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STOCK UPDATE ITC
Recommendation: Buy
Price target: Rs369
Current market price: Rs328 Price target revised to Rs369 Result highlights -
Revenue growth remains muted; margin expansion led to decent operating performance: ITC's Q2FY2014 performance was disappointing in terms of the revenue growth as some of the key businesses, such as the cigarette business and non-cigarette fast moving consumer goods (FMCG) business, witnessed a moderation in the revenue growth, while the revenues of the agri business declined in double-digits during the quarter. However, the significant margin improvement in the core cigarette business and commoditised agri business along with the declining losses in the non-cigarette FMCG business aided the company to post a decent operating performance with the operating profit margin (OPM) improving by above 100 basis points during the quarter. -
Cigarette business' sales volume declined by ~4%: In Q2FY2014, ITC's cigarette sales volume declined by ~4% on account of the significant price increases (of around 18%) in its portfolio after the second consecutive year of 18% hike in the excise duty and value added tax (VAT) hike in some of the key states. The brands under 65mm cigarette segment gained good response and helped arrest the substantial drop in ITC's cigarette sales volume. We don't expect ITC to increase prices of the cigarette in the near term and would rather focus on improving the sales volume in the near term. With price increases getting absorbed in the coming months, we might see a gradual improvement in the sales volume of the cigarette business. The non-cigarette FMCG business' revenue growth decelerated to 16% in line with the overall slowdown in the domestic FMCG market. The hotel business is bearing the brunt of a bleak macro-economic environment. -
Downward revision in earnings estimates: We have revised downward our earnings estimates marginally for FY2014 and FY2015 by 1% and 3% respectively to factor in the lower revenue growth in the core cigarette business and the agri business. We have marginally revised upward our margin expectation to factor the higher than expected margin in the cigarette and agri businesses. -
Maintained Buy on account of better earnings visibility and decent valuation: A volume decline of 4% in the core cigarette business in Q2FY2014 has disappointed us as well as the Street. However, the historical trend has shown that the sales volume in the cigarette business recovered once the price increases get stabilised in the market. We expect the non-cigarette FMCG business to witness an improvement in the growth rates with the inflationary pressure easing, while the higher margin commodity exports would continue to help the agri business to score good margin in the coming years. This along with the higher yields earned on cash on books would help ITC to achieve a decent growth of close 20% over FY2013-15, which is better in comparison with some other large-cap FMCG stocks such as Hindustan Unilever Ltd (HUL).
We have revised downward our price target to Rs369, which is in line with our downward revision in our earnings estimates. After the announcement of Q2FY2014 results, ITC's stock price has corrected by almost 5% and provides a decent upside of 10% from the current levels to our price target. In view of the better earnings visibility, strong cash generation ability and a decent upside from the current levels, we maintain our Buy recommendation on ITC and maintain it as our top pick in the large cap FMCG space. At the current market price, the stock trades at 29.7x its FY2014E earnings per share (EPS) of Rs11.1 and 24.9x its FY2015E EPS of Rs13.2. Hindustan Unilever
Recommendation: Reduce
Price target: Rs540
Current market price: Rs589 Margin surprise unsustainable; Reduce maintained Result highlights -
Q2 reported earnings boosted by unexpected firming of margin; unfavourable demand environment and valuation makes us retain our Reduce rating: Hindustan Unilever Ltd (HUL)'s Q2FY2014 results surprised positively with a higher than expected operating profit margin (OPM). The volume growth of 5% and revenues were largely in line with our expectations and were boosted by a double-digit growth in the personal care segment. However, the demand environment remains challenging and the sustainability of the margin is questionable given the lag effect on the raw material cost due to the depreciation of the rupee. We maintain our negative stance on the stock with a Reduce rating and price target of Rs540. -
Management commentary-moderation in demand; hedging and low inventory boost to margin: The management in the conference call stated that the sales of discretionary categories are under pressure and the premiumisation trend in some of the key categories has scaled down in the recent past. Despite the rupee depreciating by ~10%, the gross profit margin (GPM) remained higher by above 169 basis points year on year (YoY) due to an efficient hedging mechanism and certain upholding of the low-cost inventory. The personal products segment has witnessed the revenue growth coming back to double digits, which can be attributed to the favourable base effect and higher sales of winter products during the quarter. -
Segmental performance shows mixed trend: The commoditised soap and detergents segment registered a volume-led growth of 6% YoY with the profit before interest and tax (PBIT) margin remaining almost flat at 14.0% in Q2FY2014. The personal products segment regained its double-digit growth with the revenues growing by 12% YoY. The improved growth can be attributed to the low base of Q2FY2013 and higher sales of winter products during the quarter. The PBIT margin of the personal products segment declined by 141 basis points YoY to 22.8% during the quarter. The beverages segment continued to post a revenue growth of around mid- to high-teens (16% YoY for Q2FY2014). The lower tea and coffee prices aided the margin of the beverages segment to improve by 264 basis points YoY to 17.0%. The packaged food segment picked up some growth rate with a higher single-digit revenue growth of around 9% YoY. However, the growth in the packaged food segment has remained volatile for the past several quarters. -
Maintained Reduce rating on back of cautious outlook and premium valuation: For the past four quarters, HUL's volume growth has been hovering around 5% and we expect the demand environment to remain challenging due to the sustained inflationary pressures hurting the discretionary spends and the intensifying competition in some of the key categories, such as soaps, detergents and oral care. On the other hand, the impact of the rupee's depreciation on the raw material cost, and the need for higher advertisement and promotional spends would put pressure on the margin in the coming quarters.
