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AMBIT INSIGHTS 2 May 2016

DAILY

G&C 10.0

Company name Weight (%) Rating FY17

P/E (x)

PI Industries 3.3 BUY 24.2

Tata Motors 3.3 BUY 8.9

TVS Motors 3.3 BUY 21.5

MRF Ltd. 3.3 NR 7.4

Mahindra CIE. 3.3 BUY 19.7

Atul Ltd. 3.3 NR 16.7

Titan 3.3 BUY 33.3

Page Industries 3.3 BUY 45.4

ITC 3.3 BUY 21.6

HUL 3.3 BUY 36.5

Marico 3.3 BUY 36.4

AIA Engineering 3.3 BUY 24.5

Axis Bank 3.3 BUY 12.8

IndusInd Bank 3.3 BUY 21.7

Bank of Baroda 3.3 BUY 10.0

SCUF 3.3 BUY 14.7

City Union Bank 3.3 BUY 10.4

DCB Bank 3.3 NR 14.4

Havells. 3.3 BUY 30.2

Berger Paints 3.3 BUY 36.5

Supreme Industries 3.3 BUY 25.1

Gujarat Pipavav 3.3 NR 25.9

TCS 3.3 BUY 19.0

HCL Tech 3.3 BUY 12.1

IGL 3.3 BUY 15.5

Lupin 3.3 NR 23.0

Torrent Pharma 3.3 NR 18.8

Ajanta Pharma 3.3 NR 28.3

Idea Cellular 3.3 NR 24.0

Power Grid 3.3 BUY 9.6

Source: Bloomberg, Ambit Capital research

NR – Not Rated

Note: For further details, please refer our note dated Feb 05, 2016

Updates

Parag Milk Foods – Pre IPO Note

Richly priced B2C dairy play; AVOID

Atul Limited (NOT RATED)

Right place, right focus

Utilities

India’s power story, retold

Results Update

Marico (BUY)

Solid all-round performance

Cholamandalam Finance (BUY)

Strong trends + key catalysts materializing

Federal Bank (SELL)

Execution risks stay high

Motilal Oswal (BUY)

One-offs impact the results

Weeklies

BFSI

Weekly tracker

Economy

Ambit’s qualitative leading indicators’ (QLI) tracker

Utilities

Weekly tracker

Please refer to our website for complete coverage universe

http://research.ambitcapital.com

http://research.ambitcapital.com

http://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_Good&Clean10_05Feb2016.pdf

AMBIT INSIGHTS

Ambit Capital Pvt Ltd 2 May 2016

Analyst Notes: Consumer: Jubilant Foodworks - High on promotions low on tech and SSG Abhishek Ranganathan, CFA, +91 22 3043 3085

Domino’s has been able to clock consistent SSG in the UK, Australia and the USA largely due to limited price hikes combined with technologically backed innovations in delivery and customer outreach. Domino’s UK, for instance, has taken price hikes at a CAGR of 1.5% (including product mix change) over CY10-CY15 as against the 10% CAGR by Jubilant in India. More importantly, internationally, Domino’s has continuously engaged consumers by introducing unique innovations such as 13 minute delivery (in Australia) and one click ordering. The India business has lagged on this front even as it pursues an own store model as against the sub-franchising model followed in other countries. Moreover, impact of promotions seems to be waning as web traffic/searches declined in 4QFY16. Continued weak volume growth could pressure gross margins (see our report dated 4th March 2016). The stock is trading at expensive multiple of 57x FY17E earnings (just below 60x of high-SSG phase). We remain SELLers. Source: Ambit Capital research

AMBIT INSIGHTS


Parag Milk Foods Richly priced B2C dairy play; AVOID Parag Milk Foods (PMFL) has two of the strongest B2C dairy brands (Gowardhan and Go) among private players in India. With 80% of milk sourced directly from farmers and chilling centres, PMFL has the best milk procurement mix. While strong brands and reliable milk procurement should help PMFL deliver over 15% sales CAGR over FY16-18, we see limited potential for EBITDA margin growth as pan-India expansion plans would inflate A&P investments. Forensic checks reveal concerns over: a) weak ROCEs (10-12% historically) as working capital requirements rise with focus on cheese segment; b) related-party transactions for raw material; c) delayed interest payments over the past 2 years; and d) lower gross/EBITDA margins than peers despite higher share of value-added products. Beyond the de-leveraging led ~42% EPS CAGR over FY15-18 (with FY15-18 EBITDA CAGR of only 15%), we expect only mid-teens PAT growth over the longer term. As a result, at 21x FY18E EPS at the upper IPO price band of Rs227, it factors in more than the company’s strengths and growth prospects. AVOID.

About the company

PMFL started operations in 1992 as a 20,000 litres per day (lpd) dairy buying surplus cow milk from farmers in Manchar (near Pune in Western India). The promoter’s family has resided in this area since the 1950s. PMFL focused on selling liquid milk in the areas adjoining Mumbai and Pune and exporting skimmed milk powder (SMP). By 2004, when the Government banned export of milk powder due to a milk shortage in India, PMFL had become the largest exporter of SMP in India. When the ban hit sales, PMFL decided to focus on growing its value-added dairy products (VADP) under the brand, ‘Gowardhan’, with products such as ghee and butter. In 2008, PMFL set up the largest cheese manufacturing facility by a private player in India and started selling cheese to institutional and retail clients under the brand name ‘Go’. The company then launched brands such as ‘Pride of Cows’ (premium fresh milk) and ‘Topp Up’ (flavoured milk). About 90% of the company’s sales come from the B2C channel. Its B2B business comprises sale of cheese to institutional clients.

PMFL uses only cow milk and sources ~80% of it directly from farmers, village collection centres and chilling centres. It has two dairy plants – one at Manchar with processing capacity of 1.2mn lpd and another at Palamaner in Andhra Pradesh, set up in 2010, with processing capacity of 0.8mn lpd. The capacity for various products at the individual plants is provided in the Annexure.

Exhibit 1: PMFL has focused on building its brand portfolio over the last 15 years

1992 Parag Milk Foods started dairy operation in Manchar, near Pune

1998 Gowardhan brand launched to focus on ghee and butter

2005 Launched Bhagyalaxmi Dairy Farms

2008 Raised Rs600mn from Motilal Oswal PE; setup 40T cheese plant

2010 Launched 'Go Cheese' to market its cheese in retail channel; setup Palamaner Dairy plant

2011 Launched 'Pride of Cows' branded premium fresh milk

2013 Launched 'Topp Up' branded flavoured milk

2014 Launched whey products

2015 Launched 'Go Almette' cream cheese and 'Go Fresh' cream

Source: Company, Ambit Capital research

AVOID PRE-IPO NOTE Issue details

Price band Rs220-227/share

Number of shares (Pre-dilution) 70.4

Public issue of shares (mn) 33.8

- Offer for sale (mn) 20.6

- Fresh issue (mn) 13.2

Number of shares (Post-dilution) 83.6

FY15 EV/EBITDA at upper band 22.5


Research Analysts

Ritesh Vaidya, CFA [email protected] Tel: +91 22 3043 3246

Rakshit Ranjan, CFA [email protected] Tel: +91 22 3043 3201

mailto:[email protected]


AMBIT INSIGHTS


Use of funds

From the Initial Public Offer (IPO), PMFL plans to raise Rs3bn of fresh equity and Rs4.7bn of offer for sale (OFS) giving partial exit to: (1) two private equity investors Motilal Oswal and IDFC, and (2) the promoter family. With the fresh equity, PMFL plans to augment its milk processing capacity at both the plants and increase production capacity of VADP such as cheese, paneer, flavoured milk and whey. The company also plans to use some of the funds to set up an R&D facility and for marketing activities. Rs1bn will be used to pay down working capital loans.

Exhibit 2: Rs3bn of fresh equity to be largely spent on expanding value-added products capacity

Purpose Amount (Rs mn)

Fresh equity raised 3,000

Part pre-payment of working capital loan 1,000

Expansion and modernisation Plan 1,477

Capex at Manchar facility 923

Capex at Palamaner facility 452

Expansion of Marketing Infrastructure 103

Capex at subsidiary 23

General Corporate purpose 523

Source: Company

Exhibit 3: Milk handling and cheese capacity of Manchar plant to be expanded

Expansion and modernisation of the Manchar facility Outlay (Rs mn)

Expansion and modernisation of the effluent treatment plant 307

Expansion of cheese manufacturing facility from 40 MTD to 60 MTD 115

Expansion of milk handling capacity from 12 LLPD to 20 LLPD 38

Expansion of whey processing facility from four LLPD to 10 LLPD 146

Establishment of fully automated paneer manufacturing with capacity of 20 MTD 78

Expansion and modernisation of milk packing facility from two LLPD to three LLPD 82 Expansion of milk procurement facilities across various procurement centres in and around the Manchar facility 52

Setting-up of research and development facility 102

Contingency 2

Total outlay at Manchar 922

Source: Company

Exhibit 4: Milk handling and flavoured beverages capacities will be increased at Palamaner

Expansion and modernisation of the Palamaner facility: Outlay (Rs mn)

Setting-up new production line of milk based beverages of 0.3 LLPD 177

Expansion and modernisation of milk handling capacity from eight LLPD to 14 LLPD 33

Expansion and modernisation of curd manufacturing facility from 40 MTD to 60 MTD 5

Expansion and modernisation of liquid milk packing facility from 1.75 LLPD to 2.25 LLPD 4

Expansion and modernisation of UHT processing facility by 0.80 LLPD 41

Enhancement and modernisation of cold storage and warehousing facilities 124

Expansion of milk procurement facilities across various procurement centres 65

Contingency 1

Total outlay at Palamaner 452

Source: Company

AMBIT INSIGHTS


Key strengths Parag Milk Foods has delivered stellar growth rates in both sales as well as earnings over the past 3 years (see exhibits below), driven by the following strengths:

Strong brand equity: PMFL has created strong dairy brands such as Gowardhan (fresh milk) and Go (cheese).

Largest private dairy player: Amongst private dairy companies, PMFL has the largest cheese facility (40 tonnes per day), which it set up in 2008. It has created a niche for itself in the cheese category with a 32% market share.

Milk largely procured from direct sources: Milk procurement is one of the most important activities of a dairy company. PMFL sources ~80% of its milk directly from farmers or chilling centres, which ensures purity.

Good Board composition: PMFL’s Board has a good mix of dairy expertise (B M Vyas, who was MD of GCMMF, or Amul, for more than 15 years) and FMCG expertise (Narendra Ambwani, who was MD of Johnson & Johnson’s consumer group).

Exhibit 4: Net sales recorded a CAGR of 27% over FY12-15


Exhibit 5: PAT recorded a CAGR of 30% over FY12-15 due to improved profitability


Key concerns Our forensic analysis of the company suggests the following four areas of concern that investors need to address before subscribing to the IPO:

a) PMFL’s gross margin and EBITDA margin of ~25% and ~8%, respectively, are only in-line with those of peers despite a higher proportion of value-added product sales;

b) PMFL has high working capital requirements (~25% of sales) due to high working capital required for cheese production. As the firm focuses on cheese as a key revenue growth driver in the future, it runs the risk of further expansion in working capital cycle;

c) In the past, the company has defaulted on or delayed interest payments possibly due to lack of financial discipline or liquidity constraints;

d) PMFL procures some of its raw milk requirement from entities whose employees are majority shareholders, resulting in the possibility of conflict of interests.

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FY11 FY12 FY13 FY14 FY15

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EBITDA (LHS) EBITDA Margin

AMBIT INSIGHTS


Value-addition not reflected in PMFL’s margins Though PMFL derives over 50% of sales from value-added dairy products (VADP) compared with regional peers that derive most of their sales from B2B and liquid milk sales, PMFL’s margins are only in-line with those of peers.

Exhibit 6: PMFL’s margins are only in-line with regional peers despite higher VADP sales

Gross Margin FY11 FY12 FY13 FY14 FY15 9MFY16

Prabhat Dairy 20.9% 21.4% 21.5% 22.4% 22.7%

Hastun Agro 25.0% 24.8% 24.5% 25.8% 25.5% 28.1%

Dynamix 18.8% 22.4% 23.2% 20.4% NA NA

Kwality 9.2% 9.5% 8.4% 8.5% 8.7% 9.8%

Heritage Foods 23.5% 22.4% 25.5% 24.8% 21.4% 20.7%

Parag Milk Foods 22.0% 21.8% 25.4% 23.1% 23.6% 25.1%

EBITDA Margin FY11 FY12 FY13 FY14 FY15 9MFY16

Prabhat Dairy 10.1% 11.3% 10.6% 10.1% 10.7%

Hastun Agro 7.0% 6.8% 6.8% 7.1% 6.8% 9.1%

Dynamix 3.5% 7.1% 6.5% 4.7% Kwality 6.3% 6.9% 5.7% 5.9% 6.0% 6.3%

Heritage Foods 3.4% 3.8% 6.5% 5.6% 4.0% 7.0%

Parag Milk Foods 7.8% 8.8% 9.2% 7.5% 7.5% 8.7%


Sales realisation shows variance almost in-line with cost of raw milk, indicating low pricing power

Though 50% of its sales come from VADP, PMFL’s sales realisation per litre of milk procured shows variations in-line with cost of milk procured, which indicates weaker pricing power for its value-added products (see exhibit below). This is also reflected in the fact that variation in gross margin is in-line with the variation in the cost of raw milk.

Exhibit 7: PMFL’s sales realisation shows variance almost in-line with cost of raw milk

FY13 FY14 FY15 9MFY16

Raw milk cost (Rs/ltr) 18.3 23.8 23.9 16.1

Sales/ltr of milk procured (Rs) 28.6 34.1 34.7 29.9

Raw milk as % of sales/ltr 64% 70% 69% 54%

Gross margin (%) 25.4% 23.1% 23.6% 25.1%


Cost of raw milk as a percentage of sales/ltr is lower in 9MFY16 (see exhibit above) due to a sharp drop in milk prices (~30% down YoY) and also because the company resorted to producing ghee by using fat from butter procured from third parties. Producing ghee from its own procured cow milk (which has low fat content) leads to build of SMP (skimmed milk powder) which isn’t advisable in a low milk price environment. Purchase of butter from third parties has led to lower gross margin expansion of only 150bps although the cost of milk decreased by 1500bps YoY. We believe this can happen in future as well when milk prices correct similarly.

AMBIT INSIGHTS


Management’s explanation for lower gross margin not reflected in company’s accounting policy

Management attributes the lower margins to higher A&P spends undertaken to build brand equity. While this is a justified explanation for lower EBITDA margin, PMFL should have ideally had higher gross margin due to a higher proportion of value-added products in its mix. The company claims that it nets-off its ‘Below the Line’ (BTL) promotional spends directly from revenue in-line with the upcoming Indian Accounting Standards (Ind AS); however, its accounting policy as stated in the prospectus suggests that it is still using Indian GAAP. Also, its revenue recognition policy doesn’t mention this different sales booking policy.

Despite higher capacity utilisation of VADP production facilities, VADP’s proportion in sales mix hasn’t changed materially

Exhibit 8: Proportion of value-added products hasn’t changed materially in PMFL’s sales mix over the past 4 years Sales mix of manufactured goods by value FY13 FY14 FY15 9MFY16

Fresh Milk - includes sales of T-Star 23% 24% 20% 23%

Skimmed milk powder 21% 21% 23% 11%

Ghee 25% 22% 20% 32%

Cheese/ Paneer 20% 21% 20% 21%

UHT Products 1% 3% 4% 5%

Whey products 2% 2% 2% 3%

Other products 9% 7% 12% 5%

Total 100% 100% 100% 100%

Sales of VADP (ex- fresh milk and SMP) 56% 55% 58% 66%


As shown in the exhibit above, the proportion of VADP in the sales mix hasn’t changed materially over FY13-15. In 9MFY16, the proportion of VADP was higher due to lower SMP sales. We believe SMP sales were materially lower in 9MFY16 can be attributed to ~35% price correction rather than to reduced volumes. Moreover, despite higher capacity utilisation at the cheese facility (81% in 9MFY16 vs 44% in FY13), its proportion in the sales mix has remained constant at ~20%.

Exhibit 9: Utilisation of cheese capacity has been increasing at the Manchar plant; the Palamaner facility remains under-utilised

Manchar Palamaner

Capacity utilisation (%) 2013 2014 2015 9MFY16 2013 2014 2015 9MFY16

Milk processing 61 55 77 74 32 39 50 66

Milk powders 68 62 79 65 19 55 67 86

Liquid milk in pouches 54 70 82 62 76 50 34 41

Flavoured Milk 2 28 29 28 - - - 16

UHT Products - - - - 9 18 18 33

Cheese/Paneer 44 47 67 81 - - - -

Ghee 49 45 39 72 8 5 10 13

Butter* 18 6 17 17 13 30 62 81

Curd 55 48 27 43 48 63 51 75


AMBIT INSIGHTS


High working capital and low margins are a drag on RoCEs As shown in the exhibit below, PMFL’s working capital requirement at ~25% of sales is one of the highest amongst peers.

Exhibit 10: PMFL has among the highest working capital requirements in the peer space… Working capital as % of Sales FY11 FY12 FY13 FY14 FY15

Prabhat Dairy 0% 3% 7% 14% 20%

Hastun Agro 0% -2% 1% 0% -4%

Dynamix 11% 11% 15% 12% NA

Kwality 28% 31% 26% 26% 27%

Heritage Foods -2% -2% -3% -1% 1%

Parag Milk Foods NA 20% 30% 32% 25%

Source: Company. Ambit Capital research

Exhibit 11: …so considerable capital has been deployed for working capital needs by PMFL Working capital as % of Capital Employed FY11 FY12 FY13 FY14 FY15

Prabhat NA 4% 9% 21% 27%

Hastun Agro NA -7% 4% -1% -11%

Dynamix 37% 39% 45% 35% NA

Kwality 91% 89% 84% 87% 83%

Heritage Foods -7% -13% -12% -3% 4%

Parag Milk Foods 38% 48% 57% 57% 52%


PMFL’s working capital is high due to three reasons: a) high inventory days given 3-4 months needed to cure cheese and high inventory levels of SMP; b) high debtor days as the company has to offer credit in the channel to incentivise distributors and modern trade retailers to stock their products; and c) on-time payments to dairy farmers to maintain good ties.

While the higher working capital requirement is acceptable given Parag’s focus on cheese manufacturing, its impact isn’t offset by higher asset turns or higher margins. This has led to RoCE levels of just 10-12% for PMFL.

Exhibit 12: PMFL’s gross block turns are only in-line with that of peers

Gross block turnover (x) FY11 FY12 FY13 FY14 FY15

Prabhat Dairy 1.6 2.0 2.3 2.3

Hastun Agro 3.8 4.4 5.4 4.8 4.6

Dynamix 4.9 5.6 6.3 5.8 NA

Kwality 38.4 45.6 53.9 47.8 37.5

Heritage Foods 4.7 5.9 6.6 6.5 7.2

Parag Milk Foods 2.8 3.7 3.7 4.1 4.8


Exhibit 13: Higher working capital, lower asset turns and EBITDA margin lead to sub-standard RoCE for PMFL

RoCE FY11 FY12 FY13 FY14 FY15

Prabhat NA 5.9% 8.4% 8.9% 8.2%

Hastun Agro 14.5% 16.5% 18.9% 23.8% 14.4%

Dynamix 5.3% 12.4% 11.7% 7.6% NA

Kwality 15.0% 23.6% 18.7% 17.9% 16.9%

Heritage Foods 3.5% 10.3% 28.5% 20.9% 12.8%

Parag Milk Foods 0.5% 12.3% 12.6% 12.0% 10.4%


AMBIT INSIGHTS


Low scope for WC improvement as cheese remains the key focus area

PMFL plans to continue focusing on cheese as one of its main drivers of growth and has planned to expand cheese-making capacity from 40tpd to 60tpd by FY18. As mentioned, cheese has higher working capital requirement. Lower SMP sales are expected to only partly offset the impact of higher cheese sales on working capital. So, working capital will remain high and, if not offset by higher asset turns and EBITDA margin, would lead to mid-teens RoCE.

