Rural India: at a crossroads

Transcription

ECONOMY &
STRATEGY
February 2015
2004 - 2014
2014 onwards
Rural India: At the crossroads
Analysts:
Saurabh Mukherjea, CFA
[email protected]
Tel: +91 22 3043 3174
Ritika Mankar Mukherjee, CFA
[email protected]
Tel: +91 22 3043 3175
Nitin Bhasin
[email protected]
Ashvin Shetty, CFA
[email protected]
Pankaj Agarwal, CFA
[email protected]
Rakshit Ranjan, CFA
[email protected]
Bhargav Buddhadev
[email protected]
Ritesh Gupta, CFA
[email protected]
Economy & Strategy
CONTENTS
Rural India: At the crossroads…………………………………………………………………. 3
Executive summary of sector specific impacts………………………………………………..4
Rural and semi-urban India: What are we seeing on the ground?.............................. 5
How will the rural demand story evolve in the coming years?................................... 11
Can the rural India story stage a comeback under the NDA?....................................14
SECTOR
Consumer………………………….………………………….………………………………..15
Automobiles………………………….………………………….……………………………. 22
Cement………………………….………………………….………………………………….. 28
Home building materials………………………….………………………….………………36
NBFCs………………………….………………………….………………………….…………42
Light Electricals………………………….………………………….…………………………. 48
Agri Inputs………………………….………………………….………………………………. 61
February 24, 2015
Ambit Capital Pvt. Ltd.
Page 2
Economy & Strategy
THEMATIC
Whilst the lower tier of rural India may recover, this will take time
Whilst the effects of weak monsoon and weak commodity prices might be
temporary, the Government is set to use the DBT platform to plug leakages and
to better target subsidy spends. Whilst the plugging of leakages will adversely
affect the top tier of the rural economy, the lower tiers will benefit owing to the
superior targeting. Furthermore, in a bid to create jobs, the Modi Government is
likely to administer a ‘big push’ to the infrastructure sector (see our note dated
16 February for details) which will buoy the rural economy, albeit with a lag.
Investment implications
Even if we assume that the NDA moves swiftly on DBT and big-ticket capex
focused on road building and low-cost housing, we are likely to see a lull for 26 quarters, during which the old game of pilfering subsidies comes to an end
with the new construct yet to fire. The companies which appear to be the most
exposed are those that have relied heavily on rural India to drive their growth
through the downturn including M&M (MM IN, unrated) as SUVs and tractors
account for ~70% of its total volumes, Maruti (MSIL IN, SELL) as ~30% of its
revenues comes from rural sales, HUL (HUVR IN, SELL) as 40% of its revenues
come from rural segments, Colgate (CLGT IN, SELL) as 35% of its revenues
come from rural segments, MMFS (MMFS IN, SELL) as >95% of its loan book is
driven by rural India, Havells (HAVL IN, SELL) as ~30% of its revenues come
from rural India, Ambuja (ACEM IN, SELL) as ~35% of revenues come from
rural segments and Ramco Cements (TRCL IN, SELL) as ~35% of its revenues
come from rural segments.
60%
24%
26%
40% 20%
20%
23% 18%
9%
2%
0%
-1%
-20%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15 (BE)
Expenditure on
subsidies
(YoY change, in %)
83%
80%
Source: CEIC, Ambit Capital research
Exhibit B: Government expenditure
growth has slowed down in FY15
30%
20%
10%
FY15 (YTD)
FY14
FY13
FY12
FY11
FY10
0%
FY09
The NDA Government seems to have hit the brakes on these subsidies
Despite creating allocations for subsidies and plan spends in the FY16 Union
Budget, the new Government seems to have hit the brakes on subsidy spends
and MSP hikes. As per the latest data available, total expenditure growth over
Apr-Dec 2014 was at 6% YoY vs budget estimates of 13% YoY and the ten-year
average growth rate of 13% YoY. Similarly, Minimum Support Prices (MSPs) for
rice and wheat grew at 4% YoY in FY15 vs an average growth of 9% YoY in the
previous decade (see Exhibit C on the right). This combined with poor monsoons
and global moderation in food prices has weakened rural demand.
100%
FY08
Growth in rural India was fuelled by a blast of subsidies
The average top-line growth of 15.2% YoY recorded in the FMCG space over
FY09-15 was driven mainly by the dramatic levels of subsidies pumped into the
rural economy by the previous Government. For instance, India’s subsidy bill
under the UPA regime grew at a staggering CAGR of 19% p.a. during FY05-14
(see Exhibit A on the right). Most research studies suggest that ~40% of the
subsidies disbursed by the Central Government are lost in the form of leakages.
This in turn implies that ~US$17bn or 0.8% of GDP alone was pilfered in FY15
itself, thereby buoying the incomes of the top tiers of the rural economy.
Govt. expenditure
(YoY change, in %)
After seven years of frenetic growth, the rural and semi-urban India
story now faces a serious challenge, as the old construct of pilfered
subsidy cash being used to buy land, gold, SUVs, cars, 2Ws, electricals
and other aspirational items by the rural elite comes to an end. The
NDA will gradually unveil new rules which will govern rural growth
henceforth. However, even if one takes an optimistic view of the NDA’s
as yet unproven execution skills, it will take at least 2-3 quarters for the
NDA construct – centered on capex and DBT – to bite. In the meantime,
the unwinding of the previous UPA construct will condemn a range of
reasonably well-managed companies to a spate of poor results.
Exhibit A: Subsidies under the UPA
regime grew at a CAGR of 19% p.a.
Exhibit C: Rate of MSP increases has
slowed down in the past two years
15%
Avg. Growth in MSPs
(YoY change, in %)
Rural India: At the crossroads
February 24, 2015
14%
11%
10%
4%
5%
4%
0%
Avg. FY08-13 Avg. FY14-15
Rice
Wheat
Analyst Details
+91 22 3043 3174
[email protected]
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Economy & Strategy
Executive
impacts
summary
of
sector-specific
Exhibit 1: The slowdown in rural demand will impact sectors and stocks which rely heavily on rural India
Sector
Consumer
Automobiles
Cement and
Homebuilding
NBFCs
Light Electricals
Agri Inputs
Impact
Adversely affected stocks
Volume growth rates in consumer staples have moderated from 9-10% over FY08-12
to 5-6% over FY13-15E. Discretionary consumer revenue growth rates have
moderated from 25-30% to 13-15% over the same period. Whilst the moderation in
FY13 and FY14 was led predominantly by weakness in urban demand, that in FY15
has been driven mainly by weakness in rural demand. Going forward, we expect
rural demand revival to lag behind urban by 6-12 months, although the longer-term
rural consumption story remains intact. HUL, Colgate and Dabur have the highest
exposure to rural demand in our coverage universe. GCPL, HUL and Jubilant
Foodworks are our TOP SELL ideas and Page is our TOP BUY idea.
Whilst rural prosperity has aided auto volume growth in recent years (domestic 2W
sales recorded a CAGR of 8% and Maruti’s rural sales witnessed a CAGR of 14% over
FY11-14), a moderation in rural income and prosperity may negatively impact rural
demand. However, we believe this negative impact would be offset to some extent by
the moderating cost of ownership helped by declining fuel prices and falling interest
rates. We believe the impact would be higher on PVs and SUVs (given the high ticket
size) as compared to 2Ws. We expect Mahindra & Mahindra to be the most impacted
followed by Maruti Suzuki to a smaller extent. Whilst we believe the impact would be
muted on 2Ws (being relatively small-ticket-sized items), we remain concerned of the
rising competitive intensity in and high penetration of 2Ws in rural India.
Rural housing forms 40% of overall cement sales in India, which is largely supported
by agricultural income and rural wages. Poor agri output, low MSP growth and
moderation in rural wage growth has constricted rural income growth and resultantly
led to a slowdown in housing construction. Our discussions with managements and
primary data sources suggest that the ‘rural wealth effect’ also supported mid-ticket
housing construction in nearby towns, which has declined materially in recent
months. Companies such as Ambuja Cements and Ramco Cements have high
exposure to rural/retail markets and are the most susceptible to a slowdown in rural
cement consumption.
We believe that the unwinding of the wealth effect in rural India could lead to: (i)
some demand decline in aspirational and discretionary plays in the auto sector such
as passenger cars and UVs; and (ii) decline in property prices in semi-urban/rural
India, which could affect the loan against property and self-employed segment.
MMFS, with ~47% exposure to cars and UVs in the rural space, would be the most
impacted amongst auto-financers. Repco, with ~20%/56% exposure to LAP/selfemployed segment and with higher contribution of increasing ticket sizes in its loan
growth, would be the most impacted amongst Housing Finance Companies (HFCs).
Magma is our TOP BUY idea.
Revenue growth for the Indian light electricals (LE) industry has deteriorated
significantly since November led by sluggish demand due to: (a) slowdown in
industrial capex and tight liquidity; (b) weak consumer sentiment due to recessionary
environment in rural areas led by weak monsoon and falling crop prices (especially
cash crops); and (b) falling copper prices which is leading to inventory de-stocking at
distributors’ end and delay in purchases from the end customers in anticipation of
falling prices. However, there is an expectation that demand will improve in FY16 if
copper prices stabilise and if the monsoon season is good.
Moderating growth in MSPs and lower farm realisations would impact farmer
sentiment in FY16. However, we believe the growth rates could still be supported by
good monsoons and healthy absolute MSP levels. Whilst sustained weaker growth in
MSPs for the next 2-3 years would clearly hit growth, we believe that if such a
reduction in subsidies is used to invest in irrigation/storage infrastructure then this
would be a positive step from a medium- to long-term perspective. Reduction in
leakages and a move to DBT for a significant proportion of subsidies would also give
more cash in the hands of farmers. On the agrochem side, we believe that growth
rates for agrochem players would be supported by rising adoption of high-value
molecules (due to increasing awareness amongst farmers), rising adoption of
herbicides (rising cost of labour due to urban migration) and fungicides (due to
demand for high-quality agri produce). Companies having higher share of generic
products may be impacted more if weak realisations persist for long. PI Industries is
our TOP BUY idea.
HUL, CLGT
M&M, Maruti
Ambuja Cements,
Cements
Ramco
MMFS, Repco
Havells, Bajaj Electricals
No adverse effect on stocks
Source: Ambit Capital research
February 24, 2015
Page 4
Economy & Strategy
Rural and semi-urban India: What are we
seeing on the ground?
Ritika Mankar Mukherjee, CFA, [email protected], +91 22 3043 3175
The most recent set of company results point to a material slowdown across those B2B
and B2C companies that rely on rural demand. This spans sectors from FMCG to twowheelers and light electricals as well as cement (see the exhibit below)
The most recent set of company
results point to a material
slowdown across those B2B and
B2C companies that rely on rural
demand
Exhibit 2: The most recent set of results point to a slowdown in sales growth…
Revenue growth* (YoY change, in %)
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
Change
(3QFY15
vs 2QFY15
Hero
-1%
11%
11%
6%
14%
20%
-1%
-21%
V-Guard
Havells
(standalone)
TVS
Bajaj
Electricals
(non-E&P)
Finolex
Cables
HUL
17%
-12%
-14%
26%
35%
2%
-17%
-19%
2%
22%
12%
12%
21%
16%
5%
-11%
-4%
18%
14%
22%
30%
34%
28%
-6%
9%
17%
6%
0%
40%
-4%
-10%
-5%
7%
1%
5%
3%
3%
7%
3%
-4%
7%
9%
9%
10%
13%
11%
8%
-3%
Maruti
-5%
27%
-3%
-5%
11%
17%
15%
-2%
Dabur
11%
10%
13%
14%
11%
12%
12%
0%
Colgate
14%
14%
14%
12%
11%
11%
12%
1%
M&MFS*
4%
4%
5%
4%
6%
6%
7%
1%
Company
Source: Bloomberg, Ambit Capital research. Note: *For M&MFS, gross NPAs are given instead of revenue
Exhibit 3: … and a slowdown in volume growth
Volume growth* (YoY change, in %)
Company
1QFY14
2QFY14
3QFY14
Hero
-5%
6%
TVS
-5%
4%
-10%
Maruti
M&MFS*
3QFY15
Change
(3QFY15
vs 2QFY15
20%
-2%
-22%
31%
26%
-5%
13%
17%
12%
-5%
4QFY14
1QFY15
2QFY15
7%
4%
10%
0%
10%
18%
20%
-7%
-5%
34%
30%
27%
21%
15%
14%
10%
-4%
HUL
4%
5%
4%
3%
5%
5%
3%
-2%
Dabur
9%
11%
9%
9%
8%
9%
7%
-2%
Colgate
9%
10%
10%
7%
5%
7%
5%
-2%
Source: Bloomberg, Ambit Capital research. Note: *For M&MFS, loan book growth is reported instead of volume
February 24, 2015
Page 5
Economy & Strategy
Leaving the results aside, our extensive discussions over the past month with primary
data sources and management teams across India point to the following:

A marked slowdown in volume growth (and underlying demand growth) in
cement, gensets, FMCG, light electricals, two wheelers and tractors.

A drying up of black money across the rural and semi-urban economy with the
result that working capital management has become a challenge for listed
companies and for their distributors and dealers.

A stagnation in rural land prices for the first time in a decade.

A marked slowdown in construction activity and real estate sales in rural India and
in Tier 2/3/4/5 cities. (Tier 1 cities like the National Capital Region and Mumbai
already had subdued growth or declining growth in their real estate markets.)

A drop in the demand for gold and jewellery especially outside Tier 1 cities.
So what is going on? Why has growth in rural India slowed down so abruptly?
Commentary from the senior managements of these companies as well as our own
channel checks suggest that five sets of factors are responsible for this visible
slowdown in rural demand, namely:

Sub-par South-West monsoons in FY15,

Slowdown in Government spending on rural India,

Moderation in prices of agricultural commodities globally,

Clear slowdown in rural wage inflation, and

Decline in property and gold prices.
In the section below, we elaborate on each of these dynamics.
Factor #1: Sub-par South-West monsoons in FY15
Note that 53% of the area under production in India is rainfall-dependent and hence
history points to a positive relationship between the extent of summer rains and the
agricultural sector performance in India (see the exhibit below).
Exhibit 4: The magnitude of the South-West monsoon and
agricultural sector GDP are positively related
R² = 0.5444
0%
-10%
-20%
-30%
-5%
5%
15%
20%
Kharif foodgrain
production
(YoY change, in %)
Monsoon rains
(% departure from LPA)
10%
-15%
Exhibit 5: The sub-normal South-West monsoons led to a
contraction in kharif production in FY15
16%
15%
9%
10%
5%
1%
0%
-5%
-2%
-7%
-10%
Agricultural GDP
(YoY change, in %)
FY11
Source: CEIC, Ambit Capital research, Note: Data pertains to FY01-FY14
FY13
FY14
FY15
As the South-West monsoon in FY15 was below normal (11% below the long-period
average), kharif crop production (i.e. the summer crop) declined by 7% YoY in FY15
(see the exhibit above). It is critical to note that kharif production in India accounts for
51% of the total agricultural production and hence poor South-West rains affect
agricultural sector production in a given year meaningfully.
February 24, 2015
FY12
As the South-West monsoon in
FY15 was below normal (11%
below the long-period average),
kharif crop production (i.e. the
summer crop) declined by 7%
YoY in FY15
Page 6
Economy & Strategy
Factor #2: Slowdown in Government spending on rural India
The generous spends on rural India administered by the previous Government had
played a pivotal role in driving demand in rural India.
For instance, MSPs for rice and wheat were increased at an average rate of 14% YoY
and 11% YoY respectively over FY08-13. This pace of increases decelerated
meaningfully from FY14 onwards, as MSP growth rates slowed down to 4% YoY for
wheat and rice (see the exhibit below).
40%
5% 5% 4% 4% 4%
Rice
FY15
FY14
FY13
FY12
FY11
FY10
FY09
FY08
0%
9%
10%
4%
0%
0%
FY15 (E)
2%
0%
FY14
2%
FY13
10%
15%
10%
FY12
8%
8%
20%
FY11
15%16%
11%
25%
21% 21%
FY10
18%
20%
30%
FY08
30%
34%
FY07
33% 32%
Growth in Govt's plan
expenditure
(YoY change, in %)
Growth in MSPs
(YoY change, in %)
40%
Exhibit 7: The Government’s plan expenditure is set to
grow at 4% YoY in FY15
FY09
Exhibit 6: The slower growth in MSPs in the past two years
has dampened rural demand
The generous spends on rural
India
administered
by
the
previous Government had played
a pivotal role in driving demand
in rural India
Wheat
Source: CEIC, Ambit Capital research. Note: FY15 factors the Rs800bn cut in
plan expenditure.
Another channel through which the NDA has turned off the supply of cash to rural
India is the Food Corporation of India (FCI). In FY14, the FCI – a notoriously corrupt
institution – spent a staggering `0.9 trillion. By the time the General Elections were
held in May 2014, the FCI’s grain stockpile was a record 62mn tonnes. Since then,
this stockpile has steadily come down and now stands at 35mn tonnes. Provided the
FCI does not embark upon a buying spree in the final month of FY15, the reduction in
its stockpile would suggest that the FCI’s outlay will dramatically reduce in FY15
(relative to FY14).
Pace
of
growth
in
the
Government’s Plan spending also
decelerated from an average of
17% YoY over FY07-14 to 4% YoY
in FY15
Besides a pullback in spending on grains, the pace of growth in the Government’s
Plan spending also decelerated from an average of 17% YoY over FY07-14 to 4%
YoY in FY15 (see the exhibit above). Within the Plan expenditure category,
Government spending on the Mahatma Gandhi National Rural Employment
Guarantee Act (MGNREGA) also slowed down meaningfully. Whilst the quantum of
jobs created by this scheme is limited, this employment guarantee scheme plays a
critical role in providing an artificially inflated minimum wage.
400
40
300
200
20
100
-
0
FY13
FY14
FY15*
Households provided work (Left scale)
Total expenditure (Right scale)
Source: nrega.nic.in. Note: *FY15 is till 31 January 2015
February 24, 2015
40,000
50
40
30
20
10
0
30,000
20,000
10,000
FY13
FY14
FY15*
Avg. employment
provided per household
(days)
500
Exhibit 9: Number of Gram Panchayats not spending money
has risen by 39% YoY in FY15 YTD
Number of gram
panchayats with no
expenditure
60
Total spending on
MGNREGA
(in ` bn)
Households alloted
work
(in million)
Exhibit 8: Spending on MGNREGA has slowed down with a
26% decline in expenditure on this scheme
No. of gram panchayats with no expenditure (Left
scale)
Avg. employment provided per household (days, Left
scale)
Source: nrega.nic.in. Note: *FY15 is till 31 January 2015
Page 7
Economy & Strategy
The latest data shows that out of the total `400bn earmarked for FY15, the spending
on the scheme until January 2015 has been only `288bn (i.e. 72% of total). Also, the
total number of households allotted work has been declining (see the exhibits above).
The data also suggests that the number of Gram Panchayats (i.e. the local body which
has the primary responsibility of the scheme) with no expenditure has increased by
39% YoY. Thus, average employment provided per household (days) has fallen
sharply by 24% YoY.
Factor #3: Moderation in prices of agricultural commodities globally
The latest data shows that out of
the total `400bn earmarked for
FY15, the spending on the
MNREGA scheme until January
2015 has been only `288bn
Besides the lower Government spending and sub-par monsoons, another factor that
has dampened rural demand has been the moderation in the prices of agricultural
commodities globally (particularly non-cereals).
International futures prices
(YoY change, in %)
Exhibit 10: The prices of agricultural commodities have fallen dramatically in
international markets
60%
47%
40%
26%
21%
20%
11%
4%
0%
-7%
-8%
-20%
-4%
-21% -19%
-11%
-40%
-60%
-42%
Cotton
CY11
Sugar
CY12
CY13
Soyabean
CY14



Cotton prices have fallen by 8% YoY in CY14 (vs a 4% YoY rise in CY13), as per
data from the CME Group (see the exhibit above for details regarding futures
prices). Three states namely Gujarat, Maharashtra and Andhra Pradesh are the
top-three producers of this crop and have suffered the consequences of the fall in
cotton candy prices.
Sugar prices have fallen by 7% YoY in CY14 (vs a 19% YoY rise in CY13), as per
data from the CME Group (see the exhibit above for details regarding futures
prices). Three states namely Uttar Pradesh, Maharashtra and Karnataka are the
top-three producers of sugarcane and have suffered the consequences of the fall
in sugar prices.
Soyabean prices have fallen by 11% YoY in CY14 (vs a 4% YoY rise in CY13) as
per data from CME group (see the exhibit above for details regarding futures
prices). Three states namely Madhya Pradesh, Chhattisgarh and Gujarat are the
top-three producers of this crop and have suffered the consequences of the fall in
soyabean prices.
February 24, 2015
Besides the lower Government
spending and sub-par monsoons,
another
factor
that
has
dampened rural demand has
been the moderation in the prices
of
agricultural
commodities
globally (particularly non-cereals)
Page 8
Economy & Strategy
Exhibit 11: The farmers in the states which are the largest producers of cotton,
sugarcane and soybean have been the most affected by the fall in prices
Source: Ministry of Agriculture, Govt. of India, Ambit Capital research
Factor #4: Clear slowdown in rural wage inflation
The pace of growth in average daily wages in rural India systematically rose from 6%
YoY in CY06 to a staggering 21% YoY by CY11. However, this pace has been
systematically decelerating since CY11 and has fallen to 4% YoY in CY14 YTD (see the
exhibit below).
Exhibit 12: The growth rate in rural wages has slowed
down considerably in the past year
Exhibit 13: The difference between rural and
inflation turned negative during Sep-Dec 2014
urban
1.6%
21%
20%
18%
17%
15%
15%
15%
10%
10%
6%
7%
4%
5%
Source: RBI, Ambit Capital research. Note: *CY14 excludes December 2014
1.2%
1.2%
0.8%
0.4%
0.0%
-0.1%
-0.4%
-0.8%
CY14*
CY13
CY12
CY11
CY10
CY09
CY08
CY07
CY06
0%
Average spread between
rural and urban CPI
inflation
(YoY change, in %)
25%
Avg. daily rural wages
(YoY change, in %)
The pace of growth of rural
wages has declined systematically
since CY11 and has fallen to 4%
YoY in CY14 YTD
-0.6%
CY12
CY13
CY14
CY14
(Jan-Aug) (Sep-Dec)
Yet another indicator namely the spread between rural and urban inflation points to a
deflation that is underway in the rural economy. This spread turned negative over
Sep-Dec 2014 after being positive over Jan-Aug 2014 (see the exhibit above).
The main source of job creation in India over the past five years has been
construction. Therefore, with construction activity slowing down sharply over the past
six months, this source of demand for labour has dried up.
February 24, 2015
-0.2%
With construction activity slowing
down sharply over the past six
months, this source of demand
for labour has dried up.
Page 9
Economy & Strategy
5%
5%
12/2014
2%
09/2014
1%
06/2014
1%
03/2014
09/2013
1%
06/2013
03/2013
2%
12/2013
4%
12/2012
09/2012
06/2012
03/2012
12/2011
14% 12% 12%
12%
10%
10%
8%
6%
3%
4%
1%
2%
0%
-2%
-2%
-4%
09/2011
Construction GDP
(YoY change, in %)
Exhibit 14: Slowdown in construction has adversely affected job creation in the last
year
Source: CEIC, Ambit Capital research.
Factor #5: Decline in property and gold prices
Besides the adverse income effect in rural India, the wealth effect too has been
negative, as the prices of the two asset classes that are the most popular in rural
India, namely property as well as gold, have come under pressure off late.
The pace of growth in housing prices has moderated from 24% YoY in FY12 to 9%
YoY in FY15 YTD. In fact, the decrease is more profound in Tier 2 cities (see the
exhibit below). The moderation in property prices in Tier 2 cities reflects the overall
slowdown in property prices in rural India. In fact, going beyond Tier 2 cities, rural
land prices across India seem to be stagnating for the first time in a decade.
35%
31%
9%
2%
FY13
FY14
-4%
-1%
2%
Patna
2%
5%
Lucknow
2%
Gold prices
(YoY change, in %)
30%
Jaipur
FY12
Exhibit 16: Gold prices have fallen by 13% since the peak
in September 2012
30%
Faridabad
35%
29%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
Bhopal
Housing prices
(YoY change, in %)
Exhibit 15: Housing prices in Tier 2 cities have stopped
rising lately
The prices of the two asset classes
that are the most popular in rural
India, namely property as well as
gold, have come under pressure
off late
24%
25%
20%
15%
10%
5%
0%
FY15*
Source: RBI, Ambit Capital research. Note: *Till 2QFY15
-5%
CY11
CY12
CY13
-1%
CY14
-3%
Similarly, falling gold prices too have created an adverse wealth effect for rural
households.
Whilst it is difficult to know the exact reason behind falling gold and land prices, a
believable explanation is that the expenditure by the UPA Government on subsidies
and MSPs (subsidies equal to average of 2% of GDP over FY05-14, out of which
around 40% seems to have been pilfered by the rural elite and then invested in land,
real estate and gold) has been stopped by the new PM.
February 24, 2015
Page 10
Economy & Strategy
How will the rural demand story evolve in
the coming years?
Given the material sales slowdown in companies that are driven by rural demand and
given the factors driving this slowdown, it is easy to conclude that the rural demand
story in India is likely to remain under pressure.
However, it is critical to note that:

Both Factor #1 (i.e. sub-par South-West monsoons in FY15) as well as Factor #3
(i.e. moderation in prices of agricultural commodities globally) are likely to be
temporary rather than structural. According to a study done by OECD and Food
and Agricultural Organisation (FAO), “Crop prices are expected to drop for one or
two more years, before stabilizing at levels that remain above the pre-2008 period”.

Factor #5 (i.e. the decline in property and gold prices) is likely to affect the rural
elite more profoundly than the rural middle and lower income classes.

Factor #4 (i.e. the slowdown in rural wage inflation) is the ‘consequence’ of the
above-stated factors rather than the ‘cause’.

