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Eight bottom-up investment ideas
Inflation concerns, infrastructure project delays, commodity
price increases and governance issues have put the brakes on
the thesis of a secular bull market in India. In our view,
bottom-up stock-picking assumes increased significance in
such an environment. We have picked eight such ideas on the
basis of their pricing power, visibility of revenues, strong
management execution track record and balance-sheet
strength on the face of a liquidity squeeze/hardening rates.
The eight companies that we recommend are Amara Raja
Batteries, Bajaj Electricals, Bajaj Finance, Emami, Havells
India, HT Media, Indraprastha Gas and Pidilite.
A time for stock-picking: In the Indian stock markets, macro and
systemic risks have taken centre stage recently, but our exploratory
study suggests serious value in successful mid-cap stock-picking, as
return distribution has a fat right tail - the probability estimate of a
>30% annualised return is 17.9% in mid-caps versus 5.1% in largecaps,
based on our study. The mid-cap space has borne the brunt of
the current correction, with the CNX Midcap Index down 22.8% from
its peak, while the Nifty is down 14.1%.
Consumption theme remains strong: We believe that
consumption growth in India is likely to sustain in the 14-18% band
achieved in the last five years versus 5-10% achieved earlier. This
will continue to be driven by faster income growth across the
segments of the income pyramid, the demographic dividend,
increasing media penetration and a significant uptick in rural
consumption empowered by government schemes like NREGS
(National Rural Employment Guarantee Scheme).
Criteria-based stock selection: We believe that the key
differentiating factors for successful stock-picking in an uncertain
environment are: 1) resilient demand scenario; 2) pricing power to
combat margin pressures from commodity inflation; and 3) strong
competitive positioning that would allow healthy capital return ratios
even in periods of vulnerability. Based on the consumption theme,
our picks are Bajaj Electricals, Bajaj Finance, Emami, Havells India,
HT Media, and Pidilite. We also pick Amara Raja Batteries and
Indraprastha Gas. While these stocks are also vulnerable to a sharp
correction in the markets, we expect healthy absolute returns over
the next 12 months.
A time for stock-picking
Mid-cap valuation discount far from its highs despite
correction
The CNX Midcap Index has corrected 22.8% from its peak, while the
Nifty has corrected 14.1%. The CNX Midcap Index is trading at 16.7x
TTM P/E versus 21.04x TTM P/E for the Nifty. The valuation discount
of mid-caps to large-caps at 20.7% is rather far off from the peak of
40% witnessed in the past five years. This means that while midcaps
have been sold down compared to larger peers in the current
fall, the discount does not yet justify any basket buying, as absolute
levels are not near a historical rock bottom. It will be beneficial to
cherry-pick, in our opinion.
Value in bottom-up stock-picking
The Indian market has rewarded successful stock-picking in midcaps
handsomely through cyclical downturns (admittedly adjusting
for survivorship bias). To understand this phenomenon, we study the
5-year (2006-2011) annualised return histograms of current BSE500
stocks with a market cap of more than Rs50bn in February 2006
versus stocks with a smaller market cap.
From the above charts it is evident that the right skew (probability of
asymmetric positive return) appears higher in the mid-cap group.
This puts a premium on stock-picking in the mid-cap space. Also
chances of a sub-10% return (which one can define as failure in the
investment context) are remarkably similar across both groups.
As far as success stories go, consider the examples of Shriram
Transport Finance and Titan Industries that have delivered
annualised returns of 47.5% and 34.2% over the last five years vs
13.1% for the Nifty Index. It is worthwhile to note that most such
success stories have been dominant players in large opportunity
spaces with a business model that has been profitable through
cycles. They have also been typically entrepreneurial organisations.
Consumption unbound – a structural shift
We believe that consumption growth in India is likely to sustain in
the 14-18% band achieved in the last five years versus 5-10%
achieved earlier. This will continue to be driven by faster income
growth across the segments of the income pyramid, the
demographic dividend, increasing media penetration and a
significant uptick in rural consumption empowered by government
schemes like NREGS.
While the drivers for consumption growth are very strong,
penetration and per capita consumption in India are very low in most
personal care and foods categories. In most personal care
categories, over 50% of Indians are yet to enter the consumption
basket, and over 80% of Indians are yet to enter the foods
categories. Even among present users, per capita consumption is
very low when compared to other emerging markets. Skin care per
capita consumption in India is 1/25th that of Thailand and 1/10th that
of China. This gap in penetration and consumption will lead to the
high growth opportunity in India over the next decade.
