Investor's Eye: Stock Idea - AGC Networks; Update - Sun Pharmaceutical Industries, India Cements, Godrej Consumer Products, Fertilisers

 

Investor's Eye [August 13, 2012]  Sharekhan www.sharekhan.com

Summary of Contents STOCK IDEA AGC Networks Cluster: Ugly Duckling Recommendation: Buy Price target: Rs400 Current market price: Rs265 Spreading its network Key points  Spreading wings to reap large industry opportunity: AGC Networks (AGC; formerly known as Avaya Global Connect) has transformed its business from a single-partner (Avaya) relationship into a diversified business with multi-level global partners (Cisco, Juniper, HP, IBM, Dell, Polycom etc) to significantly multiply the addressable market and growth opportunities in its focus area of IT network infrastructure and related services. Currently, it gets around 80% of its business from India, where the addressable product & services target market was close to Rs30,000 crore in FY2011 and is growing at 20% per annum. However, with its renewed strategy (named as 10^3) the company is spreading its wings through a multi-solution, multi-alliance and multi-geography strategy, which augurs well as it will provide much more diversified revenue traction in the coming years.  Parent Aegis adds muscle to AGC's growth prospects: AGC's parent Aegis is ranked among the top Indian BPO companies with presence in 13 countries, 55 locations and over 300 clients across verticals, such as BFSI, telecom, healthcare, travel and hospitality, consumer goods, retail and technology. AGC would be leveraging the strong presence of Aegis and get access to the parent's elite client base across geographies. After being acquired by Aegis in May 2010, AGC has significantly grown its product portfolio, geographical markets and partners. Over the last two years after coming to the fold of Aegis, AGC has transformed from a single-product (unified communications[UC]) and single-partner (Avaya) entity into a diversified integrated player with multiple partners and businesses spread across geographies.  Solid financials, healthy prospects ahead: In the last two years AGC has reported a strong growth in the top line and the bottom line. Going forward, with diversified product offerings and a wider client base, the company is well poised to raise its growth trajectory. We estimate an over 40% CAGR in its earnings over FY2012-14 with a 33% revenue CAGR over the same period. We expect the OPM to remain stable at 10% over the next two years with a judicious mix of products (70%) and services (30%) in the revenues. Further, with an increase in the addressable market opportunities and the successful implementation of the 10^3 strategy, the management aspires to reach $1 billion in revenues (Rs5,500 crore) by 2015 through both organic and inorganic initiatives.  Undemanding valuation, rich dividend play: AGC is a distinguished player in the enterprise communications space in India and its pertinent focus on delivering industry-specific solutions with customised services proves to be a key differentiator from the others. With increasing clients and an expanding geographical network through the Aegis legacy and own sales and marketing initiatives, the company is well poised to witness significant traction in profitability in the coming years. At Rs265 the stock is currently available at undemanding valuations of 3.9x and 3x FY2013E and FY2014E earnings respectively. Further, the company is a strong dividend play in FY2012 150% dividend, 33.5% pay-out). Going forward, with the company all set to receive a windfall of Rs97 crore through the sale of the Aegis stake (5.7 million shares at Rs170 per share) by December 2012, its per-share value works out to Rs68. Thus, there is a higher prospect of a special dividend pay-out in FY2013 over and above the usual dividend. We initiate coverage on AGC with a Buy rating and a 12-month price target of Rs400. At our price target the stock would be valued at modest 4.5x FY2014E earnings.  STOCK UPDATE Sun Pharmaceutical Industries Cluster: Ugly Duckling Recommendation: Buy Price target: Rs743 Current market price: Rs682 Price target revised to Rs743 Result highlights Better than expected performance: For Q1FY2013 Sun Pharmaceuticals (Sun Pharma) reported a 62.5% year-on-year (Y-o-Y) rise in its net sales to Rs2,658.1 crore, which is 12% higher than our estimate. The operating profit margin (OPM) jumped by 1,231 basis points to 45.8%, which is substantially higher than our estimate of 38.6%. The quarter's OPM is better than the margin achieved in the previous 14 quarters. Despite a foreign exchange (forex) loss (netted off in the other income) and a higher effective tax rate (17.3% in Q1FY2013 vs 2.5% in Q1FY2012), the net profit jumped by 58.8% year on year (YoY) to Rs796 crore during the quarter. The net profit exceeds our estimate by 19%.  Strong results of Taro and exclusive supplies of Lipodox help: The better than expected performance was driven by three main factors: (1) stronger revenues (up 42% YoY to $159 million) and higher profit (up 110% YoY to $62.9 million) from Taro Pharmaceuticals (Taro); (2) better revenue and profitability from the supplies of Lipodox (through Caraco Pharmaceuticals [Caraco]; opportunity arose out of a drug shortage in the USA); and (3) a strong growth in the emerging markets (ex Taro the growth stood at 45% YoY). Besides, Sun Pharma's base business also seems to have grown impressively during the quarter.  