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At Sterlite, our BUY call stands on a new price target of INR 97.5, down from INR
110. It has a dominant position in the local-optical fibre and power-conductor
businesses, both of which have strong demand drivers. Owing to a delay in orders
from PGCIL, low margin orders in the power conductor business and a fall in
realisation of optical fibre, performance may not meet our prior expectations.
Catalysts
Capacity expansion plans and continuing demand for its products will likely lead to
EPS growth of more than 20% from FY12 onwards.
Anchor themes
We think Sterlite is a play on industrial (telecom) and infrastructure (power
transmission) capex in India. In line with our theme report — small plays on big
capex idea — we expect a pick-up in industrial and infrastructure capex, especially
from FY12F onwards.
Bottoming out
Q3FY11 — lower margin impacts profitability
The top line was better than our expectation while the bottom line was
much below our as well as street expectation. In order to compensate
for delay in orders from Power Grid Corporation of India (PGCIL) and
lower lead time, the company had to bid for projects at very low
margin which impacted the bottom line heavily and thus PAT, in our
view. Low margin orders are likely to drag the profitability of this
business in the next 1-2 quarters. The optical fibre business is also
seeing some weakness in prices due to a fall in demand from China.
Management — key business drivers are intact
As per management, demand drivers for both the optical fibre and
power conductor businesses remain intact. The company stated it has
won two big orders from PGCIL and is in the process of bidding for
one more. Also, the first stage of the new vendor selection process is
complete and the company expects orders to start flowing very soon.
Change in estimates and price target
In view of the short-term delay in orders from the power sector, drop
in EBITDA margin in the power conductor business, weakness in the
optical fibre business and lower profitability in Q3FY11, we have
reduced our net profit estimates for FY11F and FY12F by 15.7% and
5.1% respectively. We cut our target price to INR 97.5 from INR 110.
Maintain BUY — 77% implied upside
Although we think the company faces short-term weakness in both
businesses (optical fibre and conductors) which is likely to impact
growth in profitability for the next few quarters, we still like the
business model and note the strong competitive positioning of the
company in our view. Maintain BUY.
Q3FY11 — lower margin impacts profitability
The company’s top line was better than our expectation and below the street’s
expectation. But the bottom line was much below our as well as the street’s
expectation.
PGCIL for the first time introduced a two-step process for selection of vendors, as the
company has many vendors. This has resulted in a delay in order flow from PGCIL,
especially in Q3FY11. Generally, PGCIL constitutes 40% of company revenue from
the power conductor business. In order to compensate for slower order flow from
PGCIL, use power conductor plant capacity and lower lead time, the company needed
to bid for projects at very low margin which impacted the bottom line heavily, in our
view.
As per management, the company still has low margin orders which will be executed
by Q4FY11 or Q1FY12 at the latest.
In our view, China is the major consumer of fibre in the world (~40%); demand in
China fell by 8% and the price of optical fibre fell by US$1 in Q3FY11 as compared
with Q3FY10. Also there were no sales from accessories and system integration in the
telecom business, which reached INR 3,000mn in Q3FY10 and contributed INR
300mn to EBITDA.
Management — key business drivers are intact
Telecom Products and Solution Business
Although demand in China has fallen by 8%, global demand has increased by 5% as
per management. As can be seen from the table below, company sales quantity has
increased.
We believe the company is aggressively seeking business in Europe and America in
order to reduce its dependence on China. International revenue from Europe and the
US was INR 2,010mn in Q3FY11 against INR 1,870mn in Q3FY10. We think Telecom
Service Providers (TSPs) in India will need to start building optical fibre links between
the towers soon, once 3G usage picks up in the country. We think the company is
already seeing some requests for proposals (RFQs) in the Indian market for these
activities.
As per management, the company has bid for INR 1,100 – 1,200mn of orders in the
system integration business and expects to win some of them and considers this
business to be a big opportunity based on infrastructure.
Power Conductor Business
We think the outlook for the power business is positive and should improve. As per
management, the company has already received two big orders from PGCIL and is in
the process of bidding for one more big order. As per management, the company
should receive an order of INR 6,000mn from PGCIL in Q4FY11.
As per Bloomberg (27 January 2011), Sterlite Technologies has been selected to
develop India’s first privately owned 765kV double circuit transmission system on a
“build, own, operate” (BOO) basis. The transmission line is expected to be
commissioned within 36 months and the company would maintain tenure for a
minimum of 35 years. It was reportedly a tariff-based competitive bidding process and
Sterlite won on the basis of its technical and financial credentials. This project is
expected to cost around INR 13,000mn in our view.
