Investor’s Eye · 2020-01-03 · in volume growth, improved product mix and operating...

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IndexStock Update - Housing Development Finance Corporation

Stock Update - ICICI Bank

Stock Update - Torrent Pharmaceuticals

Viewpoint - Atul Limited

Sector Update - Automobiles

January 27, 2020

January 27, 2020 2

Housing Development Finance CorporationSteady performance

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Sharekhan Research, Bloomberg

HDFC Limited (HDFC) posted steady Q3FY2020 results operationally, helped by exceptional gains from de-recognition of the investment in GRUH Finance, which saw rise in provisions as well as PAT. Overall loan growth improved (up 14% y-o-y on AUM basis), helped by growth in total individual loans by 16%. The individual category’s approvals grew by 15% y-o-y and disbursements grew by 13% y-o-y, which is relatively modest growth. HDFC preferred calibrated growth in the non-individual segment (grew slower by 7% y-o-y). We prefer strong growth in the individual segment at these times, for margins as well as asset-quality comfort. Operationally, HDFC posted steady net interest income (NII; Calculated) growth of 25% y-o-y (we expected 29% y-o-y). Net interest margin (NIM) remained stable q-o-q at 3.3%, while spreads during the quarter were also largely stable at 2.27% versus 2.26% q-o-q. In accordance with Ind AS rules, HDFC recognised fair value gain of Rs. 9,020 crore during Q3 for investments in Gruh Finance. As a result, net profit for Q3 jumped to Rs. 8,372 crore, up 296% y-o-y (we expected 236% y-o-y growth). Balance sheet strength, consistency and quality of earnings continue to be the key differentiators for HDFC, which are key support to the premium valuations it enjoys. Over the past few quarters, HDFC has maintained a cautious stance on the wholesale segment and continues to do so in this quarter as well. The company is well capitalised (Tier I at 17.3%), helped by capital infusions, warrant conversion as well as strong internal accruals over the years. We expect AUM growth to remain healthy (on market share gains) with spreads maintained and well-contained credit costs. We maintain our Buy rating on the stock with an unchanged price target (PT) of Rs. 2,800.

Key positives

� As per NHB norms, HDFC is required to carry total provision of Rs. 3,624 crore, against which total provisions carried at the end of Q3FY2020 were at Rs. 9,934 crore, providing investor comfort.

� Despite slower growth and conservative approach, spreads at 2.27% and NIM at 3.3% are stable; moreover, largely stable asset quality indicates the quality of franchise.

Key negatives

� Sequential rise in NPA in the non-individual segment from 2.87% to 2.91%.

Our CallValuation: HDFC is currently available at ~4.2x its FY2022E BV, which we believe is reasonable considering its robust operating metrics, pedigree, strong brand recall across product categories and sustainable business model. Even as the NBFC industry faces its own challenges, the consistency and relative outperformance of HDFC will help it to sustain growth as well as its valuations. We maintain our Buy rating on the stock with a revised PT of Rs. 2,800.

Key RisksCredit rating downgrades leading to defaults in the developer portfolio, may impact the industry.

Company details

Market cap: Rs. 4,14,240 cr

52-week high/low: Rs. 2,499/1,822

NSE volume: (No of shares)

224.9 lakh

BSE code: 500010

NSE code: HDFC

Sharekhan code: HDFC

��shares)

172.7 cr

Promoters 0.0

FII 72.8

DII 16.3

Others 11.0

Shareholding (%)

Price performance

Price chart

Sector: Banks & Finance

Result Update

(%) 1m 3m 6m 12m

Absolute 1.6 14.3 12.2 25.5

Relative to Sensex

1.2 7.1 1.7 7.9


Change

Reco: Buy CMP: Rs. 2,396

Price Target: Rs. 2,800

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Valuation Rs cr

Particulars FY19 FY20E FY21E FY22E

Net Interest Income 11,403 12,689 14,452 16,671

Adj. PAT 9,632 12,394 12,794 14,092

EPS 55.9 71.7 74.1 81.6

P/E (x) 42.7 33.3 32.3 29.3

BVPS 449.4 482.4 521.8 565.2

P/BV (x) 5.3 5.0 4.6 4.2

ROE % 12.3 22.1 14.2 14.4

ROA % 2.2 3.7 2.2 2.1

Source: Company; Sharekhan estimates

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Key result highlights

� Exceptional item impact: In accordance with ‘Ind AS rule for Investments in Associates and Joint Ventures’, regarding the investment in GRUH, HDFC recognised fair value gain of Rs. 9,020 crore during Q3. Consequently, as per its earlier stated policy,

HDFC took provisions of Rs. 2,956 crore, which includes ~30% of fair value gain as extra provision of Rs. 2,621 crore (Calculated) during Q3. As a result, net pr��t for Q3 stood at Rs. 8,372 crore, up 296% y-o-y (we expected 236% y-o-y growth). Due to the exceptional nature of gains, PAT is not strictly comparable on a q-o-q or y-o-y basis.

� Calibrated AUM growth: HDFC’s AUM was up 14% y-o-y (was 13% in Q2FY2020) to Rs. 5,02,765 crore, driven by 16.4% y-o-y growth in individual loans (15% in Q2). Non-individual loan book grew by 2.9% q-o-q, up 6% y-o-y.

� Stable spreads and NIMs: Reported spreads were 2.27% (versus 2.26% in Q2FY2020), stable from 2.26% in Q3FY2019.

� Coverage on Gross Stage 3 increases: Overall coverage on gross stage 3 loans increased to 49% from 43% q-o-q. Overall coverage inched up to 2.25% from 1.7% q-o-q.

Results Rs cr

Particulars Q3FY20 Q3FY19 YoY% Q2FY20 QoQ%

Interest Income & Fees 11009.5 9634.1 14.3 10851.9 1.5

Interest and Other Charges 7769.6 7044.5 10.3 7830.7 -0.8

Net Interest Income 3239.9 2589.6 25.1 3021.2 7.2

Other Income 249.9 731.5 -65.8 1408.4 -82.3

Total Income 3489.8 3321.1 5.1 4429.6 -21.2

Total Expenses 410.7 322.1 27.5 449.9 -8.7

PPoP 3079.2 2999.0 2.7 3979.7 -22.6

�� 0.0 891.3 NA 1304.8 NA

Fair value gain consequent to merger of GRUH with Bandhan Bank

9019.8 0.0 NA 0.0 NA

Provisions and Loan losses 2956.0 401.3 636.6 754.1 292.0

PBT 9143.0 3489.1 162.0 4530.4 101.8

Tax Expense 770.5 1022.0 -24.6 568.9 35.4

Profit After Tax 8372.5 2467.1 239.4 3961.5 111.3Source: Company; Sharekhan Research

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Outlook

HDFC’s results were steady and the pragmatic growth stance are in line with the stance taken by the management, especially considering the present industry scenario. We �nd stable asset quality, high provisions cover and stable margins to be supportive. At such times, we believe the need to have cautious growth, especially for players such as HDFC, is justi�ed. Balance sheet strength, consistency and quality of earnings continue to be the key differentiators for HDFC, which are key support to the premium valuations it enjoys. The company is well capitalised at CRAR of 18.6% and Tier-1 of 17.3% (minimum requirement of 13% and 10%, respectively) and is comfortably placed. Given the market dominance of HDFC, we expect the leadership to sustain going forward, as HDFC capitalises on the ben��ts of reduced competitive pressure from other NBFC peers and PSU banks. HDFC’s strong operating metrics, supported by its industry’s best credit rating, enable it to attract best rates and, hence, optimum COF, which are crucial supports for margins.

Valuation

HDFC is currently available at ~4.2x its FY2022E BV, which we believe is reasonable considering its robust operating metrics, pedigree, strong brand recall across product categories and sustainable business model. Even as the NBFC industry faces its own challenges, the consistency and relative outperformance of HDFC will help it to sustain its growth as well as its valuations. We maintain our Buy rating on the stock with a revised PT of Rs. 2,800.

One-year forward P/BV (x) Band

Source: Sharekhan Research

Peer Comparison

ParticularsCMP P/BV(x) P/E(x) RoA (%) RoE (%)

Rs/Share FY20E FY21E FY20E FY21E FY20E FY21E FY20E FY21E

HDFC Ltd 2,396.00 5.0 4.6 33.4 32.4 2.6 2.6 15.1 16.1

LIC Housing Finance 453 1.3 1.1 8.8 7.6 1.4 1.6 15.3 15.6

Cholamandalam 329 3.4 2.9 18.1 14.4 2.1 2.2 19.8 19.9

Source: Company, Sharekhan research; Bloomberg

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About company

The Housing Development Finance Corporation (HDFC) Limited It is a major provider of �nance for housing in India. It also has a presence in banking, life and general insurance, asset management, venture capital, realty, education, deposits and education loans. As pioneers in housing mortgages, it is a brand name that has been characterised by trust, solidity, both �nancial and managerial and sound principles. Established in 1977, HDFC has been able to maintain and set high standards in the housing �nance sector. Currently, the gross loan book stood at Rs 426,739 crore as of Sept 2019 of which individual loans comprise 72%.