Business restructuring and full control of Taro to help sustain the strong growth: Sun Pharma is in the process of restructuring its business. It has announced a plan to spin off its domestic formulation business (which contributes about 22% of its revenues) to its wholly owned subsidiary called Sun Resins and Polymers Pvt Ltd with effect from March 31, 2012. This is being done with a view to enhance the focus on the business and to allow for quicker responses to the competitive market conditions. Besides, the company has announced a plan to acquire the entire stake in Taro which will give it a stronger foothold in the USA and Europe. We revise our earnings estimates and price target; maintain Buy: Despite an impressive performance in Q1FY2013, the management has maintained its guidance of an 18-20% revenue growth for the base business in FY2013. We have revised our earnings estimates upward by 14% each for FY2013 and FY2014, in view of Sun Pharma's plan to gain full control of Taro (which will result in a lower minority interest) and the operational synergies that would result from such a move. Accordingly, our price target stands revised by 14% to Rs743. We maintain our Buy rating on the stock.    India Cements Cluster: Ugly Duckling Recommendation: Buy Price target: Rs110 Current market price: Rs85 Operating performance in line with estimates Result highlights Operating performance in line with estimates; adjusted net profit below estimates: In Q1FY2013 India Cements posted an adjusted net profit of Rs82 crore (a decrease of 21.9% year on year [YoY]). The same is below our estimate on account of a higher than expected interest cost of Rs95 crore (an increase of 63% YoY) and a foreign exchange (forex) loss of Rs25 crore. However, the operating profit of the company is much in line with our estimate at Rs277.7 crore (higher by 14.9% YoY).  Revenue growth driven by healthy realisation and IPL income; in line with estimates: The net sales of the company grew by 13.7% YoY to Rs1,201.4 crore (largely in line with our estimate), which also includes revenues from the Indian Premier League (IPL), wind power and shipping businesses. The revenues from the cement division (cement is its core business) improved by 10.8% YoY to Rs1,062.9 crore largely driven by a 7.6% growth in the average cement realisation. However, on the volume front, the southern region continues to witness a lacklustre demand environment. Hence, the volume grew by just 2.9% YoY to 2.38 million tonne (mt). On the other hand, the revenues from the IPL division jumped to Rs122 crore as against Rs84.8 crore in the corresponding quarter of the previous year. The shipping division booked Rs12.5 crore of revenues during the quarter.  Cost pressure largely offset the benefit of improvement in cement realisation: On the margin front, in spite of a 7.6% improvement in the cement realisation YoY, the continued cost pressure-in terms of (a) a higher power & fuel cost (up 16.8% on per tonne basis); (b) higher freight charges (up 21% YoY); and (c) higher employee cost (up 23.6% YoY to Rs78.7 crore)-largely offset the benefit of the increased realisation. Hence, the operating profit margin (OPM) could expand marginally by 25 basis points YoY to 23.1%. The overall cost of production on a per-tonne basis increased by 8.4% YoY and the EBITDA per tonne increased by 5% YoY to Rs1,033. Consequently, the operating profit of the company increased by 14.9% YoY to Rs277.7 crore.   Surge in interest cost due to forex loss: The interest cost increased by 63% YoY to Rs94.9 crore on account of an increase in the borrowings at a higher rate to redeem the outstanding foreign currency convertible bonds and a forex loss of Rs25 crore. The total borrowings of the company stood at Rs2,880 crore as compared with Rs2,700 crore at the end of FY2012. Further, a one-time expense of Rs20 crore was incurred on account of the operations of the IPL franchise. Hence, the reported net profit declined by 39.2% YoY to Rs62 crore whereas the adjusted net profit works out to Rs82 crore (a decline of 21.9% YoY).  CCI has imposed a penalty of Rs187.5 crore; the company will appeal against the CCI order: The Competition Commission of India (CCI) has imposed a penalty on around 11 cement companies for making a cartel and managing cement prices at higher levels. As per the CCI order, India Cements will have to pay Rs187.5 crore as a penalty. However, based on the legal opinion the company will appeal against the order before the Tribunal. Accordingly, the company has not made any provision for the CCI penalty.  Fine-tuned earnings estimates for FY2013 and FY2014: We have fined-tuned our earnings estimates for FY2013 and FY2014 mainly to incorporate the higher than expected cost pressure (a higher freight cost) and a lower than expected volume growth. We have also factored in the higher than expected cement realisation in our estimates. Consequently, the revised earnings per share (EPS) estimates for FY2013 and FY2014 are Rs9.6 and Rs11 respectively.  Maintain Buy with price target of Rs110: The demand for cement in the key market (southern region) of India Cements is likely to witness a partial recovery driven by the private sector housing industry and a pick-up in the rural demand. Further, in order to get better volumes and realisations the company is trying to change its market mix in favour of the non-Andhra Pradesh states and the western region. On the realisation front, the cement price in the southern region stands at a healthy level and we expect the average realisation in FY2013 to remain higher compared with that in FY2012. Moreover, with the commissioning of its captive power plant (CPP) the company will benefit by saving cost and gaining a regular supply of power. However, in order to deliver higher volumes the realisation could come under pressure. Cost pressure in terms of any adverse movement in the price of imported coal and a higher freight cost would partially offset the positive impact of the increased realisation and the savings from the CPP. We maintain our Buy recommendation on the stock with a price target of Rs110. At the current market price the stock trades at a PE of 7.7x discounting its EPS for FY2014 and EV/EBITDA of 4.4x its FY2014E earnings.   