Balmer Lawrie – An Update

  • 19th Dec 2016
  • CMP Rs 1085
  • Advice: SELL – It has achieved its price target and is Overvalued 

Dear Readers,

We had published a report on Balmer Lawrie and Co (BLC) on 17th Oct, 2016. This is a follow up report where we have changed our recommendation due to significant recent events.

  • We had recommended a BUY at a price of Rs 677 with a Mar 2019 price target of Rs 1,057. We had also predicted a bonus/ split because of the small equity base. This has come true. Details of this report are available on link – Balmer Lawrie – Is Traveling Fast Now
  • The share price is now Rs 1,085 giving our investors a 60% return in a span of 2 months.
  • The sharp rise is due to a bonus issue declared. The firm approved on Nov 10, bonus shares in the proportion of 3:1, giving 3 new Equity Bonus Shares for every 1 share held as on the record date. BLC fixed Dec 27, 2016 as the Record Date for Issue of Bonus The share will quote ex-bonus thereafter. The share is likely to fall by 75% ex bonus.
  • The main reason the share has risen so sharply is that there is high interest from traders to purchase the share before bonus, which may later be sold ex bonus to book a loss on short term capital gains. This is also called Bonus Stripping. (to find out more about this, visit LINK. To do this yourself, please also consult your Chartered Accountant and Investment Adviser).
  • There is no other significant event in the firm (it continues its steady progress).
  • We expect selling in this share to intensify post bonus ie after 27th Dec.
  • The current PE is 18.7 times, much above the 5 year historical average of 8 times and above the Oct 2014 peak of 14 times.
  • Hence we recommend investors in Balmer Lawrie to SELL, as the valuations have shot up sharply and it has moved into overvalued territory.

Additional details: Here is the brief on the company and the price history.

Overview: Balmer Lawrie & Co is a diversified PSU firm into Travel and Tourism, logistics, Industrial packaging, greases, lubricants and Leather chemicals. In each of these areas it occupies good niches. The FY16 revenues were Rs 3,229 cr. and profits 179 cr. The Revenues, EBITDA and Profits of BLC are up by 7%, 6.8% and 7.3% CAGR over 7 years. The balance sheet is strong and RoCE is over 21%. Investors have got a return of 34% CAGR over 8 years.

Price History: Here is a chart of the recent 6 month share price performance.

JainMatrix Investments, Balmer Lawrie

Balmer Lawrie – 6 month price history

We hope you make handsome gains on BLC.

Visit and bookmark www.jainmatrix.com for such valuable investment reports and updates.

Happy investing,

Punit Jain, Founder, JainMatrix Investments

JAINMATRIX KNOWLEDGE BASE 

See other useful reports:

  1. Why Stocks and Investment Outlook Dec 2016
  2. Investment Outlook – Short Term Pain, Medium Term Gain
  3. The Natural Quotient: A Sustainability Metric for Business
  4. PNB Housing Finance IPO: A Transformed Lender
  5. Endurance Technologies IPO 
  6. ICICI Prudential Insurance IPO – An Expensive BUY
  7. GNA Axels IPO
  8. L&T Technology Services IPO 
  9. RBL Bank IPO 
  10. New Banks: Big Changes in Small Change 
  11. Equitas IPO – Leader in SF Banks
  12. Do you want to be a value investor?
  13. Mahanagar Gas IPO 
  14. How will Brexit impact Indian investors?
  15. A Repurpose for our PSUs
  16. How to Approach the Stock Market – A Lesson from Warren Buffet
  17. Thyrocare IPO – Wellness for your Wealth
  18. Announcement – SEBI approval as a Research Analyst
  19. Alkem Labs IPO
  20. Goods And Services Tax (GST): Integration And Efficiency
  21. Syngene IPO: Good Pharma R&D spinoff from Biocon

DO YOU FIND THIS SITE USEFUL?

  • Visit the Investment Service offering page to find how you can get more.
  • Register Now to get our Free reports and much more, on the top right of this page, or by filling this Signup Form CLICK.

Disclaimers

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no known financial interests in Balmer Lawrie & Co or any related firm. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Punit Jain is a registered Research Analyst and compliant with SEBI (Research Analysts) Regulations, 2014. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

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PNB Housing Finance IPO: A Transformed Lender

  • Date: 25th Oct 2016; IPO Period: 25-27th Oct
  • IPO Price: Rs. 750-775; P/E 39.2 and P/B 2.45 times
  • Mid Cap: Rs 12,800 crore Mkt cap
  • Industry – Housing Finance NBFC
  • Advice: Investors may BUY with a 1 year perspective

Summary

  • Overview: PHF is the 5th largest housing finance company by loan portfolio. Over 5 years, PHF has implemented a business process transformation and re-engineering program, which contributed to them becoming the fastest growing large HFC in India. PHF’s revenue and PAT have grown 55.6% and 43.4% CAGR from FY12 to FY16. PHF’s loan portfolio also grew at 61.8% CAGR in this period. The operations have become broad based and cover North, West and South India quite equally.
  • At a FY16 P/B post IPO of 2.45 times, the valuations are reasonable. The P/E at 39 (ttm) does look stretched but with good growth and margin expansion, this will stay in a good range.
  • The risks that must be understood include high competition and a flat housing market.
  • Opinion: As an investment, the PHF IPO is rated a medium risk, high return type of offering. Investors may BUY PHF with a 1 year perspective.

Here is a note on PNB Housing Finance (PHF).

IPO highlights

  • This IPO opens: 25-27thOct 2016 with the Price band: Rs.750 – 775 per share.
  • Shares offered to public number 3.87 cr. (UMP). The FV of each is Rs. 10 and market Lot is 19.
  • Shares offered are 23.4% of equity. The IPO will collect Rs 3,000 cr. with a fresh issue of shares. The IPO shares are available to institutional, non-institutional and retail in ratio of 50:15:35.
  • PNB Bank holds 51% stake of PHF, and 49% is held by Destimoney Enterprise Ltd (DEL). DEL got sold to Quality Investments Holding in Feb2015, an affiliate of the Carlyle Group, a global investment firm. Post IPO s’holding will be PNB 39%, DEL 38%, QIB 12%, retail 8% and NIB 3%
  • PHF would benefit from the IPO as it is a fresh issue of shares. The IPO proceeds of Rs 3,000 cr. would improve capital adequacy of PHF and help fund the growth for the next few years.

Introduction

  • PHF is the 5th largest HFC in India by loan portfolio and 2nd largest by deposits. PHF offers “housing loans” for the purchase, construction, extension or improvement of residential properties or for the purchase of residential plots, and “non-housing loans” in the form of loans against property.
  • Over 5 years, PHF has implemented a business process re-engineering (BPR), and transformation program, which helped them become the fastest growing large HFC in India.
  • Total income for FY16 was Rs 2,697 cr. and profit Rs 326 cr. The HFC’s AUM was Rs. 27,000 cr.
  • PHF’s loan portfolio was at Rs 27,177 cr. in FY16, a 61.8% CAGR in 4 years. By June 2016, it further increased to Rs 30,900 cr.
JainMatrix Investments, PNB Housing Finance

Fig 1 – Loan Portfolio / Fig 2 – Housing Loan Portfolio / Fig 3 – Non Housing Loan Portfolio

  • PHF’s has an operating model which includes branches (47) across the north, west and south of India, processing hubs (16) which include three co-located zonal offices and one central support office in New Delhi.
  • Branches act as the primary point of sale and assist with origination, collection processes, sourcing deposits and enhancing customer service. The processing hubs and zonal offices provide support functions, such as loan processing, credit appraisal and monitoring, and their CSO supervises their operations nationally. There are totally 847 employees.
  • In FY16, the sources of funds were NCD’s (33.5%), deposits (27.2%) and comm. paper (19.2%).
  • Regional: the loan portfolio origination is from north – 39.7%, west 30.4% and south 29.9%.
  • Leadership: Sanjay Gupta is MD; Jayesh Jain (CFO) and Shaji Varghese (Business Head).

Promoter (Punjab National Bank) – Snapshot and Financials

  • PNB is a full service public sector bank. It provides a wide range of banking services such as digital banking, personal banking, social banking, micro, small and medium enterprises banking, etc.
  • PNB operates through 4 segments: Treasury, Corporate/Wholesale, Retail and others.
  • Income grew by 8.5% CAGR over 5 years. But PAT and EPS fell due to losses in Q4 FY16.
  • Major cleansing had happened in the NPA books of PNB. The gross NPA of the bank increased by Rs. 30,000 cr. in 2015-16 to Rs. 55,818 cr., which was 12.9% of its gross advances. Net NPAs jumped to 8.61% as against 4.06%. The share price also corrected sharply. See Fig 4.
  • There was a weakening in the balance sheets of many banks over FY11-15. Some of this was RBI driven, as the policy focus was to clean the books of all banks.
  • However post this IPO PHF will no longer be a subsidiary of PNB, so we downplay the influence and effects of PNB as a promoter. In fact PNB products portfolio does overlap with that of PHF already.
JainMatrix Investments, PNB Housing Finance

Fig 4 – PNB financials

News and Updates for PHF

  • The BPR undertaken by PHF over 4-5 years included investments in a scalable operating model, an integrated infotech platform, centralization and standardization of back-end processes, the hiring of experienced personnel and subject matter experts, hikes in salaries and other employees benefits, the refurbishment of offices, and repositioning of the “PNB Housing” brand.
  • PHF has a strong distribution network with over 7,110 channel partners across different locations in India, including the in-house sales team, external direct marketing associates, deposit brokers and national aggregator relationships with reputed brands. In recent months they sourced 56.5% of new loans from their in-house channels and the rest from external sources.
  • Currently PHF’s housing loans constitute 70.3% of total loan portfolio and retail constituted 86.5% of the housing loan portfolio. The average loan size (at origination) of the retail housing loans was Rs 31.8 lakh, with a weighted average loan-to-value ratio of 66.1%. The loan size of retail non-housing loans is Rs 56.8 lakh, with a weighted average LTV ratio of 46.5%.
  • Total borrowings are Rs 30,045 cr. and average cost of borrowings was 8.65%. During the same period the spread was 1.93% and the cost to income ratio stood at 25.03%.
  • PHF’s gross NPAs as % of total loan portfolio were 0.2% in FY15 and 0.27% as of June 2016, which was the lowest among the leading HFCs in India. Also the overall Capital to Risk (Weighted) Assets Ratio (“CRAR”) and Tier I Capital CRAR were 13.04% and 8.4%, resp.
  • PHF is planning to grow in Indian tier-II and tier-III. From the present 48 branches at 28 locations, they will expand to 60 more locations with a population of more than 80-90 lakhs.
  • PHF received high credit ratings for deposits, long-term loans, NCDs (secured & unsecured) and commercial paper from agencies like CRISIL, ICRA, CARE and India Ratings (Fitch). This helped raise low cost deposits in high volumes.
  • PHF had raised Rs.500 cr. in April 2016 from International Finance Corporation (IFC) by issuing secured fixed rate non-convertible debentures (NCDs) to fund green residential projects.
  • As of June 2016, 12.6% & 87.4% of the portfolio were fixed & variable interest rate loans, resp.
  • PHF selected AuthShield in Aug 2016 as a security installation to safeguard customers accounts. With hacking cases, better security has become vital for financial service providers.
  • The unofficial/ grey market premium for this IPO is in the range of Rs 50 – 52. This is a positive.

Indian Housing Finance Industry Outlook

  • In India, the housing industry is significant contributor to the country’s development and GDP.
  • Total outstanding housing loans in FY15 were Rs 11.3 lakh crores, a 17.7% increase since FY11.
  • Still, India has a low mortgage-to-GDP ratio. As of FY15, India’s mortgage-to-GDP ratio was 9% compared to China 18%, Thailand 20%, Germany 45% and USA 62%. (CRISIL/ RHP).
  • Banks held 63% of the housing finance market in FY15, based on loan assets. The higher market share of banks is due to big networks, broad customer bases and relationships.
  • The key growth drivers in the housing finance industry in India include:
    • Low mortgage penetration and housing shortage;
    • Urbanization; Population growth and changes in demographics.
    • Slowing average loan ticket size growth; Tax benefits and
    • Government implemented schemes (including Smart Cities and Housing for All by 2020)
  • The NHB was established pursuant to the NHB Act to operate as a principal agency and statutory body to promote housing finance institutions and to provide financial and other support to such institutions. The NHB is wholly-owned by the RBI. Under the provisions of the NHB Act, it regulates how HFCs conduct business in India. Through its refinance schemes, the NHB has made cumulative disbursements (from its inception until June 2014) of Rs 1,204 bn.
  • In the last 15 years, the total outstanding housing loans of HFCs and banks has increased at a CAGR of 23.4% from Rs 439 bn in FY00 to Rs 10,205 bn in FY15.
  • Among lenders, HFCs have better capitalised on the demand in non – metro cities, and grew their disbursements by 20.1% YoY. By contrast, banks’ advances grew at 14% YoY.
  • The distinguishing feature of the housing loan portfolio in India is the low NPA level, which is partially the result of financiers’ adequate appraisal systems and effective recovery mechanisms, as well as greater information availability. In FY15, the gross NPA level for HFCs in housing loans was estimated at 0.5% while it was slightly higher for banks, at 1.6%.
  • NPAs are likely to decline marginally in FY16 and FY17 owing to economic recovery, lower interest rates, better control, system checks, follow-ups, and improvement of job security.
  • The housing finance market in India is forecast to grow 20-22% over FY15 to FY20.

