The Front Page - media.bajajfinserv.in · Nasdaq 2,242 0.3 (1.2) Wipro 13.2 1.0 50.6 DJIA 10,463 0.5 0.3 ICICI Bank 45.6 0.9 1.0 IBOV 66,807 0.3 ... investments and reviving the sick

The Front Page

September 13, 2010

Market Front Page

Charts Front Page

18,600

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Sensex intraday

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Sep-06 Aug-07 Aug-08 Sep-09 Sep-107,0009,500

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Sensex price volume trend

SensexVolumes (Rs bn)

• The government expects to complete the ONGC and IOC divestments in this financial year and raise up to Rs190bn from the process. (BS)

• Dr Reddy's plans to spend Rs16bn for capacity expansion over the next two years. (BS)

• HCL Tech bags 3-year IT infra deal from New Zealand government. (ET)

• PowerGrid Corporation’s Rs80bn FPO is set to be launched in the second week of November 2010. (ET)

• Infosys BPO stated that it would increase the total headcount of its Poland operations to 1,500 in the next one year. (BS)

• Reliance Industries agrees to sign a gas supply contract with Essar Oil. (BS)

• Reliance Industries completes its deal to acquire a 60% stake in the Marcellus Shale gas asset in the US for US$392mn. (BL)

• Gujarat NRE Mineral Resources is set to offer 25% of its equity to the public. The company is the controlling stake holder in Gujarat NRE Coke. (BS)

• IOC plans to rope in a strategic investor for its proposed Rs100bn project at Ennore, Tamil Nadu. (BS)

• IVR Hotels & Resorts, a SPV formed by IVRCL Assets & Holdings plans to promote a Rs50bn township project at Sriperumbudur. (BS)

• DLF plans to invest Rs9bn in a luxury residential project in Chennai. (BS)

• Atlas Copco stated that plans to invest Rs1bn in the next 2 years for capacity expansion purposes. (BL)

• Natco Pharma does not rule out a settlement over the patent issue with Celgene, which has said it would file a complaint against the former for alleged infringement of its cancer drug Revlimid. (ET)

• Cholamandalam Investment & Finance Co. is in plans to make a pref. issue of equity shares for Rs 1.5bn. (BL)

• Crompton Greaves has entered into an agreement with the Spain-based ZIV Aplicaciones y Tecnologia to set up a JV in India to manufacture substation automation systems. (BS)

• What’s Inside: Bajaj Finance (BUY); IT Services; Reliance Infra (ADD); Maruti Suzuki (REDUCE); Events

Corporate Front Page

Index Movements Closing % Chg % YTD ADR/GDR (US$) Latest % Chg % Prem

Sensex 18,800 0.7 7.6 HDFC Bank 168.6 1.0 16.3

Nifty 5,640 0.6 8.4 Reliance 41.7 0.1 1.2

BSE Smallcap 10,249 0.3 22.6 Infosys 62.3 0.8 0.1

CNX Midcap 9,085 0.6 22.2 Satyam 5.2 (0.4) 32.3

Nasdaq 2,242 0.3 (1.2) Wipro 13.2 1.0 50.6

DJIA 10,463 0.5 0.3 ICICI Bank 45.6 0.9 1.0

IBOV 66,807 0.3 (2.6) SBI 128.3 0.4 (0.1)

FTSE 5,502 0.1 1.6 Sterlite 14.1 0.5 (0.8)

CAC 3,726 0.1 (5.3) Tata Motors 22.8 0.5 4.2

Turnover US$m % Chg Commodities Latest %Chg %YTD

BSE 1,035 (17.2) Gold (US$/ounce) 1,246 (0.0) 13.6

NSE 3,280 8.0 Crude (US$/bl) 76 3.0 (3.7)

Derivatives (NSE) 21,213 6.2 Aluminium (US$/MT) 2,130 1.4 (4.5)

Index Stocks Copper (US$/MT) 7,601 1.5 3.1

Net buying 340 98 Forex Rates Closing % Chg %YTD

Open interest 20,098 8,460 Rs/US$ 46.6 (0.1) (0.3)

Chg in open int. 862 192 Rs/EUR 59.1 (0.3) (11.9)

Equity Flows (US$m) Latest MTD YTD Rs/GBP 71.8 (0.0) (4.3)

FII (8/9) 99 614 13,495 Bond Markets Closing bps Chg

DII (9/9) (43) 98 407 10 yr bond 7.9 (4.0)

MF (8/9) (23) 113 (3,385) Interbank call 5.3 50.0

FII F&O (US$m)

Top GainersPrice (Rs)

Chg (%) YTD (%) Top Losers

Price (Rs)

Chg (%)

YTD (%)

KSK Energy Ventures Lt 176 6.6 -12.2 Gujarat State Petronet 116 -2.5 19.9

Bank of India 489 5.7 27.2 Ashok Leyland Ltd 72 -2.1 45.9

Ispat Industries Ltd 21 5.7 -2.3 Petronet LNG Ltd 111 -2.0 56.0

Godrej Industries Ltd 245 5.4 32.6 Power Grid Corp of Ind 105 -1.9 -5.1

MAX India Ltd 172 4.8 -22.7 Tata Motors Ltd 1015 -1.7 28.2

Top Movers BSE 200

Volume spurts

Company CMPM.Cap (US$

m) Vol. (in '000)10D A.Vol (in '000) % Chg

KSK Energy Ventures Ltd 176.4 1,411 3,342 548 510

IDBI Bank Ltd 139.8 2,176 18,108 4,992 263

Adani Enterprises Ltd 661.1 8,687 2,562 768 233

Bank of India 489.5 5,521 2,621 876 199

Aditya Birla Nuvo Ltd 871.4 1,928 688 238 189

MAX India Ltd 171.7 857 3,345 1,216 175

HDFC Bank Ltd 2,244.9 22,238 1,483 602 147

Chambal Fer tilizers & Chem 75.9 678 9,612 3,922 145

Hindustan Oil Exploration C 245.0 687 2,604 1,113 134

Idea Cellular Ltd 76.8 5,441 14,579 6,517 124 FII - FII trades

Volume '000 Price Prem % Volume '000 Price Prem %

Maruti 106 1,357 3.5 256 1,363 3.8

Pnb 105 1,335 9.5 11 1,355 9.8

Rec 330 346 0.2 83 1,227 0.2

Ing vysya bank 27 344 1.0 1.7 344 0.8

Grasim 112 2,291 3.3 2 2,176 1.0

Union bank 12 347 0.2 75 351 0.2

Bob 185 844 0.7 15 847 0.4

Scrip 8/9/2010 9/9/2010

Market Front Page

• Lanco Infratech is setting up a combined 720MW combined cycle gas-based power plant for an investment of Rs25bn at Humnabad in Bidar district. (BS)

• Shipping Corporation of India plans to invest up to US$4bn in the next four years to double its total cargo carrying capacity to 10m dead weight tonnage. (BS)

• IFGL Inc, wholly owned US subsidiary of IFGL Refractories acquires two US companies engaged in manufacturing and ancillary services in alumina graphite continuous casting refractories for US$13mn. (BL)

• The Company Law Board allows Zenotech Laboratories’ founder and managing director to sell a part of his 25% stake in Daiichi Sankyo’s open offer to shareholders. (ET)

Corporate Front Page

• India’s Industrial Production rose 13.8% in July, registering the highest growth in two months and exceeding market expectations of 7.8%. (BS)

• The government plans to review the New Investment Policy of 2008 in order to overhaul the production of the urea sector by attracting more investments and reviving the sick fertiliser units. (BS)

• The Department of Information Technology plans to set up a dedicated fund with an initial corpus of Rs 50bn with an aim to promote the electronics manufacturing industry. (BS)

• India’s Foreign Exchange Reserves rose US$2.5bn to US$283bn during the week ended September 3. (ET)

• The Finance Minister has stated that industrial output is likely to grow between 12-13% in FY11. (BL)

• PSUs and FIs have managed to mop up over Rs560bn through private placements in the first quarter of FY11. (BL)

• The DIPP proposes to ease investment norms for foreign companies that have existing JVs or technical collaborations in India. (BS)

Economy Front Page

Company Name of Acquirer / Seller Transaction Date Buy /Sale Quantity Price

(Rs) Deal Size

(Rs m) Shares

Transaction (%) Holding after

Transaction (%)

Anuh Pharma Ltd Bharat Nemchand Shah HUF -- Sell 16,000 595.0 10 0.0 1.4

Dr Reddys Lab Dr K Anji Reddy 06/09/2010 Sell 50,000 1,427.0 71 0.0 0.0

Dr Reddys Lab Dr Cartikeya Chennuru Reddy 30/08/2010 Buy 11,150 1,346.0 15 0.0 0.4

