India Economy Macro Story
Sunday, January 10, 2010
Two-wheelers have always enjoyed commuter preference in India and it is a segment whose growth in terms of production and sales has constantly outpaced other segments. Between April and December 2009, two-wheeler sales expanded by 23.7 per cent, while production rose 22 per cent compared to the corresponding previous period.
While stocks of two-wheeler makers have seen a sharp re-rating in a year, makers of their components continue to trade at reasonable valuations. India Nippon Electricals (India Nippon), manufacturer of electric ignition systems, is one such case. At Rs 217.70, the stock discounts its trailing four quarter earnings nine times. India Nippon caters mainly to the needs of two-wheelers and the widespread customer base is the biggest positive for the company.
India Nippon is a joint venture between Lucas Indian Service, a wholly-owned subsidiary of Lucas-TVS, and Kokusan Denki, Japan, a group company of Hitachi. India Nippon manufactures electronic ignition systems for two-wheelers, three-wheelers and portable engines. TVS Motors is one of its important customers. However, the company has a sizeable exposure to other manufacturers such as Hero Honda and Bajaj Auto. These three companies, along with Honda Motorcycles and Scooters, account for 70 per cent of India Nippon's business. It also supplies electric ignition systems to other bike-makers such as Yamaha Motors and Royal Enfield.
In the three-wheelers space, India Nippon's major customers are Piaggio and TVS Motors, while Honda SIEL Power and Birla Power Solutions are the main customers in the genset space. Recently, the company entered a new line of business to supply external combustion units for diesel passenger cars and has a contract with Tata Motors for the same.
The two-wheeler segment remained relatively unscathed even during the slowdown in 2008 and since April 2009, almost every sub-segment within this space has grown 10-12 per cent year-on-year.
This is a positive factor for India Nippon. Though the technology in three-wheelers is not very different from that of two-wheelers, the company's ability to cater to clients such as Piaggio and TVS Motor makes it independent of just one segment. Three-wheeler sales have grown by 23.7 per cent between April-December 2009.
The ignition system is one of the critical components in two-wheelers, three wheelers and portable engines, as it provides the initial power to start the engine, the continued spark that keep the engine running and is responsible for a safe shut-down operation. With an increase in buyer expectations and a fall in the costs related to the technology (electronic ignition systems) it is increasingly becoming imperative for many two-wheeler manufacturers to incorporate this component in their vehicles.
Moreover the cost differential is also relatively low now, thereby not affecting the affordability of the bike or scooter.
Electronic ignition systems can also play a key role in improving fuel efficiency and lowering the emission levels of the two-wheeler.
The probable flip factor for India Nippon is its absence in the replacement market and the company is trying to establish a direct presence in the after-sales market. The after-market for a component like electronic ignition systems has been traditionally been limited, and it is only in the recent years that the replacement demand for the components has reached a critical size.
In year a when most auto part-makers saw a huge shrinkage in both revenues and profits, India Nippon remained relatively resilient. The company saw its top-line grow by 6 per cent in 2008-09. But with product mix, pressure on pricing and profit margins, profits declined by 22 per cent during the year. Recovery since then has been quite strong. The company ended the half year September 2009 with sales of Rs 80.59 crore and net profits of Rs 10.64 crore, sales growing 22 per cent and net profits 76 per cent. Improvement in sales volumes and realisations are the primary drivers behind this growth.
Input costs, which account for nearly 74 per cent of the sales, began to inch up from April 2009 and the latest quarter saw a 11 per cent increase in raw material costs. Currently the company operates at comfortable operating profit margins of 17 per cent.
Being a component maker, India Nippon has limited scope to pass on input costs pressures to its customers and, going forward, the company may have to absorb some of this cost into its margins. This may weigh on its operating profits in the coming quarters. India Nippon will, therefore, have to focus on increasing its sales volumes to mitigate this problem.
India Nippon is a small-cap stock with thin volumes being traded at the stock exchanges. Investors may have to hold on to this stock for a longer duration to enjoy returns in the 20-25 per cent range. Investors are advised to book profits once these targets are achieved.
Investors with a medium- to long-term horizon can consider buying the stock of the mid-cap cement player Shree Cements. Positioned in the northern region, the company's rising market share, self-sufficiency in power and cost-efficiency augur well for earnings over the medium term, even as most other cement players struggle with excess supply.
At the current market price of Rs 2,205, the stock is trading at 10 times its expected FY10 earnings and eight times its expected FY11 earnings, at a discount to large-size peers.