Financials of PHF

JainMatrix Investments, PNB Housing Finance

Fig 5 – PHF Financials

  • PHF’s revenue and PAT have grown 55.56% and 43.41% CAGR from FY12 to FY16. (Note: The projected FY17 data is a simple extrapolation from the Q1 FY17 results, see Fig 5).
  • The revenue growth is high, as is absolute PAT over FY12-16. We can see that the diluted EPS has grown at a slower pace. This is because of a flat to falling NII and Profit Margins in this period. In addition, there have been several dilutions to the equity base since FY12.
  • PHF has a ROE of 17.6% (FY16) which is good, however not the best in the industry.
  • We have assumed an IPO dilution of equity base to 16.56 crore shares to recalculate EPS in Fig 5. In addition, since the IPO premium will flow into the balance sheet of PHF, we recalculated the Book Value post IPO at the upper end of price band. The BV increases to Rs 316/share. Basis these, the P/E will be 39.19 times FY16 earnings and the P/B will be 2.45 times.
  • The dividend has been rising – PHF declared dividend of Rs 3.4 in FY16, a yield of 0.44% which is low. The dividend growth rate has been moderate at 11.5% CAGR from FY12 to FY16.
  • Net interest margin has improved from 2.93% (FY14), 2.94% (FY15) to 2.98% (FY16).
  • The NHB directions require HFCs to comply with a CRAR where an HFC’s Tier I and Tier II capital may not be less than 12% of sum of HFC’s risk-weighted assets and the risk adjusted value of off-balance sheet items. As of June 30, 2016, PHF’s CRAR was 13.04%. This is low, but will be boosted by the IPO.

Benchmarking

We benchmark PHF against listed housing finance, microfinance and BFSI peers. See Fig 6.

JainMatrix Investments, PNB Housing Finance

Exhibit 6 – Benchmarking

  • PHF appears to have high valuations in terms of PE. But in terms of P/B, the IPO will add to the net worth of the company and make the P/B very reasonable at 2.45 times.
  • PHF has the highest sales and PAT growth among peers, a positive. EBITDA margins are high.
  • But profit margins are on the lower side. RoE too looks low. Dividend yield is low too.
  • PHF will use the IPO to augment its capital base so post IPO capital adequacy will improve.
  • PHF has moderate margins. PHF has a low RoE in the industry. PHF has a low dividend yield (0.44%) amongst its peers which is a negative.

Positives for PHF and the IPO

  • High growth in revenues & profits for PHF combined with low NPAs is a wonderful combination.
  • PHF is the 5th largest HFC in India and the fastest growing among large HFCs. It has also broad based its growth equally across North, West and South India.
  • The Punjab National Bank brand is strong and rubs off feelings of confidence and trust. PHF has a PSB brand but is a well-managed private sector HFC, so it may have the best of both worlds.
  • PHF has a strong distribution network with penetration of key Indian urban centers. It also has a very efficient employee workforce with just 847 employees.
  • It has a scalable operating model and centralized and streamlined operational structure.
  • It is managed by experienced and qualified professionals with strong industry expertise. Many from top management have held senior positions at leading banks and NBFCs.
  • The 5 year financial performance of the company is outstanding with strong revenue, EPS and PAT growth. Clearly it is a growth stock and is placed well in a high potential industry.
  • The RBI has reduced interest rates in recent quarters. In this scenario, with transmission to home loan customers, the loan products become more attractive and demand grows rapidly.
  • The weak performance by PSBs in the last year was due to high NPAs and an attempt by the regulator to clean the books of banks. PSBs look weak, loss making and undercapitalized, and GoI is not in a position to fund them back to health. We may actually be seeing a massive permanent loss of market share by PSBs to private – banks, HFCs and NBFCs. This of course benefits PHF.

Risks and Negatives for PHF and the IPO

  • The recent crackdown by GoI on black money and tax evaders has resulted in housing prices going flat to negative across India. Its possible that housing prices are artificially high in relation to income levels and the related housing rental market. We may be at the start of a multi-year price correction. This could affect housing loan demand for PHF.
  • The pricing and valuations of PHF look stretched in comparison to peers. The P/E of 39 times (of post IPO capital base and FY16 EPS) is high. However a more critical parameter is P/B and at 2.45 times post IPO, this is reasonable. See Exhibit 6.
  • The growth rate of PHF over the past 5 years may be difficult to continue over the next 5 due to high competition from banks and HFCs, and the natural high base effect.
  • Margins appear low for PHF compared to peer group. This is acceptable with high revenue growth rates, but if growth slows down, PAT will slow sharply and affect perceived valuation.
  • The banking sector offered limited competition to HFCs with few new licenses given by RBI. However this is changing with RBI doling out 20+ new licenses to Payment Banks and Small Finance Banks. See article New Banks: Big Changes In Small Change. RBI is also moving towards Bank licenses on tap in future. This can intensify competition over the years for PHF.
  • A slowdown in economic growth in India or global economic instability could result in an adverse effect on their business, financial condition and results of operations.

Overall Opinion and Recommendation

  • India’s housing sector will remain high growth for many years given low penetrations. The best way for investors to play this opportunity has been through HFCs. Their stocks have done exceedingly well over the last decade. Regulatory, tax and interest environments are also benign for HFCs.
  • The BFSI industry is a proxy to the overall economy, and one can expect, as a thumb rule, the industry to grow at 2-3 times the GDP growth. The Indian economy is growing at 7-7.5%, so the HFC sector may see a 20%+ p.a. growth over the next few years.
  • In this space, PHF has over the last five years implemented a business process transformation and re-engineering program with very strong growth from a small base. The firm looks quite capable of expanding to new locations and continuing the high growth momentum.
  • At a FY16 P/B post IPO of 2.45 times, the current valuations are reasonable. The P/E parameter at 39 does look stretched but with good growth and margin expansion, this will stay in an acceptable range.
  • There are a few risks that must be understood, like higher competition and flat housing prices.
  • We feel this offering is attractive for investors. As an investment, the PHF IPO is rated a medium risk, high return type of offering.
  • Investors may BUY PHF with a 1 year perspective.

JAINMATRIX KNOWLEDGE BASE 

See other useful reports:

  1. Balmer Lawrie – Is Traveling Fast Now
  2. Endurance Technologies IPO 
  3. ICICI Prudential Insurance IPO – An Expensive BUY
  4. GNA Axels IPO
  5. L&T Technology Services IPO 
  6. RBL Bank IPO 
  7. New Banks: Big Changes in Small Change 
  8. Equitas IPO – Leader in SF Banks
  9. Dilip Buildcon IPO 
  10. Do you want to be a value investor?
  11. Mahanagar Gas IPO 
  12. How will Brexit impact Indian investors?
  13. A Repurpose for our PSUs
  14. How to Approach the Stock Market – A Lesson from Warren Buffet
  15. Thyrocare IPO – Wellness for your Wealth
  16. Announcement – SEBI approval as a Research Analyst
  17. Alkem Labs IPO
  18. Goods And Services Tax (GST): Integration And Efficiency
  19. Syngene IPO: Good Pharma R&D spinoff from Biocon

DO YOU FIND THIS SITE USEFUL?

  • Visit the Investment Service offering page to find how you can get more.
  • Register Now to get our Free reports and much more, on the top right of this page, or by filling this Signup Form CLICK.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no known financial interests in PNB Housing Finance Ltd. or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

Balmer Lawrie – Is Traveling Fast Now

  • Date: 17th Oct 2016
  • CMP: Rs 677
  • Industry: PSU, diversified
  • Small Cap with Mkt Cap 1980 crores
  • Advice: BUY with a target price of Rs 1057 by Mar 2019, a 56% upside 
  • Overview: Balmer Lawrie & Co is a diversified PSU firm into Travel and Tourism, logistics, Industrial packaging, greases, lubricants and Leather chemicals. In each of these areas it occupies good niches. The FY16 revenues were Rs 3,229 cr. and profits 179 cr. The Revenues, EBITDA and Profits of BLC are up by 7%, 6.8% and 7.3% CAGR over 7 years. The balance sheet is strong and RoCE is over 21%. Investors have got a return of 34% CAGR over 8 years.
  • Why Buy Now: 1) It has been restructuring and strengthening operations by exiting weak segments and undertaking investments in logistics, warehouses, distribution, manufacturing and lubricants. Cash with the firm will be deployed very productively over 2-3 years. 2) The share price has fallen 7% from a recent high of Rs 748. This gives investors an opportunity to enter at lower prices. 3) The cash on balance sheet* is high (Rs 161/sh.), so BLC operations are available for Rs 516. Buy with a target price of Rs 1,057 by Mar 2019, a 56% upside from current price levels.
  • JainMatrix Investments had reported on Balmer Lawrie in Nov-2013 with CMP of Rs 306. Since then, the stock is up 121% in 3 years. See link – Balmer Lawrie – A Steady Boat. We continue to be positive.

Here is a note on Balmer Lawrie & Co (BLC).

BLC – Description and Profile

  • BLC is a 150 year old firm, and is a PSU under Ministry of Petroleum and Natural Gas. Based in Kolkata, this is a Mini-Ratna I public sector enterprise.
  • The FY16 revenues were Rs 3,229 cr., profits 179 cr. and market capitalization today is 1,980 cr.
  • It has 5 JVs and the global operations have about 1,729 employees.
  • BLC is the market leader in steel barrels, greases and oilfield services in India. Its logistics division is the profit driver. BLC is into many business segments: (See Fig 1)
    • Travel & Tours – Travel (Ticketing), Vacations & Money Changing Activities.
    • Greases & Lubricants – Globally BLC is a top grease maker, and its brand is Balmerol.
    • Logistics infrastructure and Services
    • Industrial Packaging – barrels and Drums made of Plain Steel and many variations.
    • Leather Chemicals, Refinery & Oil field Services, etc.
  • Travel: BLC is one of the oldest IATA accredited travel agencies in India. The travel segment operates in 88 locations in 19 cities in the country with a good clientele.
  • Greases & Lubricants: BLC is the largest grease producer in India having 3 mfg. plants in Chennai, Kolkata and Silvassa. It also focuses on R&D with an applications research laboratory in Kolkata. The firm is aggressively marketing its Balmerol brand and continues expanding its distribution network of 20 strategically located stock points, 250 distributors & 4,500 dealers in the country.
  • Logistics: BLC has three state-of-the art Container Freight Stations located at Nhava Sheva, Chennai and Kolkata and offers a wide range of logistics solutions for ocean, air & road freight.
  • These three ports do account for 54% of the total container traffic handled in Indian Ports.
  • BLC is an established player in the Indian industrial packaging industry with 35% share in the 200 liter capacity steel drum segment. It holds the leadership position in this segment, market size of which is estimated to be 12 mn. units. It has a pan-India presence with over 6 drum mfg. facilities in Taloja (Mah.), Asaoti (Haryana), Chennai, Kolkata, Chittoor (AP) & Silvassa.
  • Leadership is Prabal Basu-CMD, D Sothi Selvam-Dir mfg, K Swaminathan-Dir Services
  • Shareholding % is: GoI 61.8, DIIs 10.9, FIIs 2.9, Individuals 18.3, Corporates 3.5, Others 2.6%.
JainMatrix Investments, Balmer Lawrie

