domestic Scooters 85 63 35% 81 5% 449 304 48% 471 514 -9% 920 819 12%

Domestic Volumes 645 590 9% 601 7% 2,828 2,526 12% 4,142 3,896 6% 6,970 6,422 9%

Export Volumes 15 17 -13% 15 -2% 66 88 -25% 138 122 13% 204 210 -3%

Total Volumes 660 607 9% 616 7% 2,894 2,614 11% 4,280 4,018 7% 7,174 6,632 8%

Bajaj Auto

Domestic Motorcycle 210 188 12% 175 20% 1,108 955 16% 1,070 944 13% 2,178 1,899 15%

Domestic 3W's 26 23 14% 26 2% 148 118 25% 144 136 6% 292 254 15%

Total Domestic 236 211 12% 200 18% 1,255 1,073 17% 1,447 1,292 12% 2,702 2,365 14%

Exports Motorcycle 110 143 -23% 105 5% 650 823 -21% 775 636 22% 1,425 1,459 -2%

Exports 3W's 21 31 -33% 20 6% 107 173 -38% 155 107 46% 262 280 -6%

Total Exports 131 174 -25% 125 5% 757 997 -24% 1,061 916 16% 1,818 1,913 -5%

Total volumes 367 384 -5% 325 13% 2,013 2,070 -3% 2,508 2,208 14% 4,520 4,278 6%

TVS Motors Domestic Motorcycle 92 64 43% 90 2% 459 348 32% 441 364 21% 900 712 26%

Domestic Scooters 77 71 8% 74 4% 399 363 10% 423 411 3% 822 774 6%

Domestic Mopeds 75 55 38% 75 0% 443 353 25% 412 371 11% 855 724 18%

Domestic 3W's 1 1 -2% 1 0% 7 7 -3% 9 8 15% 17 16 6%

Total Domestic 245 191 28% 240 2% 1,063 880 21% 1,531 1,345 14% 2,594 2,225 17%

Total Exports 34 41 -19% 34 -1% 177 204 -13% 263 250 5% 440 454 -3%

Total 279 233 20% 274 2% 1,240 1,084 14% 1,794 1,595 13% 3,034 2,679 13%

HMSI Domestic motorcycles 135 147 -8% 130 4% 826 767 8% Domestic scooters 336 264 27% 336 0% 1,779 1,403 27% Total domestic 471 412 15% 466 1% 2,605 2,170 20% Exports 26 19 37% 26 0% 133 102 31% Total 497 431 15% 492 1% 2,738 2,272 21% Eicher Motors

Motorcycle 58 44 30% 56 4% 315 234 34% 361 274 32% 675 508 33%

Top 5 players Domestic Motorcycle 1,057 970 9% 970 9% 5,734 5,116 12% Domestic Scooters 498 399 25% 491 1% 2,627 2,070 27% Total Domestic 2W (ex-Mopeds) 1,555 1,369 14% 1,462 6% 8,361 7,186 16% Source: Company, Ambit Capital research

AMBIT INSIGHTS


Passenger vehicles – capacity constraints to limit Maruti’s festive volumes

Demand for Maruti’s PV portfolio continues to be strong, particularly for Baleno and Brezza, which have an average waiting period of ~6 months. Demand for PVs during Ganesh Chaturthi was good. However, due to the Shradh period, the overall retail volumes in September 2016 are expected to be flat MoM.

Discount levels have been flat MoM expect for a few models like Celerio diesel and Wagon R, where discounts have increased.

Enquiries and festive bookings have been good. However, due to capacity constraints, Maruti has not been able to fill inventory at the dealers. We expect domestic wholesale volumes for Maruti in September 2016 to largely mirror August 2016 levels and grow by 14% YoY to 121k units

For Mahindra & Mahindra, the recently launched Bolero Power+ has seen good enquiries and dealers expect this model to help recover volumes for the Bolero portfolio. Bolero Power+ is priced ~60k lower than the existing model of Bolero. However, due to the adverse base of last year (due to launch of TUV300 in September 2015), we expect M&M to register just 2% wholesale volumes growth in September 2016.

Exhibit 2: Domestic 4W August 2016 volume estimates

Volumes in '000 Sep-16E Sep-15 YoY Aug-16 MoM Apr-Sep 16

Apr-Sep 15 YoY Oct-Mar

17 Oct-Mar


Maruti Domestic 121 106 14% 120 1% 689 629 10% 770 676 14% 1,459 1,305 12%

Exports 11 8 47% 12 -8% 61 66 -7% 63 58 8% 124 124 0%

Total Volumes 132 114 16% 132 0% 750 695 8% 833 735 13% 1,583 1,429 11%

M&M

UVs + PVs 20 20 2% 18 10% 115 102 13% 136 114 19% 251 215 16%

Source: Company, Ambit Capital research

MHCVs: Near-term demand weakness continues As per our recent dealers interactions, MHCV volumes remain weak. Some dealers are also indicating MoM deterioration in volumes. We expect wholesale volumes for September 2016 to remain weak. Moreover, the base effect will also be adverse as September 2015 saw 64% growth in industry volumes ahead of the implementation of ABS from October 01, 2015.

We expect Ashok Leyland to report a 32% YoY decline in the MHCV wholesale volumes in September 2016 (including exports). We expect domestic MHCV wholesale volumes of Tata Motors to fall by 37% YoY in September 2016.

Exhibit 3: Commercial vehicle August 2016 volume estimates

Volumes in '000 Sep-16E Sep-15 YoY Aug-

16 MoM Apr-Sep

16 Apr-Sep

15 YoY Oct-Mar

17 Oct-Mar


Ashok Leyland CVs Ex-Dost (including exports)

8.3 12.1 -32% 8.2 1% 48.7 51.3 -5% 71.0 59.2 20% 119.7 110.5 8%

Dost 2.8 2.6 6% 2.7 4% 14.9 14.2 5%

Total volumes 11.1 14.8 -25% 10.9 2% 63.7 65.5 -3%

Tata Motors

MHCV 10.0 15.9 -37% 10.0 0% 66.8 72.2 -7%


Where do we go from here?

2Ws: TVS remains our Top pick in 2Ws

We expect 12% growth for 2W industry in FY17. This would be led by continued strong demand for scooters and premium bikes in urban areas and better demand for motorcycles in rural areas due to a normal monsoon and low base.

AMBIT INSIGHTS


Our top pick in the two-wheeler segment continues to be TVSM (best-placed to ride scooterisation and premiumisation shifts in 2Ws). We maintain our SELL stance on Hero MotoCorp (uncertain product development capabilities and low exposure to fast growing scooters/premium bikes), Bajaj Auto (rising competition in the premium segment, weak export markets and lack of presence in the fast growing scooter segment) and Eicher Motors (potential competition from several upcoming launches in the 250-500cc segment, uncertainty on RE’s exports and trading at expensive valuation).

4Ws: Maintain SELL on Maruti and M&M

We maintain PV industry volume growth estimate of 10% for FY17 on the back of: (i) continuing improved consumer sentiment surrounding lower fuel prices/interest rates; (ii) numerous new launches (which was also a big driver of industry growth in FY16); and (iii) low base in recent years (volume CAGR of only 2% over FY12-FY16).