Educomp Solution Gopal Jain 07/09/2010 - 08/09/2010 Sell 55,000 570.0 31 0.0 0.1

HDFC Bank Ltd Nitin Rao 18/08/2010 Sell 4,000 2,189.0 9 0.0 0.0

HDFC Bank Ltd Paresh Sukthanakar 18/08/2010 Sell 4,000 2,189.0 9 0.0 0.0

ITC S B Mathur 03/09/2010 Buy 54,000 164.3 9 0.0 0.0

Kotak Mahindra Bank Ltd Raghunath T V 04/08/2010 Sell 13,000 810.0 11 0.0 0.0

Kotak Mahindra Bank Ltd Vikram Sud 05/08/2010 Sell 10,000 813.0 8 0.0 0.0

Kotak Mahindra Bank Ltd Paul Parambi 05/08/2010 Sell 8,000 813.0 7 0.0 0.0

Kotak Mahindra Bank Ltd Paul Parambi 06/08/2010 Sell 7,000 813.0 6 0.0 0.0

Oracle Financial Services Software Ltd Joseph John 19/08/2010 Sell 13,809 2,099.0 29 0.0 0.0

Deal size worth more than Rs5m considered. The exchange does not report transaction prices, so we have assumed them to be closing prices for the respective days. Hence, actual deal sizes may vary from the figures above.

Company Name of Acquirer / Seller Transaction Date Buy /Sale Quantity Price

(Rs) Deal Size

(Rs m)

Ashiana Hous Axismutualfund 9/9/2010 Buy 161,420 167.1 27

Bajaj Auto Finance Ltd Shinhan Bnp Paribas Investment Trust Management Co Ltd Ac Sh 9/9/2010 Buy 253,000 755.0 191

Bajaj Auto Finance Ltd Sundaram Bnp Paribas Mutual Fund A/C Sundaram Bnp Paribas Se 9/9/2010 Buy 481,660 755.0 364

Bajaj Auto Finance Ltd Sundaram Bnp Paribas Mutual Fund A/C Sundaram Bnp Paribas Ta 9/9/2010 Buy 306,340 755.0 231

Etc Networks Acacia Partners L. P. 9/9/2010 Sell 133,000 269.0 36

Etc Networks Ltd Acacia Ii Partners Lp 9/9/2010 Sell 54,000 266.9 14

Etc Networks Ltd Acacia Institutional Partners Lp 9/9/2010 Sell 101,000 266.9 27

Etc Networks Ltd Acacia Partners Lp 9/9/2010 Sell 112,000 266.9 30

Gujarat Pipavav Port Ltd Credit Suisse (Singapore) Ltd A/C Credit Suisse (Singap 9/9/2010 Buy 2,800,000 53.7 150

Gujarat Pipavav Port Ltd Credit Suisse (Singapore) Ltd A/C Credit Suisse (Singap 9/9/2010 Sell 1,174,495 56.4 66

Gujarat Pipavav Port Ltd Sbi Life Insurance Co.Ltd. 9/9/2010 Sell 2,190,923 55.5 122

Gujarat Pipavav Port Ltd State Bank Of India 9/9/2010 Sell 2,300,000 53.6 123

Talwalkar Fitness Ltd Prusik Asia Fund Public Ltd Company 9/9/2010 Buy 298,184 249.5 74

Torrent Pharma Ltd. Reliance Capital Trustee Company Ltd A/C Reliance Regular Sa 9/9/2010 Buy 720,000 525.0 378

BSE/ NSE - Bulk Deals

Insider Trading

12-mth TP (Rs) 1000 (31%) Market cap (US$ m) 600

52Wk High/Low (Rs) 781/200 Diluted o/s shares (m) 37 Daily volume (US$ m) 2 Dividend yield FY11ii (%) 1.5 Free float (%) 49.5

Shareholding pattern (%) Promoters 50.5 FIIs 16.6 DIIs 8.6 Others 24.3

Price performance (%) 1M 3M 1Y

Bajaj Finance 25.0 60.6 248.2 Rel. to Sensex 22.2 47.7 232.0 Shriram City Union

-1.4 26.5 49.8

M & M Fin 4.6 38.2 182.6

Stock movement

0500

1,0001,5002,0002,5003,000

Sep-

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Sampath Kumar [email protected] 91 22 4646 4665

Prabodh Agarwal [email protected] 65 6511 6161

Sumeet Singh [email protected] 91 22 4646 4673

Bajaj Finance Ltd – BUY BAF IN Rs762 Banks 13 September 2010 Initiating coverage

Financial Summary Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiPre prov. operating inc. (Rs m) 2,146 3,949 4,828 6,642 8,829

Net profit (Rs m) 339 894 1,650 2,660 3,785

EPS (Rs) 9.3 24.4 45.1 72.7 103.4

Growth (%) 68.6 163.6 84.5 61.2 42.3

PER (x) 82.2 31.2 16.9 10.5 7.4

Book value (Rs) 297 315 347 398 471

PB (x) 2.6 2.4 2.2 1.9 1.6

CAR (%) 38.4 26.0 17.8 14.8 13.4

ROA (%) 1.0 2.3 2.7 3.0 3.2

ROE (%) 3.2 8.0 13.6 19.5 23.8

Dividend yield (%) 0.3 0.8 1.5 2.4 3.4Price as at close of business on 09 September 2010

Primed for growth Bajaj Finance Ltd (BFL) is well-poised to deliver 40% assets CAGR and 62% earnings CAGR during FY10-13ii, driven by a favourable lending environment, strategic shift in focus, and normalisation of credit costs. The stock has risen by 128% YTD. It has priced in the normalisation of growth, in our view, but not the benefits of a strategic shift in focus fully. The stock currently trades at FY12ii P/B of 1.9x. We initiate coverage on BFL with a BUY and target price of Rs1000 (upside of 31%). From consolidation to growth phase: We believe BFL is well-positioned to deliver robust growth in assets and earnings after consolidation during FY08–10. We forecast 40% CAGR in assets for BFL during FY10-FY13ii, driven by foray into new lending segments, namely, business loans—secured and unsecured. We forecast 62% CAGR in earnings for the same period, driven by decline in cost/income ratio and credit costs. Favourable environment, strategic shift are key drivers of performance: Access to finance for small businesses and consumers remains constrained, as evidenced by declining share of bank finances to these segments. Untapped potential, decline in competitive intensity and investments by BFL in establishing key processes for origination and credit administration would enable it sustain strong growth momentum in assets. Shift in focus towards niche market opportunities in small businesses and consumer lending will likely reduce cyclicality in growth rates seen in the past and help de-risk portfolio from sharp swings in NPA. Robust earnings growth, significant uplift to ROE likely to sustain re-rating: BFL’s stock price has risen by 128% YTD suggesting that the market has priced in the upside to the growth outlook partially. A sharp run-up in the stock price may deter investors. However, we believe it is yet to capture the upside from the sustainable nature of growth in assets and earnings, benefits of economies of scale, and strong accretion to tangible book value. We expect BFL to raise additional capital to boost its capital position over the next 12 months, which will be accretive to book value and moderate valuation further.

RoA continues to improve

2.11.6

0.5

1.0

2.32.7

3.0 3.2

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

FY06FY07FY08FY09FY10FY11

iiFY12

iiFY13

ii

(%)

Source: Company, IIFL Research

2

Bajaj Finance Ltd – BUY

sampath.kumar@iif lcap.com

Company snapshot

Background Bajaj Finance Ltd (BFL) was incorporated in March 1987. BFL was promoted by the erstwhile Bajaj Auto Limited and Bajaj Auto Holdings Limited. BFL was subsequently listed in 1994. As per the scheme of demerger of the erstwhile Bajaj Auto Limited, the shareholding of Bajaj Auto Limited in BFL was transferred to Bajaj FinServ Limited. As of September 2010, the company was renamed from Bajaj Auto Finance Ltd to Bajaj Finance Ltd. BFL is engaged primarily in the business of financing two-wheelers, consumer durables, personal loans, small business loans, loan against property, mortgages, and loan against securities. The company has also recently begun financing construction equipment and plans to gradually scale up this business. BFL is present across 375 Bajaj Auto dealerships and over 2,000 consumer-durable outlets spread across the country. Small business lending is carried out through 63 branches spread across the top 16 cities.

