India

In this briefing:

1. India – NPL Sale Is Not a Panacea
2. India: Thermal Coal Imports Are Rising, What Does It Mean For End User Industries and the Economy?
3. India Banks – HDFC Bank Subsidiary Stalled Profit
4. Metropolis Healthcare Pre-IPO Quick Take – Steady Performance but Growth Lagged Network Expansion
5. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids

1. India – NPL Sale Is Not a Panacea

Selling bad loans to the government, and asset management company or to a distressed loan buyer is not necessarily a remedy to the crisis for India’s banks. This is because their non-performing loan (NPL) levels are high compared with their buffer to absorb losses, e.g loan loss reserves and capital. Where it is rare to know about the selling price of NPLs in any market, there is news out today of a large NPL sale at 24 cents on the dollar. The market is not India, rather Indonesia, but this only raises concerns further: it is more likely that an NPL divestiture in India yields a worse price than in Indonesia. This is due to wildly different NPL trends and NPL levels in each country. 

2. India: Thermal Coal Imports Are Rising, What Does It Mean For End User Industries and the Economy?

India’s coal imports have risen 10% in the first eight months of FY19 and this year is likely to be the repeat of previous financial year when after falling for two years, India’s coal import had grown 8.1% yoy. After the NDA took over in May 2014, Indian Govt has spoken about eliminating coal imports altogether. However, there are serious problems with domestic production, logistics issues and poor track record of coal sector PSUs. Coal India Ltd (COAL IN) contributes more than 80% of India’s domestic coal output and FY19 has been a little better in comparison of previous years so far for the company. But, its performance has dipped over previous few months and it is very likely that coal imports will grow significantly again in FY19.

The higher coal imports is relevant for several sectors and many companies. The major implications are, 1) This is bad news for Coal India Ltd (COAL IN) and the company’s ability to increase supplies in the more profitable e-auction segment, 2) Increase in cost of power generation affects specific GENCOs and later, the entire power sector because cost of power procurement goes up for DISCOMs, 3) with increase in electricity prices, inflation may also increase and there is negative impact on balance between imports and exports, 4) it is also good news for renewables as they get more competitive on cost which makes them more attractive, 5) this is bad for entire value chain of coal based power plants which includes companies such as Bharat Heavy Electricals (BHEL IN).

3. India Banks – HDFC Bank Subsidiary Stalled Profit

When most analyze HDFC Bank (HDFCB IN), there is little emphasis on its non-banking finance company (NBFC) subsidiary, HDB Financial Services (HDBFS). Perhaps in the current environment, this is more important than ever. At the same time, where HDFC Bank’s subsidiary has had significant growth in recent periods, where this begins to change, it has important implications. Most do not believe HDFC Bank can ever show poor earnings growth, let alone high bad loans and credit costs. We disagree. As India’s second largest bank, it is  beholden to the macro economic overlay; even if delayed or not clearly visible. We wonder if HDBFS’s latest figures showing just 1% gross profit growth, is one sign of this?

4. Metropolis Healthcare Pre-IPO Quick Take – Steady Performance but Growth Lagged Network Expansion

Metropolis Health Services Limited (MHL IN) (MHL) plans to raise US$100m+ in its Indian IPO. MHL is one of the largest diagnostic chains in the country. Carlyle invested in the company in 2015. 

MHL has registered steady growth and margins over the past few years. It has also aggressively expanded its network over the past few years, although revenue growth hasn’t matched the network expansion.

MHL’s recent financial performance has been in-line with its listed peers, Dr Lal Pathlabs (DLPL IN) and Thyrocare Technologies (THYROCAR IN), while the company continues to lead its two listed peers in terms of revenue generated per test.

5. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids

Hitachi Ltd (6501 JP) announced the acquisition of an 80.1% stake in ABB Ltd (ABBN VX)’s power grids business for $6.4 billion. ABB will retain the remaining stake in the divested unit, which is valued at an EV of $11 billion. ABB’s power grids is a global #1 player and makes transformers, long distance electricity-transmission systems and energy storage units.

In this briefing:

1. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

1. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

Bharat Heavy Electricals (BHEL IN) had announced a sizeable share buyback a couple of weeks ago. This buyback amounting to total Rs16.3 bn has opened yesterday, but we think that it is unlikely to help much. In the coming years, the Indian power distribution companies (DISCOMs) are likely to buy more power from renewable sources and the proposed changes in regulation will expedite the shift. In addition, resolution of power assets in distress continues to remain slow and new orders for Bharat Heavy Electricals (BHEL IN) which is already struggling with slow moving orders, remain sluggish. Another interesting development is shift in interest from company’s key customers. For example, NTPC Ltd (NTPC IN) is exploring acquisition opportunities much more than greenfield expansion. All of this is certainly bad news for the Bharat Heavy Electricals (BHEL IN) stock. While the PAT nos. are small in absolute terms and even a slight positive change will make valuations look attractive for the stock, this will not have a meaningful impact unless things improve structurally for the company.

In this briefing:

1. India Monthly Report Nov-Dec 2018
2. India: How “Free Electricity” Schemes May Be Linked to Excellent Industrial Growth Numbers?
3. Overview of My Winners and Losers in 2018…and 5 High Conviction Ideas Going into 2019
4. RRG Global Macro – US Fed Positive Outlook – Stocks Fall.  Politics Take Over from Fundamentals
5. Universal, SegaSammy & Dynam Sit Best Positioned Among Japan Companies in Race for IR Partnerships

1. India Monthly Report Nov-Dec 2018

The Indian indices have been seeing an ebb and flow with bearish indicators accounting for market dips with a recovery towards the end of the period. Overall the Indian indices have outperformed the global market this month with positive returns across sectors except for pharma and the metal sector.

