09 April 2011

52-WEEK FLOP: USHA MARTIN: Business Line

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The share price of steel wire maker Usha Martin has been on a downward spiral, on rising raw material costs and high interest expenditure , while realisations failed to keep pace. Further, there is a surfeit of domestic capacity for the production of billets and wire rods where the company is present.
Usha Martin produces wire rods and steel products used in the construction and automotive segments. While both segments have grown at a good pace over the last year, the company continues to operate several product lines at utilisation levels which are well below 50 per cent.
The low utilisation rate resulted in rising fixed costs with little gain in revenues or profits.
The nine-month period ending December 2010 saw flat net profits even as net sales grew 17 per cent. This was due to higher raw material and power bills which were up seven and 54 per cent respectively.
Interest costs ballooned to 42 per cent during the same period as the company is expanding its steel capacity and product line.
All of the above, in addition to higher depreciation, took their toll on the company's after-tax margins which were down to 4.6 per cent from 5.3 per cent for the nine month period ended December 2010

Business Line, Pivotals: Reliance Industries, Infosys, SBI and Tata Steel:: Week of April 11-15

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Pivotals: Reliance Industries (Rs 1,024.2)


The stock continued testing the Rs 1,055 level last week and failed to move beyond this. Falling by one per cent, the stock a formed a bearish engulfing candlestick pattern in the weekly chart signalling a short-term trend reversal. We go with the prior view that short-term traders should tread with cautiousness and initiate fresh short positions only if the stock declines below Rs 1,015 levels. Downwards targets are Rs 990 and Rs 956. On the other hand, a reversal from the current levels and strong move above Rs 1,055 will mitigate the bearish view. The stock can move higher to Rs 1,076 and then to Rs 1,090.
Over the medium-term, the stock is expected to consolidate sideways in the wider range between Rs 880 and Rs 1,160. A strong dive below Rs 956 can pull it down to Rs 920 or Rs 880 in the medium-term.
State Bank of India (Rs 2,779)
Last week, SBI moved higher contrary to expectations and gained 2 per cent. However, the volume accompanying this move was low. A decline in daily volumes over the past five trading sessions implies weakness in the current up move. The stock is currently testing the 200-day moving average around Rs 2,800. Short-term traders can consider initiating fresh short positions if the stock slips below Rs 2,740 with an initial target of Rs 2,693 and then Rs 2,650 or Rs 2,565. Nevertheless, a strong move above Rs 2,865 will mar the bearish stance and lift the stock higher to Rs 2,950 or to Rs 3,000 in the short-term.
However, the medium-term trend points downwards for the stock since its November 2010 peak. As long as the stock hovers below Rs 3,000, this downtrend will remain in place. But a strong close above this level will mitigate the trend.
Tata Steel (Rs 629.7)
Tata Steel increased by Rs 4 in the previous week, with low volumes once again, signalling caution in the near-term. The stock is reversing from the key resistance at Rs 640. Traders can initiate short position with stop-loss at Rs 640. The stock can decline to Rs 610 and then to Rs 600 in the days ahead. Subsequent supports are pegged at Rs 592 and Rs 575 levels.
Conversely, an emphatic rally beyond Rs 645 can lift the stock higher to Rs 660. As long as this resistance level is not breached, the medium-term down trend stays in place.
Infosys Technologies (Rs 3,226.9)
After gaining 2 per cent on Monday, the stock encountered resistance around Rs 3,300 and gave up those gains in the subsequent trading sessions. The stock formed a dragon fly doji candlestick in the weekly chart signalling bearishness. However, it is hovering above a key support level of Rs 3,200. Reversal from this level can lift the stock higher and consolidate between Rs 3,200 and Rs 3,300 band.
Fresh long position is advisable only on a strong move beyond Rs 3,300 levels. Targets are Rs 3,350 or Rs 3,400 and then Rs 3,450 in the ensuing weeks. However, a fall below its immediate support will extend the stock's decline to Rs 3,150 or Rs 3,100 in the near-term.

India Strategy 4Q FY11 Earnings Preview ::Macquarie Research,

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India Strategy
4Q FY11 Earnings Preview
Event
􀂃 Consumption strong, costs rising: We expect the 4Q FY11 earnings to
show 22% YoY growth in revenues and 20% growth in PAT for our coverage
universe. This translates to full year top-line growth of 20% and bottom-line
growth of 21%. We expect flat margins YoY and QoQ, as rising input prices
offset higher sales volumes, which have so far held up due to strong
underlying demand.
􀂃 Position your portfolio for FY12: Our overweight sectors – IT, Materials,
Healthcare and Energy – look well positioned to deliver strong results and
look ripe for accumulation. However, we will look to book profits in Cement,
Utilities, Autos and Financials in the upcoming strong results.

Build a portfolio of construction stocks:: Business Line,

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Construction stocks have steadfastly held on to their status as underperformers in 2011, with the bigger players losing between 1 per cent and 39 per cent of their share price from the start of the year. Slower execution of projects because of the prolonged monsoons and the resultant drag on net profits, along with the burden of rising interest rates, clouded the sector's prospects over a good part of last year.
Here's the silver lining though. With stock prices declining, valuations of construction companies are now rather attractive. Most of the major players are now available at a PE of less than 11 times trailing twelve month earnings. Low valuations, combined with healthy order-books and steady operating margins, suggest that these may be good additions to your portfolio.
Construction companies primarily undertake contracts to build anything from roads and bridges to industrial complexes and residential buildings. The growth prospects of these companies hinge on the potential in the infrastructure, commercial and residential real-estate space and industrial expansion.

WHY MARKET LAGGARDS

Nineteen of the 25 construction contractors in our coverage have declined between 1 per cent and 69 per cent from the start of 2010 to now. Collectively, the market capitalisation of the entire universe has dropped 24 per cent. In contrast, bellwether indices Sensex and Nifty generated positive returns of about 11 per cent, while the broader index BSE-500 returned about 8 per cent in the same period. Companies such as Man Infraconstruction and ARSS Infra, which posted stellar gains following initial public offers in early 2010, faltered towards the end of the year, while Ramky Infra and Ashoka Buildcon, which debuted in late 2010, plunged on listing, regardless of prospects or valuations.
Ranking among the worst performers are BL Kashyap & Sons, C&C Constructions and Patel Engineering — down 47 to 69 per cent - on concerns over delays in awarding of road projects, slackening residential construction and slowdown in project execution in the politically turbulent Andhra Pradesh . Moreover, the furore over corruption in the Commonwealth Games spilled over to the contractors who executed projects for the Games — particularly Ahluwalia Contracts and MBL Infrastructure.
Delays in key projects and prolonged monsoons in the second half of 2010 resulted in tame revenue growth after a robust June quarter. Interest costs, however, remained high due to working capital requirements and a rising interest rate. The quarters ending September and December 2010 saw collective revenues growing 14 per cent each. A 49 per cent rise in interest costs in the December quarter though, caused net profits to slid 14 per cent. Still, operating profits were fairly healthy, rising 7 and 11 per cent respectively in the September and December quarters.