Between April and December, the company's despatches rose 25 per cent against the industry average of 13 per cent and the regional average of 17 per cent.
Strong cement offtake in the North following Government-led housing projects in the rural areas and construction activity related to the Commonwealth Games in the Delhi NCR have seen quick absorption of the additional cement supplies. Shree Cements' units are all running at full capacity currently. There may be some correction in utilisation rates over the next six months with some 9 million tonnes of capacity in the pipeline for the region (new capacities of Grasim Industries, JP Associates and Ambuja Cements).
With over 2 million tonnes of capacity addition, Shree Cements will close FY10 with a capacity of 10 mtpa (7.7 mtpa last year) and increase it to 12-12.5 mtpa by FY11. The company reported a five-year annualised growth of 22 per cent in volumes and 38 per cent in sales. Its power needs are met in-house through captive power capacities of 120 MW. The surplus power (close to 35 MW) is also sold in the market.
The company recently announced entry into power generation, to take advantage of high merchant power tariffs, by building a 300-MW thermal power capacity with an investment of around Rs 1,200 crore. As this project is expected to be ready only by the first quarter of 2012 and coal linkages have not been fully arranged, we have not factored this in our earnings estimation. For capex in the cement segment, the company has planned an outlay of Rs 600 crore for 2010. It intends funding the capex activities through a combination of debt and internal accruals. Shree Cement has strong cash coffers and the debt-to-equity ratio stands at 1.2.
The company's power-fuel costs have come down 11 per cent in the half-year ended September 2009, thanks to the fall in prices of pet coke and imported coal. Operating margins were higher by 10 percentage points at 35 per cent. Net profit for the half-year ended September 2009 more than doubled to Rs 587 crore.
Investors can consider holding on to their holdings in Bhushan Steel. The stock trades at 13.6 times on the basis of the trailing 12-month earnings at Rs 1,592.
The company is a secondary steel producer, selling cold-rolled steel to various sectors. Peers such as Uttam Galva trade at similar multiples. Bhushan Steel's trump card is its transition into a fully integrated steel producer, which is under way in phases through a five-mtpa plant in Orissa.
Bhushan Steel produce one million tonnes of value added cold rolled steel at Khopoli, Maharasthra and Sahihabad, UP. Cold rolled steel is used in the production of automobiles and consumer durable products.
The company is building a new integrated steel facility at Meramandali, Orissa in a phased manner. The faclility currently produces 0.3 million tonnes of billets and 0.6 million tonnes of sponge iron, both of which are intermediaries in steel production.
By the end of the current fiscal, 1.9 million tonnes of hot rolled coiled which will be for captive consumption and external sales is slated to come into production.
Once completed by 2013, the facility is expected to produce around 5 million tonnes of steel products per annum.
A tie-up with the Japanese conglomerate, Sumitomo, to produce and market automotive grade steel should bolster Bhushan Steel's products' standing by meeting the ‘quality' requirements of several automobile companies.
Its track record indicates that the company should be able to pull off the ambitious expansion programme which, when completed, will account for 6-8 per cent of the expected Indian production by 2014.
Other projects lined up include a steel plant in West Bengal, in which Sumitomo is expected to take a stake; however, the holding structure of this venture remains unclear. Bhushan Steel's current roster of clients include Yamaha, Tata Motors, Maruti, Whirlpool, Samsung and LG.
Automotive steel is one of the most lucrative segments in the steel business, by virtue of the amount of processing required to produce it and the fact that few Indian producers have the complete know-how to produce the various grades of steel required by the industry.
The encouraging signs of recent growth and aggressive entry of several global automobile majors indicate good potential and opens ups the possibility of adding a few more marquee names to Bhushan's client list.
While there may be more players competing in the market, the market pie which Bhushan Steel sells to is also likely to get larger. Consumer durables already see the major global players warring for market share and several sub-segments grow between 10-40 pe rcent.
As a secondary value-add steel producer, Bhushan Steel's current upside is limited by the spread between the cost of hot-rolled coils — the raw material — and the processed cold-rolled coils they sell.
Flat steel products, whose prices had remained soft over the last few months, saw their prices hiked in December by most major steel producers.
Prices are expected to remain steady and rise through 2010 as the global demand scenario improves. Bhushan Steel, like most other secondary players, has shown the ability to pass on raw material cost increases to the end-user.
However, with the proven integrated model it is moving towards, Bhushan is looking to secure its supply of hot-rolled coils and the raw materials that go into making it. A 420 MW power plant and tie-ups for coking coal and technical assistance are some of the moves to try and ensure the move is smooth.
