Author: anubhavsays

Infosys Q2 results: Focus shifts back to business

Infosys quarterly update was positive on the operational performance. However, revenue guidance cut was a disappointment leading to adverse stock reaction seen for the ADRs trading in the USA market. Having said that, investors can take note the company is gradually getting back to business, setting aside some of the non-operational issues.

Sustenance of operating performance

Infosys’ dollar revenue growth of 2.9 percent quarter-on-quarter (QoQ) was slightly lower compared to expectations, and that of its closest peer TCS (3.2 percent). Realizations for the quarter have slightly improved on sequential basis. However, realisations for the first half of the year have remained essentially stable year-on-year.

The operating performance has been upbeat with operating profit being 4 percent ahead of the consensus expectations. Operating profit margin of 24.2 percent was tad higher than the margin in previous quarter due to better pricing, onsite mix and utilization being partially offset by higher compensation.

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Revenue guidance cut

The company now expects revenues to grow by 5.5 – 6.5 percent in constant currency terms compared to previous guidance of 6.5 – 8.5 percent. The cut was much steeper than anticipated. However, in constant currency terms, the company has already clocked about 5.7 percent growth in H1 2018. With Q3 and Q4 being seasonally weak quarters, the revised outlook seems closer to reality.

Margin guidance band has been maintained at 23–25 percent. Since the performance so far is closer to the midpoint of the guidance, this suggests the company expects a stable pricing environment for the rest of the year.

Increasing share of digital

High-margin “New Services” contributed 9.4 percent of the revenue in the quarter compared to 8.3 percent in Q1 2018. Including “New software”, high margin digital solutions contributed 11 percent to the revenue. It is noteworthy that, New Services, as recently categorized by the company, includes Cloud Ecosystem, Big Data and Analytics, API and Micro services, Data and Mainframe Modernization, Cyber Security, IoT Engineering Services. Management mentioned good traction for Infrastrucure services and Enterprise cloud services.

Segments: Improved traction for insurance

Though management was positive about the traction so far this year in financials, healthcare, life science segments, it guided for seasonal softness in the some of the segments, particularly BFSI (33.4 percent of revenue Q2 2018). However, it has been positive about insurance sub segment where it saw addition of 13 new accounts this quarter. It also mentioned that retail and telecom end markets are witnessing various technology led transitions.

Strategy assessment – execution is the key

Nandan Nilekani, the recently-appointed Non-Executive Chairman, outlined the strategic plans after a thorough assessment. He acknowledged multiple disruptive challenges for end-markets the company is serving which includes customer-led innovations in the digital front. This has led to huge disruption in the distribution network of product and services for the clients (eg: media, film distribution). Among the challenges outlined are integration of product and services offerings, scale-up of new services, secure integration of legacy applications, huge need for re-skilling.

Focus on On-shore offerings was mentioned for a comprehensive IT solution offerings for the client.

In a nutshell, it was a reiteration of the earlier priorities with an emphasis on execution.

Acquisition of Panaya and the severance payment issue

The management reported there is no merit to the allegations of wrongdoing after reviewing earlier investigations on the Panaya acquisition, and severance payment to the former CFO. A quick investigation closure by the company, and Nilekani’s statement should now put the clamour on corporate governance to rest.

Next key event – selection of new CEO

Overall, first quarterly result of Infosys, after Nilekani took office, is about a refocus on earlier defined strategic and operational priorities. To that extent, it allays some of the investors’ concerns, affirms confidence in the current management, and appears to have been able to take along promoter shareholders, till now.

Operationally, it was a good quarter guided by better utilisation levels, and stable pricing. Guidance cut, though, was a disappointment.

However, the ongoing buyback offer provides a downside protection in the near term. Infosys is getting back to business with a refocus on strategy execution, improved contribution from new services and higher automation, and investors should  take a note of that. Selection of the new CEO would be a key event to watch out for.