Godrej Consumer Products Cluster: Apple Green Recommendation: Hold Price target: Rs665 Current market price: Rs631 Downgraded to Hold; price target revised to Rs665 Result highlights Q1FY2013 results-strong growth momentum sustained: The Q1FY2013 results of Godrej Consumer Products Ltd (GCPL) are in line with our expectations largely on account of a higher than expected revenue growth during the quarter. The strong growth momentum of the previous quarters was sustained with the revenues growing by 39.2% year on year (YoY) and the adjusted profit after tax (PAT) growing by 47.9% YoY during the quarter. Q1FY2013 is the fourth consecutive quarter of a strong double-digit volume growth in the company's domestic soap segment, an above 20% growth in its domestic household insecticide (HI) business, and a more than 25% year-on-year (Y-o-Y) revenue growth in its Indonesian business. The strong growth could be attributed to adequate media spends as well as innovations and renovation in the respective portfolios. Results snapshot: In Q1FY2013 the consolidated net sales of GCPL grew by 39.2% YoY to Rs1,388.6 crore. The robust revenue growth was largely driven by a 24.3% Y-o-Y growth in the domestic business and a 67.5% Y-o-Y growth in the international business (an organic growth of 31% YoY). The consolidated gross profit margin (GPM) improved by 64 basis points YoY to 52.2% while the operating profit margin (OPM) stood flat at 14.7%, largely on account of it being a weak quarter for the HI business in India and seasonally the weakest quarter for the Latin American business. Thus, the operating profit grew by 38.2% YoY to Rs202.3 crore (the growth is in line with the revenue growth). This along with a lower incidence of tax resulted in a 48% Y-o-Y growth in the adjusted PAT (before the minority Interest) to Rs151.8 crore. The foreign exchange (forex) loss stood at Rs17.6 crore in Q1FY2013 as against a forex gain Rs2.4 crore recorded in Q1FY2012. Upward revision in earnings estimates: We have revised upwards our earnings estimates for FY2013 and FY2014 by 5.5% and 7.9% respectively to factor in the higher than expected revenue growth in Q1FY2013 and the lower tax rate indicated by GCPL's management in its commentary.  Outlook and valuation: Q1FY2013 was yet another quarter of a strong operating performance and a strong start to the fiscal year 2013. According to the management, there are no signs of a slowdown in the categories in which GCPL has a strong presence in the domestic market. It has maintained its thrust on innovation-led and distribution-led growth in the domestic and international markets. We expect GCPL's top line and bottom line to grow at compounded annual growth rate (CAGR) of 22.8% and 32.1% over FY2012-14. We have revised our price target for the stock upwards to Rs665 (based on 23x its FY2014 earnings of Rs28.9 per share). However, due a limited upside (of 5.3%) from the current level we have downgraded our recommendation on the stock from Buy to Hold. At the current market price the stock trades at 26.7x its FY2013E earnings per share (EPS) of Rs23.7 and 21.8x its FY2014E EPS of Rs28.9. SECTOR UPDATE Fertilisers Fertiliser sales hit by lower production  Key points Lower production of non-urea fertilisers weighed on total fertiliser sales: In July 2012, the aggregate sales of fertilisers (by 15 leading manufacturers) declined by 24% year on year (YoY) led by a steep decline in the sales of the non-urea fertilisers. In July 2012 the production and import of non-urea fertilisers, mainly di-ammonium phosphate (DAP), and complex fertilisers declined drastically on account of the non-availability of phosphoric acid and price negotiation by the Indian importers for DAP (imported). The imports of DAP and complex fertilisers decreased by 59% and 43% respectively during July 2012 mainly on account of lower production and lower imports by Coromandel International, India Potash and IFFCO. The imports of MOP and urea were higher by 69% and 48% respectively in the same month. YTD sales of fertilisers decline: The year-till-date (YTD) sales of fertilisers declined by 17% as compared with the sales in the same period of the previous year. The decline in the fertiliser sales volume was largely driven by the lower both production and import of non-urea fertilisers on account of a tight supply of phosphoric acid and the expiry of the contracts for the import of DAP. The sales of DAP, urea and complex fertilisers were lower by 59%, 1% and 43% respectively whereas the sales of MOP increased by 69% mainly due to higher imports by the Indian importers (potash plays an important role in a drought-type scenario). The imports of urea on a YTD basis declined by 50% to 2.71 lakh tonne as compared with that in the same period of FY2012.  Outlook: We maintain our cautious outlook on non-urea fertiliser manufacturers mainly due the lacklustre demand for these fertilisers on account of price hikes, margin pressure due to higher raw material cost and a demand shift towards cheaper fertilisers like urea and SSP. We prefer a pure urea manufacturer like Chambal Fertiliser as well as SSP manufacturers like Rama Phosphates and Liberty Phosphate in view of the existing demand-supply scenario.   Click here to read report: Investor's Eye   Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a postition in the companies mentioned in the article.

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