Brief India: Upstream Oil & Gas M&A Review: Surge of Takeovers and Mergers in 2018 – What to Expect in 2019 and more

In this briefing:

1. Upstream Oil & Gas M&A Review: Surge of Takeovers and Mergers in 2018 – What to Expect in 2019
2. Vodafone Idea Needs a 55% Price Increase to Return to Viability
3. Postcard from Surat (India)
4. ITD Cementation India Ltd- Uncomplicated Pure Play Infra Service Provider with No Asset Ownership!!
5. Embassy Office Parks REIT IPO – FY19 Revised Down, Yield Propped up by Zero Coupon Bond

1. Upstream Oil & Gas M&A Review: Surge of Takeovers and Mergers in 2018 – What to Expect in 2019

The last three years have been characterized by significant M&A activity in the upstream oil and gas industry. As the oil cycle recovered from the price bottom in January 2016, lower asset prices and corporate valuations created opportunities for the companies with a stronger balance sheet to grow inorganically while their weaker competitors were forced to downsize their portfolios. 2018, in particular, has seen a surge of corporate M&A which has been driving consolidation in the industry. This insight examines the trends that have shaped the M&A markets since 2016 with a closer view of 2018 and the outlook for 2019.

Exhibit 1: M&A volume compared to the E&P index and the oil price since 2016

2. Vodafone Idea Needs a 55% Price Increase to Return to Viability

Underlying profitability continues to deteriorate at Vodafone Idea (IDEA IN) (IDEA). Chris Hoare has updated his liquidity analysis, and estimates that IDEA needs prices to rise by over 50% to hit cash flow break-even in the medium term. That needs market behavior to change from Jio in particular. Bulls will point to IDEA’s current capital raising and the large capital raising planned at Bharti Airtel (BHARTI IN) as signalling a possible end to hostilities. However, the math at IDEA is such that even a $3.5bn injection gives only temporary relief. What they really need are price increases. Without them (and even with the capital increase), Chris thinks IDEA runs out of cash in about 2 years. We retain our Reduce recommendation and cut our price target to INR16.

3. Postcard from Surat (India)

With our Post Card Series, our aim is to bring on-ground realities & perspectives from cities across India.  In this insight, we share our takeaways from our visit to Surat, the diamond hub of India. Our focus is Titan Co Ltd (TTAN IN) and the impact on margins. 

Studded jewellery has more margins than plain gold jewellery. Part of Titan’s plan is to improve the mix in favour of studded jewellery which could help it command even higher margins. Titan anticipates this mix to improve to 50% by FY2023. Our interactions indicate a limited possibility of this change in mix. Operating leverage may be the only driver that can help in margin expansion.

We revise our FY20 EBIT margin & EPS estimates. Our FY20 EBIT margin is revised from 12.63% to 11.6% for FY20, continues to be higher than consensus which is at 10.82%. While we see limited margin expansion possibility, revenue growth likely to surprise. We introduce our FY21 EPS estimate at INR 28.75 compared to consensus EPS which is at INR 25.50.

Trust is a factor which cannot be easily replicated or acquired. The trust that Titan enjoys argues for a higher PE multiple. Based on a two-year average forward multiple 51x, our target price for Titan is INR 1466 which represents an upside of 37% from the last close price of INR 1070

4. ITD Cementation India Ltd- Uncomplicated Pure Play Infra Service Provider with No Asset Ownership!!

ITD Cementation India Ltd (ITDCIL) is one of the few pure-play infrastructure execution companies left in India, in the last decade the entire infra space in India has diversified into debt funded asset heavy infra ownership which has led to tremendous value destruction. The company is engaged in the construction of marine structures, highways, bridges & flyovers, metros, airports, hydro-tunneling, dams & canals, water & wastewater segment, industrial structures, buildings and specialist foundation engineering projects with presence across India. IDTCIL receives technological support from its parent company Italian-Thai Development Public Company Ltd (ITDPCL). ITDPCL has a presence across the globe and has expertise in the airport, Mass Rapid Transit System (MRTS), high-speed bullet train projects, marine projects among others.

In the last 12 months, ITDCIL has grown at 24% with revenue at INR 25.9 bn. EBITDA and PAT stood at INR 3.34 bn and INR 1.18 bn receptively with EBITDA margin and  PAT margin at 12.9% and 4.57% receptively. EBITDA margins contracted by 174 bps and PAT margin expanded by 109 bps. During the same period EBITDA grew by 9% and PAT increased by 62.4%.

The company’s order book as of Dec’18 stands at INR 95 bn with 45 bn order inflow between Jan’18 to Dec’18 its Book to Bill ratio is 3.73 times.

Drivers:
India is an infra deficit country. In 2015, India spent about 5% of GDP on Infra and this expenditure needs to cost about 8.5% (Climate adjusted investment under high growth scenario of 7.8% GDP growth) over 2016-2030 and estimated infra spending though 2030 is expected to be USD 5.5 tn. Per the Global Competitive Index, India’s infrastructure score had increased from 3.4 out of 7 in 2008 to 4.2 points out of 7 in 2017. Being the fastest growing among large economies and infra deficit country, India offers enough opportunities for investment in the infrastructure sector.

ITDCIL has proven expertise in urban infra ( especially metro rail) and marine structures which are seeing a huge impetus in India with almost all major cities either building or planning to develop metro rails and significant investments going into developing port infrastructures and inland waterways through the Sagarmala, river cleaning through Namami Gange among others. The Government of India (GOI) is expected to spend about INR 8 trillion through Sagarmala and INR 200 bn through Namami Gange. ITD Cementation India Ltd is expected to be one of the beneficiary due to its experience in metro and marine segment.

The company is expected to grow at 65% in FY19 (15-month financial year) and is expected to register EBITDA margin of 12.4% and Profit margin of 4.26% with EBITDA at INR 4.3 bn and Profit at INR 1.57 bn. The company’s shares at the current price of INR 132 are trading at a PEx 19.21x its TTM EPS, 19.12x its FY19F EPS (calculated for 12 months) and 16.31x its FY20F EPS. The company’s ROE and ROA for the previous financial year stood at 11.81% and 3.05% respectively.

5. Embassy Office Parks REIT IPO – FY19 Revised Down, Yield Propped up by Zero Coupon Bond

Embassy Office Parks REIT (EOP IN) plans to raise around US$680m in its India IPO. Of this, it has already raised around US$125m from Capital Group, who came in as a strategic investor. EOP will primarily hold office assets in Bengaluru, Pune and Noida with a total portfolio size of around US$4.5bn. 

In my previous insights I’ve covered the company background, its projected growth and compared it to its main listed peer and other yield assets in India: 

• Embassy Office Parks REIT – Good Assets but Projections Might Be a Tad Too Bullish, and
• Embassy Office Parks REIT – Comparison with AIT and a Look at the Required Yield

In this insight, I’ll cover the deal dynamics, compare the revised forecast in the RHP with the earlier one from the DRHP, comment on the yield boost from the zero coupon debt and run the deal through our framework.