26 SEP 2019 Hits & Misses

26 SEP 2019

Hits & Misses

If wishes were horses… If wishes were horses, sell side analysts would become successful Fund Managers! Opinions are cheap; backing them with money and accountability can get painful. Most sell side analysts (incl. us) can hand out stock opinions recommendations faster than trades are matched on the NSE.

Brokers can be observers, analysts and opinion writers but (by definition) do not put their skin in the (messy) game of investing. The occasional (and now, much more frequent) rap on the knuckles is the price they pay for their failed ideas.

In sharp contrast, if you are a fund manager managing real money, you face real pain when your funds under-perform. Big exposures drag fund performance (and sear your heart) when they sour. Missed ideas are paraded about in canteen conversations, internal reviews and public events to reinforce your mental agony. Erosion of investor savings (relative or absolute) stabs

your conscience and hammers your self esteem.

Our introspection is not yet complete… In the following pages, we take a self-flagellating

look at what we've blown up, messed with and simply lost the plot for, over the trailing 18 months. We've made an effort to document (and hopefully, learn) some tough lessons in our journey as equity analysts. The not so obvious risk in such efforts is that we may be wrong even in identifying how we've gone wrong!

Sometimes, our research thesis on a ‘miss’ is flawless, but it so happens that price stays out of favour for an extended period. Even here, we deserve some flak for not seeing through how investors (and the market, at large) would value such a business.

Just in case you think we are good only at missing the good stuff, we've also compiled a few 'hits' and the corresponding lessons.

Finally, an exercise like this invariably succeeds in delivering a key objective: that of keeping us humble. It makes us conscious of our biggest follies, foibles and fallacies. And therein lies a durable benefit for you, dear investor.

Industry Company HITS

Banks & NBFCs

ICICI Bank Kotak Mahindra Bank City Union Bank Axis Bank

Life Insurance SBI Life Insurance

IT Services TCS L&T Tech

Consumer

Havells Dabur Britannia Marico

Oil & Gas GSPL Autos Eicher Motors Pharma Dr Reddy’s Labs MISSES

Banks & NBFCs

RBL Bank Karur Vysya Bank Shriram Transport Finance

Broking ICICI Securities IT Services Cyient Exchanges BSE

Cement Orient Cement Shree Cement

Consumer Emami Symphony

Oil & Gas ONGC Chemicals Balaji Amines Auto Maruti Suzuki

Pharma Jubilant Life Sciences Strides Pharma

Infra & Construction NCC Dilip Buildcon

Team Research [email protected]

HDFC securities Institutional Research is also available on Bloomberg HSLB <GO> & Thomson Reuters

HITS & MISSES

HITS & MISSES : Our best/worst calls since Apr-18 SECTOR/ INDUSTRY COMPANY STOCK PRICE 1

APR 2018 Current

RECO STOCK

PRICE NOW RETURNS

on RECO % THE STORY SO FAR…

HITS Banks ICICI Bank 262 BUY 434 65.9 Persistent healing visible across parameters over the trailing 18m, in line with

cautious strategy. Our recommendation (BUY) is unchanged over the period.

Banks Kotak Mahindra Bank 1,097 BUY 1,601 45.9 Nothing’s wrong here, except the price. We downgraded to NEUTRAL in 1QFY20, valuations look rich.

Banks City Union Bank 159 BUY 222 39.9 Mr Consistent! Strong regional SME franchise and pricing power with tight asset quality leash. Our BUY is now over three years old. And we’re not budging.

Banks Axis Bank 582^ BUY 695 19.4 Upgraded as we sensed a DNA change with the top mgt rejig and greater clarity on RoAE expansion and asset quality improvement.

Life Insurance SBI Life 684 BUY 796 16.4 Franchise leader in growing industry with tight cost structure and improving metrics. We’ve maintained BUY over the trailing 18 months.

IT Services TCS 1,875 BUY 2,088 11.4 We upgraded TCS to BUY (from NEUTRAL) in Jun-18, with persistently superior metrics and improved growth visibility. We STILL prefer TCS over Infy, unlike most of the Street...

IT Services LTTS 1,198 BUY 1,592 32.9 We upgraded LTTS when growth acceleration set in and looked sustainable to us. FY19 more than met our street high estimates. Our BUY continues…

Consumer Durables Havells 507 NEU 670# 32.1 We did not agree with the implied growth (reflected in rich valuations) and downgraded our BUY in Jan-19. Havells subsequently disappointed on growth.

FMCG Britannia 2,551 BUY 3,150# 23.5 We had a BUY rating 18 months ago. We downgraded in Jul-18 at Rs 3,150. We have upgraded BRIT to BUY post the recent corp tax cuts.

FMCG Dabur 335 BUY 445 32.8

Dabur was one of our top picks, as volume growth was expected to accelerate led by improving macros, ‘naturals’ fad and decline in competition (Patanjali). We maintain BUY owing to a renewed intent (outperform vs. riding the tide) and change in strategy (new CEO).

FMCG Marico 325 NEU 391# 20.3 We upgraded Marico to BUY as copra cycle reversed. In a deflationary cycle, Marico cuts prices judiciously so as to revive margins. We downgraded (Sep-19) Marico as near-term positives are priced-in and stock doesn’t warrant a re-rating.

Oil & Gas GSPL 180* BUY 217 20.6 Our initiation with a BUY in Mar-19 is premised on a steady business with volume growth visibility and its ownership of a gas distribution utility (GGL).

Autos Eicher Motors 22,612* NEU 17,860^ 21.0 We initiated on Eicher with a SELL in Mar-19, in view of its changed margin trajectory and limited volume upside, but have upgraded it to NEUTRAL after the government's announcement of corporate tax rate cuts.

Pharmaceuticals Dr Reddy's Lab 2,340^ BUY 2,773 18.5 We upgraded DRRD to BUY in Oct-18 based on improved visibility on US business, post Duvvada plant clearance and confidence on its cost control initiatives.

* Price as at initiating date (4 Apr 2018 for Symphony, 25 Sep 2018 for ISEC, 14 Mar 2019 for GSPL, 15 Mar 2019 for Eicher) ^ Price on upgrade date (22 Sep 2019 for Eicher Motors, 3 Oct 2018 for Maruti, 01 Nov 2018 for Axis Bank, 10 Oct 2019 for DRRD) # Price on downgrade date (20 May 2018 for Strides Pharma, 9 Jul 2018 for Britannia, 9 Jan 2019 for Havells, 29 Jul 2019 for Maruti, 27 May 2019 for Cyient, 14 Jan 2019 for ISEC, 23 Sep 2019 for Marico)

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HITS & MISSES

SECTOR/ INDUSTRY COMPANY

STOCK PRICE 1 APR

2018

Current RECO

STOCK PRICE NOW

RETURNS on RECO

% THE STORY SO FAR…

MISSES Banks RBL Bank 483 NEU 384 -20.6 Was a many-splendoured conviction pick, till the stumble on corporate asset

quality. We downgraded to NEUTRAL in 1QFY20.

Banks Karur Vysya Bank 104 BUY 59 -43.6 Hopes were belied as the expected recovery never materialised, post a CEO change. We downgraded the stock to NEUTRAL in 3QFY19 and upgraded to BUY again in 1QFY20.

NBFCs Shriram Transport Finance 1,468 BUY 1,115 -24.1 Nos have not missed estimates materially. But the 3-way merger overhang, CV

slowdown and concerns on funding have hit valuations.

Broking ICICI Securities 295* NEU 279# -5.4 Initiated with BUY, with the promise of rising profits in line with strong yields and heavy broking volume. Op lev reversed when yields cracked. Downgraded to NEUTRAL (Jan-19).

IT Services Cyient 630 NEU 551^ -12.5 Our BUY was premised on steady growth and sticky franchise. Both evaporated in the face of top account slowdown. We downgraded in May-19; the stock is down 26% from the 1-Apr-18 price.

Exchanges BSE 818 BUY 563 -31.2 The core business has steadily deteriorated, even as other streams show promise but consume capital. With a BUY, we can only fish for value till the core revives.

Cement Orient Cement 146 BUY 94 -34.9 While we remained Neutral on the stock throughout FY19, we upgraded it to Buy in 1QFY20 on strong earnings outlook

Cement Shree Cement 15,100 NEU 19,350 -32.0 We upgraded SRCM to Neutral in Jan-19 from SELL

FMCG Emami 546 BUY 330 -39.6 Business has stagnated. Promoter pledge overhang has taken its toll on the stock. Our BUY has floundered over the last 18 months.

Consumer Durables Symphony 1,799* BUY 1,298 -28.5 Our BUY had all the right ingredients, except timing! However, our business thesis remains intact. Symphony is on a long term growth runway with unyielding dominance on its category.

Oil & Gas ONGC 180 BUY 131 -27.2 PSU disillusionment and concerns on capital allocation have all but killed valuation multiples at ONGC (currently ~6.5x FY21E EPS). We have maintained BUY rating over the last 18 months, but to no avail!

Chemicals Balaji Amines 594 BUY 319 -46.3 We grossly over-estimated growth and margins at this amines maker. Management guidance is often injurious to investor health, as we learnt. We’ve reduced target multiple to 13x (from 17x) in our note in 4QFY19.


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HITS & MISSES

SECTOR/ INDUSTRY COMPANY

STOCK PRICE 1 APR

2018

Current RECO

STOCK PRICE NOW

RETURNS on RECO

% THE STORY SO FAR…

MISSES (Contd.)

Autos Maruti Suzuki 7,465^ NEU 5,806# -22.2 We upgraded MSIL to BUY in Oct-18 in view of market share gains, new launches & strong gasoline portfolio. We were surprised by the extent of the downturn and downgraded to NEUTRAL.

Pharmaceuticals Jubilant Life Sciences 839 BUY 557 -33.6 Our BUY thesis was dashed as management continued to leverage up rather than conserve cash. Our current stance hopes for revival in chemicals business.

Pharmaceuticals Strides Pharma 689 BUY 387# -43.8 Post 4QFY18 disaster, we downgraded the stock to Neutral, as weak performance of the US was expected to continue.

Infra NCC 128 BUY 65 -49.5 We maintained BUY rating over the last 18 months, reducing our SOTP based valuation from Rs 155/sh to Rs 154/sh

Infra Dilip Buildcon 1,154 BUY 439 -62.0 We maintained BUY rating over the last 18 months, reducing our SOTP based valuation from Rs 1,449/sh to Rs 720/sh


65.9

45.9

39.9

32.9

32.8

32.1

23.5

21.0

20.6

20.3

19.4

18.5

16.4

11.4

-5.4

-12.