Fig 1 – BLC Business Segments/ Geographical Segments

Recent events, Business Plans and Strategies

  • BLC has a focus on in-house R&D for all its manufactured products.
  • Travel: In Feb 2014, BLC acquired the holidays brand “Vacations Exotica” (VEX) for Rs 20 cr., and became one of the top five leisure travel companies in India. VEX has been growing at 25% with revenues of Rs 120 cr. and a potential to rise to around Rs 450 cr. over 3-4 years (per management). BLC can now offer holiday packages and corporate travel services to its portfolio of corporate and govt. clients which number 7.5 lakh. The acquisition is yet to add to the bottom-line, and the accumulated loss is Rs 8-9 crore, but this year BLC will minimize loss and in FY18 is expecting profit.
  • Currently, 90% of BLC’s travel business is from the central govt. and 10% from the private sector. This year BLC has targeted to increase the pvt. sector proportion to 25% over 2 years.
  • BLC has embarked on a major technology upgrade for the travel segment, which will help to improve its service levels and reduce overheads.
  • Greases & Lubricants: It launched the new TechTonic Pack for diesel and 4T oils for the auto sector.
  • AVI-OIL India Pvt. Ltd is a JV between BLC, Indian Oil and NYCO France established in 1993 where BLC is a 25% partner. It is involved in indigenous production & supply of aviation lubricants to defense services & aircraft operators in India and manufactures aero engine oils, hydraulic fluids, greases, protectives & other specialty products for the aviation sector.
  • Application Research Laboratory (ARL) has focused towards the R&D of high performance greases for steel and heavy duty open gear grease for sponge iron plants, engine oil for new generation passenger cars, power sector, fine blanking & cold forging (auto) and hobbling (gear mfg. industry).
  • The ARL located in Kolkata, developed tribological solutions using “DEKATROL technology” which is eco-friendly, helps reduce frictional losses, enhance fuel economy and also life of the product.
  • Logistics: During FY16 Logistics Services achieved a growth of 8% in topline which is on account of a surge (20% growth YOY) in air freight services activity.
  • BLC plans to invest Rs 400 crore over the next two-three years, including Rs 60-70 crore during the current fiscal. Most of the investment would be in logistics business. BLC is setting up 3 cold chain facilities in Hyderabad, Delhi NCR and Mumbai and a multimodal logistics park at Vizag Port in JV with Vizag Port Trust (VPT). The project will be built over 53 acres of land. In this Hub, facilities will be created for handling Exim and Domestic Cargo.
  • BLC is searching for a strategic partner to sell its loss making subsidiary Transafe Services Ltd. engaged in the business of container leasing and logistics services.
  • Industrial Packaging: The new state-of-the-art barrel mfg. plant at Navi Mumbai has stabilized and being close to the large consumption centers in the Western Region, has a competitive advantage.
  • There is a fall of available market size for BLC to an extent of 2 million drums per year due to GoI policy on procurement of Drums from MSME manufacturers. Also there are new entrants in Gujarat, Taloja and Chittoor (in and around the Fruit-pulp Market).

Industry Views:

Indian Travel and Tourism Industry: India has moved up 13 positions to 52nd rank from 65th in Tourism & Travel competitive index. Total contribution by travel and tourism sector to India’s GDP is expected to increase from US$ 136.3 billion in 2015 to US$ 275.2 billion in 2025. The number of Foreign Tourist Arrivals has grown at a CAGR of 3.7% to 5.29 lakh YoY in May 2016. Forex earnings during May 2016 grew at a rate of 8.2% YoY to Rs 10,285 cr. (US$ 1.52 billion). Tourists arriving on e-Tourist Visa during June 2016 totaled 36,982 registering a YoY growth of 137.7%. The industry may see good growth on the back of visa reforms. The rupee depreciation against major currencies has improved demand and positively impacted foreign arrivals as India becomes an affordable destination. The medical tourism market in India is projected to reach US$ 3.9 billion in size having grown at a CAGR of 27% over the 3 years, and is expected to clock over 20% gains annually through 2017.

Indian Logistics Industry: India’s logistics sector is set for accelerated growth, led by GDP revival, ramp up in transport infrastructure, e-commerce, impending GST rollout, and ‘Make in India.’ Indian logistics market is expected to grow at a CAGR of 12.17% till 2020. Empirical evidence indicates that Indian logistics industry grows at 1.5-2 times the GDP growth. A large number of upcoming SEZs have necessitated the development of logistics for the domestic market as well as for global trade. Mumbai has emerged as the preferred location for the development of logistics parks with an investment of approximately $200 million. The development of seven to eight logistics parks are in pipeline on 600 acres around Mumbai. Poor Infrastructure, warehousing & storage and trade Regulations have been hindering growth. The proposed new GST regime and e-commerce will together alter the landscape in warehousing, supply chain management and third party logistics business particularly for organized sector.

Indian Lubricants & Leather Industry: India is the 5th largest lubricant market in volume terms behind the US, China, Russia and Japan. In terms of revenue, the lubricants market size was valued at USD 37 billion in 2014, which is expected to surpass USD 74 billion by 2022, at a CAGR of 8.5%. Increasing automobile sales is expected to drive lubricants market size over the forecast period. India’s leather industry has grown well, transforming from a raw material supplier to a value-added product exporter. Today, around 50% of India’s leather business comes from international trade. The GoI had identified the Leather Sector as a focus sector in the Indian Foreign Trade Policy in view of its immense potential for export growth prospects and employment generation.

Indian Industrial Packaging Industry: The packaging industry in India should reach $73 billion in 2020 from $32 b (FY15), per FICCI and TSMG. The Indian packaging industry constitutes about 4 % of the global packaging industry. (Source IBEF). Indian packaging industry is anticipated to register 18% annual growth, with the flexible packaging and rigid packaging expected to grow annually at 25% and 15%, respectively. Germany & Italy are the main suppliers of packaging machinery but emerging are Taiwan, Korea, China. There are about 600-700 packaging machinery manufacturers, 95% of which are from SMB. Competition is from alternative packaging like PE Drums, IBC/ISO Tankers/ Flexi – Tanks, etc. BLC indicated that sales volume in FY16 were marginally less than FY15 in spite of shrinkage of demand due to GoI directives to procure MS Drums only from Small & Medium Enterprises.

Stock evaluation, Performance and Returns

  • BLC’s price history is detailed in Fig 2. The share price shot up sharply in 2014.
  • Investors in BLC over 8 years got a return of 34% CAGR including bonus and dividends.
  • Dividends have been generous, and are currently 180% or Rs 18/share giving 2.6% yield.
JainMatrix Investments, Balmer Lawrie

Fig 2 – Price History

  • The recent low is 491 in Feb 2016, and the high was Rs 748 in Sep 2016, so BLC has risen sharply this year, but is currently 7% below the highs.
  • Revenues, EBITDA and Profits of BLC are up by 7%, 6.8% and 7.3% CAGR over 7 years.
  • BLC has EBITDA and profit margins of 9.9% and 5.5% resp., which are good, see Fig 3.
  • Current P/E is 11.86 times (of trailing twelve months earnings), while the Price/ Book is 1.71 times. The current valuations look reasonable, which is a positive.
  • The Q1 every year (Apr-June) is the best by revenue. This may be due to the holiday season. But In Q1 FY17, revenues fell due to fall in aviation fuel price and austerity measures from the government.
  • Debt equity ratio is 0.11 which is low. This is a sign of a healthy balance sheet.
  • BLC has positive free cash flows over 8 years, and it has been investing this in assets, a positive. Fig 4.
  • BLC balance sheet* has cash & equivalent (Rs 457), which is Rs 161/sh., so BLC operations are available for (677-161) = Rs 516.
JainMatrix Investments, Balmer Lawrie

Fig 3 – Quarterly Financials (click to enlarge)

JainMatrix Investments, Balmer Lawrie

Fig 4 – Free Cash Flow

  • In Fig 5, the 8 year PE chart for BLC has historic avg PE of 8 times, a range of 4-12 times.
  • Today it is at 11.86 times. The PE has recently fallen from a high of 13.66 times. With good cash levels and a healthy balance sheet, we expect PE levels to rise further.
  • In Fig 6 we can see that the EPS TTM is rising in a steady fashion over the last 8 years within a channel.
  • Beta of stock is 0.9 (Reuters) indicates lower than Sensex volatility, which is good.
JainMatrix Investments, Balmer Lawrie

Fig 5 – Price and PE Chart (click to enlarge)

JainMatrix Investments, Balmer Lawrie

Fig 6 – Price and EPS Chart

JainMatrix Investments, Balmer Lawrie

Fig 7 – Financial Metrics

  • From Fig 7 we can see that the debt equity ratio has been reduced and is currently low. This is positive. The interest coverage ratio has improved. Dividend yield is healthy at 3%. The inventory turnover ratio improved, implying efficient inventory management. Operating & profit margins are flat to positive.
  • BLC’s ROCE fell in the last five years, but it is still high at 21.1% in FY16. Similarly RoNW.

The picture that emerges of BLC is a healthy balance sheet, conservative financials and improving cash.

Benchmarking and Financial Estimates

In a benchmarking exercise we compare BLC with listed peers in similar businesses. See Exh 8.

JainMatrix Investments, Balmer Lawrie

Exhibit 8 – Financial Benchmarking

  • From the exhibit, we can see that BLC has low valuations and high dividends.
  • Margins are low but steady. Similarly the 3 year growth numbers.
  • Return ratios are high for the peer group. Debt is low. Interest coverage is good.
  • This is consistent with its conservative PSU character and steady performance so far. If we bring together the solid past with the recent good growth initiatives, a positive picture emerges.
JainMatrix Investments, Balmer Lawrie

Exhibit 9 – Financial Projections

  • The financial projections for 3 years for BLC in Fig 9 are based on conservative assumptions of investments in operations, stability in crude prices at current levels and no dilution of equity base.
  • Based on projections and a target PE of 12, we project a Mar 2019 price of Rs 1057, a 56% upside from current levels.

Strengths of BLC

  • It has diversified businesses and even during poor economic cycles, BLC has not been hit. The BLC stock has low beta, with stability of a large cap, and the returns, growth potential and upside of a small cap.
  • Strong balance sheet, low debt and good cash balance provides stability and room for growth.
  • BLC has been consistently generating high dividend yields and has robust ROCE numbers.
  • Many of the BLC businesses are high potential with good growth prospects, including Travel & Tourism, logistics, lubricants and industrial packaging.
  • With good investment plans across businesses, BLC is showing a new found aggression. BLC also has exited some legacy businesses with bad returns, such as tea. This too is a bold step.
  • As a Mini-Ratna I PSU, BLC can invest up to Rs. 500 crore or equal to their net worth, whichever is lower without explicit government approval. This allows BLC to move fast on investment plans.

Weaknesses and Risks

  • A likely partial disinvestment in future could give a temporary downside pressure on the stock price.
  • In the import-export trade, there is an ongoing reduction in volumes through ports due to slowdowns in developed economies and China. This may affect the logistics business.
  • BLC may face competition from packing products like PE Drums, and IBC/ISO Tankers/FlexiTanks.
  • BLC profitability is exposed to volatility in commodity prices, especially crude oil & steel, which impact the industrial packaging and oil & lubricants divisions.
  • The travel business faces low entry barriers, threat of govt./PSUs withdrawing the preferred travel agency status and efforts from airlines for direct sale of tickets. BLC will mitigate this by distribution on online portals and focus on value added segments of leisure travel.
  • BLC is over dependent on GoI/ PSEs for its ticketing business as around 90% comes from public sector.
  • There is competitive pressure for Balmerol with established brands such as Castrol, Veedol & Gulf enjoying a lion’s share in the retail lubricants business.
  • BLC is facing challenges with delayed payments from public sector customers.
  • Shipping lines/ CHAs & Forwarders continue to exert pressure for payment of increased incentives for moving their boxes to a particular Container Freight Stations (CFS) & demand more storage free days.
  • Being a small cap share, there can be low trading volumes on the exchanges.

Opinion, Outlook and Recommendation

  • At first glance BLC looks like a small cap that is a complex conglomerate with legacy issues.
  • However on closer analysis we can see that it is into 4-5 high potential segments which together give it a stable portfolio. BLC is shedding / closing down the weak businesses, and investing in the potentials.
  • The balance sheet of BLC is excellent with low debt, good cash and is strengthened by free cash flows.
  • With a small and stable equity base, it appears likely that BLC will reward shareholders with higher dividends, splits and bonuses in the next few years.
  • BUY Balmer Lawrie with a Mar 2019 target price of Rs 1057, a 56% upside from current levels.

JAINMATRIX KNOWLEDGE BASE 

See other useful reports:

  1. Endurance Technologies IPO 
  2. ICICI Prudential Insurance IPO – An Expensive BUY
  3. GNA Axels IPO
  4. L&T Technology Services IPO 
  5. RBL Bank IPO 
  6. New Banks: Big Changes in Small Change 
  7. Equitas IPO – Leader in SF Banks
  8. Dilip Buildcon IPO 
  9. Do you want to be a value investor?
  10. Mahanagar Gas IPO 
  11. How will Brexit impact Indian investors?
  12. A Repurpose for our PSUs
  13. How to Approach the Stock Market – A Lesson from Warren Buffet
  14. Thyrocare IPO – Wellness for your Wealth
  15. Announcement – SEBI approval as a Research Analyst
  16. Alkem Labs IPO
  17. Goods And Services Tax (GST): Integration And Efficiency
  18. Syngene IPO: Good Pharma R&D spinoff from Biocon

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  • Visit the Investment Service offering page to find how you can get more.
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Disclaimer and Notes

Note on * – we made an edit to this report on 19th Oct, removing an erroneous calculation.

