Sun Pharmaceutical- Target Price (INR) 950 USD550mn payout is a mild hurdle on the M&A path: Avendus

SUNP and TEVA have admitted to patent infringement on gProtonix. Of
the windfall USD2.15bn payoff to PFE, the burden for SUNP falls at
USD550mn, payable in 2013. The payout a) Is significantly higher than
the cUSD105mn provision of 2QFY13; b) And cuts SUNP’s consolidated
net cash by c50%, the balance is held by TARO, to which SUNP has no
direct access; c) It reduces SUNP’s ability for an immediate big‐ticket
acquisition and even smaller, bolt‐on deals; and d) Though smaller in
impact, SUNP’s INR‐denominated cash reserves continues to take a hit
from the weakening INR. Our Jun14 TP is lowered to INR950; maintain
Hold. An immediate, knee‐jerk reaction is likely, led by the expected
impact on acquisition plans in the near future. However, with strong
cash flows, SUNP’s long term funding capabilities stay intact.

Sundaram Finance Target price (INR) 452 Momentum in loans sustains, upgrade to Hold ::Avendus

The higher‐than‐expected growth in the NII was driven by an
improvement in NIMs along with continued momentum in aggregate
loans. Calculated NIMs improved c30‐bp q‐o‐q to 7.4%, likely to have
been led by a rising proportion of used vehicles in the overall loan mix.
The proportion of used vehicles may not rise beyond current levels in
the near term, as per the management; consequently, the rise in NIMs
may not sustain. We forecast stable NIMs at a three‐year mean of 6.9%
over FY13f–FY15f. The marginal uptick in GNPLs from 0.78% at Sep12‐
end to 0.88% at Dec12‐end is unlikely to be alarming. We raise our
earnings by 2%–5% over FY13f–FY15f, driven largely by higher
disbursements and consequently loans. We raise our Dec13 TP to
INR452 and upgrade to Hold. Slowdown in loans & high NPLs are key
risk factors.
Strong NII growth driven by sequential improvement in spreads
A c20‐bp improvement in spreads was aided by a 50‐bp sequential expansion in
the yields. Combined with a 5% q‐o‐q loan growth drove a 24% y‐o‐y NII
expansion, higher than expectations. Used vehicles now constitute c13%, while
cars and new CVs continue to be the dominant segments at 34% and 53% of
overall loans, respectively. We raise our disbursement forecast from a CAGR of
14% to 16%, while aggregate loans are forecast to increase at a CAGR of 18%
over FY13f–FY15f.
Improvement in NIMs may not sustain
NIMs improved c30‐bp q‐o‐q to c7.4%, likely to have been driven by a rising
proportion of used vehicles in the overall loan mix. The proportion of used
vehicles may not rise beyond the current levels as per the management;
consequently, the rise in NIMs may not sustain. We forecast stable NIMs at a
three‐year mean of 6.9% over FY13f–FY15f.
Marginal uptick in NPLs, though not alarming
GNPLs, as a proportion of aggregate loans, increased from 0.78% at Sep12‐end
to 0.88% as at Dec12‐end. We project incremental gross NPLs at 0.6% of loans
and loan‐loss provisions to average loans at a mean of 0.3% over FY13f–FY15f.
Raise earnings by 2%–5%, upgrade to Hold
We raise our FY13f–FY15f earnings by 2%–5%, led by higher disbursements and
loans. The stock has underperformed the Bankex by 6% and the NBFC Index by
10% over the past three months. Valuations at 2.6x one‐year fwd P/B still
appear rich. The Dec13 TP is raised to INR452 and we upgrade to Hold.

Utilities- Turning point may be getting closer :Avendus

Reforms are likely to be undertaken in FY13f to revive the Indian
power sector. If left unchecked, annual losses of all state‐level
distributing companies are likely to reach 1.2% of the GDP. Likely tariff
hikes by DISCOMs need to be supplemented by measures that would
ensure a steady coal supply to the new thermal generating capacity of
c7GW at a stable and reasonable price. The benefits of such reforms
and expected firming up of merchant tariffs are likely to improve
earnings from FY14. Even with the well‐known stress, the consensus
forecasts for the power companies’ FY13 and FY14 earnings growth
exceed that of the Nifty. This is likely to preserve the premium in the
P/E over the Nifty. We initiate coverage with Buy ratings on NTPC and
ADANI, an Add rating on TPWR and a Hold rating on JSW.

Reliance Communications Target Price (INR) 59 Concerns on growth remain :Avendus

Dishman Pharmaceuticals & Chemicals Target Price (INR) 52 Confidence yet to flow, but operating leverage can deliver :: Avendus

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Bank of India Target Price (INR) 455 Other income and low opex drives profitability: Avendus,

