Sunday, November 29, 2009
It is FMCG makers which can deliver strong volume growth that have been outperformers in the stock market in recent months. That's why Indian players such as Marico, Dabur India and Godrej Consumer have seen a sharp expansion in their PE multiple to 25-30 times over the past year.
It is in this context that mid-sized FMCG company Jyothy Labs appears to be a good investment proposition. A value-for-money positioning for all its brands, extensive rural market presence and largely volume-driven growth suggest that recent buoyancy in the company's sales could be sustained. At the current market price of Rs 158, the stock is among the cheapest FMCG plays trading at 16 times its trailing 12-month earnings.
From being heavily dependent on just one brand, Ujala fabric whitener five years ago, Jyothy Labs has managed to broad-base its portfolio, adding Maxo mosquito repellants (36 per cent of 2008-09 revenues), Exo dishwash products (17 per cent) and a few smaller brands such as Jeeva soap and Ujala washing powder (10 per cent contribution).
After delivering sluggish numbers in the maiden year after its listing, Jyothy Labs has managed to post superior growth over the past year and a half. It managed a 27 per cent growth in adjusted sales and profits in the curtailed financial year ended March 2009 (the company reported numbers for 9 months due to a change in accounting year). This has been followed by a 34 per cent expansion in revenues and 56 per cent net profits growth in the first half of this year.
Over the past three years, the company has more than doubled its gross block to Rs 228 crore, without taking recourse to equity raising (the IPO in 2007 was an offer for sale by PE investors) or adding debt to the balance-sheet.
Jyothy Labs' brands increased their market share, even in the hotly competed segments of the FMCG business. While the flagship brand, Ujala fabric whitener has seen its market share climb from 68.5 per cent to 73.5 per cent between 2006 and 2009, Maxo mosquito repellant has seen shares rise from 19 to 22.8 per cent. Both these categories feature deep-pocketed competitors such as Hindustan Unilever, Godrej and Reckitt Benckiser. The company's expanding distribution presence in the South has also helped its Exo dishwash products double their South India market share from 11.7 to 23.8 per cent over the same period.
While Jyothy Labs' overall margin profile is lower than that of larger FMCG peers such as Dabur India or Godrej Consumer, it has managed to keep its adspend to sales ratio in the moderate 8-9 per cent range over the past three years, even while most other players saw a steep escalation in these spends to 12-13 per cent of their sales.
The company expects to keep adspend within this range, expanding market share mainly through investments in bettering its distribution reach.
Shift to value
The accelerated growth for Jyothy Labs is in line with the growth momentum witnessed by several smaller and mid-sized FMCG companies in this period. Mass market FMCG brands — whether in laundry, soaps or smaller categories — have seen strong growth momentum over the past year, helped by two factors.
One, the combination of upbeat farm product prices, higher support prices and better rural credit have helped keep rural and semi-urban demand for products quite strong, despite an erratic monsoon.
Jyothy Labs, with 60 per cent of its revenues originating from rural areas and an expanding distribution presence outside of urban India, has been a beneficiary of this trend. Two, the inflationary spiral of 2007-08 has prompted a consumer shift towards value offerings, helping regional and mid-sized players which have kept product prices under check.
With Jyothy Labs making almost no changes to its priceline over the past year, it has witnessed healthy volume-driven growth. In fact, packaging materials and plastics make up a chunk of raw material costs for the company and prices for these remain well below 2008 peaks.
The lag between commodity price corrections and their actual impact on costs and the three-four month raw material inventory held by the company may shield its margins from the increases in crude oil prices for the next couple of quarters.
The fact that the company has refrained from selling price increases for much of the past two years also lends it the flexibility to increase prices, if absolutely necessary, over the next year or two. A recent foray into laundry services, at a minimal investment may also lift overall margins, if it clicks.
Is Dubai World's debt repayment problem merely a delayed aftershock of last year's credit crisis or a fresh tremor likely to shake up the financial system? Opinion may be divided on this; but the event is certainly reason for stock market investors to turn more cautious. For this may be just the excuse the market is waiting for, to launch into a much-needed correction.