Returns in USD

2. India: How “Free Electricity” Schemes May Be Linked to Excellent Industrial Growth Numbers?

If we look more closely at the latest Industrial Production (IIP) increase data which reported a strong overall growth of 8.1% yoy, we find a mixed picture emerging on the component wise contribution and growth across categories. The industry group ‘Manufacture of furniture’ has shown highest positive growth of 41.0% followed by 39.0% in ‘Manufacture of wood and products of wood and cork’, which is not as such the indicators of robust capacity creation for an economy. There are other interesting data points as well. Among top five item groups with positive percentage increase in production, some are purely consumption items which will have rather limited impact in terms of long term positive implications for the country.

But, what is that we are most worried about? For several previous months, IIP growth data is getting massive support from huge growth in electricity consumption. Electricity has contributed the most in growth even in October data (almost 20% more than mining, the second most important contributor and the one which has double the weight as compared to electricity). But, this could also be primarily driven by Government schemes such as SAUBHAGYA and other initiatives for rural electrification which are in overdrive. If this is not managed well, massive growth in electricity could lead to more stress for DISCOMs (power distribution companies) and that could be harmful for the entire power sector.

3. Overview of My Winners and Losers in 2018…and 5 High Conviction Ideas Going into 2019

In a follow up to my note from last year Overview of My Winners and Losers in 2017…and 5 High Conviction Ideas Going into 2018 I again look at my stock ideas that have worked out in 2018, those that have not and those where the verdict is still pending.

Last year I provided 5 high conviction ideas and here is their performance in a brutal year for Asian Stock Markets:

4 out of 5 had a positive performance.

Below I will make a new attempt to provide five high conviction ideas going into 2019.

4. RRG Global Macro – US Fed Positive Outlook – Stocks Fall.  Politics Take Over from Fundamentals

• US: Stocks fall on political turmoil despite positive noises from the Fed with a dovish rate hike, a reduction in expected 2019 hikes and positive trends on employment and inflation.
• Russia: Unexpected 25 bps rate hike in the face of higher inflation in Nov. Watch for impact of lower oil prices in coming quarters.
• Turkey: Economic developments remain negative. The outlook for retail sales is poor as the economy in general is faltering.
• Indonesia: Trade deficit in November. Exports down 3.3%; imports up 11.68%. This disappointing performance could be the beginning of a trend.

5. Universal, SegaSammy & Dynam Sit Best Positioned Among Japan Companies in Race for IR Partnerships

• We’ve reviewed 10 companies in the sector. Of those, three are the consensus favorites of our Tokyo based panel of industry, financial and economics observers of the IR initiative over many years.
• Based on pachinko alone, the stocks of these companies are fully valued. Based on potential tailwind from a license award within 6 months, they could be vastly undervalued.
• Each of the three noted here brings strength to a bid less based on financials than corporate focus, outlook and experience in the field.

In this briefing:

1. REPCO Home – 2QFY19 – Focus on LAP to Maintain the NIMs and Spread
2. Mahindra & Mahindra Ltd- 2QFY19 – New Launches Cause Margin Pain, Benefits to Follow
3. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

1. REPCO Home – 2QFY19 – Focus on LAP to Maintain the NIMs and Spread

Repco Home Finance (REPCO IN) 2QFY19 results were in line with our estimates. The outstanding loan book portfolio reflected 11% YoY growth (v/s our expectation of 12%) at Rs 103,820 mn. The Net Interest Income (NII) was Rs 1,154 mn (v/s our estimates of Rs 1,230 mn), reflecting a YoY decline of 5%. The PAT was Rs 670 (v/s our estimates of Rs 618 mn), reflecting a YoY decline of 4%.

The management stated that the sand mining issue in Tamil Nadu (TN) (58.4% of outstanding loan book as of 1HFY19) lasted longer than expected. This has led to lower construction activity and demand for housing loans in Tamil Nadu. The company has guided for an improvement in 2HFY19 with the target of 15-16% loan growth.  They are focusing more on the other markets like Maharashtra, Gujarat, Karnataka to grow the loan book.

We have revised our NII estimates by -5.3%/-5.2%/ -1.5%, PPOP by -7.3%/-7.2%/-5.1% and PAT by -3.5%/ -3.5%/-1.9% for FY19E/FY20E/FY21E respectively.  We have revised our P/ABV multiple from 2.3x to 1.9x. Applying it to the adjusted book value for September-20E of Rs 306 per share, we arrive at the fair value of Rs 570 (earlier Rs 630)  for the next 12 months.

2. Mahindra & Mahindra Ltd- 2QFY19 – New Launches Cause Margin Pain, Benefits to Follow

• Mahindra & Mahindra (MM IN) reported 2QFY19 PAT of Rs 17,788 mn vs our estimate of Rs 15,240 mn. The revenues were 2.5% lower than estimated. EBITDA was Rs 18,493 mn as against our estimate of Rs 20,721 mn. EBITDA margins were  14.5% against our estimate of 15.8%.  Overall the performance was lower than our expectation.
• EBITDA margins were impacted due to higher raw material cost and higher launch cost related to Marazzo (7/8 seater utility vehicle). We expect the margins to remain under pressure for the 2HFY19E as the Company has lined up more new model launches.
• The shift in the festive season from 2Q to 3Q impacted the tractor sales volume in this quarter. M&M management expects the tractor industry to growth in the range of 12-14% YoY in FY19E where M&M is expected to grow at 12.5% YoY in FY19E.
• We have lowered EPS estimates for FY20E by 8%. Over FY18-21E, we expect revenue and PAT to grow at CAGR 14% and 13% respectively. We expect EBITDA margin to expand from 14.8% in FY18 to 15.5% in FY21E.
• Our EPS estimates for FY20E & 21E stand at Rs 47.3/- & Rs 53.7/- respectively. We have maintained the PE multiple of 17x with an EPS of Rs 47.2/- for the year ending September- 20E and valued its share in the subsidiaries at Rs 315/- to arrive at the fair value estimate of Rs 1,115/- for the next 12 months.

3. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

Bharat Heavy Electricals (BHEL IN) had announced a sizeable share buyback a couple of weeks ago. This buyback amounting to total Rs16.3 bn has opened yesterday, but we think that it is unlikely to help much. In the coming years, the Indian power distribution companies (DISCOMs) are likely to buy more power from renewable sources and the proposed changes in regulation will expedite the shift. In addition, resolution of power assets in distress continues to remain slow and new orders for Bharat Heavy Electricals (BHEL IN) which is already struggling with slow moving orders, remain sluggish. Another interesting development is shift in interest from company’s key customers. For example, NTPC Ltd (NTPC IN) is exploring acquisition opportunities much more than greenfield expansion. All of this is certainly bad news for the Bharat Heavy Electricals (BHEL IN) stock. While the PAT nos. are small in absolute terms and even a slight positive change will make valuations look attractive for the stock, this will not have a meaningful impact unless things improve structurally for the company.

In this briefing:

1. India: How “Free Electricity” Schemes May Be Linked to Excellent Industrial Growth Numbers?
2. Overview of My Winners and Losers in 2018…and 5 High Conviction Ideas Going into 2019
3. RRG Global Macro – US Fed Positive Outlook – Stocks Fall.  Politics Take Over from Fundamentals
4. Universal, SegaSammy & Dynam Sit Best Positioned Among Japan Companies in Race for IR Partnerships
5. India Politics: Long Before 2019 Results, Fight Begins for PM Candidate in Opposition = Good for BJP

1. India: How “Free Electricity” Schemes May Be Linked to Excellent Industrial Growth Numbers?

If we look more closely at the latest Industrial Production (IIP) increase data which reported a strong overall growth of 8.1% yoy, we find a mixed picture emerging on the component wise contribution and growth across categories. The industry group ‘Manufacture of furniture’ has shown highest positive growth of 41.0% followed by 39.0% in ‘Manufacture of wood and products of wood and cork’, which is not as such the indicators of robust capacity creation for an economy. There are other interesting data points as well. Among top five item groups with positive percentage increase in production, some are purely consumption items which will have rather limited impact in terms of long term positive implications for the country.

But, what is that we are most worried about? For several previous months, IIP growth data is getting massive support from huge growth in electricity consumption. Electricity has contributed the most in growth even in October data (almost 20% more than mining, the second most important contributor and the one which has double the weight as compared to electricity). But, this could also be primarily driven by Government schemes such as SAUBHAGYA and other initiatives for rural electrification which are in overdrive. If this is not managed well, massive growth in electricity could lead to more stress for DISCOMs (power distribution companies) and that could be harmful for the entire power sector.

2. Overview of My Winners and Losers in 2018…and 5 High Conviction Ideas Going into 2019

In a follow up to my note from last year Overview of My Winners and Losers in 2017…and 5 High Conviction Ideas Going into 2018 I again look at my stock ideas that have worked out in 2018, those that have not and those where the verdict is still pending.

Last year I provided 5 high conviction ideas and here is their performance in a brutal year for Asian Stock Markets:

4 out of 5 had a positive performance.

Below I will make a new attempt to provide five high conviction ideas going into 2019.

3. RRG Global Macro – US Fed Positive Outlook – Stocks Fall.  Politics Take Over from Fundamentals

• US: Stocks fall on political turmoil despite positive noises from the Fed with a dovish rate hike, a reduction in expected 2019 hikes and positive trends on employment and inflation.
• Russia: Unexpected 25 bps rate hike in the face of higher inflation in Nov. Watch for impact of lower oil prices in coming quarters.
• Turkey: Economic developments remain negative. The outlook for retail sales is poor as the economy in general is faltering.
• Indonesia: Trade deficit in November. Exports down 3.3%; imports up 11.68%. This disappointing performance could be the beginning of a trend.

4. Universal, SegaSammy & Dynam Sit Best Positioned Among Japan Companies in Race for IR Partnerships

• We’ve reviewed 10 companies in the sector. Of those, three are the consensus favorites of our Tokyo based panel of industry, financial and economics observers of the IR initiative over many years.
• Based on pachinko alone, the stocks of these companies are fully valued. Based on potential tailwind from a license award within 6 months, they could be vastly undervalued.
• Each of the three noted here brings strength to a bid less based on financials than corporate focus, outlook and experience in the field.

5. India Politics: Long Before 2019 Results, Fight Begins for PM Candidate in Opposition = Good for BJP

The Opposition parties discussing who will be their Prime Minister after 2019 elections is not just premature, it is also a distraction from their main objective which is to defeat the BJP first in the next Lok Sabha elections. Notwithstanding some recent reversals and visible signs of nervousness in the BJP, Prime Minister Narendra Modi is still miles ahead of any other candidate and even BJP is still the dominant force, both in absolute terms and as compared to any other political party in India today. Without any significant threat to his popular appeal and personal charisma, Mr. Modi remains the best bet for leading the NDA (National Democratic Alliance) in the next Lok Sabha elections.

However, this discussion that who should be the PM candidate for Opposition in next elections began when M K Stalin who is a prominent leader from Tamil Nadu and chief of DMK (the party not in power in the state today but clearly one of the two most powerful political forces in this Southern state) proposed Rahul Gandhi (leader of Congress, the other national party apart from BJP) for PM’s job next year. Almost immediately, several other Opposition parties opposed the proposal and said it is best decided after the elections.

There are several reasons why it will work better for BJP if Opposition has a joint candidate for Prime Minister’s post next year, a) It will harm the fragile Opposition unity because there are several contenders but there is no one who will be acceptable to all the Opposition parties, b) If Rahul Gandhi is the PM candidate and his party takes this decision unilaterally, Congress will become less acceptable to other parties. As things stand today, Congress is far away from becoming a strong force in the next Lok Sabha, c) The voters will get more polarized and it will help BJP in winning over even neutral voters who may not have been really happy with BJP.