PMFL is eligible for a partial sales tax refund on sales in Maharashtra until FY19 under a tax incentive scheme by the State Government. PMFL pays the complete tax initially and then claims refunds. However, our channel checks suggest that the State Government normally delays these refunds, resulting in increased trade receivables and, hence, higher working capital for PMFL.

Exhibit 14: PMFL’s tax receivables as a percentage of working capital have been increasing over the years


Delay/default in meeting interest payments historically Auditors’ observations for FY14 and FY15 in PMFL’s Red Herring Prospectus (RHP) indicate that the company delayed payment of dues to banks. Also, for FY14 and FY15, subsidiary Bhagyalaxmi Dairy Farm Pvt Ltd defaulted on or delayed payment of dues to the bank. Consequently, two credit rating agencies, CRISIL and CARE, suspended their ratings on PMFL in Dec’14 and Apr’15, respectively, as the company failed to furnish financial details of its debt repayment plans. Our discussions with credit analysts suggest that suspension of rating is normally done when the agency believes a company could be facing liquidity issues. The company has also delayed paying the dues of one of its lenders due to a dispute. India Ratings & Research, another credit rating agency, issued a ‘Default’ rating to PMFL in Nov’15 following its delay in interest payment. This was subsequently upgraded to a moderate risk rating.

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PSI Incentive receivables (Sales Tax) Rs mn as % of Working Capital

AMBIT INSIGHTS


Exhibit 15: PMFL has a very high debt-to-equity ratio due to requirement of short-term borrowings to finance its working capital requirements


Given PMFL’s high debt-to-equity ratio, one cannot rule out a liquidity problem as a reason for delay in loan repayment. However, management claims the delay was caused by lack of financial discipline and not liquidity issues.

Exhibit 16: PMFL and its subsidiary delayed several bank repayments over FY14-FY15

Bank Amount (including interest) in Rs mn

Period of delay (days)

Delays by PMFL in FY14 EXIM Bank 5.86 61

EXIM Bank 5.74 40

EXIM Bank 5.76 49

Delays by PMFL in FY15 EXIM Bank 10.28 0 to 30 days

State Bank of India 29.65 0 to 30 days

Union Bank of India 113.55 0 to 30 days

Delays by Bhagyalaxmi Dairy Farms in FY14 Jammu & Kashmir Bank 30.55 100 to 268 days

Delays by Bhagyalaxmi Dairy Farms in FY15 Jammu & Kashmir Bank 48.25 0 to 90 days


Related-party transactions for ~20% of raw milk procured PMFL procures ~20% of its raw milk (see exhibit below) from related parties (where PMFL employee is a majority shareholder). In addition to procuring milk, the company has also extended advances to these companies. Poojan Foods is one of the key related parties from whom the company purchases a significant quantity of raw milk. These transactions raise the risk of conflict of interest.

8.1 7.5

6.1 5.9

4.4

- 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0


PMFL Debt/Equity (x)

AMBIT INSIGHTS


Exhibit 17: PMFL procures ~20% of its raw milk from related parties


Exhibit 18: Related parties have PMFL employees as their major shareholders

Related party Relation

Poojan Foods Pvt. Ltd. Sachin Shah, an employee of our Company and a cousin of our Promoters, was a director until September 5, 2015 and is a minority shareholder of Poojan Foods.

Akshara Milk Products Pvt Ltd.

Employee of PMFL along and his brother were 100% owners of Akshara till Mar'15. As per last filing, the employee is no more a shareholder of Akshara.

Shree Jogeshwari Milk Processors

An employee of PMFL together and his spouse are the majority partners of Shree Jogeshwari Milk Processors.

S.S. Milk Traders An employee of PMFL is the sole proprietor of S.S. Milk Traders.


Valuation: Overvalued We believe PMFL can deliver ~15% sales CAGR over the next 5 years given: a) strong brand equity of Gowardhan and Go, and b) ability to increase milk procurement from existing catchment areas. However, we remain sceptical about the potential for EBITDA margin expansion beyond 9-10% given: a) focus on highly competitive value-added product categories like ghee and flavoured milk will result in higher A&P spends; b) focus on cheese will lead to increase in working capital requirements; and c) global dairy and cheese majors operate at high single-digit EBITDA margins. These factors would limit RoCE to mid-teen levels. Beyond the de-leveraging led ~42% EPS CAGR over FY15-18 (EBITDA CAGR of only 15% over FY15-18), we expect only mid-teens PAT growth over the longer term. As a result, at 21x FY18E EPS at the upper IPO price band of Rs227, it factors in more than the company’s strengths and growth prospects. AVOID.

PMFL has sustainable competitive advantages in cheese…

In the VADP space, PMFL is the largest private dairy company in the cheese category with a 32% market share. We believe PMFL has a sustainable competitive advantage in cheese given it has: 1) the technical knowhow to produce cheese, and 2) high entry barriers provided by significant capital investments needed to set up and run a cheese facility and a strong brand to sell cheese. Apart from Britannia, which manufactures cheese through a third party, no other private dairy player has the attributes mentioned to create a competing cheese franchise.

…but faces high competitive intensity in other VADP categories

PMFL is adding capacity in flavoured milk, UHT milk, curd, paneer and whey proteins to drive growth in VADP. However, it will face intense competition in these VADP segments. This is because categories like curd, flavoured milk and yoghurt, UHT (under heat treatment) milk and paneer require low capital requirements and technical knowhow and, hence, would continue to see entry of regional private dairy companies and cooperatives.

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Raw milk procured from related parties as % of total milk procured

AMBIT INSIGHTS


Analysis of margins of global dairy companies suggests limited margin upside

An inspection of the profitability of global dairy companies like Nestle and Danone suggests that they derive higher operating margin (~20%) from categories such as baby milk and medical nutrition. However, In the fresh dairy products category that PMFL is targeting, these companies make an operating margin in the high-teens, except for Nestle which make mid-teens operating margin due to its premium positioning. More importantly, Bel which is a global cheese player with a diversified portfolio of premium cheese offerings, makes only ~30% gross margin and 8-9% operating margin.

Exhibit 19: Global dairy players make high single-digit operating margin in categories that PMFL is targeting to expand in India

Global player Category Operating margin

Nestle SA - Milk products and Ice cream 16-17%

- Nutrition 23-24%

Danone - Fresh dairy products 9-10%

- Nutrition 18-19%

Bel Cheese Gross margin of ~30%; Operating margin of ~8%


Limited scope for EBITDA margin expansion with mid-teens PAT growth after the initial de-leveraging benefit

With increased focus on cheese category, we believe PMFL can increase its EBITDA margin up to 9-10%. However, expansion beyond these levels will be limited by need to increase A&P spends to create brand equity in other highly clutter commoditised categories like ghee, flavoured milk beverages and yoghurt. As a result, whilst de-leveraging will support ~42% PAT CAGR over FY15-18, EBITDA margin CAGR over FY15-18 is unlikely to be higher than 15%. Hence, beyond FY18 (i.e. post deleveraging), we see limited scope for PAT growth beyond mid-teens. Increased focus on cheese category will increase working capital requirements with possible frequent needs for debt/equity infusion. As a result, we do not expect PMFL’s RoCE to expand beyond mid-teens over the longer term.

…hence, ~35% premium to dairy peers seems unjustified for PMFL

We believe PMFL deserves a 10-15% premium to peers given the strong brand equity of Gowardhan and Go. However, given our concerns around: a) Expectations of only mid-teens PAT growth and mid-teens RoCE, and b) Governance issues about company’s related party transactions for milk procurement and the lack of financial discipline in the recent past add to the concerns, we believe the ~35% premium vs its peers seems unjustified.

Exhibit 20: PMFL’s ~35% premium to its peers at the upper end of its IPO price band seems unjustified

Company Mcap (Rs bn) P/E (x) P/B (x) EV/EITDA (x)

FY14 FY15 FY14 FY15 FY14 FY15

Prabhat Dairy 10.8 49.1 48.5 3.2 3.0 14.7 14.2

Kwality 28.8 17.3 15.2 6.3 4.1 13.4 11.6

Hatsun Agro 48.9 59.3 125.0 27.0 22.1 28.5 26.7

Heritage Foods 12.0 26.3 42.1 6.8 6.2 13.4 14.7

Parag Milk Foods 19.0 133.5 64.9 10.8 9.8 30.2 22.5

Median excl. Parag 49.1 48.5 6.8 6.2 14.7 14.7

Divergence 172% 34% 59% 60% 105% 53%

Source: Company, Ambit Capital research Note: We calculate Parag Milk Foods valuations at the upper end of its IPO price band @ Rs227/share

AMBIT INSIGHTS


Balance sheet (Consolidated)

Year to March (Rs mn) FY14 FY15 FY16E FY17E FY18E

Net Worth 944 1,239 3,545 7,206 8,046

Total Debt 5,561 5,448 3,948 2,948 2,948

Deferred Tax Liability 38 60 233 233 233

Current Liabilities 1,659 2,492 2,322 2,702 3,075

Total Liabilities 8,202 9,239 10,047 13,089 14,302

Fixed Assets 2,790 3,194 3,267 3,733 3,918

Investments 3 3 3 3 3

Current Assets 5,409 6,043 6,776 9,353 10,381

Total Assets 8,202 9,239 10,047 13,089 14,302


Income statement (Consolidated, post-dilution)


Net Income 10,870 14,408 16,425 19,054 22,102

% Growth 17% 33% 14% 16% 16%

Gross Profit 2,512 3,399 4,127 4,730 5,553

EBITDA 811 1,085 1,401 1,473 1,665

PBIT 548 822 1,082 1,103 1,286

PBT 109 353 638 827 1,050

PAT 146 295 415 661 840

EPS 2 4 5 8 10

EPS Growth -34% 102% 41% 60% 27%


Cash flow statement (Consolidated)


PBT 109 353 638 827 1,050

Non-cash adjustments 745 780 764 646 615

Change in working capital (386) (442) (1,482) (1,641) (1,578)

Tax paid (5) (6) (80) (165) (210)

Cash flow from operations 463 685 (161) (333) (124)

Cash flow from investments (592) (248) (394) (836) (564)

Cash flow from financing 145 (423) (23) 1,724 (236)

Change in cash 16 14 (578) 555 (923)

Free cash flow (122) 434 (9) (257) (44)


Ratio analysis / Valuation parameters (Consolidated)


Gross margin (%) 23.1% 23.6% 25.1% 24.8% 25.1%

EBITDA margin (%) 7.5% 7.5% 8.5% 7.7% 7.5%

Net profit margin (%) 1.3% 2.0% 2.5% 3.5% 3.8%

Net debt: equity (x) 5.9 4.4 1.1 0.4 0.4

RoCE (%) 12.0% 10.4% 9.9% 10.0% 9.7%

RoE (%) 16.7% 27.0% 16.5% 12.3% 11.0%

CFO/EBITDA 57.7% 63.7% 33.6% 51.8% 47.8%

P/E (x) 130.1 64.4 45.8 28.7 22.6

Price/Sales (x) 1.7 1.3 1.2 1.0 0.9

EV/EBITDA (x) 30.2 22.5 16.3 13.9 12.4

Source: Company, Ambit Capital research Note - we take upper band price of Rs227/share as the market price for calculating valuation parameters

AMBIT INSIGHTS


Annexure Exhibit 21: Existing and forthcoming production capacity at Manchar and Palamaner

Capacity Manchar Palamaner Total

Milk processing capacity (lpd) 1,200,000 800,000 2,000,000

Additional milk processing capacity 800,000 600,000 3,400,000 Milk powder (includes drying capacity for whey powders and dairy whiteners) (MTPD) 70 40 110

Liquid milk in pouches (lpd) 200,000 175,000 375,000

Additional Liquid milk capacity 50,000 425,000

Flavoured milk (packs per day) 30,000 70,000 100,000

Additional Flavoured milk capacity 30,000 130,000

UHT milk (lpd) - 165,000 165,000

Additional UHT milk capacity 80,000 245,000

Cheese/Paneer (MTPD) 40 - 40

Additional cheese capacity 20 60

New capacity for Paneer 20 20

Ghee (MTPD) 40 30 70

Butter (MTPD) 50 25 75 Curd (includes pouch curd, cup curd, fruit yoghurt and shrikhand) MTPD 20 40 60

Additional curd capacity 20 80

Whey processing (lpd) 400,000 - 400,000

Additional Whey processing facility 600,000 1,000,000


AMBIT INSIGHTS


Atul Limited Right place, right focus We attended Atul’s post-annual-result analyst meeting. Atul has consistently improved ROCEs (~31% in FY16 vs 8% a decade back) despite increase in capex for multiple projects, driven by: 1) consistent improvement in asset turns, 2) gradual margin expansion (~20% in FY16 vs. 8% in FY06) and 3) PBT growth of ~34% over last decade. Hence, capex of Rs5.5bn for FY14-FY16, which is similar to quantum over FY06-FY14, could help deliver much better growth rates. Focus on increasing value-added portfolio, geographical reach and penetration in existing clients will support growth momentum. We like Atul for its wide portfolio (which will benefit from rising restrictions on Chinese chemicals players), healthy capital allocation and clean governance.

Background

Atul is one of the leading suppliers of dyes, pigments, agrochemicals, pharmaceuticals, fragrances & cosmetics intermediates, polymers and rubber intermediate chemicals to global manufacturers. Its bouquet of 920 products caters to 5,700 customers in 68 countries. Atul was founded in 1947 by Kasturbhai Lalbhai. The company’s key manufacturing operations are in Ankleshwar and Valsad (Gujarat) and Tarapur (Maharashtra). Atul is now run by Sunil Lalbhai and a professional management team. The company generates nearly 18% of sales from Asia ex India, 14% from Europe, and 13% from North America.

4QFY16 and FY16 performance – healthy in challenging environment globally

Atul reported a strong set of results. Sales were flat on a YoY basis due to impact of crude prices. However, EBITDA growth was strong at ~31% driven by 210bps gross margin expansion and drove PAT growth of 40%. On a full-year basis, PBT grew by 25% before exceptional items and volumes by 3%.

EBITDA margins improved by ~400bps YoY driven by a 11% decline in raw material costs and a 3% decline in other expenses due to lower fuel and logistics costs. Domestic business was impacted more due to 6% decline in sales and a 2% decline in exports off a soft base. WC remained broadly flat YoY.

On a segmental basis, Life Science Chemicals reported sales/EBIT growth of 15%/96% in 4Q and 12%/41% in FY16. However, growth of performance and other chemicals was muted with sales/EBIT changes of -7%/10% in 4Q and -9%/-3% on a full-year basis. Strong growth in the Life Sciences division was driven by pharma division and a modest recovery in the agrochemicals division.

Exhibit 1: Summary of Q4FY16 and FY16 results

(Rs mn) 4QFY16 4QFY15 YoY (%) FY16 FY15 YoY (%)

Sales 6,209 6,190 0% 26,014 26,564 -2%

EBITDA 1,054 807 31% 4,636 4,013 16%

PAT 626 449 40% 2,693 2,262 19%

4QFY16 4QFY15 YoY (%) FY16 FY15 YoY (%)

Revenue Life Science Chemicals 1,736 1,513 15% 7,868 7,002 12%

Performance & Other Chemicals 4,618 4,947 -7% 18,952 20,799 -9%

EBIT Life Science Chemicals 466 238 96% 1,752 1,239 41%

Performance & Other Chemicals 622 568 10% 2,482 2,550 -3%

Source: Company

NOT RATED Quick Insight Analysis Meeting Note News Impact

Stock Information Bloomberg Code: ATLP IN

CMP (Rs): 1,801

TP (Rs): NR

Mcap (Rs bn/US$ mn): 53/803

3M ADV (Rs mn/US$ mn): 35/0.8

Stock Performance (%)

1M 3M 12M YTD

Absolute 21 24 44 12 Rel. to Sensex 18 21 50 14 Source: Bloomberg, Ambit Capital research

Research Analysts

Ritesh Gupta, CFA [email protected] Tel: +91 22 3043 3242

Aakash Adukia [email protected] Tel: +91 22 3043 3273



AMBIT INSIGHTS


China-related issues could benefit colorants business (19% of sales): China has become stricter on environmental compliance and other subsidies, which has increased costs for some competitors of Atul. We believe realisations in some businesses such as dyes/pigments could benefit from such actions by China. In aromatics and 2,4,D herbicide, too, China is a key competitor.

Volume grew 3%: Management noted that volume growth was relatively better at 3%. Though this has been much below management expectation and is expected to improve over medium term. Pricing growth has been negative due to fall in crude prices.

Aggressive growth capex: Management is looking to pursue aggressive growth with capex of Rs5.6bn over FY14-FY16. This, along with de-bottlenecking, can generate additional sales of Rs8.5bn-13.5bn over the next 2-3 years compared with the current revenue base of Rs27bn. The company recently expanded capacity for turbine and boiler at a capex of ~Rs1bn.

New product launches and capacity expansion to drive growth: Atul is looking to leverage its existing chemistry capabilities to launch more value-added downstream projects. Atul plans to improve its presence in key countries and cross-sell more products to existing clients to leverage its product and client strengths. Key growth areas for the company are: (a) pharma intermediates, (b) aromatic products (flavours, fragrances and sunscreens), (c) new generics and CRAMS in agrochemicals, and (d) new products in colorants, pigments and polymers.

Comfortable balance sheet position: Debt:equity continues to gradually come off (currently 0.23x vs 0.27x in FY15) despite substantial capex over the last two years. Absolute debt number remains flat, at ~ Rs 3bn.

Leadership positions in key products: Atul has market leadership in para Cresol (~35% market share), Resorcinol (used in tyres), epoxy resins, sulphones and epoxy formulations. Management attributes these to backward integration which ensures much better purity and consistency.

Where do we go from here? Atul Ltd is in a sweet spot to capitalise on the fast-growing specialty chemicals exports opportunity given its wide range of process capabilities (phosgenation, aromatics, sulphones, etc) and low cost manufacturing. We expect the agrochemicals business to start generating strong growth rates after FY17 driven by: a) recovery in global agrochemical markets, which will support weedicide sales; b) introduction of new off-patented products; and c) focus on branded sales in India and launch of Nominee Gold generics. Similarly, the pharma business will benefit from enhanced capacities in phosgenation and a clean record with US FDA audits. Both these businesses have been seeing margin expansion led by improved product mix and efficiencies. We note that the life sciences business makes ROCEs of 42%.

In performance chemicals, Atul should benefit from closure of certain colorant capacities in China and improvement in cost competitiveness in aromatics. Atul’s broad range of chemistry capabilities will benefit this business. Key growth drivers are: i) widening market reach, ii) increasing manufacturing efficiencies, iii) generating and adding capacities; and iv) introduction of downstream products.

Strong focus on mix improvement, efficiency enhancements and better asset utilization has driven improvement in RoCEs from 7% in FY05 to 31% in FY15. Over the last decade, Atul has significantly turned around efficiencies. It significantly reduced exposure to the lower-margin colorants business in favour of higher-margin products under life sciences. Thus, PBT registered a CAGR of 34% as against sales CAGR of 11% over FY05-15. Cumulative CFO/EBITDA of 88% was led by improvement in inventory days (from 96 to 58) and receivable days (from 98 to 60) over FY07-15. Fixed asset turns have also improved from 1x in FY10 to 2.1 in FY15. The stock is trading at an attractive valuation of 15x FY18 consensus EPS. We believe the multiples could re-rate as Atul continues to improve its return ratios alongside a healthy ~20% EPS CAGR.