Rural market has been the key growth driver and will remain
so
The key driver for the shift in consumption growth has been the rural
market, which forms c70% of India’s population. Rural markets,
which were earlier a laggard to urban market growth, have actually
outgrown the urban markets in the past three years. The key factors
that have led to this growth are: 1) strong price increases of agri
commodities; 2) sustained investment by the government in rural
income generation programmes like the National Rural Employment
Guarantee Act (NREGA) and rural infrastructure; and 3) the
increasing media reach in rural areas, which have created
awareness. Consumer companies have also done their bit by
bringing out low unit packs to generate trials among rural consumers
and expanding rural distribution. We feel that the policy focus on
such rural schemes is here to stay and there is much more capacity
available in the distribution framework that consumer companies
have created. These drivers should sustain the buoyancy in the rural
economy.
Eight investment ideas – criteria-based
selection
We highlight eight bottom-up stock ideas with a strong thematic
opportunity, on the basis of our exploratory study on the BSE500
stocks that suggest serious value in successful mid-cap stockpicking.
All our recommended companies in this report have the
following factors in common:
They represent a thematic opportunity that is sizable, and within
that space, they have a dominant and profitable presence.
They do not have stretched balance-sheets that are vulnerable to
a liquidity squeeze.
The manufacturing companies have significant pricing power to
manage demand profitably in an inflationary environment.
These are well-managed companies with the management
bandwidth to make the most of the opportunity.
Stock picks suited to uncertain times
Key issues facing Indian equity markets today are:
Interest rate hikes targeted at reining in inflation, thereby
adversely affecting the indigenous demand environment.
Worsening of corporate balance-sheets through a stretched
receivables cycle, as liquidity worsens and it becomes more
difficult to obtain debt.
Squeeze on manufacturing margins from commodity price hikes
that cannot be passed on fully.
Worsening of fiscal deficit from a further rise in oil subsidies, as
oil prices rise.
Corporate governance issues coming to the forefront for multiple
Indian companies.
Slowing down on infrastructure orders from the government
leading to margin destruction for existing projects.
Possible stress on the banking system from the non-viability of
various infrastructure projects.
Clear slowdown in the investment cycle with industrials order
flow slowing down.
In spite of these uncertainties, we have recommended eight
investment ideas that are smaller companies, as we believe these
companies have business models that although not entirely immune
to these stress points are strong enough to withstand the headwinds
creditably.
Other important trends we choose to ride
Robust print media expansion
The Indian print media industry is set for sustained growth and is
likely to easily outshine the global print space over the next few years.
A combination of social sector spending, employment schemes and
the trickle-down effect of strong economic growth in urban India has
buoyed semi-urban and rural economies. This has brought into the
fold new advertisers in the form of small-scale and regional
enterprises, and also resulted in more local content in newspapers.
This new class of advertisers now accounts for more than 50% of
advertisements in print media. Meanwhile, overall ad spends, at
0.41% of GDP, remains one of the lowest globally, and offers great
scope for growth. This, combined with an uptick in print penetration
from the current ~38% and rising literacy rates, sets the stage for
Indian print media’s multi-year growth story. We expect the regional
print ad markets to maintain at least high-teen growth rates outpacing
the 8-10% growth in English print.
Urban gas distribution Gas consumption in India is set for structural growth, on the back of increasing supplies, an evolving gas pipeline network, and pricing reforms. New gas discoveries such as RIL’s KG-D6 and GSPC’s Deendayal fields have significantly improved India’s gas supply outlook. Based on published development schedules, domestic gas availability is expected to increase at 7% annually over FY10–16. Including gas imports through LNG terminals of Petronet, Shell and RGPPL, gas availability could increase to 270mmscmd by FY16 from 165mmscmd in FY10. A regulatory framework that defines expected return ratios for infrastructure developers has attracted investments from GAIL, RIL, GSPL and others—and this would quadruple India’s gas transmission pipeline network from the current ~6,100km through FY16-17. This, clubbed with pricing reforms, should improve gas penetration among sectors other than power and fertilisers, which currently account for 60% of India’s gas consumption. Furthermore, the government’s thrust on developing city gas distribution (CGD) will significantly expand the user base. Government plans to appoint 201 new operators through competitive bidding across India by 2015. Expansion of CGD networks will bring new users into the fold, such as small and medium industries, households, and vehicle owners. We also think that since CGD strikes a balance between economic and environmental imperatives, the government would continue to extend its support for a pan-India rollout. Average consumption of 0.20mmscmd per area by 2015 would lead to 40mmscmd additional demand from CGD operations, which is 25-30% of present consumption.
