L&T’s subsidiaries are valued at a combined Rs 575/share (incorporating a 10% holding company discount) as against Rs 606 earlier. (Reuters)

A  combination of increased competition and slower-than-expected recovery in domestic infrastructure and industrial capex sectors hurt L&T’s new orders during Q2FY16 (down 28% y-o-y). Consequently, the share of international orders within its Q2FY16 portfolio increased to c38% from 31% in Q1FY16 and 25% during FY15. The company expects to tap R3.7tn of new orders during H2FY16 of which c25%-30% are once again based in the international market and the Middle East in particular. However, a sustained focus on the Middle East market during the current weak business environment prevalent in the region could pose near-term challenges.

Industrial capex segment continues to hurt profitability

L&T reported 11% y-o-y (year on year) growth in overall sales during Q2FY16 along with a similar growth rate in its key segment —infrastructure. However, some of the industrial capex segments remained weak, deteriorating further, such as Heavy engineering (HE), Metals and Material Handling (MMH), and Electrical and Automation. Despite this weakness, the industrial capex portfolio managed to report a modest growth of 2% y-o-y driven largely by the Power and hydrocarbons segment. However, with one or two segments turning up losses every quarter in the industrial capex segments, we argue that the business environment seems much tougher than we had expected and a near-term recovery looks difficult.

Execution pick up in infrastructure segment is encouraging, though not enough

While infrastructure segment growth slowed down to 11% y-o-y, we highlight the improvement in the domestic infrastructure segment, which after two quarters of weakness once again grew 6% y-o-y. This is important given that the segment has been showing weakness despite a strong order book growth (21% y-o-y) as against the overall order book being up 14% y-o-y. However, the pace of order book execution needs to pick up given the current strong order book position, which has not yet materialised. We argue that this could potentially be due to a growing share of slow moving orders.

Margin slide in the infra segment is temporary

Ebitda (earnings before interest taxes depreciation and amortisation) margin in the infrastructure segment fell 150bp during the quarter. While some part of the slide in margins, is led by a growing share of international revenues (c31% during Q2), management argued that the majority of the drop in margins is due to the fact that many of the projects are yet to reach the margin recognition stage while costs get booked during the early stages of the execution cycle.

Working capital intensity has stabilised

L&T reported a marginal improvement in working capital (ex-financial services) intensity of 24% of sales during Q2, which was an improvement over Q1FY15’s level. The improvement, although marginal, comes on the back of expectations that deteriorating working conditions in the Middle East could hurt L&T’s receivables cycle. The improvement was largely led by better receivables recovery. Operating cash flow during H1 FY16 almost doubled, while net capex fell 28% to Rs 24.2 bn during the same period.

Guidance downgrade along expected lines

L&T management cut its FY16 new orders growth guidance to c5%-7% from c15% earlier and sales growth outlook to 10%-15% from 15% earlier. Company management maintained its Ebitda margin (ex-services and IDPL) outlook of 100bp expansion. While the new order growth guidance cut was largely expected, the weak Q2 orders coupled with a slower-than-expected domestic investment recovery and weakening Middle East growth outlook suggest management could miss its revised guidance. We revise our FY16e order inflow growth outlook to -11%, below that of management’s guidance.

Cut earnings estimates by 6%-8% over FY15e-FY18e

We revise down our earnings forecast to reflect lower-than-expected Q2 earnings during FY16e and the impact of lower new orders outlook. Although our FY16e earnings have been cut by c6%, the impact is largely reflected in below Ebitda to factor in the higher-than-expected depreciation and interest expense. Our FY17e and FY18e earnings cut reflects the impact of the cut in new order growth.

Downgrade to Hold with a lower TP of Rs 1,490 (down 17%)

We continue to value L&T using a sum-of-the-parts methodology. However, we have revised our target PE (x) for L&T’s EPC business from 27x September 2016e earnings to 23x. The lower target PE (x) reflects Industrial stocks’ greater correlation with order inflow growth as against earnings. While we do expect the company to report a healthy 23% EPS CAGR over FY15e-FY18e, we account for this outlook by allocating a premium valuation to its past business cycle mean. Downside risks to our earnings forecast are now elevated from its high Middle East exposure and a slower-than expected domestic investment cycle recovery.