Factor #2 (i.e. slowdown in Government spending on rural India) which was so
far in the form of social spends is likely to be replaced, at least partially, by
infrastructure spend.
In fact, analysing the rural population in India through the lens of two-tiers provides a
more nuanced answer to the question, ‘How will the rural demand story evolve in the
coming years?’ Whilst we expect the top-tier of the rural economy to remain under
pressure going forward, the lower tier is likely to regain its purchasing power over the
next few quarters, as:
(1) The ramp-up of the DBT platform will create better targeting of subsidies for the
lower socio-economic-classes (SECs), which in turn will make up for some of the losses
that the rural economy will suffer as the subsidy leakage game comes to an end.
Whilst we expect the top-tier of
the rural economy to remain
under pressure going forward,
the lower tier is likely to regain its
purchasing power over the next
few quarters
(2) The increased spending on infrastructure (T&D, roads, freight corridors, affordable
housing) that the Union Government is expected to undertake from FY16 onwards is
likely to create jobs in the rural economy.
Exhibit 17: The ‘top-tier’ in the rural economy is likely to remain under pressure going forward whilst the lowest
tier is likely to regain its purchasing power over the next few quarters
Tiers of the rural economy
Factors supporting demand over FY09-14
Likely way forward
1)
1)
Top-tier
2)
1)
Lower-tier
2)
Leakages in the subsidy disbursement mechanism benefited
the top-tier of the rural economy disproportionately.
Research shows that 40% of all the Government subsidies
are lost in leakages.
This leakage thus amounts to an average of 0.9% of GDP
over FY09-14 or a cumulative sum of `3.7trn ($60bn).
Corruption in the infrastructure spending mechanism also
benefitted the top-tier of the rural economy.
The lower tier benefitted by the sharp increases in MSP
prices. For instance, MSPs for rice and wheat were increased
at an average rate of 14% YoY and 11% YoY respectively
over FY08-13. This pace of increases decelerated
meaningfully from FY14 onwards, as MSP growth rates
slowed to 4% YoY for wheat and rice.
The lower tier benefited from sharp increases in the quantum
of Central Government subsidies. The remaining 60% of this
amounted to an average of 1.4% of GDP over FY09-14 or a
cumulative sum of `5.5trn
2)
1)
2)
We expect the Government’s subsidy spends to
amount to only 1.5% of GDP in FY16 and this
is likely to be targeted efficiently through the
DBT platform, thereby benefiting entirely the
lower-tier of the rural economy.
As the Government steps up capex on roads,
railways, defence, power T&D and low-cost
housing, some proportion of the money is
likely to flow back into the hands of the toptier of the rural economy.
We expect the Government’s subsidy spends to
amount to only 1.5% of GDP in FY16 and this
is likely to be targeted efficiently through the
DBT platform, thereby benefiting entirely the
lower-tier of the rural economy.
As the Government steps up capex on roads,
railways, defence, power T&D and low-cost
housing, this is likely to create jobs for the
lower tier economy albeit with a lag.
February 24, 2015
Page 11
Economy & Strategy
Ramp-up of the DBT mechanism likely to benefit the lower strata of rural
India at the cost of the top-tier
Rural India can be divided into two tiers, namely:

The top-tier, constituting the ‘rural elite’ which includes large farmers, village
heads and middlemen, and

The middle-income and lower-tier which consists of small, marginal and landless
farmers besides including self-employed professionals.
Over FY09-14, the Central Government’s subsidy bill expanded at a CAGR of 15% vs
a CAGR of 12% over FY04-08. However, this benefitted the top-tier disproportionately
owing to the corruption in the system and vast leakages in the subsidy transfer
mechanism.
Over FY09-14, the Central
Government’s
subsidy
bill
expanded at a CAGR of 15% vs a
CAGR of 12% over FY04-08
Our sources suggest that once the PMJDY has universal coverage and the bank
accounts are seeded through Aadhaar cards, the Government eventually plans to
route all transfers, including fertiliser subsidies, food subsidies, petroleum subsidies,
pensions as well as scholarships through the Direct Benefits Transfer (DBT) platform.
In fact, the Finance Minister has already passed an order saying that henceforth all
schemes involving the transfer of cash or other benefits from the Government to the
citizenry has to go through the DBT platform.
In specific, whilst the seeding of the Aadhar card as well as the bank account are
challenges that the Government is grappling with, the Government is aiming to
achieve the following:

Move the disbursement of LPG subsidies (0.05% of GDP in FY16) onto the DBT
platform by March 2015, and

Move the disbursement of food and kerosene subsidies (0.9% of GDP and 0.03%
of GDP in FY16 respectively) onto the DBT platform by September 2015.
As leakages in the subsidy mechanism are reduced and as the DBT mechanism
becomes more ubiquitous, there is likely to be a redistribution of wealth in favour of
the poorest deciles of society (which, ironically, will hit aspirational consumption, and
help small ticket consumption).
Besides the ramp-up of the DBT mechanism, the current Government’s explicit effort
aimed at checking pilferage in the subsidy disbursement mechanism is likely to also
magnify this effect (see the exhibit below).
As leakages in the subsidy
mechanism are reduced and as
the DBT mechanism becomes
more ubiquitous, there is likely to
be a redistribution of wealth in
favour of the poorest deciles of
society
Exhibit 18: Steps taken by the current Government to check pilferage from the subsidy system
Step
Description
Date
Publication of the Shanta Kumar This committee was formed within two months of the new Government coming to power. The report
committee report
recommends transferring food subsidies onto the DBT platform to check leakages.
Forcing the Food Corporation of Out of the total food subsidy bill of `1.15trn in FY15, the operating cost of FCI alone is `940bn.
India
(FCI)
to
make
its Recently the Government has forced the FCI to get rid of surplus stock and it also plans to withdraw
operations more efficient
FCI from grain-surplus states to bring down the huge operating costs of FCI.
Transferring the LPG on to the
The Government has transferred the LPG onto the DBT platform and this marks the first in a list of
DBT
subsidies to be transferred onto the DBT.
Rapid progress on Aadhaar and The Government’s commitment to roll out all the subsidies on to the DBT platform is visible in the
PMJDY
rapid progress made on PMJDY and rolling out Aadhaar cards which is a prerequisite for the DBT.
Source: Media reports, Ambit Capital research. Note: PMJDY stands for Pradhan Mantri Jan Dhan Yojna
Jan 2015
FY15
Jan 2015
FY15
Government focus on infrastructure funding likely to create jobs in rural India
As night follows day, Government spending in India follows a five-year cycle in which
the Government inevitably slows down spending growth in the first year post-election.
Then it gradually ramps up spending growth with an aim of climaxing it in the run-up
to the General Election (see the exhibit below).
February 24, 2015
Page 12
Economy & Strategy
Exhibit 19: Government spending increases in the run-up to the General Elections
Govt. expenditure
(YoY change, in %)
30.0%
GE-2009
25.0%
GE-1999
20.0%
GE-2004
15.0%
10.0%
5.0%
FY90
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
0.0%
Source: CEIC, Ambit Capital research. Note: GE refers to General Elections.
Whilst the Government was undertaking meaningful expenditure growth over the last
five years, infrastructure creation in India had come to a halt.
0.3%
FY14
FY13
FY12
FY11
FY10
FY09
FY08
FY07
0.0%
0.2%
under-investment
in
electricity
0.1%
0.1%
0.1%
0.1%
0.0%
0.1%
0.0%
0.0%
-0.1%
-0.1%
FY11
FY10
FY09
FY08
FY07
Source: Planning Commission, Ambit Capital research
FY12
-0.1%
-0.2%
FY06
Exhibit 23: …which has led to slower
employment in the construction sector
80%
0.2%
0.2%
-0.1%
Source: Planning Commission, Ambit Capital research
Number of people
employed in construction
(growth over specified
period)
Exhibit 22: …and
generation…
0.0%
-0.1%
growth
in
73%
70%
60%
45%
50%
40%
30%
20%
13%
10%
0%
FY00-FY05 FY05-FY10 FY10-FY12
Source: NSSO, various rounds, Ambit Capital research
As highlighted in our note dated February 16, 2015, we expect the Government to
step up capex on roads, railways, defence, power T&D and low-cost housing. Whilst
some proportion of the money is likely to flow back into the hands of the top-tier of
the rural economy (as infrastructure spends are increased), this impetus is likely to
create jobs for the lower tier economy albeit with a lag.
February 24, 2015
FY12
5.6%
5.0%
0.0%
FY11
6.5%
FY10
10.0%
0.1%
FY09
11.6%
9.3%
9.9%
0.2%
FY08
15.0%
15.0%
0.3%
FY07
15.0%
0.4%
0.3%
0.3%
0.2%
0.2%
0.1%
0.1%
0.0%
-0.1%
-0.1%
-0.2%
FY06
20.0%
GFCF in roads and bridges
(as % of GDP, change from
previous yr.)
20.1%
GFCF in electricity
(as % of GDP, change from
previous year)
Exhibit 21: …which has resulted in under-investment in
roads and bridges…
25.0%
FY06
GFCF growth
(YoY, 2 yr. moving average)
Exhibit 20: Investment growth in the economy collapsed in
the last two years…
We expect the Government to
step up capex on roads, railways,
defence, power T&D and low-cost
housing
Page 13
Economy & Strategy
Can the rural India story stage a comeback
under the NDA?
Several investors have asked us whether rural India can at all stage a revival under
the NDA, given its supposedly ‘business class’ oriented sympathies (as opposed to the
UPA’s more ‘rural underclass’ oriented sympathies).
Leaving aside political considerations (no politician who aspires to win elections in
India can ignore the rural and semi-urban vote bank), there are a few other reasons
for believing that the rural India story will regain some of its vitality once the
temporary impacts arising from the sub-par monsoons subside:

As the NDA Government settles down into its capex programme, we should see
the road-building and low-cost house building programmes kick off from 2HFY16.
These programmes are likely to once again create demand for construction labour
and thus have a positive effect on wage growth. Whilst rural wage growth is
unlikely to recover to the 15-21% levels seen over CY09-12, a mean reversion
from the 4% wage growth seen in CY14 seems likely. (For more details on how
much fiscal slack the NDA has for its capex programs, click here for our 16
February 2015 pre-budget note.)
 Food inflation accounts for half of the CPI. Within food inflation, the rising cost of
fruit, vegetables, poultry and dairy accounts for three-quarters of inflation. As per
capita income continues to rise in India, demand for more nutritious food i.e.
fruits, vegetables, poultry and dairy will continue to outstrip supply. This should
continue to generate not only food price inflation but should also – with some
support from the Government – encourage the creation of a rural cold chain and
food processing industry. The Shanta Kumar Committee’s recommendations on
this front seem likely to be pursued enthusiastically by the PM given the twin
electoral benefits – lower CPI inflation for all alongside rural job creation.
 Over the past ten years, the vast majority of industrial jobs have actually been
created in rural India as almost all new factories in India tend to come up in rural
India rather than urban India. Over CY03-12, 75% of all the new factories in India
were set up in rural areas. Similarly 70% of all new manufacturing jobs in India
were created in rural areas. The pattern of greenfield rather than brownfield
development is likely to continue given that it is next to impossible to get
affordable brownfield land for new factories. Hence, as the capex cycle recovers
gradually through FY16 and FY17, we should see this additional source of labour
demand kicking in for rural India.
That said, even if we assume that the NDA has considerable skill in executing projects
(something which is yet to be proven), it will take at least 2-3 quarters for these
sources of demand to kick in. Not only will the private sector capex cycle get off the
ground slowly, even Government capex will have to follow its traditional path of
Request for Proposals, vetting of bids, identification of L1 bids, signing off by the
relevant minister, etc. Hence, it appears that the traditional drivers of rural India’s
prosperity (generous subsidies which partly were stolen by the rural elite and then
were channelled into land, gold and real estate) would be missing for 2-6 quarters
without the new drivers kicking in.
Over the past ten years, the vast
majority of industrial jobs have
actually been created in rural
India as almost all new factories
in India tend to come up in rural
India rather than urban India
Traditional drivers of rural India’s
prosperity (generous subsidies
which partly were stolen by the
rural elite and then were
channelled into land, gold and
real estate) would be missing for
2-6 quarters without the new
drivers kicking in
The companies which appear to be the most exposed at these crossroads are those
that have relied heavily on rural India to drive their growth through the downturn:
M&M (MM IN, Unrated): SUVs and tractors account for ~70% of total volumes.
Maruti (MSIL IN, SELL): ~30% of revenues come from rural India.
HUL (HUVR IN, SELL): 40% of revenues come from rural India.
Colgate (CLGT IN, SELL): ~35% of revenues come from rural India.
MMFS (MMFS IN, SELL): >95% of loan book is rural India.
Havells (HAVL IN, SELL): ~30% of revenues come from rural India.
Ambuja (ACEM IN, SELL): ~35% of revenues come from rural India.
Ramco Cements (TRCL IN, SELL): ~35% of revenues come from rural India.
February 24, 2015
Page 14
Economy & Strategy
Consumer
Rural consumption moderated in FY14 and FY15
Rakshit Ranjan, CFA, [email protected], +91 22 3043 3201
Volume growth rates in consumer staples have moderated from 9-10% over
FY08-12 to 5-6% over FY13-15E. Discretionary consumer revenue growth rates
have moderated from 25-30% to 13-15% over the same period. Whilst the
moderation in FY13 and FY14 was led predominantly by weakness in urban
demand, that in FY15 has been driven mainly by weakness in rural demand.
Going forward, we expect rural demand revival to lag behind urban by 6-12
months, although the longer-term rural consumption story remains intact.
HUL, Dabur and Britannia have the highest exposure to rural demand in our
coverage universe. GCPL, HUL and Jubilant Food are our TOP SELL ideas and
Page is our TOP BUY idea.
Revenue growth rates in the consumer sector have moderated substantially over the
past 2-3 years.
Exhibit 24: Consumer sales growth across staples and discretionary has been on a downward trend since FY12
FMCG average volume growth YoY
11.0%
Consumer Discretionary Value growth YoY (RHS)
40.0%
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
4QFY13
3QFY13
2QFY13
1QFY13
4QFY12
3QFY12
2QFY12
1QFY12
4.0%
Source: Company, Ambit Capital research; Note: Average growth has been calculated using sales growth for stocks under our coverage
Exhibit 25: FMCG value growth slowed down over FY11-14
Exhibit 26: Consumer discretionary value growth slowed
down over FY12-14
FMCG average value growth YoY
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Consumer Discretionary avg. value growth YoY
37%
32%
27%
22%
Source: Company, Ambit Capital research
FY14
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
12%
FY05
FY14
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
17%
As highlighted in the exhibits above, after a period of exceptionally robust revenue
growth rates over FY08-12, both the consumer staples as well as consumer
discretionary sectors have seen a steady moderation in growth over FY13-15.
Moreover, the moderation in revenue growth has been particularly strong in 3QFY15.
February 24, 2015
Page 15
Economy & Strategy
Rural India has contributed substantially to the
consumer sector’s revenue growth rates
As highlighted in the exhibit below, staples companies like HUL and Colgate generate
the highest proportion of revenues from rural India. Discretionary firms, on the other
hand, do not have a meaningful exposure to rural sales.
Exhibit 27: Consumer staples vs discretionary have higher exposure to rural India
Consumer Staples
Rural sales as % of consolidated sales
Britannia
30-35%
Colgate
35-40%
Dabur
30-35%
GCPL
15-20%
GSK Consumer
24-26%
HUL
HUL and Colgate have one of the
highest rural exposures in our
coverage
>40%
Marico*
30%
Nestle
30-35%
Consumer Discretionary
Rural sales as % of total sales
Asian Paints
15%
Berger Paints
12%
Pidilite Industries
7%
Jubilant Foodworks
0%
Bata India
4%
TTK Prestige
8%
Page Industries
4%
As highlighted in the exhibit below, industry data suggests that rural demand growth
acceleration was steeper than urban demand growth acceleration over FY05-11.
Exhibit 28: Rural value growth picked up pace after CY05
Urban (%)
30
Rural (%)
Overall FMCG (%)
25
20
Rural growth accelerated at a
faster pace than urban over
FY05-11
15
10
5
(5)
CY03
CY05
CY07
CY09
CY11
(10)
Source: Industry, Ambit Capital research
Nielsen data suggests that moderation in demand growth over CY12 and CY13
was led mainly by urban growth moderation whilst rural growth rates remained
relatively robust. As a result, towards the end of FY14, rural revenue growth rates
for many firms were 2-3x higher than urban growth rates.
February 24, 2015
Page 16
Economy & Strategy
Exhibit 29: Nielsen data suggests moderation in urban value growth over CY12-13
Overall
Rural
25%
25%
20%
Urban
21%
19%
17%
22%
19%
21%
20%
18%
17% 17%
14%
15%
Rural growth has also
decelerated in the past 9-12
months
15%
13%12%
14%
12%
10%
10%
5%
2008
2009
2010
2011
2012
2013
Source: Nielsen report
However, rural demand has also seen a substantial moderation over the past 912 months, thereby resulting in the narrowing of the ratio between rural and
urban growth rates to 1-2x.
Exhibit 30: Rural growth has moderated over the last 3-4 quarters, as highlighted by key management commentaries
Company Quarter Management Comments
3QFY14 “Second half of 2013 is showing slowdown in rural sales vs. first half across all categories.”
“If you go back in time of rural growth, it used to outstrip urban growths significantly. But if you see as these curves have started
1QFY15 coming down, both the urban curves and the rural curves have started coming down, but they are also narrowing, which means the
days of rural outstripping it substantially is not there.”
HUL
2QFY15 “The decline in rural market has been with a lag….the rural growth is muted but faster than urban growth.”
“The market appears to be showing some signs of a pickup in recent months as reported by Nielsen across several categories, but
3QFY15 more so in rural than in urban. We will have to look at another quarter or two to really come to a conclusion whether the upliftment
in the growth in rural markets is sustainable or not.”
“Now there is a squeeze in rural income over the last couple of quarters, at least the rural income is not being as buoyant as what it
4QFY14
was and the rural markets which were instrumental in driving growth are now no longer driving growth.”
“Our trajectory of growth was significantly driven by rural over the last couple of years…..our rural growth has slowed down from
1QFY15
13-14% to 11-12%.”
Dabur
2QFY15 “We did expect that rural demand will soften (during the quarter) which it has.”
“Rural showed a surprising resilience this quarter, reversing a few quarters of downward trend and grew at a much higher pace in
3QFY15
fact than urban. Now having said that I don’t think this rural growth is sustainable.”
Our view of the drivers of the historical consumer
demand trends across India
Festive season in 3QFY15 has failed to bring about a revival in footfalls for
discretionary consumption categories, unlike what was previously expected, due to a
combination of the following factors:



Lack of asset value creation continues to dampen consumer sentiment:
One of the drivers of consumer sentiment across India (particularly in rural India)
includes a ‘feel good factor’ related to asset value creation. This in turn is related,
predominantly, to an increase in land/real estate/gold valuations. No such rise in
asset values for households has been visible over the past 12-18 months.
Euphoria around political stability is yet to translate into consumer
spending: The Government’s delayed progress around restarting the investment
cycle including infrastructural projects has resulted in a delay in expansion plans
by corporates and hence has led to a lack of hope in a meaningful revival in new
job creation over the next 12 months. This has resulted in a lack of consumer
spending despite a gradual fall in consumer price inflation rates.
Credit offtake remains low: As per the RBI, YoY credit growth in the banking
system has continued to moderate across all categories like services (including
tourism and hotel services and wholesale trade), industrials (predominantly MSME
entities) and export credit. A revival in credit growth is a direct indicator of a rise
in discretionary consumer spends and hence an upcoming revival in staples
category spends.
February 24, 2015
Lack of asset value creation,
delay in restarting the investment
cycle by the government and
lower credit offtake have led to
slowdown in consumer demand
Page 17
Economy & Strategy
Demand revival expectations have been delayed to mid-FY16 at the earliest:
A revival in consumer demand is likely to be driven by a combination of the two
factors: (a) disposable household income revival (likely only in mid-FY16) due to
sustained low inflation, and gradual rise in job creation over the next 12-24 months;
(b) revival in discretionary consumer demand in 1HFY16 due to a gradual translation
of positive sentiment around economic growth into retail consumer spends.
Consequently, we expect discretionary consumer demand to revive in 1HFY16
and staples consumer demand to revive in 2HFY16.
Lower inflation, job creation and
conversion of consumer
sentiment into actual consumer
demand should increase
discretionary demand in 1HFY16
followed by staples pick-up by
2HFY16
We expect rural demand revival to lag behind urban;
long-term rural consumption story intact

Timing of rural vs urban demand revival: We expect the new Government’s
initiatives to drive economic growth, which will result in a combination of: (a)
sustained low consumer price inflation; and (b) new job creation. This should in
turn result in a rise in disposable household income for urban consumers, and
hence lead to an urban-led revival in the consumer sector’s revenue growth rates
over the next 6-12 months. However, we expect rural demand acceleration to lag
behind that of urban by 6-12 months due to a combination of the following: (a) it
will not be before 2HFY16 when the NDA Government’s expected capex
programmes will result in wage growth through demand creation for construction
labour; and (b) there is a gestation period of 6-12 months for the Direct Benefits
Transfer (DBT) schemes to be fully implemented for food, kerosene and LPG
subsidies.

Impact of rural demand revival on FMCG growth rates: Over FY08-13, the
elite-rural households were getting a disproportionately higher share of a large
rural welfare budget from the Government through the black economy route (as
highlighted on page 11). However, in the future, in light of how the new
Government’s rural welfare schemes are likely to be executed, we expect that the
elite-rural will see a substantial reduction in household income. Instead, a higher
proportion of these welfare spends by the Government will be received by the
non-elite-rural households, albeit in a smaller overall budget of welfare schemes.
We believe that this phenomenon will NOT result in a substantial moderation in
the quantum of rural FMCG growth rates over the medium to longer term
because: (a) elite-rural households do NOT contribute substantially to small-ticket
consumption segments within the overall rural sector; and (b) given the nondiscretionary nature of consumer demand in FMCG segment, we do NOT expect a
lifestyle downgrade for elite-rural households to the extent that it leads to a
reduction in their consumption of FMCG products.
The cut-down in black money for
the elite-rural could impact nearterm rural FMCG demand;
however, the longer-term rural
FMCG demand prospects remain
solid
Hence, overall rural growth rates for the FMCG sector from FY17 onwards are
likely to be similar to those achieved over FY08-13. However, we see a high
possibility of weak rural spends in FY16 amidst a revival in urban spends in
2HFY16, as highlighted previously.

Impact of rural demand revival on discretionary consumer growth rates:
Elite-rural contributes meaningfully to the rural revenues of discretionary
consumer categories. Therefore, these revenues WILL see an adverse impact from
the theme discussed in the previous bullet (unlike FMCG). However, since the
contribution of rural to overall sales for most of these players is less than 10-15%,
the overall impact from the theme on the revenue growth rates will be up to a
maximum of 150-200bps with an average of ~50bps moderation in revenue
CAG` for these discretionary companies.
Rural discretionary demand could
be impacted over the longer term
due to the reduction in black
money with the elite-rural;
however, only 10-15% of
discretionary sales come from
rural areas
As highlighted in the table below, factoring in these expectations of a demand revival,
we forecast higher revenue CAGR and EPS CAGR for most firms across our consumer
sector coverage universe.
February 24, 2015
Page 18
Economy & Strategy
Exhibit 31: Revenue CAGR and EPS CAGR are likely to increase for FY15-18 vs FY13-15
for most companies in our coverage
Consumer Staples
Company
Sales
EPS
FY13-15
FY15-18
FY13-15
FY15-18
Britannia
13%
16%
48%
15%
Colgate
12%
14%
6%
19%
Dabur
13%
13%
18%
17%
GSK CH
16%
14%
16%
17%
GCPL
15%
14%
12%
16%
HUL
10%
13%
16%
17%
Marico
11%
17%
29%
23%
Nestle
9%
15%
4%
19%
FY13-15
FY15-18
FY13-15
FY15-18
Pidilite Inds Ltd
17%
17%
10%
23%
TTK Prestige Ltd
2%
21%
-10%
33%
Jubilant Foodworks
22%
27%
-3%
36%
Berger Paints
15%
17%
15%
26%
Asian Paints
15%
19%
12%
26%
Bata India
22%
10%
13%
21%
Page Inds
33%
32%
36%
35%
Consumer Discretionary
Company
Despite an expected demand revival, we retain our
SELL stance on most companies
We have used a DCF-based approach towards valuing all the covered stocks in the
consumer sector. This approach also differentiates the longevity of growth rates of the
firms on the basis of the following parameters: (a) longevity of category growth rates;
(b) position of the company on a competitive advantage framework; (c) key man risk
in the senior management team; (d) potential to leverage on the existing portfolio to
enter into new categories in the future; and (e) diversification of the product portfolio.
Although we expect both rural as well as urban growth rates to remain robust in the
long term, we currently have a SELL stance on most stocks under coverage (with the
exception of Page, TTK Prestige and Marico) due to a combination of one or more of
the following factors: (a) current rich valuations more than adequately factor in the
growth revival; (b) lack of sustainable competitive advantages amidst high competitive
intensity for some firms in a few categories will constrain market share gains (unlike
what could have been achieved in the past by the same firm); and (c) penetration
saturation in certain categories (like soaps and detergents, hair oil and oral care) will
result in a moderation in growth rates vs what has been achieved over the past
decade.
February 24, 2015
Page 19
Economy & Strategy
Exhibit 32: Consumer valuation summary
Company Name
CMP
Mcap
(`)
($mn)
Stance
Target
Upside/
Price Downside
P/E
FY16E
EV/EBITDA
ROCE (%)
Implied P/E
FY17E FY16E FY17E FY16E FY17E FY16E
FY17E
EPS
Growth
Rev
growth
FY14-17 FY14-17
Consumer Staples
HUL
Nestle
Dabur
892
30,625 SELL
700
-22%
40.8
35.9
31.0
26.7 84.3% 76.4%
32.0
28.2
15%
12%
7,052
9,643 SELL
5,600
-21%
49.0
41.6
25.6
22.1 47.1% 61.5%
38.9
33.0
14%
13%
272
7,525 SELL
200
-27%
37.4
32.0
27.6
23.3 31.1% 31.4%
27.5
23.5
17%
12%
Godrej Consumer
1,190
6,422 SELL
750
-37%
41.2
36.0
17.4
15.0 18.4% 19.8%
26.0
22.7
14%
13%
GSK Consumer
5,800
3,813 SELL
4,950
-15%
34.8
30.5
26.2
22.3 33.9% 34.0%
29.7
26.0
14%
13%
Colgate
1,905
4,112 SELL
1,480
-22%
37.6
32.0
25.5
21.6 83.9% 83.2%
29.2
24.9
19%
13%
360
2%
29.1
24.3
20.2
16.8 39.9% 43.8%
29.6
24.6
25%
18%
Marico
Britannia
Median
Consumer
Discretionary
Pidilite Inds Ltd
355
2,025
3,635
UR
3,038 SELL
1,480
-27%
37.6
32.4
23.0
19.5 45.0% 43.7%
27.5
23.7
24%
16%
-22%
37.6
32.2
25.6
21.8 42.4% 43.7%
29.4
24.8
16%
13%
575
4,678 SELL
370
-36%
43.9
36.1
29.8
24.9 26.2% 26.8%
28.3
23.3
22%
17%
TTK Prestige Ltd
3,460
639 BUY
3,907
13%
25.4
19.9
16.9
13.4 26.0% 31.9%
28.7
22.4
26%
16%
Jubilant Foodworks
1,626
1,689 SELL
928
-43%
66.6
48.9
28.9
21.6 20.0% 22.7%
38.0
27.9
23%
25%
214
2,355 SELL
157
-27%
38.1
31.3
22.7
19.7 20.0% 21.2%
28.0
23.0
24%
16%
Berger Paints
Asian Paints
825
12,568 SELL
649
-21%
40.6
33.9
26.1
21.8 35.3% 36.0%
31.9
26.7
19%
17%
Bata India
1,255
1,280 SELL
1,174
-6%
36.3
26.6
22.7
17.3 21.0% 24.8%
34.0
24.9
15%
14%
Page Inds
11,768
2,083 BUY
13,000
10%
45.2
34.1
29.8
22.5 48.8% 51.7%
49.9
37.6
36%
32%
-21.3%
40.6
33.9
26.1
21.6 26.0% 26.8%
31.9
24.9
23%
17%
Median
Stock implications
Top BUY recommendations
Page Industries, TP `13,000, 10% upside, Mcap US$2.1bn

Sustainable demand momentum for Page in the future will be supported by: (a)
macro tailwinds resulting from low penetration, low ticket size and high utility; (b)
expansion of distribution network and product portfolio; and (c) market share
gains through an aspirational brand recall.