We have broadly maintained our earning estimates for FY2014 and FY2015. Any significant deceleration in the GPM or drop in the sales volume growth in the coming quarters would act as a risk to our earning estimates. At the current market price, the stock trades at 36.4x its FY2014E and 32.6x its FY2015E. In view of the near term head winds and premium valuation, we maintained our Reduce rating on the stock with the price target of Rs540. Maruti Suzuki India
Recommendation: Hold
Price target: Rs1,618
Current market price: Rs1,513 Price target revised to Rs1,618 Q2FY2014 results' snapshot-ahead of expectations due to increased localisation and forex gains -
Maruti Suzuki India Ltd (MSIL)'s Q2FY2014 results were ahead of our as well as the Street's estimates on account of a strong operating performance. -
The revenues at Rs10,468.1 crore were marginally ahead of our estimate. The realisation per vehicle at Rs370,550 was ahead of our estimate by 2.3%. -
The operating profit margin (OPM) at 12.6% was significantly ahead of our estimate of 11.6%. This is on account of increased localisation and foreign exchange (forex) gains. The operating profit at Rs1,321 crore was ahead of our estimate by 11%. -
The net profit at Rs670.2 crore was significantly ahead of our estimate of Rs566.9 crore. Guidance lowered on volume growth in H2FY2014: MSIL reduced the volume outlook for H2FY2014 on account of the continued weakness in the domestic demand. While Q3FY2014 would see a relatively better demand on account of the festive season, the situation after the festive season would remain challenging. Given the challenging outlook provided, we expect MSIL to post a 2% decline in FY2014 as against the flattish volumes estimated earlier. Q2FY2014 margin surprises positively but likely to moderate in H2: While the margin for Q2FY2014 saw benefits from the currency, the margin is likely to moderate in H2FY2014 as the enhancement of vendor compensations due to the rupee's depreciation would hit in the second half. Outlook and valuation-Neutral view maintained with revised price target: We have reduced our revenue assumptions on account of a lower volume guidance given by the company. Also, the realisation would be impacted given the fall in the demand of the diesel cars. However, we have raised our margin assumptions given the strong performance in Q2FY2014 and increased localisation efforts by the company. We have marginally raised our FY2014 and FY2015 earnings estimates to Rs90.5/share and Rs107.9/share respectively. Given the pressure on the demand, we maintain our "Hold" recommendation on the stock with a revised price target of Rs1,618. Shree Cement
Recommendation: Hold
Price target: Rs4,500
Current market price: Rs4,425 Hold retained with revised price target of Rs4,500 Result highlights -
Cement business dented by a sharp dip in realisation; power business shows strong volume-driven growth: Like most of its peers, Shree Cement also witnessed a sharp decline in the blended realisation (13% down) that negated the volume growth of 7% and led to a 36% decline in the operating profit during the quarter. At the profit after tax (PAT) level, the decline was restricted to 24.5% due to a higher other income, a lower effective tax rate and a better performance of the power business. The power business' revenues grew by 16% (led by a volume growth of 35.8% in the units sold) and it also witnessed a 75% growth in the segmental profit. -
Cost pressure mounts in cement business; power business provides support: The operating profit margin (OPM) during the quarter contracted by 1,015 basis points to 20%. The margin contraction was largely on account of a decline in the average cement realisation and the continued cost pressure in terms of: (a) an increase in the freight cost by 10.8% on a per tonne basis; (b) an increase in the other expenses by 14.6% to Rs247.4 crore; and (c) an increase in the employee cost by 22% to Rs101.3 crore. Hence, the EBITDA of the cement business declined by 43.1% year on year (YoY) to Rs670 per tonne. On the other hand, the EBITDA from the power division for Q2FY2014 declined by 30.2% to Rs0.74/unit as compared with Rs1.1/unit in the corresponding quarter of the previous year. -
Hold maintained; power business provides cushion: The demand outlook for the cement business is challenging in the near term. However, we expect the power business to do better in terms of the merchant power sales in the election year and limit the pressure on its financial performance. Consequently, it is better placed than some of its peers to face the cyclical downturn, but the same is already reflected in the valuation (EV/EBITDA of close to 8.8x FY2014 earnings). We retain our Hold rating on the stock with a price target of Rs4,500. Bharat Electronics