Consumer lending – a large opportunity Consumer lending would remain an attractive segment given the low penetration of such lending. Consumer loans/GDP (excluding mortgages) at 7% suggests low leverage of households’ balancesheet. Consumer lending other than mortgages has been confined mostly to secured loans. Penetration of unsecured lending is low and offers huge potential, in our view. With consumption being a key growth driver for the economy, rising income levels and increasing sophistication of households would drive demand for consumer lending robustly over the long term. Ease of access to consumer finance, innovation and multitude of channels for distribution would enable lenders to capitalise on the evolving opportunity, in our view. While the market opportunity is large, lenders have faced two key challenges in consumer lending: 1) achieving higher economies of scale; and 2) very large deviation in credit losses during cyclical downturn. Many lenders withdrew from the market as a result of negative operating leverage from declining volume and large credit losses impairing the profitability significantly during the previous downturn. Key to success includes creating strong technology platform for loan origination and administration, product diversification and strong credit culture within the organisation.
A growing battery market
The Indian battery market is estimated at Rs65bn and will register
12-15% CAGR over the next five years. Low vehicle penetration and
rising incomes would drive healthy double-digit growth across
segments in the auto industry. Meanwhile, the high-margin
replacement segment is set for a surge, as strong growth in vehicle
sales in the last few years (12% CAGR in five years) translates to
replacement demand for batteries, and users increasingly opt for
branded batteries. Margin expansion in the medium term would be
driven mainly by a shift in market share in the replacement segment
from unorganised battery manufacturers to organised ones. This
shift will help expand battery manufacturers’ margins for two
reasons: 1) margins in the replacement segment are intrinsically
higher than in the OEM segment; and 2) raw-material costs will fall
as prices of scrap batteries come down.
Summary of investment theses
Amara Raja (The Challenger): Amara Raja Batteries Ltd (ARBL) is
the second-largest manufacturer of lead-acid batteries in India, with
~23% share by volume of the organised battery market. We
estimate an earnings CAGR of ~30% over the next two years, driven
by capacity expansion in the automotive and two-wheeler segments.
In our view, concerns over its high exposure to the telecom sector
are overdone, and ignore the company’s strong performance in the
automotive and UPS segments. On the telecom side too, there are
initial signs of bottoming; we expect substantial improvement in this
segment’s revenues and margins in FY12. Valuations, at 9x FY12ii
EPS, are attractive for a branded consumer company.
Bajaj Electricals (Resilient rural growth play): Bajaj Electricals
(BJE) is a leading player in consumer appliances, fans and lighting
products, which together account for 55% of its revenues. The
company enjoys an established brand franchise in India, with a
market share of 20-30% in most of the consumer-durable categories
in which it operates. It is well-placed to benefit from the potential
25%+ volume growth in consumer durables, driven by underpenetrated
semi-urban markets. With the government’s focus on
rural infrastructure also remaining high, growth in sales of its
industrial products too should stay high at over 20%+ annually. The
stock is trading at 11.5x FY12ii EPS, and we reckon the 1-yearforward
multiple should re-rate to 14x, given BJE’s leadership
position in a fast-growing market. We recommend BUY with a target
price of Rs280.
Bajaj Finance (Primed for a new phase): Bajaj Finance (BFL) is a
play on the consumer and small business lending opportunities in
India. Positioned initially as a consumer finance company, BFL
expanded its scope to include opportunities in small businesses as
well. BFL’s competitive advantage includes strong parentage,
favourable funding position, and an experienced senior management
team. High asset growth, improving efficiency and a renewed focus
on asset quality would drive 70% CAGR in earnings during FY10-13ii.
Strong and sustainable earnings growth, rising ROE and an
inexpensive valuation (P/B of 1.6x on FY12ii) makes BFL an
attractive play, in our view.
Emami (The niche advantage): Emami is one of India’s fastestgrowing
FMCG companies, with a unique product mix of leadership
positions in niche segments such as ‘cooling oils’, pain balms and
antiseptic creams. With minimal competition from large companies,
Emami commands high pricing power, which would help it tide over
commodity inflation. Growth in low-penetration core categories,
product innovation and expansion in the international business will
drive 24% earnings CAGR over FY10-13. Margin pressures and an
expensive bid for Paras Pharmaceuticals have led to a correction of
24% in the past six months, which we believe is an attractive entry
point into the stock.
Havells India (Charged up): Electrical consumer-goods major
Havells is a beneficiary of robust demand growth based on upgrading
consumer preferences and increased construction activity in its key
verticals—switchgears, lighting fixtures, consumer durables (fans)
and cables/wires. Strong brands built through aggressive advertising
strategy and extensive distribution networks are sustainable growth
drivers. Consolidated leverage is set to decline, with its European
lighting-fixtures acquisition Sylvania looking to breakeven in FY12,
post restructuring. The stock’s current P/E of 11.8 on FY12ii is
reasonable, in our view, and our target price of Rs475 (ascribing
zero equity value to Sylvania) indicates 36% upside. We retain BUY.
