Investor's Eye: Update - Larsen & Toubro (Annual report review; price target revised to Rs1,627), Eros International Media (Annual report review)

 

Investor's Eye [September 06, 2012]  Sharekhan www.sharekhan.com

Summary of Contents   STOCK UPDATE   Larsen & Toubro Cluster: Evergreen Recommendation: Buy Price target: Rs1,627 Current market price: Rs1,317 Annual report review; price target revised to Rs1,627  Key points FY2012 performance driven by a pick-up in execution especially in the overseas business: In FY2012, Larsen & Toubro (L&T)'s stand-alone revenues rose by 21% led by a pick-up in execution in its engineering and construction (E&C) business and a growth of 36% year on year (YoY) in the overseas business. Even on a consolidated basis, the revenue growth of 24% was decent, given the macro environment. However, the slowdown in the order inflows remains a concern with muted order inflow from the domestic market.  Management positive on opportunities in hydrocarbon sector (including overseas), IES business: In the annual report, the management has pinned hopes of better flow of orders from the Middle East region. It believes that the hydrocarbon segment has faced a lull in the last two years and could see order inflow of over Rs10,000 crore in FY2013. Moreover, it also expects policy changes to revive investments in the domestic gas pipeline and fertiliser (especially urea) manufacturing projects.  Working capital cycle deteriorates sharply: In FY2012, the company saw a marked deterioration in its working capital cycle led by an increase in the debtor days to 129 days from 103 days in FY2011. The net working capital cycle tripled to 33 days in FY2012 from 11 days in FY2011. Overall, the net cash flow from operations (CFO) witnessed a steep decline to Rs1,081.6 crore during the year (from Rs3,833.3 crore in FY2011) while the gross CFO (before working capital changes) increased to Rs6,774.7 crore from Rs6,094.81 crore in FY2011. RoCE deteriorated as developmental projects yet to break even: Heavy investments in developmental projects (whose benefits are yet to accrue) and a notable increase in the short-term borrowings caused the return on capital employed (RoCE) to decline to 19.1% from 20.9% in FY2011. Out of its seven road and bridge projects that have been commissioned since FY2009, five were making losses and the overall loss in the segment stood at Rs94 crore in FY2012. Moderation in capex, focus on cost optimisation: The company moderated its capital expenditure (capex) to Rs1,730 crore during the year as compared with the past three years' capex level of Rs1,600-1,700 crore. Further, the company is trying to contain costs in the electrical and electronics (E&E) business (whose margin reduced by 226 basis points in FY2012) by gradually shifting its manufacturing activities to low-cost locations like Vadodara and Ahmednagar.  Estimates fine-tuned: We have fine-tuned our projections for the company in line with the FY2012 annual report. Overall, our estimates remain largely unchanged. There appears to be a strong correlation between the growth in the country's gross domestic product (GDP) and L&T' sales with a lag effect of one year (a correlation coefficient of 0.83x). Hence, the recent slowdown in the economy is likely to get reflected in the performance of L&T in the coming quarters. The company's plans to lower the investment commitment in its various development projects might also not see any major progress due to the continued policy paralysis in the infrastructure sector.  Price target revised to Rs1,627: The achievement of a 12-15% growth guidance in the yearly order inflow would be subject to an uptick in the infrastructure development activities in the country and in the Middle-East region. Moreover, excluding the build-operate-transfer (BOT) projects might limit the growth in the order inflow especially in the public private partnership projects. At the current market price, the stock is trading at 12.5x its FY2010E consolidated earnings. We maintain our Buy recommendation on the stock with a new sum-of-the-parts (SOTP)-based price target of Rs1,627.   Eros International Media Cluster: Emerging Star Recommendation: Buy Price target: Rs267 Current market price: Rs165 Annual report review  Eros International Media Ltd (EIML)'s FY2012 annual report highlighted the following: (a) its revenue growth was strong during the fiscal driven by some high-profile films with more wider screen releases; (b) it is de-risking its film investments with accelerated monetisation from pre-sales; (c) higher amortisation restricted its margin improvement, though adjusted for the one-offs the margins improved year on year (YoY); (d) its negative free cash flow (FCF) increased during the year owing to the repayment to the parent and higher production advances; (e) it has a strong film slate for the coming years; and (f) it has increased the content investments.  