Recommendation: Buy
Price target: Rs1,485
Current market price: Rs1,065 Slow execution remains key concern Result highlights -
Revenues largely in line with estimate; slow execution of order remains key concern: In Q2FY2014, Bharat Electronics Ltd (BEL) posted a year-on-year (Y-o-Y) decline in the revenues, which is largely in line with our expectation. For the quarter under review, the operating revenues declined marginally by 2% to Rs1,044.8crore year on year (YoY), which is mainly on account of a slower execution of the large orders. The profit after tax (PAT) for the quarter stood at Rs59.3 crore, which is 26% lower as compared with the same period of the last year. The key reason for the lower profit was a decline in the other income (24% YoY to Rs109.3 crore). An increase in the requirement of working capital impacted the cash balance, which declined by 15% to Rs4,512 crore as compared with Rs5,302 crore at the end of March 2013. -
OPM improves; better cost management remains key focus: An improvement in the operating profit margin (OPM) during the quarter was mainly on account of a lower input cost. During the quarter under review, the OPM turned positive and stood at 0.2% as against -6.3% in Q2FY2013. Hence, going ahead, as the execution of the orders improves, the company's focus on managing cost through change in the product mix (in favour of the higher margin products) will improve the margin. Generally, H1 is a soft quarter for the company in terms of execution and margin which will pick-up in H2. Therefore, the margin performance in H1 doesn't represent the full year performance of the company. -
Valuation and view: Looking at the order book and the pipeline of deals on the anvil, we maintain our preference for BEL as a proxy player on the defence spending. We believe BEL would be the front runner in the defence capital expenditure (capex) spends to be done by the government of India. The order book at 4.2x FY2013 sales gives BEL a strong revenue visibility at least for the next three to four years. However, the timely delivery of orders and the margin performance remain the key risks. On the valuation front, currently the stock is trading at 9.9x its FY2014E earnings per share (EPS) of Rs107.2 and 8.6x its FY2015E EPS of Rs124. We maintain our Buy rating on the stock with a price target of Rs1,485.
VIEWPOINT Colgate Palmolive India Higher media spend affected bottom line Result highlights -
Sustains strong double-digit volume growth despite intense competition: Colgate Palmolive India (Colgate)'s net sales grew by 15.8% to Rs895.7 crore in Q2FY2014, largely driven by a steady volume growth of 10% in the quarter. The steady volume growth sustained despite increased competition in the oral care segment with the entrance of Procter and Gamble (P&G) in the toothpaste segment. Colgate reported a volume growth of 9% in the toothpaste segment and further consolidated its leadership with a market share of 56% during the quarter. The growth was contributed by the flagship brands Colgate Dental Cream, Active Salt, Max Fresh and Colgate Total along with the recently launched Visible White. Its toothbrush market share rose by 210 basis points to 41.4% during the same period. -
Gross margin improves but A&P spend dents operating margin: The gross profit margin (GPM) improved by 142 basis points year on year (YoY) to 59.6%. The improvement in the GPM can be attributed to a low input cost and the price increases undertaken in the product portfolio. However, the entry of P&G during the quarter saw the existing players increasing their media spending in the oral care segment. Colgate's advertisement spending as a percentage of sales was up by 185 basis points to 13.3% and the other expenses (including promotional spending) as a percentage of sales was up by 516 basis points YoY to 24.5%. This led to a 453-basis-point year-on-year (Y-o-Y) decline in the operating profit margin (OPM, excluding the other operational income) to 15.8%. Hence, the operating profit declined by 16.8% YoY to Rs146.3 crore. This along with a lower other income resulted in a 24.5% decline in the adjusted profit after tax (PAT) to Rs109.5 crore during the quarter. -
Focus on innovation: Colgate has maintained its focus on innovation to sustain the growth momentum as well as its strong leadership in the oral care category. It has recently launched Colgate Visible White aimed at creating a new whitening segment in the domestic market. The company has also launched new toothpaste, Colgate Active Salt Healthy White, which offers a most sought-after benefit of "Yellowness removal" from the teeth. In the toothbrush category it has launched Colgate Slim Soft toothbrush with enhanced qualities in the domestic market. -