TIME TO BET

While concerns do cloud prospects, these have been hovering for a couple of quarters. Current valuations seem to have factored in most of the challenges. From a trailing twelve-month valuation of 14.9 times in January 2010, construction stocks now trade at very reasonable 11 times trailing earnings. Here are the key reasons to bet on construction stocks:
Order book: Construction companies, on an average, have order-books executable in two to three years, providing good near-term earnings visibility. Many construction contractors also undertake State and municipal projects, where incidence of repeat orders are high and where contractors have established good relations.
Barring a few, most construction companies have seen healthy growth in order-books so far this fiscal. Companies such as Ramky Infra, Simplex Infrastructure, Supreme Infrastructure, Pratibha Industries, Unity Infraprojects and ARSS Infra score well on the order-book front.
Diversification: Though the shifting fortunes of real estate and roads, where lacklustre prospects execution delays have depressed growth, have impacted investor fancy for construction stocks, most construction players straddle multiple segments, allowing them to shift focus depending on segment prospects. Companies such as JMC Projects, Simplex Infrastructure, Sadbhav Engineering and Unity Infraprojects are diversified across industrial projects, mining, roads, power and realty. On the other hand, companies such as Man Infraconstruction, Simplex Projects and Ahluwalia Contracts have a high real estate presence which may dampen growth prospects for the next few quarters.
Presence in the growth segments of irrigation and waste management, which come under the purview of urban infrastructure development, will help companies build on orders and revenues. Here, Ramky Infra and Pratibha Industries score well.
Geographically, companies with a high exposure to the politically unstable Andhra Pradesh, such as Patel Engineering, have made a concerted effort to reduce exposure which will lessen the drag of stalled projects. Companies such as MBL Infra are also moving into the high-potential, better-margin North-Eastern States.
Backward integration: While raw material costs are a worry across sectors, players such as MBL Infra own stone quarries and manufacture ready mix concrete for own consumption, which reduces input costs. Price escalation clauses built into most contracts help shield companies from rising commodity prices. In fact, collective operating margins for the first nine months of FY-11 held strong at 14 per cent, even as prices of key commodities such as steel were on the rise.
Companies have also made heavy investments in ownership of capital equipment. For instance, ARSS Infra saw an 82 per cent increase in machinery in FY-10. Ownership of key equipment will help reduce hiring charges besides ensuring timely availability of equipment.
Scaling up: Contractors are slowly moving up the value chain to become developers, using consortiums to qualify. Their expertise in construction allows them to execute own projects, resulting in lower dependence on sub-contracting and better margins. Simplex Infrastructure, Sadbhav Engineering, Ashoka Buildcon, KNR Constructions, Ramky Infra and MBL Infra all have completed projects as developers and are in line to secure further orders.

RISKS

A rising interest rate scenario does create challenges for contractors looking to improve their net profit margins. Increase in equipment investments may entail higher depreciation. Net margins, therefore, at about 4-5 per cent now, are unlikely to show significant improvement in the near term, even as growth may be topline-driven. Debt requirement for players transitioning to developers may also shoot up, depending on the projects secured.
Companies with relatively lower debt, such as BL Kashyap, KNR Constructions and JMC Projects, may weather higher interest costs better than peers

52-WEEK BLOCKBUSTER: HEXAWARE TECHNOLOGIES: Business Line

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The stock of Hexaware Technologies has had a resounding run over the past several months. After a couple of challenging years in 2008 and 2009, when the company was grappling with fall in revenues, the situation seems to have substantially improved. The company was earlier struggling with anaemic volumes and pricing cuts.
But for the three quarters in succession in FY10, the company has posted healthy growth rates in revenues, with a double digit expansion in the last couple of quarters.
Billing rates have improved by about three per cent for onsite projects, though it is yet to pick up for offshore ones. Client additions in the $5-10 million and $20 million plus categories have been strong. Its top clients have started increasing IT spends over the past couple of quarters, allowing the company to benefit from the trend.
Hexaware still has levers such as increasing its utilisation levels and offshore component of revenues at its disposal, for optimising costs.
What has been even more heartening for Hexaware is the fact that with the September 2010 quarter, its forex losses have come to an end due to better management of its hedging programme.
Emboldened by improving traction in volumes and revenues, Hexaware has projected guidelines for at least 25 per cent growth in revenues in FY-11 compared to the previous fiscal and a double digit operating margin to go with it. A stock split that was carried out recently too has increased the activity in the counter

Commodities Comment The wrong kind of nickel in 2011::Macquarie Research

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Commodities Comment
The wrong kind of nickel in 2011
Feature article
 We update our nickel supply/demand estimates and reiterate our expectation
of a first-half deficit and second half surplus. We also note that there appears
to be too many ferronickel units being produced this year.

QUERY CORNER: Long-term uptrend in Tata Motors: Business Line

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Please give the technical view of Titan Industries.
R. Jain
Titan Industries (Rs 3,911.1): In our review of this stock in January, we had indicated that the stock was in a very strong uptrend and that the medium-term correction that began last November could halt in the zone between Rs 2,900 and Rs 3,000. We had given Rs 2,850 as the stop-loss for short-term investors and Rs 2,000 as the stop-loss for long-term investors.
The stock reversed higher from the low of Rs 2,943 formed in February after declining 30 per cent from its peak. As explained earlier, sideways move between Rs 2,950 and Rs 4,250 will be positive from a long-term perspective ushering in a rally to Rs 4,250 and beyond that to Rs 5,150 over the ensuing months. Investors with short- to medium-term perspective can book some profit if the stock stutters around the previous peak around Rs 4,250.

Cairn India – Vedanta deal: continues to be in limbo:: RBS

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The CCEA could not take a final decision on the deal and the matter has now been referred to a
GOM to be headed by the finance minister. We believe the real threat right now comes from
delays in approval to raise production (rather than non-approval of the takeover deal) which could
reduce FY12-13F EPS by 11-17%.

Info Edge India – Primed for growth: target price of Rs772: RBS

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We view Info Edge, India's leader in online classifieds, as a leveraged play on economic
growth, demographics and rising internet penetration. In our view, its strong balance
sheet/margins give it an edge over VC-backed peers to invest for growth. We believe
consensus underestimates momentum for FY12. Buy.