In this briefing:

1. Anmol Industries Pre-IPO Quick Take – No Growth, Generous Payments to Founders
2. Time-Out Not Time up for Trade War
3. Indian Housing Finance Companies-Series 1 – Sector Outlook and Companies Profile
4. Motherson In Merger Talks with One of Our Previously Short-Listed Candidates – Leoni
5. Semiconductor WFE Outlook. Things Just Got Really Ugly

1. Anmol Industries Pre-IPO Quick Take – No Growth, Generous Payments to Founders

Anmol Industries (ANMOL IN) plans to raise US$100m+ in its India IPO via a sell-down of secondary shares. As per Frost & Sullivan, Anmol is the fourth largest biscuit manufacturer in India, behind the likes of Britannia Industries (BRIT IN), Parle and Sunfeast (owned by ITC Ltd (ITC IN)).

In FY17, the company undertook a restructuring wherein it merged three of its operating entities and demerged its treasury operations. Owing to this one can’t really come up with a clear picture of its past performance.

The picture on the demerger is a lot clearer though, as it led to the founders getting US$38m worth of liquid investments. Furthermore, the founder’s employment arrangements seem to be designed in such a way to let them take 12% of the PATMI each year, with no strings attached and additional 13% of FY17 PATMI as salary.

2. Time-Out Not Time up for Trade War

• Xi and Trump walk away from Buenos Aires with something to sell at home
• But trade negotiations will be dominated by fraught disagreements
• After 90-day negotiations, further delays to tariff escalation are likely 

3. Indian Housing Finance Companies-Series 1 – Sector Outlook and Companies Profile

The Indian housing sector is arguably one of the most important contributors to the country’s GDP with 9% contribution in FY17 and is expected to improve to 13% GDP by FY25. We believe that if any investor intends to participate in the Indian growth story, they simply can’t overlook the housing sector and the companies those are going to be the direct beneficiaries. 

We intend to cover the Housing finance sector and address key issues and companies in the sector through a series of articles over the next few weeks. We will highlight and identify sustainable business models in the Housing finance Sector that have not only created long-term shareholder wealth but have also maintained high levels of asset quality and prudence. These are the companies that have consistently maintained the highest credit rating through the entire cycle, by credible names like Crisil and ICRA. 

The stock prices of many of these companies have corrected by 30-50% in the past few months due to liquidity concerns in the financial system post the ILFS default, which affected the NBFC sector including HFCs.

We believe the concern is overrated as many of these HFCs have a parentage with strong balance sheets. Moreover, reforms in recent times have helped to diversify the borrowing profile of these HFCs who in the past largely relied on the banks, thereby reducing the liquidity risk to a large extent.

This article, the first in the series, delves into the outlook of the housing finance sector that has got a significant boost due to several reforms from the government. It also provides a glimpse into the profile of key HFCs that cumulatively enjoys near 85% market share. Through some key indicators, we would understand their growth history and whether it has come at the cost of low asset quality.

4. Motherson In Merger Talks with One of Our Previously Short-Listed Candidates – Leoni

On Friday, following news about entering merger/acquisition talks with Leoni AG (LEO GR), shares of Motherson Sumi Systems (MSS IN) closed up 3.1% up to INR166. Leoni’s stock, on the other hand, increased by 2.7% at Friday’s close, although the stock has been experiencing a declining trend over the past year. We mentioned in Two More Acquisitions on the Way for Motherson Sumi, that Leoni could be a potential acquisition target for Motherson in its wire harnessing segment, although on the higher end of the size spectrum. The company representatives have not commented on this acquisition news and the deal is not finalised yet. Thus, this could simply remain at the discussion stage with no real transaction taking place.

 Leoni has been experiencing a decline in its earnings during the recent quarters of FY2018, expecting negative free cashflows for FY2018E. However, recent news is that Leoni has recently been undertaking a comprehensive restructuring programme after cutting its earnings target for FY2018E and has appointed a new chief executive in September to lead these efforts. Further, it should be noted that Leoni is a well-established company in the auto components business and thus, could overcome its current struggles and be in a good position to exploit the long-term growth prospects of this market. Thus, acquiring Leoni is likely to strengthen Motherson’s position globally by providing the latter with increased coverage geographically and product wise. 

5. Semiconductor WFE Outlook. Things Just Got Really Ugly

SEMI, the global industry association serving the manufacturing supply chain for the electronics industry, published three different forecasts for wafer fab equipment (WFE) sales in the past week. While the forecasts differ in approach and detail, they all agree on one thing, WFE revenues are continuing to fall and the outlook for 2019 is sharply down on previous estimates.

Specifically, Q4 2018 WFE revenues are set to decline 20.8% or $3.3 billion QoQ and the forecast which had just six months ago predicted 7% growth in 2019 is now calling for an 8% decline next year. 

These latest forecasts cast a dark shadow over the predictions of the leading WFE manufacturers that H1 2019 would be stronger than H2 2018 and we anticipate a strong downward revision of forward guidance in the upcoming earnings season. 

There may be a glimmer of hope on the horizon however as SEMI forecasts a strong rebound in the second half of 2019 leading to a return to growth of ~20% in 2020. Let’s see.  