HT Media (A ‘fine’ print): HT Media, a leading print media
conglomerate, boasts of a strong product portfolio catering to the
lucrative English and Hindi print markets. Well-entrenched leadership
of its flagship dailies, Hindustan Times in English and Hindustan in
Hindi in their respective legacy markets would enable it to capitalise
on ad-spend strength. In the new markets, namely Hindustan Times
in Mumbai and Hindustan in Uttar Pradesh we expect, its adrevenues
to surge, as its readership market share is nearing
inflection. Having made peak investments in these markets, a strong
operating leverage would come into play, leading to 34% earnings
CAGR over FY11-13ii.
Indraprastha Gas (Quality play on gas retailing): Indraprastha
Gas (IGL), the sole distributor of gas in the National Capital Region
(NCR), has extensive network penetration. This, we reckon, will
enable it to maintain its monopoly in Delhi and pass on any increase
in input prices, as reflected in the 32% increase in CNG prices since
June 2010. IGL plans to replicate its network in markets adjoining
Delhi—Noida, Greater Noida and Ghaziabad—where demand for gas
remains strong. This, we reckon, will translate into a volume CAGR
of 23% and earnings CAGR of 18% over FY11-13ii. Trading at 15x
FY12ii EPS, IGL offers a quality play on gas retailing in India.
Pidilite (Niche innovator): Pidilite Industries is a niche consumer
and specialty chemicals player in India. It has pioneered multiple
brands of national top-of-the-mind recall like Fevicol and M-Seal.
Construction chemicals (primarily retail consumption) is the
company’s new growth driver, as legacy strengths remain in place
for now mature categories like adhesives and sealants. This should
drive ~16% revenue CAGR leading to 20.3% EPS CAGR over FY10-
13ii. The stock is valued at 17.9x FY12ii P/E and offers 12-month
upside of 25%. We recommend BUY.
Key risks
1. Generally the market position and dominance of smaller players
is weaker than their larger peers. However, most of our featured
stocks are dominant in their own niches. For example, Emami
has over 65% market share in pain balms.
2. Pricing power and ability to negotiate with suppliers is generally
higher in a large company than in a generic mid-cap. However,
there are exceptions to this rule as each market niche has it own
dynamics.
3. The bargaining power that the smaller companies enjoy in
institutional and wholesale debt markets is lower and the
vulnerability to a liquidity squeeze is higher (in terms of both cost
and availability of debt).
4. Mid-cap companies often tend to be promoter-driven entities,
where the number of highly qualified professionals is lower. This
could prove to be a serious impediment to gaining and managing
scale. A key criterion in our choice of investment
recommendations is if the management is keen or not on
divesting authority to a carefully chosen team that can take the
company forward. In the case of Emami, for example, although
outside managers are not in abundance, promoter managers
themselves are qualified professionals.
5. The biggest risk from the investment point of view in mid-caps is
possibly liquidity risk. Typically the companies do not have
adequate free-float and liquidity generally dwindles in a bear
market as risk appetite falls. The key to investment in mid-caps
is a long enough investment horizon to overcome the need for
immediate liquidity in a distress situation.
6. The level of disclosures in most mid-caps is lower compared to
large-caps. Given the sporadic model of information
dissemination, earnings shocks are more likely.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Eight bottom-up investment ideas
Inflation concerns, infrastructure project delays, commodity
price increases and governance issues have put the brakes on
the thesis of a secular bull market in India. In our view,
bottom-up stock-picking assumes increased significance in
such an environment. We have picked eight such ideas on the
basis of their pricing power, visibility of revenues, strong
management execution track record and balance-sheet
strength on the face of a liquidity squeeze/hardening rates.
The eight companies that we recommend are Amara Raja
Batteries, Bajaj Electricals, Bajaj Finance, Emami, Havells
India, HT Media, Indraprastha Gas and Pidilite.
A time for stock-picking: In the Indian stock markets, macro and
systemic risks have taken centre stage recently, but our exploratory
study suggests serious value in successful mid-cap stock-picking, as
return distribution has a fat right tail - the probability estimate of a
>30% annualised return is 17.9% in mid-caps versus 5.1% in largecaps,
based on our study. The mid-cap space has borne the brunt of
the current correction, with the CNX Midcap Index down 22.8% from
its peak, while the Nifty is down 14.1%.
Consumption theme remains strong: We believe that
consumption growth in India is likely to sustain in the 14-18% band
achieved in the last five years versus 5-10% achieved earlier. This
will continue to be driven by faster income growth across the
segments of the income pyramid, the demographic dividend,
increasing media penetration and a significant uptick in rural
consumption empowered by government schemes like NREGS
(National Rural Employment Guarantee Scheme).
Criteria-based stock selection: We believe that the key
differentiating factors for successful stock-picking in an uncertain
environment are: 1) resilient demand scenario; 2) pricing power to
combat margin pressures from commodity inflation; and 3) strong
competitive positioning that would allow healthy capital return ratios
even in periods of vulnerability. Based on the consumption theme,
our picks are Bajaj Electricals, Bajaj Finance, Emami, Havells India,
HT Media, and Pidilite. We also pick Amara Raja Batteries and
Indraprastha Gas. While these stocks are also vulnerable to a sharp
correction in the markets, we expect healthy absolute returns over
the next 12 months.
