Coal India Iifl Jul10

8/4/2019 Coal India Iifl Jul10

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Vardhman Textiles

s ang e e t ha@ i i f l c a p . c o m

Company snapshot

VTL, with an 870,000-spindle capacity, is Indias largest yarnmanufacturer. Yarn manufacturing is a highly fragmented industryVTL, the largest player, has a volume market share of just about 2%,and Nahar Spinning, the second-largest player, has a share of about1%. No single supplier has pricing power, so yarn prices are largelymarket-determined. Similarly, no single yarn manufacturer hassignificant control over raw-material prices, as none has any majorshare of procurementVTL, the largest cotton procurer, accounts for

less than 2% of Indias cotton production.

The company has forward-integrated into producing fabrics and sewingthreads, and plans to commence garment production soon. As a result,revenues from yarn currently account for less than 60%, while value-added products (mainly fabrics and sewing thread) account for ~20%and ~10%, respectively.

Figure 1: Yarn accounts for a little over half of VTLs its revenues; forward integration

has increased value-added products share of revenue to about a third of the total

FY10 reve nue composit ion

Fibre

7%

Fabric

21%

Sewing thread

10%Steel

6%

Yarn

56%

Source: Company, IIFL Research

Promoter background

The Vardhman textile group was set up by Mr S P Oswal in 1962 in thenorth Indian city of Ludhiana. The group, under his familysmanagement, has since expanded its capacities to become the largestyarn manufacturer in the country. Mr Oswal remains actively involved inmanaging the firms operations and in setting its strategy and direction,and is aided in the groups various businesses by his daughter MsSuchita Jain and son-in-law Mr Sachit Jain. The promoters own 67% ofthe companys equity.

Figure 2: Promoters own over 2/3 of the companys equity

FII

1%

Domestic

investors

13%

Others

18%

Promoters

68%



6/23

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Vardhman Textiles


I. Indias largest diversified yarn manufacturer

VTL started as a yarn manufacturer in 1965, with a 12,000-spindleyarn-spinning capacity, and currently has an 870,000-spindle yarn-manufacturing unit. From manufacturing plain greige yarn, the companyhas grown to become a leading manufacturer of a range of value-addedyarn products, including blended yarns, sewing threads, and hand-knitted yarn. It is also Indias largest exporter of cotton yarn,accounting for almost 5% of the countrys total yarn exports.

De-risking by value addition: Greige yarn is a commoditised product,

with both realisations and input prices being market-determined. Toimprove its pricing power, VTL started manufacturing value-addedproducts such as compact yarn, melange, dyed, hand-knitted, slubs andmercerised yarn, which command 3-5% pricing premium.

Figure 3: Commodity products now account for 50% YoY. This was also reflected in VTLs EBITDAmargin, which widened from ~15% in FY09 to 21% in FY10.

Figure 4: Thanks to soaring yarn prices, yarn-cotton spreads are at a multi-year high

0

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120

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180

Jun06 Dec06 Jun07 Dec07 Jun08 Dec08 Jun09 Dec09 Jun10

0

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30

40

50

60

Yarn prices Cotton prices Spreads (RHS)

(Rs/kg) (Rs/kg)

Source: Bloomberg, Company, IIFL Research

Figure 5: High yarn-cotton spreads boosted EBITDA margins to a multi-year high

Yarn

12.0%

14.0%

16.0%

18.0%

20.0%

FY06 FY07 FY08 FY09 FY10

EBITDA margins



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Vardhman Textiles


IV . Sewing-thread is VTLs only B2C business

VTL started its sewing-threat business in FY02, in a joint venture withAmerican & Efird (A&E); VTL owns 51% in this subsidiary. Unlike itsother businesses (yarn, fabric, steel and fibres), where the companysells to industrial customers (including apparel manufacturers andvendors of large retailers), sewing thread is the only business whereVardhman sells its products to consumers. This makes it one of themost profitable segments for the company (EBITDA margins of ~20%,vs consolidated margins of 16-18%).