Investment theme

HDFC Ltd has a strong portfolio of subsidiaries which are market leaders in their own respective �elds, which add to the value of the parent. By virtue of its strong market position it has been able to withstand most market headwinds in recent past, and even in the present liquidity squeeze, had a negligible impact. Going forward, we believe that HDFC’s strong rating pr��le and strong book quality bolsters its ability to raise funds at market competitive rates provide cushion to its NIMs. Though the retail lending book of HFCs is witnessing healthy growth trends, a conservative growth approach in the corporate book was due to sluggish demand from good quality corporates along with the cautious stand preferred by management. We believe due to its buoyant retail book, a quality developer �nance book (with suf�cient cover) and opportunity of quality market share gains (AUM growth), access to reasonably priced funds and superior underwriting practices it is an attractive business franchise.

Key Risks

Credit rating downgrades leading to defaults in the developer portfolio, may impact the industry.

Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

Additional Data

Key management personnel

Deepak Parekh Chairman

Renu S Karnad Managing Director

Keki M Mistry Vice Chairman & CEO

Mr Nasser Munjee Independent DirectorSource: Company Website

Top 10 shareholders

Sr. No. Holder Name Holding (%)

1 Vanguard Group Inc/The 4.4

2 Republic of Singapore 3.8

3 Life Insurance Corp of India 3.7

4 BlackRock Inc 3.6

5 Invesco Ltd 3.5

6 Oppenheimer Holdings Inc 3.0

7 JPMorgan Chase & Co 2.8

8 SBI Funds Management Pvt Ltd 2.3

9 SBI ETF NIFTY 50 1.9

10 FMR LLC 1.9Source: Bloomberg

January 27, 2020 6

ICICI BankHealthy performance despite tough environment

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ICICI Bank posted healthy Q3FY20 results in a difficult environment, with smart operating performance, improvement in margins, and sequential improvement in asset quality (though elevated slippages were dampeners). The Net interest income (NII) in Q3FY20 increased by 24% y-o-y to Rs 8,545 crore and were below expectations (we expected 31% y-o-y growth). The PAT at Rs 4146 crores, was up by 158% y-o-y (in line with our expectations), helped by lower provisions (Rs 2083 crores, down 51% y-o-y) due to recovery benefits. Smart improvement in Net Interest Margin (NIM) at 3.77% in Q3 FY2020 (improved by 13BPS q-o-q and 37BPS y-o-y). Most importantly, the GNPA/ NNPA ratio (as % of Gross Advances) decreased to 6.39% / 1.6% down by 51BPS / 14 BPS respectively from Q2FY20. Despite a rise in gross additions (Rs 4,363 cr for Q3) they were balanced by strong recoveries, upgrades etc (Rs 4,088 cr). Also, most slippages were from known corporate additions (a broking co which is fully provided, and a South India based Industrial co which is paying regularly) which together accounted for Rs 1686 crores slippages which came from outside of the watch list. Recoveries from a Steel Account and Edible Oils company helped in the redemption of Rs 2090 cr Security Reciepts (SRs). Overall, earnings of ICICI bank for the quarter is healthy with strong NIM and fee based income, and even though slippages were higher, they were anticipated. The bank is adequately capitalized (CET-1 at 13.6%) and the management has ruled out equity dilution in the near term. We expect the tail end of the NPL cycle and consistency in earnings performance will reflect in valuation multiple expansion and will be positive support for the stock price. We maintain our BUY rating on the stock with an unchanged price target of Rs 630.

Key positives

� The Domestic loan growth was decent at 16% y-o-y, driven by Retail loans (up by 19% y-o-y) and the high yielding retail business (Including NFB outstanding) now comprises of 52% of the total portfolio and Retail fees constitute 77% of total fees in Q3FY20 indicating strong traction (and importance) of the retail business.

� Of gross corporate slippages of Rs 2473 crores, roughly ~Rs 225 cr was due to the devolvement of Non Fund Based (NFB) exposure to existing NPAs.

Key negatives

� Retail slippages were higher at ~Rs 1890 cr (1.9% ann.) which included Rs 312 cr of Kisan Credit Card (KCC) and some elevated CV stress.

Our CallWe value ICICI Bank by our SOTP methodology, where we value the standalone bank at ~2.3x its FY2022E BV and rest of the subsidiaries at ~Rs. 153 per share. We believe valuations are reasonable, considering the overall franchise as a whole and trends in improvement in asset quality. ICICI’s Q3FY20 earnings performance were healthy, especially in the backdrop of a dif�cult quarter. We believe ICICI Bank is positioned to bene�t from normalised credit cost and earnings faster than several peers. Normalization in earnings, strong CAR and a high PCR will help drive the stock’s re-rating. Considering its consistent improvement in operating metrics over the last few quarters in a tough and dynamic macro environment, we have �ne-tuned our FY20E/FY21E estimates. We maintain our Buy rating on the stock with an unchanged price target of Rs 630.

Key RisksLarge chunky slippage from the corporate book, especially from BB and below-rated portfolio could impact earnings outlook.

Company details

Market cap: Rs. 3,47,007 cr

52-week high/low: Rs. 552/336


200.3 lakh

BSE code: 532174

NSE code: ICICIBANK

Sharekhan code: ICICIBANK

��shares)

646.0 cr

Promoters 0.0

FII 45.8

DII 41.1

Others 13.1

Shareholding (%)

Price performance

Price chart

Sector: Banks & Finance

Result Update

(%) 1m 3m 6m 12m

Absolute -1.3 17.4 30.7 46.7

Relative to Sensex

-1.7 10.1 18.5 26.2


Change

Reco: Buy CMP: Rs. 536

Price Target: Rs. 630


Valuation Rs crParticulars FY19 FY20E FY21E FY22ENet Interest Income (NII) 27014.8 30824.7 36795.3 42502.6�� 2970.8 9563.2 16798.4 20400.8EPS (Rs) 4.6 14.9 26.1 31.7P/E (x) 116.0 36.0 20.5 16.9BVPS (Rs) 163.0 173.6 190.8 211.8P/BV (x) 3.3 3.1 2.8 2.5RoE (%) 2.8% 8.5% 13.9% 15.3%RoA (%) 0.3% 0.9% 1.3% 1.4%Source: Company, Sharekhan Research

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Key Concall Highlights � Around ~68% of corporate slippages were from outside the BB and below rated pool. These primarily include,

a beleaguered broking company. and a South India based industrial co, where payments are being received. ICICI Bank has provided for its entire exposure to the broking co. in Q3 FY20. The South India-based industrial company where servicing is regular, but where a re�nancing activity undertaken in 2018 has now been assessed as restructuring, leading to classi�cation as a non-performing asset by lenders to the company.

� Downgrades into the BB and below pool (~Rs 2670 cr) came from the telecom and that too from mostly Non fund based (NFB) exposure. An account in the telecom sector was downgraded in Q3 FY20 pursuant to the Supreme Court ruling on AGR related dues in the telecom sector. Other downgrades were spread across sectors, including construction.

� The management continues to expect in�ows into the pool of BB and below rated exposures to remain elevated.

� Net investment in security receipts of asset reconstruction companies decreased to Rs 2087 cr from Rs 3276 cr in Q2 FY20 on account of redemptions related to recoveries in a steel a/c

� The management highlighted the risk that might stem from guarantees given by the sector to the DoT for telecom Cos

� The increase in credit cost primarily re�ects NPA additions in the Kisan Credit Card (KCC) portfolio and the commercial vehicle loan portfolio. Retail slippages were higher at ~Rs 1890 cr (1.9% ann.) inclusive of ~Rs 310 cr of KCC and some elevated CV stress. There was some seasonality factor involved as the KCC book generally has higher slippages in Q1 and Q3.

� Retail portfolio asset quality: The gross NPA additions from the retail portfolio were Rs 1890 cr. The credit trends in the overall retail portfolio continue to be stable. The delinquency parameters across vintages in the personal loan and credit card portfolios have been stable and well within the internally de�ned thresholds.

