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STOCK UPDATE Bharti Airtel
Recommendation: Buy
Price target: Rs395
Current market price: Rs343 Upgraded to Buy Key points -
Q2FY2014 performance vindicates our positive stance on telecom sector: The Indian telecommunications (telecom) environment is turning favourable with a reduction in the competitive intensity and the benefits of consolidation flowing to the incumbent players. The same has been visible in the improving performance indicators of the leading players over the past three quarters (viz improving revenue per minute, expanding margins and high data growth). The Q2FY2014 performance of the telecom operators further vindicates our stance that the overall domestic business environment continues to improve, with data as the next driver of growth in both revenues and margins. -
Stock correction provides opportunity: Since our last update on the stock published on October 30, 2013, Bharti Airtel has declined by around 5% and currently provides around 15% upside to our price target of Rs395. We believe that the market has punished the company for its poor performance in Africa and the high dollar-denominated loans in its balance sheet. We believe the concerns are overdone and that going forward the operations in Africa are likely to stabilise and grow, albeit at a lower pace as against the level of high double-digit growth envisaged by the management earlier. -
Improving regulatory environment: The Telecom Regulatory Authority of India (TRAI)'s new recommendation on 2G spectrum pricing is in favour of the industry as it looks at the spectrum pricing from a fresh perspective. It suggests a 37% lower pan-India price for 1,800mhz spectrum and also delinks the 900mhz spectrum pricing from the 1,800mhz spectrum pricing, putting circle-wise reserve price for the airwaves as and when the same come up for renewal. We also understand from various government as well as media sources that new merger and acquisition guidelines are expected to be out soon, which is likely to spur further consolidation in the sector. Thus, we believe these resolutions on regulatory issues, which continue to hinder the sector, are likely to recede and by virtue of being an incumbent player, Bharti Airtel, would gain. -
Upgraded to Buy: Taking cognisance of the improving business fundamentals, the receding regulatory roadblocks and the recent price correction, we upgrade our rating on Bharti Airtel from Hold to Buy, maintaining our price target of Rs395. Our price target provides an upside of about 15% from the current levels. At the current market price the stock is trading at FY2015 enterprise value/earnings before interest, tax, depreciation and amortisation of 6.9x. Selan Exploration Technology
Recommendation: Buy
Price target: Rs365
Current market price: Rs317 Muted Q2 numbers but commencement of drilling to improve volume soon Result highlights -
Impact of delay in approval visible; quarterly performance remained subdued: In Q2FY2014, the net revenues (adjusted for the petroleum profit) of Selan Exploration Technology (Selan) remained flat on a year-on-year (Y-o-Y) basis and grew by 6% on a quarter-on-quarter (Q-o-Q) basis. Though a stronger dollar helped the company (its realisation improved during the quarter on both Y-o-Y and Q-o-Q bases), but a muted production volume resulted in a flattish sales growth YoY. A delay in obtaining regulatory approval in the past had a cascading effect on its production during the quarter. However, on the positive side, the company has received the requisite approvals recently and the development work on its wells is in progress. During the quarter the net profit remained flat year on year (YoY) but grew by 6% quarter on quarter (QoQ) due to the benefit of the dollar's appreciation against the rupee. -
But commencement of drilling post-development approvals to drive production volumes, outlook improves drastically: Based on the approvals received from the Directorate General of Hydrocarbons (DGH) for developing eleven wells in its key oil fields of Bakrol and Lohar, the company has commenced drilling operations and the early signs from the four wells drilled recently are encouraging. The long delays experienced by most exploration companies in obtaining approvals for development of assets from DGH is a thing of past now and we believe the steady progress made by Selan in exploring oil fields (after a gap of almost four years) would considerably boost production volumes over the next couple of years. In the past also, the company was able to boost its production volumes by four times in a period of three years (FY2006-2009). -
Revising estimates: We have fine-tuned our FY2014 and FY2015 estimates to factor in the revised production ramp-up schedule (delay in commencement of drilling due to the company's inability to mobilise onshore rig), lower oil prices and exchange rate. -
View-remain bullish; re-rating triggers ahead: Given the commencement of drilling operations and improving regulatory environment (faster clearing of field development proposals), we believe the company would be able to execute its aggressive field development plans that would result in a significant ramp-up in production volumes and financial performance. Consequently, we remain bullish on the stock and retain our Buy rating on it with a price target of Rs365. We see scope for further upward revision in the price target based on the progress made in the development of oil fields. Jaiprakash Associates
Recommendation: Reduce