AMBIT INSIGHTS


Exhibit 2: Profits have growth at a much faster 34% CAGR vs. Sales (11% CAGR)

Source: Company

Exhibit 3: Focus on capacity expansion to drive growth (Capex in Rs mn)

Source: Company

Exhibit 4: Debt:equity ratio has improved significantly

Source: Company

-

5,000

10,000

15,000

20,000

25,000

30,000

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Sales PBT

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

- 500

1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Debt (Rs mn) Debt/Equity (x)(RHS)

AMBIT INSIGHTS


Exhibit 5: Snapshot of Atul’s growth plans

% contribution

Sales CAGR (%) Key points

Agrochemicals 13% 3%

Expansion of branded business across India Introduce new products going off-patent (7 products) Development of new formulation mixtures which can be patented (6 products) Pursuing contract manufacturing opportunities

Pharma 13% 12%

Obtained first USFDA approval for Dapsone API plant in January 2015 Expand capacities through new capacities and de-bottlenecking Growing overseas sales in the USA, Japan and EU Pursuing CRAMS business with strategic customers; increased phosgenation

capabilities to help Expansion of kilo lab and pilot plant for introduction of new products

Aromatics 20% 29%

Debottleneck capacities of existing products (2 products) Introducing more downstream products Expanding product portfolio in Personal Care (3 products) and Aroma

ingredients (2 products) Establish kilo lab facility for product development and scale-up Targeting acquisitions for inorganic growth

Bulk chemicals, Adhesion promoters 4% 11%

Increase market share for RF resins Attain full capacity utilisation for new Caustic & Chlorine plant Adding Chlorine downstream product directly or through a joint venture Introduce new products (2)

Colors: Dyes and Pigments

19% 10%

Increase market share in Vat (12% to 16%), Sulphur (8% to 12%), and Reactive (1.2% to 2.0%) dyes

Re-introduce some dispersion dye products (8) Expanding range of High Performance pigments Driving growth in Textile chemicals through Rudolf Atul Chemicals in India

Polymers - Epoxy 26% 13%

Reach full utilisation of BLR, Solids and RDL capacities Commission new RDL facility Increase sale of high margin products (41) Expansion plans –

o Specialty resins (27) o Intermediates for sulphones

Source: Company Presentation

Exhibit 6: Segmental performance – Life Science segment is much more efficient vs. performance chemicals segment

(Rs mn) Life Science Chemicals

Performance and Other Chemicals Total

Particulars FY16 FY15 FY16 FY15 FY16 FY15

Net revenues from operations 7,480 6,760 16,590 18,340 24,070 25,100

Profit before interest and tax 1,730 1,190 2,420 2,420 4,150 3,610

Segment assets 5,150 4,290 11,790 10,390 16,940 14,680

Total assets - - - - 20,840 17,620

Total liabilities - - - - 4,940 4,650

Capital employed 4,110 3,410 8,860 7,680 15,900 12,970

Source: Company

Exhibit 7: Market size of key product segments for Atul

Product segment Market size (Usd bn) Expected growth

Textile dyes chemicals 8.0-8.5 4%

HP pigments 1.6-1.7 4%

Speciality intermediates 1.2-1.4 3%

Food colors 1.4-1.5 6%

Solvent colors 0.3-0.4 5%

Epoxy markets 7.1 6%

Paints and Coatings 6.8 20%

Civil and Construction 11.9 12%

Adhesives 5.7 8%

Source: Company

AMBIT INSIGHTS


Balance sheet (consolidated)

Year to March (Rs mn) FY11 FY12 FY13 FY14 FY15

Shareholders' equity 297 297 297 297 297

Reserves and surpluses 5,409 6,244 7,246 9,189 10,093

Total net worth 5,706 6,541 7,542 9,486 10,390

Minority Interest 40 44 58 59 57

Debt 3,272 3,924 3,662 3,671 2,988

Deferred tax liability 230 228 273 371 461

Total liabilities 9,248 10,737 11,535 13,587 13,896

Gross block 9,731 10,754 11,903 12,952 12,958

Net block 3,905 4,436 5,061 5,703 5,137

CWIP 359 662 659 591 1,121

Long term loans and advances - - - - -

Investments (non-current) 851 749 667 628 661

Cash & cash equivalents 220 186 149 211 367

Debtors 2,900 3,589 3,517 4,371 4,424

Inventory 2,820 3,332 3,665 4,342 4,153

Loans & advances 1,594 1,633 1,921 2,333 2,369

Investments (current) - - - - -

Total current assets 7,534 8,739 9,251 11,256 11,313

Current liabilities 2,854 3,297 3,690 4,101 3,739

Provisions 547 553 414 490 596

Total current liabilities 3,401 3,850 4,104 4,591 4,335

Net current assets 4,133 4,889 5,147 6,665 6,978

Miscellaneous expenditure Total assets 9,248 10,737 11,535 13,587 13,896


Income statement (consolidated)


Net Sales 15,553 17,924 20,429 24,578 26,564

% growth 28.2% 15.2% 14.0% 20.3% 8.1%

Operating expenditure 13,845 16,044 17,938 20,940 22,650

EBITDA 1,708 1,880 2,491 3,637 3,914

% growth 54.8% 10.1% 32.5% 46.0% 7.6%

Depreciation 386 440 514 583 603

EBIT 1,322 1,440 1,977 3,055 3,311

Interest expenditure 263 433 334 334 257

Non-operating income 229 294 166 363 202

Adjusted PBT 1,389 1,301 1,864 3,083 3,256

Tax 492 350 583 881 994

Adjusted PAT 837 911 1,161 2,192 2,407

% growth 62.3% 8.8% 27.4% 88.8% 9.8%

Extraordinary income/ (expense) 101 - 54 - -

Minority Interest 0 3 (1) 3 2

Share of profit of associates 5 (42) (82) (13) 143

Reported PAT after minority interest 943 867 1,133 2,177 2,548


AMBIT INSIGHTS


Cash flow statement (consolidated)


Net profit before tax 1,389 1,301 1,864 3,083 3,256

Depreciation 386 440 514 583 603

Others 98 198 380 144 70

Tax (459) (420) (546) (742) (765)

(Incr)/decr in net working capital (828) (633) (340) (1,550) (100)

Cash flow from operations 586 886 1,871 1,517 3,063

Capex (net) (479) (1,271) (1,039) (1,138) (1,761)

(Incr)/decr in investments 66 28 37 245 26

Other income (expenditure) 74 239 (118) 313 114

Cash flow from investments (617) (1,040) (1,157) (831) (1,652)

Net borrowings 341 633 (287) (69) (734)

Issuance/buyback of equity - - - - -

Interest paid (254) (373) (337) (333) (260)

Dividend paid (138) (164) (155) (207) (260)

Cash flow from financing (51) 162 (778) (605) (1,253)

Net change in cash (82) 8 (64) 82 158

Free cash flow (before investments) 107 (385) 832 379 1,302


Ratio analysis (consolidated)

Year to March FY11 FY12 FY13 FY14 FY15

PBT marigin (%) 8.3% 7.3% 8.9% 12.5% 12.3%


Net debt: equity (x) 0.5 0.6 0.5 0.4 0.3

Net profit margin 5.4 5.1 5.7 8.9 9.1

RoCE (post-tax) (%) 11.5% 12.7% 13.2% 19.4% 17.8%

RoE(%) 15.8% 14.9% 16.5% 25.7% 24.2%

Working Capital Turnover 4.2 4.8 5.3 6.2 5.5

Gross Block Turnover 1.6 1.8 1.8 2.0 2.1


Valuation parameters (consolidated)

Year to March FY11 FY12 FY13 FY14 FY15

EPS (Rs) 28.2 30.7 39.1 73.9 81.1

Diluted EPS (Rs) 27.4 29.8 39.1 73.9 81.1

Book value per share (Rs) 192.2 220.4 254.1 319.6 350.1

P/E (x) 65.7 60.4 46.0 24.4 22.2

P/BV (x) 9.4 8.2 7.1 5.6 5.1

EV/EBITDA (x) 33.1 30.4 22.9 15.6 14.3

EV/Sales (x) 3.6 3.2 2.8 2.3 2.1


AMBIT INSIGHTS


Utilities India’s power story, retold Takeaways of meeting with former power regulatory official: (1) APTEL tariff hike for Tata Power’s Mundra is a landmark order, providing 100% fuel pass-through (includes past under-recoveries). SEBs may appeal to Supreme Court; but order should stay as 90% of APTEL orders were upheld in previous such cases. (2) Lowering AT&C losses is tough; high losses in cities remain despite smart metering due to political interference in SEB working. (3) New emission norms are too ambitious – NOx norms recommended not prevalent in US; SOx norms require re-consideration, especially for coastal/old plants. (4) Policies favour solar over wind given higher predictability, potential and cheaper pricing. (5) Cut in CEA power demand forecast for FY22 led by sluggish industrial use, reliance on statistical methodologies over on-ground surveys and energy efficiency initiatives. We remain negative on utilities and BTG due to weak demand outlook, but are positive on Tata Power due to compensatory tariff hike and attractive valuation.

Mundra UMPP should get full fuel pass-through The recent APTEL order on grant of compensation to Tata Power’s Mundra UMPP plant is a landmark judgment as it should allow 100% pass-through of fuel cost, including receipt of past under-recoveries. APTEL order is different from that of CERC which had recommended: (a) reducing compensatory tariff to the extent of net profit earned by Tata Power from its investment in Bumi and (b) sacrificing ROEs of 100bps (4 paise/unit). APTEL has considered the change in the Indonesian regulation as a force majeure event and granted compensation based on force majeure clause of the PPA. Whilst the PPA does not have any methodology on computing tariff hike, the expert believes that the computation will be very similar to CERC’s calculation in its Feb’2014 order. If we go by that calculation, the present tariff hike should be ~39paise/unit as per the prevailing fuel prices and exchange rate.

NEUTRAL Quick Insight

Analysis Meeting Note News Impact

Tata Power BUY Bloomberg Code: TPWR IN

CMP (`): 71

TP (`): 103

Mcap (` bn/US$ bn): 192/3.0

3M ADV (` mn/US$ mn): 373/5.6

NTPC SELL Bloomberg Code: NTPC IN

CMP (`): 139

TP (`): 118

Mcap (` bn/US$ mn): 1,149/17.3

3M ADV (` mn/US$ mn): 698/10.5

JSW Energy SELL Bloomberg Code: JSW IN

CMP (`): 68

TP (`): 73

Mcap (` bn/US$ bn): 111/1.7

3M ADV (` mn/US$ mn): 171/2.3

BHEL SELL Bloomberg Code: BHEL IN

CMP (`): 125

TP (`): 118

Mcap (` bn/US$ bn): 307/4.6

3M ADV (` mn/US$ mn): 1,181/17.8

Research Analyst

Bhargav Buddhadev [email protected] Tel: +91 22 3043 3252

Deepesh Agarwal, CFA [email protected] Tel: +91 22 3043 3275



AMBIT INSIGHTS


Exhibit 1: Tata Power should get tariff hike of ~44 paise for FY16 and ~39 paise as per prevailing prices

Particulars Reference Unit FY13 FY14 FY15 FY16E FY17E

Fuel charges as per tariff quoted in the PPA (FOB only)

Non Escalable 1a US$/unit 0.0071 0.0071 0.0071 0.0071 Escalable 1b US$/unit 0.0059 0.0059 0.0059 0.0059 CERC escalation index 2 1.9641 1.2580 1.1275 1.0681 Escalable cost after indexation 3 = 1b x 2 US$/unit 0.0115 0.0074 0.0066 0.0062 Fuel energy tariff component (2a+4) 4 = 1a + 3 US$/unit 0.0185 0.0144 0.0136 0.0133

Actual FOB cost of imported coal 5 US$/tonne 63.8 53.0 47.5 45.0 Effective import duty 6 % 6.3% 6.3% 6.3% 6.3% FOB cost of imported coal after adjusting for duties 7 = 5 x 6 US$/tonne 67.8 56.3 50.5 47.8 Qty of imported for per unit of power 8 units/kg 0.4 0.4 0.4 0.4

Actual fuel cost 9 = 7 X 8 / 1000 US$/tonne 0.02 0.02 0.02 0.01

Tariff hike 10 = 9 -4 US$/unit 0.008 0.008 0.006 0.006 Exchange rate 11 INR/unit 59.5 61.1 65.4 66.0

Tariff hike 12 = 10 x 11 INR/unit 0.52 0.50 0.43 0.39

Units sold 13 Mn units 26,630 24,451 23,628 23,628

PLF(%) 83% 76% 73% 73%

Tariff hike 14 = 12 x 13 Rsmn 3,294 13,937 12,405 10,366 9,327 Source: CERC, Company, Ambit Capital research

Exhibit 2: Calculation of CERC escalation index

US$/tonne FY14 FY15 FY16 FY17E

Prevailing market price at time of bidding a 42.1 42.1 42.1 42.1

Market price now B 82.7 53.0 47.5 45.0

CERC escalation index c = b / a

1.9641

1.2580

1.1275

1.0681

Tata's cost under the contract with mines at the time of entering into PPA D 29.0 29.0 29.0 29.0 Source: CERC, Company, Ambit Capital research

Exhibit 3: CERC order asked Tata to take a haircut, which is not the case in the APTEL order

Deductions made by CERC in its tariff order Deductions made by APTEL in its order

Mining Profits at Indonesia None

Profit on sale of merchant power None

Haircut on RoE (100bps) None

Savings due to use of low GCV coal None

Source: CERC, APTEL, Ambit Capital research

There is a possibility of SEBs (especially Punjab which was not a signatory to the CERC’s order) appealing against the APTEL’s order in the Supreme Court. However, the probability of the Supreme Court upholding the APTEL’s decision is high given precedence of 90% of appeals made to the Supreme Court having been in favour of the APTEL order. Also, the APTEL order has taken care of the reservations put forth by SEBs against allowing the change in Indonesian regulation as force majeure.

AMBIT INSIGHTS


Exhibit 4: APTEL order has addressed the reservations put forth by SEBs

Sr. No. Question raised Answer

1 Permission to CGPL for raising the plea of force majeure or change in law to support the compensatory tariff order (Feb-2014) claiming parity with Adani Power

CGPL is allowed to raise such a plea on grounds of parity with Adani Power

2 Regulatory power of CERC to vary/modify tariff or grant compensatory tariff outside the provisions of the PPA

CERC has no regulatory powers to vary or modify terms and tariffs of PPA or grant compensatory tariff. However, relief under force majeure or change in law can be provided as per the PPA provisions.

3 Regulatory power of any other appropriate commission to change provisions of PPA

No other regulatory commission has the powers to change the provisions of PPA but a relief can be granted for force majeure or change in law cases.

4 Does CERC have powers to grant compensatory tariff under any other provision if force majeure or change in law provisions are held to be inapplicable?

CERC cannot grant compensatory tariff under any other powers in such cases.

5 Can the original CERC order granting compensatory tariff to CGPL be considered valid irrespective of final amicable settlement?

With APTEL having ruled that CERC does not have the regulatory powers to grant compensatory tariff except as relief under force majeure or change in law provisions, the matter is not relevant

6 Can the CERC grant such a compensatory tariff to CGPL retrospectively from the COD?

With APTEL having ruled that CERC does not have the regulatory powers to grant compensatory tariff except as relief under force majeure or change in law provisions, the matter is not relevant

7 Can the change in law provisions include the laws other than Indian laws, such as the Indonesian laws for benchmark export price of coal?

Change in law provisions cannot include laws other than Indian laws.

8 Can the increase in coal price due to change in Indonesian National Coal Distribution Policy be construed as change in law?

Such a price increase due to Indonesian policy change cannot be construed as change in law.

9 Does the increase in price of coal on account of Indonesian regulation and non-availability of domestic coal constitute a force majeure under the PPA?

Yes, the Indonesian coal price increase and domestic non-availability of coal can be considered a force majeure.

10 Did CGPL have fuel supply agreements for coal supply to Mundra plant, at prices less than the market prices?

Yes, CGPL had fuel supply agreements of coal for Mundra project at a price less than the market price.

Source: APTEL, Ambit Capital research

As far as read-across of this order is concerned, there is none given that this order has been restricted to defining the change in Indonesian regulation as a force majeure event. Apart from Tata and Adani Power, the expert suggested there is no read-across for any other power company.

Emission norms will require reconsideration The expert believes that the new emission norms will require reconsideration in terms of timelines and relaxation of norms, especially for older/coastal plants. He said a realistic time frame for adherence to these emission norms by the new power plants is 5-10 years given that South Africa, China and the US, where such technological changes had been implemented, took 5-10 years. For old power plants which have a residual life of less than 10 years (~62GW), adherence to new emission norms is not economical given these plants may not be able to recover the cost of retrofitting through the proposed tariff hike of Rs0.4 to Rs1.5 per unit.

For new plants, the timeline should be extended (vs 2 years currently) as domestic capacity for technological changes is a meagre 15GW compared with requirement of 160GW. Lastly, the under-construction plants will have to extend their scheduled commissioning dates and approach banks to retain their ‘standard asset’ classification. It seems that emission norm notifications were issued under international pressure after COP 21.

NOx norms: These rules are very difficult to follow given that these are very stringent and hardly any plant globally complies with such stringent norms. Even the US has not been able to improve NOx emission norms for its plants to such levels despite efforts for the past 2 decades.

Selective Catalytic reduction (SCR) technology is required to comply with this norm. Cost of complying is very high, at Rs8mn-10mn per MW, for old and recent sets and Rs12mn-15mn per MW for future sets.

Nobody has SCR technology in India. Alstom Global has the technology but not Alstom India. Thermax does not have SCR technology, but its technology partners Babcock & Wilcox and SPX have it. Thermax is yet to initiate the technology transfer agreement on SCR with its partners.

AMBIT INSIGHTS


Moreover, honeycomb facilities are required for manufacturing SCR-based components. Honeycomb is a niche market with even Babcock & Wilcox outsourcing it to specialized players. Unless honeycomb facilities are built in India, a large proportion of the components would have to be imported. If emission norms are implemented, India would become the largest honeycomb market in the world.

SO2 norms: These rules can be complied with as it needs commissioning of full gas desulfurization (FGD) technology which, however, would need massive changes to the boiler. The new coastal power plants have already put FGD as they use imported coal, which needs higher sulphur content. However, there are some modifications needed to be done in order to regulate the temperature limit for discharge of Condenser Cooling water from the thermal power plant for which these plants will have to incur extra capex for commissioning cooling towers.

There are two types of technology to comply with this norm: (a) dry type, which is used if sulphur content in coal is low – cost Rs5mn per MW; and (b) wet type if sulphur content in the coal is high (Imported coal) – cost Rs6mn-7mn per MW

In India, only 2-3 boilers have been installed with FGD technology. BHEL and Alstom have executed these projects. Thermax has technology from its tie-up with MET, USA (for both dry and wet types).

No major capex is required for setting up FGD manufacturing facility. However, skilled human resources would remain a challenge.

Power demand to grow at 6-7% over FY16-22 A recent 20% downgrade in power demand estimate by CEA to 239GW in FY22 was expected given Electric Power Survey (EPS; the power demand estimation wing of CEA) had set an aggressive demand target. However, we believe even the revised estimates are optimistic because it assumes GDP/power-demand growth of 8.6%/7.7% over FY16-22. According to the expert, power demand can at best grow in the range of 6-7% over FY16-22.

Exhibit 5: CEA’s reduction in FY22 power demand estimate by 20% was anticipated as earlier estimates were aggressive

Source: CEA, Ambit Capital research

According to the expert, there is little accuracy to ESP’s estimates as they use statistical variables rather than on-ground reality checks to estimate power demand. The impact of use of energy conservation devices such as LED, BEE rated pumps and fans can be materially higher than just reducing the elasticity of power demand growth to GDP from 1.0x (earlier estimate) to 0.9x. Also the elasticity of power demand growth to GDP growth has been only 0.7x over FY06-15 given the rising share of the services sector (less energy-intensive) in GDP.

153 239

298

0

50

100

150

200

250

300

350

FY16 FY22

Actual Revised forecast Earlier forecast

Revised forecast - 7.7% CAGR

Earlier forecast - 11.8% CAGR

Peak power demand (GW)

AMBIT INSIGHTS


Exhibit 6: Energy consumption in agriculture can reduce by 30 to 40% with BEE star pumps

Particulars

Number of pumps ~20mn

Power consumption by pumps ~173bn units

Share in total power consumption (%) ~16%

Likely reduction with shift towards BEE Star 30-40%

Source: Industry, Ambit Capital research

Exhibit 7: Correlation of power demand with GDP over FY06-15…


Exhibit 8: …implies elasticity of power demand to GDP at 0.7x

Particulars

Real GDP CAGR over FY06-15 7.9

Power demand CAGR over FY06-15 5.4 Elasticity of power demand to GDP over FY06-15 0.7


The UDAY and Power for ALL by FY19 schemes are unlikely to impact power demand as only 10-15% of power demand is not met by SEB on account of non-availability of funds. As per our expert, latent demand could be in the range of 10-15%, implying limited scope for increase in power demand even if the entire latent demand is met over FY16-22. Unless industrial capex recovers, it is unlikely that power demand will improve. This is because industry now accounts for 41% of power demand.