In case of Maruti Suzuki, we expect FY16-18 revenue CAGR of 16% driven by strong franchise and new launches to be severely undermined by adverse currency impact on margins (14.7% in FY17/18; 80bps lower than FY16). So, we expect a modest EBITDA CAGR of 13% over FY16-18. Similarly, capex spends are likely to be elevated due to spends for marketing infrastructure, product development and real estate. However, valuation of 11x FY18E EBITDA (20% premium to five-year historical average) seems to ignore these margin/capex concerns. Our estimates and TP of Rs4,450 (implied 9.6x FY18 EBITDA) remain unchanged. Maintain SELL. For M&M, we remain concerned about challenges surrounding the domestic UV business from increasing competitive and regulatory headwinds, namely: (i) MNCs (strong product development) and large car makers (Maruti and Hyundai with distribution advantages) target the segment aggressively; and (ii) significant regulations surrounding diesel vehicles. While the domestic UV industry witnessed strong volume growth in April-August 2016 at 41%, M&M’s growth lagged at 17%. Consequently, M&M’s market share in the domestic UV market has come down from almost 40% in March 2016 to 29% in April-August 2016. We are currently building in 19% growth for M&M’s domestic UV volumes in FY17 on account of a low base of FY16 and incremental volumes from recent launches. However, we expect a muted 9% growth in volumes in FY18. Maintain SELL with an SOTP-based TP of Rs1,300.

MHCVs: Slow one now will later be fast Near-term MHCV goods industry demand will remain subdued (down 5% over Aug’15-Dec’16) due to high YoY base, fuel hikes and seasonal factors (monsoon freight constraints). Demand will rebound in 4QFY17 (+25% YoY) catalysed by BSIV-led pre-buying and higher freight availability due to revival in rural demand and resumption of construction activity. Though replacement demand should taper by FY17-end, volume growth in FY18 (10%) will be driven by favourable macro; Ambit’s key sector estimates imply volume acceleration driven by low demand base, pick-up in infra/construction activity and Pay Commission grants. We maintain BUY on Ashok Leyland. Exhibit 4: PVs are likely to perform better than motorcycles

mn units FY15 FY16 FY17E FY18E CAGR (FY16-18)

PVs 2.6 2.8 3.1 3.5 12%

YoY growth 4% 7% 10% 14% Motorcycles 10.7 10.7 11.8 12.9 10%

YoY growth 3% 0% 10% 10% Scooters 4.5 5.0 5.8 6.7 15%

YoY growth 25% 12% 15% 15%

2Ws (ex-mopeds) 15.2 15.7 17.6 19.6 12%

YoY growth 8% 3% 12% 12%

MHCV (goods + passenger) 0.23 0.30 0.33 0.36 10%

YoY growth 16% 30% 9% 11%

Source: SIAM, Ambit Capital research

AMBIT INSIGHTS


Exhibit 5: Comparative valuations

Company Mcap

Stance TP EV/EBITDA (x) P/E (x) CAGR (FY16-18E) RoE

US$mn Rs FY16E FY17E FY18E FY16E FY17E FY18E Sales EBITDA EPS FY16E FY17E FY18E

Tata Motors* 23,699 BUY 565 6.6 5.2 4.5 14.7 11.5 10.1 18% 20% 21% 23% 22% 19%

Maruti Suzuki 23,388 SELL 4,450 16.6 15.1 13.0 36.1 29.2 23.2 16% 13% 25% 18% 20% 21%

M&M ̂ 11,622 SELL 1,300 10.1 8.9 7.7 18.0 15.8 13.7 13% 14% 13% 15% 15% 16%

Bajaj Auto 12,261 SELL 2,520 14.9 13.9 12.3 23.3 21.3 18.5 11% 10% 12% 31% 30% 32%

Hero MotoCorp 10,166 SELL 2,880 14.7 13.1 11.8 21.9 19.6 18.0 10% 12% 10% 43% 40% 37%

Eicher Motors** 10,084 SELL 17,575 34.5 22.8 18.9 66.9 40.2 33.0 29% 35% 42% 39% 46% 41%

Ashok Leyland 3,035 BUY 102 10.7 9.3 7.9 19.7 16.3 12.8 14% 16% 24% 25% 24% 26%

TVS Motor 2,458 BUY 330 22.2 17.8 11.8 37.0 30.3 18.5 21% 37% 41% 25% 26% 35%

Source: Bloomberg, Ambit Capital research. Note: All figures are based on Ambit estimates; *Tata Motors figures are arrived at by adjusting EBITDA/PAT for normalised R&D spends (by expensing 70% of R&D costs instead of current 20%); ^excluding investments in listed entities; **The company has changed its accounting year-end from December to March; hence FY16 is for the 15 months ended March 31, 2016. FY16 and FY17 YoY growth has been adjusted and annualised

AMBIT INSIGHTS


Metals & Mining Steel - Lacks pricing power despite protection Worsening demand-supply dynamics (8% production growth vs 1% demand growth in 5MFY17), declining capacity utilisation (~75%) and imported parity pricing provide little room for further improvement in unitary EBITDA for domestic steel players in FY17 (vs 1QFY17). The bull argument that valuations of Indian steel companies should re-rate to rich valuations enjoyed by Indian cement players is optimistic. Pricing power of cement companies is led by: (a) higher share of retail sales; (b) regional demand-supply dynamics; (c) ability to manage production to maintain pricing; and (d) no threat of imports. Indian steel companies lack these fundamental drivers of pricing; hence, we do not expect pricing power of steel companies to improve structurally. As further re-rating is unlikely, we reiterate SELL on Tata Steel and SAIL.

No near-term upside to domestic steel margins Underlying weak domestic demand (below 6%) for the last four years and rising imports from China, Japan and Korea have resulted in declining capacity utilisation for domestic steel industry (down from ~88% in FY11 to ~75% in FY16).

Exhibit 1: Domestic steel demand has been sub-6% for the last four years


With the imposition of Minimum Import Price (MIP) in Feb-16 and later substituted by Anti-Dumping Duty in Aug-16, the Government has been able to significantly reduce imports (down 35% YoY in 5MFY17) and drive a 20% increase in domestic steel prices in CY16. With increased trade protection for the domestic steel industry, can steel players continue to take price hikes for the rest of FY17? We do not think so as demand-supply dynamics are unfavourable given: (1) production grew by 8% in 5MFY17 while demand rose by just 1%, (2) capacity additions restrict improvement in capacity utilisation, and (3) domestic steel prices are already at import parity.

Utilisation unlikely to rise in FY17 despite fall in imports given strong capacity additions

Whilst steel consumption growth has dipped to merely 1.3% for 5MFY17 [from 5.1% in FY16], net imports declined by ~35% for 5MFY17 due to trade protection measures such as MIP and anti-dumping law. This enabled domestic players to increase production by ~7%. However, ~11mt of new steel capacity (10% of FY16 capacity) is expected to be commissioned in FY17 from the three major steel players alone (Tata Steel, JSW Steel and SAIL). Hence, despite the rise in steel production, we expect utilisation to remain under pressure at below 75%.

