Sunday, October 25, 2009
Being among the first to participate in the rally, automobile stocks may appear expensive at the current levels. Investors can instead look to add automobile component stocks to their portfolio, particularly those which have sizeable exposure to well-known auto companies.
Munjal Showa, which makes shock absorbers, is one such stock. Priced at Rs 64, the stock discounts its trailing four-quarter earnings by 12 times. Hero Honda, Honda Motors and Scooters, Honda Siel Cars and Maruti Suzuki are Munjal Showa’s major customers, with a bulk of sales coming from Hero Honda (about 78 per cent). From catering mainly to the entry-level buyers, Hero Honda has been fortifying its position in the premium bikes market.
As Munjal Showa is the sole supplier of shock absorbers to Hero Honda, the former appears well-placed to reap benefits from the latter’s expanding product portfolio.
Showa Corporation of Japan, a global leader in manufacture of shock absorbers, holds a 26 per cent equity stake in Munjal Showa. In terms of client profile, Munjal Showa has 90 per cent exposure to two-wheelers and 10 per cent to cars.
With credit availability easing up, fuel prices moderating and signs that urban spending is picking up, demand for two wheelers is expected to be on a sound footing this year.
Recently, Munjal Showa commissioned its third plant at Haridwar with an initial installed capacity of 5 million shock absorbers per year mainly to cater to Hero Honda’s new facilities.
Though there were doubts whether Hero Honda will be able to make headway in the premium segment of the two-wheeler market, it has managed to increase its presence in this space from 8 per cent to 11 per cent over the past year through new launches.
That augurs well for Munjal Showa. Apart from Hero Honda, Munjal Showa supplies parts to Honda Motorcycles and Scooters India (makers of Honda Activa and a market leader in the scooter segment).
Maruti Suzuki, the market leader in passenger cars, is another major customer of Munjal Showa (accounting for 8 per cent of total sales) and makes shock absorbers for premium and export models such as A-Star, Swift, Swift Dzire and Ritz.
The remaining 2 per cent comes from supplies to Honda Siel Cars, for models such as Honda City and Honda Jazz. So far, sales growth in these segments has been robust, guided by healthy festival demand and new launches.
Shock absorbers are an important part of a vehicle’s suspension systems and, therefore, the industry is technology intensive and caters more to original equipment manufactures’ requirements, as the replacement cycle is long (5-8 years).
Munjal Showa commands a market share of 60 per cent in two-wheeler shock absorbers and about 8 per cent in the passenger cars segment. While Gabriel India has a huge presence in the passenger cars segment and replacement market, Munjal Showa is a key OEM player for two-wheelers.
After posting a CAGR of 15 per cent for two years till FY’07, Munjal Showa saw brakes being applied on its growth in FY’08 due to the slowdown in two-wheeler sales. Sales in FY’08 marginally rose by two per cent and net profits plunged by 25 per cent. But with two-wheeler majors, particularly Hero Honda, bouncing back quickly, the company registered a sales and net profits growth of 17 per cent and 7 per cent, respectively, in FY’09.
A capex to the tune of Rs 175 crore for its Haridwar plant, funded by debt and internal accruals, resulted in interest cost doubling from Rs 2.2 crore in FY’08 to Rs 5.4 crore last fiscal.
Helped by excise duty cuts, the June quarter of FY’10 registered a sales growth of 17 per cent, though profits were down by 7 per cent due to steep increase in interest cost, which may continue to dampen profits growth. However, with production ramping up in the plant, the tax concessions derived from it may partly offset the interest burden. Debt-equity ratio is at a comfortable 0.43:1. Operating profit margins for the quarter were maintained at 7.8 per cent.
Munjal Showa has a small exposure to foreign current fluctuations. While it exports a very negligible portion to Showa Corporation, it imports about 8 per cent of raw materials from Japan. With the prices of domestic steel looking stable in the medium term, Munjal Showa may not face much pressure on the input costs front.