Exhibit 9: Industry accounts for 41% of power demand Share in power consumption (%)

Industries Commercial Traction

and Railways

Agriculture Domestic Others Total

FY08 37.7 9.3 2.2 20.8 24.1 5.9 100.0

FY09 37.8 9.8 2.1 19.8 23.8 6.8 100.0

FY10 38.6 9.9 2.0 19.6 23.9 6.0 100.0

FY11 39.3 9.7 2.0 19.0 24.4 5.6 100.0

FY12 44.9 8.3 1.8 18.0 21.8 5.3 100.0

FY13 44.4 8.8 1.7 17.9 22.3 4.9 100.0

FY14 43.8 8.7 1.7 18.0 22.5 5.2 100.0

Average 40.9 9.2 1.9 19.0 23.2 5.7 100.0

Source: CEA, Ambit Capital research, Note – data beyond FY14 not available

-

2.0

4.0

6.0

8.0

10.0

12.0

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

GDP growth (%) Power demand growth (%)

AMBIT INSIGHTS


UDAY is nothing more than repackaging of FRP scheme Clearly, political willingness is a big factor in ensuring that UDAY becomes successful. Just signing up for the scheme by states (10 states have already signed up) does not guarantee compliance. This is corroborated by FRP 2012, wherein 7 states (Uttar Pradesh, Tamil Nadu, Rajasthan, Andhra Pradesh + Telangana, Haryana, Bihar, Jharkhand) had signed up and agreed to reduce AT&C losses and undertake timely tariff hikes; however, only limited progress was made in this direction.

Exhibit 10: AT&C losses – state-wise trends (%)

State FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

States signed/given in-principal approval for UDAY

Maharashtra 33.2 34.6 31.3 31.2 25.0 23.3 21.6 22.0 18.0

Uttar Pradesh 43.9 44.3 43.1 40.1 39.7 42.9 42.0 42.9 NA

Gujarat 26.7 23.6 22.8 22.1 22.8 16.9 19.3 19.9 15.9

Rajasthan 42.2 35.7 33.0 29.8 30.1 24.7 24.8 24.5 26.8

Andhra Pradesh 16.7 17.9 16.2 13.0 16.4 17.5 15.3 13.6 14.8

Madhya Pradesh 44.4 45.7 45.9 46.6 41.0 37.3 38.3 31.2 28.0

Punjab 23.3 22.5 19.1 18.5 17.7 19.6 19.0 17.7 17.9

Haryana 42.8 25.6 33.0 33.3 29.0 28.0 28.3 32.6 34.3

Jharkhand 52.1 54.4 23.3 54.0 NA 46.8 42.8 47.5 42.2

Chhattisgarh 38.8 29.3 27.6 32.7 37.9 28.8 29.1 25.1 23.2

Bihar 83.8 44.0 47.4 34.4 43.9 47.4 59.2 47.4 46.3

J&K 63.3 64.7 71.9 69.1 70.5 72.9 71.2 60.9 49.1

Uttarakhand 28.0 35.5 38.3 35.4 33.5 28.5 25.8 23.2 19.0

H.P. 17.1 13.5 17.2 12.9 18.5 10.1 18.0 9.5 15.1

Other key states

Tamil Nadu 17.1 16.2 16.2 14.4 20.2 18.9 21.7 20.7 22.4

West Bengal 28.3 30.7 23.2 25.8 33.2 27.4 32.9 34.4 32.1

Karnataka 38.0 32.8 32.1 24.9 25.4 23.7 23.3 20.8 22.0

Kerala 23.6 23.3 21.5 21.6 14.9 14.1 12.2 10.5 16.4

India’s average 33.0 30.6 29.5 27.7 27.2 26.0 27.0 25.4 22.7

Source: PFC, Ambit Capital research

The UDAY scheme lays down aggressive AT&C loss reduction targets by mandating the states to reduce AT&C losses to 15% by FY19 irrespective of current AT&C losses. However, there is no clear road-map for achieving this tall task (UDAY MoU has given only targets). Whilst states are incentivised by central devolution of grants worth Rs1.2tn over FY16-FY22 under Deendayal Upadhyaya Gram Jyoti Yojana (DDUGJY) and Integrated Power Development Scheme (IPDS) to ramp-up capex on reduction AT&C losses, there is no guarantee that these schemes will reduce AT&C losses. Moreover, it must be noted that these schemes lag their allocation quite often. For instance, in FY15, only 61% of the budget of RGGVY + APDRP (erstwhile versions of DDUGJY and IPDS) was utilised. Despite presence of such schemes, ordering has been scant in the last two years. Lastly, capex incurred on RGGVY + APDRP schemes has not translated into fruitful results due to lack of energy audits by the state. According to our expert, three-fourth of the GPS modems installed for automatic electronic metering under earlier schemes is malfunctioning due to inefficiencies and corruption at line manager level. Political connectivity shields the line manager against any inquiry of corruption or inefficiency.

AMBIT INSIGHTS


Exhibit 11: Total spends under both schemes combined will exceed Rs1.2tn and is seemingly a strong incentive

Source: Power Ministry, Ambit Capital research; Sub-transmission and distribution includes 11-66KV lines/ sub-stations, GIS substations and LT lines

Exhibit 12: However, Government has not spent full budgeted amount on schemes in any of the last five years

Source: India Budget, Ambit Capital research

Solar taking prevalence over wind The thrust on renewables is likely to continue given falling tariffs and push from PMO. However, within renewables, wind is losing favour to solar given:

Land availability: In wind, there are only finite wind sites (potential of 300GW at 100 metres); for solar there is no shortage of land given plenty of waste land in India alongside more than 300 sunny days in a year.

Minimal challenges on offtake given predictable PLF and year-around generation vs volatile PLFs (given changing wind patterns) and barely 3-4 months of generation for wind. Consequently, discoms are willing to invest in setting up of dedicated transmission corridors.

Generation during peak load: In solar, the entire generation happens during the day when power load is at its peak. However, in wind, the bulk of generation happens at night when power load is low. Consequently, the conventional power producer has to back down to accommodate supply from wind, which is not the case with solar.

Falling solar tariffs: Recent solar bids of Rs4.34-5.0/unit are cheaper than wind feed-in tariffs of all the states except Tamil Nadu.

The expert is sceptical about the aggressive targets for wind power, with states reluctant to support the sector given falling tariffs in solar. Madhya Pradesh and Maharashtra have cut wind tariffs by 19%/3% for FY17; Rajasthan and Maharashtra are not signing PPAs. Moreover, the Central Government may not extend Generation Based Incentives (GBI) for wind in FY18 as the same is not available to solar.

Solar prices are likely to stabilise at Rs4.6-5.0/unit once euphoria amongst bidders settles. However, rooftop solar is unlikely to pick up given lack of policy incentives; consequently, the Government may miss its rooftop target of 40GW by FY22.

Rural Electrification

30%

IT enablement

20%

Sub-T &D infra*25%

Feeder separation

16%

Metering5%

Others4%

DDUGJY+IPDS Government support: Rs1.2tn

0%

20%

40%

60%

80%

100%

-

20

40

60

80

100

FY11 FY12 FY13 FY14 FY15 FY16

RGGVY+APDRP spending

Budgeted (Rs bn) Actual (Rs bn) %spent (RHS)

AMBIT INSIGHTS


BTG in bad shape As per the expert, the heydays of boiler-turbine-generator (BTG) sector are over given there is sufficient installed/under-construction capacity to meet power needs over FY16-22. As against the peak power demand of 153GW in FY16, installed coal-based power capacity stood at 185GW (balance 113GW in nuclear, gas, hydro and renewables) as on March’16 with another 87GW capacity under construction. Consequently, industry ordering is unlikely to exceed 10GW per annum over the next 5 years. Even in FY16, if we exclude the one-off Telangana orders of 5.6GW, only 4.7GW of BTG was awarded.

Exhibit 13: Sensitivity of peak power supply to coal-based PLF in FY16

Coal based PLF Peak supply (MW)

55% 201,669

60% 215,579

65% 229,490

70% 243,400

75% 257,310

80% 271,220

Source: Ambit Capital research; Note: We assume current under-construction coal based capacity of 87GW gets commissioned over FY16-22 and no other coal based capacity gets commissioned; renewable capacity increases to 175GW (in-line with government target); we assume no change in installed base of gas, hydro, diesel and nuclear capacities; gas + hydro + diesel + renewables to operate at 20% PLF; nuclear to operate at 80% PLF

Exhibit 14: Sensitivity of peak power demand

Power demand CAGR over FY16-22 Peak demand (MW)

5% 205,525

6% 217,553

7% 230,161

8% 243,373

9% 257,210

10% 271,697

Source: Ambit Capital research

Exhibit 16: Sensitivity of power surplus/(deficit) to coal-based PLF and power demand growth

Coal based PLF Power demand CAGR

5% 6% 7% 8% 9% 10%

55% (2,411) (14,438) (27,047) (40,258) (54,096) (68,583)

60% 11,210 (817) (13,426) (26,637) (40,475) (54,962)

65% 24,832 12,804 196 (13,016) (26,853) (41,341)

70% 38,453 26,425 13,817 605 (13,232) (27,719)

75% 52,074 40,046 27,438 14,226 389 (14,098)

80% 65,695 53,668 41,059 27,848 14,010 (477)


AMBIT INSIGHTS


Exhibit 17: 55% of the 10.3GW orders awarded in FY16 pertain to non-recurring orders

Developer Project name Equipment Contract type (MW) Configuration (MW) (Rs bn)

Recurring orders

TANGENCO Ramanathapuram BHEL BTG 1600 2x800 56

TANGENCO North Chennai BHEL BTG 800 1x800 28

APGENCO Damodaram Sanjeevaiah, Nellore BHEL BTG 800 1x800 23

APGENCO Narla Tata Rao BHEL BTG 800 1x800 23

UPRVUNL Harduagunj JSW-Toshiba EPC 660 1x660 35

Total recurring orders 4,660 One-off orders

NTPC Karimnagar BHEL BTG 1,600 2x800 35

TSGENCO Yadadri BHEL EPC 4,000 5x800 180

Total one-off 5,600

Total orders 10,260


Excess BTG manufacturing capacity of 31GW vs annual demand of at best 10GW will continue to disrupt industry pricing and profitability. According to our expert, BTG manufacturers such as BHEL are in dire need to diversify into non-power areas such as defence where they can utilise their forging and other BTG facilities.

Exhibit 18: Domestic BTG capacity stands at 31GW…

Company Technology supplier Boiler Turbine

FY15 FY15

BHEL Alstom (Boiler) / Seimens (Turbine) 20,000 20,000

L&T - MHI Mitsubishi, Korea 5,000 5,000

Thermax Babcock Babcock, USA 3,000 -

Doosan Heavy Doosan, Korea 3,000 -

Bharat Forge - Alstom Alstom, France - 5,000

JSW - Toshiba Toshiba, Japan - 3,000

Total 31,000 33,000

Source: Company, Industry, Ambit Capital research

Exhibit 19: …vs annual demand of ~10GW

Source: Industry, Ambit Capital research

Investment implications

Reiterate SELL on BHEL and Thermax We are not bullish on power demand and fresh capex in the sector. This is negative for BTG manufacturers like BHEL and Thermax. BHEL and Thermax trade at rich valuations of 40x/37x FY17 P/E and 0.8x/3.5x FY17 P/B. Though EPS CAGR is likely to be strong (prima facie due to low base) over FY16-FY18, RoE for BHEL/Thermax is likely to be a dismal 3%/11% lower than cost of equity of 14%/15%.

Even if power demand improves, we are sceptical of BTG demand recovery given:

Reduction in AT&C losses will lead to improvement in supply from the existing installed capacity;

Rising preference for renewables given falling tariffs (especially in solar) alongside rising costs for coal-based plants if the new stringent emission norms get implemented effectively (cost of generation is likely to increase by 10-12%);

-

5.0

10.0

15.0

20.0

25.0

30.0

FY10

FY11

FY12

FY13

FY14

FY15

BTG industry ordering (GW) Peak power deficit (%) on RHS

FY16 includes oneoff orders of 5.6GW

AMBIT INSIGHTS


Exhibit 20: Relative valuations of BTG companies

Company Reco Mcap CMP P/E (x) P/B (x) RoE (%) CAGR (%) over FY16-18

($ mn) (Rs) FY16E FY17E FY18E FY16E FY17E FY18E FY16E FY17E FY18E Revenue EBITDA EPS

BHEL SELL 4,693 128 N/A 40.8 15.8 0.8 0.8 0.8 (0.5) 1.9 4.9 4% 42% 45%

Thermax SELL 1,395 779 30.4 36.7 28.0 3.8 3.5 3.3 8.1 10.0 12.1 10% 26% 18%

L&T SELL 17,722 1,265 31.1 27.6 22.2 3.0 2.8 2.7 10.0 10.7 12.5 16% 16% 18% Industry median 30.7 36.7 22.2 3.0 2.8 2.7 8.1 10.0 12.1 10% 26% 18%

Source: Bloomberg, Ambit Capital research, Prices as on 27 April 2016

Reiterate SELL on NTPC and JSWE

We reiterate SELL on NTPC as we are not bullish on power demand. However, even if power demand improves, we believe IPPs are best placed to benefit versus NTPC given PLFs for NTPC’s old plants (commissioned before 2009), where cost of generation is low, are already running at ~90%. For the new plants, we don’t believe NTPC’s cost of generation is very low relative to IPPs. Lastly, most of the new PPA bids are likely to be international competitive bids where NTPC may not participate as it prefers negotiated bids.

JSWE should be interested in signing new PPAs, especially for its Vijayanagar project, which currently 100% on merchant power. However, we don’t believe it can get better realizations under PPA than current level of Rs5.1/unit (calculated figure) given higher competitive intensity. This should impact JSWE’s EBITDA given ~39%/66% (calculated figure) of JSWE’s FY15 EBITDA/PAT came from Vijayanagar. Even if JSWE does not sign a PPA, we expect merchant realization to correct in the south given: (a) South India grid synchronization with the national grid may lead to 4.3GW being pumped into the southern region; this would mean tariff will be ~Rs4/unit compared with JSWE’s Vijayanagar realization of Rs5.1/unit; and (b) coal-based generation capacity to double to 61.2GW by FY19 in the South.

Exhibit 21: 39% and 66% of JSWE’s EBITDA and PAT, respectively, came from Vijayanagar in FY15 FY15 figures in Rsmn unless specified

Vijayanagar (estimated)

JSW Consolidated

Vijaynagar's share in total

Revenue 34,726 93,802 37%

Fuel cost 19,145 50,980 38%

Gross Profit 15,581 42,822 36%

O&M expenses* 1,362 6,588 21%

EBITDA 14,219 36,234 39%

Fixed Cost (Interest + Depreciation)# 1,702 16,365 10%

PBT 12,517 18,921 66%

Tax ̂ 3,380 5,150 66%

PAT 9,137 13,771 66%

Source: Company, Ambit Capital research, Note - * we take O&M expenses at Rs0.25/unit for Vijayanagar, # interest and depreciation at Rs0.25/unit for Vijayanagar (in-line with management guidance of O&M + interest + depreciation at Rs0.5/unit), ^we assume tax rate of 27% which is same as JSW’s consolidated tax rate

Exhibit 22: Vijayanagar earned FY15 RoE of 104% on original invested equity Particulars Rsmn unless specified

Capital cost - 260MW (2 x 130MW) 11,006^

- 600MW (2 x 300MW) 18,201^

Total Vijayanagar (860MW) 29,206^

Invested equity (@ 30%) 8,762

FY15 PAT 9,137

RoE on invested equity (%) 104%

Source: Ambit Capital research, we take the gross block as on FY10 i.e. before the commissioning of Ratnagiri as the capital cost of Vijayanagar plant

AMBIT INSIGHTS


At CMP, JSWE is trading at 1.3x FY17E P/B. This is a fair price given RoE of 14.5% in FY17E and 18% EPS CAGR over FY16-FY18E. When compared with peers like Tata Power, Torrent Power, Adani Power and NTPC, JSWE is trading at a premium of 9%.

Tata Power: Mundra and Bumi overshadow Mumbai circle and SED Mundra and Bumi account for just 13% of our SOTP; Mumbai circle, TPDDL and Tata SED together account for 44% of SOTP (~22% of capital employed). The value accretive businesses will consume ~60% of incremental capital deployed over FY16- FY19 whilst the balance gets consumed in other smaller assets and maintenance of Mundra. Assuming Mundra breaks even due to the compensatory tariff hike, the valuation multiple for other businesses would re-rate as investor concerns over cash burn at Mundra would abate. Though there is no clear peer for Tata Power given its presence in multiple businesses (power generation, transmission, distribution, coal mining and defence), when we compare it with utilities such as CESC, KSK, RattanIndia, JSPL, Lanco, JP Power, NHPC, Adani Power, NTPC, Torrent Power and JSW Energy, we find that Tata Power, at 1.2x FY17 P/B, trades in line with peers.

Exhibit 23: Relative valuations for the utilities sector

Company CMP Mcap (US$mn)

P/B (x) P/E (x) RoE (%) CAGR (FY16-18) (%)

FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 Revenue EPS

CESC 553 1,104 1.3 1.1 1.0 20.0 10.0 7.4 6.0 10.9 13.2 9.4 NA

KSK 238 1,719 NA NA NA 11.2 10.5 NA 14.2 13.2 NA NA NA

JSPL 68 1,675 1.3 1.2 1.0 8.8 8.0 7.7 15.6 15.7 14.7 3.7 (6.8)

Lanco 5 205 NA NA NA NA NA NA NA 86.8 20.2 25.8 83.2

JP Power 32 1,620 1.9 1.9 1.9 NA NA NA (18.9) (8.6) 0.9 2.8 NA

NHPC 22 3,590 0.7 0.7 0.7 9.2 8.8 7.8 8.2 8.2 8.9 5.5 (8.1)

Adani Power 32 1,620 1.9 1.9 1.9 NA NA NA (18.9) (8.6) 0.9 2.8 NA

NTPC 141 17,491 1.3 1.3 1.2 11.9 13.7 11.1 11.6 9.6 11.2 14.6 3.4

Torrent Power 237 1,685 1.5 1.3 1.2 12.2 9.7 17.6 13.1 14.3 7.1 (8.4) (17.0)

Tata Power 71 2,889 1.3 1.2 1.2 16.4 13.6 13.6 8.5 9.4 13.6 3.6 17.8

JSW Energy 68 1,678 1.4 1.3 1.2 10.5 8.9 7.5 13.6 14.5 15.4 3.6 17.8 Sector median 1.3 1.2 1.2 11.9 10.0 9.5 8.5 10.2 11.2 3.7 (1.7)

Source: Bloomberg, Ambit Capital research; Note: Prices as on 27 April 2016

AMBIT INSIGHTS


Cholamandalam Finance Strong trends + key catalysts materialising Cholamandalam Finance (CIFC) reported PAT of Rs1.9bn (up 42% YoY), which was 30%/16% ahead of our/consensus expectations. Earnings beat was driven by better than expected performance in margins, operating efficiencies and asset quality. Operating trends continue to be strong for CIFC, with improving AUM growth (up 17% YoY), expanding NIMs (up ~100bps), improving asset quality (150dpd gross NPAs down by ~10bps YoY) and improving operating efficiencies (opex/AUM down ~15bps). With key catalysts of pick-up in used CV financing and LCV sales materialising, we upgrade our FY18 PAT estimates by 13% and target price by 10% on the back of higher growth and margins. Strong visibility of 28% EPS CAGR over FY16-18E and 20% RoEs by FY18 underpin our high-conviction BUY on CIFC, with a revised TP of Rs905/share (3.3x FY17E P/B and 20x FY17E P/E).

Results overview: CIFC reported PAT of Rs1.92bn (up 42% YoY), which was 30%/16% ahead of our/consensus expectations. Earnings beat was driven by better than expected performance in margins, operating efficiencies and asset quality. Operating trends continue to be strong – with AUM growth continuing to improve (up 17% YoY), NIMs continuing to expand (up ~100bps), improving asset quality (150dpd gross NPAs down by ~10bps YoY), and operating efficiencies also improving (opex/AUM down ~15bps).