VTL is the second largest producer of sewing thread in India, afterMadura Coats, according to company sources. The company does notplan any significant capacity addition in this segment in the near future,as returns on its yarn and fabric manufacturing businesses appear moreprofitable at current prices.

Figure 7: Strong domestic consumer demand has supported high margins in FY08-10

Sewing thread

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

FY07 FY08 FY09 FY10

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

Revenue growth (YoY) EBITDA margins (RHS)


V. De-merger of unrelated (steel) business

Following the acquisition of a sick textile company, which also had steelassets, the company came into steel-manufacturing capacities, whichhave since been integrated into the books of VTL. The steel divisioncontributed ~6% of VTLs consolidated revenues during FY10 andregistered EBITDA margin of ~15% in FY10. As the steel business is nota part of the core textile-manufacturing business, the company hasdecided to de-merge it, with effect from January 2011 onwards.

Capacity addition likely to continue to take advantage of TUFS

The TUFS scheme introduced in April 1999, which provides subsidy onimport of capital goods, has been extended multiple times. Based oncurrent information, it is due to expire at the end of FY12thegovernment recently clarified that it would not be extending it furtherbeyond FY12. However, industry lobbying efforts are on in full swing.

Figure 8: Free cash flows to remain positive as above-normal yarn margins shouldsupport strong operating cash flow

(8,000)

(6,000)

(4,000)

(2,000)

-

2,000

4,000

FY07 FY08 FY09 FY10 FY11ii FY12ii FY13ii

-

2,000

4,000

6,000

8,000

10,000

Free cash flows Capex (RHS)



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Vardhman Textiles


Should the scheme indeed expire in FY12, VTL plans to launch a

significant capacity addition programme, adding ~20% to its currentcapacities (Rs10bn capex on its current gross block of ~Rs40bn).Currently, only a Rs3bn investment in yarn capacities has beenfinalised, and the rest will depend on the extension of the TUFS scheme.We estimate that the company will secure funding for the entire TUFSscheme during the next 18 months, and this expansion plan should becompleted by FY13. Despite such significant capex spending, weestimate that VTL should remain FCF-positive during FY11-13ii,supported by operating cash flows (due to super-normal high margins).

Change in accounting policy offers upside potential to ourestimatesVTL depreciates its assets over an average period of 10 years. UnderIFRS, the management could potentially decide to depreciate its assetsover 15-20 years, given that average age of these assets is well above15 years. Should the management consider such a shift in its policy, thelower depreciation could lead to 7-9% upside to our FY12-13 EPS

estimates.

Stock trades at ~50% below its historical peak multipleAt its current 1-year-forward PER of 6.4x FY11ii EPS, the stock trades ata >50% discount to its historical peak multiple of 15.4x, and also belowits 5-year average multiple of 7.7x. The continued bull run in yarnprices and higher volumes should support a re-rating in the stock. Thatsaid, given that risk to yarn realisations remains high (global indicatorsstill tepid), we believe the stock should trade closer to its historical

average levels. Based on this, we value the stock at 8x 1-year forwardPE, which gives a 12-month target price of Rs37419% above the CMP.

Figure 9: Trading below historical average P/E

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Aug-0

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Dec-0

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Apr-

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Aug-0

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Apr-

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Aug-1

0

(x)

1-yr fwd PE 5-yr his tor ical average

Source: Bloomberg, Company, IIFL Research


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Vardhman Textiles


Annexure 1

VTL started business as a yarn manufacturer, but has since expandedinto fabrics, garments, sewing threads, fibres and steel manufacturing.