News headlines: April 8, 2011, The Royal Bank of Scotland

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News headlines
Oil & Gas
�� Cairn-Vedanta extend deal deadline after govt delays decision (Economic Times)
�� Power Ministry concerned over gas shortfall from RIL's KG-D6 (Economic Times)
Banks
�� SIB clocks Rs505.6bn business in 2010-11 (Economic Times)
�� Banks explore non-traditional markets to raise money (Economic Times)
�� Banking licence draft guidelines in next 15-20 days: Finance Ministry (Economic Times)
�� Foreign operations set to get a leg up at SBI (Business Standard)
�� Bahrain unrest gets to Indian banks (Business Standard)
Pharma
�� USFDA nod likely for Ranbaxy generic drug (Economic Times)
�� Glenmark inks pact with Canadian firm for anti-aging products (Economic Times)
�� Drug resistant superbug retains Delhi tag (Economic Times)
�� Zydus gets USFDA nod for diabetes drug trial (Business Standard)
Commodity
�� Stalemate continues among ministries over forest areas open for mining (Economic Times)
�� Orissa considers signing a fresh agreement with Rio Tinto (Economic Times)
�� SAIL FPO to hit market by May-end (Economic Times)
�� Volkswagen selects Steel Strips Wheels for supply of wheels worth Rs536m (Business
Standard)
Consumer
�� Godrej eyeing acquisitions in Asia, Africa (Economic Times)
�� IBM to provide shared services to PepsiCo India (Economic Times)
Retail/ Real Estate
�� Dubai properties 60% cheaper than Mumbai (Economic Times)
�� TVS Group plans foray into budget housing (Business Standard)
�� Ambuja Realty to come up with three new tourist resorts (Business Standard)
IT & Telecom
�� Vodafone-Essar deal: Essar to ask Vodafone to pay $700m more for 33% stake (Economic
Times)
�� BSNL's FY11 losses increase 50% to Rs27.25bn (Economic Times)
�� MNP response in Punjab not on expected lines: Tata Docomo (Economic Times)
�� Mobile subscriber base touches 791.38m (Economic Times)
�� BRPSE moots merger of BSNL, MTNL and ITI (Economic Times)
Power, engineering & infrastructure
�� GVK in talks to fund Hancock mines buy: Sources (Economic Times)
�� Reliance Infra asked to apply afresh for distribution license in Mumbai (Economic Times)
�� Incor Infra looking to add land parcels (Business Standard)
Automobiles
�� Ford India stops production of Ikon (Economic Times)
�� Ford mulls fresh investments, plant expansion in India (Economic Times)
�� BMW posts highest ever monthly sales in India in March (Economic Times)
�� Workers' inputs helped Maruti Suzuki save Rs1.6bn last fiscal (Economic Times)
�� Atul Auto sales up 60 % in FY-11 (Economic Times)

Shree Cement: Cement business to improve, but merchant power a drag; target price of Rs2,166 (Motilal oswal).

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Shree Cement: Cement business to improve, but merchant power a drag; maintain Neutral
Volume growth
 We expect volume growth to return, after a
muted FY11. Volumes would grow at 10.9%
CAGR over FY11-13 as against 9.9% CAGR
over FY09-11.
 Volume growth is likely to be in line with the
industry, unlike higher than industry average
growth of 33% CAGR over FY06-10.
 We expect capacity utilization to improve
from 77% in FY11 to 85% in FY12 and 95%
in FY13.
Market/business mix
 Shree Cement is a regional player focused
on North India. However, it has been gradually
diversifying into the Central region and now
derives ~72% of its volumes from North India
and 28% from Central India.
 Its incremental market mix is not expected
to change and would be driven by the northern
and central regions, where price increases
have been the highest in 4QFY11.
 Revenue contribution of merchant power is
likely to increase substantially to ~14% in
FY12 and 14% in FY13 (v/s 5% in FY10 and
8.6% in FY11E).
Cost and profitability
 Shree Cement is entirely dependent on pet
coke and imported coal. The recent increase
in domestic coal prices would not have any
impact on its costs or profitability.
 With pick-up in volumes of cement and
merchant power, it would benefit from higher
operating leverage.
 We estimate EBITDA/ton to improve by
Rs380 QoQ in 4QFY11 to Rs939 and by
Rs140 in FY12 to Rs922.

India Cements: Light at the end of the tunnel; buy target Rs117 (Motilal oswal).

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India Cements: Light at the end of the tunnel; maintain Buy
Volume growth
 We expect volume growth to return after degrowth
in FY11. We estimate volume CAGR
of 10% over FY11-13 as against 4.9% over
FY09-11.
 Volume growth would be driven by demand
pick-up in South India and entry into North
India.
 We expect capacity utilization to improve
from 65% in FY11 to 74% in FY12 and 78%
in FY13.
Market mix
 India Cement is focused on South India and
enjoys market leadership there. It has
recently diversified into North India, with a
1.5m-ton plant in Rajasthan.
 Incremental volumes would be driven by the
North and the South.
 In the short term, we expect South India to
be plagued by excess capacity.
 Given India Cement's concentration in South
India, we expect its 4QFY11 realization to
improve by Rs8/bag QoQ.

Birla Corp: Good market mix at great value; Buy; target Rs452 (Motilal oswal).

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Birla Corp: Good market mix at great value; maintain Buy
Volume growth
 We expect volume growth to improve to
10.8% CAGR over FY11-13, as against 6.5%
CAGR over FY09-11.
 Volume growth over the next two years would
be driven by ramp-up at the 1.7m-ton
expanded capacities.
 The company is adding a further 2.7m-ton
capacity through the brownfield route in
Rajasthan, which would be fully operational
by 2QFY13.
Market/business mix
 Birla Corp is a regional player focused on
North, Central and East India.
 Incremental volumes are expected to be driven
by the North and Central regions. These
markets have seen the highest price
increases on QoQ basis.
 We expect 4QFY11 realization to improve by
Rs22/bag QoQ.
 Its non-cement business contribution is
expected to remain stable at 7.7% of revenues.
Cost and profitability
 Birla Corp has high dependence on domestic
coal at ~70%, with linkage coal contributing
~65% of its total fuel requirement.
 We estimate Rs4-5/bag increase in energy
cost due to increase in prices of domestic
linkage coal by Coal India.
 We expect EBITDA/ton to improve by Rs440
QoQ in 4QFY11 to Rs1,159 and by Rs124
in FY12 to Rs1,055.

Jaiprakash Associates: Emerging giant; maintain Buy ; target Rs108 :: Motilal oswal,

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Jaiprakash Associates: Emerging giant; maintain Buy
Volume growth
 Jaiprakash Industries is likely to emerge as
the third largest cement group in India, with
total capacity of ~33m tons (~36m tons
capacity under control). In the next round of
capacity additions, it is targeting production
of 50m tons.
 We estimate volume growth of 24.2% CAGR
over FY11-13, driven by ramp-up in new
capacities.
 Volume growth would be driven by the
recently commissioned ~11m-ton capacities
(over FY10-12).
Market mix
 We expect Jaiprakash to diversify its cement
operations to become a pan-India play, with
a strong foothold in North and Central India.
 Incremental volumes would be well diversified,
as its operations in new regions scale up.
 We expect the company's 4QFY11
realization to improve by Rs20/bag QoQ.
Cost and profitability
 Jaiprakash is highly dependent on domestic
coal for its energy requirement; ~90% of its
current requirement is being met by
domestic coal (45-50% linkage). We
estimate Rs3-4/bag increase in cost due to
increase in domestic coal prices by Coal
India.
 However, benefit of fiscal incentives (at UP
and HP plant) coupled with benefit of higher
operating leverage would offset cost push.
 We estimate EBITDA/ton to improve by
Rs400 QoQ in 4QFY11 to Rs1,123 and by
Rs40 in FY11 to Rs1,018.

