Investor's Eye: Update - Bajaj Corp (Annual report review), Gas transportation (Business environment toughens); Market outlook - (Negotiating within a range)

 

Investor's Eye [August 28, 2012]  Sharekhan www.sharekhan.com

Summary of Contents Bajaj Corp Cluster: Ugly Duckling Recommendation: Hold Price target: Rs177 Current market price: Rs163 Annual report review  Key points FY2012 margin affected by high input cost: In FY2012 Bajaj Corp posted a strong top line growth of 31% year on year (YoY) driven by a strong sales volume growth of 21.44% (in the flagship brand Bajaj Almond Drops, which grew by ~20% YoY in the fiscal). However, the operating profit margin (OPM) contracted by 566 basis points YoY to 24.6% largely on account of the higher prices of the inputs (notably LLP and refined oil) and higher advertisement spending to support Kailash Parbat Cooling hair oil launched at the start of FY2012. Hence, the adjusted profit after tax (PAT) grew by 16.5% YoY to Rs120.1 crore. The highlights of the fiscal were the improvement in the sales volume growth to 21% (from ~15% in FY2011) due to an improvement in the penetration and expansion of the distribution reach and the launch of Kailash Parbat Cooling hair oil. The only disappointment was the investment of Rs75 crore in some non-yielding assets (acquisition of land in Worli, Mumbai).  Inventory days increased in FY2012: The inventory days rose to 47 days in FY2012 from 34 days in FY2011. This led to a positive operating cash cycle to three days from minus 11 days earlier. We believe the inventory days could have increased due to the stocking up of raw materials in the face of a sharp increase in the prices of some of the key commodities. However, we expect the operating cash cycle to improve in the coming years.  Return ratios decline on a high base: Bajaj Corp's return ratios declined in FY2012 largely on account of a high equity base due to the raising of funds through an initial public offering. In FY2012 the return on net worth (RoNW) and the return on capital employed (RoCE) stood at 29.9% and 37.6% as against 51.0% and 61.4% respectively in FY2011. With a sustained strong top line growth and an improvement expected in the margins, the return ratios are likely to improve in the coming years.  Cash and cash equivalents of above Rs350 crore: Despite a dividend payment of Rs68.6 crore and the acquisition of the non-yielding assets worth Rs75 crore, the company's cash and cash equivalents stood at Rs340 crore in FY2012 (a little lower than Rs410 crore in FY2011). With the operating cash flow poised to improve, the cash balance is expected to improve too in the coming years. The management has indicated the cash balance of close to Rs350 crore will be extensively utilised for future growth prospects (including acquisitions in the domestic personal care space). Outlook and valuation: With the company's volume growth likely to remain in strong double digits, Bajaj Corp is expected to maintain the strong revenue growth momentum in the coming years. With the prices of the key inputs stabilising in recent times, the OPM is expected to improve in FY2013 and FY2014. Overall, we expect the company's top line and bottom line to grow at a compounded annual growth rate (CAGR) of 23.4% and 25% respectively over FY2012-14. Any inorganic growth activity would improve the growth prospects of the company in the long run. At the current market price the stock trades at 15.4x its FY2013E earnings per share (EPS) of Rs10.5 and 12.8x its FY2014E EPS of Rs12.7. We maintain our Hold recommendation on the stock with a price target of Rs177. SECTOR UPDATE Gas transportation Business environment toughens Key points The business conditions have worsened for the gas transportation and distribution companies with the mounting regulatory pressure to reduce tariffs on the one hand and the depleting domestic gas supply on the other hand.  The situation has resulted in a severe de-rating of the valuation multiples of the companies operating in this space. However, we believe that the regulatory activism would continue to act as an overhang on companies like Gujarat Gas Company Ltd (GGCL), Gujarat State Petronet Ltd (GSPL), Indraprastha Gas Ltd (IGL) and GAIL.  Among these companies, we actively cover GAIL and believe that most of the negatives are already factored in the price of the stock and the stock is least affected by the regulatory uncertainties; therefore, GAIL remains our preferred pick in the sector.   