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Click LINK Below for detail fact box of TOP PICKS:: Goldman Sachs India : October 2011
Click LINK Above for detail fact box of TOP PICKS:: Goldman Sachs India : October 2011
Spotlight: Our analysis indicates first quartile CROCI stocks
generate positive alpha across the cycle
> This is even true during uncertain market environments, as experienced in 2008 and 2011 ytd
We reiterate our view that cash returns are primary drivers of stock performance and better predictors of value than other commonly used
measures such as growth (see Introducing Director’s Cut – Returns matter more than growth - August 7th , 2009). To address the question
of whether investors should focus on high-return firms with strong balance sheets, or more risky (but cheap) stocks—we have examined
our coverage group in India through the prism of their cash returns.
We observe, as evident from the exhibit below, that companies with first quartile cash returns appear to be a consistent source of alpha
whereas companies with fourth quartile returns have consistently underperformed our coverage group in India. This is particularly true in
turbulent market conditions. The (short-lived) exception to this pattern occurred in 2007 when market exuberance drove modest
outperformance by companies with third and fourth quartile returns.
WeWe are not are not – for for a moment a moment – suggesting suggesting that investors should seek exposure to all first quartile companies Stock selection that investors should seek exposure to all first quartile companies. Stock selection – asas always always –
plays a critical role. What this data does, however, suggests that companies with first (and second) quartile returns provide more fertile
grounds for alpha generation than stocks that occupy the third and fourth quartiles.
Premium placed on direction and sustainability of first quartile
returns
Turning to the question of stock selection, we need to establish the sustainability of a particular company’s returns and finally, whether
this has been adequately priced in by the market.
On the first of these variables our analysis suggests that the market places a premium on the sustainability of first quartile returns and
> 10 first quartile Buy-rated companies that are undervalued
On the first of these variables, our analysis suggests that the market places a premium on the sustainability of first quartile returns and
rewards stocks for improvements to those returns (the average number of years for which a company can maintain first quartile returns is
2.8 years in Japan and 2.4 years in AEJ). This suggests that investors should focus on companies, which effectively manage drivers of
returns – namely cost efficiency, cash flow conversion, asset utilization, and capital efficiency.
Finally, to establish what is priced in, we have plotted our coverage group in India (excluding financials) on our Director’s Cut framework
(see slide 5). The underlying assumption of the methodology is that a company’s EV/GCI vs. CROCI/WACC ratio will converge with the
average average over time as under/overvaluations are arbitraged away We find the following: over time as under/overvaluations are arbitraged away. We find the following:
• First, despite the heterogeneous universe of stocks that we are examining, we find a 90% correlation between returns and market value
for our Indian coverage.
• Second, we have identified 10 ‘Buy’ rated companies, with first quartile returns that are – for the most part – improving and where these
returns do not appear to be adequately priced in by the market. These stocks are distributed across sectors, span the market cap spectrum, but are unified in that they deliver superior returns and appear to be undervalued.
Classifying our top quartile CROCI ideas
> Top Quartile ideas offer opportunities from structural change and lead to improving cash return profile
> Buy-rated stocks with sustained 1st quartile cash returns trading at attractive valuations offer good entry
levels
Automobiles: Exide Industries (EXID.BO, Buy, on our Conviction List)
• Battery replacement cycle follows the auto OEM demand cycle with about a 3-year lag, in our view. Trailing auto demand will approach its
peak in FY13-FY14, as the Indian auto industry experienced its strongest demand growth across segments during FY10-FY11. As a result,
India’s battery industry could witness its strongest revenue growth during FY13-FY14, as vehicles sold in FY10-FY11 require replacement
batteries.
• We believe Exide Industries is an ideal exposure to this investment theme, given its market leading manufacturing and distribution presence,
stable revenue and profit share during the weak demand period of FY10-FY11, and top quartile cash returns on capital invested.
Banks: IndusInd Bank (INBK.BO, Buy, on our Conviction List)
• In our view, INBK is best placed to create value for investors supported by improved strength of franchise (we forecast branch network to be at
550 by FY2013E vs. 310 in FY11), improving profitability and higher growth versus peers (22% earnings CAGR vs. 18%- 20% for the industry).
• We believe the re-rating will continue and INBK could potentially surprise over the long-term with better-than expected execution: (1) CASA
benefits from branch expansion (32.3% by FY2013E vs. 27.2% in FY11), (2) fee income to grow by a CAGR of 30% till FY14E and (3) aboveindustry industry asset growth asset growth.