Page’s new product launches will utilise the company’s efficient manufacturing,
wide distribution and strong aspirational brand, which will propel revenue growth
further (~32% in FY15-18E vs 35% in FY10-15). Its recently initiated IT
investments should address the inefficiencies in its distribution channel and hence
support scalability across product segments and SKUs.

Competitive threats to Page’s leadership are low (in a large growing opportunity),
due to: (a) Rupa’s/Maxwell’s lack of control on distribution and manufacturing
with poor aspirational connect; and (b) hurdles for international brands like FCUK,
CK, USPA and Hanes to build a strong distribution network beyond modern retail
into hosiery stores.

Our implied valuation of 50x FY16E EPS (TP of `13,000) factors in the longevity of
the growth momentum from low macro penetration, further market share gains,
and several unexplored sub-segments in the women’s category. Page’s exemplary
financials (healthy EPS growth of 36% and RoCE of ~47% in FY14-17E) justify a
25% premium to quality consumer peers. Page Industries currently trades at 45x/
34x FY16/FY17 EPS.
February 24, 2015
Page 20
Economy & Strategy
Top SELL recommendations
Godrej Consumer, TP `750, ~33% downside, Mcap US$5.9bn

Slowdown in domestic soaps category due to intense MNC competition and
saturating market share in household insecticides are likely to help it deliver only
12.4% domestic business revenue CAGR over FY14-18E.

Moderation of growth in Indonesia due to saturation in key categories and
integration issues in Africa are likely to result in only ~14% revenue CAGR over
FY14-18E in GCPL’s international business, which has seen its RoCEs drop from
14% in FY08 to 7% in FY14.

The stock is trading at expensive valuations of 38.7/33.8x FY16/17E EPS with
sales CAGR and EPS CAGR of only 16% over FY15-18E and RoCE of less than 20%
over FY15-18E.
HUL, TP `700, 18% downside, Mcap US$31.7bn

HUL’s Soaps & Detergents (S&D) portfolio (~50% of sales) faces intense
competitive pressure from organised and unorganised peers in a soft input cost
environment, and hence price-led growth for this part of the portfolio will be
minimal to zero in the near term. (Note that the company took 5% price cuts on
S&D in December 2014). Also, uncertainty around urban demand recovery should
keep the demand for HUL’s personal care products such as skin and hair care
(~20% of sales) muted for the next 2-3 quarters.

Over the long term, HUL faces very high penetration levels in S&D and Tea (~60%
of sales) and high competitive intensity in oral care (5% of sales) from Colgate and
in premium skin care categories from L’Oreal. Consequently, we expect HUL’s
overall volume growth rates to remain subdued (5-6% CAGR over FY14-18E).

After the recent ~20% rally in the share price, the stock currently trades at
41.6x/36.6x FY16/17E EPS with sales/EPS CAGR of 13%/16% over FY15-18E.
These rich valuations more than adequately factor in the inherent strengths of the
business and the benefits from a soft input cost environment
Jubilant Foodworks, TP `928, 43% downside, mcap US$1.7bn

Jubilant’s SSG faces pressure from: (a) 35-40% price hikes over the past 20
months amidst price elastic demand; (b) high competitive intensity; and (c) store
splits in tier-1 cities. A revival in discretionary consumer demand will be partly
offset by these headwinds.

Two comments by the management in the 3QFY15 conference call support our
thesis on Jubilant Foodworks: (a) the improvement in SSG was ‘Cosmetic’ i.e. on
account of a favourable base effect and the company does NOT see any
meaningful revival in the consumer sentiment as yet, and (b) the management
reiterated that it will take the firm at least 3-6 more quarters before it reaches
high single-digit SSG, which is slightly more pessimistic We expect SSG of 4%/10%
in 4QFY15/FY16, resulting in revenue CAGR of 25% over FY14-17E.

Operating leverage benefits will accrue to EBITDA margins only once SSG for the
firm exceeds 10-11%. Moreover, we expect a ~150bps EBITDA margin drag from
Dunkin Donuts to continue for another three years (which the management
confirmed on the call). As a result, we forecast 350bps EBITDA margin expansion
to 16.4% over FY15-19E.
The stock currently trades at 66x FY16 P/E with 22% FY14-17 EPS CAGR and 22%
RoCE. Jubilant’s key profitability metrics (EPS CAGR and RoCE) and its competitive
advantages compare unfavourably against other higher-quality discretionary
consumption plays such as Page, Bata and Asian Paints, which trade at a 40%
discount to Jubilant’s P/E multiple.
February 24, 2015
Page 21
Economy & Strategy
Automobiles
Demand trends deteriorating in recent months
Ashvin Shetty, CFA, [email protected], +91 22 3043 3285
Whilst rural prosperity has aided auto volume growth in recent years
(domestic 2W sales recorded a CAGR of 8% and Maruti’s rural sales witnessed
a CAGR of 14% over FY11-14), a moderation in rural income and prosperity
may negatively impact rural demand. However, we believe this negative
impact would be offset to some extent by the moderating cost of ownership
helped by declining fuel prices and falling interest rates. We believe the
impact would be higher on PVs and SUVs (given the high ticket size) as
compared to 2Ws. We expect Mahindra & Mahindra to be the most impacted
followed by Maruti Suzuki to a smaller extent. Whilst we believe the impact
would be muted on 2Ws (being relatively small ticket size items), we remain
concerned of the rising competitive intensity in and high penetration of 2Ws
in rural India.
The domestic PV industry’s volumes, after witnessing a YoY growth of 8% in 2QFY15,
have been deteriorating in recent months. The industry volume growth moderated in
3QFY15 to 3% YoY and remained at similar levels in January 2015. The fall has been
steep for the utility vehicles segment, with 3QFY15 volumes declining 6% YoY (vs 22%
YoY growth in 2QFY15). Similarly, motorcycle volumes grew strongly until September
2014 (19% YoY growth in September 2014), post which there has been a significant
moderation, with volumes declining 6% YoY in January 2015.
-5%
1QFY14
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
-10%
Domestic motorcycle industry ('000s)
YoY growth - RHS
Source: SIAM, Company, Ambit Capital research
PV YoY growth
3QFY15
0%
2QFY15
5%
1QFY15
10%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
4QFY14
15%
3QFY14
2,850
2,800
2,750
2,700
2,650
2,600
2,550
2,500
2,450
2,400
Exhibit 34: …so has been the case with passenger vehicles,
especially utility vehicles
2QFY14
Exhibit 33: Motorcycle volumes have declined significantly
in 3QFY15…
UV YoY growth
Source: SIAM, Company, Ambit Capital research
Over the past five years (FY09-14), the domestic motorcycle industry has recorded a
CAGR of 12%, whereas the domestic passenger vehicle industry has recorded a CAGR
of 10%. The growth in passenger vehicle category is mainly driven by strong CAGR
(18%) in the SUV segment. However, in 9MFY15, SUV volumes have increased only
6% YoY whilst motorcycle volumes have witnessed a 5% YoY growth. This is
significantly lower than the average CAGR recorded by these vehicle categories over
the past five years (FY09-14).
February 24, 2015
Page 22
Economy & Strategy
Exhibit 35: 9MFY15 YoY growth for motorcycle and SUVs is significantly lower than the average CAGR over FY09-14
Domestic UV industry ('000s)
Domestic passenger car industry ('000s)
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
4QFY13
3QFY13
2QFY13
1QFY13
4QFY12
3QFY12
2QFY12
1QFY12
4QFY11
3QFY11
2QFY11
1QFY11
4QFY10
75%
65%
55%
45%
35%
25%
15%
5%
-5%
-15%
-25%
Domestic motorcycle industry ('000s)
Source: SIAM, Ambit Capital research
major
surprises/
The 3QFY15 results for the major PV and 2W companies (Maruti Suzuki, Bajaj Auto,
Hero MotoCorp and TVS Motor) were a mixed bag. Whilst the aggregate revenue
growth for the four companies was broadly in line with our expectations, the EBITDA
margin performance was marginally lower than our expectations. The YoY revenue
growth decelerated in 3QFY15 (reflecting the underlying volume trends) vs 2QFY15.
The revenue growth for these four companies was 11% YoY vs a 19% YoY growth in
2QFY15.
The aggregate gross margin (calculated as aggregate gross profit of all four
companies divided by their aggregate revenues) improved from 29.0% in 2QFY15 to
29.7% in 3QFY15. This is largely attributable to the softening of commodity prices and
change in product mix. The gross margin for all the companies exceeded our
expectations except for Hero MotoCorp whose gross margin remained flat QoQ and
was ~60bps lower than our expectations.
The EBITDA margin for Bajaj Auto and TVS Motor exceeded our expectations driven by
higher export realisations (for Bajaj Auto) and operating leverage benefits (for TVS
Motor). However, EBITDA margin for Hero MotoCorp and Maruti Suzuki were lower
than our expectations due to higher operating expenses and one-time events. The
aggregate EBITDA margin (calculated as aggregate EBITDA of all four the companies
divided by their aggregate revenues) declined from 13.9% in 2QFY15 to 13.7% in
3QFY15.
24%
19%
20%
16%
12%
11%
12%
8%
4%
2%
1QFY15
2QFY15
3QFY15
Revenue YoY growth
February 24, 2015
2%
90
48
1%
(60)
(212)
2%
77
(29)
TVS
0%
6
10
Total
1%
39
(53)
Source: Company,
research
Ambit
Capital
15.0%
14.6%
14.2%
13.8%
13.4%
13.0%
Gross margin
Source: SIAM, Company, Ambit Capital research; Note: We have considered
standalone financials for Maruti Suzuki, Bajaj Auto, Hero MotoCorp and TVS
Motor Company
Bajaj
Hero
MotoCorp
Maruti
31.0%
30.5%
30.0%
29.5%
29.0%
28.5%
28.0%
27.5%
27.0%
0%
4QFY14
Divergen
Gross EBITDA
ce vs
Revenue margin margin
Ambit
(bps)
(bps)
Exhibit 37: Whilst gross margins improved, EBITDA margin
deteriorated in 3QFY15
3QFY14
in 3QFY15 as
2QFY14
Exhibit 36: Revenue growth moderated
compared to 1HFY15
Revenues were in line whilst
EBITDA margin was marginally
lower than expectations
3QFY15
No
2QFY15
–
1QFY15
roundup
4QFY14
3QFY15 results
disappointments
EBITDA margin - RHS
Source: SIAM, Company, Ambit Capital research; Note: We have considered
standalone financials for Maruti Suzuki, Bajaj Auto, Hero MotoCorp and TVS
Motor Company
Page 23
Economy & Strategy
Management commentaries – More negatives than positives on demand
An analysis of the 3QFY15 results commentaries and our recent management
discussions pertaining to demand indicate that most auto manufacturers/auto
financiers are witnessing subdued demand (see the exhibit below).
Exhibit 38: Recent management commentaries on demand
Company
3QFY15 – Management commentary
Maruti Suzuki
“Rural continues to record healthy growth.”
“Not seen any significant slowdown in the rural demand on the automotive segment. Bolero continues to do
well. However, tractor sales have been impacted by lower farm income and monsoons. Expect another 6
months for tractor sales to pick up.“
“Rains have been reasonably good, even though a little bit untimely. Will have to wait for a couple of
months to see how the harvesting would be. January was a bit slow. Hoping that things will improve in
February and March.”
“Demand in the rural belts has been impacted as the crops have not been too good. With the marriage
season starting in March, expect demand to pick up.”
Mahindra & Mahindra
TVS Motor
Hero MotoCorp*
Vehicle financiers
“So far the rural balance sheet is doing much better on credit quality. This is driven by growth in better
performing areas like Maharashtra and Gujarat. Entering into Karnataka which is again better performing.”
“Whilst there are higher delinquencies in the tractor business due to rural economic slowdown in the last 4-5
Magma Fincorp
quarters, given the higher risk rates, it is one of the more-profitable product-lines. The outlook is positive
and continues to remain positive going into the future.”
“Rural economy continues to remain under pressure. Below average monsoon has put pressure on the
Mahindra & Mahindra Financial Services
yields.”
Source: Company. Note: * As per our discussions with the company.
Bajaj Finance
On-the-ground checks corroborate subdued demand
trends
We carried out a round of dealer checks across 2Ws and PVs categories to
understand: (a) how the demand is panning out in the new calendar year; (b) the
demand outlook; (c) the dealer inventory levels; and (d) the trends in
incentives/discounts.
Exhibit 39: Our dealer survey points towards subdued demand
Domestic PVs
Current demand trends
Promotions and incentives
Inventory levels
Near-term outlook
Market share trends
Domestic 2Ws
0-5% YoY decline in sales. Demand is subdued due to
Around 5% YoY growth seen in sales. January sales have
increase in prices (owing to excise duty benefit rollback).
been impacted to some extent by price hikes to compensate
Demand in most rural areas impacted by monsoon and
for the excise duty benefit rollback.
lower crop prices.
Discounts on Maruti’s petrol cars, however, came down as
compared to December 2014.
Average cash discounts on popular petrol models: Alto and
Wagon R – `25k; no discounts offered on Swift petrol
models.
No discounts/promotional schemes.
Average discount on popular diesel models: Swift - `20k;
Dzire – `10k; Ertiga – `15k; Bolero - `35k; Scorpio - `15k
and XUV5OO - `12k.
Exchange bonuses offered by all manufacturers on all
models at most dealers.
Inventory levels are at an average level of around 4-5
Inventory at average levels of 4-5 weeks.
weeks.
Demand likely to remain at similar levels for some time.
Demand to improve only post April due to marriage season
Pickup expected only after April driven by lower fuel prices
and income from crop harvest.
and income from crop harvest.
Maruti continues to outperform peers and retains its
leadership on the back of strong response to new launches
(Celerio, Ciaz) and demand shift towards petrol variants.
Honda (due to its scooter leadership) and TVS (due to
M&M continues to face tough environment with demand
successful response to launches) have been able to clock
due to: (a) weak demand for UVs as compared to other
better than industry sales growth.
passenger cars; (b) diesel-dominated portfolio; and (c)
market share loss in UVs to competitors accentuated by lack
of new launches.
Source: Dealer checks
February 24, 2015
Page 24
Economy & Strategy