Margins will improve significantly on securing raw material linkages. Considering that the foray into integrated steel production is a new territory, Bhushan Steel, as an investment over the next three-four years, depends on how this foray pans out operationally and financially.
Bhushan Steel's gross sales have grown at a compounded annual rate of around 20 per cent since FY-06 and net profits by around 40 per cent. This in spite of heavy borrowing for expanding their cold-rolling facilities and the Orissa plant which has taken leverage to 3.6 :1. FY-09's EBIT, however, covered interest costs more than five times over. Their operating margins have hovered around the 20 percent mark which is significantly better than peers such as Uttam Galva. The first half of FY-10 saw gross sales slip by over 8 per cent on weaker realisations, as raw material costs corrected steeply.
But operating profits and net profits grew by over 4 per cent and 31 per cent respectively with the latter being helped by considerably lower interest and depreciation expenses.
The current price provides little room for error for the conservative investor. The company has significant leverage and any moves to ease it through equity raising will be at the expense of the shareholder.
That said, the upside through sales and profit growth with new capacities, coupled with the healthy demand from Indian markets, should serve the company well.
Investors can give the initial public offering of Infinite Computer Solutions, an IT services provider, a miss considering the relatively high valuation that it demands and the several business challenges that the company faces.
At the upper end of the price band (Rs 155-165), the offer is priced at 16 times its 2008-09 per share earnings and about 14 times its likely 2009-10 earnings, both on a post offer equity base.
This is at a premium to most small- and mid-tier IT companies. Although larger in size, Sasken Communications, which also has a telecom focus, trades at 12 times trailing earnings. Others mid and small IT companies such as Zylog Systems and Sonata Software trade at single digit PE multiples.
Infinite has seen its revenues grow at a compounded annual rate of 13 per cent over 2005-09 to Rs 495.8 crore. The profit growth has been inconsistent and top-line growth has been lower than other mid-tier IT companies. Much of even these figures of Infinite is distorted by the FY09 numbers when it registered a 45 per cent growth in revenues and more than doubled its profits over FY08, thanks to ramp up of one client and signing up another large one.
From a loss recorded at the net level in 2005-06, the company reported small profits in the subsequent year and a spike in the year after. Net margin has remained in the 2-5 per cent range for most of the last few years, spiking to 9 per cent in 2008-09.
From a business perspective, high client concentration, heavy US dependence and dollar dependence and a service-mix that largely tends towards low-margin ones are key negatives. A high onsite component also makes for high costs, reducing the edge over competitors.
Among macro trends in the IT industry, vendor consolidation undertaken by clients could result in several smaller players such as Infinite losing out to top-tier players. In the low-end services segment, the number of players vying for deals is large , which brings in pricing and other competitive pressures on the company.
Infinite provides IT services to a limited set of verticals. Telecom (59.4 per cent of revenues) and healthcare (16.6 per cent) are its largest verticals. Its top five clients contribute close to 80 per cent of revenues, with its top-client (IBM) accounting for nearly 40 per cent of revenues. Though smaller companies do have higher client concentration, these levels seem quite high.
In recent interactions with the media, many large IT services players have indicated that telecom and manufacturing are not yet out of the woods.
This means that Infinite, with its heavy dependence on telecom, faces added risks on volume growth on this front.
The presence of players such as Tech Mahindra and Sasken Communications with greater execution capabilities, especially on the R&D front, a key to success in the telecom vertical, as well as top-tier IT layers puts heavy competitive pressure on Infinite.
The presence in the healthcare vertical though is welcome, especially as activity on this from clients may improve when the US passes the healthcare reforms Bill. The company also delivers lower-billed services such as application development and maintenance and testing, which account for over three-fourths of revenues. This space is a highly crowded one, what with companies of all sizes and especially the mid-tier ones looking to tap these non-discretionary deals from clients. These services are also exposed to pricing pressures.
Macro factors skewed
Another point of concern for the company is that the US contributes nearly 90 per cent of the company's revenues. With the rupee appreciating against the dollar from 51 levels to 45.6, and a weak dollar predicted for some time to come, smaller companies such as Infinite would be hard hit on the realisation front.
From a cost perspective, the company derives over 70 per cent of revenues from services delivered from onsite locations.
This creates a sub-optimal structure as these are high-cost revenues and would significantly affect margin.
The proportion of offshore revenues has increased in recent years, but it is still quite a way away from the ideal proportion.
Vendor consolidation undertaken by several large clients in recent times, where they restrict their projects to two or three large Indian vendors apart from a few global ones, has also meant that smaller players such as Infinite may find the equation skewed against them.
