Investor's Eye: Update - ITC (Annual report review); Automobiles (FY2014 to remain lacklustre, expect meaningful recovery in FY2015)

 

Investor's Eye [July 01, 2013]  Sharekhan www.sharekhan.com

Summary of Contents     STOCK UPDATE ITC Recommendation: Hold Price target: Rs342 Current market price: Rs326 Annual report review  Key points FY2013-performance continues to be strong: ITC continued to perform strongly with its top line and bottom line growing by about 20% each in FY2013. The company's operating profit margin (OPM) remained stable at around 35.5%. The strong performance of the non cigarette fast moving consumer goods (FMCG) business was the highlight of the fiscal with the revenues of the business growing by 27% and the losses at the profit before interest and tax (PBIT) level declining by almost 60% (the business broke even at the PBIT level in Q4FY2013). The cigarette business' revenues grew by about 17% year on year (YoY; with the volume growing at about 2%). The PBIT margin of the cigarette business stood at over 30% due to the price increases undertaken in the portfolio.  Cash conversion cycle remains negative: ITC's cash conversion cycle (CCC) remained negative at seven days (as against 11 days in FY2012). The inventory days reduced to 75 days in FY2013 from 79 days in FY2012. This was largely on account of efficient sourcing of raw materials for its various businesses. The creditor days reduced to 95 days in FY2013 from 104 days in FY2012. Strong cash generation ability: ITC has one of the strongest balance sheets in the FMCG space with strong cash generation ability. After the capital expenditure (capex) the free cash of the firm at the stand-alone level grew by 12% YoY to Rs5,143.9 crore in FY2013. The Company continued to reward investors with a strong dividend payment. The dividend pay-out ratio stood at close to 65% in FY2013. The cash on books at the end of the year stood at Rs3,615 crore in FY2013 as compared with Rs2,818.9 crore in FY2012. Return ratios remained strong: The return ratios have continued to improve YoY for the past four to five fiscals. The return on net worth (RoNW) and the return on capital employed (RoCE) stood at 36.1% and 45.4% in FY2013 compared with 35.5% and 44.6% respectively in FY2012. Outlook and valuation: We have incorporated the FY2013 annual report's financials in our financial model. ITC has one of the strongest balance sheets amongst the FMCG companies with a gradual increase in the cash flow. We expect the strong performance of the non-cigarette FMCG business to sustain in the coming years with the business breaking even in FY2014. The cigarette business' sales volume is likely to decline YoY on account of a sharp increase in the excise duty on cigarettes for second consecutive year. However, price hikes in the cigarette portfolio would help in maintaining the revenue growth in double digits and the PBIT margin at above 30.0% in FY2014. The company maintained its thrust on investing the cash generated by the cash cow, the cigarette business, in the other key businesses. At the current market price the stock is trading at 28.5x its FY2014E earnings per share (EPS) of Rs11.4 and 23.7x its FY2015E EPS of Rs13.7. We maintain our Hold recommendation on the stock with the existing price target of Rs342. SECTOR UPDATE Automobiles  FY2014 to remain lacklustre, expect meaningful recovery in FY2015 IIP contraction leads to downtrend in automotive volumes during FY2012-13 A slowdown in the Index of Industrial Production (IIP) directly affects the automotive demand. Our analysis reveals that whenever the IIP growth falls below 5% there is a marked slowdown in the automotive (auto) demand. The IIP growth plunged below the 5% mark in FY2012 declining to 2.9%. The growth further slowed to a mere 0.9% in FY2013, which is the lowest in a decade. A sub-5% IIP growth had led to a demand slowdown in FY2001, FY2002 and FY2009. The same trend was witnessed in the last two years, ie FY2012 and FY2013.  The auto industry witnessed a downtrend from H1FY2012 when the IIP fell below the 5% mark. The growth rapidly retarded across auto segments. The fiscal 2011-12 saw a sharp deterioration in demand with the growth in truck and car volumes slipping to single digits from healthy double digits. The two-wheeler and tractor volumes also moderated sharply. The slowdown was more pronounced in FY2013, with the growth in the truck, car and tractor segments slipping into negative territory. The two-wheeler segment barely managed to stay in the positive territory.  FY2014 likely to see sluggish sales, expect meaningful recovery only in FY2015 The economic environment is expected to remain subdued, with no substantial improvement in FY2014. Limited policy action by the government and overall weak sentiments would continue to weigh on the economy. A subdued economy, higher fuel prices (particularly diesel as the government aims to decontrol prices) and high inflation would continue to restrict the auto demand. With a challenging macro-economic environment, the auto volumes would remain lacklustre in FY2014. The demand is expected to recover in FY2014 but the recovery would be mild, in our view. The IIP needs to move above the 5% mark for any meaningful recovery in the auto demand. With a mid single-digit IIP growth as an optimistic case, we expect the auto growth to be restricted to single digits in FY2014. We expect a significant revival in the demand only in FY2015.  The light commercial vehicle (LCV) and utility vehicle (UV) segments have bucked the overall slowdown trend growing in strong double digits in FY2012 and FY2013. We expect the two segments to continue to outperform, though the growth rates may moderate going in FY2014.  Prefer M&M and Maruti, avoid Hero MotoCorp  We prefer Mahindra and Mahindra (M&M) in the auto space, given its leadership in the UV segment and strong presence in the LCV space; both the segments are expected to defy the overall slowdown and record a double-digit growth. Also, the demand for tractors would recover given the expectations of a normal monsoon. Though passenger car sales are subdued, Maruti Suzuki (Maruti) has managed to increase its market share in the segment. Also, the merger of Suzuki Powertrain India (the engine manufacturing arm of Suzuki) with itself is likely to have a positive impact on Maruti's earnings. We would avoid Hero MotoCorp as the company is vulnerable to market share loss due to heightened competition in the two-wheeler space.  June 2013 sales: Downtrend intact The auto sales continued to remain weak in June 2013. Most of the players (except M&M's tractor division) showed a decline on a year-on-year (Y-o-Y) basis. A subdued economic growth and a continued increase in the fuel prices continue to weigh on the demand. Even M&M's automotive division disappointed with the sales declining across categories (except the LCV space). Even the UV segment declined for the company, the first decline in the last three years. Click here to read report: Investor's Eye   Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

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