Indian IT Services Sector – Add the Digitals

February 26, 2021March 10, 2021Leave a comment

JainMatrix Investments presents an Industry report on the Indian IT Services sector. It’s a sector that is growing at 8-10% annually and has significant share in global outsourcing. An ecosystem of good college education and a large pool of talent, feed a clutch of globally competitive Indian IT Service firms. The digital demand has only grown post-covid, so the industry is looking at many years of global growth in early double digits. See the Conclusion section for our recommended IT Services portfolio.

We make our 11th Jan 2021 IT Services sector report public for your investing pleasure and success.

Additional sector reports: Happiest Minds IPO – Ride the Digital Wave – Sept 2020

LT Tech Services IPO – The Make in India Firm – Sept 2016

Introduction and Profile

Indian IT services industry started over 30 years ago, but is now very large with revenues US$ 191 billion (INR 14 lakh crores). About 81% of revenues are from exports. See Fig 1a.
It has 17,000 firms & is an emerging global hub for Digital Skills, with 75% of global digital resources.
IT Services have contributed 7.7% to the India GDP in 2019 which is expected to grow to 10% by 2025 (IBEF). In FY19, the industry employed 41 lakh people. It is also fueling innovation, as there are around 5,300 tech start-ups in India.
Exports rose at a CAGR of 8.05% during FY16-19. Export of IT services has been the major contributor, accounting for 54% of total IT export (including hardware) during FY19.
Globally, the sector is headed towards achieving USD 1 trillion (INR 75 lakh crores) of revenues by 2022.

Fig 1a – Market Size in India and Fig 1b – Share of Demand by Country

USA dominates global Country Share of demand, with EU, China and Japan coming next, see Fig 1b.
In Fig 1b, market share of Indian IT industry looks small but this is domestic demand in USD. India is a dominant supplier of IT services globally and has the fastest growing industry in the world with most key players having a HQ or development centers here.
BFSI is a key business vertical for IT & BPM industry, in terms of major revenue-share. Adoption of new technologies is needed for growth & competitive advantage in Banking & Insurance domain.
Other important sectors are Life Sciences & Healthcare, Retail & CPG, Communications & Media, Manufacturing, Telecom and Technology & Services.
Indian IT industry’s USP is cost competitiveness, good skills, resource availability and project management skills for providing IT services.
Tier II and III cities are gaining traction among IT firms aiming to grow business in India, facilitated by skilled local resources, affordable real estate, favorable Govt. regulations, tax breaks and SEZ schemes. A hub and spoke model is developing with Tier I city as hubs and tier II, III and IV as spokes.
India is a top location for Global Capability Centers (GCCs), which concentrate on workers and infra to handle operations (back-office, corporate business-support, accounting & finance, transaction processing and contact centers) and IT support (app. development and maintenance, remote IT infra, and help desks), to enhance productivity. Some large companies use GCCs as a center of excellence for innovation and research.
About 70% of India-based GCCs belong to US companies, 20% European and 10% Asia-Pacific.
According to Nexdigm, India is home to over 1,750 GCCs, which is 50% of all such centers globally. GCCs here employ over 10L employees, generating a total economic value of around $28.3 billion.
IT Services in India are growing at a fast pace due to the globally competitive firms that provide world-class services. The Human talent pool available in India is highly skilled and trainable, a key strength of the IT Services sector. The IT infra here has also developed to global standards.

IT Sector Progress and News

NASSCOM (National Assn. of Software & Services Cos.) launched an online platform to up-skill 40 lakh tech professionals. It partnered with GE Healthcare for digital healthcare solutions for the market.
IT service firm DXC Technology, will set up its first global analytics unit in Bengaluru.
Govt. of India (GoI) announced a national program on AI (artificial intelligence) and a new National AI portal. GoI has identified IT as one of 12 champion service sectors for developing an action plan. It has set up a ₹5,000 crore ($ 745 m) fund for realizing the potential of these champion service sectors.
As of Feb’20, there were 421 approved SEZs (Special Economic Zone) across the country, and of these, 276 are from IT & ITeS. These provide tax incentives for exports. Software Technology Parks of India (STPI) has set up 57 centers for single window clearance and infra facilities, and for Excise Duty exemptions on buying local goods.
Technology for many businesses was considered a support function. This has changed as tech. has become business critical, enabling employee productivity, revenue growth from eCommerce, cost savings and faster customer support & communication.
TCS took the #1 spot with M-cap of $144 b among IT Services organizations, dethroning Accenture which is trailing by just $1b (Dec ‘20).

Impact of Covid

In Q1FY21, Indian IT sector has emerged as a winner post lockdown. With Work from Home (WFH) at 95%, all the big IT firms saw robust demand from clients, particularly cloud & automation. Infosys gained in revenue and profits; IT index gained 22% in July. Similarly in Q2FY21, IT sector gained due to increased tech spending by clients in digital transformation.
Due to automation, spending on IT infra has outpaced HR. Job creation has been limited with offers being rolled out more on contractual basis than full-time, in both emerging & developed markets.
Many firms found that WFH employees are equally productive & this saves real estate costs as well. It also relieves firms of covid related responsibility and litigation.
IT Deals – Indian IT stocks jumped by 50%, on an average, between Mar-Sept ’20. Top IT firms have been closing deals – Infosys closed 2 big deals, Vanguard and Consolidated Edison (digital transformation); TCS won deals from Phoenix Group (life insurance and pension) for client analytics tool, and Morrisons (retail); Wipro from Marelli (auto software engg.) and HCL Tech from Ericsson.
Broker comments: Girish Pai of Nirmal Bang said that global clients shifted spending from internal IT, selling, general and administrative (SG&A) and hardware, to outsourcing and digital, to speed up the digital transformation processes such as migration to cloud.
Motilal Oswal, a brokerage firm, said that demand & utilization has normalized to pre-Covid levels with discussions being revived for deferred deals and margins expected to be resilient as well.

