Sunday, December 13, 2009
Investors with a penchant for risk can consider buying the Federal Bank stock at the current levels. The stock seems to be undervalued despite the bank displaying strong growth in earnings in the last few quarters.
At the current market price of Rs 246, the stock is trading at a FY10 earnings multiple of 7.6 and FY10 price-to-adjusted book value of 0.9. This is at a steep discount to other private banks. Though the discount is partly justified due to the geographical concentration of risk and reliance on remittances, it is still significantly cheap and has huge upside.
Federal Bank may see a modest earnings growth this year due to lower credit demand and some slippages. However the bank's earnings may outperform peers' beyond next fiscal as the credit off-take improves due to its superior net interest margin and as the asset quality improves.
The bank has historically posted better-than industry average credit growth and may continue to do so, going forward. In addition, the acquisition of Catholic Syrian Bank may significantly increase the size of the total branches which the bank can leverage to improve low-cost deposit base.
High credit-deposit ratio of 77 per cent, superior margins and high levels of operating efficiency (cost-income ratio of 35 per cent) support the earnings growth. Federal Bank is the fourth largest private sector bank. Around 60 per cent of its branches are in Kerala which contribute to 51 per cent of its total deposits and 42 per cent of total advances.
Comfortable levels of capital adequacy (capital adequacy of18.5 per cent), high levels of provision coverage (83 per cent) and strong return on assets (1.3 per cent) are the other key positives for the bank.
As of September 30, 2009, the loan book of the bank was well-diversified and comprised corporate credit (40 per cent), retail (29 per cent), and SME (31 per cent). Majority of the retail loan portfolio is home loans. The top industry exposures for the bank are in infrastructure, petrochemicals and iron and steel sectors, which are seeing signs of recovery.
On the liability side, one-fourth of the total deposits are current account and savings account deposits and 28 per cent of retail deposits are NRI deposits, resulting in a low cost of funds. The investment-deposit ratio is as high as 35 per cent which puts pressure on the net interest margin (NIM) as the yields on investment are low. NIM fell from 4.1 per cent to 3.5 per cent in a year, which is still at relatively healthy levels. The net profit of the bank saw an annualised growth of 30 per cent in the period between 2005 and 2009, thanks to a 24 per cent growth in advances during the same period. For the half year ended September 2009, the advance growth moderated to 20 per cent and net profit grew by 30 per cent.
The net profit growth in the latest half was aided by other income, which grew by 40 per cent, even as the net interest income remained flat. Though the net NPA/ advances of the bank have deteriorated to 0.54 per cent from 0.3 per cent in last six months, it is still low compared with most of its peers.
Capital adequacy may moderate once the bank acquires Catholic Syrian Bank (CSB). Federal Bank also has scope to improve its capital adequacy in form of Tier-2 capital which is relatively untapped.
The proposed acquisition of CSB may turn out to be advantageous for the bank despite CSB having higher net NPAs, cost of deposits and lower business per branch. Federal Bank's better efficiencies and ratings may stand the latter's business in good stead.
The acquisition may increase the branch network of Federal Bank by more than 50 per cent. Though CSB's business size is only 18 per cent of Federal Bank's, the latter can be scaled up using the branch network and offers an opportunity for Federal Bank to improve the operational parameters of CSB, while gaining low cost deposits.
Going forward, the banking industry may take a hit on earnings as the yields harden. The hit may be severe in case of Federal Bank as 31 per cent of the total investment book is available for sale or held for trading portfolio. The investment book has increased by 44 per cent for the bank due to deployment of excess cash in these investments.
Even if larger corporates are able to seek out other avenues of credit, off-take is likely to improve from the retail and SME segments. Margins may not improve from current levels for the next couple of quarters despite the re-pricing of deposits and demand for credit increasing.
Yield on advances is likely to come under pressure due to predatory pricing of certain loans and the bank's continued reliance on wholesale deposits (22 per cent of the total deposits including the certificate of deposits).
However, over the medium term, as the bank sets up more branches, the dependence on wholesale and certificate of deposits will fall which would in turn reduce the cost of funds. The NIMs may also improve over medium-term as excess investments shift to meet the demand for credit.
Investors may consider holding on to their Tata Steel shares. Uncertainties at its acquired European operations have been the key challenge for this profitable integrated low-cost steel producer, whose Indian and South East operations continue to remain one of the best bets in the steel industry. The stock trades at an EV/Tonne of about Rs 35,000. This is at discount to several Indian peers such as SAIL but at a slight premium to global peers such as Arcelor Mittal. While the European operations have shown early signs of revival, the key risk to Tata Steel's prospects arise from a delayed private demand recovery, especially once idling capacity is reinstated.