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Rise in other income, sequential NIM expansion and decline in
operating expenses led to c93% y‐o‐y growth in the net profit in the
Mar12 quarter. Other income was driven by recovery from written‐off
accounts. Domestic NIM expanded 43‐bp sequentially to 3.29%. Gross
NPL and net NPL ratios declined for the second consecutive quarter up
to 40‐bp sequentially. Restructured loans increased c31% q‐o‐q to
INR179bn, 7.1% of the total loans. We raise our FY13f PAT forecast by
up to 27% to factor in lower NPL provisions and operating expenses.
We rollover the TP to Mar13 and raise it by 8% to INR455. The TP
values BOI at 1.1x the one‐year forward adjusted book value. We
upgrade the rating to Buy. Higher‐than‐estimated incremental NPL and
NPL provisions are the key risks.
Other income and decline in operating expenses drive net profit
Other income growth of c17.5% y‐o‐y was largely driven by strong recovery in
the written‐off accounts, amounting to INR1.9bn (107% y‐o‐y). Furthermore,
operating expenses fell c24.5% to drive the c93% growth in the net profit. The
43‐bp q‐o‐q rise in domestic NIM to 3.29% was led by a 33‐bp rise in yield on
domestic loans. Savings deposits growth continued to moderate at 13% y‐o‐y.
However, CASA ratio (domestic) improved 60‐bp sequentially, mainly due to
the moderation in term deposits growth. Domestic loan growth (7% y‐o‐y)
continued to decelerate due to a slowdown in the corporate segment and rose
7.4% y‐o‐y, while retail (15% y‐o‐y) and agri (33% y‐o‐y) grew faster.
Strong recovery coupled with low slippage drives fall in NPL ratios
Gross NPL and net NPL ratios dropped sequentially by 40‐bp and 31‐bp to
2.34% and 1.47%, respectively. Slippages declined c27% q‐o‐q to INR3.8bn
(0.6% of annualized loans). However, outstanding restructured loans increased
sequentially by c31% to INR179bn. Restructured loans, as a percentage of gross
loans, were 7.1% at the end of Mar12. We lower our assumption for
incremental NPL up to 20‐bp and reduce the NPL provisions forecast for FY13f–
FY14f. However, NPL ratios are forecast to rise in FY13f.
Raise net profit forecast up to 27% for FY13f–FY14f
We raise our FY13f–FY14f net profit forecast up to 27%, driven by lower NPL
provisions and operating expenses. We have reduced our assumption for
growth in the average pay per employee by up to 5% for the period. While we
lower our assumption for incremental NPL by up to 20‐bp to 60‐bp, it remains
above that in FY12. The NPL provision‐to‐asset is estimated at 49‐bp during
FY13f–FY15f (above the last two years’ average at 45‐bp).
TP values BOI at 1.1x one‐year forward P/B
Large improvement in the asset quality during the Mar12 quarter is likely to
drive the near‐term outperformance. We rollover the TP to Mar13 and raise it
to INR455. The TP values BOI at 1.1x the one‐year forward book value. We
upgrade the rating to Buy. Higher‐than‐estimated incremental NPL due to large
restructured loans and NPL provisions are key risks.

Power Finance Corporation Target Price (INR) 224 Forex reversal drives net profit growth, maintain Buy:: Avendus

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Net interest income was in line with estimates at INR10.9bn, driven by
28% y‐o‐y growth in the loan book. NIMs declined 12‐bp sequentially,
driven by interest income reversal of INR190mn on account of stressed
assets during the Dec11 quarter. Stable operating costs along with a
reversal in foreign exchange provision drove 68% y‐o‐y growth in net
profit, ahead of estimates. GNPLs increased to INR6bn on account of
slippage in one project. Management maintains the stress is limited to
only two projects. We maintain our estimates and forecast a CAGR of
22% in loans over FY12‐FY14. We forecast NIM to average at 3.9% over
FY12‐FY14. We lower our TP to INR224, as we roll it over to Dec12.
Maintain Buy. A higher‐than‐estimated rise in NPLs and sharp
slowdown in loan growth are risk factors.
Growth in loan book continues, disbursements and sanctions pick up
Balance sheet loans grew 28% y‐o‐y, driven by generation loans and sharp pick
up in short‐term loans. The 21% q‐o‐q growth in sanctions was encouraging,
after modest growth during 1HFY12. Disbursements grew 40% y‐o‐y during the
quarter, driven by the generation segment and APDRP‐related disbursements.
We maintain our forecast of a CAGR of 22% in loans, driven by a CAGR of 13%
in disbursements between FY12 and FY14.
Spreads stable; NIMs decline 12‐bp due to interest reversal
Spreads were stable sequentially; however, NIMs declined by 12‐bp q‐o‐q due
to interest reversal of INR190mn on account of a stressed asset. Adjusted for
interest reversals, NIMs would have increased sequentially. The pressure on
spreads is likely to ease in FY13f with improvement in system liquidity, equity
issuance and higher re‐pricing of assets (cINR330bn) than liabilities (cINR54bn).
We forecast stable NIMs, at a three‐year mean of 3.9% over FY12‐FY14.
Higher net profit driven by reversal of foreign exchange provisions
POWF reversed INR4.1bn of foreign exchange provisions during the quarter out
of the INR6bn recognized during 1HFY12, post adjusting the INR1.9bn booked
during the Dec11 quarter. Operating costs remained stable at INR2.9bn. Thus,
net profit growth of 68% y‐o‐y and 164% q‐o‐q was higher than estimates. We
maintain our estimates and forecast a CAGR of 20% in earnings for POWF
between FY12 and FY14.
Rise in GNPLs; management maintains stress is limited to two projects
GNPLs increased to INR6.3bn during the quarter from INR130mn outstanding at
end Sep11 due to slippage in a large project in Andhra Pradesh. The project is
facing issues on account of unavailability of coal. Management maintains the
stress is limited to just this project and another wind‐based project.
Lower Dec12 TP to INR224; valuations inexpensive
Our target is based on the DCF, P/E and P/B methods. Our DCF‐based fair value
stands at INR242/share. We rollover the target price to Dec12 and lower it to
INR224. Valuations at 1.2x one‐year forward P/B remain inexpensive. Maintain
Buy. Higher‐than‐estimated NPLs and a sharp slowdown in loan growth are risk
factors.

MOIL Target Price (INR) 249 Downgrade to Reduce due to recent out performance:: Avendus