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Graphite India Q2: Gains from improved pricing; Watch out for fresh contracts

Graphite India, one of the leading global manufacturers of graphite electrode, posted robust quarterly numbers on the back of better realizations. As the second half of the calendar year progresses, the company has apparently put to use its spare capacity at pricing closer to spot prices which are at a record high. While it is expected to continue with the healthy operating performance as it benefits from the pricing trends, investors should keep an eye on long-term contracts to be inked during October-December in 2017.

That said, the current valuation already factors a significant improvement in realizations for the next calendar year.

Quarterly result: Significant margin expansion

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Graphite India’s Q2 FY18 numbers were upbeat with the sales growth of 45 percent YoY led by higher graphite electrode realization and volumes. It clocked a capacity utilization of 89 percent (against 75 percent in Q2 2017) implying a production volume increase of 19 percent. However, on a QoQ basis, production volumes decreased by 6 percent. EBITDA margin expanded majorly to 28.1 percent from sub 5 percent in Q2 2017 (10.1 percent in Q1 FY18). Other income witnessed a decline of 12 percent YoY. Higher realizations and margin expansion, however, helped net earnings to jump three times, sequentially.

Higher realizations

Sales reported for the second quarter of this fiscal year is net of GST and, therefore, not exactly comparable to earlier quarters which are net of excise duty paid only. Effective excise duty for Graphite India was about 7 percent in the earlier quarters. Prevalent GST rate for graphite electrodes is 18 percent. Thus, a comparable sales number for Graphite India would be about 11 percent higher implying 60 percent YoY growth. Implied graphite electrode pricing realizations come to around USD 3600/tonne for the company which is about 35 percent higher on a YoY basis (+56 percent QoQ basis).

As the graphite electrode manufacturers follow a convention of annual contracts, a bulk of the Graphite India’s contract execution is still based on contracts inked in the start of 2017.

However, reportedly limited spare capacity has been utilized for short term/on-spot contracts at the prevalent pricing which results in better realization.

Easing pricing pressure on needle coke

Sequentially, the company reported a lower capacity utilization (89 percent against 95 percent in Q1 FY18) which may have been impacted by the scarcity of its key raw material  – needle coke. However, media buzz suggests that availability of needle coke is improving and that it may see some ease in pricing. One of the reasons cited is that needle coke which was earlier diverted for lithium-ion applications is partially available for graphite electrodes due to higher pricing.

Other product segments witness structural improvement

Though a bulk of the manufacturing capacity is utilized for graphite electrodes, Graphite India also offers various other carbon products like calcined petroleum coke, carbon electrode paste which are also witnessing higher realization and demand. Calcined petroleum coke, in particular, used for aluminum industry has witnessed higher pricing on account of limited supply and a rise in raw material (pet coke) price.

Valuation and pricing trends

The stock has undergone a sharp re-rating given the multiple drivers for the industry. Steel capacity curtailment in China and subsequently plans for steel production elsewhere through EAF (electric arc furnace method) and the consolidation of global graphite electrode manufacturing have been the key drivers.

There has been media buzz about a clamp-down in the graphite electrode manufacturing capacity in China which has cited weak pollution norms. This would lead to the closure of idle capacity. Export data of graphite electrodes from China have not slowed down so far according to data available till June).

Needle coke pricing, though expected to ease after an improved supply, would remain a key contributor to the elevated graphite electrode prices.

In this scenario, global manufacturers are resorting to short-term/quarterly contracts instead of annual ones. Long-term contracts are not expected to be inked at the spot prices of USD 10,000/tonne; however, we await management commentary from other graphite electrode manufacturers. Some of the CY 2018 deals struck globally are on volume visibility and commitment for pricing is not ascertained.

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Given this context, when we revisit our scenarios, we find the stock is already pricing a healthy pick-up in realizations for the next year. While we don’t rule out scenario 2 in near term, a possibility of a sustained pricing level for graphite electrode for multiple years is capped as talks of new capacity additions (eg: HEG) have already taken weight.