A time for stock-picking
Mid-cap valuation discount far from its highs despite
correction
The CNX Midcap Index has corrected 22.8% from its peak, while the
Nifty has corrected 14.1%. The CNX Midcap Index is trading at 16.7x
TTM P/E versus 21.04x TTM P/E for the Nifty. The valuation discount
of mid-caps to large-caps at 20.7% is rather far off from the peak of
40% witnessed in the past five years. This means that while midcaps
have been sold down compared to larger peers in the current
fall, the discount does not yet justify any basket buying, as absolute
levels are not near a historical rock bottom. It will be beneficial to
cherry-pick, in our opinion.
Value in bottom-up stock-picking
The Indian market has rewarded successful stock-picking in midcaps
handsomely through cyclical downturns (admittedly adjusting
for survivorship bias). To understand this phenomenon, we study the
5-year (2006-2011) annualised return histograms of current BSE500
stocks with a market cap of more than Rs50bn in February 2006
versus stocks with a smaller market cap.
From the above charts it is evident that the right skew (probability of
asymmetric positive return) appears higher in the mid-cap group.
This puts a premium on stock-picking in the mid-cap space. Also
chances of a sub-10% return (which one can define as failure in the
investment context) are remarkably similar across both groups.
As far as success stories go, consider the examples of Shriram
Transport Finance and Titan Industries that have delivered
annualised returns of 47.5% and 34.2% over the last five years vs
13.1% for the Nifty Index. It is worthwhile to note that most such
success stories have been dominant players in large opportunity
spaces with a business model that has been profitable through
cycles. They have also been typically entrepreneurial organisations.
Consumption unbound – a structural shift
We believe that consumption growth in India is likely to sustain in
the 14-18% band achieved in the last five years versus 5-10%
achieved earlier. This will continue to be driven by faster income
growth across the segments of the income pyramid, the
demographic dividend, increasing media penetration and a
significant uptick in rural consumption empowered by government
schemes like NREGS.
While the drivers for consumption growth are very strong,
penetration and per capita consumption in India are very low in most
personal care and foods categories. In most personal care
categories, over 50% of Indians are yet to enter the consumption
basket, and over 80% of Indians are yet to enter the foods
categories. Even among present users, per capita consumption is
very low when compared to other emerging markets. Skin care per
capita consumption in India is 1/25th that of Thailand and 1/10th that
of China. This gap in penetration and consumption will lead to the
high growth opportunity in India over the next decade.
Rural market has been the key growth driver and will remain
so
The key driver for the shift in consumption growth has been the rural
market, which forms c70% of India’s population. Rural markets,
which were earlier a laggard to urban market growth, have actually
outgrown the urban markets in the past three years. The key factors
that have led to this growth are: 1) strong price increases of agri
commodities; 2) sustained investment by the government in rural
income generation programmes like the National Rural Employment
Guarantee Act (NREGA) and rural infrastructure; and 3) the
increasing media reach in rural areas, which have created
awareness. Consumer companies have also done their bit by
bringing out low unit packs to generate trials among rural consumers
and expanding rural distribution. We feel that the policy focus on
such rural schemes is here to stay and there is much more capacity
available in the distribution framework that consumer companies
have created. These drivers should sustain the buoyancy in the rural
economy.
Eight investment ideas – criteria-based
selection
We highlight eight bottom-up stock ideas with a strong thematic
opportunity, on the basis of our exploratory study on the BSE500
stocks that suggest serious value in successful mid-cap stockpicking.
All our recommended companies in this report have the
following factors in common:
They represent a thematic opportunity that is sizable, and within
that space, they have a dominant and profitable presence.
They do not have stretched balance-sheets that are vulnerable to
a liquidity squeeze.
The manufacturing companies have significant pricing power to
manage demand profitably in an inflationary environment.
These are well-managed companies with the management
bandwidth to make the most of the opportunity.
Stock picks suited to uncertain times
Key issues facing Indian equity markets today are:
Interest rate hikes targeted at reining in inflation, thereby
adversely affecting the indigenous demand environment.
Worsening of corporate balance-sheets through a stretched
receivables cycle, as liquidity worsens and it becomes more
difficult to obtain debt.
Squeeze on manufacturing margins from commodity price hikes
that cannot be passed on fully.
Worsening of fiscal deficit from a further rise in oil subsidies, as
oil prices rise.
Corporate governance issues coming to the forefront for multiple
Indian companies.
Slowing down on infrastructure orders from the government
leading to margin destruction for existing projects.