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MOIL’s operational performance in the Dec11 quarter was lower than
estimates due to 7.3% decline in realizations and increase in other
expenditure. Other expenditure increased by 45.9% q‐o‐q to
INR481.9mn. Net profit increased by 0.5% q‐o‐q to INR1bn (against our
estimates of INR1.3bn). We lower our net profit forecast for FY12‐FY14
by up to 22.3% as we cut our realization estimates by 12.5% and raise
other expenditure by up to 10.0%. We lower our target to INR249,
after a rollover to Dec12 and downgrade rating on the stock to Reduce
due to 25.5% increase in stock price since Dec11.
Net sales declined by 3.5% q‐o‐q to INR2.4bn due to lower realizations
Net sales declined by 3.5% q‐o‐q to INR2.4bn (against our estimate of
INR2.7bn) due to 2.3% decline in manganese ore sales and 7.3% decline in sales
of electro manganese oxide. The decline in sales of manganese ore is due to
7.3% decline in realizations due to sales of low grade manganese ore and fines.
Sales volume increased by 5.4% q‐o‐q to 285,500 tonnes. Downward revision of
prices starting Jan12 for various grades of manganese ore has led us to lower
our realization estimate for FY12f‐FY14f by up to 12.5%. Our revenue estimates
for FY12f – FY13f are lowered by up to 13.2%.
EBITDA declined by 1.5% q‐o‐q to INR1.1bn
EBITDA declined by 1.5% q‐o‐q to INR1.1bn due to higher other expenditure.
Other expenditure increased 45.9% q‐o‐q to INR482mn. Royalty and cess
payment declined by 2.3% q‐o‐q with lower revenues. Staff cost declined by
7.4% q‐o‐q to INR567.2mn. We raise our estimates for other expenditure for
FY12f – FY14f by up to 10% to account for the increase in cost during 3QFY12.
This along with the decline in revenue estimates has led us to cut our FY12f –
FY14f EBITDA by up to 31.6%.
Net profit up 0.5% q‐o‐q due to higher other income
Net profit increased 0.5% q‐o‐q to INR1bn (against our estimate of INR1.3bn)
due to higher other income. Other income increased 5.3% q‐o‐q to INR498mn
due to increase in cash and cash equivalents and higher yield on investments.
Depreciation provisioning increased q‐o‐q by 1.3% to INR72.8mn. Tax/PBT of
33.2% was in line with estimates. We estimate cash and cash equivalents of
INR128/share as on Mar12.
Cut net profit forecast by up to 22.3%; Downgrade to Reduce
We cut our net profit forecast for FY12‐FY14 by up to 22.3% as we lower our
realization estimates by 12.5% to account for the downward revision in prices
with effect from Jan12 and raise other expenditure by up to 10.0%. We lower
our target price to INR249, after a rollover to Dec12, as we discount the
historical average (Dec10 – Feb12) EV/EBITDA and P/E by 30% to reflect the
commodity cycle of the manganese ore business. The 25.5% increase in stock
price since beginning Dec11 has led us to downgrade our rating on the stock to
Reduce. Risk factors include an increase in international manganese ore prices
and higher than estimated volumes.

Pharmaceuticals - Much more than a defensive:: Avendus

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Outperformance by Pharma helped add c200‐bp to its weight in the
Nifty over 2010 and 2011. This is a part of a long‐term reversal that
may lift the weight to c5% by end of FY13f. Our model also points to
high absolute return of c40% during FY13. Pharma scores well among
‘defensive’ sectors due to its relatively low P/E, higher earnings growth
and the shrinking PEG gap. Within Pharma, investors’ perception
points to a peaking mind share of US exports and the larger role of the
domestic market in shaping valuations. In US generics, the focus is
likely to shift to the base pipeline; DRRD is our preferred play. SUNP is
our classical defensive pick; CIPLA is a defensive in a volatile
environment. DIVI is our pick to participate in the upturn.
Expansion in sector’s Nifty weight, high absolute returns may persist
We observe a strong correlation between the pharma sector P/E’s
premium/discount (P/D) to the Nifty P/E and the corresponding change in the
sector’s weight. If the trend sustains, the sector’s weight may rise through
FY13f to settle at 5.0% by Mar13, c70‐bp up from current levels. A similar
outcome (of a rising weight) in broader indices can, thus, be expected. The past
years also reveal a link between the rise in MCap (over revenue growth) and
the sector’s Nifty weight. Riding on this correlation, a set of Pharma stocks
could potentially deliver 48% return in FY13f. Further, Pharma is likely to
deliver PAT growth higher than the Nifty during FY12f/FY13f; and based on past
years’ data, this earnings trend could support continued outperformance.
Earnings growth, valuation look good, even among defensives
While the pharma sector faces headwinds, there are significant protectives too.
Pharma may also hold an edge over other defensives on account of its higher
earnings growth, relatively lower and more stable P/E and the shrinking PEG
gap, supporting a thesis of investments into the sector.
Perception changes: India clawing back; US likely losing mind share
Monitoring changing perceptions throws a few pointers to what investors
believe constitutes the next wave of growth. Peaking mindshare of US generics
is noticeable. With the meaty gains from the market expected to truncate, the
prominence of non‐US exports is likely to increase. The perceived health of the
domestic segment may evolve to be the prominent influence on valuation.
DRRD play on base US, SUNP a defensive, CIPLA a bet in a volatile envt.
The slimming Para‐IV opportunities are pushing to the forefront the strength of
the base generic pipeline. We prefer DRRD on its pipeline strength; the
company also enjoys the most significant correlation, with incremental revenue
share coming from the base US generics and the change in MCap. With a strong
inverse correlation with the Nifty P/E, SUNP is a classical defensive, while in a
volatile environment CIPLA has also emerged as a defensive. In a rising market
too, SUNP has delivered amongst the strongest relative gains; DIVI and BIOS
could also be likely bets to ride the wave up.

Strategy: Early rays of a recovery are visible: Avendus

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Amidst the pervasive gloom, a few signs are pointing to better times


returning sooner rather than later. The rapid fall of the Nifty PEG has

brought it to within 10% of the band where it stabilized in 2009, before

the next rally began. A ‘time‐correction’ could pull down the PEG to

0.7x in 1Q2012. The yield‐gap is down to near its three‐year mean. In

the real economy, two lead indicators – Electricity generation and LCVs

– are pointing to a rebound in Manufacturing. The missing element –

lower interest rates – may be back soon, as seen in the recent fall in

bond yields. Shifts in earnings momentum suggest that sectors with

strong links to the recovery are more likely to outperform in 2012. We

advise cuts in allocations to Two‐wheelers and Consumer, and

increases in Commercial vehicles, Passenger vehicles, Cement,

Pharmaceuticals, Telecom, Metals and IT Services.

Steep fall in valuation; Nifty within 10%, three months of stable level

After falling from 2.0x to 0.8x in nine months, the Nifty PEG is within 10% of the

range where the Nifty stabilized in 2009, before the next rally began. If prices

and FY13 earnings forecasts stay at end‐Dec11 levels, the ‘time‐correction’

could push down the PEG to that range within three months. The yield‐gap to

the 1‐year government bond too has fallen close to its three‐year mean, partly

due to the fall in the Nifty, but more due to the large fall in the bond yield itself.

Latent signs suggest manufacturing recovery may be impending

Previous cycles saw the Electricity segment of the IIP rebound about six months

before Manufacturing. A strong rebound in Electricity has now been under way

for 14 months. Another similar lead indicator has been growth in sales of LCVs.

