Large Caps and Small Caps
Sunday, April 19, 2009
Bata India, the Indian arm of global shoe major, Bata Shoe Organization, trades at Rs 115.7, 12 times its trailing four quarter earnings, at a premium to retail as well as footwear peers. It stands at an enterprise value of 0.8 times its trailing four quarter sales, and 0.7 times estimated sales for the year ending December 2009.
Having firmly established itself as a footwear retailer with a sizeable market share, Bata has moved on to designing footgear for institutions, wholesale trade of footwear and, recently, protective industrial shoes. In a largely unorganised fragmented market, Bata has a sizeable brand advantage and a presence across a range of price points.
However, Bata faces competition from imports and the unorganised sector, which also has a cost advantage. Majority of the consumers, too, are not yet brand-conscious when it comes to footwear. With valuations being comparatively on the high side, exposure to the stock need not be taken at this level, but investors may hold the stock.
Primarily a footwear retailer, Bata holds 35 per cent of the organised footwear market; its retail footprint spans more than 1,250 stores.
Bata has licensed brands (Hush Puppies and Dr Scholl, licensed respectively from Wolverine Worldwide and Dr Scholl’s) besides those of its parent (such as Power, Marie Claire and Bubblegummers).
With the men’s segment hogging more than half the market, women’s footwear remains largely untapped. Bata aims to capitalize on this by focussing on designer women’s footwear.
Bata’s institutional division caters to corporates, designing footwear according to industry specifics such as hospitals. Other divisions are the wholesale urban and branding divisions.
Under the former, it supplies retail stores through 150 distributors while the latter uses 15 distributors in major cities, concentrating on Bata’s brands alone. Bata is targeting a 15 per cent contribution from these divisions.
The latest sales stream explored is Bata Industrials, offering protective footwear to industries, backed by the expertise of its parent’s own industrial footwear division.
To better utilise its surplus land, Bata is developing, via joint ventures, a 262-acre township at its Batanagar premises with commercial and residential zones, including a 25-acre IT SEZ (notified). Funding for this foray will be undertaken by the respective developers and Bata’s own capital investment here has been minimal.
Bata has had a prolonged period of poor performance; it posted net losses between 2002 and 2004, slipping into operating level losses in 2004. During this period, the company had a troubled relationship with its labour, with lock-outs and suspension of employees and high staff costs. Leaving out raw material, the biggest contributor to expenditure was staff costs, taking up more than 25 per cent of sales .
Recovery from troubles has taken time, but the company managed a complete write-off of losses by 2007 (utilizing part of its securities premium following an approved scheme of reduction of the account). Number of unviable stores was cut by 105 ; a further 74 may be on the block. About 118 stores were remodelled, manufacturing and staff costs were brought under control.
New stores were opened on a franchise model thus limiting the capital required. Currently, franchise stores number 143.
Expansion on the cards
After the above restructuring efforts, Bata remains ambitious about its network expansion; it plans to open 240 stores in a span of three years calling for a minimum investment of Rs 400 crore.
With a low leverage at 0.3 times, and an improving interest cover from 2.1 times in 2005 to the present 12.1 times it may not run into funding roadblocks.
Financials holding up
Bata India’s three-year sales growth has been at 13 per cent while profits have grown at a CAGR of 51 per cent largely due to a lower base. Since turning profitable in 2005, net margins have improved steadily from 1.5 per cent to 6.1 per cent in 2008.
In its financial year ending December 2008, Bata posted a 13 per cent growth in sales and a 28 per cent growth in profits. Interest costs actually declined on the backs of retirement of long-term debt. Staff costs, too, fell by 5.5 per cent on a year-on-year basis.
With debt-equity being on the low side from the start, interest costs do not significantly impact margins. Bata has been positive on cash flows for the past two years.
It plans to restrict credit period to a maximum of 45 days; debtors turnover has increased from 19 to 40 times in a three-year span.
With streamlining of costs still being actively pursued along with new streams of revenue, margin expansion may yet continue.
Investors in the stock of Grasim Industries can hold the stock. The company’s impressive capacities post-expansion are set to support its topline growth, even as cement despatch numbers suggest that the sector has managed to sidestep the worst of this slowdown. The sharp correction in global coal prices from $193 last year to $62 now will help the company expand margins by saving significantly on fuel cost. Grasim Industries imports nearly one-fourth of its coal requirements. At Rs 1,634, the stock trades at an attractive price-to-earnings ratio of 8 times (lower than ACC that trades at 10 PE).
The demand-supply situation is also conducive now for the cement manufacturers. Higher demand from government-backed infrastructure projects and supply shortage in some pockets of the country are contributing to a firm trend in cement prices. Between February and April this year, prices have increased, on an average, by Rs 15-20 per 50 kg bag.