Grasim: Firing on both cylinders; maintain Buy :: Motilal oswal,

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Grasim: Firing on both cylinders; maintain Buy
Volume growth
 We expect cement volume growth for
subsidiary, UltraTech to improve to 12.2%
CAGR over FY11-13 as against 6.7% CAGR
over FY09-11.
 We estimate VSF business volume growth
at 10.4% CAGR, driven by new capacity
addition in FY13.
 Grasim is investing to expand capacity of
both cement (~9m tons) and VSF (~156,500
tons) to cater to future growth.
Market/business mix
 UltraTech's incremental volumes are expected
to be driven by the North and South. However,
its product mix is expected to improve, with
lower contribution from clinker, as new grinding
unit at Gujarat begins operations by FY12.
 Cement business contribution to pro-rata
consolidated revenue is estimated at ~65%
in FY12 (v/s 57% in FY11), with VSF
contributing the balance 35%.
Cost and profitability
 We expect cement business profitability to
improve by Rs290/ton QoQ in 4QFY11 to
Rs1,004/ton, and by Rs80/ton in CY11 to
Rs869/ton.
 VSF business profitability is likely to improve
by 100bp over FY11-13, driven by strong VSF
prices (assume Rs7/kg increase).
 We expect Grasim's consolidated EPS to
grow at 20% CAGR over FY11-13.

UltraTech Cement: Investing for future; upgrade to Buy :: Motilal oswal,

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UltraTech Cement: Investing for future; upgrade to Buy
Volume growth
 We expect volume growth to improve to
12.2% CAGR over FY11-13 as against 6.7%
CAGR over FY09-11.
 Volume growth would be driven by ramp-up
at the 15m-ton new capacities, which would
be sufficient to drive growth over the next two
years.
 However, in its cash cow business of white
cement, UltraTech is operating at peak
capacity and is likely to grow at just 3.7%
CAGR (FY11-13E).

Ambuja Cements: Market mix favorable in short run; upgrade to Buy :: Motilal oswal,

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Ambuja Cements: Market mix favorable in short run; upgrade to Buy
Volume growth
 We expect volume growth to improve to
10.5% CAGR over CY10-12 as against 6%
CAGR over CY08-10.
 The recently commissioned capacities of 7m
tons would be sufficient to drive growth over
the next two years.
 Since it would be replacing purchased clinker
with captive clinker, its incremental volumes
from these capacity additions would be lower.

Buy ACC: Return of volume growth; target 1,104 :: Motilal oswal,

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ACC: Return of volume growth; maintain Buy
Volume growth
 Volume growth has returned after three
years. We expect volumes to grow at a
CAGR of 11% over CY10-12 as against flat
volumes over CY08-10.
 The recently commissioned capacities of
7.2m tons would be sufficient to drive growth
over the next three years.
 With operations at new capacities stabilizing,
we expect volume growth to pick up in
1QCY11 to ~10% on a low base of last year
(volumes had declined by 2.6%).

BUY Cement: Bouncing back :: Motilal oswal,

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The cement sector has witnessed strong recovery in prices as rationality has prevailed. We believe
that the worst is behind us, with trough operating performance witnessed in 2HCY10. Long-term
demand drivers are intact, which would ensure return of normal growth. We are upgrading our
FY12 estimates by 2-18% to partly factor in for current prices. However, sustenance of discipline and
current prices in FY12 could drive further upgrades of 9-33%. Valuations are attractive and offer a
good entry point for the next upcycle. We prefer Ambuja Cements, JP Associates and Grasim
among large-caps, and Birla Corp and India Cements among mid-caps.
Worst is behind, trough made in 2HCY10
The cement industry witnessed a trough in its operating performance during 2HCY10. Muted demand (~4.5%
growth in 9MFY11) and excess capacity (~75% utilization) impacted realizations (~Rs35/bag decline from
peak of Rs255/bag) and profitability (decline of Rs1,100/ton from the peak to Rs450/ton in 2QFY11).
Revival in demand to be key catalyst for the next upcycle
Revival in demand is critical and would be the key catalyst for the next upcycle, especially considering limited
visibility in the short-run. Demand has disappointed in 9MFY11. However, long-term drivers in the form of
higher infrastructure spend, strong growth in rural housing and normal growth in urban housing remain intact.
While short-term visibility is limited, levers in the form of higher number of assembly elections over the next
3-5 years, FY12 being the terminal year of the Eleventh Five-year Plan, pent-up demand and low base of
FY11 could help to bring growth momentum back on track.
Peak capacity addition, bottom utilization behind; expect gradual improvement
Majority of the capacity additions are behind as only ~66mt of new capacities are expected to be added over
FY11-14 as against ~105mt over FY08-11. With expected pick-up in demand and decline in the pace of
capacity addition, we believe capacity utilization has bottomed out in 2HCY10 and should gradually improve.


Sharp recovery in cement prices to drive profitability 4QFY11 onwards
Cement prices have recovered by Rs30-40/bag. Peak construction season and production discipline would
lead to further price increases till 2QFY12 and would offset any cost inflation. We expect EBITDA/ton to
improve to ~Rs894/ton in FY12 and Rs993/ton in FY13 (v/s FY11 average of Rs760/ton) from the trough of
Rs525/ton in 2HCY10.
Upgrading FY12 EPS by 2-18% to partly factor in for current prices
We are upgrading our FY12 estimates by 2-18% to partly factor in current prices. This upgrade is on top of
the 3-9% upgrade post-Budget (to factor in the then prevailing cement prices and increase in coal prices by
Coal India). We are now assuming realization to be higher by Rs12/bag in FY12 (similar to 4QFY11 average
prices, but Rs10/bag lower than March 2011 exit prices).
What if discipline prevails for longer period?
Cement price recovery over the last two quarters can be largely attributed to discipline on production and
pricing in all the key markets, after a phase of irrationality. While it is futile to estimate longevity of these
arrangements, the longer they sustain, the higher would be the upgrades. If current prices sustain in FY12,
our EPS estimates would be upgraded by 9-33%.
Strong cash flows, cheap secondary market valuations drives stake increases by promoters
The Cement Industry has been generating strong operating cash flows driven by recovery in cement prices.
This coupled with limited capex plans have resulted in strong free cash flow generation for the industry.
Further, attractive secondary market valuations (at replacement cost of US$120/ton for large caps and
US$45-90/ton for mid-caps) is driving promoters to increase their stakes (Holcim’s creeping acquisition of
ACC/ Ambuja, A.V.Birla’s intention to increase stake in Grasim, Binani Industries de-listing Binani Cement,
Orient Paper’s issuing warrants at 20% premium to CMP etc).