Despite the leading indicators being flashed, the rebound in Manufacturing has

not commenced. We believe the missing element in this cycle, that was active

in the previous economic cycle, is a low interest rate regime. The fall in food

inflation in Dec11 is significant as the food segment contributed over half the

rise in wholesale inflation during 2011. The fall in the one‐year government

bond yield has been a strong indicator of the fall in the Repo.

Tilt away from defensives may have begun

Late 2011 saw sectoral performances begin to shift from previous trends. There

is a tilt away from ‘defensive’ sectors and towards stocks with stronger linkages

to the next rebound. These changes are linked to the shifts in earnings

momentum and have signaled the revival of ‘normal’ sectors such as Cement

and Commercial vehicles. For 2012, we advise cuts in allocations to Twowheelers

and Consumer and increases in Commercial vehicles, Passenger

vehicles, Cement, Pharmaceuticals, Telecom, Metals and IT Services. Our top 10

stocks for 2012 are Bharti Airtel (BHARTI IN, Buy), Hindalco Industries (HNDL IN,

Buy), HCL Technologies (HCLT IN, Buy), ICICI Bank (ICICIBC IN, Buy), Larsen and

Toubro (LT IN, Hold), LIC Housing Finance (LICHF IN, NR), Maruti Suzuki (MSIL

IN, NR), State Bank of India (SBIN IN, Buy), Sun Pharmaceuticals (SUNP IN, Add)

and UltraTech Cement (UTCEM IN, Add).

IT Services - Opportunities from global crisis may outweigh risks :: Avendus

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The relative stability of consensus forecasts of S&P500 earnings in 2011
suggests that the risks are lower compared to 2008. Key sectors in the
US, such as Financials, have shown greater resilience, while the changing
attitude towards outsourcing by European companies may provide an
opportunity. Indian firms are likely to continue adding to their global
market share, as they benefit from secular trends such as a rise in
offshoring in SI and Consulting. Contrary to general perception, the
outperformance of the CNXIT Index in late 2011 may not be largely
driven by the INR decline, but is attributable more to the relative
stability of global demand. The potentially stronger earnings growth is
likely to support the premium valuation of the CNXIT Index relative to
the Nifty with secular trends favoring Tier‐I firms. Resume coverage on
TCS (Add); initiate coverage on HCLT (Buy).
Opportunities from the global crisis may outweigh the risks this time
The relative stability of consensus forecasts in 2011 suggests that the risks are
lower compared to 2008. Earnings forecasts of the S&P500 have declined by just
4.0% in 2011, well below the 23.5% erosion in 2008. Key sectors such as
Financials and Manufacturing, that drive revenues of the Indian IT industry, have
shown greater resilience. Consensus forecasts of earnings of the FTSE and Stoxx
also suggest a better outlook for Europe than in 2008. The changing attitude
towards outsourcing by European firms may provide an opportunity for Indian IT.
Share of global pie likely to expand even further
The 2008‐2009 recession had seen Indian IT firms add an estimated 2% to their
global market share against global peers. The market share is likely to expand
even further as Indian firms continue to benefit from secular trends such as
vendor consolidation and deal churn, owing to their large scale and diverse
offerings. Indian vendors are well‐poised to gain from a rise in offshoring in
System Integration (SI) and Consulting. A tilt in revenue mix towards non‐linear
pricing models would also help sustain pricing and overcome cost pressures.
INR weakness only partly drives rally, business outlook a stronger force
The outperformance in late 2011 may not have been largely driven by the INR
decline—as seen from the stability of FY12 EPS forecasts. Moreover, the
comparable situation in 2008 indicates that a weak INR cannot offset the
weakness in ultimate demand. Performance of the CNXIT Index is attributable
more to the relative stability of global demand and greater opportunities.
Premium valuation has solid grounds; still room for upside
2011 saw the CNXIT Index regain its premium over the Nifty, yet it is at a
discount to its two‐year mean PEG. The relative stability of earnings drivers and
potentially stronger earnings growth are likely to support the premium, with
secular trends in offshoring favoring Tier‐I firms.
Resume coverage on TCS and initiate coverage on HCLT
We resume coverage on TCS (Add) with a Dec12 target of INR1,304, and initiate
coverage on HCLT (Buy) with a Dec12 target of INR500. Key risks are INR
volatility and a worsening global economy.

Deep value holds promise of strong rebound :: Avendus

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TOP PICKS (click on company name below)

Axis Bank

Biocon 

Hindalco Industries

ICICI Bank

IDBI Bank 

Maruti Suzuki 

NCC 

Sanghvi Movers

Shriram Transport Finance 

SKS Microfinance 

Deep value holds promise of strong rebound

Several stocks that fell sharply during 2011 may possess the properties
that could drive an equally large rebound when equities valuations
recover. This was visible in the previous cycle that stretched from 2008
to 2010. During this period, a large number of the initial
underperformers not only recovered lost ground, but their
appreciation was also strong enough to make them outperform the
Sensex from the peak of the previous cycle to the next peak. The
promising underperformers are scattered across sectors and market
capitalization. In this report we put the spotlight on 10 stocks that are
capable of such a rebound – Axis Bank (Buy), Biocon (Buy), Hindalco
Industries (Buy), ICICI Bank (Buy), IDBI Bank (Buy), Maruti Suzuki (NR),
NCC (Buy), Sanghvi Movers (NR), Shriram Transport Finance (Buy) and
SKS Microfinance (Buy).
Beaten down stocks tend to recover value in the next upturn
268 stocks in the BSE500 had underperformed the Sensex during the rapid fall
in the wake of the global financial crisis of 2008. The mean erosion in market
capitalization of these stocks was 58.9%, well above the 45.5% fall in the
Sensex. The rebound during 2009‐2010 saw the market capitalization of these
268 stocks rise by 227.9%, well above the 157.4% rise in the Sensex.
Several outperform across the cycle
123 of the 268 underperformers during 2008 also outperformed the Sensex
from the peak of the previous cycle (Aug08) to the more recent peak in Nov10.
Therefore, a significant portion of the underperformers not only recovered the
value that was lost in the initial phase, but they also more than made up for the
initial losses in the later phase of the cycle.
Dispersed across a range of sectors and market capitalization
Contrary to common perceptions, we find that underperformers were
dispersed across a large number of sectors. In 2008, Engineering (27) and
Financials (27) had the largest number of stocks within the 268
underperformers, followed by IT Services, Metals, Construction and Real
Estate. In 2011, 343 of the BSE500 have underperformed and Financials (46),
Engineering (28), Metals (27) and Construction (23) make up the large part.
The Avendus ‘Deep‐value picks’
In this report we have focused on the factors that provide resilience to these
stocks during the ongoing downturn and those that would facilitate a rebound
in their growth, earnings and valuation over the medium term. We also
estimate the potential ‘worst‐case’ value for the stock under sustained adverse
conditions.



