Asit C Mehta: Buy Transport Corporation of India

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Asit C Mehta: Buy Transport Corporation of India 


We initiate coverage on Transport Corporation of India (TCI) with a “BUY”
recommendation with target price of ` 135. We are valuing the stock at 13.5x FY12E
EPS of ` 10. An increasing contribution from high margin businesses like express
delivery solutions (XPS) and supply chain solutions (SCS), improving volumes from
the automobile industry with continual and sustainable margin expansion, we believe
TCI will register a growth of 17.9% and 29.5% CAGR in topline and bottomline,
respectively, during FY10-FY12E.

Investment Rationale
●● Largest integrated logistics service provider
TCI is the largest integrated player, having 15% market share of the organized
logistics industry. Over the years, TCI has built a strong infrastructure network.
It has a branch network of over 1,200 company-owned offices. It operates
approximately 7,000 trucks on a daily basis, of which 1,200 are owned trucks
and 1,000 attached trucks and trailers. Apart from transportation, the company
has one of the largest warehousing space of about 8.5 mn sq ft. It also has a fleet
of six ships with a total capacity of 16000 DWT.
●● Timely freight revision
TCI operates 65-70% of the business on contractual basis with a fuel cost escalation
clause, where the fuel price hike is passed on immediately to the customers. The
balance portion that is exposed to spot freight rates is further transferred with a
lag effect of 1.5 – 2 months. Therefore, owing to timely freight revision, TCI’s
exposure to fuel price hikes is minimal.
●● Major beneficiary of introduction of GST
Road transportation is a costlier mode of transportation when compared to rail,
seaways or pipelines. Introduction of GST will eliminate multiple taxes presently
charged while carrying goods by road, thereby reducing the overall transportation
cost, making road freight rates more viable. Since GST is expected to standardize
rates across the nation, considerable consolidation is expected in the warehousing
segment, as companies would be able to manage bigger warehouses at few strategic
locations. TCI being a largest integrated logistics service provider, we believe the
company to be a major beneficiary
●● Expansion to trigger growth
TCI is on course to invest ~ ` 1,600 million in FY11E of which it has already
invested ~ ` 460 million in H1FY11. The planned capital expenditure (capex)
would be utilized for acquisition of trucks and containers (~ ` 655 million), ship
(~ ` 500 million), warehouses (~ ` 250 million) and upgrading IT infrastructure
(~ ` 195 million).

Valuation
At the current price of ` 111, the stock is trading at 13.9x its FY11E EPS of ` 8 and
11.1x its FY12E EPS of ` 10. We value the core standalone business at 13.5x FY12E
EPS to arrive at our target price of ` 135. Considering the recent price correction,
we recommend a “BUY” rating on the stock.


Industry Overview
Fragmented market structure
Structure of the road freight transport industry in India is highly fragmented.
The industry broadly consists of players who provide the transportation services,
intermediaries (transport contractors / booking agents) who offer haulage services,
brokers supplying equipment, drivers for commission and the consignors constituting
the ultimate demand for the services.
Road transport operators provide point-to-point transportation. These operators are
classified into small fleet operators (SFOs), medium fleet operators (MFOs) and large
fleet operators (LFOs). Over the years, LFOs have witnessed a gradual increase in the
pie of vehicle ownership, while SFOs have been steadily losing share. Further, during
the slowdown, several SFOs exited the industry, owing to hardening interest rates and
reduced freight availability. It was quite difficult for SFOs to bear the capital costs of
their assets. Unlike SFOs, LFOs have their presence in other logistics businesses like
warehousing, supply chain solutions, cold chains etc. LFOs generally have a multiregional
network or a pan-India network, supported by adequate infrastructure. TCI
is a LFO with pan-India presence operating over 7,000 trucks per day.


Indian national companies are quite skeptical to outsource their logistics operations
owing to safety and security concerns. The complex tax structure prevailing in
India also induces corporates to invest in small warehouses all over the country,
thus handling their logistics operations themselves. Therefore, 46% of the logistics
operations in India are handled by the Corporates themselves through their in-house
logistics department. Unorganized players dominate the balance 54% outsourced
arena. TCI the largest road transport player has ~15% share in the organized logistics
industry i.e. ~8% share in the total outsourced logistics. Undersized market share of
the industry leader demonstrates the extremely fragmented nature of the industry


Trend in road freight rates
Road freight rates are primarily determined on the basis of demand-supply scenario
prevalent at any time in the country. This in turn is driven by economic activity,
existing truck capacities on road and cost factors like diesel prices, which is the prime
input cost for truck operators. Substitutes and industry structure also play a key role
in determining freight rates, in addition to regulations. Road transport attracts the
highest freight rates followed by rail, pipelines and waterways.