Subdued demand trend: Dealers highlighted that the demand for PVs and
motorcycles across India has slowed down. The demand in rural areas has been
particularly impacted by the weak monsoon and lower crop prices. Most dealers
expect demand to remain at similar levels, with a pick up likely only after April
driven by lower fuel prices and higher income from crop harvest.
Inventory levels back to normal: Dealers of both PVs and 2Ws indicate that
inventory levels are close to the normalised levels. Dealers highlighted that
inventory levels were above average in December 2014 in anticipation of the
rollback of the excise duty benefit wef January 2015. However, with many
manufacturers observing plant maintenance shutdowns in January and with
subdued despatches, the inventory levels for both PVs and 2Ws are back to
normal.
Discount levels have moderated: In the PV space, discounts have come down
as compared to December 2014. Average cash discounts on popular petrol
models are: Alto and Wagon R – `25k (vs `32k in December); no discounts
offered on Swift petrol model (vs `5k in December). Average discount on popular
diesel models are: Swift - `20k (vs `5k); Dzire – `10k (vs `5k); Ertiga – `15k (vs
`10k); Bolero - `35k; Scorpio - `15k and XUV5OO - `12k.
Maruti, TVS and HMSI continue to outpace peers: In the PV space, Maruti has
been able to outperform the industry mainly on the back of the success of its new
launches (Celerio and Ciaz) and the demand shift in favour of petrol variants.
M&M, on the other hand, has been losing market share (154bps YoY in AprilJanuary 2015) due to lack of new launches and a diesel-dominated portfolio. In
the case of 2Ws, Honda Motorcycle and Scooters India (HMSI) and TVS have been
able to garner market share driven by a strong scooter portfolio and a spate of
successful launches.
Current demand for PVs and
2Ws is subdued
Maruti,
TVS,
and
HMSI
continue to outpace their peers
Where do we go from here?
Rural prosperity has aided vehicle growth in recent years…
During the last 2-3 years, the demand for motorcycles and passenger vehicles in the
urban markets were impacted by high inflation, surging interest rates and the general
economic slowdown (impacting consumer sentiment). At the same time, however,
demand remained buoyant in the rural markets. Whilst Maruti’s overall volumes
recorded a negative CAGR of 2% over FY11-14, its rural sales saw a healthy 14%
CAGR over the same period. Similarly, rural sales helped the domestic two-wheeler
(2W) industry (including mopeds) to post a volume CAGR of 8% over FY11-14.
Exhibit 40: Maruti’s rural sales have outpaced urban sales
in recent years
Exhibit 41: Higher exposure to rural areas helped 2Ws
outperform PV sales in recent years
70%
33%
60%
50%
31%
29%
40%
30%
20%
27%
25%
23%
20%
10%
0%
21%
19%
5%
-10%
-20%
17%
15%
-5%
FY11
FY12
FY13
FY14
30%
25%
15%
10%
0%
-10%
FY11
Urban YoY growth - LHS
Rural YoY growth - LHS
Rural sales as % of total domestic sales
February 24, 2015
FY12
2W YoY growth
FY13
FY14
PV YoY growth
Source: SIAM, Ambit Capital research
Page 25
Economy & Strategy
Our discussions with the dealers and managements of auto companies indicated that
the higher pace of growth in the rural areas was attributable to increasing rural
prosperity. This improvement in income levels in rural India in recent years was driven
by higher minimum support prices (MSPs), increased government spending in rural
areas such as that under the MNREGA scheme and increasing real estate prices in
rural areas. Furthermore, automobile sales in rural areas were also driven by
relatively lower penetration levels. These factors helped rural India overcome the
negative impact of the overall general economic slowdown and contribute significantly
to vehicle sales growth.
A moderation in rural income levels may impact rural demand, offset
to some extent by declining cost of ownership
Our channel checks and our macro team (please refer to the thematic portion) now
suggest a likely moderation in rural income due to: (a) sub-par South-West monsoons
in FY15; (b) slowdown in Government spending on rural India; (c) moderation in
prices agricultural commodities globally; and (d) clear slowdown in rural wage
inflation. We believe this could have a negative impact on vehicle demand in rural
areas. We, however, expect the negative impact to be offset to some extent by lower
cost of ownership on the back of declining fuel prices and moderating interest rates.
Passenger vehicles sales in rural India to be impacted more than
motorcycles sales…
We expect moderation in rural income/wealth to have a higher impact on the sales of
big-ticket items like passenger cars and sports utility vehicles (SUVs). We expect the
impact to be somewhat muted on the two-wheeler space on account of its low-ticket
size and it being a pre-dominant mode of transport in rural areas. We expect
Mahindra & Mahindra (M&M) to be most impacted and Maruti Suzuki to be impacted
by a smaller extent on account of moderation in rural demand for passenger vehicles.
…however, we remain concerned of rising
penetration levels of motorcycles in rural India
competition/high
Whilst we expect the impact of moderation of rural income/prosperity to be somewhat
muted for the 2W industry (which has ~40% of sales coming from rural sales), we
remain concerned of the rising competitive intensity in the domestic 2W space as well
as increasing penetration levels of motorcycles in rural India.
Increasing competitive intensity in domestic 2Ws, with Honda’s aggression and rapid
scooterisation are likely to impact the domestic 2W market share of incumbents like
Hero and Bajaj Auto. Overall, we expect Hero and Bajaj to lose a market share of
about 421bps (to 39.2%) and 327bps (to 11.6%) in domestic 2Ws (ex-mopeds) over
FY14-17.
Exhibit 42: Sector comparative valuation
Mcap
US$ mn
EV/EBITDA (x)
FY15
P/E (x)
FY16
FY17
FY15
FY16
CAGR (FY14-17)
FY17
Sales EBITDA
Price perf (%)
EPS
3m
RoE
1 yr
FY15
FY16
FY17
Tata Motors*
28,017
5.4
4.9
4.5
12.8
11.0
9.9
14
18
22
10
49
25
23
22
Maruti Suzuki
17,311
15.5
11.7
9.4
29.7
21.1
16.0
18
25
34
7
110
16
19
21
M&M
12,262
16.5
13.9
11.7
22.1
18.6
15.9
10
12
7
(1)
30
18
19
20
Bajaj Auto
10,421
12.7
10.9
9.7
19.0
16.1
14.3
14
13
12
(16)
23
32
33
32
8,550
13.7
11.2
9.6
19.6
15.7
13.4
13
14
24
(11)
37
43
45
44
Eicher Motors
7,384
40.4
24.1
16.0
68.5
41.0
27.9
33
58
61
15
246
29
37
39
Ashok Leyland
3,166
24.6
14.8
10.8
NA
28.0
16.9
26
133
NA
31
342
3
14
20
TVS
2,304
22.9
15.9
11.8
39.2
25.0
17.9
23
38
45
27
264
24
30
32
18.9
13.4
10.4
30.1
22.1
16.5
Hero Motocorp
Average
Source: Bloomberg, Ambit Capital research. Note: Proforma figures are arrived at by adjusting EBITDA/PAT for normalised R&D spends (by expensing 70% of R&D
costs instead of current 20%).
February 24, 2015
Page 26
Economy & Strategy
Stock implications
Mahindra & Mahindra (MM IN, Mcap US$11.3bn, Not Rated)
We believe the impact of moderation in rural demand for passenger vehicles would
have the most impact on M&M. This is because its Bolero and Scorpio models which
are essentially sold in rural areas constituted nearly 67% of M&M’s total passenger
vehicle volumes in 9MFY15. There are already signs of demand stress in these
models, with their aggregate sales declining 4% in 9MFY15. Besides moderation in
rural demand, M&M also faces the following challenges: (i) Increasing competition in
the utility vehicle space with a number of recent and planned launches from the
competition. M&M’s market share in the domestic UV space has come down from
47.7% in FY13 to 41.7% in FY14 and further to 36.9% in 9MFY15; and (ii) the
narrowing gap between the diesel and petrol prices (from 31% in August 2012 to 19%
currently) is resulting in shift away from diesel vehicles to petrol vehicles. M&M with its
diesel-dominated portfolio is getting negatively impacted by this shift.
Maruti (MSIL IN, Mcap US16.8bn, SELL, TP `3,100, 13% downside) – Urban
dominance and shift to petrol cars saves the day
Rural areas contributed close to 32% of Maruti Suzuki’s sales in FY14 and recorded
14% volume CAGR over FY11-14. Whilst we believe Maruti would be impacted by the
moderation in rural demand, the impact would be offset to a significant extent by the
following factors: (i) the narrowing gap between the diesel and petrol prices (from
31% in August 2012 to 19% currently) is resulting in a shift away from diesel vehicles
to petrol vehicles; Maruti, with a strong portfolio of petrol cars is well positioned to
benefit from this shift, and (ii) An uptick in the demand for passenger vehicles in the
urban markets (constituting nearly 68% of Maruti’s sales) on the back of moderating
cost of ownership can help offset the weakness in rural demand.
We expect Maruti Suzuki to deliver a healthy 15% volume CAGR over FY15-17.
Similarly, we expect Yen depreciation relative to INR to help EBITDA margins improve
from 12.0% in 1HFY15 to 13.7% in 2HFY15 and further to 14.2% in FY16/FY17.
However, the declining diesel mix and high discounts are likely to disappoint most
consensus margin upgrades (average 15-15.5% for FY16/FY17). Furthermore, the
stock is currently trading at 17.2x FY17 earnings vs the historical average of 15.0x,
which looks expensive.
Hero MotoCorp (HMCL IN, Mcap US8.8bn, SELL, TP `2,650, 4% downside): Hero
has been able to hold on to its market share in domestic motorcycles in the last 18
months on the strength of its strong distribution network in rural areas. However, with
Honda fast spreading its reach in the interiors of India, we believe Hero is highly
susceptible to market share loss (our expectation of 276bps in FY14-17). Further, lack
of a credible scooters portfolio (scooters contribute to only ~11% of volumes) and
rising scooterisation in W industry (from 26% in FY14 to 31% in FY17) would adversely
affect its overall domestic 2W market share. Whilst we factor in strong export volume
growth on a low base, we believe this is insufficient to mitigate the domestic market
share loss.
Rising competitive intensity in the domestic 2W market, costs required to set-up a
brand and distribution network in the exports market, and the deteriorating product
mix (rising share of scooters and lower cc models) will restrict significant EBITDA
margin expansion. We expect Hero’s margin to increase by just 40bps in FY14-17,
much lower than the management’s target (~300bps). The stock is trading at 15x
FY17 EPS; falling market share and the resultant poor EPS growth would drag
multiples lower; our 12-month TP of `2,650 implies exit 14x FY17 EPS.
February 24, 2015
Page 27
Economy & Strategy
Cement
Demand deceleration across segments in 3QFY15
Nitin Bhasin, [email protected], +91 22 3043 3241
Moderation in retail/rural demand, amid persistent weakness in institutional
demand, curtailed cement industry’s growth in 3QFY15. Demand remains
weak in 4Q and price hikes led by production cuts have been rolled back.
Rural housing forms 40% of the overall cement demand in India, which is
suffering owing to poor farm output and moderation in rural wages.
Moreover, unwinding of the ‘rural wealth effect’ has impacted housing growth
in Tier 3/4 towns. Large-cap cement companies’ valuations remain lofty (3550% premium to the five-year average) and we prefer efficiently run midcaps available at reasonable valuations such as Orient Cement.
Cement - Infra holds the key now that the momentary
blip in rural housing is behind us
After several quarters of muted demand growth, cement demand grew sharply during
2QFY12-1QFY13 as retail demand grew sharply, owing to a sharp increase in
housing construction in both rural markets and tier II/III cities. The subsequent
deceleration in 2QFY13 was primarily due to the slowdown in infrastructure
construction (both public and private capex). However, rural/retail demand continued
to post strong growth rates which helped sustain mid- to single-digit volume growth
for the industry.
Quote from ACC’s Chief commercial officer on rural demand in 2010: “The
demand in the rural markets of North and East increased due to a very good harvest
and remunerative minimum support prices (MSP) announced by the Government. The
disposable funds available in the hands of the farmers were partly used for meeting
their basic needs such as housing and the balance was put aside in the form of savings
to meet their future needs”.
Lately, cement volume grew by ~8% in 1HFY15 (after several quarters of volume
growth at 3-5%). Industry participants highlight that the strong growth in 1H was
supported by the delayed monsoons and pick-up in retail demand after the General
Elections (due to improvement in consumer sentiment). However, volume growth
decelerated to 4% in 3Q, due to weakness in institutional sales and moderation in
housing construction in Tier 2/3 and rural cities. We highlight that cement
consumption in large retail markets such as south India declined sharply (evident from
Ramco Cement’s volume decline of 10% YoY for the second-consecutive quarter).
Strong growth in rural demand
supported industry growth rates
in the last 3-4 years
Moderation in rural demand
growth amid persistent weakness
in institutional demand leading to
deceleration in demand growth
Quote from Shree Cement’s Whole-time director, Mr Prashant Bangur in
February 2015: The dispatch scenario is very gloomy. The January-March quarter is
generally a good quarter, but not this time. Pricing is weak, specifically in north India.
Exhibit 43: Rural/retail demand kept industry volume growth (YoY) positive despite macro adversities
Tapering growth rates - sharp decline
in infrastructure construction,
moderate retail demand growth
9.3%
7.9%
7.0%
2.1%
3.8%
9.8% 9.2% 10.1%
Significant drop in
infrastructure, yet strong
retail demand kept growth
rates in mid-single digits
8.5% 8.0%
4.9% 5.7% 5.7% 4.8%
5.6%
4.9%
Pick-up in 1H driven by postelection positive sentiment,
subsequent deceleration due to
low retail demand
2.7%
4.4%
3.5%
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
4QFY13
3QFY13
2QFY13
1QFY13
4QFY12
3QFY12
2QFY12
1QFY12
4QFY11
3QFY11
2QFY11
1QFY11
0.1%
4QFY10
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
Strong retail demand growth
led to high single-digit growth
Source: Ministry of Statistics and Programme Implementation (MOSPI), Ambit Capital research; Note: MOSPI data is not the most representative but given lack of
other sources we use MOSPI data; cumulative volume of top-10 companies also shows a similar trend
February 24, 2015
Page 28
Economy & Strategy
Whilst cement prices surged in 1H (10-15% increase across India with the maximum
hikes in south and west India), this was supported by production cuts (15 days/month
of production holidays in Andhra Pradesh). However, prices fell subsequently in 3Q,
as demand growth tapered. Prices were hiked sharply again in January 2015, but
companies highlight that these have been rolled back in certain regions such as west
India (primarily Gujarat), north India and certain pockets of east India (Jharkhand and
Bihar), due to an insignificant improvement in demand.
A Delhi-based dealer on cement prices: “In January, cement manufacturers
increased prices by almost `.30 per cement bag; however most of this was rolled back
in February”.
Price hikes being rolled back
owing to weak demand
An Indore-based dealer on cement prices: “For Indore prices in January were
increased by `.15 per bag, but it had to be rolled back in February due to low demand.
For the rest of Madhya Pradesh, prices were hiked by about `.10 per bag in January,
which again was rolled back in February”.
Exhibit 44: Sharp price hikes undertaken in January 2015 (supported by production cuts); companies and channel partners
indicate roll backs of price hikes due to low demand
(`/ 50kg bag)
360
340
South
320
North
300
West
280
Central
260
East
Jan-15
Nov-14
Sep-14
Jul-14
May-14
Mar-14
Jan-14
Nov-13
Sep-13
Jul-13
May-13
Mar-13
Jan-13
Nov-12
Sep-12
Jul-12
May-12
240
Source: Industry participants, Ambit Capital research
Retail-focused players grow slower than the industry
UltraTech reported volume growth of 10% in 3QFY15, out of which 6% was on
account of sales from the recently acquired Jaypee’s Gujarat unit; hence, the
company’s like-to-like growth was a mere 4%. Shree’s volume grew by 10% YoY due
to its rising market share in north India and sales in Bihar post capacity additions. The
volumes of ACC, a dominant retail player, dropped by 2% YoY and Ramco Cement’s
volumes dropped by 11% YoY, as retail demand weakened in their key markets.
Other regional players grew in mid-single digits, barring players such as OCL and
Heidelberg, which grew due to significant capacity additions. Realisation and
EBITDA/tonne for the large part of the industry grew marginally (by 2.6% and 3.3%
YoY, respectively).
February 24, 2015
Page 29
Economy & Strategy
Exhibit 45: Company-wise quarterly performance assessment
Large/pan-India
Volume (mn tonnes)
Realisation (`/tonne)
SepDecDec- SepDecDec- Sep14
13
14
14
13
14
14
19.9
19.3
20.5 4,743 4,554 4,627
795
UltraTech*
10.4
10.0
11.0 5,200
4,796
5,000
872
797
872
9.8%
4.3%
9.4%
5.6%
-3.8%
0.0%
3.9
3.4
3.7 3,656
3,468
3,618
766
702
714
10.0%
4.3%
1.7%
-4.1%
-1.0%
-6.8%
ACC
5.6
5.9
5.8 4,650
4,773
4,572
674
618
440
-1.5%
-4.2%
-28.8%
2.5%
-1.7%
-34.7%
Mid-caps
9.4
9.1
9.6 4,230
3,983
4,180
695
522
598
5.2%
4.9%
14.5%
1.9%
-1.2%
-13.9%
Orient Cement
1.0
1.0
1.0 3,740
3,499
3,740
799
510
597
5.1%
6.9%
17.1%
4.0%
0.0%
-25.3%
JK Lakshmi Cement
1.5
1.4
1.5 3,928
3,530
3,683
612
445
486
6.0%
4.3%
9.2%
3.1%
-6.2%
-20.6%
Sagar Cement
0.3
0.3
0.3 3,714
3,596
3,714
261
65
175
2.4%
3.3%
170.3%
0.0%
0.0%
-32.9%
Dalmia
1.5
1.6
1.7 4,745
4,335
4,616
798
756
702
3.1%
6.5%
-7.1%
10.0%
-2.7%
-12.0%
Ramco Cement
1.9
1.9
1.7 4,595
4,332
4,570
958
787
750
-11.3%
5.5%
-4.7%
-11.3%
-0.5%
-21.7%
OCL India
0.9
0.8
1.1 4,430
4,449
4,434
558
615
802
35.9%
-0.3%
30.3%
23.3%
0.1%
43.7%
Prism Cement
1.3
1.1
1.2 4,060
3,841
4,271
518
114
356
6.3%
11.2%
213.3%
-7.1%
5.2%
-31.3%
Particulars
Shree
Heidelberg Cement
Sector average
EBITDA (`/tonne)
YoY growth
DecDecEBITDA/
Volume Realisation
13
14
tonne
726
722
6.4%
1.6%
-0.6%
Volume
2.8%
QoQ growth
EBITDA/
Realisation
tonne
-2.4%
-9.3%
1.0
1.0
1.1 3,905
3,774
3,804
542
285
556
19%
0.8%
95.3%
5.8%
-2.6%
2.6%
29.3
28.4
30.1 4,578
4,371
4,484
763
660
682
6.0%
2.6%
3.3%
2.5%
-2.0%
-10.6%
Source: Company, Ambit Capital research; Note: *UltraTech includes sales of the acquired Jaypee Cement unit in Gujarat
Rural demand remains a secular opportunity
Rural housing accounts for ~40% of the cement demand in India, out of which ~15%
is supported by welfare initiatives such as Indira Aawas Yojana and the balance 85%
demand is supported by agricultural income and rural wages. The sharp increase in
rural income in the last 3-4 years was led by higher MSPs, higher welfare allocations
and higher rural wages, which in turn led to significant improvement in rural demand.
As per Census 2011, the rural housing count increased at a CAGR of 2.1% over FY0111; however, pucca houses grew at 4%. Nearly 50% of the houses in rural India are
still kutcha/semi-pucca and we believe that the shift would continue to drive rural
cement consumption.
Exhibit 46: Rural accounts for 40% of overall cement
consumption in India
Industrial ,
10%
Commerical,
10%
40% of cement demand comes
from rural housing
Exhibit 47: High proportion of kutcha/semi-pucca houses
Kutcha,
17.0
Rural
Housing ,
40%
Semi-Pucca,
27.6
Infrastructur
e , 15%
Pucca, 55.4
Urban
Housing,
25%
Commentary of primary data sources on demand dynamics of rural
cement/home building materials
Our checks with industry participants suggest that rural demand in the last five years
should be demarcated into two components: ‘Gradual and steady’ and ‘Aberration’.
‘Gradual and steady’: This segment primarily consists of the agri-dependent
population that constructs houses gradually (from a mud-house to concrete flooring
and concrete walls/roof in a phased manner). Demand growth from this segment has
remained steady, barring minor volatilities, depending on the farm output.
‘Aberration’: This segment constitutes the population that amassed significant wealth
(unexpectedly) due to a sharp increase in land prices (mainly in north and west India),
which enabled them to construct houses (typically outside the rural markets) and
purchase vehicles, white goods, etc. Industry experts believe that cement demand
February 24, 2015
Retail-institutional mix of top6 cement companies
Company
Retail
Institutional
UltraTech
73
27
ACC
82
18
Ambuja
80
20
Shree
65
35
Ramco
80
20
India Cement
70
Source: Company,
research
30
Ambit
Capital
Page 30
Economy & Strategy
from this customer base will moderate in the coming years. However, this should not
impact overall cement demand materially.
We highlight that the base level of the rural economy (which our Economy team
defines as the ‘lower tier’, is highly dependent on agricultural income and support
from the Government through subsidies and MSPs (a point also made by the cement
managements). Whilst the poor rainfall and low MSPs in FY15 have reduced
disposable income, our Economy team holds the view that the Government would
route all subsidies through the Direct Benefits Transfer scheme, which would facilitate
redistribution of wealth in favour of the lower tier of the rural population. Hence, we
do not see a major impediment to the long-term rural housing construction
story and expect the segment to report a 5-7% CAGR over the next 4-5 years
(in line with the historical averages).
How important are rural sales for cement companies?
Not only is rural cement consumption a large demand component, but more
importantly it provides price stability, given that rural clients (first-time/continuing
home builders) are brand-conscious and purchasers of Tier 1 brands. The large
brands have invested a significant amount on brand building and setting up
distribution in these markets. The tier-I brands usually have a strong channel influence
and hence their bargaining power in rural markets is significantly better than Tier 2/3
brands; however, the weakness in urban/institutional markets led to some of the Tier
3/4 brands investing in branding/reach in these markets.
Exhibit 48: Some of the key rural marketing initiatives of cement companies
Company
Strategy
UltraTech
The company does several educational seminars with masons and contractors. It also meets the sarpanch in the villages to establish its brand
in micro markets.
ACC
ACC Cement ventured out to establish the superiority of ACC Suraksha blended cement and to build an image of premium cement for the
brand. To reach the opinion leaders viz. architects, engineers, contractors, etc., the assistance of the regional local press was sought and
other direct marketing efforts such as field meetings with small groups of masons and customers were made.
Ambuja
Holcim hired NCAER to conduct a detailed study on the rural market of India and planned several initiatives. The company will seek
participation in government programmes as well as private housing by engaging local government, local builders and skilled manpower.
Shree
The company plans to open 2,000 new dealers in rural India over the next one year and it has set a target of 40% revenue (from 20%) from
the rural market in two years.
Ramco
Ramco appointed Percept Out of Home, Rural Vertical, as their outdoor activity partner to promote their brand, ‘Ramco,’ across south India.
Rural vertical will be carried out in three phases. In the first phase, pre-publicity activity will take place through branded mobile van units,
retail branding, in-shop branding, gate arches and other visibility mediums including signages, leaflets, danglers, posters and kiosks. In the
second phase, a ‘Mystery Shopper’ contest will be announced, and in the third phase, the Mystery Shopper’s name will be declared after a
Lucky Draw. Apart from increasing brand visibility, Percept Out of Home, Rural Vertical, will also be reaching out and motivating the dealer
network with loyalty programmes.
Binani
It is creating awareness for its cement brand in rural India. It is increasing its penetration in the rural market and villages through retail
outlets. The company is targeting villages with a population of 5,000-12,000 in the districts of Panchmahal, Dahod, Jamnagar, Porbandar,
and Junaghad in Gujarat and identifying 118 new retailers. The company will reach another 300 villages with a population of 10,000.
Our view on the sector and does it need a revisit?
We had estimated volume growth of 8%/10% for FY15/FY16 in our cement thematic,
‘How expensive can it get?’ in October 2014; we had assigned a 20-year average
multiplier of 1.2x to our Economy team’s GFCF assumption. However, given the weak
3Q and no significant improvement in 4Q, we believe that demand growth in FY15
would be 6-7% at best (vs 9MFY15 volume growth of 6%).
However, the key question is whether our FY16 estimates of a double-digit volume
growth faces downside risk? Companies believe that it would take a few quarters for
infrastructure execution to ramp-up and they remain hopeful that the budget
announcements would be followed by on-ground changes; our checks also suggest Prolonged demand weakness
that roads projects could be awarded in March/April 2015 which should be a poses a downside risk to our 10%
marginal kicker. Possible reduction in housing construction in tier-II/III/IV markets FY16 volume growth estimate
(due to the wealth effect), could be adequately offset by the Government’s impetus on
infrastructure and affordable housing; however, it hinges on the effective
February 24, 2015
Page 31
Economy & Strategy
implementation of these programmes. Whilst we retain our volume growth estimate
of 10% in FY16 for now, we might need to revisit our estimates if the implementation
of the infrastructure orders remains tepid as our key thesis for the 10% volume growth
were: (a) infrastructure/ institutional-housing pick up; and (b) revival in South India
(an otherwise declining market—earlier AP and now TN).
Pricing growth to be 7-8% at best
We factor in a price hike of 8% in FY16 for cement companies under our
coverage (assuming the recent price hikes sustain). Based on our discussions
with cement companies, further price hikes seem difficult to push in Feb/Mar 2015,
and hence we do not build in over-optimistic realisation growth assumptions with
demand stability. Note that prices have grown higher than 10% only in four out of the
last twenty years; moreover, barring FY12, in the other three years, capacity utilisation
was higher than 90%. Note that apart from FY05-08, the three-year cement price
CAGR has been 1-6% over the six three-year periods.
Exhibit 49: Cement price has grown by 1-6% for most of the three-year periods, barring FY05-08
15.3%
14.9%
10.6%
8.7%
7.6%
8.4%
9.6%
8.0%
7.3%
4.7%
8.0%
7.5%
5.9%
4.7%
4.6%
2.1%
FY95-98
5.4%
1.4%
0.9%
FY99-02
8.5%
8.0%
FY02-05
FY05-08
Cement Price CAGR
FY08-11
Cement demand CAGR
FY11-14
FY14-16E
Capacity CAGR
Source: CMA, Ambit Capital research
Exhibit 50: Prices declined due to poor demand and sharp capacity increase
30%
100%
90%
20%
Rolling 3-year cement
capacities CAGR
Rolling 3-year cement
despatches CAGR
80%
Cement price growth
70%
Annual capacity
utilisations (RHS)
10%
-10%
FY16E
FY15E
FY14
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
FY04
FY03
FY02
FY01
FY00
FY99
FY98
FY97
FY96
0%
60%
50%
Source: CMA, Ambit Capital research
February 24, 2015
Page 32
Economy & Strategy
Valuations building in unreasonable hope
Despite the unexciting 3QFY15 earnings, cement stocks remain expensive given the
hope of strong demand and pricing growth with a recovery in cement demand. We
believe that the cement stocks are trading at extremely rich valuations, without any
significant change in the underlying fundamentals and also pricing in pricing
expectations which are unlikely to be met. The exhibit below shows that cement stocks
(represented by the blended valuations of the top-5 companies) are trading at peak
multiples (across the last two cycles), i.e. a 63% premium to the ten-year average.
Whilst we understand that the earnings multiple looks expensive at the cusp of a
cyclical recovery (margins and RoCE bottoming out), we do not think that the current
multiples are justified by the growth expectations and RoCEs (we believe that RoCEs
would remain at nearly half of the peak levels of FY05-08 in FY15-18).
Stocks trading at peak valuations
and results disappointments have
not dampened the hope for a
strong demand and pricing
revival
We highlight that multiple times in the last 2-3 quarters, cement companies have
missed consensus earnings expectations significantly, which is yet to be seen in the
stock price (for instance, ACC reported the lowest unitary EBITDA in the last 17
quarters alongside a volume decline of 2% YoY). Investors believe that the near-term
disappointments will be adequately offset by the strong growth expectations but how
much more than 10% that we are already building in; general argument around
demand growth from Infrastructure/ institutional activity should be considered in the
light of the fact that this is a brand-agnostic/bargain seeking demand. We believe
earnings disappointments for a few more quarters could de-rate these expensive
stocks significantly.
Exhibit 51: Cement stocks are trading at all-time peak EV/EBITDA multiples…
(%)
(X)
40
16
14
12
10
8
6
4
2
35
30
25
20
One-yr fwd EV/EBITDA
Jan-15
Sep-14
May-14
Jan-14
Sep-13
May-13
Jan-13
Sep-12
May-12
Jan-12
Sep-11
May-11
Jan-11
Sep-10
May-10
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
Sep-07
May-07
Jan-07
Sep-06
May-06
Jan-06
Sep-05
May-05
Jan-05
Sep-04
15
EBITDA margin
Source: Ambit Capital research, Company, Bloomberg. Note: The chart includes UltraTech, Ambuja, ACC, Shree and Ramco Cement
Exhibit 52: …despite the materially lower margins and RoCEs
One-yr fwd EV/EBITDA
Jan-15
Sep-14
May-14
Jan-14
Sep-13
May-13
Jan-13
Sep-12
May-12
Jan-12
Sep-11
May-11
Jan-11
Sep-10
May-10
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
Sep-07
May-07
Jan-07
Sep-06
May-06
Jan-06
Sep-05
May-05
Jan-05
(%)
40
35
30
25
20
15
10
5
Sep-04
(X)
16
14
12
10
8
6
4
2
ROCE
Source: Ambit Capital research, Company, Bloomberg. Note: The chart includes UltraTech, Ambuja, ACC, Shree and Ramco Cement
February 24, 2015
Page 33
Economy & Strategy
Relative valuation
Large-cap cement companies continue to trade at a significant premium to mid-cap
peers, although consensus expects higher growth and RoEs for the mid-cap peers.
Whilst the valuation discount of the mid-sized peers can be explained by exposure to
one or two regions (at best) and high leverage, these factors can erode earnings
significantly in times of weak demand and poor pricing. However, we believe that
certain mid-cap peers such as Orient Cement have shown capital discipline and cost
controls and have upcoming capacities in large regions recovering from growthrestricting challenges (AP/Maharashtra). We prefer such high-quality mid-caps over
the expensive large-cap space.
Exhibit 53: Relative valuation summary
Capacity
Advt
6m
Mcap
Rating
(mn tonnes)
(` bn)
FY15 FY16 FY17
US$
mn
EV/EBITDA
P/E
EV/tonne
CAGR (FY15-17)
(x)
(x)
US$
(%)
US$
mn FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 Sales EBITDA
ROE
(%)
EPS FY16 FY17
Large cap
UltraTech
62.0
67.0
72.0 SELL
808 13,468
Ambuja*
28.0
30.0
31.0 SELL
396
Grasim^
ACC*
Shree
Cement **
JPA #
Total /
Average
Mid cap
Ramco
Cements **
Jk Lakshmi
Cement
Century
Tex#
JK Cement
Prism
Cement #
Birla Corp
#
India
Cements
Total /
Average
Small Cap
Dalmia
Bharat #@
Orient
Cement
OCL India
Mangalam
Cement
Sagar
Cement
Total /
Average
NA
10.7
19.6
14.5
11.2
35
25
19
229
212
197
18
32
37
16
18
6,604
7.0
19.0
14.7
12.1
27
25
21
210
196
190
13
25
15
15
17
NA
NA
NR
340
5,670
4.8
8.9
6.7
5.3
18
13
10
NA
NA
NA
15
30
33
10
12
30.1
33.6
33.6 SELL
294
4,899
9.1
19.1
14.2
11.2
26
23
18
154
138
138
14
30
20
15
17
21.0
25.0
28.0
366
6,095
2.6
22.2
15.9
12.4
44
28
20
293
246
220
21
34
49
22
24
23.4
23.4
23.4 SELL
58
974
22.7
28.0
25.0
23.0
(12)
46
16
575
575
575
7
10
NA
1
3
164
179
188
377 6,285
9.5
19
15
13
23
27
17
292
274
264
15
27
30
13
15
12.5
13.0
14.5 SELL
76
1,274
1.2
14.3
10.7
8.5
33
20
14
130
125
112
17
30
55
14
18
9.0
10.0
11.0
NR
42
700
2.1
14.2
9.1
6.3
27
20
12
101
91
83
26
50
51
14
21
12.8
12.8
12.8
NR
47
785
8.0
14.7
10.7
NA (228)
33
NA
119
119
119
NA
NA
NA
8
NA
10.8
10.8
10.8
NR
50
834
1.1
14.5
9.5
6.8
42
20
11
113
113
113
23
45
99
13
22
8.0
8.0
8.0
NR
54
894
1.0
19.6
11.8
7.9
99
28
13
153
153
153
17
57
NA
17
28
10.5
10.5
10.5
NR
35
585
0.6
9.1
6.6
4.9
16
11
8
55
55
55
15
37
47
11
15
18.5
18.5
18.5
NR
30
504
5.4
8.2
6.4
5.7
41
13
8
59
59
59
11
20
NA
6
9
82
84
86
48
797
2.8
14
9
6.7
4
21
11
104
102
99
18
40
63
12
19
13.7
18.0
18.0
NR
36
607
0.5
16.1
8.5
6.3 (191)
26
10
92
70
70
32
60
NA
4
11
5.0
8.0
9.0 BUY
34
560
0.6
12.8
8.3
5.7
20
18
11
133
83
74
32
49
36
19
25
6.7
6.7
6.7
NR
31
522
0.3
10.2
7.7
6.0
22
14
9
89
89
89
16
30
54
17
21
3.5
3.5
3.5
NR
7
121
0.7
8.7
5.6
4.4
18
9
6
49
49
49
21
42
75
15
19
2.5
3.5
3.5
NR
6
96
0.0
17.4
6.9
4.8
114
16
10
59
42
42
35
91
NA
13
11
31
40
41
23
381
0.4
13
7
5
(3)
16
9
84
67
65
27
54
55
13
18
UR
Source: Ambit Capital research, Bloomberg, Company
February 24, 2015
Page 34
Economy & Strategy
Stock implications
TOP BUY idea - Orient Cement – TP `214; 25% upside