Relative Price Performance

The graph in Fig 2 – Relative Share shows the stock returns given by listed Indian IT Services firms over Oct’18 – Jan’21.
We can see that performance was steady for these firms till early 2020 in a +25 to -10% ranges, then there was a sharp fall due to Covid. Recovery came by July’20 and in next 6 months there was a dramatic price rise for many of them.
On the right side we can see the resultant share performance by order for the 2+ years.
Among large caps, L&T Infotech is #1, marked L1, Infosys #2, HCL Tech #3 and next are Wipro #4, TCS #5 and Tech Mahindra #6. Among mid-caps, the rankings are Persistent is #1, marked M1, others are Mindtree #2, Mphasis #3, LTTS #4 and Sonata Software #M5.
Even so, the entire IT Services pack has performed very well as even the lowest performance was 42% gains over 2+ years, while the highest is an amazing 179% gain.

Fig. 2 – Relative Share Price

Large Cap Firms – Benchmarking and Sales Charts

Fig 3a – LC revenue and Fig 3b – MidCap

In Fig 3a we map the FY20 revenues for Large Cap Firms. Revenue from exports is the major source.

TCS has the highest sales by value, almost two-fold to the nearest competitor Infosys.
In terms of India revenues, Tech Mahindra has the highest domestic sales followed by TCS.

Fig 4a – LC Benchmarking

In Fig. 4a – Benchmarking, we compare large cap IT services firms on key financial parameters.
The leader is marked in green and the laggard in red. The sum total of these parameters is the Score.
We can see that TCS is a clear leader, including RoCE and Return of Equity, while Wipro lags on this comparison amongst 6 large cap firms. L&TI however appears as a growth and profit leader.

Mid-Cap Firms – Benchmarking and Sales Charts

In a similar manner, we compare mid cap IT services firms. In Mid-cap basket, Sonata is the leader on financial parameters, including RoCE and RoE, whereas Persistent lags among the 5 firms.

Fig. 4b – Mid-caps Benchmarking

Among mid-caps, Mphasis has the highest revenues or sales, followed by Mindtree.
Sonata Software has the highest domestic sales by value and proportions.
Fig 4b above captures the MidCap firms revenue by domestic and exports.

Future of the Indian IT Services Industry

The comparative advantages of the country are – young population, good college education and ample science and technical courses. These feed this sector with quality resources.
India is developing as a critical part of execution and delivery of global business and IT Services, across industries & locations. Firms like TCS are covering more countries & expanding the market.
The growth of Telecom networks like 2G-4G and now 5G are bringing the world closer.
Covid has actually accelerated the rise of digital, eCommerce, internet and the IT Services industry. As larger firms enforced WFH for their employees’ safety, the physical presence has become unnecessary for work, for large swathes of industry.
TCS as the #1 firm globally in terms of market capitalization has been able to sustainably mix high margins, high growth and a global vision. The other firms in the industry are growing in its wake and developing their own niches and strengths.
The industry is looking at many years of global growth in early double digits, even as IT services take early baby steps of growth in its own backyard, India. With programs like Aadhar card, UPI payments, GST, digital tax filing and FASTag, technology is proving the best way to transact at scale with speed and transparency, and also reduce corruption.
The success of the Indian IT Services firms has spawned the second generation of services firms such as Syngene Intl. (pharma R&D) and Tata Elxsi & LTTS (Engineering R&D) which are niche services players by technology or industry.
The key new IT services trends are WFH, cloud services, AI, IoT, robotics, mobile apps and machine learning.

Conclusion:

IT Services firms are always going to be needed to stitch together solutions for large Enterprises, and to help them navigate, evaluate and deploy in complex IT landscapes with multiple technology options.
Indian IT services companies have time and again proven their mettle and have the skilled resources and project management skills to deliver successfully. It is a dynamic, globally focused sector.
The 11 firms had an excellent share price performance range of 42% to 179% gains over 2+ years.
The weak INR may help India to continue to be a good base for service delivery teams and exports.
Large Caps: A LC IT Services portfolio will be more stable and safer for investors. We conclude from Fig 2, Fig 3a, and Fig 4a that of the 6 LC firms, the best 3 are L&T Infotech, TCS and Infosys.
Mid-Caps: A MidCap IT Services portfolio will be more volatile, but possibly provide better returns. We can see from Fig 2, Fig 3b and Fig 4b that of the 5 LC firms, the best 2 are Mindtree and LTTS.
We recommend investors to buy this 5 firm portfolio in an equi-weight mode.

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 equity holdings in LTTS, Sonata Software, TCS and L&T Infotech, all <1%. Punit Jain has worked at TCS (1995-2002) and in Sonata Software (2003-2012). Other than this, JM has no known financial interests in any of these firms. 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 JM at punit.jain@jainmatrix.com.