Fuel costs typically constitutes more than 50% of the total operating costs of the
transport operator. Hence, any increase in diesel prices may affect their operating
margins. Typically, transport operators pass on the hike in fuel cost to their customers
with a lag effect of ~1.5 – 2 months. However, transport operators are able to pass on
the increase in cost in the form of higher freight rates only in a scenario of good freight
availability. Therefore, most of the LFOs in the industry have contractual agreements
with clients that cushion them from severe fluctuations in freight availability. Almost
all contractual arrangements have an escalation clause, clearly stating that for any
increase in fuel price, the freight rate shall automatically increase to the same extent
or for fuel hikes at X %, freight shall increase automatically at Y %, with effect from
the date of the fuel hike.
However, it should be noted that the costs of delay and uncertainty in transportation,
increases the effective cost to the users significantly. Thus, there exists tremendous
potential for reduction in indirect costs associated with inefficiencies caused by
infrastructure and regulations.

Infrastructure and Regulations
India has the third largest road network in the world stretching 3.32 million kilometer
in length. As per World Bank, national highways aggregating a length of close to
70,748 km, constitutes a mere 2 % of the road network but carries about 40 % of
the total road traffic in India. On the other hand, state roads and major district roads
carry another 40 % of traffic and account for 18 % of the road length. This inevitably
leads to traffic jams.


To add to this the Indian taxation system is quite complex. In order to avoid multiple
taxation, companies typically have warehousing operations in every state. This
results in large number of small warehouses across the country that lack in the latest
warehousing processes and technologies. Lack of adequate infrastructure and complex
taxation and regulations are major obstacles for logistics players in India. Roads
occupy a crucial position in the growth and development of the transportation industry.
Hence, Government has undertaken several projects to expand the road network
nationwide for providing connectivity and mobility in both the rural and urban areas.


Despite the limitations, we visualize a strong potential in this sector. Several initiatives
and projects are underway to boost development of roads while the complex Central
Sales Tax is to be phased out in coming years to welcome GST. The emergence of India
as a manufacturing hub, growth of the organized retail industry, increased domestic
consumption, and the global best practices of multinationals are all expected to boost
the logistics industry. The key initiatives that could further trigger the growth of the
industry includes, spurring growth in third party logistics (3PL), introduction of GST
and upcoming multi-modal logistics parks. Increasing IT penetration will further improve
the efficiency of the players by enabling smooth movement of goods by online tracking,
better cargo management and record maintenance of huge cargo handled on daily basis.


Company Background
Transport Corporation of India is India’s leading integrated supply chain and logistics
solutions provider. With expertise developed over five decades and customer centric
approach, TCI is equipped with an extensive set up of 1200 branch offices, a large
workforce of 6,500 employees, huge fleet of customized vehicles and managed
warehouse space of 8.5 million sq ft. Leveraging on its extensive infrastructure, strong
foundation and skilled manpower TCI offers seamless multi-modal logistics solutions.
TCI formerly started its operations in Calcutta with single truck in 1958 and since then,
the company has expanded its footprints as India’s leading integrated supply chain
solutions provider with a global presence. TCI has been continuously introducing
new and innovative services from multi-modal transportation (road, rail, air, sea)
to express delivery solutions, from freight forwarding and customs clearances to
warehouse management services. TCI is well equipped to take on new challenges
with a host of value added services and has plans to further strengthen its presence in
India and Asia. The company has plans to invest in state of the art, large scale multi
user multi product warehouses, ships, trucks, trailers and technology to establish
itself as a complete supply chain solutions provider.


Freight Division
TCI is one of India’s premier organized freight services provider with pan India
presence. They operate around 7,000 trucks and trailers, to provide freight movement
services on a daily basis. The freight division handles FTL (Full Truck Load), LTL (Less
Than Truck Load), FCL (Full Container Load), and ODC (Over Dimensional Cargo).
TCI’s network of 1,200 company owned offices makes them closer to the source of
raw material and customers across the country. TCI also has tactical partnership with
Container Corporation of India to provide integrated rail – road container haulage.
The company has become quite watchful in this business, owing to existence of large
number of unorganized players shrinking the profitability margins. TCI is looking at
creating value addition where margins could be better. Thus, the growth rate in this
segment is expected to be moderate. This is the major division contributing ~50% to
the topline in FY10. We expect the revenue from this segment to grow at 9.5% CAGR
during FY10-12E, while revenue contribution to come down to ~43% in FY12E, owing
to increased focus towards other high margin businesses.