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same JM has no known financial interests in Balmer Lawrie & Co or any related firm. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from your Investment Adviser. Punit Jain is certified and registered under SEBI (Research Analysts) Regulations, 2014. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

Endurance Technologies (IPO) – the Firm has Stamina

  • Date: 04th Oct 2016
  • IPO Period: 5th-7th October, IPO Price range: Rs. 467-472
  • Sector: Auto Components
  • MidCap: Rs 6,639 cr. Mkt cap 
  •  Advice: Investors may BUY with a 1 year perspective.

endurance-technologies-logo

Summary

  • Overview: ETech is the largest 2 and 3-wheeler auto component manufacturer in India, with 25 plants across India, Italy and Germany.
  • ETech had revenues and profits of Rs 5,241 cr and Rs 291 cr. resp. in FY16. Its revenue, EBITDA and PAT have grown 8.1%, 7.8% and 12.4% CAGR from FY12 to FY16.
  • ETech has a significant size, improving margins and marquee customers. It has a healthy balance sheet indicating conservative financials. It has good Indian and global presence.
  • It is not well-known, but with this IPO it may emerge among the leading firms in the segment.
  • At a FY16 PE of 22.8 times, the pricing & valuations leave something on the table for investors.
  • Negatives include sector high competition, cyclical business and currency & global biz risks.
  • Overall, ETech is a good offering and is a high stamina player in the auto ancillary space. As an investment, the ETech IPO is rated a medium risk, high return type of offering.
  • Outlook: Investors can go ahead and BUY this ETech IPO with a 1 year perspective.

Here is a note on Endurance Technologies (ETech).

IPO highlights

  • IPO opens: Wed 5-7th Oct 2016 with Issue Price band: Rs. 467-472 per share.
  • Shares offered are 2.46 crore nos of Face Value Rs. 10 per share and the market Lot is of 30.
  • Shares offered are 17.5% of equity. The IPO will raise Rs 1,162 cr. (upper band) which is a sale by promoter Mr Anurang Jain and investor Actis; there is no fresh issue of shares. So the IPO does not benefit the company directly.
  • The promoter of ETech is Mr Anurang Jain who holds 62%. Actis also holds 14% stake.
  • The IPO shares are available to institutional, non-inst. and retail in ratio of 50:15:35. Post IPO shareholding will be Anurang Jain 58%, Naresh Chandra 12%, Suman Jain 12%, IPO QIB 9%, IPO retail 6% and IPO NIB 3%. Actis is completely exiting.

Introduction

  • ETech is one of the largest 2 & 3 wheeler auto component manufacturer.
  • It had revenues and profits of Rs 5,241 cr and Rs 291 cr. resp. in FY16. Its revenue, EBITDA and PAT have grown 8.14%, 7.83% and 12.42% CAGR from FY12 to FY16.
  • ETech has 25 plants across India, Italy and Germany. The 18 plants in India are located in the auto belts, comprising Aurangabad (8), Pune (5), Pantnagar, Uttarakhand (2) and 1 each in Manesar, Chennai and Sanand. Also, ETech has plants in Germany (2), and Torino, Italy (5).
  • ETech is also setting up a new plant at Halol (Gujarat), possible completion in FY18; a new plant in Germany (FY17) and are planning an auto proving ground (test track) in Aurangabad.
  • Utilization levels in current plants appear in the 20-30% range, indicating growth will be easy.
  • ETech is a tier one supplier for most of their products, and supply directly to OEMs.
  • For FY15, FY16 and Q1 FY17, their revenue contribution from India was 71.5%, 70.1% and 66.8%, resp., while the contribution from Europe was 28.5%, 29.9% and 33.2%, resp.
  • ETech manufactures the following products: (See Fig 1)
    1. Aluminium castings and alloy wheels.
    2. Suspension components: Shock absorbers, Front forks and hydraulic dampers.
    3. Transmission components: Clutch assemblies, friction plates and CVT’s.
    4. Braking Systems: Hydraulic disc brakes, rotary disc brakes and hydraulic drum brakes.
JainMatrix Investments, Endurance Tech IPO

Fig 1 – Geographic Revenue / Fig 2 – Category wise product revenue 

  • In India, ETech manufactures auto components for the 2 & 3 wheeler segments. In Europe, they mostly cater to four-wheeler OEMs, focusing on engine and transmission components.
  • In FY16, ET’s large customers in India were Bajaj, Royal Enfield, Honda Motorcycle and Yamaha. Baja Auto is their largest customer. In addition they supply other OEMs in India, such as Hero, Mahindra, Tata, Suzuki, H-D Motor and Fiat India. In Europe, their largest customer is FCA Italy S.p.A., who in turn supply to Jeep, Chrysler, Alfa Romeo, Abarth, Fiat, Lancia and Daimler. They also supply a few other four-wheeler Europe OEMs.
  • According to the Aluminium Casters’ Association of India, they are the #1 aluminium die-casting firm in India in terms of actual output and installed capacity in FY16.
  • ETech is an innovation-driven company with a focus on R&D, which allows them to develop new products suited to customer requirements. ETech’s R&D process includes design, development, validation, testing, manufacturing, delivery and aftermarket sale service.
  • ETech has been successful in diversifying their products due to their R&D and technology capabilities. Their tech partners include WP Performance Systems GmbH a leading global brake and suspension firm and Adler SpA, a European brakes technology provider.
  • They employ 167 R&D engineers, designers, technicians and support staff in India & overseas.
  • In India, ETech has been granted 4 patents with another 41 patents pending approval. They also have 1 design registration granted and 3 design registrations pending.
  • ETech’s long-term bank facilities are rated CRISIL AA-/Positive and short-term are CRISIL A1+.
  • Leadership is Anurang Jain (MD), Satrajit Ray (ED & CFO), and Ramesh Gehaney (COO). For FY16, the following amounts were aggregate compensation to the executive directors:
JainMatrix Investments, Endurance Tech IPO

Exhibit 3 – Executive Compensation in Rs

  • Over time, ETech has grown organically in India, including consolidating its promoter’s companies into one firm. ETech diversified its capabilities by introducing suspension products in 1996, transmission products in 1998 and braking systems in 2004. Starting from one mfg. facility in 1985, they have grown to now operate 18 facilities in India.

News and Updates for ETech

  • The management of ETech in Feb 2016 discussed their five-year business plan in which they are targeting a turnover of Rs 10,000 cr. for ETech by 2020, obtained through organic growth.
  • ETech is banking upon advancements in product technologies such as braking (combined braking systems (CBS / anti-lock braking systems) and suspension systems (adjustable damping front forks) for growth in the near and medium term.
  • According to ETech, mandatory legislative requirement for ABS of 125cc and above 2-wheelers is good news for ETech as scooters is a growing segment.
  • Mr Naresh Chandra is the father of Anurang Jain, and holds 12% stake (pre and post IPO). Thus ETech is a family controlled business which has a structure in which the family would continue to control 82% of the business (post IPO). Mr Rahul Bajaj (Chairman of Bajaj Group) is the maternal uncle of Mr Anurang Jain. Bajaj Auto was the only client of ETech until 2004.
  • Actis is a leading private equity investor in growth markets across Africa, Asia and Latin America. It had invested Rs 372.5 cr. in ETech 5 years ago buying equity from StanChart PE. The cost of acquisition per equity share for Actis was Rs 190.8. They will gain 147% in 5 years from the IPO.
  • ETech had prepared for an IPO in 2011 but perhaps opted for Actis PE instead.
  • The unofficial/ grey market premium is in the range of Rs 60-65. This is a positive indication.

Two and Three Wheeler Industry Outlook in India    

  • In FY16, auto production in India was 2.45 cr. with 2-wheelers (motorcycles, mopeds and scooters), accounting for over 75%. India’s 2-wheelers industry revenue was Rs 82,000 cr., with a production of about 1.9 cr. 2-wheelers growing at a moderate 5.1% CAGR from FY12-16 mainly due to two years of bad monsoon in 2014 and 2015.
  • It is estimated that two-wheeler production will grow at a CAGR of 8-10% from the period FY16 to FY19. Motorcycles continued to dominate the two-wheelers industry. Source RHP
  • India’s 3-wheeler industry comprises of passenger three-wheelers and cargo three-wheelers. Industrial demand is a key growth driver for the three-wheeler industry.
  • It is expected that consumption would pick up in FY17 with lower commodity prices, inflation and softer interest rates. Currently the capacity utilization is low and these factors will prove to be the growth trigger.
  • India is the largest 3-wheeler industry in terms of production, with a large domestic market and export base. In FY16, India’s 3-wheeler production volume was 9.33 lakh. Over the past five years, India’s 3-wheeler production has grown at 3% CAGR, with steadily rising exports as well as domestic demand. It is estimated that the overall three-wheeler production will grow at a CAGR of 7-8% during the period of FY16 to FY19. Source RHP
  • Rapid technology changes are taking place in automobiles with demand for fuel efficiency, lightweight bodies and a shift from fossil fuels to electric/ renewables.

Financials of ETech

  • ETech revenue, EBITDA and PAT have grown 8.1%, 7.8% and 12.4% CAGR from FY12 to FY16. (Note: The projected FY17 data is a simple extrapolation from the Q1 FY17 results). See Fig 4.
  • The revenue growth is moderate, and margins have been stable to improving over the years.
  • ETech has free cash flows in 4 out of last 5 financial years. This is a positive. Fig 5.
  • ETech has generated high ROE of 20% (FY16). The dividend growth in 5 years has been good considering the cyclical of the nature of the business. Fig 5.
JainMatrix Investments, Endurance Tech IPO

Fig 4 – ETech Financials

JainMatrix Investments, Endurance Technologies IPO

Fig 5 – ETech cash flows

  • The cash per share including Reserves & Surplus and Cash on Balance sheet as on June 2016 is Rs 114/share. So operations of ETech are available at (472-114) = Rs 358/share (at UMP).

Benchmarking

JainMatrix Investments, Endurance Tech IPO

Exhibit 6 – Benchmarking (to enlarge, click image)

We benchmark ETech against Indian listed peers, See Exhibit 6.

  • ETech seems to be fairly priced in terms of P/E and P/B, about 30-40% cheaper than the leaders, Motherson Sumi and Bharat Forge and similar range as Sundaram Clayton.
  • On growth parameters and margins, ETech is fair. Debt is medium and in control.
  • Consistently high RoE and RoCE is a positive. Dividend yield is also impressive in comparison.
  • With an IPO, ETech may achieve visibility and recognition putting it on par with well-known leaders.

Positives for ETech and the IPO

  • IPO pricing and valuations look reasonable.
  • ETech has a consistent track record of organic and inorganic growth. It has strong customer relationships with high quality OEMs in India and Europe.
  • ETech offers products in 4 broad segments which helps to expand customers relationships.
  • ETech has strong R&D and technological capabilities. It has invested in high-quality testing equipment, software, human resources, in its R&D centers for each of their product segments.
  • The balance sheet looks healthy with good cash/share and fair debt.
  • The firm is led by a team with good experience in the auto component industry. The MD has been in the industry since 1985. The next line of management has experience in their respective areas, and have been with ETech for over 5 years. Executive compensation is high but fair compared to profits.
  • The firm has successfully executed a large overseas acquisition in Europe and gained as customers reputed OEMs, and has a fast growing and profitable European business.

Internal Risks 

  • Auto ancillary sector is considered a working capital and asset heavy business. New orders involve big additions to working capital, so ETech has to manage growth and financial health.
  • Competition is high in this space and ETech may get pressured on price or margins in future.
  • ETech is subject to environmental and safety regulations that may adversely affect business.
  • ETech’s business is dependent on certain principal customers, especially Bajaj Auto in India and FCA Italy S.p.A in Europe. Sales to their top 3 customers was 65.3%, 61.8% and 62.1% of their revenue for FY14, FY15 and FY16 resp. However this is a typical auto B2B situation.
  • Their success depends on the success of the models launched by OEMs. Thus several key success factors for Tier-1 suppliers are out of their control.

External Risks

  • The cyclical and seasonal nature of auto sales and production can adversely affect business.
  • As a primarily Tier-1 supplier to OEMs, ETech may be exposed to price and demand squeeze during cyclical slowdowns. In comparison, the replacement/ aftermarket business is typically much steadier and more profitable, while being smaller in size.
  • Forex fluctuations and international issues could negatively impact their business.
  • Current expectations are that the domestic market’s current uptrend will continue for 2-3 years. However if it slows earlier, domestic business will be affected.