Figure 10: Group structure

Vardhman textiles

Yarn,fabric,steel Sewing thread

J&V with A&E,

USA

Vardhaman Textile

Vardhman Yarns

and Threads

Vardhman

Spinning

Vardhman Acrylics

Cotton Yarn

JV with Marubeni

& Toho Rayon,

Japan

Acrylic Staple

fibre


VTL sources most of its raw materials domesticallyCotton constitutes over 80% of VTLs raw-material utilisation. Thecompany depends almost entirely on the domestic market for cottonprocurement, except in the case of specific customer requirements thatnecessitate procurement of a certain variety of cotton from specificcountries. The company manufactures yarn from a wide variety of rawcottonfrom counts as low as 20 to as high as 200. India, being one ofthe few countries in the world with climatic conditions that suit theoutput of a variety of raw cotton, offers ready supply of all counts.

Figure 11: Cotton accounts for the largest share of raw materials largely procureddomestically

Raw materials

Cotton

79%

Others

13%

Acrylic

8%


VTL sells mostly to vendors directlyAlthough VTL sells most of its yarn to its customers directly (Gap and

Esprit, among others), these prices are driven largely by marketconditions. While supply to customers directly assures the company ofofftake at assured margins, maintaining quality is key to retainingvendor relationships.

Figure 12: Yarn demand is mainly driven by global markets (US and Europe mainly)

Yarn

33% used for captive

purposes

33% to domestic fabric

manufacturers

33% exported

80% sold directly to

vendors

20% sold in the wholesale

market Source: Company, IIFL Research


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Vardhman Textiles


Financial summary

Income statement summary (Rs m)

Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13ii

Revenue 29,654 33,507 36,590 38,411 45,459

EBITDA 4,524 7,050 8,386 8,362 9,804

EBIT 2,090 4,484 5,607 5,414 6,518

Interest expense 1,068 852 1,165 1,369 1,521

Exceptional items 1,134 222 0 0 0

Others items 70 -260 -207 -129 -167Profit before tax 2,226 3,595 4,236 3,916 4,830

Tax expense 513 980 1,355 1,266 1,547

Net profit 1,713 2,615 2,881 2,650 3,282

Cashflow summary (Rs m)


Profit before tax 2,226 3,595 4,236 3,916 4,830

Depreciation & Amortization 2,434 2,566 2,778 2,948 3,286

Tax paid -372 -736 -1,355 -1,266 -1,547

Working capital 859 -6,288 -2,731 -1,361 -2,856

Other operating items 501 644 1,091 1,195 1,361

Operating Cash-flow 5,648 -219 4,019 5,433 5,073

Capital expenditure -1,781 -2,271 -3,000 -3,500 -3,500

Free cash flow 3,867 -2,490 1,019 1,933 1,573

Equity raised 1,307 26 0 0 0

Investments -1,283 553 0 0 0

Debt financing/disposal 405 1,444 2,109 1,980 -293

Dividends paid -271 -215 -236 -218 -269

Other items -1,015 -756 -4,591 -1,195 -1,361

Net change in Cash & cashequivalents 3,010 -1,438 -1,700 2,500 -350

Source: Company data, IIFL Research

Balance sheet summary (Rs m)Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13ii