The initial stock market reaction to the Dubai World crisis has been to batter down companies which have their fortunes directly tied to Dubai or its troubled investment arm.
The stock of Spicejet, in which a subsidiary of Dubai World owns a 13.4 per cent stake, has been marked down and so have the stocks of Bank of Baroda and SBI, which have admitted to retail and corporate loan exposures in Dubai. History, however, suggests that investors need not worry too much about how these individual stocks may fare because of the crisis. The Dubai entities do not have a significant portfolio exposures to Indian stocks. Even if they hold indirect stakes, the past two years have seen numerous instances of troubled financial giants liquidating their stakes in Indian companies.
Despite recurring investor worries about `Bear Stearns' stocks, `Lehman' stocks, `Merrill Lynch' stocks and recently `Galleon' stocks, the impact of the holders' troubles on stock prices has been quite shortlived.
Stocks with good fundamentals have rebounded to pre-crisis levels, finding ready buyers at lower prices. Stocks with little claim to fundamentals have remained battered.
Given that Indian banks emerged relatively unscathed from the much larger credit crisis of last year, investors in banking stocks may have little to fear from the Dubai scare.
It is the broader market ramifications of this event that stock investors need to worry about. Some financial experts are betting on this crisis being quickly contained through a bail-out of Dubai World by other UAE nations. But if this scenario does not play out, it is feared that this may trigger a fresh bout of risk aversion on the part of lenders around the world. Going by what followed last year's credit crisis, this could lead to a sharp spike in the borrowing costs for businesses (and countries) with inferior credit ratings and a drying up of the now-ample liquidity.
This certainly cannot augur well for the many Indian companies which are now relying heavily on foreign funds to repair their debt-leavened balance sheets. This stock market rally has been led mainly by highly leveraged companies from the commodity and realty space, making such a scenario worrisome.
A phase of risk aversion, once it starts, can also have a big impact on the overall liquidity flows into the emerging markets, India included. Remember that it was returning risk appetite on the part of global investors which laid the foundation for this entire stock market rally.
It is rising risk-taking which has prompted global investors to abandon the safer developed markets and money market funds, and to pour money into all manner of risky assets - commodities, emerging market bonds and emerging market stocks - over the past eight months. The returns from these assets have by now exceeded everybody's wildest expectations.
The temptation to take money off the table and lock into those sizeable profits, is, therefore, bound to be quite high. The Dubai scare has also cropped up at a time when the global markets are being assailed by fresh doubts about the sustainability of the ongoing economic recovery. Will governments be able to exit from their big-ticket stimulus spending?
Will the "recovery" sustain once the props of stimulus are removed? Is consumer confidence robust enough to carry the baton from here on? If the answer to any of these questions turns out to be a "No", then the current stock market rally, which is built on optimism, would certainly be due for a pause.
Indian investors also need to weigh a few additional factors on the scale. At over 21 times trailing earnings, the BSE Sensex is already quite close to the inflexion point at which previous bull markets (of 2007- 08 and 1999-00) halted. With topline growth proving elusive for many companies, even in the recent September quarter, doubts are beginning to emerge on whether Corporate India can deliver on these high expectations.
But, most important, irrespective of how its own corporate or economic fundamentals look, India has always proved to be a high Beta market in the global scheme of things. It races ahead of most other markets when the going is good, but takes a merciless battering when liquidity flows suffer the mildest blip. That may be reason enough for Indian stock market investors to take some money off the table now.
Investors with a two-year perspective can buy the shares of Tulip Telecom, an enterprise data connectivity player, given the strong growth prospects and the company's expanding margins. At Rs 895, the share trades at 10 times its likely 2009-10 per share earnings. Between 2006 and 2009, Tulip's revenues rose at a compounded annual rate of 47 per cent while net profit grew by 72 per cent. The company has seen its revenues grow by 30 per cent in the first half of this fiscal over last year to Rs 933.9 crore, while net profit expanded by 32 per cent to Rs 126.8 crore.
The profit expansion would have been much higher but for increased depreciation on the back of completion of projects, and higher provisioning for taxes in the light of the new minimum alternative tax regime.