Cement: Grasim Industries (GRAS.BO, Buy)
• Compelling Valuations: At 4.4X FY12E EV/EBITDA, Grasim is trading at a 20% discount to its mid-cycle of 5.5X and a 37% discount to peers
• This would imp y ( ) g % p , p g ply that either (1) the VSF business is trading at a 80% discount to peers, despite better EBITDA margins and returns; ( ) ; or (2) the
implied holding company discount for the cement business is a steep 50%, both of which appear unjustified
Consumer Staples: Marico (MRCO.BO, Buy)
• We expect Marico to exhibit sustained value growth on the back of a strong domestic business led by franchise brands - (Parachute and
Saffola) and the high growth in its international business
Goldman Sachs Global Investment Research 27
Saffola) and the high growth in its international business
• In our view, current valuations do not capture the high growth and return potential and we see a potential upside of 15%
Healthcare: Cipla Ltd. (CIPL.BO, Sell, on our Conviction List)
• Domestic revenue growth to underperform peers (past 2-yr CAGR was 11% vs. industry CAGR of 17%). We forecast a 12%/14% 3-yr revenue/EPS
CAGR (FY11-FY14E).
• Cipla’s cash returns have declined 900 bp over FY06-FY11 and we expect it to remain below sector average and offer no valuation support to the
stock
• Despite underperforming peers over the past 3 years, it trades at a premium valuation of 21% and 19% to peers on FY13E P/E and EV/ EBITDA,
respectively.
Industrials: Sintex Industries (SNTX.BO, Buy, on our Conviction List)
• We expect the strong revenue growth to continue (6 consecutive quarters of +20% growth) on good execution. We forecast the foreign custom
molding subsidiaries to record a 8% sales growth in FY12E and see limited impact from non-core investments
• Sintex is currently trading at 39% discount to its historical P/E. We expect the stock to trade at 10X average FY12-13E due to the strong growth and
returns for the company.
Infrastructure: IRB Infrastructure (IRBI.BO, Buy , on our Conviction List)
• Best direct exposure to road development and traffic growth, in our view. We note the company’s execution track record (3,413 lane km under
operation, 2322 lane km under development) and high cash generation ability.
• We believe current valuations are attractive (47% discount to historical median 12-m fwd P/E), with improving ROE and EPS growth over next two
years.
Information Technology: HCL Technologies (HCLT.BO, Buy, on our Conviction List)
• We prefer HCL Tech as it continues to transform from a low profile AD&M player to a total outsourcing IT services company with expertise in
Enterprise Application (through Axon) and Remote Infrastructure Management. We expect a sustained 21%/15% US$ revenue growth in
FY12E/FY13E as deal wins over past couple of years continue to ramp up volumes.
Goldman Sachs Global Investment Research 28
• We believe Infrastructure Management Outsourcing (IMO) will be the fastest growing segment in global IT outsourcing over next few years where
HCL is one of the best positioned firms globally. We forecast 29% revenue CAGR in FY11-FY14E (an extra US$1bn over US$830mn in FY11) for
the IMO business.
• At 11.8X FY13E P/E, below historical avg. (15X), we expect stock to trade at a premium at 14.4X on FY13E P/E
Metals & Mining: Jindal Steel and Power (JNSP.BO, Buy, on our Conviction List)
• In our view, JSPL is best positioned vs. peers to benefit from a potential hard landing scenario – given its diverse business mix, best-in-class
resource ownership (for steel and power), strong pipeline of growth projects, and robust balance sheet. We like JSPL for its strong earnings
growth trajectory (we expect 28% FY12-FY14E CAGR) and attractive valuation (trading near trough levels on both P/B and P/E basis)
• Currently trading near trough valuations on FY12E P/B and FY12 P/E. Our Rs 771 12-m SOTP-based target price implies FY12E P/B of 3.8x
and FY12 P/E of 16.5x, below mid-cycle levels of FY12 P/B 5.2x and P/E 17x.
Oil & Gas: Cairn India ( y) (CAIL.BO, Buy)
• Our Buy rating on Cairn India is based on our expectation of positive operational updates going forward after the Vedanta deal concludes this
month and the deal overhang on the stock ends. We forecast growth of Cairn’s production volumes by 2X between FY11-FY14E – one of the
best growth profiles among the emerging market “oily” stocks.
