Investor's Eye: Update - CESC, NIIT Technologies, Construction

Investor's Eye [December 26, 2013]  Sharekhan www.sharekhan.com

Summary of Contents    STOCK UPDATE CESC Recommendation: Buy Price target: Rs494 Current market price: Rs441 Spencer's on the cusp of break-even; price target raised to Rs494 CESC's power utility business is a steady generator of cash. However, a large part of the free cash is utilised to support the loss-making retail subsidiary (Spencer's) which acts as a drag on the stock's valuation. In recent times the management has taken steps to restructure the retail business. Consequently, the performance of Spencer's has improved considerably since Q1FY2011-it has broken even at the store level (with the closure of the loss-making stores and improvement in operational efficiencies). It now aims to break even at the company level over the next three to four quarters. This would be a very crucial development for CESC as despite being one of the most integrated electricity utilities, the company is valued below its peers due to its ailing retail subsidiary. When we initiated coverage on CESC, one of the key investment arguments was a possible turnaround of Spencer's and a subsequent re-rating of the stock. Now Spencer's is on the cusp of break-even. Hence, we recently interacted with Mohit Kampani, chief executive officer of Spencer's, to have a close look at the company's break-even plan. The highlights of our interaction are presented below. Moving from store-level profit to company-level profit in a year: The earnings before interest, tax, depreciation and amortisation (EBITDA) per square feet per month at store level has moved up from Rs30 in Q2FY2012 to Rs70 in Q2FY2014. The management feels Spencer's is just on the cusp of break-even at the corporate level and could break even in the next three to four quarters. To break even at the operating level, the management is looking at earning a store-level profit of around Rs85 per square feet per month. To achieve the same, it is looking at selective expansion in some regions by setting up large format stores. Further, it has improved the offering mix to achieve a better margin and eventually improve the profitability.  View-break-even of retail business a potential re-rating trigger; price target revised, Buy retained: The improving financial health of the retail business and the growing scale of the power utility business reduced the loss of the utility business meaningfully in the last three years. The net loss of the retail business was almost 50% of the profit generated from the power business during FY2011; the same has now dropped to 30% in FY2013 and is likely to come down to around 20% in FY2014 and to 15% in FY2015. Hence, we believe the valuation discount due to the concerns over the retail business should come down gradually. To factor in the same, we have lowered the discount for the ailing retail business in our sum-of-the-parts (SOTP) based valuation by 30% to Rs105 per share (from Rs150 per share previously). Therefore, we have revised upward our price target to Rs494 and maintained our Buy rating on CESC.    NIIT Technologies Recommendation: Buy Price target: Rs435 Current market price: Rs350 Upgrade to Buy with a price target of Rs435 Key points Change is on the horizon, gearing up for a better tomorrow: Since the joining of Mr Sudhir Chaturvedi (the erstwhile senior Vice President and Financial Services Head-Infosys, US) in August 2013 as the chief operating officer (COO) of NIIT Technologies Ltd (NTL), the stock has witnessed an impressive run up of around 24% in the last three months and incidentally the stock has got re-rated to 8x (as compared to 6.5x six months back, based on one-year forward earnings). Notably, NTL has reported soft earnings performance in the recent quarter and also raised concerns on the working capital management (owing to higher debtor days of more than 100 days) and the quality of earnings (the revenues from government business touched 13% in Q1FY2014). Nevertheless, with a new COO at the helm and almost eight other big recruitments in last two years, NTL is heading for a change in the horizon and preparing itself for sustainable and substantial growth opportunities in the coming years. The management aspires to reach $1 billion in revenues in the next five years.  