5

-20.

6

-22.

2

-24.

1

-27.

2

-28.

5

-31.

2

-32.

0

-33.

6

-34.

9

-39.

6

-43.

6

-43.

8

-46.

3

-49.

5

-62.

0

-80.0

-60.0

-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

ICIC

IBC

KMB

CUBK

LTTS

DABU

R

HAVL

BRIT

EIM

GUJS

MRC

O

AXSB

DRRD

SBIL

IFE

TCS

ISEC CY

L

RBK

MSI

L

SHTF

ONG

C

SYM

L

BSE

SRCM

JUBI

LANT

ORC

MNT

HMN

KVB

STR

BLA

NJCC DB

L

RETURNS (%)

Page | 4

HITS & MISSES

BANKS & NBFCs Darpin Shah, [email protected], +91-22-6171-7328 Aakash Dattani, [email protected], +91-22-6171-7337

INDUSTRY VIEW

Then On banks, our stance on our coverage universe was positive except for

corporate heavy banks – both PSBs and PVT banks.

With the withdrawal of various restructuring schemes (SDR, S4A, 5/25, etc.), we expected PSBs to disappoint over FY19, with a front ended stumble on both stress recognition and provisioning.

We anticipated divergence to continue between retail-focussed and corporate-heavy banks. Ergo, we preferred the former category (KMB, DCBB and CUBK). We also included ICICBC in our top picks owing to attractive valuations and the (then likely) end of its stress recognition cycle.

On NBFCs, too, we were positive across the asset financiers group, esp. as the CV cycle looked strong. Our preferred bet was CIFC.

Now Corporate heavy PVT banks (and SBIN) saw a sharp improvement in

asset quality over FY19, and a shore up in coverage that depressed earnings in the first half.

Stress pools, too, trended downward through FY19 for these banks. Meanwhile, fresh concerns have emerged on the mid-corporate segment, post a bout of rating downgrades.

Even as corporate heavy banks have increased coverage, earnings are slowly expanding back to normalized levels. IBC resolutions have been delayed, but hold hope. Consistent outperformance across parameters has continued for retail heavy private banks (CUBK, KMB and DCBB).

Worsening macros have prompted us to reduce growth and increase NPA assumptions across the board in 1QFY20. Slowing deposit traction

(especially CASA) is an evolving concern for the industry, which is accentuated by the pressure to transmit policy rate changes.

After a multi-year gallop, NBFCs ran into serious headwinds in 2HFY19, post the IL&FS default and the liquidity squeeze in wholesale debt markets. Most players were affected, but the final impact was extremely skewed. Our coverage companies (asset financiers) were relatively unscathed owing to better parentage (disproportionate access to funds) and granular loan books.

While the shakeout has had its casualties (DHFL, Reliance Capital, etc.), we believe that quality NBFCs actually stand to benefit with receding competition. Portfolio granularity, asset quality and parentage will continue to drive polarization in this space. CIFC remains our preferred bet amongst NBFCs.

HIT #1 : ICICI BANK

How has our stance changed? Our stance on ICICIBC evolved positively over FY19, especially post 2QFY19

(reflected in our multiple upgrade from 1.7x Core ABV to 2.0x), as the bank delivered across a host of parameters. A positive surprise on slippages (1.9% over FY19 vs 3.0% est.) and stress pools (2.6%), better than expected growth (15%, retail-driven), improving NIM (~3.7% in FY19) and coverage (74%) underpinned this evolution.

Change in estimates

Parameter 18 months ago Today Change

FY19E FY20E FY19A FY20E FY19 FY20E

NII 260.1 291.1 270.1 311.8 3.86% 7.10%

PPOP 249.6 271.8 234.4 272.5 -6.10% 0.24%

PAT 94.0 124.1 33.6 110.8 -64.22% -10.73%

GNPA (%) 8.47 6.25 6.70 5.94 -177 bps -31 bps

Loan Growth (%) 13.80 15.20 14.49 15.57 69 bps 37 bps

LLP (%) 2.50 1.80 3.06 2.18 56 bps 38 bps

ABV 114 136 138 156 20.42% 14.53%

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HITS & MISSES

HIT #2 : KOTAK MAHINDRA BANK How has our stance changed? Our stance on KMB’s business (and prospects) remains unchanged with

consistent superior growth, margins and calibrated credit filters resulting in better asset quality. Inherent strengths (strong liability franchise, limited exposure to stressed sectors and a measured approach to growth) position KMB to deliver sustainably, even in times of economic uncertainty.

However, with limited upside in sight, we have downgraded KMB to NEUTRAL. A multiple in excess of 4.5x Core ABV cannot be justified despite all the obvious virtues that KMB has.

Change in estimates

Parameter 18 months ago Today Change FY19E FY20E FY19A FY20E FY19 FY20E

NII 115,394 139,209 112,590 134,213 -2.43% -3.59% PPOP 88,985 110,344 83,482 103,763 -6.18% -5.96% PAT 52,616 65,846 48,653 67,901 -7.53% 3.12% GNPA (%) 2.07 1.82 2.14 1.97 7 bps 15 bps Loan Growth (%) 25.8 24.2 21.20 20.46 -460 bps -374 bps LLP (%) 0.5 0.5 0.51 0.54 1 bps 4 bps ABV 207 238 201 242 -2.96% 1.95%

HIT #3 : CITY UNION BANK How has our stance changed? Our thesis on CUBK remains unchanged. CUBK’s bet on the MSME segment

has paid off well, due to its strong regional focus and customer connect/ understanding. In spite of geographical concentration, we believe CUBK has sufficient headroom to grow in TN (3.6% mkt-share) and that its time tested lending model will continue to deliver RoAAs of ~1.5% sustainably.

Change in estimates


NII 16,205 18,676 16,115 18,406 -0.56% -1.45% PPOP 12,950 14,634 12,400 14,577 -4.25% -0.39% PAT 6,910 8,041 6,829 8,417 -1.17% 4.67% GNPA (%) 2.72 2.46 2.95 2.88 23 bps 42 bps Loan Growth (%) 19.00 20.00 17.30 16.50 -170 bps -350 bps LLP (%) 1.19 0.98 0.89 1.03 -30 bps 5 bps ABV 60 70 58 68 -3.58% -2.03% HIT #4 : AXIS BANK How has our stance changed? We upgraded AXSB in Nov-18* as we saw signs of a DNA change in works at

the bank - the process still continues. The top mgt rejig along with a well articulated business plan bolsters our faith. Reduction in identified stress combined with a shore up in coverage bodes demonstrably well for RoAE expansion. While additional stress may pop up in the near term, strategic changes appear to be pointing in the right direction.

Change in estimates

Parameter 10 months ago* Today Change

FY19E FY20E FY19A FY20E FY19 FY20E NII 222,126 262,101 217,082 251,951 -2.27% -3.87% PPOP 186,545 221,611 190,051 231,533 1.88% 4.48% PAT 51,501 92,133 46,766 86,757 -9.19% -5.83% GNPA (%) 5.71 3.94 5.26 4.93 -45 bps 99 bps Loan Growth (%) 17.50 18.00 12.54 15.25 -496 bps -275 bps LLP (%) 2.40 1.67 2.19 1.85 -21 bps 18 bps ABV 225 267 215 252 -4.17% -5.68%

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HITS & MISSES

MISS #1 : RBL BANK

How has our stance changed? Our consistently positive stance on RBK took a near u-turn post the

shocking 1QFY20 commentary. After consistently ticking all the boxes over FY19 (best in class growth and margins, decent opex control, a potential book accretive fund raise and what seemed like a good grip on asset quality), commentary on expected lumpy slippages in 1QFY20 shocked. We long saw the high yielding credit card and micro-finance portfolios as top contenders for stress accretion, but misjudged RBK’s corporate underwriting capabilities. Recent allegations of insider trading in the media certainly raise red flags. The bank’s capital raising and growth prospects can be seriously impaired.

RBL Bank : Lessons learnt We learnt that shiny, fast growing and picture-perfect darlings of the stock

market face ‘fat tail’ risks with onerous consequences for their shareholders. We expected superior asset quality to persist, given that RBK had weathered the large corporate asset quality cycle successfully. We were wrong. We did not anticipate the lumpy crystallisation of mid-corporate stress. Subsequent revelations by RBK on single borrower/exposure metrics (largest exposure is 15% of net worth) and allegations of possible insider trading have further rattled investors and us alike.

Change in estimates


NII 23,476 30,660 25,395 31,894 8.17% 4.02% PPOP 17,272 22,331 19,398 24,265 12.31% 8.66% PAT 8,873 11,898 8,670 10,216 -2.29% -14.14% GNPA (%) 1.23 1.00 1.39 2.96 16 bps 196 bps Loan Growth (%) 34.20 33.00 34.87 31.20 67 bps -180 bps LLP (%) 0.71 0.59 0.99 1.60 28 bps 101 bps ABV 170 194 168 218 -1.18% 12.25%

MISS #2 : KARUR VYSYA BANK

How has our stance changed? Our initially positive stance on KVB was based on expected moderation in

slippages and credit costs paving the way for normalised earnings and RoAAs. We were wrong to believe (early on) that the worst in terms of asset quality was behind the bank. In 3QFY19, management guided for higher slippages over the rest of FY19 (and over FY20) despite elevated slippages over 1HFY19. Further, the sweeping changes we expected post the appointment of the new CEO (Dec-17) have not played out. After downgrading KVB to NEUTRAL in 3QFY19, we recently upgraded the stock to buy on valuation comfort.

Change in estimates


NII 25,278 28,767 23,628 25,585 -6.53% -11.06% PPOP 19,215 22,056 17,108 19,525 -10.97% -11.47% PAT 4,957 8,988 2,109 3,635 -57.46% -59.56% GNPA (%) 5.46 3.93 8.79 8.80 333 bps 487 bps Loan Growth (%) 15 17 8.44 11.50 -656 bps -550 bps LLP (%) 2.48 1.67 2.82 2.78 34 bps 111 bps ABV 70.2 78.1 50 52 -28.67% -32.78%

Karur Vysya Bank : Lessons learnt Sweeping changes at a bank suffering from legacy asset quality issues

require time and an extensive shake-up in top management. This is especially true when the business environment is sluggish.

A CEO change is necessary for transformation, but not sufficient!