Infinite is offering 11.5 million equity shares to raise about Rs 190 crore (at the upper end of the price band) which includes an offer for sale of about 5.76 million shares by existing shareholders.
You've just seen an apartment you would really like to book, but don't have enough cash for the down payment. Where would you raise the cash? If you're thinking personal loan, do consider a loan against your jewellery first.
Loans against jewellery, which several finance companies and banks offer today, allow you to make use of the gold and jewellery you have safely tucked away in your home or in a bank locker. If you're in a bind, taking out a loan against jewellery may prove to be the quickest route to raising cash.
These loans come with processing time of less than a day, virtually no documentation and flexible payment options. You don't even have to state the purpose for which the loan is required.
How to get it
The mechanics of a jewellery loan are simple enough. You pledge your jewellery with the bank, which then sanctions loans based on the value of your jewellery. When you repay the loan, you reclaim your jewellery. Application and sanction of the loan can be completed in a single day, allowing immediate access to the cash.
Not all banks offer loans against gold. But among those who do are Indian Bank, Axis Bank, Canara Bank, HDFC Bank and Syndicate Bank. Financial companies such as Manappuram Finance and Muthoot Finance specialise in such loans.
Gold loans are typically much cheaper than personal loans or loans you may take on your credit card.
Interest rates range from 12 to 15 per cent per year. Rates vary slightly between banks; for instance, Indian Bank charges a 13.25 per cent interest rate while Axis Bank charges less than 12 per cent. Muthoot Finance has rates from 1 per cent a month, while it is 0.96 per cent a month at Manappuram Finance.
Gold is accepted in the form of jewellery or as coins by these lenders. If it is in the form of ornaments, only the gold component in the ornament will be considered.
No value is ascribed for gems or stones, should there be any in the jewellery. Silver, platinum or any other metal cannot be pledged, either.
You also cannot hope to get a loan for the full value of your jewellery (or the cost at which you bought it). First, the jewellery will be checked for purity and the lender will arrive at a value based on what the internal appraiser says.
Then, loans may be provided for 70 to 85 per cent of the value of this gold, while others specify the rate per gram at which they provide loans. This varies from time to time according to gold price changes.
The quantum of loan you can avail has minimum and maximum limits. HDFC Bank, for instance, will consider a minimum of seven sovereigns – that is 56 grams – of gold for loans. Other banks specify minimum loan amount rather than grams.
Maximum limits vary wildly; Axis Bank has an upper limit of Rs 2,00,000, while HDFC Bank caps loans at Rs 10,00,000. Finance institutes such as Manappuram Finance and Muthoot Finance don't specify minimum limits, though the former has a ceiling of Rs 1 crore.
Payments and tenures
Besides limiting loan amounts and value of gold, banks make gold loans for a short period. Repayment periods range from six months to two years. Jewellery loans do not require regular EMI payments.
As a rule, payments need to be made at the end of the tenure, although they can also be made at any time with partial payment options during the period of the loan. Some banks, however, require regular servicing of the interest if not the principal. Until the entire sum is repaid, the gold will be held by the lender.
Loans against gold hold an edge over other loans due to the ease and speed of processing. Banks have appraisers at select branches who value the gold, regardless of any valuation you may have previously done. Based on that appraisal, loan amounts are determined.
Sanctioning the loan and transfer of the amount is then a simple process that takes less than an hour in most cases. Note that, for immediate access to the loan amount, it is beneficial to have an account with the bank. Amounts given through cheques can be used only after the cheque is cleared, which take at least a couple of days.
Documentation is the next area where jewel loans score. All that is required are proofs of identification and address. Income levels, bank statements, salary slips and others that are required for most other loans are not needed here. This contributes to the minimal process time.
Payment of loans in full before the end of the tenure does not trigger any penalty. However, should you fail to repay even at the close of the loan period, interest will be charged at a higher rate, usually 2 per cent above the loan rate.
The gold will be auctioned off by the bank, but the amount of sale proceeds that would come to you would depend on the terms of the agreement you've signed.
The jewellery pledged will be held by the bank till the time the loan is entirely repaid; part payments do not lead to partial release of the jewellery.
Some banks require that you hold an account before applying for a jewellery loan. Also, application and processing of these loans are not carried out at all branches. Should the price of gold fall drastically during the period of the loan, to the extent that it fails to cover the amount outstanding, some banks require payment of the difference. Again, this depends on the terms of the loan agreement. However, given the relatively short term of gold loans, a very steep fall in gold prices may not be likely.