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Demonetised Disruption

The demonetisation-driven cash crunch will impact most sectors in 2HFY17; sectors with real-estate linkage and discretionary in nature (home building, jewellery, durables) could see weak demand continue in FY18 as well. Loss-of-wealth and income-uncertainty (for informal sector promoters/ employees) will be the key deterrents to an immediate recovery in consumption; however, the elevated pace of formalisation of the Indian economy over FY18/19 could be the key reliever. The near-term impacted companies could come out stronger as many sectors witness increased formalisation; however, some sectors could find new entrants capitalising on formalisation. The BFSI sector will witness a major change – the shift in favour of financial savings and formalisation bodes well for banks whilst MFIs are staring at material disruption and NBFCs could see a sharp slowdown in growth and rise in NPAs. Hence, we expect material downward revisions and downgrades to our stance in the BFSI sector.

THEMATIC November 23, 2016

Strategy

Research Analysts

Nitin Bhasin

[email protected]

Tel: +91 22 3043 3241

Research Team

[email protected] Tel: +91 22 3043 3000

Summary table (Continues on next page)

Impact On

Till FY18 Structural Key Stocks

Demand Supply Chain

Earnings Cut Demand Supply

Chain Industry Structure

Long Term Winners

At Maximum Risk

Agri Inputs/ Chemicals

Agrochem () () () <-> <-> () PI, Rallis, Dhanuka, Bayer

Seeds () () () <-> <-> () Kaveri Seeds

Fertilizers () () () <-> <-> <-> NA NA

Specialty Chemicals <-> <-> <-> <-> <-> () Aarti, Vinati, Atul, SRF

Autos

2W <-> <-> <-> <-> <-> <-> - -

4W () <-> () () <-> () - Maruti Suzuki

CV () <-> () () <-> () - Ashok Leyland

Auto Components

B2B () <-> () () <-> <-> - -

Batteries <-> <-> <-> () <-> () Amara Raja, Exide -

Tyres () <-> () () <-> <-> - -

Banks

Large Banks () <-> () () () () - -

Small Banks () <-> () () () <-> - -

Small Finance Banks () () () () <-> <-> - -

Building Materials

Pipes () <-> () <-> <-> () Supreme, Astral -

Ply/ Laminates () () () () () () ??? Near-term: Century

Tiles/ Sanitaryware () () () () () () ??? Near-term: Kajaria, Cera

Adhesives/ Construction Chemicals

() <-> () <-> <-> <-> Astral -

Capital Goods

Gensets () () () <-> () () - Cummins

Auto engines () () () () () () Greaves Cotton -

BTG <-> <-> <-> <-> <-> <-> - -

Cement Cement () <-> () () <-> () Dalmia Bharat Near-term: Shree Cement, Orient

Cement

Source: Ambit Capital research; Note: () – Large negative impact; () – Some negative impact; <-> – No impact; () – Some positive impact;

() – Large positive impact

mailto:[email protected]


Strategy

November 23, 2016 Ambit Capital Pvt. Ltd.

Summary table

Impact On

Till FY18 Structural Key Stocks

Demand Supply Chain

Earnings Cut Demand Supply

Chain Industry Structure

Long Term Winners

At Maximum Risk

Consumer Discretionary

Jewellery () () () () () () Titan

Apparel & Footwear () () () () () () Trent, ABFRL

Leisure () () () () () () PVR, Wonderla

Consumer Staples

Home & Personal () () () <-> () () HUL, Dabur, Colgate, Marico Emami

Food & Beverage () () () <-> () () Britannia GSK Consumer, Nestle

Tobacco () () () <-> <-> <-> ITC

Alcohol () <-> () <-> <-> () United Spirits United Breweries

Paints () () () () () () Asian Paints Akzo Noble

E&C/ Infra

Engineering & construction

<-> () <-> <-> () () - -

Infrastructure () <-> () <-> <-> <-> - -

Healthcare

Domestic () <-> () <-> <-> <-> NA NA

Export <-> <-> <-> <-> <-> <-> NA NA

API / CRAMS <-> <-> <-> <-> <-> <-> NA NA

Light Electricals B2C products () () () <-> () () Havells -

B2B products () () () <-> () () Havells, Finolex -

Media

Television broadcasters () <-> () () <-> () ZEEL NA

DPOs - DTH () () () () () () Dish TV NA

DPOs- Cable MSOs () () () <-> () <-> NA NA

Newsprint () <-> () () <-> () NA NA

NBFCs

HFCs () () () () () () LICHF

Auto NBFCs () () () () <-> () MMFS

SME financers () () () () () () BAF

MFIs () () () () <-> ()

Oil and Gas

Upstream <-> <-> <-> <-> <-> <-> NA

OMCs () <-> () () <-> () NA HPCL

Gas stocks () <-> () () <-> <-> NA PLNG, GAIL

Technology IT services <-> <-> <-> <-> <-> <-> NA NA

Telecom Telcos <-> <-> <-> <-> () <-> NA NA

Towercos <-> <-> <-> <-> <-> <-> NA NA

Utilities Generators () <-> <-> () <-> <-> - JSW Energy

Discoms () () () () () <-> Torrent Power -

Source: Ambit Capital research; Note: () – Large negative impact; () – Some negative impact; <-> – No impact; () – Some positive impact;

() – Large positive impact

Strategy


Macroeconomic impact of demonetization: M+R+T resets to the fore The demonetisation-driven cash crunch that is playing out in India will paralyse economic activity in the short term. Hence, we expect GDP growth to decelerate from 6.4% in 1HFY17 (as per Ambit est.) to 0.5% YoY in 2HFY17 with a distinct possibility of GDP growth contracting in 3QFY17. However, from 3QFY17 until 4QFY19, we expect a strong ‘formalisation effect’ to play out as nearly half of the non-tax paying businesses in the informal sector (40% share in GDP) become unviable and cede market share to their organised sector counterparts. We expect this dynamic to crimp GDP growth in India in FY18 as well and hence we cut our FY18 GDP growth estimate to 5.8% YoY (from 7.3%). We also scrap our March 2017 Sensex target of 29,500 and unveil our March 2018 Sensex target of 29,000. The ‘three effects’ that will be triggered by the demonetisation move The demonetisation affected by the Government on November 8, 2016 will trigger three sets of effects. Effect #1 will be the transactional hit created by a hard cash deficit as banks are unable to replace the demonetised cash expeditiously. This effect will be temporary and will kill business activity mainly over 2HFY17. Effect #2 will entail an adverse structural hit: (1) to non-tax paying businesses in the informal sector that become unviable; and (2) to the real estate sector where 30-40% of the value of purchases is funded using black money. Finally, effect #3 is likely to be a structural boost to tax-paying businesses in the formal sector which are able to capture the market share vacated by the informal sector. We cut our GDP growth est. for FY17 by 330bps, FY18 by 150bps Owing to effect #1 (i.e. the transactional impact created by the cash deficit) we expect real GDP growth in 2HFY17 to come under meaningful pressure. In specific, we expect GDP growth to decelerate from the 6.4% YoY growth recorded in 1HFY17 as per Ambit estimates (vs Government estimate of 7.1% YoY in 1QFY17) to 0.5% YoY in 2HFY17. Furthermore, we highlight the distinct probability of GDP growth contracting in 3QFY17. As regards FY18 we cut our GDP growth estimate to 5.8% YoY from 7.3% YoY. We build in far stronger growth in FY18 as compared to 2HFY17 mainly as we expect effect #3 (i.e. the structural market-share booster received by tax-paying businesses in the formal sector) to propel GDP growth higher in FY18. As a response to the slowing GDP growth, we expect the RBI to consider rate cuts of 25-50bps over 2HFY17 itself. Furthermore, we highlight the distinct risk of fiscal slippage materializing in FY17 (to a lesser extent) and FY18 (to a greater extent) as against the stated target of 3.5% and 3% of GDP as the Government is expected to provide support to the lowest economic strata in the form of fiscal transfers. Investment Implications In the light of negative effects of the recent steps taken by the NDA Government and with just 4 months to go before FY17 comes to a close, we scrap our current Mar’17 Sensex target of 29,500 and unveil our Mar’18 Sensex target of 29,000. As highlighted in our November 10, 2016 note the Government’s latest move to squeeze the economy will disrupt economic activity in the short term, especially those segments where cash-based transactions are the norm like real estate, unsecured lending, real estate construction services and building materials. Whilst in the near term we expect these businesses to suffer, over the next couple of years the strongest players in these sectors will gain market share as competition from unscrupulous/unorganised players reduces. For more details on our GPD growth estimates, click here for our November 18, 2016.

Exhibit A: 87%of all transactions in India took place in cash-form in FY12

Payment Type FY10 FY11 FY12

Card Payment Transactions (Excluding Commercial)

3% 4% 4%

Electronic Direct / ACH Transactions 5% 6% 7%

Cash Transactions 90% 88% 87% Other Paper Transactions (Checks, Demand Drafts)

3% 3% 3%

Source: Euromonitor, Ambit Capital research.

Exhibit B: We cut our GDP forecast for FY17 and FY18

Source: CEIC, Ambit Capital research

Exhibit C: We expect the RBI to cut rates by 25-50bps in 2HFY17

Source: CEIC, Ambit Capital research

Research Analysts

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

Sumit Shekhar +91 22 3043 3229 [email protected]

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

6.8%

3.5%

7.3%

5.8%

0%

3%

6%

9%

FY17(old)

FY17(new)

FY18(old)

FY18(new)

Rea

l GD

P g

row

th(Y

oY

cha

ng

e, in

%)

50

25

50

0 0

25

0

25 25

0

25

50

75

4QFY

151Q

FY16

2QFY

163Q

FY16

4QFY

161Q

FY17

2QFY

173Q

FY17

(E)

4QFY

17 (E

)

Rep

o r

ate

cu

t per

q

ua

rter

(in

bp

s)




Strategy


Agri Inputs Moderate demand weakness; working capital cycles could be extended Demonetisation will adversely affect demand in the near term. Channel checks suggest: a) low liquidity among farmers due to delay in kharif payouts; b) wholesalers/retailers are not extending credit given paucity of cash; and c) debtor days for companies could increase due to delayed kharif payouts. Given short-term liquidity-led delays in offtake, 2HFY17 growth will be somewhat affected. However, there are no structural issues as agri input demand is non-discretionary and farmers have to spend to save crops. In the long term, shift to cheques and online transfers alongside GST will create barriers for unorganised players. Given 30-40% of agrochem demand is unorganised, we expect organised players (Bayer India, PI, Dhanuka, Rallis) to benefit. In chemicals, exporters like PI Industries, SRF, Aarti and Vinati Organics will not be hit as 70-80% of earnings driven by B2B exports. Our top ideas are SRF (TP Rs1850, 29% upside) and PI (TP Rs1100, 44% upside).

Summary table

Exhibit 1: Demonetisation impact on agri inputs and chemicals players Segment Particulars 2HFY17 FY18 Structural

Agro Chemicals

Demand Outlook Demand would moderate due to cash crunch in the near term

Demand would normalise by FY18 if monsoons are normal.

No wealth destruction for end-user as agri income is tax exempt

Supply chain change No significant changes given low dependence on informal channels (vendors/ distributors)

Industry structure Creditor days could increase, thereby impacting near-term ROCE

Unorganized players may lose market share given return ratios will get impacted due to higher tax outgo. Number of dealers in the channel may also shrink, posing challenges for tier 3- tier 4 players.

Seeds

Demand Outlook

Demand may be affected as farmers may downtrade or use saved seeds given cash crunch. Most rabi seed sales happen around this time.

No impact on medium/long-term demand

No impact on medium/long-term demand

Supply chain change The proportion of black money transactions in seeds is very high for domestic players. Would create longer a longer cash crunch and impact ROCE

Industry structure Inventory/creditor build-up can impact working capital/RoCE

MNCs will gain market share as white transactions increase; domestic players will face difficulties given most of transactions are cash

Fertilisers

Demand Outlook Demand is likely to be hit due to cash crunch in the near term No change No change

Supply chain change No significant change given low dependence on informal channels (vendors/distributors)

Industry structure Fertilisers is very organised given it is controlled by government agencies at many levels of the supply chain. No change in industry structure.

Specialty Chemicals Exporters

Demand Outlook No impact on demand for exports No impact on demand for exports No impact on demand for exports

Supply chain change No impact on demand

Industry structure

We should see positive benefits for domestic sales of these companies as smaller players get weeded out. However, the proportion of domestic sales is smaller in most of these companies except Indian subsidiaries of MNCs

Source: Ambit Capital research

Channel checks suggest a mixed picture

Western India dealer: This has impacted cash sales. Farmers haven’t been able to sell their cotton and soybean from the kharif season.

Gujarat-based dealer: Most of our sales are now happening in credit. Now, 80% of sales is on credit vs 20% earlier.

Punjab based dealer: This is not the season for purchasing pesticides and hence do not do expect a major impact; but earlier credit not yet cleared because of lack of funds with farmers. Pesticide consumption will start a month down the line, hopefully by that time demand will revive.

North-based retailer: Everybody is in a state of panic. In the North, farmers got cash given harvest was before the demonetisation drive and, hence, that area is less affected.

POSITIVE

Key Recommendations PI Industries BUY

SRF Limited BUY Rallis India SELL

Research Analyst

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


Strategy


How are companies/industry reacting to the disruption?

Given this is a relatively lean season (as kharif is behind and rabi is just starting), most companies haven’t yet rolled out any major help to dealers. Companies believe that while demand has been affected, it will pick up as the liquidity position eases.

This period of the year is post-kharif cash collection time for most companies. However, given the recent liquidity crunch, they haven’t been pushing for cash collection.

Impact on demand over the following periods

2HFY17: We expect demand growth to moderate. Demand would improve once the cash crunch is resolved. With healthy reservoir levels, we had expected ~15% growth in agrochemicals in 2HFY17; this could moderate to high single-digit. Increase in cash withdrawal limit for APMC traders and farmers should improve liquidity in the channel. The Government has also allowed farmers to buy seeds with old Rs500 notes, which would boost seed demand. However, seeds and fertilisers are likely to be hit more than agrochemicals as their usage is more widespread.

FY18: There would be no material impact on agri input demand beyond 2HFY17. As agri inputs are non-discretionary for farmers, demand would normalise if monsoons are normal and crop prices and pest infestation levels remain the same.

Beyond FY18: Organised players would gain market share from unorganised players as the increase white transactions could reduce return ratios for unorganised private players by 500-700bps. Unlike in consumer goods, farmers will not be impacted by the demonetisation wave over the medium to long term as: a) farm income is tax exempt, and b) agri input demand is non-discretionary. There is a high likelihood of rural stimulus as the Government redistributes the dividend gains from demonetisation to rural areas. This would have a long term positive impact on rural demand.

Biggest changes to the industry structure

2HFY17: Debtor days for agri inputs companies would get stretched as receivables from sales in this year’s kharif season would be delayed. Note that debtor days for seeds/agrochemicals are higher than those of fertilizers.

FY18: Debtor days would remain extended in FY18 as credit to farmers may remain constrained. For some dealers, the cost of capital might increase as they move from black working capital to white working capital.

Long term: We expect some channel consolidation as a few dealers may no longer be competitive given higher tax incidence and increased cost of capital for white money; however, end-demand won’t be impacted.

From the companies’ perspective, there could be delays in normalisation of debtor days as some channel working capital is funded by credit from companies.

In the long term, improved credit access and lower credit cost will improve overall investments by farmers.

Unorganised players will find it difficult to survive given high working capital required to support all-white transactions and higher tax incidence. Domestic seeds players would face difficulties as all their transactions had been in cash. They typically get cash from farmers as advances and pay in cash to farmers who sow their seeds.

What factors should investors consider in picking winners/losers?

We recommend focusing on companies with: a) higher share of exports; and b) tight working capital management as debtor days are likely to increase. We prefer agrochemicals over seeds as the proportion of black money transactions is less in the former. MNC seed companies would benefit from the crackdown on black money and would gain market share. In agrochemicals, top tier players such as PI Industries, Dhanuka and Rallis will benefit from these changes over the long term as they have a better dealer base and would benefit from inevitable industry consolidation. Our top picks are PI Industries (44% upside, TP Rs1100) and SRF (29% upside, TP Rs1850).

Strategy


Exhibit 2: Relative valuation table

Company Name Mcap (USD mn)

ADVT-6m (USD mn)

P/E P/B EV/EBITDA ROE CAGR (FY16-FY19)

FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E Sales EBITDA EPS

Global Agri Majors

Monsanto 44,396 6.1 21.4 18.4 15.2 9.1 8.0 8.5 13.2 11.8 10.4 41.0 40.2 36.4 5.9 16.9 30.3

Dow Chemicals 60,555 5.0 14.8 13.5 12.8 2.4 2.1 2.0 8.3 7.7 7.4 17.3 17.7 17.4 2.2 10.6 (13.2)

FMC Corp 7,289 0.8 19.3 16.6 15.0 3.3 2.8 2.9 12.9 11.7 10.9 17.0 17.0 17.4 3.6 134.3 (0.3)

Syngenta 35,567 1.4 23.3 20.5 18.4 4.1 3.9 3.7 14.8 13.3 12.2 17.0 19.1 20.2 2.4 9.5 13.0

Bayer AG 79,971 3.3 12.3 11.3 10.5 2.9 2.6 2.4 8.4 7.9 7.5 22.2 21.7 21.9 3.2 8.8 20.4

BASF 78,271 2.6 16.9 15.6 14.3 2.4 2.3 2.2 8.5 8.0 7.5 13.8 14.7 15.6 (4.1) 2.4 9.0

Domestic Agchem

PI Industries 1,558 1.4 26.4 21.1 16.9 7.6 6.3 5.2 19.7 15.7 12.7 31.1 32.3 33.3 18.5 25.5 25.5

Rallis India 522 1.1 19.0 17.2 14.8 3.3 2.9 2.5 12.2 10.3 8.4 19.1 18.9 20.2 15.0 19.3 23.5

Bayer CropScience 1,969 1.0 33.1 26.8 22.7 6.4 5.4 4.5 23.6 19.3 16.3 21.0 22.0 22.5 9.3 24.1 26.1

UPL Ltd 4,523 16.8 16.7 13.8 11.4 3.4 2.8 2.3 10.9 9.5 8.1 22.5 22.1 22.5 16.2 16.9 20.8

Dhanuka Agritech 502 0.5 27.2 22.0 17.9 6.1 5.1 4.1 19.2 15.6 12.8 23.8 24.9 25.1 17.1 23.8 21.4

Insecticides India 133 0.2 16.1 12.2 10.6 2.0 1.7 1.5 9.1 7.4 6.9 13.1 15.2 15.3 15.4 19.4 29.8

Domestic Seeds Kaveri Seeds 374 3.6 12.9 10.4 9.6 2.4 2.1 1.8 9.9 8.1 6.9 20.3 21.8 23.0 3.4 16.1 15.5

Monsanto India 568 2.9 30.1 25.3 N/A N/A N/A N/A 27.1 23.0 N/A 29.8 30.7 N/A N/A N/A N/A

Source: Company

Strategy


Auto OEMs Near-term hit for 2Ws; longer struggle for PVs/CVs Near-term demand across categories could be significantly affected. In 2Ws, a high proportion of transactions are in cash. In PVs, impact will be largely felt on downpayments and consumer sentiment. MHVC sales may not be hit but high dependence on cash for operations will impact the value chain. In FY18 and beyond, we expect 2W demand to recover (low-ticket, utility-driven purchases) while risk aversion and wealth impact could affect replacement purchases/upgrades (~50% of sales) in PVs. Similarly, weak end-user segments like real estate (10% of sales) and any prolonged weakness in resale truck markets (important source of liquidity/profitability for fleet operators) could impact MHCV sales. We envisage certain changes to industry structure like rising financing penetration in 2Ws, downtrading in PVs and consolidation of fleet operators in CVs. There would be no clear winner amongst auto OEMs due to demonetisation but 2W players will fare better than PV/CV peers. Any significant government stimulus could be a key surprise factor, especially for 2Ws.

Exhibit 3: Demonetisation impact on auto OEMs Segment Particulars 2HFY17 FY18 Structural

Two-wheelers

Demand Outlook Given high proportion of cash transactions, demand will be significantly impacted

Being low-ticket 'utility driven' purchases, no meaningful impact on FY18 demand

No structural impact on demand; scooters should continue to gain ground

Supply chain change No significant changes given low dependence on informal channels (vendors/distributors)

Industry structure Inventory build-up can impact working capital/RoCE

Increase in finance penetration may entail higher investments in captive finance ventures by Hero MotoCorp and TVS Motor which may impact consolidated RoCE.

Passenger vehicles

Demand Outlook Weak consumer sentiment and downpayment requirement (about 10-15%) to impact demand

Risk aversion/wealth destruction to impact replacement/upgrade purchases (~50% of industry sales)

Same as FY18



Trend towards upgradation in recent years could reverse and then pick up slowly over the next 2-3 years

Medium & Heavy commercial vehicles

Demand Outlook Demand impacted by weak freight/cash restrictions. Significant risks emerging to pre-buying that was expected in 4QFY17

Certain end-user segments like real estate (10% of new CV sales) could witness prolonged demand weakness

Prolonged weakness in resale markets (wealth destruction) could impact longer-term demand



Demonetisation along with implementation of GST could result in consolidation of fleet operators. This may shift demand shift towards heavier trucks.