Orient Cement’s cost competiveness (13-14% lower cost than the industry average)
facilitated market share gains in AP and Maharashtra (9.5% in FY14 vs 7% in FY09)
despite the adverse market conditions. Post the corporate restructuring and
management revamp, Orient is adding scale—(commencement of 3mn tonne
expansion in Karnataka in 1QFY16 followed by 2-3mn tonne brownfield expansions).
With expanding geographical presence and market share gains, we estimate
21%/38%/31% volume/EBITDA/EPS CAGR over FY15-18E. The stock is trading at 8x
FY16 EBITDA, at a 15% discount to Ramco, despite higher growth/better RoCEs. The
growth levers to scale support our implied 8.2x exit FY17 EBITDA.
TOP SELL idea - Ambuja Cement – TP `208; 22% downside
Ambuja’s long-dated capacity expansion at a time when regional players aggressively
built scale has led to market share erosion in key markets like north and west India (it
has lost its leadership position to Shree Cement in north India). The company’s market
share dropped to 8.1% in CY14 vs 10.1% in CY07. Significant increase in industrywide capacities (up 40% over CY09-13) amidst Ambuja’s minimal additions (up 12%)
would lead to continued loss of market share and lower growth than industry for at
least the next two years. Holcim controls the capital allocation decisions of Ambuja
and in the last five years it has preferred to hoard cash rather than invest for growth.
With Holcim merging with Lafarge globally, the management’s bandwidth in India
might be limited and delay decision-making in India. Also, the management’s
guidance on the savings generated from ACC’s absorption appears to be overestimated. The stock is trading at 14.3x one-yr fwd EV/EBITDA, a 50% premium to its
five-year average. We find valuations expensive and despite building in a strong 31%
EBITDA CAGR in CY13-15, we expect RoCEs to remain low (14.5-15.5% vs five-year
average of 16.5%). Our target price of `208 implies 8.8x CY16 EBITDA.
February 24, 2015
Page 35
Economy & Strategy
Home building materials
Achint Bhagat, [email protected], +91 22 3043 3178
Industry participants (corporates/channel partners) highlight demand
deceleration across home improvement products such as plyboards, tiles and
pipes. Sharp reduction in liquidity with mid-to-small real estate developers
and slowdown in low-ticket semi-urban and rural housing led to weak
demand growth in 3QFY15 and we do not hear any significant improvement
in 4Q. Although industry volumes remain weak, we note that certain players
with enhanced capacities, distribution and a strengthened brand are fast
gaining market share and hence growing significantly higher than industry
average.
Tiles, ply and pipes
Limited rural exposure
Home building materials such as tiles, plyboards, and pipes have consistently reported
strong growth rates in the last decade (see Exhibit 54). For most of these categories,
the key growth driver was rising penetration in tier-II/III/IV cities alongside higher
aspirational consumption. From our channel checks and management discussions, we
understand that the rural consumption of home improvement products such as tiles
and plyboards is limited due to the low-ticket housing pattern.
Home improvement products do
not have a significant exposure to
the rural market
Exhibit 54: Home building materials reported strong revenue growth in the last
decade
FY04
FY09
`mn
`mn
Sectors
Sector growth / nominal
GDP growth (x)
FY04- FY09- FY04FY04FY09FY04`mn
09
14
14
09
14
14
FY14
Revenue CAGR
Paints
39,159
91,240
206,024
18%
18%
18%
1.2
1.2
1.2
Light electricals
55,872
121,581
251,971
17%
16%
16%
1.1
1.1
1.1
Pipes
4,613
16,434
46,993
29%
23%
26%
1.9
1.6
1.8
Tiles
8,630
21,059
46,128
20%
17%
18%
1.3
1.2
1.2
Adhesives
6,538
19,863
42,832
25%
17%
21%
1.6
1.1
1.4
Plyboards
2,899
14,862
34,597
39%
18%
28%
2.6
1.3
1.9
Sanitaryware
1,744
4,919
15,447
23%
26%
24%
1.5
1.8
1.6
119,454 289,959
643,992
19%
17%
18%
1.3
1.2
1.2
10,733
19%
17%
18%
1.3
1.2
1.2
Total Size (` mn)
Total Size (USD mn)
1,991
4,833
Source: Ambit Capital research, Company; Note: we consider only the organised players for the respective sectors
What has caused the recent slowdown?
Muted real construction, high channel inventory, poor liquidity of the developers and
channel, and moderation in aspirational consumption have led to deceleration of
volume growth for most categories. Dealers in smaller towns believe that it could take
a few quarters before real estate construction gathers pace and industry volumes
recover.
Plyboards - Organised players replacing unorganised
Industry volume growth has moderated in the last 2-3 quarters on account of
lower offtake from retail customers in tier-II/III markets. Distributors
highlight that plyboard sales in rural markets are limited and hence the
lower agri income does not have a major impact on plyboard sales. Industry
participants highlight that industry volumes declined by 2% in 3QFY15;
however, organised players’ sales in the mid category of plyboards grew
sharply with rising distribution network across smaller towns. The export ban
of face timber from Myanmar led to waning competitiveness of unorganised
players and facilitated market share gains and better pricing power of
organised players (price hikes of 10% YTD). Century Ply, on the back of
February 24, 2015
Page 36
Economy & Strategy
enhanced capacities and consistent brand-building initiatives and dealer
channel ramp-up, has outpaced competition in the last 18 months (volume
growth of 13% in 9MFY15 vs 2-3% growth of the industry).
Larger brands gain market share as unorganised players lose sheen
Similar to most home building categories, plyboards’ sales decelerated in the last 2-3
quarters due to the slowdown in residential housing construction. Century Ply has
been able to gain market share post the recent capacity additions through significant
investments in brand building and expansion of its dealer network. Dealers in smaller
cities highlight that the larger brands support the dealers through better inventory
management with timely despatches (within 24-48 hours), which reduces dealers’
inventory investments. Century Ply’s and Greenply’s affordable segment brands,
Sainik and Ecotec have found increasing acceptance in tier-II/III cities.
Leading brands gain market
share owing to strengthening
brand and distribution
The exhibit below highlights the revenue growth of Century and Greenply (in ply and
laminates); whilst industry volumes have slowed down, it is not visible in the exhibit
below, as these two players have significantly improved market share due to the raw
material constraints faced by the unorganised players.
Exhibit 55: Slowdown in industry volume growth not visible in Century’s and Greenply’s sales growth given continuous
market share gains
YoY growth
27
2019
11
8
14
98
7
13
16
13
9
7
9
7
3QFY15
2QFY15
1
1QFY15
1
2QFY13
(2)
1QFY13
4QFY12
3QFY12
2QFY12
2
14
12
22
4QFY14
11
23
18
3QFY14
9
1QFY12
Lam
2QFY14
25
1QFY14
25
19
4QFY13
24
3QFY13
23
4QFY11
30
25
20
15
10
5
(5)
Ply
Source: Company, Ambit Capital research; Note: we add segment-wise revenues of both Century Ply and Greenply for the above chart
Dealer checks—housing slowdown
Dealers highlight that although real estate construction in large cities was muted for
the last 2-3 years, individual housing construction in smaller towns kept plyboard
demand stable. However, growth rates tapered in FY15, as housing/real estate
construction in smaller towns decelerated. Dealers highlight that the use of plyboard
in low-ticket and rural housing is limited and hence rural consumption does not have
a direct impact on plyboard sales.
A large addressable market
We believe that the organised plyboard industry has significant room to grow, as
furniture penetration increases in India alongside the rising share of the organised
segment (with the shift in consumer preference towards branded products). A gradual
adoption of GST, continuing thrust by the companies in brand-building, increasing
reach and portfolio expansion across price points will increase the market share of
organised players. Managements estimate that the organised players’ share could
increase to 50% by FY20 (from 30% of the `150bn market); given that Century and
Greenply hold two-third of the market share, these players are well poised to grow in
the future.
Exhibit 56: Plyboard relative valuation summary
Companies
Mcap EV/EBITDA (x)
US$
FY15 FY16
mn
1,144 15.6 13.1
Rating
CMP
TP
Up/
Down
Century Plyboard
BUY
211
215
2%
752
22.1
18.1
Green Ply
NR
1,010
NA
NA
392
9.1
8.1
PLYBOARDS (Avg)
P/E (x)
FY15
FY16
25.0
33.7
16.3
P/B (x)
RoE (x)
CAGR (FY14-16)
FY15
FY16
FY15
FY16
Sales EBITDA
EPS
22.0
7.7
5.9
31.4
24.8
17.3
24.2
44.1
25.8
12.1
9.1
39.5
38.4
21.1
31.2
63.8
18.1
3.3
2.7
23.2
11.2
13.4
17.1
24.4
Source: Bloomberg, Company, Ambit Capital research
February 24, 2015
Page 37
Economy & Strategy
Century Plyboards, our top pick in the plyboards segment
Century is doing the right things in terms of building scale, distribution and brand
recall to position itself strongly to participate effectively in the large growth
opportunity. We estimate 24%/31% sales/EBITDA CAGR and 50% earnings CAGR over
FY14-17E. We expect strong volume growth and margins to sustain beyond FY16 as
well, given that the company is increasing scale, adding product-lines and assuring
long-term raw material procurement. Our 12-month target price of `215 for Century
Ply implies an inexpensive 14.2x FY17 EPS. Multiples should remain rich/ even get
further rich if the management is able to increase the asset turnover of the company
by using more outsourcing capacities, reducing working capital intensity and
increasing the dividend payout ratio (to 30%).
Tiles: Evident slowdown; top-2 brands gain market
share
Slowdown in real estate construction in tier-II/III cities led to volume growth
deceleration of tiles in 9MFY15. Dealers highlight that channel inventory
remains high, which could lead to poor volume growth for 2-3 quarters.
However, management teams/industry participants believe that the secular
opportunity is intact, as not only is the penetration low (only 11% Indian
households have tiles/mosaic flooring) but unorganised players (50% market
share) have been ceding market share to organised players, given product
premiumisation, rising brand awareness and significant improvement in
distribution. Kajaria and Somany, the two strongest franchises, have been
continuously increasing scale (through own capacities and forming JVs with
unorganised players) alongside brand building, which has enabled market
share gains and higher-than-industry volume growth in recent years.
Note in the exhibit below that revenue growth decelerated from 2QFY15 onwards
(3QFY15 appears due to the low base of 3QFY14 since the Morbi cluster was
shutdown). Note that the below exhibit represents sales growth, and given the sharp
increase in realisations for players such as Somany (due to rising mix of premium
products), the growth appears high despite lower industry volume growth.
Moreover, we highlight that Kajaria and Somany reported single-digit volume
growth for the first time in the last 12 quarters (barring 3QFY14) in 2QFY15.
Exhibit 57: Revenue growth (YoY) has decelerated from 2QFY15 onwards (3QFY15 revenue growth appears high due to low
base)
Tiles YoY growth (%)
35
30
30
26
28
30
27
26
23
25
20
20
22
20
18
16
15
10
13
13
12
10
3
5
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
4QFY13
3QFY13
2QFY13
1QFY13
4QFY12
3QFY12
2QFY12
1QFY12
4QFY11
3QFY11
-
Source: Company, Ambit Capital research. Note: * Revenue growth of top-5 companies
February 24, 2015
Page 38
Economy & Strategy
Exhibit 58: Kajaria’s volume growth rates have decelerated
Kajaria Voume growth (%)
30%
28%
24%
25%
20%
13%
15%
24%
21%
20%
16%
15%
3QFY15 is an aberration due to
the low base of last year, as a
large manufacturing cluster,
Morbi, was shut down for two
months
15%
11%
7%
10%
4%
5%
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
4QFY13
3QFY13
2QFY13
1QFY13
4QFY12
0%
Primary data sources/managements—industry volume growth moderates; top
franchises gaining market share
Industry participants highlight that whilst industry growth rates have moderated,
Kajaria and Somany are gaining market share over both unorganised players and
organised manufacturers like H&R Johnson and Nitco. Dealers ascribe the share gains
to: (a) industry-leading design innovation and branding initiatives to create a ‘pull’
brand recall, (b) improvement in distribution network and continuous expansion in
dealer network. For instance, Somany’s management highlighted a three-pronged
strategy to improve distribution: (a) increasing footprint in smaller towns (50-60
dealers added in 1H), (b) upgrading the exclusive showrooms to larger format tiles,
and (c) adding new exclusive tiles showrooms (for large format tiles).
Kajaria and Somany continue to
grow higher than industry growth
rates by displacing the
unorganised players
Our view - Stick to high-quality franchises
Although the industry growth rates have decelerated, leading brands such as Kajaria
and Somany continue to gain market share, given continuous product innovation and
ahead-of-the-curve design launches; these companies will continue to grow materially
higher than the industry average. Moreover, both these players are expanding their
product-lines into sanitaryware and faucets, which are growing in scale. Steadily
Somany plans to enter into the wellness faucet range from the entry mid-level
products and it will possibly set up a faucet manufacturing unit next year. Whilst the
valuations are rich, we expect these to sustain given the sustenance of the profitability
and market share gain, making these larger profitable-cash-generating franchises.
Exhibit 59: Tiles and Sanitaryware relative valuation summary
Mcap EV/EBITDA (x)
Companies
Rating CMP
TP
P/E (x)
P/B (x)
RoE (x)
CAGR (FY14-16)
Up/
US$ mn
Down
FY15
FY16
FY15
FY16
FY15
FY16
FY15
FY16
2,208
18.3
14.6
37.6
27.5
6.8
5.0
19.5
21.2
17.2
19.6
48.3
8.6
7.0
26.6
26.5
22.0
23.4
32.0
Sales EBITDA
EPS
TILES AND SANITARY
WARE (Average)
Kajaria Ceramics
NR
783 NA
NA
1,001
18.7
15.0
36.6
28.6
Somany Ceramics
NR
368 NA
NA
230
15.4
12.0
32.2
22.3
5.4
2.4
18.3
22.3
21.2
21.2
48.9
Cera Sanitaryware
NR 2,637 NA
NA
536
27.8
22.0
49.0
38.0
10.6
8.5
25.2
24.5
11.9
12.4
13.5
HSIL
NR
NA
441
11.5
9.3
32.8
21.0
2.5
2.2
8.0
11.5
14.0
21.4
98.5
416 NA
Source: Company, Bloomberg, Ambit Capital research
February 24, 2015
Page 39
Economy & Strategy
Plastic piping—Rural/irrigation slowdown, housing
moderation and now declining raw material prices
Plastic piping companies (Supreme and Astral) are primarily selling pipes for
urban/semi-urban and rural housing with agricultural usage forming very
less share of pipes sold for them. Finolex has a larger share of pipes sold for
agricultural usage and rural housing. Continuous product innovation (fittings,
use-specific pipes), ease of usage by intermediaries, active engagement with
intermediaries and expanding capacities/reach have helped both Supreme
and Astral (more so Astral) gain market share over smaller organised and
unorganised players. Whilst Supreme’s pipe volumes grew at 37% CAGR over
FY10-14, Astral’s volumes grew at 31% CAGR over the same period. However,
for the last nine months now, the volumes have declined for the industry but
Astral continues to post low/mid-teen volume growth given product
portfolio/reach/capacity expansion; Supreme posted marginal decline in
volumes. Industry participants highlight that alongside real-estate slowdown,
PVC price decline was one of the major reasons for declining volumes.
Declining PVC prices impacted channel inventory amid soft demand
PVC resin prices declined by 27% from `80/kg in June 2014 to `58/kg in December
2014. As a result, the volume growth of PVC pipes was weak in 2QFY15 and
3QFY15, as the intermediaries delayed the purchase of PVC pipes in anticipation of
lower PVC pipe prices. CPVC volumes increased ~17% YoY in 3QFY15, as CPVC
prices were stable. Astral reported revenue growth of 14% YoY led by revenue growth
of 18% YoY in the CPVC segment. Supreme Industries reported volume growth of 12%
YoY in 3QFY15 after a 7% YoY decline in 2QFY15. Finolex Industries was the worst hit
due to lower PVC resin prices, as PVC pipe volumes declined 8% YoY in 3QFY15. The
EBITDA margins of organised companies declined by ~200-300bps in 3QFY15 due to
inventory loss in PVC resin.
Supreme sales YoY
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
4QFY13
3QFY13
2QFY13
Supreme Industries
Astral sales YoY
Astral Polytechnik
Finolex Industries
Finolex sales YoY
Source: Ambit Capital research, Company
1QFY13
2QFY12
3QFY15
2QFY15
1QFY15
0%
-20%
4QFY14
4%
0%
3QFY14
8%
20%
2QFY14
40%
1QFY14
12%
4QFY13
60%
3QFY13
16%
2QFY13
80%
1QFY13
20%
4QFY12
100%
4QFY12
Exhibit 61: Sharp fall in EBIT margin in 2QFY15 and
3QFY15
3QFY12
Exhibit 60: Astral the outperformer, Finolex the laggard
Volume growth of PVC pipes was
weak in 2QFY15 and 3QFY15, as
the intermediaries delayed the
purchase of PVC pipes in
anticipation of lower PVC pipe
prices
Source: Ambit Capital research, Company
Dealer checks—stability in prices to lead to inventory re-stocking
Our dealer checks suggest that demand for PVC pipes would pick-up after the prices
of PVC stabilise (which have actually increased over last two weeks). Dealers believe
that an annual volume growth of 10-12% is sustainable for the next five years
(marginally ahead of the last five years) because of rising acceptance of the product
and gradual shift to pucca houses and better construction practices. Dealers believe it
is too early to suggest that this slowdown in housing and agriculture activity is a
structural slowdown. Astral has very low exposure to rural housing and agriculture
(less than 10%). Sales to rural housing and agriculture account for 35% of the total
volumes sold by Supreme Industries. Rural housing and agriculture account for more
February 24, 2015
Page 40
Economy & Strategy
than 85% of the total volumes sold by Finolex Industries. Thus, Finolex Industries
would be the most affected by a slowdown in rural housing.
Supreme Industries—efficient capital allocator amid volume moderation;
stock valuation rich
We like Supreme Industries owing to its unmatched distribution and manufacturing
reach, superior capital allocation by high-quality management and consistent product
innovation. Supreme is setting up a manufacturing facility in Kharagpur, east India, to
further increase reach; it launched bathroom fittings and composite cylinders to
expand its product portfolio. We believe that Supreme will generate cumulative
operating cash flow of `16.8bn in FY14-17E, which would be sufficient to fund its
mega capex plans of `7.9bn in FY14-17, creating a snowball effect. However, we put
our stance on Supreme Industries UNDER REVIEW, as the stock price continues to
rally despite the recent weakness in performance (CMP of `680/share is above our
12-month TP of `653). We do not find little margin of safety in valuation of 24x FY16E
EPS given its stagnating plastic piping franchise which is losing market share to Astral.
Secondly, its foray into composite cylinders, though promising, is yet to yield results.
Relative to peers, Supreme trades at a discount to Astral, which trades at 32x FY16E
EPS; Finolex Industries is trading at 14x FY16E EPS, a justified discount to Supreme
and Astral.
Astral PolyTechnik (NOT RATED)—graduating to a larger home building
brand from a fast-growing pipes franchise
Astral has continuously gained market share over its peers through its focus on
product innovation, reach expansion and more recently large brand investments (to
influence the intermediaries, a practice followed by cement, paints and adhesives
manufacturers/brands). As a result, the company’s revenues not only grew at 38.6%
CAGR over FY10-14, but it also sustained/improved its RoCE/RoE, leading to multiple
re-ratings; Astral is currently trading at 32X FY16 EPS (consensus; yet to build in
impact of acquisitions) much closer to adhesives (34x FY16E EPS) and paints
companies (33.4x FY16E EPS) than the other home building categories such as cement
(20x FY16E EPS), tiles and sanitaryware (22x FY16E EPS). Whilst we believe that the
core franchise and the acquired adhesives businesses should continue to grow faster
over FY15-17, effective integration of these businesses is the key for sustenance of
30%+ growth rates beyond FY17 alongside higher RoCEs.
Exhibit 62: Relative valuation summary - Pipes
Mcap EV/EBITDA (x)
Companies
Rating
CMP
TP
Up/
Down
PIPES
Astral Poly
NR
448
NA
NA
Supreme
BUY
661
NA
NA
Industries
Source: Company, Ambit Capital research, Bloomberg
February 24, 2015
P/E (x)
P/B (x)
RoE (x)
CAGR (FY14-16)
US$
mn
FY15
FY16
FY15
FY16
FY15
FY16
FY15
FY16
2,867
20.2
16.1
36.3
27.0
8.8
6.5
26.8
28.6
17.0
19.1
35.5
853
28.3
20.0
51.3
33.6
9.2
7.5
22.1
23.8
33.7
30.4
40.8
1,349
15.6
12.3
30.4
21.7
7.0
5.9
24.1
29.1
13.7
11.7
15.8
Sales EBITDA
EPS
Page 41
Economy & Strategy
NBFCs
Aadesh Mehta, CFA, [email protected], +91 22 3043 3239
Auto financers
The results declared by auto NFBCs over the past 2-3 quarters demonstrate
stress in the rural economy underpinned by slowing growth and increasing
pressure on asset quality. We believe the unwinding of the wealth effect in
rural India could lead to some demand decline in aspirational and
discretionary plays in the auto sector such as passenger cars and UVs. MMFS,
with ~47% exposure to these products, would be the most impacted.
Slowing growth, deteriorating asset quality for NBFCs
AUM growth for auto NBFCs has slowed down meaningfully to 9% in 3QFY15 vs
>20% in most of FY13. However, disbursement trends have been mixed, with
commercial vehicle financiers like Shriram Transport (SHTF) and Sundaram Finance
demonstrating improving disbursement growth vs declining disbursement trends for
M&M Finance (MMFS), Magma Fincorp (MGMA) and Cholamandalam Finance (CIFC)
which have a higher proportion of cars/utility vehicles/tractors/light commercial
vehicles.
Exhibit 63: AUM growth remains muted for most NBFCs…
Exhibit 64: …but CV NBFCs are showing improving trends
25%
40%
20%
30%
15%
20%
Disbursement growth (%, YoY)
10%
10%
0%
5%
-10%
0%
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
-20%
SHTF
AUM growth - All auto NBFCs
MMFS
MGMA
CIFC
FY13
FY14
9MFY15
SUF
Similar trends are visible in asset quality as well, where both credit costs and gross
NPAs have increased sharply over the last 2-3 quarters. However, similar to the
growth trends, asset quality is stabilising for CV lenders (SHTF and SUF) but
deteriorating for MMFS, Magma and CIFC which have a relatively higher non-CV
portfolio.
Exhibit 65: Increasing credit costs…
Exhibit 66: … across most NBFCs
2.0%
3%
1.8%
3%
Credit costs (%)
2%
1.6%
2%
1.4%
1%
1.2%
1%
1.0%
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
0%
SHTF
MMFS
MGMA
CIFC
9MFY13
9MFY14
9MFY15
Credit costs/AAUM - All auto NBFCs
February 24, 2015
SUF
Page 42
Economy & Strategy
Current trends are weakest in the past five years…
We observe that the current trends have been weakest for auto financing NBFCs in
our coverage over the past 5 years not only in loan growth but also in terms of asset
quality, as demonstrated by the exhibit below.
Exhibit 67: Current trends are weakest in the past five years
3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15
AUM growth
SHTF
0%
25%
25%
23%
20%
24%
22%
20%
16%
11%
13%
16%
19%
24%
25%
22%
15%
7%
4%
3%
7%
MMFS
13%
21%
29%
31%
42%
44%
47%
47%
47%
41%
39%
36%
32%
35%
34%
30%
27%
21%
15%
14% 10%
MGMA
NA
NA
NA
NA
NA
17%
20%
23%
24%
26%
29%
31%
31%
35%
28%
23%
20%
10%
12%
13% 13%
Gross NPA (%)
SHTF
2.4% 2.8% 2.5% 2.6% 2.4% 2.6% 2.7% 2.7% 2.8% 3.1% 3.0% 2.9% 2.9% 3.2% 3.1% 3.3% 3.6% 3.9% 3.7% 3.7% 3.6%
MMFS
8.7% 6.4% 6.9% 5.8% 5.6% 4.0% 4.6% 4.0% 4.1% 3.0% 3.8% 3.9% 4.0% 3.0% 4.2% 4.1% 4.8% 4.4% 6.2% 6.3% 7.1%
MGMA
0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 1.3% 1.6% 2.2% 2.9% 3.6% 3.6% 4.1% 4.5% 4.9%
What led to such trends?
Based on our discussions with management teams and ground-level staff and also
based on management commentaries, we believe that the slowdown in rural India is
one of the main drivers for the weak trends for auto NBFCs. The slowdown in rural
India has been driven by:
(i)
(ii)
(iii)
(iv)
(v)
Crop failures in some big states like Madhya Pradesh, Uttar Pradesh and
Maharashtra due to adverse weather conditions.
Pressure on yields in key cash crops such as cotton and sugarcane.
Decelerating increase in minimum support prices (MSPs) for major crops (wheat
and paddy) from 9-12% CAGR over FY07-14 to ~4% over FY14-15.
Low government spending in rural India in recent years.
Declining/stagnating real estate prices impacting wealth, and in turn impacting
the spending tendencies of rural India.
What lies ahead?
Going forward, we believe that the slowdown related to crop failures/lower crop
yields should abate with better rains. Hence, growth and asset quality issues in the
tractor segment seem to be transient in nature and should abate in the next 2-3
quarters.
However, with the wealth effect unwinding in rural India due to declining/decreasing
real estate prices, we could see weakness in aspirational and discretionary purchases
like passenger cars, which could persist for a longer time. Hence, NBFCs with higher
exposure to cars/utility vehicles could continue to see lower growth going forward.
Despite an expected pickup/decline interest rates, we are SELLers on most
auto financers…
Despite the declining interest rates and pickup in auto sales, we expect auto lenders
to miss consensus expectations on earnings growth for FY15-17E due to: (i) higher
competition pressuring yields; (ii) regulatory changes limiting decline in cost of funds
and bringing down accounting profits; and (iii) asset quality issues in rural India
keeping credit costs high. Barring Magma Fincorp, which is trading at 0.8x FY17 P/B,
we continue to find risk-reward unfavourable in other auto financing NBFCs.
February 24, 2015
Page 43
Economy & Strategy
Exhibit 68: Auto financers – Relative valuation snapshot
Mcap Reco.
TP
US$bn
P/B
P/E
EPS CAGR
ROA
ROE
`
Upside/
downside
FY16E
FY17E
FY16E
FY17E
FY15-17E
FY16E
FY17E
FY16E
FY17E
Shriram Transport
4.6 SELL
990
-21%
2.7
2.3
19.0
15.2
22%
2.0%
2.1%
14.9%
16.3%
M&M Finance
2.4 SELL
230
-12%
2.2
1.9
13.9
11.4
25%
2.5%
2.5%
16.0%
17.0%
Magma Fincorp
0.3 BUY
155
56%
1.0
0.9
8.3
5.9
37%
1.2%
1.3%
14.2%
15.6%
Sundaram Finance
2.7
NA
NA
NA
5.3
4.6
29.7
25.1
17%
3.0%
3.2%
18.7%
19.9%
Cholamandalam
1.3
NA
NA
NA
2.4
2.1
15.8
12.2
27%
2.1%
2.3%
17.0%
18.0%
2.7
2.4
17.3
14.0
26%
2.1%
2.3%
16.2%
17.4%
Average
Source: Bloomberg; Note: * Estimates for SUF and CIFC are consensus estimates.
MMFS would be the most impacted…
We find MMFS (47% of AUM exposed towards passenger vehicles) to be the most
impacted due to the continued slowdown in this segment going forward.
Magma (BUY, 55% upside) also has 26% of its AUM in passenger cars but the
decreasing proportion of this segment and increasing proportion of tractors, used CVs
and mortgage loans (from a small base) mean that Magma is relatively better
positioned to improve its profitability. Cholamandalam (Not Rated) should also be
relatively immune to these trends due to the increasing diversification on its loan
book.
CV financiers like SHTF (SELL, 10% downside) and SUF (Not Rated) should be
relatively less impacted by the rural wealth effect and these companies would
continue to be a play on the overall improvement in the Indian economy.
Mortgage financers
The results for mortgage lenders over the past few quarters have been
healthy and stable, albeit not reflecting the slowdown in property prices in
rural and semi-urban India. We believe the unwinding of the wealth effect in
semi-urban/rural India could see a meaningful decline in property prices,
which could affect loan against property products and the self-employed set
of customers. Repco, with ~20%/56% exposure to LAP/self-employed segment
and with higher contribution of increasing ticket sizes in its loan growth
would be most impacted amongst HFCs.
Disbursements have seen a blip
Loan growth for rural/semi-urban mortgage financers (Repco Finance and Gruh
Finance) is holding up, although some growth moderation has been clearly visible in
the last couple of quarters. However, disbursement trends are showing weakness, with
slightly lower disbursement growth in 9MFY15 vs FY14.
Exhibit 69: AUM growth is robust…
32%
31%
30%
29%
28%
27%
26%
25%
24%
23%
Exhibit 70: …disbursements showing mixed trends
50%
AUM growth (%, YoY)
Disbursement growth (%, YoY)
40%
30%
20%
10%
4Q14
1Q15
GRHF
February 24, 2015
2Q15
3Q15
0%
46% 19% 23%
GRHF
FY13
REPCO
FY14
12% 47% 19%
REPCO
9MFY15
Page 44
Economy & Strategy
However, asset quality trends for mortgage lenders remained stable, in continuation
with the trends observed in the previous quarters.
Exhibit 71: Asset quality continues to be steady
3.0%
Gross NPAs (%)
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
GRHF
2QFY15
3QFY15
REPCO
The trends and management commentaries highlight that property prices in semiurban and rural markets have slowed down, with certain pockets even experiencing a
decline in prices. However, the management teams have highlighted that the growth
trends would remain at the historical levels, due to the relatively small size of their
loan book and due to scope for further customer penetration in India especially in the
self-employed segment.
Current trends in line with past seven years…
We observe that mortgage financers have mainly sustained their trends over the past
7 years both in terms of growth and asset quality, as demonstrated by the exhibit
below.
Exhibit 72: Current trends are weakest in the past five years
FY08
FY09
FY10
FY11
FY12
FY13
FY14
1Q15
2Q15
3Q15
GRHF
29%
18%
17%
30%
28%
34%
29%
29%
29%
28%
REPCO
50%
52%
41%
47%
35%
26%
32%
31%
30%
27%
HDFC
29%
17%
15%
20%
20%
21%
16%
15%
15%
14%
LICHF
25%
26%
38%
34%
23%
23%
17%
17%
17%
18%
1.1%
0.9%
1.1%
0.8%
0.5%
0.3%
0.3%
0.4%
0.4%
0.6%
REPCO
1.3%
1.0%
1.2%
1.2%
1.4%
1.5%
1.5%
2.5%
1.7%
2.0%
HDFC
0.8%
0.8%
0.8%
0.8%
0.7%
0.7%
0.7%
0.7%
0.7%
0.7%
LICHF
1.7%
1.1%
0.7%
0.5%
0.4%
0.6%
0.7%
0.8%
0.6%
0.6%
AUM growth (%)
Gross NPA (%)
GRHF
What lies ahead?
With the unwinding of the wealth effect, real estate prices could start moderating, the
evidence of which is already visible from our channel checks. Property prices have
been a key driver of loan growth for these rural mortgage financers over FY129MFY15, contributing to at least half of the growth.
Exhibit 73: Growth driven by customer acquisition and increase in ticket sizes
FY12-9MFY15 CAGR
Loan book
No. of Customers
Avg. Ticket size
LICHF
20%
9%
10%
GRUH
32%
16%
14%
REPCO
28%
10%
17%
February 24, 2015
Page 45
Economy & Strategy
Hence, a decline in property prices could result in lower than historical growth levels
for these lenders going forward and this could have a bearing on asset quality, which
has been pristine over the last 4-5 years.
Nevertheless, to some extent, these rural lenders could sustain growth through
increased penetration, as most of the houses financed in rural India are for selfconstruction (~50% of the houses in rural India are still kutcha/semi-pucca) and such
construction of low-ticket-size properties is not affected much by property prices but
more by prices of raw materials like cement and structures.
Exhibit 74: High proportion of semi-pucca and kutcha houses indicate scope for further
penetration of rural mortgage financers in India
Kutcha, 17.0
Semi-Pucca,
27.6
Pucca, 55.4
Despite an expected decline interest rates, we are SELLers on LICHF/HDFC…
With declining interest rates, stable asset quality and stable growth, valuations of
mortgage financiers have expanded significantly in the recent past with many of them
trading at their historical peak multiples. However, the growth and earnings trajectory
of these financiers could disappoint consensus expectations due to: (i) slowdown in
growth due to softening real estate prices and increasing competition from banks; (ii)
competition from banks putting pressuring on yields; and (iii) asset quality pressure if
the real estate prices keep on coming down. We continue to maintain our SELL stance
on HDFC Ltd and LIC Housing Finance.
Exhibit 75: Mortgage financers – Relative valuation snapshot
Mcap Reco.
US$bn
TP
Up/ down
P/B
P/E
EPS CAGR
ROE
FY16E
FY17E
33.5 SELL
908
-32%
6.1
NA
34.1
NA
7%
1.9%
NA
22.4%
NA
LIC Housing Finance
3.7 SELL
330
-28%
2.3
2.0
14.4
12.6
13%
1.4%
1.4%
17.3%
17.2%
Indiabulls Housing Finance
3.6 NA
NA
NA
3.0
2.6
9.8
8.2
19%
4.0%
4.0%
32.9%
34.2%
Gruh Finance
1.6 NA
NA
NA
10.9
8.9
39.8
30.2
27%
2.5%
2.5%
29.6%
32.7%
Dewan Housing Finance
1.0 NA
NA
NA
1.4
1.2
8.2
6.6
24%
1.4%
1.4%
17.9%
19.4%
Repco Home Finance
0.7 NA
NA
NA
4.4
3.8
26.0
21.3
24%
2.4%
2.2%
18.2%
19.2%
4.7
3.7
22.0
15.8
19%
2.3%
2.3% 23.0% 24.5%
HDFC
`
FY16E FY17E FY16E FY17E
ROA
Average
FY15-17E FY16E FY17E
Source: Bloomberg; Note: * Estimates for HDFC and LICHF are Ambit estimates.
February 24, 2015
Page 46
Economy & Strategy
Repco would be more impacted than Gruh…
That said, we believe that decline in property prices could impact both the growth and
asset quality of Repco Finance and Gruh Finance. However, between these two
companies, Gruh Finance seems to be better placed than Repco Finance, as:

Repco has a smaller rate of customer acquisition than Gruh finance. Repco’s
growth has come more from an increase in loan ticket sizes rather than increased
customer acquisition. Repco’s loan book CAGR has been at 28%, with the increase
in ticket sizes accounting for 17% CAGR and with the increase in customer count
accounting for ~10% CAGR as compared to Gruh’s customer count growth of
16% and ticket size growth CAGR of 14%.

Repco has a higher proportion of loan against property at ~20% as compared to
~4% for GRHF. Given that home loans are collateralised against the residence of
the borrower, which a borrower would part with only as a last resort, asset quality
in home loans are less linked to a decline in property prices. Repco’s loan book
would be more exposed to property prices than GRHF.

Repco also has a higher proportion of self-employed customers at ~56%, as
compared to ~39% for GRHF. Given that self-employed customers have more
volatile cash flows and sucking out of the black economy, Repco’s loan book
would be more exposed to property prices than GRHF.

Further, Repco has more exposure in semi-urban regions where the slowdown in
more prominent as compared to GRUH.
However, at valuations of 4.2x FY16E P/B for Repco and 10.5x FY16E P/B for Gruh,
the odds are certainly against investors in the light of declining real estate prices
February 24, 2015
Page 47
Economy & Strategy
Light Electricals
Demand is falling off the cliff
Bhargav Buddhadev, [email protected], +91 22 3043 3252
Revenue growth for the Indian light electricals (LE) industry has deteriorated
significantly since November led by sluggish demand due to: (a) slowdown in
industrial capex and tight liquidity; (b) weak consumer sentiment due to
recessionary environment in rural areas led by weak monsoon and falling
crop prices (especially cash crops); and (b) falling copper prices which is
leading to inventory de-stocking at distributors’ end and delay in purchases
from the end customers in anticipation of falling prices. However, there is an
expectation that the demand will improve in FY16 with an expectation of
stable copper prices and a better monsoon. We prefer regional players like
V-Guard that are expanding into pan-India franchises with higher PAT
growth (31% PAT CAGR over FY14-17E vs 11% and 7% for Havells and Bajaj
Electricals’ non-E&P business).
Revenue growth in 9MFY15 has slowed down to 8% vs
19% CAGR over FY10-14
Exhibit 76: Revenue growth for light electrical companies have tapered down from 19% CAGR over FY10-14 to 8% in 9MFY15
19% revenue CAGR over FY10-14
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
4QFY13
3QFY13
2QFY13
1QFY13
4QFY12
3QFY12
2QFY12
1QFY12
4QFY11
3QFY11
2QFY11
1QFY11
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
4QFY10
Revenue growth YoY (%)
8% revenue growth in 9MFY15
Source: Company, Ace Equity, Ambit Capital research; Note: We have taken revenue growth for the sum of the revenues of Havells standalone, Bajaj Electricals
non-E&P, V-Guard, Finolex Cables (electrical cables and wires), Crompton Greaves (consumer business), Orient (electric consumer business), Surya Roshni
(electrical business) and Khaitan Electric as a representative for the sector
The industry growth has declined from 19% over FY10-14 to 8% in 9MFY15 due to:

Deterioration in demand environment since 3QFY15: The demand
environment YTD has been weak due to slowdown in the industrial capex (IIP
growth in 9MFY15 at 2.1% vs 3.5% over FY10-14) and liquidity challenges. This
has impacted the B2B (project led) demand severely; real estate activity which has
been a major revenue driver for the light electrical companies is going through
tough times, with several developers announcing price corrections in several parts
of India. Also, consumer sentiment has turned adverse due to the recessionary
environment in rural areas led by weak monsoon, falling crop prices (especially
cash crops), high inflation and higher interest rates.

Fall in the copper prices: Average copper prices since September have declined
by 27% in INR terms and are down YoY as on February 18. This is impacting
demand especially from the distributors to stock inventory, as they fear inventory
losses. Note that the fall in copper prices is immediately passed on to the end
consumer by cutting the prices of finished goods. Also, demand from the end
customers tends to be weak, as they delay purchases in anticipation of a further
February 24, 2015
Page 48
Economy & Strategy
drop in prices. Whilst volume growth in cables and wires has been reasonable at
11%, 9% and 7% on a YoY basis for Finolex Cables, Havells and V-Guard in
3QFY15, revenue growth has been weak at 5%, 6% and 3% respectively, given
the cut in finished good prices.