Hero Honda accounted for 85 per cent of Munjal Showa’s sales in FY’05. Though the dependence has been marginally reduced to 78 per cent in the current fiscal, prospects of Munjal Showa are still highly leveraged to the fortunes of Hero Honda
Automation and control solutions provider Honeywell Automation India Ltd’s (HAIL) financial performance in 2008 and over the first three quarters of 2009 has been superior to most other automation players in the country.
A well-entrenched presence in the automation and process solutions space, especially in hydrocarbons and other process industries, combined with steady business from the parent company hold out good prospects for HAIL’s earnings growth. The company’s almost zero-debt status and utilisation of accruals for expansion also lend strength to its financial credibility.
At Rs 2000, the HAIL stock offers a good buying opportunity; it currently trades at 14 times its likely per share earnings for the year ending December 2009. Investors with a two-year perspective can add the stock on declines linked to broad markets.
HAIL is an 81 per cent subsidiary of Honeywell US. The company derives its business from five major divisions — process solutions, building solutions, environment and combustion control, sensing and control and the export business group. The first division, with a contribution of over 65 per cent to revenues, has been the key growth driver. HAIL has traditionally been a domestic market leader in the hydrocarbon space, and tops the ranking in the list of process control equipment players in the country (CMIE Market Size & Shares 2007-08), with market share of 22 per cent.
ABB stands second in this list. However, it is important to note that larger players such as ABB and Siemens are leaders in the power automation space, specialising in power transmission and distribution equipment, while HAIL’s market share in this space is miniscule.
This limited contribution could have stemmed from the company’s lack of participation in state utility orders as they limit the profitability from after-market revenue streams (such as annual maintenance contracts) given that they are typically pegged to tariffs.
HAIL has, therefore, been selective in this space and has been targeting captive power projects.
However, with increased private participation in the power generation space, HAIL may be expected to actively participate in this segment as well. The company has bagged orders from private power players such as Tata Power. HAIL’s strength in the hydrocarbon space has enabled it to partner with clients such as ONGC, HPCL, IOC, BPCL. A high level of automation and after-sales services sought by the hydrocarbon industry tie in with HAIL’s sales-cum-service business model. Maintenance contracts often account for as much as 15 per cent of the project cost in the process solution segment. This could translate into an extended alternative revenue stream for HAIL, in times of slowdown in capex spending in the above industries.
Currently, HAIL offers services across the hydrocarbon value chain — exploration, transportation (pipelines) and retail (distribution). While volatility in oil prices during most of 2008 did see some delay in capex spending decisions in the segment, the more stable pricing regime prevailing now is likely to benefit HAIL. The company also serves firms in the metals, chemicals and sugar industries.
We also expect an uptick in HAIL’s building solutions space, with the revival in real estate activity in the country. HAIL’s products and offerings in this space, such as fire automation, security solutions, energy conservation and building management systems fit together well with the requirements of the massive housing projects and large commercial complexes currently in vogue, especially in Tier-I cities.
Some of the above requirements have become mandatory for certain large facilities under the law. This division is also likely to benefit from infrastructure development work in areas such as railways and airports. The company has already won several projects from the Airports Authority of India, including a terminal at the Delhi airport as well as projects from the Delhi Metro Rail.
Exports accounted for a fourth of HAIL’s revenues in CY-08, partly aided by a depreciating rupee. The company has an export manufacturing unit in Pune which addresses the manufacturing and engineering service needs of the parent as well as other global customers. The cost advantage and skill available locally is likely to ensure that the Indian unit remains the preferred outsourcing destination for Honeywell US.
HAIL’s revenue expanded at a compounded annual rate of 25 per cent over the three years ending CY-08 to Rs 962 crore, while net profits grew 34 per cent annually to Rs 82 crore. For the nine months ending September 2009, net profits jumped 70 per cent over a similar period in 2008.
While operating profit margins shifted to 17 per cent levels in the current year , perhaps as a result of superior product mix, OPMs at 12 per cent levels appear more sustainable. Further, competition from international players as well as larger peers such as ABB and Siemens could thin margins, especially if the company expands in the power industry.