Channel checks Two-wheelers (2Ws)—demand picking up gradually but still down: About

60-65% of 2W purchases are in cash, so the cash crunch would impact sales. Demand has started recovering from the lows of initial days of demonetisation announcement but is still significantly lower (~50%) compared to the normal projected sales levels. Most 2W dealers believe that as 2Ws are low-ticket items, the impact may not last beyond the near term.

Four-wheelers (4Ws)—financing challenges impacting demand; no cancellations, but rising inventory: While the financing proportion is high (60-65%), the cash crunch has impacted the ability to make downpayment (75% of the vehicle value). Further, consumer sentiment has been at one of the lowest levels in recent times. However, dealers have not reported any significant cancellations so far. There is risk of higher discounts in the four-wheeler industry due to inventory build-up.

Medium and heavy commercial vehicles (MHCVs)—slump in freight rates; risk to pre-buying: Lack of cash availability is putting a significant strain on fleet operators’ operations as most expenses (besides toll, petrol) are cash-based. Freight movement is weak and, hence, freight rates are down by 15-20% across India. Cash crunch has also impacted the truck body-building segment, which works primarily on cash (85% of the body-building industry is unorganised).

NEGATIVE Key Recommendations Tata Motors BUY

Maruti Suzuki SELL

Research Analysts

Ashvin Shetty, CFA [email protected] Tel: +91 22 3043 3285

Gaurav Khandelwal, CFA [email protected] Tel: +91 22 3043 3132




Strategy


How are companies/industry reacting to the disruption? There exist significant uncertainties amongst auto OEMs on the potential impact of the demonetisation. As of now, almost all companies are in wait-and-watch mode. No production cuts have been announced so far and most measures are restricted to tide over the near-term cash availability crisis.

2Ws: Dealers/companies are attempting to tide over the near-term cash crisis by accepting cheques (after verifying bank statements), reducing downpayment requirements, waiving off credit card and debit card swap charges among other such measures.

4Ws: PV players are now accepting cheques as well as debit/credit card payments and e-wallet transactions at their dealerships. In addition, service centres of certain OEMs are providing free pick-up and drop of vehicles from customers.

MHCVs: Since 70-75% of MHCV transactions are conducted in the last week of the month, CV OEMs are currently in wait-and-watch mode and would assess the market condition at the end of November 2016 before taking appropriate steps.

Impact on demand over the following periods We expect significant near-term impact across automobile categories. However, in FY18 and beyond, we expect demand for 2Ws to be relatively immune to disruption as compared to PVs and MHCVs.

2Ws: No structural issues

2HFY17: Since 60-65% of the industry transactions are in cash the impact is expected to be quite pronounced, particularly in Nov and Dec 2016.

FY18: However, being a low-ticket, utility-oriented purchase, we do not see the negative impact persisting in FY18 due to remonetisation.

Longer term: We do not see any long-term structural impact on 2W demand. We continue to expect that scooters would continue to gain share in the domestic 2W space.

4Ws: Impact on replacement purchases could be profound

2HFY17: While financing penetration is high in the case of PVs, weak consumer sentiment towards discretionary purchases and requirement of downpayments are likely to impact demand in the near term.

FY18 and beyond: In FY18, due to risk aversion and wealth destruction, demand for the replacement segment (vs first-time buyers and those used for commercial segments) would continue to be affected. Our channel interaction indicates that replacement/upgrade purchases account for ~50% of industry purchases and more prominently for price points above Rs7mn.

MHCVs: Real estate slowdown and weak resale market could prolong demand weakness

2HFY17: Given significant demand reduction in most sectors, freight demand/freight rate is expected to witness sharp reduction in the near term. Given remonetisation is taking longer than expected, there is a possibility that demand may not return fully by 4QFY17. This, together with rather subdued sentiment amongst fleet operators, could impact pre-buying that we expect to play out in 4QFY17.

FY18: Demand could be strong in certain user industries like real estate, which contributes close to 10% of total MHCV sales.

Longer term: Besides structural weakness in certain user segments like real estate, prolonged slowdown in resale markets (which serve as an important revenue source for fleet operators) could also weigh on long-term demand.

Strategy


Changes to the industry structure Given the likelihood of inventory build-up, we expect working capital and RoCE to be impacted across automobile categories/companies. Beyond this short-term impact, some sector-specific implications are:

2Ws: In the long term, as customers move away from cash-based transactions to more formal payment channels like banks, cards, etc. the finance penetration of the 2W industry would increase (currently 35-40%). This may entail higher investments in captive finance ventures by Hero MotoCorp and TVS Motor, which may impact consolidated RoCE.

4Ws: In the last five years, there was a clear trend of uptrading in the domestic 4W industry with declining share of entry-level cars such as Alto and Wagon R. Demonetisation can have a negative impact on customers’ risk aversion, which may reverse the uptrading trend for the next 2-3 years.

MHCVs: Implementation of GST in the longer term will result in reduced share of unorganised players. This, together with higher impact of demonetisation, could result in consolidation of fleet operators. This consolidation in favour of larger fleet operators may result in demand shift towards heavier trucks.

What are the factors investors should consider to pick winners and losers? There would be no clear winner amongst the auto OEMs due to demonetisation measures, both from short-term and long-term perspectives. Certain categories/players (within a category) could be less impacted than others.

We believe the 2W category would be relatively immune than passenger vehicles and commercial vehicles as it is a low-ticket, utility purchase.

Within PVs, positive benefits of higher market share to Maruti from downtrading would be offset by negative impact from lower sales realisation/profitability due to weaker product mix (note that Maruti was finding increasing traction in higher-value cars such as Baleno, Brezza and Ciaz in the recent years).

Surprise factors

Uncertainty around Government stimulus or income redistribution measures. These may have a positive impact on demand, particularly for 2Ws.

Any increase in the pace of Government infrastructure development. This can significantly offset any end-user demand weakness in the MHCV sector.

Exhibit 4: Relative valuation sheet

Company Mcap

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

US$ mn FY16 FY17 FY18 FY16 FY17 FY18 Sales EBITDA EPS FY16 FY17 FY18 FY16 FY17 FY18

Tata Motors* 20,661 BUY 5.3 4.9 3.7 12.8 13.3 9.0 18% 20% 20% 10.6% 9.2% 10.9% 23% 18% 20%

Maruti Suzuki 20,561 SELL 14.5 11.6 10.5 31.8 19.5 17.5 19% 18% 35% 15.5% 16.0% 15.3% 18% 25% 23%

M&M 10,159 SELL 8.5 7.5 6.5 15.2 13.4 11.6 12% 14% 13% 13.2% 13.5% 13.7% 15% 15% 16%

Bajaj Auto 10,820 SELL 12.9 12.1 10.7 20.6 18.8 16.3 11% 10% 12% 21.7% 21.7% 21.4% 31% 30% 32%

Hero MotoCorp 8,660 SELL 12.4 10.8 9.8 18.5 16.4 15.0 10% 13% 11% 15.5% 16.3% 16.3% 44% 41% 38%

Eicher Motors** 8,194 SELL 28.0 18.5 15.3 54.4 32.7 26.8 15% 35% 42% 15.6% 17.3% 17.2% 39% 46% 41%

Ashok Leyland 2,986 BUY 10.5 9.5 8.1 19.4 17.0 13.2 13% 14% 21% 11.5% 11.3% 11.5% 25% 23% 25%

TVS Motor 2,429 SELL 23.0 18.0 13.0 37.4 27.6 19.9 19% 33% 37% 6.7% 7.5% 8.3% 24% 28% 32%

Median 12.7 11.2 10.2 20.0 17.9 15.7 14% 16% 21% 14.4% 14.8% 14.5% 25% 27% 29%

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

Strategy


Auto Components Mixed picture Given deceleration in auto OEM growth and impact of cash crunch on replacement segment sales, we expect near-term demand to be impacted across B2B and B2C auto component players. We expect B2B players with higher exposure to 2Ws (Endurance Technologies, Fiem Industries and Gabriel) to be better placed than peers with higher exposure to CVs/PVs (Bosch, Wabco). In the B2C space, we expect battery players like Amara Raja and Exide (higher exposure to 2W/PV replacement segments and opportunity to gain share from the unorganised sector) to be better placed than tyre makers (higher exposure to truck segment).

Exhibit 5: Demonetisation impact on automobile ancillary companies

Segment Particulars 2HFY17 FY18 Structural

B2B Auto component

Demand Outlook Weak demand across Auto OEMs to impact demand

We expect 2W demand to be relatively immune vs. PV and CV demand. Hence, auto OEMs with higher exposure to domestic 2Ws will be better placed than ones with higher exposure to PV/CVs.

Supply chain change Most of the large B2B auto component players have relatively low exposure to unorganised vendors.

Industry structure No major changes envisaged

Battery players

Demand Outlook Battery purchases are mostly made in cash; liquidity crunch to weaken demand

No impact on the automotive battery replacement demand as battery is a low-ticket requirement for vehicles. Industrial battery segment would recover quickly as most of the end-user segments (telecom, investors and UPS) are immune to demonetisation impact. Auto OEM battery segment would track auto OEM volume recovery

Supply chain change No significant disruption in the supply chain as dependence on small vendors is low (lead is mostly imported).

Industry structure No significant impact Demonetisation along with implementation of GST could result in faster-than-expected shrinkage of unorganised players in the automotive replacement segment.

Tyre companies

Demand Outlook We expect negative impact across OEM and replacement sub-segments in the near term.

On the replacement side, we expect 2W and PV sub-segments to recover in FY18 but truck tyre sub-segment would take a longer time. Auto OEM sub-segments to track Auto OEM volume recovery.

Supply chain change No significant dependence on unorganised channels and, hence, no impact.

Industry structure Share of Chinese imports could come down in near term, but there is uncertainty surrounding the same over the medium to longer term


Reactions from channel and companies to the disruption B2B auto ancillary companies

So far there has been no impact on production or any intimation from the auto OEMs. However, companies are expecting production cuts to be announced given weak demand environment for OEMs.

Companies continue to adopt a wait-and-watch policy and would respond accordingly to any measures taken at the auto OEM level. The general expectation amongst auto ancillary players is that there could be only short-term disruption and auto demand should recover in the next few months.

Battery companies

The demand for automotive replacement batteries has been impacted because of the cash crunch. However, the situation is better in Metros and Tier-I cities, where cheques and credit/debit cards are also used for transactions.

In the short term, demand for inverter batteries can see some moderation. However, November-February is a seasonally weak period for inverters and hence impact on overall sales is not expected to be significant.

NEGATIVE Key Recommendations Mahindra CIE BUY

Amara Raja SELL

Research Analysts

Ashvin Shetty, CFA [email protected] Tel: +91 22 3043 3285

Gaurav Khandelwal, CFA [email protected] Tel: +91 22 3043 3132




Strategy


Battery players like Amara Raja have increased the credit period allowed to dealers/distributors by 5-6 days (from 7-8 days of credit allowed prior to demonetisation) to ease liquidity pressure on their distributors and dealers.

Tyre companies

While the demand has been clearly impacted in the replacement segment, the companies are currently adopting a wait and watch policy.

How would demand shape up over the near-term and the long-term? B2B auto ancillary companies

2HFY17: Given weak demand outlook for automobile OEMs (due to cash crunch, weak consumer sentiments), we expect demand for B2B auto ancillary companies to be impacted.

FY18 and beyond: As discussed in the section on auto OEMs, we expect longer term demand for 2Ws to be relatively immune to disruption as compared to PVs and MHCVs. As a result, we expect vendors exposed to 2W segment would be relatively better placed than companies having significant exposure to domestic PVs/CVs.

Battery companies

2HFY17: Since automotive replacement and inverter batteries are generally bought in cash, demand may see some moderation over 2QFY17

FY18 and beyond: In the longer term, however, we see negligible impact on the replacement demand for automotive batteries, since batteries are low-ticket items necessarily required for vehicles in use. Further, we expect, Industrial battery segment to recover as most of the end user segments (telecom, investors and UPS) are immune from demonetisation impact. Auto OEM battery segment will track Auto OEM volumes in the longer term.

Tyre companies

2HFY17: We expect impact across OEM and replacement sub-segments in the near term.

FY18 and beyond: As discussed in the auto OEM section, we expect PVs and MHCVs to remain impacted in FY18 on the back of weak sentiment among consumers and fleet operators. On the replacement side, while 2W and PV sub-segments would recover, we expect a slow recovery in truck tyre replacement as it is a highly cost-sensitive segment.

Biggest change to the industry structure B2B auto ancillary companies – no major change envisaged

Our interaction with managements of most large B2B auto component companies indicates that exposure to unorganised vendors is relatively small and hence no major change in supply chain is expected. Furthermore, the presence of unorganised competitors is also negligible across most B2B auto component suppliers.

Battery companies – unorganised to organised shift could accelerate

Demonetisation will accelerate the shift from unorganised (who predominantly transacted through cash in order to avoid taxes) to organised battery manufacturers. Unorganised manufacturers constitute one-third of the two-wheeler and automotive (mostly commercial vehicle and tractors) battery replacement volumes and together constitute 41% of the battery industry size. With the implementation of GST, the unorganised players would no longer remain cost competitive.

Strategy


Tyre companies – share of Chinese imports could fall in near term, low visibility in medium to long term

The domestic tyre industry is oligopolistic with market share concentrated in the top five players. The share of Chinese imports has been rising in recent years but there could be some negative impact on share of the Chinese imports due to higher concentration amongst smaller fleet operators. However, there is uncertainty surrounding how the Chinese imports would trend over the medium to long term. This is because, on one hand, there could be consolidation of fleet operators which could favour Indian tyre makers; but on the other hand prolonged demand weakness could lead to downtrading which favour Chinese tyre makers.

What are the factors investors should consider to pick winners/losers? B2B auto ancillary companies

While there will be no clear winners of the demonetisation drive, we believe amongst the domestic-focussed auto component players those with higher exposure to the domestic 2W segments would fare better than those with high exposure to the domestic CV and PV segments.

Amongst the frontline domestic-focussed auto OEM companies, Endurance Technologies, Gabriel and Fiem Industries with 55-60%, 55% and 80-85% revenues from the domestic 2W segment, respectively, appear to be better placed than Wabco (65-70% of revenues from domestic CVs) and Bosch (50% of revenues from domestic CV and PV segments).

Battery companies

Organised players like Amara Raja and Exide industry will be the biggest beneficiaries of formalisation of the industry.

In case of a slowdown in the automobile OEM segment, Amara Raja is better placed since it derives only 15% of revenues from this segment as against Exide which derives 24% (FY16).

Tyre companies

Players with the highest exposure to domestic CVs would be worst impacted. Amongst the listed tyre companies, JK Tyres (55-60% of consolidated revenues from domestic CV segment) appears the most vulnerable.

Surprise factors

Uncertainty surrounding the impact of demonetisation on Chinese tyre imports.

Strategy


Exhibit 6: Relative valuation

Company Mcap

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

US$ mn FY16 FY17 FY18 FY16 FY17 FY18 Sales EBITDA EPS FY16 FY17 FY18 FY16 FY17 FY18

B2B auto ancillary companies

Bosch 8,483 NA 29.7 26.8 20.8 46.4 34.8 29.2 14% 18% 26% 18% 18% 23% 16% 19% 19%

Motherson Sumi 5,772 NA 10.8 9.9 8.0 29.1 23.4 17.9 15% 18% 27% 10% 10% 13% 34% 31% 31%

Bharat Forge 2,932 NA 15.2 15.9 13.2 30.7 30.7 23.3 4% 7% 15% 19% 18% 23% 19% 17% 19%

WABCO India 1,394 NA 30.8 22.0 18.5 46.4 33.3 27.5 20% 29% 30% 16% 18% 23% 21% 23% 22% Endurance Technologies 1,080 NA 11.7 NA NA 25.4 NA NA NA NA NA 13% NA NA 22% NA NA

Mahindra CIE Automotive* 1,007 BUY 14.4 11.8 9.9 19.9 22.5 14.9 -6% 7% 4% 10% 11% 12% 11% 12% 15%

Suprajit Engineering 349 NA 15.3 12.7 10.4 30.5 21.7 17.6 22% 21% 31% 17% 17% 18% 21% 23% 24%

FIEM Industries 200 NA 11.8 10.3 8.6 21.7 21.3 16.9 18% 17% 13% 13% 13% 15% 23% 17% 18%

Gabriel India 215 NA 11.3 9.6 8.2 19.5 17.4 14.5 12% 18% 16% 9% 10% 11% 21% 20% 21%

Median 14.4 12.3 10.2 29.1 23.0 17.8 15% 18% 21% 13% 15% 17% 21% 20% 20%

Battery companies

Amara Raja* 2,337 SELL 19.0 16.9 15.1 32.7 29.8 26.0 12% 12% 12% 17% 17% 17% 25% 23% 24%

Exide Industries* 2,158 SELL 15.8 14.3 13.0 23.4 20.7 18.8 10% 11% 12% 15% 15% 15% 23% 23% 22%

Median 17.4 15.6 14.1 28.1 25.3 22.4 11% 12% 12% 16% 16% 16% 24% 23% 23%

Tyre companies

MRF 2,905 NA 5.8 6.1 5.5 11.8 11.1 10.3 10% 3% 7% 25% 22% 24% 19% 22% 21%

Apollo Tyres 1,356 NA 5.5 5.3 4.8 8.5 8.5 8.1 12% 7% 2% 17% 15% 17% 19% 16% 15%

Balkrishna Industries* 1,365 SELL 9.4 9.1 8.5 16.6 16.0 14.5 8% 8% 5% 31% 31% 30% 22% 19% 18%

Ceat 687 NA 5.7 6.9 5.6 10.5 11.8 9.2 11% 1% 7% 16% 12% 15% 24% 17% 19%

JK Tyre & Industries 378 NA 4.7 4.0 3.5 5.6 5.4 4.5 14% 15% 11% 16% 17% 21% 29% 25% 24%

TVS Srichakra 349 NA 8.1 NA NA 12.1 13.5 11.7 13% 12% 2% 15% 15% NA 57% 34% 29%

Median 5.8 6.1 5.5 11.2 11.5 9.75 12% 8% 6% 17% 16% 21% 23% 21% 20%

Source: Bloomberg, Company, Ambit Capital research. Note: Multiples and return ratios computed on Ambit estimates.

Strategy


Building Materials Likely product down-trading in high growth categories The near-term demand across all building material categories will be severely affected. Sales would most likely decline over 2HFY17/1HFY18, however, it should recover in 2HFY18 due to a low base. Weakness in demand would magnify and prolong across discretionary categories, such as ply, laminates and tiles. However, accelerated formalisation in these categories would benefit the organised players. With the adoption of GST, and exit of the unorganized and a likely consolidation in categories such as ply, the fight would remain between organized and potential new entrants; over next couple of years changing cost structures would change for formalization of channel and rise in A&P spends. Further, the organised players would have to introduce products at lower price points to fill gaps vacated by the unorganised players and this might reduce the blended realisations of industry participants (a key risk for the Ply sector) a pertinent risk for ply industry. We expect material earnings cuts for FY17/18 for Century.

Exhibit 1: Summarising the impact of demonetisation on building materials

Category Impact 2HFY17 FY18 Structural

Pipes

Demand Outlook

Decline in plumbing pipe volume due to reduction in real estate construction mainly projects; sharp adverse impact on agri (cash customer); expect flat to 5% decline

Decline in 1HFY18; volume rebound in 2HFY18 due to low base effect

No major impact, will recover with housing demand – low ticket, staple product unlike other discretionary home building products

Supply chain change

Channel in inventory liquidation phase; very low restocking

Cash transactions within agri pipes to decrease as channel educate farmers; plumbing historically non-cash given; adoption of banking till the last mile retailer

No major change except increase in non-cash dealings; adoption of banking till the last mile retailer

Industry structure No major change

No major change though some smaller unorganised players should start losing ground

No structural change because largely organised industry; unorganised to reduce from present 30%

Ply/ laminates

Demand Outlook

Significant volume decline due to discretionary nature of spends; down-trading by the customer

Decline in 1HFY18; slight recovery in 2HFY18 due to low base effect; though industry size to start shrinking as customers trade down and MDF adoption picks up

Discretionary home furnishing spend to decline; demand to increase for low-cost substitutes; use of pre-lam MDF to impact laminates market

Supply chain change

Channel in inventory liquidation phase, very low restocking (from organised/ unorganised)

Increase in dealing through formal banking channel and organised players; shrinkage of retailers

Majority transactions to become non-cash

Industry structure

No major change due to minimal restocking; some small players to suspend operations

First leg of industry consolidation, with the implementation of GST; capital intensity to increase with use of low-cost substitutes like MDF

Small unorganised players to either exit or their capacities to be acquired; share of organised to materially increase from current 30%; industry size to shrink

Tiles/ Sanitary ware

Demand Outlook

Significant volume decline due to discretionary nature of spends and high dependence of organised real estate construction (esp high end)

Decline in 1HFY18; slight recovery in 2HFY17 due to low base effect

Discretionary home furnishing spend to decline; increase use of low cost varieties

Supply chain change

Channel in inventory liquidation phase, very low re-stocking (from neither org or unorg); working capital intensity to rise

Increase in dealing through formal banking channel and organised players; working capital intensity to rise

Majority transactions to become non-cash; unless the bank credit like electricals and pipes doesn’t get adopted, WC cycles will increase.