� ICICI Bank has recently launched India’s largest API Banking portal consisting of 250 APIs which enables developers of businesses, �ntechs, corporates and e-commerce start-ups to easily partner with the bank and co-create innovative solutions.

� Raised Guidance on Credit cost: Had earlier guided credit costs in FY2020 were expected to reduce signi�cantly compared to FY2019 and be in the range of 1.2% to 1.3% of average advances due to expectations of large recoveries. The credit cost for 9M of 2020 was 1.79% and the credit cost for FY2020 is likely to be similar compared to 9M of 2020.

� No Capital raise: The management clari�ed that they were not in the process of raising capital. � The impact of interest on income tax refund and interest collections from NPAs was about 10 basis points this

quarter compared to 6 basis points in Q2 FY20. � The Bank had 100,422 employees at December 31, 2019. � During the quarter, there was a write-back in provisions for retirals due to increase in yields on government

securities. � Provisions declining on a y-o-y basis had the blended impact of full provision on the broking company exposure

and provision on the industrial company, as well as the recovery from the steel exposure under IBC. � Retail growth within the retail portfolio, the mortgage loan portfolio grew by 15% y-o-y wherein auto loans

grew by 5% y-o-y, business banking by 47% y-o-y, rural lending by 17% y-o-y and commercial vehicle and equipment loans by 15% y-o-y. The personal loan and credit card portfolio grew by 49% y-o-y on a relatively small base, to Rs 58,348 cr and was 9.2% of the overall loan book as of December 31, 2019.

� Gross NPA additions during the quarter were Rs 4363 cr which includes additions of Rs 2473 cr from the corporate and SME portfolio.

Results Rs crParticulars Q3FY20 Q3FY19 YoY % Q2FY20 QoQ %Interest earned 19,064 16,280 17.1 18,565 2.7Interest expense 10,519 9,405 11.8 10,508 0.1Net interest income 8,545 6,875 24.3 8,057 6.1Non-interest income 4,574 3,883 17.8 4,194 9.1Net total income 13,119 10,758 21.9 12,252 7.1Operating expenses 5,571 4,612 20.8 5,378 3.6Pre-provisioning profit 7,549 6,146 22.8 6,874 9.8Provisions 2,083 4,244 -50.9 2,507 -16.9�� 5,465 1,902 187.3 4,367 25.1Tax 1,319 297 343.6 3,712 -64.5Profit after tax 4,146 1,605 158.4 655 533.1Gross NPA (%) 6.39 7.38 -99 bps 6.90 -51 bpsNet NPA (%) 1.60 2.87 -127 bps 1.74 -14 bpsSource: Company; Sharekhan Research

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OutlookICICI Bank continues to be our preferred pick and is among the best plays on the improving trend in asset quality issues. We expect ICICI Bank to see tailwind ben��ts of lower competitive intensity in the market as well as ben��ts of abatement of credit cost/NPL pressures, which will be a positive trigger for its return ratios going forward. Going forward, lower slippages as well as strong capitalisation will enable the bank to pursue sustainable growth and eschew risky growth avenues. Moreover, it allows the bank to expand its reach, important for its retail business growth. ICICI Bank has shown improving trends in key operating parameters with improving asset-quality outlook. While some resolutions have happened, we believe the corporate segment is yet to see demand revival and resolutions are yet to gain momentum. ICICI Bank is an attractive franchisee with good reach, well positioned to gain market share and its well-performing subsidiaries also add value. We��nd the bank has a strong re-rating potential and, hence, expect it to see improved performance in the medium to long term.

ValuationWe value ICICI Bank by our SOTP methodology, where we value the standalone bank at ~2.3x its FY2022E BV and rest of the subsidiaries at ~Rs. 153 per share. We believe valuations are reasonable, considering the overall franchise as a whole and trends in improvement in asset quality. ICICI’s Q3FY20 earnings performance were healthy, especially in the backdrop of a dif�cult quarter. We believe ICICI Bank is positioned to ben��t from normalised credit cost and earnings faster than several other peers . Normalization in earnings, strong CAR and a high PCR will help drive the stock’s re-rating. Considering its consistent improvement in operating metrics over the last few quarters in a tough and dynamic macro environment, we have��ne-tuned our FY20E/FY21E estimates. We maintain our Buy rating on the stock with an unchanged price target of Rs 630.

One year forward P/BV (x) band


Peer Comparison

ParticularsCMP P/BV(x) P/E(x) RoA (%) RoE (%)

Rs/Share FY20E FY21E FY20E FY21E FY20E FY21E FY20E FY21EICICI Bank 536 3.1 2.8 36.0 20.5 0.9 1.3 8.7 13.9HDFC Bank 1213 3.9 3.4 24.8 20.1 1.9 2.0 16.5 18.2Axis Bank 740 2.4 2.1 28.7 14.6 0.9 1.0 11.2 14.0Source: Company, Sharekhan Research

ICICI Bank SOTP valuation Rs. Valuation Methodology

Value of Standalone ICICI Bank 477 2.3x FY22E BVPSNon Banking Subsidiary Valuation ICICI Bank Holding Value/share Life Insurnace Subsidiary 52.9% 67 2.5x EV FY22EGeneral Insurance Susbidiary 56.8% 44 26x FY22E PATBroking business 79.2% 15 20% Holding Discount to McapRest 27 SOTP Valuation (Rs per share) 630 Source: Company, Sharekhan Research

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About company

ICICI Bank offers a wide range of banking products and �nancial services to corporate and retail customers through a variety of delivery channels and through its group companies. It is the 2nd largest private sector bank in terms of loan book size, having a pan India presence . It subsidiaries, ICICI Prudential Life Insurance, ICICI Lombard General Insurance Company Ltd , ICICI Securities Ltd are all strong entities in their respective �elds, and are developing well as a strong franchise, and provide support to overall value. In its banking business, It has continued to improve the portfolio mix towards retail and higher-rated corporate loans and has made signi�cant progress in de-risking the balance sheet. Hence, today the proportion of retail loans in the portfolio mix has increased to 62%, while an increasingly high proportion of corporate loans disbursed are to customers rated A- and above, which helps de-risking of the overall loan book.

Investment theme

The bank has built an attractive franchise consisting of Banking, Insurance, Securities business over the years. Since �scal 2016, the bank has unlocked more than Rs. 14,000crore of capital in its subsidiaries, which not only demonstrates the value created, it has also resulted in value unlocking along with leaner balance sheet obligations for the parent. We believe the NPA cycle has peaked for the bank and going forward, we expect to see improved ROE/ROA by virtue of faster growth (waning of competition, adequate capital etc) as well as better pr��tability (lower slippages, lesser drag of provisions, resolutions/ recovery). It has continued to improve its portfolio mix towards retail (granular) and higher-rated corporate loans, and hence, in last four years, it has not only de-risked its balance sheet but also enhanced the franchise value.The bank is well placed to ben��t from reduction in competitive intensity from NBFCs and recoveries/ resolutions from NCLT etc accounts would be further aid to ROE/ROA expansion.

Key Risks

Large chunky slippage from the corporate book, especially from BB and below-rated portfolio could impact earnings outlook.


Additional Data


Sandeep Bakhshi CEO/Managing Director

Rakesh Jha ��

Vishakha V Mulye Executive Director

Anup Bagchi Executive DirectorSource: Bloomberg

Top 10 shareholders


1 Life Insurance Corp of India 7.9

2 Dodge & Cox 5.3

3 HDFC Trustee Co Ltd/India 4.0

4 HDFC Asset Management Co Ltd 3.4


6 BlackRock Inc 2.5

7 ICICI Prudential Asset Management 2.4

8 Capital Group Cos Inc/The 2.1

9 Aditya Birla Sun Life Trustee Co P 2.0

10 Franklin Resources Inc 1.8Source: Bloomberg

January 27, 2020 10

Torrent PharmaceuticalsUSFDA woes to remain an overhang

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Torrent Pharmaceuticals Limited (Torrent) reported a muted set of results for Q3FY2020. Sales at Rs. 1966 crore were almost flat (down 1% y-o-y) and are marginally below estimates. Operating profit at Rs. 540 crore grew 3% y-o-y (as against the estimated Rs 557 cr). Operating margin expanded by 100 BPS to 27.5% aided by an improvement in gross margins. PAT at Rs. 251 crore, was up by a meager 2% y-o-y. During the quarter, performance across geographies was subdued. Torrent’s three plants – Indrad, Dahej and US (Levittown - Pennsylvania) have been under USFDA regulatory issues with a warning letter issued to all the three plants. As a result of this, new product approvals from all the three plants have been withheld. Off the three plants, the Dahej plant is a critical one for Torrent as it has several new product fillings coming from this unit. The management expects the re-inspection at Dahej plant to happen in mid of CY2020, while the other two plants would have a re-inspection by end of CY2020. We feel this event is likely to remain as an overhang until successfully closed/resolved.