TATA STEEL INDIA
Indian steel price trends usually track global trends, remaining at asmall premium due to tight demand-supply.
With clear signs of recovery, the Indian economy has witnessed very healthy demand growth for almost all steel users — automobiles, electronics, industrial machinery. With steel supply expected to fall short of demand, the last two years have seen a slew of expansion plans by global and Indian majors. Tata Steel plans to ramp up capacities to 10 million tonnes from the current 7 million, with a greater percentage being flat products, which have better margins as a result of potential value addition. Automobile sales, which have seen a strong acceleration in volumes, even with some moderation, may provide Tata Steel with tremendous opportunities to capitalise on.
Emerging opportunities such as packaging, construction solutions and high-end flat products should see Tata Steel well poised to piggy-back on the well established Corus product line and research. Tata Steel's domestic operating margins have hovered around the 40 per cent mark and sales volumes grew 10 per cent between FY06 and FY09.
Realisations, in line with international steel prices, grew between 10 and 25 per cent over the same period. Profits after tax grew at an average of 13 per cent. With capacity being ramped up by up to 50 per cent by FY11, this should reflect on the standalone top line.
TATA STEEL: EUROPEAN STORY
Corus Steel, a wholly-owned subsidiary of Tata Steel, has a capacity of around 20-21 million tonnes of steel per annum accounting for roughly 10 per cent of European capacity and 65 per cent of Tata Steel's revenues in FY09. At the time of Tata Steel's acquisition, Corus had just returned to marginal profitability, after several years of sustained losses as a result of a high cost structure and legacy costs.
The scope for value addition and higher margins in the European markets, research and expertise in packaging, construction, automobiles and engineering grade steel are among the major reasons why Tata Steel acquired Corus. Though Corus by virtue of its huge capacity and wide product line is exposed to a variety of sectors all of them have been severely affected by the recession across Europe.
Tata Steel's European operations have seen very rough seas over the last four quarters taking a double hit from lower realisations and volumes.
The first half of FY10 saw revenue collapse by 51 per cent compared with the same period last year and a cumulative EBIDTA loss of close to Rs 2,500 crore. Lower raw material costs seem to have had minimal effect on the red bottom line. Efforts to streamline Corus' high cost structure include downsizing, mothballing plants and buying mines to secure raw material assets in an effort to hedge against commodity price fluctuations, the last of which is expected to take effect in 2012.
However, until these measures take effect, prospects for Corus may remain quite vulnerable to whether the recovery pans out. European commercial automobile sales are down 30-60 per cent in 2009, with sales sliding for 18 months in a row. But weighed against this, passenger automobiles, thanks to tax rebates and other incentives, have shown some early signs of growth in the last few months in contrast to the brutal drops witnessed earlier this year. Real-estate, industrial machinery and other sectors appear to have already bottomed out and some have managed single-digit growth. However, the numbers remain quite fragile as evidenced by the unexpected drop in German industrial output by 1.8 per cent in October.
Seen in this backdrop, Corus' plans to reinstate idling capacity does carry the risk of ‘oversupply'. The operations have, however, seen an improvement in capacity utilisation from the 50 per cent to about 75 per cent in the latest quarter. The second risk to the outlook arises from the uncertainty about private demand picking up once the stimulus-induced demand tapers off.
If private demand from infrastructure, real-estate, capital expenditure, automobiles and other sectors does not pick up, carrying forward the momentum provided by stimulus measures, steel producers could find themselves in the unenviable position of dealing with higher fixed costs and a renewed correction in realisations. Global steel prices, which are currently 40-50 per cent off their peak prices of mid-2008, have had a flat 2009 due to lack of demand in the second half of 2008 being balanced out by huge production cuts.
Tata Steel, which in retrospect did pay a high price for Corus, now carries a net debt position of $9.8 billion, down from $11 billion at the end of FY09. Several efforts have been taken to repay portions of the debt by raising funds through a GDR issue and shoring up the balance sheet by raising capital.
Other measures include deferring conversion of debt instruments on more convenient terms. The company has planned to repay another $180 million by end of this fiscal year. The dilutive effect for current shareholders, of equity expansion to pay back debt, is one of the downsides of this steel bet.
In the near term, steel realisations are likely to remain depressed, given the lumpy nature of Chinese demand and still shaky growth in developed nations. The latter makes volume growth an uncertainty.
However, what makes Tata Steel an interesting bet for long-term investors is its geographic profile, product mix and operational efficiency which in the long run are likely to serve investors well, even during downturns in the steel cycle.