Possible stress on the banking system from the non-viability of
various infrastructure projects.
Clear slowdown in the investment cycle with industrials order
flow slowing down.
In spite of these uncertainties, we have recommended eight
investment ideas that are smaller companies, as we believe these
companies have business models that although not entirely immune
to these stress points are strong enough to withstand the headwinds
creditably.
11:Pricing power – few examples
Companies Example
Amara Raja Batteries Lead, which
is the key raw material, is a pass through for
Amara Raja in the auto OEM and industrial segments
(which accounts for 80% of revenues for Amara Raja). In
the remaining 20% (auto replacement) market there is a
duopoly with both Exide and Amara Raja passing on raw
material inflation to customers (Amara Raja though
typically increases prices only after Exide, which is the
dominant player with a 70% share).
Bajaj Electricals During 3QFY11,
the consumer segment margins expanded
190bps YoY, despite 15 20% increase in raw material costs.
Bajaj Finance The latest rate
hikes have been passed on (on the back of a
250bps hike in borrowing costs, the company has raised
lending rates by about 200bps).
Emami Raised prices in Fair
& Handsome’s sachet by 40% from Rs5
to Rs7 in 1QFY10 and yet saw volumes grow 15 20% in the
segment. Dropped grammage in Navratna sachets from
3.5ml to 3ml in 4QFY09 and yet saw 15% volume growth in
the next few quarters.
Havells India The company has
taken 15 20% price increases across
categories in 3QFY11, as prices of key raw materials,
copper and aluminum, hardened.
Indraprastha Gas In 1QFY11,
IGL hiked CNG prices by 26% post the
government doubling the prices of domestic natural gas.
Pidilite The company has taken
6 8% price increases in industrial
chemicals and 3 4% in consumer and bazaar products as
VAM (Vinyl Acetate Monomer, key raw material) prices
inflated 20% YoY.
Source: Company, IIFL Research
Demand resilience – key arguments
Companies Argument
Amara Raja Batteries Given the
healthy volume growth witnessed in the last five
years, the replacement battery market will see continued
traction for the next few years giving good viability on
volumes from this segment. Even OE volumes are expected
to remain strong, given the healthy growth in incomes and
low penetration. Bulk of the telecom tower additions
happened in FY07 08 and hence demand from this
segment too should be healthy.
Bajaj Electricals Since rural
and semi urban markets are the main drivers of
demand growth for the company, with agricultural incomes
remaining strong, we anticipate little dip in the volume
offtake for appliances in these regions. Additionally, with
the government having pulled its act together in semi
urban towns (if not in rural areas) in improving their access
to electricity, infrastructure supporting the demand growth
for appliance products should also support resilience in
demand for their products.
Bajaj Finance Demand for consumer
financial services is driven by
consumption growth and rising income levels. Both these
remain as key drivers of the broader economy and hence
demand for consumer lending should remain robust.
Emami Emami’s key segments draw
c50% revenues from rural
areas, where income growth has been very strong helped
by rising agri commodity prices and government spending.
Havells India Just as in the
case of Bajaj Electricals, the company is a
beneficiary of the electrification drive in rural areas and
smaller towns.
HT Media We expect ad spend
in the country to remain robust driven
by strong consumption growth in the country. Further ad
spend of large categories like education and services
among others will not be significantly impacted by external
factors.
Indraprastha Gas Cost economics
for CNG as compared to liquid fuels (65%
cheaper to petrol and 25% cheaper to diesel) makes it a
natural choice for fuel, resulting in more demand for gas.
Also penetration in new markets will result in higher
demand. Availability of R LNG to meet this demand along
with the pricing power gives us enough comfort that IGL
can meet our earning estimate of 18% pa over FY11 13ii.
Pidilite Pidilite‘s key categories
are consumer staples and quasi
discretionary whose demand is not likely to be significantly
affected by a slowdown.
Source: Company, IIFL Research
Other important trends we choose to ride
Robust print media expansion
The Indian print media industry is set for sustained growth and is
likely to easily outshine the global print space over the next few years.
A combination of social sector spending, employment schemes and
the trickle-down effect of strong economic growth in urban India has
buoyed semi-urban and rural economies. This has brought into the
fold new advertisers in the form of small-scale and regional
enterprises, and also resulted in more local content in newspapers.
This new class of advertisers now accounts for more than 50% of
advertisements in print media. Meanwhile, overall ad spends, at
0.41% of GDP, remains one of the lowest globally, and offers great
scope for growth. This, combined with an uptick in print penetration
from the current ~38% and rising literacy rates, sets the stage for
Indian print media’s multi-year growth story. We expect the regional
print ad markets to maintain at least high-teen growth rates outpacing
the 8-10% growth in English print.