Cash & cash equivalents 5,130 3,546 1,846 4,346 3,996

Sundry debtors 3,459 4,758 5,814 6,314 7,473

Trade Inventories 7,396 12,970 14,645 15,506 17,203

Loans and advances 4,091 3,483 4,210 5,157 6,601

Fixed assets 26,308 25,986 26,207 26,759 26,973

Other assets 51 29 29 29 29Total assets 46,435 50,772 52,753 58,112 62,276

Short-term debt 2,889 3,752 6,483 7,844 10,700

Sundry creditors 2,734 3,004 3,375 3,551 3,990

Other current liabilities 4,538 5,297 4,802 5,572 6,578

Long-term debt/Convertibles 22,443 22,679 19,407 20,026 16,877

Networth 13,832 16,042 18,686 21,119 24,132

Total liabilities & equity 46,435 50,772 52,753 58,112 62,276

Ratio analysis


Sales growth (%) 24.2 13.0 9.2 5.0 18.3

Core EBITDA growth (%) 35.9 55.8 18.9 -0.3 17.2

Core EBIT growth (%) 22.4 114.6 25.1 -3.4 20.4

Core EBITDA margin (%) 15.3 21.0 22.9 21.8 21.6

Core EBIT margin (%) 7.0 13.4 15.3 14.1 14.3

Net profit margin (%) 5.8 7.8 7.9 6.9 7.2

Tax rate (%) 23.1 27.3 32.0 32.3 32.0

Net Debt/Equity (%) 170.9 152.0 140.4 130.6 119.6

Return on Equity (%) 4.2 14.9 15.4 12.5 13.6

Return on Assets (%) 3.7 5.1 5.5 4.6 5.3

Source: Company data, IIFL Research


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Insurance

[email protected]

Moderation in the growth rate of renewal premium brings added

risk to valuation

Insurance majors reported a moderation in the growth rate of renewalpremium in 1QFY11. Renewal premium for a few, such as Bajaj AllianzLife (BALIC) and ICICI Prudential Life (ICICI Pru Life), registered

declines. BALIC reported a decline for the second consecutive quarters.We believe this points to a higher surrender rate of policies thanpreviously expected.

Figure 1: YoY growth in renewal premium

(20)

0

20

40

60

80

100

120

BALIC Reliance Life ICICI Pru Life Max New York Life

1QFY10 2QFY10 3QFY10 4QFY10 1QFY10

(%)

Source: Companies, IIFL Research

An increase in surrender rates is reflected in the conservation ratioreported by life-insurance companies. The conservation ratio iscomputed as renewal premium received during a quarter, divided byrenewal and new business premium during the year-ago period. In1QFY11, the conservation ratio declined YoY for BALIC, ICICI Pru Lifeand Max New York Life (MNYL), while it rose for SBI Life, Birla Sun Life(BSLI) and HDFC Standard Life (HDFCSL). The ratio remained

unchanged for Reliance Life.

Figure 2: Reported conservation ratio

0

20

40

60

80

100

BALIC Reliance

Life

ICICI Pru

Life

Max New

York Life

SBI Life Birla Sunlife HDFCSL

1QFY10 FY10 1QFY11

(%)


Our sensitivity analysis shows that every 10pps increase in surrender

rate of policies will affect NBV adversely by 1519%, depending on theresidual life of policies in force. Surrender of policies before residual life,but after the lock-in period will result in negative variance betweenexpected and realisable revenue (assuming the contracted policystenure at 10 years). The impact is likely to be higher for policiescontracted for longer terms.

Should a larger portion of policies run off on account of surrender, valueaccruing through NBV in EV will get affected significantly, and perhaps

may not provide any significant value uplift above the invested capital.Currently, EV/invested capital ranges from 1.4x to 1.8x, depending onthe valuation methodology and other associated factors such as

guarantees and options underwritten by the insurer.


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Insurance

[email protected]

Figure 3: Impact of a 10pps increase in surrender rate of policies in force on newbusiness value (NBV) for a 10-year contract

(19.2)(18.4)

(16.9)

(14.7)

(25.0)

(20.0)

(15.0)

(10.0)

(5.0)

0.0

5th year 6th year 7th year 8th year

(%)

Source: IIFL Research

Figure 4: EV/invested capital

1.41.5

1.8

0.0

0.5

1.0

1.5

2.0

MNYL BSLI HDFCSL

(x)


Estimating the impact of the above on EV would be difficult. We will

have no choice but to wait for life insurers to provide guidance on theabove issue. As such, we keep our EV estimates and appraisal value forlife insurers unchanged.