Investors can consider subscribing to the initial public offer of DB Corp, a print media company that publishes the widely read Hindi daily, Dainik Bhaskar. Its strong regional footprint in the Hindi speaking states has enabled it to drive advertising revenues, the lifeline of the industry. Strong position in readership, the ability to tap regional and national advertisers even during a slowdown and lower newsprint costs and an appreciating rupee are key positives for the company.
At the upper end of the price band (Rs 185-212), the offer discounts the company's trailing 12- month earnings by about 28 times and its likely 2009-10 per share earnings by about 24 times, both on a post-offer equity base. This makes the offer a bit pricey as DB Corp asks for about the same multiples as Jagran Prakashan. In our view, the offer would be fairly priced at the lower end of the price band.
While DB Corp enjoys 20 per cent higher revenues than Jagran, it has a lower margin profile as it incurs higher employee and selling expenses. However, this may be a function of the ramp-up in its editions. DB Corp has seen its employee costs go up by 40 per cent annually over the last three years, due to staff recruitments for launch of new editions.
According to the ABC figures for January-June 2009, Dainik Bhaskar has a daily circulation of 2.547 million, higher than Dainik Jagran's 2.168 million. But the asking price is at a discount on a forward basis to players such as Deccan Chronicle Holdings and HT Media (which also publishes a Hindi Newspaper). DB Corp has seen its revenues grow annually by 21.7 percent annually over a three-year period to Rs 961 crore in FY-09, while net profits grew at 11.1 per cent to Rs 47.7 crore.
The company suffered a sharp decline (of 37 per cent) in profits for 2008-09, when the company was saddled with a 21 per cent rise in newsprint cost and, simultaneously, a 21 per cent increase in operating expenses.
However, a recovery is evident in the current fiscal with the company almost doubling its last year's profits in the first half itself.
DB Corp owns seven newspapers that have 48 editions. Dainik Bhaskar, one of its flagship newspapers, has 27 editions published across nine largely Hindi-speaking States (Madhya Pradesh, Rajasthan, Chhattisgarh, Haryana, Delhi, Punjab, Himachal Pradesh, Uttrakhand and Chandigarh).
According to the IRS 2009 R2 statistics, it has a readership of nearly 3.3 crore, making it the second most read newspaper in India. In Gujarat, it brings out Divya Bhaskar, where it claims top circulation.
There are also relatively smaller readership commanding newspapers such as Saurashtra Samachar, Business Bhaskar and DNA(in partnership with Zee Group).
These facts augur well for attracting advertisements, which contribute to over 75 per cent of the company's overall revenues.
DB Corp derives over 60 percent of its revenues from regional advertisers, which compares favourably to peer Jagran. The broad trend among broadcasters and print media companies seems to be suggesting an increasingly regional focus both in terms of audience and garnering advertisements.
HT Media, for example, has looked to expand in the Hindi language genre under the Hindustan brand and is now the fourth largest read in this category, according to recent IRS surveys (IRS 2009 R2). Zee Entertainment has acquired all of Zee News' entertainment channels to have sharper regional focus.
Recovery in advertisements of education, automobiles, insurance, telecom, especially with the several new entrants coming in and operators seeking to expand rurally, and FMCG companies means that both regional and national advertising are likely to be healthy for the company.
Even in 2008-09, when advertising revenues were hard to come by, DB Corp saw advertising revenues grow by close to 12 per cent, helped by regional advertising. The company's subscription revenues also rose over 10 percent.
DB Corp also has 17 FM radio stations in operations. But this business is nascent .
Newsprint prices, which were hovering around $900 per tonne levels in mid- 2008, have now declined to $500 levels, and this should help substantially rein in raw material cost, which accounted for over 40 per cent of FY-09 revenues. The benefits of this have begun to trickle in during the recent couple of quarters.
The rupee has also appreciated nearly 10 per cent from its peak to Rs 46.5 levels against the dollar, a saving for DB Corp because most of the paper sourced is denominated in dollars.
The key risks to this recommendation would be competition from papers such as Hindustan and Amar Ujala, especially if it reduces pricing power.
Interest expense has increased by over 30 percent in the last fiscal. But the interest coverage for the company is still a healthy 4.4 times. A part of the issue proceeds will go towards repayment of nearly a fourth of its long-term loans of Rs 457 crore.
DB Corp hopes to raise Rs 385 crore from the IPO, of which nearly Rs 116 crore would go to Cliffrose Investment, an existing shareholder in an offer for sale. About 1.8 crore shares would be on offer.
The company seeks to use the offer proceeds towards setting up publishing units, upgrading machinery and for sales and marketing purposes. Enam Securities, Citigroup Global Markets and Kotak Investment Banking are the lead managers. The offer is open from December 11-15.