XPS Division
This division provides express door-to-door service for time sensitive and high value
documents and parcels. The company operates through its own fleet of 300 dedicated
XPS trucks and delivers to 13,000 locations in India & more than 200 countries
overseas. This division has four sub-segments viz. TCI XPS Surface, TCI XPS Air,
TCI XPS Courier and TCI XPS priority services, classified according to client needs.
This is the second major division contributing ~26% to the topline in FY10. We expect
the revenue from this segment to grow at 20% CAGR during FY10-12E.

Supply Chain Solution (SCS) Division
TCI’s SCS division provides inbound / outbound logistics and supply chain solutions
right from conceptualization to implementation. This division operates with a
customized fleet of 800 owned trucks. Auto sector currently contributes to 75%
of total SCS revenue. TCI also provides transport solutions for perishable cargo in
pharma, foods & chemicals by reefer vehicles. Going forward, the company is also
targeting some non-auto segment clients from retail, FMCG and telecom sectors to
reduce the dependency on auto sector from current level of 75% to 50% in coming
years. The uniqueness of the TCI-SCS is their domain knowledge, assets (vehicles,
modern warehouses) coupled with footprint of group companies in freight, express
cargo and courier, shipping, freight forwarding & custom clearance.
Revenue contribution from this segment has scaled up to ~17% in FY10 from ~8% in
FY06 and we expect it to further stretch to ~23% in FY12E. We expect the revenue
from this segment to grow at ~37% CAGR during FY10-12E.


Seaways Division
This division provides coastal shipping services for transporting container and bulk
cargo along the eastern coast of India. TCI has also formed 50-50 JV called “Ann
Sofie Scan ApS” with Scan Trans – world’s sixth largest seaways company to focus
on Europe. The company owns and operates 5 domestic ships with capacity of 2500
– 4500 DWT (deadweight- tonne); including project ships equipped with own cranes
and 1 international ship with Ann Sofie Scan ApS. The revenue from this segment
has been quite subdued, owing to lack of new fleet addition and 1 ship per quarter
being sent for dry-docking from past few quarters.
Global Division
The Global business division of TCI provides complete logistics & SCS across
boundaries. TCI Global has set up offices in Brazil, China, Germany, Indonesia,
Hong Kong, Malaysia, Mauritius, Netherlands, Singapore and Thailand. However,
operations have started only at 5 wholly owned subsidiaries in Asia / South East
Asia (Singapore, Hong Kong, Indonesia, Thailand and China). Businesses at other
locations are expected to be operational shortly. It is planning to expand its horizon of
services to other Asian countries and selected centers in Europe as well. TCI Global
offers freight forwarding, customs clearance activities, transportation, warehousing
and courier services. This segment is expected to breakeven by end of FY12E.
Others
Other businesses include wind power generation, where the company has a cumulative
capacity of 11.5 MW. The company is also engaged in fuel trading business, mainly
constituting one fuel station, which contributed about 1% to the topline in FY10 and
had PBIT margin ~1.5%. In FY07, the company sold eight of the then nine outlets.
Going forward, no major growth is expected in this division.
De-merger of Real Estate and Warehousing division
TCI recently de-merged its real estate & warehousing division into TCI Developers
Ltd (TDL) to have greater efficiency and synergy in operations. De-merged entity TDL
has plans to develop every individual property on the basis of its size, location and
feasibility as a residential and/or commercial project. Other projects would include
state-of-the-art multi modal logistics parks, truck terminals, free-trade warehousing
zones etc. Post de-merger, every Shareholder of TCI received 1 equity share of `
10/- each in TDL for every 20 equity shares of ` 2/- each held in TCI. The company
is planning to list TDL on stock exchanges in the near term.


Investment Rationale
Largest integrated logistics service provider
TCI is the largest integrated player, having a 15% market share of the organized logistics
industry. Over the years, TCI has built a strong infrastructure network. It has a branch
network of over 1,200 company-owned offices. It operates approximately 7,000 trucks
on a daily basis, of which 1,200 are owned trucks and 1,000 attached trucks and trailers.
Apart from transportation, the company has one of the largest warehousing space of
about 8.5 mn sq ft. It also has a fleet of six ships with a total capacity of 16000 DWT.