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HUL Q2: Traction in natural portfolio & rural recovery to be closely monitored

It has been a smooth transition to GST for Hindustan Unilever (HUL) as it posted a volume growth of 4 percent. Volume pick-up was broadly uniform with both urban and rural areas benefitting from a lower base and restocking. While we acknowledge the improved operating performance, the key factors to monitor would be the traction in natural portfolio, premiumisation trend and the pick-up in rural growth. Investors need to be watchful about raw material cost inflation and the competitive intensity.

Quarterly update: Comparable sales growth of 10 percent YoY

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HUL posted a like-for-like sales growth of 10 percent, taking GST accounting impact into consideration, with a volume and pricing mix of 4 percent and 6 percent respectively. Comparable EBITDA margin improvement of 180 bps YoY was driven by lower cost of goods that was partly offset by higher advertising spend and employee costs.

While the surge in raw material costs was lower than the topline growth, in the near term, inputs costs are expected to edge higher.

As far as GST transition is concerned, company took price cuts of about 3‐4 percent which had partially offset gains on the input taxes received.

CSD (Canteen Stores Department) channel uptick

Unlike some of the other FMCG players, HUL reported fast recovery in the CSD channel (~7 percent of HUL’s sales) wherein sales to the channel is now 85 percent of the normal level. While a part of the uptick could be related to restocking from the diminished levels in the last quarter, the company has guided for near normalcy in the near future.

Wholesale channel remains a laggard but sale through modern retail channel has picked up.

Gradual improvement in rural areas

Volume pick-up was similar in both urban and rural areas. Further, HUL expected a steady improvement in rural demand with near normal monsoon, government’s spending on infrastructure and support from MSP (minimum support prices) for the crops in place.

Premiumisation trend continues; focus on naturals

With premium portfolio roughly contributing 25 percent of sales, HUL’s management appeared confident on the premiumisation trend. The company mentioned double-digit growth in brands like Surf and Rin. In personal care, Indulekha hair oil witnessed strong growth.

The foods segment reported 11 percent YoY with strong support from Kisan and new variants in Knorr.

HUL’s recent focus is on the naturals range led by its Lever Ayush campaign, which is positioned for the intensely competitive ayurvedic/naturals category.

Oral care remains a let-down

While HUL is pursuing a new Lever Ayush push for the oral care, overall oral care growth remains subdued, impacted by intense competition and market share loss to Patanjali and Dabur.

Elevated valuations

Overall, HUL posted a good recovery in volume and had a relatively smooth transition through GST. While its focus on the natural portfolio is worth noting, competitive intensity cannot be wished away. Key trends to watch out in near term are premiumisation, competitive intensity led by Patanjali and pick-up in rural growth. The stock trades at an expensive valuation of 45x 2019e earnings that leaves little room for near-term upside.

Emami Q2: On a faster track to normalcy post the GST transition

Emami posted a volume-led rebound in Q2 FY18. This is interesting since Emami was one the most impacted (-18 percent volume degrowth) among the FMCG universe in the first quarter due to pre-GST destocking. Another key trend to keep in mind includes the growing importance of direct reach and the reduction in the contribution of wholesale channel.

Quarterly update

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Emami’s Q2 2018 gross sales were up 14 percent YoY aided by 10 percent volume growth (vs -18 percent volume growth in Q1 FY18) and recovery in international operations (+22 percent YoY).

Domestic business was aided by continued strong traction in BoroPlus (+38 percent in Q2 YoY vs +20 percent in Q1, 16 percent of 2017 sales) and the V-shape pick-up in Navratna range (+16 percent vs -11 percent in Q1, 24 percent of 2017 sales). A sharp volume pick-up was witnessed for Fair and Handsome and pain management range, as well, on account of restocking from diminished levels in the last quarter.

However, the company continued to face sequential weakness for Kesh King brand (-16 percent YoY vs -28 percent in Q1) and healthcare range (2 percent YoY vs -23 percent in Q1).

Reported EBITDA grew in line with gross sales (including GST/VAT) indicating stability in margin. While reported advertising spend was flat on a YoY basis, in its conference call the company mentioned that like-to-like advertising spend had increased by 10 percent YoY.