Disbursement trend

1014

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2630

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46

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30

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50

FY04FY05FY06FY07FY08FY09FY10

(Rs bn)

Shareholding pattern as of June 2010

FIIs(17%)

Promoters

(51%)

Others(24%)

DIIs(9%)

Key management personnel Name Designation Comments

Rahul Bajaj Chairman

He heads the Bajaj Group of companies, which manufacture a range of products (from 2 wheelers to insurance) in India and abroad. He holds an Honors Degree in Economics from Delhi University, a degree in Law from Bombay University and an MBA from Harvard Business School.

Sanjiv Bajaj Director

He is the Managing Director of Bajaj FinServ, which operates primarily in life and general insurance, apart from the lending business through BFL. He holds a degree in engineering from University of Pune, a Master’s degree from University of Warwick, UK and an MBA from Harvard Business School.

Rajeev Jain CEO

He has over 18 years of experience in the consumer lending industry, having worked in the past with AIG, General Electric and American Express. Prior to joining BFL, he was the Deputy CEO of the consumer finance business at AIG. He holds an MBA degree.

Pankaj Thadani CFO

He has over 28 years of experience having previously worked in Bajaj Auto Limited, Eicher, Mico Bosch and Corporate Database. He is a Mathematics Graduate and a Chartered Accountant.

Source: Company, IIFL Research Break-up of receivables under finance (FY10)

Consumer finance

12%Auto Finance

34%

Mortgage & Other secured assets

29%

Personal loans & Small Business

Loans25%


3



Upside to earnings not priced in We initiate coverage on BFL with a BUY and a 12-month target price of Rs1000, which is an upside of 31% from the current price. BFL is emerging as a niche play on the opportunity in small business and consumer finance segments. A favourable lending environment, new avenues for driving balance-sheet growth, and decline in risk profile of assets would likely drive assets and earnings CAGR of 40% and 62%, respectively during FY10-13ii.

BFL had a pre-dominant focus on 2-wheeler financing and consumer durable financing that was built around the distribution architecture of auto-finance until FY07. Using the distribution outlets of 2-wheeler financing for consumer-durable finance pushed the company into smaller markets, which lead to unfavourable risk-reward. BFL initiated a strategic shift in FY08 that coincided with two other major events: 1) transfer of shareholding of Bajaj Auto and Bajaj Holdings to a newly formed entity, Bajaj FinServ; and 2) downturn in auto-finance and consumer durable financing businesses. BFL undertook business and organisational restructuring in FY08 and re-defined small business and consumer financing to be key niches. While the legacy problems continued to affect the financial performance adversely, new initiatives began delivering tangible results in FY10. We believe the new initiatives helped re-rate the stock from distress valuation levels in March 2009 to an FY12ii P/B of 1.9x.

We believe the market has priced in normalisation of growth and benefits that are likely to accrue from new business segments partially, as reflected by the strong YTD price performance (up 128%). The strong price performance could deter investors. However, rapid growth in assets, benefits from economies of scale in lending and a more benign outlook to asset quality would likely drive the re-rating process further, in our view. Earnings CAGR of 62% during FY10-13ii, prospect of raising new capital over the next 12-18 months, and less demanding absolute valuation levels on P/PPOP and P/E as well as on P/B, when compared to peers makes BFL a compelling investment argument.

Figure 1: Shifting focus into niche markets

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Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10

Pre-dominant focus on auto f inance

Niche focus on small business and consumer f inance

(Rs)

Source: IIFL Research

Figure 2: Re-rating process not yet complete

0.0

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Sep-05 Mar-06 Sep-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10

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High grow th

Grow th deceleration Consolidation

Normalization


4



Figure 3: Peer comparison FY10 FY12e Company name

P/E P/B RoE(%) P/E P/B RoE (%)

EPS CAGR FY10-FY12e

Bajaj Auto Finance 30.6 2.4 8.0 10.3 1.9 19.5 61.8Shriram City Union Finance 14.3 2.9 22.7 - - - -Shriram Transport 19.3 4.4 29.4 11.7 2.8 26.2 28.4India Bulls Financials 14.8 1.1 7.7M&M Financials 17.3 3.6 22.0 12.7 2.6 23.0 17.0Source: Bloomberg, IIFL Research

Figure 4: Still below 5-year P/PPoP average…

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5-year average forward PPOP/share5.3x


Figure 5: …. and 5-year P/E average

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5-year average forward PE 25.3x


Key risks to our recommendation, target price and earnings include an unfavourable lending environment, rapid increase in interest rates, less proven track record in the new business segments and increase in risk weights.

We believe asset quality outlook would likely remain benign, given our favourable outlook for the economy. The management, though less proven in the current set-up, brings a wealth of experience in the chosen business segments from various multi-national organisations. We believe this should hold in good stead even during periods of distress. We attach less probability to a rapid increase in interest rates, and hence, on its adverse effects on NIM and earnings at this juncture. But, interest rates will likely remain a concern.

Increase in risk weight on loans could be a key risk if the Reserve Bank of India (RBI) sees rapid credit growth in the entire system as a key risk. Increase in risk weight could constrain the growth rate of BFL, but this could be mitigated through capital augmentation. Higher capitalisation will likely depress RoE, which could be partially offset by higher RoA.

5



Favourable environment, strategic shift would be BFL’s key performance drivers Huge untapped potential in small business and consumer lending: Access to finance for small businesses and consumer segments has remained as a constraint for several years, as evidenced by the decline in the share of credit from banks to these segments. Lack of focus and skills for origination and management of credit and pre-emption of credit by the government and corporate sector has lead to dwindling share of credit from banks to these segments, in our view. We believe inadequate access to finance from the banking sector has enabled non-banking financial companies (NBFC), including BFL, to carve a niche in small business and consumer lending.

Figure 6: Share of bank credit to consumer durables and small business

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Consumer durables Small business (RHS)

(%) (%)

Source: RBI, IIFL Research

Figure 7: Banking sector loans to small business have been growing at below the system growth rate

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Source: RBI, IIFL Research Figure 8: Banking sector loans for consumer-durable purchases have remained stagnant over the years

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Source: RBI, IIFL Research

6



Well-timed entry by BFL into new niches: BFL’s investment in new initiatives could not have had a more opportune time. Lenders including well-established NBFCs such as CitiFinancial Consumer Finance and GE Money and banks such as HDFC Bank, Kotak Mahindra Bank and Standard Chartered Bank were withdrawing from small business and consumer lending, owing to rising delinquencies and a worsening lending environment in FY08. In our view, competitive intensity had ebbed completely by FY10, leaving the opportunity entirely to fewer players. This allowed BFL the time to invest in processes and systems for credit management. BFL made a beginning in small business loans and consumer financing in FY09 and began scaling up in FY10, while at the same time withdrawing from its legacy businesses.

Competitive intensity is low, but likely to rise over the medium term: With many key players withdrawing from small business lending and consumer financing, competitive intensity remains very low. Given BFL’s head start, it is likely to derive significant pricing power and ability to cherry pick assets. However, competition would likely intensify, as risk appetite of banks return. There is some evidence of new entrants,

particularly, new generation private-sector banks such as IndusInd Bank and Yes Bank. Much of the focus remains on secured lending products. Given the gap in financing needs, new competition may not pose a threat to the pricing power that BFL enjoys. As the risk appetite increases and expands into unsecured products too, we believe pricing power would likely wane. Recognising the threat to pricing power, BFL continues to invest in process improvements to drive down costs.

Figure 9: Key product features and competition landscape for consumer loans

Products offered Two wheeler loanConsumer durable

loan Personal loan

Minimum loan size (Rs) 7,500 20,000

Maximum loan size (Rs) 50,000 500,000 2,000,000

Average loan size (Rs) 37,000 20,000 50,000

Maximum duration of loan (months) 24 8 12-48

Key competitors All banks, lead by HDFC BankAll banks through

credit cards, SCUF All banks

Consumer loans


Figure 10: Key product features and competition landscape for small business loans

Products offered Small Business loansLoan against

propertyLoan against

shares

Construction equipment financing

Minimum loan size (Rs) 300,000 2,000,000 5,000,000 -

Maximum loan size (Rs) 3,000,000 125,000,000 100,000,000 500,000,000

Average loan size (Rs) 1,700,000 14,000,000 - -

Maximum duration of loan (months) 12-36 180 24 48

Key competitorsAll banks (primarily HDFC Bank, SCB, Kotak), SCUF

All banks, India Bulls Financials,

SCUF

Some banks, India Bulls Financials

All Banks, SREI

Finance

Business loans


Unique customer proposition in consumer durables: BFL finances only high-value items such as LCD, refrigerators, and air conditioners in the consumer-durable segment, where BFL effectively competes with credit cards. BFL has invested considerable resources to bring down the turnaround time for loan applications, from a few hours to 15mins, thus allowing it to compete with credit cards in this segment. This reduction in the turnaround time has also been made possible largely due to better data availability with the Credit Information Bureau (India) Limited (CIBIL). A customer taking a consumer durable loan from BFL pays 0% interest on the loan, which has a duration of 8 months and is required to make 30% down-payment for the product. This is in contrast to a credit card purchase, where the consumer would end up paying 25-35% for the same purchase, but with no down-payment. BFL on its part earns its entire spread from the manufacturer, who sub-vents the consumer’s purchase.