AUM growth continued its improving trend at 17% YoY (vs 13% in 3QFY16) with continued pick-up in vehicle financing (up 14% YoY, versus 8% YoY in 3QFY16) and steady growth in home equity book (up 24% YoY). Disbursements in vehicle financing have also been robust at 47% YoY driven by a broad-based growth in all product segments except cars. We expect such trends to sustain and CIFC to eventually deliver AUM CAGR of 23% over FY16-18E.

NIMs expanded by ~100bps YoY to 8.3%, driven by improvement in both yields and cost of funds. Yields improvement (up ~75bps YoY) has surpassed our expectations probably due to improvement in collections and higher share of processing fees (which are up-fronted) due to pick-up in disbursements. Cost of funds declined by ~24bps primarily due to system-wide decline in interest rates (both wholesale and bank-based). With costlier bank borrowings still accounting for a lion’s share of CIFC’s liability mix, we believe CIFC has further room to lower its funding costs and improve its margins. We expect CIFC’s total income (as a % of AUM) to improve by ~20bps over FY16-18E to 8% driven primarily by declining cost of funds and resilient yields.

CIFC currently follows 120days NPA recognition norm vs the 150dpd norm it followed in 4QFY15 and hence asset quality trends are not strictly comparable between these time periods. On a YoY basis, asset quality has improved, with gross NPAs on 150dpd basis decreasing by ~10bps to 3.03% led by improvement in asset quality in the vehicle financing book. The company had provided additional provisioning of Rs548mn for meeting 90dpd NPA recognition norms. Despite lower provisioning coverage, migration to 90dpd NPA recognition norms and expectations of further stress in home equity segment, we expect only a marginal increase in credit costs of ~10bps over FY16-18E. This is because we expect improved asset quality in the core vehicle financing book to significantly offset the headwinds mentioned above.

Operating costs improved by ~15bps to 2.9% of AUM as elevated costs in vehicle financing segment were offset by marginally improving operating efficiencies in the home equity segment and higher share of low opex home equity segment in AUM mix. We believe that improving growth in low ticket LCV/used CV financing should eventually result in improving operating leverage for CIFC and we continue to factor-in ~30bps of improvement in opex/AUM over FY16-18E.

BUY Result Update Stock Information Bloomberg Code: CIFC IN

CMP (Rs): 799

TP (Rs): 905

Mcap (Rs bn/US$ bn): 124/1.9



1M 3M 12M YTD

Absolute 15 25 34 25

Rel. to Sensex 12 22 40 25


Ambit Estimates (Rs bn)

FY16 FY17E FY18E

Net Revenues 21.4 25.7 32.3

PAT 5.7 7.2 9.6

EPS (Rs) 37.5 45.8 61.1


Research Analysts

Aadesh Mehta, CFA [email protected] Tel: +91 22 3043 3239

Pankaj Agarwal, CFA [email protected] Tel: +91 22 3043 3206



AMBIT INSIGHTS


Where do we go from here?

CIFC continues to demonstrate robust earnings growth (4QFY16 diluted EPS up 33% YoY) driven by expanding NIMs, improving operating efficiencies, improving asset quality and improving growth. We believe that as the economy recovers and LCV sales increase with a lag, CIFC’s AUM growth, NIMs and operating efficiencies should further improve. We upgrade our FY18 PAT estimates by 13% on the back of higher growth and margin estimates due to pickup in growth in lucrative segments with high entry barriers such as LCV and used CV financing business. Consequently, we are confident that CIFC would deliver 28% EPS CAGR over FY16-18E driven by ~30bps improvement in RoAs and 23% AUM CAGR. Whilst valuations of 2.9x one-year forward P/B and 17x one-year forward P/E are at a premium to historical averages and peers’, it is best placed to sustain its earnings growth by capitalising on structural disruptions in the auto-NBFC space as highlighted in our thematic ‘Auto NBFCs – Multiple headaches’ (click here). We reiterate our high-conviction BUY on the stock with a revised target price of Rs905/share (upgraded by 10%), implying 13% upside. Out target price implies 3.3x FY17E P/B and 20x FY17E P/E for a company likely to deliver 20% RoEs by FY18.

Exhibit 1: Quarterly snapshot (Rs mn)

Income statement 4QFY16 4QFY15 YoY (%) 3QFY16 QoQ (%) 4QFY16E Deviation from Ambit Estimates

Interest and Income 11,324 9,359 10,491 8%

Interest expenditure 5,330 4,861 5,109 4%

Net Interest Income 5,994 4,498 33% 5,382 11%

Other Income 41 21 48 -15%

Total Income 6,034 4,519 34% 5,430 11% 5,626 7%

Total Operating Expenditure 2,086 1,904 10% 2,151 -3% 2,236 -7%

Operating Profit 3,948 2,615 51% 3,279 20% 3,390 16%

Provisions 986 581 70% 1,070 -8% 1,154 -15%

Profit Before Tax 2,962 2,034 46% 2,209 34% 2,236 32%

Total Tax 1,041 677 752 38% 760

Net Profit- Standalone 1,920 1,356 42% 1,457 32% 1,476 30%

Diluted EPS-Standalone (Rs) 2.6 3.6 -29% 1.6 65%

Standalone BVPS 104 96 8% 101 3%

AUM growth (%) 17% 9% 17%

RoA tree (% of AUM)

NII 8.3% 7.2% 7.8%

Interest income 15.7% 14.9% 15.3%

Interest expense 7.4% 7.7% 7.4%

Other Income 0.1% 0.0% 0.1%

Total Income 8.3% 7.2% 7.9%

Opex 2.9% 3.0% 3.1%

Employee costs 0.9% 0.9% 0.9%

Other opex 1.9% 2.1% 2.3%

Operating Profit 5.5% 4.2% 4.8%

Provisions 1.4% 0.9% 1.6%

Pre-Tax RoAs 4.1% 3.2% 3.2%

Taxes 1.4% 1.1% 1.1%

RoAs 2.7% 2.2% 2.1%

Leverage 8.0 8.0 7.9

RoEs 21.3% 17.3% 16.8%


http://reports.ambitcapital.com/reports/Ambit_AutoNBFCs_Thematic_MultipleHeadaches_08Oct2015.pdf

AMBIT INSIGHTS


Key estimates and forecasts Exhibit 2: Key assumptions and estimates (Rs mn unless specified)

Key Assumptions FY16 FY17E FY18E Remarks

YoY AUM growth (%) 17% 22% 23% AUM growth will be driven by pickup in LCV volumes and increased growth in the used CV space.

Total income on AUM (%) 7.8% 7.8% 8.0% Total income as a % of AUM will expand by ~20bps on back of lower funding costs and resilient yields.

Opex (as a % AAUM) 3.1% 2.9% 2.8% Operating efficiencies will improve due to scaling up of the low-ticket LCV and used CV business.

Credit costs (% of avg loan book) 1.5% 1.6% 1.6%

Improved asset quality in the core vehicle financing book to significantly offset the headwinds of lower provisioning coverage, migration to 90dpd NPA recognition norms and expectations of further stress in home equity segment, resulting in only a moderate increase in credit costs.

Key Output

Net revenues (Rs mn) 21,431 25,664 32,332

Operating profit (Rs mn) 12,980 16,062 20,962

Profit after tax (Rs mn) 5,685 7,210 9,615

Diluted EPS (Rs) 37.5 45.8 61

BVPS (Rs) 242 273 326


We upgrade our FY18 PAT estimates by 13% primarily to factor in higher growth and margin expectations owing to the pick-up in the LCV volumes. This has resulted in a marginal 10% increase in our target price.

Exhibit 3: Change in estimates (Rs mn unless specified)

Particulars New estimates Old estimates Change

FY17E FY18E FY17E FY18E FY17E FY18E

Net revenues (Rs mn) 25,664 32,332 24,026 28,693 7% 13%

Operating profit (Rs mn) 16,062 20,962 15,039 18,549 7% 13%

PAT (Rs mn) 7,210 9,615 7,231 8,539 0% 13%

Diluted EPS (Rs) 45.8 61.1 45.9 54.2 0% 13%

Adjusted BVPS (Rs) 273 326 272 319 0% 2%

Target Price (Rs) 905 823 10%


Our EPS estimates are 8-15% ahead of consensus expectations due to higher growth expectations.

Exhibit 4: Ambit vs consensus Rs mn Ambit Consensus % divg.

Net Revenues

FY17E 25,664 23,835 8%

FY18E 32,332 28,203 15%

PAT

FY17E 7,210 6,700 8%

FY18E 9,615 8,325 15%

EPS (Rs)

FY17E 45.8 42.9 7%

FY18E 61.1 53.4 14%


AMBIT INSIGHTS


Income statement (Rs mn) FY14 FY15 FY16 FY17E FY18E

Net interest income 12,116 14,640 21,267 21,997 27,782

Interest Income 29,827 34,244 41,774 46,660 58,267

Interest Expense 17,711 19,604 20,508 24,663 30,485

Other income 2,801 2,668 164 3,667 4,549

Total Income 14,917 17,308 21,431 25,664 32,332

Total expenses 6,582 7,489 8,450 9,602 11,369

Operating and other expenses 4,707 5,272 5,911 9,602 11,369

Employee Cost 1,875 2,217 2,540 - -

Pre provision profit 8,335 9,819 12,980 16,062 20,962

Provisions 2,833 3,247 4,272 5,301 6,612

Profit before tax 5,502 6,572 8,708 10,762 14,351

Tax 1,862 2,221 3,023 3,551 4,736

PAT - Standalone 3,640 4,351 5,685 7,210 9,615


Balance Sheet (Rs mn)

FY14 FY15 FY16 FY17E FY18E

Net worth 22,947 26,733 36,574 42,650 50,746

Borrowings 221,806 235,234 269,027 330,129 407,575

Total liabilities 244,753 261,967 305,601 372,779 458,321

Fixed assets 729 683 683 751 826

Investments 824 675 675 743 817

Loans and Advances 232,535 254,525 298,149 364,057 448,031

Cash and Bank Balance 8,008 3,407 3,407 3,748 4,122

Net working capital 2,657 2,677 2,677 3,480 4,525

Total assets 244,753 261,967 305,591 372,779 458,321


Key Metrics FY14 FY15 FY16 FY17E FY18E

AUM growth (%) 22.4 9.5 17.1 22.1 23.1

Dil Consol EPS growth (%) 11.2 18.1 25.0 22.2 33.4

Net interest margin (NIM) (%) 7.1% 7.1% 7.8% 7.8% 8.0%

Cost to income (%) 44.1 43.3 39.4 37.4 35.2

Opex (% of AAUM) 3.1 3.1 3.1 2.9 2.8

Gross NPAs (%) 1.9 3.1 3.5 5.0 4.7

Credit costs (% of AAUM) 1.34 1.33 1.55 1.60 1.63

Provision Coverage (%) 63.2 35.5 40.0 43.0 50.0

Capital adequacy (%) 17.2 21.2 19.7 19.5 18.5

Tier-1 (%) 10.5 13.0 13.3 14.0 13.0

Leverage (x) 10.4 10.2 9.0 8.5 8.8


Valuation parameters FY14 FY15 FY16 FY17E FY18E

BVPS (Rs.) 160.0 184.1 241.7 272.6 326.3

Dil. EPS (Rs) 25.4 30.0 37.5 45.8 61.1

ROA (%) 1.6 1.7 2.0 2.1 2.3

ROE (%) 17.1 17.5 18.0 18.1 20.4

P/E 31.5 26.7 21.3 17.4 13.1

P/BV 5.0 4.3 3.3 2.9 2.4

Dividend yield (%) 0.4 0.4 0.6 0.7 0.9


AMBIT INSIGHTS


Marico Solid all-round performance Consolidated 4QFY16 sales grew 7% YoY to Rs13bn (~3% above estimates). PAT grew 19% YoY to Rs1.3bn (~3% below estimates). India FMCG (~78% of sales) grew 4% YoY, with volume growth of 8.4% driven by growth across categories. International business (~22% of sales) grew 11% YoY (constant currency) with recovery across geographies. Marico’s urban and rural sales grew 3% YoY with Modern Trade (~9% of India sales) up 17%. Management expects soft demand conditions to prevail in 1HFY17, with recovery from 2HFY17 led by rural. Volume growth would remain in high single-digits. We expect sales/EPS CAGR of 16%/25% over FY16-20, driven by: (a) innovation in non-coconut oil portfolio; (b) nurturing high-quality talent; and (c) better use of IT and data analytics. Hence, we expect Marico to trade at a premium to Indian peers and MNCs like GSK Consumer and Colgate. We raise our DCF-based TP to Rs287 (Rs270 earlier; 10% upside), implying 32x FY18E EPS.

Results overview: Marico’s 4QFY16 consolidated sales grew 7% YoY to Rs13bn (~3% above our estimates), whilst PAT grew 19% YoY to Rs1.3bn (~3% below our estimates). India FMCG sales (~78% of total sales) grew 4% YoY, with volume growth of 8.4% YoY driven by growth across categories. International business (~22% of sales) reported 11% YoY growth in constant currency with recovery across geographies. Lower input costs (copra/liquid paraffin down 41%/25%) led to gross margin expansion of 630bps YoY. However, this was partially offset by higher A&P spends (+283bps YoY as % of sales) leading to EBITDA margin expansion of 260bps YoY to 16.6%. Consolidated PAT grew 19% YoY to Rs1.3bn, 3% below our estimates. We have marginally increased our FY18 EPS estimates.

Exhibit 1: International segmental performance

Segment

FY16E contribution

to total sales %

Reported 4QFY16 growth

Comments Volume growth

YoY%

Value growth

YoY%

International Business 21%

11%

Course correction continued during the quarter with recovery in growth rates across geographies albeit on a low base. Outlook: Bangladesh, Vietnam and MENA are 'Invest to grow' markets with growth coming from organic and inorganic sources (new geographies and acquisitions/alliances)

Bangladesh 9%

11%

Parachute coconut oil volumes grew 15% YoY but value growth of 5% YoY due to price-cuts; non-coconut oil portfolio is now 20% of sales and grew by 37% in constant currency during the quarter. Outlook: >80% of incremental growth from the non-coconut oil portfolio; expect ~15% constant currency growth in medium term; will be impacted by deflation in the near term

South East Asia 6%

8% Growth led mainly by Vietnam where company remains leader in male shampoos and #2 in male deodorants. Outlook: Brand restages, new product launches will continue to drive growth

MENA 4%

13%

Middle East business grew in double digit in FY16 and reported operating profits. Distributor transition in Egypt is complete and reaping rewards from 3QFY16 with 4% constant currency growth impact due to weak macro. Outlook: Expect double-digit constant currency growth in Middle East with operating profits; North Africa could be impacted by weak macro.

Consolidated margin profile

Delivered operating margin of 16.6% in 4QFY16 vs 14% in 4QFY15 driven by lower input costs. Company looks to maintain margin between 17-18% and invest excess behind brands to drive growth.


BUY Result Update Stock Information Bloomberg Code: MRCO IN

CMP (Rs): 260

TP (Rs): 287




1M 3M 12M YTD

Absolute 8 17 30 15

Rel. to Sensex 5 14 36 17


Ambit Estimates (Rs mn)

FY16 FY17 FY18

Revenues 64,193 75,215 88,009

EBITDA 10,928 13,331 16,038

EPS (Rs) 11.5 14.5 17.6


Research Analysts

Rakshit Ranjan, CFA [email protected] Tel: +91 22 3043 3201

Ritesh Vaidya, CFA [email protected] Tel: +91 22 3043 3246



AMBIT INSIGHTS


Exhibit 2: Domestic segmental performance

Segment

FY16E contribution

to total sales %

Reported 4QFY16 growth

Comments Volume growth

YoY%

Value growth

YoY%

India Business 79% 8.4% 4%

There was broad-based volume growth; Rural growth moderated and grew in-line with urban at 3% YoY. Modern Trade (~9% of India sales) grew 17% YoY. Outlook: Expect high single-digit value growth in 1HFY17 with weak consumer demand limiting volume growth; 2HFY17 is expected to witness a pickup in rural and urban demand and also witness modest price-inflation leading to double-digit value growth. Growth is expected across categories

Parachute & Nihar Coconut oil 35% 6% -5%

Despite a deflationary environment grew volume by 6% YoY aided by timely price-cuts of ~12% YoY. Increased volume share over last 12 months in branded coconut to 59%. Outlook: Expect copra prices to remain soft in 1HFY17 so initiated a 6% price cut in Apr'16. Expect volume growth of 5-7% YoY with negative value growth in 1H and positive value growth in 2H as price cuts annualise and volume growth improves in an inflationary environment.

Value Added Hair Oils (VAHO) 19% 11% 12%

Nihar Shanti Amla and the new product launches drove volume growth. Increased volume/value share by 179/132bps YoY to 32%/25% in VAHO. Nihar Shanti Amla increased volume share to 37%. Outlook: Will use new product launches (anti-hair fall hair oil) for driving category volumes and focus on driving premiumisation; expect 12-15% YoY volume growth in the near term

Saffola 15% 13% 14%

Increased market share by 322bps YoY to 62%; pushing sales of Saffola Tasty and Active and media support; using regional pricing and localised brand initiatives to drive adoption of Saffola; helped by inflation in other base oils. Outlook: Will continue with its regional pricing strategy and also refresh the existing portfolio of products. Expect double-digit volume growth in the near term.

Youth Portfolio 4%

19%

Hair gels portfolio continues to do well post its relaunch 4QFY15; Seeing promising signs in deodorants following its relaunch last month. Livon portfolio declined due to issue of counterfeits. The portfolio is currently split as 40%/35%/25% across Hair Gels/Serums/Deos. Outlook: Will do investments in youth portfolio and expect to >20% YoY value growth in near term.

Others 5%

Saffola Oats remains the market leader in flavoured oats with 70% value share; crossed Rs1bn of annual sales in FY16, expect to reach Rs2bn sales by FY18.


Near-term headwinds with possible price deflation

The management indicated that volume growth is expected to remain weak in 1HFY17 with price deflation further impacting value growth. With expectations of normal monsoon, rural demand is expected to revive from 2HFY17 and deliver high single-digit volume growth and low double-digit value for the company in FY17. There is limited scope for margin expansion in FY17 given expectations of increase in input prices over the next 12 months.

Genesis built around quality of talent, Board and loyal distributors

Marico has maintained leadership in its core categories through: (a) a unique work culture (entrenched in values such as empowerment, meritocracy, innovation, openness and integrity) which has enabled the firm to attract and retain high quality talent; (b) a high quality Board which is truly ‘independent’ in helping drive strategic decision-making; and (c) a strong focus on building supportive relationships with its distributors. This has helped Marico deliver: a) 17%/19% sales/EPS CAGR over FY01-15; b) most consistent organic growth amongst Indian FMCG companies since 1995; and c) innovation-led growth of six brands to more than Rs2bn each in annual sales (two brands >Rs10bn). Please refer to (Coffee Can legends note on Marico) for a detailed discussion on this theme.

Focus on key transformational areas driving the next leg of growth

Over the last two years, Marico has implemented several transformational changes, including: (a) shift in control from a promoter-led management team to professionals; (b) changes to the incentive structure of the management team with a greater focus on long-term growth drivers; (c) capital deployment focused on organic growth and dividend payouts; and (d) IT-led distribution changes such as automated order system which should further enhance Marico’s trade equity.

http://reports.ambitcapital.com/reports/Ambit_Marico_CompanyInsight_Theartofpeoplemanagement_09Feb2016.pdf

AMBIT INSIGHTS


VAHO, Saffola and Bangladesh to lead business growth

Over FY16-20E, we expect the domestic business to deliver 17% revenue CAGR led by: (a) increasing value share in VAHO (~20% CAGR, market share increase of ~330bps) helped by new launches; and (b) Saffola (~18% CAGR) through increased urban penetration. Focus on non-coconut oil growth in Bangladesh (11% CAGR) and organic growth in the rest of the international business should lead to ~15% CAGR in FY16-20E for the overseas business.