In this briefing:

1. India: New Tariff Regulation Is Temporary Relief For NTPC Ltd (NTPC IN) ​and Power Grid (PWGR IN) ​
2. India – NPL Sale Is Not a Panacea
3. India: Thermal Coal Imports Are Rising, What Does It Mean For End User Industries and the Economy?
4. India Banks – HDFC Bank Subsidiary Stalled Profit
5. Metropolis Healthcare Pre-IPO Quick Take – Steady Performance but Growth Lagged Network Expansion

1. India: New Tariff Regulation Is Temporary Relief For NTPC Ltd (NTPC IN) ​and Power Grid (PWGR IN) ​

This is something you really don’t see often, a sharp and positive stock price movement in Govt owned Indian power utilities. But after the latest draft regulation on the tariff norms for 2019-24 from CERC (the Central Electricity Regulatory Commission, which is the highest regulatory body for power sector in India) was released on 14th of December, both NTPC Ltd (NTPC IN) and Power Grid Corporation Of India (PWGR IN) have done well in absolute terms and also outperformed the broader markets. After CERC suggested continuation of the 15.5% regulated return on equity (RoE) for the power generation and transmission companies, this was seen as a positive regulatory development and helped these stocks.

However, investors should also look at the risks before getting too optimistic on Govt owned Regulated Power Utilities, a) these are not final norms and CERC has invited comments from the stakeholders and Regulator may still tweak the tariff norms for period starting 1st April 2019 depending on feedback and inputs from DISCOMs and consumer groups, b) Usually, the political rivalry between Centre and States doesn’t affect the PSUs but as some of recent developments such as Odisha where the state blamed Centre for increased tariff burden suggest, this is changing and could be damaging for future long term contracts of NTPC Ltd (NTPC IN) and Power Grid Corporation Of India Limited (PWGR IN).

There are question marks on future growth for both these companies. While NTPC Ltd (NTPC IN) will have to compete with renewable sources, there is a risk that capex growth will slow down for Power Grid Corporation Of India Limited (PWGR IN) as well. While latest draft regulation has come as positive, we don’t expect sustained stock price outperformance from NTPC Ltd (NTPC IN) and Power Grid Corporation Of India Limited (PWGR IN) as there are structural challenges for them and a Govt ownership and its impact on strategic decision making continues to remain an overhang.

2. India – NPL Sale Is Not a Panacea

Selling bad loans to the government, and asset management company or to a distressed loan buyer is not necessarily a remedy to the crisis for India’s banks. This is because their non-performing loan (NPL) levels are high compared with their buffer to absorb losses, e.g loan loss reserves and capital. Where it is rare to know about the selling price of NPLs in any market, there is news out today of a large NPL sale at 24 cents on the dollar. The market is not India, rather Indonesia, but this only raises concerns further: it is more likely that an NPL divestiture in India yields a worse price than in Indonesia. This is due to wildly different NPL trends and NPL levels in each country. 

3. India: Thermal Coal Imports Are Rising, What Does It Mean For End User Industries and the Economy?

India’s coal imports have risen 10% in the first eight months of FY19 and this year is likely to be the repeat of previous financial year when after falling for two years, India’s coal import had grown 8.1% yoy. After the NDA took over in May 2014, Indian Govt has spoken about eliminating coal imports altogether. However, there are serious problems with domestic production, logistics issues and poor track record of coal sector PSUs. Coal India Ltd (COAL IN) contributes more than 80% of India’s domestic coal output and FY19 has been a little better in comparison of previous years so far for the company. But, its performance has dipped over previous few months and it is very likely that coal imports will grow significantly again in FY19.

The higher coal imports is relevant for several sectors and many companies. The major implications are, 1) This is bad news for Coal India Ltd (COAL IN) and the company’s ability to increase supplies in the more profitable e-auction segment, 2) Increase in cost of power generation affects specific GENCOs and later, the entire power sector because cost of power procurement goes up for DISCOMs, 3) with increase in electricity prices, inflation may also increase and there is negative impact on balance between imports and exports, 4) it is also good news for renewables as they get more competitive on cost which makes them more attractive, 5) this is bad for entire value chain of coal based power plants which includes companies such as Bharat Heavy Electricals (BHEL IN).

4. India Banks – HDFC Bank Subsidiary Stalled Profit

When most analyze HDFC Bank (HDFCB IN), there is little emphasis on its non-banking finance company (NBFC) subsidiary, HDB Financial Services (HDBFS). Perhaps in the current environment, this is more important than ever. At the same time, where HDFC Bank’s subsidiary has had significant growth in recent periods, where this begins to change, it has important implications. Most do not believe HDFC Bank can ever show poor earnings growth, let alone high bad loans and credit costs. We disagree. As India’s second largest bank, it is  beholden to the macro economic overlay; even if delayed or not clearly visible. We wonder if HDBFS’s latest figures showing just 1% gross profit growth, is one sign of this?

5. Metropolis Healthcare Pre-IPO Quick Take – Steady Performance but Growth Lagged Network Expansion

Metropolis Health Services Limited (MHL IN) (MHL) plans to raise US$100m+ in its Indian IPO. MHL is one of the largest diagnostic chains in the country. Carlyle invested in the company in 2015. 

MHL has registered steady growth and margins over the past few years. It has also aggressively expanded its network over the past few years, although revenue growth hasn’t matched the network expansion.

MHL’s recent financial performance has been in-line with its listed peers, Dr Lal Pathlabs (DLPL IN) and Thyrocare Technologies (THYROCAR IN), while the company continues to lead its two listed peers in terms of revenue generated per test.

In this briefing:

1. India Politics: Long Before 2019 Results, Fight Begins for PM Candidate in Opposition = Good for BJP
2. Anmol Industries Pre-IPO Quick Take – No Growth, Generous Payments to Founders
3. Time-Out Not Time up for Trade War
4. Indian Housing Finance Companies-Series 1 – Sector Outlook and Companies Profile
5. Motherson In Merger Talks with One of Our Previously Short-Listed Candidates – Leoni

1. India Politics: Long Before 2019 Results, Fight Begins for PM Candidate in Opposition = Good for BJP

The Opposition parties discussing who will be their Prime Minister after 2019 elections is not just premature, it is also a distraction from their main objective which is to defeat the BJP first in the next Lok Sabha elections. Notwithstanding some recent reversals and visible signs of nervousness in the BJP, Prime Minister Narendra Modi is still miles ahead of any other candidate and even BJP is still the dominant force, both in absolute terms and as compared to any other political party in India today. Without any significant threat to his popular appeal and personal charisma, Mr. Modi remains the best bet for leading the NDA (National Democratic Alliance) in the next Lok Sabha elections.