An increased focus on high-margin enterprise data connectivity business, a slew of new deal wins and revenues to be received from completed projects and increase in annuity based revenues are key earnings drivers. Tulip offers wireless last-mile (virtual private network) connectivity for corporates from its ‘point of presence' in that city. This is a key advantage not easily matched by competitors. The company also has a system integration division, which is a hardware intensive low-margin business. The company has over 1,500 clients across over 1,400 locations in India, both of which have increased substantially over the last one year.
The enterprise data connectivity business has grown from 69.5 per cent levels last year to over 85 per cent currently. This augurs well for the company as it ensures higher margins for the company. It has also witnessed growth in recurring revenues from clients, in addition to installation charges, which is indicative of revenue visibility of the company as well as its execution capabilities. The company has also been active in the Government State-wide area network (SWAN) deals, having won several such deals. SWAN in West Bengal has been completed and revenues are set to flow in from the next quarter. Assam and Madhya Pradesh networks are under implementation.
Tulip has also won a array of deals from new clients such as TCS, Etisalat, AT&T and from banks and insurance companies. As the company has a wide network across India, opportunities, in the form of new telecom players wanting to lease circuits could be a key revenue generator for the company.
Competition from integrated telecom players such as Bharti Airtel and Reliance Communications who are seeking to expand their non-mobile businesses could create pricing pressures in the data connectivity business.
Investors with a two-year horizon may buy the shares of eClerx Services, considering the improving business prospects for the segments (financial services, manufacturing) that the company caters to and the ramp-ups in business that the company is witnessing.
At Rs 376, the stock trades at 11 times its estimated 2009-10 per share earnings. Though not strictly comparable, this is at a discount to most listed mid to small tier IT/BPO players. Strong deal wins and increase in the run-rate of key clients are positives.
We had given an ‘avoid' to eClerx's initial public offering in December 2007, because of concerns on the macro-environment, especially in the US, stiff valuations and scalability factors. The stock did take a knock from its offer price of Rs 315 to Rs 91 levels in October 2008.
Concerns heightenedover bad debt from the failed Lehman Brothers, as it was one of its clients. The company has recovered over half of the Rs 4.9 crore in dues and has written off the rest as bad debt. But eClerx has managed what has been a turbulent 12 months for most IT/BPO/KPO companies quite well.
In FY09, the company saw its revenues grow by 51 per cent over 2007-08 to Rs 193.2 crore, while net profits expanded by 39 per cent to Rs 61.7 crore. In the recent September quarter, eClerx has seen its revenues and operating profits (EDITDA) increase by 10 per cent over last year.
eCerx is a KPO (Knowledge Process Outsourcing) services provider. It provides data analytics — collection and analysis of data, document management and catalogue management services. These services may be deemed to be of higher value than plain data entry or transaction processing work, but lower than services such as business and investment research, financial analysis and the like.
eClerx has a high client concentration, as is the case with most small sized BPO/KPOs. But the company has witnessed a ramp-up in the revenues from its top five clients, who account for nearly 80 per cent of its revenues, higher than the 75 per cent a few quarters ago.
This suggests that despite the shake-up in the financial services sector in the US and elsewhere, eClerx has not been very significantly affected. Also, the company works on deals that are spread over multiple years, which increases revenue visibility.
The company has also won two large deals in the quarter gone by, competing with BPO/KPO majors. This in an environment of vendor consolidation undertaken by large clients that favour BPO/KPO majors, lends confidence on eClerx's execution capabilities.
From an industry perspective, the fact that most captive KPOs are being sold off or are being scaled down in favour of third party vendors is also positive for a player such as eClerx. The company has increased its operations in SEZs (Special Economic Zones). From accounting for around 24 per cent of revenues a year ago, revenues from SEZs now contribute 38 per cent. This would neutralise the impact of MAT of 15 per cent on the company as current tax incidence is around 12 per cent.
The company derives nearly 61 per cent of its revenues from clients in the US and the rest from Europe.