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HITS & MISSES

MISS #3 : SHRIRAM TRANSPORT FINANCE COMPANY

How has our stance changed? Our take on SHTF’s business remains unchanged. We continue to like their

deep upcountry presence and focus on the niche used CV market. Our stance (and assigned multiple) has changed over the year to reflect: (1) Challenges faced in raising funds over 2HFY19 post IL&FS curtailing growth, (2) The potential three way merger within the group, which we believe is detrimental to the interest of investors in SHTF, (3) General slowing of economic growth and (4) Questions raised post the exit of marquee investors in the group.

Change in estimates


NII 76,432 85,106 78,730 86,539 3.01% 1.68% PPOP 61,490 67,949 61,631 67,997 0.23% 0.07% PAT 23,213 28,238 25,640 31,965 10.45% 13.20% GNPA (%) 8.75 8.25 8.37 8.29 -38 bps 4 bps Loan Growth (%) 16.70 15.10 9.63 12.71 -707 bps -239 bps LLP (%) 2.90 2.40 2.39 2.28 -51 bps -13 bps ABV 555 670 449 596 -19.19% -11.00%

Shriram Transport : Lessons learnt We have learnt that while earnings (and other) financial parameters may

well play out close to estimates, valuation multiples can get volatile for businesses that are perceived to be relatively vulnerable. While the inherent franchise and sustainability of SHTF’s business is unquestionable, stock markets seem to exhibit cyclical love for it, in tandem with macro, rural and CV cycles. Also, corporate governance issues have dogged valuation multiples consistently over the trailing two years – whether it was the corporate guarantee for a group co’s debt or the proposed three-way merger.

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HITS & MISSES

LIFE INSURANCE Madhukar Ladha, [email protected], +91-22-6171-7323 Keshav Binani, [email protected] +91-22-6171-7325

INDUSTRY VIEW

Then Individual New Business Premiums (Indiv. NBP) for the private life insurers

had grown at ~26% pa over FY17 and FY18.

We expected FY19 APE growth for private life insurers to moderate to 12-14%.

We expected companies to focus on protection to improve margins.

Now Private life indiv. NBP grew 17% in FY19 to Rs 471bn.

Indiv. NBP growth for private life insurers continues at high pace as evidenced by a 24% FY20TD (Aug-19). This is despite 1Q generally being lean season for the industry.

Reduction of TERs for the mutual fund industry (competitor for savings flow) has also led to more focused in selling of insurance products.

Uncertain equity markets and launch of guaranteed pension plans by some players has also been a key driver of growth.

We estimate FY20E Indiv. NBP growth for private life insurers will remain in the range of 16-22%.

HIT #1: SBI LIFE INSURANCE

How has our stance changed? APE estimates for SBILIFE have remained fairly constant.

We were positively surprised by increased protection share (6.8%, +143bps YoY) and higher margins in FY19 (19.8%, +50bps vs. expectation), leading us to revise our VNB margins upwards (FY20/21E at 20.2/20.6%, +80/100bps) for FY20-21E.

Strong industry tailwinds and SBI’s distribution reach have led to SBILIFE’s continued outperformance vs. industry with FY20TD (Aug-19) NBP/APE growth of 23/14% YoY.

SBILIFE also reported strong 1QFY20 adj. VNB margin of 19.9% (+10bps vs. FY19).

Our VNB estimates increased by 3.3/6.5% for FY20/21E.

In Apr-18, SBILIFE was trading at 2.6x FY20 P/EV, with our Mar-19 TP of Rs 810 (FY19EV + 26.8x FY20E VNB).The stock currently trades at 3.0/2.6x FY20/21E EV, we continue to rate SBILIFE a BUY with TP of Rs 914 (Jun-20 EV +22.1x FY21E VNB). The stock continues to be our top pick over the last year.

Given the strong distribution footprint of its parent SBI (24k+ branches), improving protection share (1QFY20: 11.2%), lowest operating cost ratios (11.2%), improving margins (VNBM: 19.9%) and tailwinds from financialisation of savings we expect SBILIFE to deliver strong FY19-22E VNB CAGR of 19.8% p.a. and RoEVs of ~17.5. SBILIFE is our top BUY with a TP of Rs 914 (Jun-20 EV + 22.1x FY21E VNB). Lower than expected growth and protection share remain key risks to our call.

Change in estimates

(Rs bn) Jul-18 Aug-19 Change (%)

FY19E FY20E FY19 FY20E FY19 FY20E APE 100.3 116.4 96.9 115.6 -3.4 -0.7 VNB 19.3 22.6 19.2 23.3 -0.7 3.3 VNB Margin (%) 19.3 19.4 19.8 20.2 55 80 Embedded Value 240 284 237 281 -1.0 -1.1

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HITS & MISSES

BROKING Madhukar Ladha, [email protected], +91-22-6171-7323 Keshav Binani, [email protected] +91-22-6171-7325

INDUSTRY VIEW

Then In Sep-18, we believed that the broking industry had already seen intense

price competition, and with traditional brokers already having responded by reducing broking rates substantially, we expected pricing pressure to ease off.

We expected market ADTVs to grow ~ 20% in FY19 and anticipated a substantial increase (10-15% pa) in the margin funding book.

Beginning Oct-18, regulatory impact on MF TERs was expected to result in decline in revs for distributors.

Now During FY19, ADTV grew 49.9% YoY much above our 20% growth estimate.

However, pricing continued to slip as mix deteriorated with higher F&O growth vs. cash, and even within cash equity lower delivery volumes.

Strong growth continued in active accounts of discount brokers eg. Zerodha ended Mar-19 with active subscribers of 0.9mn (+68.1% YoY).

Axis securities, Angel broking started to offer fixed rate/subscription based pricing beginning Apr-19, indicating industry is moving to a fixed fee/subscription model.

MTF of brokers were largely stable as markets remained subdued. Additionally, MF distribution income has also seen a large decline.

MISS #1: ICICI SECURITIES

How has our stance changed? ISEC’s broking revenues had grown at ~18.8% CAGR over FY13-18, despite

severe pricing pressure 25.4% CAGR decline in yields over FY13-18; we expected a much more moderate pricing decline going forward.

We had initiated coverage on ISEC with a BUY rating and a target price of Rs 352 (based on 16x Sep-20 EPS). At initiation, stock was trading at FY20/21E P/E of 14.3/12.7x

In Jan-19, after two earnings releases (2Q and 3QFY19), we realized that our initial BUY rating, was a mistake as: (1) Pricing pressure (-36% YoY), offset strong volume growth (+33% YoY), (2) Margin funding book had stabilized at ~Rs 5.5bn and was not growing.

Post 3QFY19, we revised our call and downgraded the stock to NEUTRAL with a TP of Rs 298 (16x Dec-20 EPS).

Pricing pressure continues in 1QFY20, as pricing again declined by 23.1% YoY. ADTVs improved by 37.1% YoY resulting in YoY flat broking revenues.

With increased competitive intensity and changing mix, we except broking yields decline further. Also, reduction in MF TERs will pressure distribution revs in the short term. Cost control will be a key earnings driver (~-10% YoY in FY20E). We expect an anemic FY19-22E APAT CAGR of 5.4%. We currently have a NEUTRAL on ISEC with a TP of Rs 225 (14x Jun-21 EPS).

I-Sec : Lessons learnt We learnt not to underestimate digital led disruption, led by the discount

brokers; this led to us prematurely judging easing of pricing pressure. We also learnt not to excessively rely on management guidance. We were

informed that most of ISEC’s MF distribution commission was trail based and hence the changes in regulation would only have a minor impact on distribution yields. We also underestimated the importance of running a low fixed cost structure. ISEC has a high cost structure compared to peers.

Change in estimates

(Rs mn) Sep-18 Aug-19 Change (%)

FY19E FY20E FY19 FY20E FY19 FY20E Adj. Revs 19,014 20,021 16,456 15,709 -13.5 -21.5 EBITDA 9,274 9,957 7,358 8,069 -20.7 -19.0 PAT 6,181 6,647 4,773 4,733 -22.8 -28.8

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HITS & MISSES

IT SERVICES Apurva Prasad, [email protected], +91-22-6171-7327 Amit Chandra, [email protected], +91-22-6171-7345 Akshay Ramnani, [email protected], +91-22-6171-7334 INDUSTRY VIEW In our Apr-18 note titled ‘Skin in the game’ we called out that the IT sector

had reached an inflection point. Since then, the IT index has outperformed the NIFTY by a staggering 19% and 10% YTD (with absolute gain of 26/11% over same period for IT index). Our view then was based on (1) Up-scaling of value proposition (digital-at-scale, pipeline, partner eco-system), (2) Accelerating demand environment (improving macros, contract trends, rebid opportunity) and market-share gains (full-service portfolio, offshore leverage, large deals), (3) Strong operational metrics (new logo addition and midcap IT’s large account scalability, favourable supply metrics), and (4) Strength in balance sheet and cash generation.

We now believe that Indian IT has achieved early success in transitioning its business model (pivot to digital), evident in its growth leadership vs. global peers. Despite improving pricing power (digital, supply constraints) and growing addressable market, global macros turning adverse (Trade war, Brexit, slowdown) will create ‘first among equals’ in the sector. Indian IT ex-TCS/INFY trades at a discount to its historical valuations (TCS/INFY at ~20% premium). We have altered our stance by being more stock selective, preferring names that have strong durability and stable core business. Our moderation in view was also driven by the trifecta of (1) Higher localization/lower H-1B, (2) Captive intensity and (3) Sub-contracting surge increasing margin headwinds. Over this period cross currency headwinds have increased (EUR/GBP/AUD crack), while USD-INR swings added to the volatility.

FY19 revenue performance was largely in-line (vs. our est. in Apr-18) with tier-IT at -1.7% variance and Tier-2 IT at 1.2% variance (vs. our est. in Apr-18). Our FY20 rev estimates are now lower (vs. our est. in Apr-18) by 1.8/1.7% for Tier-1/2 IT respectively and EPS lower by ~4% on margin cuts during the course. Wipro/TechM from Tier-1 IT and Cyient/Persistent/eClerx from Tier-2 IT have seen the biggest cuts in estimates.

Lessons learnt The cyclicality of Tier-2 IT vs. Tier-1 IT can be steeper than expected (either

ways) based on higher concentration of clients/verticals and higher sensitivity to currency. Down cycle amplifies the differential between strong performers and weaker ones.