Ambiguity over applicability of new tax rules under DTCtaxation ofproceeds on redemption or at the end of contract maturitycould

accentuate the propensity to surrender policies before the new rulestake effect. DTC is likely to be implemented from 1 April 2012. Withouttransitory provisions from the existing regime to the new regimeproviding relief for policies in force, surrender levels could besignificantly higher and hence will have a significant negative impact onEV as well.

Negative impact on EV from higher tax rate for life insurersunder DTC

Tax rate on profits attributable to shareholders will increase from 12.5%plus surcharge to 30% from FY13. NBV and EV disclosed and estimatedfor most life insurers have thus far considered a tax rate of 12.5% plussurcharge. Our discussions with life insurers suggest that EV would needto written down for higher effective tax rate. A higher tax rate wouldlikely shave off new business margin (NBM) by at least 300bps and NBVby 19%.

In our previous note (Industry in turmoil, 26 July 2010), we hadconsidered the effect of higher tax rate of 25% when estimatingsustainable NBM for life insurers. With the effective tax rate beinghigher than anticipated, there could be further downside to our estimateof sustainable NBM of 8-14%.

Estimating the adverse impact of higher tax rate on NBM and NBV ismuch simpler, but that on EV is less simple. Here too, we will have nochoice but to wait for life insurers to provide guidance on the impact onEV.

Current valuations do not adequately factor in downside risksWith valuations of most life insurers at FY12ii implied market

capitalisation/EV of 2X or more, we believe current market prices do not

factor the downside risks adequately. We believe this would likely bedue to uncertainty on many fronts, including outlook for growth, margin


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Insurance

[email protected]

and capital requirement. We believe valuations would likely reflect the

underlying risk over the next 12 months as the uncertainties in manyareas begin crystallizing

Figure 5: Value for life insurance business/Invested capital

0.0

1.0

2.0

3.0

4.0

5.0

6.0

MNYL Reliance

Life

BSLI ICICI Pru

Life

HDFCSL BALIC SBI Life

(x)



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[email protected]

Cement

2

Figure 3: All-India average cement prices continue to decline owing to poor demandand increasing supplies

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(Rs per 50kg bag)

Source: Industry, IIFL Research

Figure 4: Valuation snapshot

Marketcap

CMP RatingEV/EBIDTA

(x)PER (x) P/BV EV/tonne

(US$m) (Rs) FY11ii FY12ii FY11ii FY12ii FY12ii FY12ii

ACC* 3,572 894 Sell 8.4 7.7 14.4 14.7 2.3 106

Ambuja Cements* 4,052 125 Sell 7.8 7.2 14.3 14.1 2.2 151

Grasim Inds 4,138 2,089 Add 3.4 2.8 9.1 8.2 1.0 NA

India Cements # 696 107 Sell 13.6 9.7 50.0 20.2 0.9 62

Kesoram Inds # 289 297 Sell 9.8 9.8 11.5 10.9 0.8 96

Madras Cements 519 103 Sell 10.5 7.4 20.6 10.8 1.5 84

Shree Cement # 1,401 1,890 Add 5.8 5.1 16.6 11.3 2.4 86

UltraTech Cement 5,429 925 Sell 8.5 7.5 14.9 12.8 2.0 121

*CY10ii and CY11ii numbers. #Adjusted for other segmentsSource: IIFL Research


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bil [email protected]

Dumb Commodities

2

Figure2:Soybeanoilprice FOBspotArgentina

Source:Bloomberg,IIFLResearch

Overall, we believe there is still downside to soybean oil price when theUS harvest is firmly in hand. This could imply an even largerdownside to palm oil prices, as the soybean oil price premium needsto widen to at least US$100-150 per tonne to be healthy.

Coal India any way out?Forget about insurgency in Indias coal regionsthat will soon be the

least of Coal Indias woes. The companys biggest worry, from myvantage Chinese viewpoint, is how to move its coal out.