We believe Sterlite was earlier awarded the “East North Interconnection Project” to
develop a transmission system with a total line length of about 450 km, for two 400kV
Quad Double Circuit transmission lines in Assam, Bihar and West Bengal. We believe
this project will cost INR 9,000 -10,000mn which will be 70% debt-financed (tariff: INR
1,480mn). With these two big orders, the company’s total portfolio stands at a total
length of 1,100 km for development of transmission systems. As per management, the
company should be able to finance both these projects internally and has no plans to
raise equity.
In our view, both projects from PGCIL are a big positive — both will earn annuity
revenues with ROE in the high teens, per management. Management is very bullish
and provided a guidance of INR 4,000-5,000mn at EBITDA level form FY12.
Change in estimates
In our view, the short-term weakness in both businesses (optical fibre and power
conductors) is likely to impact growth in profitability for the next few quarters.
Accordingly, we have reduced our margins in Q4FY11 and Q1FY12 and thus net profit
estimates for FY11F and FY12F by 15.7% and 5.1% respectively.
Stock has underperformed the Sensex
The stock has underperformed the market with YTD (since 1 January 2010) returns of
-26.2% as against the Sensex which rose 4.8% during the same period. This
underperformance has been largely due to lower than expected Q2FY11 and Q3FY11
numbers and expectations of near-term weakness in volume growth in both
businesses, drop in realization of optical fibre and drop in margin in the power
business, in our view. In our view the stock has bottomed out.
Valuation methodology
We like the company’s business model and strong competitive positioning. In view of
slower earnings growth and short-term challenges, we have reduced our PT to INR
97.5 from INR 110. This is based on 12x one-year forward EPS. SOTL is trading at
8.3x one-year forward EPS and implied upside is 76.7%. This is based on one-year
forward EPS multiple of 12x now from 13.5x before but we reiterate our BUY call.
Investment risks
Delay in pick-up of capex cycle: demand for optical fibre and cables is dependent on
growth in the number of telecom subscribers, 3G and broadband services. Therefore,
any economic shock to the global economy could have a negative impact on the
growth of these demand drivers. Also, revenues of the power conductor business
could be affected if transmission capex in India is delayed.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Action
At Sterlite, our BUY call stands on a new price target of INR 97.5, down from INR
110. It has a dominant position in the local-optical fibre and power-conductor
businesses, both of which have strong demand drivers. Owing to a delay in orders
from PGCIL, low margin orders in the power conductor business and a fall in
realisation of optical fibre, performance may not meet our prior expectations.
Catalysts
Capacity expansion plans and continuing demand for its products will likely lead to
EPS growth of more than 20% from FY12 onwards.
Anchor themes
We think Sterlite is a play on industrial (telecom) and infrastructure (power
transmission) capex in India. In line with our theme report — small plays on big
capex idea — we expect a pick-up in industrial and infrastructure capex, especially
from FY12F onwards.
Bottoming out
Q3FY11 — lower margin impacts profitability
The top line was better than our expectation while the bottom line was
much below our as well as street expectation. In order to compensate
for delay in orders from Power Grid Corporation of India (PGCIL) and
lower lead time, the company had to bid for projects at very low
margin which impacted the bottom line heavily and thus PAT, in our
view. Low margin orders are likely to drag the profitability of this
business in the next 1-2 quarters. The optical fibre business is also
seeing some weakness in prices due to a fall in demand from China.
Management — key business drivers are intact
As per management, demand drivers for both the optical fibre and
power conductor businesses remain intact. The company stated it has
won two big orders from PGCIL and is in the process of bidding for
one more. Also, the first stage of the new vendor selection process is
complete and the company expects orders to start flowing very soon.
Change in estimates and price target
In view of the short-term delay in orders from the power sector, drop
in EBITDA margin in the power conductor business, weakness in the
optical fibre business and lower profitability in Q3FY11, we have
reduced our net profit estimates for FY11F and FY12F by 15.7% and
5.1% respectively. We cut our target price to INR 97.5 from INR 110.
Maintain BUY — 77% implied upside
Although we think the company faces short-term weakness in both
businesses (optical fibre and conductors) which is likely to impact
growth in profitability for the next few quarters, we still like the
business model and note the strong competitive positioning of the
company in our view. Maintain BUY.
Q3FY11 — lower margin impacts profitability
The company’s top line was better than our expectation and below the street’s
expectation. But the bottom line was much below our as well as the street’s
expectation.