L&T’s subsidiaries are valued at a combined Rs 575/share (incorporating a 10% holding company discount) as against Rs 606 earlier. Our revised fair value TP declines to Rs 1,490 (from Rs 1,793), driven by: (i) 6%-8% downward earnings revision and (ii) lower target PE (x) reflective of a demanding business environment. Our new TP implies the stock will trade at 24.6x September 2016 EPS, while it is currently trading at 23.3x.

ITC reported net sales of R85 bn (down 1% y-o-y), 6% below our estimate. Cigarette net sales increased 2% y-o-y, implying a cigarette volume decline of 14-15% y-o-y. (File Photo: Reuters)

In-line cigarettes results; share price fall overdone Although ITC’s overall sales in Q2FY16 were 6% lower than our estimates, the all-important cigarettes net sales (Rs 43.2 bn, up 2% y-o-y) and Ebit (Rs 29.7 bn, up 3% y-o-y) were in line with our estimates. We believe cigarette volumes for the quarter declined by 14-15% y-o-y. The share price decline of ~5% after the results was largely due to consensus’ misplaced optimism of 8-9% y-o-y Ebit (earnings before interest and taxes) growth for the quarter. Based on our recent channel checks, we expect flat y-o-y cigarette volumes and cigarette Ebit growth of 11-12% y-o-y for 2HFY16. We expect cigarette volume CAGR (compound annual growth rate) of 3%, with overall sales/EPS CAGR of 14% over FY15-20e. At 22x FY17e P/E (price-to-earnings ratio), the stock is trading at a steep 35% discount to staples firms like HUL. The more than 15% excise hikes announced over the past five years has had an unsustainable impact of rapid rise in illegal cigarette consumption, decline in government’s tax collections and increase in chewing tobacco consumption. We reiterate BUY, with TP (target price) of R405 (21% upside).

Cigarette business reports in-line performance

ITC reported net sales of R85 bn (down 1% y-o-y), 6% below our estimate. Cigarette net sales increased 2% y-o-y, implying a cigarette volume decline of 14-15% y-o-y. Other FMCG sales growth of only 7% y-o-y was disappointing vs our expectation of 11% y-o-y growth. Gross margin expanded 325bps y-o-y to 63.9%, due to lower prices of tobacco in the Cigarette and Agri-business. This was partially offset by higher employee cost and other expense, resulting in Ebitda margin expansion of 132bps y-o-y to 40%.

Cigarettes—Volume growth impacted by increasing prevalence of illegal cigarettes. ITC  reported cigarette net sales growth of 2% y-o-y, implying cigarette volume decline of 14-15% y-o-y. Whilst legal cigarette volumes have remained flat over FY10-14, illegal cigarette volumes have expanded at a CAGR of 10% over the same period and hence their proportion has increased from ~10% in FY05 to 14% in FY10 and ~20% in FY14.

Other FMCG–Maintains steady pace of topline growth

The non-cigarette FMCG business grew net sales by only 7% y-o-y; excluding the impact of weak noodles sales, net sales grew 10% y-o-y. Aashirvaad atta and Bingo snack foods and Mom’s Magic continued to perform well.

Hotels–Revenue growth

The hotels business delivered sales growth of 11% y-o-y due to better room occupancy rate and strong growth in the F&B segment. However, profitability was impacted by lower room rates, due to surplus room inventory.

Other businesses

Agri business: Revenue was impacted by lack of wheat, soya and coffee exports.

Paperboards, Paper & Packaging: Sales growth in this segment was impacted by lower FMCG and cigarette category sales.

Sanjiv Puri–The possible successor to YCD?