7



Credit behaviour remains pro-cyclical: Small businesses and consumer lending are more vulnerable to downturn/distress in the economy. BFL’s entry into small business and consumer finance coincided with the trough levels in economic activity in FY09. With the economy on the upswing since then and outlook remaining robust, we believe asset quality outlook would remain benign for BFL.

Focus on secured assets would cushion against sharp rise in credit cost: The key thrust product for BFL would be secured loans for small businesses, which will help in lengthening the duration of assets and at the same time provide protection against significant increase in credit costs. BFL would not have the leverage of using foreclosure as a disincentive against default; nevertheless, secured loans would provide significant downside protection.

Figure 11: Trend in deployments – auto finance share has declined since FY08

4932 30

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2321

1326

51 56 60 59

46 40 36 39

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0102030405060708090

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FY04 FY05 FY06 FY07 FY08 FY09 FY10Auto Finance Consumer f inance

Personal loans & Small Business Loans Mortgage & Other secured assets


Advantage for BFL includes experienced team and sophistication in processes: As part of organisational restructuring in FY08, BFL inducted several management personnel who were well-experienced in small business lending and consumer finance. We believe BFL gained significant expertise through these new hires.

Figure 12: Business division heads – experienced management

Name Business division Profile

Devang Mody Sales Finance

He has over 15 years of experience; latest assignment prior to joining BFL was with AIG, where he worked as Vice President – Business Development & CRM for the consumer finance business. He has also worked with GE Money and E&Y. He is a chartered accountant.

Deepak Reddy Personal & Small Business Loans

He has over 17 years of experience in distributing financial services & consumer durables. Prior to joining BFL, he was with American Express, where he held various positions in their personal loans & consumer card businesses, with the last assignment being Director - Sales (Consumer Cards). He has also worked with Standard Chartered and Onida. He is a management graduate.

Amit Gainda Loan against properties

He has over 13 years of varied experience. He was previously working with GE Money, where he held the position of National Sales Manager - Mortgages. He has also worked with Citi Group. He is a management graduate.

Sanjeev Vij Construction equipment finance

He has over 19 years of experience in retail consumer finance, SME mid-markets, and corporate finance. He was previously working with ABN Amro Bank, where he headed the asset backed finance (ABF) business in the infrastructure and healthcare segment. Prior to that, he worked with CitiFinancial Consumer Finance, Citicorp Finance India Limited, Alpic Finance, 20th Century Finance, and RPG Enterprises. He is a chartered accountant.

Vivek R. Likhite Loan against securities

He has over 20 years of varied experience. His last assignment was with Tata Motor Finance. He has also worked with Larsen & Toubro Ltd for eight years. He is a chartered financial analyst and holds a cost accountant degree from ICWAI.


Investments in loan origination and underwriting processes should give competitive edge over peers: For consumer finance, it employs analytics (score card system) for risk assessment of borrowers and fully integrated processes to enable quick response to customers. This unique selling proposition is likely to give BFL an edge over its competitors.

8



Figure 13: Standardised and technologically advanced processes allow BFL to approve/reject a consumer-durable loan within 15mins

Customer inquires about a CD loan

Is an existing customer?

BFL personnel at the shoplogs onto salesforce.com

and fills out the online form

Has a pancard/credit card?

Yes

No

α

β

Yes

No

Request for further documentationin order to perform a

comprehensive credit check

Customer inquires about a CD loan

Is an existing customer?

BFL personnel at the shoplogs onto salesforce.com

and fills out the online form

Has a pancard/credit card?

Yes

No

α

β

Yes

No

Request for further documentationin order to perform a

comprehensive credit check

Check CIBIL

Check internalrecords

Loan approved?

α

β

Collect one chequefrom customer and process other

paperwork

Yes

No

Inform customer aboutrejection

Check CIBIL

Check internalrecords

Loan approved?

α

β

Collect one chequefrom customer and process other

paperwork

Yes

No

Inform customer aboutrejection


For small business lending, it employs a traditional approach of field verification and due diligence on borrowers. The key differentiators are: a) BFL generates significant volume of new loans through its own sales force; and b) makes its sales team accountable for collection as well. The differentiated approach for origination and collection would likely make the credit selection and administration process more robust, but it

does not provide an edge against higher competitive intensity in the future.

Deployments likely to grow at a rapid clip: Deployments (loan disbursements) grew 87% in FY10, driven by a focus on new niches. We believe BFL would scale up business volumes in existing locations and expand selectively into new markets mainly for small business lending.

For consumer finance, BFL’s focus is on tapping opportunities in major urban markets, with a specific emphasis on large retail chains/outlets. With a presence already in 71 cities, BFL would likely push for rationalisation of distribution set-up and look to increase its wallet share with large retailers. Personal loans are originated through cross-sell from the customer base of durable finance. The origination process would be largely technology driven, as the company is likely to rely on its customer relationship management tools.

Small business lending would likely see expansion into new markets to sustain volume growth apart from scaling up volume in the existing locations. Currently, BFL operates from 16 cities. Our discussion with BFL suggests that the company would likely expand its operation to 25/27 cities over the medium term to sustain volume growth.

We forecast deployments to show 35% CAGR during FY10-13ii, driven by expanding wallet share in existing locations and through a selective push into new geographies. Construction equipment financing would likely be added as a new product. BFL is weighing the opportunity and risks in lending to this segment. As such, the outlook for growth is less clear to us at this juncture.

We expect receivables under finance to show 44% CAGR during FY10-13ii, led by loan against property for small business and consumer durable financing. Growth rate and share of 2-wheeler financing in receivables under financing is expected to decline, as the prospects for volume are linked to the prospect of Bajaj Auto. Our Auto analyst forecasts double-digit volume growth and higher realisation. This along

9



with an increase in penetration of financing to Bajaj Auto products would likely drive a CAGR of 24% in receivables from this segment.

Figure 14: Expected deployment mix

30 25 25 24

23 29 30 31

21 20 19 18

26 25 26 27

0

20

40

60

80

100

FY10 FY11ii FY12ii FY13ii2 w heelers Consumer durables

Small business and personal loans Mortgage and other secured loans

(%)

Source: Company, IIFL Research Figure 15: Deployments set to grow at a rapid pace

70,414

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45,85140000

80000

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Figure 16: Receivables under finance mix - share of LAP to rise

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2525 24 24

29 36 39 41

0

20

40

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FY10 FY11ii FY12ii FY13ii2 w heelers Consumer durables

Small business and personal loans Mortgage and other secured loans

(%)

Source: Company, IIFL Research Figure 17: We forecast a 44% CAGR (FY10-FY13ii) in receivables under finance

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Robust earnings growth, significant ROE uplift likely from improving cost efficiency and falling provisions NIM to moderate going forward: We expect NIM to moderate from 18.6% in FY10 to 12.1% by FY13ii, as incremental growth would largely come from LAP and small business loans, thus putting pressure on overall NIM. Furthermore, BFL benefited from a relatively benign interest rate environment over the past year, which aided the company in keeping the cost of funds low, despite the rapid growth in borrowings. Going ahead, we expect the change in loan mix along with an increase in cost of funds to put pressure on the NIM. However, owing to its rapid growth, we believe BFL would be in a position to deliver stellar earnings growth.

Figure 18: NIM to moderate, owing to change in asset mix and rising cost of funds

0

5

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30

FY05 FY06 FY07 FY08 FY09 FY10 FY11ii FY12ii FY13ii

NIM Yield on advances Cost of funds

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Cost/income to moderate: BFL has aggressively been investing in building its presence across consumer retailing chains for consumer durables financing and across the top-16 cities for small business lending. As such, the company will see only limited geographical expansion from hereon, primarily in small business lending. Furthermore, the commission paid out to direct marketing agents (DMA)

and staff for sourcing loans is broadly in-line with the fees charged to the customer for loan processing, which effectively provides for the variable payouts. Thus, in our view, BFL will be able to keep cost growth under check, even though the company is set to witness robust growth in disbursements. We expect operating costs to register a 23% CAGR over FY10-13ii, while we expect total income to register a CAGR of 28% over the same period. Thus, we expect the cost/income ratio to be steady in FY11ii and improve by 100bps by FY13ii to 39.6%.