Overall Opinion

  • Indian auto ancillary mfg. is a high potential space with ample domestic demand and global opportunities. India has many competitive & comparative advantages. Two wheelers and small cars – R&D and manufacture will shift here with many global players already present.
  • ETech has a significant size, steadily improving margins and marquee customers. It has a healthy balance sheet with conservative financials. It has good Indian and global presence.
  • It is not well-known, but with the IPO may emerge among the leading firms in the segment.
  • Current equity market conditions are positive for IPOs, and auto-ancillaries is a good sector.
  • At a FY16 PE of 22.8 X, valuations appear right and leave something on the table for investors.
  • The negatives include high competition, cyclical sales and currency & global business risks.
  • Overall, we feel that ETech is a good offering and is a high stamina player in the auto ancillary space. As an investment, the ETech IPO is rated a medium risk, high return type of offering.
  • Investors can go ahead and BUY this ETech IPO with a 1 year perspective.

JAINMATRIX KNOWLEDGE BASE 

See other useful reports:

  1. ICICI Prudential Insurance IPO – An Expensive BUY
  2. GNA Axels IPO
  3. L&T Technology Services IPO 
  4. RBL Bank IPO 
  5. New Banks: Big Changes in Small Change 
  6. Equitas IPO – Leader in SF Banks
  7. Dilip Buildcon IPO 
  8. Do you want to be a value investor?
  9. Mahanagar Gas IPO 
  10. How will Brexit impact Indian investors?
  11. A Repurpose for our PSUs
  12. How to Approach the Stock Market – A Lesson from Warren Buffet
  13. Thyrocare IPO – Wellness for your Wealth
  14. Announcement – SEBI approval as a Research Analyst
  15. Alkem Labs IPO
  16. Goods And Services Tax (GST): Integration And Efficiency
  17. Syngene IPO: Good Pharma R&D spinoff from Biocon

DO YOU FIND THIS SITE USEFUL?

  • Visit the Investment Service page to find how you can get more. Or Click LINK.
  • Register Now to get our Free reports and much more, on the top right of this page, or by filling this Signup Form CLICK.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no known financial interests in Endurance Technologies Ltd. or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

ICICI Pru Life IPO: An Expensive BUY

  • Date: 19th Sept 2016. IPO Period: 19-21st Sept
  • IPO Price range: Rs. 300-334
  • Large Cap: Rs 47,940 crore Mkt cap
  • Industry – Insurance
  • Advice: Investors may BUY with a 3 year perspective

Summary

  • Overview: IPRU is the largest private sector life insurer in India. IPRU offers a good range of life insurance, health insurance and pension services.
  • IPRU had revenues and profits of Rs 18,999 cr. and Rs 1,653 cr. resp. in FY16. Its revenue and PAT have grown just 8.1%, and 4.5% CAGR from FY12 to FY16.
  • The industry is getting over a number of regulatory and structural changes by regulator IRDA.
  • IPRU has made impressive strides with ecommerce and strong sales network, improving productivity and proactive customer service.
  • However there are a few risks: 1) Changes in the regulatory environment 2) IPRU is subject to claims by the customers and/or regulators for mis-selling.
  • High valuations make this IPO attractive only for long tern investors. It is rated a low risk, medium return type of offering.
  • Opinion: Investors may BUY IPRU with a 3 year perspective.

Here is a note on ICICI Prudential Life Insurance Company (IPRU).

IPO highlights

  • This IPO is the biggest since Coal India’s market debut in 2010.
  • Shares offered to public: 18.13 crore out of which 1.81 cr. are reserved for ICICI bank shareholders. The FV of each share offered is Rs. 10 and the market Lot is multiples of 44.
  • Shares offered are 12.63% of equity. The IPO will collect Rs 5,451 cr. (at upper band) which is a sale by promoter ICICI bank; there is no fresh issue of shares. The IPO shares are available to institutional, non-institutional and retail in ratio of 50:15:35.
  • ICICI bank holds 67% stake of IPRU. Post IPO shareholding will be ICICI Bank 55%, Prudential Corp 26%, other investors 6%, and in IPO – QIB 6%, retail 4%, NIB 2%, ICICI Bank s’holders 1%.
  • The beneficiary of the IPO is promoter ICICI Bank which will unlock value in this firm.

Introduction

  • IPRU is the largest private sector life insurer in India. It is a JV between ICICI Bank and Prudential Corp. The vision is to be a dominant Life, Health & Pensions firm.
  • IPRU had revenues and profits of Rs 18,999 cr. and Rs 1,653 cr. resp. in FY16. Its revenue and PAT have grown 8.1% and 4.5% CAGR from FY12 to FY16.
  • IPRU was one of the first private sector life insurance firms and started operations in 2001.
  • In FY16, their market share among all insurance companies in India was 11.3%. Among the 23 private life insurance companies in India, the share of 21.9%.
  • In FY16, IPRU’s gross premium income was Rs 19,164 cr., which comprised Rs 4,924 cr. of retail new business regular premium, Rs 432 cr. of retail new business single premium, Rs 11,995 cr. of retail renewal premium and Rs 1,813 cr. of group premium. Also see Fig 1 for product wise details.
JainMatrix Investments, icici Prudential IPO

Fig 1 – Product wise revenue

JainMatrix Investments, ICICI Prudential IPO

Fig 2 – Geographic revenue

  • IPRU has a 100% subsidiary, ICICI Prudential Pension Funds Management, which is registered as a fund manager with the Pensions Fund Regulatory and Development Authority of India.
  • IPRU’s 13th month persistency ratio in FY16 was 82.4%, which was one of the highest in the sector. As on FY16 IPRU had Rs 1,04,000 lakh cr. of AUM. Their expense ratio of 14.6% for FY16 was one of the lowest among the private life insurance cos. in India.
  • IPRU sells its products through a multi-channel network which includes own branches, sales employees, promoter ICICI Bank branches, sales agents, corporate agents, and own website. In FY16, IPRU had 121,016 individual agents and their bank partners had 4,500 branches.
  • IPRU had a strong capital position with a solvency ratio of 320% in FY16 compared to the IRDAI-prescribed level of 150%. The claim settlement ratio was 96.2% for FY16, up from previous 94.1% in FY14. The grievance ratio was down to 153 for FY16 from earlier 253 in FY14.
  • Leadership: Sandeep Bakshi is MD-CEO; Sandeep Batra is ED (corp.); Puneet Nanda is ED (business).

Promoter (ICICI Bank) – Snapshot and Financials

  • ICICI Bank is a firm providing a range of banking and financial services, including commercial banking, retail banking, project & corporate finance, working capital, insurance, venture capital and private equity, investment banking, broking and treasury products and services.
  • It is the largest private sector bank in India. Income, PAT and EPS grew by 11.1%, 7.4% and 7.1% CAGR resp. over 5 years. Due to a fall in share price and EPS, P/E ratio fell to 13.59 times. See Fig 3.
  • ICICI Bank has a high net profit margin of 17.2%. The current dividend yield for ICICI Bank stands at 1.86%. The RoE stands at 12.42%. This is average performance.
JainMatrix Investments, icici Prudential IPO

Fig 3 – ICICI Bank financials

  • There was a weakening in the balance sheets of banks witnessed since FY11-15. During the year 2014-16, ICICI Bank saw asset quality concerns rising and higher NPAs. Some of this was RBI driven, and the policy focus was to clean the books of all banks.
  • However we are positive that private banks will grow faster at over 20% and gain market share over PSB’s. ICICI bank too is expected to recover rapidly from the 2015-16 asset clean up. Private banks are currently well placed to lead credit growth supported by strong capitalization.

News and Updates for IPRU

  • Prudential Corp. Holdings Ltd is likely to trim its stake in IPRU by up to 5.8% after the listing. As per the revised terms of their JV agreement, ICICI Bank and Prudential have agreed to reduce stake in IPRU to achieve minimum public holding norms with a floor of 54% and 20% resp.
  • IRDAI has proposed that life insurers need to list their shares after 10 years of operations. But insurers are apprehensive and claim that when they started up, this was not a pre-condition.
  • HDFC and Max Group announced a deal merging their life insurance businesses to create what may become India’s largest listed life insurance firm with an estimated market value of Rs 67,000 cr. once the all-share transaction is completed. In this merger the value for HDFC Life Insurance was Rs 47,000 crore with market share of 7.6% against IPRU’s share of 11.3%.
  • As per an article IPRU offers the best online insurance plans with a good variety of policies.
  • As per the management, 90% of their retail business premium comes via the digital mode.
  • The IRDAI recently said that insurance portability will be the next big initiative for the industry. The portability (of insurance) is possible currently only if the policy is standardised. The regulator will assess the pros and cons of introducing the same.
  • Employee productivity improved, measured as retail weighted received premium per employee per annum, from Rs 28 lakhs in FY14 to Rs 46 lakhs in FY16, representing a growth of 29.1% CAGR.
  • IPRU sold a 6% stake in Nov 2015, for Rs 1,950 cr., valuing the company at Rs 32,500 cr. The IPO, however, values it at Rs 47,870 crore at the upper band, a 47% rise in 10 months.
  • Ahead of its IPO, IPRU is believed to have allotted shares worth Rs 1,635 cr. to a clutch of investors, including Singapore Govt,. Nomura and a pension trust for Boeing employees.
  • IPRU believes that they are adequately capitalized for now, but may raise debt in future.
  • The unofficial/ grey market premium for this IPO is in the range of Rs 17 – 18. This is a positive.

Indian Life Insurance Industry and Outlook

  • The size of the Indian life insurance sector was Rs 3.7 lakh crore on a total premium basis in FY16, making it the 10th largest life insurance market in the world and the 5th largest in Asia.
  • There are 55 insurance companies, of which 24 are in life and 30 in non-life, and one reinsurer.
  • The total premium in the Indian life insurance sector grew at a CAGR of 17% between FY01-16. Despite this, India continues to be an underpenetrated with a life insurance penetration of 2.7% in FY15, as compared to 3.7% in Thailand, 7.3% in South Korea and a global average of 3.5% in 2015.
  • In 2015, the GoI increased the foreign investor max. shareholding from 26% to 49% of paid-up equity capital. This led to a foreign investment inflow of US$1.13 bn in FY16, a 170% YoY increase.
JainMatrix Investments, ICICI Prudential IPO

Fig 4 – Total LIP (2014-15)

  • LIC with Rs 2,39,668 crores of Total life insurance premium in FY16 still has 73% market share.
  • Since the opening up of the sector, private sector companies have gained market share, which peaked at 57% in FY09, on a Retail Weighted Received Premium (RWRP) basis. The financial crisis in 2008 and regulatory changes in FY10 resulted in loss of market share, to 37% in FY12. But they have recovered in the last 2 years, increasing share from 38% in FY14 to 52% in FY16.
  • The growth in market share was been driven by improved product design, focus on equity linked products that offer flexibility and superior customer value propositions and distribution. Private sector firms have also increased their focus on bancassurance for marketing their products.
  • Profitability of the sector fell recently as under new IRDA rules, the corpus of lapsed or surrendered policies goes into a discontinuance fund that returns the money to the policyholder on completion of five years after deduction of surrender charges that are lower and capped.
  • The sale and servicing of insurance policies on e-commerce sites may start in Oct 2016 (IRDA).
  • The insurance sector is growing well – health insurance is expanding at 31%. The life and non-life insurance segments are expanding at about 15%, per a senior executive.
  • ULIPs accounted for 92% and 75% of the new business premiums for private sector companies and the overall industry, resp. in FY08. The unit-linked product regulations introduced in Sept 2010, and growth in the equity markets led to expansion in this category.
  • In recent years, the commissions on ULIPs was reduced, which was a challenge to distributors (and agents). This resulted in a decline of the share of equity linked products in the life insurance sector from 55% to 7% and from 83% to 29% for private sector firms in FY14. The demand revived in FY15 and the new business premium for linked products increased by 54.9% for private sector.
  • The total AUM for the life insurance sector were Rs 22.47 lakh cr. in FY15, with the majority of the investment in debt instruments. The high share of debt instruments reflected the portfolio mix of LIC, which held 78% of its investments in debt instruments in FY15. Investment in equity was also driven by the proportion of ULIPs. Source: IPRU RHP
  • The GIC Re is the 14th largest reinsurer globally and is the only reinsurance company in India. Several global reinsurance firms are expected to set up soon in India.