Indian Automobile Sector – A Solid Portfolio

January 29, 2021January 29, 2021Leave a comment

Here is an Industry report on the Indian Automobile sector. It’s a sector that suffered weak sales post covid, but has recovered quite sharply in the last few months. The growing confidence and global growth plans of Indian auto firms can see the rise of many Indian auto MNCs in the next few decades. We recommend investors buy an Auto portfolio of Escorts Ltd., Eicher Motors, Bajaj Auto, Hero Motocorp, and Maruti Suzuki.

We make our Dec2020 Auto sector report public for your investing pleasure and success.

Additional sector reports: Eicher Motors – It’s Firing On Both Engines

Hero Motocorp – A Splendid Core Holding

jainmatrix investments, auto sector report

Introduction

The automobile industry of India is in the top 5 markets in the world. It is one of the driving forces of the Indian economy, contributing 49% to the mfg. GDP and 7.5% to overall GDP. The sector’s value chain employs about 3.2 crore people, directly or indirectly.
The auto sector can be divided into four sub-segments: Passenger cars, Two- Wheelers, Tractors and Commercial Vehicles (PC, 2W, TT and CV). The segment shares by volume is depicted in Fig. 1

2W and PC dominate the domestic Indian auto market. Passenger car sales are dominated by small and mid-sized cars. 2W and PCs together had a combined sale of over 2.01 crore vehicles in FY20.

Sector Market Shares

The brand which dominates in the 2W segment is Hero MotoCorp having 36% market share, as depicted by Fig. 2a. In the case of TT, it is (M&M) Mahindra and Mahindra (41.17%), see Fig 2b.

Fig 2a and 2b – Market share by firms – 2W and Tractors; Fig 2c and 2d – PC and CVs

In the PC Vehicles, it is Maruti Suzuki (51.30%), Fig 2c, and in case of CVs, it is M&M with a market share of 35.04%, Fig. 2d.

Electric Vehicles – In the year 2020 the electric vehicle market in India took off. The Auto Expo 2020 in Feb saw the introduction of many EVs of different sizes and prices from the automakers. The models that were soon commercially launched were Tata Nexon EV, Morris Garages ZS EV and Mahindra eVerito. M&M also launched the Mahindra eKUV100 at the Auto Expo 2020 and has priced the car from ₹8.25 lakhs making it the most affordable electric car in India.
The shift of industry towards electric vehicles has brought uncertainty in the sector. Govt. goal of 100% electrification in auto industry has open doors for the new products in India.
However, electrification is the initial phase in India. EVs may find it difficult to grow significant share without 1) Tax benefits from GoI 2) an EV make, charge and repair ecosystem 3) the entry of luxury EV products from Tesla, JLR (Tata Motor) and Audi, that can make the products attractive.

Auto Industry Updates

Auto exports reached 47.7 lakh vehicles in FY20, growing at a CAGR of 6.94 % during FY16-FY20. 2W were 73.9% of vehicles exported, PCs were 14.2%, three wheelers at 10.5% and CVs at 1.3 %.
In Nov’20, FM announced the ₹2 lakh crore production-linked mfg. incentives (PLI) to encourage companies in 10 sectors to boost local mfg. and increase exports. The auto sector, including vehicle makers and parts suppliers, will receive the biggest share at ₹57,000 cr. The export-related revenue and localization of production are the two primary criteria for benefits.

Fig 3 – Sector Wise Sales

The Corona pandemic caused a 2020 slowdown of Auto Industry, which was already been performing poorly in FY20. In FY21 auto companies are expected to have weaker sales numbers. Trading tension between India and China, can also affect the Industry, as 27% of auto parts are and imported from China. Indian mfg firms are looking for alternative to Chinese imports.
Millennials don’t prefer owing a car due to high maintenance cost and availability of local taxi rides.
Fig 3 explains the sales pattern of four sub-sectors of automobile sector for the period of five financial years. Figure clearly depicts that Indians preferably choose two-wheelers. Every sub sector has seen a downfall in FY20 after the increase in the recent years.
Two Wheelers – India is the largest mfg. of 2W in the world. 2W market has grown rapidly for Indians because of convenience and low cost of ownership and is expected to grow at a CAGR of 7.33%. Recently, industry has seen a downturn due to rising fuel prices, safety concerns, BS-VI norms and covid uncertainties. Motorcycle consisted of around 65% of the total 2W sales in the FY20, followed by Scooters and Mopeds with contribution of 32% and 3% respectively.
2W sales in India reached an all-time high in 2019, when they sold some 2.1 crore units. This figure is almost double the 2011 sales, when just 1.18 cr. two-wheeler units were sold in India.
Passenger Cars – In Nov’20, India’s domestic PV sales rose 12.73%, due to ease in lockdown restrictions & increase in demand due to festive season. Maruti Suzuki has been a dominant player in PV sector, owning a market share of more than combined of all the rivals. Motor vehicle sales in India have doubled between 2008 and 2018, but has been seeing downward trend recently. Various regulatory norms have impacted the automobile sector to change their production methods leading to increase in cost.
Commercial Vehicles – In 2018, India was the world’s 3rd largest CVs market and the fastest growing globally. Various factors affect the sales of CVs i.e., mfg. and agricultural output. India has faced the shift of emission standards from BS IV to BS VI from April 2020 leapfrogging BS V, a move that is aimed to curb threatening levels of air pollution in urban areas. Many CV mfg firms are looking to adopt EV tech, keeping the future developments in consideration. Majority of the CVs are Load Carrier Light CVs (LCVs) followed by Medium & Heavy CVs (M&HCVs).