High quality franchise; deserves to trade at a premium to Indian peers

Marico’s genesis highlighted above should allow it to replicate its historical success in the future as well. As a result, we expect the firm to trade at a premium to other Indian FMCG players like Dabur and GCPL as well as MNCs like GSK Consumer and Colgate. We expect Marico to deliver FY16-20 sales/EPS CAGR of 16%/25% with RoCE improving from 29% to ~41%. Our DCF-based TP of `287 (10% upside) is 6% higher than our previous valuation of `270 and implies FY18E P/E of 32x.

Exhibit 3: Quarterly snapshot

Rs mn 4QFY16 3QFY16 4QFY15 4QFY16E YoY QoQ Deviation from Ambit Estimates

Net Sales 13,070 15,564 12,263 12,713 7% -16% 3%

Total revenues 13,070 15,564 12,263 12,713 7% -16% 3%

Raw materials 5,978 7,504 6,381 5,980 -6% -20% 0%

Gross Profit 7,093 8,060 5,882 6,734 21% -12% 5%

Gross Margin 54.3% 51.8% 48.0% 53.0% 630 248 130

Employee cost 933 913 785 814 19% 2% 15%

Advertisement & Sales Promotion 1,832 1,878 1,372 1,602 34% -2% 14%

Other expenditure 2,161 2,331 2,012 2,225 7% -7% -3%

Total expenditure 4,927 5,122 4,169 4,641 18% -4% 6%

EBITDA 2,166 2,938 1,713 2,093 26% -26% 4%

EBITDA margin 16.6% 18.9% 14.0% 16.5% 260 (231) 11

Other income 201 169 188 180 7% 18% 11%

Depreciation 326 247 200 210 63% 32% 55%

PBIT 2,041 2,861 1,700 2,063 20% -29% -1%

Interest 67 56 56 60 19% 20% 12%

PBT 1,974 2,805 1,644 2,003 20% -30% -1%

Exceptional Items (EI) 75 - - - PBT after EI 2,049 2,805 1,644 2,003 Tax 644 800 528 634 22% -19% 1%

Tax rate(%) 31% 29% 32% 32% -69 291 -26

PAT before MI 1,330 2,005 1,116 1,368 19% -34% -3%

Minority Interest 21 27 16 20 31% -24% 3%

PAT after MI 1,309 1,978 1,100 1,348 19% -34% -3%

EPS 2.0 3.1 1.7 2.1 19% -34% -3%


Exhibit 4: Change to estimates; we have increased our FY18 PAT estimate

Rs mn New estimates Old estimates Ch%

FY17E FY18E FY17E FY18E FY17E FY18E

TP (Rs) 287 270 6.5%

Sales 70,890 82,790 71,775 83,778 -1.2% -1.2%

EBITDA 12,898 16,057 13,080 15,518 -1.4% 3.5%

EBITDA margin (%) 18.2% 19.4% 18.2% 18.5% -3 87

PBT 12,872 16,420 13,087 15,881 -1.6% 3.4%

PAT 9,025 11,544 9,178 11,161 -1.7% 3.4%

EPS 7.0 8.9 7.1 8.7 -1.7% 3.4%


AMBIT INSIGHTS


Balance sheet


Net Worth 13,606 18,248 20,968 25,302 30,980

Total Debt 5,259 3,342 1,532 - -

Others 454 215 142 256 371

Current Liabilities 10,330 9,448 11,588 14,566 17,012

Total Liabilities 29,650 31,253 34,231 40,125 48,362

Fixed Assets 8,920 10,790 10,537 10,803 11,038

Investments 3,105 2,838 4,164 4,164 4,164

Current Assets 17,624 17,625 19,262 24,890 32,892

Total Assets 29,650 31,253 33,962 39,857 48,094


Income statement


Net Income 46,865 57,330 62,100 70,890 82,790

% Growth 2% 22% 8% 14% 17%

Gross Profit 22,874 26,139 31,047 36,150 42,550

EBITDA 7,480 8,701 10,740 12,898 16,057

PBIT 7,290 8,446 10,407 12,941 16,420

PBT 6,759 8,102 10,074 12,758 16,306

PAT 4,854 5,735 7,099 9,025 11,544

EPS 3.8 4.4 5.5 7.0 8.9

EPS Growth 34% 18% 24% 27% 28%


Cash flow statement

Year to March (Rs mn) FY14 FY15E FY16E FY17E FY18E

EBIT 7,290 8,446 10,407 12,941 16,420

Depreciation 769 843 1,073 834 865

Others (2,392) (2,950) (3,382) (3,802) (4,762)

Change in working capital 2,538 (2,898) 1,551 (1,250) (978)

Cash flow from operations 8,205 3,441 9,650 8,724 11,545

Cash flow from investments 6,902 (2,446) (2,146) (1,100) (1,100)

Cash flow from financing (5,667) (3,010) (6,188) (6,223) (5,866)

Change in cash 9,440 (2,015) 1,316 1,400 4,579

Free cash flow 15,284 3,077 8,918 7,624 10,445


Ratio analysis / Valuation parameters

Year to March (Rs mn) FY14 FY15E FY16E FY17E FY18E

Gross margin (%) 48.8% 45.6% 50.0% 51.0% 51.4%

EBITDA margin (%) 16.0% 15.2% 17.3% 18.2% 19.4%


Net debt: equity (x) 0.1 0.1 (0.1) (0.2) (0.3)

RoCE (%) 21.5% 28.7% 32.6% 37.7% 40.6%

RoE (%) 29.0% 36.0% 36.2% 39.0% 41.0%

P/E (x) 69.1 58.5 47.2 37.2 29.1

Price/Sales (x) 7.2 5.9 5.4 4.7 4.1

EV/EBITDA (x) 45.0 38.7 31.1 25.7 20.3


AMBIT INSIGHTS


Federal Bank Execution risks stay high Federal Bank reported another disappointing set of quarterly results, with net profit plunging 96% YoY to Rs103bn due to continued pressure on asset quality. Delinquencies were elevated (4.2%) and all loan segments witnessed asset quality stress. Weakness in operating profit (up 11% YoY) has also persisted. With income profile under pressure (normalised NIM of 3.1% and fee income to assets of 0.7%), cost to income ratio rose as well to 57%. We have maintained that whilst any structural improvement in the bank’s assets-side franchise would be a gradual affair, there remain significant risks on profitability and credit quality in the interim (underscored by FY16 results). We have marginally cut our already-below-consensus FY17-FY18 earnings estimates by 3-7% and expect average FY17-FY18E RoA of 0.9% and RoE of 11%. We remain SELLers with target price of Rs47 (0.85x FY18E BV).

Results overview: Federal Bank’s (FB’s) 4QFY16 net profit fell by 96% YoY to Rs103mn (our estimate of Rs1.6bn) due to sharp growth in provisions. Rate of new NPA addition remained elevated at 4.2% (3.7% in 9MFY16). Operating performance was in-line with our expectation with core operating profit growth of 11% YoY, driven by loan growth of 13% YoY, NIM at 3.3% (flat YoY), fee income to assets of 0.7% and cost to income ratio of 57%.

Continuing with the trend in the last three quarters, FB’s asset quality stayed under stress, with fresh addition to NPAs jumping to 4.2% of opening standard loans vs ~3.7% in 9MFY16. Slippages rose across all the sectors, i.e. corporate, SME, retail and agri. Roughly 55% of corporate slippages (Rs2.5bn vs average of Rs2.3bn in 9M) arose from restructured book. In SME book (slippage of Rs1.5bn vs average of Rs1.2bn in 9M), the bank highlighted certain pockets of stress arising due to troubles in rubber sector and SMEs linked with non-resident population in the Middle East. In retail book (slippages of Rs850mn vs average of Rs550bn in 9M), the bank saw stress in its LAP book.

While the reported gross NPAs were flat QoQ due to high write-offs and sale of loans (Rs1.3bn) to ARCs, credit cost spiked to ~200bps vs ~77bps in 9MFY16. Outstanding security receipts stand at ~1.1% of loans. Standard restructured loans now stand at 2.7% of loans (vs 4.3% at end-3Q). The bank has highlighted restructured corporate loans worth ~Rs1-2bn completing moratorium in FY17 to be at the high risk of turning into NPAs.

Loan book growth picked up marginally to 13% YoY (10% YoY at end-3QFY16), driven by corporate loans (up 19% YoY, 33% of loans), SME loans (up 17% YoY, 26% of loans) and retail, ex-gold loans (up 18% YoY, 26% of loans). NIMs were up by 27bps QoQ to 3.31%, mostly due to 18-19bps one-off impact of interest income on IT refunds. CASA deposits grew by 19% YoY, leading to CASA ratio of 32.5% (vs 30.4% at end-FY15). NII, thus, grew by 10% YoY.

Non-interest income showed some signs of improvement with fee income growth of 22% YoY. Fee income, as percentage of average assets, came in at 0.72% (vs 0.66% in 4QFY15). Opex, however, grew by 13% YoY despite almost no branch expansion in the last four quarters. The bank highlighted higher pension costs due to fall in yields as main driver of opex growth. Cost-to-income ratio was thus at 56.8% (vs 49.5% in 4QFY15). Core operating profit grew by 11% YoY to Rs3.30bn, in-line with our subdued expectation.


Since we turned SELLers on Federal Bank in June 2014, we have been sceptical about the bank being able to raise its income profile due to structural constraints that the bank faces on its assets-side business (very high concentration in a small state). In particular, low core non-interest income generation (~0.7% of assets) and small size of current account deposits (unchanged at ~5% of deposits for a long time) indicate very low cross-selling in the business. In addition to this challenge on operating profit,

SELL Result Update Stock Information Bloomberg Code: FB IN

CMP (Rs): 46

TP (Rs): 47




1M 3M 12M YTD

Absolute (2) (2) (30) (19)

Rel. to Sensex (5) (8) (20) (18)


Ambit Estimates (Rs bn)

FY16 FY17E FY18E

NII 25.0 28.7 33.0

PAT 4.8 8.4 11.0

EPS (Rs) 2.8 4.9 6.4


Research Analysts

Ravi Singh Tel: +91 22 3043 3181 [email protected]

Pankaj Agarwal, CFA Tel: +91 22 3043 3206 [email protected]

Rahil Shah Tel: +91 22 3043 3217 [email protected]




AMBIT INSIGHTS


asset quality has taken a downward turn in the last four quarters, raising execution risk while the bank is trying to address the structural issue on the income side.

Whilst most underlying trends were in-line with our expectation, asset quality stress spread to all the loan segments. We have cut our earnings estimates for FY17 and FY18 by 3-7%. We expect profitability to stay subdued with average RoA/RoE of 0.9%/11% over FY17-FY18E.

The stock has significantly underperformed the Bankex in the last 6 months (down ~15% vs Bankex down ~3%). Whilst we stay SELLers on the stock with unchanged target price (Mar’17) of Rs47/share (implying fair valuation of 0.85x FY18E BV), the current share price is now broadly in-line with target price.

Exhibit 1: Quarterly results snapshot

Rs mn 4QFY15 3QFY16 4QFY16 YoY (%) QoQ (%) 4QFY16Est. A/E (%)

NII 6,232 6,052 6,859 10% 13% 6,600 4%

Non-Interest income 3,060 1,833 2,269 -26% 24% 2,958 -23%

Core Non-Interest income 1,330 1,200 1,620 22% 35% 1,400 16%

Total Income 9,292 7,885 9,128 -2% 16% 9,558 -5%

Employee Cost 2,487 2,586 2,930 18% 13% 2,590 13%

Other Operating Expenses 2,114 2,044 2,252 7% 10% 2,167 4%

Total Operating Expenses 4,601 4,630 5,183 13% 12% 4,757 9%

Operating Profit 4,692 3,255 3,945 -16% 21% 4,802 -18%

Total Provisions 398 751 3,886 877% 417% 2,514 55%

PBT 4,294 2,504 59 -99% -98% 2,288 -97%

Tax 1,488 877 -44 NA NA 721 NA

Reported Profit 2,805 1,627 103 -96% -94% 1,567 -93%

Balance sheet (Rs. bn.) Deposits 708.2 747.9 791.7 12% 6% 814.5 -3%

Net Advances 512.8 527.5 580.9 13% 10% 566.3 3%

Total Assets 828.5 885.1 914.3 10% 3% 930.2 -2%

Loan-Deposit ratio (%) 72.4% 70.5% 73.4%

Key Ratios Credit Quality Gross NPAs (Rs. mn.) 10,577 16,841 16,678 58% -1% 18,407 -9%

Net NPAs (Rs. mn.) 3,733 8,761 9,500 155% 8% 10,124 -6%

Gross NPA (%) 2.04% 3.14% 2.84% 3.20% Net NPA (%) 0.73% 1.66% 1.64% 1.79% Loan Loss Provisions (%) 0.24% 0.31% 1.99% Coverage Ratio (%) 64.7% 48.0% 43.0% 45.0% Capital Adequacy Tier I (%) 14.81% 13.74% 13.36% CAR (%) 15.46% 14.32% 13.93% Du-pont Analysis NII / Assets (%) 3.07% 2.77% 3.05% 2.91% Non-Interest Inc. / Assets (%) 1.51% 0.84% 1.01% 1.30% Operating Cost / Assets (%) 2.27% 2.12% 2.30% 2.10% Operating Profits / Assets (%) 2.31% 1.49% 1.75% 2.12% Provisions / Assets (%) 0.20% 0.34% 1.73% 1.11% ROA (%) 1.38% 0.74% 0.05% 0.69%


AMBIT INSIGHTS


Balance sheet

Year to March (Rs mn) FY14 FY15 FY16 FY17E FY18E

Networth 69,456 77,331 80,862 86,742 94,511

Deposits 597,313 708,250 791,717 910,475 1,065,255

Borrowings 56,880 23,082 21,766 23,742 25,916

Other Liabilities 22,243 19,791 19,905 21,896 24,086

Total Liabilities 745,891 828,455 914,250 1,042,855 1,209,768

Cash & Balances with RBI & Banks 45,294 47,800 54,198 60,324 68,213

Investments 241,179 205,688 222,175 248,168 281,690

Advances 434,361 512,850 580,901 671,225 788,527

Other Assets 25,058 62,117 56,976 63,137 71,339

Total Assets 745,891 828,455 914,250 1,042,855 1,209,768


Income statement


Interest Income 69,461 74,195 77,447 84,713 94,605

Interest Expense 47,175 50,391 52,405 56,016 61,643

Net Interest Income 22,286 23,804 25,042 28,696 32,961

Total Non-Interest Income 6,938 8,783 7,864 9,526 11,215

Total Income 29,225 32,587 32,906 38,223 44,176

Total Operating Expenses 14,421 16,309 18,668 20,892 22,484

Employees expenses 7,715 8,920 10,529 12,101 12,989

Other Operating Expenses 6,705 7,390 8,140 8,791 9,494

Pre Provisioning Profits 14,804 16,278 14,238 17,331 21,692

Provisions 2,684 1,067 7,041 4,676 4,973

PBT 12,120 15,210 7,197 12,655 16,719

Tax 3,731 5,153 2,440 4,303 5,685

PAT 8,389 10,057 4,757 8,352 11,035


Ratio analysis


Credit-Deposit (%) 72.7% 72.4% 73.4% 73.7% 74.0%

CASA ratio (%) 31.2% 30.8% 33.0% 34.5% 35.3%

Cost/Income ratio (%) 49.3% 50.0% 56.7% 54.7% 50.9%

Gross NPA (Rs mn) 10,874 10,577 16,678 17,528 18,592

Gross NPA (%) 2.46% 2.04% 2.84% 2.58% 2.33%

Net NPA (Rs mn) 3,216 3,733 9,500 9,465 9,668

Net NPA (%) 0.74% 0.73% 1.64% 1.41% 1.23%

Provision coverage (%) 70.4% 64.7% 43.0% 46.0% 48.0%

NIMs (%) 3.16% 3.20% 3.08% 3.12% 3.11%

Tier-1 capital ratio (%) 14.6% 14.8% 13.4% 12.5% 11.7%


AMBIT INSIGHTS


Du-pont analysis

Year to March FY14 FY15 FY16 FY17E FY18E

NII / Assets (%) 3.1% 3.0% 2.9% 2.9% 2.9%

Other income / Assets (%) 1.0% 1.1% 0.9% 1.0% 1.0%

Total Income / Assets (%) 4.0% 4.1% 3.8% 3.9% 3.9%

Cost to Assets (%) 2.0% 2.1% 2.1% 2.1% 2.0%

PPP / Assets (%) 2.0% 2.1% 1.6% 1.8% 1.9%

Provisions / Assets (%) 0.4% 0.1% 0.8% 0.5% 0.4%

PBT / Assets (%) 1.7% 1.9% 0.8% 1.3% 1.5%

Tax Rate (%) 30.8% 33.9% 33.9% 34.0% 34.0%

ROA (%) 1.15% 1.28% 0.55% 0.85% 0.98%

Leverage 10.9 10.7 11.0 11.7 12.4

ROE (%) 12.6% 13.7% 6.0% 10.0% 12.2%


Valuation parameters

Year to March FY14 FY15 FY16 FY17E FY18E

EPS (Rs) 4.9 5.9 2.8 4.9 6.4

EPS growth (%) 0% 20% -53% 76% 32%

BVPS (Rs) 40.6 45.1 47.0 50.5 55.0

P/E (x) 9.4 7.8 16.6 9.5 7.2

P/BV (x) 1.13 1.02 0.98 0.91 0.84


AMBIT INSIGHTS


Motilal Oswal One-offs impact the results Motilal Oswal Financial Services (MOFS) reported a 6% QoQ decline in PAT (12% below our estimates) due to one-offs in brokerage and fund-based businesses. Whilst PAT from capital market business declined by 27% QoQ, a strong performance in the housing finance business (PAT up 88% QoQ) restricted earnings decline to a modest 6% QoQ. Even as operating trends in brokerage business are uncharacteristically weak this quarter, trends in AMC and HFC business continue to be strong. MOFS should re-rate as it delivers EPS CAGR of 26% over FY16-FY18E, driven by: (i) retail broking and asset management receiving a boost from savings moving away from physical assets towards equities; and (ii) new businesses like asset management and housing finance scaling up. We retain our BUY stance on the stock with an SOTP-based target price of Rs367/share, implying 23x FY17E P/E.

Results overview: MOFS reported a net profit of Rs472mn (down 6% QoQ and 12% below our estimates) due to one-offs in brokerage and fund-based businesses. PAT from capital market business declined by 27% QoQ due to lower revenues in fund-based and brokerage business. However, a strong performance in the housing finance business (PAT up by 88% QoQ, led by strong loan growth of 48% QoQ) restricted the earnings decline to a modest 6% QoQ.

One-offs impact stock-broking revenues: MOFS’ stock-broking revenues decreased by 6% QoQ despite increase in cash volumes of the industry/retail segment by 6%/4% QoQ. Whilst a marginal market share loss (market share down ~20bps QoQ) explains this, most of this disconnect can be explained by certain tax planning measures adopted by the company – MOFS has re-deployed liquid MFs kept as margin funds with stock exchanges from dividend option to growth option for tax planning purposes, and hence has stopped accruing interest income (~Rs60mn previous quarter) on such funds. We remain bullish on MOFS’s prospects of maintaining its market share in the retail segment as MOFS continues to demonstrate strong retail customer acquisition (up 7% YoY, the highest since FY12), which is driven by: i) continued investments in employees (up 42% YoY) and franchisees (up by at least 27% YoY); ii) initiatives on activating dormant retail clients; and iii) increasing thrust on digital and mobile lead generation.

Lack of exits impacted fund-based income: Fund-based income declined by 77% QoQ as MOFS could not exit a few of its marquee investments in 4Q. However, with few exits lined up in 1Q17 (e.g. Parag Milk Foods), we believe the fund-based income engine should start firing in FY17.

AMC business continues to gain traction: MOFS’ asset management business continued its strong momentum, with revenue growing by 8% QoQ driven by a 7% increase in AUM and steady gross yields. AUM growth was driven by continued increase in market share in inflows from 2.1% in FY15 to ~3.8% in FY16. Such market share gain is driven by MOFS’ continued traction with large distributors and IFAs and shift into financial savings from physical savings. In terms of equity AUM, MOFS AMC is currently the 12th largest AMC (18th in FY14).