64 69 70 74 74 75

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FY11 FY12 FY13 FY14 FY15 FY16 5MFY16 5MFY17

Production (mt) Net imports Real Consumption - RHS

NEGATIVE Quick Insight Analysis Meeting Note News Impact

Tata Steel SELL Bloomberg Code: TATA IN

CMP (`): 369

Target Price (`): 250

Mcap (` bn/US$ bn): 358/5.4

3M ADV (` mn/US$ mn): 2,828/42.5

SAIL SELL Bloomberg Code: SAIL IN

CMP (`): 45

Target Price (`): 37

Mcap (` bn/US$ mn): 187/2.8

3M ADV (` mn/US$ mn): 428/6.4

Research Analyst

Parita Ashar, CFA [email protected] Tel: +91 22 3043 3223


AMBIT INSIGHTS


Exhibit 2: Strong capacity addition by domestic steel players in FY17

FY16E FY17E Incremental in FY17 Comments

Tata Steel 9.7 12.7 3.0 Kalinganar expansion

SAIL 13.5 16.0 2.5 Modernisation & Expansion

JSW Steel 14.0 18.0 4.0 Vijaynagar + Dolvi expansion

JSPL 3.5 5.0 1.5 Angul expansion

Total for large players 40.7 51.7 11.0 Source: Company, Ambit Capital research

Prices already at imported parity, leaving little room for price hikes

India has largely been a steel importer; hence domestic steel prices are largely in line with similar to imported parity steel prices. With a sharp fall in global steel prices over the last two years (~25%), Indian steel companies saw a sharp fall in realisations (~18%) and, thereby, margins. On the back of protectionist measures by the Government in CY16, domestic steel players increased prices by ~20% in the last seven months

Exhibit 3: Domestic HRC prices have always mirrored imported parity prices (Rs/t)

Source: Steelmint, Bloomberg, Ambit Capital research

We highlight that domestic steel prices are currently in line with imported prices from Japan/Korea and at 5% discount to China; so, we see little room for a rise in domestic steel prices from hereon. Further, we highlight that given US$70-80 protection provided to domestic steel players in the form of safeguard/anti-dumping duty, domestic steel prices are unlikely to rise even if global steel prices rise.

Exhibit 4: A comparison of imported parity prices and domestic prices

China Japan & Korea

Import Prices (US$/t) (CFR) 400 430

Basic Custom Duty @ 12.5% 50

Safeguard duty @ 18% from Sep-16 (-) ADD, if any 57 33

ADD: US$474/t less cost of steel 24 44

CVD @ 12.5% 63 58

Cess @ 3% 6 4

Total Cost (US$/t) 600 569

Exchange rate (INR/US$) 66.9 66.9

Total cost of import (Rs/t) 40,136 38,075

Domestic HRC prices (incl. excise) 38,000 38,000

Premium of domestic to imported (2,136) (75)

Source: Companies, Ambit Capital research

25,000

35,000

45,000

55,000

Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16

Domestic HRC Imported from China

AMBIT INSIGHTS


In Aug-16, India turned net exporter of steel given: (1) declining imports due to trade protection measures, and (2) rise in exports as domestic steel demand grew by only 1%. We highlight that if domestic steel demand does not recover and India continues to be a net steel exporter, domestic steel prices could move from import parity to export parity. With export prices being ~US$50-60/t lower than import parity prices, there could be downside risk to prices if demand does not recover.

Spreads have contracted; FY17 EBITDA margins may be lower than 1QFY17

The sharp ~US$100/t rise in global coking coal prices (see exhibit below) has been driven by short-term supply concerns in the form of flooding at various coal mines in China and mine and logistical issues in Australia. Whilst coking coal prices are likely to normalise as these short-term issues abate, the recent rise in spot and contracted coking coal prices is likely to impact EBITDA margins of domestic players partly in 2QFY17 and fully in 3QFY17. In order to offset the ~Rs5,000-6,000/t hike in coking coal price per tonne of steel, steel players have taken price hikes though only of Rs2,500-3,000/t. Hence, we expect margins for the rest of FY17 to be lower than levels in 1QFY17.

Exhibit 5: Coking coal prices increased by ~US$100/t in the last three months (US$/t)

Source: Bloomberg, Ambit Capital research

Exhibit 6: Spreads could decline if domestic players do not take adequate steel price hikes to offset rise in coking coal prices (US$/t)


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Spreads - Rs/t of steel (HRC price - 0.8x coking coal)

AMBIT INSIGHTS


Re-rating unlikely as industry lacks structural improvement in pricing power Given the increase in protection to the domestic steel industry in CY16, valuations of domestic steel players have seen a significant re-rating. Tata Steel and SAIL currently trade at peak one-year forward EV/EBITDA of 7x/15x, a significant premium to their 10-year averages of 5.6x/7.6x respectively.

Exhibit 7: Tata Steel’s one-year forward EV/EBITDA at a premium to historical multiple

Source: Bloomberg, Ambit Capital research; Note: Based on consensus estimates

Exhibit 8: SAIL’s one-year forward EV/EBITDA at a premium to historical multiple

Source: Bloomberg, Ambit Capital research; Note: Based on consensus estimates

The bull argument is that valuations of domestic steel companies should re-rate further and move closer to the rich valuations enjoyed by Indian cement players. The argument is that rising protection now makes steel a domestic commodity with strong pricing power for steel players similar to that of domestic cement players.

Exhibit 9: One-year forward EV/EBITDA – Cement companies have historically been at a premium to steel


We believe this is too optimistic. Pricing power of cement companies in India is driven by: (a) higher share of retail sales; (b) regional demand-supply dynamics; (c) ability to manage production to maintain pricing; and (d) no threat of imports or entry by global majors. Given that Indian steel companies lack these fundamental drivers, we believe pricing power of steel companies is unlikely to improve structurally and, hence, a valuation re-rating is unlikely.

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ACC ACEM UTCEM Tata Steel SAIL JSW Steel

AMBIT INSIGHTS


Exhibit 10: India’s steel industry lacks the key drivers of pricing enjoyed by the cement industry

Cement Steel Steel vs Cement

Retail sales

On average, ~60% of India’s cement production is sold through the retail channel.

Moreover, for the larger cement players like ACC/Ambuja/Ultratech, the share of retail sales is higher at 75%-80%.

Over the past 4-5 years, large steel players like Tata Steel, JSW Steel and SAIL have started selling steel through the retail channel/outlets.

However, majority of the steel demand is still driven by institutional customers with retail sales being only a third of total sales even for the larger steel players.

Regional market

Low shelf life and high transportation cost make cement a regional commodity.

Empirical evidence suggests pricing discipline is largely maintained despite low utilisation.

Steel is largely a heterogeneous market. Majority of steel plants are located in North India and steel is transported across the country.

Ability to cut production

Low shutdown and re-start costs for cement plants enable players to cut production to manage pricing. For instance, manufacturers in Andhra Pradesh are running their plants only for 15 days in a month

Shutdown and re-start costs for steel plants are high and, hence, it is difficult to manage production.

This results in high steel inventory as companies prefer to maintain inventory rather than incurring shutdown costs.

No threat of imports

The domestic cement industry does not face competition from imports as low value and high volume are deterrents.

Whilst the domestic steel industry has been protected by the Government from a flood of imports, it is difficult to completely de-link the domestic steel industry with what is happening globally as steel imports are unlikely to dry out (there are ways of circumventing duties).

Source: Companies, Ambit Capital research

Tata Steel (SELL, TP Rs250, 32% downside) Average steel prices in 2QFY17 are expected to be lower than in 1QFY17 as domestic steel prices declined sharply in July and August. Hence, EBITDA/t in 2QFY17 is likely to be lower than in 1QFY17. Though prices have recovered in September, spot prices are only Rs2,000-3,000/t higher than the 1QFY17 average. Meanwhile, coking coal prices rose by ~US$100/t (Rs6,000-7,000/t). Therefore, we expect margins for 3QFY17 as well as FY17 to be lower than in 1QFY17. Our target price of Rs250 implies 6.2x FY18E EV/EBITDA, which is at a premium to historical average of 5.6x.