Macro/enterprise client trends are dominant lead indicators as compared to deal/hiring trends.

HIT #1 : TCS How has our stance changed? We upgraded TCS to BUY in Jul-18, Our (belated) upgrade derived

confidence from TCS’ growth trajectory, supported by (1) Scale and growth dominance of Digital business, (2) Growth visibility (deal wins), (3) Strong recovery and outlook in BFSI vertical (across geos) and NorthAm geography and (4) Continuity in efficient capital allocation (80 to 100% of FCF as payout). TCS is now our Top-pick within Tier-1 IT pack. Growth in digital, momentum in deal wins and strong hiring trends continue. TCS’ offshore leverage in digital (location independent Agile framework), outperformance in BFSI (vs. Accenture) and superior execution (margin/attrition differential) stand out.

Change in Estimates FY19 largely turned in-line with our estimates. TCS clocked 9.6% USD

revenue growth (vs. est. of 10%) with Digital galloping at 47.8%. EBIT margin was in-line at 25.6%, +80bps YoY (vs. est of 25.5%). Deal wins in FY19 were strong at USD 21.9bn (Book-to-bill of 1.05x).

Our FY20 revenue estimates are largely unchanged, we expect 9.6% USD revenue growth in FY20 (vs. 10.1% earlier), we have cut EBIT margin estimates for FY20 by ~170bps given the elevated sub-contracting (+26% in FY19), higher localization and accelerated hiring. FY20 PAT estimate remains unchanged (-1.1%).

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HITS & MISSES

Change in estimates

TCS Then Today Change

FY19E FY20E FY19A FY20E FY19 FY20

Revenue (USD mn) 20,989 23,100 20,913 22,931 -0.4% -0.7%

EBITDA margin (%) 27.2 28.0 27.0% 26.6% -21bps -143bps

APAT (Rs bn) 299.87 333.27 314.72 329.73 5.0% -1.1%

HIT #2 : L&T TECHNOLOGY SERVICES

How has our stance changed? L&T Technology Services (LTTS) has been one of our Top-picks within Tier-2

IT pack, our positive outlook on LTTS was premised on (1) Large client mining opportunity with strong client base, (2) Limited competition in LTT’s Industrial products, Process industry/ plant engineering and Transportation (commercial & off-highway) verticals (>40% of aggregate rev), (3) Strong deal pipeline and deal wins across verticals with secular growth, (4) Recovery in Plant engineering supported by deal wins (including Covestro).

LTTS is the strongest play in ER&D and our stance has largely remained unchanged, we continue to maintain our positive outlook based on (1) Business resilience supported by vertical diversification and low client concentration (vs. peers), (2) Broad-based deal wins & deal pipeline, (3) Growth outperformance in largest vertical (Transportation) vs. peers and (4) Shift in business-mix to support margins.

Change in Estimates FY19 turned out better than our estimates. LTTS posted industry leading

USD revenue growth of 24.6% (vs. est. of 19.9%), revenue growth was spread across verticals and was led by Process Industry (+37.6%). EBITDA margin of 18.0% was ~150bps higher than our est (better business mix and offshoring). FY19 revenue growth was spread across client buckets with Top 20/Non-Top-20 up 23.1/26.5% YoY which reflects good account mining across client buckets.

Our FY20 revenue estimate is up by 2.3% in absolute terms but the expected growth for FY20 is down to 12.9% (vs. 15.8% earlier) the downward revision of revenue growth comes on a strong FY19 (+24.6%) and also factors macro concerns in Telecom & Hi-Tech vertical (large account and stress in semiconductor segment). We have increased EBITDA margin estimate (19.5%) for FY20 by ~140bps on better business mix and higher offshore. FY20 PAT estimate is up by 9.5%.

Change in estimates

LTTS Then Today Change


Revenue (USD mn) 689 798 723 816 4.9% 2.3%

EBITDA margin (%) 16.5% 18.1% 18.0% 19.5% 152bps 138bps

APAT (Rs bn) 5.62 6.99 7.07 7.66 25.9% 9.5%

MISS #1 : CYIENT

How has our stance changed?

We had a BUY on Cyient, our positive stance was based on (1) Recovery in Aerospace & Defence (largest vertical), (2) Ramp-up in DLM business, (3) Continued traction in Communication & Transportation verticals, (4) Improvement in deal pipeline, and (5) Expansion in margins. Management also guided for double digit growth in services business and ~20% growth in DLM with ~50bps expansion in margins. We expected services business to deliver 10-11% YoY growth and margin improvement of ~70bps.

We later downgraded Cyient to Neutral in May 2019 as the company was struggling with issues such as (1) Slowdown in services business, (2) Challenges in top accounts (3) Issues in core vertical (Aerospace and Communication), (4) Increased focus on lower margin DLM business and (5) Decline in services margin due to higher investments. Concerns related to slowdown in decision making, accelerated trade war risks and higher mix of legacy services (Mechanical) is impacting services growth. The stock is trading at a P/E multiple of 9.7x (5-year low) and we now assign a multiple of 11x (27% lower).

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HITS & MISSES

Change in Estimates FY19 revenue growth was lower than our estimates. Revenue growth was

8.6% (vs. est. of 13.8%), revenue miss was largely on services revenue, which grew 6.3% in FY19 (vs. guidance of double digit growth). Challenges in Top clients both in Aerospace (34%) and Communications (23%) impacted services growth. FY19 EBITDA margin stood at 14.0% (vs. est. of 14.9%) margin and was flat YoY (vs. guidance of 50bps expansion). Margins were impacted by higher sub-contracting cost (+27.2% YoY) and deteriorating business mix (higher growth in lower margin DLM business).

We now expect FY20E revenue growth to be muted at +1.5% YoY (vs. est. of +13.6%). Revenue is impacted by sluggish growth in services (+0.3% YoY) and moderation in DLM growth (+10.3% YoY). We now expect FY20E margin to be at 15.2% (vs. 15.8% earlier) impacted by muted revenue growth offset by ongoing cost optimisation initiatives.

Cyient : Lessons learnt We have learnt that high client concentration carries a higher risk of

slowdown, especially when macros are turning adverse (trade wars). Also, higher mix of mechanical services (legacy) and focus on manufacturing (differentiated strategy and lower margin) can lead to bigger challenges than anticipated. Declining growth rate in the core business can lead to massive multiple de-rating. Investors like growth and diversification, and are fine assigning higher multiples (example : LTTS).

Change in estimates

Cyient Then Today Change

FY19E FY20E FY19A FY20E FY19 FY20 Revenue (USD mn) 690 784 660 670 -4.4% -14.5% EBITDA margin (%) 14.9% 15.8% 14.0% 15.2% -91bps -64bps APAT (Rs bn) 4.87 5.84 4.79 4.80 -1.6% -17.9%

MISS #2 : BSE (Exchanges)

How has our stance changed? We had a BUY on BSE, we saw value in BSE based on (1) Embedded non-

linearity, (2) Stability in traditional market linked revenue streams, (3) Increased contribution from new growth engines, (4) Dividend yield of ~5%, and (2) Huge net cash of Rs 26bn.

BSE failed to deliver on traditional revenue stream with continued loss in cash market share, the company now investing in new growth engines leading to erosion in margins. Stress in transaction revenue has led to operating de-leverage. The cash market share declined to 7.4% vs ~13.1% in FY18. We believe that the cash market share has bottomed out and will gradually improve with interoperability of clearing corporations. Growth in StAR MF, higher listing fee and improvement in market linked revenue will lead to growth of 11.1/11.8% in FY20/21E. We expect operating leverage to play out with growth (EBITDA margin of 11.4/15.8% for FY20/21E).

Change in Estimates FY19 revenue was down 11.2% YoY (vs. est. of 10.0% growth), revenue miss

was largely contributed by fall in transaction charges, -28% YoY in FY19 (vs. est. of 16.4% growth). EBITDA margins came at 6.5% in FY19 (vs. est. of 23.1%). Margins were impacted by muted revenue growth coupled with increase in cost (higher investments).

Our FY20 revenue growth is slightly lowered (on a low base) to 11.3% YoY (vs. 12.1% earlier), but our EBITDA margin estimates have cracked by ~1,500bps largely on BSE’s continued investment in new initiatives. FY20E PAT is revised downwards by ~33% based on lower growth and margins.

BSE : Lessons learnt We have learnt that when there is stress in core business (transaction

charges) and market share loss, then arguments like as cash on books, high dividend yield and embedded non-linearity don’t matter. Core business performance (key monitorable) and cost management in a challenging environment are the prime factors for fetching higher multiples.

Change in estimates

BSE Then Today Change


Revenue (Rs bn) 5.25 5.89 4.50 5.00 -14.2% -15.0%

EBITDA margin (%) 23.1% 26.5% 6.5% 11.6% -1,661bps -1,488bps

APAT (Rs bn) 2.60 2.96 2.08 1.98 -20.1% -33.3%

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HITS & MISSES

CEMENT Rajesh Ravi, [email protected], +91-22-3021-2077 Saurabh Dugar, [email protected], +91-22-3021-2072 INDUSTRY VIEW

Then vs. Now At start of FY19, the industry sales volume continued to grow in double

digits which was expected to help recover cement prices which were under pressure.

Profitability was further impacted then owing to elevated opex driven by rising coal/ petcoke/ diesel prices. Cost inflation remained elevated until 3QFY19.

All of these pulled down margins in FY19, against our estimate of margin recovery in FY19.

The situation has reversed currently: demand growth flattened in 1QFY20. Industry became price conscious which lead to strong realization recovery in 1QFY20.

Opex has started to cool off from 4QFY19 owing to steady reduction in petcoke/coal/ diesel prices in 1HFY20.

Thus, despite subdued volume growth outlook, industry’s profitability outlook looks strong in FY20.

MISS #1 : ORIENT CEMENT

How has our stance changed? At the start of FY19, we were neutral on Orient Cement at ~ Rs 146/sh, as

the stock had already been flat over the preceding six months and the valuations appeared undemanding (USD 85/MT).

Cheap valuations made us remain neutral on the stock, even though we were wary of its inorganic acquisition plans.

While the company did cancel its inorganic acquisitions plans by end of May 2019, high cost inflation and weak pricing during FY19 led to earnings downgrade for FY19, and the stock price corrected 50% by end of FY19.

We have turned positive on the stock in May 2019 as earnings outlook is strong in FY20/21E, boosting cashflow and profitability metrics.