Industry body Nasscom has observed that the US geography and the BFSI segment are stabilising and most industry research firms indicate a revival in IT/BPO spends by clients. This could benefit vendors such as eClerx.
The company had unfavourable hedges against the dollar pegged at Rs 41-42, which had resulted in forex losses of Rs 11 crore for hedges that matured this fiscal.
But the remaining $12.5 million hedged are at favourable rates of Rs 45-46 in the December quarter and Rs 50 for the March quarter, which should bring in better realisations for the company.
Billing pressure from top-clients and attrition, which has increased in the recent quarter are key risks to this recommendation.
Investors can subscribe to the Lakshmi Vilas Bank (LVB) rights offer which is at a 25 per cent discount to its current market price. LVB is a small-sized old private bank with two-thirds of its branches located in Tamil Nadu. Though the bank's loan book growth has lagged the industry in the past, it has managed superior growth over the last one-and-a-half years.
Comfortable capital adequacy, improving operating metrics and reasonable asset quality over the past one year, despite the slowdown in the economy, are the bank's key advantages. LVB may witness improved growth in advances as the corporate sector (it is exposed to industries such as textiles, gems and jewellery, infrastructure) has shown early signs of revival.
The company expects to raise Rs 265 crore from the rights offer at Rs 54 per share. At this price, the price-to-adjusted book value (post rights) for FY-10 would be 0.8, which is at a steep discount to peers such as Karur Vysya Bank, Dhanalakhsmi Bank and South Indian Bank. The book value is adjusted for NPA provision coverage and transition liability. The FY-10 price-earnings multiple works out to a reasonable 7.6 times on the expanded equity base.
Business and Finance
LVB's deposits and advances grew at an annualised 19 per cent and 21 per cent during the period 2006-09, lower than the industry average. Net profits grew by 33 per cent annually over this period. Priority sector and large corporates make up 34 per cent of LVB's total advances.
While the bank has short-tenors on deposits and advances, it has seen higher maturity loans increasing in the last few years, which gives stability to the topline. Capital constraints limited loan book growth till 2008 despite the bank making two rights issues since 2005.
The infusion of Rs 265 crore through this rights offer may improve capital adequacy to as much as 15 per cent from the current 9.72 per cent. However, for the bank to maintain comfortable levels of capital beyond next fiscal, capital infusion may be necessary in the form of Tier-II instruments. The bank has not yet tapped this option fully. An upgrade in the bank's credit ratings would help reduce the cost of funds.
Already, in FY-09 and this year, LVB has seen better-than-industry growth in advances. The bank has trebled its net profits on a low base in the first half of the year, with improving net interest margins and higher credit off-take. Last year's profits were depressed by higher provisioning required in the preceding year, owing to the depreciation of the treasury portfolio.
The above-average topline growth may continue to help profits. However, this may be partly offset by higher provisions. The bank's net interest margins (NIMs) which stood at 2.26 per cent, as of June 30, may improve as the liabilities get repriced. LVB continues to lose CASA share to other competitors, which is of concern.
While the bank has had troubles in the past in terms of asset quality, it has managed to significantly curtail NPAs. Net NPA, as a proportion of advances, has come down from 4.59 per cent in 2004-05 to 1.24 per cent in 2008-09. In the September quarter, the bank's asset quality slipped up with net NPA rising from 1.24 per cent to 1.55 per cent in six months. The net NPAs were limited due to restructuring of 3.3 per cent of advances as of March 31; but the figure may have increased in the last six months. Treasury losses are likely to pose a lower risk in future as LVB has done well to reduce the proportion of bonds held under AFS category, thus shielding its portfolio from bond price fluctuations. Around 80 per cent of the SLR portfolio is now in the held-to-maturity category. Early signs of recovery in sectors such as infrastructure, gems and jewellery and textiles may also help limit asset quality slippages for the bank.
The bank's cost-income ratio fell from 65 per cent to 54 per cent in the first half of this fiscal and may improve as the bank expands business. LVB was previously viewed as an attractive takeover target with Federal Bank picking up a 4.99 per cent stake in the bank.