Figure 19: Trend in cost/income ratio – operating leverage likely

37.2

46.845.3

56.7

49.4

43.7 44.241.6 39.6

25.0

35.0

45.0

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(%)


Provision charges set to normalise: BFL’s asset quality woes over the past two years resulted in provision charges as a % of average loans rising to 815bps in FY10. Provision charges are likely to stay high in FY11ii, as BFL would have to write-off more legacy loans to bring down gross NPAs. However, with the peak in gross NPAs having already passed in FY09, we expect provision charges to drop to 450bps in FY11ii before normalising between 250-300bps. This would provide a substantial kicker to earnings, as provision charges on legacy issues made up 66% of PPoP in FY10. We estimate this to effectively fall to 30-35% of PPoP by FY13ii.

11



Figure 20: Fall in provision charges, due to declining risk profile of assets to aid earnings growth

1.82.6

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Significant improvement in return ratios likely: We expect BFL’s RoA to rise by 120bps to 3.2% during FY10-13ii mainly driven by improving cost efficiency and falling provisions. We believe BFL would likely sustain above average RoA, as we believe credit costs are likely to undershoot during the early phase of growth in secured loans, i.e. loan against property. Consequently, we expect RoE to show substantial improvement in FY11ii and rise to 13.6%, from 8% in FY10. We expect RoE to improve further to 20% by end-FY12ii, on the back of increase in leverage. However, higher leverage may not be sustainable, requiring BFL to raise additional capital in FY12ii. We believe BFL’s sustainable RoE will be 21-22%. Normalisation of credit costs would likely drive RoA closer to 3%; regulatory and other market-driven discipline would likely require BFL to maintain a leverage of 7x and hence, we expect a sustainable RoE of 21-22%.

Figure 21: RoA to improve, owing to operating leverage and falling provision charges

4.7

2.11.6

0.51.0

2.32.7

3.03.2

0.0

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2.0

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(%)

Source: Company, IIFL Research Figure 22: RoE to improve, owing to increase in RoA and leverage

21.9

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Financial summary Income statement summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiNet interest income 4,139 6,545 7,923 10,307 13,071Others 212 600 901 1,261 1,765Non-interest income 212 600 901 1,261 1,765Total operating income 4,350 7,145 8,823 11,568 14,836Total operating expenses 2,204 3,196 3,995 4,926 6,007Pre provision operating profit 2,146 3,949 4,828 6,642 8,829Provisions for loan losses 1,636 2,606 2,366 2,672 3,179Profit before tax 510 1,343 2,462 3,970 5,649Taxes 171 449 813 1,310 1,864Net profit 339 894 1,650 2,660 3,785 Balance sheet summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiNet loans & advances 26,075 43,539 69,833 97,178 127,529Cash & equivalents 418 225 414 533 476Other interest-earning assets 2,739 3,018 1,660 1,826 2,009Total interest-earning assets 29,456 47,029 72,228 99,955 130,557Fixed assets 202 505 732 988 1,284Other assets 506 692 692 692 692Total assets 30,164 48,226 73,652 101,634 132,533Other interest-bearing liabilities 16,114 32,268 55,016 79,333 105,236Total interest-bearing liabilities 16,114 32,268 55,016 79,333 105,236Non-interest-bearing liabilities 3,162 4,433 5,943 7,726 10,044Total liabilities 19,276 36,700 60,960 87,060 115,280Total Shareholder's equity 10,887 11,525 12,693 14,574 17,252Total liabilities & equity 30,164 48,226 73,652 101,634 132,533Source: Company data, IIFL Research

Ratio Analysis - I Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13ii Balance Sheet Structure Ratios (%) Loan Growth -19.9 67.0 60.4 39.2 31.2 Growth in Total Assets (%) -21.6 59.9 52.7 38.0 30.4 Profitability Ratios Net Interest Margin 13.7 18.6 14.3 12.8 12.1 Return on Average Assets 1.0 2.3 2.7 3.0 3.2 Return on Average Equity 3.2 8.0 13.6 19.5 23.8 Non-Interest Income as % of Total Income 4.9 8.4 10.2 10.9 11.9

Net Profit Growth 68.6 163.6 84.5 61.2 42.3 FDEPS Growth 68.6 163.6 84.5 61.2 42.3 Efficiency Ratios (%) Cost to Income Ratio 50.7 44.7 45.3 42.6 40.5 Salaries as % of Non-Interest costs 33.1 31.1 32.3 31.5 31.0

Ratio Analysis - II Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13ii Credit Quality Ratios (%) Gross NPLs as % of loans 17.6 7.9 5.5 3.9 2.9 NPL coverage ratio 32.1 55.0 48.9 49.2 51.0 Total provision charges as % avg loans 628.5 814.8 447.1 340.0 300.0 Net NPLs as % of net loans 11.9 3.6 2.8 2.0 1.4 Capital Adequacy Ratios (%) Total CAR 38.4 26.0 17.8 14.8 13.4 Tier I capital ratio 38.4 26.0 17.8 14.8 13.4 Source: Company data, IIFL Research

Sandeep Muthangi [email protected] 91 22 4646 4686

IT Services Visibility improves – for FY12! 13 September 2010

We see the demand surge leading to better revenue growth for the remainder of FY11 and demand remaining at a sustained high in FY12

‐1.3%‐1.7% ‐1.6%

5.6% 5.5%4.5%

5.9% 5.6% 5.3%4.8%

4.3% 4.2%

‐3%‐2%‐1%0%1%2%3%4%5%6%7%

Infosys TCS Wipro

2QFY09 to 2QFY102QFY10 ‐ 1QFY111QFY11 to 4QFY11iiFY12ii

Revenue cqgr (US$ m)

Source: IIFL Research Demand for discretionary services is picking up strongly

‐0.3%

‐8.0%

1.6% 1.1%

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ADM

ERP

Testing

Infra.

BPO

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diversified

2QFY09 to 2QFY102QFY10 ‐ 1QFY11

TCS ‐ Revenues cqgr (US$ m)


Demand is becoming diversified at Indian IT vendors. Growth rates in 1HFY11 were helped by pent-up demand and BFSI M&A integration work. As these projects’ intensity subsides, work related to application migration, regulatory compliance and many discretionary services is picking up. Also, commentary on the pricing environment is increasingly sanguine. In the meantime, visibility on volume growth for FY11 remains high, with a possible upside surprise from the ongoing pick-up in discretionary services. While worries over attrition have not fully abated, we see minimal risk of further cost escalation associated with high attrition. We remain positive on the larger Indian IT vendors. Infosys and HCL Tech are our top picks.

From a surge to a sustained high: Lack of IT spending since mid-2008 and the consequent surge due to pent-up demand formed a considerable part of the robust revenue growth since 2QFY10 (US$: ~5.5% CQGR). This demand will gradually ease off, but industry participants tell us that demand is picking up for a diverse range of IT services—both near-term discretionary (testing, high-tech R&D, etc) and medium-term strategic/essential spending (migration of applications to cloud computing, modernisation of legacy systems, ERP implementation, etc).

Minimal risks of further cost escalation from attrition: Our recent interactions indicate that after the robust salary hikes, employee attrition at leading IT vendors is waning. We don’t see attrition returning to comfortable levels (17% to 20%) before the current batch of freshers is absorbed (by 3QFY11), but risks of cost escalation due to attrition at larger vendors have abated.

Protectionism – not a worry, but can’t be dismissed: Given the high unemployment and the increasingly populist nature of ‘protectionist’ rhetoric, the threat is real. But, rather than it affecting the viability of the offshore business model, we see the damage being limited to a minor margin headwind (increase in local recruitments onsite), as vendors hire more locals in their overseas markets.