Industry structure

Major change as minimal restocking; some small players to suspend operations

First leg of industry consolidation, with the implementation of GST

Industry consolidation; increase in JVs with or absorption of Morbi players; sanitary ware (only 30% unorganised) least imapcted

Adhesives/ Construction chemicals

Demand Outlook

Volume decline due to low liquidity with consumer/weak real estate demand

Decline in 1HFY18; volume growth in 2HFY17 due to low base effect

No major impact, will recover with housing/consumer demand – low ticket, staple product

Supply chain change

Channel in inventory liquidation phase, very low restocking

Formalisation of certain product categories (e.g. waterproofing)

No major change except increase in non-cash dealings

Industry structure No major change No major change

No structural change because largely organised industry; local unbranded players should gradually exit


POSITIVE Key Recommendations Supreme Ind BUY

Century Ply BUY

Research Analysts

Nitin Bhasin [email protected] Tel: +91 22 3043 3241

Girisha Saraf [email protected] Tel: +91 22 3043 3211

Strategy


Channel checks Apart from weak demand (for both new construction and refurbishment), our

channel checks across building material categories commonly suggest change in working capital structure of dealers due to increased recovery, and in some cases advance payments from debtors. Though this might seemingly indicate only little liquidity support required from the organised companies, it is not the case because, despite recovery of debtors, dealers have not been able to deposit the payments into the formal banking channel; thus implying liquidity crunch with dealers.

Pipes: Demand for plumbing pipes is gradually picking up, but still very low compared to pre-demonetisation days (~20% lower). Demand from projects has come to a standstill; whatever sales made are from small-scale retailing.

The situation is worse with agri pipes, due to chaos in the rural areas regarding the whole demonetisation scheme. Further, given that spends per customer on agri pipes is larger (compared to that on plumbing pipes) and more of a business investment, impact on purchases is more severe.

Ply/laminates/tiles/sanitaryware: Current inventory is getting partially liquidated because the channel still accepting old currency notes at a 10-15% premium; this is expected to continue till the end of November. This occurrence is more prevalent in these categories because of a large unorganised sector working on cash.

Real estate has traditionally been used to park black money. With fall in property prices and interest rates (expected), real estate will increasingly be purchased by real home buyers; this would increase demand for home interiors (ply, laminates, tiles, sanitary ware)

Imports have become more expensive; rates of all building materials and hardware products that are imported from China are drastically increasing (20-30% up already). This is because now with the use of black money not being an option, all material imports will have full import duty.

Adhesives: Manufacturers/companies are only fulfilling old (pre Nov-9) orders at the moment, and the order book is not replenishing; hence in the coming few months the industry might take a hit.

The problem lies at the distributor level; even though retailers/dealers might be recovering from debtors, the same does not seem to be reaching the distributors. The distributors are under severe liquidity crunch, and hence unable to place any new orders.

How are companies/industry reacting to disruption? Currently the industry seems to be at a standstill; organised manufacturers

suggest a ‘wait and watch’ approach. Barring paints, we hear little effort from companies to quickly move the channel to non-cash mode of dealings.

Though building material companies do not seem to have officially announced any working capital support to the channel yet, company managements suggest willingness to do so if and when the need arises.

We hear that a large number of unorganised ply players have currently suspended operations, and are currently too focused on recovery and disbursements.

Strategy


Impact on demand over various time periods We expect near-term impact across all building material categories. Revenue growth for building material (incl. paints and light electrical) companies to further decline from 5% in 1HFY17 given weak retail/institutional demand and inventory destocking. However, FY18 and beyond, we expect quicker recovery in the pipes and adhesives categories, as compared to ply, laminates, tiles and sanitaryware.

Pipes: Expect quicker recovery

2HFY17: Plumbing pipe volumes to decline due to weak real estate construction and some slowdown in projects. Given that agriculture pipes are sold on cash (to farmers), the impact to be far more adverse. Overall, we expect flat to 5% decline in pipe volume sales.

FY18: Volume growth to decline YoY in 1HFY18; however, volume should rebound in 2HFY17 due to low base effect.

Beyond FY18: No major impact on demand beyond FY18. The plumbing pipes market, in particular, should recover with housing demand, given that plumbing pipe is a low-ticket (~Rs6k spent on internal piping in a bathroom), staple-like product used in buildings. The agriculture pipes market should recover once farmers adopt the formal banking channel for transactions.

Ply/Laminates: Profound impact and prolonged recovery

2HFY17: Volumes to significantly decline due to discretionary nature of spend on ply and laminates. Further, we expect material down-trading by the customer.

FY18: Volume growth to decline YoY in 1HFY18; slight recovery expected in 2HFY17 due to low base effect. However, the industry size might start shrinking as customers trade down and MDF adoption picks up.

Beyond FY18: Discretionary spend on home furnishings to decline. Further, the demand for low cost substitutes to ply is expected to increase. The use of pre-lam MDF might impact laminates market.

Tiles/Sanitaryware: Profound impact and prolonged recovery

2HFY17: Volumes to significantly decline due to: (a) discretionary nature of the spends on these categories; and (b) high dependence of industry participants on organised real estate construction (high-end products in particular).

FY18: Volumes to decline in 1HFY18; however, slight recovery is expected in 2HFY17 due to low base effect.

Beyond FY18: Discretionary spends on home furnishings to decline, with increase in use of low cost varieties.

Adhesives/Construction chemicals: Expect quicker recovery

2HFY17: Volumes to decline due to: (a) low liquidity with consumer; and (b) weak real estate demand.

FY18: Sales to decline in 1HFY18; however, growth expected in 2HFY17 due to low base effect.

Beyond FY18: No major impact beyond FY18. Given that adhesives and construction chemicals are low-ticket items, we expect demand to will recover with consumer/housing demand.

Strategy


Changes to the industry structure Given the short time horizon, we do not foresee any change to industry structure

in 2HFY17. Moreover, during this period retailers/distributors are liquidating their current inventory (from both organised and unorganised players).

In FY18 and beyond, we expect some degree of industry consolidation given that unorganised players: (a) will no longer be cost competitive (since they will have to operate through formal channels and thus pay tax); and (b) have weaker balance sheets making their business unviable during the downturn.

Pipes: No structural change No structural change because largely organised industry; unorganised to reduce

from present 30%. Ply/Laminates: Industry consolidation, shrinkage in industry size

Expect the first leg of industry consolidation with the implementation of GST in FY18.

Small unorganised players to either exit or their capacities acquired by larger players (share of organised sector to materially increase from current 30%).

Industry size to decline due to increased use of low-cost substitutes like MDF; capital intensity to increase with adoption of MDF/other engineered substitutes

Tiles/Sanitaryware: Industry consolidation within tiles

Expect the first leg of industry consolidation with the implementation of GST in FY18.

Large organised players to either increase JVs with or absorption of small morbi players. Larger players in morbi, on the other hand, will get organised to build pan-India brands.

Given that only 30% of the sanitaryware market is unorganised, structural impact to be limited.

Adhesives/Construction chemicals: No structural change No structural change because adhesives is largely an organised industry.

However, some local unbranded players might gradually leave the industry.

What are the factors investors should consider to pick winners and losers in a sector? At the category level, we advise investors to play the demonetisation theme on building materials with a large proportion of unorganised sector. Informal players will not only see cost of operations rise but in many cases find business becoming unviable; ply should benefit most from formalisation but only after surpassing tough FY18. Sectors, such as tiles could see rise in WC though gradually we expect the bank funding for channel to start (akin to pipes and electricals). This should gradually increase share of organised players; we expect larger morbi players to create larger brands with the exit of some smaller players

Amongst all the building material categories, the wood substrate market, i.e., plywood, would be the most affected by the more to a cashless economy. Given materially higher share of unorganised and small-scale units, the channel has had a penchant for operating on cash in order to improve RoI through pushing tax-evading higher margin unorganised products. The clampdown on cash transaction will impose severe liquidity constraints on the channel as well as on the operations of the unorganised players.

Strategy


Add to this the impending GST adoption, we are ready to see a major dislocation in the industry structure; inevitable exits of smaller players and potential acquisition/partnership possibilities will help strong brands like Century and Greenply. However, on a company/stock-specific level, this longer term win will be a factor of the intent/capability of these brands improve their processes and build dealer trust.

Surprise factors Interest rate cuts, along with collective slash in prices of high rise buildings by

builders (who have been resisting price cuts on new construction over the past 2-3 years in hope for recovery), might boost housing demand more than expected.

Continued liquidity crunch in the rural areas, and slower adoption of cash-less economy might impact demand from farmers (affecting agriculture pipes in particular).

Exhibit 2: Relative valuation of building material companies

Company Mcap

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

US$ mn FY16 FY17 FY18 FY16 FY17 FY18 Sales EBITDA EPS FY16 FY17 FY18 FY17 FY18

Adhesives

Pidilite Industries* 614 BUY 27.1 28.1 22.6 44.8 43.8 34.6 15.2 16.5 18.0 21 21 22 27.2 28.7

Pipes

Supreme Industries* 789 BUY 14.5 14.7 11.9 26.3 27.8 21.2 18.7 17.5 19.6 17 16 17 28.3 30.0

Astral Poly 409 NR 24.6 19.2 15.0 48.3 34.8 25.3 18.9 28.4 38.1 12 13 14 16.4 19.2

Finolex Inds 417 NR 13.8 11.9 10.6 22.1 19.3 16.6 9.4 14.1 15.6 16 15 15 25.6 26.6

Median 14.2 14.7 11.9 26.3 27.8 21.2 18.7 17.5 19.6 16 15 15 25.6 26.6

Plyboard

Century Plyboards* 176 BUY 15.2 17.7 15.2 23.4 31.5 22.8 24.8 13.1 21.3 17 17 14 28.9 31.1

Green Ply 260 NR 13.2 12.2 10.3 24.0 21.7 17.2 12.2 13.2 18.1 15 15 15 20.5 19.2

Median 14.2 15.0 12.8 23.7 26.6 20.0 18.5 13.2 19.7 16 16 15 24.7 25.2

Tiles

Kajaria Ceramics 465 NR 16.2 14.3 12.2 32.3 26.8 22.0 13.1 15.1 21.0 19 20 20 26.5 26.6

Somany Ceramics 515 NR 15.8 13.0 10.1 31.7 23.8 18.8 11.9 24.6 29.8 9 10 11 19.1 20.2

Median 16.0 13.7 11.2 32.0 25.3 20.4 12.5 19.9 25.4 14 15 16 22.8 23.4

Sanitary Ware

Cera Sanitaryware 1,921 NR 17.4 13.9 11.5 29.9 23.3 19.1 16.6 23.0 25.3 15 16 17 22.5 22.6

HSIL 292 NR 8.5 7.9 6.6 23.7 17.1 12.8 12.3 13.7 36.1 16 16 16 9.2 11.4

Median 13.0 10.9 9.1 26.8 20.2 16.0 14.5 18.4 30.7 16 16 17 15.9 17.0

Source: Bloomberg, Company, Ambit Capital research. Note: *Multiples and return ratios computed on Ambit estimates for others Bloomberg estimates have been used.

Strategy


Banks Disruption before the opportunity arises Slowdown in loan growth and increase in NPAs (particularly in SME, retail and agri segments) will be the key near-term adverse impacts of demonetisation. The fall in G-sec yields will drive treasury gains but won’t be enough to offset the negatives. The current surge in CASA deposits is temporary and would reverse as a significant part of deposits flow back into the economy. Muted loan growth (more so in higher yielding SME/retail segments) means that NIMs would be under pressure. Overall, banks with higher share of SME/retail loans look vulnerable in FY17/18. We will have to significantly decrease our earnings estimates for FY17/FY18 and target prices for stocks under coverage. Over the longer term, the shift in favour of financial savings and the formalisation of the Indian economy bode well for banks. For MFI companies transitioning into small finance banks, the disruption in core businesses could not have come at a worse time given that costs were in any case accelerating during the transition.

Exhibit 7: Impact of demonetisation on banks

2HFY17 FY18 Structural

Large banks

Growth Outlook

Fall in disbursements and rise in prepayments to stall growth in retail and SME segments. With corporate loan growth already weak, growth in disbursements would take a major hit in 2HFY17.

Growth should gradually improve in line with normalisation in economic activity. However, lower GDP growth and lower discretionary spends should lead to lower than expected loan retail/SME growth.

Formalisation of economy would drive market share gains for banks from NBFCs/informal sector. A possible government stimulus in FY18 should induce capex cycle, leading to improving growth from FY19.

Asset quality

Delinquency to rise in SME/retail/agri segments due to cash crunch. Regulatory forbearance would, however, help NPA recognition in 2HFY17.

NPA increase in SME and retail segments due to struggling economy and structural impact on wealth and income of some segments of retail/SME.

Long-term structural asset quality to reflect underwriting standards.

Margins/Bond Gains

Flow of low cost deposits would be offset by fall in loan disbursements (falling CD ratio). Thus, impact on margins will be neutral. G-sec yields will lead to healthy treasury gains.

Monetary stimulus would lead to rate cuts. Subdued loan growth, high competition and faster re-pricing of assets than funds will negatively impact NIM. Treasury gains to continue with further fall in G-sec yields.

No structural impact on NIMs.

Industry structure

No changes in industry structure are anticipated in the short term.

No changes in industry structure are anticipated in the medium term.

Over the long term, banks will take market share from NBFCs and informal lending segment.

Small banks

Growth Outlook Sector and geographical concentration could lead to sharper slowdown in growth than that for large banks.

Banks with higher SME exposure to continue seeing muted growth due to continued disruption.

Long-term outlook is better than that of large banks as small businesses shift to the formal economy.

Asset quality NPAs to rise meaningfully in the SME segment.

NPA overhang for longer as the value chain of SMEs undergoes disruption.


Margins/Bond Gains

Fall in credit demand would impact loan yields and, hence, margins. G-sec yields would support treasury gains.

Higher share of wholesale/non-CASA funding will benefit from monetary easing, offsetting pressure on yields. Treasury gains to continue with further fall in G-sec yields.

Long-term margins to be more resilient than that of large banks due to niche positioning allowing better pricing power.

Industry structure


No changes in industry structure are anticipated in the medium term.

Market share gain from informal segment, but competition to intensify from larger banks for small business lending.

Small finance banks

Growth Outlook Growth at a standstill due to cash crunch impacting disbursements.

Subdued cash economy means demand recovery will be gradual.

Higher welfare support and economic stimulus to drive growth recovery in the longer term.

Asset Quality NPAs to rise meaningfully in MFI/SME. NPA overhang for a longer time as value chain of economically active poor/SMEs undergoes disruption.


Margins/Bond Gains

No meaningful benefit of better deposit flow because of limited branch network. Bond gains are not applicable.

Fall in cost of funds (due to monetary stimulus) to support margins.

Despite a secular shift to financial savings, customer segment focus limits gains on liability side.

Industry structure

Aggressive lenders could witness high defaults and deep disruptions, challenging their survival.

Under-stress customer segment may lead to consolidation among struggling lenders.

There is opportunity to take market share from informal lenders, but competition to intensify from banks/NBFCs.


NEGATIVE Research Analysts

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

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

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

Strategy


Our channel checks

There is complete disruption in fresh disbursements due to weak demand. Prepayments have risen; customers are paying in cash using old notes (given that banks can absorb the old currency).

Severe cash crunch has led to a drop in economic activity, particularly in segments where cash transactions were high, including vehicle finance and small businesses.

While the cash crunch is easing, if it continues for longer than 2-3 weeks defaults would rise in MFI, vehicle finance and SME loans.

How are the companies/industry reacting to disruption?

Banks are currently focusing on cash deposits and conversion and meeting currency demand.

To capture long-term trend of shift away from the cash economy, banks are trying to popularise alternative distribution channels like cards, digital banking and mobile banking.

Banks, in general, are confident of protecting asset quality of their LAP/SME books from deterioration due to low LTV, ticket sizes and self-occupied property as collateral.


2HFY17: Loan growth would slow down due to weaker disbursements and higher prepayments. The slowdown will be sharper in loan segments such as auto loans, home loans, microfinance and SME loans due to weak consumer sentiment and unavailability of cash. Delay in home buying decisions, subdued consumer sentiment impacting sales across auto categories and consumer products would hit growth.

FY18: Segments such as real estate and home loans, vehicle loans and small businesses would continue to struggle due to subdued consumer sentiment. However, with significant fiscal and monetary stimuli in FY18, economic activity will likely pick up with a lag in FY18, leading to recovery in credit demand by end-FY18.

Beyond FY18: With the effects of the expected economic stimulus from the Government settling in and continued crackdown on the black economy, the “formalisation” of the Indian economy will gain pace. Thus, over the longer term, the size of the opportunity for banks will increase at the expense of the informal economy.

Biggest change to the industry structure

2HFY17: Except for microfinance lenders, where severe customer stress could lead to the existence of a few aggressive lenders being challenged, banks should not see any significant shift in industry structure in the near term. Due to lower dependence on cash disbursements/collections, banks are better placed than NBFCs to weather the cash crunch even as loan growth slows due to muted demand.

FY18: The continued clampdown on the black economy will support the ongoing shift from physical savings to financial savings. The larger PSU and private sector banks, with wide distribution networks, would be better placed to garner deposits inflows and compete on loan-pricing to consolidate their position in the corporate and retail segments.

Beyond FY18: The banking sector as a whole will benefit from growing opportunities arising from the economy migrating to the formal segment. Banks will get more opportunities in self-employed, SME and low income customer segments. Banks will take market share away from both NBFCs (as more of borrowers’ businesses get captured in their reported financials) and informal lenders (who will come under pressure as it becomes harder to evade taxes in India).

Strategy


Factors investors should consider to pick winners and losers

With higher retail/SME loan portfolios, banks such as IndusInd Bank, Kotak Mahindra Bank and HDFC Bank would witness greater incremental pressure on growth and asset quality in 2HFY17 and FY18. Over the long term, banks with wide traditional and alternate distribution channels (HDFC Bank, ICICI Bank, SBI and Axis Bank) are placed better to benefit from a shift from physical to financial savings. Specialist lenders for SME/retail (IndusInd Bank and City Union Bank) would, over the long term, benefit more by taking market share away from NBFCs and informal lenders.

Exposure to impacted sectors

Given the disruption in certain segments (e.g. vehicle finance, small businesses and MFI) which rely heavily on cash disbursements/collections, banks (IndusInd Bank, Equitas and Ujjivan) that have greater exposure to these segments will see deeper impact on growth and asset quality. With market interest rates likely to fall, banks with bigger fixed rate loan books (HDFC Bank and IndusInd Bank) are better placed in protecting NIMs.

Shift to formal lending

With more and more small businesses and consumer transactions (auto, consumer durables) shifting to formal financing, banks stand to gain market share from NBFCs and informal lenders. Banks with specialist knowledge and track records in these customer segments (Axis Bank, IndusInd Bank and City Union Bank) are better placed to expand and rebound from near-term growth and asset quality headwinds.

What could surprise us?

A stronger-than-expected economic stimulus (a large PSU banks recap or sharp monetary easing) can surprise positively. Amongst the PSU banks, the biggest beneficiaries would be SBI (strong distribution network) and PNB (relief on capital position and low-cost deposits franchise).

Further, while it is expected that a large part of informal economy will continue to face structural headwinds, it is not clear what the banks’ direct and indirect exposures to these struggling segments of economy are (e.g. small businesses surviving on tax arbitrage). While banks have low direct exposure than NBFCs, the value-chain links and indirect impact are difficult to gauge at this stage.