Key positives

� Gross margin of 72.4% (160 BPS y-o-y improvement) was reported during the quarter because of a better product mix.

� Operating pro�t margin (OPM) also improved by 100 BPS to 27.5% during the quarter.

Key negatives

� Domestic business growth moderated substantially to 3% y-o-y. While the European and US business report a steep decline of 18% and 22% y-o-y for the quarter.

� US plant received a Warning Letter (WL) from the US FDA after Indrad and Dahej get WL in the past. This would delay product approvals.

Our CallValuation Maintain Hold with a revised PT of Rs 2,105: Torrent’s Q3FY2020 performance was muted impacted primarily by moderation in growth in the domestic business. European and US business performance was also weak. Consequently, we have tweaked our earnings estimates to factor in the above. We have also introduced FY2022 earnings estimates in this note. We expect the Revenues and PAT to grow by 11% and 26% CAGR respectively over the next two years. Torrent Pharma is currently trading at 21x its FY2022E earnings, which is close to its long-term historical average multiple thus leaving very less scope for multiple expansion. Further we believe uncertainty related to USFDA outcome (of OAI / WL) for Dahej, Indrad and US facility are likely to remain an overhang until successfully resolved. Hence, we maintain our Hold recommendation on the stock with a revised PT of Rs 2,105.

Key RisksDelays in resolution for the US FDA issues at Dahej, Indrad and the US facility

Company details

Market cap: Rs. 34,299 cr

52-week high/low: Rs. 2,073/1,453


2.6 lakh

BSE code: 500420

NSE code: TORNTPHARM

Sharekhan code: TORNTPHARM

��shares)

4.9 cr

Promoters 71.3

FII 8.7

DII 12.3

Others 7.8

Shareholding (%)

Price performance

Price chart

Sector: Pharmaceuticals

Result Update

(%) 1m 3m 6m 12m

Absolute 9.7 15.2 26.8 8.9

Relative to Sensex

9.3 8.0 14.9 -6.3


Change

Reco: Hold CMP: Rs. 2,027

Price Target: Rs. 2,105 á


Valuation (Consolidated) Rs cr

Particulars FY2018 FY2019 FY2020E FY2021E FY2022E

Net sales 5825.0 7462.0 8144.5 8987.6 10091.4

�� 1222.0 1773.0 2093.1 2372.7 2714.6

OPM (%) 21.0 23.8 25.7 26.4 26.9

�� 676.0 793.0 1022.5 1308.3 1626.9

EPS (Rs) 39.8 46.6 60.1 77.0 95.7

PER (x) 51.0 43.5 33.7 26.3 21.2

EV/EBITDA (x) 33.1 22.6 17.7 15.0 12.4

ROCE (%) 13.2 12.6 15.6 18.0 20.4

RONW (%) 15.1 17.0 19.7 20.9 21.3Source: Company; Sharekhan estimates

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Q3FY2020 results muted: Torrent reported muted results for the quarter. Revenues for the quarter stood at Rs 1966 cr, marginally drop of 1% y-o-y. Domestic revenues (~50% of the sales) growth moderated to 3% y-o-y for the quarter. Revenues from the European region declined sharply by 18% y-o-y as the company upgraded back end supply systems, which impacted its performance. Operating margins for the quarter expanded 100 bps y-o-y to 27.5% on the back of improvement in gross margins and low employee cost. Operating pr��ts for the quarter stood at Rs 540 cr, up 2.7% y-o-y. The other income for the quarter stood at Rs 53 cr as against Rs 3 cr in the corresponding quarter. High other income is on the back of forex hedging gains. Consequently, the reported PAT stood at Rs 251 cr (up 2% y-o-y) and was marginally above ours as well as street estimates of Rs 236 cr.

USFDA regulatory issue to be an overhang on the stock; to withhold new approvals: Torrent’s plant at Dahej, which was inspected by the USFDA between March 11-19, 2019, has received Form 483 with �ve observations with none of them relating to data integrity. USFDA classi�ed this inspection under OAI/WL, indicating an unsatisfactory response submitted by the company (for Form 483). The OAI status would result in withholding of new product approvals. Although the Dahej plant is relatively new, it is strategically important for the company as several new �lings come from this unit. Secondly, the company’s Indrad facility (inspected between April 8-16, 2019) has received a warning letter and is red �agged by the USFDA. If the issue is not resolved satisfactorily within a stipulated timeframe, then it could result in escalation to Import Ban Alert. Also the US manufacturing plant located at Levittown (Pennsylvania) was inspected by USFDA between 11 March 2019 to 9 April 2019 and has been issued a warning letter for CGMP violations relating to �nished Pharmaceutical products. Collectively, the OAI/WL point at withholding approvals for new products over the medium term from the said plants. Hence, we feel this event is likely to remain an overhang in the near term (until successfully closed/resolved).

Q3FY2020 Conference call highlights

� Geographical Revenue Mix:

� Torrent’s domestic revenue (50% of total sales) growth moderated to 3% y-o-y for the quarter. Volumes grew 2% y-o-y while prices increased 8% for the quarter. The share of new products grew 2% y-o-y.

� Revenue from the U.S. (19% of sales) dropped steeply by 22% y-o-y, attributable to the ongoing USFDA issues.

� Revenue from Brazil grew in double digit by 13% y-o-y to Rs 189 cr. While those from the rest of the world (10% of sales) increased by 12%.

� Europe sales declined for the quarter by 18% attributable to back end supply issues on account of internal system upgradations.

� ANDA approvals: Torrent has 45 ANDAs pending approvals; and of this, six are with tentative approvals.

� Product Portfolio: The management has mentioned that all products under the Unichem brand are on a good footing. However a double digit growth seems a few quarters away.

� R&D Cost: Torrent has incurred R&D cost of Rs. 110 crore in Q3FY2020, (Q3FY2019 R&D expense Rs 135 cr) which is around 5.6% of sales. Management has indicated that it aims to maintain R&D cost at around 7% of sales going ahead.

� Debt Repayment: In 1HFY2020, Torrent repaid debt amounting to Rs. 443 crore. The management has guided for a debt repayment of Rs 900-1000 cr in FY2021. As of March 2019, the total debt on books stood at Rs 6385 cr.

� Capital Raising: The board of directors have approved an enabling resolution for issuance of Equity Shares including Convertible Bonds / Debentures through QIP and / or Depository Receipts or any other

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Results (Consolidated) Rs cr

Particulars Q3FY2020 Q3FY2019 YoY % Q2FY2020 QoQ %

Total Sales 1,966.0 1,988.0 -1.1 2,005.0 -1.9

�� 540.0 526.0 2.7 541.0 -0.2

Other income 53.0 3.0 1666.7 34.0 55.9

EBITDA 593.0 529.0 12.1 575.0 3.1

Interest 111.0 133.0 -16.5 116.0 -4.3

Depreciation 163.0 156.0 4.5 163.0 0.0

PBT 319.0 240.0 32.9 296.0 7.8

R�� 251.0 246.0 2.0 244.0 2.9

OPM % 27.5 26.5 101 BPS 27.0 48 BPSSource: Company; Sharekhan Research

modes for an amount not exceeding Rs. 5000 crores. Further the management has clari�ed that this is only a enabling resolution and would be considered for acquisitions only.

� US-FDA Regulatory Updates: Three manufacturing facilities of Torrents – Indrad, Dahej and US are facing USFDA regulatory issues. Management has stated that it expects the USFDA inspection at Dahej plant to happen in mid 2020. While the inspection at the rest of the two plants (Indrad and US) is expected by the end of CY2020. Also, the management has stated that it takes around 15-18 months (from the date of receipt of warning letter/observations) for the issues to be resolved and till such period, the new approvals from the said plants is withheld. Consequently, the U.S. business is expected to be impacted adversely.

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Outlook

Torrent Pharma’s performance has been impacted by a challenging environment in the U.S., US FDA regulatory issues and slowdown in domestic business. The management stated that it is in the midst of remediation process at three of its plants and it would take at least 12-15 months for resolution of regulatory issues. Till such time the approvals for new products would be withheld and consequently, no new launch is expected in the near term. We expect the company to report sales and adjusted pro�t CAGR of 11% and 26%, respectively, over FY20-FY22E. USFDA woes will continue to remain an overhang on the stock price, until successfully resolved.