However, this discussion that who should be the PM candidate for Opposition in next elections began when M K Stalin who is a prominent leader from Tamil Nadu and chief of DMK (the party not in power in the state today but clearly one of the two most powerful political forces in this Southern state) proposed Rahul Gandhi (leader of Congress, the other national party apart from BJP) for PM’s job next year. Almost immediately, several other Opposition parties opposed the proposal and said it is best decided after the elections.

There are several reasons why it will work better for BJP if Opposition has a joint candidate for Prime Minister’s post next year, a) It will harm the fragile Opposition unity because there are several contenders but there is no one who will be acceptable to all the Opposition parties, b) If Rahul Gandhi is the PM candidate and his party takes this decision unilaterally, Congress will become less acceptable to other parties. As things stand today, Congress is far away from becoming a strong force in the next Lok Sabha, c) The voters will get more polarized and it will help BJP in winning over even neutral voters who may not have been really happy with BJP.

2. Anmol Industries Pre-IPO Quick Take – No Growth, Generous Payments to Founders

Anmol Industries (ANMOL IN) plans to raise US$100m+ in its India IPO via a sell-down of secondary shares. As per Frost & Sullivan, Anmol is the fourth largest biscuit manufacturer in India, behind the likes of Britannia Industries (BRIT IN), Parle and Sunfeast (owned by ITC Ltd (ITC IN)).

In FY17, the company undertook a restructuring wherein it merged three of its operating entities and demerged its treasury operations. Owing to this one can’t really come up with a clear picture of its past performance.

The picture on the demerger is a lot clearer though, as it led to the founders getting US$38m worth of liquid investments. Furthermore, the founder’s employment arrangements seem to be designed in such a way to let them take 12% of the PATMI each year, with no strings attached and additional 13% of FY17 PATMI as salary.

3. Time-Out Not Time up for Trade War

• Xi and Trump walk away from Buenos Aires with something to sell at home
• But trade negotiations will be dominated by fraught disagreements
• After 90-day negotiations, further delays to tariff escalation are likely 

4. Indian Housing Finance Companies-Series 1 – Sector Outlook and Companies Profile

The Indian housing sector is arguably one of the most important contributors to the country’s GDP with 9% contribution in FY17 and is expected to improve to 13% GDP by FY25. We believe that if any investor intends to participate in the Indian growth story, they simply can’t overlook the housing sector and the companies those are going to be the direct beneficiaries. 

We intend to cover the Housing finance sector and address key issues and companies in the sector through a series of articles over the next few weeks. We will highlight and identify sustainable business models in the Housing finance Sector that have not only created long-term shareholder wealth but have also maintained high levels of asset quality and prudence. These are the companies that have consistently maintained the highest credit rating through the entire cycle, by credible names like Crisil and ICRA. 

The stock prices of many of these companies have corrected by 30-50% in the past few months due to liquidity concerns in the financial system post the ILFS default, which affected the NBFC sector including HFCs.

We believe the concern is overrated as many of these HFCs have a parentage with strong balance sheets. Moreover, reforms in recent times have helped to diversify the borrowing profile of these HFCs who in the past largely relied on the banks, thereby reducing the liquidity risk to a large extent.

This article, the first in the series, delves into the outlook of the housing finance sector that has got a significant boost due to several reforms from the government. It also provides a glimpse into the profile of key HFCs that cumulatively enjoys near 85% market share. Through some key indicators, we would understand their growth history and whether it has come at the cost of low asset quality.

5. Motherson In Merger Talks with One of Our Previously Short-Listed Candidates – Leoni

On Friday, following news about entering merger/acquisition talks with Leoni AG (LEO GR), shares of Motherson Sumi Systems (MSS IN) closed up 3.1% up to INR166. Leoni’s stock, on the other hand, increased by 2.7% at Friday’s close, although the stock has been experiencing a declining trend over the past year. We mentioned in Two More Acquisitions on the Way for Motherson Sumi, that Leoni could be a potential acquisition target for Motherson in its wire harnessing segment, although on the higher end of the size spectrum. The company representatives have not commented on this acquisition news and the deal is not finalised yet. Thus, this could simply remain at the discussion stage with no real transaction taking place.

 Leoni has been experiencing a decline in its earnings during the recent quarters of FY2018, expecting negative free cashflows for FY2018E. However, recent news is that Leoni has recently been undertaking a comprehensive restructuring programme after cutting its earnings target for FY2018E and has appointed a new chief executive in September to lead these efforts. Further, it should be noted that Leoni is a well-established company in the auto components business and thus, could overcome its current struggles and be in a good position to exploit the long-term growth prospects of this market. Thus, acquiring Leoni is likely to strengthen Motherson’s position globally by providing the latter with increased coverage geographically and product wise. 

In this briefing:

1. Semiconductor WFE Outlook. Things Just Got Really Ugly
2. India: New Tariff Regulation Is Temporary Relief For NTPC Ltd (NTPC IN) ​and Power Grid (PWGR IN) ​
3. India – NPL Sale Is Not a Panacea
4. India: Thermal Coal Imports Are Rising, What Does It Mean For End User Industries and the Economy?
5. India Banks – HDFC Bank Subsidiary Stalled Profit

1. Semiconductor WFE Outlook. Things Just Got Really Ugly

SEMI, the global industry association serving the manufacturing supply chain for the electronics industry, published three different forecasts for wafer fab equipment (WFE) sales in the past week. While the forecasts differ in approach and detail, they all agree on one thing, WFE revenues are continuing to fall and the outlook for 2019 is sharply down on previous estimates.