Exhibit 8: Relative valuations

Mcap Price P/B P/E EPS CAGR ROA ROE

US$bn Rs FY17E FY18E FY17E FY18E FY16-18E FY17E FY18E FY17E FY18E

Banks New Private HDFC Bank 44.5 1,199 3.61 3.11 20.5 17.1 20% 1.92% 1.94% 18.9% 19.5%

ICICI Bank* 22.3 261 1.06 0.78 10.6 7.8 13% 1.00% 1.20% 10.1% 12.8%

Kotak Mahindra Bank 20.5 763 3.76 3.33 30.6 25.0 27% 1.46% 1.52% 12.9% 14.1%

Axis Bank 16.3 466 1.93 1.68 21.2 10.6 13% 0.91% 1.53% 9.4% 16.9%

IndusInd Bank 9.3 1,059 3.19 2.73 21.5 16.2 28% 1.87% 1.99% 15.8% 18.1%

Yes Bank 6.9 1,113 2.62 2.21 15.2 12.2 24% 1.76% 1.79% 19.5% 19.8%

IDFC Bank 3.4 68 1.60 1.50 23.2 19.1 56% 1.13% 1.06% 7.0% 7.9%

RBL Bank 1.8 334 2.90 2.38 28.6 23.0 27% 0.91% 0.92% 11.8% 11.8%

DCB Bank 0.4 106 1.56 1.36 15.4 12.4 20% 0.93% 0.94% 10.5% 11.6%

Average 2.47 2.12 20.8 15.9 25% 1.32% 1.43% 12.9% 14.7%

Small Finance Banks Equitas Holdings 0.7 150 2.22 2.00 24.9 19.4 12% 2.27% 1.96% 11.2% 10.8%

Ujjivan Financial 0.6 341 2.28 2.03 18.6 17.0 7% 3.10% 2.33% 14.7% 12.6%

Average 2.25 2.01 21.7 18.2 9% 2.69% 2.15% 12.9% 11.7%

Strategy




Large PSUs State Bank of India* 29.3 257 1.00 0.93 12.3 9.9 22% 0.50% 0.54% 8.1% 9.4%

Bank of Baroda 5.4 161 0.94 0.88 15.5 7.1 n.a. 0.35% 0.70% 6.5% 13.0%

Punjab National Bank 4.3 136 0.72 0.67 11.5 8.8 n.a. 0.37% 0.45% 6.6% 7.9%

Bank of India 1.8 117 0.44 0.45 -3.4 -33.4 -78% -0.47% -0.05% -12.1% -1.3%

Union Bank of India 1.5 149 0.50 0.46 7.5 5.8 14% 0.33% 0.41% 6.7% 8.3%

Average 0.72 0.68 8.7 -0.4 -14% 0.21% 0.41% 3.2% 7.4%

Old Private Federal Bank 1.7 67 1.32 1.22 13.3 10.5 52% 0.87% 0.94% 10.3% 12.1%

Karur Vysya bank 0.8 88 0.22 0.20 1.9 1.5 13% 0.90% 1.03% 11.6% 14.1%

South Indian Bank 0.4 20.9 0.70 0.64 6.7 5.5 24% 0.63% 0.68% 10.9% 12.1%

City Union Bank 1.1 130 2.24 1.94 14.7 11.6 23% 1.59% 1.70% 16.2% 17.9%

Average 1.12 1.00 9.1 7.3 28% 1.00% 1.09% 12.3% 14.0%

Source: Bloomberg, Ambit Capital research; Note: * We have adjusted valuation of SBI and ICICI Bank for standalone bank multiples; we have used Bloomberg estimates for companies not under our coverage

Strategy


Consumer Discretionary The ‘small’ ticket to resilience Demonetisation will impact the discretionary sector in varying degrees depending on ticket size and nature of offering. Low-ticket and consumption-oriented offerings like multiplexes, apparel (non-luxury), and leisure parks will see short-term disruption in demand while high-ticket and investment-motivated (jewellery, luxury watches, etc.) items will witness market size shrinkage by up to 30%. While opportunity to gain market share in jewellery is high, it may not be enough to offset sales lost due to market share gains. Our channel checks suggest that demand for jewellery has been severely affected while other categories like apparel and movies are showing early signs of recovery. The disruption is likely to be the longest in jewellery (extending into FY18), whereas other categories would recover in FY18. We like companies like PVR (TP Rs1,594; upside 43%), Trent (TP Rs221; upside 21%) and Wonderla (TP Rs515; upside 60%) given their strong balance sheets, low ticket sizes and proven execution.

Exhibit 9: Impact of demonetisation on Consumer Discretionary


Jewellery

Demand Outlook Demand to take a hit as gold loses its value as a black money parking vehicle.

Expected to pick up in 2HFY18 led by adornment jewellery due to low base and festive season.

Investment demand to take a hit; purchases will be dominated by adornment jewellery

Supply chain change Depends on informal sector for manufacturing with payments in cash

Informal sector may seek digital payments and create a trail

Shift will be towards compliance and, hence, higher making charges

Industry structure Industry will shrink by 20-30% with increasing cost of compliance….

…will mean unorganised players lose advantage of lower making charges

Industry may shrink by 10-15% but will accelerate shift from unorganised to organised sector with more focus on low-ticket size fashion jewellery.

Apparel & Footwear

Demand Outlook Frequent trips to banks/ATMs for cash withdrawals will result in postponement of demand

Footfalls expected to be driven by discounts and EoSS in1HFY18. Expect 2HFY18 to be better due to low base and festive season.

Higher cost of compliance for unorganised players will accelerate the shift towards organised players.

Supply chain change

Near term disruption in operations of players whose distribution chain is cash driven; implies inventory issues.

Destocking expected to happen in FY18 which will hit margins in 1HFY18; 2HFY18 will see uptick in margins.

Normalcy in entire supply chain along with transactions becoming cashless.

Industry structure Unorganised players whose purchases and sales are in cash will get affected

Value fashion players will gain from disruption of unorganised players.

Unorganised players (mostly in women’s wear) are likely to come under GST, thus eroding their value proposition and aiding shift towards organised.

Leisure

Demand Outlook To be muted as consumers cut back on spending.

Demand expected to pick up as everything is restored to normal.

NA

Supply chain change NA NA NA

Industry structure NA Entertainment tax and multiple taxes at state level to be subsumed by GST.

GST to be a game changer for the multiplex industry.


NEUTRAL Key Recommendations Trent BUY

PVR BUY

Titan SELL

Arvind SELL

Research Analysts

Abhishek Ranganathan, CFA [email protected] Tel: +91 22 3043 3085

Mayank Porwal [email protected] Tel: +91 22 3043 3214



Strategy


Exhibit 10: Low-ticket and urban, white-collar-centric categories will be resilient

Multiplex Apparel Amusement Parks Jewellery

Impact of Ticket Size

Average ticket size – Rs170

Average ticket size – Rs1,860

Average ticket size – Rs720

Average ticket size – Rs70,000

Urban/white collared customer base

With 62% screens in top 8 cities, the customer base is wide and has a large portion of white-

collar/urban consumers.

With 40% stores in top 8 cities, the customer base is wide and has a large portion of white-

collar/urban consumers.

With most amusement parks in top 4 cities the customer base is wide and has large portion of

white collared/urban consumers.

With nearly half the customers in non-urban locations the customer

base while wide includes non-white collared customer base.

Share of cash

With nearly 50% of revenues

through digital along with low ticket size, it is less vulnerable to such disruption. Cash purchases would be largely on account of

food and beverages.

With nearly 60% of revenues

through digital along with low ticket size, it is less vulnerable to

disruption. Channel checks suggest customers who made cash purchases have moved

seamlessly to cards.

Leisure park tickets are bought

on site as visit decisions are made based on weather

conditions. The relatively small ticket size and urban locale make

it less vulnerable to disruption from demonetisation.

Over 70% of sales are in cash.

Given implicit investment motive, significant portion of revenues are from unaccounted income.

This makes it most vulnerable to demonetisation.

Source: Ambit Capital research . Note: Note: - Very High; - High; - Moderate; - Low

Channel checks

Jewellery

o Cash purchases have reduced by 20-30%; card sales have shot up and most of the purchases are by the corporate clientele.

o Credit card customers, too, are restricting purchases so as to cover their basic needs. Customers have other priorities such as managing cash and daily essentials; hence, footfalls are low.

o Deposit schemes run by various jewellers have taken a hit to the extent that instead of redeeming gold, customers are asking for refund of deposited amounts.

Apparel & Footwear

o Customers have other priorities such as managing cash and daily essentials; hence, footfalls are low.

o Footfalls which had reduced by around 45-50% at stores across the country post the demonetisation have started recovering across apparel brands and departmental stores.

o Credit card sales have seen an upswing; have reversed for some of the stores from 60% cash sales to 60% card sales. However, overall sales have fallen by 20-30%.

o Wedding-related purchases have not been postponed but have been significantly curtailed and, as a consequence, November sales have been dented severely.

Leisure

o Impact was evident in the week in which demonetisation was announced - Rock On 2 was a washout; but the movie received at best average reviews. However, Force 2, which released in the following week garnered an encouraging response in its first weekend, an indication that demonetisation is unlikely to have a pronounced impact on the multiplex industry.


Jewellery

o Organised jewellers such as Titan are focusing on controlling costs and improving gross margins through studded jewellery to protect profitability.

o We expect leading brands with strong balance sheets to lower making charges to accelerate market share gains from unorganised jewellers.

Strategy


Apparel & Footwear o Since purchasing had come to a standstill, channel checks suggest that

stores/brands are considering rolling out discounts in the near term (indicating longer EoSS) to enable destocking (especially those that have long supply chains) and drive footfalls.

o Companies plan to extend longer credit periods to distributors to counter the cash crunch.

Leisure o Payment wallets are offering incentives on booking tickets online in the form

of discounts on F&B and waiver of convenience fees on direct booking in order to drive footfalls to cinema halls.

Impact on demand over 2HFY17, FY18 and beyond

Jewellery – Market size shrinkage will be tough to offset o 2HFY17: Demand expected to be weak (down by 20%) in the near term as

jewellery, which used to be a vehicle to park black money, loses its utility. However, demand will be led by recycling of jewellery and adornment jewellery.

o FY18: Consumer sentiment is expected to be muted in 1HFY18. However, 2HFY18 is expected to fare better due to festive season, marriages and low base effect.

o Beyond FY18: Organised players like Tanishq would benefit in the near term from market share gains.

Apparel and Footwear – Small ticket size and urban centricity will aid quick recovery o 2HFY17: Companies will have a weak 2HFY17 despite the presence of an

elongated wedding season. Discounts and elongated end-of-season sales (EoSS) driven by unsold inventory could impact margins in 4QFY17.

o FY18: Footfalls in 1HFY18 are expected to be discount-driven. However, 2HFY18 is expected to see an uptick due to festivals and marriages and low base effect.

o Beyond FY18: Parity is expected to be restored as quite a few customers who used to pay by cash are expected to have shifted to cashless transactions.

Leisure – Smaller ticket size will driver recovery o 2HFY17: Footfalls are expected to decline in the amusement park space in

the near term given the costs involved for a one-day outing. Multiplexes are not expected to see a major decline in footfalls given the relatively low average ticket size (Rs170).

o FY18 and beyond: No impact in the longer term given the low ticket sizes.


Jewellery – Making charges to increase o 2HFY17: The industry is expected to shrink in the near term by 20-30% as

unorganised players bear the brunt of increased cost of compliance. o FY18: The above might lead to consolidation in the industry with unorganised

players losing their advantage of lower making charges. o Beyond FY18: Making charges will increase for unorganised players due to

higher cost of compliance. Consequently, organised players like Tanishq will gain market share. Also, GST will bring the unorganised players in the tax net, reducing their competitive advantages. The drive against black money will also impact diamond traders who have attempted to enter the jewellery industry. With erosion of their wealth, increased scrutiny and compliance, the jewellery business will see fewer new entrants.

Strategy


Apparel and Footwear – Decreasing competitiveness of unorganised players

o 2HFY17: Unorganised players’ entire chain - from procurement to sales - will be affected. This will erode local area competition, especially in women’s ethnic wear.

o FY18: Operations and inventory levels should normalise in FY18E.

o Beyond FY18: While GST can result in efficient taxation (due to set-offs between input and output credits), the rates, which are not declared yet, will also be important to evaluate net gains/loss from GST. With the entire chain coming under the tax net, it will be difficult to generate unaccounted revenues. This will erode local area competition, especially in women’s ethnic wear. Global brands’ perception of ease of doing business would improve and they might enter/expand in India.

Leisure – GST the big game changer

o 2HFY17: No near-term impact on the industry.

o FY18 and beyond: However, countrywide multiplex chains like PVR are expected to benefit in the GST regime as taxes under various states will be subsumed under GST; outgo of entertainment tax is expected to significantly decline.


Strong balance sheet: This will help sustain near-term working capital pressures from inventory/debtor build-up.

Low ticket size: Low ticket size items such as movies, apparel and footwear will be unaffected given their purely consumption nature (unlike jewellery) and high share of card-driven business

Low share of organised: Unorganised players will not only be stretched for working capital (given wealth erosion) but will also have higher cost of compliance thus, eroding their competitiveness.

Which sub-sectors would be better placed?

Apparel and leisure companies (multiplexes and leisure parks) are better placed in this sector given their strong balance sheets, cash generation and low ticket size.


Accelerated market share gains in jewellery by organised players, which will offset the impact of the shrinking market.

Strategy



Mcap TP Stance EV/EBITDA (x) P/E (x) CAGR (FY16-19)(%) RoE(%) RoCE(%)

US$ mn Rs FY17E FY18E FY17E FY18E Revenue EBITDA FY16 FY17E FY18E FY15 FY16

Retail Trent 914 221 BUY 22.3 15.8 35.8 27.1 27.4 48.9 4.6 11.2 13.4 5.3 7.6

Shoppers Stop 384 NA NA 13.6 11.1 44.4 30.5 14.3 17.8 3.2 7.8 10.4 12.4 7.8

Arvind 1,301 311 SELL 10.0 8.0 21.0 14.3 12.5 13.5 11.6 13.5 14.7 11.0 9.3

ABFRL 1,513 182 BUY 24.8 20.9 788.5 92.4 14.5 24.8 1.3 7.6 18.8 NA 2.1

Jewellery Titan 3,970 312 SELL 23.4 20.1 37.6 31.5 9.7 15.5 24.6 21.8 23.1 25.2 25.8

PC Jewellers 920 NA NA 8.5 7.5 14.7 13.3 19.5 22.7 18.6 18.5 17.4 60.0 37.6

Footwear Bata 806 382 SELL 17.1 15.3 31.4 28.1 7.5 7.9 13.9 14.7 14.9 36.7 23.7

Relaxo 722 NA NA 17.3 14.6 35.8 22.1 18.5 18.0 28.4 22.7 21.1 19.7 16.1

Leisure PVR 745 1,594 BUY 14.2 11.2 36.5 27.8 19.5 22.9 14.4 14.3 17.7 7.2 11.7

Wonderla 281 515 BUY 19.8 13.7 40.1 26.1 24.1 24.8 15.8 10.7 14.9 26.6 16.5

Source: Bloomberg, Ambit Capital research

Strategy


Capital Goods Interest rate sensitives ; real estate exposed In the near term, genset sales will decline significantly given real estate accounts for ~50% of sales. Working capital cycle is likely to get stretched given the severe credit crunch in the channel. Genset industry is unlikely to face any structural change given high share of organised players. For the 3W auto engine players, volumes are likely to decline in the near term with a decline in replacement demand (~50% of the market) due to liquidity crunch. However, replacement demand is likely to recover post FY18 fiscal stimulus and any cut in interest rates. BTG sector will be unaffected. We prefer companies with high correlation of revenue and interest rate cycle (Greaves Cotton); avoid companies with high exposure to real estate (Cummins).

Exhibit 12: Impact of demonetisation on Capital Goods Particulars 2HFY17 FY18 Structural

Genset

Demand outlook Sales are likely to decline as ~50% of gensets are sold to real estate.

Weakness to continue due to weak real estate

Application of gensets to shift from low KVA to medium KVA

Supply chain change

Increase in working capital due to liquidity crunch in the channel.

Working capital to ease with improvement in liquidity.

Large genset OEM partners like Powerica to gain market share

Industry structure Players with strong balance sheets to gain market share.

Organised players to gain market share

MNC players to enter with rising share of organised players

3W engine

Demand outlook

Sales to decline led by decline in replacement demand due to liquidity crunch.

Sales growth in high single digit led by pick-up in replacement demand due to interest rate cut.

Strong growth as pace of urbanisation picks up given low penetration across smaller cities

Supply chain change

Inventory build-up due to sales decline

Normalisation of inventory with volume growth kicking in.

Unorganised 3W OEM to lose market share to organised

Industry structure Organised players to gain Greaves market share to increase as unorganised players get marginalized.

Spares business to become lucrative as share of unorganised players declines.

BTG No impact No impact No impact



2HFY17: Genset sales would decline in 2HFY17 as ~50% of gensets are sold to real estate, where demand is decreasing with decline in power deficit to 1%. 3W auto engine sales will decrease due to decline in replacement demand (~50% of sales) due to liquidity crunch. There would be no impact on BTG companies.

FY18: Unless infra spending recovers, genset sales will remain weak. Replacement demand for 3Ws should revive on fiscal stimulus and rate cuts.

Beyond FY18: Demand for 3Ws could accelerate as pace of urbanisation picks up. For gensets, we believe the industry is facing a structural decline.


We prefer companies with high correlation between revenue growth and interest rate cycle. As per our economy team, post demonetisation, the interest rate is expected to be cut by 50bps in 2HFY17. Greaves should benefit from the cut in interest rates as replacement demand, which accounts for ~50% of 3W sales (~50% of Greaves’ revenue), would pick-up with the EMI for the 3W buyer declining (~80% of 3W purchases are financed by loan).

Avoid Cummins as real estate forms a high 50% share of domestic powergen revenue.


Delay in pick-up in replacement demand in 3Ws beyond FY18 is a risk to our expectation of revenue growth for Greaves.

POSITIVE Key Recommendations Greaves Cotton BUY

Cummins SELL

NTPC SELL

Research Analysts

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

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



Strategy


Exhibit 13: Relative valuation – Capital Goods

Company CMP Mcap P/E (x) P/B (x) EV/ EBITDA (x) RoE (%) CAGR (%) over

FY16-18

(Rs) ($ mn) FY17E FY18E FY17E FY18E FY17E FY18E FY16 FY17E FY18E Revenue EPS

BHEL 125 4,826 31.9 13.3 0.9 0.9 32 9 (3) 3 7 9.5 N/A

Cummins 765 3,217 27.7 25.2 5.9 5.2 27 23 25 23 22 10.4 5.8

Thermax 847 1,458 39.9 30.4 3.9 3.5 24 19 8 10 12 (3.9) 4.2

Inox Wind 178 591 7.3 9.9 2.0 2.0 6 8 29 28 20 1.8 (8.5)

Greaves Cotton 123 448 15.0 13.5 3.2 2.9 11 9 21 22 22 10.9 12.6

Average 24.4 18.5 3.2 2.9 20.0 13.6 16.1 17.2 16.7 5.7 3.5

Source: Bloomberg, Ambit Capital research, Note – prices as on 22 November 2016

Strategy


Cement Another year of 5% demand in FY18 Sharp decline in cement demand (40-80% decline in the last 10 days) is driven by liquidity issues and should normalise over the next month. On a structural note, we believe ~15% of total cement demand is exposed to risks from income/wealth effect of demonetisation (largely real estate in semi-urban and urban areas); demand in this segment could decline by 10-20%. Demand should grow by 0-4% in the last 4 months of FY17 and 4-5% in FY18 (vs ~8% estimated earlier); North and Central India will be the worst impacted while South India will be largely resilient. However, pricing discipline would be maintained; companies have surprisingly raised prices in some regions last week. We do not rule out production cuts in the short term to protect overall EBITDA amid demand weakness. Orient Cement, Shree Cement and UltraTech are most exposed to estimate cuts. We prefer regional players such as Dalmia Bharat and Ambuja amongst the large caps.

Exhibit 14: Demonetisation impact on Cement

Segment Particulars 2HFY17 FY18 Structural

Cement

Demand Outlook

Lack of liquidity (cash) with individual house builders (urban or rural) as well as real estate developers to drive 15-25% decline in cement sales over Nov-Dec 2016; this should recover to 0-4% over Dec-Mar 2016.

Income/wealth effect to impact ~15% of demand structurally. Assuming this 15% declines by ~20%, overall demand should grow by ~5% (vs 8% earlier); however, Government capex led demand could be the real driver

~45% of India’s cement demand is driven by semi-urban IHBs and organised real estate developers. A third of this (15% of total demand) is exposed.

Supply chain change ~70% of India’s cement sales are through the trade channel (retail), where customers pay cash to dealers. However, payments from dealer to distributor to cement companies are 100% through the banking route and, hence, imply no major impact on the supply chain.

Industry structure No major change in structure as cement production in India is completely organised.


Channel checks

Our interaction with industry participants suggests that cement sales in the trade segment are down 40-80% over the last 10 days due to lack of liquidity with individual house builders.

Non-trade sales to institutional buyers retain the same pace as in the pre-monetisation period.

Collections from dealers/distributors have picked up significantly.

How are companies/industry reacting to demonetisation disruption?

Whilst managements of most cement companies suggest that dispatches have not declined, we expect dispatches to see a slowdown in the next 1-2 weeks given inventory in the channel is rising.

Hence, we expect cement companies to take production cuts in the next 1-2 weeks to maintain inventory and minimise inventory losses.

Structurally, we expect cement companies to maintain pricing discipline by adjusting production.

POSITIVE Key Recommendations Dalmia Bharat BUY

Ambuja Cement BUY

Shree Cement SELL

UltraTech SELL

Research Analysts


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

Strategy


How would demand shape up?

About 15% of total cement consumption is exposed: About 30% of India’s total cement demand comes from individual house buyers in rural India, which is largely dependent on agriculture and allied activities and, hence, unaffected by demonetisation except in the intermittent period. Another 25% of demand is driven by infrastructure and corporate capex, which is also largely immune to demonetisation. The remaining 45% is driven by individual home builders in semi-urban towns and organised real estate. Industry participants suggest that ~30% are pure white money transactions either because the buyers have white money (more so in South India) or circle rates are closer to market value of rates. Hence, only ~15% of cement demand is exposed to income/wealth effect of demonetisation and could see a decline. As liquidity in the economy improves over the next 1-2 months, retail sales are expected to normalise by Jan 2017.