With the appointment of Sanjiv Puri to the board following the retirement of Kush Grant and Mr Dhobale, ITC seems to be working towards a succession plan for YC Deveshwar (YCD). Sanjiv Puri, currently the President of the FMCG business, seems to be the front-runner to succeed YCD in case the Chairman retires in 2017.
Valuations

At CMP of R334/share, the market ascribes ~R235/share to the cigarette business. Our reverse-DCF for the cigarettes business suggests that this valuation factors in -5%/15% volume/excise duty CAGR over FY15-20. With more positive catalysts from H2FY16, the weak Q2FY16 results will be a good entry point into the stock.

Over the past week, the BSE benchmark Sensex had fallen by 391.59 points to 26,265.24. (Photo: PTI)

With the BJP-led NDA getting trounced in Bihar assembly polls, the stock market is expected to turn volatile, with experts anticipating a knee-jerk downward move tomorrow.

Besides the election results of politically-important state, the last leg of quarterly earnings will have a bearing on stock-specific trading during the Diwali-shortened week, as per the analysts.

“The market was building on this outcome over the week gone by, with Nifty slipping below 8,000. We could see a knee-jerk reaction tomorrow and then a phase of recovery and consolidation over the Diwali-shortened week,” Centrum Broking CEO K Sandeep Nayak said.

Victory of Nitish Kumar-led Grand Alliance, comprising of JD9U), RJD and Congress, in Bihar is expected to have a bearing on the economic reform agenda of the BJP-led NDA government at the Centre as well as it does not have majority in the upper house of the Parliament.

“With Bihar behind us, markets would focus on the domestic front on the progress of GST and other pending Bills in the winter session of Parliament and the ask of the government on this front now stands elevated. On the international front, the market would keenly watch the US Fed’s rate hike commentary/action,” Nayak added.

Stock markets would remain closed on Wednesday and Thursday for Diwali Laxmi pujan and Diwali Balipratipada, except for a one-hour Muhurat trading on Wednesday evening.

CapitalVia Global Research’s Vivek Gupta said, “Outcome of Bihar election, macroeconomic data, trend in global markets, investment by foreign investors, movement of the rupee against the dollar, CPI and IIP to be announced on November 12 and upcoming quarterly results will dictate the trend of the market in the near term.”

Companies like Tata Power, REC, HPCL, Coal India and Hindalco will declare their quarterly results this week.

“Now, we will be seeing market reaction on the Bihar election result in early trade on Monday and that would set the tone for the rest of the session,” Religare Securities President, Retail Distribution, Jayant Manglik said.

Over the past week, the BSE benchmark Sensex had fallen by 391.59 points to 26,265.24.

The ranking of top 10 firms was yet again led by TCS, followed by RIL, HDFC Bank, ITC, Infosys, CIL, ONGC, Sun Pharma, HDFC and SBI. (Photo: PTI)

Led by Sun Pharma, three of the top 10 most valued Indian companies together saw erosion of Rs 32,447.1 crore from their market capitalisation last week.

The rest seven companies saw rise in their valuation, taking their cumulative addition to Rs 27,302.16 crore.

However, their cumulative gain was less than the total loss suffered by the three companies – Sun Pharma, HDFC Ltd and HDFC Bank.

Sun Pharma saw its market valuation slump by Rs 20,526.9 crore to Rs 1,93,405.29 crore, taking the steepest hit in the top 10 list.

The market cap of HDFC tumbled Rs 8,101.38 crore to Rs 1,90,244.37 crore and that of HDFC Bank plunged by Rs 3,818.82 crore to Rs 2,72,439.57 crore.

In stark contrast, CIL added Rs 13,738.09 crore to Rs 2,15,798.59 crore in its valuation.

SBI’s m-cap surged by Rs 4,696.48 crore to Rs 1,88,829.55 crore and ONGC saw a rise of Rs 3,464.98 crore to Rs 2,15,512.80 crore.

The valuation of ITC climbed Rs 1,766.34 crore to Rs 2,70,491.78 crore and that of TCS soared by Rs 1,665.01 crore to Rs 4,93,739.98 crore.

Similarly, RIL’s m-cap advanced by Rs 1,511.87 crore to Rs 3,08,504.14 crore and Infosys added Rs 459.39 crore to Rs 2,61,403.79 crore.