Price target: Rs40
Current market price: Rs48 Downgraded to Reduce; balance sheet concerns to weigh on valuation Result highlights -
Q2 results driven by construction business: JP Associates Ltd (JAL) reported a net sales growth of 5.6% to Rs3,149 crore, which was primarily driven by the construction division (revenues up 12.6% to Rs1,453 crore) with flattish cement revenues and a decline in the revenues of the power division (down 17.8%). In addition to the muted revenue growth, the pressure on the margin (down 240 basis points) and higher interest charge led to a decline of 47% in the adjusted earnings. -
Ballooning debt could trigger additional distress actions: In the last quarter, to deleverage the balance sheet the company sold part of its cement business at a steep discount to the deals done in the cement sector. Given the huge debt burden of Rs25,000 crore on its stand-alone balance sheet, we would not be surprised if the company resorts to more similar actions and exits some real estate or power assets at a discount to the fair value. -
Outlook-remains muted for all its business segments; earnings estimate downgraded with scope for further downgrades: The highly stretched balance sheet in the prevailing tough business environment would continue to create uncertainty and weigh on its valuations. Moreover, the outlook for its key businesses of construction, real estate and power remain challenging prompting us to revise downwards the estimates for FY2014 and FY2015. We see further scope for earnings downgrades if the macro conditions remain tough and the company is unable to get decent valuations for the sale of its non-core assets. -
View-recent steep appreciation offers opportunity to exit: Given the muted growth outlook, highly leveraged balance sheet and unfavourable macro environment, it is advisable to use the recent strong rally (about 60% upsurge over a three-month period) to exit the stock. Consequently, we remain cautious and downgrade our rating on the stock to Reduce with a price target of Rs40 (lowering our net asset value [NAV] for real estate projects along with a lower than expected performance from the cement and construction divisions). An improvement in the business environment in the business segments yielding faster and fair monetisation of assets remain the key risks to our valuation.
SHAREKHAN SPECIAL Q2FY2014 Telecom earnings review
Robust Q2 performance with improving outlook Result snapshot -
Good performance in a seasonally soft quarter: The Q2FY2014 performance of the telecommunication (Telecom) service operators was largely in line with the expectation on the profitability front, while the revenue performance was a tad soft, due to pronounced seasonality. Despite a seasonally weak quarter, operators witnessed sequential uptick in their realisation (1-2%), incating that they are gaining pricing comfort. -
Tata Communication posted stellar results: Tata Communication Q2FY2014 performance was strong, with the revenue/operating profit growth at 10.1% and 28.4% sequentially. The margin expanded by 240 basis points (bps), quarter-on-quarter (QoQ) from 14.5% to 16.3%, led by a margin expansion across segments (viz-voice, data as well as Neotel). The company turned profitability at the net level, after posting losses now for four years in a row. The adjusted net earnings stood at Rs80.1 crore for the quarter as against loss of Rs122 crore for Q1FY2014. -
Upgrade Bharti Airtel to Buy: Post our Q2FY2014, results on the updated note on Bharti Airtel (Bharti) is that the stock has declined by about 5% (we believe that the market has punished Bharti for its poor Africa performance, which we believe is likely to improve from here on, though at a slower pace), and the stock now provides 15% upside to our target price of Rs395. Further, we believe that Bharti's business in India is improving and is resilient, with strong data growth that will continue to positively impact the margins. Further, the reserve price of 2G spectrum coupled with the likely announcement of mergers and acquisitions (M&A) norms also provides us confidence of an improving regulatory environment ahead. Hence, taking cognisance of all these factors we have upgraded our rating on this stock from Hold to Buy, maintaining our target price of Rs395. -
We maintain our positive stance: After the Q2FY2014 management interactions, the operators sounded confident of the improving business environment, and the likely sustenance of the pricing discipline. The benign competitive environment, relatively soft regulatory hurdles and attractive valuations make us continue with our positive stance on this sector. Our top pick in the sector is Bharti Airtel. We also have a positive stance on Tata Communications (though it is not under our active coverage as of now). Q2FY2014 Pharma earnings review
Strong Q2 results; triggers in place to sustain premium valuations Key points -
Q2 performance exceeds expectations: Most of players in Sharekhan's pharmaceutical (pharma) universe reported a robust performance on a healthy growth in international business (especially the US business), foreign exchange (forex) gains and, in some cases, an improvement in the contract research and manufacturing services (CRAMS) business. On an aggregate basis, the universe reported a 25.5% growth in net sales (higher than our estimate of 19.5%) with an improvement of 115 basis points in the operating profit margin (OPM) to 27.6% during the quarter. The companies that surprised positively and outperformed their peers are Aurobindo Pharma (Aurobindo), Dishman Pharma (Dishman) and Sun Pharmaceutical Industries (Sun). -