Fig 4 – Tractor Market

Tractors – The tractors market is quite dependent on the seasonal rainfall, overall GoI MSP and pricing, and demand conditions. This year has been positive for agriculture sector with good rainfall (in fact floods in some areas), firm GoI pricing and otherwise healthy demand. The migration of workers from urban to rural in May-June this year also helped in labour availability. The rural economy was relatively unaffected by lockdowns and covid. See Fig 4 – Tractor Market.
The tractor market was impacted by closure of dealerships, but rebounded well by June itself.
The new trend is development and export of cutting edge new tractors from India.

Why is Auto sector doing well in India?

The sector has grown on account of traditional strengths in mfg., and cost advantages of abundant low-cost skilled labor, and significant foreign direct investment (FDI) inflows.
The GoI has allowed 100% FDI under the automatic route. The GoI aims to develop India as a global mfg. center and a R&D hub. Under NATRiP, the GoI is planning to set up R&D centers at a cost of US$ 388.5 m to enable the industry to be on par with global standards.
With a population of more than 130 cr. people, the addressable market for vehicle sales is large. A growing working population and expanding middle-class have been the demand drivers for auto in India. We have the second largest road network in the world at 4.7m km. The GoI policy to set aside substantial investment layout for infra development in every 5-year plan has included the focus on roads. This has given a fillip to the demand for cars and other vehicles.
The global auto industry has embraced digital. Revenues generated by online vehicle retail, after-sales, and services are likely to grow almost five times, from about $120 billion in 2018 to about $605 billion by 2025. Volkswagen launched the Digital Workplace initiative across its dealerships in India around two years ago.
There are various developments in Indian Auto sector which has triggered its growth. In Sept 2020, Toyota Kirloskar Motors announced investments of more than ₹2,000 cr. in India directed towards electric components and technology for domestic customers and exports. Also, M&M signed a MoU with Israel-based REE Automotive to collaborate and develop commercial EVs. In April 2020, TVS Motor Company bought UK’s iconic sporting motorcycle brand, Norton, for a sum of about ₹153 cr., making its entry into the top end (above 850cc) segment of the superbike market.
India has engineering and design centers for many global auto firms. Here maintenance and upgrade work of current models as well as planning & engineering work for new launches, and product development work is done by skilled engineers in an IT enabled environment in close coordination with teams in many countries. Thus an auto ecosystem has developed in India of skills, local manufacturing, OEMs, components, and global business centers.
India also has various cost advantages. Auto-firms save 10-25% on operations vis-à-vis Europe and Latin America. India has a well-developed, globally competitive Auto Ancillary Industry and established automobile testing and R&D centers.
India is a prominent auto exporter and this segment may grow in the near future.

Benchmarking of Key Players

We have done a benchmarking of selected Auto sector players. Fig. 5 depicts the comparison between the selected Indian companies on basis of key parameters.

Fig. 5 – Benchmarking

In this peer group, Bajaj Auto showed best returns (ROCE & ROE) & even dividend yield, and is the lowest in terms of debt as well as being undervalued. Eicher Motor and Escorts were not far behind.
Profitability was negative in FY20 for Tata Motors & Mahindra and 3 year cagr profit is negative for many firms. The leader on this parameter is Escorts.
Margins are the best for Eicher Motor and next for Bajaj Auto. Eicher Motor has operations in niche high margin segment while Bajaj clearly shows once again its efficiency in operations.
Among these auto companies, the best positive outcomes and Score are of Bajaj Auto and Eicher Motors in two-wheeler segment, Escorts in Tractors and Maruti Suzuki in Passenger Car segment. TVS Motors and Tata Motors appear weak from this group.

Relative Prices

Fig 6 – Relative Prices

Fig 6 – Relative Prices shows the stock returns given by major listed Indian auto firms by keeping the base of prices as 29^th Oct 2018. On the right side we can see the share price performance by order.
The share prices fell sharply when the first lockdown started, but soon had a V-shaped recovery. We can see that 7 of the 10 firms have emerged in the positive by now, over a 2 year period.
Escorts Group is the #1 in this group and has posted high returns of 140% gains. The agriculture sector has done well even in lockdown times and there has been a good rainfall too. Escorts Group has been increasing its market share by launching new models recently.
In the group #2 is Bajaj Auto, #3 is Eicher Motors, #4 is Hero Motocorp, and #5 is Maruti Suzuki. Relative underperformers are Ashok Leyland, Tata Motors and TVS Motors.

Future of the Indian Auto Industry

A young population, rising GDP and growing middle class will drive domestic demand for automobiles in India. This will be aided by a healthy domestic industry that is innovative and producing at scale.
Several Indian automobile firms have global expansion plans for sales, mfg. and exports. These include Eicher Motors, Hero Motocorp and Bajaj Auto. Maruti, Hyundai and Escorts among others use India facilities for exports.
India is expected to emerge as the world’s third-largest PC market by 2021. In FY 2018-19, sale of PC has increased by 2.70%, 2W by 4.86% and 3W by 10.27% as compared to FY 2017-18.
From just small cars, India will grow as a hub for design, components and mfg. of all automobiles.
Auto companies like Kia Motors, MG have entered the Indian market with premium vehicles and are making a mark by selling in higher volumes. Many automotive companies are looking to enter the business in India which can result in cut-throat competition, and will push Indian companies to innovate and increase the quality of their product to retain their market share.