Five point agenda from the new COO for a better tomorrow: With Mr Chaturvedi taking the forefront on the company's sales strategy, we expect that it will bring a much needed aggression for the company's growth trajectory. In our recent interaction with the management, we had discussed on the various initiatives that Mr Chaturvedi is chalking out for the future growth: (1) increasing their focus on the international market (US and Europe); (2) moving out from the low margin government business (which accounts for 10% of the revenue); (3) further strengthening of the growth verticals like travel and transport (target to become No.1 in the travel and transport vertical), and banking, financial services and insurance (BFSI); (4) cross selling of platform solutions in the US and the Middle East market to increase penetration (NIIT insurance technologies); and finally (5) increasing the focus on the infrastructure management services (IMS) space (currently around 12% of revenues) to benefit from the opportunities in the market place and also bundling of the deals that could lead to large deal wins.  Near-term pain to persist, expect improvement by Q1FY2015: Though, the management is gearing up for a paradigm shift in the growth strategy for the future, the near-term pain will continue to reflect in the financial performance. We expect a soft revenue growth for FY2014E at around 6% in US Dollar terms, with a 100-basis-points decline in margins as compared to FY2013. Further, debtors days (which were 100 days in Q2FY2014) is expected to improve gradually by Q4FY2014 with the government business starting to taper off (currently at around 10% of the revenue and domestic revenue at 16%). The management has stated that, margins will start seeing improvement from Q4FY2014, led by the improvement in the margin from the Geographic Information Systems (GIS) business and the Morris joint venture coupled with lower hardware revenues while Airport Authority of India (AAI) contract margins are higher than other domestic contracts.  Valuation: In our earlier updates, we had stressed upon the rich potential of NTL with a strong case for re-rating among mid-cap information technology (IT) companies. In the last three months, the stock has been re-rated by almost 20-25% in line with the IT sector's re-rating (led by the improved business sentiments) and inclusion of Mr Chaturvedi as the COO of the company. At the current level, the stock is trading at around a 30% discount to mid-cap IT companies average one-year forward PER (based on FY2015E earnings estimate). We believe, the next trigger of re-rating will be driven more by the execution of the management strategy with respect to an improvement in the quality of earnings. We have tweaked our earnings estimate and introduced the FY2016E estimates. We have increased our price target multiple from 6.5x to 8.5x, and rolled over our target multiple to FY2016 and arrive at price target of Rs435. We upgrade our rating on NTL from Hold to Buy.      SECTOR UPDATE Construction Pain persists but light at the end of tunnel  Our interaction with the major industry players in the road construction sector reveals that the project award activity is likely to remain weak in H2FY2014 too (both FY2013 and H1FY2014 has seen a slowdown in new project awards due to a lacklustre response for the build-operate-transfer (BOT) projects by cash strapped road construction companies), and the National Highways Authority of India (NHAI) would miss the reduced project award targets for FY2014. Second, NHAI is expected to focus on engineering, procurement and construction (EPC) based projects (construction tenders and not BOT projects) over the next couple of quarters that would be taken up by smaller players (with limited or no interest from large established players like Larsen & Toubro [L&T], Infrastructure Leasing & Financial Services [IL&FS] Transportation, IRB Infrastructure Developers [IRB Infra], Ashoka Buildcon). Thus, the bill-to-book ratio of large players would moderate further in the near term. However, we find the confidence level of larger players improving considerably on the back of the government's efforts to restructure premium of some BOT projects. Moreover, the general feeling is that the BOT project award activity would pick up significantly after the parliamentary elections and only few large established players would be able to get a bulk of the projects; that too at much better terms due to lower competitive intensity from most of the other players (due to stressed balance sheets and funding constraints).  To summarise, the pain in the road sector could continue for next two quarters. But the outlook has certainly improved for the large players and is visible in the renewed interest of large institutional investors in some of the established names like Ashoka Buildcon and IRB Infra. On the other hand, IL&FS Transportation Networks Ltd (ITNL) has suffered due to equity expansion through rights issues and relatively high leverage (but some of the concerns would get mitigated due to the recent strengthening of the balance sheet including preferential shares). We have our Buy rating on L&T, IL&FS Transportation and IRB Infra.  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.

Regards, The Sharekhan Research Team

 

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