Valuation summary

EPS PEX Company Price (Rs) Mcap (US$m) FY11ii FY12ii FY11ii FY12ii

FY10-12 EPS CAGR

TCS 879 36,727 43.8 49.2 20.1 17.9 18.4% Infosys 2,879 35,242 124.9 160.0 23.1 18.0 21.2% Wipro 411 21,384 22.7 26.7 18.1 15.4 19.2% HCLT 406 5,805 26.3 33.7 15.4 12.0 36.9% Patni 452 1,309 41.8 37.1 10.8 12.2 -9.6% Hexaware 75 230 4.9 7.1 15.3 10.5 -12.7% Tech M 710 1,846 70.7 70.2 10.0 10.1 -3.2% KPIT 168 282 10.1 15.1 16.6 11.1 18.0% Mindtree 517 422 27.9 41.2 18.5 12.5 -12.0% Infotech 163 385 12.8 15.8 12.7 10.3 1.0% Infoedge 1,142 666 25.4 34.8 40.1 29.3 35.1%

Source: Bloomberg, IIFL Research

2

IT Services

sandeep.muthangi@iif lcap.com

From a surge to a sustained high After falling at 1.3–1.7% on average per quarter during the relatively ‘slow’ period of 2QFY09 to 2QFY10, revenues rose at a robust 4.5–5.6% per quarter during 2QFY10–1QFY11. As 2Q is normally the best quarter for Indian IT vendors, we see revenue growth accelerating a bit further through the rest of FY11.

Lack of IT spending since mid-2008 and the considerable integration work related to BFSI-M&As were partly responsible for the demand surge. While this demand will ease off as projects are completed, our recent interactions indicate a pick-up in demand for a diversified range of IT services.

As such, we continue to believe that revenue growth rates may taper off from the surge witnessed in FY11, but are likely to remain high (~4.5% CQGR or 20%+ YoY) for the medium term (FY12). Figure 1: We see the demand surge leading to better revenue growth through the rest of FY11 and demand remaining at a sustained high in FY12

‐1.3%‐1.7% ‐1.6%

5.6% 5.5%

4.5%

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Infosys TCS Wipro

2QFY09 to 2QFY10 2QFY10 ‐ 1QFY11

1QFY11 to 4QFY11ii FY12iiRevenue cqgr (US$ m)


Our recent interactions indicate that demand is picking up for a diversified range of IT services. Demand for some services, such as migration into cloud, are likely to pick up in FY12, but many medium-

term IT services projects such as modernisation of legacy systems and ADM work for regulatory compliance, is already underway.

Figure 2: Demand generators for a diversified range of IT services • Regulatory compliance-related demand for IT services from BFSI. • Modernisation of legacy core systems in US BFSI. • Migration of existing applications as movement of peripheral processes ‘into the cloud’ picks up

pace. • Consolidation of vendors and processes. • ERP and business intelligence-related spending continue to accelerate. • US healthcare reforms related to data reporting and standardisation are driving demand for IT

services. • For technology and other ‘consumer’ related clients, the rapid ‘consumerisation’ of high-tech

(iPhone, Android devices, etc), is leading to standardisation of processes and normalisation of spikes in R&D spending for faster feature deployment.


Figure 3: Demand is picking up for a diversified range of IT services

-4%

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2QFY09 to 2QFY10 2QFY10 - 1QFY11 2HFY11ii FY12ii

ADM ERP Infra. BPO Products Diversif iedInfosys - revenue cqgr (US$ m)

65% of

revs.

High visiblity on robust volume growth.

Likely upside as the pickup in discretionary services is strong.

Revenue growth in some services like testing is accelerating.

Robust demand for products

High focus on infra. and BPO. A robust growth will likely be lagged.

Robust growth in ADM - M igration, Compliance and Feature deployment

Buoyant demand for ERP - Total outsourcing, BI implementations, focus on analytics increases

BPO growth to accelerate Total Outsourcing, P latform BPO and analyticsM ovement of peripheral services into the 'cloud' intensifies

M odernization of legacy systems


3

IT Services


Visibility of volume growth for FY11 remains high, based on our recent interactions with company managements and Infosys’s upward revision after 1QFY11 of its revenue growth guidance for FY11 (from 20% YoY to 25% YoY). Also, demand for discretionary services has been picking up strongly—which would not only help increase realisations, but also accelerate volume growth through the rest of FY11. Figure 4: Demand for discretionary services is picking up strongly

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ADM ERP Testing Infra. BPO Other ‐ diversified

2QFY09 to 2QFY10 2QFY10 ‐ 1QFY11TCS ‐ Revenues cqgr (US$ m)


Increasingly sanguine commentary on realisations Given the robust pick-up in demand for discretionary services, we see leading IT vendors’ business mix shifting towards higher-priced offerings and realisations improving towards 2HFY11.

Also, given the robust improvement in demand, our channel checks indicate that many leading Indian vendors are reversing the price cuts introduced last year. In addition, COLA adjustments in MSAs are also likely to resume.

Net, we see a benign environment for realisations toward 2HFY11, and expect realisations to start rising as early as 3QFY11. Figure 5: Better realisations in 2HFY11

High value resources as discretionary

demand remains buoyant

Discontinuation of some temporary price cuts

+ Resumption of COLA

adjustments

Improving mix of high value

services

Better realizations

1 2 3


Minimal risks of further cost escalation from attrition The low employee addition during the slowdown caught Indian IT vendors unprepared for the demand surge. The consequent ‘scramble’ for laterals led to a spike in attrition levels and consequently to high offshore wage increases. These strong salary hikes have to an extent curbed the attrition associated with wage asymmetries.

4

IT Services


Figure 6: Employee attrition levels even at leading Indian IT vendors spiked

5%

10%

15%

20%

25%

30%

1QFY07

2QFY07

3QFY07

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Infosys Wipro*Employee attrition (quarterly annualised)


Given the acceleration in demand growth and the consequent need for lateral resources, we see attrition levels remaining higher than the comfortable level till the 2010 batch of freshers is absorbed (in 2QFY11 and 3QFY11). That said, we think risks of further cost escalation have reduced considerably.

Protectionism – not a major worry, but can’t be dismissed The Ohio government’s ban on offshoring of all IT services is the latest protectionist move by a Western government. While the Ohio event will not have a material impact on Indian IT vendors, the threat of protectionism has been increasing. Economic rationale favours more offshoring, but given the high unemployment in the West and the increasingly populist appeal of protectionist measures, worries on this front will linger.

That said, we don’t think protectionism poses any material threat to the viability of the offshore model. We think Indian vendors will respond to Western governments’ concerns by stepping up hiring of locals in these markets—which would, at worst, be a near-term margin headwind.

12-mth TP (Rs) 1150 (14%) Market cap (US$ m) 4,973

52Wk High/Low (Rs) 1405/950 Diluted o/s shares (m) 245 Daily volume (US$ m) 40 Dividend yield FY11ii (%) 1.8 Free float (%) 57.3

Shareholding pattern (%) Promoters 42.7 FIIs 15.0 DIIs 26.5 Others 15.8


Reliance Infra -9.5 -5.4 -15.2 Rel. to Sensex -12.3 -18.2 -31.4 NTPC 1.6 2.0 -1.2 Tata Power -5.0 4.0 -2.8

CESC 0.0 4.9 10.5

Stock movement

01,0002,0003,0004,0005,0006,000

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Oct

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Nov

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Dec

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10

Feb-

10M

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02004006008001000120014001600


(Rs)Shares (000')

Harshvardhan Dole [email protected] 91 22 4646 4660

Devesh Agarwal [email protected] 91 22 4646 4647

Reliance Infra – ADD RELI IN Rs1011 Utilities 13 September 2010 Company Update

Financial Summary Y/e 31 Mar FY09 FY10ii FY11ii FY12ii FY13iiRevenues (Rs m) 96,965 96,285 1,19,043 1,43,982 1,70,175EBITDA Margins (%) 7% 12% 10% 11% 11%Pre-Exceptional PAT (Rs m) 4,389 11,517 12,487 14,940 18,001Reported PAT (Rs m) 10,461 11,517 12,487 14,940 18,001EPS (Rs) 19.4 47.0 46.6 55.7 67.1Growth (%) -36.1 142.2 -1.0 19.6 20.5PER (x) 52.1 21.5 21.7 18.1 15.1ROE (%) 8.6 8.8 7.7 8.5 9.5Debt/Equity (x) 0.6 0.5 0.3 0.2 0.2Price/Book (x) 1.9 1.9 1.7 1.5 1.4Consol Price/Book (x) 1.4 1.3 1.1 1.1 1.0Price as at close of business on 09 September 2010

Favourable risk-reward The Maharashtra Electricity Regulatory Commission (MERC) has lifted its stay order (imposed in June 2009) on Reliance Infrastructure’s (RELI) Mumbai discom tariff plan, as the regulatory audit found no irregularities in the books. Hence, RELI will earn the prescribed 16% RoE, and also recover Rs17bn in unrecovered costs. Separately, RELI will commence operations of the Delhi Metro shortly (3QFY11), which should lay to rest concerns on the company’s execution abilities. RELI trades at 1.1x FY11 consolidated BV; and given its portfolio of quality infrastructure projects we do not expect valuations to further deteriorate. The risk-reward is favourable, in our view; upgrade the stock to ADD.