Government intervention, breakdown in discipline and demand slowdown are key risks
We are positive on the cement industry, as we believe that operating performance has recovered from the
trough of 2HCY10. However, lack of pick-up in demand, government intervention in pricing and hyperinflation
in energy prices are the key risks to our view. While, supply issues and related pricing concern are addressed,
re-rating will be a function of revival in demand.
Good entry point – Buy
The worst is behind and we expect gradual improvement in operating performance. Though the sector would
continue to be plagued by over-capacity at least till December 11, cement prices would remain buoyant at
least till 2QFY12, driven by seasonality in demand and pricing discipline. However, long-term demand drivers
continue to be present. We believe current valuations offer a good entry point for the next upcycle. Valuations
for the cement stocks currently factor in bottom-of-the-cycle profitability. We prefer Ambuja Cements
(favorable market mix, return of superior profitability, creeping acquisition by Holcim and reasonable
valuations), JP Associates (emerging cement giant with pan India presence) and Grasim (positive outlook
for both Cement and VSF, and very attractive valuations) among large-caps, and Birla Corp (an efficient
player with strong balance sheet available at cheap valuations) and India Cements (very high operating
and financials leverage and option value in form of IPL and Indonesian coal mine) among mid-caps.


Worst is behind, trough made in 2HCY10
The cement industry witnessed a trough in its
operating performance during 2HCY10, as muted
demand and excess capacity impacted realizations
and profitability.
 Demand growth was muted at 4.5% in 9MFY11
as against estimated growth of 10-12%,
impacted by significant slowdown in
infrastructure activity and muted demand from
urban housing.
 This coupled with full impact of ~68mt capacity
addition since April 2009 resulted in drop in
capacity utilization to ~75% in 9MFY11 as against
~86% in FY10 and ~92% in FY09.
 Cement prices corrected significantly by ~Rs6/
bag in 9MFY11 (v/s average of FY10) and by
~Rs35/bag from peak to trough. This coupled
with cost push, in the form of higher energy cost,
higher freight cost and lower operating leverage
impacted EBITDA/ton by ~Rs620/ton in
9MFY11 (v/s Rs1,303/ton in FY10) and by
Rs1,100/ton to ~Rs450/ton from peak to trough.
 Cement stocks have out-performed in-line with
the benchmark over the last 12 months, as the
industry witnessed headwinds resulting in bottomof-
the-cycle operating performance.


Revival in demand to be key catalyst for the next upcycle
Revival in demand is critical and would be the key
catalyst for the next upcycle, especially considering
limited visibility in the short-run. Demand has
disappointed in 9MFY11. However, long-term
drivers in the form of higher infrastructure spend,
strong growth in rural housing and normal growth in
urban housing remain intact. While short-term
visibility is limited, levers are in place to help bring
growth momentum back on track.
 State elections: FY12 would witness assembly
election in five states viz. Assam, Kerala,
Pondicherry, Tamil Nadu and West Bengal. Spurt
in pre-election infrastructure development is
expected to drive cement demand. Recent
history corroborates this argument.
 Eleventh Five-year Plan’s terminal year:
Being terminal year of the Eleventh Plan, FY12
would see heightened execution to complete
planned projects. Terminal years of the Ninth
and Tenth Plans witnessed cement volume
growth of 9.6% and 9.4%, respectively.
 Pent-up demand: Pent-up demand due to
muted FY11 demand could support higher growth
in FY12. Historcially, demand growth has
bounced back after a muted year, with not a
single consecutive period of below average
demand growth.


Peak capacity addition is behind us, expect slowdown in pace of capacity addition
Majority of the capacity additions are behind only
~66mt of new capacities are expected to be added
over FY11-14 as against ~105mt over FY08-11. With
expected pick-up in demand and decline in the pace
of capacity addition, we believe capacity utilization
has bottomed out in 2HCY10.
 Pace of capacity addition to slow down from
FY12: Based on announcements of capacity
additions so far, we estimate only ~66mt of new
capacity over FY11-14 as against ~105mt of new
capacities over FY08-11. Further, annual
capacity addition expected from FY12 is <25mt.
 New capacity addition plans for FY15 and
beyond: Next round of capacity addition is
expected to begin now to prepare for meeting
growth for FY15 and beyond. There have been
announcements for new capacities by UltraTech
(~9.2mt by FY14) and Ambuja Cement (~3mt
by FY14).
 Delays in execution, ramp-up not ruled out:
We note that short-term pressure on operating
performance influenced few companies to delay
their projects or ramp-up of their recently
commissioned plants. Such delays, though not
factored in, can positively surprise on demandsupply
equilibrium. Also, lack of M&A deals has
deterred opportunistic new entrants.


Bottom-of-the-cycle utilization witnessed in 2HCY10, should improve gradually
With expected pick-up in demand and decline in the
pace of capacity addition, we believe capacity
utilization has bottomed out in 2HCY10.
 2HCY10 utilization at trough levels: Muted
demand and full impact of ~68mt capacity
addition since April 2009 resulted in 2HCY10
capacity utilization of ~72%, which we believe
is trough capacity utilization. We note that
capacity utilization in the previous down cycle
(FY02) also bottomed-out at ~72%.
 Utilization to improve gradually from here:
With expected pick-up in demand and decline in
pace of capacity addition, we estimate gradual
improvement from here-on. We estimate
capacity utilization to improve from ~77% in
FY11 to ~78% in FY12 and 80% by FY13
(assuming no further delays in new capacities).
 North & South regions – managing
utilization a key challenge: With significant
capacity addition happening in the North and the
South, capacity utilization in these regions is likely
to remain lower than national average. Any
predatory pricing in these regions will have
cascading impact on the other regions as well.



Cement prices recover sharply to near peak levels; expect further increases
Cement prices have witnessed sharp recovery of
Rs30-40/bag, after correcting from peak levels.
While cement prices are near peak levels, peak
construction season and production discipline would
lead to further price increases till 2QFY12.
 Recovery in cement prices much sharper
and faster than correction: Cement prices
have witnessed very sharp recovery of Rs30-
40/bag in the last two months across markets,
after witnessing correction of ~Rs35/bag (from
peak to trough in current cycle). Recovery has
been aided by pick-up in demand since January-
2011 and adherence to production discipline.
 Pricing stable despite trough utilization…:
As a result of production discipline, cement
prices have been stable in the medium term
despite bottom-of-the-cycle utilization levels.
While utilization levels have dropped from ~86%
in FY10 to ~77% in FY11, average cement
prices are expected to be lower by just Rs3/bag
in FY11 compare to FY10 cement prices.
 …impliys up even better pricing power
when utilization picks up: The stability of
pricing during a trough makes a foundation for
higher pricing power when utilization picks up
over next few quarters.