TOP PICKS (click on company name below)

Axis Bank

Biocon 

Hindalco Industries

ICICI Bank

IDBI Bank 

Maruti Suzuki 

NCC 

Sanghvi Movers

Shriram Transport Finance 

SKS Microfinance 

SKS Microfinance :: Avendus 2012 top ideas

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Erosion in price exceeds worst case in non‐AP loans
 The excessive price correction for SKSM over the past six months has
been driven by accelerated write offs in AP, lower disbursals in the
non‐AP portfolio and higher slippages in the non‐AP book. The erosion
in market price far exceeds the worst case in growth for the non‐AP
book. We value the AP and non‐AP books independently. Growth
outside AP remains the key driver of profitability. We forecast non‐AP
loans to grow at a CAGR of 37% over FY11‐FY14. Current capitalization
levels and the ROA cap of 3% do not present a hurdle to growth once
credit availability improves. We lower our earnings, driven by
accelerated write‐offs in AP and lower disbursals in the non‐AP
portfolio. The loss per share in the AP book when adjusted with the
fair value of the non‐AP book results in a Dec12 TP of INR137. We
maintain our Buy rating.
Underperformance driven by accelerated write offs
The excessive price correction for SKSM over the past six months has been
driven by accelerated write‐offs in Andhra Pradesh (AP), lower disbursals in the
non‐AP portfolio and creeping up of NPLs in West Bengal and Gujarat. The
lender wrote off INR3.5bn during the quarter ended Sep11, thus, lowering the
outstanding AP loan book to INR8bn.
Potential upside may be high, once growth outside AP picks up
Our assessment indicates a potential upside of 37% from the current price. We
value the AP and the non‐AP businesses independently. Growth outside AP
remains the key driver of profitability. We forecast non‐AP loans to grow at a
CAGR of 37% over FY11‐FY14. The loss per share in the AP book when adjusted
with the fair value of the non‐AP book results in a Dec12 TP of INR137.
Current valuation implies distress case scenario in non‐AP loans
Our base case assumes non‐AP loans to decline by 5% in FY12 and thereafter
rebound, to translate into a CAGR of 37% over FY11‐FY14. Sensitivity to growth
in the non‐AP book indicates the worst case being priced in.
Exhibit 25: Sensitivity of fair value to growth in the Non‐AP book
Scenario 1(Base case) Scenario 2 Scenario 3
Loan growth CAGR (FY12‐FY14) 37% 32% 42%
DCF based value for Non‐AP book 221 207 237
Loss per share in AP ‐84 ‐84 ‐84
Fair Value of Non‐AP book 137 123 153
ROA cap and current capitalization not a hurdle
Our assessment indicates capital adequacy would continue to stay above
prescribed levels, even in case of a delay in raising fresh capital. The proposed
ROA cap too is unlikely to hamper operations, once credit availability to the
microfinance industry improves. Recent developments indicate this is under way.
Maintain Buy; roll over TP to Dec12
We lower our earnings, driven by accelerated write‐offs in AP and lower
disbursals in the non‐AP portfolio. We maintain Buy with a revised Dec12 TP of
INR137. Lower growth in the non‐AP book remains the key risk factor


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Impact of regulatory headwinds manageable
 SHTF’s underperformance over the past year was driven by a cyclical
decline in profitability and a combination of structural changes in
regulations. The impact of these forces is likely to result in lower asset
growth, contraction in NIM and a rise in NPLs and provisions. Our
forecasts for FY12 amply reflect these adversities. Profitability is likely
to stabilize at a level well above peers due to higher fees and lower
operating expenses. We estimate a three‐year CAGR of 17% in net
profit, with ROA well above 3%. The underperformance may reverse as
regulatory headwinds recede and the core strengths of SHTF receive
attention. Our TP is a weighted average, based on the DCF, P/E and
P/B methods. We revise our Dec12 TP to INR710, which translates into
a potential upside of 60%. Maintain Buy.
High potential upside once headwinds recede
SHTF has a potential upside of 60% from our Dec12TP of INR710. Our Dec12 TP
is a weighted average of the mean for the DCF, P/B and P/E‐based fair values
for the past year. The TP values SHTF at 2.1x one‐year forward P/B. If the P/B
returns to normal ‐ the mean of 2.5x during FY10‐FY11 ‐ the potential upside
could be even larger, at 70%.
Regulatory headwinds led to underperformance
The underperformance of SHTF over the past year was driven by a cyclical
decline in profitability and a combination of structural changes in regulations.
The impact of these forces is likely to result in lower asset growth, contraction
in NIM and a rise in NPLs and provisions. Our forecasts for FY12 amply reflect
these adversities. Profitability is likely to stabilize at a level well above peers
due to higher fees and lower operating expenses. We estimate a three‐year
CAGR of 17% in net profit, with ROA well above 3%. We maintain our credit
cost forecast at a mean of 2.3% of loans over FY12‐FY14. The
underperformance may reverse as regulatory headwinds recede and the core
strengths of SHTF receive attention.
Impact of proposed regulatory changes likely to be manageable
The working committee constituted by the Central bank has recommended
aligning asset classification and provisioning norms for NBFCs with those
currently followed for banks. The provision cover for large asset financials is
higher than that for banks and is unlikely to fall materially after the new norms.
The shift from 180‐dpd (days past due) asset recognition norms to 90‐dpd asset
recognition would expand NPLs by up to 12%. We estimate a maximum
one‐time erosion of 20% in profitability. Sensitivity to securitization volumes
suggests ROE may stay above 20% in the extreme case of nil securitization.
Maintain Buy, rollover TP to Dec12
We maintain our forecasts for SHTF. Our Dec12 TP is a weighted average, based
on the DCF, P/E and P/B methods. We revise our TP to INR710, as we roll it
forward to Dec12. We maintain our Buy rating. Higher NPL provisions and
lower growth are the key risk factors.