PGCIL for the first time introduced a two-step process for selection of vendors, as the
company has many vendors. This has resulted in a delay in order flow from PGCIL,
especially in Q3FY11. Generally, PGCIL constitutes 40% of company revenue from
the power conductor business. In order to compensate for slower order flow from
PGCIL, use power conductor plant capacity and lower lead time, the company needed
to bid for projects at very low margin which impacted the bottom line heavily, in our
view.
As per management, the company still has low margin orders which will be executed
by Q4FY11 or Q1FY12 at the latest.
In our view, China is the major consumer of fibre in the world (~40%); demand in
China fell by 8% and the price of optical fibre fell by US$1 in Q3FY11 as compared
with Q3FY10. Also there were no sales from accessories and system integration in the
telecom business, which reached INR 3,000mn in Q3FY10 and contributed INR
300mn to EBITDA.
Management — key business drivers are intact
Telecom Products and Solution Business
Although demand in China has fallen by 8%, global demand has increased by 5% as
per management. As can be seen from the table below, company sales quantity has
increased.
We believe the company is aggressively seeking business in Europe and America in
order to reduce its dependence on China. International revenue from Europe and the
US was INR 2,010mn in Q3FY11 against INR 1,870mn in Q3FY10. We think Telecom
Service Providers (TSPs) in India will need to start building optical fibre links between
the towers soon, once 3G usage picks up in the country. We think the company is
already seeing some requests for proposals (RFQs) in the Indian market for these
activities.
As per management, the company has bid for INR 1,100 – 1,200mn of orders in the
system integration business and expects to win some of them and considers this
business to be a big opportunity based on infrastructure.
Power Conductor Business
We think the outlook for the power business is positive and should improve. As per
management, the company has already received two big orders from PGCIL and is in
the process of bidding for one more big order. As per management, the company
should receive an order of INR 6,000mn from PGCIL in Q4FY11.
As per Bloomberg (27 January 2011), Sterlite Technologies has been selected to
develop India’s first privately owned 765kV double circuit transmission system on a
“build, own, operate” (BOO) basis. The transmission line is expected to be
commissioned within 36 months and the company would maintain tenure for a
minimum of 35 years. It was reportedly a tariff-based competitive bidding process and
Sterlite won on the basis of its technical and financial credentials. This project is
expected to cost around INR 13,000mn in our view.
We believe Sterlite was earlier awarded the “East North Interconnection Project” to
develop a transmission system with a total line length of about 450 km, for two 400kV
Quad Double Circuit transmission lines in Assam, Bihar and West Bengal. We believe
this project will cost INR 9,000 -10,000mn which will be 70% debt-financed (tariff: INR
1,480mn). With these two big orders, the company’s total portfolio stands at a total
length of 1,100 km for development of transmission systems. As per management, the
company should be able to finance both these projects internally and has no plans to
raise equity.
In our view, both projects from PGCIL are a big positive — both will earn annuity
revenues with ROE in the high teens, per management. Management is very bullish
and provided a guidance of INR 4,000-5,000mn at EBITDA level form FY12.
Change in estimates
In our view, the short-term weakness in both businesses (optical fibre and power
conductors) is likely to impact growth in profitability for the next few quarters.
Accordingly, we have reduced our margins in Q4FY11 and Q1FY12 and thus net profit
estimates for FY11F and FY12F by 15.7% and 5.1% respectively.
Stock has underperformed the Sensex
The stock has underperformed the market with YTD (since 1 January 2010) returns of
-26.2% as against the Sensex which rose 4.8% during the same period. This
underperformance has been largely due to lower than expected Q2FY11 and Q3FY11
numbers and expectations of near-term weakness in volume growth in both
businesses, drop in realization of optical fibre and drop in margin in the power
business, in our view. In our view the stock has bottomed out.
Valuation methodology
We like the company’s business model and strong competitive positioning. In view of
slower earnings growth and short-term challenges, we have reduced our PT to INR
97.5 from INR 110. This is based on 12x one-year forward EPS. SOTL is trading at
8.3x one-year forward EPS and implied upside is 76.7%. This is based on one-year
forward EPS multiple of 12x now from 13.5x before but we reiterate our BUY call.
Investment risks
Delay in pick-up of capex cycle: demand for optical fibre and cables is dependent on
growth in the number of telecom subscribers, 3G and broadband services. Therefore,
any economic shock to the global economy could have a negative impact on the
growth of these demand drivers. Also, revenues of the power conductor business
could be affected if transmission capex in India is delayed.
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