Exhibit 11: Tata Steel’s implied multiple-based SOTP valuation

EV/EBITDA valuation EBITDA (Rs mn) Multiple (X) EV (Rs mn)

Indian operations (EBITDA of Rs10,100/t vs Rs7,250/t in FY16) 90,157 6.5 586,021

European + South East Asia operations 33,929 6.0 203,573

Consolidated 124,086 789,593

Add: 3mt Kalinganagar capacity (EBITDA of Rs10,100/t) 27351 6.5 177,782

Add: Non core investments 56,083

Total Enterprise Value 1,023,458

Less: Net Debt 779,346

Total Equity Value 244,112

No of shares (mn) 971

Equity value per share (Rs) 250

Source: Ambit Capital research

SAIL (SELL, TP Rs37, 18% downside) SAIL is struggling to generate positive EBITDA and sell incremental volumes from its new capacities (sales volume has been flat over FY08-16) despite integrated operations. Our DCF-based TP of Rs37 factors in volume ramp-up from 11.7mt in FY15 to 19.6mt by FY20 and recovery in EBITDA/t to Rs3,000/tonne by FY18E due to a gradual recovery in steel prices and operating leverage from the volume ramp-up. In the event that SAIL is unable to push through incremental sales volumes and ramp-up utilisation at new capacities, and steel prices remain at current levels, SAIL would continue to face challenges to generate any EBITDA. Hence, we see high risk to SAIL’s current market-cap. At CMP, the stock trades at FY18E EV/EBITDA of 11.2x, which is at a premium to the historical average of 7.5x.

AMBIT INSIGHTS


Relative valuation The pricing power of global steel companies has eroded due to global overcapacity. and hence, RoEs are at cyclical lows. In India, domestic demand growth has deteriorated and, hence, EBITDA margins and RoEs have declined significantly. Amongst domestic steel companies, Tata Steel is trading at an FY18E EV/EBITDA of 6.9x, premium to JSW Steel (6.2x). SAIL’s FY18E EV/EBITDA of 11.4x is significantly higher than peers due to its poor margin profile.

Exhibit 12: Relative valuation of global steel companies

Companies Mcap EV/EBITDA (x) P/E (x) P/B (x) EBITDA CAGR %

(FY16-18) RoE (%)

US$ mn FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18

India

Tata Steel 5,364 8.1 6.9 16.2 9.5 1.3 1.2 47.9 8.2 12.3

SAIL 2,796 21.5 11.4 NA NA 0.5 0.5 NA (3.5) (0.3)

JSW Steel 6,076 6.7 6.2 11.8 10.3 1.7 1.5 46.2 15.1 15.2

India Average 12.1 8.2 14.0 9.9 1.2 1.1

Asia

JFE Holdings 8,881 8.3 6.7 19.2 10.5 0.5 0.5 11.5 2.3 4.5

Nippon Steel 19,824 9.1 7.4 20.0 11.7 0.7 0.7 8.6 3.8 6.2

Hyundai Steel* 6,218 6.0 5.8 7.8 7.1 0.4 0.4 4.7 5.5 5.7

POSCO* 18,251 6.1 5.9 13.1 10.8 0.5 0.4 6.1 3.6 4.2

Angang Steel* 4,779 10.0 9.8 NA NA 0.6 0.5 141.7 1.1 1.1

Maanshan Steel* 2,855 8.7 9.4 NA NA 0.6 0.6 NA 2.3 0.1

Asia Average 8.1 7.5 15.0 10.0 0.5 0.5

Brazil

Usinas* 2,717 30.1 12.6 NA NA 0.8 0.9 NA (6.0) (3.4)

Gerdau* 4,452 7.3 6.4 NA NA 0.6 0.5 3.5 0.6 2.2

CIA* 3,986 12.0 10.3 NA NA 1.9 2.1 NA (16.8) (5.7)

Brazil Average 16.5 9.8 NA NA 1.1 1.2

US & EU

Nucor* 15,819 8.0 7.1 18.4 15.6 2.0 1.8 27.3 11.0 12.6

US Steel* 3,238 7.2 5.6 NA NA 1.2 1.1 NA (4.0) 7.3

ThyssenKrupp 13,489 6.9 5.8 NA 14.0 4.0 3.2 14.0 15.6 25.7

Arcelor Mittal* 19,130 5.8 5.5 NA 13.3 0.5 0.5 NA 2.6 3.2

Salzgitter* 1,988 4.0 3.5 NA 14.5 0.6 0.5 11.6 1.7 3.7

Voestalpine 6,162 6.0 5.4 11.7 10.0 1.0 0.9 8.1 8.5 9.5

US and EU Average 6.3 5.5 15.1 13.5 1.5 1.4

Source: Bloomberg, Ambit Capital research; Note: * indicates December-ending (CY16=FY17), Based on Bloomberg consensus estimates

AMBIT INSIGHTS


Technology Accenture’s guidance muted, but better than feared After 10.5% YoY revenue growth (cc) in FY16, Accenture has guided for 5-8% growth in FY17. Apart from Energy, management was cautious on Communications given likely loss of share to Indian vendors which reported strong growth in the segment recently. Notably, management said it has not seen any impact of Brexit on BFSI yet and expects this segment to grow in-line with the company average; this is likely a function of its better portfolio and low growth thresholds. We remain confident that Indian vendors like TCS will be able to roll with the punches of the “volatile macro-environment” and growth will accelerate in a year or so. In that context, current valuations are attractive. TCS trades at 18x one-year forward earnings vs 22x for Accenture despite faster organic revenue growth (10-11% YoY in organic, cc terms, LTM vs 6-7% for Accenture) and better operating margin (26% vs 15% for Accenture, LTM).

Revenue growth slightly ahead of consensus

Revenue grew 9% YoY in cc terms, which is at the top-end of its guidance range of 6-9%. Revenue growth was 8% YoY in USD terms, 0.6% ahead of consensus.

Revenue growth guidance of 5-8% YoY in cc terms was lower than FY16 revenue growth of 10%. However, this is likely better than what consensus had feared given worries around Brexit and anecdotes of customers underspending budgets.

Key takeaways from the conference call

BFSI segment grew by a healthy 9% YoY in cc terms driven by spends in: 1) digitizing the customer channel, 2) cost rationalization, and 3) risk and regulatory compliance. Management said it has not seen any impact of Brexit so far but it remains cautious.

Still early days for digital: Management highlighted that digital adoption is still in the early stages and expects the opportunity to last at least a decade. Whilst Indian IT is relatively disadvantaged in the early stages of digital, eventually its traditional advantages of lower cost structure, knowledge of legacy systems, and relationships with CIOs will become important.

Segmental growth

(Unless mentioned, all the growth numbers below are YoY in cc terms.)

Consulting segment (telling customers what to do in digital) grew 15% whereas outsourcing grew 6%. This material outperformance was due to higher growth in the digital segment (30%).

Among verticals, products grew the strongest at 15% while communications, media and technology grew the slowest at 9%. Management indicated caution in the communication segment, especially in Europe. We think it is losing market share to Indian peers which reported decent growth in this segment recently.