• Our 12-m SOTP-based target price of Rs351 for Cairn India implies potential upside of 30%. We estimate that Cairn stock is currently implying
long-term Brent price of US$72/bbl from FY13E into perpetuity. We estimate annual free cash flow of US$2.0+bn from FY13E.
Real Estate: Sobha Developers Ltd. (SOBH.BO, Buy, on our Conviction List)
• Sobha recently launched new projects in Bangalore and Gurgaon. Coupled with other upcoming launches in the next few quarters and unsold
inventory that represents a revenue and cash flow potential of about Rs65bn and Rs24bn, respectively.
• In addition, p y g p y , we value the company’s contractual and manufacturing business at Rs4bn. This compares favorably with Sobha’s current EV of
Rs34bn.
Telecom: Idea Cellular (IDEA.BO, Buy)
• Attractive risk-reward in the sector: With incumbent GSM operators increasing headline tariffs, we see further potential tariff hikes and see more
favorable risk-reward for Idea given better financial/operating leverage and given that it is a pure wireless operator.
• Valuations not expensive in the context of growth: We see more upside to our target price and find Idea’s valuations more attractive than Bharti
(BRTI.BO; Buy) (FY12E EV/EBITDA of 7.8X/9.2X for Idea/Bharti and FY11-FY14E EBITDA CAGR of 26%/21% for Idea/Bharti).
Utilities: Reliance Power (RPOL.BO, Sell)
•• WeWe do not believe the company do not believe the company s’s ROE will improve sufficiently to justify its current P/B until the commissioning of the Chitr ROE will improve sufficiently to justify its current P/B until the commissioning of the Chitrang angii power project power project.
We believe the current market price implies complete execution of 24.3GW of projects under construction and development. With RIL not likely
to ramp up gas production from its KG D-6 basin, we believe the gas-based projects are likely to be delayed further.
• The stock has high earnings sensitivity to changes in utilization risks and its earnings have potential downside risk if the operation environment
deteriorates further.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Click LINK Below for detail fact box of TOP PICKS:: Goldman Sachs India : October 2011
Conviction BUY Exide Industries
Conviction BUY IndusInd Bank
Conviction BUY Sintex
Conviction BUY IRB Infrastructure
Conviction BUY HCL Tech
Conviction BUY Jindal Steel
Conviction BUY Sobha Developers
BUY Grasim Industries
Buy Marico
Buy Cairn
Buy Idea Cellular
Sell Reliance Power
Sell Cipla
Spotlight: Our analysis indicates first quartile CROCI stocks
generate positive alpha across the cycle
> This is even true during uncertain market environments, as experienced in 2008 and 2011 ytd
We reiterate our view that cash returns are primary drivers of stock performance and better predictors of value than other commonly used
measures such as growth (see Introducing Director’s Cut – Returns matter more than growth - August 7th , 2009). To address the question
of whether investors should focus on high-return firms with strong balance sheets, or more risky (but cheap) stocks—we have examined
our coverage group in India through the prism of their cash returns.
We observe, as evident from the exhibit below, that companies with first quartile cash returns appear to be a consistent source of alpha
whereas companies with fourth quartile returns have consistently underperformed our coverage group in India. This is particularly true in
turbulent market conditions. The (short-lived) exception to this pattern occurred in 2007 when market exuberance drove modest
outperformance by companies with third and fourth quartile returns.
WeWe are not are not – for for a moment a moment – suggesting suggesting that investors should seek exposure to all first quartile companies Stock selection that investors should seek exposure to all first quartile companies. Stock selection – asas always always –
plays a critical role. What this data does, however, suggests that companies with first (and second) quartile returns provide more fertile
grounds for alpha generation than stocks that occupy the third and fourth quartiles.
Premium placed on direction and sustainability of first quartile
returns
Turning to the question of stock selection, we need to establish the sustainability of a particular company’s returns and finally, whether
this has been adequately priced in by the market.
On the first of these variables our analysis suggests that the market places a premium on the sustainability of first quartile returns and
> 10 first quartile Buy-rated companies that are undervalued
On the first of these variables, our analysis suggests that the market places a premium on the sustainability of first quartile returns and
rewards stocks for improvements to those returns (the average number of years for which a company can maintain first quartile returns is
2.8 years in Japan and 2.4 years in AEJ). This suggests that investors should focus on companies, which effectively manage drivers of
returns – namely cost efficiency, cash flow conversion, asset utilization, and capital efficiency.