Strong revenue performance: For FY2012, EIML reported a 33.5% jump in revenues to Rs943.9 crore. The strong performance was partly driven by the wider screen releases-on an average, big-budget films were released on 5.5% more screens as compared with the last year. Added to this, an increase in the price of satellite rights of the big star-cast films helped to post a strong top line growth. During the fiscal EIML released 77 films, out of which 27 were Hindi films, which reported a robust growth of 68% to Rs802 crore (stand-alone revenues). Overall, the company released 77 films (27 Hindi films and 50 regional films) in FY2012-the same as in FY2011 (16 Hindi films and 61 regional films). Four of the company's films were among the top ten box-office grossers of CY2011 (namely "Ra.One", "Rockstar", "Ready" and "Zindagi Na Milegi Dobara"), up from three in CY2010. Two of the films ("Ra.One" and "Ready") grossed more than Rs100 crore each.  Higher amortisation and surge in other expenses restricted margin improvement: Despite a strong growth in the top line (33.5%), the operating profit margin (OPM) failed to show any meaningful improvement (up 40 basis points) and remained stable at 22.5% as compared with 22.1% in FY2011. In FY2012, the cost increased led by a higher amortisation cost (up 43% YoY to Rs347.7 crore) which was in sync with the company's strategy of increasing its own/co-production films and lowering its dependence on outright purchase of film rights. As a result, the proportion of amortisation of film rights to the total film content cost increased significantly to 61% in FY2012, up from 57% in FY2011 and 48% in FY2010. Further, for FY2012 the other expenses jumped substantially, by 57%, to Rs46.4 crore, primarily led by an increase in the legal expenses (relating to Eros Plc initial public offering) and provisioning as well as the write-off of content advances and foreign exchange (forex) losses. Adjusted for the doubtful provisioning as well as the write-off of content advances and forex losses, the OPM improved by around 130 basis points YoY.  Accelerated investments in content to enhance revenue predictability: During the year, content investments went up by 33% YoY to Rs724 crore. This included an investment of about Rs224 crore toward the purchase of film rights (up from Rs183 crore in FY2011) and Rs501 crore toward funding own/co-production deals (up from Rs380 crore in FY2011). Out of Rs501 crore, Rs474.7 crore was advances towards film production for FY2013 and FY2014. In FY2012, the company had some big-budget releases like "Ra.One", "Ready", "Zindagi Na Milegi Dobara" and "Rockstar". For FY2013E the company has high-profile movies lined up, namely "Housefull 2" (released), "Khiladi", "Kochadaiyaan" and "Chakravyuh" among others. During the year, EIML also launched EROS Now to exploit its large film library through the digital platform.  Pressure on FCF intensified owing to repayment to parent and production advances: At the end of FY2012, EIML reported negative FCF of Rs189 crore as compared with negative FCF of Rs116 crore in FY2011. The negative FCF increased on account of (1) the repayment of the advances of Rs146 crore taken from Eros Worldwide FZ LLC (promoter) and (2) an outflow of Rs474.7 crore on account of the advances for film production. Adjusting for the same, the negative FCF stands at Rs45.7 crore. At the end of March 2012, the total debt on the books stood at Rs436 crore as compared with Rs238.7 crore.  Valuation: EIML with its niche expertise in film distribution and co-production is well poised to capitalise on the upswing in the Indian film industry. The Indian film industry is going through a good phase with an increased number of screens (multiplex, megaplexes and single screens leading to wider releases), acceleration in digital prints (cost rationalisation and improved realisation) and improved pricing in TV syndication (risk mitigation). We have fine-tuned our estimates based on the annual report of FY2012. At the current market price of Rs165, the stock trades at 8.7x and 7x FY2013 and FY2014 earnings estimates. We remain positive on EIML and maintain our Buy rating on the stock with a price target of Rs267. 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.

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