Higher prices to offset any cost push and improve profitability
Cost inflation driven by higher energy prices is
expected to be off set by higher cement prices. We
believe that EBITDA/ton would witness meaningful
improvement from the 2HCY10 average of ~Rs525/
ton.
 Cost inflation to persist…: Cost inflation is
expected to persist, driven by higher energy
prices (impacting power & fuel, freight and
packing costs). Coal cost is likely to remain high
and increase further as domestic linkage coal
supply shrinks and is progressively linked to
international prices. We are factoring in 5%
energy cost inflation for FY12.
 …but would be passed on…: Cost push being
industry-wide phenomenon, we believe that the
industry would pass it to consumers, albeit with
a lag effect. This coupled with benefit of higher
operating leverage will off set cost push. We
assume average ~Rs12/bag increase in FY12
realizations over FY11 (similar to 4QFY11 levels
and increase Rs10/bag lower than March 2011
levels) and Rs10/bag in FY13.
 …driving improvement in profitability: We
estimate improvement in EBITDA/ton from
trough levels of ~Rs525/ in 2HCY11. We
estimate EBITDA/ton at ~Rs894 in FY12 and
Rs993 in FY13 (v/s FY11 average of Rs760).



Prefer North region in short term as demand picks-up
For the short term, we prefer cement players focused
on North, Central and East India due to pick-up in
demand and sharp improvement in prices. However,
for the long term, we do not have regional bias.
 North region to benefit the most in the
short term…: With pick-up in demand in the
North and rationality prevailing, cement prices
have increased sharply by Rs25-30/bag in
CY11YTD, having a cascading impact on
Central and East India. With relatively higher
level of consolidation in North, Central and East
India, cement prices are expected to remain
stronger. Also, visibility of demand pick-up is
better in the North as against the South.
 …cascading impact in long run eliminates
any regional biases: Although cement is a
regional commodity, in the long run demandsupply
equilibrium in one region would have
cascading impact on other regions. We do not
have preference for any particular market in the
long run.


Discipline has prevailed so far…What if it prevails for longer period?
Cement price recovery over the last two quarters
can be largely attributed to discipline in production
and pricing in all the key markets, after going through
phase of irrationality. While it is futile to estimate
longevity of these arrangements, the longer they
sustain the higher would be the upgrades.
 Discipline has led to ~Rs40/bag increase
from trough: Discipline in production and
pricing since September 2010 has led to ~Rs40/
bag recovery in national average cement prices
from trough levels of 3QCY10, with increase of
~Rs80/bag in the South and ~Rs25-30/bag in the
North. Disciplined approach was triggered by
significant erosion in profitability of the industry
and its to service debt.
 What if it prevails for longer period?:
Disciplined approach has prevailed over the last
six months and has enabled recovery in
profitability despite muted demand and cost
inflation. What if this disciplined approach lasts
longer? Such cohesive discipline would enable
industry to take periodic price increases and passon
cost push, despite operating below optimal
utilization, and in turn positively surprise on
profitability and drive earnings upgrades.


Discipline has prevailed so far…What if it prevails for longer period?
 Cement prices can remain high despite low
capacity utilization: While cement prices and
capacity utilizations are correlated, in the short
to medium term, production discipline would lead
to divergence in this correlation. If discipline
prevails for longer period, we may see extended
period of lower utilization and higher prices.
 Focus on profitability rather than market
share: Smaller and marginal cement players did
not attempt to gain market share by dropping
prices. After witnessing significant erosion in
profitability (even cash losses for smaller player)
due to focus on market share, we believe these
smaller players are much more rational now. This
would aid sustenance of discipline.
 How long does this discipline need to
sustain? Sustaining these production
arrangements over the medium term would be
difficult as demand-supply dynamics would be
the key determinants of pricing. However,
discipline needs to sustain, especially in the South,
at least till monsoon (seasonally weakest period
for demand).


Sharp price recovery to drive significant earnings upgrades
Sharp recovery in cement prices over the last few
months has been surprising, considering demandsupply
imbalance. Consensus estimates are yet to
factor in these price increases.
 Sharp price increases to drive earnings
upgrades: The sharp recovery in cement prices
over the last few months has been surprising
and is not yet fully modeled in our and consensus
estimates. Our FY12 estimates partly model in
current cement prices and increase in coal prices
by Coal India. As a result, our estimates witness
upgrade of 2-18%. If we assume March 2011
exit prices to sustain for FY12, our FY12
estimates would see an upgrade of 9-33%.
 Cement prices near peak, but well below
long-term viable prices: Cement prices have
increased sharply and might look unsustainable.
However, current prices are still well below longterm
viable prices by ~Rs25/bag based on 15%
RoIC requirement (~5 year average) and ~Rs3/
bag lower than 10% ROIC-based pricing (~15
year average).


Government intervention, breakdown in discipline, demand slowdown and cost inflation are key risks
We are positive on the cement industry. Operating
performance has been recovering from the trough
of 2HCY10. However, lack of pick-up in demand,
government intervention in pricing and hyperinflation
in energy prices are the key risks to our view.
 Government intervention in pricing: Any
intervention of the government to curb cement
prices would be the key risk. The government
has in the past intervened in free pricing of
cement to curb inflation, severely impacting
operating performance by the cement compaines
and their stock prices.
 Breakdown in discipline: Any disruption in
prevailing discipline of production and pricing
would have a short-term impact on the
profitability of the industry. However, given the
recent experience of cash losses, we do not
expect discipline to break down.
 Demand slowdown: We are estimating strong
recovery in demand from ~5% growth in FY11
to 12% CAGR in FY12-14. Any failure of
demand pick-up would delay improvement in
utilization and operating performance.
 Energy cost inflation: Any hyperinflation in
energy prices would impact profitability of the
industry, if it is not passed through.



Valuations reasonable; good entry point
The worst is behind and we expect gradual
improvement in operating performance, though
volatility would remain high. This coupled with longterm
demand drivers and current valuations makes
a compelling Buy case.
 Trough behind us…: We believe that we have
already witnessed bottom-of-the-cycle
utilization, and expected gradual improvement
driven by of sustainable demand drivers.
 …but volatility to prevail: Although the sector
would continue to be plagued by over-capacity
at least till December 2011, cement prices are
expected to remain buoyant at least till 2QFY12,
driven by seasonality in demand. We expect high
volatility in cement prices and cement companies
performance over the next 6-9 months.
 Good entry point: Presence of sustainable
demand drivers and gradual recovery from the
trough of 2HCY10 would make the foundation
for the next upcycle. Valuations are attractive
and offer a good entry point for the next upcycle,
notwithstanding volatility in cement prices and
operating performance.
 Prefer Ambuja Cement, JP Associates and
Grasim among large-caps, and Birla Corp and
India Cement among mid-caps.