TCI has altered its business model from core low margin trucking service provider
to high margin SCS and express delivery business. The SCS division is expected
to grow rapidly above the industry growth rate owing to increase in outsourcing by
companies looking at re-aligning their supply chains. TCI also provides dedicated
multi modal services through its XPS division. These two segments are expected to
provide higher growth, going forward


Timely freight revision
TCI operates 65-70% of the business on contractual basis with a fuel cost escalation
clause, where the fuel price hike is passed on immediately to the customers. The
balance portion that is exposed to spot freight rates is further transferred with a lag
effect of 1.5 – 2 months. Therefore, owing to timely freight revision, TCI’s exposure
to fuel price hikes is minimal. However, hike in the fuel / freight rates are usually
passed on only when there is freight availability. Therefore, during recession it was
apparent that TCI had to absorb certain small fuel / freight hikes in order to ensure
volumes. As a result, freight expenses as percentage to sales had augmented by 165
bps YoY in FY10. However, going forward, we believe this hike would be gradually
passed on to the customers in coming quarters.


We believe passing on of any further hike in the fuel price would not be a major
concern at this point of time when volumes have picked up at the global and national
level. Revival in freight volumes comforts us with higher possibility of fuel price
hike to be passed on to the customers.

Major beneficiary of introduction of GST
The introduction of Goods and Services Tax (GST) will abolish centre as well as
state level taxes such as sales tax, octroi tax etc and a single tax will be charged when
a good is up for sale. GST would help to bring in more transparency in the system,
as it will solve the problem of cascading taxes that are levied across the goods. The
introduction of GST is a significant step towards the betterment of the industry.


Major benefits
●● Manufacturers would be entitled to input tax credit of all inputs and capital goods
purchased from within the State as well as inter-State, from a registered dealer for
setting off the output tax liability on the sale of their finished products. Similarly,
distributors would also be able to pass on the duty burden to their customers.
This would ensure that there is no cascading effect of taxes and would result in
a reduction in the cost of doing business
●● Road transportation is a costlier mode of transportation when compared to rail,
seaways or pipelines. Introduction of GST will eliminate multiple taxes presently
charged while carrying goods by road, thereby reducing the overall transportation
cost, making road freight rates more viable
●● Since GST is expected to standardize rates across the nation, considerable
consolidation is expected in the warehousing segment, as companies would be
able to manage bigger warehouses at few strategic locations
●● TCI being a largest integrated logistics service provider, we believe the company
to be a major beneficiary
We believe that industrial productivity and earnings will improve, more investments
will happen and GDP will get a boost. Introduction of GST will encourage foreign
companies to enter the Indian market as they will not have to deal with different
types of taxes to be paid and at the same time it will consolidate the Indian logistics
sector. In the absence of definite information on what would be the combined rate
of CGST and SGST it is difficult to estimate the impact of GST at this point of time.
However, the belief that trade and industry will benefit from implementation of GST
is widely accepted.

Expansion to trigger growth
TCI is on course to invest ~ ` 1,600 million in FY11E of which it has already invested
~ ` 460 million in H1FY11. The planned capital expenditure (capex) would be utilized
for acquisition of trucks and containers (~ ` 655 million), ship (~ ` 500 million),
warehouses (~ ` 250 million) and upgrading IT infrastructure (~ ` 195 million). Of the
planned capex, the management is uncertain about acquisition of the ship in FY11E
itself. Therefore, we have assumed a capex of `1,100 million for FY11E and the
ship to be acquired in FY12E. We believe, shipping division to register better growth
only after further capacity addition. The investment in trucks, containers, warehouses
and IT infrastructure are incorporated in our estimates of 17.9% and 29.5% CAGR
growth in topline and bottomline, respectively, during FY10-FY12E.


Financials
TCI registered net sales of `14,506.6 million in FY10, growth of 11.8% YoY. EBITDA
margins improved 45 bps YoY to 7.6% during the same period. The company recorded
net profit of `434.5 million in FY10 against `283.4 million in FY09, growth of
53.3% YoY.

Continual and sustainable improvement in profitability margins and return
ratios
Considering the ongoing bend towards the high margin businesses, TCI has been able
to register notable improvement in profitability margins over the years and we believe
the same trend to continue going forward in FY11E and FY12E as well.


The company has also registered improvement in the return ratios that indicates
efficiency in profitability of company’s capital investments


Valuation and Recommendation
The revision in road freight rates and subsequent passing on of the same by the
company to its customers will boost the topline and bottomline. With increasing
contribution from high margin businesses like XPS and supply chain, improving
volumes from the automobile industry and continual and sustainable margin
expansion, we believe TCI will register a growth of 17.9% and 29.5% CAGR in
topline and bottomline, respectively, during FY10-FY12E.
At the current price of ` 111, the stock is trading at 13.9x its FY11E EPS of ` 8 and
11.1x its FY12E EPS of ` 10. We value the core standalone business at 13.5x FY12E
EPS to arrive at our target price of ` 135. Considering the recent price correction,
we recommend a “BUY” rating on the stock.