Valuation

Valuation Maintain Hold with a revised PT of Rs 2,105: Torrent’s Q3FY2020 performance was muted impacted primarily by moderation in growth in the domestic business. European and US business performance was also weak. Consequently, we have tweaked our earnings estimates to factor in the above. We have also introduced FY2022 earnings estimates in this note. We expect the Revenues and PAT to grow by 11% and 26% CAGR respectively over the next two years. Torrent Pharma is currently trading at 21x its FY2022E earnings, which is close to its long-term historical average multiple thus leaving very less scope for multiple expansion. Further we believe uncertainty related to USFDA outcome (of OAI / WL) for Dahej, Indrad and US facility are likely to remain an overhang until successfully resolved. Hence, we maintain our Hold recommendation on the stock with a revised PT of Rs 2,105.

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About company

Torrent Pharma, the �agship company of Torrent Group, was incorporated in 1972. Torrent Pharma has a strong international presence across 40 countries with operations in regulated and emerging markets such as the U.S., Europe, Brazil and the Rest of the World. The company operates through its wholly owned subsidiaries spread across 12 nations with major setups in Brazil, Germany and the U.S. The company is also one of the leading pharmaceutical companies present in India as a dominant player in the therapeutic areas of cardiovascular (CV) and central nervous system (CNS). The company also has signi�cant presence in gastro-intestinal, diabetology, anti-infective and pain management segments.

Investment theme

Torrent Pharma continues to focus on branded business mix from India and Brazil, which balances well for sustainable growth in a challenging global environment for the pharma sector. U.S. business is also stable. Operating leverage from acquired domestic business is likely to be visible from FY2020. Three manufacturing plants of Torrents are reeling under regulatory issues with a warning letter being issued by the USFDA. The management expects at least 12 – 15 months for the issues to be resolved and till such time, the approvals from these plants would be withheld. We expect the regulatory issues to be an overhang on the stock performance.

Key Risks

� Slowdown in ANDA approvals and USFDA-related regulatory risks could hurt business prospects.

� Delay in product launches in Brazil, Germany and the U.S. could restrict growth in these key geographies.

� Currenc��uctuation poses a risk to the export businesses.


Additional Data


Mr. Sudhir Mehta Chairman (Emeritus)

Mr. Samir Mehta Chairman

Mr. Sudhir Menon CFO

Dr. Chaitanya Dutt Director (R&D)

Mr. Mahesh Agrawal VP (Legal) & Company SecretarySource: Company Website

Top 10 shareholders



2 UTI Asset Management Co Ltd 1.58

3 MIRAE ASSET FOCUSED 1.51

4 Mirae Asset Global Investments Co 1.39

5 HDFC Life Insurance Co Ltd 1.26

6 Pictet Funds SA 0.87

7 Vanguard Group Inc/The 0.85


9 T Rowe Price Group Inc 0.8

10 Reliance Capital Trustee Co Ltd 0.79Source: Bloomberg

Atul LimitedMargin expansion surprises positively

Company details

Market cap: Rs. 14,602 cr

52-week high/low: Rs. 4,980/3,268


0.2 lakh

BSE code: 500027

NSE code: ATUL

Sharekhan code: ATUL

��shares)

1.6 cr

Promoters 45

DII 23

FII 7

Others 25

Shareholding (%)

Price performance

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Sector: Speciality Chem

Result Update

Atul Limited (Atul) reported revenue of Rs. 978 crore during Q3FY2020, lower by 4.1% y-o-y (7.7% below our expectation of Rs. 1,060 crore). EBITDA witnessed an increase of 9.6% y-o-y to Rs. 232 crore, leading to margin expansion of 295 BPS to 23.7% (ahead of our expectation of 20.9%). PAT grew at a robust pace of 36.7% y-o-y to Rs. 160 crore (ahead of our expectation of Rs. 144 crore). The company is likely to expand capacities in a calibrated manner without relying on external borrowings, as it generates a healthy cash flow and wants to remain debt-free. Future growth is likely to be driven by improved utilisation levels of enhanced capacities.

Key positives

� Operating margin improved by 295 BPS to 23.7%, ahead of expectations of 20.9%.

� Pro�tability at the EBIT level improved in both lifesciences chemicals and performance and other chemicals segments at a consolidated level.

Key negatives

� Revenue declined by 4.1% y-o-y to Rs. 978 crore, 7.7% below our expectation of Rs. 1,060 crore.

� Revenue in life sciences chemical was lower by 5.6% y-o-y to Rs. 318 crore at a consolidated level.

Our CallValuation: Reiterate Neutral stance with potential upside of 6-8%: Atul earns a higher margin pro�le and delivers healthy return ratios as it is a net debt-free company with a strong balance sheet. Future growth is likely to be driven by improved utilisation levels of enhanced capacities. We like Atul from a long-term perspective as its business model generates superior margins and return ratios in the speciality chemicals space. We have �ne tuned our numbers for FY2020E and FY2021E and have introduced FY2022E numbers. We expect the company to report revenue and earnings CAGR of 8.9% and 23.1%, respectively, over FY2019-FY2022E. At the CMP, the stock is trading at 22.2x/20.1x/18.0x its FY2020E/FY2021E/FY2022E earnings. However, we maintain our Neutral stance on the stock as signi�cant run-up of 15%+ in the past one month limits potential upside.

Key Risks

� Delay in commissioning of capex project, slower demand offtake than expected coupled with delay in launch of new products might affect revenue growth momentum.

� Adverse raw-material prices and a delay in the ability to pass on price hikes adequately in time might affect margins.

Change

View: Neutral CMP: Rs. 4,923

Upside potential: 6-8% á

Valuation Rs cr

Particulars FY18 FY19 FY20E FY21E FY22E

Revenue 3,296 4,038 4,273 4,680 5,208

OPM (%) 15.3 19.0 22.9 23.1 22.8

Adjusted PAT 281 436 657 727 813

% y-o-y growth (12.9) 55.0 50.7 10.6 11.8

Adjusted EPS (Rs.) 94.8 146.9 221.4 244.9 273.9

P/E (x) 52.0 33.5 22.2 20.1 18.0

P/B (x) 6.5 5.4 4.4 3.6 3.1

EV/EBITDA (x) 28.9 18.8 14.3 12.6 11.2

RoNW (%) 13.4 17.6 21.8 19.8 18.5

RoCE (%) 17.6 25.1 27.0 24.9 23.5Source: Company; Sharekhan estimates


(%) 1m 3m 6m 12m

Absolute 14.9 7.1 25.9 31.2

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Missed on the revenue front, however beats on margins and PAT front: Atul reported revenue of Rs. 978 crore during Q3FY2020, lower by 4.1% y-o-y and 7.7% below our expectation of Rs. 1,060 crore. Eased input cost pressure coupled with product mix changes led to signi�cant y-o-y gross margin expansion of 537 BPS to 52.8% (q-o-q 142 BPS improvement). Increased employee cost and other operating cost (up by 14.1% and 3.5% y-o-y, respectively) restricted the margin expansion at the operating level to 295 BPS at 23.7% (ahead of our expectation of 20.9%). PBT grew by 18.6% y-o-y to Rs. 212 crore, led by increased operating pr��t coupled with favourable other income (loss of Rs. 5 crore in Q3FY2019) and partly offset by increased depreciation (up by 5.2% y-o-y). PAT grew at a robust pace of 36.7% y-o-y to Rs. 160 crore (ahead of our expectation of Rs. 144 crore), led by lower tax rate of 24.4% as against 34.5% in Q3FY2019. Adjusted PAT increased by 24.5% y-o-y to Rs. 158 crore (forex adjustment of Rs. 10 crore loss in Q3FY2019).

Muted revenue growth, while margin expands at the consolidated level too: Revenue grew marginally by 1% y-o-y to Rs. 1,041 crore. Ease in input cost pressures coupled with product mix change led to 401 BPS y-o-y improvement in gross margin at 52.3% (q-o-q 83 BPS improvement). However, operating margin expansion was lower at 325 BPS at 23.9% as employee cost increased by 13.9% y-o-y. EBITDA grew by 16.8% y-o-y to Rs. 249 crore. PBT grew by 26.6% y-o-y to Rs. 227 crore, led by increased operating pr��t coupled with favourable other income (loss of Rs. 4 crore in Q3FY2019) and partly offset by increased depreciation (up 11.5% y-o-y). PAT jumped by 44.3% y-o-y to Rs. 169 crore, owing to lower tax incidence of 25.4% as against 35.2% in Q3FY2019. Adjusted PAT was up by 32.0% y-o-y to Rs. 167 crore (forex adjustment of Rs. 10 crore loss in Q3FY2019).