Distribution channel strategy- lowering wholesale dependence

The management underlined the ongoing change in its distribution channel strategy wherein reliance on the wholesale channel has reduced to 42 percent from 50 percent earlier. Due to the focus on direct reach, wholesale contribution is expected to reduce to 35 percent by March 2019.

GST transition: Trade channel to recover by March’18

Restocking in the trade channel, the management said, has reached to about 75 percent of the normal level. While wholesale channel remains a laggard, it is expected to fully recover by March of next year. Sales to CSD (Canteen Stores Department) channel remains weak (-20 percent YoY) and the running inventory in CSD is substantially lower than prevalent in pre-GST time. At the same time, modern retail trade growth contribution has increased to 5-5.5 percent from 4 percent, sequentially.

In terms of regional divergence, the northern region has recovered better than southern region.

Sales growth of 16-17 percent in next two quarters

The management has guided to a 16-17 percent sales growth in next two quarters aided by a double-digit volume growth. While a low base effect could play a role, company expects to benefit from a gradual rural recovery.

Kesh King brand on weak footing

Amongst the key concerns for the company is the continued sales decline in its Kesh King brand. Though the dependence on the wholesale is partially responsible, competition from Kesh Kanti (Patanjali) and Indulekha (HUL) remains a factor to watch for.

Uptrend in raw material price

Another key aspect which investors should keep a watch for is the price trend for mentha oil (key raw material). Though management is hopeful that margins would not be impacted due to price hikes, a spurt in mentha price by about 40 percent in the last four months make it a key monitorable.

Overall, the company is on a faster track to normalcy post the GST transition. Volume growth in Q2 FY18 was decent though lower than the management’s expectation for double-digit recovery. However, the management remains confident about the continued rebound during the rest of the year.

Going forward, gradual rural recovery, focus on direct reach, volume traction in winter skin care (Boroplus) remains key variables to monitor.

While the stock looks fully priced at 46x 2019e earnings, we are comforted by the company’s multiple growth levers ahead and would recommend gradual accumulation for the long term.

ECB’s ‘lower for longer’ stimulus plan could hit Indian exporters

ECB’s ‘lower for longer’ stimulus plan could hit Indian exporters

At the much-awaited ECB meeting on Thursday, the central bank moved ahead with its version of “tapering” its quantitative easing (QE) programme. The announcement was short of expectations, wherein the ECB shied away from putting a definite end date to QE. European equity markets reacted positively to this dovish stance. The Euro Stoxx 50 ended +1.35 percent yesterday followed by a rise of 0.7 percent at the time of writing today. EUR/USD and German bond yields were lower.

What did the ECB do?

In a major policy shift, the ECB scaled down its QE programme wherein the quantum of bond-buying was reduced from EUR 60 billion a month to EUR 30 billion from January 2018 until September 2018. While this significant directional shift is along expected lines and is tantamount to unwinding, it comes with a caveat that it is “open-ended”.

Why is it still seen a dovish step?

Given the strength of the Eurozone economy and the ECB’s own assessment in earlier policy meets, the Street was expecting a plan to phase out QE. While Mario Draghi has initiated a gradual exit, his assertion that the programme remains open-ended (and hence bond-buying could increase if conditions worsen), along with the possibility that bond-buying can extend beyond September, is seen as a continuation of easy money for a longer duration.

In fact the amount of scale-down in bond-buying also doesn’t look as substantial when we account for re-investment proceeds. In an email conversation, Giles Keating, Chair of Investor Advisory Firm Werthstein Institute, says that if we add re-investment of maturing holdings, which averages about EUR 15 billion a month,  gross bond-buying is still EUR 45 billion.

As per reports, 4 of the 25 members of the ECB Council wanted a more concrete plan for unwinding QE with an end date to it. However, ECB opted for a gradual exit plan without causing any spurt in bond yields and Euro appreciation.