Specifically, Q4 2018 WFE revenues are set to decline 20.8% or $3.3 billion QoQ and the forecast which had just six months ago predicted 7% growth in 2019 is now calling for an 8% decline next year. 

These latest forecasts cast a dark shadow over the predictions of the leading WFE manufacturers that H1 2019 would be stronger than H2 2018 and we anticipate a strong downward revision of forward guidance in the upcoming earnings season. 

There may be a glimmer of hope on the horizon however as SEMI forecasts a strong rebound in the second half of 2019 leading to a return to growth of ~20% in 2020. Let’s see.  

2. India: New Tariff Regulation Is Temporary Relief For NTPC Ltd (NTPC IN) ​and Power Grid (PWGR IN) ​

This is something you really don’t see often, a sharp and positive stock price movement in Govt owned Indian power utilities. But after the latest draft regulation on the tariff norms for 2019-24 from CERC (the Central Electricity Regulatory Commission, which is the highest regulatory body for power sector in India) was released on 14th of December, both NTPC Ltd (NTPC IN) and Power Grid Corporation Of India (PWGR IN) have done well in absolute terms and also outperformed the broader markets. After CERC suggested continuation of the 15.5% regulated return on equity (RoE) for the power generation and transmission companies, this was seen as a positive regulatory development and helped these stocks.

However, investors should also look at the risks before getting too optimistic on Govt owned Regulated Power Utilities, a) these are not final norms and CERC has invited comments from the stakeholders and Regulator may still tweak the tariff norms for period starting 1st April 2019 depending on feedback and inputs from DISCOMs and consumer groups, b) Usually, the political rivalry between Centre and States doesn’t affect the PSUs but as some of recent developments such as Odisha where the state blamed Centre for increased tariff burden suggest, this is changing and could be damaging for future long term contracts of NTPC Ltd (NTPC IN) and Power Grid Corporation Of India Limited (PWGR IN).

There are question marks on future growth for both these companies. While NTPC Ltd (NTPC IN) will have to compete with renewable sources, there is a risk that capex growth will slow down for Power Grid Corporation Of India Limited (PWGR IN) as well. While latest draft regulation has come as positive, we don’t expect sustained stock price outperformance from NTPC Ltd (NTPC IN) and Power Grid Corporation Of India Limited (PWGR IN) as there are structural challenges for them and a Govt ownership and its impact on strategic decision making continues to remain an overhang.

3. India – NPL Sale Is Not a Panacea

Selling bad loans to the government, and asset management company or to a distressed loan buyer is not necessarily a remedy to the crisis for India’s banks. This is because their non-performing loan (NPL) levels are high compared with their buffer to absorb losses, e.g loan loss reserves and capital. Where it is rare to know about the selling price of NPLs in any market, there is news out today of a large NPL sale at 24 cents on the dollar. The market is not India, rather Indonesia, but this only raises concerns further: it is more likely that an NPL divestiture in India yields a worse price than in Indonesia. This is due to wildly different NPL trends and NPL levels in each country. 

4. India: Thermal Coal Imports Are Rising, What Does It Mean For End User Industries and the Economy?

India’s coal imports have risen 10% in the first eight months of FY19 and this year is likely to be the repeat of previous financial year when after falling for two years, India’s coal import had grown 8.1% yoy. After the NDA took over in May 2014, Indian Govt has spoken about eliminating coal imports altogether. However, there are serious problems with domestic production, logistics issues and poor track record of coal sector PSUs. Coal India Ltd (COAL IN) contributes more than 80% of India’s domestic coal output and FY19 has been a little better in comparison of previous years so far for the company. But, its performance has dipped over previous few months and it is very likely that coal imports will grow significantly again in FY19.

The higher coal imports is relevant for several sectors and many companies. The major implications are, 1) This is bad news for Coal India Ltd (COAL IN) and the company’s ability to increase supplies in the more profitable e-auction segment, 2) Increase in cost of power generation affects specific GENCOs and later, the entire power sector because cost of power procurement goes up for DISCOMs, 3) with increase in electricity prices, inflation may also increase and there is negative impact on balance between imports and exports, 4) it is also good news for renewables as they get more competitive on cost which makes them more attractive, 5) this is bad for entire value chain of coal based power plants which includes companies such as Bharat Heavy Electricals (BHEL IN).

5. India Banks – HDFC Bank Subsidiary Stalled Profit

When most analyze HDFC Bank (HDFCB IN), there is little emphasis on its non-banking finance company (NBFC) subsidiary, HDB Financial Services (HDBFS). Perhaps in the current environment, this is more important than ever. At the same time, where HDFC Bank’s subsidiary has had significant growth in recent periods, where this begins to change, it has important implications. Most do not believe HDFC Bank can ever show poor earnings growth, let alone high bad loans and credit costs. We disagree. As India’s second largest bank, it is  beholden to the macro economic overlay; even if delayed or not clearly visible. We wonder if HDBFS’s latest figures showing just 1% gross profit growth, is one sign of this?

In this briefing:

1. Indian Housing Finance Companies-Series 1 – Sector Outlook and Companies Profile
2. Motherson In Merger Talks with One of Our Previously Short-Listed Candidates – Leoni
3. Semiconductor WFE Outlook. Things Just Got Really Ugly
4. India: New Tariff Regulation Is Temporary Relief For NTPC Ltd (NTPC IN) ​and Power Grid (PWGR IN) ​
5. India – NPL Sale Is Not a Panacea

1. Indian Housing Finance Companies-Series 1 – Sector Outlook and Companies Profile

The Indian housing sector is arguably one of the most important contributors to the country’s GDP with 9% contribution in FY17 and is expected to improve to 13% GDP by FY25. We believe that if any investor intends to participate in the Indian growth story, they simply can’t overlook the housing sector and the companies those are going to be the direct beneficiaries. 