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To benefit from revival in investment cycle
↓ Continuous investment in fleet expansion and a likely pick up in the
investment cycle on account of peaking out of interest rates may augur
well for SGM’s business momentum. We estimate the company to
report revenue and PAT CAGR of 9% and 7%, respectively, over FY12f‐
FY14f. This implied growth is based on a cut of up to 20% in earnings
and factors in flat yields and lower capex of INR3bn over FY12f‐FY14f.
We arrive at a Dec12 fair value range of INR118‐INR130 based on a
one‐year forward P/E range of 5.0x‐5.5x, which is at a discount to the
average P/E of 7.4x since Jan09. The potential upside stands at 48%.
Potential upside of 48% over the next 12‐month period
Our Dec12 fair value range has a potential upside of 48%. Our fair value range
assumes a one‐year forward P/E range of 5.0x‐5.5x, which is lower than the
average P/E of 7.4x since Jan09. If the P/E reverts to its three‐year mean, led by
a revival in the investment cycle, then the potential upside can be c100%.
Weak macro environment led to underperformance
A weak macro environment and rising competition in the domestic market
have raised concerns on growth prospects over the medium term. Also, weak
2QFY12 numbers due to certain one‐offs had a bearing on stock performance.
In the worst case, yields and capex may taper off from current levels
The potential upside is likely to reduce to 24%, assuming the macro
environment remains challenging for an extended period and is likely to lead to
cancellation of fleet expansion plans. Yields are also likely to witness slight
moderation, given the competition and rising asset base in FY12f. Monthly
yields are assumed to be at a five‐year low at 2.2%. The improvement in free
cash flow (c45% of sales) over FY13f‐FY14f ‐ on account of reduced capex ‐ is
likely to be utilized for paying off debt. This is likely to lead to de‐leveraging,
which may restrict the downside from current levels.
Pick up in investment cycle to trigger improvement in valuations
SGM has reported an improvement in its business momentum during the past
three quarters, but sustenance of the same is contingent upon a revival in the
macro environment. The likely reversal in the interest rate cycle may lead to a
pick up in investment activity. SGM is likely to invest INR2bn in FY12f, in
addition to the INR6.4bn during FY09‐FY11, towards fleet expansion. An
improvement in economic activity is likely to benefit SGM in terms of better
capacity utilization and yields.
Assign fair value range of INR118‐INR130
We reduce our FY12f‐FY14f EPS by up to 20%, factoring in lower fleet
expansion plans and flat yields. Our capex estimate has been reduced from
INR4.2bn to INR3.0bn and yields are assumed to be flat over FY12f‐FY14f. We
roll over our TP to Dec12 and assign a fair value range of INR118‐INR130
(INR137‐INR151 earlier), based on a one‐year forward P/E range of 5.0x‐5.5x.
The implied revenue and PAT CAGR works out to be 9% and 7%, respectively,
over FY12f‐FY14f, against 14% and 15% earlier. Prolonged weak investment
cycle and increase in competition are the key risk factors.



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Market price ignoring value of BOT assets
 NJCC’s current market cap of INR9bn ignores the true value of the
INR7.5bn it has invested as equity in road and power projects. Our
Dec12 TP of INR52 ‐ arrived at after taking a discounted P/B of 0.7x for
BOT assets ‐ implies an upside of 60%. The power project has received
sanction letters from lenders, and a likely stake sale to PE investors
would help unlock value. Even excluding the power project value in the
worst case, there would be a 26% upside in the stock. We cut our
FY12f‐FY14f EPS by up to 17%, factoring in lower order inflows and
execution. Our TP is rolled over to Dec12 and cut to INR52 on factoring
in lower earnings and the value of investments. Maintain Buy.
60% upside even after valuing BOT assets at discounted P/B of 0.7x
NJCC’s current market cap of INR9bn ignores the value of the INR7.5bn invested
as equity in road and power projects ‐ on increased risk aversion to the sector.
Our Dec12 TP of INR52 implies a 60% upside. Our TP is based on 0.7x P/B for
BOT assets ‐ a discount to: (i) P/B of 1.5x and above at which PE deals for road
and power assets have been concluded in the past 12 months and (ii) one‐year
forward P/B of 0.9x for IL&FS Transportation Networks (ILFT IN, Hold). Assuming
a P/B of 1.0x, (a c29% discount to our implied P/B target for ILFT’s BOT assets),
the potential upside would be higher at 94%.
Underperformance driven by fall in profitability and uncertain outlook
Higher interest rates and a slow down in orders have led to increasing pressure
on profitability. A rise in working capital has led to an increase in gearing and a
slow down in execution – leading to significant contraction in net margins and a
sharp y‐o‐y fall of up to 77% in PAT over the past few quarters.
In worst‐case, investments in real estate and power may be sunk
Assuming at worst that the power project fails to take off, the potential upside
would reduce to 26%. NJCC also has large exposure to the real estate business
in the form of equity (c15% of parent networth) and advances (c17% of parent
borrowing). In case of a sharp downturn in the real estate market, the company
may need to write off some investments or provide additional funding support.
Stake sale in power and road assets a catalyst for value unlocking
NJCC has received sanction letters from lenders for the 1320MW power project
and financial closure is likely by Mar12. The company would need to infuse
another cINR6bn in the power project. Given its limited resources, a PE stake
sale in assets is imperative and would help form a benchmark for valuations.
Cut TP to INR52; maintain Buy
We cut our FY12f‐FY14f EPS by up to 17%, factoring in lower order inflows and
execution. We value the standalone business at INR23/share, based on the
average value arrived using a P/E of 5.0x and EV/EBITDA of 5.0x. We ignore the
value of the real estate business (0.5x P/B earlier) and value the BOT assets and
international business at INR29/share using a 0.7x P/B multiple (1.0x earlier).
Based on the SOTP method, we arrive at our Dec12 TP of INR52 (INR72 earlier)
– implying an upside of 60%. Maintain Buy. Prolonged high interest rates and a
decline in the investment rate are the key risk factors.