Finally, to establish what is priced in, we have plotted our coverage group in India (excluding financials) on our Director’s Cut framework
(see slide 5). The underlying assumption of the methodology is that a company’s EV/GCI vs. CROCI/WACC ratio will converge with the
average average over time as under/overvaluations are arbitraged away We find the following: over time as under/overvaluations are arbitraged away. We find the following:
• First, despite the heterogeneous universe of stocks that we are examining, we find a 90% correlation between returns and market value
for our Indian coverage.
• Second, we have identified 10 ‘Buy’ rated companies, with first quartile returns that are – for the most part – improving and where these
returns do not appear to be adequately priced in by the market. These stocks are distributed across sectors, span the market cap spectrum, but are unified in that they deliver superior returns and appear to be undervalued.
Classifying our top quartile CROCI ideas
> Top Quartile ideas offer opportunities from structural change and lead to improving cash return profile
> Buy-rated stocks with sustained 1st quartile cash returns trading at attractive valuations offer good entry
levels
Automobiles: Exide Industries (EXID.BO, Buy, on our Conviction List)
• Battery replacement cycle follows the auto OEM demand cycle with about a 3-year lag, in our view. Trailing auto demand will approach its
peak in FY13-FY14, as the Indian auto industry experienced its strongest demand growth across segments during FY10-FY11. As a result,
India’s battery industry could witness its strongest revenue growth during FY13-FY14, as vehicles sold in FY10-FY11 require replacement
batteries.
• We believe Exide Industries is an ideal exposure to this investment theme, given its market leading manufacturing and distribution presence,
stable revenue and profit share during the weak demand period of FY10-FY11, and top quartile cash returns on capital invested.
Banks: IndusInd Bank (INBK.BO, Buy, on our Conviction List)
• In our view, INBK is best placed to create value for investors supported by improved strength of franchise (we forecast branch network to be at
550 by FY2013E vs. 310 in FY11), improving profitability and higher growth versus peers (22% earnings CAGR vs. 18%- 20% for the industry).
• We believe the re-rating will continue and INBK could potentially surprise over the long-term with better-than expected execution: (1) CASA
benefits from branch expansion (32.3% by FY2013E vs. 27.2% in FY11), (2) fee income to grow by a CAGR of 30% till FY14E and (3) aboveindustry industry asset growth asset growth.
Cement: Grasim Industries (GRAS.BO, Buy)
• Compelling Valuations: At 4.4X FY12E EV/EBITDA, Grasim is trading at a 20% discount to its mid-cycle of 5.5X and a 37% discount to peers
• This would imp y ( ) g % p , p g ply that either (1) the VSF business is trading at a 80% discount to peers, despite better EBITDA margins and returns; ( ) ; or (2) the
implied holding company discount for the cement business is a steep 50%, both of which appear unjustified
Consumer Staples: Marico (MRCO.BO, Buy)
• We expect Marico to exhibit sustained value growth on the back of a strong domestic business led by franchise brands - (Parachute and
Saffola) and the high growth in its international business
Goldman Sachs Global Investment Research 27
Saffola) and the high growth in its international business
• In our view, current valuations do not capture the high growth and return potential and we see a potential upside of 15%
Healthcare: Cipla Ltd. (CIPL.BO, Sell, on our Conviction List)
• Domestic revenue growth to underperform peers (past 2-yr CAGR was 11% vs. industry CAGR of 17%). We forecast a 12%/14% 3-yr revenue/EPS
CAGR (FY11-FY14E).
• Cipla’s cash returns have declined 900 bp over FY06-FY11 and we expect it to remain below sector average and offer no valuation support to the
stock
• Despite underperforming peers over the past 3 years, it trades at a premium valuation of 21% and 19% to peers on FY13E P/E and EV/ EBITDA,
respectively.
Industrials: Sintex Industries (SNTX.BO, Buy, on our Conviction List)
• We expect the strong revenue growth to continue (6 consecutive quarters of +20% growth) on good execution. We forecast the foreign custom
molding subsidiaries to record a 8% sales growth in FY12E and see limited impact from non-core investments
• Sintex is currently trading at 39% discount to its historical P/E. We expect the stock to trade at 10X average FY12-13E due to the strong growth and
returns for the company.