Limited scope for further shift in the share from unorganised sector to
organised sector: Bulk of the growth in the past was led by a shift in market
share in favour of organised players. Our channel checks and discussions suggest
limited scope for further shift in market share given the share of the organised
players has already peaked to 65% in FY14 from 54% in FY10. Stagnation of the
share of organised players in the paint industry at 65% in the last three years
corroborates this argument.
Exhibit 77: Share of organised players has increased from
30% to 65% in the last eight years
Share of organised
players (%)
FY06
FY10
FY14
Domestic switchgears
40%
43%
70%
Industrial switchgears
60%
72%
80%
Switches
25%
50%
70%
Cables and wires
20%
56%
62%
Lighting & Luminaries
25%
40%
55%
Fans
40%
55%
70%
Industry
30%
54%
65%
Exhibit 78: Limited scope for further expansion, as share of
organised players in paints has stagnated at 65% since the
last three years
400
(` bn)
70%
Paints
65%
60%
200
55%
50%
2010
2011
2012
2013
2014
Unorganised as % of total
Organised as % of total
3QFY15 results round-up
The 3QFY15 results season was a disappointment for light electrical companies, given
weak revenue growth and EBITDA margin decline. Companies under our coverage
(Havells, V-Guard, Crompton and Finolex Cables) recorded revenue growth of 12% to
-3% YoY (we have included the performance of the consumer businesses only; for
instance, we have excluded Sylvania’s and Bajaj’s E&P performance whilst calculating
Havells’ and Bajaj’s consumer revenue growth performance).
Gross margin improvement of 30-380bps YoY has not flowed down into the EBITDA
margin which remained flat YoY, due to poor operating leverage. Companies which
are not under our coverage, Orient Paper and Industries, Surya Roshni and Khaitan
Electric also reported weak revenue growth of -6% to 3% and EBITDA margin decline
of 130-1,320bps. The weak revenue growth was on account of: (a) sluggish B2B
demand (project-led) given weak private sector capex (led primarily by liquidity
crunch), (b) weak recovery in the B2C demand given only a marginal improvement in
the consumer sentiment and (c) weakness in the re-stocking of the inventory by the
channel given the declining copper prices (down 9% YoY in 3QFY15 in INR terms)
February 24, 2015
YoY revenue growth for 3QFY15
was disappointing at 12% to 3%...
…led by weak consumer
sentiment, poor industrial capex
and weakness in re-stocking
(given declining copper prices)
Page 49
Economy & Strategy
Exhibit 80: ….led by weak demand and sliding copper
prices
Revenue
growth
YoY (%)
Gross margin
YoY change
(bps)
EBITDA margin YoY
change (bps)
12.0%
30bps
-280bps
500
5.3%
180bps
50bps
450
Crompton
11.1%
NA
30bps*
Bajaj
-3.6%
NA
-210bps*
Finolex
3.4%
380bps
270bps
Orient
-6.0%
NA
-130bps*
Khaitan
-35%
-640bps
-1320bps
Surya Roshni
-3.7%
NA
80bps
Source: Company, Ambit Capital research; Note: * For Crompton, Bajaj and
Orient Paper we have compared the change in the EBIT margin; NA – Not
available
400
350
Jan-15
Nov-14
Sep-14
Jul-14
May-14
Mar-14
Jan-14
Nov-13
Sep-13
300
Jul-13
Havells
May-13
V-Guard
MCX Copper Spot `/kg
Jan-13
Company
Mar-13
Exhibit 79: 3QFY15 results for light electrical companies
were weak…
Source: Bloomberg, Ambit Capital research
The reduction in EBITDA margin was primarily led by unfavourable operating leverage
given weak revenue growth. Gross margins, however, improved by 30-380bps for
companies under our coverage led by falling copper prices. Companies have not
passed on the entire drop in copper prices, as they are trying to offset the weak
revenue growth through higher gross margins.
Gross margin improved by 30380bps across companies led by
a fall in copper prices
Our discussions with dealers suggests that the demand environment in January has
also been weak; until the copper prices stabilise or some sops for the housing sector
are announced in the budget or until the summer sets in by mid-February, even the
fourth quarter is likely to be weak on revenue growth.
In our 4QFY15 forecasts, we have assumed YoY revenue growth of -2% to 5% for
Havells, Finolex and Crompton. Whilst for V-Guard we have assumed revenue growth
of 13% due to improvement in its non-south market share, for Bajaj we have assumed
revenue growth of 14% due to lower base impact.
Exhibit 81: Our 4QFY15 forecasts for light electrical companies do not assume any
significant recovery
Gross margin YoY
change (bps)
EBITDA margin YoY
change (bps)
13.0%
130bps
140bps
5.1%
-210bps
-80bps
14.3%
NA
250bps
Finolex
-1.6%
110bps
-20bps
Crompton
-2.2%
NA
190bps
Company
Revenue growth YoY
(%)
V-Guard
Havells
Bajaj
February 24, 2015
Page 50
Economy & Strategy
The story of the 3QFY15 results season
Here are some of the key trends of the results reported by the three light electrical
companies under our coverage:
a) Sluggish revenue growth; V-Guard’s revenue growth is the strongest at
12% led by strong performance in non-south
V-Guard’s 3QFY15 revenue growth of 12% was the highest amidst its peers led by
18% YoY growth in non-south. The revenue growth was led by stabilisers, fans and
digital UPS which saw strong growth of 23%, 42% and 30% respectively. Crompton,
Bajaj, Finolex and Havells reported YoY revenue growth of 11%, 3%, -4% and 5%
respectively. The revenue performance of V-Guard though was lower than our
expectation of 20% YoY growth due to: (1) lower growth of 8% YoY in cables and
wires segment (though volume growth was strong at 14% YoY but realisations
declined 7% YoY due to fall in copper prices) and (2) an 8% YoY decline in pumps due
to restrictions put in Karnataka on digging bore wells.
Exhibit 82: V-Guard
amidst peers…
reported
the
strongest
growth
V-Guard’s revenue growth at
12% YoY was the highest amidst
its peers led by 18% YoY growth
in non-south
Exhibit 83: …led by strong growth of 23%, 42% and 30% YoY
in stabilisers, fans and digital UPS
Product
3QFY15 revenue (` mn)
growth in % YoY
Stabilisers
684
23%
20.0%
Fans
228
42%
10.0%
Digital UPS
305
30%
Water Heaters
702
21%
1,210
8%
Pumps
373
-9%
LT Cables
124
-27%
43
-25%
284
151%
3,954
12%
-30.0%
-40.0%
Surya
Khaitan
Orient
Finolex
Bajaj
Crompton
-20.0%
Havells
-10.0%
V-Guard
0.0%
Wires
UPS
Others
Total
For Havells, apart from the electrical consumer durables segment which reported 12%
YoY growth, all other segments reported marginal-to-flat growth (of 0-6%). The cables
and wires business which is its largest segment by revenues reported a 4% YoY
revenue growth given the 9% YoY decline in copper prices during 3QFY15.
Also, as copper prices fall, the prices of cables and wires also fall given the
commoditised nature of the business. In switchgears, which is the most profitable
segment, revenue grew by only 6% YoY given the weak institutional demand; EBIT
margins contracted by 110bps YoY. Given that Finolex Cables has already launched
switchgears in 4Q, we expect Havells’ margins in switchgears to remain under
pressure. In domestic appliances, Havells seems to be struggling given the meagre
12% YoY growth (vs 23% in 1HFY15). Our discussions with primary data sources
suggest that Havells is struggling in domestic appliances due to its aggressive pricing.
In some products it competes head on with MNC players like Philips. This poor
performance in the domestic appliance is worrisome given that the management is
targeting higher growth in this segment over FY15-17; the domestic appliance market
in India is at `50bn and it recorded 25% CAGR over FY09-14. Bajaj and TTK Prestige,
leaders in this segment, recorded sales of more than `19.4bn per annum as
compared to less than `2.8bn for Havells.
February 24, 2015
Havells is struggling in domestic
appliances, with growth
decelerating to 12% YoY in
3QFY15 vs 23% in 1HFY15
Page 51
Economy & Strategy
Exhibit 84: Apart from consumer durables, all other
categories reported marginal-to-flat YoY growth
Exhibit 85: Decelerating growth in consumer durables
(includes appliances) is a worry, as this is the biggest
driver of future growth
35%
YoY Growth (%) in electrical consumer
durables
30%
Switchgears Cables and Lightning &
Wires
Fixtures
1QFY15
2QFY15
Electrical
consumer
durables
3QFY15
3QFY15
0%
1HFY15
5%
FY14
10%
FY13
15%
40%
35%
30%
25%
20%
15%
10%
5%
FY12
20%
FY11
25%
For Bajaj, the non E&P segment disappointed, with revenue growth declining by 3.6%
YoY led by a revenue decline of 6.2% YoY and 2.3% YoY in lighting and consumer
durables. Whilst in lighting, Bajaj is getting impacted by its minimal presence in the
LED segment, the market share loss in other categories is due to high attrition. BJE is
facing attrition with the recent exits of the Head of Morphy Richards and the Head of
Lighting. We fear more attrition as well from the senior management in the near
future given the large opportunity available in the market, with several regional
players aspiring to become pan-India players.
Bajaj’s non-consumer business is
losing steam given the severe
underperformance in growth
relative to its peers
Alongside the head of businesses leaving, in several instances the senior VPs also start
leaving the firm given the industry trend of the head taking key team members as
well. Note that several players have been launching new categories like fans, lighting
and appliances. The reason for this attrition seems to be the cultural change in the
company, with Anant Bajaj becoming the new person in command (which reminds us
of the earlier ED’s exit).
Lighting
margin
9%
5%
7%
3%
5%
1%
Lighting
3QFY15
2QFY15
1QFY15
4QFY14
3%
Consumer durable on RHS
For Finolex Cables, whilst the volume growth was strong at 11% YoY in electrical wires
and power cables, the ~4% drop in average realisation in November (~7% YoY) due
to a drop in copper prices led to revenue growth of only 3%. All the sectors except
auto saw double-digit volume growth; the auto business was weak due to weak
primary sales, as channel inventory during the quarter was high; lower demand is
likely in 4Q due to the rollback of the excise duty cut. Communication cables’ revenue
February 24, 2015
EBIT
11%
Consumer durable on RHS
with
13%
3QFY14
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
1QFY14
4QFY13
3QFY13
-20%
2QFY13
-10%
1QFY13
0%
case
7%
2QFY14
10%
the
1QFY14
20%
is
EBIT margin (%)
9%
4QFY13
30%
so
3QFY13
40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
2QFY13
50%
Exhibit 87: …and
1QFY13
Exhibit 86: Bajaj’s non-E&P’s revenue have been declining
since the past four quarters
Finolex Cables has reported
sluggish revenue growth since the
last four quarters given the
slowdown in industrial capex
Page 52
Economy & Strategy
grew 35% YoY led by strong demand from Reliance Jio. We expect electrical cables
and wires’ revenue growth to improve in FY16 led by recovery in the auto sector; our
Auto analyst expects a pick-up in commercial vehicle and four-wheeler passenger
vehicle sales from FY16 onwards. Also, communication cables’ revenue growth is
likely to revive led by revenue booking for the NOFN order and fibre optic capex by
Reliance Jio.
-30%
capex,
as
Nov-14
Sep-14
Jul-14
May-14
Mar-14
Jan-14
Jul-13
May-13
-2%
Mar-13
3QFY15
2QFY15
1QFY15
4QFY14
3QFY14
2QFY14
-20%
1QFY14
-10%
4QFY13
0%
3QFY13
0%
2QFY13
2%
1QFY13
10%
4QFY12
4%
3QFY12
20%
2QFY12
6%
1QFY12
30%
industrial
IIP growth YoY (%)
8%
Nov-13
40%
Exhibit 89: …given
sluggish
represented from IIP growth
Sep-13
Exhibit 88: : Finolex Cables has been reporting sluggish
revenue growth for the last four quarters…
-4%
-6%
Source: MOSPI, Ambit Capital research
b) Gross margins improve for all players; Havells reports the highest
improvement
Gross margins for all the companies under our coverage have improved by 30380bps led by a 9% YoY decline in copper prices in 3QFY15. Other than cables and
wires, prices across other product categories have not seen much decline, as
companies are trying to offset sluggish revenue growth with higher gross margins.
Even the prices of electrical cables and wires have corrected with a lag (whilst the
prices of electrical cables and wires declined by 4% from October to December 2014,
it declined further by 5% in January 2015). Consequently, Finolex reported the highest
YoY increase (380bps) in gross margin, as it has the highest percentage of copper cost
to revenue at 61% in FYT14.
Exhibit 90: Finolex Cables showed the highest YoY improvement in gross margins…
YoY improvement in gross margin (bps)
400
350
300
250
200
150
100
50
0
V-Guard
Havells
Finolex
February 24, 2015
Page 53
Economy & Strategy
Dealer checks indicate weak demand but dealers
expect a pick-up in FY16
Our discussions with eight channel partners across India (Delhi, NCR, Lucknow,
Mumbai, Pune, Jabalpur, and Chennai) in the last week of December suggest that
demand has remained weak so far in 4QFY15 led by no signs of pick-up in consumer
sentiment, persistent slowdown in real estate activity and weak industrial capex.
However, there is an expectation that demand should pick-up in FY16 led by an
expectation of increased allocation in the Budget towards rural schemes like MNREGA
and affordable housing. Several companies have started focusing on Tier 3/4 cities
given the saturation in Tier 1/2 cities. Companies like Havells and Anchor have
launched products like Reo switches and Rider switches, and Bajaj Electricals is
guiding for a launch of a separate brand targeted towards tier-III and tier-IV cities.
Exhibit 91: Demand deceleration is evident from our channel checks
Product
Market
size (`bn)
in FY14
Volume
Volume
growth so
growth in
far in
3QFY15 Unorganised
4QFY15
share
(YoY)
(YoY)
Market share in FY14
Organised
share
Comment
Gainers
Losers
V-Guard
Havells
Slowdown in real estate activities has led to demand
deceleration
Finolex
KEI
Funding challenges have led to a slowdown in
project (B2B) demand and stalled any hopes of a
recovery over the next 4-6 months
Legrand
Havells
Similar to housing wires, domestic switchgears have
seen a demand deceleration due to weak real estate
activity
Havells
Anchor
Slowdown in real estate has impacted demand for
switches
Electrical cables and wires
Housing wires
84
-2%
5%
35%
Industrial and
power cables
125
-2%
5%
35%
Polycab - 20%
Finolex - 9%
Havells - 9%
V-Guard - 6%
Polycab - 20%
KEI – 12%
Finolex - 11%
Havells - 9%
Switchgear and switches
Domestic
switchgears
24
0%
5%
30%
Switches
21
0%
5%
35%
Havells - 29%,
Legrand - 25%
Schneider - 16%
Anchor - 35%
Havells – 20%
Fans
Premium
27
5%
6.5
Small
appliances
65
8%
Crompton
Havells
35%
Havells - 10%
Luminous,
Polycab
Bajaj
35%
Racold – 25%
V-Guard – 21%
20%
V-Guard
AO Smith – 9%
Induction
cooktops
6
Stabiliser
12
79
Philips + Preethi – 20%
Bajaj – 15%
Havells
Maharaja – 9%
TTK Prestige – 23%
50%
Philips – 15%
TTK Prestige
Bajaj Electrical – 15%
V-Guard – 25%
67%
Capri – 9%
V-Guard
Premiere – 7%
Luminous – 23%
Microtech – 12%
15%
V-Guard
Sukam – 11%
V-Guard – 1%
30%
8%
UPS, digital
UPS
Crompton – 22%
Orient – 13%
Bajaj – 11%
10%
Sub-economy
28
and economy
Consumer appliances
Electric water
heaters
10%
10%
10%
13%
10%
10%
After an impressive growth in 1HFY15 due to an
extended summer, demand has moderated in
2HFY15
Strong winter (temperature dropped to the lowest in
AO Smith,
five years in Delhi) has led to strong demand for
Racold, Bajaj water heaters; V-Guard’s Pebble series is helping the
company to gain market share
Bajaj
Bajaj
The demand recovery which was visible during the
festival season in September and October has
disappeared and the volume growth from November
has decelerated compared with 2QFY15
Everest
Sukam
After registering a splendid growth of 26% in
1HFY15, stabiliser, UPS and digital UPS have seen a
moderation in growth due to decline in power
outages across India
Lighting & Fixtures
CFL, LED,
lighting
23
40%
6%
Luminaries
36
5%
40%
Philips – 23%
Bajaj – 24%
Crompton – 15%
Havells – 7%
Philips - 35%
Havells – 13%
Bajaj – 11%
Syska,
Philips,
Chinese
players
Syska,
Havells
Bajaj, Crompton
The decline in LED prices by 60% over the past one
year is leading to a fast shift in demand from CFL to
LED Consequently, traditional CFL players are losing
market share to Philips, Syska and Chinese players
Weak industrial capex and consequent poor project
Bajaj, Philips,
demand (B2B demand constitutes 50% of the overall
Crompton
market) have impacted demand materially
February 24, 2015
Page 54
Economy & Strategy
Here are the key takeaways from our channel checks:
Deceleration in demand since November: Demand since November 2014 has not
recovered across several categories, as per our discussions with channel partners.
Whilst the recovery in B2C demand has been slower than our expectation, B2B
(project) demand has slowed down further. The liquidity challenges have stalled any
hope of a revival in project orders for the next 3-5 months.
Consequently, demand for cyclical products, such as electrical cables and wires,
switchgears and lightings, has been impacted more than the demand for consumerled products such as consumer appliances and fans. Cyclical products such as
electrical cables and wires, switchgears and lightings are likely to grow at a slower
pace of -2 to 5% YoY vs consumer-led products such as consumer appliances and
fans, which are likely to grow by 8% YoY. Stabilisers and inverters, which registered a
healthy growth of 26% in 1HFY15, are likely to see a moderation in growth (10% YoY
growth in 2HFY15E), as power outages have declined across India.
Falling raw material prices may lead to margin expansion: Margin expansion
will likely be a silver lining for the light electrical companies. Our channel checks
suggest that the prices of the final products have not declined (expect for wires),
despite a 12% and 25% correction in copper and crude prices (key raw material for
PVC and plastic) in INR terms over the last three months. Cables and wires have seen
price cuts of 9%. Management teams suggest that companies are looking at
improving margins, as topline growth has been lower than their expectation and
industry margins have been depressed for the last two years.
Exhibit 92: Copper and crude prices have corrected by
12% and 25% respectively over the past three months
430
5,500
410
5,000
Exhibit 93: This should aid in margin expansion, as it forms a
major component of the raw material cost
FY14 (in ` mn)
Share of cables and wires in total
revenue
Finolex V-Guard
94%
Havells
36%
41%
1,876
449
2,212
8.0%
3.0%
4.7%
10.6%
9.1%
8.7%
4,500
390
4,000
Total plastic / PVC consumed
3,500
- as a % of revenue
350
3,000
- as a % of total raw material consumed
330
2,500
4-Feb-15
21-Jan-15
7-Jan-15
24-Dec-14
10-Dec-14
26-Nov-14
12-Nov-14
370
MCX copper spot (Rs/kg)
MCX crude spot (Rs/barrel)
Source: Bloomberg, Ambit Capital research
Total copper consumed
14,288
3,505
8,701
- as a % of revenue
61.1%
23.1%
18.4%
- as a % of total raw material consumed
80.9%
70.9%
34.2%
Source: Company, Ambit Capital research; Note: We have excluded the goods
purchased from vendors, as the break-up of the raw material consumption therein
is not available; we have excluded Bajaj Electricals from the above analysis as
the break-up of raw material consumption segment-wise is not available and the
company also operates in the E&P business
Demand likely to pick up in FY16 led by expectation of increased allocation
towards rural spending and stabilisation of copper prices: Inventory levels
(especially for cables and wires) in the channel are currently very low given the falling
copper prices (prices of cables and wires are cut whenever there is a fall in the copper
prices and vice versa given the commoditised nature of the business). However, since
the first week of February, copper prices have started stabilising; if this trend continues
or if the prices started trending upwards then companies could see strong revenue
growth led by re-stocking from the channel partners.
Furthermore, there is an expectation amidst corporates and channel partners that the
upcoming Budget may dole out more allocation towards rural spending (schemes like
MNREGA, Indira Awaas Yojna, etc) and affordable housing, which can lead to a
recovery in rural demand. Further, if in FY16, the monsoon is relatively better as
compared to FY15 and prices of cash crops start recovering, this should help in
supporting rural demand.
February 24, 2015
Page 55
Economy & Strategy
V-Guard continues to gain market share: The non-south dealers highlighted that
V-Guard continues to gain market share in the non-south market. Whilst it is gaining
market share from Havells and Polycab in wires, it is gaining market share from AO
Smith, Racold and Havells in water heaters. V-Guard’s brand perception is improving
in the non-south market. Bajaj continues to lose market share across categories due
to the rollout of its new marketing strategy (‘Theory of Constraints’). In lighting, Syska
is gaining market share from Havells, owing to its strong brand promotion and strong
range of LED products.
Across categories, the market share for Havells has plateaued, given the rising
competitive intensity in the industry, and the lower than industry incentives by Havells
to dealers. Whilst the strength of the channel was the biggest competitive advantage
for Havells in gaining market share across categories over the past decade, this
advantage seems to be fading, with the company focusing more on controlling the
channel to maximise profits.
V-Guard continues to gain
market share in non-south
market
Bajaj is losing market share due
to the channel friction caused by
the implementation of its strategy
‘theory of constraints’
Exhibit 94: V-Guard gaining market share in non-south market
Product
Gaining market share from
Housing wires
Havells, Polycab
Stabiliser
Everest, unorganised players
UPS, digital UPS
Luminous, Sukam
Water heater
AO Smith, Racold, Havells
Industry growth would likely decline in the coming
decade; we prefer regional players
Although we expect a pick-up in rural demand in FY16 (we have modelled 14%
revenue growth for our coverage universe in FY16 vs 5% in FY15), we believe the
industry growth will slow down to the low teens in the coming decade (FY15-24) vs
high teens during FY04-14. Our discussions with channel partners suggest that the
bulk of the growth in the last decade was led by a shift in market share for organised
players from ~30% in FY06 to ~65% in FY14. Furthermore, with likely demand
saturation in tier-I and tier-II cities (as per our discussions with channel partners) and
with companies now shifting focus to tier-III and tier-IV cities, the market size is likely
to see decelerate, as the per square feet spend in tier-III and tier-IV cities is 30% lower
than tier-I and tier-II cities. Moreover, with the rising trend of premiumisation kicking
in, the life of a product has increased, which in turn is likely to lead to deceleration in
the replacement market.
Exhibit 95: Share of organised players has increased from 30% in FY06 to 65% in FY14
Share of organised players (%)
FY06
FY10
FY14
Domestic switchgears
40%
43%
70%
Industrial switchgears
60%
72%
80%
Switches
25%
50%
70%
Cables and wires
20%
56%
62%
Lighting & Luminaries
25%
40%
55%
Fans
40%
55%
70%
Industry
30%
54%
65%
February 24, 2015
Page 56
Economy & Strategy
Negative outlook on pan-India players but positive on
regional players
Given our expectation of deceleration in revenue growth for the industry over the next
decade, we believe the revenue growth for pan-Indian players like Havells and Bajaj
Electricals will decelerate in the coming decade as compared to the last decade.
Alongside this, competition has intensified significantly in the last five years, with
single product companies launching new product categories (companies like V-Guard,
Polycab and Luminous which were hitherto selling stabilisers, electrical wires and
inverters have launched new categories like fans, switchgears, switches and lighting)
and regional players like V-Guard, Polycab and Finolex Cables becoming pan-India
players.
Exhibit 96: Several new companies have entered into new product categories…
Company
Flagship product
New products launched
V-Guard
Stabilisers
Fans, switchgears, induction cooktops
Havells
Switchgear
Consumer appliances
Polycab
Electrical wires
Fans, lighting, switchgears, switches
Anchor
Switches
Electrical cables, lighting, switchgears
Luminous
Invertors
Fans, switches, CFL, switchgears
Source: Company, Industry, Ambit Capital research
Exhibit 97: …and several regional players have expanded on a pan-India basis
Company
Strong in
Expanding in
Comment
V-Guard
South
North, West, East
Finolex Cables
South, West
North and East
Polycab
West
North, South, East
Revenue share from non-south increased from 5%
in FY08 to 30% in FY14
Revenue share from North and East increased from
10% in FY08 to 20% in FY14
Data not available
RR Kabel
West
North, South, East
Data not available
Source: Company, Industry, Ambit Capital research
We reiterate BUY on V-Guard and Finolex Cables and SELL on Havells and
Bajaj.
Exhibit 98: Relative valuation – light electricals
Mcap
CMP
US$mn
INR
Havells (consolidated)
2,659
270
Havells *(standalone)
2,604
263
TTK Prestige
592
3,295
V-Guard
463
982
Company
TP
Upside/
(Downside)
INR
(%)
FY15
FY16
FY17 FY14 FY15 FY16 FY17
SELL
248
-8%
40.3
30.1
22.8 28.7 23.1 26.0
NA
NA
NA
35.9
32.3
25.2 23.9 19.8 19.1
BUY 3907
BUY 1267
STANCE
P/E (x)
RoE (%)
CAGR (FY14-17)
Revenue
EPS
28.1
8.7
18.6
21.3
13.4
10.5
19% 33.93 23.88 18.68 19.1 26.7 32.0
36.2
16.2
25.5
29%
31.2
19.6
32.9
36.1
24.4
17.8 24.3 23.3 28.2
Finolex Cables (standalone)
613
254
BUY 318
25% 19.3 16.0
13.3 20.5 17.2 18.3 19.6
11.2
14.0
Finolex Cables (core
613
254
NA
NA
NA 17.5 13.9
11.1 25.1 20.2 21.4 22.6
11.2
14.7
business)#
Bajaj (non-E&P)
364
226
SELL 204
-10% 32.0 41.3
28.8 19.4 10.5 16.8 24.6
11.2
7.3
Average (excl. Havells
consolidated and Finolex
29.1 25.3
19.1 21.3 19.1 22.1 25.4
13.8
17.5
Core)
Source: Bloomberg, Ambit Capital research; Note: * We have calculated standalone P/E by reducing Ambit’s fair value of Sylvania of Rs9/share), # we have taken
core EPS and P/E for Finolex Cables by reducing the fair value of investments of Rs75/share from CMP and reducing the investment income from EPS; ^ we have
reduced the Ambit fair value of Rs13/share for the E&P business from CMP for calculating Bajaj’s non-E&P valuation; Prices as on 18 February 2015
February 24, 2015
Page 57
Economy & Strategy
Stock implications
Top BUYs
V-Guard (BUY, Mcap US$463mn, TP `1,267/share, 29% upside)
 Fast emerging as a pan-India player: V-Guard is strengthening its non-south
franchise by beefing up its distribution network and recruiting marketing
employees from leading competitors. Consequently, the company is gaining
market share in all the five product categories in non-south.
 Expansion of scale in non-south is margin-accelerative: Non-south’s EBITDA
margins have starting improving with expanding scale (improved from -1.3% in
FY12 to 1.5% in FY15). There is tremendous scope for further improvement, as
non-south EBITDA margin is 980bps lower than south margin.
 Product diversification: V-Guard is successfully reducing its dependence on
stabilisers by launching new products. The revenue share of stabilisers has
declined from 37% in FY08 to 18% in FY14 led by strong growth in newer
products such as inverters, fans, induction cooktop and switchgears
 At CMP, V-Guard is trading at a one-year forward P/E multiple of 25.7x, a 91%
premium over its five-year average forward P/E multiple of 13.3x. The premium is
justified and is likely to widen further, as the company achieves scale in the nonsouth market, leading to improvement in margin by 180bps and in RoE by 680bps
over FY14-17E. Moreover, V-Guard is trading at 17.8x FY17 P/E, a 30% discount
to Havells standalone despite higher FY14-17E EPS CAGR of 33% vs Havells’
10.5% and 7000bps higher FY17E RoE of 31.2% vs Havells’ 22.8%. We believe a
‘growth company’ like V-Guard deserves to trade closer to the price multiple of
a ‘market leader’ like Havells. We value V-Guard at `1,267, implying FY17 P/E
of 22.9x (a 7% discount to Havells).
Finolex Cables (BUY, Mcap US$613mn, TP `318/share, 25% upside)
 Beneficiary of a recovery in industrial capex; operating at 60% utilisation:
Empirical evidence suggests a strong correlation between IIP growth (represents
B2B businesses) and Finolex’s revenue growth. Finolex is already sitting on a
meagre 60% utilisation given its recent brownfield expansion at Roorkee (north
India). Consequently, if revenue growth picks up, Finolex will see favourable
operating leverage. Also, its J-Power system joint venture has recently
received certification for 132KV which means it will be a beneficiary as and
when the capex on strengthening the T&D infrastructure picks up. Thus, a recovery
in the capex cycle remains the biggest catalyst for the stock.
 EBITDA margin to expand given positive impact of operating leverage:
Finolex’s EBITDA margins in the past have expanded in line with a high revenue
growth led by the favourable impact of operating leverage. Given our expectation
of revenue growth of 15% in FY16 and 17% in FY17, we expect EBITDA margins to
improve from 10.5% in FY14 to 11.2% in FY16 and 11.7% in FY17.
 Entry into high-margin product (switchgear): Finolex is geared to launch
switchgears in FY16. As three players (Legrand, Havells and Schneider) account
for ~70% of the LV switchgear market (~`50bn), there is ample of opportunity for
Finolex to grab market share. Industry participants suggest that Finolex is well
placed to succeed, as: (1) technology is no longer an entry barrier to manufacture
switchgears, (2) its brand is already perceived as ‘safe’ (its wires are known for
higher conductivity), and (3) it already has a distribution network that can be
leveraged to sell switchgears in the replacement market (~50% of the market).
 On core EPS, the stock is trading at 13.9x, a 48% discount to its peers despite its
FY16E core RoE of 21% vs peers’ 22% and FY14-17E core EPS CAGR of 15% (vs
peers’ 18%). We have calculated core P/E by excluding the investment income
from EPS and excluding the fair value of investments of `71/share from CMP.
However, as the company increasingly invests in new product categories (like
switchgears which are high-margin and niche categories) and also increases its
advertisement spend to further improve its premium pricing in cables and wires,
we expect its RoIC to improve to 24.6% in FY16 from 20.4% in FY14. As this
happens, we expect the valuation multiples to re-rate closer to its peers.
February 24, 2015
Page 58
Economy & Strategy
Top SELLs
Havells (SELL, Mcap US$2.7bn, TP `248/share, 8% downside)

Havells to lose market share: Havells will lose market share from hereon due
to a rise in competitive intensity and attrition at the senior marketing level. Havells
has not launched any blockbuster new products in the last three years apart from
domestic appliances wherein its range is restricted to the premium category (20%
of market). Losing market share is not uncommon in LE, given low barriers to
entry and reducing scope for product innovation/portfolio expansion. Havells has
already seen stagnation in market share in switchgears and fans.

Life after QRG’s demise may not be the same: Our discussions with exemployees and channel partners suggest that Mr Anil Gupta (CMD) is not as
aggressive and as quick a decision-maker as Mr Qimat Rai Gupta (QRG).
However, he is more professional and process-oriented. His connection with
dealers is good, but he does not enjoy the same ‘emotional’ bond as dealers
enjoyed with QRG. The next 9-12 months will be a testing time for Anil, as he
engages with channel partners (Havells’ key strength) in the absence of QRG.

Ability to launch new product categories is limited: Whilst Havells is the
most-diversified light electrical company, it also has limited avenues to expand its
product portfolio given there are very few product categories wherein Havells is
not amongst the top-four players. Our discussion with the channel suggests that
security systems and pipes are the only two product categories which Havells can
enter by leveraging its existing distribution network. However, competition in this
segment is very high given that both these product categories are B2B and hence
scope for earning similar margins as the light electrical business is limited.

Havells’ standalone franchise (after adjusting for Sylvania’s fair value of 9/share;
implied FY17E EPS of 5.8x) is currently trading at its all-time high multiple of
25.2x on FY17E EPS. Whilst Havells is a market leader in the light electrical
sector, it is also the most expensive stock in the sector despite its lowest EPS CAGR
of 10.5% over FY14-17E (vs 16.1% for Finolex Cables, the second-lowest, and
22.0% for the sector). Moreover, Havells standalone is likely to see a deterioration
of RoE of 270bps over FY14-17E vs an 880bps improvement for peers over FY1417E.
Bajaj Electricals (SELL, Mcap US$364mn, TP `204/share, 10% downside)

Theory of constraints weakening the franchise: The implementation of the
new marketing strategy (Theory of Constraints - ToC) is leading to channel friction
and causing market share loss. Under this strategy, a first time for the industry,
BJE will not dump its products to distributors at the end of the month in order to
protect its gross margin. In an industry where pricing and dealer push is the main
driver, unless BJE improves customer-connect, growth rates (11%) will be lower
than industry (~15%) over FY14-17E. Currently only 20% of the region has been
covered under the ToC and a pan-India rollout of the ToC by end-FY16
(management guidance) looks unlikely and hence we model lower than industry
growth for Bajaj over FY14-17E.

Continuing attrition and stagnating franchise: Post the exit of Mr
Ramakrishnan in 2012, BJE’s consumer business has stagnated alongside weak
financials due to multiple senior management exits; channel partners/peers
suggest continuing attrition risk. BJE has not only lost market share in products
such as appliances, lighting, and fans but also has been unable to launch any new
categories, the growth driver for most of its peers. The consumer business grew
13% over FY12-14 vs 24%/18% for V-Guard/ Havells.
February 24, 2015
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Economy & Strategy