Revenue mix remains unchanged, revenue declines in life sciences chemicals segment, while margin improves in both the segments: Revenue mix at the consolidated level broadly remained unchanged for life sciences chemicals, performance and other chemicals and others at 29:70:1 as against 30:69:1 during Q3FY2019. Revenue in the life sciences chemicals segment was lower by 5.6% y-o-y to Rs. 318 crore, while in performance and other chemicals was marginally down by 0.3% y-o-y to Rs. 760 crore. Pr��tability at EBIT level improved in both life sciences chemicals and performance and other chemicals. EBIT margin improved by 158 BPS and 353 BPS on y-o-y basis to 17.9% and 22.1%, respectively, during Q3FY2020. Overall EBIT margin improved by 289 BPs to 21.9% at the consolidated level.

Results

(Rs crores) Standalone Consolidated

Q3FY20 Q3FY19 y-o-y (%) Q2FY20 QoQ (%) Q3FY20 Q3FY19 y-o-y (%) Q2FY20 QoQ (%)

Revenue 978 1,019 (4.1) 1,013 (3.5) 1,041 1,032 1.0 1,046 (0.4)

Material Cost 462 536 (13.9) 493 (6.3) 497 533 (6.9) 507 (2.1)

Gross Profit 516 483 6.8 520 (0.8) 545 498 9.3 538 1.2

Employee Expenses 63 55 14.1 63 (0.6) 75 66 13.9 77 (2.2)

Power and Fuel Expenses 93 92 0.4 94 (1.2) 95 94 0.7 96 (1.5)

Other Expenses 129 125 3.5 149 (13.7) 125 124 0.6 140 (10.9)

EBITDA 232 211 9.6 214 8.3 249 213 16.8 224 11.1

Other Income 10 (5) - 24 (58.3) 12 (4) - 21 -

Depreciation 29 28 5.2 29 0.3 32 29 11.5 32 0.3

Interest 1 1 53.7 0 260.0 3 2 67.0 2 54.7

PBT 212 178 18.6 209 1.2 227 179 26.6 212 6.8

Tax 52 61 (15.9) 1 - 57 63 (8.9) 2 -

Reported PAT 160 117 36.7 208 (23.3) 169 117 44.3 209 (19.2)

Adjusted PAT 158 127 24.5 204 (22.5) 167 127 32.0 205 (18.5)

EPS (Rs.) 53.9 39.4 36.7 70.2 (23.3) 56.9 39.5 44.3 70.5 (19.2)

Margins bps bps bps bps

�� 52.8 47.4 537 51.4 142 52.3 48.3 401 51.5 83

EBITDA margin 23.7 20.7 295 21.1 258 23.9 20.7 325 21.5 248

�� 16.3 11.5 488 20.6 (422) 16.2 11.3 487 20.0 (377)

Source: Company; Sharekhan Research

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Outlook

Ambition to achieve US$ 1 billion revenue continues: Management continues to maintain that it wants to achieve a revenue target of US$1 billion and is striving hard to meet its goal. However, a �uctuation in exchange rate has been pushing the goal a year ahead. Commissioning of capacities and debottlenecking are expected to drive volumes higher, which will fuel growth because of improved utilisation levels; positive pricing tailwinds and operating leverage will also enhance margin pr��le. Opportunities available for players in South Asia as innovators seek a reliable partner for assured sourcing, as the situation in China, have not changed much. The company wants to explore organic and inorganic growth opportunities and wants to take a conservative approach by relying mostly on internal accruals and remain debt-free.

Valuation

Reiterate Neutral stance with potential upside of 6-8%: Atul earns a higher margin pr��le and delivers healthy return ratios as it is a debt-free company with a strong balance sheet. Future growth is likely to be driven by improved utilisation levels of enhanced capacities. We like Atul from a long-term perspective as its business model generates superior margins and return ratios in the speciality chemicals space. We have �ne tuned our numbers for FY2020E and FY2021E and have introduced FY2022E numbers. We expect the company to report revenue and earnings CAGR of 8.9% and 23.1%, respectively, over FY2019-FY2022E. At the CMP, the stock is trading at 22.2x/20.1x/18.0x its FY2020E/FY2021E/FY2022E earnings. However, we continue to maintain our Neutral stance on the stock as signi�cant run-up of 20%+ in the past one month limits potential upside.

One-year forward P/E (x) band – Risk-reward unfavourable as upside potential looks limited


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Peer valuation

ParticularsCMP (Rs /

Share)

O/S Shares

(Cr)

MCAP (Rs Cr)

P/E (x) EV/EBIDTA (x) P/BV (x) RoE (%)

FY20E FY21E FY20E FY21E FY20E FY21E FY20E FY21E

Atul 4,923 3.0 14,602 22.2 20.1 14.3 12.6 4.4 3.6 21.8 19.8

Aarti Industries 854 17.4 14,887 27.3 20.1 15.1 11.3 4.7 3.8 18.8 21.1

SRF 3,675 5.8 21,122 27.2 21.6 14.9 11.8 4.4 3.7 17.6 18.8

Sudarshan Chemicals 475 6.9 3,290 29.3 24.8 14.7 12.7 5.1 4.5 18.5 19.3

Vinati Organics 2,291 5.1 11,777 31.2 26.4 23.6 19.3 8.5 6.6 31.0 28.1Source: Sharekhan Research

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Additional Data


Sunil Lalbhai Chairman and Managing Director

Samveg Lalbhai Jt Managing Director

Bharathy Mohanan Executive Director

Gopi Kannan Thirukonda Executive Director cum CFO

Rajendra Shah Non-Executive - Non Independent Director

Lalit Patni ��Source: Bloomberg

Top 10 shareholders



2 DSP Investment Managers Pvt Ltd 3.79

3 Aditya Birla Sun Life Asset Management 2.61

4 Trivedi Tejas B 2.04

5 Trivedi Shivani Tejas 1.97

6 Goldman Sachs Group Inc/The 1.79

7 Kotak Mahindra Asset Management Co 1.62

8 Canara Robeco Asset Management Co 1.42

9 Franklin Resources Inc 1.30

10 FundRock Management Co SA 1.28Source: Bloomberg

About company

Incorporated in 1947 and headquartered in Gujarat, Atul, a member of the Lalbhai Group is an integrated chemical company and has a diverse product portfolio. The company’s businesses are broadly classi�ed into two segments i.e. lifesciences chemicals and performance and other chemicals. Crop protection and pharmaceuticals are sub segments of the lifescience chemicals segment, while aromatics, bulk chemicals and intermediates, colours, �oras, and polymers are sub-segments of the performance and other chemicals segment. The company owns 114 brands and manufactures ~900 products and ~450 formulations in its production facilities situated at Ankleshwar, Atul, Panoli and Tarapur and through facilities situated at Ambernath, Ankleshwar, Atul and Bristol (U.K.) in various subsidiaries. The company operates a network of over 38,000 retail outlets in India and serves more than 6,000 customers across 92 countries.

Investment theme

Atul intends to expand capacities in a calibrated manner without relying on external borrowings. Capex of Rs. 569 crore planned at the parent level and Rs. 370 crore set aside for investments in subsidiaries and joint ventures for FY2019-FY2020 to tap opportunities. The situation in China still ben��cial for other players in the region, as the Chinese government cracks down further. Future growth is expected to be driven by improved utilisation levels backed by a strong demand outlook along with positive pricing tailwinds and operating leverage. The company achieved debt-free status in FY2018 and return ratios are expected to see a northward trend (after a gap of four years) on account of improved pr��tability (largely due to ease in input cost pressure) and strong free cash-�w generation. This gives the company ample scope to explore organic and inorganic growth opportunities further.

Key Risks

� Delay in commissioning of capex project, slower demand offtake than expected coupled with delay in launch of new products might affect revenue growth momentum.

� Adverse raw-material prices and delay in the ability to pass on price hikes adequately in time might affect margins.

AutomobilesPerformance to improve; sustained recovery to take time

The automotive industry is expected to clock much better numbers in January 2020 as we expect substantially lower decline in the volumes. The average decline for the industry is likely to be 6% as compared to an 18% drop as seen in 9MFY2020. Average inventory levels across segments have dropped to 4-5 weeks as compared to 6-7 weeks in the past three months. Two-wheeler sales are expected to drop by 5% (as compared to a 13% drop in Q3FY2020). Hero and TVS Motors are expected to witness a decline of 3% and 11% (as against 14% and 19% in Q3FY2020). Passenger vehicle industry is expected to clock flat sales in January (as compared to a 1% drop in Q3FY2020). Maruti Suzuki is expected to report flat sales during the month. Commercial vehicle (CV) sales are expected to decline by 13% owing to weak economic growth and the impact of axle load norms. However, the performance is expected to improve as CV sales had dipped 19% in Q3FY2020. For Ashok Leyland, sales volumes are expected to drop 24% y-o-y (as compared to 31% y-o-y drop in Q3FY20). Tractor sales volumes are expected to remain flat in January as compared to a 6% drop reported in Q3FY20.