Chart: EUR/USD vs. differential yield for US treasury and German 10-year yield

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Source: Moneycontrol Research

EUR/USD

EUR/USD has appreciated by about 15 percent this year till mid of September after retracing first due to political crises in Catalonia and then owing to the dovish ECB stance.

EUR/USD pair can further retrace as the market waits for year-end Fed meetings. FOMC’s September meeting minutes revealed that most members opine that another increase in the policy rate later this year is warranted. The implied probability of a Federal Reserve policy rate increase in December is higher than 90 percent.

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For Indian exporters, this means that the currency headwinds from the Eurozone, which started with Catalonia, extend a bit further.

Colgate: Weak volumes despite price cuts signal further market share decline

Fast moving consumer goods (FMCG) segment has been witnessing a steady disruption on account of competition from both listed and unlisted companies. Colgate Palmolive (India), caught in this crossfire, has recently attempted to claw back its market share. Its subdued volume growth doesn’t look too encouraging either. Given this context, Colgate’s quarterly results can be seen as one of the most awaited earnings updates.

Quarterly result: Muted topline growth

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In Q2 FY18, Colgate posted a muted sales growth of 3 percent YoY aided by pricing effects and offset by weak volumes (-0.9 percent YoY). Gross margins (+40 bps YoY) benefitted from a subdued increase in raw material prices. EBITDA margins expanded by 170 bps wherein higher employee costs (+13 percent YoY) were more than compensated for by lower advertisement spend (11.0 percent of sales vs. 12.1 percent of sales in Q2 2017) and a curtailment in other expenses.

Lower promotional spending is surprising

In recent times, Colgate has been positioning for the ayurvedic segment of toothpaste to resurrect its market leadership. It had recently launched a premium variant of Cibaca Vedshakti, Colgate Swarna Vedshakti, in the southern parts of India. Given its intent to create an improved natural portfolio, lower advertising spend from the company (-7 percent YoY) was below our expectations.

Lower volumes point towards further contraction in market share

Colgate Toothpaste

Interestingly, Colgate has been a beneficiary of GST rates (18 percent vs 25 percent earlier), on account of which the company had reduced prices (~9 percent) recently for both toothpaste and tooth brush categories. However, inspite of such steps, the lower volume indicates further deterioration in the company’s market share. It has reportedly been impacted by disruption in wholesale channel.

As per industry sources, in the first half of 2017, market share for Colgate stood at 52.4 percent (vs. 55.1 percent in FY17). While Dabur has gained from 10.8 percent (CY 2014) to 12.2 percent. As we earlier briefed, the big disruptor has been Patanjali which had gained market share from 0.6 percent (CY 2014) to about 6 percent now. This figure doesn’t factor in sales from Patanjali’s own stores.

PE ratio

While stock has recently corrected from the all-time high by about 10 percent, 12m forward PE multiple is still elevated in our view. The falling market share for this single product category company keeps us concerned and we prefer to wait on the sidelines before we see any definitive signs of improvement.

Diwali sparklers: Moneycontrol Research’s 12 picks for Samvat 2074

When we set up Moneycontrol Research earlier this year, our aim was to help our readers understand the macro and micro environments in which they were investing, and to use that knowledge to profit.

We have also been making stock recommendations over the last six months that factor in changes in policy, market trends, and, of course, company fundamentals.

Below is our latest offering: 12 conviction picks that could fetch you strong returns if held from this Diwali to the next, along with the rationale for our choices. The list is in alphabetical order.

May your investments on the auspicious occasion yield you handsome profits!