Financials of IPRU

JainMatrix Investments, icici Prudential IPO

Fig 5 – IPRU Financials

  • IPRU’s revenue and PAT have grown 8.07% and 4.5% CAGR from FY12 to FY16. (Note: The projected FY17 data is a simple extrapolation from the Q1 FY17 results)
  • The revenue growth is moderate, and profit margins fell until FY16. See Fig 5.
  • The EPS growth has been slow from FY12 to FY16. From Q1FY17 data, financials are not good. However in reality, Q4 every year is best for insurance, as customers focus on tax savings.
  • The dividend has been rising over the years. IPRU paid a dividend of Rs 8.4 in FY16, a yield of 2.51%. This is a positive for investors as it is the highest in the industry.
  • IPRU has been able to generate Free Cash Flow for 3 of the last 5 years, a positive, see Fig 6.
  • IPRU has a ROE of 31.2% (FY16) making it the best in the industry.
  • The cash per share including Reserves & Surplus and Cash in balance sheet as on June 2016 is Rs 29/share. So the current operations of IPRU are available at (334-29) = Rs 305/share. (At UMP).
JainMatrix Investments, icici prudential IPO

Fig 6 – IPRU cash flows

Benchmarking

We benchmark IPRU against a listed peer Max Financial, and Bajaj Finserv & HDFC (Holding companies of firms including insurance) and other BFSI firms. See Fig 7.

JainMatrix Investments, icici prudential ipo

Exhibit 7 – Benchmarking

  • IPRU appears to be available at high valuations in terms of PE and P/B. Max Fin. Serv. is higher but profits are very low, so it is not comparable.
  • Highest ROE and dividend yield amongst peers is a differentiator and a positive.
  • Margins and growth are low indicating both high competition in the industry, and the effect of IRDA regulatory changes, however they are improving.
  • Benchmarking against global majors isnt too insightful as there are differences: like China Life (monopoly with low profits) and Metlife (high competition, low valuation)

Positives for IPRU and the IPO

  • IPRU is the leader among the private sector insurance firms. It has built on the strong ICICI Bank franchise, which gives it bancassurance and distribution & customer access.
  • It has built a diversified multi-channel sales distribution network.
  • IPRU has a comprehensive and customer friendly product portfolio, so offers a good choice.
  • IPRU has consistently generated the most new business premiums among private life insurers in India since FY02, and market share increased from 5.9% in FY12 to 11.3% in FY16 (CRISIL Research).
  • IPRU has responded successfully to the rapid regulatory changes since 2010.
  • With a strong technology and ecommerce platform, IPRU is improving revenues and productivity.
  • IPRU has a strong senior management team experienced in life insurance. The CEO Sandeep Bakshi has 32 years of experience in BFSI. 28 of the top 36 members of the management team have worked within the ICICI Group for over 10 years and have an average work experience of 20 years.

Internal Risks 

  • The IPRU offer appears to be at high valuations in terms of PE and P/B. We can see that leading banking franchises like Bajaj Finserv, Yes Bank and HDFC are available at lower multiples. Only China Life is higher in terms of P/E but much lower in terms of P/B. The IPO pricing has assumed a premium for 1) the first insurance IPO 2) high ROE and dividend yields 3) private sector leadership
  • Insurance is a long term financial product, and the demand for this depends on awareness, financial education and planning. However most consumers do not think long term.
  • A falling interest rate will have a negative effect on IPRU business and profitability. About 53.5% of their investments are in debt securities, and the returns from this will fall.
  • IPRU is subject to claims by the customers and/or regulators for alleged mis-selling.

External Risks

  • Changes in the regulatory environment in India could have a material impact on their business.
  • Any epidemic (medical) or natural disaster (floods, earthquake) can massively impact claims and hence profitability.
  • The Indian insurance market has experienced volatility in growth and the future is uncertain.
    • However given low penetration and awareness, this industry is expected to grow rapidly.
  • IPRU’s business is substantially affected by prevailing economic, political and such conditions.

Overall Opinion and Recommendation

  • The Insurance sector is at an early stage in India with low penetration and awareness. It has also been besieged with regulatory changes and many complaints of mis-selling. The good news is that a troubled phase may be behind us, and with favorable demographics the future looks more stable.
  • The sector dominator is govt. owned LIC, and it is easy to imagine that a nimble private sector may gain market share against LIC over the next few years.
  • Given the leadership status of IPRU, and its strong brand, we are positive about the firms prospects.
  • At a FY16 PE of 29.0 times and P/B of 8.99 times, the valuations are expensive. There are a few risks listed above that must be understood.
  • We feel this offering is attractive only for investors with a minimum 3 years perspective. As an investment, the IPRU IPO is rated a low risk, medium return type of offering.
  • Investors may Buy IPRU with a 3 year perspective.

JAINMATRIX KNOWLEDGE BASE 

See other useful reports:

  1. GNA Axels IPO
  2. L&T Technology Services IPO 
  3. RBL Bank IPO 
  4. New Banks: Big Changes in Small Change 
  5. Equitas IPO – Leader in SF Banks
  6. Dilip Buildcon IPO 
  7. Do you want to be a value investor?
  8. Mahanagar Gas IPO 
  9. How will Brexit impact Indian investors?
  10. A Repurpose for our PSUs
  11. How to Approach the Stock Market – A Lesson from Warren Buffet
  12. Thyrocare IPO – Wellness for your Wealth
  13. Announcement – SEBI approval as a Research Analyst
  14. Alkem Labs IPO
  15. Goods And Services Tax (GST): Integration And Efficiency
  16. Syngene IPO: Good Pharma R&D spinoff from Biocon

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Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain is a customer of ICICI Bank (savings account) and of IPRU (life insurance policy). Other than this, JM has no known financial interests in ICICI Prudential Life Insurance Company Ltd. or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

LT Tech Services IPO – The Make in India Firm

  • Date: 11th Sept 2016
  • IPO Period: 12-15th Sept and Price range: Rs. 850-860
  • Mid Cap: Rs 8,700 crore Mkt cap
  • Industry – Engineering R&D services
  • Advice: Investors may BUY with a 2 year perspective.

technologyserviceslogo

Summary

  • Overview: LTTS is a global pure-play engineering R&D services firm, a part of L&T group.
  • LTTS had revenues and profits of Rs 3,143 crores and Rs 416 cr. resp. in FY16. Its revenue, EBITDA and PAT have grown 18.9%, 40.7% and 34.0% this year.
  • The contract R&D services help firms develop and deliver products to end customers. After the IT services sector growth over the last 2 decades, the ER&D sector appears to be the next generation opportunity for more advanced, sector specific product development services.
  • The govt. has set up a Make in India program to encourage mfg. However ER&D services seem a more likely candidate for local success as it accelerates mfg. and innovation.
  • LTTS key customers include BMW, Calsonic Kansai, Caterpillar, Danaher, Eaton, Intel, John Deere, P&G, Rockwell Automation, Scania, Shell and UTC.
  • The primary risks are: 1) highly dependent on customers in North America and Europe 2) Forex fluctuation risks 3) Uncertainty around M&A and growth potential.
  • As an investment, the LTTS IPO is rated a medium risk, medium return type of offering.
  • Outlook: Investors may Buy LTTS with a 2 year perspective.

Here is a note on L&T Technology Services Ltd (LTTS).

IPO highlights

  • IPO opens: Monday 12-15th Sept 2016 with Issue Price band: Rs. 850-860 per share.
  • Shares offered to public: 1.04 crore of FV Rs. 2/share, Market Lot is multiples of 16.
  • Shares offered are 10.2% of equity. The IPO is of Rs 894 cr. (upper end of band) which is a sale by promoter L&T; there is no fresh issue. L&T held 100% in LTTS pre-IPO.
  • The IPO shares are available to institutional, non-inst. and retail in ratio of 50:15:35. Post IPO shareholding will be L&T promoter 89.8%, QIB 5.1%, NIB 1.5% and retail 3.6%.The IPO will unlock value for L&T. The grey market premium is Rs 95 – 96, a positive. (as on Friday 9th Sept).

Introduction

  • LTTS is a global pure-play engineering R&D services firm, a 100% subsidiary of L&T.
  • LTTS had revenues and profits of Rs 3,143 crores and Rs 416 cr. resp. in FY16. Its revenue, EBITDA and PAT have grown 18.9%, 40.7% and 34.0% in one year. There are only 2 years of data on LTTS.
  • LTTS has 26 sales & 12 delivery offices globally, and totally 9,400 employees.
  • LTTS was created by a business restructuring in 2014, merging 1) the Integrated Engg. Services div. of L&T and 2) Product Engg. Services div. of L&T Infotech.
  • LTTS has verticals such as transportation, industrial products, telecom etc. Fig 2. They provide a set of services to mfg. technology and process engineering firms, to help develop and build products, and deliver these to their end customers.
  • LTTS offers design & development solutions to the product dev. teams in the areas of manufacturing, engineering, embedded systems, software and process engineering.
  • For “new” technologies, LTTS provide services and solutions in the areas of product lifecycle management, engineering analytics, power electronics, M2M connectivity and IoT. They focus on innovation and tech. leadership and have set up labs specific to industry verticals to replicate customers’ environment, enabling them to work closely with their R&D teams on innovations.
JainMatrix Investments, L&T Tech Sercices IPO

Fig 1 – Geographic revenue/ Fig 2 – Revenues by Vertical

JainMatrix Investments, L&T Tech Services IPO

Fig 3 – LTTS’s segment revenue and operating Margins

  • LTTS ‘s key customers include BMW, Calsonic Kansai, Caterpillar, Danaher, Eaton, Intel, John Deere, P&G, Rockwell Automation, Scania, Shell and UTC. Revenue geography is in Fig 1.
  • LTTS’s revenues are generated from services provided on either a time-and-materials (T&M) or a fixed-price (FP) basis. For contracts on a T&M basis, they charge their customers on the basis of the hourly billable rates of employees. 31.9% of LTTS’s revenue were from FP contracts and the remaining 68.1% of the contractual revenue was T&M based for FY16.
  • Repeat business from existing accounts was 98.7% of customers in FY15 and 94.6% in FY16. The top 5, 10 and 20 customers gave 22.8%, 36.2% and 53.8% resp. of FY16 revenues.
  • LTTS had 3 $20m+ clients and 8 $10-20m clients in FY16. LTTS added 36 new customers in FY16. Today, LTTS has 200+ clients out of which 50 are among the Fortune 500 companies.
  • LTTS has been recognized by Zinnov in the “leadership zone” in 8 industry verticals (industrial automation, construction and heavy machinery, medical devices, aerospace, auto, rail and marine, telecom, energy and utilities) and 2 horizontal service offerings (embedded systems & mechanical) in Zinnov’s GSPR Ratings 2015.
  • Leadership: A.M. Naik is non-exec. Chairman; Keshav Panda is MD-CEO and P. Ramakrishnan is CFO.

Promoter – Larsen and Toubro (L&T) – Snapshot and Financials

  • L&T is a diversified engineering, construction, mfg., technology and financial services company. Income and PAT has grown at 12.4% and 4.3% CAGR respectively over 5 years.
  • In the same duration EPS witnessed a fall of -8.03% CAGR. P/E ratio has however risen to 27.5 times today. See Fig 4.
JainMatrix Investments, L&T Tech Services IPO

Fig 4 – L&T financials

  • L&T has low net profit margin of 5.21%. The dividend yield for L&T is 1.24%. The RoCE stands at 10.6% and RoE at 11.33%. This is average performance.
  • This is the third listing from the group after L&T Ltd, L&T Finance and L&T Infotech.
  • L&T has struggled in the last 3 years. Profitability in segments such as power, material handling and metallurgy were flat. In West Asia, there is uncertainty due to falling crude prices. There was slow revenue recognition in Indian projects due to weak project execution and delay in client
  • L&T’s share price gained only 12% CAGR over the last 5 years with CMP Rs 1,518.
  • However we are positive that the investment cycle and infra focus has started as the economy picks up. Sectors like defense, railways, roads and construction are recovering. L&T is best placed to benefit from this, given its exposure to diverse sectors, its strong balance sheet and good cash flow.

News and Updates for LTTS

  • LTTS will double revenues in 3-4 years, per Chairman AM Naik, partly from M&A.
  • LTTS is collaborating with startups to either take or jointly built solutions in the IoT space to its global customers. They believe there is a level playing field for startups with large companies.
  • LTTS is a sponsor of the Nasscom’s centre of excellence for IoT in Bengaluru.
  • LTTS plans to invest in start-ups valued at $50m or less with revenues of $20m which need financial muscle to grow, in areas of IoT, cloud & automation tech.
  • The Indo-American Chamber of Commerce (IACC) conferred LTTS with the Company of the Year award in June 2016. This is the highest distinction conferred by the IACC.
  • LTTS in Aug 2016 opened a new engineering center in Dublin.
  • LTTS collaborated with Redknee Solutions in June 2016, to offer the architecture for enterprises to enable connectivity, analytics and monetization for IoT.
  • Attrition rates at LTTS in Q1FY17, FY16 and FY15 were 13.2%, 12.1% and 14.3% resp., quite low compared to the IT services industry.
  • The company has filed 34 patents and co-authored 134 patents with clients & others.
  • The Rs/$ rate is 66.5. We expect a range of 65-70 Rs/$, over 6 months, a flat outlook.
  • The unofficial/ grey market premium for this IPO is in the range of Rs 95 – 96.
  • L&T Tech Services raised Rs 268 cr. via anchor (institutional) investors on 9th Sept.