Change in estimates

Rs bn 18 MONTHS ago TODAY change

FY19E FY20E FY19 FY20E FY19 FY20E Revenue 29.93 39.64 25.22 28.47 (15.7) (28.2) EBITDA 4.32 6.82 3.12 4.90 (27.8) (28.2) PAT 0.92 1.75 0.48 1.81 (48.3) 3.4

Note: Orient’s earlier estimates had factored in the amalgamation of the inorganic acquisition hence not strictly comparable with current estimates

Orient Cement : Lessons learnt We have learnt that while asset based valuations may appear cheap,

earnings based valuations are also critical. At the beginning of FY19, Orient was trading at 13/8x FY19/20E EBITDA, and the stock price collapsed as anticipated profits did not materialise.

While we goofed up the downside, we believe the valuations are now extremely cheap at USD 60/MT and at 6.3/6x FY20/21E EBITDA (vs 13.5x/8x FY19/20 EBITDA, and at EV of USD 84/MT, 18 months ago). Hence, we are bullish now on the stock since early FY20.

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HITS & MISSES

MISS #2 : SHREE CEMENT

How has our stance changed? At start of FY19, we were negative on Shree Cement given its expensive

valuations. It was trading at industry leading EV of USD 200/MT and 17/14x FY19/20 EBITDA.

The co was delivering industry leading return ratios. While weak pricing and cost inflation drove 8% disappointment in FY19E EBITDA estimates, valuations soared to almost 20/20x FY19/20E EBITDA by end of 1QFY20.

The stock price has currently cooled off, but valuation remains elevated at 18/15x its FY20/21E EBITDA and EV of USD 230/MT currently!

Change in estimates

18 MONTHS ago TODAY change FY19 FY20 FY19 FY20E FY19 FY20E

Revenue 116.64 136.73 117.22 124.42 0.5 (9.0) EBITDA 30.25 36.36 27.70 36.42 (8.4) 0.2 PAT 13.57 15.96 12.50 17.85 (7.9) 11.8 Shree Cement : Lessons learnt We learnt that a business with strong sustainable margin profile and return

ratios along with good corporate governance continues to remain expensive, even if there is a mild earnings miss.

We are currently neutral on the stock as we believe amid good profit outlook, its valuation de-rating is unlikely. We also upped our valuation multiple to 15x from 13x a year back to factor in the positives as mentioned above.

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HITS & MISSES

CONSUMER Naveen Trivedi, [email protected], +91-22-6171-7324 Siddhant Chhabria, [email protected], +91-22-6171-7336

INDUSTRY VIEW (FMEG) Then

In FY19, we believed that consumption dynamics are expected to improve after two years of disruption

Trade channels will normalize after GST implementation

GST rate cuts (switches, switchgear, fans) will accelerate premiumisation and drive growth

Now

Industry growth has moderated over the last 6-9 months owing to elections (B-B and B-G orders) and general slowdown

We expect industry growth to recover in 2HFY20 led by new B-B and B-G orders. Recovery in B-B orders will be driven by corporate tax cuts which is expected to drive private capex cycle

Slowdown in real estate will impact demand for new construction products

HIT#1: HAVELLS

How has our stance changed? 18 months ago, we were bullish on Havells as we expected the co. to (1)

Capitalize on its brand strength amidst a recovery in industry demand, (2) Gain market share post GST, (3) Benefit from distribution expansion, (4) Drive incremental growth via new launches in consumer durables. High growth coupled with healthy RoIC (>35%) makes Havells a compelling buy. We expected a re-rating in the stock. Our thesis played out which drove a re-rating in the stock.

We downgraded Havells in Jan-19 (at Rs 670), as we believed growth is expected to moderate and we don’t expect a further re-rating scope, given its presence in cables & wires, B-B businesses and limited scope for positive earnings surprise. Growth in core biz has moderated but company could gain market share for its core business.

We expect core biz to rebound in 2HFY20 and Lloyd to be a WIP in FY20 (recovery in FY21). We expect margins to mean revert in FY20 as costs have peaked and inflation has turned benign

Change in estimates Havells beat our street-high revenue growth estimate by 2% in FY19

Sharp commodity inflation and higher than expected investment in capability building led to a miss in profitability

Lloyd’s profitability was dented owing to management’s strategy to premiumise the brand (backfired).

Change in estimates

Then Now Change (%)

FY19E FY20E FY19 FY20E FY19 FY20

Revenue 98,594 113,306 100,576 112,064 2% -1%

EBITDA 13,831 16,446 11,922 13,993 -14% -15%

APAT 9,388 11,385 7,915 10,067 -16% -12%

Valuation The stock re-rated from 30x (2 yr forward P/E) to 34x, as the street began

to believe that Havells has the ability to enter newer categories successfully (expand addressable market). Along with strengthening its presence in existing categories via premiumisation and share gains.

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HITS & MISSES

INDUSTRY VIEW (FMCG) Then

FMCG industry was impacted by a double whammy (demonet and GST implementation) which impacted growth

The industry is expected to benefit from a favorable base and normalization in trade channels

Rural demand is expected to revive

Leaders are expected to outperform during a recovery in demand

Now

After a healthy FY19 for the FMCG sector, growth rates began to moderate from Nov-18.

We expect industry growth to recover from 2HFY20 owing to normal monsoons (driving rural recovery) and moderation in base

Liquidity stress in trade channels will normalize over the next 2-3 quarters

Sector margins are expected to expand driven by benign commodity inflation and favorable base

Companies with a reinvestment opportunity will benefit from corp. tax cuts

HIT #2: DABUR

How has our stance changed? 18 months ago, Dabur was our top pick in the consumer space. Our thesis

on Dabur was (1) Competitive intensity is declining (Patanjali underperforming), (2) Rural is gaining steam, (3) Rising consumer preference for ‘naturals’ and (4) Opportunity to aggressively launch new products and scale niche brands.

We have maintained our BUY rating on Dabur. We believe Dabur is more than just a ‘rural play’ given its change in intent (outperform vs. riding with the tide). Renewed intent and strategy has been driven by change in management (new CEO Mohit Malhotra). Mohit’s strategy is around scaling 8 power brands (~65% revenue mix) along with expanding direct reach in rural. We will be keen to see how Mohit will drive Dabur’s large but under

indexed portfolio. Revitalizing the strategy should fill the gaps in product/distribution/ communication.

Change in estimates

Then Now Change (%) FY19E FY20E FY19 FY20E FY19 FY20

Revenue 88,052 100,196 85,331 93,937 -3% -6% EBITDA 19,095 22,979 17,396 20,311 -9% -12% APAT 16,506 20,384 14,436 16,908 -13% -17%

Valuation The stock re-rated from 29x (2 yr fwd P/E) to 36x, as volume growth

accelerated. We increased our target multiple from 35x to 40x over the last 18 months.

HIT #3 : BRITANNIA

How has our stance changed? We had a BUY 18 months ago as we expected BRIT to (1) Outperform given

its distribution strength (channel disruption) and premiumisation, (2) Expanding addressable market to become a total foods company, (3) Market share gains led by Hindi belt (rural recovery), (4) Stable RM environment and (5) Cost savings program.

We downgraded the stock in Jul-18 (at Rs 3,150) after a dream run of 40/88% in the stock over the last 6/12 months. We downgraded as we believed most of the positives were priced-in and everything had to go right hereon. As anticipated, everything didn’t go right for Britannia and the stock fell by ~20%.

We upgraded the stock to BUY post corp. tax cuts (at Rs 2,867), as we believed that not only consumer sentiments will turn positive but Britannia has a lucrative reinvestment opportunity (entering newer categories).

Change in estimates


Revenue 113,294 131,349 110,549 121,079 -2% -8% EBITDA 18,077 22,778 17,336 18,950 -4% -17% APAT 12,387 16,060 11,557 14,211 -7% -12%

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HITS & MISSES

Valuation The stock de-rated from 41x (2 yr fwd P/E) to 39x, as earnings trajectory

moderated. We had cut our target multiple to 40x vs. 45x earlier and maintained our 1 year old NEUTRAL rating. Post corp tax cuts we upgraded our target multiple to 45x and rating to BUY from NEUTRAL.

HIT #4: MARICO

How has our stance changed? Our BUY rating on Marico 18 months ago was based on (1) Copra inflation

is expected to reverse, (2) Historically, Marico cuts prices judiciously to revive margins, (3) Co. reinvests RM savings in higher A&P spends to drive new launches and (4) International biz performance is expected to accelerate. As a result, Marico’s performance (EBITDA growth) will stand out when its peers are witnessing erratic commodity inflation.

We downgraded Marico (at Rs 380) post corp tax cuts as we believed near-term positives are priced-in. The stock doesn’t warrant a re-rating as new launches have not fired and copra deflationary cycle is expected to reverse over the next 2 quarters.

Change in estimates


Revenue 73,120 83,589 73,336 79,915 0% -4%

EBITDA 14,244 18,275 12,809 16,106 -10% -12%

APAT 10,605 13,853 9,309 11,383 -12% -18%

Valuation The stock rated from 31x (2 yr fwd P/E) to 35x, as earnings trajectory

improved. We maintained our target multiple of 35x. Post corp tax cuts, we downgraded the stock to NEUTRAL.

MISS #1 : EMAMI

How has our stance changed? We have held our BUY rating over the last 18 months. 18 months ago we

expected Emami’s performance to accelerate based on (1) Favorable base

for all categories, (2) Dependence on wholesale channel is declining (38% now vs. 50% in FY17), (3) Co is increasing its share from modern trade (6% with an aim to double), (4) Kesh King is expected to recover led by its re-launch, (5) Higher A&P spend will support new launches (up 30/17% in 4QFY18/3QFY18) and (6) Valuations are not demanding if growth rebounds.

18 months of hope and the struggle continues. Market share gains have becoming meaningless. Growth is coming in bits & pieces and has failed to revive overall domestic performance. The company has made some progress in the last 2 years in diversifying its distribution from wholesale (~35% mix now vs. 52% earlier) to modern trade (9% mix now vs. 4% earlier) and direct reach (0.95mn stores vs. 0.63mn earlier). Recovery in macros (rural) coupled with a favorable season can lead to a rebound in Emami’s performance. We remain believers, given favorable risk-reward and high probability for a consumer business to rebound.