MERC lifts stay on tariffs - a big positive: ASCI (Administrative Staff College of India), appointed by MERC to conduct a cost audit on RELI’s Mumbai distribution business, found no irregularities in RELI’s books. Hence, MERC has lifted the stay order imposed in June 2009 on tariff increases. As a result of the tariff cap, RELI has been incurring under-recoveries over the past 15 months; they added up to an estimated Rs17bn as at end-1QFY11. Withdrawal of the stay will allow RELI to recover these dues along with carrying costs, and earn the prescribed 16% RoE on its Mumbai distribution business. RELI is required to submit a plan to MERC for recovery of dues.

Key infra projects approaching completion: Separately, RELI is executing 25 infra projects—11 roads, three metros, five transmission lines, one sea-link and five airports—entailing a capex of Rs400bn. While its Mumbai metro phase-I is facing delays, the Delhi metro project is set to commence operations with the Commonwealth Games in October 2010. In addition, RELI is well-poised to commence operations of five road projects in FY11. Completion of key projects will improve RELI’s operating cash flows in FY12.

Favourable risk-reward; upgrade to ADD: After underperforming the broader market over the past year, we think RELI’s valuations are attractive, at 1.1x consolidated BV on FY11ii. Completion of the key projects and visible improvement in the Mumbai discom’s finances are key triggers for the stock’s outperformance. We believe the risk-reward is favourable, and upgrade the stock to ADD. RELI has 25 key projects at various stages of construction

Projects No. Project

cost (Rs bn) Roads 11 120 Metro 3 160 Transmission Line 5 66 Sea Link 1 51 Airports 5 3

Source: Company

2

Reliance Infra – ADD

harsh.dole@iif lcap.com

MERC vacates stay on RELI’s Mumbai discom tariffs RELI distributes around 1,200MW of power to around 2.5m consumers in the western suburbs of Mumbai. According to regulations, this business is entitled to earn an assured post-tax RoE of 16% and its tariffs are set by the MERC. MERC had set RELI’s tariffs for FY10 through its tariff plan issued in 1QFY10. Figure 1: RELI sells around 9BU units annually in its Mumbai distribution business

0

1,0002,000

3,0004,000

5,0006,000

7,0008,000

9,000

FY05 FY06 FY07 FY08 FY09

Industrial Commercial Residential

(MU)


However, the Government of Maharashtra (GoM) issued a directive to MERC after this tariff order. MERC was to investigate whether RELI had discharged its duties as envisaged in the Act in the most economical and efficient manner, so as to avoid unnecessary burden on the consumers of its area. MERC submitted a detailed report to GoM, where it pointed out a need for an independent investigation into power purchase transactions, accuracy of the electronic meters installed and a steep increase in capital expenditure being undertaken. It appointed the Administrative Staff College of India (ASCI) to investigate three broad areas of RELI’s Mumbai business: 1. power purchase cost; 2. capital investment; and 3. expenses of regulated business vis-à-vis other business.

Further, MERC also reversed its own tariff order and capped RELI’s tariffs at FY09 levels, till completion of such business cost audit. ASCI has recently submitted its final report to MERC, stating that it has found RELI’s business practices in-line with the provisions of the Electricity Act. Hence, MERC has vacated stay on RELI’s tariffs. Meanwhile, RELI has been buying power from external sources, as its own generation is well short of the total demand (500MW from Dahanu, as against demand of 1,200MW). Since its tariff was capped at FY09 levels, it was unable to pass through even the actual power purchase costs and incurred under-recoveries of Rs17bn through 1QFY10-1QFY11. Such under-recovery of costs has been dragging down RELI’s RoE from the Mumbai business. For instance, in 1QFY11, RELI’s standalone profits declined 25% YoY, as it could not pass through Rs1.1bn of additional costs that it incurred as a result of the cap on its tariffs. Figure 2: In 1QFY11, RELI’s power sales declined 14% YoY… Rs m 1QFY10 1QFY11 % YoY Sale of Electricity Energy 18,805 16,266 -14% EPC and Contracts 5,658 6,014 6% Gross Turnover 24,463 22,280 -9% Source: Company, IIFL Research

Figure 3: ... and EBIT declined by 43%, on account of the tariff cap imposed by MERC Rs m 1QFY10 1QFY11 % YoY Sale of Electricity Energy 1,769 1,010 -43% EPC and Contracts 541 839 55% Total EBIT 2,310 1,848 -20% Source: Company, IIFL Research

Now, with vacation of the stay from MERC, RELI would be able to recover the amount from consumers, along with interest. RELI will submit a proposal to MERC, detailing a plan to recover arrears. We reckon such regulatory intervention will have a positive effect on RELI.

3



Separately, RELI’s Delhi power distribution business, run by its subsidiaries BSES Rajdhani and BSES Yamuna, is doing well. As per management, these subsidiaries have seen significant improvement in the AT&C losses and from FY11 onwards would earn incentives. Approaching completion of key infra projects RELI currently has 25 infrastructure projects, comprising roads (11), metros (3), transmission lines (5), sea link (1) and airport management contracts (5). These projects are at various stages of completion, and RELI is estimated to spend Rs400bn. In FY10, RELI commenced operations of two toll road projects in Tamil Nadu, and the management expects to complete five additional projects in FY11. Thus, by FY11, RELI will have seven operational road projects. Figure 4: RELI – Road portfolio


While its flagship Mumbai Metro (phase 1) has seen some time overruns, the Delhi Metro, which connects Delhi International Airport to

Connaught Place, has begun trial runs. The management expects commercialisation of this project in time for the Commonwealth Games scheduled to start in October 2010. RELI has also made good progress in the Western Grid Strengthening projects, and expects to complete two lines in FY11. Figure 5: Delhi Airport Metro to commence operation by the end of Sept 2010


Thus, over the next 12 months, RELI is well-poised to emerge as one of the key infrastructure players in India, with a well-diversified project portfolio. Moreover, completion of large projects should allay investors’ concerns on the company’s execution abilities, and improve visibility on other large projects that are underway. At the end of FY11, there would be 11 revenue-generating projects with a total capital outlay of Rs192bn.

4



The management has plans to separate each of its businesses into separate SPVs, and is working on a re-organisation scheme. Such re-organisation would not only allow effective monitoring of the ongoing projects, but would also allow value unlocking through a partial stake sale in the future. The scheme is pending approval from various stakeholders, and is to be applicable retrospectively from April 2009. Figure 6: Proposed re-organisation would allow RELI to unlock value in each SPV


Favourable risk-reward; upgrade to ADD RELI’s stock has underperformed the markets by 30% over the past 12 months. Such underperformance was largely due to the challenges faced by the company in each of its business verticals (under recovery in Mumbai discom, delays in metro project, etc). At CMP, the stock trades at 1.1x consolidated BV on FY11ii. As such, given the infrastructure project portfolio, we do not expect the stock to trade below its book value. However, the positive regulatory verdict and completion of key projects are key triggers for the stock’s outperformance hereon. We therefore think the risk-reward is favourable and upgrade the stock to ADD. In the 1QFY11 conference call, RELI disclosed that it had gross cash (and equivalents) of Rs81bn (net of Rs40bn). Of this, around Rs53bn is invested in preference shares and inter-corporate deposits of the various group companies. The management said that there has not been any material change QoQ as well as YoY in this number, and is likely to remain at current levels in the next couple of years. The investors would look forward to reduction in such inter-corporate deposits extended to the unlisted group companies.