Conclusion

Automobile sector will continue to grow in India due to rising domestic demand, growing strengths in outsourcing of engineering services to India, and global growth plans of Indian OEMs. The supporting ecosystem of auto component manufacture too is developing in tandem.
The weak INR may help India to be a good base for manufacture and global exports.
In 2W India is already #1. In the PC and CV categories, India became the #4 largest market in 2019 displacing Germany with about 3.99 m units sold. India may displace Japan for #3 by 2021.
The growing confidence and global growth plans of Indian auto firms can see the rise of many Indian auto MNCs in the next few decades.
The key new auto sector trends of digitalization, software based auto controls and EVs can also be accelerated by India based R&D and developer firms.
We can see from Fig 5 – Benchmarking and Fig 6 – Relative Prices that 6-7 firms out of the selected 10 for this study are performing well on many parameters and should continue to lead.
We recommend investors buy an Auto portfolio of Escorts Ltd., Bajaj Auto, Eicher Motors, Hero Motocorp, and Maruti Suzuki in equi-weight mode.

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 stock ownership positions in Escorts Ltd. (since Feb 2017) and Eicher Motors (since June 2017) out of all firms mentioned in this report, and they are small (<1%). Other than this, JM has no known financial interests in any firm mentioned here. 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 JM at punit.jain@jainmatrix.com.

Burger King India IPO – Try the Whopper!!

December 1, 2020December 1, 2020Leave a comment

Date 01st Dec; IPO Opens 2-4th Dec, at ₹59-60/share
Small Cap: ₹ 2,438 cr. Mkt cap
Sector – Restaurant chain, QSR
Valuations: P/E negative, P/B 10.5 times, EV/EBITDA 4.4.
Loss making entity; profit looks 2 years away, so this is a private equity type, high risk investment
Advice: SUBSCRIBE

Summary

Why Buy Now: The Burger King chain is at an early stage of growth in India. The organization and structure set up looks good to handle the growth imperatives.
The Burger King brand is quite strong in India.
We expect profitability in BKG in 2 years, by FY23, even as it grows rapidly in revenues and outlets. Once this happens, BKG valuations will rise and this IPO entry price will look attractive.
Relative to other MNC QSR chains in India, BKG valuations look reasonable.
It has handled the covid period well, reducing costs and getting by. We expect normalcy in revenues to return in H2FY21.
Risks: 1) Loss making entity; profitability looks 2 years away, so this is a private equity type, high risk investment 2) Intense competition from Indian and MNC QSR chains in Tier 1 towns 3) Covid induced challenges – demand from customers as well as employee health. 4) High royalties to Principal.
Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

JainMatrix Subscription Pricing and Payment Options

JainMatrix Investments reports….

Here is a note on Burger King India IPO (BKG) IPO.

IPO Highlights

The IPO opens from 2-4th Dec 2020 in a Price Band of ₹ 59-60 per share
The IPO includes a Fresh Issue of ₹ 450 cr. and Offer for Sale (OFS) of 6 cr. shares. So the total IPO size is max 810 cr. of about 13.5 cr. shares, and about 35.5% of the equity share capital.
The promoter is QSR Asia and it owns 94% in BKG which will fall to 60% post-IPO.
The main objects of Fresh Issue are funding new Company-owned Burger King Restaurants by 1) Repayment of borrowings taken for this of ₹ 165 cr. and 2) Capex for new Restaurants ₹ 177 cr. 3) Remaining ₹ 108 cr. are for general corporate purposes like paying for this IPO.
The promoter is a PE firm and the listing will help to monetize and profit from investments.
The lot size is 250 shares and Face Value ₹ 10 per share
The IPO share quotas for QIBs: Non-Institutional Investors: Retail is 75:15:10%.
The unofficial/ grey market premium of BKG is ₹ 20-25 /share over IPO price. This is a positive.

Introduction

Burger King India is one of the fastest growing international QSR (Quick Service Restaurant) chains in India, started in Nov 2014.
In FY20 the Revenues, EBITDA and Profits of BKG were ₹ 847 crore, ₹ 105 cr. and ₹ (77) cr. resp.
It already has 261 restaurants across 57 cities, including Delhi-NCR, Mumbai, Pune, Chennai, Hyderabad, Bengaluru, Chandigarh and Ludhiana.
The restaurants serve food and beverages, see Fig 1a, with offerings like:

Fig 1a – Menu Range, Fig 1b – Cluster Map and Fig 1c – Outlets by Region

The globally recognized Burger King brand, also known as the “HOME OF THE WHOPPER®”, was founded in 1954 in USA and is owned by Burger King Corp., a subsidiary of Restaurant Brands Intl. Inc. The Burger King brand is the #2 largest fast food burger brand globally by number of restaurants, with a network of 18,000 restaurants in 100 countries and USA.
BKG has used a well defined restaurant roll out and development process. The Principal (BKG AsiaPac) helps and supports in this process.
BKG AsiaPac has to be paid monthly royalty (of 4-5% of sales annually). BKG is also required to pay BKG AsiaPac a non-refundable one-time fee on opening each new BK Restaurant of US$15k (₹11.25L), increasing to $25k (19L) from CY 2020-22 and US$35k (26L) for all periods thereafter.
Everstone Capital, the Singapore-HQ India-focused mid-market PE firm, owns 99.39% stake in BKG India, through investment vehicle QSR Asia Pte Ltd.
As of Sept 30, the number of BKG employees was 4,836.
Key leaders: Shivakumar Pullaya Dega (Chairman and Independent Director), Rajeev Varman (CEO and Whole Time Director) and Abhishek Gupta (Chief of Biz. Dev. and Operations).