GAIL is the least affected; we prefer GAIL  Given the environment where the regulator has criticised the arbitrary pricing of gas by the CGD companies, there could be some steps in the future to regulate the price (a uniform gas pricing policy could be the outcome). Eventually, this could lead to a contraction in the margins and return ratios of the gas distribution companies, especially the less regulated CGD companies. We believe though IGL's case is being highlighted currently, but the regulation, if it comes, would affect all CGD players adversely. We see the possibility of contraction in the margins and returns ratios of these companies. Hence, we opine the sector would witness regulatory headwinds in the future which will affect their earnings and valuations. However, we believe GAIL would be the least affected in the scenario foreseen as most of the pipeline of the company is already regulated and approved by the regulator. Therefore, GAIL remains our preferred pick in the sector with a price target of Rs410, which allows for a 16% upside potential. MARKET OUTLOOK Negotiating within a range  It is prudent to turn cautious near the higher end of the market's multi-month trading range Market climbs the wall of worries: Contrary to the consensus opinion but in line with our positive stance, the market moved closer to the higher end of its multi-month trading range rather than grinding down towards the lower end of the range. We had stated in our earlier report that the emerging positives globally and domestically coupled with the acute despondency and polarised short view would make the following two months relatively better than the previous two months. In spite of a deterioration in the economic data points and a fairly weak monsoon this year, the market's resilience has surprised positively.  Q1FY2013; so far, so good: Though the macro situation remains challenging, the headline corporate earnings growth sustained at a double-digit level (over 10%) in Q1FY2013. The performance was aided by State Bank of India, the oil companies (GAIL, Oil and Natural Gas Corporation; due to lower than expected provisions for the under-recoveries) and a few other companies. On a broader basis, in spite of around 14% growth in the revenues, the earnings of around 1,150 companies declined by 19% largely due to margin pressure and a surge in the interest cost. The silver lining is that the downgrade in the consensus earnings estimates slowed down considerably post-Q1FY2013 results as compared with the sharp cuts seen after the Q4FY2012 results. Globally; euro remains fragile; fiscal cliff in USA emerges as a key worry for equities: Though the European debt crisis is occupying a lot of attention, but there has been insignificant structural action to resolve the same. The markets expect the European Central Bank (ECB) to continue to support the bonds of the peripheral nations (Spain, Greece etc) but the euro nations dither on the rescue policy for these countries. On the other hand, in the USA the presidential elections and an impending fiscal cliff (the impact of around $500 billion due to expiring tax concessions) is making investors nervous. The US markets have firmed up due to better than expected data releases but that also casts a shadow on the third round of quantitative easing (QE3), which many people expect by Q4CY2012. Near higher end of trading range; time to take some money off the table: The Nifty has moved in a broader range of close to 1,000 points (4,600-5,600) for the last 18 months. After the recent upmove, it has moved closer to the higher end of the trading range. Crude oil prices have also firmed up recently which coupled with the potential populist measures (due to a weak monsoon) could delay or slow down the expected pace of monetary easing (or policy rate cuts) in the system. The political impasse after the publication of the Comptroller and Auditor General of India (CAG)'s report on a coal scam is likely to block any fiscal measures by the government. Thus, we see no major trigger for the market to convincingly break out of the 18-month range. It would be only prudent to turn a bit cautious and take some money off the table (if you have a very active investment strategy).  Valuation still at discount to LPA, defensives to stay in vogue: In terms of valuations, the Sensex is trading at 13.2x one-year forward estimated earnings, which is below the long-period average (LPA) multiple but not at a significant discount, unlike the case two months back. Also, given the multiple concerns surrounding the global and domestic economies, the re-rating of the market seems difficult. However, we believe that the valuation gap between the defensives and the cyclicals has widened to historic levels.   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.

Regards, The Sharekhan Research Team myaccount@sharekhan.com Manage your newsletter subscriptions

 

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