Infrastructure: IRB Infrastructure (IRBI.BO, Buy , on our Conviction List)
• Best direct exposure to road development and traffic growth, in our view. We note the company’s execution track record (3,413 lane km under
operation, 2322 lane km under development) and high cash generation ability.
• We believe current valuations are attractive (47% discount to historical median 12-m fwd P/E), with improving ROE and EPS growth over next two
years.
Information Technology: HCL Technologies (HCLT.BO, Buy, on our Conviction List)
• We prefer HCL Tech as it continues to transform from a low profile AD&M player to a total outsourcing IT services company with expertise in
Enterprise Application (through Axon) and Remote Infrastructure Management. We expect a sustained 21%/15% US$ revenue growth in
FY12E/FY13E as deal wins over past couple of years continue to ramp up volumes.
Goldman Sachs Global Investment Research 28
• We believe Infrastructure Management Outsourcing (IMO) will be the fastest growing segment in global IT outsourcing over next few years where
HCL is one of the best positioned firms globally. We forecast 29% revenue CAGR in FY11-FY14E (an extra US$1bn over US$830mn in FY11) for
the IMO business.
• At 11.8X FY13E P/E, below historical avg. (15X), we expect stock to trade at a premium at 14.4X on FY13E P/E
Metals & Mining: Jindal Steel and Power (JNSP.BO, Buy, on our Conviction List)
• In our view, JSPL is best positioned vs. peers to benefit from a potential hard landing scenario – given its diverse business mix, best-in-class
resource ownership (for steel and power), strong pipeline of growth projects, and robust balance sheet. We like JSPL for its strong earnings
growth trajectory (we expect 28% FY12-FY14E CAGR) and attractive valuation (trading near trough levels on both P/B and P/E basis)
• Currently trading near trough valuations on FY12E P/B and FY12 P/E. Our Rs 771 12-m SOTP-based target price implies FY12E P/B of 3.8x
and FY12 P/E of 16.5x, below mid-cycle levels of FY12 P/B 5.2x and P/E 17x.
Oil & Gas: Cairn India ( y) (CAIL.BO, Buy)
• Our Buy rating on Cairn India is based on our expectation of positive operational updates going forward after the Vedanta deal concludes this
month and the deal overhang on the stock ends. We forecast growth of Cairn’s production volumes by 2X between FY11-FY14E – one of the
best growth profiles among the emerging market “oily” stocks.
• Our 12-m SOTP-based target price of Rs351 for Cairn India implies potential upside of 30%. We estimate that Cairn stock is currently implying
long-term Brent price of US$72/bbl from FY13E into perpetuity. We estimate annual free cash flow of US$2.0+bn from FY13E.
Real Estate: Sobha Developers Ltd. (SOBH.BO, Buy, on our Conviction List)
• Sobha recently launched new projects in Bangalore and Gurgaon. Coupled with other upcoming launches in the next few quarters and unsold
inventory that represents a revenue and cash flow potential of about Rs65bn and Rs24bn, respectively.
• In addition, p y g p y , we value the company’s contractual and manufacturing business at Rs4bn. This compares favorably with Sobha’s current EV of
Rs34bn.
Telecom: Idea Cellular (IDEA.BO, Buy)
• Attractive risk-reward in the sector: With incumbent GSM operators increasing headline tariffs, we see further potential tariff hikes and see more
favorable risk-reward for Idea given better financial/operating leverage and given that it is a pure wireless operator.
• Valuations not expensive in the context of growth: We see more upside to our target price and find Idea’s valuations more attractive than Bharti
(BRTI.BO; Buy) (FY12E EV/EBITDA of 7.8X/9.2X for Idea/Bharti and FY11-FY14E EBITDA CAGR of 26%/21% for Idea/Bharti).
Utilities: Reliance Power (RPOL.BO, Sell)
•• WeWe do not believe the company do not believe the company s’s ROE will improve sufficiently to justify its current P/B until the commissioning of the Chitr ROE will improve sufficiently to justify its current P/B until the commissioning of the Chitrang angii power project power project.
We believe the current market price implies complete execution of 24.3GW of projects under construction and development. With RIL not likely
to ramp up gas production from its KG D-6 basin, we believe the gas-based projects are likely to be delayed further.
• The stock has high earnings sensitivity to changes in utilization risks and its earnings have potential downside risk if the operation environment
deteriorates further.
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