News, Updates and Strategies

Burger King India aims to have 370 stores (101 additional) by Dec 2022. Under the Master Franchise and Development Agreement (MDA), BKG is required to develop and open 700 restaurants (both Company-owned and Sub-Franchised) by Dec 2026. This agreement renewal is by Dec 31, 2039.
Fund raising through the IPO will be used for expanding its store base in India and reducing debt.
The Indian promoter is a private equity firm Everstone Capital, even as BKG works under a MDA with Burger King Corp. USA.
Based on the FIFO methodology, Everstone will earn 3.58 times returns on its 7-year investment. Its cost of investment (of the IPO shares) is pegged at ₹ 110 cr. In return, it will fetch ₹ 360 cr. from the partial exit at upper end of IPO band, per VCCircle.
The company’s average meal ticket size is ₹ 500-550.
Covid had a massive impact on BKG, as first a lockdown, and later the containment zones, lack of permission from authorities and public fear of infection kept away dine in customers.
BKG responded by reducing costs: it negotiated with landlords on rentals, reduced inventories, etc.
In Sept 2020, the number of BKG employees decreased to 4,836 employees compared to 6,141 in Mar due to attrition, effect of Covid, and redundancies.
On date of RHP of 25^th Nov., out of 268 total restaurants, only 249 are operational.
BKG has a strong supply chain for all food ingredients and raw materials, to ensure traceability, freshness, long term contracts, low prices and quality ingredients.

Food Industry Outlook in India

The Indian food service sector can be divided into 4 segments, see Fig 2.
QSR have fast food cuisines and minimal table service, and cater to youngsters and working professionals, offering quick delivery of food, good ambience and option of home delivery. QSRs generally target people in the 16-35 years range. Frequency of eating out (4-5 per month) is low so there is headroom to grow.
QSRs are the most preferred destination, followed by casual dining restaurants when it comes to eating out, per the India Food Services Report 2016, made by the National Restaurants Association of India (NRAI) and consulting firm Technopak Advisors Pvt. Ltd.
The most popular eating out options in India are North Indian food (28% of the time), followed by Chinese (19%) and South Indian style (9%), according to a Livemint.com report.
Restaurants, cafes and international fast food outlets have proliferated in India and eating out has become popular. About 81% of consumers prefer to eat out, and 19% get delivery or takeaway.
The QSR segment is nascent and has a lot of scope for growth in India. A large number of global QSRs have established their outlets with franchise rights of various companies like McDonalds, KFC, Pizza Hut, Subway, Taco Bell, Burger King and Domino’s, in addition to Indian QSRs.
BKG has a 5% market share in India’s ₹ 34,800 crore QSR market.
With factors such as urbanization, rising income levels and improved investment climate, the food service sector holds a huge opportunity. The sector has observed tremendous development in the past 3 years, which grew at 11% CAGR during 2015-19. The sector is estimated to grow at a 9% CAGR by 2022-23 (Source: NRAI India Food Services, IFSR 2019).
GST rate cut from 18% to 5% for the restaurant business was a significant tailwind for the sector, and generally led to a sharp recovery in SSSG’s.

Financials of BKG

BKG revenues, EBITDA and PAT over the years are in Fig 3a. The firm grew revenues well over 3 years, and is EBITDA positive but loss making.
A possible profit in FY21 quickly became a loss in H1 due to Covid.
In Fig 3b we can see that from a FCF positive FY18, the firm has made many investments and become FCF negative in FY19-20. We can also see the number of outlets by FY.

Fig 3a – BKG Financials and Fig 3b – Free Cash Flow

Benchmarking

We benchmark BKG against listed food service firms, entertainment firms and the principals. See Fig 4.

Fig 4 – Benchmarking

As a loss making firm, PE is negative for BKG. So valuations are tracked using P/B and EV/EBITDA. On these parameters, the valuations of BKG are lower than the others. This is positive.
Sales growth has been good at BKG. On Profits BKG is in the negative.
D/E ratio is low, may fall after IPO. One of the objects of the fresh issue in IPO is to reduce debt.
Margins are still on the lower side as BKG is building scale for its operations.
Return ratios are low due to losses.
The Revenue per outlet is low, perhaps reflecting BKG is a newer restaurant chain.
Putting this together, we sense that BKG is an asset available at low valuations due to current losses. It’s entirely possible that if not for covid, BKG may have been much less lossmaking by now. Post covid, BKG should focus on growth, with branch expansion, brand building and consumer loyalty.

Positives for BKG and the IPO

Burger King is a strong global brand. It’s been handled well so far in India with high street, airport and malls locations of restaurants, good visibility and positive customer reviews.
As a customer, my visit to BKG in 2018 in Bangalore was memorable and the focus is excellent with burgers available in both veg. and non veg. It was tasty and fairly priced, and a good experience.
The core offering of burgers can work for both snacks and meals for the Indian palate. Traditional consumers may not be satisfied as it’s a light fried meal, but others can find it novel and tasty. The BKG brand is well positioned for the millennial customers.
The global franchise model has succeeded for competitors in Indian markets, and the BKG rollout looks like a lower risk proposition that has a fairly unique offering and good chance of success.
The growth plans of 700 outlets by 2026 looks achievable and necessary to get a scale of operations.
The firm has an experienced, passionate and professional management team
Due to the covid infection, BKG has been able to bring down its costs structures. In particular, real estate costs for QSR may reduce and stay low for some time. Employee nos too have reduced.
BKG has an MDA with Burger King USA is till 2039, giving a good visibility.