However, with LVB continuing to gain strength, a takeover has become less likely. There is a possibility that the banking industry may grapple with higher NPAs arising out of future slippages, especially the restructured assets and this poses a risk for LVB as well, given the shorter maturity of the loan book.
Investors with a high risk appetite and a two-year perspective can subscribe to the initial public offer of MBL Infrastructures Ltd (MBL), a player in the road segment. A healthy order-book, sound clientele, backward integration and steady margins are key positives for this construction contractor. While MBL does not possess any unique selling proposition, a steady business model, sustained earnings growth combined with attractive valuations buttress this offer. The company small size, competition and concentrated business model remain risks attached to similar businesses.
In the price band of Rs 165-180, the stock is valued at about 5.8 to 6.3 times its expected earnings for FY-10 on an expanded equity base. This valuation places it at a slight discount to similar sized peers such as KNR Construction and Tantia Constructions.
MBL's project portfolio comprises road construction and maintenance contracts. Clientele is primarily made up of the Public Works Department and municipal corporations of various cities and states such as Mumbai, Delhi, Haryana and West Bengal. Projects are also funded by the World Bank and the Asian Development Bank. MBL, thus, has the credibility to secure repeat orders, especially in road maintenance contracts. The client base is likely to ensure a steady stream of contracts as public works is seldom affected by economic slowdown. MBL has also not seen project cancellations or payment delays thus far.
Having used joint ventures in project execution before, MBL plans to use such alliances to boost eligibility to bid for larger-sized build-operate-transfer contracts. It has completed a one-road BOT project. However, it has neither bid for nor won contracts since then. While small companies have ramped up operations to jointly bid and win BOT projects, MBL's current status can be said to be that of a contractor.
Given the competition and presence of large players in the BOT space, it may be challenging for the company to successfully venture into this space. However, even if it does not, we believe that as a contractor, it is positioned to secure ample business opportunities. Apart from local municipal works, the company is likely to get its pie of business from large road developers, which may subcontract the projects bagged by them.
Geographically, the company's projects cover a majority of the north and mark a presence in the south. Unexecuted order book stands at Rs 815.3 crore, about 2.2 times revenues for FY 09. Slated to be completed over a period of 18 - 24 months the order book provides medium-term earnings visibility. MBL has plans to increase contribution from industrial and urban infrastructure, but does not have any definite orders in hand, resulting in a heavy dependence on the road sector posing concentration risk.
About a third of MBL's revenues is sourced from waste management of steel plants such as SAIL. But with an operating margin of merely 1 per cent, it hardly aids overall profitability. This revenue stream is set to cease by the end of the current financial year; such a move could be positive as this business is unlikely to integrate with the primary road business and may act as a drag on resources.
The company plans to raise about Rs 100 crore through this issue. About Rs 55 crore is marked for acquisition of equipment and machinery. Funds raised will also be used to finance working capital.
Equipment ownership, though requiring higher capex in the short term, will ensure timely availability of key equipment, mobility between projects besides helping to reduce costs. MBL also operates its own ready mix concrete and bitumen divisions that serve captive consumption. It takes stone quarries on lease, mines and produces stone aggregates to meet raw material requirement.
It is, perhaps, this backward integration that has resulted in operating profit margin (OPM) jump to 14.5 per cent in FY-09, compared with the 10 per cent levels in FY-06. The profits margin achieved in FY-09 is commendable, given the raw material pressures faced by most infrastructure players. At 15.6 per cent, OPMs have been maintained in the June 09 quarter as well. Price escalation clauses built into most contracts would further protect margins.
MBL clocked health revenue and net profit growth of 46 and 48 per cent respectively, compounded annually over the last three years. The growth, while superior to many other players, comes from a small base. A repeat performance in future years may be a tough task. Further, debt taken to fund working capital, and depreciation on equipment have dented net profit margins. Comfort, though, may be derived from the fact that interest as a percentage of sales has remained around 4 to 5 per cent.
The offer is open from November 27 to December 1. Motilal Oswal Investment Advisors is the book running lead manager. Given its risk factors, investors may consider setting target returns and exit the stock on meeting the same.