View-volume growth ahead of peers; margin pressure to ease off: Responding to the intensified competition (P&G's entry in the oral care segment) Colgate enhanced its advertisement and promotional activities in Q2FY2014. In the past also, it had adopted a similar strategy to counter competition from Hindustan Unilever Ltd (HUL) and GlaxoSmithKline Consumer Healthcare though the margin had got dented in the short run. Thus, we believe that the advertisement spending could taper off in the coming quarters and ease the pressure on the margin. Moreover, the valuation of 27.5x its FY2015E (Bloomberg consensus estimate) earnings is supportive since Colgate trades at a steep discount to HUL and some of the other multinational consumer companies listed in India. KEC International Signalling bottom out in margin Key points -
Decent top line performance with healthy order book: The consolidated sales of KEC International (KEC) grew by 7% year on year (YoY) and 2% quarter on quarter (QoQ) to Rs1,778 crore in Q2FY2014. The stand-alone sales grew by 17% YoY and 4% QoQ to Rs1,511 crore during the same period. The sales growth was backed by a healthy order book that stood above Rs10,200 crore, ie 9% higher YoY. The order book of KEC implies 1.5x its FY2013 sales, which indicates healthy revenue visibility. -
Improved share of transmission line orders-a positive sign: In the existing order book, the share of transmission business went up to 77% in Q2FY2014 from 67% in Q2FY2013 (refer table "Order book break-up business-wise"). In the meanwhile, the share of the order book of power systems and the railways fell from 17% to 11% and 6% to 3% respectively during the same period. We read this as a positive sign as the transmission business is enjoying a stable and healthy margin compared with the other businesses, like the railways, power systems and the water segment, which were having a negative or a thin margin. -
Margin starting to look up; low-margin projects coming to an end: The operating profit of the consolidated entity grew by 30% YoY and 27% QoQ in Q2FY2014. The net profit improved by 34% YoY and 137% QoQ to Rs22 crore, backed by a better margin. After reporting weak margins for eight quarters (with a declining trend), KEC showed an improvement in the operating profit margin (OPM) during Q2FY2014 (refer chart "Margin performance"). The stand-alone business also showed some improvement on the margin front during Q2FY2014 (both YoY and QoQ). We believe the margin improvement was caused by the execution of a higher share of transmission orders compared with the other segments (where the margins are low). Moreover, we learned from the management that the remaining low-margin projects are likely to come to an end in the next two quarters. Hence, KEC expects the margin to gradually move up from FY2015. We believe this would be a key positive for the company. -
Implied subsidiaries' margin was impressive: If we look at the implied numbers of the subsidiaries (ie deduct the stand-alone numbers from the consolidated numbers), the margin performance appears impressive (about 14% in Q2FY2014) largely contributed by SAE towers. The management shared that the margin is not sustainable at this level. Nevertheless, SAE towers is expected to earn an OPM of around 10% on an annual basis. -
Balance sheet remains largely stable: The engineering, procurement and construction (EPC) business is working capital intensive and consequently, we expect the working capital days to remain high. During mid year, usually the receivable days go up and then taper down at the end of the year with the payment coming in from the state electricity boards and other customers; hence, the management is confident of managing the working capital in line with the historical trend. In keeping with the same trend, it expects the debt to hover around the current level too. -
View: Based on the existing order book position and the ability of the company to sustain healthy order inflow, we expect it to deliver a 10-15% steady growth in the top line. Currently, the stock is trading at 5x its forward earnings (Bloomberg consensus estimate), 4x its FY2015 earnings before interest, tax, depreciation and amortisation. Moreover, with signs of improvement in the OPM, the earnings growth could be better than the revenue performance. We believe that if the company manages to exhibit a margin improvement as expected, it would be a key positive trigger for the stock. The stock was beaten down and its valuation contracted in the past for the same reason. Currently, we don't have any rating on the stock .
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