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Product launches and diesel vehicles to drive recovery
MSIL’s earnings growth is likely to recover to 32.3% in FY13 after a fall
of 17.2% in FY12. This recovery is likely to be led by robust sales
volume growth in diesel vehicles on account of a healthy order book,
and supply of diesel engines from Fiat Automobiles India. This growth
may get further impetus with two product launches by Feb12. We
estimate a Dec12 fair value of INR1,217 after applying a P/E of 12.5x,
which is at a 20% discount to the five‐year mean P/E. This discount
factors in the lower earnings growth over FY12f‐FY14f in comparison to
FY07‐FY11. Risk factors are an increase in competition, fuel prices and
interest rates.
Reversion to mean may provide a huge upside
We have arrived at a Dec12 fair value of INR1,217 for MSIL, after applying 12.5x
P/E to our estimates. This fair value would increase to INR1,518 (upside of
58%), if we assume reversion to the five‐year mean P/E of 15.6x. This is likely
on the back of product launches. MSIL has lined up two product launches to aid
sales volume growth: 1) launch of Ertiga MPV in Jan12 ‐ to compete with the
Toyota Innova; and 2) launch of a compact Swift Dzire in Feb12 ‐ to benefit
from lower excise duties on smaller vehicles.
Underperformance led by lower sales volume growth
In 2011, MSIL underperformed the BSE Auto Index and Sensex by 12.7% and
9.2%, respectively. The underperformance was largely driven by lower sales
volume growth. The negative impact on sales volumes was on account of an
increase in competition and production constraints due to labor unrest and
lower production capacity in diesel engines. Market share has reduced to
38.0% in FY12 year‐to‐date, in comparison to 45.5% in the corresponding
period of the previous year.
Worst‐case scenario provides an upside of 16%
In our worst‐case scenario, we assume 9% sales volume growth over FY13f‐
FY14f, in comparison to 12% sales volume growth in the base‐case scenario. In
this scenario we arrive at a Dec12 fair value of INR1,112, which provides an
upside of 16%.
Earnings growth likely to revive from FY13f
As per our estimates, earnings growth is likely to recover to 32.3% in FY13 after
a fall of 17.2% in FY12. This recovery is likely to be led by robust growth in
diesel vehicles on account of a healthy order book, supply of diesel engines
from Fiat Automobiles India.
Dec12 fair value of INR1,217 implies potential upside of 27%
We arrive at a Dec12 fair value of INR1,217 after applying a P/E of 12.5x, which
is at a 20% discount to its five‐year mean. This discount is to factor in lower
earnings growth over FY12‐FY14 in comparison to FY07‐FY11. We do not have a
rating on the stock. Risk factors are an increase in competition, fuel prices and
interest rates.


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Rise in NIM, improved liability‐mix may drive the rebound
 Improvement in the deposit mix along with a rise in the proportion
and growth in savings deposits have been key positives in the past few
quarters. While rise in slippages and NPL ratios are concern areas, the
decline in outstanding restructured loans is a positive. Despite rising
NPLs, net profit growth in 1HFY12 was 25% y‐o‐y, ahead of most peers.
The slippage in restructured loans in 1HFY12 has stayed below that in
FY11. Improvement in the concern areas is underway and may lead to
a rebound in valuations over the next 12 months. Our FY12‐FY14
forecasts for NPL provisions have been raised by 8‐bp to 0.63%, while
those for net profit have been lowered by up to 12%. We roll over the
TP to Dec12 and lower it to INR148. Maintain Buy. High slippages and
rising NPL provisions are key risk factors.
Large value, even if we exclude the value of subsidiaries
Our Dec12 TP implies a potential return of c83% over the next 12‐month
period. The TP values IDBI, including strategic investments, at a one‐year
forward adjusted P/B of 1.0x. We value the core banking business at 0.8x P/B. If
the P/B returns to the normal mean of 0.8x (by applying a 10% de‐rating to the
FY11 P/B) during FY10‐FY11, the potential upside may be c79%.
Rising NPLs; large restructured book drove underperformance in 2011
In 2011, IDBI underperformed the CNXPSBK and the Nifty by 9% and 27%,
respectively. The large underperformance was driven by a rise in slippages and
the concerns on rising NPLs from restructured loans. Gross and net NPL ratios
increased by 71‐bp and 51‐bp to 2.47% and 1.57%, respectively, in 1HFY12.
Restructured loans as a percentage of total loans declined to 5.7% at end
Sep11. Despite rising NPLs, PAT growth in 1HFY12 was 25% y‐o‐y.
Large upside, even if the worse case is applied
If the worst‐case scenario is applied for FY12f‐FY14f – incremental NPL, net NPL
ratio and NPL provisions/assets at 1.33%, 2.12% and 0.97%, respectively (46‐
bp, 32‐bp and 34‐bp higher than the base case) – the DCF fair value falls 11% to
INR155/share. The CMP implies a distress scenario for asset quality, net NPL
ratio at 3.4% and NPL provision/assets at 2.0%. With other forecasts remaining
same, the CMP also implies a cumulative loss of INR27.9bn over FY12f‐FY14f.
We forecast 38‐bp NIM expansion during FY12f‐FY14f
We forecast a 38‐bp rise in NIM to 2.21% till FY14, partly driven by savings
deposits growth, which has stayed above 30% in the past two quarters despite
a sharp rise in rates. We estimate a CAGR of 14% in PAT over FY12f‐FY14f. After
the decline in FY12, RoE is forecast to rise by 150‐bp to 15.0% in FY14.
Rollover TP to Dec12; Maintain Buy
We value IDBI using a combination of the DCF, P/E and P/B methods. For the
semi‐explicit period, we assume a CAGR of 14% in loans and RoA of 0.80%. We
raise our forecast for NPL provisions by 8‐bp to 0.63% and lower our PAT
forecast by up to 12%. We roll over the TP to Dec12 and lower it marginally to
INR148. Maintain Buy. High slippages and rising NPL provisions are risk factors.