Growth was broad-based across geographies with North America, Europe, and Rest of World growing by 11%, 11% and 8%, respectively. Management informed that the company is well-positioned to respond to the consequences of Brexit in Euro zone.

Other metrics

Attrition slightly increased to 16% vs 15% (May-16 quarter).

Headcount grew at 7.3% YoY while utilization increased to 92% from 91% (May-16 quarter)

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Sagar Rastogi [email protected] Tel: +91 22 3043 3291 Sudheer Guntupalli [email protected] Tel: +91 22 3043 3203



AMBIT INSIGHTS


Where do we go from here?

The demand environment has worsened since Brexit as reflected in commentary by both customers (Citigroup, Caterpillar, McDonalds) and IT services players and as per channel checks. However, the headwinds are temporary for top-tier Indian vendors and, in that context, current valuations are attractive. We prefer vendors with resilient portfolios, low price positioning, and strong customer connect like TCS and TechM (our top BUYs).

TCS (BUY): Despite high exposure to BFSI (40%), TCS is well-placed among peers to manage headwinds in demand environment due to its resilient portfolio mix (much higher proportion of revenue from annuity-like, run-the-business IT spend), low price positioning (backed by best-in-class cost structure) and strong customer connect (it has over 37 US$100mn customers, more than 2x the nearest Indian IT competitor).

TCS remains well-positioned to gain market share (currently under 3%) in global IT services driven by low cost structure, conservative investments in new growth areas (e.g. Japan, automation) and track record of high-quality delivery (has best customer references in almost every segment). Its processes and culture are hard to replicate, which ensures high RoE (FY16A: 37%). The business is also highly cash-generative (FY16 pre-tax CFO/EBITDA: 93%, FY16 FCF/net-income: 78%), which management is willing to share with investors (FY16 dividend payout at 57%).

TCS trades at 18x one-year forward earnings vs. 22x for Accenture despite faster organic revenue growth (10-11% YoY in organic, cc terms, LTM vs. 6-7%) and better operating margin (26% vs. 15%, LTM).

TechM (BUY): We like TechM because of its strong capabilities in telecom (50% of revenues, Top-3 globally ahead of all Indian peers) as well as numerous internal margin levers such as offshoring, lower usage of subcontractors, improving employee productivity through code re-use, low-level automation, and cost rationalisation at the recently acquired LCC. Its FY17 EBIT margin is about 600bps below its normalised target margin of 19.5%, which it last achieved in FY14. Over each of the past five quarters (adjusted for seasonal volatility, impact of currency movements and drag from LCC), margins have been steadily improved. In this context, current valuations are attractive at 11x one-year forward earnings.

Exhibit 1: Accenture’s Q4 and FY16 results were in line with expectations

US$mn Aug-16 Aug-15 YoY May-16 QoQ Consensus est. % Diff

Revenue 8,489 7,889 7.6% 8,435 0.6% 8,437 0.6%

Adj. EBIT 1,195 1,094 9% 1,306 -8% 1,190 0.4%

EBIT margin 14.1% 13.9% 20bps 15.5% -140bps 14.1% 00bps

Adj. EPS 1.2 1.2 5% 1.4 -14% 1.3 -4%

Source: Company, Ambit Capital research; Note: EBIT, EBIT margin and EPS adjusted for one time pension settlements and gain on asset sale

AMBIT INSIGHTS


Strategy Ten interesting things that we read this week At Ambit we spend a lot of time reading articles that are not directly relevant to Indian stocks. However, since the Indian economy is now umbilically linked to its global counterparts, the articles that we come across have relevance for Indian stocks and the Indian economy. In that context, this report contains the ten most interesting pieces that we read this week.

1) The return of Bollywood’s unconventional hero [Source: LiveMint] (https://goo.gl/llOZgF)

The recently released sports film, Freaky Ali, banked singularly on the rustic appeal of its lead actor Nawazuddin Siddiqui – an Indian actor who has made a mark in Bollywood in spite of his commonplace vibe and looks. This evolution in the industry’s dynamics has stemmed from audiences wanting to see characters who looked and behaved like them, people who lived in commonplace Indian settings rather than in fancy houses abroad.

Middle-of-the-road cinema may have been a significant phenomenon in the 1980s but the period afterwards was far bleaker. The coming of video, in the words of director Tigmanshu Dhulia, killed cinema. Plus, the condition of theatres, then single-screens, started going down and family audiences stopped going to movie theatres altogether. The decade of the 1990s is remembered for the crucial positioning of the NRI (non-resident Indian) in Hindi films marked by stereotypes like big stars, affluent lifestyles and fancy locations, and the work of young filmmakers like Aditya Chopra, Karan Johar and Sooraj Barjatya. “All these south Indian remakes and corny films came up. Then the overseas market came in, films became beautiful and we forgot about real Indians again” said Dhulia.

Things changed in the 2000s — there was the multiplex explosion and it became viable to make alternative cinema, as theatres went from 500-700 seaters to 50-80 seaters. And 40 out of 500 seats filling up didn’t make commercial sense, 40 out of 80 seats did. Secondly, filmmaking itself changed with directors and writers who were not part of film families coming from different parts of the country to Mumbai to tell different stories. The likes of Kabir Khan, born in Hyderabad and educated in Delhi; Imtiaz Ali from Jamshedpur; and Anurag Kashyap and Abhinav Kashyap, who grew up in Uttar Pradesh, have all changed the texture of filmmaking. Along with the new talent came the evolution in budgets. An “item” film which follows a certain formula and has an almost fixed kind of return thanks to a dynastic star cast, has a budget that requires producers to go for actors that are bankable. Strong content driven films had smaller budgets and complimented their returns through pre-sales and selling other rights. The focus of smaller budget films is not on the box-office collections but on longevity - content-driven high-concept films have a shelf life far beyond the films made primarily for money.

2) Banks face $5bn hit to research teams as asset managers cut spending [Source: Financial Times] (https://goo.gl/siSqLg) Text for google: Drop in asset managers’ budgets driven by new European rules

Asset managers intend to cut their analyst research budgets by 30 per cent, heaping more pain on the investment banking industry that has already been forced to make thousands of people redundant on the back of falling profitability. The sharp reduction in how much fund houses are willing to pay for research will be felt most strongly in Europe, where asset managers plan to halve how much they spend on sell side research. The cuts to research budgets, which are estimated to be worth $15bn a year, will trigger further job cuts for analysts and the potential elimination of entire research divisions.

The drop in asset managers’ research budgets has been driven by new European rules that have forced fund companies to provide a clear budget for research costs to their investors. Previously asset managers paid for research as part of a bundled mix of services that included payments for equity or fixed income trading.

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Prashant Mittal, CFA [email protected] Tel: +91 22 3043 3218

Saurabh Mukherjea, CFA [email protected] Tel: +91 22 3043 3174

http://www.livemint.com/Consumer/G6P6dM8MNK4zNsgtEUFtEL/The-return-of-

https://www.ft.com/content/14bee15e-7c15-11e6-



AMBIT INSIGHTS


The new regulatory regime has made investment groups question how much research from analysts or brokers is truly worth. On the back of this some large fund companies are turning to high-quality independent research providers, or doing more research in-house, rather than relying on bank analysis that comes with unclear pricing policies.