Pidilite Industries BUY Niche innovator :target Rs 170: IIFL

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Pidilite Industries BUY
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.

Indraprastha Gas BUY - Quality play on gas retailing ::target Rs400: IIFL

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Indraprastha Gas BUY - 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.

HT Media Limited BUY :A ‘fine’ print - taregt Rs 171: IIFL

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HT Media Limited BUY

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 ad-revenues 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.

:Havells India BUY:: Charged up: Target rs 475:: IIFL

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Havells India BUY:: 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.

Excerpts from IIFL’s interview with the founders of Emami, RS Agarwal and RS Goenka

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Excerpts from IIFL’s interview
with the founders of Emami, RS Agarwal and RS
Goenka
We met the co-founders of Emami in Kolkata. They discussed
the beginnings of Emami and how the company has used
product differentiation as the central pillar of their strategy.
They also outlined their approach towards organisation
building and implementing systems and processes as the
company looks to transform to a much larger scale.
Tell us about the beginnings of Emami.
RS Agarwal: We used to study in the same school and became very
close friends. After graduation, we used to meet almost every day
and started thinking about what we could do together, and decided
to start a small business together. That is how the journey started.
With an initial investment of Rs20,000, we started our business from
a 60-sq-ft space in the godown. Our first big success came in 1974,
we launched the Emami brand name and launched talcum powders
and vanishing creams under the brand name. Both products were
hugely successful—so much so that in talcum powder, we became
the second-largest player in the country and in vanishing cream, we
actually became the market leader, beating established MNC brands.
How did you go about the key marketing tasks—branding,
product design, etc?
RS Agarwal: Right from the start, our mantra has been
distinctiveness, differentiation and innovation. We studied the gaps
in portfolios of the top FMCG companies, and we tried to use these
gaps to position our brands. When all other established brands were
selling skin creams in tin containers, Emami was the first to come up
with plastic packaging, which was a refreshing change and looked
significantly better. While all established brands were using cheaper
perfume, we came with French perfume in our talcum powder and
creams. If you ask consumers who bought these products around
the 1970s, they still remember the perfume of Emami talcum
powder—it was so distinctive. We have followed the same mantra of
distinctiveness, differentiation and innovation in creating Boro Plus,
Navratna Oil and Fair & Handsome. Ours is the first company to have
come up with advertising in Hindi movies, a medium that was
probably the only form of entertainment for most people in the
1970s. So there was distinctiveness even in our style of advertising.
Were there failures in new products?
RS Goenka: Whenever the company faced any difficulty in any new
product launch, we were very fast to take decisions and withdraw
before any major loss was incurred. Our feedback mechanism and
MIS has been very strong from the very beginning, and this has
been the biggest reason we have managed to avoid major failures.
What has been your approach towards systems & processes?
RS Goenka: Our experience of having worked in the corporate world
stood us in good stead. For instance, from the very beginning, we
put in place a strong MIS for all parts of our business, be it sales,
purchase, manufacturing or supply chain. As early as 2003, we

introduced ERP in our company, when even many of the large MNC
FMCG companies in India were operating on far inferior IT systems.
We have a large internal audit team with over 60 persons who
constantly audit operations, including forensic audit. Beyond this,
whenever we need to look at improvements in our operations, we
appoint best-in-class consultants to give us the advice.
Emami group has very large businesses outside of FMCG.
RS Goenka: We are today one of the largest business groups in
eastern India. We are the India’s largest player in newsprint. In
hospitals, we are the biggest private sector player in the eastern
zone. We have a pharmacy chain, which is the biggest in the eastern
zone, and probably the biggest in the country after Apollo. In real
estate, what we have built in Bengal would be a matter of pride for
anyone.
There is a perception that Emami is a family-run business and
hence professionals do not work in the senior.
RS Agarwal: There is a big difference between owners running a
company and professional owners managing a company. We are
professional owners. Both Goenkaji and I have strong higher
education backgrounds and we have worked in the corporate world
in important positions. If I am a chartered accountant, MCom, LLB,
FCS, am I not a professional myself? Today, we have around 140
MBAs and around 100 CAs working in our group.
Emami has a diverse set of business and a number of family
members are involved in running the businesses. What are
the key aspects of managing such a structure?
RS Agarwal: To begin with, each of the companies in our group is a
completely separate entity. None of our companies can fund another
within the group. In each company, one member of the second
generation from each of the two families is involved. Either Goenkaji
or I is chairman of each company. We have very well-defined and
documented rules for all family members. The rules cover a large
number of aspects—owning fixed assets, making investments,
personal expenses, and so on. Independent directors on our board
include the former chairman of Ernst & Young India, Mr K N Memani;
former governor of West Bengal Mr Viren J Shah; and eminent
lawyer Mr Y P Trivedi.
How do you evaluate acquisitions?
RS Goenka: Way back in 1982, we took over Himani, which was a
sick business in Kolkata. We launched Boro Plus cream in 1983 and
followed it up with Navratna oil under the Himani brand name. We
acquired Zandu for a price that many analysts then thought was too
high, but it was based on a very thorough and highly detailed
internal analysis of potential returns. We were clear that Zandu was
a valuable franchise, and would generate very high returns after cost
rationalisation. Sure enough, profits multiplied 4x within 1-2 years
after we took over the company. The Zandu brand’s revenues, which
were growing at less than 10% annually, are today growing higher
than 30%, thanks to our innovative marketing strategy. The same
rigorous process of evaluation was done for Paras Pharmaceuticals
when we bid for the company. The evaluation was done for every
product in the Paras portfolio, looking at possible synergies and
opportunities for growth. We know the value of money as we started
very small and are very careful when we use our resources.

Emami BUY - The niche advantage :traget Rs 490: IIFL

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Emami BUY - The niche advantage

Emami is one of India’s fastest-growing 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.

Bajaj Finance Ltd BUY- Primed for a new phase :Target Rs1,050: IIFL

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Bajaj Finance Ltd BUY


Primed for a new phase

Bajaj Finance (BFL) is a play on the consumer and smallbusiness 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.

Bajaj Electricals BUY Resilient rural growth play :Target Rs280: IIFL

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Bajaj Electricals BUY
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-year-forward 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.
Strong brand name cum distribution to keep consumer
growth high: In consumer appliances, fans and lighting products,
BJE is primarily a marketing company and outsources most of its
manufacturing, which mitigates risk of competition from lower-cost
regional producers and Chinese exporters. The company plans to
launch new products (such as pressure cookers), which are underpenetrated
in rural areas. In these products, competition from other
incumbents is unlikely, as they would have to incur distribution costs,
whereas BJE already has an established network in rural markets.
Robust growth from government’s infrastructure programme:
The company derives 45% of its revenues from projects won under
various infrastructure development schemes (including transmission
tower development under the Accelerated Power Development and
Reform Programme, APDRP), on which spends are growing at 20%
annually.
Pricing power to partly offset cost pressure: BJE’s pricing power
enabled it to contain EBITDA margin losses at just 30bps during the
commodity inflation cycle of FY08–09. The company’s pricing power is
supported by a rational competitive environment both in its
consumer and engineering segments.