Urban gas distribution Gas consumption in India is set for structural growth, on the back of increasing supplies, an evolving gas pipeline network, and pricing reforms. New gas discoveries such as RIL’s KG-D6 and GSPC’s Deendayal fields have significantly improved India’s gas supply outlook. Based on published development schedules, domestic gas availability is expected to increase at 7% annually over FY10–16. Including gas imports through LNG terminals of Petronet, Shell and RGPPL, gas availability could increase to 270mmscmd by FY16 from 165mmscmd in FY10. A regulatory framework that defines expected return ratios for infrastructure developers has attracted investments from GAIL, RIL, GSPL and others—and this would quadruple India’s gas transmission pipeline network from the current ~6,100km through FY16-17. This, clubbed with pricing reforms, should improve gas penetration among sectors other than power and fertilisers, which currently account for 60% of India’s gas consumption. Furthermore, the government’s thrust on developing city gas distribution (CGD) will significantly expand the user base. Government plans to appoint 201 new operators through competitive bidding across India by 2015. Expansion of CGD networks will bring new users into the fold, such as small and medium industries, households, and vehicle owners. We also think that since CGD strikes a balance between economic and environmental imperatives, the government would continue to extend its support for a pan-India rollout. Average consumption of 0.20mmscmd per area by 2015 would lead to 40mmscmd additional demand from CGD operations, which is 25-30% of present consumption.
Consumer lending – a large opportunity Consumer lending would remain an attractive segment given the low penetration of such lending. Consumer loans/GDP (excluding mortgages) at 7% suggests low leverage of households’ balancesheet. Consumer lending other than mortgages has been confined mostly to secured loans. Penetration of unsecured lending is low and offers huge potential, in our view. With consumption being a key growth driver for the economy, rising income levels and increasing sophistication of households would drive demand for consumer lending robustly over the long term. Ease of access to consumer finance, innovation and multitude of channels for distribution would enable lenders to capitalise on the evolving opportunity, in our view. While the market opportunity is large, lenders have faced two key challenges in consumer lending: 1) achieving higher economies of scale; and 2) very large deviation in credit losses during cyclical downturn. Many lenders withdrew from the market as a result of negative operating leverage from declining volume and large credit losses impairing the profitability significantly during the previous downturn. Key to success includes creating strong technology platform for loan origination and administration, product diversification and strong credit culture within the organisation.
A growing battery market
The Indian battery market is estimated at Rs65bn and will register
12-15% CAGR over the next five years. Low vehicle penetration and
rising incomes would drive healthy double-digit growth across
segments in the auto industry. Meanwhile, the high-margin
replacement segment is set for a surge, as strong growth in vehicle
sales in the last few years (12% CAGR in five years) translates to
replacement demand for batteries, and users increasingly opt for
branded batteries. Margin expansion in the medium term would be
driven mainly by a shift in market share in the replacement segment
from unorganised battery manufacturers to organised ones. This
shift will help expand battery manufacturers’ margins for two
reasons: 1) margins in the replacement segment are intrinsically
higher than in the OEM segment; and 2) raw-material costs will fall
as prices of scrap batteries come down.
Summary of investment theses
Amara Raja (The Challenger): Amara Raja Batteries Ltd (ARBL) is
the second-largest manufacturer of lead-acid batteries in India, with
~23% share by volume of the organised battery market. We
estimate an earnings CAGR of ~30% over the next two years, driven
by capacity expansion in the automotive and two-wheeler segments.
In our view, concerns over its high exposure to the telecom sector
are overdone, and ignore the company’s strong performance in the
automotive and UPS segments. On the telecom side too, there are
initial signs of bottoming; we expect substantial improvement in this
segment’s revenues and margins in FY12. Valuations, at 9x FY12ii
EPS, are attractive for a branded consumer company.
Bajaj Electricals (Resilient rural growth play): Bajaj Electricals
(BJE) is a leading player in consumer appliances, fans and lighting
products, which together account for 55% of its revenues. The
company enjoys an established brand franchise in India, with a
market share of 20-30% in most of the consumer-durable categories
in which it operates. It is well-placed to benefit from the potential
25%+ volume growth in consumer durables, driven by underpenetrated
semi-urban markets. With the government’s focus on
rural infrastructure also remaining high, growth in sales of its
industrial products too should stay high at over 20%+ annually. The
stock is trading at 11.5x FY12ii EPS, and we reckon the 1-yearforward
multiple should re-rate to 14x, given BJE’s leadership
position in a fast-growing market. We recommend BUY with a target
price of Rs280.
Bajaj Finance (Primed for a new phase): Bajaj Finance (BFL) is a
play on the consumer and small business lending opportunities in
India. Positioned initially as a consumer finance company, BFL
expanded its scope to include opportunities in small businesses as
well. BFL’s competitive advantage includes strong parentage,
favourable funding position, and an experienced senior management
team. High asset growth, improving efficiency and a renewed focus
on asset quality would drive 70% CAGR in earnings during FY10-13ii.