Sector outlook Transition to BS-VI norms to affect sales volumes in the near term; expect a gradual recovery: Automotive companies (two-wheeler and CVs) would continue to ramp down production of BS-IV vehicles as they gradually start introducing high cost BS-VI variants in the market as the deadline for BS-VI (April 2020) norms approaches. Transition to BS-VI norms would keep automotive volumes under pressure in the near term. We expect sales volumes to recover gradually led by an improving �nancing situation and improved rural sentiments (due to expectations of a better rabi crop).

Sector viewAutomotive sales volumes have improved in the past four months (average volume decline for automotive segments is expected to come down to 9% as compared to 21% drop in H1FY2020). Moreover, retail volumes are better as compared to wholesale volumes reported (wholesale volumes are lower as companies shift from BS-IV to BS-VI emission norms). The Nifty Auto Index has surged by about 10% in past four months (after improved volume performance), which is marginally better than 6% gains in the Nifty. We had upgraded our view on the sector to “Neutral” from “Cautious” (in our report dated November 5, 2019) in the wake of better volumes and a reduction in inventories. We expect a gradual improvement in the volumes and expect a sustained recovery from H2FY21 post transition to BS 6 norms and improvement in the economy. Among original equipment manufacturers (OEMs), we prefer M&M (due to volume growth visibility in tractors space and new launches in the UV space) and Bajaj Auto (due to market share gains domestically and healthy exports). Among auto-ancillary companies, we like Balkrishna Industries (due to favourable agricultural outlook and market share gains) and Exide Industries (due to healthy replacement and industrial demand). We also like Alicon Castalloy due to new order wins.Personal income tax cuts/scrappage policy could be a boost for sector: To boost the consumption demand, the government is contemplating a reduction in personal income tax rates in the upcoming Union Budget to be presented on February 1, 2020. Any tax cuts would increase disposable income in the hands of consumers and is likely to boost automotive demand. The government is also working on a scrappage policy to revive the automotive sector. If adequate incentives are provided by the government to replace the old vehicles with new ones, it could result in signi�cant jump in the demand for automotive companies.

Key risks:

1) Slow recovery in demand; and 2) increased discounting ahead of BS-VI transition can adversely affect margins.

Sector: Automobiles

View: Neutral

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Valuation

Auto OEM’s CMPP/E EV/EBITDA

Reco/View PTFY19 FY20E FY21E FY19 FY20E FY21E

Ashok Leyland 85 12.2 19.8 21.3 7.0 9.7 9.7 Hold 86

Hero Motocorp 2,455 14.5 15.0 14.8 8.7 9.9 10.0 Hold 2650

M&M 578 13.2 16.6 18.2 8.6 9.5 9.7 Buy 655

Maruti Suzuki India 7,144 28.8 32.6 27.1 19.2 19.5 16.2 Hold 7500

Bajaj Auto 3,082 20.6 18.0 16.9 15.7 12.3 9.7 Buy 3575

TVS Motor Company 465 33.0 32.3 29.1 15.5 15.4 15.0 Reduce 385

Tata Motors 183 NA NA 13.8 5.2 5.7 4.0 Not Under Coverage -

Escorts 734 13.8 14.5 12.5 8.9 9.6 7.9 Booked Out -

Eicher Motors 21,110 26.1 27.4 24.3 18.7 21.6 18.5 Not Under Coverage -

Soft coverage

Balkrishna Industries 1,074 26.5 25.5 21.4 15.4 15.9 13.4 Positive

Exide Industries 203 18.6 15.1 14.0 12.0 10.6 9.5 Positive

Sundram Fasteners 513 23.6 30.0 25.8 14.7 15.8 14.0 Neutral

Lumax Auto Technologies 116 12.1 13.2 13.3 7.0 6.7 6.1 Neutral

Alicon Castalloy 415 10.5 14.6 10.3 6.1 6.2 5.4 Positive

Source: Company, Sharekhan Estimates

Sectoral expectations

Two-wheeler volumes to fall but pace of decline to moderate

� We expect two-wheeler sales to fall in mid single digits (about 5% yoy) for the month. While the sales would drop, the decline is expected to moderate as compared to Q3FY20 where sales had dipped 13% yoy.

� Discounts remained higher as companies are clearing BS-IV inventories to ensure a smooth transition to BS-VI norms. Market leader Hero Motocorp continued to offer incentives of about Rs 2,000 per bike, similar to incentives offered in December 2019.

� Our channel checks indicate that inventories are slightly higher (at about 5 weeks) as compared to a normalised inventory of four weeks.

� Most key players (excluding Bajaj Auto) have started to roll out BS-VI vehicles in a phased manner starting from January 2020.

� In two-wheeler segment, TVS Motors is expected to underperform the industry with sales expected to drop by 11% y-o-y. HeroMotocorp would marginally outperform the industry with a drop of 3% while Bajaj Auto would perform in line with the industry reporting 6% fall in volumes.

PV sales to remain muted

� We expect PV sales to be �at during the month of January 2020. PV segment is expected to remain muted (Q3FY20 PV industry sales dropped by 1%).

� Our channel checks indicate that inventories of PV manufacturers have reached comfortable levels of 3-4 weeks as against 4-5 weeks in December 2019.

� Discounts for Maruti Suzuki have reduced vis-à-vis December 2019. With the company introducing majority of variants with the BS-VI emission norms, discounts have reduced by Rs. 5,000-12,000 per vehicle as compared to December 2019.

� In PV segment, market leader Maruti Suzuki is expected to perform in line with the industry reporting��at sales for January 2020. Tata Motors is expected to outperform with 5% growth (due to new launches). M&M is expected to marginally outpace the industry with expected growth of 2%.

January 27, 2020 21

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Source: Company, Sharekhan Research

Tata Motors


-30

-20

-10

0

10

0

25000

50000

75000

100000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E

no of units Growth yoy (%)

-60

-50

-40

-30

-20

-10

0

0

25000

50000

75000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E


Escorts


Sales trend of companies

Maruti Suzuki


-40

-30

-20

-10

0

10

40000

80000

120000

160000

200000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E


-20

-10

0

10

20

0

3500

7000

10500

14000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E


CV segment to continue double-digit drop but pace of decline moderates substantially

� CV sales are expected to continue trend of double digit drop in January 2020 and we expect 13% yoy drop in sales. The decline is likely to be much lower than 19% drop reported in Q3FY20.

� CV demand continues to remain weak impacted by slower economic growth and impact of axle load norms.

� The effect of pre-buying of CVs due to a change from BS-IV emission to BS-VI emission norms is unlikely to be seen in January 2020 as demand continues to remain weak.

� In the CV segment, Ashok Leyland is expected to underperform, clocking a drop of 24% in sales volumes. A higher share of MHCVs, in the company’s sales mix, which are bearing the brunt of a slowdown would lead to underperformance. Market leaders Tata Motors and M&M are likely to outperform, recording a lower decline of 8% and 10%, respectively due to higher share of LCVs, in their sales mix, which are relatively less impacted by the slowdown.

Tractor sales to remain flat: Tractor sales are expected to remain �at as we expect a 1% y-o-y growth in January 2020. They were��at in December 2019 as well. Market leader M&M is expected to outperform with growth of 3% indicating market share gain. Escorts is expected to underperform with a double-digit drop in sales.