Investors with a penchant for high risk can consider the Motilal Oswal Financial Services (MOFS) stock. MOFS, with its diversified model straddling broking and wealth management, private equity and investment banking, appears well placed to benefit from the trend of improving market sentiment, promising pipeline of primary offers and increasing corporate deals. At current market price of Rs 166, the stock trades at about 15 times its likely FY10 per share earnings. Though the valuation is at a discount to the market, investors may be better off phasing out their exposure to the stock.
Increasing retail participation and improving investor sentiment bode well for MOFS that derives a chunk of its earnings from equity broking.
Though the company has reported consecutive market share losses over many quarters — currently at 3.4 per cent down from previous quarter’s 3.7 per cent (4.5 per cent in the same quarter last year) — this hasn’t impacted its broking yield.
MOFS has improved its yield to 6.3 per cent from 5.8 per cent in the previous quarter (5 per cent in the corresponding quarter last year). This suggests that the company is veering away from chasing volumes to more profitable trades.
Despite the increasing share of derivative volumes in the stock exchanges (especially options trading), MOFS appears to have increased its focus on cash trades that enjoy higher brokerage commissions. Strengthening FII inflows may also help the company’s institutional broking business — its strong research team providing an extra fillip.
That said, improving overall yields from hereon might not be as easy, thus making it imperative for the company to focus more on the expansion of its client network. While the highly competitive nature of the business may keep client additions in check, MOFS’ expanding geographic presence and economies of scale do lend confidence.
Over the past year, it has expanded its reach to 576 cities from the earlier 487. What’s more, the expansion did not weigh on its margins, as it offset this through an optimisation of its branches. That this helped business is clear from the fact that MOFS grew its client base 14 per cent to 5.80 lakh over the past year. Addition of new clients would not only help improve volumes but also expand the scope for cross-selling.
To align with the cyclical nature of the business, MOFS has managed to move to a flexible cost structure, through a model that hinges considerably on expansion through franchise networks. The company’s large size and strong market position also make it better placed to survive capricious fund flows in PMS business or even erratic volumes in its broking division.
This may explain how the company, despite the difficult market conditions throughout last year, managed to maintain its operating profit margins at about 40 per cent.
That the company has successfully steered itself through a number of market cycles also lends confidence on risk-management skills.
Improving revenue mix
Though broking income continues to be MOFS’ breadwinner — over 70 per cent of total revenues in FY09 — it has made significant strides in deriving revenues from its other businesses as well.
Increasing contributions from the investment banking, fund-based activities (margin funding and prop trading) and asset management fee (which includes fees from PMS and assets under advice in private equity) have helped arrest margin contraction as these businesses yield better margins.
For the coming years, the company is looking to further raise its non-broking business contribution to 40-45 per cent from the present 30 per cent. This may be achievable if the company’s AMC arm takes off.
For the quarter-ended September, the company clocked a sequential revenue growth of 15 per cent, driven primarily by improving brokerage yields, investment banking revenues and high ‘other income’ component (courtesy profit on sale of investments). Earnings too grew 31 per cent sequentially, helped by a three-percentage point expansion in operating margins to 44 per cent. Its fund-based income however fell 7 per cent sequentially (22 per cent down y-o-y), in spite of a stable loan book (now at Rs 170 crore).
This can be explained by the lower interest received on term deposits and the 3 percentage point dip in its margin funding yieldsSEBI’s move to allow exchanges to extend trading hours may however tell on the company’s margins (likely increase in costs). While the move could also help garner additional institutional interest and retail participation, the extent of benefit may be difficult to point out.
In August 2007, the company had tapped the primary market to raise over Rs 246 crore to build on its competitive position and support working capital requirements. It also planned to enhance financing facility for broking customers, infuse funds into subsidiaries and buy itself additional office space.
While it has since added generously to its client base (up by 77 per cent) and geographical reach, the company’s loan book has reduced by over 30 per cent - attributable mainly to market conditions and lack of retail participation in the current rally. Its PMS AUM on the contrary has grown, despite the equity downturn.
As for segment-wise performance, while the company’s retail broking, wealth management and institutional broking revenues have vacillated in tandem with the markets, those from its private equity and investment banking divisions have shown definite improvement.