Exhibit 15: Segment-wise demand components

Source: Ambit capital research

10-30% decline in Nov-Dec 2016: Lack of liquidity with retail consumers would result in a 10-30% decline in cement demand in Nov-Dec.

0-4% demand growth in 4QFY17: Assuming 85% of the market which is immune to demonetisation grows at ~6% and the 15% of the market which is exposed declines by 30%/20%/10%, cement demand would still grow by 0-4% in the last four months of the year.

Demand to recover to 4-5% in FY18: Even if the impacted 15% of demand (real estate) declines by another 10% in FY18, we expect demand to normalise to 4-5%, supported by: (a) pick-up in housing demand due to good monsoons in CY16 and possibly higher spends by the Government for rural India; and (b) pick-up in infrastructure spend by the Government.

Exhibit 16: Demand to recover to 4-5% in FY18E

Demand drivers FY18

Housing + Organised real estate (75% of market) ---- 60% immune grows at 6% 3.6%

---- 15% impacted declines another 10% -1.5%

Infrastructure (20%) grows at 15% 3.0%

Industrial (5%) grows at moderate 4% 0.3%

FY18 growth ~5%%

Source: Ambit capital research;

Changes to the industry structure

We do not expect any major change to the cement industry structure as cement production in India is completely organised.

Infrastructure, 20%

Industrial capex, 5%

IHB - Rural, 30%

Largely white30%

Exposed to demonetisation risk

15%

Semi Urban / Urban

(IHB / Organised Real Estate)

45%

Strategy



The impact of demonetisation would be different across various parts of the country. We expect…

North India (20% of the market) and Central India (18% of the market) to be the most severely impacted given high share of cash transactions; and

East India (18% of the market) and West India (20% of the market) would be the next in order;

South India (25% of the market) would be least impacted as it is largely a white money economy (in real estate), demand growth in AP/Telangana is holding up due to large infrastructure spends, and there are no issues of a real estate bubble like in other states.

In our coverage universe, we expect Shree Cement (North India, NCR dependence) to be impacted the most, followed by ACC, Ambuja and UltraTech. Dalmia Bharat is the best placed followed by Orient. We prefer regional players such as Dalmia Bharat and Orient Cement and maintain our SELL stance on Ultratech and Shree Cement. Ambuja remains our preferred play in the large-cap space.

Exhibit 17: Shree’s exposure to North and East India makes it the most vulnerable to volume cuts Company Central North West South East

ACEM 23% 25% 22% 22%

SRCM 75% 25%

ACC 18% 22% 22% 18% 20%

UTCEM 11% 21% 31% 18% 19%

ORCMNT 10% 55% 35% DBL 10% 40% 50%


Surprise factors

A sharp increase in the Government’s fund allocation towards “Housing for all” or increase in subsidies to rural India will be positive and remains an upside risk to our FY18 cement demand estimate of 5%.

Strategy


Exhibit 18: Relative valuation of Indian cement companies

Capacity (mn tonnes) Rating

Mcap Advt 6m EV/EBITDA

(x) P/E (x)

EV/tonne Rs

CAGR (FY16-18) ROE (%)

(Rs bn)

US$ mn US$ mn Sales EBITDA EPS FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18

Our estimates for Covered companies

UltraTech 69.6 69.6 SELL 939 13,776 15.5 17.9 15.2 36 28 13,293 13,293 6 15 22 12 13

Shree Cement ** 26.6 29.5 SELL 517 7,587 3.6 18.2 16.3 42 35 17,504 15,783 15 30 52 17 18

Ambuja 31.7 32.7 BUY 388 5,692 11.9 13.4 10.4 33 25 7,707 7,464 4 22 23 7 7

ACC 34.1 34.1 BUY 243 3,561 9.6 13.0 9.8 29 20 6,940 6,736 3 24 28 10 13

Orient Cement 8.0 8.0 BUY 27 396 0.7 18.8 9.1 (153) 19 5,052 5,052 23 56 51 -2 13

Dalmia Bharat #@ 25.0 25.0 BUY 127 1,888 2.0 11.4 9.4 39 22 7,900 7,900 14 16 75 8 13

Large cap UltraTech 69.6 69.6 SELL 939 13,776 15.5 16.9 13.5 31 24 13,632 13,632 15 21 34 14 15

Shree Cement ** 26.6 29.5 SELL 517 7,587 3.6 18.8 15.4 32 25 19,638 17,707 22 42 91 23 23

Grasim ̂ NA NA NR 371 5,514 11.1 5.9 4.9 11 9

11 19 30 12 13

Ambuja* 31.7 32.7 BUY 388 5,692 11.9 17.3 13.1 28 22 10,710 10,382 14 29 30 10 11

ACC* 34.1 34.1 BUY 243 3,561 9.6 15.4 11.8 33 24 6,727 6,727 7 12 32 9 12

Mid cap Ramco Cements ** 13.5 13.5 NR 130 1,934 1.8 12.6 10.6 21 18 11,350 11,350 12 12 16 19 19

Dalmia Bharat #@ 25.0 25.0 BUY 127 1,888 2.0 9.9 8.5 34 21 7,503 7,503 16 18 70 10 14

Century Tex# 12.8 12.8 NR 76 1,131 16.4 12.6 NA 105 NA 9,162 9,162 NA NA NA 5 NA

Prism Cement # 8.0 8.0 NR 44 653 0.7 12.3 8.8 37 16 8,127 8,127 9 38 NA 12 24

JK Cement 10.8 10.8 NR 44 661 0.4 10.4 8 22 12 6,767 6,767 15 29 144 12 19

Jk Lakshmi Cement 11.0 11.0 NR 40 599 0.9 10.9 7.5 34 15 4,961 4,961 22 64 NA 9 18

Small Cap Birla Corp # 10.5 10.5 NR 50 744 1.3 9.2 6.9 16 12 4,534 4,534 16 55 64 11 13

OCL India 6.7 6.7 NR 40 594 0.4 6.6 5.6 12 9 5,777 5,777 9 10 39 21 21

Orient Cement 8.0 8.0 BUY 27 396 0.7 13.7 7.8 47 13 4,941 4,941 27 66 83 6 18

India Cements 18.5 18.5 NR 35 516 10.3 7.1 6.2 16 11 3,651 3,651 10 12 58 7 9

Heidelberg India 6.0 6.0 NR 24 359 0.6 10.0 7.8 27 15 5,055 5,055 10 24 104 10 15

Mangalam Cement 3.5 3.5 NR 6 92 0.4 6.9 5.1 11 7 2,725 2,725 19 106 NA 9 15

Sagar Cement 3.5 3.5 NR 10 153 0.3 7.5 5.9 23 11 3,516 3,516 20 29 41 9 14

Source: Company, Ambit Capital research

Strategy


Consumer Resilience of small-ticket consumption will hold Demonetisation will cause disruption in the near term through: 1) supply chain issues at wholesaler/retailer level and 2) demand compression as consumers delay purchases to conserve cash. Near-term impact on sub-segments will be lowest on home and personal care (HPC) followed by tobacco, food & beverages (F&B), alcohol and paints. However, structurally this will be a positive as 1) efficiency of supply chain improves as companies reduce reliance on wholesale; 2) use of IT to support transition to cashless supply chain increases sales visibility; 3) increase in fiscal/monetary stimulus will drive consumption, offsetting potential impact from job losses in the informal sector; and 4) shift of market share to organised players from unorganised players who will struggle due to lack of liquidity and higher cost of doing business. Biggest beneficiaries will be companies with 1) higher direct distribution, 2) IT-supported, streamlined supply chains, and 3) exposure to categories with low ticket size, large unorganised segment and low price differential with unbranded products.

Exhibit 19: Exhibit 1: Quick summary table Sub sectors Particulars 2HFY17 FY18 Structural

HPC

Demand Outlook Essential nature and small ticket size limits demand impact

Slowdown at Premium end. entry/mid-level normalise Premiumisation to slowdown.

Supply chain change Wholesale (30-40% of sales) is hit Supply chain normalises. Wholesale will lose share.

Industry structure Unorganised market disrupted Unorganised players start closing down

Unorganised market to shrink and share shift to Organised.

Foods & Beverages

Demand Outlook Discretionary and Impulse F&B hit Relative slowdown in Discretionary Demand normalises

Supply chain change Channel less impacted Channel unaffected Wholesale will lose share

Industry structure Large Unorganised segment struggling Unorganised starts shrinking Unorganised market to shrink and share shift to Organised

Paints

Demand Outlook Sharp slowdown Slow demand recovery Growth recovers on a smaller base

Supply chain change Channel jammed on large share of cash based transactions

Channel gradually shifts to lower cash Channel clean up helps market leaders

Industry structure Unorganised segment stalled Unorganised unlikely to revive Unorganised segment largely wiped out.

Tobacco

Demand Outlook Cigarette volumes could remain flat vs expectations of 3-4% YoY growth Do not expect significant reduction in sales of illegal cigarettes or bidis

Supply chain change Supply chain impacted as consumers and channel partners deal mostly in cash Supply chain will normalise No impact over the longer term

Industry structure Do not expect structural changes due to demonetisation or GST as we expect marginal impact on sales of bidis or illegal cigarettes

Alcohol

Demand Outlook High ticket size hurting demand Demand recovery complete Marginal impact at Premium end

Supply chain change Govt-controlled channel remains normal Channel remains normal Transparency within channel improves

Industry structure Country / Illicit segment struggling Country struggles but Illicit recovers Share of Country Liquor comes down

Our channel checks

In the first few days of demonetisation starting 8 Nov, demand fell by 40-50% for distributors and by 70-80% for wholesalers.

This demand slump was both due to working capital constraints in the channel as well as due to households delaying consumption of even staples by a few days.

Channel partners see demand destruction in November across both staples and small-ticket discretionary, with no visibility yet on the pace and timing of revival.

POSITIVE Key Recommendations HUL BUY

Asian Paints BUY

GCPL SELL

GSK Consumer SELL

Research Analysts Rakshit Ranjan, CFA

+91 22 3043 3201 [email protected]

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

+91 22 3043 3264 [email protected]




Strategy


How are companies/industry reacting to disruption?

Many large companies like Marico, Dabur, Asian Paints and Berger have extended credit in the channel to help ease liquidity constraints. This has helped revive demand partially over the last few days.

A few firms (e.g. Berger in the paints industry) have undertaken initiatives to help their dealers set up infrastructure for accepting payments through credit/debit cards and mobile wallets.

In order to reduce the adverse impact on earnings from operating leverage, many consumer companies have decided to cut down on TV advertising and deployed these savings to offer higher trade promotions.


2HFY17: FMCG especially Home and Personal Care products at entry to mid-levels and Tobacco should have low impact (<10% decline) due to small ticket size and essential nature. Sales in Pharmacy channel would have been buoyant as well benefiting from channel being allowed to accept old notes. Premium FMCG, Food & Beverages and Alcohol are impacted more (10-15% decline) due to larger ticket size and discretionary/impulse positioning. Impact on Paints will be highest (>15% decline) due to larger ticket size, deferments and stalling of real estate development.

FY18: FMCG, tobacco and alcohol should recover completely but premiumisation will slow down due to negative wealth effect for consumers losing out from demonetisation. We believe fiscal and monetary stimulus should offset negative impact of job losses from shrinking of informal economy. This should drive overall consumption. F&B will remain impacted (5% decline) due to its discretionary positioning. Paints will be weak (5-10% decline) as negative wealth effect is more pronounced and recovery in real estate development can take long.

Beyond FY18: For FMCG (HPC and F&B), lower tax rate post GST implementation combined with demand support from increased fiscal/monetary stimulus can aid demand. Also, as economy turns increasingly cashless, e-wallet and cards penetration will increase and drive propensity to spend. Premiumisation and high-ticket spending like paints will also revive the growth trends but on a new smaller base. Long-term impact on alcohol and tobacco would be only marginally positive as large price gap between unorganised and organised will prevent migration of demand and closure of any illicit supply will shrink the unorganised sector without benefiting organised segment.


2HFY17: Wholesale (30-40% of sales) is facing a liquidity crunch as the channel largely deals in cash. There are also issues at the distributor-retailer level as this transaction has a large cash component. However, credit period extension and moving to non-cash transactions are easing the trade. Also, unorganised segment that ranges from 10-20% for HPC and tobacco, 30-40% for F&B and paints and 50% for alcohol (country and illicit liquor) is stalled due to lack of cash.

FY18: Companies should be able to reduce reliance on wholesale and work with distributors to reduce cash dealings and enhance IT integration. Implementation of GST will allow tax offsets through the value chain and reduce incentive for cash-based transactions. Smaller/marginal unorganised players are likely to start struggling as higher cost of doing business and lack of liquidity will force them to raise prices and make them less attractive to customers. Sub-segments which will witness the largest benefit are HPC (lower price gap with unorganised), paints (unorganised is a large market) and F&B (low price gap with unorganised products). Impact will be lower on tobacco (as illicit cigarettes are already illegal but still thrive) and alcohol (controlled distribution, large price gap with unorganised).

Beyond FY18: Market leading players with stronger control over supply chain and channel will emerge with higher market share. Reduction of cash-based transactions and greater IT integration within the channel will increase efficiency by bringing more visibility on sales and inventory levels within various layers of channel. Unorganised

Strategy


segment will lose its cost advantage and price gap between organised and unorganised will narrow. This will lead to large-scale closure of unorganised businesses as: 1) demand shrinks at the lower end as affordability reduces due to price rise; and 2) at the higher end, lower price gap between organised and unorganised will drive market share shift towards organised.

Factors investors should consider to pick winners and losers?

Businesses with the following attributes are likely to emerge winners: 1) lower reliance on wholesale, 2) more control (through better servicing, larger product portfolios) over distributors to shift them from cash to non-cash and push for greater IT integration; 3) higher presence in categories with greater share of unorganised segment; and 4) higher presence in categories where price gap between branded and unbranded products is low.

Based on these criteria, we believe HPC will do well due to improvement in distribution. Paints and F&B will benefit due to large unorganised segments, which should help organised players gain significant market share. For alcohol and tobacco, while unorganised remains a large segment, benefit is likely to be lower due to large price gap and lower control over distribution which will prevent large scale migration.


Wealth effect of consumers impacted by demonetisation could turn out to be positive (vs our expectation of negative impact) as the residual wealth of such consumers will become a part of the formal economy and can be spent more freely. Also, more cash joining the formal economy instead of being stashed away unproductively can have a multiplier effect and lead to higher-than-expected positive impact on economic growth and, hence, consumption growth. On the negative front, channel disruption and demand suppression from lack of cash can continue for a longer duration than currently anticipated.

Exhibit 20: Exhibit 2: Relative valuation table

Relative valuations

CMP Mcap Stance TP

Up / Down

P/E based on CMP

EV/EBITDA ROCE (%) Implied P/E based on TP

Div. Yield

(%)

Rev growth

EPS Growth

(Rs) (LC bn) FY17E FY18E FY17E FY18E FY17E FY18E FY17E FY18E FY16 FY16-19 FY16-19

Staples

HUL 803 1,738 BUY 925 15% 37.3 31.1 25.9 21.7 119.7 136.0 42.9 35.8 2.0% 12.6% 19.0%

Nestle 5,882 567 SELL 6,100 4% 51.5 37.4 29.2 21.6 35.2 43.7 53.4 38.8 0.7% 16.9% 19.1%

GSK Consumer 4,960 209 SELL 5,300 7% 29.2 26.6 26.7 22.5 28.5 27.2 31.2 28.4 1.4% 10.8% 9.7%

Colgate 917 250 SELL 900 -2% 36.8 31.7 23.1 19.5 60.2 60.1 36.1 31.1 1.1% 14.8% 16.2%

Godrej Consumer 1,421 484 SELL 1,150 -19% 36.4 33.2 26.5 22.8 17.0 16.2 29.5 26.9 0.4% 13.0% 13.1%

Dabur 278 490 SELL 282 1% 35.8 30.6 27.6 23.3 26.0 26.6 36.2 31.0 0.8% 14.0% 14.3%

Marico 250 323 BUY 298 19% 37.0 30.1 24.7 20.5 36.5 38.2 44.1 35.9 1.0% 13.4% 22.5%

Britannia 2,903 348 SELL 2,700 -7% 38.2 32.6 24.5 20.3 44.6 42.7 35.5 30.3 0.7% 14.0% 16.3%

ITC 228 2,750 BUY 285 25% 25.6 22.6 16.6 14.3 29.5 30.7 32.0 28.2 2.5% 13.9% 12.1%

Median

4% 36.8 31.1 25.9 21.6 35.2 38.2 36.1 31.0 1.0% 13.9% 16.2%

Consumer Discretionary

Asian Paints 908 871 BUY 1,270 40% 39.8 30.9 24.9 19.4 34.2 36.5 55.6 43.3 0.8% 17.7% 24.3%

Berger Paints 187 182 BUY 296 58% 32.8 26.8 19.7 16.2 29.5 31.2 52.0 42.5 0.6% 18.2% 30.7%

Median

49% 36.3 28.9 22.3 17.8 31.8 33.9 53.8 42.9 0.7% 17.9% 27.5%


Strategy


Media B2B income to suffer The B2C income, subscription for distribution platforms (DPOs: Cable MSOs and DTH) and the circulation income for newspaper publishers remain unaffected by demonetisation given low-ticket (Rs200-500/month) spend. However, channel checks indicate downward revision in the B2B income comprising advertising (60% of broadcast income/80% of newsprint income). Thus, the industry’s advertising spends’ outlook for 2HFY17 (currently 13% as per Pitch Madison) would move downwards in line with the nominal GDP growth. Print media would face a greater adverse impact (than TV) in 2HFY17 given higher contribution from cyclical categories (real estate/jewellery/retail). In this period, strong balance sheets and access to credit allows the organised players (DB Corp, Dish TV and ZEEL) to gain market share from the unorganised ones. The ‘formalisation effect’ will support long-run advertising growth as the organised players step-up advertising to build strong brands. DPOs’ subscription growth is driven by penetration gains, which is supported by DBT-based transfers to rural consumers.

Exhibit 21: Summary


Television broadcasters

Demand outlook Advertising revenue growth challenged by weak macro

Advertising could bounce back, in line with GDP growth. Delayed digitisation could hurt subscription

Long-run advertising growth could be boosted by the 'formalisation effect.'

Supply chain changes

Considering that television attracts large organised advertisers, we don’t foresee any liquidity impact

No change No change

Industry structure No change

Small/niche broadcasters lose market share as large broadcasters are able to weather challenging 2HFY17

Small/niche broadcasters are unable to sustain investments and there is further industry consolidation

DPOs - DTH operators

Demand outlook No change in subscription income given small ticket size, prepaid nature of product

No change

Rural-centric DTH operators could get a fillip owing to demand tailwinds from DBT transfers

Supply chain changes Slowing STB deployment owing to liquidity crunch and delayed digitisation

Delays in digitisation to continue Higher proportion of online recharges to result in reduced channel commission

Industry structure

Owing to its prepaid nature, DTH to weather the challenges of demonetisation better than cable MSOs

No change Doesn't change our long-term stance of DTH consolidating the TV distribution landscape

DPOs - Cable MSOs

Demand outlook No change in subscription off-take given small-ticket spending No change No change

Supply chain changes Balance sheet stress due to delayed cash collections from LCOs.

Delays in digitisation to continue Given the high leverage of the sector, reduced interest rates to result in significant easing.

Industry structure No change Weak MSOs exit the business; ceding ground to DTH operators

No change to our long-term view of unorganised cable MSOs being unable to digitise rural markets

Newsprint

Demand outlook

Sharp deceleration in advertising outlook given dominance of cyclical categories (real estate, retail). No impact on circulation income

Continued crackdown on black money further pressures real estate; unlikely to see strong advertising bounce back

Long-run advertising growth could be boosted by the 'formalisation effect.'

Supply chain changes Stretched working capital cycles owing to advertisers facing liquidity challenges

No change No change

Industry structure

Weak players (Punjab Kesri, Prabhat Khabar) lose market share as they are unable to offer credit to advertisers

Organised newsprint companies continue to gain market share

Exit/consolidation of weaker players as they are unable to sustain market-share losses to organised players.


NEGATIVE Key Recommendations Dish TV BUY

Hathway Cable SELL

Zee Entertainment SELL

Research Analysts

Vivekanand Subbaraman, CFA Tel: +91 22 3043 3261 [email protected]


Strategy


Channel feedback

Broadcasters/FMCG advertisers: Given demand uncertainties, there is curtailment of advertising spends, even for steady advertisers, such as FMCG/staples.

DPOs: No impact on cash collections given the low-ticket nature of spends. Also, given that cash collections are monthly, it is too early to ascertain the impact of this move.

Print media: Real estate, jewellery, local retail and even FMCG are cutting advertising spends.

Strong balance sheet the key differentiator

Broadcasters/print companies: Companies with strong balance sheets are likely to extend credit to liquidity-constrained advertisers and gain market share from small/poorly-funded rivals.

DPOs: The set-top box (STB) deployment challenges are lower for DTH vis-à-vis cable multiple-system operators (MSOs) given that the former has significant STB inventory, which can be leveraged.