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Concerns on the asset quality may be overdone
 We forecast c3% improvement in standalone RoE over the next three
years. NPL provision as a percentage of assets is likely to stay below
the peak of FY07‐FY10. Restructured loans have fallen from the peak of
3.0% to 1.1% of loans at end Sep11. However, there may be an
increase in restructured loans and slippages in the corporate segment
in the near term, therefore, we raise our assumptions for incremental
NPL and lower our net profit forecast for FY12‐FY14 by up to 12%. We
roll over the TP to Dec12 and lower it to INR1,075. The TP values the
stock at a one‐year forward P/B of 1.88x. We maintain Buy. Higher
than estimated NPL provision is the key risk.
Large potential upside over the next 12‐month period
Our Dec12 TP implies a potential return of c54% over the 12‐month period. The
TP values ICICIBC at a one‐year forward adjusted P/B of 1.88x. If the P/B for the
core business returns to the normal mean of 1.32x during FY10‐FY11, and the
value of subsidiaries remains constant, the potential upside could be c43%.
Growth concerns; NPL risk from infra sector drove underperformance
In 2011, ICICIBC underperformed the Bankex and the Sensex by 8% and 14%,
respectively. The underperformance was largely driven by concerns on revival
in loan growth, falling market share in the retail segment and the NPL risk
emerging from the infrastructure sector. However, despite high concerns, gross
and net NPL ratio fell by 33‐bp and 14‐bp, to 4.1% and 0.8%, respectively, over
the past two quarters. While loan growth revived to 20% y‐o‐y, it was driven by
corporate loans. Retail loan growth has stayed below consensus.
20% upside to fair value even if NPLs rise to the peak of FY07‐FY08
Even if the worst‐case scenario is applied for FY12f‐FY14f – incremental NPL at
1.45% (mean during FY07‐FY08), net NPL ratios at 0.98%, NPL provisions/assets
at 0.71% and semi‐explicit period growth of 17% – the DCF value for the
standalone bank is INR625/share. Including the value of subsidiaries
(INR243/share), the fair value has a potential upside of 24% to the CMP.
Forecast 287‐bp improvement in RoE over FY12‐FY14
Net interest income and falling growth in NPL provisions in FY13f‐FY14f are
likely to support a 287‐bp rise in RoE to c13%. The NPL provision is likely to fall
by 11‐bp to 0.40% y‐o‐y in FY12f. Achieving a provision coverage ratio higher
than the regulatory requirement has reduced the burden, unlike in FY11. A fall
in the proportion of restructured loans from the peak of 3.0% in Dec08 to 1.1%
of loans at end Sep11 is likely to restrict slippages from this portfolio.
Roll over TP to Dec12; maintain Buy
We value ICICIBC based on the P/E, P/B and DCF methods. We lower the semiexplicit
period growth assumption in the DCF by 5% to 20%. We raise our
estimates for incremental NPL and NPL provisions/assets by 15‐bp and 5‐bp,
respectively, for FY12f. We lower our net profit forecast for FY12‐FY13 by up to
12%. We roll over the TP to Dec12 and lower it to INR1,075. Maintain Buy. Rise
in incremental NPL and NPL provisions are key risk factors.


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Stable cashflows, project commissioning to boost outlook
We have a Dec12 TP of INR152 for HNDL, which represents a potential
upside of 30% and includes a 20% discount to (Apr06‐Dec11) historical
average EV/EBITDA and P/E multiple. This target may have additional
upside of 37%, if the uncertainty in earnings ‐ due to weak aluminium
prices and a delay in expansion of greenfield projects ‐ recedes. In the
worst‐case scenario, we estimate a delay in commissioning of
brownfield projects and aluminium prices of USD2,000/tonne for
FY13f‐FY14f. Based on this, we arrive at a worst‐case fair value of
INR105/share. Considering the favourable risk reward‐ratio, we
upgrade our rating to Buy.
Target likely to rise by 37%, if uncertainty on projects, prices declines
We have a Dec12 target of INR152, which represents a potential upside of 30%
and includes our 20% discount to the average historical multiple to account for
the uncertainty in earnings due to weak aluminium prices, global demand and
delay in expansion of greenfield projects. Our TP has the potential to be raised
by 37%, if valuation multiples revert to their mean due to improvement in the
global demand environment and price outlook.
Weak aluminium prices, earnings downgrade led to underperformance
HNDL underperformed the Sensex by 29% during the past year. This was due to
c25% decline in aluminium prices since Jun11, which has been partially offset
by the 17% depreciation in the INR. Lower‐than‐estimated realizations and an
increase in coal cost by Coal India (COAL IN, NR) led to downgrade in earnings.
This is unlikely to extend as the global cost curve restricts further downsides, as
25% of global producers incur losses at current LME price of USD2,000/tonne.
Fair value in worst‐case scenario likely to be INR105/share
In the worst‐case scenario, volume growth in the aluminium business for FY13f is
likely to remain flat, if there is a delay in the commissioning of the 52,000 tonne
brownfield expansion at Hirakud. We forecast average aluminium price of
USD2,000/tonne for FY13‐FY14 against our earlier estimate of USD2,250/tonne.
Our revised EPS estimate for FY13f and FY14f is likely to be INR10.7 and INR11.6,
respectively. Applying a 20% discount to the historical average multiple, our
worst case fair value is likely to be INR105/share.
Clearance to greenfield project likely to be a catalyst for growth
On‐schedule commissioning of greenfield projects, obtaining clearance for coal
mining at Mahan and reduced demand and price uncertainty in global markets
are likely to provide clarity on projects and reduce costs.
Upgrade rating to Buy; Dec12 target of INR152
We discount the historical average (Apr06‐Dec11) EV/EBITDA of 6.8x and P/E of
12.4x by 20% to account for weak aluminium demand, low prices in the global
market and uncertainty on greenfield projects. Roll over target to Dec12. Our
TP of INR152 is the average of the fair values based on these multiples. We
upgrade our rating to Buy, considering the favourable risk‐reward ratio and the
past underperformance. Risk factors include weak aluminium prices and delay
in project commissioning.


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