January 27, 2020 22

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Ashok Leyland


Hero Motocorp


-80-70-60-50-40-30-20-1001020

0

3000

6000

9000

12000

15000

18000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E


-30

-20

-10

0

0

125000

250000

375000

500000

625000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E


TVS Motor


-30

-20

-10

0

10

0

50000

100000

150000

200000

250000

300000

350000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E


Bajaj Auto


-30

-20

-10

0

10

20

0

125000

250000

375000

500000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E


Eicher Motors Royal Enfield


-30

-20

-10

0

10

0

15000

30000

45000

60000

75000

Jan-

19

Feb-

19

Mar

-19

Apr-

19

May

-19

Jun-

19

Jul-1

9

Aug-

19

Sep-

19

Oct

-19

Nov

-19

Dec-

19

Jan-

20E


January 27, 2020 23

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Company-wise volume expectations for December 2019:

Maruti Suzuki India Limited

Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

Mini & Compact

Segment

102,000 98,931 3.1 90,916 12.2 891,277 1,044,067 (14.6)

Mid Size- Ciaz 2,100 2,934 (28.4) 1,786 17.6 22,116 39,413 (43.9)

Total passenger cars 104,100 101,865 2.2 92,702 12.3 913,393 1,083,480 (15.7)

UVs- Gypsy, Ertiga,

XL6, S-Cross, Brezza

27,000 22,430 20.4 23,808 13.4 211,330 216,800 (2.5)

Vans- Omni, Eeco 9,000 15,145 (40.6) 7,634 17.9 97,887 147,603 (33.7)

LCV - Super Carry 2,500 2,710 (7.7) 1,591 57.1 20,688 19,104 8.3

Total domestic PV 142,600 142,150 0.3 125,735 13.4 1,243,298 1,466,987 (15.2)

Export 10,000 9,571 4.5 7,561 32.3 87,574 88,704 (1.3)

Total Sales 152,600 151,721 0.6 133,296 14.5 1,330,872 1,555,691 (14.5)

Tata Motors Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

M&HCV 12,000 15,579 (23.0) 10,954 9.5 99,903 158,273 (36.9)

LCV 22,000 21,510 2.3 20,515 7.2 182,696 220,391 (17.1)

Total CV 34,000 37,089 (8.3) 31,469 8.0 282,599 378,664 (25.4)

Passenger cars 11,000 11,007 (0.1) 6,597 66.7 62,928 112,208 (43.9)

Utility vehicles (Safari,

Nexon, Hexa, Harrier)

7,750 6,819 13.7 6,188 25.2 55,019 62,015 (11.3)

Total PV 18,750 17,826 5.2 12,785 46.7 117,947 174,223 (32.3)

Total Domestic Sales 52,750 54,915 (3.9) 44,254 19.2 400,546 552,887 (27.6)

Export Sales 2,200 3,270 (32.7) 2,649 (16.9) 23,158 38,746 (40.2)

Total Sales 54,950 58,185 (5.6) 46,903 17.2 423,704 591,633 (28.4)

Mahindra & Mahindra Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

Utility vehicles 23,500 22,263 5.6 15,225 54.4 169,664 185,212 (8.4)

Cars+Vans 800 1,609 (50.3) 466 71.7 7,495 15,734 (52.4)

LCV 19,750 21,776 (9.3) 15,540 27.1 173,667 193,789 (10.4)

MHCV 575 849 (32.3) 478 20.3 4,761 9,235 (48.4)

Three wheelers 6,750 6,003 12.4 5,372 25.7 56,536 54,104 4.5

Total domestic 51,375 52,500 (2.1) 37,081 38.5 412,123 458,074 (10.0)

Exports 2,275 3,222 (29.4) 2,149 5.9 25,147 31,565 (20.3)

Total automotive 53,650 55,722 (3.7) 39,230 36.8 437,270 489,639 (10.7)

Tractors - domestic 21,750 20,948 3.8 17,213 26.4 256,027 280,191 (8.6)

Tractors - exports 1,100 1,264 (13.0) 777 41.6 9,448 11,579 (18.4)

Total tractors 22,850 22,212 2.9 17,990 27.0 265,475 291,770 (9.0)

Total Sales 76,500 77,934 (1.8) 57,220 33.7 702,745 781,409 (10.1)

Escorts Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

Domestic 5,500 5,762 (4.5) 3,806 44.5 68,630 74,974 (8.5)

Exports 250 229 9.2 308 (18.8) 3,030 2,293 32.1

Total Sales 5,750 5,991 (4.0) 4,114 39.8 71,660 77,267 (7.3)

Ashok Leyland Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

MHCV 10,250 14,694 (30.2) 7,025 45.9 71,904 113,533 (36.7)

LCV 4,750 5,047 (5.9) 4,143 14.7 42,845 44,053 (2.7)

Total Sales 15,000 19,741 (24.0) 11,168 34.3 114,749 157,586 (27.2)

January 27, 2020 24

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Eicher Motors Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

Eicher LD+ LMD (3.5 -

15Ton)

2,800 3,921 (28.6) 3,048 (8.1) 25,475 34,688 (26.6)

Eicher HD 925 1,023 (9.6) 771 20.0 7,199 13,110 (45.1)

Eicher Buses 1,000 864 15.7 1,091 (8.3) 8,362 9,132 (8.4)

Extra Heavy Duty

trucks

110 98 12.2 132 (16.7) 891 935 (4.7)

CV's - Total Sales 4,835 5,906 (18.1) 5,042 (4.1) 41,927 57,865 (27.5)

Two-wheelers (Royal

Enfield)

68,000 72,701 (6.5) 50,416 34.9 601,089 702,637 (14.5)

Hero Motocorp Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

Total Sales 565,000 582,756 (3.0) 424,845 33.0 5,640,208 6,620,657 (14.8)

Bajaj Auto Limited Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

Motorcycles Domestic 165,000 203,358 (18.9) 124,125 32.9 1,840,264 2,134,584 (13.8)

Motorcycles Export 164,000 147,102 11.5 160,677 2.1 1,582,764 1,450,766 9.1

CV Domestic 35,000 28,103 24.5 29,038 20.5 325,683 325,298 0.1

CV Export 26,000 28,587 (9.0) 22,215 17.0 264,540 322,415 (18.0)

Total Sales 390,000 407,150 (4.2) 336,055 16.1 4,013,251 4,233,063 (5.2)

Domestic 200,000 231,461 (13.6) 153,163 30.6 2,165,947 2,459,882 (11.9)

Exports 190,000 175,689 8.1 182,892 3.9 1,847,304 1,773,181 4.2

TVS Motors Jan-20 Jan-19 YoY(%) Dec-19 MoM(%) YTD FY20 YTD FY19 YoY(%)

Motorcycle 105,000 111,253 (5.6) 93,697 12.1 1,189,025 1,295,660 (8.2)

Mopeds 55,500 72,795 (23.8) 47,206 17.6 562,702 760,901 (26.0)

Scooters 80,000 85,229 (6.1) 74,716 7.1 988,012 1,115,594 (11.4)

Total two-wheelers 240,500 269,277 (10.7) 215,619 11.5 2,739,739 3,172,155 (13.6)

Three-wheelers 16,400 13,353 22.8 15,952 2.8 147,709 128,248 15.2

Total Sales 256,900 282,630 (9.1) 231,571 10.9 2,887,448 3,300,403 (12.5)

Domestic (incl above) 191,900 229,980 (16.6) 158,059 21.4 2,185,488 2,681,640 (18.5)

Exports (from above) 65,000 52,650 23.5 73,512 (11.6) 701,960 618,763 13.4

Source: Sharekhan Estimates


Sharekhan Stock Ideas

AutomobilesApollo TyresAshok Leyland Bajaj AutoGabriel IndiaHero MotoCworpM&MMaruti Suzuki Rico Auto IndustriesTVS Motor

Banks & FinanceAxis BankBajaj Finance Bajaj FinservBank of BarodaBank of IndiaCapital FirstFederal BankHousing Development Finance CorporationHDFC BankICICI BankLIC Housing FinancePunjab National BankSBIUnion Bank of IndiaYes Bank

Consumer goodsBritanniaEmami GSK ConsumersGodrej Consumer Products Hindustan UnileverITCJyothy LaboratoriesMaricoZydus Wellness

IT / IT servicesHCL TechnologiesInfosysPersistent SystemsTata Consultancy Services Wipro

Capital goods / PowerCESCFinolex CablesGreaves CottonKalpataru Power TransmissionKEC InternationalPTC IndiaThermaxTriveni TurbineV-Guard Industries

Infrastructure / Real estateITNLIRB Infrastructure DevelopersJaiprakash AssociatesLarsen & ToubroSadbhav Engineering

Oil & gasOil IndiaPetronet LNG Reliance Industries Selan Exploration Technology

PharmaceuticalsAurobindo PharmaCiplaCadila Healthcare Divi’s LabsLupinSun Pharmaceutical IndustriesTorrent Pharmaceuticals

Building materialsGrasim IndustriesThe Ramco Cements Shree CementUltraTech Cement

Discretionary consumptionArvind LtdCentury Plyboards (India)Inox Leisure Info Edge (India)Kewal Kiran ClothingOrbit ExportsRelaxo Footwear Titan CompanyWonderla Holidays

Diversified / MiscellaneousAditya Birla NuvoBajaj Holdings & InvestmentBharti AirtelBharat ElectronicsGateway DistriparksMax Financial ServicesPI IndustriesRatnamani Metals and TubesSupreme Industries UPL

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