CMP Rs1,308

12-mth Target price (Rs) 1,200

Market cap (US$ m) 8,099

Bloomberg MSIL IN

52Wk High/Low (Rs) 1,740/1,127 Diluted o/s shares (m) 289 Daily volume (US$ m) 21 Dividend yield FY11ii (%) 0.5 Free float (%) 45.8

Shareholding pattern (%) Promoters 54.2 FIIs 20.1 Domestic MFs 17.0 Public 8.7


Maruti 7.0 1.0 -13.9 Rel. to Sensex 4.2 -11.3 -29.6 Mah & Mah -2.1 11.4 51.8 Tata Motors 15.6 40.4 82.6

Ashok Leyland 3.9 20.7 79.2

Stock Performance

0

2,000

4,000

6,000

8,000

10,000

Sep

-09

Oct

-09

Nov

-09

Dec

-09

Jan-

10

Feb-

10M

ar-1

0

Apr

-10

May

-10

Jun-

10Ju

l-10

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-10

0

500

1000

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(Rs)Shares (000')

Maruti Suzuki - REDUCE Autos 13 September 2010

Quick Take

Jatin Chawla [email protected] 91 22 4646 4654

Financial Summary Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13ii Revenues (Rs m) 204,553 290,989 360,292 398,232 439,439

EBITDA Margins (%) 7.0 11.8 8.8 8.9 9.2

Pre-Exceptional PAT (Rs m) 12,187 24,977 23,783 25,208 27,529

Reported PAT (Rs m) 12,187 24,977 23,783 25,208 27,529

EPS (Rs) 42.2 86.5 82.3 87.3 95.3

Growth (%) -29.0 104.9 -4.8 6.0 9.2

PER (x) 31.0 15.1 15.9 15.0 13.7

ROE (%) 13.7 23.6 18.4 16.7 15.7

Debt/Equity (x) 0.1 0.1 0.1 0.1 0.0

EV/EBITDA (x) 24.4 9.6 10.2 9.4 8.0

Price/Book (x) 4.0 3.2 2.7 2.3 2.0 Source: IIFL Research, Priced as on 08 September 2010

Discounts higher in spite of robust demand • Maruti has recently announced its discounts for the Ganesh

festival in Mumbai. The Ganesh festival marks the start of the festive season and discounts tend to be similar for the main festival period of Diwali.

• Surprisingly, in spite of robust demand, discounts are similar or higher on most models compared to last year.

• Most surprising is the discount of the recently launched WagonR. • It also highlights the fact that even though demand has surprised

on the upside, competitive intensity in the space would keep margins muted. Hence, though volumes may surprise positively in the near term, we retain REDUCE.

Figure 1: Comparison of discounts on Maruti models Model Total

benefit in 2009

Total benefit in

2010

Comments

Alto F8 24,000 33,000 Alto K10 NA No benefit

Alto K10 has been received very well, but with the Alto F8 being a better-margin product, the company is trying to push F8 and hence, the higher discounts.

WagonR 42,000 NA WagonR - new

NA 19,000 The new WagonR has lower margins than the older one, so it is surprising to see discounts within six months of the launch.

Estilo 42,000 44,000 Not a very high-volume product for the company. A-star 30,000 50,000 In spite of doing well in export markets, it is one of the few Maruti

hatchbacks which has not been received well by Indian consumers. SX4 30,000 60,000 In spite of a refurbishment, the SX4 continues to struggle; those opting

for a Maruti sedan chose to go with the Dzire instead. Swift 5,000 5,000 Remains one of Maruti's hottest-selling brands. Ritz No benefit 27,000 Even with a lower price tag and the same engine as the Swift, the Ritz

has struggled against both Maruti's own Swift and new competition. Dzire No benefit No benefit Still enjoys a three-month waiting period. Maruti 800

13,000 15,000 Gradually being phased out.

Omni 13,000 17,000 Volumes have not been cannibalised by the Eeco, which continues to do well.

Eeco NA No benefit Has done very well since its launch in April 2010. Versa 20,000 No benefit Very low volumes; negligible impact Source: IIFL Research

Maruti Suzuki - REDUCE

[email protected]

2

Figure 2: In 2009, with the market just recovering, manufacturers were still not confident on the demand environment and hence, discounts were higher

Source: Times of India, IIFL Research

Figure 3: In 2010, in spite of a very robust demand environment, discounts remain high. Our concern is that discounts could go up once demand moderates.

Source: Times of India, IIFL Research

2009

2010

Monday Tuesday Wednesday Thursday Friday Saturday

S E P T E M B E R – 2 0 1 0

6 7 8 9 10 11

Jul IIP- 13.80%

13 14 15 16 17 18

Aug WPI-

20 21 22 23 24 25 Aug CPI- AL/RL

27 28 29 30 Aug CPI- AL/RL

HDFC – 18 Oct

Black: Quarterly results, Blue: Economic data, Red: India Holiday.

Jul-Sep 10 Oct-Dec 10 Jan-Mar 11

Economics / Politics

• RBI’s Monetary Policy meeting on 27th July, 2010

• 1QFY11 Quarterly GDP

• RBI’s Monetary Policy meeting (end Oct) • 2QFY11 Quarterly GDP

• RBI’s Monetary Policy meeting (end Jan) • 3QFY11 Quarterly GDP

Cement • India Cements 1.5mtpa plant in Rajasthan to start (Sep)

• Bharathi Cement 2mtpa (2nd unit) in Cuddapah to start (Dec)

• Ambuja Cements 1.5mtpa unit in Bhatapara to start (Dec)

• Shree cements 1.5mtpa plant in Ras to start (Nov)

• ACC Wadi clinker unit to support 3mtpa cement to start (Oct)

• Prism Cements 3mtpa plant to start (Dec) • JP Associates 2nd phase addition in Gujarat to

start (Nov)

• Chettinad Cement 2mtpa expansion at Karikali, TN (Mar)

• Jaiprakash Associate’s 3.5mtpa expansion at Nalgonda, AP (Mar)

• Jaiprakash Associate’s 3mtpa expansion at Dalla, UP (Mar)

Media • Sun TV – To release its high budget movie – “Indhiran”

Metals • Sterlite: 1st phase of 2400MW will commence operation

• JSW’s Chilean iron ore mine to commence shipments

• Sterlite: 100ktpa lead smelter is expected to commence operation

• Sterlite: 2nd phase of 2400MW will commence operation

Oil & Gas

• FPO of IOC (Dec)

Pharma • Sun Pharma: Israeli Supreme court decision on Taro acquisition agreement

• Dr Reddy’s: Potential USFDA approval for fondaparinux

• Lupin: launch of Allernaze in US

• Ranbaxy: Launch of generic Aricept in US • Sun Pharma: resolution of Caraco

manufacturing quality issues in US • Opto Circuits: Launch of Dior drug eluting

balloon in Europe • Dr Reddys: court review decision on Allegra

D24 preliminary injunction • Piramal Healthcare: Closure of sale of

domestic formulations business to Abbott Labs

Jul-Sep 10 Oct-Dec 10 Jan-Mar 11

Real Estate • Peninsula land – QIP fund raising • Anantraj - QIP fund raising • IPO of Oberoi constructions

• Listing of Unitech Infrastructure on completion of restructuring of Unitech’s non-core assets.

Telecom • DoT to revert on TRAI 2G recommendations • BWA spectrum allocation expected

• MNP to be implemented • Indus to complete court process for tower

transfer • RCOM GTLI tower deal to be implemented • 3G spectrum allocation expected

• 3G services will be rolled out

Utilities • JSPL - Second 135 MW unit of 540MW plant at Chhattisgarh (Jul / Aug)

• KSK – Unit III & IV (135MW each) at Wardha Warora

• EGoM meeting on July 27 to decide on gas allocation to Reliance Power from RIL’s KG-D6 field

Key to our recommendation structure BUY - Absolute - Stock expected to give a positive return of over 20% over a 1-year horizon. SELL - Absolute - Stock expected to fall by more than 10% over a 1-year horizon. In addition, Add and Reduce recommendations are based on expected returns relative to a hurdle rate. Investment horizon for Add and Reduce recommendations is up to a year. We assume the current hurdle rate at 10%, this being the average return on a debt instrument available for investment. Add - Stock expected to give a return of 0-10% over the hurdle rate, ie a positive return of 10%+. Reduce - Stock expected to return less than the hurdle rate, ie return of less than 10%. Published in 2010. © India Infoline Ltd 2010 This report is published by IIFL’s Institutional Equities Research desk. IIFL has other business units with independent research teams separated by Chinese walls, and therefore may, at times, have different or contrary views on stocks and markets. This report is for the personal information of the authorised recipient and is not for public distribution. This should not be reproduced or redistributed to any other person or in any form. This report is for the general information of the clients of IIFL, a division of India Infoline, and should not be construed as an offer or solicitation of an offer to buy/sell any securities. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, so far as it relates to current and historical information, but do not guarantee its accuracy or completeness. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. India Infoline or any persons connected with it do not accept any liability arising from the use of this document. The recipients of this material should rely on their own judgment and take their own professional advice before acting on this information. India Infoline or any of its connected persons including its directors or subsidiaries or associates or employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained, views and opinions expressed in this publication. India Infoline and/or its affiliate companies may deal in the securities mentioned herein as a broker or for any other transaction as a Market Maker, Investment Advisor, etc. to the issuer company or its connected persons. India Infoline generally prohibits its analysts from having financial interest in the securities of any of the companies that the analysts cover. In addition, the company prohibits its employees from conducting F&O transactions or holding any shares for a period of less than 30 days.

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