Operating costs in control in capital market business: Increase in consolidated operating costs (up 8% YoY) is attributable to increased investments in employees and branches for Aspire (opex up 129% YoY). Operating costs of the capital market business remained in control, with a modest 2% QoQ and 1% YoY increase. However, a 5% decline in revenues owning to disappointments from brokerage and fund-based income led to a 27% decline in PAT.

BUY Result Update Stock Information Bloomberg Code: MOFS IN

CMP (Rs): 297

TP (Rs): 367




1M 3M 12M YTD

Absolute (16) (17) (7) (15)

Rel. to Sensex (8) (8) 9 (8)


Ambit Estimates

(Rs bn) FY16 FY17E FY18E

Net revenues 8.1 9.2 9.6

Net profit 1.7 2.2 2.7

Diluted EPS (Rs) 12.1 15.8 19.1


Research Analysts

Aadesh Mehta, CFA [email protected] Tel: +91 22 3043 3239

Pankaj Agarwal, CFA [email protected] Tel: +91 22 3043 3206



AMBIT INSIGHTS


Aspire continues stellar performance, but high prepayment rates need to be monitored: The contribution of Aspire Housing is clearly increasing in the consolidated entity, with its contribution to consolidated PAT increasing from 8% in 4QFY15 to 38% in 4QFY16. Its growth trends remain robust, with the disbursement run-rate touching Rs7.4bn/quarter, resulting in loan book of Rs20.9bn in 4QFY16. The HFC business is now clocking RoAs of 3.3% and RoEs of ~16%. That said, competitive pressures have resulted in high prepayment rates for an unseasoned book (~12% in 4Q and ~14% in 3Q), which needs to be closely monitored.


MOFS’ muted set of numbers are mainly due to one-offs in brokerage business even as operating trends remain very healthy across its asset management and lending businesses. Whilst operating trends in the brokerage business are uncharacteristically weak, inflows continue to be robust in the AMC business. The housing finance business also continues to see good traction. MOFS should re-rate as it delivers EPS CAGR of 26% over FY16-FY18E, driven by: (i) boost for retail broking and asset management from shift in savings from physical assets to equities; and (ii) expansion of new businesses like asset management and housing finance. We retain our BUY stance with an SOTP-based target price of Rs367, implying 23x FY17E P/E.

Exhibit 1: Quarterly snapshot

Y/E Mar (Rs. m) 4QFY16 4QFY15 3QFY16 4QFY16 Ambit Estimates YoY (%) QoQ (%) Deviation from

Ambit estimates(%)

Ex-Aspire Income statement Income 2,054 2,089 2,170 2,291 -2% -5% -10%

Net Interest Income 40 65 175 187 -38% -77% -79%

Fund based income 247 193 345 Interest 207 128 170

Brokerage & operating income 1,265 1,333 1,339 1,433 -5% -6% -12%

Investment banking fees 84 92 36 30 131% 180%

Asset Management Fees 653 589 604 631 11% 8% 4%

Other income 12 10 16 10 Expenditure 1,555 1,537 1,525 1,578 1% 2% -1%

Operating Costs 585 605 601 616 -3% -3% -5%

Employee cost 632 593 568 573 7% 11% 10%

Administration & other expense 338 339 356 389 0% -5% -13%

EBITDA 499 552 645 713 -10% -23% -30%

Depreciation and amortisation 90 93 93 93 Exceptional Items - - - - Profit Before Tax 409 459 552 620 -11% -26% -34%

Tax 106 114 137 161 -34% Net Profit Before Extra-ordianaries and MI 303 345 415 459 -12% -27% -34%

Minority Income (8) (4) (8) (5) Ex-Aspire PAT 295 341 407 454 -14% -27% -35%

Aspire PAT 177 28 94 86 529% 88% 107%

Consolidated PAT 472 369 501 539 28% -6% -12%


AMBIT INSIGHTS


Income statement (Rs mn)


Total Income 4,654 7,445 8,102 9,202 9,628

Brokerage Income 2,870 4,855 5,092 5,095 5,260

Net Interest Income 908 1,056 479 521 644

Other Income 876 1,534 2,532 3,586 3,724

Operating expenses 3,261 5,159 6,000 6,421 7,101

Direct Costs 1,053 1,950 2,312 2,038 2,104

Employee Costs 1,273 1,899 2,277 2,619 2,880

Admin Expenses 934 1,311 1,411 1,764 2,117

Operating Profit 1,394 2,285 2,102 2,782 2,527

Depreciation 243 307 340 347 364

Exceptional items -550 0 0 0 0

Profit before tax 601 1,979 1,762 2,435 2,162

Less:Tax 179 523 444 755 649

PAT - Capital markets business 422 1,455 1,318 1,680 1,514

Extraordinary items & MI (21) (20) (28) (32) (37)

Net Profit (ex-HFC) 401 1,436 1,290 1,648 1,477

HFC PAT - 21 400 572 1,200

Consol PAT 401 1,436 1,690 2,220 2,676


Balance sheet (ex-Aspire) (Rs mn)


Networth 11,703 12,930 13,956 15,622 17,630

Minority Interest 51 63 162 75 82

Borrowings 1 6,131 7,450 4,560 4,225

Net Deferred taxes 117 120 62 71 82

Total Sources of funds 11,871 19,244 21,630 20,328 22,019

Cash 1,678 2,553 2,867 3,297 3,792

Investments 2,930 9,440 15,311 17,608 20,249

Fixed Assets 3,072 2,992 2,921 3,067 3,220

Loan book 4,100 5,997 3,670 4,221 4,854

Net working capital 91 (1,738) (3,139) (7,864) (10,095)

Total Application of funds 11,871 19,244 21,630 20,328 22,019


Key ratios


Broking Market share (%) 1.6 1.5 1.7 1.7 1.5

Brokerage Yield (bps) 3.6 3.9 3.5 3.5 3.9

Operating Cost/Income 70.1 69.3 74.1 69.8 73.8

Debt to Equity (%) 0.0 0.5 0.5 0.3 0.2

Revenue Growth (0.6) 59.9 8.8 13.6 4.6

PAT Growth (63.2) 257.9 17.7 31.4 20.6


AMBIT INSIGHTS


Valuation parameters


BVPS (Rs) 84.7 92.3 99.6 111.5 125.8

Dil. EPS (Rs) 3.0 10.2 12.1 15.8 19.1

ROA (%) 3.3 9.2 6.3 8.8 8.8

ROE (%) 3.4 11.7 12.6 15.0 16.1

P/E 100.7 29.0 24.6 18.7 15.5

P/BV 3.5 3.2 3.0 2.7 2.4

Dividend yield (%) 0.7 1.0 1.0 1.3 1.6


AMBIT INSIGHTS


BFSI Weekly tracker In this weekly update, we have compiled all the key news flows, regulatory developments, key management interviews, summary of takeaways from our meetings with management teams/primary data and summary of key notes we published last week. On the negative front, judicial and public scrutiny of Indian banks’ bad loans stays intense. On the positive front, Bank Board Bureau is likely to move on more pressing needs of PSU bank reforms, i.e. new CEOs and boards.

Exhibit 1: Key news-flow during last week

Title Description Implications

RBI Defaulters List: The Rs5trn secret; Meet the Top 10

News: According to the RBI’s list, leaked by a media portal, the top 10 corporate defaulters owe over Rs560bn to banks and financial institutions. Most of these defaults are to state-owned banks and insurance companies (LIC, GIC). According to CIBIL, total NPAs stand at about Rs5.5 lakh crore, of this, only Rs1.5 lakh crore (both suit and non-suit filed accounts) are termed willful defaults by banks. (Source: http://goo.gl/bs2644). Lloyds Steel tops the list with willful defaults of Rs63.1bn followed by Usha Ispat (Rs50.1bn) and Cranes Software International (Rs25.1bn). (Source: http://goo.gl/OQzBbP)

Views: While RBI has asked Supreme Court to keep the defaulters list private, it is likely that the list does not stay private and eventually is made public. As per the news article, LIC is overall largest lender (Rs657bn) to these companies and in banks SBI leads with exposure of Rs423bn (~3% of the SBI loan book). If the list is made public, it will put additional pressure on banks to make NPA recognition uniform across banks, thus impacting profitability in FY17.

Negative

Initiative for merger of PSBs has to come from their Boards: Jayant Sinha

News: The initiative for merger of PSU banks has to come from boards of the banks concerned and the government's and RBI's role would be that of a facilitator. The guiding principle for the consolidation process of banking in India has so far been the Narasimham Committee. According to it, the move towards restructured organization of the banking system should be market-driven based on profitability considerations and brought about through a process of mergers and amalgamations. (Source: http://goo.gl/fhkfhx) Views: In-line with our expectation, the news highlights there is unlikely to be any decisive progress on bank consolidation in the near term. The focus, for bank reforms, is largely to remain on NPA clean-up and new CEOs/boards.

Neutral

Bank Board Bureau to soon start selection of PSB MDs: Vinod Rai

News: The Bank Board Bureau (BBB) will soon initiate the process of selecting managing directors of public sector banks. BBB chief Vinod Rai said after the second meeting of BBB that tangible decision is selection of MDs and that they would start that immediately. (Source: http://goo.gl/55ImBu) Views: In our note, Bank Board Bureau – what and what not to expect?, we highlighted that the immediate focus of BBB (working with the Government and the RBI) will be installing better boards/CEOs at PSU banks and creating an enabling environment (higher autonomy, protection from witch hunting and a probable hiving off of bad loans). Whilst progress on these lines will be structurally positive for PSU banks, in near to medium term, high focus on balance sheet clean-up could lead to elevated credit costs and muted profitability (amid intense competition). We retain our negative stance on PSU banks. Bank of Baroda is our only BUY recommendation given better visibility on governance reforms.

Positive

Bring in banking reforms to deal with NPAs: Supreme Court to government

News: The Supreme Court asked the Central Government to overhaul the banking system to prevent bad loans and hasten recovery from defaulting borrowers. The bench asked the Government to set up a committee and debate how things can be improved. The bench had earlier sought details from the RBI about all those who had defaulted on loans of Rs5bn and above. (Source: http://goo.gl/uJT43l) Views: A rise in judicial and public scrutiny of bad loans in Indian banking is likely to lead to higher recognition of NPAs and pressure on defaulters. In the near term, this could lead to elevated credit cost and growth in NPAs.

Negative

RBI to harmonise regulations between banks and NBFCs

News: In a move that could remove reduce clutter and possibilities of arbitrage for NBFCs, the RBI is working towards harmonising regulations for banks and NBFCs. Common activities of banks and NBFCs will be subject to similar regulations to remove regulatory arbitrage. RBI will also continue to approve new kind of NBFCs if the situation warrants. Reiterating that peer-to-peer lending will soon come under the regulator’s radar. Mr. Gandhi pointed out that while encouraging innovation the Reserve Bank cannot stay oblivious to the risks posed by such institutions. (Source: http://goo.gl/5tuIEa) Views: Whilst this is positive for commercial banks, it will be negative for most NBFCs since the regulatory arbitrage which NBFCs used to enjoy will start diluting. Banks will gain from the harmonise regulations apart from enjoying higher branding, lower cost of funds, higher distribution network and opportunities for cross selling. NBFCs that do not have differentiation on the asset side and are competing head-to-head with the banks would be the biggest losers, as their regulatory advantages vis-a-vis banks are taken away. Housing Finance companies appear to be the most adversely exposed to any regulatory changes in favor of banks.

Negative

Source: Media reports, Ambit Capital research

Quick Insight Analysis Meeting Note News Impact

Analysts

Pankaj Agarwal, CFA Tel: +91 22 3043 3206 [email protected]

BFSI Team [email protected]

http://goo.gl/bs2644).

http://goo.gl/OQzBbP)

http://goo.gl/fhkfhx)

http://goo.gl/55ImBu)

http://goo.gl/uJT43l)

http://goo.gl/5tuIEa)



http://reports.ambitcapital.com/reports/Ambit_BFSI_BankBoardBureau_13Apr2016.pdf

AMBIT INSIGHTS


Exhibit 2: Key Interviews given by management during last week

Interview with Summary

V Srinivasan, Deputy MD, Axis Bank

Retail key for growth; watchlist to help check asset pain; Expect 60% of 'watch list' accounts to turn bad: We expect credit cost to be around 125bps for FY17, vs around 111bps in FY16. However, if things turn out better it could

be lower. The bank has assessed the status of the corporates, their current payment track records, their fundamentals, and the

probability of the slippages before taking a call on making the close-ended watch list. We believe that the environment in terms of overall banking sector will possibly be more positive than what we have seen

over FY16. But as far as credit costs are concerned, we will continue to stay elevated. We expect retail to be driving our loan growth even in FY17. However, we also hope that corporate would grow at a

decent pace in FY17. (Source: http://goo.gl/QmmZWa; http://goo.gl/4jrntL)

VP Nandakumar, MD & CEO Of Manappuram General Finance.

Company poised to grow at CAGR of 20% in next few years: The microfinance segment's assets under management will grow to Rs30bn in the next 2-3 years. As some of the microfinance companies are reshaping into small finance banks, big ones like Manappuram will gain in

the near term. Companies will be able to source funds at cheaper rates once competition moves away. Manappuram is betting on new initiatives such as micro finance, home finance and commercial vehicle finance segments

to drive performance. (Source: http://goo.gl/AkTTQD)

Ramesh Iyer, MD, M&M Financial Services

Focus is on improving rural reach; company sees normal monsoon: The company has identified high-pressure states and created separate customer buckets to improve its GNPL situation.

The company witnessed cash flows from states such as Assam, Tamil Nadu and parts of Maharashtra. About 65% of the NPAs accounts have registered collection this year. This implies customers are not intentional defaulters

and that the delays are circumstantial. Therefore, these will not lead to credit loss but may involve some delays. If the monsoon is below average or normal, the company will be more aggressive and will try adding branches. The focus

will be on commercial vehicles as well as pre-owned vehicles. (Source: http://goo.gl/hQcu4J)


Exhibit 3: Recent notes published by Ambit team relevant to BFSI sector


Axis Bank: Different strokes for different times (Coffee Can Legends)

A strong and independent Board, an employee friendly culture, and a DNA flexible to changes form the foundation of Axis Bank’s success. These strengths have helped the bank transform from a quasi-PSU bank

to a universal bank over the past two decades under three different leaders. The bank’s strength on both sides of the balance sheet is visible in its strong operating profitability, which enables it to absorb higher credit cost of ~125bps in FY17-18 and still deliver average ROE of 17.4% and EPS CAGR of 16% over FY16-18. Axis Bank is trading at ~30% discount to peers despite healthier ROE and better franchise. We maintain our BUY stance with TP of Rs600 (2.1x FY18 P/B)

Positive

M&M Financial Services: Is it an inflection point?

MMFS reported better than expected profits during the quarter due to sequential asset quality improvement being ahead of expectations, leading to lower than expected credit costs. However, growth trends remain weak with 9% AUM and 8% disbursement growth as growth trends in tractors and passenger vehicle remained muted. It would be too early to say that asset quality and growth would show sustained improvement hereon given the weak state of rural economy. On the contrary, we expect asset quality to worsen in 1HFY17 vs 1HFY16 due to muted growth trends. Asset quality and growth performance beyond 1HFY17 would be a function of monsoons this year and State/Central government spends in rural areas, where visibility is still not very high. FY16 consolidated ROEs at 12.4% and valuation at 2.2x FY17 consolidated P/B (in line with historical average) imply that a fair amount of recovery is already built into the stock. Even factoring a moderate recovery in rural economy over FY17/FY18, we don’t think MMFS would be able to deliver over 17% by FY18 due to increased competition from banks in some segments and shift to tougher NPA recognition norms. As risk-reward remains unfavourable, we maintain our SELL stance.

Negative

Axis Bank: Navigating the rough waters

Axis Bank delivered broadly in-line 4QFY16 core performance. Asset quality was stable, with total bad loans unchanged QoQ at 5.9% of loans. To indicate size of residual stress, the bank revealed 13% of corporate book (watch-list) will be key source of NPAs over next two years. Thus, the management guided for F17 credit-cost of 125-150bps, which we believe is not materially different from what was expected based on bad loan formation trends so far. Hence, focus would shift to bank’s ability to protect profitability as pain from legacy corporate book plays out. Continued focus on retail businesses and smarter corporate growth (targeting higher-rated large corporates) are the right strategy given ingredients to execute are in place. Our estimates remain largely unchanged; we expect RoE of 16-17% over FY17-18 despite high credit costs. Maintain BUY with TP of Rs600 (2.1x Mar ’18E BV).

Positive

Shriram City Union Finance: Higher coverage ratio warrants earnings cuts

SCUF reported PAT of Rs555bn (down 63% YoY), which is ~60% below our and consensus expectations. The disappointment was primarily due to more aggressive provisioning policy on additional NPAs due to 150dpd NPA migration (~46% versus regulatory minimum of ~15%). Adjusting for one-offs such as additional NPAs and employee bonus, underlying operating performance continues to improve on all key metrics in terms of growth, asset quality and operating efficiency. However, management’s intent to maintain higher coverage on additional NPAs leads to a marginal 9%/2% cut in our FY17/18 PAT estimates. We reiterate BUY with a revised TP of Rs2,190 (Rs2,260 earlier), implying 2.7x 1-year fwd P/B and 21x 1-year fwd P/E.

Positive

http://goo.gl/QmmZWa;

http://goo.gl/4jrntL)

http://goo.gl/AkTTQD)

http://goo.gl/hQcu4J)

http://reports.ambitcapital.com/reports/Ambit_AxisBank_Navigatingtheroughwaters_27Apr2016.pdf

http://reports.ambitcapital.com/reports/Ambit_M&MFinancialServices_Isitaninflectionpoint_25Apr2016.pdf

http://reports.ambitcapital.com/reports/Ambit_AxisBank_CompanyInsight_Differentstrokesfordifferenttimes_26Apr2016.pdf

http://reports.ambitcapital.com/reports/Ambit_ShriramCityUnionFinance_Highercoverage_28Apr2016.pdf

AMBIT INSIGHTS



ICICI Bank: A difficult year ahead

ICICI Bank’s 4QFY16 net profit collapsed to Rs7.0bn (down 76% YoY) as the bank had to make contingency provisions of Rs36bn for its risky exposures. Core performance in 4QFY16 itself was weaker than our expectation as NIM contracted and “bad loans” touched 9.1% of loans (vs 8.5% at end-3Q). Gains on stake sales and low tax rate salvaged some profitability. The bank highlighted “below investment grade” exposure (~Rs440bn) in five stressed sectors and its restructured book (~Rs86bn) as key sources of NPA in the near term, but the bank shied away from articulating its near-term expectations on slippages and credit costs. We expect credit costs to stay elevated (175bps in FY17), with average RoA and RoE of 1.45% and 12-13%, respectively, in FY17- 18. We retain SELL with our revised TP of Rs230, implying valuation of 1.2x FY17E consolidated BVPS).

Negative

Shriram Transport Finance: Improving trends; but RoEs below 16%

SHTF’s standalone PAT declined by 55% YoY to Rs1.44bn. PAT would have declined 90% YoY had SHTF provided only the regulatory minimum on the new 150dpd NPAs and not lowered its coverage on legacy 180dpd NPAs. That said, SHTF’s core CV financing business demonstrated better trends across key metrics, with improving growth and margins and stabilizing asset quality. Further, performance of the CE business is also improving, with the asset quality in line with guidance and the ongoing improvement in resale values

of CEs brightening the prospects of recoveries from this book. However, SHTF is unlikely to deliver RoEs beyond 16% over FY16-18E as its margins expansion will not be significant and operating costs will inch up hereon. We retain SELL with a target price of Rs813/share (from Rs789 earlier), implying a generous 1.6x 1-year fwd P/B and 11x 1-year fwd P/E.