Risks & Negatives for BKG in the IPO

The covid pandemic has been a blow as BKG has switched from a growth mode to a ‘cutting costs’ and survival mode for H1, to get by during this dip. Even today after most of the outlets reopened, there is a demand issue as customers are worried about public gatherings and infection spread. The economic impact of covid means that people celebrate less and even eating out may be done at more ‘economic’ or ‘reasonable’ priced outlets than BKG. At the luxury end, demand is down.
- Having said this, our opinion is that in T1 cities, demand will normalize in Q3FY21 and a combination of takeaway and home delivery should be able to bring demand back.
BKG has not declared a profit so far in all these years. As a result, the IPO has been allowed by SEBI but the Retail portion is retained at the lowest, 10% of shares offered, due to higher risks.
- So on PE we have a negative value, but on other valuation parameters like PB and EV/EBITDA, BKG looks attractive and undervalued.
BKG directly competes with McDonalds and Subway in India on bread based light food options. Thus this QSR food subcategory looks a little crowded and top heavy.
BKG is at an early growth phase in its Indian network. There is a possibility that it may take several years to make a profit or dividend as it opens new outlets and invests in branding and supply chain.
Investors looking for normal valuation parameters may not find this attractive. Conversely this investment may only give good gains over several years.
Food delivery aggregators like Swiggy and Zomato intensify competition by offering massive choice and delivery to customers. BKG partners with them, but they get large commissions on orders.
Royalties for BK USA are high and a big hurdle to franchisee profitability. In FY18-20 they were ₹ 12, 24 and 34 crores for BKG.

Overall Opinion and Recommendation

QSR has a good future in India with improving affluence, and a growing eating out culture. Beyond the FY21 covid blip, this category should grow fast.
The social type businesses like BKG have been hardest hit by covid. As a result, the BKG IPO offering is undervalued. Most stock investors today are ignoring H1FY21 results, and high but temporary valuations, and expecting a full recovery by H2.
On a big picture basis, BKG is at an early stage of growth in India. The organization and structure set up looks good to handle the growth imperatives.
We expect profitability in BKG in 2 years, by FY23, even as it grows rapidly in revenues and outlets. Once this happens, BKG valuations will rise and this IPO entry price will look reasonable.
Risks: 1) Loss making entity. Profitability also looks 2 years away, so this is a private equity type, risky investment opportunity. 2) Intense competition from Indian and MNC QSR chains in Tier 1 towns 3) Covid induced challenges – demand from customers as well as employee health. 4) High royalties.
Opinion: Investors with a risk appetite can SUBSCRIBE to this IPO with a 2 year perspective.

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 stake ownership or financial interests in BKG or any group company. Punit Jain intends to apply for this IPO. 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.

UTI AMC is Losing Share (IPO)

September 29, 2020Leave a comment

Date 28^th Sept; IPO Opens 29-01^st Oct at ₹ 552-554
Valuations: P/E 25.4 times TTM
Mid Cap: ₹ 7,024 cr. Mkt cap
Industry – Asset Management
Advice: AVOID

Summary

Key Strengths: UTI AMC is the second largest AMC in India in terms of Total AUM and the eighth largest in terms of mutual fund AUM. UTI has a strong brand due to its presence in India for 55 years. Valuations are low in terms of P/E. This allows some upside potential to investors. With a GoI institutional ownership, the firm is perceived as safe and stable. Post IPO, T Rowe Price will continue to be the largest shareholder.
Risks: 1) The financials of UTI have been weakening over the last 3 years. 2) The share of equity MFs has reduced in percentage, as the debt, liquid, hybrid, PMS and pension products grew faster. 3) Competition from the top 5 MFs is intense. With digital sales and distribution networks growing in importance for sales, UTI may have to invest more in sales and marketing. 4) AMCs are closely regulated by SEBI and are subject to changes or tightening of norms.
Opinion: UTI is a fair business available at a low valuation. AVOID this IPO.

Here is a note on UTI Asset Management Company (UTI) IPO.

IPO highlights

The IPO opens: 29/Sept – 01/Oct 2020 with Price band: ₹ 552-554 /share. Listing is 12/Oct.
Shares offered number 3.89 crore. The FV of each is ₹ 10 and market Lot is 27 nos.
The IPO is of ₹ 2,160 cr. for 30.75% equity by institutions SBI, LIC, and BoB who are selling 1.05 cr. shares each, and T Rowe Price and Punjab National Bank are selling 38 lakhs each.
UTI AMC is a institutionally owned firm with T Rowe Price (26%), and PNB, SBI, LIC, and BoB holding 18.2% each being the major shareholders.
The IPO share quotas for QIB, NIB and retail are in ratio of 50:15:35.
Grey market premium has dropped from ₹ 75 to ₹ 45 in the past few days of market volatility.

Introduction to UTI AMC

UTI AMC is the second largest AMC in India in terms of Total AUM and the eighth largest in terms of mutual fund AUM (June 30, 2020, by CRISIL). UTI AMC and its predecessor (Unit Trust of India) have been active in asset management for more than 55 years, having established the first MF in India.
Revenues and profit were ₹ 855 cr. and ₹ 276 cr. resp. for FY20. See Fig 1a. It has 1,386 employees with 658 in sales, 47 in investment, 278 in Support/other and 403 non-officers.
It has an AUM of ₹ 9,79,600 cr. in FY20 split between MFs (1,51,500 cr.) and Others (8,28,100 cr.).
We can see that Revenues, EBITDA and PAT have been falling for the last 3 years. See Fig 1a.
FY21-E is a projection based on Q1FY21 results and can be lower also.