Make no mistake: I dont discount the bright long-term fundamentals ofCoal India. But my only surprise on hearing of Coal Indias struggle toget more rail wagons to deliver its coal to customers was that thisproblem didnt come up earlier. Indias electricity generation is onlyone-fifth of Chinas, yet India already has this coal transportationheadache. It can only get worse.

There is a big price difference between coal at pit-mouth and coal atdestination. In 2005 (when Chinas coal transportation bottlenecks wereendemic), thermal coals sold for RMB150 (US$22 or Rs1,031) per tonne

at pit-mouth in Inner Mongolia could fetch RMB400 (US$59 or Rs2,749)in Shenyang (a second-tier city in the nearby Liaoning Province).

The Chinese bottlenecks have been somewhat eased by freneticconstruction of railway infrastructure. But the problem still lingers: asevere snowstorm in 2008 had shut down almost all coal deliveries fromthe Shanxi Province, and last month China had coal trucks to thank forthe biggest traffic jam in human history (120km long, lasting 11 days;see photo below).

Figure3:Aglimpseofwhatstobecome

Source:AP,IIFLResearchGiven Indias speed record on infrastructure building, Im not holdingmy breath for major railway expansions anytime soon. Coal India canchoose to generate electricity itself, but in that case, it may face griddeficiencies, not to mention the unpleasant subsidy rates. It can extendeven further into aluminium smelting (like China Power InvestmentCorporation is doing), but that can only consume a small portion of itstotal production. Or maybe it can build railways itself?


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Monday Tuesday Wednesday Thursday Friday Saturday

A U G U S T 2 0 1 0

23 24 25 26 27 28Mphasis Havells India, HCL Info Pantaloon Retail

S E P T E M B E R 2 0 1 0

30 Aug 31 Aug 1 2 3 4

Jul CPI- IW

Shiv-vani Oil & Gas (FY10)

Jul Exports- 13.20%

Jul Imports- 34.30%

Tanla Soln (FY10) 5 Sep

6 7 8 9 10 11

Jul IIP-

13 14 15 16 17 18

Aug WPI-

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


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

Economics /Politics

RBIs Monetary Policy meeting on 27th July,2010

1QFY11 Quarterly GDP RBIs Monetary Policy meeting (end Oct) 2QFY11 Quarterly GDP

RBIs Monetary Policy meeting (end Jan) 3QFY11 Quarterly GDP

Cement India Cements 1.5mtpa plant in Rajasthanto start (Sep)

Bharathi Cement 2mtpa (2nd unit) inCuddapah to start (Dec)

Ambuja Cements 1.5mtpa unit in Bhataparato start (Dec)

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

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

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

start (Nov)

Chettinad Cement 2mtpa expansion atKarikali, TN (Mar)

Jaiprakash Associates 3.5mtpaexpansion at Nalgonda, AP (Mar)

Jaiprakash Associates 3mtpa expansionat Dalla, UP (Mar)

Media Sun TV To release its high budget movie Indhiran

Metals Sterlite: 1st phase of 2400MW willcommence operation

JSW s Chilean iron ore mine to commenceshipments

Sterlite: 100ktpa lead smelter is expected tocommence operation

Sterlite: 2nd phase of 2400MW willcommence operation

Oil & Gas FPO ofIOC (Dec)

Pharma Sun Pharma: Israeli Supreme courtdecision on Taro acquisition agreement

Dr Reddys: Potential USFDA approval forfondaparinux

Lupin: launch of Allernaze in US

Ranbaxy: Launch of generic Aricept in US

Sun Pharma: resolution of Caracomanufacturing 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


22/23

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 completionof restructuring ofUnitechs 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

RCOMGTLI tower deal to be implemented 3G spectrum allocation expected

3G services will be rolled out

Utilities JSPL - Second 135 MW unit of 540MW plantat Chhattisgarh (Jul / Aug)

KSK Unit III & IV (135MW each) atWardha Warora

EGoM meeting on July 27 to decide on gasallocation to Reliance Pow er from RILsKG-D6 field


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