Sluggish demand trends are transient

Broadcasters/print media companies

o 2HFY17: Advertising income is likely to be affected due to sluggish nominal GDP growth trends. Subscription/circulation and low-ticket spends are unlikely to be affected.

o FY18: Advertising growth could bounce back, in line with the GDP growth. The government’s black money crackdown is likely to result in sustenance of weak advertising demand from real estate, which affects print media much more than television. Delayed digitisation could affect subscription growth trajectory.

o Beyond FY18: Long-run advertising growth trajectory could improve due to ‘formalisation effect.’ Also, streamlined supply chain for consumer goods will result in below-the-line spends getting redeployed to discretionary brand building advertising spends.

DPOs: Cable MSOs/DTH

o 2HFY17: No impact on subscription income given low-ticket spends. Both DTH and MSOs will witness sluggish STB deployment given liquidity constraints. MSOs to further witness balance sheet stress owing to delayed local cable operator (LCO) payments.

o FY18: Digitisation delays persist, affecting STB deployment. However, there is no change in subscription revenue trajectory.

o Beyond FY18: No change to our long-term view as unorganised cable MSOs would not be able to digitise rural markets. We expect DTH to consolidate India’s Pay TV distribution landscape.

Industry structure changes

Broadcasters/print media companies; consolidation hastened

o 2HFY17: Given the challenges to advertising growth, we expect large organised players to leverage their balance sheets to gain market share.

o FY18: We expect small and weak players to exit by selling out to large players.

o Beyond FY18: Both broadcast and print media are likely to undergo industry consolidation – a trend that we expect to sustain given that small regional players can no longer sustain against deep-pocketed pan-India rivals.

Strategy


DPOs: DTH to consolidate the market as small cable MSOs exit

o 2HFY17/FY18: We don’t foresee any meaningful change in the industry structure given persistent delays in digitisation.

o Beyond FY18: We expect DTH to consolidate the Pay TV content distribution landscape given: (a) strong balance sheet; (b) credible rural-focused products; (c) inability of small and fragmented MSOs to digitise their subscribers.

How to pick winners?

Broadcasters/print media companies; prefer broadcasting: The print media has higher dependence on sectors, such as real estate (~6% of advertising) and education (~7% of advertising), which are vulnerable to the clampdown of black money. TV, on the other hand, derives ~70% of advertising revenue from sectors which witness streamlining of supply chains (auto and FMCG), and hence sustained improvement in advertising growth. Thus, we prefer television over print media.

DPOs; prefer DPOs with strong balance sheets and healthy cash flows: Among DPOs, we view strong balance sheets and healthy operating cash flows as key differentiators, enabling platforms to consolidate the Pay TV distribution landscape. We prefer DTH over cable MSOs.

Exhibit 22: Valuation summary

Company M-Cap

(US$ mn)

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

FY17E FY18E FY19E FY17E FY18E FY19E Sales EBITDA EPS FY17E FY18E FY19E

Zee Entertainment 7,069 SELL 40.3 26.6 18.9 20.3 22.3 26.5 11.3 31.4 31.7 22.5 16.4 12.2

Dish TV ̂ 1,425 BUY 45.9 25.3 22.6 NM NM NM 9.1 13.3 40.5 11.3 9.8 8.1

Hathway Cable~ 370 SELL NM NM NM NM NM NM 12.4 76.9 NM 28.5 20.6 12.6

VDTH 834 NR NM 38.3 NA 5.6 17.6 NA 14.5 25.7 NM 5.3 4.5 NA

Siti Cable 420 NR NM NM NA 7.3 21.1 NA 25.5 42.2 NM 9.2 5.4 NA

Den Networks 213 NR NM NM NA (5.8) (8.2) NA 19.0 57.6 NM 5.9 5.3 NA

DB Corp 1,019 NR 14.6 12.7 NA 26.7 27.7 NA 13.5 23.0 25.6 9.9 8.5 NA

Jagran Prakashan 896 NR 13.4 12.3 NA 23.3 23.9 NA 11.3 13.3 0.4 9.1 8.1 NA

HT Media 274 NR 9.8 9.4 NA 7.7 8.3 NA 7.8 (21.4) 5.6 7.2 6.5 NA

HMVL 318 NR 9.2 9.0 NA 18.9 18.1 NA 9.7 (0.8) 12.9 8.8 7.7 NA

Source: Company, Bloomberg, Ambit Capital research; ^ For Dish TV, we consider licence fee provisions as debt; ~ For Hathway, we compute ratios on recurring EBITDA; For Siti, Den, DB Corp, Jagran, HT Media and HMVL, estimates are taken from Bloomberg

Strategy


E&C/Infrastructure Diverging fortunes The typically resilient contracting industry should adapt to the new norms quickly in terms of operations; our checks indicate no material decline in the pace of project execution. However, fortunes will be split; Government contractors will have better execution and project visibility as private sector capex could teeter further. Organised players may emerge stronger in the longer run as local players get marginalised by an expanding tax net. In the infra space, road developers are likely to be the most impacted; Nov-16 loss of revenue aside, weaker economic activity and traffic decline in FY18 could result in balance sheet stress. Look for players with most A-rated assets. This could also be an ideal time for financial players to enter the asset ownership space backed by lower cost of funds. PGCIL, with fixed, annuity revenue streams and helped by lower interest rates, is the clear winner.

Exhibit 23: Impact on E&C/Infra - Fate to be linked to the end-client market that is serviced by the contractors

Segment 2HFY17 FY18 Structural

Construction

Demand Outlook

Government-driven projects likely to continue; awards may pick up if social infra focus increases. Private sector capex may be delayed if the economic slowdown hits capacity utilisation and health deteriorates. Real estate construction will decline.

Government orders may pick up if the Centre increases funding for social infrastructure. Private sector capex is unlikely to recover if economic growth is weak. Real estate construction will decline.

No structural impact on demand.

Supply chain change

Liquidity crunch at the subcontracting/labour market level; vendor funding by listed players could increase.

This should normalise soon as channels will adapt to the new normal; subcontracting may become more expensive.

Subcontracting may become more expensive as unorganised players get taxed.

Industry structure

Increased competition in unaffected segments like roads from contractors that operated elsewhere

Same as in 2HFY17. Local, unorganised players will be marginalised as tax net widens

Infrastructure

Demand Outlook

Depends on end-market; if linked to economic activity, then expect a decline in revenue and poorer interest coverage; transmission not affected.

If traffic declines materially, balance sheet health could deteriorate rapidly.

No material impact.

Supply chain change

No material impact

Industry structure No immediate impact Competition could reduce if balance sheet health deteriorates on the back of traffic decline.

Prevalence of financial players will increase as the cost of funds reduces with balance sheet stress at contractor-cum-developer level.



E&C: Our channel checks suggest no material impact on operations in the near term. Pace of construction has not slackened materially. Companies are providing more facilities to labourers in the form of enabling banking support and paying for on-site expenses. Subcontractors are pre-paying salaries to labourers. Companies currently disagree that funding vendors through their own balance sheet is required. However, we do expect this to happen if the cash crunch gets acute.

NEGATIVE

Key Recommendations Power Grid BUY

Techno E&E BUY

Engineers India SELL

NBCC(India)) SELL

Research Analysts


Utsav Mehta, CFA [email protected] Tel: +91 22 3043 3209

Shrenik Bachhawat [email protected] Tel: +91 22 3043 3234




Strategy


Infrastructure: The main impact is from stoppage of tolling for over a week throughout the country. Road companies have applied to NHAI for compensation of traffic loss in Nov-16. However, timing of the payment is unclear as various participants indicate varying timelines. Road companies are finding new ways of collecting toll like prepaid cards, installing point-of-sale machines and cashless transfers. No impact on transmission players.

How would demand shape up over FY17-19?

E&C: The sector is completely dependent on the end-market serviced. For Government contracts, the pace of execution and new order awards will not change materially. It could accelerate if the social stimulus package involves a thrust on social infra. Private sector over-capacity is likely to sustain, thereby causing further delays to capex plans. Real estate oriented contractors could struggle. However, infra/asset creation in the country could be boosted by declining interest rates. Therefore, we expect the demand scenario to improve towards FY18-end. There would be no impact on transmission.

Infrastructure: Traffic declined by 15-20% in Nov-16. Whilst this is likely to normalise, we expect growth to be subdued. The key risk here is the extent of decline in 2HFY17. In the longer run, total economic activity will normalise.


E&C: In the near term, there could be migration of contractors from allied, struggling segments into Government-facing infra projects. For instance, state-owned consultants such as MECON may vie for infra projects. In the longer run, smaller, unorganised players may get marginalised. Lack of tax coverage and easy access to funds through unaccounted cash made these players competitive, an advantage that should fade.

Infrastructure: In the near term, traffic decline could impact interest coverage ratios and, therefore, competitive intensity could subside. This could enable financial players (like pension funds) to play a more prevalent role in the industry backed by lower cost of funds.

Factors investors should consider to pick winners and losers In the E&C space, winners will be contractors that participate in Government projects and subcontract the least. In the roads sector, companies that have the most headroom in terms of debt service coverage ratio (DSCR) should be the most secure. Companies that are rated A or higher should have a headroom of absorbing 15-20% traffic decline whilst those rated lower would have lesser headroom. PGCIL is the clear winner here due to declining interest rates and a revenue stream not impacted by weakness in economic activity.

Strategy


Exhibit 24: Ratings of SIPL and ASBL’s assets

Name Rating agency

Crisil CARE

ASBL Ashoka Dhankuni Kharagpur BBB- Belgaum Dharwad BBB Sambalpur BBB Bhandara A- Mudhol Nipani BBB SADE Bijapur Hungund A Aurangabad Jalna CARE A

Ahmedabad ring road CARE A+

Nagpur Seoni CARE AAA

Dhule Palesner CARE A

Hyderabad Yadgiri CARE BBB

Maharashtra Border check post CARE A-

Rohtak Panipat CARE BBB-

Shreenathji Udaipur CARE BBB

Source: CARE, Crisil


A pick-up in private capex due to low cost of funds would be a major positive for the sector.

Stalled/defunct construction projects which have funding issues may resume due to increased accessibility to funds.

Exhibit 25: Relative valuations Mcap 6M ADV CAGR (FY13-16) CAGR (FY16-18) EBITDA margin PAT margin

US$ mn Rs bn US$ mn Revenue EBITDA Revenue EBITDA FY17E FY18E FY17E FY18E

Larsen & Toubro* 18,745 1,277 42 5% 6% 22% 23% 11% 12% 7% 7%

Larsen & Toubro 18,745 1,277 42 11% 8% 12% 11% 12% 12% 5% 5%

Engineers India* 1,402 96 6 -16% -35% 14% 53% 18% 20% 22% 22%

Voltas 1,421 97 9 2% 27% 11% 13% 8% 9% 7% 7%

VA Tech Wabag 398 27 1 16% 13% 20% 25% 9% 9% 4% 5%

KEC International 525 36 1 8% 21% 9% 13% 8% 9% 3% 3%

Kalpataru Power* 529 36 1 10% 22% 19% 6% 11% 11% 5% 5%

Punj Lloyd 95 6 1 -28% -195% NA NA NA NA NA NA

HCC* 360 25 5 2% 30% 13% 9% 18% 18% 2% 3%

NCC* 644 44 7 13% 15% 8% 10% 9% 9% 3% 3%

J Kumar Infra* 203 14 2 12% 29% 24% 2% 17% 17% 7% 8%

Simplex Infrastructure* 222 15 0 0% 10% 8% 7% 11% 11% 1% 2%

Techno Electric 492 34 0 17% -2% 27% 27% 22% 20% 13% 14%

Median 525 36 2 8% 13% 13% 12% 11% 11% 5% 5%

Mean 3,368 229 9 4% -4% 16% 17% 13% 13% 7% 7%

Strategy


Mcap 6M ADV CAGR (FY13-16) CAGR (FY16-18) EBITDA margin PAT margin

US$ mn Rs bn US$ mn Revenue EBITDA Revenue EBITDA FY17E FY18E FY17E FY18E

Larsen & Toubro* 14 12 14 24.6 20.2 15.8 13.2 2.7 2.5 Larsen & Toubro 12 11 13 24.0 19.5 16.8 14.1 2.6 2.4 Engineers India* 10 12 15 26.9 21.4 24.1 17.7 3.4 3.3 Voltas 17 17 17 22.5 18.9 17.7 14.8 3.6 3.1 VA Tech Waba 10 13 15 19.3 14.9 10.3 8.4 2.4 2.2 KEC International 13 16 16 14.0 11.7 7.7 6.9 2.1 1.8 Kalpataru Power* 9 11 12 13.8 11.6 7.0 6.0 1.4 1.3 Punj Lloyd NA NA NA NA NA NA NA NA NA HCC* 5 3 7 34.6 15.5 8.5 7.2 1.1 1.0 NCC* 7 7 8 17.9 13.8 7.6 6.8 1.2 1.1 J Kumar Infra* 10 10 12 10.9 8.3 5.7 4.5 1.0 0.9 Simplex Infrastructure* 4 6 9 16.2 10.5 7.1 6.5 0.9 0.9 Techno Electric 15 18 19 18.3 14.7 11.9 10.4 2.9 2.5 Median 10 12 13 18.8 14.8 9.4 7.8 2.2 2.0 Mean 11 11 13 20.2 15.1 11.7 9.7 2.1 1.9 Source: Company, Bloomberg, Ambit Capital research. Note: * indicates standalone

Strategy


Healthcare No material impact The recent demonetisation drive has little impact on the pharma sector (in terms of change in industry structure or demand pattern) as consumption is need-based. Our channel checks suggest trends of forward buying by consumers, albeit limited, due to acceptance of old notes at pharmacies as per government directives. Lumpy sales are expected in 3QFY17, specifically in chronic therapies for lifestyle related diseases. However, these purchases would be offset in subsequent quarters. Also, discussion with industry participants suggests that working capital cycle would be extended in 2HFY17 as stockists have requested for additional 10-15 days of credit period. For export-driven companies (50-75% of revenues), we expect tailwind of rupee depreciation. A sensitivity analysis suggests that for every percentage point appreciation/depreciation in INR/USD, pharma companies’ net profit decreases/increases by 1-2%. For B2B businesses like API, CRAMS and CRO, we do not expect any impact of demonetisation.

Exhibit 26: Quick summary table


Domestic pharma

Forward buying in chronic therapies; extended credit period for stockists

No impact of the structure of the industry due to needs based consumption

Need based consumption, do not expect any structural change

Export pharma Depreciation in rupee to aid exports, sensitivity of 1-2% for every 1% change in USD/INR

Prolonged period of rupee depreciation to provide windfall gains

Impact of rupee depreciation to provide tailwind to export revenues

API / CRAMs / CROs No major impact due to B2B business. Demand environment unaffected Do not expect any structural change


Our channel checks

No impact on demand for medicines due to necessity-based consumption.

Stockists have requested pharma companies to provide additional credit period of 10-15 days.

In pharmacies, where old notes are being accepted, there is forward purchase by consumers, in some instances up to one year, especially in the case of chronic therapies like diabetes, cardiac and central nervous system.


Chronic-heavy domestic portfolio companies are expecting marginal increase sales in the near term due to forward buying by consumers.

We do not expect the demonetisation to change the demand pattern for pharma products.

Decline in yields and depreciation in rupee could provide tailwinds as pharma companies earn 50-75% of revenues from the export market.


2HFY17: Chronic therapies pertaining to lifestyle-related disease will see marginally higher growth. Working capital would increase due extended period of credit provided by pharma companies to stockists. Demand environment will remain unaffected due to need-based consumption. With depreciation in INR, we expect windfall gain in export revenues, which contribute 50-75% to total revenues.

FY18: Chronic therapies would report lower than IPM (Indian pharmaceutical market) growth due to forward buying by consumers in 2HFY17. We do not expect demand to be impacted by demonetisation. Sustained pressure on INR will improve revenues from the export market. API business is B2B and, hence, unaffected.

POSITIVE Key Recommendations Lupin BUY

Cadila BUY

Research Analyst

Paresh Dave, CFA [email protected] Tel: +91 22 3043 3212


Strategy


Beyond FY18: Domestic pharmaceutical consumption would remain unaffected.


2HFY17: Apart from extended working capital cycle, we do not expect the industry structure to change. With rupee depreciation, we expect companies to earn windfall gains as 50-75% of total revenue is derived from exports. A sensitivity analysis suggests that for every percentage point appreciation/depreciation in INR/USD, pharma companies’ net profit decreases/increases by 1-2%.

FY18: We expect IPM to report growth of 12-15% post NLEM and FDC impact in FY17. Whilst chronic therapies could report lower growth, it would largely be restricted to lifestyle-related drugs consumed regularly (<15% of overall IPM). Extended period of depreciation in rupee augur well for exports.

Beyond FY18: No material impact or change in structure given consumption is necessity-based.

Factors investors should consider in picking winners and losers Companies with higher chronic revenues from the domestic market will gain in the near term due to forward buying of lifestyle-related chronic therapy drugs. However, the increase in revenue in 2HFY17 will be offset in FY18.

Companies with higher exposure to the export market will benefit from currency depreciation.

API and CRAMs businesses are B2B; hence, we do not expect any material impact of demonetisation.


Extended periods of payment terms with stockists and any write-off of debtors due to their inability to make payments would be negative for pharma companies.

Sharp depreciation in INR would be beneficial for pharma companies as they earn 50-75% of revenue from exports.

Strategy



CMP Rating Consensus

TP Upside

(%)

Mcap EV/EBITDA (x)

P/E (x) P/B (x) EV/Sales (x) CAGR (FY16-18)

ROE (%)

US$ mn FY17E FY18E FY17E FY18E FY17E FY18E FY17E FY18E EBITDA EPS FY16 FY17E FY18E

Large caps

Sun Pharma 687 NR 850 24 24,266 14.9 13.5 22.4 19.6 4.4 3.6 5.1 4.6 19 34 17 21 20

Lupin* 1,404 BUY 1,851 32 9,286 15.2 11.2 21.5 15.5 5.1 4.0 4.1 3.2 29 34 23 24 27

Dr. Reddy's* 3,144 SELL 2,793 (11) 7,644 17.2 12.5 31.1 21.4 3.6 3.1 3.4 2.9 1 12 17 13 16

Cipla* 545 SELL 516 (5) 6,427 16.3 13.9 24.3 20.5 3.6 3.2 3.1 2.7 21 20 13 14 15

GSK Pharma 2,670 NR 2,815 5 3,319 39.9 28.9 54.2 41.0

7.0 6.2 NA NA 21 25 34

Aurobindo Pharma 717 NR 959 34 6,157 11.9 10.2 17.1 14.4 4.5 3.5 2.8 2.5 18 21 32 29 27

Cadila* 365 BUY 430 18 5,483 14.2 11.2 18.9 14.9 5.7 4.5 3.4 2.7 21 28 32 33 32

Divi's Laboratories 1,167 NR 1,286 10 4,547 18.3 15.0 24.7 20.6 6.1 5.1 6.9 5.8 19 16 29 27 27

Torrent Pharma 1,311 NR 1,618 23 3,257 14.6 12.3 21.9 17.7 5.4 4.4 3.7 3.3 (18) (15) 59 27 27

Glenmark 884 NR 1,032 17 3,659 12.0 11.0 18.9 16.8 4.6 3.6 2.9 2.6 32 45 19 27 24

Average

14.9 12.3 22.3 17.9 4.8 3.9 3.9 3.4

Mid caps IPCA Laboratories 538 NR 573 7 996 14.3 11.1 28.3 18.8 2.7 2.4 2.2 1.9 35 97 4 10 13

Biocon 849 NR 861 1 2,492 17.8 14.9 29.7 25.7 3.7 3.4 4.3 3.7 17 (14) 24 13 13

Sanofi India 4,132 NR 5,563 35 1,397 16.5 14.1 28.1 24.1 5.0 4.3 3.7 3.3 17 11 21 20 22

Wockhardt 703 NR 896 27 1,140 18.5 10.1 23.5 14.2 1.9 1.6 2.0 1.7 35 29 9 8 16

Alembic Pharma 610 NR 698 14 1,688 17.3 13.6 25.8 20.1 6.0 4.9 3.5 3.1 (9) (11) 58 25 26

Ajanta Pharma 1,749 NR 2,075 19 2,259 20.7 16.7 29.7 23.9 9.6 7.4 7.2 5.8 24 27 40 35 33

Pfizer Ltd 1,798 NR 2,130 18 1,207 15.0 12.6 29.1 23.6 3.5 3.1 3.2 2.9 NA

11 12 14

Abbott India 4,475 NR 4,480 0 1,396 19.0

29.3 24.2 7.2 6.0 2.8 2.4 NA NA 25 26 27

Jubilant Life Sciences

614 NR 752 23 1,434 8.9 7.8 15.8 12.6 2.8 2.3 2.2 1.9 NA NA 16 19 19

Strides Arcolab 1,025 NR 1,297 26 1,344 14.9 11.9 24.0 17.1 2.8 2.4 2.8 2.4 NA NA 10 12 15

Natco Pharma 591 NR 581 (2) 1,511 21.1 17.9 31.3 26.2 6.5 5.3 6.4 5.4 45 58 14 22 21

Average 16.7 13.1 26.8 20.9 4.7 3.9 3.7 3.1 Small caps FDC Ltd 212 NR NA NA 553 11.6 10.1 15.7 13.6 3.1 2.6 3.1 2.8 NA NA 16 21 21

Unichem Labs 252 NR 331 31 336 11.3 8.7 18.0 13.1 2.2 1.9 1.5 1.3 28 27 12 13 15

Indoco Remedies 282 NR 314 11 381 13.7 11.0 22.4 18.0 3.9 3.3 2.4 2.0 19 32 15 18 20

Merck 890 NR 990 11 217 7.7 6.7 15.9 12.6 2.0 1.8 1.1 1.0 NA NA

12.9 14.8

Dishman Pharma 231 NR 279 21 546 9.7 8.5 18.2 14.4 2.3 2.0 2.6 2.4 13 23 13 13 13

Average

11.6 9.6 18.6 14.8 2.9 2.5 2.4 2.1

Source: Company, Bloomberg, Ambit Capital research. Note: * indicates Ambit Capital estimates

Strategy


Light Electricals The darkness before the dawn Demonetisation will cause disruption in the near term through (a) decline in fresh project announcements in real estate; and (b) demand compression as consumers delay purchases to conserve cash. Near-term impact on B2B products (cables & wires, switchgears) will be lowest as the execution of ongoing projects has not slowed down materially. However, with no fresh project announcements, demand weakness would intensify in FY18. Sales for B2C products (fans, appliances, lighting) has declined by 30-35%; however, it should recover in 1QFY18 as the new currency circulation increases. From a long-term perspective, demonetisation is a positive as market share shifts to organised players; albeit competition may also increase as MNC/Chinese players enter with market becoming organised. Havells and Finolex should emerge as the biggest beneficiaries given high share of revenue from cables & wires, where share of unorganised is the highest at 40-45%. Bajaj should also benefit given its leadership in appliances, where the share of unorganised is also a high 40%.