Change in estimates Emami consistently disappointed on recovery which led to earnings cut

Then Now Change (%)


Revenue 29,234 33,628 26,929 29,299 -8% -13%

EBITDA 8,414 10,072 7,343 8,355 -13% -17%

APAT 6,326 7,670 5,004 5,905 -21% -23%

Valuation The stock de-rated from 32x (2 yr fwd P/E) to 20x, as investors began to

lose patience (recovery in growth) and promote pledge backfired (entered a vicious cycle).

Emami : Lessons learnt We learnt that it is crucial to track promoter pledges and group level debt!

We overlooked the risks from promoter pledge and didn’t incorporate the risks while valuing the co.

We learnt that tracking quality of growth is vital and not absolute growth. In Emami’s case, it was about understanding the quality of its distribution

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HITS & MISSES

We didn’t give enough weight to Emami’s weak distribution model. Depending on the wholesale channel is not a sustainable strategy, especially in an evolved distribution environment in India.

INDUSTRY VIEW (Cooling Appliances) Then

Rising demand for cooling products driven by growing disposable incomes, cheaper financing options and increasing up-country penetration of electricity

A large unorganised air cooler market, opportunity for organized to grab share

We believe RAC and air cooler will grow in tandem as there are two types of consumer in India

Now

Summer-19 confirms our thesis that air coolers will thrive in a hot summer Organised air cooler market will deliver healthy growth despite rising

affluence towards RAC Trade inventory for air cooler industry is at historically low levels and hence

off-season stocking will be healthy

MISS #2 : SYMPHONY

How has our stance changed? We maintained our BUY over 18 months. Our bullish stance on Symphony

during our initiating report (Feb-18) was based on (1) Symphony commands 50/42% value/volume share in India’s organised air cooler market, but its overall volume share is still at ~12%, (2) It will ride the post-GST shift in the market from unorganised to organised players, (3) Strong track record of product innovation and unique distribution model will help cement further gains and (4) Untapped opportunity in RoW markets.

Today, we maintain our thesis on Symphony and remain bullish. Summer 2019 confirmed our thesis that Symphony will deliver a strong show if the

season has no disruption. Symphony’s constant focus on product innovation and superior franchise with distributors will make the company competitive. With trade inventory now at historical low levels, Symphony will enjoy off-season stocking, opportunity to launch tech-rich coolers and benefit from a favorable base. Besides, its international performance will improve given the various initiatives undertaken.

Change in estimates A spillover impact from a weak season (summer-18) led to sharp earnings

cut.

Then Now Change (%)


Revenue 9,722 11,859 8,440 11,712 -13% -1%

EBITDA 2,884 3,682 1,320 2,605 -54% -29%

APAT 2,411 3,081 1,078 2,117 -55% -31%

Valuation Valuations have not changed for Symphony despite sharp earnings cut. The

stock continues to trade at 33x (2yr fwd P/E) as the outlook for Symphony remains bright with low channel inventory.

Symphony : Lessons learnt We learnt that we had underestimated the seasonality risks, particularly when valuations were rich. We learnt that channel checks are crucial to investment decisions in the consumer discretionary sector. Symphony’s off-season stocking business model (a competitive strength)

backfired during a weak summer 2018. Peak valuations and a high base turned out to be disastrous for the stock. This is something we could have confirmed via channel checks.

We tuned in as we focused on pan-India channel checks during summer-19. Symphony beat our street-high revenue estimates in 1QFY20. As the street turned bearish, we were thumping the table with confidence. The stock moved up, in line with our findings.

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HITS & MISSES

OIL & GAS Nilesh Ghuge, [email protected], +91-22-6171-7342 Divya Singhal, [email protected], +91-22-6639-3038

INDUSTRY VIEW In Mar-18, we were of the opinion that GoI may ask upstream companies

to share cooking fuel subsidy as budgetary provision of Rs 247bn seemed lower than the then prevailing (high) oil prices. A year ago, investors were wary of the tariff revision to be set by PNGRB for a period of 5 years starting FY19. Another concern was withdrawal of 3mmscmd of gas (~8.6% of current vols) by Reliance Industries from H1FY20 post commissioning of its petcoke gasifier.

HIT #1: GSPL Contrary to market fears, PNGRB approved a tariff hike of 27.4% to Rs

1,440/tscm in Sep-18 taking cognizance of the expected 3mmscmd loss in volume, among other factors. Moreover, soft LNG prices compelled RIL to continue using LNG to fuel its refinery, doubly benefitting GSPL.

How has our stance changed? In our initiating coverage note on GSPL in Mar-19, we had expected volumes of 35.1/33.0 mmscmd and blended tariffs at Rs 1,449/1,436/tsm for FY19E/20E. We remained optimistic on a robust volume growth considering, (1) GSPL’s sole right to transmit gas from the upcoming Mundra terminal, and (2) Expansion in Petronet LNG’s capacity by 2.5mmtpa to 17.5. This also factored in a loss in volume of ~3mmscmd from early FY20, post commissioning of RIL’s petcoke re-gasifier. We had rightly foreseen the soft LNG prices, which would boost gas demand for manufacturing in Gujarat.

Our thesis played out correctly with actual volume for FY19 coming at 34.6mmscmd and tariffs at Rs 1,457/tscm. The benign LNG prices led to strong uptake from power plants as well as refineries, resulting in volume growth of 9.8% YoY. In fact, demand exceeded our forecasts owing to NGT order for Morbi tile manufacturers and benign LNG prices. These factors impel us to revise our volume estimates upwards for FY20.

The continuation of softer LNG prices and successful commissioning of PLNG’s Dahej terminal to 17.5mmtpa in Jun-19 gives us confidence to retain our stance.

Change in estimates

Rs bn Mar-19 1QFY20 Change (%)

FY19E FY20E FY19A FY20E FY19 FY20 Net Revenue 18.93 17.58 18.77 21.43 -0.8 21.9 EBITDA 15.99 14.53 15.43 16.81 -3.5 15.7 APAT 8.32 7.45 7.95 9.06 -4.4 21.6 AEPS (Rs/sh) 14.8 13.3 14.1 16.1 -4.7 21.1

We continue to remain positive on GSPL owing to (1) Robust volume outlook on the back of strong demand, (2) Smoothening of cyclicality in its earnings, post an acquisition of a controlling stake in Gujarat Gas, and (3) Steady cash flows (FCF of Rs 38.73bn over FY20-23E) from transmission business which will turn the company’s position to a net cash one.

Valuation There is no change in our valuation methodology. However, an upward

revision in our volume assumptions has inched our DCF based target price up to Rs 247/share from Rs 207. Acquiring a controlling stake in Gujarat Gas seems to playing out well for GSPL. This is not only an investment in a self propelling, quasi-monopolistic and growing CGD business but it also helps to smoothen out cyclicality/volatility in GSPL’s earnings arising out of PNGRB’s tariff determination policy.

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MISS #1 : ONGC

How has our stance changed? In May-18, we believed that OMCs could comfortably pass on crude oil

price inflation by raising Petrol/Diesel prices till the former remained under USD 80/bbl. This played out perfectly as there was no government intervention till oil prices reached >USD85/bbl.

We were also right in anticipating no subsidy burden or under recoveries on auto fuels as long as oil prices remained below USD80/bbl. GoI asked OMCs to cut fuel prices by Rs1/ltr each by reducing their marketing margin when oil prices exceeded USD85/bbl. Soon after, oil prices corrected to USD50/bbl and OMCs were allowed to recoup their marketing margins and recover their losses. Hence, there were no under recoveries on auto fuels in FY19. This boosted our confidence in our stance.

However, we went wrong in assuming that ONGC might have to share cooking fuel subsidy along with the Government as budgetary provision of Rs 247bn seemed contextually lower than the (high) oil prices then. Although the cooking subsidy was ~Rs 470bn for FY19, government didn’t ask ONGC to share this burden. Therefore, GoI did not ask ONGC to share under recoveries on Kerosene/LPG in FY19. This boosts our confidence in our stance that there will be no subsidy burden on ONGC.

Better than expected oil price realisation at Rs 4,770/bbl resulted in better revenues (2.78% above estimates). However, lower than anticipated statutory levies resulted in higher EBITDA. APAT was 1.4% below estimates owing to higher exploratory and survey costs and lower than expected other income.

Valuation Considering the skepticism on GoI’s stance on deregulation amid increasing

crude oil prices, depreciating rupee, and an election packed year, we cut our P/E multiple from 10x to 8x.

ONGC : Lessons learnt We have learnt that government’s stake sale (to achieve its disinvestment

targets) can turn out to be a key overhang even if nos don’t crack. In FY19, ONGC realised the highest ever oil price in the past 10 years. Yet, the stock corrected sharply (35%) from Rs 174/share (18th May, 2018) to Rs 128 (14th Aug, 2019) while Nifty was up 5.7%. In the last 15months alone, GoI’s shareholding has shrunk from 68.07% to 64.25%.

Change in estimates

Rs bn 4QFY18 1QFY20 Change (%)

FY19E FY20E FY19A FY20E FY19 FY20 Net Revenue 1,066.88 1,124.28 1,096.55 1,084.47 2.7 -3.5 EBITDA 551.68 575.39 594.63 567.67 7.8 -1.3 APAT 271.17 288.20 267.16 252.90 -1.5 -12.2 AEPS (Rs/sh) 21.5 22.5 21.2 20.1 -1.4 -10.7

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HITS & MISSES

CHEMICALS Nilesh Ghuge, [email protected], +91-22-6171-7342 Divya Singhal, [email protected], +91-22-6639-3038

INDUSTRY VIEW With Chinese (global manufacturing leader) exports of Aliphatic Amines

(including Amine derivatives) to India declining in FY17, we were optimistic about the future prospects of Indian Amine companies. Post the environmental clampdown and capacity cuts in China, both Balaji and Alkyl Amines (accounting for 90% of India’s Amines output) augmented their capacities and were set to reap volume benefits. Our thesis played out in Alkyl’s favour. The company expanded aggressively in the last one year and ate into Balaji’s market share.

MISS #1 : BALAJI AMINES

How has our stance changed? In May-18, we had expected BAL to deliver a volume growth of 8-10% in

FY19E/20E, driven by commissioning of their Acetonitrile plant and higher utilisation of Di-methyl formamide (DMF) (from 25% to 50%) & Di-Methyl Acetamide (DMAC) plants. Additionally, we foresaw a likely imposition of anti-dumping duties on DMF, and benefits accruing from its 55% subsidiary, Balaji Specialty Chemicals.