We intend to cover the Housing finance sector and address key issues and companies in the sector through a series of articles over the next few weeks. We will highlight and identify sustainable business models in the Housing finance Sector that have not only created long-term shareholder wealth but have also maintained high levels of asset quality and prudence. These are the companies that have consistently maintained the highest credit rating through the entire cycle, by credible names like Crisil and ICRA. 

The stock prices of many of these companies have corrected by 30-50% in the past few months due to liquidity concerns in the financial system post the ILFS default, which affected the NBFC sector including HFCs.

We believe the concern is overrated as many of these HFCs have a parentage with strong balance sheets. Moreover, reforms in recent times have helped to diversify the borrowing profile of these HFCs who in the past largely relied on the banks, thereby reducing the liquidity risk to a large extent.

This article, the first in the series, delves into the outlook of the housing finance sector that has got a significant boost due to several reforms from the government. It also provides a glimpse into the profile of key HFCs that cumulatively enjoys near 85% market share. Through some key indicators, we would understand their growth history and whether it has come at the cost of low asset quality.

2. Motherson In Merger Talks with One of Our Previously Short-Listed Candidates – Leoni

On Friday, following news about entering merger/acquisition talks with Leoni AG (LEO GR), shares of Motherson Sumi Systems (MSS IN) closed up 3.1% up to INR166. Leoni’s stock, on the other hand, increased by 2.7% at Friday’s close, although the stock has been experiencing a declining trend over the past year. We mentioned in Two More Acquisitions on the Way for Motherson Sumi, that Leoni could be a potential acquisition target for Motherson in its wire harnessing segment, although on the higher end of the size spectrum. The company representatives have not commented on this acquisition news and the deal is not finalised yet. Thus, this could simply remain at the discussion stage with no real transaction taking place.

 Leoni has been experiencing a decline in its earnings during the recent quarters of FY2018, expecting negative free cashflows for FY2018E. However, recent news is that Leoni has recently been undertaking a comprehensive restructuring programme after cutting its earnings target for FY2018E and has appointed a new chief executive in September to lead these efforts. Further, it should be noted that Leoni is a well-established company in the auto components business and thus, could overcome its current struggles and be in a good position to exploit the long-term growth prospects of this market. Thus, acquiring Leoni is likely to strengthen Motherson’s position globally by providing the latter with increased coverage geographically and product wise. 

3. Semiconductor WFE Outlook. Things Just Got Really Ugly

SEMI, the global industry association serving the manufacturing supply chain for the electronics industry, published three different forecasts for wafer fab equipment (WFE) sales in the past week. While the forecasts differ in approach and detail, they all agree on one thing, WFE revenues are continuing to fall and the outlook for 2019 is sharply down on previous estimates.

Specifically, Q4 2018 WFE revenues are set to decline 20.8% or $3.3 billion QoQ and the forecast which had just six months ago predicted 7% growth in 2019 is now calling for an 8% decline next year. 

These latest forecasts cast a dark shadow over the predictions of the leading WFE manufacturers that H1 2019 would be stronger than H2 2018 and we anticipate a strong downward revision of forward guidance in the upcoming earnings season. 

There may be a glimmer of hope on the horizon however as SEMI forecasts a strong rebound in the second half of 2019 leading to a return to growth of ~20% in 2020. Let’s see.  

4. India: New Tariff Regulation Is Temporary Relief For NTPC Ltd (NTPC IN) ​and Power Grid (PWGR IN) ​

This is something you really don’t see often, a sharp and positive stock price movement in Govt owned Indian power utilities. But after the latest draft regulation on the tariff norms for 2019-24 from CERC (the Central Electricity Regulatory Commission, which is the highest regulatory body for power sector in India) was released on 14th of December, both NTPC Ltd (NTPC IN) and Power Grid Corporation Of India (PWGR IN) have done well in absolute terms and also outperformed the broader markets. After CERC suggested continuation of the 15.5% regulated return on equity (RoE) for the power generation and transmission companies, this was seen as a positive regulatory development and helped these stocks.

However, investors should also look at the risks before getting too optimistic on Govt owned Regulated Power Utilities, a) these are not final norms and CERC has invited comments from the stakeholders and Regulator may still tweak the tariff norms for period starting 1st April 2019 depending on feedback and inputs from DISCOMs and consumer groups, b) Usually, the political rivalry between Centre and States doesn’t affect the PSUs but as some of recent developments such as Odisha where the state blamed Centre for increased tariff burden suggest, this is changing and could be damaging for future long term contracts of NTPC Ltd (NTPC IN) and Power Grid Corporation Of India Limited (PWGR IN).

There are question marks on future growth for both these companies. While NTPC Ltd (NTPC IN) will have to compete with renewable sources, there is a risk that capex growth will slow down for Power Grid Corporation Of India Limited (PWGR IN) as well. While latest draft regulation has come as positive, we don’t expect sustained stock price outperformance from NTPC Ltd (NTPC IN) and Power Grid Corporation Of India Limited (PWGR IN) as there are structural challenges for them and a Govt ownership and its impact on strategic decision making continues to remain an overhang.

5. India – NPL Sale Is Not a Panacea

Selling bad loans to the government, and asset management company or to a distressed loan buyer is not necessarily a remedy to the crisis for India’s banks. This is because their non-performing loan (NPL) levels are high compared with their buffer to absorb losses, e.g loan loss reserves and capital. Where it is rare to know about the selling price of NPLs in any market, there is news out today of a large NPL sale at 24 cents on the dollar. The market is not India, rather Indonesia, but this only raises concerns further: it is more likely that an NPL divestiture in India yields a worse price than in Indonesia. This is due to wildly different NPL trends and NPL levels in each country.