Negative


http://reports.ambitcapital.com/reports/Ambit_ICICIBank_Adifficultyearahead_30Apr2016.pdf

http://reports.ambitcapital.com/reports/Ambit_ShriramTransportFinance_Improvingtrends_30Apr2016.pdf

AMBIT INSIGHTS


Economy Ambit’s qualitative leading indicators’ (QLI) tracker

With qualitative data collected through primary data networks often proving to be a stronger leading indicator of changes in the economy, we collate a weekly tracker that captures these critical qualitative inputs. On the positive front: (1) The Real estate regulatory bill comes to effect from May 1; (2) 4QFY16 saw M&A activity rise to a 4-year high; and (3) A Parliament panel gave its nod to the new bankruptcy code. On the negative front: (1) A recent report suggest that India will face a severe shortage of jobs in the next 35 years as it fails to provide jobs to the numbers entering the labour force; (2) Our agriculture analyst highlights that the recent rally in agricultural inputs space appears to be ahead of fundamentals; and (3) High frequency indicators suggests that India’s economic growth decelerated in FY16.

Exhibit 1: Ambit’s qualitative indicators tracker for the week commencing 25th April 2016

Head Description Positive/ Negative

Economy: Real estate regulation comes to effect from May 1

The Real Estate (Regulation and Development) Act, 2016 will come into effect from May 1. It has set in motion, the process of making necessary operational rules and the creation of institutional

infrastructure for protecting the interests of consumers. As per the notification of the Ministry of Housing and Urban Poverty Alleviation (HUPA) rules under the act have to

be formulated by the Central and State Governments within a maximum period of six months (source: http://www.dnaindia.com/money/report-new-real-estate-act-to-come-into-effect-from-today-2207885).

Positive

Economy: First quarter M&A activity at its highest since 2012

Mergers and acquisitions (M&A) worth $8.2 billion were closed in India during the first three months of 2016, according to MergerMarket, a global deal-tracking platform. The amount is the highest since 2012 and an increase of 5.2% as compared to the same period last year.

The construction sector was the most active in terms of deal-making and accounted for 43% of the value of all the deals closed.

The largest of these was Aditya Birla Group firm UltraTech Cement Ltd’s acquisition of 21 million tonnes in cement capacity from debt-laden Jaiprakash Associates Ltd. Birla Corp’s $706 million acquisition of Reliance Cements assets was the other big deal in this segment during the quarter (source: http://www.livemint.com/Money/pjJq2SYfOGko3ZeVRro2XJ/First-quarter-MA-activity-at-its-highest-since-2012.html).

Positive

Economy: RBI proposes P2P lending regulations

The Reserve Bank of India (RBI) on April 28 initiated steps to regulate the nascent and hitherto unregulated peer-to-peer (P2P) lending business. RBI has proposed registering P2P lending platforms as non-banking financial companies (NBFCs).

Online P2P lending companies work as marketplaces that bring individual borrowers and lenders together for loan transactions without the intervention of traditional financial institutions such as banks and NBFCs (source: http://www.livemint.com/Industry/Vx9iwySoYwxHxfIsPq2r1L/RBI-proposes-regulatory-framework-for-P2P-lending-platform.html).

Positive

Economy: Parliament panel approves new bankruptcy laws

An Indian parliamentary panel approved a bill aimed at overhauling century-old bankruptcy regulations, taking a key reform measure aimed at improving ease of doing business closer to implementation.

The Insolvency and Bankruptcy Code, which makes it easier to wind up a dying company or recover dues from a defaulter, could come up for passage in the current session of Parliament that ends on 13 May, Finance Minister Arun Jaitley said (source: http://www.livemint.com/Politics/tOeX87bQ2aUnEf63d8FJDN/Parliamentary-panel-approves-insolvency-laws-sets-stage-for.html).

Positive

Strategy: Ind AS impact on auto OEMs

The four key areas where auto OEMs are likely to be impacted are - accounting for financial instruments, acquisitions, revenue recognition and consolidation.

Our analysis suggests that while book value and net worth are likely to be positively impacted under Ind AS, reported earnings and return ratios could be adversely impacted.

We expect M&M to be affected the most, with the key impact areas being accounting for consolidation, business acquisitions and treasury shares

While Ashok Leyland too could be impacted by the new consolidation norms, Bajaj Auto, Hero Motocorp and Eicher Motors would see changes in accounting due to fair valuation of investments and derivatives. TVS Motor Company, however, looks likely to be the least impacted by the transition to Ind AS.

Neutral


Quick Insight Analysis Meeting Note News Impact

Resarch Analysts

Ritika Mankar Mukherjee, CFA [email protected] Tel: +91 22 3043 3175

Sumit Shekhar [email protected] Tel: +91 22 3043 3229

http://www.dnaindia.com/money/report-new-real-estate-act-to-come-into-effect-from-today-2207885).

http://www.livemint.com/Money/pjJq2SYfOGko3ZeVRro2XJ/First-quarter-MA-activity-at-its-highest-since-

http://www.livemint.com/Industry/Vx9iwySoYwxHxfIsPq2r1L/RBI-proposes-regulatory-framework-for-P2P-lending-

http://www.livemint.com/Politics/tOeX87bQ2aUnEf63d8FJDN/Parliamentary-panel-



AMBIT INSIGHTS


Exhibit 2: Ambit’s qualitative indicators tracker for the week commencing 25th April, 2016 (continued)

Head Description Positive/ Negative

Economy: India to see severe shortage of jobs in the next 35 years

India faces the serious challenge of finding jobs for a growing population over the next 35 years; its economy could absorb less than half the new entrants into the labour market between 1991 and 2013, the latest Asia-Pacific Human Development Report said.

The report, released by the United Nations Development Programme (UNDP) on Wednesday, said that between 1991 and 2013, the size of the “working age” population increased by 300 million.

Of this, the Indian economy could employ only 140 million, suggesting a limited capacity to generate jobs. The report estimated that by 2050, at least 280 million more people will enter the job market in India (source: http://www.livemint.com/Politics/Tpqlr4H1ILsusuBRJlizHI/India-to-see-severe-shortage-of-jobs-in-the-next-35-years.html).

Negative

Economy: In yet another flip-flop government rolls back EPF interest rate cut

The government made yet another concession to working-class anger on the Employees' Provident Fund by raising the interest rate payout for FY16 to 8.8% from the 8.7% that had been approved by the Finance Ministry earlier in the week.

The backpedalling follows the uproar sparked by the Finance Ministry scaling down the 8.8% recommended by the Central Board of Trustees (CBT) of the Employees' Provident Fund Organisation (EPFO) (source: http://economictimes.indiatimes.com/wealth/personal-finance-news/government-gives-in-to-pressure-epf-interest-rate-increased-to-8-8-from-8-7/articleshow/52041500.cms).

Negative

Economy: A few green shoots, more dying saplings

In the fourth iteration of our high frequency indicators note (click here for the previous iteration published on 12th February), we analyse the status of 16 real economy indicators.

Our analysis suggests that: (a) 9 of 16 indicators recorded a sequential improvement in 4QFY15 although gauges related to the pricing power in the broader economy, namely core CPI as well as core WPI remain weak; (b) the second derivative of 8 of 16 indicators was negative in 4QFY16 implying the rate of growth decelerated in last quarter; and (c) on an annual basis, 11 of the 16 high frequency indicators slowed in FY16 vs FY15

We remain of the view that an economic recovery is not yet underway in India (click here for our note dated 25th April for details).

Negative

Economy: India likely to become net importer of sugar as drought dries fields

India is likely to become a net importer of sugar in 2016/17 as back-to-back drought years dry irrigation channels and ravage cane fields, with output in the country's biggest producing state seen dropping over 40%.

That would mark the first time the nation has been a net importer of the sweetener in four years, with the switch likely to support global prices that have already been rising this year.

The El Nino weather phenomenon, which brings dry conditions to many regions, has stoked the worst drought in decades in some parts of India, with thousands of small-scale sugar cane growers in Maharashtra state failing to cultivate crops for the next marketing year, starting October (source: http://in.reuters.com/article/india-sugar-output-idINKCN0XO0IA).

Negative

Agri Inputs: Recent rally appears to be ahead of fundamentals

Agri stocks have seen a sharp run-up over the past two months (UPL +39%, PI +20%, Rallis +31%, Dhanuka + 15%, Bayer +10% and IIL 27%). We maintain our positive bias on agrochemicals over the long term

However, our checks suggest FY17 may not turn out to be all rosy as the recent rally seems to be suggesting.

We see three key challenges for the domestic segment (50% of the market): a) farmer sentiment will take time to pick up given weaker profitability for last two years; b) high channel inventories, leading to 300-400bps difference between primary and secondary volume growth rates; c) flat to negative pricing growth YoY, driving lower prices for a large section of generic technical

In exports, a global recovery seems to be at least 2-3 quarter away as farm economics remain under pressure.

Negative


http://www.livemint.com/Politics/Tpqlr4H1ILsusuBRJlizHI/India-to-see-severe-shortage-of-jobs-in-

http://economictimes.indiatimes.com/wealth/personal-finance-news/government-gives-in-

http://in.reuters.com/article/india-sugar-output-idINKCN0XO0IA

http://reports.ambitcapital.com/reports/Ambit_Economy_Indiashighfrequencyindicators_12Feb2016.pdf

http://reports.ambitcapital.com/reports/Ambit_Economy_Afewgreenshootsmoredyingsaplings_25Apr2016.pdf

AMBIT INSIGHTS


Utilities Weekly tracker In this weekly update, we have compiled the key news flow, regulatory developments and key management/regulator interviews that occurred last week. The key positive news is: JSW Energy calls off the potential deal with JSPL to buy Tamnar I. The negative news is: (a) Union Power Ministry cuts power demand for FY22 by 20%; (b) Uttarkhand to buy short-term power through e-auction; (c) NTPC ventures into wind power; and (d) special court slaps criminal charges against Naveen Jindal.

Exhibit 1: Key news flow during last week

Sub-sector / Company Title Implications Description Source

JSW Energy JSW Energy's power plant deals with JSPL hits a roadblock

Positive

According to media sources, JSW Energy's (JSWE) acquisition of JSPL's Tamnar I plant (1GW) was called off due to differences on valuation. JSWE had agreed to pay Rs60bn if JSPL arranged for 90% PPA for the plant. However, without PPA the price offered by JSWE was Rs45bn. JSPL rejected JSWE's offer. http://goo.gl/gUVTGa

Our view: Calling off the deal is positive as it abates the concern of JSWE paying higher price for JSPL's plant. Our DCF-based valuation suggested a fair value of Rs38bn for JSPL's Tamnar I plant.

Renewables

Investors interested in acquiring stake in company: SunEdison India

Neutral

Given the weak financial situation of global parent, SunEdison, India is looking to offload some of the Indian assets from its portfolio of 0.7GW operational and 1.7GW under-construction capacities.

http://goo.gl/xigIvQ

According to SunEdison India's MD, the company is seeing lot of interest from potential buyers for asset sale. Earlier news reports suggested that Adani group is looking to acquire SunEdison's asset in India. Our view: We do not expect the financial woes of the parent to have any impact on SunEdison India's solar ambition as these are primarily due to failure of SunEdison's yieldco model in the USA and not due to aggressive bidding in India. Though SunEdison was a leading investor in Indian solar, we believe there are a sufficient number of other large global and domestic investors to support the Government’s target of 60GW ground-mounted solar capacity by FY22. Recent solar bids of less than Rs5/unit apart from SunEdison were also from various other investors such as Softbank, Indiabulls, Acme Solar, Hero Future Energy, etc.

Power demand Union Power Ministry cuts power demand for FY22 by 20%

Negative

Power demand for FY22 has been cut by 20% to 239GW by the Union Power Ministry.

http://goo.gl/Iz0uLK

Lower forecast in power demand is due to expectation around (a) AT&C losses reducing and (b) use of energy-efficient equipment.

The capacity expansion in the last five years has satisfied unmet power demand and in the absence of pent-up demand, only the actual demand growth needs to be taken care of by further capacity expansion, implying only 6% growth in capacity expansion.

Our view: We believe even the 239GW number is optimistic given that it assumes 8.6% economic growth over FY17-22. Clearly, the country does not need to incur any fresh capex in generation over FY17-19 given that the present coal-based capacity of 185GW is likely to increase to 272GW by FY22 alongside 175GW of renewables.

NEUTRAL Quick Insight Analysis News Note Meeting Note

Research Analysts

Bhargav Buddhadev [email protected] Tel: +91 22 3043 3252

Deepesh Agarwal, CFA [email protected] Tel: +91 22 3043 3275

http://goo.gl/gUVTGa

http://goo.gl/xigIvQ

http://goo.gl/Iz0uLK



AMBIT INSIGHTS


Sub-sector / Company Title Implications Description Source

Short term PPA Uttarkhand to be first state to buy short-term power through e-auction

Negative

Uttarakhand has sought 100-200MW short-term PPA for 2QFY17 through e-auction route.


Our view: We believe other states will follow the e-auction route for short-term PPA. This is negative for JSWE as the online bidding for short-term PPAs would result in increased competition and lower tariffs. Currently, ~50% of JSWE's revenue comes from short-term bilateral PPAs of up to 3-12 months.

NTPC NTPC entering into wind generation Negative

NTPC has proposed bids of 100MW to enter wind generation.

http://goo.gl/1UNZ27

The winner of the contract will implement the project from concept to commissioning. Our view: Rising focus on renewables (NTPC is guiding for increase in share of renewables to ~28% by FY32) is a negative for NTPC as it does not have any expertise in running renewable plants. NTPC is India's most efficient coal-based power generator given its cost of generation is the lowest at Rs3.1/unit; NTPC has the most efficient heat rate in India and its freight cost is the lowest as most of its plants are located at pit head.

JSPL Special court slaps criminal charges against Naveen Jindal

Negative

Naveen Jindal is co-accused for criminal conspiracy in the Amarkonda Murgadangal coal block allocation in Jharkhand.

http://goo.gl/N9fMHz

Our view: This is a negative for JSPL as it will act as a headwind in JSPL trying to liquidate its assets for reducing its high leverage.



http://goo.gl/1UNZ27

http://goo.gl/N9fMHz

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]

Aakash Adukia Oil & Gas / Chemicals / Agri Inputs (022) 30433273 [email protected]

Abhishek Ranganathan, CFA Retail / Mid-caps (022) 30433085 [email protected]

Achint Bhagat, CFA Cement / Roads / Home Building (022) 30433178 [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]

Kushank Poddar Technology (022) 30433203 [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 (022) 30433223 [email protected]

Prashant Mittal, CFA 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]

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 7614 8374 [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]

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]

E&C = Engineering & Construction














































AMBIT INSIGHTS


Tata Power (TPW IN, BUY)


NTPC Ltd (NTPC IN, SELL)


JSW Energy Ltd (JSW IN, SELL)


0

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TATA POWER CO LTD

020406080

100120140160180

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NTPC LTD

020406080

100120140

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JSW ENERGY LTD

AMBIT INSIGHTS


Bharat Electronics Ltd (BHE IN, BUY)


Marico Ltd (MRCO IN, BUY)

Source: Bloomberg, Ambit Capital research Federal Bank Ltd (FB IN, SELL)


0200400600800

1,0001,2001,4001,600

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BHARAT ELECTRONICS LTD

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MARICO LTD

0102030405060708090

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FEDERAL BANK LTD

AMBIT INSIGHTS


Cholamandalam Investment (CIFC IN, BUY)


Motilal Oswal Financial Serv (MOFS IN, BUY)


0100200300400500600700800

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CHOLAMANDALAM INVESTMENT AND

050

100150200250300350400

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MOTILAL OSWAL FINANCIAL SERV

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 Disclaimer This report or any portion hereof may not be reprinted, sold or redistributed without the wri tten consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases , in

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However, such information has not been independently verified by AMBIT Capital and/or the analyst(s) and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties. The information, opinions , views expressed in this Research Report are those of the research analys t as at the date of this Research Report which are subject to change and do not represent to be an authority on the subject. AMBIT Capital may or may not subscribe to any and/ or all the views expressed herein.

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Additional Disclaimer for U.S. Persons 10. The research report is solely a product of AMBIT Capital 11. AMBIT Capital is the employer of the research analyst(s) who has prepared the research report 12. Any subsequent transactions in securities discussed in the research reports should be effected through Enclave Capital LLC. (“Enclave”). 13. Enclave does not accept or receive any compensation of any kind for the dissemination of the AMBIT Capital research reports . 14. The research analys t(s) preparing the email / Research Report/ attachment is resident outside the United States and is/are not associated persons of any U.S. regulated broker-dealer and that therefore the analyst(s)

is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satis fy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securi ties held by a research analyst account.

15. This report is prepared, approved, published and dis tributed by the Ambit Capital located outside of the United States (a non-US Group Company”). This report is distributed in the U.S.by Enclave Capital LLC, a U.S. regis tered broker dealer, on behalf of Ambit Capital only to major U.S. institutional investors (as defined in Rule 15a-6 under the U.S. Securi ties Exchange Act of 1934 (the “Exchange Act”)) pursuant to the exemption in Rule 15a-6 and any transaction effected by a U.S. cus tomer in the securi ties described in this report must be effected through Enclave Capital LLC (19 West 44th Street, suite 1700, New York, NY 10036).

16. As of the publication of this report Enclave Capital LLC, does not make a market in the subject securi ties. 17. This document does not consti tute an offer of, or an invi tation by or on behalf of Ambit Capital or its affiliates or any other company to any person, to buy or sell any securi ty. The information contained herein has been

obtained from published information and other sources, which Ambit Capital or i ts Affiliates consider to be reliable. None of Ambit Capital accepts any liabili ty or responsibili ty whatsoever for the accuracy or completeness of any such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. The abili ty to assess such risks may also be limited due to significantly lower information quantity and quality. By accepting this document, you agree to be bound by all the foregoing provisions.

Additional Disclaimer for Canadian Persons 18. AMBIT Capital is not registered in the Province of Ontario and /or Province of Québec to trade in securities and/or to provide advice with respect to securi ties. 19. AMBIT Capital's head office or principal place of business is located in India. 20. All or substantially all of AMBIT Capital's assets may be situated outside of Canada. 21. It may be difficult for enforcing legal rights against AMBIT Capital because of the above. 22. Name and address of AMBIT Capital's agent for service of process in the Province of Ontario is: Torys LLP, 79 Wellington St. W., 30th Floor, Box 270, TD South Tower, Toronto, Ontario M5K 1N2 Canada. 23. Name and address of AMBIT Capital's agent for service of process in the Province of Montréal is Torys Law Firm LLP, 1 Place Ville Marie, Suite 1919 Montréal, Québec H3B 2C3 Canada. Additional Disclaimer for Singapore Persons 24. This Report is prepared and distributed by Ambit Capital Private Limited and distributed as per the approved arrangement under Paragraph 9 of Third Schedule of Securi ties and Futures Act (CAP 289) and Paragraph

11 of the Firs t Schedule to the Financial Advisors Act (CAP 110) provided to Ambit Singapore Pte. Limited by Monetary Authority of Singapore. 25. This Report is only available to persons in Singapore who are institutional investors (as defined in section 4A of the Securities and Futures Act (Cap. 289) of Singapore (the “SFA”).” Accordingly, if a Singapore Person is

not or ceases to be such an ins titutional investor, such Singapore Person must immediately discontinue any use of this Report and inform Ambit Singapore Pte. Limited. Disclosures 26. The analyst (s ) has/have not served as an officer, director or employee of the subject company. 27. There is no material disciplinary action that has been taken by any regulatory authority impacting equity research analysis activities . 28. All market data included in this report are dated as at the previous s tock market closing day from the date of this report. 29. Ambit and/or i ts associates have financial interest/equity shareholding in Axis Bank, ICICI Bank, Tata Power, Torrent Power. Cholamandalam Inves tment & Finance, Federal Bank, Jubilant Foodworks, Tata Motors ,

Titan, ITC, DCB Bank, Havells, Lupin, 30. Ambit and/or it associates have actual/beneficial ownership of 1% or more in the securities of DCB Bank. 31. Ambit and/or it associates have received compensation for investment banking/merchant banking/brokering services from DCB Bank. Analyst Certif ication Each of the analys ts identi fied in this report certifies, with respect to the companies or securi ties that the individual analyses, that (1 ) the views expressed in this report reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the specific recommendations or views expressed in this report. © Copyright 2015 AMBIT Capital Private Limited. All rights reserved.

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