However, by the end of FY19, the volume growth was lower than we had anticipated. Moreover, Alkyl Amines has aggressively challenged Methyl Amines by expanding its Dahej plant and capturing the latter’s market share.

The management had earlier guided Acetonitrile production to start in FY19. Delayed clearances from government authorities postponed the commissioning to 1QFY20.

The management was confident of an imposition of antidumping duty on DMF in FY19. However, it still has not been imposed resulting in low volume traction for DMF.

We have hence changed our stance on the company and reduced the multiple from 17x to 13x P/E, owing to (1) Poor volume growth, (2) Uncertainty of anti-dumping duty on DMF, and (3) Deferment of capacity augmentation projects to FY21.

Change in estimates FY19’s revenue was 7.2% lower than estimated largely because of lower

volumes sold. This coupled with lower (80bps) than anticipated margins led to a lower EBITDA (11.5%).

Expected EBITDA margins of 21.3% narrowly missed the actual margins of 20.5%.

Change in estimates

Rs bn Q4FY18 1QFY20 Change (%)


Net Revenue 10.21 11.67 9.43 9.48 -7.6 -18.8 EBITDA 2.18 2.47 1.93 1.73 -11.5 -30.0 APAT 1.25 1.4 1.15 0.99 -8.0 -29.3 AEPS (Rs/sh) 38.6 43.2 35.4 30.6 -8.3 -29.2

Valuation The tepid volume growth and postponement of Methyl Amines’ capacity

compel us to revise our valuation multiple from 17x to 13x.

Balaji Amines : Lessons learnt We have learnt to be more conservative than the management’s guidance

on volume and capex.

Also, we’ve learnt that a big miss on guidance is punished more than proportionately by market, especially if there are comparable stories that meet guidance or estimates consistently (Alkyl Amines is a case in point).

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AUTOS Aditya Makharia, [email protected], +91-22-6171-7316 Mansi Lall, [email protected], +91-22-3021-2070

INDUSTRY VIEW

Then In FY18, the industry environment was very positive as the auto sales were

growing in double digits. Over FY18, sales for 2W/MHCV/Cars grew ~15/13/8% YoY. The growth sustained over 1HFY19, with sales growing 10/ 48/7% respectively.

Slowdown from Sep-18 onwards started with weak retail sales in the festive season, which were impacted by an increase in insurance charges and a spike in oil prices. This was followed by price hikes due to the implementation of safety regulations (for eg: Prices for Royal Enfield Classic went up by ~15%). Sales for 2W/MHCV/Cars over 2HFY19 declined 1/6/1% respectively.

Now The slowdown has accentuated as the economic growth started

moderating in 4QFY19 ahead of the general elections. Over 1QFY20 sales declined sharply as volumes fell 19/17/18% for 2W/MHCV/Cars.

The macro slowdown has continued through the year, with the latest GDP print at 5% for the Jun quarter.

We believe that the downturn is more enduring and government assistance will be required (GST rate cuts and liquidity infusion) to revive sales, particularly as the upcoming BSVI implementation will result in price hikes.

We have had a segmental view on the sector and have been negative on CVs and premium lifestyle bikes while being more constructive on mass market two wheelers and passenger cars in 2019. In terms of hits, our negative stance on Eicher Motors has worked well. However, our big miss has been Maruti where we were positive on the stock throughout the year, before downgrading to a NEUTRAL in Jul-19.

HIT #1 : EICHER MOTORS

How has our stance changed? In Mar-19, the PE multiple was elevated as the market was factoring in

healthy growth potential in Royal Enfield in particular. The stock was trading at a 50% premium to the mass market OEMs.

Growth was expected to be driven by new markets including Uttar Pradesh where penetration levels are low. This was expected to more than offset the volume moderation in the mature states

650cc twin launches was expected to enhance the cos growth prospects in the developed / export markets

However, since then, sales have declined sharply over the year due to the downturn. The lifestyle segment volumes have contracted more than the mass segment.

Competition has stepped up with Jawa launching models in this segment. Other competitors are expected to roll out products over the next 2 -3 years

Change in estimates We have reduced our multiples on this stock from 22x to 19x over the past

six months as the ramp on the 650cc segment has been gradual and the high growth classic model is witnessing fatigue.

Change in estimates

Eicher Motors Mar-19 TODAY % change


Volumes 916,733 982,442 823,828 764,653 (10.1) (22.2) Net Sales 99,134 110,922 97,971 95,429 (1.2) (14.0) EBITDA margin (%) 29.9 29.3 29.6 25.6 -26 bps -377 bps PAT 22,619 25,174 22,203 20,417 (1.8) (18.9) P/E (x) 27.3 24.5 21.6 23.5 RoE (%) 28.4 25.2 27.8 20.9

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MISS #1 : MARUTI SUZUKI

How has our stance changed? We were positive on Maruti (since 2QFY19) due its dominant market share

in the PV segment and its rising share in UVs.

Also, we expected capacity expansion (Gujarat Plant) to provide incremental volumes.

We believed Maruti is well positioned to benefit from the transition to BSVI given its higher share of petrol variants.

We downgraded the stock to Neutral in Jul-19 due to the delayed demand recovery. Also, the valuations were not adequately factoring in the current downturn.

Lastly, competition continues to launch new products which have resulted in sustained competitive intensity, even in the slowdown.

Change in estimates Stock multiples have been lowered from 25x to 22x over the last 18

months.

Oct-18 TODAY % change

FY19E FY20E FY19A FY20E FY19 FY20 Volumes 1,962,626 2,133,024 1,862,449 1,674,979 (5.1) (21.5) Net Sales 914,693 1,024,591 860,203 814,940 (6.0) (20.5) EBITDA margin (%) 14.7 15.5 12.8 12.0 -195 bps -355 bps PAT 80,844 98,535 75,006 67,758 (7.2) (31.2) P/E (x) 27.9 22.9 26.7 29.6 RoE (%) 18.1 19.4 17.1 14.0 Maruti: Lessons learnt We have learnt that despite the downturn, competitive intensity has

remained elevated as new models have been launched by Hyundai, Kia and other OEMs. Further, the extent of volume decline at 24% YTD FY20 has been amongst the steepest since liberalization. After being initially positive on Maruti, we downgraded the stock to NEUTRAL in Jul-19.

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PHARMA Amey Chalke, [email protected], +91-22-6171-7321

INDUSTRY VIEW

Then Beleaguered by regulatory clampdowns, channel consolidation in the US

and increased competition, earnings of US-focused Indian pharma companies dropped 30% YoY in FY18. Despite the all-too-visible business challenges, the companies persisted with higher R&D activity (related to complex generics and specialty businesses), which aggravated the pain. As a result, the NIFTY Pharma index had corrected ~30% over FY15-18 (following a 30% CAGR over FY11-15).

We believed FY19 would witness a gradual comeback for large-cap pharma companies, driven by (1) Actual and likely regulatory resolutions, (2) Moderating price erosion, and (3) Several product-launches across the generic and specialty categories in 2HFY19.

We had expected earnings to have bottomed out.

Now Indian pharma companies, on an aggregate level, ended FY19 slightly below

our expectations. Among large-caps, Sun Pharma faced several corporate governance scrutinies, Lupin and Cadila received more warning letters, while Cipla struggled due to poor execution across businesses. Only Dr. Reddy’s and Aurobindo managed to meet our expectations in terms of operational performance.

However, in-line with our expectations, earnings did prove to have bottomed out in FY18 and grew 17% YoY in FY19 for our coverage universe.

Now, with a favourable INR/USD rate, stabilized US generics businesses, increased pace in FDA approvals and some recovery in the cost spent on the specialty businesses, we expect this recovery in earnings to accelerate for large-cap companies. Our pharma coverage universe is likely to deliver 21% earnings CAGR over FY19-21E.

HIT #1 : DR REDDY’S LABS (DRRD) How has our stance changed? At the beginning of FY19, DRRD had been suffering from USFDA’s warning

letters on three key facilities and we expected a delayed resolution, which would push lucrative product approvals to FY20. This, coupled with price erosion in the base business would leave FY19 as a soft year.

Owing to plant resolutions and lucrative product launches, our FY20 estimates were buoyant (14/31% revenue/PAT CAGR over FY18-20E).

We upgraded DRRD to BUY in Oct-18 as the co had been rapidly ramping up US revenues with lucrative oncology and injectables launches, following regulatory resolution at key formulations plants. Biosimilar and complex generics launches in EM and regulated markets, a renewed focus on India, and traction gained in EU & China will support revenue CAGR of ~15% over FY19-21E. Continued cost optimization, divestment of non-core assets, and healthy revenue growth across key geographies along with a better mix will drive ~19% PAT CAGR over FY19-21E.

Considering the improving balance sheet, healthy FCF (Rs 15bn+ annually), and largely clear regulatory status, the valuations remain supportive at 22/19x FY20/21E P/E.

Change in estimates

Rs mn 18 months ago Today Change (%) FY19E FY20E FY19A FY20E FY19 FY20

Revenue 154,069 183,414 153,851 175,210 (0.1) (4.5) EBITDA 28,657 43,653 33,288 40,298 16.2 (7.7) EBITDA Margin (%)* 18.6 23.8 21.6 23.0 300 (80) APAT 12,525 16,943 17,420 21,335 39.1 25.9 Source: HDFC sec Inst Research; *Change is in bps

MISS #1 : JUBILANT LIFE SCIENCES (JUBILANT) How has our stance changed? After ending FY18 with superior operational performance, we had expected

JUBILANT to deliver ~15/30% revenue/PAT CAGR over FY18-20E. While the sustainability of the momentum of the LSI segment was uncertain, we were expecting JUBILANT to maintain its growth in specialty pharma.

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HITS & MISSES

Moreover, the listing of its pharma entity on the Singapore stock exchange and the following de-leveraging of the balance sheet were important milestones to our earlier expectations of a potential re-rating in the stock.

The recent fall in the stock price from Rs 870 (Mar-19) to ~Rs 500 is largely led by the unfavourable IFC loan settlement, USFDA issues and the concerns of ramp up in the specialty segment.

Although IRR for IFC loan looks daunting at 20%+, it was only 7-8% of total debt and raised at a time of distress in FY15. Meanwhile, the impact of FDA issues will be partly offset by the new Roorkee block. With added capacities in CDMO and traction gained in radiopharma products, the specialty business is driving both growth and profitability.

At 10.5/8.4x FY20/21E EPS, along with 11-12% EPS CAGR, we remain positive on the stock’s recovery.