Strong and sustainable earnings growth, rising ROE and an
inexpensive valuation (P/B of 1.6x on FY12ii) makes BFL an
attractive play, in our view.
Emami (The niche advantage): Emami is one of India’s fastestgrowing
FMCG companies, with a unique product mix of leadership
positions in niche segments such as ‘cooling oils’, pain balms and
antiseptic creams. With minimal competition from large companies,
Emami commands high pricing power, which would help it tide over
commodity inflation. Growth in low-penetration core categories,
product innovation and expansion in the international business will
drive 24% earnings CAGR over FY10-13. Margin pressures and an
expensive bid for Paras Pharmaceuticals have led to a correction of
24% in the past six months, which we believe is an attractive entry
point into the stock.
Havells India (Charged up): Electrical consumer-goods major
Havells is a beneficiary of robust demand growth based on upgrading
consumer preferences and increased construction activity in its key
verticals—switchgears, lighting fixtures, consumer durables (fans)
and cables/wires. Strong brands built through aggressive advertising
strategy and extensive distribution networks are sustainable growth
drivers. Consolidated leverage is set to decline, with its European
lighting-fixtures acquisition Sylvania looking to breakeven in FY12,
post restructuring. The stock’s current P/E of 11.8 on FY12ii is
reasonable, in our view, and our target price of Rs475 (ascribing
zero equity value to Sylvania) indicates 36% upside. We retain BUY.
HT Media (A ‘fine’ print): HT Media, a leading print media
conglomerate, boasts of a strong product portfolio catering to the
lucrative English and Hindi print markets. Well-entrenched leadership
of its flagship dailies, Hindustan Times in English and Hindustan in
Hindi in their respective legacy markets would enable it to capitalise
on ad-spend strength. In the new markets, namely Hindustan Times
in Mumbai and Hindustan in Uttar Pradesh we expect, its adrevenues
to surge, as its readership market share is nearing
inflection. Having made peak investments in these markets, a strong
operating leverage would come into play, leading to 34% earnings
CAGR over FY11-13ii.
Indraprastha Gas (Quality play on gas retailing): Indraprastha
Gas (IGL), the sole distributor of gas in the National Capital Region
(NCR), has extensive network penetration. This, we reckon, will
enable it to maintain its monopoly in Delhi and pass on any increase
in input prices, as reflected in the 32% increase in CNG prices since
June 2010. IGL plans to replicate its network in markets adjoining
Delhi—Noida, Greater Noida and Ghaziabad—where demand for gas
remains strong. This, we reckon, will translate into a volume CAGR
of 23% and earnings CAGR of 18% over FY11-13ii. Trading at 15x
FY12ii EPS, IGL offers a quality play on gas retailing in India.
Pidilite (Niche innovator): Pidilite Industries is a niche consumer
and specialty chemicals player in India. It has pioneered multiple
brands of national top-of-the-mind recall like Fevicol and M-Seal.
Construction chemicals (primarily retail consumption) is the
company’s new growth driver, as legacy strengths remain in place
for now mature categories like adhesives and sealants. This should
drive ~16% revenue CAGR leading to 20.3% EPS CAGR over FY10-
13ii. The stock is valued at 17.9x FY12ii P/E and offers 12-month
upside of 25%. We recommend BUY.
Key risks
1. Generally the market position and dominance of smaller players
is weaker than their larger peers. However, most of our featured
stocks are dominant in their own niches. For example, Emami
has over 65% market share in pain balms.
2. Pricing power and ability to negotiate with suppliers is generally
higher in a large company than in a generic mid-cap. However,
there are exceptions to this rule as each market niche has it own
dynamics.
3. The bargaining power that the smaller companies enjoy in
institutional and wholesale debt markets is lower and the
vulnerability to a liquidity squeeze is higher (in terms of both cost
and availability of debt).
4. Mid-cap companies often tend to be promoter-driven entities,
where the number of highly qualified professionals is lower. This
could prove to be a serious impediment to gaining and managing
scale. A key criterion in our choice of investment
recommendations is if the management is keen or not on
divesting authority to a carefully chosen team that can take the
company forward. In the case of Emami, for example, although
outside managers are not in abundance, promoter managers
themselves are qualified professionals.
5. The biggest risk from the investment point of view in mid-caps is
possibly liquidity risk. Typically the companies do not have
adequate free-float and liquidity generally dwindles in a bear
market as risk appetite falls. The key to investment in mid-caps
is a long enough investment horizon to overcome the need for
immediate liquidity in a distress situation.
6. The level of disclosures in most mid-caps is lower compared to
large-caps. Given the sporadic model of information
dissemination, earnings shocks are more likely.
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