ER&D Services Industry Outlook

  • India’s ER&D environment is a healthy mix of service providers, captive centers and start-ups. Currently, there are over 350 captives, with around 60% focused on hi-tech verticals, and the infrastructure and industrial automation realms.
  • Firms spent a total of $ 1,007 billion on R&D and engineering activities such as product & process development, manufacturing engg. and other allied tasks in 2015.
  • India is a of key market for  the setup of ER&D centers. There is a resurgence in the setup of new ER&D centers in India. A total of 44 new offshore centers were set up globally in 2015 and nearly 70% of these were set up in India.
  • India and China are key markets for offshore in-house R&D centers.
  • Prior to 2010, the India-based ER&D service industry was providing low-end services at lower cost and augmenting resources for customers’ R&D. The providers have since moved up the value chain, taking over complex product development tasks, improving quality and decreasing time to market.
  • India’s ER&D industry is in a mature stage, and unlike in the past when cost efficiency was its edge and differentiator, it now has to deliver 1) complex, higher-end services, 2) a good business model 3) a presence across all verticals, 4) complete product development capabilities, 5) a formal innovation culture resulting in IPs and tactical innovations, and 6) fixed price including outcome based and risk reward pricing models. All of this is quite possible, based on the success of IT services.
  • According to NASSCOM, the current phase will lead to increasing home-grown innovation, resulting in higher margins and an increase in value added services.
  • In FY15, in-house ER&D centers contributed $ 12.25 bn to India’s ER&D industry whereas third-party ER&D service providers contributed $ 7.76 bn.
  • We estimate that LTTS had a 5.7% market share in the Indian ER&D market in FY2015.
  • The new trends which have a direct impact on the ER&D services industry include emerging technologies like IoT, robotics, wearable devices and 3D printing.
  • The India-based ER&D services industry grew faster than the global industry. FY15 over FY14 growth rates in the global ER&D industry for in-house R&D centers and third-party ER&D service providers were 7.6% and 8.7%, respectively. In FY15 over FY14, India-based in-house R&D centers grew by 8.3%, and India-based third-party ER&D  providers grew by 12.7%.
  • India-based captive R&D centers are projected to grow at 13.3% CAGR and India-based third-party global ER&D service providers may grow at 14.0% CAGR from FY15-20. Source: LTTS RHP.

Financials of LTTS

JainMatrix Investments, L&T Tech Services IPO

Fig 5 – LTTS financials

  • LTTS’s revenue, EBITDA and PAT grew 18.9%, 40.7% and 34.0% in FY16.
  • The FY17 data is a simple projection of the Q1 FY17 results.
  • The dividend rate is rising. LTTS paid a dividend of Rs 14.2 in FY16, a yield of 1.64%.
  • Revenue growth is moderate, but margin growth is impressive. See Fig 5.
  • The EPS growth is a positive, and it has generated Free Cash Flows, a positive, Fig 6.
JainMatrix Investments, L&T Tech Services IPO

Fig 6 – LTTS cash flows

  • LTTS has a ROE of 38.8% (FY16) making it amongst the best in the industry.
  • The cash per share including Reserves & Surplus plus Cash in Balance sheet is Rs 118/share. So the current operations of LTTS are available at (860-118) = Rs 742/share.

Benchmarking

We benchmark LTTS against peer companies like Cyient, Tata Elxsi, Mphasis etc. See Ex 7.

JainMatrix Investments, L&T Tech Services IPO

Exhibit 7 – Benchmarking

  • LTTS appears to be available at moderate valuations in terms of PE and P/B.
  • It has a high ROE and ROCE, and the dividend yield is good. The strong balance sheet can be leveraged for acquisitions.
  • Utilization rate is the lowest at 71.4% (FY16). But in Q1FY17 it improved to 76.2%, and there is room for improvement. Margins are average, however they are growing fast.

Positives for LTTS and the IPO

  • ER&D services are a very stable business linked to client product launches as it is often a critical activity for them. India offers a number of competitive advantages for ER&D, including technical and managerial talent pool, low costs, stable business environment and an open economy.
  • LTTS is part of the L&T group, which gives it a access to 1) specialized knowledge and talent in many sectors 2) a good customer base in India & Middle East 3) synergies with L&T Infotech in cross selling and sales, where they are working together.
  • The IPO pricing is fair, and at upper band of Rs 860, LTTS’s asking P/E is 25.4 times.
  • LTTS has a good balance sheet. It has high ROE and ROCE numbers with good margins. It has a diversified client base with a majority giving repeat business.
  • L&T used to own preference shares in LTTS, but they were redeemed by May 2016, so there are no outstanding preference shares. This will boost profits of LTTS in FY17 compared to previous years.
  • With revenues > Rs 3,000 crore and employees > 9,000, LTTS is well placed to pitch for and win large size $10-20 million deals and new business in ER&D. With a good geographic spread and employee strength, LTTS has the potential to grow rapidly. Attrition rates are low.
  • Per management it will double revenues in 3-4 years with M&A and organic growth.

Internal Risks 

  • LTTS might engage in acquisitions that may not be successful or meet expectations.
  • LTTS’s business could be adversely affected if they fail to develop new services and solutions or enhance existing services  or if they fail to meet customer expectations.
  • Exchange rate fluctuations could impact financials. Revenues in USD and in Euro amounted to 76.2% and 11.3% of revenues in FY16. LTTS does not hedge against all forex risks. As of now, they have outstanding unhedged forex receivables of Rs 733 cr. and payables of Rs 17.6 cr.
  • Inflation and urban costs increase affects the resource oriented business such as LTTS. It will have to ensure that costs and attrition remain in control.
  • The sister company, L&T Infotech operates in the IT services space and has global clients. While these 2 firms have well defined spaces, there will be many areas of overlap or where coordination among them is required and sales conflict.

External Risks

  • The changes in technology can be rapid, and if LTTS does not adapt fast enough, the firm can be rendered obsolete within a few years.
  • Europe and Mid-Eastern regions seem to be facing slow growth or even recession.
  • A reduction in the R&D budgets of their existing and prospective customers could affect LTTS pricing and volume of work. Similarly customers may stop or reduce the scope of outsourced ER&D work or may set up captive R&D centers, which may result in a reduction in their volumes of work.
  • 94.6% of revenue in FY16 came from existing clients whereas revenue from new customers was only 5.4%. This could be a sign of weak new business & sales pipeline.
  • LTTS has mentioned that it will grow with acquisitions. However the firm has a limited history of acquisitions and the task of M&A integration is complex and risky.
  • The recent group listings of L&T Finance Holdings (2011) and L&T Infotech (2016) met with limited success.

Overall Opinion

  • After the IT services sector growth over the last 2 decades, the ER&D sector appears to be the next generation opportunity for more advanced, sector specific product R&D services delivery. There are big opportunities for India in the global ER&D market. India is already a hub for global small car design, innovation and mfg. It is possible that the ER&D can extend this success to other auto sub sectors, telecom, industrial products, etc.
  • The govt. has set up a Make in India program to grow mfg. However ER&D services seems a more likely candidate for success as it speeds global mfg. and innovation.
  • LTTS has excellent group credentials in the ER&D space with access to L&T knowledge and skill base, and customer networks from L&T and L&T Infotech.
  • So far, the 2 year old company has shown good signs of business solidity. It is the leader in the Indian ER&D space. Most larger peers are software + ER&D players.
  • At a FY16 PE of 25.4 times, the valuations just seem to be fair. However the projected FY17 forward PE of 17.7 times based on the current run rate, looks attractive.
  • The LTTS IPO is rated a medium risk, medium return type of offering. Investors may BUY with a 2 year perspective.

JAINMATRIX KNOWLEDGE BASE 

See other useful reports:

  1. RBL Bank IPO 
  2. New Banks: Big Changes in Small Change 
  3. Equitas IPO – Leader in SF Banks
  4. Dilip Buildcon IPO 
  5. Do you want to be a value investor?
  6. Mahanagar Gas IPO 
  7. How will Brexit impact Indian investors?
  8. A Repurpose for our PSUs
  9. How to Approach the Stock Market – A Lesson from Warren Buffet
  10. Thyrocare IPO – Wellness for your Wealth
  11. Announcement – SEBI approval as a Research Analyst
  12. Alkem Labs IPO
  13. Goods And Services Tax (GST): Integration And Efficiency
  14. Syngene IPO: Good Pharma R&D spinoff from Biocon

DO YOU FIND THIS SITE USEFUL?

  • Visit the Investment Service page to find how you can get more. Or Click LINK.
  • Register Now to get our Free reports and much more, on the top right of this page, or by filling this Signup Form CLICK.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain has a small equity ownership < Rs 2 lakhs in L&T, where he is a shareholder since 2007. Other than this JM has no known financial interests in L&T Technology Services Ltd. or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

RBL Bank IPO – A Grand Revival

  • Date: 18th August 2016
  • IPO price range Rs 224 – 225, Apply from 19-23rd Aug 2016
  • Advice: BUY with a 2 year holding perspective
  • Mid Cap: Rs 7,700 crore Market Capitalization
  • Industry: Bank – Private Sector
  • PE 25.9 times and PB 2.45 times

JainMatrix Investments, RBL Bank IPO

Summary

  • Overview: RBL is a Kolhapur (Mah.) based private sector, universal, full service bank.
  • Total Income in FY16 was Rs 3,235 cr. Topline and PAT grew 57% and 45.6% CAGR over 5 years.
  • RBL occupies several valuable niches such as (50%) Maharashtra operations; agriculture, rural and microfinance focus; a startup focus in Bangalore.
  • The strategy of high growth, aggressive deposit & loan rates, and low margins is sustainable.
  • With new management since 2010, RBL is in a Grand Revival and a good business trajectory.
  • Why BUY: 1) RBL has a good record of business so far in terms of growth, nimble business focus, and differentiation. 2) In terms of valuations, RBL has priced the shares moderately.      3) High quality institutional & PE investors and good management.
  • Key risks: Rural slowdown in Maharashtra and intense competition in BFSI sector.
  • Retail Investors can BUY this IPO with a 2 year holding perspective.

Here is a note on RBL Bank Limited (RBL).

IPO highlights

  • The IPO is open from 19-23rd Aug 2016 with Issue Price band: Rs. 224-225 per share
  • The IPO will raise Rs 1,213 crore totally, as Offer for Sale (Rs. 380 cr.) and fresh issue (Rs 833 cr.)
  • Shares offered to public are 5.39 cr. of Face Value: Rs.10. The IPO offers 14.58% of the post IPO equity base, including OFS from shareholders (1.69 cr. shares) and fresh issue (3.7 cr.). Fig 4.
  • Market Lot: 65 shares and in multiples of 65 shares thereof
  • Objects of the issue are – 1) Two existing PE funds and several smaller investors exit with Rs 380 crores 2) Rs 833 cr. will augment RBL’s Tier-I capital base to meet future capital requirements, loans/advances & investment portfolio, and compliance with Basel III norms and RBI guidelines.
  • Valuations are P/E 25.9 times and P/B 2.45 times at the upper end of price band.
  • The Grey Market Premium for this IPO is Rs 40-50 (on 17th Aug).

Introduction to RBL Bank

  • RBL is a Kolhapur (Mah.) based private sector bank with operations in 16 states and UTs.
  • Total Income in FY16 was Rs 3,235 cr. and Profits were Rs 292 cr. RBL topline and PAT has grown CAGR 57% and 45.6% respectively over the last 5 years.
  • It offers banking to companies, SMEs, agricultural, retail and low-income customers, Fig 1.
RBL Bank IPO, JainMatrix Investments

Fig 1 – Business Segments (FY16) and Fig 2 – Segments Growth (click to view)

RBL Bank IPO, JainMatrix Investments

Fig 3 – RBL Branch Network  and Fig 4 – RBL post IPO shareholding (click image to view)

  • It has 3,871 employees, 201 bank branches & 365 ATMs. See Fig 3.
  • Leaders are N. Ramachandran (Ch’man), Vishwavir Ahuja (MD-CEO) & Naresh Karia CFO
  • RBL has a 73-year operating history. They have transformed in the past 6 years with a new management, from a traditional to a ‘new age’ bank. RBL has expanded presence across India through a new network of branches and ATMs, and upgraded the delivery channels with modern tech-enabled channels like phone banking, internet banking and mobile banking.
  • RBL’s business segments consist of corporate and institutional banking (C&IB), commercial banking (CB), branch and business banking (BBB), agribusiness banking (AB), development banking and financial inclusion (DB&FI) and treasury and financial markets operations.
  • RBL’s capital adequacy ratio (CAR) was 12.94% compared to the RBI mandated CAR of 9.625%. The minimum CAR will increase from 9.625% (FY16) to 11.5% (FY19); an increase of 0.625% every fiscal.
  • In addition RBI requires banks to have an additional capital buffer for absorbing risks so the capital requirement for FY17 would be around 12-12.5%.