Fig 1a – Financials and Fig 1b – Free Cash Flow

Free Cash Flow has been positive but is also falling, See Fig 1b.
Mutual Funds are further split as equity oriented and others. See Fig 2a. UTI manages 153 domestic MF schemes, comprising equity, hybrid, income, liquid and money market funds as of June 30, 2020.
The market share of MF AUM is 5.6% among AMCs see Fig 2c.
Its distribution network includes 163 UTI Financial Centers, 257 Business Development Associates and Chief Agents and 43 other Official Points of Acceptance, most of which are in each case located in B30 cities. Its Independent Financial Advisors (IFAs) channel includes 53,000 IFAs.
UTI AMC has four sponsors SBI, LIC, PNB and BOB, each of which has GoI as a majority shareholder. It also has a global asset management company T. Rowe Price International Ltd as one of its major stakeholders with a 26% stake in the Company.
Post IPO, T Rowe Price will continue to be the largest shareholder. T Rowe Price is a USD 1 trillion (75 lakh crores INR) global asset manager based in USA.
UTI AMC has 11 million live folios making up 12.8% of client base of the Indian MF industry.
Leadership is Dinesh Mehrotra (Non-Exec Chairman Dir.), Imtaiyazur Rahman (Dir.- CEO), Amandeep Chopra (Gr. President, Head Fixed Income) and Vetri Subramaniam (Gr. President, Head Equity).

Fig 2(a) – UTI AUM split – June 2020, 2(b) UTI Segment revenues and 2(c) Market share Fig 3 – Shareholding Pre and Post IPO

MF Industry Outlook and Trends

The economy has seen financial events such as demonetization, RERA implementation, GST and a crackdown on black money and shell companies. All these have rekindled interest in financial assets as compared to real estate and gold which were the most popular earlier.
The Indian MF industry as a percentage of GDP increased from 4.7% in FY05 to 10.9% in FY20. This is much below the global average of 55%. There should be a steady growth in MF industry size.
The regulations and disclosures around MFs have ensured good traceability and audit trails. SEBI has promoted MFs as good entry level equity and debt products, and MF asset growth has been good.
The growth in the AUM has been supported by a favorable macro environment, the rising of capital markets, foreign fund inflows as well as growing investor awareness and trust in the MF products.
There are 44 AMCs registered in India. But the top 10 AMCs having 83% of the industry AUM, see Fig 1c. SBI, HDFC, ICICI Prudential AMC, Aditya Birla and Nippon are the 5 largest MFs.
Average MF AUM grew at 13% CAGR of from ₹7.6 trillion in Mar 2010 to ₹27 trillion as of Mar 2020.
Global asset management firms have struggled in India as independent MF firms. Many sold out and exited. They have had a better success rate on partnering with Indian firms as the MF JV promoter.
The regulator prescribes maximum Total Expense Ratios (“TERs”) for schemes, which are calculated by dividing the total costs of the fund by its total average assets. Aggregate scheme expenses, including all fees, commissions, costs, charges, and expenses, must not exceed the applicable TER for a scheme. TER is higher for equity MFs and lower for debt.

Benchmarking

We benchmark UTI AMC against 2 AMC firms, and 4 brokerages and wealth managers. See Exhibit 4.

Exhibit 4 – Benchmarking

We can see that of the 3 AMCs, HDFC comes out leading on most parameters except valuations and dividend yield. UTI leads only in valuations.
Our conclusion is that UTI is a ‘fair business available at a good price’.

Positives for UTI AMC and the IPO

UTI has a strong brand due to its presence in India for 55 years.
Valuations are low in terms of P/E and P/B. This allows some upside potential to investors.
It is a large firm and has quasi government brand. Operations are all India.
The AUM by UTI is large, and particularly in Retirement it is a leader.
It is in the top 10 firms by MF AUM.
With a GoI institutional ownership, the firm is perceived as safe and stable.
Post IPO, GoI institutional ownership will fall to 49%, and may allow it to function like a private firm.
With financialization of savings growing, UTI should be able to grow AUM.
UTI has an experienced and stable management & investment teams.
T Rowe Price may take an active role in UTI, buy out shares from the market and take over UTI (it will trigger an open offer requirement) in future.

Risks and Negatives for UTI and the IPO

The key financials of UTI have been weakening over the last 3 years.
Partly this was because in 2019, SEBI reduced the TERs allowed for all MFs, impacting revenues and profits. AMCs are closely regulated by SEBI and is subject to changes or tightening of norms.
The equity part of UTI MFs reduced in percentage, as debt, liquid and hybrid products grew faster.
Competition from the top 5 MFs is intense. With digital sales and distribution networks growing in importance for sales, UTI may have to invest more in sales and marketing.
In July 2014, the holding period for long-term capital gains tax on debt MFs was increased from 12 to 36 months. It is possible that such regulatory changes can affect their business in future.
The tax on LTCG from equity was introduced in budget 2018 in Feb at 10%, from zero earlier. This caused a correction in markets, particularly the mid and small cap stocks, and MFs.
Competition to the MF industry is from alternatives like the PMS industry, AIF/ Hedge Funds, Private equity markets and direct equity advisory. Many of these are the next steps for MF investors after they have started their investment journey with MFs.