Change in estimates

Rs mn 18 months ago Today Change (%) FY19E FY20E FY19A FY20E FY19 FY20

Revenue 90,063 100,287 91,108 94,895 1.2 (5.4) EBITDA 18,843 21,584 17,390 18,818 (7.7) (12.8) EBITDA Margin (%)* 20.9 21.5 19.1 19.8 (183) (169) APAT 10,194 12,521 8,573 8,618 (15.9) (31.2) Source: HDFC sec Inst Research; *Change is in bps

Jubilant Life Sciences : Lessons learnt We have learnt that we must be more mindful of key events, be more

responsive and critical about imprudent management decisions which could lead to multiple de-rating.

Unfavourable IFC loan settlement, fresh issuance of debt which was higher than the required amount to pay for IFC loan settlement and postponement of IPO were major announcements on which we should have reacted and lowered the multiple as well as our earnings estimates.

MISS #2 : STRIDES PHARMA (STAR) How has our stance changed? Prior to 4QFY18 result, we had believed that the operating performance of

the Strides’ business would show a sharp improvement over next few quarters, due to improving traction in both Australia and the US and fresh institutional orders for Anti-malarial products. We had expected 12/37/46% revenue/EBITDA/PAT CAGR over FY18-20E.

However, Strides’ US revenues halved in 4QFY18, which led to a 55-58% earnings cut over FY19-20E. With the expectation of a slow recovery in the US business, we downgraded the stock to NEUTRAL.

Now with a divestment of Australia business, we project ~6% revenue CAGR and 146% PAT CAGR over FY19-21E. We are relieved to see the reduction in debt and a healthier balance sheet. The valuations remain attractive at 11.0/8.0x FY20/21E P/E. However, we are cutting down the multiple from 15x to 12x due to persistently bad return ratios and a regulatory overhang over Ranitidine, to arrive at a TP of Rs 500.

Change in estimates

Rs mn 18 months ago 4QFY18 note Change (%)


Revenue 35,364 35,364 29,495 33,225 (16.6) (21.0)

EBITDA 6,719 6,719 4,572 5,316 (32.0) (39.8)

EBITDA Margin (%)* 19.0 19.0 15.3 16.3 (370) (470)

APAT 3,490 3,490 1,649 2,350 (52.7) (55.8) Source: HDFC sec Inst Research; *Change is in bps

Strides Pharma : Lessons learnt We have learnt that the regular management interaction regarding the

health of the business and frequent channel checks about the companies with concentrated revenue exposure to select products are essential.

Moreover, there is a significant deterioration in Strides’ return ratios, there should have been a similar cut in P/E multiple assigned to the company, irrespective of the multiples given to peer companies with similar size and operational performance.

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INFRA & CONSTRUCTION Parikshit Kandpal,CFA, [email protected], +91-22-6171-7317 Shrey Pujari, [email protected], +91-22-6639-3035

INDUSTRY VIEW

Then In our Infra Thematic Note dated 12th Apr 2018 ‘On a Concrete High’ we

had highlighted (1) Strong orders booking on back of Rs 1.2tn NHAI roads awards during FY18, leading to 4x Book to Bill for our coverage universe; (2) No significant challenges to funding for HAM projects for quality developers; (3) Continuity of roads projects awards for FY19 (4) Relatively stronger Balance sheet for Infra EPC players & (5) Likely ordering continuity in case of NDA getting re-elected. Despite the logic the stock corrected sharply in the following 6-9months and upto runup to elections in May-2019.

Now We followed up on our ‘On a Concrete High’ thematic with ‘Acche Din,

Again!’ Thematic published on 23rd May 2019, date of re-election of NDA. Our thesis here was continuation of APR-18 thematic on (1) Continuity of orders flow (2) Funding availability for strong balance sheet developers (3) Reducing competitiveness with limited players having HAM equity in hand & (4) Reducing interest rates. The stocks did rally post the exit polls and favorable reports on NDA win and likely continuity on infra spending. But saw sharp price cuts, on back of multiple macro and micro factors.

What we have learnt? What we learnt was not being quick enough to downgrade multiples post

Peak ordering/ Peak sectoral valuation multiples during 4QFY18. Further, the IL&FS crisis, NBFC funding crisis and NDA losing election in few States created news flow of likely higher funds being made available towards Social Schemes at cost of Infra spend. We believe that post NDA re-election the Infra rally fizzled out due to (1) Cyclical slowdown (2) News flow surrounding NHAI debt and its impact on future ordering (3) PSU banks aversion to fund HAM projects & (4) Overall tight Liquidity conditions. We remain constructive in this transient phase as Govt MOF/MORTH has re-

iterated spending of Rs 100tn/Rs 5tn on Infra/NH over next 5yrs. Our meetings with NHAI/MORTH/Lenders suggest order momentum to continue and funding availability to remain stable for strong balance sheet players. A large part of the price correction is related to P/E multiple cut for Infra sector.

MISS #1 : NCC

How has our stance changed? The stock price has corrected from 128 to 62 (52%) over last 18months vs

our BUY and SOTP of Rs 155/154/sh then/now. NCC has beaten our estimates for FY19 by a wide margin (refer table below) largely driven by robust ordering and margin expansion. We have over last 1yr recalibrated our FY20E PAT by 1.2% lower.

Standalone (Rs mn)

18 months ago Today Change (%) FY19E FY20E FY19A FY20E FY19 FY20

Revenue 96,428 119,825 120,798 114,722 25.3 (4.3) EBIDTA 9,054 11,146 14,230 13,373 57.2 20.0 EBIDTA Margins (%) 9.4 9.3 11.8 11.7 239.1 235.5 PAT 3,462 4,496 6,229 4,550 79.9 1.2

New AP Govt suspended/halted all AP projects awarded by previous Govt in May-19. NCC had Rs 180bn of orders from AP which is 42% of order book. NCC announced cancellation of Rs 60bn (14%) of orders and balance Rs 120bn have reasonable chances of re-starting from Sep/Oct-19

Multiple contractions led to sharp price cuts as markets factored in entire AP book getting cancelled. NCC currently trades at 5.9x Core FY21E EPS.

We couldn’t factor in such sharp multiple contraction.

Added to company specific issues, the macro headwinds viz. Tight liquidity, banks’ averseness to lend to Infra sector, limited private capex and slow interest rate cut transmission too impacted correction.

Our stance remains positive; we expect AP works re-start will give major boost to execution and 15-20% earnings upgrades. Resolution of Sembcorp arbitration will yield about Rs 5bn of inflow for NCC by early FY21.

Resumption in ordering by Government authorities NHAI, NBCC, Irrigation etc will lead to multiple re-rating.

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NCC : Lessons Learnt We have learnt that multiple contraction is sharper in events like large part

of order backlog becoming susceptible to cancellation.

Fund/Non fund based limits get choked once orders execution slows down or stops.

NWC gets blocked, restricting growth capital for new orders. This leads to sharp PE de-rating.

MISS #2 : DILIP BUILDCON

How has our stance changed? The stock price has corrected from 1,154 to 438 (62%) over last 18 months

vs our BUY and SOTP of Rs 1,449/720 then/now. We have cut our FY20E estimate by 27.1%. Large part of de-rating happened due to multiple contraction.

Dilip Buildcon 18 months ago Today Change (%) FY19E FY20E FY19A FY20E FY19 FY20

Revenue 97,124 122,942 91,182 105,323 (6.1) (14.3) EBIDTA 17,288 21,761 16,044 18,306 (7.2) (15.9) EBIDTA Margins (%) 17.8 17.7 17.6 17.4 (20.4) (31.9) PAT 8,636 9,385 7,607 6,840 (11.9) (27.1) DBL had won 12 new HAM projects and concerns around Financial Closure

impacted order book execution visibility and growth guidance. DBL also marginally cut its FY19E revenue guidance by 7-10% during in 4QFY19.

Standalone Debt increased over this period exceeding our FY19E estimate of Rs 28.6bn and ending FY19 with Rs 35.7bn. This led re-calibration of interest expense and cut in FY20E EPS.

Large part of debt increase was pre-mobilization (Rs 5bn+) done by DBL in under construction HAM projects wherein Appointed Date has not even come.

Further news flow of Rs 10bn QIP fund raise resulted in sharp price correction. The fund raise was later called off.

Multiple contraction along with EPS cut led to sharp price correction. DBL currently trades at 6.4x Core FY21E EPS.

We couldn’t factor in such sharp multiple contraction.

Added to company specific issues the Macro headwinds viz Tight liquidity, Banks averseness to lend to Infra sector, limited private capex and slow interest rate cut transmission too impacted correction.

Our stance remains positive with all HAM projects achieving FC and DBL monetizing 5 Under Construction HAM to Cube Highways. Balance 7 under construction HAM projects are expected to get sold by Mar-20E. This shall lead to significant deleveraging.

This shall be a big trigger for multiple re-rating.

Dilip Buildcon : Lessons Learnt We have earlier valued DBL at 10x EV/EBIDTA. We believed DBL debt will

reduce going ahead on back of (1) Shrem Deal funds inflows (2) Improvement in NWC (3) Lower Capex. On the contrary this was a mistake and debt increased.

We have changed our valuation methodology and now value all EPC companies on P/E basis.

We were late to cut P/E for a company with increasing debt, high capex, high equity outflow. Low visibility on execution of large HAM projects portfolio (where appointed date was awaited).

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CONTRIBUTING ANALYSTS Industry Analyst Qualification Banks & NBFCs Darpin Shah, Aakash Dattani MBA, ACA Life Insurance, Broking Madhukar Ladha, Keshav Binani CFA, CA IT Services Apurva Prasad, Amit Chandra, Akshay Ramnani MBA, MBA, CA Cement Rajesh Ravi, Saurabh Dugar MBA, MBA Consumer Naveen Trivedi, Siddhant Chhabria MBA, PGDBM Oil & Gas, Chemicals Nilesh Ghuge, Divya Singhal MMS, CA Autos Aditya Makharia, Mansi Lall CA, MBA Pharma Amey Chalke MBA Infra & Construction Parikshit Kandpal, Shrey Pujari CFA, MBA

HDFC securities Institutional Equities Unit No. 1602, 16th Floor, Tower A, Peninsula Business Park, Senapati Bapat Marg, Lower Parel, Mumbai - 400 013 Board: +91-22-6171 7330 www.hdfcsec.com

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HITS & MISSES

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26 SEP 2019 Hits & Misses

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