Premium valuations to sustain; maintain positive stance: Most pharma stocks have seen expansion in trading multiples on the back of a steady growth in the core business and benefits of weakness in the rupee. The BSE Healthcare Index trades at 18.3x and 16.2x FY2014 and FY2015 consensus estimates (Bloomberg estimates) respectively which is not cheap. However, we expect the premium valuations to sustain due to consistently robust financial performance of pharma companies and the scope for further upgrades in the consensus estimates. The key growth drivers for the pharma sector include: (1) improvement in domestic business after trade related issues get settled; (2) an increased number of product launches in the US market by players like Aurobindo, Cadila Healthcare (Cadila), Glenmark Pharmaceuticals (Glenmark), Lupin and Torrent Pharmaceuticals (Torrent); (3) ramp-up at new facilities of Ipca Laboratories (Ipca) and Cipla (Indore special economic zone [SEZ] facility) and DSN SEZ facility of Divi's Laboratories (Divi's); (4) better traction in the CRAMS business of Dishman Pharma (Dishman) and the joint ventures of Cadila (additional product launches by FY2015 from its European joint venture, Hospira. Consequently, we retain our positive stance on the sector. -
Sun, Lupin, Cadila and Aurobindo are our top picks: Sun (income from Prandin under 180-day exclusivity; better traction in Doxil and stronger performance of Taro Pharma), Lupin (improved traction in the US branded business on addition of Alinia, oral contraceptives and ophthalmic products in the US market) and Aurobindo (aggressive product filings in the USA and Europe; ramp-up at the Cephalosporin line of products) are our top picks. Besides, we also see potential in Cadila which though reported a moderate performance in Q2FY2014 but whose management sounds confident of achieving a better growth in H2FY2014 on expectations of new approvals in the US market. Q2FY2014 Cement earnings review
Pain persists Key points -
Dip in blended realisation and cost pressures hurt earnings: In the second quarter of FY2014 most cement companies failed to meet the Street's expectations, which were already subdued. The realisation dipped by 7-8% (on an average) and the cost pressures increased (in terms of higher fuel & power cost, and higher freight cost due to higher diesel price/railway freight). Overall, the aggregate earnings of the Sharekhan cement universe declined by 43% on both sequential (the second quarter of a fiscal is seasonally weak due to the monsoon) and annual bases. -
Revenue growth falters despite higher volume offtake: During the quarter under review, the aggregate revenues of the cement companies in Sharekhan's universe remained flat (down 0.8% year on year [YoY], down 6% quarter on quarter [QoQ]) to Rs14565 crore. The marginal decline in the revenues was largely on account of a decline in relisation. During the quarter, the average cement realisation declined by 9% YoY due to a sluggish demand environment. The other business like power (in Shree Cement) or viscose staple fibre (VSF; in Grasim Industries [Grasim]) have restricted the fall in the revenues. The south-based cement companies with exposure to Andhra Pradesh (like The Ramco Cements and India Cements) were the worst hit due to a disruption in demand caused by the Telangana issue. -
Lower realisation and cost pressure dent margins: On the operating profit margin (OPM) front, the cumulative OPM of the cement companies under our coverage contracted by 749 basis points to 15% during the quarter under review on account of a decline in the realisation and surge in the freight cost (an increase in the price of diesel and railway freight). Among the companies under Sharekhan's cement universe Shree Cement and The Ramco Cements posted a margin contraction of 1,000 and 1,800 basis points YoY respectively. On the other hand, UltraTech Cement (UltraTech) witnessed relatively less pressure on the margin due to its pan-India presence. -
Outlook-hope for higher rural demand but business environment remains unfavourable: Though there is hope for a better rural demand on the back of a good monsoon, but the key demand drivers remain elusive due to a lack of investment in infrastructure and moderation in demand from the real estate sector. However, on the positive side, the cement companies have taken some price hikes after the monsoon and their financial performance would improve in Q3FY2014 on a sequential basis. Overall, the subdued demand environment and cost pressures would keep the earnings trajectory in negative territory in H2 as well. -
View-retain negative view; huge gap between the valuations of large pan-India players and that of the regional players offers opportunity from a longer-term perspective: Given the tough business environment and weak financial performance ahead, we remain cautious on the cement sector. Currently, we do not have a Buy rating on any cement stock. Our preference for pan-India players like UltraTech (within the cement sector) has played out well. However, the huge gap between the valuations of the large pan-India cement companies (like Ambuja Cements, ACC, UltraTech) and the regional players (which are trading at a 50-60% discount on an enterprise value [EV]/tonne basis) does offer opportunity to value investors with a longer-term perspective.
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