Business News and Updates

  • SEBI had provided a conditional go-ahead for the IPO of RBL. It had violated the Companies Act when it made 2 rights issues, allotting shares to 2,591 investors (Feb 2003), and 1,969 (Mar 2006). As per the earlier Companies Act of 1956, an unlisted company is not allowed to allot securities to more than 49 investors in a financial year. In order to fast track the IPO process, RBL has given the exit option to its existing shareholders via buyback offer.
  • RBL is looking to grow 10% above the industry average. Under the new leadership during the last 5 years, deposits and loan book rose 20 and 8 times to Rs 17,099 cr. and Rs 14,450 cr. resp. The operating profit rose 19 times from Rs 19 cr. to Rs 360 cr., and the customer base jumped from 1.5 lakhs to 17+ lakh currently. RBL Bank is aiming for a 1 crore customer base by 2020.
  • RBL launched an exclusive branch for start-ups in Bangalore. It was launched to assist entrepreneurs in setting up new companies/enterprises and offer banking services like FOREX, remittances, cash management and other value-added services with affiliates and partners.
  • Beacon and GPE are the only category 2 (PE) selling shareholders in the proposed IPO.
  • In FY14, RBL bought the credit card & home loan groups of RBS India, with 1.2 lakh customers.
  • The loan portfolio is Rs 21,229 crores. We can see that RBL has a diversified loan book. Fig 5.
JainMatrix Investments, RBL Bank IPO

Fig 5 – Loan Book Industry wise

  • RBL had signed up with IBM for their MobileFirst Platform to build, deploy and manage applications to improve the customer experience & stickiness, and employee engagement.
  • Strategy: RBL, with 60% branches in rural and semi-urban areas, is well-suited to serve the bottom of the pyramid where a slew of new payments banks and small finance banks are also expected to operate. In the past, RBL hired talent from microfinance companies for self-help group, joint liability lending and micro-lending businesses. It also has an expert team for rural agriculture, which involves lending for drip irrigation, cultivation, warehousing and transportation.
  • Personal Visit: A visit to RBL Bank branch was useful. The bank was on a main road, and visibility & location were excellent. The branch layout was good. The sales rep. was polite and helpful. All queries were addressed and there was an effort to cross sell other related products. The bank FD rates were attractive, and overall the urban bank branch had a high-end appeal. Perhaps in future we may become customers …..

Industry Outlook

  • The Indian banking sector remains under-penetrated in comparison to other countries. Even though banking industry has increased reach and scope, there is unmet demand for services.
  • Only 40% of the adult population (45% urban and 32% rural) had bank accounts in 2014.
  • Indian banking grew at a healthy pace, as deposits with banks grew at 16.6% CAGR during FY 07-15 to reach Rs 89 lakh cr. But growth slowed to 10.9% (Mar’15) from 14.6% in Mar’14.
  • Deposit accounts with banks per 1,000 adults increased from 734 in 2012 to 1,358 in 2014. Banking assets increased 14% CAGR from Rs 40.7 lakh cr. (Mar’11) to Rs 68.7 lakh cr. (Mar’15).
  • There was a slow growth in the balance sheets of banks witnessed over FY11-15, mainly due to tepid growth in loans and advances at below 10%. Investments also slowed. The decline in credit growth reflected a slowdown in industrial growth, poor corporates earnings growth, risk aversion from banks due to rising bad loans and governance related issues.
  • RBI & GoI are setting up new policies to expand and strengthen banking infra. Banks in India need to capitalize on these to support economic activity and meet financial needs of all sections of society.
  • PSB’s NPA problem: The PSB loans write-offs jumped sharply in recent years, with the state-owned banks writing off the highest-ever amount of Rs 59,547 cr. in FY16. State-owned banks’ gross NPAs by end FY16 were Rs 4.77 lakh cr. or 9.32% of the total advances. RBI has estimated that this ratio may rise to 10.1% by Mar 2017. PSB’s have recorded NPAs across the board, with corporate loans having for NPA of 11.95%, MSE had 11.13% and agriculture and allied were 6.39% of advances.
  • Recapitalisation of PSBs: The govt. proposed a recapitalization plan for the PSB’s to infuse Rs 25,000 cr. in FY16-17, followed by Rs 10,000 cr. each in FY18-19. This is aimed at shoring up the PSBs lending capacities, currently restricted by poor asset quality and weak capitalization. Moody’s has said that the 11 PSBs would need capital of about Rs 1.2 lakh cr. until 2020.
  • Market share: PSBs account for about 70% of the total banking system assets, down from 75% a few years ago. Robust growth for aggressive private banks happened in parallel to weakening of PSBs.
  • Payment Banks: The RBI in Aug 2015 granted approval to 11 entities to open PBs. PBs are tech enabled new stripped-down banks that will reach customers mainly through mobile phones rather than bank branches. PBs will provide basic savings, deposit, payment and remittance banking services, and will target like migrant workers, low-income households and tiny businesses.
  • SFBs: In Sep 2015, the RBI granted approval to 10 entities to convert to small finance banks.  The aim was to upgrade microfinance firms. SFBs would be similar to the existing commercial lenders and can undertake basic banking activities of accepting deposits and lending. The GoI and RBI have created a policy and regulatory framework for MFI to operate in the country, by setting up MUDRA for refinancing and regulating the MFI sector.
  • All universal banks (including RBL) are of course free to offer similar services as PBs and SFBs.
  • Given the large market share of PSBs, their structural issues, capitalization challenges and high NPAs we feel there is a permanent market share shift taking place to private sector banks & NBFCs. Dynamic banks & NBFCs are seeing ample scope to grow business and provide banking services.
  • The banking industry is a proxy to the overall economy, and one can expect, as a thumb rule, the industry to grow at 2-3 times the GDP growth. The Indian GDP is growing at 7% and  this should improve over the next few years. Basis this, the sector should grow at 14-16% p.a.

Financials of RBL

JainMatrix Investments, RBL Bank Financials

Fig 6 – RBL Financials

  • RBL Total Income, Net Interest Income (NII) and PAT/EPS have grown 57.0%, 56.1% and 45.6% CAGR over the last 5 years. These are very high growth rates. See Fig 6.
  • Profit margins have not suffered during this growth, and have recovered to 9%.
  • RBL has been paying dividend and also increasing this every year, a good sign. The dividend rate has improved over the years from 3% to 15% on FV Rs 10. The dividend yield is still low at 0.07%.
JainMatrix Investments, RBL Bank IPO

Fig 7 – Key Financial Metrics

  • In Fig 7 we map financial metrics of RBL over 3 years. NIM’s have improved marginally and the CAR has fallen marginally. The IPO proceeds should arrest the fall in CAR ratio.
  • ROA and RoNW is low. However RoNW has improved sharply in the last few years. The Gross NPAs to advances were 0.98% and Net NPAs were 0.59% for FY16, these look OK. CASA is low.

Benchmarking

We compare RBL with peers in the banking space (See exhibit 8).

JainMatrix Investments, RBL Bank IPO

Exhibit 8 – Benchmarking

  • RBL leads on 3 year sales growth and 3 year PAT growth.
  • The P/E, P/B and net NPA’s are in the mid-range amongst its peers.
  • RBL has the lowest margins among peers. It also has the lowest RoE in the industry. But this has risen sharply in 2 years. Dividend yield is low, but growth in dividend rate is also good.
  • PAT margin at 9.04% is the lowest among its comparable peers.

Our conclusion is that RBL is combining high growth and low margins. This is in sync with reports that RBL is addressing the semi urban and rural markets. It can prosper as a low-cost leader.

Positives for RBL Bank and the IPO offering

  • RBL is focusing on niche high growth areas. In the semi-urban and rural areas it has a MFI, agro and small business approach. In Bangalore, it has a start-up focused branch for new entrepreneurs.
  • The greatest potential sector within Indian BFSI is microfinance. RBL has focused sharply on the rural sector to combine high growth and low cost leadership. This is a sustainable success strategy.
  • The financials growth rates have been good over the last 5 years. Given this growth rate, the valuations of the IPO of a P/E of 25.9 and P/B of 2.45 do not look excessive.
  • With almost 50% of its 202 branches in Maharashtra, it has a high regional focus and visibility. Mah. is one of the fast progressing, high potential states and RBL is well placed in this region.
  • RBL has a good management team of experienced banking executives built since its 2010 revival. Mr. Vishwavir Ahuja is a post-graduate diploma from IIM-A and has about 35 years of experience in BFSI. The second rung of management too is impressive.
  • RBL uses M&A to grow rapidly. This can be a good means as long as they do not overpay for assets. Successful acquisitions lead to faster growth and improvement in bottom-line.

Internal Risks

  • Banking sector is competitive, with 120+ banks – PSBs, MNC & private Banks, SFBs, PBs, etc.
  • RBL has a concentration risk with exposure to certain industries, and if such sectors experience any sustained difficulties then RBL business would suffer. There are 3 sectors with >5% exposure, see Fig 5.
  • RBL has a concentration risk in loans to customers. Loans advanced to 20 largest borrowers were Rs 4,635 cr., representing 14% of advances. However this to be expected in a small bank.
  • Inorganic growth involves a number of risks. Additionally many M&A opportunities may be overpriced or of over-hyped assets, something RBL has to be careful about.
  • The 45-57% CAGR growth in financials over last 5 years may be unsustainable over the next 3 years as RBL has transitioned from small to midcap. Post IPO we expect a 28-40% growth.

External Risks

  • Our economic outlook is that India is recovering from a 2013 bottom in terms of GDP growth, with lower inflation, lower CAD & fiscal deficit and stable rupee against foreign currencies. However a continued recovery depends on the government policies, good execution and governance by RBI.
  • RBL is an aggressive player that has entered several new potential sectors and can make mistakes that can affect the growth trajectory and brand.
  • RBL is quite rural focused. India is recovering from 2 consecutive drought years that slowed rural demand. This year so far the rains have looked good. However good rains for the rest of this season remains an uncertainty that can affect rural farming output and demand.
  • RBL operates in a highly regulated banking industry and any changes in the regulations or enforcement initiatives may adversely affect their business.
  • RBL is operating in a good environment of falling interest rates. However recently CPI and WPI index rose to outside the comfort zone of RBI, which may trigger a reversal of this environment.
  • RBI has performed well over 3 years under the leadership of Raghuram Rajan. With his term at an end, we worry that in future RBI may not continue successfully on the reform & improvements, rupee defending and inflation control path seen so far.

Overall Opinion

  • India remains underbanked and in fact a number of NBFCs, MFIs and dynamic private banks are seeing an amazing growth in recent years, trying to fill these spaces. Private banks will grow fast and gain market share over PSB’s in a growing economy.
  • RBL has a good record of business so far in terms of growth, nimble business focus, and differentiation. The strategy of high growth, aggressive rates and lowest margins is sustainable.
  • Given the high growth, in terms of valuations, RBL is not expensive. However there is not much on the table for immediate gains.
  • Since the new management took over in 2010, RBL has seen A Grand Revival and entered a good business trajectory.
  • The key risks are rural slowdown in Maharashtra and high competition in the BFSI industry.
  • The IPO is rated a medium risk, medium return offering.
  • Retail Investors can BUY this IPO with a 2 year holding perspective.

JAINMATRIX KNOWLEDGE BASE 

See other useful reports:

  1. New Banks: Big Changes in Small Change 
  2. Yes Bank – A Rediscovery – April 2014 report
  3. Equitas IPO – Leader in SF Banks
  4. Dilip Buildcon IPO 
  5. Do you want to be a value investor?
  6. Mahanagar Gas IPO 
  7. How will Brexit impact Indian investors?
  8. A Repurpose for our PSUs
  9. How to Approach the Stock Market – A Lesson from Warren Buffet
  10. Thyrocare IPO – Wellness for your Wealth
  11. Announcement – SEBI approval as a Research Analyst
  12. Alkem Labs IPO
  13. Goods And Services Tax (GST): Integration And Efficiency
  14. Syngene IPO: Good Pharma R&D spinoff from Biocon

DO YOU FIND THIS SITE USEFUL?

  • Visit the Investment Service page to find how you can get more. Or Click LINK.
  • Register Now to get our Free reports and much more, on the top right of this page, or by filling this Signup Form CLICK.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no known financial interests in RBL Bank or any related group. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

Source for Data – RBL Bank Ltd – RED HERRING PROSPECTUS dated August 4th, 2016, company website, news reports, etc.