Axis Bank

After a difficult FY18, Axis Bank should see many of the headwinds like incremental slippage and provisions waning in FY19, which should support earnings. Alongside an enviable retail franchise, it is also building a retail focused less risky asset book. While incrementally, the bank would on-board much less risk (at the cost of margins), we see Axis as a formidable player in the incremental market share game. Read more

Bhansali Engineering Polymers

Bhansali Engineering polymers, one of the two main manufacturers of ABS (acrylonitrile butadiene styrene) plastics in India, is building a fourfold increase in manufacturing capacity (by FY22). This should help in capturing the import-dependent domestic market (industry domestic capacity 60 percent of demand), improve capacity utilization (85 percent in Q1 2018 vs 64 percent in Q1 2017) and point towards better end-market demand from consumer durable goods as well. In the near-term, prospects of lower raw material costs (styrene) aids margins. Read more

Century Plyboards

Within the organised plywood market, Century enjoys 26 percent market share having strong brand recall and presence in all key segments like laminates, plywood and others. The company is executing a new facility to manufacture 198,000 cubic metres medium-density fibreboards annually, which is expected to get operational in H2FY18. This is expected to drive earnings growth and improve margins and return ratios.

Fiberweb (India)

The company manufactures synthetic fabric used for industrial, agriculture, and hygiene purposes. Earnings are likely to be driven by an increase in export orders, completion of polypropylene spun-bound nonwoven fabric capacity expansion, conclusion of melt-blown non-woven fabric (a unique product offering with no competitors in India) manufacturing facility set-up, and a gradual shift towards margin-accretive value-added products. Read more

IRB Infra

IRB Infrastructure is a good play on the road construction sector with the government aiming to spend close to Rs 7-8 lakh crore over the next 5-6 years compared to the current run rate of about Rs 18,000-20,000 crore annually. Moreover, with the GST-related logistic issues easing, IRB’s BOT (build own transfer) road assets should post good traffic growth. Benefits of lower debt and interest led by launch of InvITs and strong revenue visibility of construction business, backed by a Rs 9,000-crore order book (3x revenue) should help in decent earnings growth. Read more

Manpasand Beverages

Manpasand Beverages should witness a steep growth in earnings on the back of doubling of its production capacity by Q1 2019. A capacity expansion plan, in sync with enhanced distribution reach (tie-up with Parle Products – 5.5 million outlets) and new product offerings (health drink), all improve earnings visibility, in our view. Read more

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Minda Corp 

Minda Corp is a well-diversified auto-component manufacturer catering to passenger vehicles, and three-wheeler, two-wheeler and commercial vehicles. With marquee clients in its kitty, no client concentration, focus on R&D to develop technologically advanced products, and a turnaround at joint venture Minda Furukawa, the company beckons investor attention. Read more

SpiceJet

SpiceJet, once on the brink of bankruptcy, has navigated well in the skies over the last few quarters. We believe SpiceJet has now got all the right ingredients that are required to fly higher. With the right management at the helm, huge capacity expansion plans, foray into ancillary services, focus on cost optimization and comfortable valuations, we advise investors to board the flight for a safe journey. Read more

Star Cement

Star Cement, belonging to the house of Century Plyboard, is the largest player in the north-eastern market, a region catered to by very few mainstream players. The company has the highest profitability in the industry due to subsidy in excise, freight, etc. The government’s agenda to develop infrastructure in this area would sustain demand. The improvement in performance was visible in Q1 FY18 earnings and the valuation looks reasonable in the context of superior earnings quality.

Tata Chemicals

With rapid restructuring under the new management, Tata Chemicals seems to be falling back on track. The proposed sale of the low-margin Haldia plant, increased focus on consumer and salt businesses, with improved volumes post-GST roll-out, neutralization of impact of demonetization-related destocking and firming-up of the soda ash prices are a few reasons why we find the stock attractive. Read more

Tata Global Beverage

We are positive about the company’s restructuring initiatives having the potential to unlock value for the shareholders, in addition to its attractive valuations. While on the one hand, the company is exiting operations (Russia and China business) which are not value-accretive, on the other hand it is focusing on building core brands and premiumisation.

Initiatives towards non-black tea in international market and the launch of premium mineral water in the United States should aid margins. Read more

Tata Sponge

Tata Sponge, which supplies sponge iron to steel manufacturers, could be a good investment candidate with the company now aiming at forward integration by building a 1.5 million tonne of steel capacity utilising cash on the books (Rs 570 crore). This could create more value. In addition, Tata Sponge enjoys cost advantage because of captive power, railway infrastructure and access to group mines. Read more

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