3) Driverless cars and MIT’s test of the crowdsourcing morality [Source: Financial Times] (https://goo.gl/UGktG9) Text for google: While your morals and ethics match those of other people

Anjana Ahuja talks about the Moral Machine — a public experiment being run by MIT — which looks at whether aggregating public opinions on ethical dilemmas is an effective way to endow intelligent machines, such as driverless cars, with limited moral reasoning capacity. Anjana herself argues against such a step and cites the recent case of Tesla being sued in China over the death of a driver of a car equipped with its Autopilot function.

Anyone with a computer and a coffee break can contribute to MIT’s mass experiment, which imagines the brakes failing on a fully autonomous vehicle. The vehicle is packed with passengers, and heading towards pedestrians. The experiment depicts 13 variations of the “trolley problem” — a classic dilemma in ethics that involves deciding who will die under the wheels of a runaway tram. In MIT’s reformulation, the runaway is a self-driving car that can keep to its path or swerve; both mean death and destruction. The choice can be between passengers and pedestrians, or two sets of pedestrians. Calculating who should perish involves pitting more lives against fewer, young against old, professionals against the homeless, pregnant women against athletes, humans against pets.

At heart, the trolley problem is about deciding who lives, who dies — the kind of judgment that truly autonomous vehicles may eventually make. She shares the results of this experiment which showcase how diverse opinions of people are. She says while we could argue over the technical aspects of dishing out death judiciously, for example, if we are to condemn car occupants, would we go ahead regardless of whether the passengers are children or criminals? If anything, this experiment demonstrates the extreme difficulty of reaching a consensus on the ethics of driverless cars.

As a result, she’s pessimistic about reaching a norm by simply pooling our morality. She believes that this is the hurdle faced by makers of self-driving cars, which promise safer roads overall by reducing human error. Who will buy a vehicle run on murderous algorithms they do not agree with, let alone a car programmed to sacrifice its occupants?

4) German consumers hit the ‘sweet spot’ [Source: Financial Times] (https://goo.gl/iL6LNj) Text for google: Low interest rates and high confidence

Germans have a well-earned reputation for thrift, but in the past year they have turned into uncharacteristically big spenders thanks to a combination of record high employment, rising wages, low inflation and near-zero interest rates. Private consumption is growing at about 2 per cent — a rate Germany has not seen since the dotcom boom of the late 1990s. For economists, the shift is significant. Germany has long relied on exports, which make up almost 40 per cent of GDP, to drive growth. The wage restraint showed by German workers helped underpin that by maintaining competitiveness. But it also came at a price — low income growth and sluggish domestic demand, one of the reasons why Germany’s current account surplus is so big.

There are signs that the model could be changing. The slowdown in emerging markets has tamed demand for German exports. As a result, companies are investing less but German domestic demand is kicking in and taking up the slack, creating a more balanced economy. For years, economists have said that Germans could help the whole eurozone economy by spending more and saving less. But so far, saving rates have remained doggedly high, at about 10 per cent.

https://www.ft.com/content/8fc7fde0-7f21-11e6-8e50-

https://www.ft.com/content/fb8a1c8c-7f00-11e6-8e50-8ec15fb462f4)

AMBIT INSIGHTS


Now Germans do feel a little bit richer — and are spending accordingly. Real disposable income grew 2.4 per cent last year, partly driven by a rise in employment. Some 43.6m people were in work in July, the highest number since German reunification 26 years ago, and the unemployment rate is just 6.1 per cent.

A long period of belt-tightening has also come to an end. In the 2000s, Germany undertook a sweeping reform of its labour market and welfare system, known as Agenda 2010. While the changes were often credited with improving the country’s economic performance, there was plenty of short-term pain, in the form of higher unemployment and cuts to out-of-work benefits. Meanwhile, during and after the 2008 financial crisis, unions agreed to a policy of wage restraint to prevent mass lay-offs. That has been cast aside, and wages rose 2.4 per cent last year. That growth, combined with low inflation and low rates is a “dream scenario for consumption”.

5) How Kickstarter became one of the biggest powers in publishing crowdfunding [Source: The Guardian] (https://goo.gl/QUtGkT)

Kickstarter - a platform that puts people who want to produce books in touch with others all over the world who want to support their projects - has an impressive tally of books published. At 2,967 literary projects it features among publishing’s “Big Four”: Penguin Random House, Harper Collins, Hachette and Simon & Schuster. While the publishing “lead”, Margot Atwell, makes it clear that the site “definitely doesn’t supplant the role of editor, publicist or publisher” and is really “just one more tool an author or publisher can use to connect with readers and spread the word about their book”, writers all over the world are choosing this new route to publication in unprecedented numbers. In 2015, pledges totalled $35.2m and already in 2016 more than $20m has been pledged for more than 1,500 projects.

For Atwell, projects that tend to be successful on the site are “ideas that ignited the imaginations of a community, creators providing greater access to their creative process, and voices that are often underrepresented among the most commercial success stories”. According to her, certain communities, such as the comics world, have been faster to integrate Kickstarter into their process. Using Kickstarter lets creators gain support for their project in advance, so they can make something great that they might not otherwise have been able to make. Projects to create beautiful hardcover books, especially art books, children’s books, and comics in colour, tend to be more costly to produce, which might be why a lot of those creators come to Kickstarter.

Atwell says one of the most exciting things about crowdfunding is the way it inverts publishing’s conventional publicity dynamic. “When you’re creating a book, it’s very affirming to know that it’s something there is desire and demand for, versus the traditional publishing model of investing in an author and the production of a book, trying your darnedest to get the word out and reach readers, but not really knowing whether there is a readership”, she says. This model has seen substantial sums of money devoted to projects in areas where traditional publishing often struggles. Literary journals raised more than $200,000 on Kickstarter in 2015, while poetry received almost $300,000. Anthologies brought in almost $500,000, while art books picked up more than $4m.

6) What goes wrong in the brain chemistry of a gambling addict [Source: nautil.us] (https://goo.gl/GOZkbn)

This piece uses the case study of a compulsive gambler at slot machines to study the reasons why we humans tend to get addicted to certain activities with skewed risk-reward profiles which are not in our favor – like gambling. Gambling addiction stands out for its destructive power and pull. With substance problems, people can blame the chemical activity of drugs and argue that addiction occurs when repeated exposure physically alters the brain. But gambling causes life catastrophes that are at least as extreme—sometimes more—without any kind of foreign psychoactive chemical getting under the skin.

https://www.theguardian.com/books/2016/sep/14/how-kickstarter-became-one-

http://nautil.us/issue/40/learning/addicted-to-anticipation)

AMBIT INSIGHTS


B. F. Skinner, who laid out the fundamental principles of learning through reward and punishment in the mid-20th century, told people that slot machines were basically human versions of the famous “Skinner boxes” he made for rats and pigeons. Like the animals in their cages, slots players would pull a lever and wait to either receive a reward or not. Early in his research, Skinner accidentally discovered an important factor that makes gambling addictive - instead of rewarding the rats every time they pushed the lever, he did it only once a minute. To his surprise, the intermittent reward made them push more, not less. He likened this scenario to random rewards of a slot machine. This is the paradox of the learning that is at the heart of addiction—whether to gambling, cocaine, shopping, or heroin—and it offers clues about what’s going wrong in the brain.