Amara Raja - The Challenger- BUY :Target Rs280: IIFL

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Amara Raja - The Challenger- BUY

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 twowheeler
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.
Capacity expansion will drive growth in the auto segment: Low
penetration and rising incomes would drive healthy double-digit
growth across segments in the auto industry. Meanwhile, the highmargin
replacement segment is set for a surge, as the last few years’
strong growth in vehicle sales translates to replacement demand for
batteries. ARBL, which plans to increase its annual battery capacity for
4-wheelers from 4.2m batteries to 6m, and for 2-wheelers from 1.8m
to 5m by October 2011, should be a key beneficiary.

India - Mid-caps: The Chosen Eight :: IIFL Bottom-up investment ideas

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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.

HDFC Bank: Operating parameters best in the class: Motilal oswal,

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Operating parameters best in the class
Superior return ratios; however, valuations are rich; Neutral
HDFC Bank is set to deliver EPS CAGR of 29% over FY10-13 v/s 25% over FY05-10. Strong
loan growth, led by expansion in rural and semi-urban areas, superior margins of over
4%+, improving operating efficiency impeccable asset quality will ensure RoA of 1.6%+,
RoE will improve to 20% by FY13 against 17% expected in FY11. While we are positive about
the bank's business, we believe valuations at PBV of 3.4x FY12E and P/E of 19.5x are rich.
Maintain Neutral.

Axis Bank: High CASA ratio and diversified income source : Motilal oswal,

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High CASA ratio and diversified income source - a key strength
Fall in credit cost, control over cost to income ratio to drive earnings growth
Axis Bank's key strengths have been its ability to grow CASA deposits (CAGR of over
40% over FY04-10) and diversified fee income (CAGR of over 50% over FY04-10). Unlike in
the past (2x of the industry growth), the bank is expected to grow 1.3x of the industry
growth, which will help CASA growth to maintain pace with overall deposit growth. We
expect return ratios to be strong with RoA of 1.5%+ and RoE of 19-20% over FY11-13 led by
strong core operating performance and a decline in credit costs.

Union Bank of India:Strong play on improvement in asset quality : Motilal oswal,

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Strong play on improvement in asset quality
Fall in credit cost and operating leverage to drive RoA; earnings CAGR of 30%
Union Bank of India (UNBK) is one of the few state-owned banks making extensive
investments in building strong IT infrastructure, manpower training, and brand and branch
makeovers. We believe this would enable the bank to grow faster than the industry.
Under the leadership of Mr Nair, UNBK has reported loan CAGR of 22% v/s ~20% for the
industry over FY06-11. Significant improvement in RoA is expected with a fall in credit
cost and operating leverage. Capital will not be a constraint for growth as the Government
of India has already infused Rs6.8b in FY11. We maintain Buy with a target price of Rs425
(1.4x FY13E BV).
Margins to remain at 3%+; positive surprise likely: Over FY10-11, UNBK has
reported significant volatility in margins, led by build-up of excess liquidity in the
balance sheet. Margins improved sharply to 3.44% in 3QFY11 after hitting the bottom
in 1QFY10 at 2.3%. We have modeled in blended margin improvement of ~60bp in
FY11 to 3.2% and a decline of ~15bp in FY12 (on a higher base). Our margin
assumptions are conservative considering (a) strong accretion in CASA deposits, (b)
expected improvement in CD ratio (72% as on 3QFY11), (c) benefit of capital infusion,
and (d) expected improvement in asset quality.
Asset quality improvement will lead to lower credit cost and improve RoA:
Over FY10-11, UNBK has reported significant stress on asset quality, led by slippages
from restructured loans, agri waiver related loans and slippages from SME and retail
segment. Slippage ratio for 9MFY11 stood at 2.8% v/s 1.9% in FY10 and average of
1.8% over FY04-09. In our view, slippage ratio is near to peak, with slippages from
restructured loans at ~18%, and strong economic growth outlook. Coupled with fall in
slippages, higher upgradations and recoveries will lead to lower credit cost in FY12.
To keep headline GNPA numbers low, UNBK aggressively wrote off NPAs over FY10-
11; higher than expected recoveries from the same will result in earnings surprises.
Operating leverage to play out; cost to core income ratio to decline: In FY11,
UNBK is likely to report 40%+ opex growth, led by 60%+ growth in employee expenses.
UNBK has reported pension deficit liability of Rs24b, translating into per employee
liability of ~Rs1.6m, significantly higher than Rs0.9m-1m for peers. Thus, downward
revision remains a possibility. On a higher base, opex growth is expected to be less
than 5%, lower than core income growth of 15%+. We expect cost to core income
ratio to come down sharply from 47% in FY11 to ~40% in FY12 and ~38% in FY13.
Opex to average assets will also decline from 1.7% in FY11 to 1.3% in FY12 and
1.2% in FY13, driving RoA improvement.
Fee income can provide positive surprises: Under the leadership of Mr Nair, UNBK's
fee income has improved sharply, with a CAGR of 25% over FY06-10. However, in
9MFY11, fee income growth has moderated (in line with the industry) to less than 5%,
led by lower processing charges. UNBK's fee income (excluding forex) to average
assets is one of the lowest at ~50bp v/s an average of 65bp for peers, indicating
significant scope for improvement. While we model in fee income growth of 15% over
FY12-13 on a lower base, positive surprise is likely.


3QFY11 highlights
Union Bank of India
Key positives
 NII grew 48% YoY and 5% QoQ, led by 67bp YoY
and 9bp QoQ improvement in NIM to 3.44%. Adjusted
for one-offs in 2QFY11, NIM improved 23bp QoQ.
 CASA ratio improved ~60bp QoQ to 33.3%. CASA
grew 27% YoY and 7% QoQ, led by strong growth
in savings deposits (33% YoY and 10.4% QoQ).
Key negatives
 Addition to GNPA was higher than expected at
Rs7.7b (annualized slippage ratio of 2.6%). High
write-offs (Rs4.5b v/s Rs1.5b in 2QFY11) and
recoveries (Rs2.6b v/s Rs1.9b in 2QFY11) resulted
in stable GNPA QoQ on reported basis.
 Core fee income growth remained muted QoQ and
grew 7% YoY.
Other highlights
 The bank has maintained its earlier guidance of
Rs24b towards second pension option (to be
amortized over five years) and of Rs2.5b towards
gratuity (to be fully provided in FY11). During the
quarter, it provided Rs1.2b (Rs3.6b till 9MFY11)
towards second pension option and Rs635m
towards gratuity (Rs1.9b provided till 9MFY11).
 Outstanding restructured loans stood at Rs52.5b
(3.9% of the loan book, facility-wise), of which ~18%
has slipped in to NPA.