Exhibit 28: Impact of demonetization on Light Electricals

Particulars 2HFY17 FY18 Structural

Cables and wires, switchgear (B2B products)

Demand outlook

Single-digit volume decline given execution of ongoing projects has not slowed-down.

1HFY18: double-digit decline as new projects announcement is weak; 2HFY18: high single-digit growth (base effect)

Margins to improve led by consolidation in the sector and higher share of organised players

Supply chain change

Channel inventory liquidation due to cash crunch; companies working capital to get stretched

Inventory re-stocking from 2HFY18 as channel liquidity improves

Share of e-commerce as an alternative channel will increase with share of digital transactions rising

Industry structure

Players with strong balance sheets to gain market share

Organised players to gain market share from unorganised

Companies with strong balance sheets will dominate given capital intensive nature of business

Fans, small appliances, lighting (B2C products)

Demand outlook Significant volume decline led by liquidity crunch at consumers; purchases would get deferred

1HFY18: Volume decline to moderate to single digit led by liquidity improvement 2HFY18: Strong recovery assuming Govt. fast-tracks social spending

Industry size can increase in underpenetrated products like small appliances with share of e-commerce rising. For matured products, premiumisation will increase

Supply chain change Same as above Inventory re-stocking, especially in

2H

Consolidation as several unorganised players become vendors

Industry structure Same as above Same as above

Entry of MNC and Chinese brands given rising share of organised players


Our channel checks B2C product category most impacted: Sales of appliances, fans and water

heaters are the most impacted given high percentage of retail transactions. First week of demonetisation saw sales declining 80-90%, however now they are down only 50 to 60% with Rs2,000 notes coming into circulation. Once Rs500 notes come into circulation, recovery is likely to be faster.

B2B category doing better: Cables & wires and switchgears are doing better with sales down just 10-15%. This is because the real estate projects which are closer to completion are seeing continued execution. Also, copper prices have increased by 10-15%, which has allowed distributors to liquidate old inventory at higher prices.

East India, UP, NCR, Gujarat and Kerala most impacted: East India, UP and NCR seems to be the most impacted given high dependence on cash. Gujarat and Kerala are also impacted given the dominance of large co-operative banks (not getting new currency from the RBI). Also, there are a lot of hawala transactions which happen herein in the form of NRI remittances.

POSITIVE Key Recommendations Havells BUY

Finolex Cables BUY

Crompton Consumer SELL

Research Analysts





Strategy


Things should normalise from April: Consensus seems to be that things should normalise by April as currency will get recalibrated by then. Also, there is an expectation of fiscal stimulus in Jan-Feb which can boost demand.


Several companies have agreed to bear charges levied by credit card companies to promote the channel to go digital. Crompton was the first company to take this initiative.

By end-November, we expect companies like Havells, Crompton, V-Guard and Bajaj to announce extension of credit cycle to the channel; in electricals, the bulk of trade happens in the last week of the month. Havells can be the most aggressive given it has the strongest balance sheet (net cash of Rs11.4bn as on 30 September).

Ad-spend may decline significantly as companies may choose to spend more on promotions to win the trust of the channel.


2HFY17: In 3QFY17, we expect 5-10% decline in sales of B2B products like cable & wires and switchgears and 15-20% decline for B2C products like fans, appliances and water heaters. Secondary sales impact may be higher given the channel is presently stocking inventory led by relaxed working capital terms from various companies. If the liquidity crunch persists for another month companies may report significant decline in 4QFY17 given the channel’s inability to stock more inventory.

FY18: B2C products may recover much early as and when liquidity returns given these are low-ticket items. Any fiscal stimulus from the Government should see strong growth for this category as bulk of the demand is replacement and, hence, not much linked to the slowdown in new housing. B2B products, on the other hand, may take time to recover unless demand for new housing recovers. This looks unlikely in the near term given negative wealth effect for consumers.

Beyond FY18: Organised industry should benefit a lot from demonetisation given their share is still low, at 65%. Given the share of cash transaction for unorganised players is high, at ~65%, these players will take a lot of time to come back to normalcy. A large portion of their wealth has vanished overnight post demonetisation. If GST is also implemented soon, the pace of shift from unorganised to organised can significantly accelerate as tax arbitrage fades. Amongst the various categories, we see cables & wires players to emerge as the biggest beneficiary given the segment has the highest share of unorganised market, at 40-45%, followed by small appliances, lighting and switches whose share of unorganised players is also high, at ~40%, ~40% and ~30%.


2HFY17: We expect players with strong balance sheets to gain market share as they will be offering the most lucrative deals, be it higher credit periods or higher commissions.

FY18: Market leading players with strong channel connect and stronger control over supply chain will emerge with higher market share. Reduction of cash-based transactions and greater IT integration within the channel will increase efficiency by bringing more visibility on sales and inventory levels within various layers of the channel. The unorganised segment will lose its cost advantage and the price gap between organised and unorganised will narrow. This will lead to large-scale closure of unorganized businesses, as 1) demand shrinks at the lower-end as affordability reduces due to price rise, and 2) lower price gap between organised and unorganised at the higher end will drive market share shift towards organized.

Strategy


Beyond FY18: We expect a lot of new foreign companies to enter India with trade becoming more organised. Categories like appliances, water heaters and fans can see a lot of entrants; these categories already have foreign entrants like Panasonic, Kenwood, Koryo, Ninja and Black & Decker in appliances; Artemis, Airfusion and Westinghouse in fans; and Panasonic and Nova in irons. As the share of e-commerce increases with the share of digital transactions rising, foreign players will be the biggest beneficiaries as the requirement of having a distribution network gets bypassed. We don’t see B2B categories like cables & wires to see more competition given the requirement of setting up factories. Also, we don’t see much competition in domestic switchgears given the industry size is small at ~Rs17bn and 80% is already organised.

Factors investors should consider to pick winners/losers

Over the longer term, all organised light electrical companies would benefit from the demonetisation as the share of unorganised players is high, at 35%. With the demonetisation and likely implementation of GST in FY18, unorganised players would lose market share as their competitive advantage of tax evasion by dealing in cash would fade.

Within electricals, we prefer companies with a high share of revenue from cables & wires and small appliances as the share of unorganised in these products is higher, at 40-45%. Havells/Finolex with 41%/84% revenue from cables & wires and Bajaj with ~46% of consumer revenue from small appliances are the key beneficiaries.

Crompton is unlikely to benefit materially given: (a) 44% revenue comes from fans, where the share of unorganised is just 10%, and (b) 30% revenue comes from lighting, where the unorganised share is high in B2B. We believe the opportunity is more in the replacement market on account of the shift from CFL to LED.

V-Guard is most likely to get impacted in the near term given ~45% revenue comes from Kerala, where near-term demand disruption from the demonetisation is the highest. Co-operative banks which dominate Kerala’s banking system are facing RBI restrictions in exchanging currency notes given they do not have records on core banking system (https://goo.gl/QCSbn1). Moreover, there could be significant job losses given a large proportion of jobs are in real estate and jewellery.


Revenue decline in 2HFY17 vs our estimate of 3% growth is a risk. The feedback from the channel across India is divergent. Whilst the channel partners in West are seeing only marginal deceleration in growth, those in the North are facing a decline.


CMP Rating TP MCap P/E (X) P/B (X) RoE (%) CAGR over

FY16-19

(Rs) (Rs) (US$ mn) FY17 FY18 FY19 FY17 FY18 FY19 FY16 FY17 FY18 FY19 Revenue EPS

Havells 317 BUY 454 2,955 34.9 29.9 24.0 6.8 6.1 5.6 20.4 20.4 21.5 24.3 12.1 17.4

V-Guard 168 SELL 145 752 32.6 28.6 23.2 8.6 7.1 5.9 26.4 29.2 27.3 27.7 14.2 24.4

Bajaj (consumer) 231 BUY 312 347 25.2 19.2 13.2 NA NA NA 36.7 31.0 38.6 57.3 6.5 17.7

Finolex (core) 390 BUY 465 890 15.5 13.6 12.9 3.9 3.3 2.9 28.9 28.0 26.3 23.6 13.0 10.9

Crompton 150 SELL 119 1,403 32.7 28.5 24.2 18.2 14.4 11.9 106.0 77.2 56.5 53.9 12.3 15.8

Average 25.5 21.8 17.8 7.3 6.1 5.2 35.7 31.7 29.5 32.3 11.6 18.2

Source: Ambit Capital research, Note – prices as on 22 November 2016; Note – Valuation is as on 10 November 2016, Note – we calculate P/E of consumer business by assuming that E&P business trades at our fair value of `90/share (implied FY18 P/E of10.3x) and the net debt is valued at FY16 book value at –`66/share

https://goo.gl/QCSbn1).

Strategy


NBFCs Bumpy ride ahead Demonetisation spells slowdown in growth and increase in NPAs for NBFCs both in the near term and the long term. Segments with high cash collections (auto loans, microfinance) would be hit the most in the near term. Housing finance companies are vulnerable over the longer term due to multiple structural headwinds to: (i) growth, owing to ticket sizes, weak consumer sentiment in primary market; and (ii) worsening asset quality in segments like developer loans, LAP and under-construction home loans. Moreover, growth for NBFCs in the discretionary and prime auto loan segments is also likely to slow down in the near term given weak consumer sentiment and as well as structurally due to market share loss to banks. Declining funding costs due to lower interest rates would offer only offer marginal respite to profitability. We will have to significantly decrease our earnings estimates for FY17/18 and TPs for stocks under coverage.

Exhibit 30: Impact of demonetisation across product segments 2HFY17 FY18 Structural

HFCs

Growth Outlook

Investors and end-users would avoid buying homes due to lack of cash as most transactions involved cash payment. Hence, growth will get impacted.

Wealth erosion coupled with anticipation of further decline in real estate prices would lead to people postponing their home buying decisions. Decline in real estate prices would decrease ticket sizes of home loans, impacting loan growth.

Decline in real estate prices would lead to average home loan ticket sizes coming down, implying growth rates in the sector will structurally decline.

NIMs NIM expansion due to fall in borrowing costs.

NIM expansion should be limited as the bank lending rates fall with a lag in the segment.

NIMs for HFCs will face structural pressures due to increasing competitive intensity.

Asset Quality

Working capital disruption in the informal economy would lead to lower collections in self-employed home loans. Salaried segment is relatively immune.

Asset quality in developer loans would worsen due to slowing offtake, disruption in working capital and wealth erosion. Asset quality in self-employed home loans should get impacted by erosion of wealth and income of this segment.

Home loans against under-construction projects could see asset quality pressures due to delayed competition.

Industry structure

No changes in industry structure in the short term.

Core segment of HFCs/NBFCs, the self-employed segment, would see continued stress and underperform on growth and asset quality compared to other segments.

HFCs that source most of their loans from developers should see structural pressure on growth as buyers prefer the secondary market due to steeper correction in prices.

Auto-NBFCs

Growth Outlook

Wealth erosion and working capital disruption have led to slowdown in sales and, hence, financing demand.

Wealth erosion should hit demand for discretionary loans (cars and UVs). Lower GDP growth and economic activity should lead to lower demand for CVs and tractors as well.

With unorganised players (major customers of NBFCs) in commercial vehicle industry being at a disadvantage post GST, growth could structurally come down for NBFCs.

NIMs NIMs should expand owing to fixed rate assets and fall in funding costs.

Declining rates and fixed rate asset book means that NIMs should expand. However, migration to 90dpd NPA norms and increase in NPAs could offset the gains from lower funding costs.

With more NBFC customers becoming part of the banking system, there should be some erosion in NIMs for NBFCs.

Asset Quality

Working capital disruption in the informal economy would lead to cash flow pressures and deteriorating collections in auto loans. Hence, NPAs should rise in the sector.

Asset quality pain would sustain in car and UV loans due to wealth erosion in self- employed segment. Lower economic growth and secondary impact of slowdown in certain sectors (e.g. construction) means that delinquencies should increase in CVs and tractors as well.

No structural pressure on asset quality as most recognition should happen in FY18 itself.

Industry structure


Core segment of NBFCs, the self-employed segment, would see continued stress and underperform on growth and asset quality compared to other segments.

NBFCs would continue to lose market share to banks in prime segments like CV/car/UV loans due to better access to data.

NEGATIVE Research Analysts

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

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

Strategy



SME Financers

Growth Outlook

Disruption in economic activity means that demand for such loans should come down in the near term.

Declining real estate prices will lower the eligible loan amount (declining collateral values), leading to lower growth in the segment.

More tax compliance from SMEs means that they should be eligible for bank loans, impacting growth of NBFCs.

NIMs NIM expansion due to fall in borrowing costs.

NIM improvement should continue due to cost of funding further falling, but competitive intensity would decline due to risk averseness by the lenders.

Margins are likely to be under pressure in SME loans (both LAP and unsecured) as it becomes easier for banks to assess these borrowers due to better tax compliance.

Asset quality

High exposure to informal segment has worsened collections in LAP and unsecured loans. This is due to a combination of wealth erosion and disruption of working capital.

Lower collateral values, higher LTVs and disruption in working capital mean that delinquencies will continue to increase.

Declining collateral values imply that haircuts on liquidation recovery will be higher. Moreover, abrupt end to refinancing could reveal the mounting stress in LAP and unsecured loans.

Industry structure


NBFCs are likely to grow slower than banks as they go slow on their riskier exposures.

Banks would gain market share in LAP and unsecured loans from banks as borrower cash flows become more accessible.

MFIs

Growth Outlook

Most of the disbursements of MFIs happen in cash. Growth is at a standstill with cash crunch impacting disbursements.

Subdued informal economy due to working capital disruption means growth recovery will be gradual.

Higher welfare support and economic stimulus could drive growth recovery over the longer term.

NIMs High delinquencies could lead to interest income write-backs over 2HFY17, leading to NIM pressure.

High delinquencies could lead to increased risk perception for the sector from lenders, putting pressure on NIMs.

If asset quality worsens in the sector, NIMs could structurally decline due to lower securitisation.

Asset quality

Asset quality will take a meaningful hit in microfinance loans due to inability of lenders to lend new money and collect old currency.

A prolonged disruption in the operations of MFIs could meaningfully impact asset quality, raising the probability of large-scale defaults.

No structural impact as most NPAs, if any, would surface in FY18 itself.

Industry structure

Aggressive lenders could witness high defaults and deep disruptions questioning their survival.

Under-stress customer segment may lead to consolidation among struggling MFIs or portfolio buyouts by banks or larger MFIs.

There is opportunity to take market share from informal money lenders as they get impacted by the demonetisation.


Our channel checks

Rural cash flows are stretched due to: i) inability of farmers to sell their harvest in the market; ii) contracting work has come to a standstill; and iii) new currency notes are taking a longer time to reach rural India.

Disruption in the working capital of the informal economy brought collections to a standstill in segments that are closely linked to the informal economy (e.g. auto loans and microfinance).

Both retail and wholesale traders are cash- strapped and instance of cheques bouncing have increased in LAP/SME loans.


NBFCs/HFCs can’t accept old currency, so they are directing their customers to a bank branch and asking them to deposit the old currency in the account of the NBFCs.

NBFCs/HFCs are trying to convince regulators to allow them to accept old currency but it looks unlikely that the RBI will cede.

Lenders are now more cautious in disbursing new loans with only declared income being considered for loan eligibility rather than the earlier practise of taking estimated income for loan eligibility.


2HFY17: Weak consumer sentiment, disruption in cash flows of the informal economy and wealth erosion have hit loan growth in auto loans, home loans, microfinance and SME loans. Moreover, growth in MFIs has come to a standstill due to the inability to disburse owing to a shortage of cash.

Strategy


FY18: Growth should remain under pressure in FY18 as well across product segments. Wealth erosion and decrease in home loan prices should lead to weak growth in the segment. Auto loans could also struggle to report a pick-up in growth as demand for discretionary items like cars and UVs would remain muted due to wealth erosion. Moreover, declining real estate prices will lower the eligible loan amount (declining collateral values) and increase probability of default (increase in LTVs). Consequently, we expect lenders to be averse in this segment and go slow on growth. With lower GDP growth and economic activity, demand for trucks/tractors would be muted too.

Beyond FY18: Growth could structurally slow down for segments closely linked to real estate for a prolonged time (home loans, developer loans and SME loans). Growth in home loans could moderate as declining real estate prices further decelerate ticket-size growth for lenders. Growth in LAP and unsecured loans could also come off structurally due to declining loan eligibility (due to lower collateral values and cash flows) and market share loss to banks due to improving ability to appraise SME loans (due to higher transparency owing to better tax compliance).


2HFY17: We do not anticipate any change in industry structure immediately as both banks and NBFCs struggle to grow and are fire-fighting on the asset quality front. However, MFIs could see their existence being questioned due to high defaults.

FY18: Wealth erosion and disruption in working capital will disproportionately impact the core lending constituency of NBFCs – the self-employed segment. Consequently NBFCs are likely to underperform on growth and asset quality across the retail segments (home loans, SME loans and auto-loans) versus banks.

Beyond FY18: The improving tax compliance of the self-employed segment would make cash flows more transparent and, thus, banks would find it easier to appraise such customers. Consequently, banks could gain further market share in prime segments in home loans, larger-ticket LAP/SME loans and new CV/car loans. Also, in home loans, HFCs that were hitherto growing robustly by virtue of builder tie-ups (e.g. LIC Housing Finance) could see a structural slowdown in growth as buyers will prefer buying homes from the secondary market due to a steeper price correction (black money component is higher in the value of resale property). However, NBFCs could still hold their turf in certain sub-prime segments like smaller-ticket LAP/SME loans (lower collateral quality), used CV/used car loans (difficulties in collateral valuation and high cost origination). In microfinance, whilst there is opportunity to take market share from informal money lenders, competition from banks/NBFCs would intensify further.


The entire NBFC spectrum would be impacted in the near term as well as in FY18; we do not see a single winner amongst NBFCs led by the demonetisation. That said, lenders closely linked to structurally impacted sectors like real estate (HFCs, SME lenders) could lose more than others. Moreover, improving tax compliance of the self-employed segment would make their cash flows more transparent, resulting in market share gains for banks across the prime segments of home loans, larger-ticket LAP/SME loans and new CV/car loans. So, we would be wary of HFCs and SME lenders with heavy concentration in real estate in the form of collateral (developer loans, e,g. HDFC; LAP, e.g. BAF; and home loans, e.g. LICHF, in that order). Moreover, we would also avoid lenders with high exposure to discretionary and prime segments in auto loans as they would continue to witness slowdown in growth due to weak sentiment and market share loss to banks. That said, lenders with high exposure to segments with high entry barriers like used CVs/cars (e.g. CIFC and SHTF) should see more moderate structural pressure and their growth and asset quality could improve beyond FY18.

Strategy


Declining real estate prices will have prolonged impact on growth and asset quality

Declining real estate prices will impact both the asset quality and growth of HFCs. Growth would be impacted as ticket-size growth for lenders would decline going forward (which used to contribute to 50-60% of growth in home loans over a decade). Moreover, asset quality will come pressure structurally as delay in project completion would increase asset quality risks in under-construction properties lent at very high LTVs for HFCs (as high as ~60% of home loans for certain HFCs). Moreover, in LAP, borrowers’ ability and willingness to service the loan will come down as: i) pressures on the informal economy will spill over to the self-employed segment; ii) declining refinancing due to lower property rates; and ii) with lower skin in the game due to higher LTVs, the borrower may be better off defaulting on the loan.