Over the course of evolution, many situations have required animals to persist despite negative outcomes; for mammals and particularly humans, finding and keeping a mate and rearing needy and demanding offspring are among the biggest such challenges. When working properly, our basic motivational systems drive us to seek partners, despite rejection, fights, fears, and other challenges. They set our priorities, pulling or pushing us toward what their calculus determines is most likely to allow us to survive and reproduce. Our emotions, in fact, are fundamentally algorithms for rapid decision-making, which may have been shaped by the history of what actions best promoted survival and reproduction. In addiction, the paraphernalia - the slot machine - becomes the focus rather than a person. And when intense drive and a feeling of biological urgency get directed toward a drug or activity like gambling, serious problems can occur.

Gambling addiction rests on intermittent reinforcement alone—the experience of risk, the fact that there will be either loss or gain, creates excitement and the more unpredictable the outcome, the more compelling it becomes. This is another reason why compulsive gamblers continue whether they win or lose—the high is in expecting an outcome, desiring that outcome, imagining it, not in its fulfillment. Brains are, in essence, prediction machines, which is why no one likes uncertainty and why solving mysteries provides such a sense of satisfaction. We seek patterns and connections especially in randomness. That makes unpredictable patterns of reward—like playing the slots—into compelling puzzles that can draw us in, even if we know rationally that the odds are against us. This patterning can fool the brain into prioritizing an addiction.

7) How important is a company’s patriarch? [Source: horizonlinetics.com] (https://goo.gl/unoNWw)

John M Studebaker was in the business of making covered wagons in the 1850s. Inspite of the threat coming from the evolution of the automobile business due to invention of the internal combustion engine in the 1880s, John M. transformed his company (Studebaker Company) into one of the leading automobile manufacturers of the time. Sadly, after John M. died in 1917, there was no longer a so-called patriarch in charge of the company. Those who subsequently took control of the company engaged in a number of transactions – takeovers, leverage, etc. that John M., despite his lack of professional training, probably would never have endorsed or, at least, he didn’t employ them while he was in charge of the company. Eventually, under the balance sheet pressure the company was unable to grow profitably and went out of business in 1966.

It’s amazing to see the number of defunct American car brands and companies that found their way into automobile history during the last 100 years. As a group, they probably have one of the lowest survivability ratios of any industry you can imagine, which probably explains why there isn’t an automobile ETF right now. The challenge is to find a quantifiable index that could be used as a predictor for lack of survivability. In searching for a common denominator in the failure of so many of these companies that had previously enjoyed periods of success, the common element that emerges is the demise of the patriarch. For example, the Stutz Automobile Company, which made the Stutz Bearcat, a luxury automobile in its day, was fabulously profitable until the founder, Harry C. Stutz, died in 1930.

http://www.horizonkinetics.com/sm_survivability_of_auto.asp)

AMBIT INSIGHTS


In 1935, Stutz went out of business. Similarly the Chrysler Corporation was never the same post the death of Walter Chrysler.

8) Wells Fargo reaches the end of its journey [Source: Financial Times] (https://goo.gl/00LHzz)

Text for google: The old lesson applies to the bank’s success

Wells Fargo’s homely and customer centric reputation has been tarnished by the revelation that its winning ways with customers owed as much to the intense pressure it placed on employees to hawk products as to its friendly culture. Managers pressed “stores” (Wells Fargo’s term for branches) to hit daily targets, leading to the faking of as many as 2m accounts. It has since dismissed 5,300 miscreant staff and been fined $185m.

Wells Fargo was the exception during the financial crisis. It has an investment bank but did not get subsumed by trading, or lose its shirt on subprime mortgages. Its brush with the 2008 crisis was to acquire Wachovia amid the financial turmoil, cleverly gaining itself a nationwide branch network. Its leaders constantly extolled its virtues: it is unglamorous, even boring compared with Wall Street, but it offers stability. Now the Wells Fargo incident brings to notice the same very sorry tale that one could’ve seen when the banks were trying to reboot themselves in the early 1990s. They were then trying to recover from credit crises in Latin America and US commercial property, particularly in California, and made inadequate returns on capital. They vowed to become more profitable and less cyclical.

While one set of banks, such as Deutsche, have tried to raise profitability by expanding into investment banking, a higher margin, more exciting business, the retail bankers have tried to improve returns by diversifying away from overreliance on lending and persuading customers to hold not only loans and current accounts, but also credit cards, mortgages, insurance, investment accounts and other financial products. Wells Fargo became the exemplar: its retail customers now have an average of more than six products and it gains almost as much revenue from fees and commissions as from interest on loans.

While the bank claims that it only offered products that the customers needed, regulators found numerous cases of staff opening accounts for customers without telling them, or fooling them into taking credit cards. The bank became more of a sales machine than a traditional bank. While Mr Stumpf – the bank’s CEO promised to clean up the mess, by stopping cross-selling, it is left with a strategic hole. That is not only a problem for his bank, but for all those that tried to do the same. The model for making retail banking profitable has run aground again.

9) What NASA could teach Tesla about Autopilot’s limits [Source: Scientific American] (https://goo.gl/WxyR9k)

Ever since the recent incident involving Tesla’s Model S which led to driver Joshua Brown’s death (when the car’s Autopilot system failed to recognize a tractor-trailer turning in front of the vehicle) came to light, the public has been debating where the fault lies: with the driver, the company or the automation technology itself. But NASA has been studying the psychological effects of automation in cockpits for decades—and this body of research suggests that a combination of all three factors may be responsible.

NASA has known for years how humans and automated vehicles behave together. Tesla may need to pay more attention to what NASA knows. The first involves constant monitoring and supervision of the automated systems called “being on the loop” of the process, something air traffic controllers do for the commercial planes flying in their airspace. However, comparison between a car and plane is not right. While an airplane is eight miles high in the sky, giving ample time to pilots to react in case anything goes wrong, automobile drivers, for obvious reasons, often have much less time to react.

Tesla acknowledges this by constraining the circumstances in which a driver can engage Autopilot. But Brown’s death suggests that, even within this seemingly conservative envelope, driving “on the loop” may be uniquely unforgiving. Tesla

https://www.ft.com/content/5fac69be-7e56-11e6-8e50-8ec15fb462f4)

http://www.scientificamerican.com/article/what-nasa-could-teach-

AMBIT INSIGHTS


also says that it has measures to counter the ordinary human negligence that can turn even the safest automation deadly. Its Autopilot “makes frequent checks to ensure that the driver’s hands remain on the wheel and provides visual and audible alerts if hands-on is not detected.” But NASA has been down this road before and reveals that in its research it found a peculiar psychological pattern: the more foolproof the automation’s performance becomes, the harder it is for an on-the-loop supervisor to monitor it. In fact, it’s extremely difficult for humans to accurately monitor a repetitive process for long periods of time. This is known as “vigilance decrement”.

These findings expose a contradiction in systems like Tesla’s Autopilot: the better they work, the more they may encourage us to zone out—but in order to ensure their safe operation they require continuous attention. This potentially dangerous contradiction is baked into the demand for self-driving cars themselves. No one is going to buy a partially-automated car [like Tesla’s Model S] just so they can monitor the automation.