Expansions sweep capacity issues
Grasim Industries recently commissioned work at its new 3.3-million tpa clinker capacity at Kotpuli, Rajasthan. With this, the company’s total capacity has risen to 21.3 mtpa. This would help the company improve volumes tonnes and retain market share as demand revives. There are already signs of demand picking up with all-India despatches for the March quarter up by 8.5 per cent. In the Northern region, particularly, the industry estimates despatches to have grown by 16.8 per cent. Grasim has outlined a capex of Rs 940 crore in 2009-10, of which Rs 757 crore would be spent on putting up grinding units, RMC plants, waste heat recovery systems, power plants and on modernising and upgrading plants.
With capacity additions and related higher borrowings, interest expenses have been on the rise for Grasim. Till last December (for the nine months of FY-09), the company’s interest expenditure had risen 30 per cent over the corresponding previous period. But what is comforting is that the company’s interest coverage ratio is still a comfortable 13 times, superior to most Sensex companies. Even if the company’s interest cover comes down to half the present (six times) levels, the company would still be well-placed to service debt.
The company’s debt-to-equity ratio stands at a moderate 0.4. Cash profits for the first nine months of 2008-09 sttod at Rs 1,743.5 crore, lower by just 8 per cent compared to the previous year.
Cost pressures to reduce
Grasim’s cement division, which contributes nearly 80 per cent of the group’s earnings, is set to see cost benefits from the sharp fall in global coal and pet coke prices, which are key inputs.
One-fourth of the company’s fuel requirements are met by imported coal and another one-fourth by pet coke and waste fuel, with the balance by coal from linkages and auctions.
Power and fuel expenses, which are 20 per cent of the company’s sales, were higher by over 45 per cent year-on-year during the third quarter of 2008-09.
Lower thermal coal prices, which had already fallen by 45 per cent from their July 2008 peak, did not reflect in the numbers as the company had locked into long-term contracts. High-cost inventory eroded savings made from the company’s cost-cutting efforts.
The effect of reduced coal price will, however, be seen from this quarter as coal stock piles have been substantially reduced. The cut in diesel prices by Rs 2 per litre will also to an extent bring down freight expenses for Grasim.
Realisation inches UP
In the third quarter of FY-09, realisations across Grasim’s divisions were higher but for the VSF business, which remained a drag on profits. Realisation in the cement division was up 6 per cent and RMC up 2 per cent over the corresponding quarter last year. The Viscose Staple Fibre division saw realisations dropping by 11 per cent on a fall in domestic and export demand.
Cement prices have been inching higher since the beginning of this year; prices have risen by around Rs 10-15 per bag between January and March this year. The improved demand follows increased orders from government infrastructure and rural housing projects Higher prices with despatches growth of around 9 per cent in the March quarter are expected to support sales growth in the period.
While the VSF division might not post encouraging numbers following the fall in VSF prices globally, one can expect decent sequential growth in earnings for the March quarter.
Investors can consider accumulating the stock of Power Finance Corporation. It has been an underperformer in the recent rally, despite the company’s strong growth prospects. PFC has consistently managed strong loan disbursals and superior margins. A focus on secured lending (as the loans are secured by escrow accounts or assets), superior asset quality (Gross NPA is 0.02 per cent of the total advances) and the ability to source funds at low costs (given its sovereign credit rating) are key positives, at a time when financial stocks have been dogged by asset quality and margin concerns. At the current market price, the stock trades at a price-earnings multiple of 13; at 1.8 times its FY09 book value.
PFC is an NBFC (not under RBI supervision), which is a specialised financier of power sector projects. Its loan book grew by 25 per cent in 2008-09 aided by higher disbursements. Improved net interest margins (3.84 per cent) helped the company manage a net interest income growth of 25 per cent. However, notional forex losses led to a muted net profit growth of 12 per cent (the company has chosen not to take advantage of the relaxation in forex accounting norms). By March 2009, only 48.3 per cent of the loans sanctioned were disbursed, leaving a gap of about Rs 1,20,000 crore which is about 1.85 times PFC’s existing loan book. That lends high earnings visibility, as credit offtake in the power sector may continue to grow at a strong pace due to funding gap of Rs 10,31,600 crore in the current Five Year Plan (2007-2012). The cost of funds for PFC is lower than other NBFCs given the sovereign rating; it also enjoys the lowest risk weight among the corporate borrowers, for bank loans.
Over the next few years, while the core power sector may be a key growth driver, the company will also benefit from its foray into related sectors such as equipment financing and coal mining projects. PFC is also looking at consortium financing along with other banks, to fund power projects. It has also set up a private equity company which will invest equity in power projects. Delays in execution of power projects or policy related hurdles to power sector capex, are the key risks to the earnings outlook. Demand for loan restructuring and slippages in asset quality also pose risks to the outlook.