The ranking of top 10 firms was yet again led by TCS, followed by RIL, HDFC Bank, ITC, Infosys, CIL, ONGC, Sun Pharma, HDFC and SBI.

Over the past week, in the broader market the Sensex fell by 391.59 points to end at 26,265.24.

During the week, rupee slid 0.87 per cent to 65.791 on November 6. The currency was at 65.223 levels on October 30. (Photo: PTI)

The BSE Sensex and NSE Nifty slid for the second consecutive week on account of some selling pressure by foreign institutional investors amid uncertainty on the political front, weak rupee and mixed quarterly results. Benchmark indices plunged around 1.5 per cent for the week ended November 6, 2015.

During the week, Sensex and Nifty lost 391 points and 111.50 points to close at 26,265.24 and 7954.30, respectively, on November 6. Brokers said market sentiments were influenced by the exit polls at the end of five-phased polling in Bihar that predicted a close fight and gave an edge to the grand alliance of JDU-RJD-Congress over the BJP-led NDA grouping. Official results of Bihar polls will be announced on Sunday(Nov 8).

In the 30-share index, share price of Dr Reddy’s Laboratories slid the most — 14.99 per cent at Rs 3,629.55, followed by Tata Steel (down 10.80 per cent), Sun Pharmaceutical Industries (down 9.60 per cent), Vedanta (down 7.75 per cent) and GAIL (down 6.49 per cent). On the other hand, share price of Coal India, Mahindra & Mahindra and Tata Motors jumped 6.80 per cent, 6.38 per cent and 3.07 per cent, respectively during the week.

Jimeet Modi, chief executive officer, SAMCO Securities, said, “Uncertainty on political front and quarterly results which just met market expectations affected sentiments during the week. Some sectors in the economy are doing extremely well, the automobiles are scorching ahead with 30 per cent to 50 per cent volume growth followed by auto ancillaries. The effect of low crude oil and raw material prices on the profitability was visible across the sectors.”

Sectorwise, the BSE Healthcare index, BSE Capital Goods and BSE Metal index fell 6.07 per cent, 2.74 per cent and 2.11 per cent, respectively, during the week under review. The BSE Auto and BSE Oil & Gas index gained 0.54 per cent and 0.47 per cent during the same period.

Foreign Portfolio Investors remained net sellers in the equity market as they sold shares worth Rs 2,667.18 crore in the past five trading session, according to NSDL data.

During the week, rupee slid 0.87 per cent to 65.791 on November 6. The currency was at 65.223 levels on October 30.

The listing of the Coffee Day Enterprises in the week was the biggest disappointment of the week. It crashed 18 per cent on the day of listing highlighting the somber mood of the markets. “The message that market has given is loud and clear, that if the shares are overpriced they will be punished,” said Modi.

IDFC Bank, the demerged banking entity of infrastructure finance company IDFC, also made its debut on the bourses this week. The stock was listed at Rs 70.50 on BSE and finally ended at Rs 70.70, up 0.28 per cent from the opening price. During the day, it touched a high of Rs 73.45 and a low of Rs 67.

Market experts believe D-Street is currently looking forward to the final result of Bihar election on November 8. Jayant Manglik, president, retail distribution, Religare Securities, said, “Now, we’ll be seeing market reaction on the Bihar election result in early trade on Monday and that would set the tone for rest of the session. Traders are advised to wait for market to stabilise before taking any fresh bets.”

In overseas stock markets, all global markets edged lower ahead of US employment data for October 2015 that is expected to bolster the case for a Federal Reserve interest rate hike as early as next month and also awaited monthly non-farm payrolls report today in evening.

Vivek Gupta, CMT, director research, CapitalVia Global Research, said, “Outcome of Bihar elections, macroeconomic data, trend in global markets, investment by foreign institutional investors, the movement of rupee against the dollar, CPI, IIP data to be announced on 12 Nov 2015 and WPI data to be announced on 16 Nov 2015 and upcoming quarterly results of companies like Tata Power, REC LTD, Havells, HPCL, Aditya Birla Nuvo, Bank of India, Coal India, Hindalco, CESC, etc. will dictate trend of the market in near term.”