10) The free time paradox in America [Source: The Atlantic] (https://goo.gl/MXFW4E)

In 1930, the economist John Maynard Keynes forecasted a future that would be governed by a different set of expectations than today. The 21st century’s work week would last just 15 hours, he said, and the chief social challenge of the future would be the difficulty of managing leisure and abundance. The rich were meant to have the most leisure time. The working poor were meant to have the least. But 60 years later, it seems more true to say that it is not leisure that defines the lives of so many rich Americans. It is work. Elite men in the U.S. are the world’s chief workaholics. In the last generation, they have reduced their leisure time by more than any other demographic.

At the other end, however, are the twenty something male high-school grads that today are less likely to work, less likely to marry, and more likely to live with parents or close relatives as compared to the past. One in five of these young men who didn’t go to college are essentially idle and three quarters of their additional leisure time is spent with video games. And yet young men in this age group self-report higher satisfaction than this age group used to, even when its employment rate was 10 percentage points higher!

What could explain this anomaly? Firstly, the availability of attractive work for poor men (especially black men) is falling whereas the availability of cheap entertainment is rising. At the very moment that the labour market obliterated manufacturing jobs and shifted toward more soft-skill service jobs, diversion became a vastly discounted experience that could provide a moment’s joy at home. Secondly, social forces cultivate a conspicuous industriousness (even workaholism) among affluent college graduates. Most rich people work long hours because they are matching the behaviour of similarly rich and ambitious people. However, those who don’t belong to this elite group have less compunction or guilt about being idle. Thirdly, and more importantly, leisure is getting “leaky.” Thanks to smartphones and computers, leisure activity is leaking into work, and work, too, is leaking into leisure fading the boundaries between our professional and personal time.

http://www.theatlantic.com/business/archive/2016/09/the-free-time-paradox-in-

AMBIT INSIGHTS


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research Analysts

Name Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected] Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected] Abhishek Ranganathan, CFA Retail (022) 30433085 [email protected] Achint Bhagat, CFA Cement / Home Building (022) 30433178 [email protected] Anuj Bansal Mid-caps (022) 30433122 [email protected] Aditi Singh Economy / Strategy (022) 30433284 [email protected] Ashvin Shetty, CFA Automobile (022) 30433285 [email protected] Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected] Deepesh Agarwal, CFA Power Utilities / Capital Goods (022) 30433275 [email protected] Dhiraj Mistry, CFA Consumer (022) 30433264 [email protected] Gaurav Khandelwal, CFA Automobile (022) 30433132 [email protected] Girisha Saraf Mid-caps / Small-caps (022) 30433211 [email protected] Karan Khanna, CFA Strategy (022) 30433251 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected] Paresh Dave, CFA Healthcare (022) 30433212 [email protected] Parita Ashar, CFA Metals & Mining / Aviation (022) 30433223 [email protected] Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 [email protected] Rahil Shah Banking / Financial Services (022) 30433217 [email protected] Rakshit Ranjan, CFA Consumer (022) 30433201 [email protected] Ravi Singh Banking / Financial Services (022) 30433181 [email protected] Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 [email protected] Ritesh Vaidya, CFA Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected] Ritu Modi Automobile (022) 30433292 [email protected] Sagar Rastogi Technology (022) 30433291 [email protected] Sudheer Guntupalli Technology (022) 30433203 [email protected] Sumit Shekhar Economy / Strategy (022) 30433229 [email protected] Utsav Mehta, CFA E&C / Industrials (022) 30433209 [email protected] Vivekanand Subbaraman, CFA Media (022) 30433261 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7886 2740 [email protected] Dharmen Shah India / Asia (022) 30433289 [email protected] Dipti Mehta India / USA (022) 30433053 [email protected] Hitakshi Mehra India (022) 30433204 [email protected] Krishnan V India / Asia (022) 30433295 [email protected] Nityam Shah, CFA USA / Europe (022) 30433259 [email protected] Parees Purohit, CFA UK / USA (022) 30433169 [email protected] Praveena Pattabiraman India / Asia (022) 30433268 [email protected] Shaleen Silori India (022) 30433256 [email protected] Vishal Mehta India / Asia (022) 30433198 [email protected]

Singapore

Pramod Gubbi, CFA – Director Singapore +65 8606 6476 [email protected] Shashank Abhisheik Singapore +65 6536 1935 [email protected]

USA / Canada

Ravilochan Pola - CEO Americas +1(646) 361 3107 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected] Sharoz G Hussain Production (022) 30433183 [email protected] Jestin George Editor (022) 30433272 [email protected] Nikhil Pillai Database (022) 30433265 [email protected]
















































AMBIT INSIGHTS


Maruti Suzuki India Ltd (MSIL IN, SELL)


Ashok Leyland Ltd (AL IN, BUY)


Bajaj Auto Ltd (BJAUT IN, SELL)


Hero Motocorp (HMCL IN, SELL)


01,0002,0003,0004,0005,0006,000

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

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-15

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-15

Jul-

15

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-

16

Sep-

16

Maruti Suzuki India Ltd

020406080

100120

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

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-15

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-15

Jul-

15

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-

16

Sep-

16

Ashok Leyland Ltd

0500

1,0001,5002,0002,5003,0003,500

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

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-15

Jul-

15

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-

16

Sep-

16

Bajaj Auto Ltd

0

1,000

2,000

3,000

4,000

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

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-15

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-15

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15

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-

16

Sep-

16

Hero MotoCorp Ltd

AMBIT INSIGHTS


Eicher Motors Ltd (EIM IN, SELL)


TVS Motor (TVSL IN, BUY)


Tata Motors (TTMT IN, BUY)


Balkrishna Industries Ltd (BIL IN, SELL)


05,000

10,00015,00020,00025,000

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

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14

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-14

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15

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-15

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-15

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15

Sep-

15

Nov

-15

Jan-

16

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-16

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-16

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16

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16

Eicher Motors Ltd

0

100

200

300

400

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13

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-13

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14

Mar

-14

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-14

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14

Sep-

14

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-14

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15

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-15

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-15

Jul-

15

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15

Nov

-15

Jan-

16

Mar

-16

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-16

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16

Sep-

16

TVS Motor Co Ltd

0

200

400

600

800

Jan-

13

Mar

-13

May

-13

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13

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13

Nov

-13

Jan-

14

Mar

-14

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-14

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14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

Nov

-15

Jan-

16

TATA MOTORS LTD

0200400600800

1,000

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

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-15

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-15

Jul-

15

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-

16

Sep-

16

Balkrishna Industries Ltd

AMBIT INSIGHTS


Tata Steel Ltd (TATA IN, SELL)


Steel Authority Of India (SAIL IN, SELL)


Tech Mahindra Ltd (TECHM IN, BUY)


Tata Consultancy Svcs Ltd (TCS IN, BUY)


0100200300400500600700

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

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-15

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15

Sep-

15

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-15

Jan-

16

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-16

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-16

Jul-

16

Sep-

16

Tata Steel Ltd

020406080

100120

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

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-15

Jan-

16

Mar

-16

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-16

Jul-

16

Sep-

16

Steel Authority of India Ltd

0

200

400

600

800

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

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-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-

16

Sep-

16

Tech Mahindra Ltd

0500

1,0001,5002,0002,5003,000

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-

16

Sep-

16

Tata Consultancy Services Ltd

AMBIT INSIGHTS


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events

NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock POSITIVE We have a positive view on the sector and most of stocks under our coverage in the sector are BUYs

NEGATIVE We have a negative view on the sector and most of stocks under our coverage in the sector are SELLs

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Additional information on recommended securities is available on request.

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AMBIT INSIGHTS


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