E&P is not showing any signs of improvement: The performance of the E&P
business continued to disappoint. Despite the management guiding for a
turnaround of the E&P business every quarter since the last four quarters, the
company continues to report losses. Even, as on date, the receivables pertaining
to the old legacy projects remain elevated at `2bn; hence, there is still a likelihood
of some pending losses on BJE although we are not assuming any losses in 4Q.
Bajaj’s consumer business is trading at 29.0x FY17 EPS, a unjustified 50% premium to
peers (assuming the E&P business is valued at `11/share; implied 3.3x FY16 P/E,
~60% discount to peers), despite the consumer business to report lower EPS CAGR of
7.3% over FY14-17 vs 19.5% for peers (Havells standalone, V-Guard, Finolex Cables
and TTK Prestige). We believe the roll out of TOC is a risk to BJE’s consumer franchise,
as it is currently creating disruption in the channel which in turn is hurting BJE’s
growth. Our SOTP-based target price of `204/share values the consumer business at
`191/share (implied FY16 P/E of 26.3x; 16% discount to Havells) and the E&P
business at `13/share (implied FY16 P/E of 3.3x; ~60% discount to peers).
February 24, 2015
Page 60
Economy & Strategy
Agri Inputs
Ritesh Gupta, CFA, [email protected], +91 22 3043 3242
Moderating growth in MSP prices and lower farm realisations would impact
farmer sentiment in FY16. However, the growth rates could still be supported
by good monsoons and healthy absolute MSP levels. Whilst sustained weaker
growth in MSPs for the next 2-3 years would clearly hit growth, if such a
reduction in subsidies is used to invest in irrigation/storage infrastructure
then this would be a positive step from a medium- to long-term perspective.
Reduction in leakages and a move to DBT for a significant proportion of
subsidies would also give more cash in the hands of farmers. On the
agrochem side, growth rates for agrochem players would be supported by
rising adoption of high-value molecules (due to increasing awareness
amongst farmers), rising adoption of herbicides (rising cost of labour due to
urban migration) and fungicides (due to demand for high-quality agri
produce). Companies with higher share of generic products may be impacted
more if weak realisations persist for long. PI Industries is our TOP BUY.
Divergent growth rates in FY15 so far…
In agrochemicals, the growth rates in FY15 have been divergent so far, with certain
players growing at mid-to-high single digits whilst certain players such as PI, UPL and
Bayer growing handsomely at 16-18% YoY. Players with a higher share of generic
molecules and lack of new differentiated product launches clearly struggled in the
absence of a differentiated proposition to the farmer at a time when acreages were
declining and output prices were also subdued.
Exhibit 99: 9MFY15 domestic business sales growth
20%
16%
17%
18%
Bayer
UPL
15%
10%
5%
8%
8%
Excel
Cropcare
Dhanuka
10%
2%
0%
Rallis
Insecticide
India
PI
Source: Company. Note: Estimated growth for Rallis India, as it does not report the segment separately.
FY15 has been a challenging year
“FY15 has been a challenging year following the very turbulent southwest monsoon.
Kharif season was quite volatile in a sense and the result of that, the numbers are there
now. The food grains output has fallen by 7% and across crops there has been a sharp
fall. So the erratic rainfall, rice spells and reduced crop acreages all have led to lower
kharif yields and lower production. This was coupled with the lower crop prices. Crop
prices for most of the crops softened. So that together they have led to lower incomes
for the farmer arising out of kharif as we entered into rabi. In addition to this lower
farm income, there is also a tight cash flow constraint in the market also led by the
shortage of urea which is also drawing out a lot of cash from the market. So this is the
fall-out of the kharif and the situation in the marketplace. So as we go down into the
rabi, the crop acreage to-date is actually down 5%. And the monsoon has been deficient
or the departure from normal is around 33%. So water deficit and commodity prices
have impacted the post rain sowing across the country. Barring wheat in a few
geographies, area under maze, oilseeds and pulses particularly got affected. Area
under these crops has dropped by over 15%.”
-
V Shankar, MD Rallis (3QFY15 call)
February 24, 2015
Page 61
Economy & Strategy
Exhibit 100: Kharif sowing patterns (in ‘000 acres)
Area sown
reported
Crop name
Normal Normal
area for area as
whole Kharif on due
date
season
Rice
This % of normal
year
for whole
2014
season
Absolute Change
over (+/-)
Last
year
2013
Normal
as on due Last year
date
391
362
380
97
376
18.5
3.6
72
75
78
109
82
3.4
-3.8
Total Coarse Cereals
208
198
182
88
196
-15.7
-13.7
Total Cereals
599
560
562
94
572
2.8
-10.1
Total Pulses
108
107
102
95
109
-5
-6.7
Soybean
100
104
110
111
122
5.9
-12
Total oil seeds
183
180
178
98
195
-1.7
-16.4
Cotton
110
111
127
116
114
15.5
12.2
47
48
49
104
50
0.4
-1.6
9
9
8
92
8
-0.4
-0.2
1,055
1,015
1,027
97
1,049
11.6
-22.9
Maize
Sugarcane
Jute
All crops
Source: GoI
Exhibit 101: Rabi season (in ‘000 acres)
Area sown reported (in lakh
hectares)
Crop name
Normal
Average
area for
area as on
whole Rabi
due date
season
Wheat
Absolute Change
over (+/-)
This year
2014
% of normal
for whole
season
Last Average as
year
on due
2013
date
105
315
9.6
-9.3
Last
year
290
296
306
Rice
43
15
15
36
18
0.4
-2.3
Maize
Total Coarse
Cereals
Total Cereals
13
13
15
113
15
1.9
-0.6
62
60
57
92
60
-3.7
-3.3
396
372
378
96
393
6.3
-14.8
Total Pulses
132
141
139
105
154
-2.7
-15.8
87
88
79
92
89
-8.2
-9.2
614
601
596
97
636
-4.6
-39.8
Total oil seeds
all crops
Source: GoI
Dhanuka’s growth was aided by new launches but we believe lower soya acreages
and higher competition for Targa Super impacted growth rates.
Rallis had its own challenges related to strict working capital norms and lack of new
differentiated products.
…however, adoption by farmers of good cost proposition products and
response to good farmer connect programmes remains strong
Bayer Cropscience India continues to deliver strong growth rates despite a bad crop
season driven by a mix of steady innovation rates of 25% (sales contribution from
products launched over the last four years) and price hikes taken over the year. We
believe the ability to take price hikes in a seemingly bad season without a significant
impact on volumes clearly shows the strength of the brand enjoyed by the company.
Our channel checks suggest that Bayer’s efforts on distribution expansion and strong
farmer connect initiatives have been aiding its growth rates.
PI Industries continued to witness good success driven by the success of Nominee
Gold and Osheen. Our channel checks suggest Osheen too had a spectacular season.
Steady rice acreages and MSP prices also aided the growth momentum. Nominee
Gold continues to grow well driven by rising penetration of the product. Melsa
(launched in FY14) also has been gaining traction. In-licensed products account for
nearly 70% of the company’s revenues. PI’s 9MFY15 growth of 16% was in line with
the domestic growth of 18% in the last four years.
February 24, 2015
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Economy & Strategy
UPL delivered strong growth rates driven by good growth in the herbicide portfolio
(led by wheat) and good performance of core brands such as Ulala, Lancer Gold,
Starthene Power, Saaf, and Saathi. New products, Iris and Eros, both herbicides
performed well ahead of the management’s expectations.
Clearly, a higher share of differentiated products, good alignment to
herbicides/fungicide products and strong farmer connect are few key drivers that we
believe are incrementally becoming important. Farmers are ready to pay 4x the price
(as demonstrated in case of certain products such as Rynaxypyr) till the time they are
more than compensated by savings in labour (due to lower number of sprays) and
better yields. Pesticides account for 15-20% of farmers’ crop expenditure but farmers
can clearly improve yields by 30-40%.
Exhibit 102: Quotes from recent calls/press releases on the domestic performance in 3QFY15
Speaker
Comment
“The performance shown by us in the domestic agri-inputs comes on the back of our strong brand introductions over the
last few years and the ongoing farmer connect initiatives that we run. I am pleased that we have been able to deliver
Mayank Singhal, CEO, PI
despite unfavourable agro-climatic scenario. We have a very capable product portfolio, that is showing progressively
Industries
better volumes YoY and it is our belief that the new broad spectrum insecticide launched by us will trace a similar growth
trajectory going forward.”
“In the crop protection category, let me also add that category like herbicides, which used to be very small, not very long
ago is increasing at a very, very fast pace, purely because it brings in a labour-saving device. It helps in cutting down
costs and agony for the farmers in finding adequate labour to do the farming. There is also a lot of requirement of
V Shankar, CEO, Rallis India
fungicides particularly on fruits and vegetables. And fruits and vegetables has been a growing category in India and
value-added fruits and vegetables are increasing in a very handsome way. So these are all good, good opportunities
unfolding. There is room for good technology; there is room for value-added solutions. So I do see that all these
categories have very, very robust future.”
“We have launched in India two products and both are herbicides. One is Iris, which is for soybean and the pulse crops.
The other herbicide we have launched is rice herbicide. It is called Eros, which is used in the transplanted rice. Both the
UPL Management
herbicides, they have performed well, especially the update of the herbicides is going quite well in our country because
of the increasing labour shortages and obviously the cost of labour also has significantly gone up.”
Source: Bloomberg transcripts, company press releases
Exhibit 103: Agrochemicals and seeds growth rates
25%
18% 16%
12%
FY15Q3
FY15Q2
FY15Q1
FY14Q4
2%
FY14Q3
FY14Q1
FY13Q4
FY13Q3
FY13Q2
FY13Q1
FY12Q4
FY12Q3
FY12Q2
FY12Q1
FY11Q4
FY11Q3
FY11Q2
FY11Q1
FY10Q4
FY10Q3
FY10Q2
FY10Q1
FY09Q4
FY09Q3
FY09Q2
50%
41%
45%
40%
32%
35%
27%
30%
26%
22%
25%
21%
20% 19% 18%
19%
18% 18%
20% 15%
16%
14%
13%
12%
15%
11%
10%
5% 5%
5%
0%
Subdued growth in 2Q/3Q due
to channel inventory correction
post
a weak Kharif season.
Weak monsoons and bigger
crops such as cotton had lower
pest incidence. Base was also
34% high after two good seasons of
FY13 and FY14.
FY14Q2
FY12 growth rates were
subdued despite normal
monsoons due to lower pest
incidence in rice and
sugarcane.
Growth rates were healthy
driven by
new product
introductions, rising MSPs
and high pest incidence.
Source: Company data
February 24, 2015
Page 63
Economy & Strategy
Exhibit 104: India domestic agrochemicals growth rates have been quite healthy over the last six years (` mn)
Revenues
FY08
FY09
FY10
FY11
FY12
FY13
FY14
6 Year CAGR
BASF India Ltd - Agri
3,702
3,277
4,863
6,309
7,914
9,229
10,448
19%
Bayer CropScience - Agrochem
6,421
9,825
11,599
13,255
14,207
16,283
20,450
21%
Bayer CropScience - Actives
1,251
1,657
1,029
3,992
4,634
5,543
6,292
31%
Dhanuka Agritech Ltd.
2,486
3,368
4,081
4,910
5,292
5,823
7,384
20%
Excel Crop Care Ltd.
5,342
7,009
6,486
7,394
6,950
7,791
9,841
11%
Gharda Chemicals Ltd.
8,433
8,433
8,948
9,864
10,583
11,591
11,591
5%
Insecticides (India) Ltd.
1,976
2,637
3,774
4,501
5,218
6,167
8,641
28%
Meghmani Organics Ltd.
6,001
7,914
8,163
10,451
10,622
10,585
11,783
12%
Nagarjuna Agrichem Ltd.
4,148
6,054
6,529
5,701
6,431
6,006
6,358
7%
PI Industries Ltd. – Domestic Business
3,703
4,057
4,140
5,800
6,133
6,869
8,860
16%
Rallis India Ltd. – Domestic Pesticide Business
5,002
6,052
7,323
8,421
8,181
8,835
10,161
13%
Sabero Organics Gujarat Ltd.
Syngenta India Ltd.
UPL Ltd. - India
Agrochemicals
Growth % (y/y)
2,073
3,773
4,303
4,108
3,584
5,148
7,240
23%
11,927
13,802
17,553
20,771
25,399
29,617
30,686
17%
8,011
10,326
11,970
14,940
17,190
18,050
22,710
19%
70,475
88,184
100,761
120,417
132,338
147,538
172,445
16%
25%
14%
20%
10%
11%
17%
High MSPs are not the only factors driving
agrochemical growth rates
Most of the leading agrochemical players have recorded strong growth rates over the
last few years led by but not limited to: (1) growth in MSP prices, (2) rising adoption of
patented molecules, and (3) growth in herbicides due to rising labour rates.
Exhibit 105: Agrochemical companies have been driving the high cost:benefit value
proposition of pesticides to farmers
India Crop Yield
Avoidable Loss
Cost: Benefit
Cotton (non BT)
40-90
1:7
Paddy
21-51
1:7
Mustard
35-75
1:12
Sunflower
36-51
1:8
Groundnut
29-42
1:26
Maize
20-25
1:3
Pulses
40-88
1:4
Sugarcane
8-23
1:13
Vegetables
30-60
1:7
Fruits
20-35
1:4
Source: IARI
We believe only 30% of arable area is under pesticide treatment. States like Punjab,
Haryana, and Andhra Pradesh lead pesticide consumption whilst UP, MP, and Orissa
lag on the consumption curve. Farmer awareness is on the rise, as the younger
generation is more educated. Also, private efforts on educating farmers have been
rising. This is driving increased use of pesticides.
February 24, 2015
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Economy & Strategy
Rapid growth in patented molecules
India’s crop protection industry is mostly generic, with around 80% of the molecules
(vs 50% globally) being generic and with the distribution network and brand image
acting as the product differentiator. However, the patented or proprietary offpatent segment is growing at a rapid pace. After India became TRIPS-compliant
and started giving product patent protection, MNCs have turned more comfortable in
launching their patented products into India. Indian companies too have been able to
in-license many patented products from global innovators in this better IP
environment.
Case study: Coragen (a Dupont product)
This new product from Dupont is able to drive much more value growth for the
company on a per acre basis, materially increasing the overall market size.
The product requires much lower dosage, resulting in better gross margins for the
company. The company is also able to charge a premium (measured in pricing
realisation/acre of area under usage) on these products, further aiding gross margins.
It’s a win-win for farmers as well, as their consumption goes down significantly, and
yield improvement takes care of additional costs. The product, as per farmer checks,
seems to be aiding yields by 5-7 tonnes/acre.
Exhibit 106: Product comparison – Coragen
Coragen (new technology)
Dosage
Cost
Number of Sprays
Yield
Caldan, Thimet (Old technology)
60 ml (paddy, soybean, tomato, arhar,
chilli) 150ml (sugarcane)
1600/acre/spray
250ml – 1000ml
350/acre/spray
1
3
35-37 tonne/acre
28-30 tonne/acre
Source: Dupont Management Interview, Hindu Business Line
Change into pest-specific chemistry a key driver
Farmers are incrementally moving toward target pest-specific chemistries rather than
general ones. This is driving a tremendous change in value realisations as well as
product effectiveness. To break up the growth in the agrochemicals space, nearly
60% would be due to improved chemistries and 40% would be from an increase in
treated area. However, the long gestation period of registration of ~5-10 years is a
big challenge in terms of bringing new products to the market.
With strong 16-18% growth over the last couple of years, many companies have
aggressively been launching new products. MNCs have launched a couple of
blockbuster products from their parent’s portfolio whilst Indian companies too have
been aggressive on licensing from other MNCs that do not have a strong Indian
distribution.
The exhibit below highlights the key factors for such a shift towards higher value
chemistries.
Exhibit 107: Whilst affordability could be challenged by lower growth in MSPs, rising farmer awareness and improved
distribution reach will continue to aid agrochemicals growth rates
Reason
Explanation
Rural affordability for higher-priced agri inputs is on the rise driven by better realisation over the last few years. Farmers
incrementally focus on better yields and invest more if they see some signs of benefit. Availability of credit too has
improved.
Improved efforts by agrochemical companies to educate farmers about advanced chemistries have led to increased
adoption of high-value agrochemicals. A significant proportion of this pesticide consumption is non-specific in nature,
Improved farmer awareness
commanding lower value. Crop- and pest-specific solutions are still limited despite significant growth over the last
decade.
On the supply side, both Indian and foreign players have been launching new products and focusing on engaging with
Availability
farmers. Companies have improved their distribution reach, which has led to far deeper availability of branded products.
Better affordability
February 24, 2015
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Economy & Strategy
Rising labour shortage to promote adoption of
weedicides
Various factors such as urban migration, NREGA spends and other opportunities in
the rural ecosystem have led to a decline in the availability of agriculture labour. As a
result, wages have shot up significantly in rural areas. That has also driven
incrementally better economics for use of weedicides. Newer generations are also less
keen on manual labour and look for weedicide solutions.
Herbicides brands such as Targa Super, Nomine Gold, and Roundup have
gained significant scale over the last few years
Launch of new products and awareness creation by individual companies amongst
farmers have also helped overall growth rates. Over the past few years, Nominee
Gold (Rice herbicide, PI Industries), Targa Super (Soybean crop herbicide, Dhanuka
Agritech) have gained tremendous success, achieving a revenue size of `2bn-3bn in a
small period of 4-5 years since launch. Monsanto’s Roundup also doubled its size
from `0.9bn in FY11 to `2.1bn in FY14. PI Industries’ Nominee Gold continued to
register strong growth rates in FY15 as well driven by rising adoption and better rice
acreages (up 4% YoY). Targa Super witnessed some impact in FY15 due to lower
soybean acreages (down 12% YoY).
“In the crop protection category,
let me also add that category like
herbicides, which used to be very
small, not very long ago is
increasing at a very, very fast
pace, purely because it brings in
a labour saving device. It helps in
cutting down costs and agony for
the farmers in finding adequate
labour to do the farming.
There is also a lot of requirement
of fungicides particularly in fruits
and vegetables. And fruits and
vegetables has been a growing
category in India and valueadded fruits and vegetables are
increasing in a very handsome
way.”
Slowdown in wage inflation to impact herbicide growth momentum?
Whilst we agree that wage inflation slowed down in FY15 but this is unlikely to affect
the strong trends in weedicide growth, as the cost proposition for weedicide is better.
However, we agree that a sustained low single-digit growth in rural wages for
multiple years may slow down the expansion in herbicide penetration. Monsoons are
important for weedicide consumption given that a dry season leads to lower
requirements for weedicide sprays.
Exhibit 108: India pesticides segment breakup
-
Mr. V Shankar, MD, Rallis
India during the 3QFY15
post-results conference call
Exhibit 109: Worldwide pesticides segment breakup
Biopesticides
and Others,
4
Fungicides,
16
Others, 7
Insecticides,
22
Herbicides,
44
Herbicides,
15
Insecticides,
65
Fungicides,
27
Source: FICCI
Source: FICCI
Exhibit 110: Rural wage inflation has slowed down but
continues to make a case on a cost basis for rising adoption
of chemical weedicides (YoY growth in %)
Exhibit 111: Rising
urbanisation
challenges on availability of
25%
21%
17%
20%
10%
6%
7%
15%
10%
4%
5%
75
72
February 24, 2015
CY14*
CY13
CY12
CY11
CY10
CY09
CY08
CY07
CY06
0%
Source: RBI
posing
(in %)
18%
15%
15%
trends
are
rural labour
1991
2001
68
67
2011
2014E
Source: ICAR
Page 66
Economy & Strategy
Exhibit 112: Monsanto Weedicide Glyphosate (generic) grew by 2.4x over FY11-14
(indexed revenues)
235
250
200
156
150
100
113
100
50
FY11
FY12
FY13
FY14
Source: Monsanto annual report
Monsoons are a dampener but FY16 to be a fresh slate
Over the last few years, agrochem growth rates have been in healthy double digits
due to: (1) rising aggression on farmer engagement programmes and distribution
expansion by MNCs and top Indian players, (2) strong growth in herbicides (led by
increasing adoption of chemicals over physical labour) and fungicides (rising demand
for better-quality fruits and vegetables), and (3) introduction of new-age molecules
(such as Rynapyxyr) which drove up value realisations per acre significantly.
Demand for high-quality fruits and vegetables is clearly rising driven by growth in
organised retail and growing affluence of consumers in India. Fruits and vegetables
contributed 13-14% to the agrochemical pie 4-5 years back and now they contribute
close to 20% of overall pesticide consumption. Pricing remains sticky, and even if
inflation comes off significantly, farmers will continue using agrochem products due to
the benefits of the product.
Exhibit 15 below clearly shows that growth rates have held up strongly even in bad
monsoon years such as FY10 and FY13.
Growth may sustain in healthy double digits in FY16
Many industry participants expect market growth to remain in double digits despite
moderation in MSP growth. In addition, organised players are gaining market share
from lower-end players which thrived due to lesser availability and reach of branded
products. These players believe unless MSPs start declining meaningfully or growth
remains muted for the next 2-3 years, current industry growth rates will not face a
material downside, as farmers are still getting much more benefit for every rupee
invested in pesticides. Clearly, drop in acreages, bad weather trends (such as fewer
incidences of pests and lower incidence of weeds due to weak monsoons), and
irreversible damage to standing crops impact pesticide consumption. But these are
temporary impacts and vary every year.
Many participants also believe that direct investments such as in irrigation
infrastructure and storage facilities are much more beneficial than subsidy or free
cash distribution programmes like MNREGA. In addition, lower base from weaker
FY15 sales and inventory correction in channel in 2HFY15 will also support sales
growth in FY16.
February 24, 2015
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Economy & Strategy
Exhibit 113: Agrochem growth for top-15 players aggregated has held up well despite
bad monsoons over the last few years
Agrochem growth (%)
30%
Monsoon Departure vs. Normal (%)
25%
20%
20%
17%
14%
10%
10%
2%
2%
FY11
FY12
11%
6%
10%
0%
-10%
FY09
-2%
FY10
FY13
-7%
FY14
FY15E
-12%
-20%
-22%
-30%
Source: Company data, Ambit research. Note: Agrochemicals growth is based on sum of leading 15 companies’
sales.
Global commodity price crash
“I think in India the agri commodity prices are relatively lower as compared to the
global prices. Wheat is still around $300 or there about or little bit plus. India’s wheat
prices are in the range of $220 at the farmer level. So I think there is still a lot of gap
between what the Indian farmer gets and what the global farmer gets. I do not think the
subsidies will be disrupted in a big way and also in a short span of time. So I think we
should not see much impact of commodity prices as far as the Indian consumption is
concerned on a lot of cash crops. Prices are still good, the price of oil seeds continues to
be good, the only commodity which is coming under major attention globally is corn
where the prices have dipped below $4 per bushel. But in India corn is not a very
significant crop price; here rice and wheat are the major drivers and both come under
MSP. So what you are saying is right for the rest of the world, it will not have major
impact on consumption…”
-
For agrochem growth, good
monsoons are important but
geographical and time
distribution are also important
Mr. Kapil Mehan, MD, Coromandel International Limited (2Q FY15 earnings
conference call)
Channel inventory levels a concern for next year’s growth?
We extensively checked with various industry participants (dealer, sales officers, midlevel managers) if unsold inventory with the channel will choke next year’s growth.
What we understand is that such issues would be player-specific. Most of the credible
industry players were forced to take corrections in 2HFY15 to aid receivable
collections and meet expiry norms.
Some of the industry players such as Syngenta took inventory correction in 3Q. Bayer
apparently had already been cautious on inventory placements and its channel
inventory seems to be in control. General feedback in our channel checks was that
MNC players were careful enough to rotate their unused inventories from one state to
another. Some domestic players corrected channel inventory in 3Q and the current
quarter. Rallis also pulled back inventory placement post 1Q once the company
realised that the season was not panning out as per their expectations.
Player such as Insecticides India and Excel had higher inventories. We believe pureplay generic players will face higher difficulties next year, as considerable inventories
are already there in the channel. Some of our channel checks suggest that the
inventories in the system are higher by about 20% for generics. Nonetheless, even the
players whose channel inventories are controlled will face repercussions of the
channel inventories of other generic players.
We believe 4Q will again be muted given the inventory correction in the channel.
February 24, 2015
Page 68
Economy & Strategy
Exhibit 114: Management commentary on inventory
Management
Comment
“Given these sets of conditions, demand has been muted along with
the inventory, which is already there in the pipeline. And therefore,
as you know, our way of working is to align our sales and
V Shankar, MD, Rallis
placements to consumption. So all this has resulted in volumes
being a bit mute on the domestic side. And we have made sure that
our focus on cash and collections is relentless and it continues.”
“As per the information definitely in the industry there is huge
M K Dhanuka, MD, Dhanuka Agritech inventory available, but with Dhanuka that is not the case. We have
normal inventory, which we have usually every year.”
Source: Company
Players with excess inventories of generics to face pressure on margins
The other bigger challenge for the players with higher inventories on their books is
that the prices for some generics (led by price cuts from the Chinese) have already
started to drop post the crude price correction. Players sitting on inventories with
higher costs might see pressure on gross margins, as they liquidate their inventories at
market prices, which could be lower.
Exhibit 115: Inventory levels – A concern for next year?
Inventory
Days
Consolidated data
Payables
Days
Receivable
Days
Cash Conversion
Cycle
1HFY15
1HFY14
1HFY15
1HFY14
151*
109
145
130
119
141
126
120
91
93
56
53
119
113
154
153
Rallis
124
105
130
123
81
85
76
67
Dhanuka
170
161
54
68
166
162
283
255
Insecticide India
173
144
141
130
121
128
153
142
Excel Crop care
136
91
133
125
112
123
114
89
PI
Bayer India
1HFY15 1HFY14 1HFY15
1HFY14
Source: Company. Note: PI inventory was higher due to stocking of finished products in CSM business for delivery
in 3Q.
Drop in cotton acreages could be a concern?
Cotton acreages are likely to go down next year, as prices have not been so attractive
over recent months. This could have a potential impact on agrochem demand, as
cotton is one of the largest contributors for the agrochem industry. Industry
participants believe it is too early to comment on any demand impact, as acreage is
just one of the parameters. Pest incidence and monsoon trends are few other
parameters that control agrochem demand. An example is that last year despite
record acreages for cotton, agrochem demand was weak given low pest incidence
and monsoon. In addition, the farmer has very limited choices apart from cotton as
soybean prices too have been muted. Agrochemicals account for nearly 20% of
farmer’s cost but have much more impact on driving yields if pest incidence is high.
Hence in that scenario, whatever be the end prices, demand on agrochem is not likely
to be impacted materially.
Agri valuations have significantly re-rated
Valuations for agrochemicals have significantly re-rated over last few months driven
by increasing institutional holding of the space and sustenance of earnings growth
trajectory and superior RoEs of the space. We believe such premium could sustain due
to structural changes such as rising farmer awareness, labour shortage, rising demand
for quality farm output and improved product availability sustaining healthy double
digits growth rates. Low penetration and consumption levels in both agrochem and
seeds would continue to aid superior growth rates in case of sustained efforts by
private players and infrastructure improvement support by the Government. In
addition, exports is also turning out to be a sizable opportunity driven by growing
generics share globally, rising government incentive, increasing propensity of
agrochemical players to outsource low technology manufacturing, and improving
competitiveness of India vs China for relatively complex agrochemicals.
February 24, 2015
Page 69
Economy & Strategy
Exhibit 116: Agri Inputs valuation summary
ADVT
P/E
P/B
EV/EBITDA
ROE
CAGR (FY14-FY17)
MCap
- 6m
(USD
(USD FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E Sales EBITDA
EPS
mn)
mn)
Company
Name
Global Agri Majors
Monsanto
Dow
Chemicals
FMC Corp
60,198
6.6
21.2
18.2
15.9
7.7
7.0
5.6
12.8
11.7
10.5
37.0
42.5
43.9
57,202
7.9
17.0
17.0
14.0
3.1
2.3
2.2
9.4
8.9
8.0
16.5
15.0
18.6 -0.1%
8,533
1.3
27.8
16.9
14.2
5.5
5.4
4.3
14.9
11.0
9.8
19.9
31.0
31.0
7.7%
9.6% 27.0%
Syngenta
32,594
1.6
18.7
17.2
15.4
3.4
3.2
3.0
14.3
12.1
10.9
17.6
18.3
19.6
2.2%
4.0%
Bayer AG
118,022
4.1
20.8
18.1
16.0
4.7
4.3
3.9
12.5
11.0
10.1
21.4
21.8
23.3
6.1%
5.9% 27.0%
86,932
4.0
15.1
15.0
13.7
2.7
2.5
2.3
8.7
8.6
8.1
17.8
17.0
17.6
0.1%
3.6%
BASF
4.8%
9.1%
9.5%
11.3% -5.7%
6.4%
4.3%
Domestic Agro Chemical Players
PI Industries
1,372
1.3
32.8
25.7
20.3
9.6
7.4
5.8
22.3
17.7
13.9
30.8
30.5
29.8 20.8%
25.7% 27.3%
Rallis India
Bayer
CropScience
UPL Ltd
Dhanuka
Agritech
Insecticides
India
Excel Crop
Care
743
1.5
29.1
22.0
17.9
5.6
4.8
4.1
1.7
12.8
10.6
20.8
23.9
25.2 13.5%
16.3% 19.2%
2,071
1.3
34.1
28.4
22.8
6.1
5.1
4.2
23.8
19.3
16.3
19.1
17.0
20.5 16.9%
21.9% 25.4%
2,942
10.9
15.5
13.1
11.2
3.0
2.5
2.1
9.0
8.0
7.1
20.1
20.2
20.1 11.9%
12.8% 19.5%
455
0.4
26.5
21.8
18.2
6.9
5.5
4.5
20.0
16.1
13.5
28.4
28.0
27.8 16.5%
20.1% 18.7%
159
0.9
17.1
12.1
9.1
3.3
2.7
2.1
11.6
9.0
7.1
21.2
24.3
25.9 19.9%
30.2% 39.5%
203
0.3
12.9
10.9
DNA
3.6
3.0
DNA
8.5
7.3
DNA
27.8
27.4
DNA
998
2.8
20.4
16.5
13.4
8.1
5.8
4.3
19.6
16.0
13.1
46.7
40.6
36.6 19.8%
27.7% 30.5%
932
3.1
44.7
33.6
28.7
15.3
13.2
11.2
39.3
30.8
26.6
33.4
37.9
42.1 10.6%
12.9% 18.0%
DNA
DNA
DNA
Domestic Seeds Players
Kaveri Seeds
Monsanto
India
Source: Company
Stock implications
PI Industries (Market cap US$1.1bn, ADV – US$2mn, 12-month TP `650)
PI’s domestic business (40% revenue share) has a differentiated approach of inlicensing new molecules (nearly 70-75% of revenues) from global innovators, thus
providing it with superior growth rates, better margins, and increased ‘pull’ effect for
its products. In the domestic business, it introduced two new products, MELSA and
PIMIX, in FY14 and KEEFUN in 3QFY15, which should aid growth rates going forward.
KEEFUN is a promising product which has both insecticidal and fungicidal properties.
The product caters to the fruits and vegetables segment which accounts for 20%
consumption of pesticides in India. Nominee Gold (>30% of domestic sales) is
growing well, driven by improving adoption of direct seeded rice. Osheen (>10 of
domestic sales) has also been growing at a good pace driven by enhanced efficacy of
the product on insects infesting the rice crop. The business is also well shielded by the
faster-growing CSM business.
Rallis India (Market cap US$ 0.8bn, ADV – US$ 2.1mn, 12-month TP ` 255)
Rallis’s domestic portfolio accounts for nearly 55% of its revenues. The domestic
business has underperformed its peers over the last few years due to lack of
aggression on new innovative products (such as Applaud and Takumi which had a
differentiated proposition to farmers at the time of their launch many years back).
However, it significantly stepped up its innovation pipeline in FY15 and launched
three new products in 1HFY15. Initial feelers are that the products are not great
products though they will aid growth rates, given Rallis’s strong distribution channel.
Our channel checks suggest that Rallis may feel some pressure on domestic margins,
due to some price correction for generics led by Chinese importers. We are awaiting
more clarity on this before building it into our numbers. Going forward, we believe
the trajectory for the stock price would be governed by exports growth and Metahelix
business’ performance (specifically margin improvement).
February 24, 2015
Page 70
Economy & Strategy
Institutional Equities Team
CEO, Institutional Equities
(022) 30433174
[email protected]
Research
Analysts
Industry Sectors
Nitin Bhasin - Head of Research
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(022) 30433241
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Aadesh Mehta, CFA
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Sales
Name
Regions
Sarojini Ramachandran - Head of Sales
UK
Desk-Phone E-mail
Dharmen Shah
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February 24, 2015
Page 71
Economy & Strategy
Explanation of Investment Rating
Investment Rating
Expected return (over 12-month)
BUY
>10%
SELL
<10%
NO STANCE
UNDER REVIEW
We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation
We will revisit our recommendation, valuation and estimates on the stock following recent events
NOT RATED
We do not have any forward looking estimates, valuation or recommendation for the stock
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February 24, 2015
Page 72

Rural India: at a crossroads

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