While the PE division has turned around, the Investment Banking division has bettered earnings. The company has jointly with its subsidiary MOSL, acquired an office building at Prabhadevi in Mumbai for a consideration of Rs 165 crore last quarter.
Investors can avoid the initial public offering of Den Networks considering the inherent challenges that the cable distribution industry faces in driving revenues and competition from alternative platforms such as DTH, that are making rapid strides.
The valuation that the offer demands is also quite steep. At the upper end of the price band (Rs 205) and on a post-offer diluted equity base, the EV/Sales (enterprise value to sales) multiple works out to 3.8, while the EV/EBITDA multiple is 255 (the company is only marginally profitable at the operating level), both based on Den’s FY’09 numbers.
The EV/Sales multiple is at a premium to Wire and Wireless, the only other listed peer, while the EV/EBITDA multiple is at a discount.
The cable industry may face several scalability hurdles, with the limited growth in television households, the pace conversion of analogue networks to digital ones and within that conversion of free-to-air viewers to pay-channel mode, all subject to uncertainty.
Den is a cable network operator with a limited two year operational history. Its 2008-09 revenues stood at Rs 719.3 crore, with wafer thin operating margins, from just Rs 81 crore the previous year. This growth, especially over the last one year has been possible due to the inorganic route that it took.
The company acquired majority interest in as many as 65 MSOs (multi-system operators) to expand its footprint across nine States last year. A Media Partners Asia report states that the company provides cable television services to 10 million homes.
Though the telecom regulator mandating conditional access in 55 cities across the country by 2011 is a positive for the company, there may still be limited scope for growth in subscribers.
Many of the challenges that Den would face affect the entire cable distribution industry. A recent report from PricewaterhouseCoopers indicates that the number of TV households would grow at just 2.7 per cent annually over 2009-13 to 135 million. Further, the report states that the number of cable households would grow from 71 million in 2008 at just 2.4 per cent annually from 2009 to 80 million by 2013.
A FICCI-KPMG report predicts a higher 5.7 per cent annual growth rate. This means that the TV household universe and within that cable television do not enjoy very rosy growth prospects.
Den is also conspicuous by its absence in lucrative markets such as Tamil Nadu, Andhra Pradesh and West Bengal, which have high number of TV and cable TV households.
Till such time Den is able to completely convert its entire network to a digital one, it may also have to grapple with the menace of local cable operators under-reporting revenues.
Even after full digitisation of its cable network is achieved, Den still faces the challenge of getting its viewers to subscribe to pay channels, which is the key revenue driver.
Empirical data suggest that the adoption of conditional access even in the metros has been slow, with most of the households content with free-to-air channels.
A report from TRAI gives out the fact that only a little over eight lakh set-top boxes have been installed in the four metros put together as of June 2009.
Even after digitising, a viewer has the option of not taking a set-top box and view only free-to-air channels. Regulatory controls on pricing also pose a threat with the regulator in fact mandating a Rs 77 package with 30 free-to-air channels. Den would thus face considerable challenge in getting households to adopt set-top boxes to drive the revenues per user.
DTH (direct-to-home) players, all backed by some of the largest conglomerates in India, are also turning the heat on cable operators by rapid subscriber addition. There are now five DTH players in the country, and all of them have fairly deep pockets. The number of DTH subscribers has already touched 16 million, which is quite large given that most of the new DTH players started operation only over the last 12-18 months.
With its reach and simplicity in delivering the last mile connectivity, DTH may be the real growth driver even if there is a trend towards digital television.
With tailor-made packages, capability to deliver both free and pay channels, and ability to drive value-added services, DTH ARPU (average revenue per user), which is in the Rs 150-160 range, could grow over the next few years.
Evidence to this fact is that latest hit-movies are being made available to DTH viewers with 2-3 weeks of their release for a fee that is much cheaper than going to a cinema hall or multiplex.
The PwC report states that DTH households are likely to increase to 35 million by 2013. Cable TV homes represent 89 per cent of the 80 million pay TV homes in 2008. This is projected to come down to 70 per cent by 2013, largely due to the share gains for DTH.