Growth slowdown for NBFCs in discretionary and prime auto-loans segments

Demonetisation has severely hit large-ticket consumption in the rural economy due to wealth erosion and weakening of sentiment. This would meaningfully slow down purchases of cars/UVs etc. in the rural areas. Moreover, better data transparency would also result in easier appraisal of borrower cash flows and could trigger market share gains in a segment where origination for banks is not difficult (e.g. car/UV/new CV loans). Consequently, growth for NBFCs is likely to be weaker in discretionary and prime auto-loan segments. This would particularly impact MMFS as ~55% of its book is exposed to such products.


A stronger-than-expected economic stimulus (e.g. increased infra spend and construction activity) could lead to faster-than-anticipated pickup in financing in CVs, tractors and CEs.

Moreover, regulatory forbearance in asset classes that will struggle in the near term (e.g. allowing cash collections of illegal tender) could alleviate NBFCs’ expected near-term pain and can surprise positively at least on the asset quality front. Moreover, in home loans, rapid customer growth to take advantage of a steep decline in prices could surprise us in terms of growth of home loans.

Strategy


Exhibit 31: Relative valuation snapshot



Housing Finance Companies

HDFC Ltd. 28.3 1,222 5.1 4.6 25.3 22.5 14% 2.5% 2.4% 21.4% 21.3%

LIC Housing Finance 3.7 501 2.4 2.1 13.3 12.5 10% 1.5% 1.4% 19.2% 17.7%

Indiabulls Housing Finance 4.0 653 2.3 2.1 10.2 8.6 17% 3.4% 3.3% 24.0% 25.8%

Gruh Finance 1.5 287 10.4 8.4 35.8 29.2 21% 2.3% 2.3% 31.7% 31.9%

Dewan Housing Finance 1.0 220 1.2 1.0 7.3 6.0 19% 1.2% 1.3% 16.8% 17.5%

Repco Home Finance 0.5 573 3.3 2.7 19.6 15.6 24% 2.1% 2.1% 17.7% 19.2%

Can Fin Homes 0.6 1,523 3.8 3.1 18.6 14.5 36% 1.8% 1.8% 22.3% 23.8%

Average 4.1 3.4 18.6 15.6 20% 2.11% 2.1% 21.9% 22.4%

Asset Financers Shriram Transport 2.8 829 1.6 1.4 11.0 8.7 36% 2.2% 2.4% 15.6% 17.3%

M&M Finance 2.2 265 2.1 1.9 17.2 13.1 22% 1.9% 2.2% 11.9% 14.3%

Magma Fincorp 0.3 96 1.0 0.8 8.8 6.5 28% 1.4% 1.7% 11.2% 13.7%

Sundaram Finance 2.0 1,227 3.7 3.3 26.6 23.2 11% 2.6% 2.7% 14.5% 14.9%

Cholamandalam 2.3 984 3.6 3.0 20.1 15.5 30% 2.3% 2.4% 19.3% 20.9%

Average 2.4 2.1 16.8 13.4 26% 2.1% 2.3% 14.5% 16.2%

Consumer finance Bajaj Finance 6.6 832 5.0 4.2 26.9 22.1 25% 3.3% 3.0% 20.5% 20.6%

Shriram City Union Finance 1.8 1,848 2.2 2.0 17.5 14.0 28% 3.2% 3.2% 14.4% 15.9%

Manappuram 0.9 70 1.9 1.6 10.0 7.8 62% 4.3% 4.6% 18.8% 21.7%

Muthoot Finance 1.7 289 1.8 1.6 10.7 9.2 30% 3.9% 3.8% 17.7% 18.2%

Bharat Financial Inclusion (SKS) 1.4 675 3.3 2.6 13.7 12.3 52% 6.3% 5.1% 30.2% 23.0%

Capital First 0.7 488 2.3 2.0 19.3 14.2 38% 1.4% 1.6% 12.6% 15.2%

Average 2.8 2.3 16.4 13.3 39% 3.73% 3.5% 19.0% 19.1%

Broker/NBFCs Motilal Oswal 0.9 447 3.9 3.3 22.0 16.4 50% 10.7% 14.6% 18.9% 21.7%

Edelweiss 1.1 88 1.8 1.5 13.3 10.5 29% 1.5% 1.5% 15.4% 16.9%

India Infoline 1.1 244 1.8 1.5 11.3 10.4 16% 3.2% 3.1% 21.2% 19.0%

Average 2.5 2.1 15.5 12.4 32% 5.10% 6.4% 18.5% 19.2%

Source: Bloomberg, Ambit Capital research; Note: We have used Bloomberg estimates for companies not under our coverage

Strategy


Technology No material impact of demonetisation Our coverage universe has no exposure to the informal economy, either in terms of customers, competitors or intermediaries. So there is no business impact of demonetisation in the short term or the long term. Even if small Indian firms shift to the formal economy and start spending on IT (e.g. ERP implementation), our coverage universe would not cater to this spend as they work only for large companies (revenue >US$1bn). However, our coverage universe could see a small dip in interest income due to reducing yields. We estimate 1% reduction in yield to hurt reported EPS by 0.1-2.3% in 2HFY17 and 0.2-2.7% in FY18, with Persistent Systems (SELL) being the most affected and Mindtree (SELL) the least. However, this would not impact our DCF-based target prices. TCS (best-in-class, attractive 15x FY18E P/E) and TechM (improvement in telecom revenue growth and profitability; attractive 12x FY18E P/E) remain our top BUYs.

Exhibit 32: No material impact on Indian IT service companies in short term or in long term


IT services

Demand outlook – No change. Supply chain change – No change. Industry structure – No change.

Demand outlook – No change. Supply chain change – No change. Industry structure – No change.

Demand outlook – No change as Indian IT firms will not cater to small Indian enterprises, even if they increase IT spend. Supply chain change – No change as hiring requirements are already reducing and the supply of graduate engineers remains very high. Industry structure – no change.


The companies in our coverage universe have a significant part of their total assets (7-43%) parked in the form of cash and current investments. We expect 100bps decline in cash yields on the back of demonetisation driven liquidity in the Indian banking system. Accordingly, we reckon 0.1-6% decline in EPS in our coverage companies for 2HFY17 and 0.2-6.1% decline in EPS over FY18. However, our target prices remain the same as we use a DCF-based methodology.

Exhibit 33: Sensitivity of our coverage universe EPS to 100bps decline in cash yields

Current EPS New EPS Change (%)

2HFY17 FY18 2HFY17 FY18 2HFY17 FY18

TCS 66.7 144.2 65.9 142.0 -1.2% -1.5%

Infosys 30.1 64.4 29.6 63.3 -1.7% -1.8%

Wipro 17.4 34.8 17.0 34.1 -2.3% -2.0%

HCLT 28.0 62.2 27.7 61.4 -1.3% -1.3%

TechM 17.8 37.4 17.8 37.4 -0.1% -0.2%

Mindtree 16.2 32.7 16.1 32.3 -0.8% -1.0%

LTI 26.2 56.2 25.6 54.8 -2.0% -2.6%

Persistent 19.8 43.7 19.4 42.5 -2.1% -2.7%

eClerx 44.1 99.6 43.4 98.4 -1.6% -1.3%

Source: Ambit Capital research, company

NEUTRAL Key Recommendations TCS BUY

Tech M BUY

Wipro SELL

Research Analysts

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

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



Strategy


Telecom Demonetisation not an issue Telcos’ consumer spends are unaffected given low-ticket spends. Channel checks indicate that the temporary disruptions in the supply chain are being tided over as telcos provided temporary credit. Towercos earning B2B income from telcos also remain unaffected by demonetisation. Despite high leverage, telcos are unlikely to benefit from reducing interest (over 2HFY17/FY18) as bulk of their debt comprises flexible borrowings from the government for spectrum payments at fixed rates (9.5-10% per annum). With net cash balance of Rs50bn (7% of Infratel’s market cap), 1% reduction in yield will hurt reported EPS by 1% and 2% in 2HFY17 and FY18. Our negative stance on the telecom sector and DCF-based target prices remain unchanged.

Exhibit 34: Summary


Telcos

Demand outlook No change No change No change

Supply chain changes No change No change Increased online recharges will result in reduced trade commissions

Industry structure No change No change No change

Towercos

Demand outlook No change No change No change

Supply chain changes No change as spends on power and fuel happen through vendors who use cash for diesel purchases

No change No change

Industry structure No change No change No change


Exhibit 35: Valuation summary

Company M-Cap (US$ mn) Stance

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

FY17E FY18E FY19E FY17E FY18E FY19E Sales EBITDA EPS FY17E FY18E FY19E

Bharti Airtel 17,978 SELL 21.3 24.8 18.8 8.2 6.8 8.5 5.4 7.9 1.1 6.1 5.6 5.3

Bharti Infratel 10,179 SELL 25.5 22.6 19.4 14.9 16.7 19.4 11.4 12.6 14.1 10.8 9.3 8.1

Idea Cellular 3,843 SELL 51.3 (96.2) 21.7 1.9 (1.0) 4.5 6.6 (8.3) NM 5.2 5.6 4.5


NEGATIVE Key Recommendations Idea Cellular SELL

Bharti Airtel SELL

Research Analysts

Vivekanand Subbaraman, CFA Tel: +91 22 3043 3261 [email protected]


Strategy


Utilities Power demand to improve In the near term, power demand will decelerate due to slowdown in industrial activity caused by demonetisation (GDP growth likely to decelerate from 6.4% in 1HFY17 vs 0.5% in 2HFY17). However, in the long run, power demand would accelerate with the increase in mechanisation led by increase in market share of organised players. Discoms are beneficiaries of demonetisation as: (a) in the near term their working capital cycle would improve as customers line up to pay pending utility bill through old currency notes; (b) in the long run, AT&C losses would decline with the shift in the economy from unorganized (highest contributors to power theft) to organised. Prefer Torrent Power given presence in distribution business as it benefits from decline in AT&C losses in its Agra/Bhiwandi distribution franchise. Avoid JSW Energy as weak power demand would impact merchant tariff.

Exhibit 36: Impact of demonetisation on Utilities 2HFY17 FY18 Structural

Power generation Power demand growth to decelerate by 250-400bps given slowdown in industrial activity (41% of power consumption).

Power demand growth to improve from 2HFY18 led by higher demand from discoms (stronger balance sheet)

Power demand growth would accelerate with shift in economy to organised (higher mechanisation)

Power distribution

Discoms’ balance sheets can improve as a lot of customers are lining up to make pending payments; old currency notes are valid for making utility bill payments up to 24 November

T&D capex can accelerate with improvement in discom balance sheets

AT&C losses would decline substantially with the shift from unorganised (high proportion of power theft) to organised



2HFY17: Power demand growth would decelerate by 250-400bps led by the slowdown in industrial activity; industries account for 41% of total power consumption. However, discoms’ working capital cycles would improve given customers are making advance payments because discoms will accept old currency until 24 November.

FY18: Power demand growth should improve from 2HFY18 led by higher demand from discoms, which until recently were cash strapped.

Beyond FY18: Power demand growth would accelerate with a shift in the economy towards organised players as they deploy higher capital on mechanised manufacturing than unorganised players.


The health of SEBs would improve led by a reduction in AT&C losses; unorganised players, which are likely to lose market share, are the key contributors to power theft. Also, average realisation would improve as organised players pay higher power tariffs (Rs6-15/unit).


We prefer power utilities with presence in the distribution business as AT&C losses would now decline at an accelerated pace. Within our coverage, Torrent Power would be the biggest beneficiary of the reduction in AT&C losses as its profitability in Agra and Bhiwandi circle (due for renewal in Jan’17) is directly linked to the decline in AT&C losses. Tata Power is unlikely to benefit from the reduction in AT&C losses given the regulated model in Mumbai and Delhi distribution.

Avoid merchant players such as JSW Energy given the weakness in the merchant market would intensify with slowdown in industrial activity. Also, the price of imported coal has surged by ~40% since July’16.

POSITIVE Key Recommendations Torrent Power BUY

Tata Power BUY

NTPC SELL

Research Analysts





Strategy


We also caution investors from buying NTPC (assured RoE) as a proxy to bond investments given the regulator would trim NTPC’s regulated RoE in its 2019 tariff regulation at least equivalent to the cut in ten-year G-sec yield (down 250bps since the announcement of the last tariff regulation).


Company CMP Mcap (US$mn)

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

FY17 FY18 FY17 FY18 FY16 FY17 FY18 Revenue EPS

CESC 575 1,114 1.2 1.0 11.7 7.8 5.9 9.7 12.8 9.9 NA

KSK 167 1,174 NA NA 15.8 NA 14.3 6.6 NA NA NA

JSPL 54 1,302 1.0 0.9 8.6 7.1 15.6 11.4 12.6 3.5 0.5

Lanco 4 141 NA NA NA NA NA 81.9 43.6 37.2 9.5

NHPC 25 4,112 0.9 0.8 10.0 9.0 8.2 8.9 9.6 8.2 (8.7)

Adani Power 24 1,199 1.1 1.1 NA NA (18.9) 0.2 7.8 4.2 NA

Torrent Power 167 80 1.0 0.9 12.9 10.8 12.4 7.9 8.7 (9.6) (7.7)

JSW Energy 54 89 1.0 0.9 8.5 6.7 16.1 11.7 13.7 (0.6) 0.9

Tata Power 69 187 1.2 1.0 12.5 7.4 8.8 10.3 14.8 4.1 47.9

NTPC 154 1,270 1.3 1.2 13.8 11.2 14.8 10.0 11.4 15.8 (5.1)

Sector median 1.1 1.0 11.7 7.6 8.8 9.3 12.6 4.2 0.7

Divergence 26% 28% 18% 48% 600bps 70bps -120bps 1160bps -580bps

Source: Bloomberg, Ambit Capital research, Note – prices as on 22 November 2016

Strategy


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected] Pramod Gubbi, CFA Head of Equities (022) 30433124 [email protected]

Research Analysts

Name Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected] Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected] Abhishek Ranganathan, CFA Retail (022) 30433085 [email protected] Anuj Bansal Mid-caps (022) 30433122 [email protected] Aditi Singh Economy / Strategy (022) 30433284 [email protected] Ashvin Shetty, CFA Automobile (022) 30433285 [email protected] Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected] Deepesh Agarwal, CFA Power Utilities / Capital Goods (022) 30433275 [email protected] Dhiraj Mistry, CFA Consumer (022) 30433264 [email protected] Gaurav Khandelwal, CFA Automobile (022) 30433132 [email protected] Girisha Saraf Mid-caps / Small-caps (022) 30433211 [email protected] Karan Khanna, CFA Strategy (022) 30433251 [email protected] Mayank Porwal Retail (022) 30433214 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected] Paresh Dave, CFA Healthcare (022) 30433212 [email protected] Parita Ashar, CFA Metals & Mining / Aviation (022) 30433223 [email protected] Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 [email protected] Rahil Shah Banking / Financial Services (022) 30433217 [email protected] Rakshit Ranjan, CFA Consumer (022) 30433201 [email protected] Ravi Singh Banking / Financial Services (022) 30433181 [email protected] Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 [email protected] Ritesh Vaidya, CFA Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected] Ritu Modi Automobile (022) 30433292 [email protected] Sagar Rastogi Technology (022) 30433291 [email protected] Sudheer Guntupalli Technology (022) 30433203 [email protected] Sumit Shekhar Economy / Strategy (022) 30433229 [email protected] Utsav Mehta, CFA E&C / Industrials (022) 30433209 [email protected] Vivekanand Subbaraman, CFA Media (022) 30433261 [email protected]

Sales

Name Regions Desk-Phone E-mail

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

Singapore

Praveena Pattabiraman Singapore +65 6536 0481 [email protected] Shashank Abhisheik Singapore +65 6536 1935 [email protected]

USA / Canada

Ravilochan Pola – CEO Americas +1(646) 793 6001 [email protected] Hitakshi Mehra Americas +1(646) 793 6002 [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] Richard Mugutmal Editor (022) 30433273 [email protected] Nikhil Pillai Database (022) 30433265 [email protected]


















































Strategy


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 written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities is available on request.

Disclaimer

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16. As of the publication of this report Enclave Capital LLC, does not make a market in the subject securities. 17. This document does not constitute an offer of, or an invitation by or on behalf of Ambit Capital or its affiliates or any other company to any person, to buy or sell any security. The information

contained herein has been obtained from published information and other sources, which Ambit Capital or its Affiliates consider to be reliable. None of Ambit Capital accepts any liability or responsibility 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 ability 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 securities. 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 Securities and Futures Act (CAP 289) and Paragraph 11 of the First 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 institutional investor, such Singapore Person must immediately discontinue any use of this Report and inform Ambit Singapore Pte. Limited.

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Additional Disclaimer for UK Persons

26. All of the recommendations and views about the securities and companies in this report accurately reflect the personal views of the research analyst named on the cover. No part of this research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in this research report. This report may not be reproduced, redistributed or copied in whole or in part for any purpose.

27. This report is a marketing communication and has been prepared by Ambit Capital Pvt Ltd of Mumbai, India (“Ambit”) and has been approved in the UK by Ambit Capital (UK) Limited (“ACUK”) solely for the purposes of section 21 of the Financial Services and Markets Act 2000. Ambit is regulated by the Securities and Exchange Board of India and is registered as a Research Entity under the SEBI (Research Analysts) Regulations, 2014. ACUK is regulated by the UK Financial Services Authority and has registered office at C/o Panmure Gordon & Co PL, One New Change, London, EC4M9AF.

28. In the UK, this report is directed at and is for distribution only to persons who (i) fall within Article 19(1) (persons who have professional experience in matters relating to investments) or Article 49(2)(a) to (d) (high net worth companies, unincorporated associations etc) of the Financial Services and Markets Act 2000 (Financial Promotions) Order 2005 (as amended) or (ii) are professional customers or eligible counterparties of ACUK (all such persons together being referred to as "relevant persons"). This report must not be acted on or relied upon by persons in the UK who are not relevant persons.

29. Neither Ambit nor ACUK is a US registered broker-dealer. Transactions undertaken in the US in any security mentioned herein must be effected through a US-registered broker-dealer, in conformity with SEC Rule 15a-6.

30. Neither this report nor any copy or part thereof may be distributed in any other jurisdictions where its distribution may be restricted by law and persons into whose possession this report comes should inform themselves about, and observe, any such restrictions. Distribution of this report in any such other jurisdictions may constitute a violation of UK or US securities laws, or the law of any such other jurisdictions.

31. This report does not constitute an offer or solicitation to buy or sell any securities referred to herein. It should not be so construed, nor should it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. The information in this report, or on which this report is based, has been obtained from publicly available sources that Ambit believes to be reliable and accurate. However, it has not been prepared in accordance with legal requirements designed to promote the independence of investment research. It has also not been independently verified and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties.

32. The information or opinions are provided as at the date of this report and are subject to change without notice. The information and opinions provided in this report take no account of the investors’ individual circumstances and should not be taken as specific advice on the merits of any investment decision. Investors should consider this report as only a single factor in making any investment decisions. Further information is available upon request. No member or employee of Ambit or ACUK accepts any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of this report or its contents.

33. The value of any investment made at your discretion based on this Report, or income therefrom, maybe affected by changes in economic, financial and/or political factors and may go down as well as go up and you may not get back the original amount invested. Some securities and/or investments involve substantial risk and are not suitable for all investors.

34. Ambit and its affiliates and their respective officers directors and employees may hold positions in any securities mentioned in this Report (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). Ambit and ACUK may from time to time render advisory and other services to companies referred to in this Report and may receive compensation for the same.

35. Ambit and its affiliates may act as a market maker or risk arbitrator or liquidity provider or may have assumed an underwriting commitment in the securities of companies discussed in this Report (or in related investments) or may sell them or buy them from clients on a principal to principal basis or may be involved in proprietary trading and may also perform or seek to perform investment banking or underwriting services for or relating to those companies.

36. Ambit and ACUK may sell or buy any securities or make any investment which may be contrary to or inconsistent with this Report and are not subject to any prohibition on dealing. By accepting this report you agree to be bound by the foregoing limitations. In the normal course of Ambit and its affiliates’ business, circumstances may arise that could result in the interests of Ambit conflicting with the interests of clients or one client’s interests conflicting with the interest of another client. Ambit makes best efforts to ensure that conflicts are identified, managed and clients’ interests are protected. However, clients/potential clients of Ambit should be aware of these possible conflicts of interests and should make informed decisions in relation to Ambit services.

Disclosures

37. The analyst (s) has/have not served as an officer, director or employee of the subject company. 38. There is no material disciplinary action that has been taken by any regulatory authority impacting equity research analysis activities. 39. All market data included in this report are dated as at the previous stock market closing day from the date of this report. 40. Ambit and/or its associates have actual/beneficial ownership of 1% or more in the securities of DCB Bank Limited. Ambit and/or its associates have received compensation for investment

banking/merchant banking/brokering services from DCB Bank Ltd, IDFC Ltd, Magma Fincorp, Dishman Pharmaceuticals & Chemicals Ltd, Hathway Cable & Datacom Ltd and Siti Cable Network Ltd in the past 12 months.

Analyst Certification Each of the analysts identified in this report certifies, with respect to the companies or securities 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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