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We#39;re adding ICICI Bank and NLC to Moneycontrol Research#39;s defensive portfolio

We#39;re adding ICICI Bank and NLC to Moneycontrol Research#39;s defensive portfolio
November 22
19:41 2017

We had created a “defensive portfolio” a couple of months ago against the backdrop of weak growth and earnings performance. A lot has changed over this period that makes us take a re-look at the portfolio despite its outperformance over the benchmark (2.4 percentage points since inception).

On October 24, the government announced a fiscally neutral structure to recapitalise PSU banks, whose performance has been weighed down by asset quality concerns. The move not only stands to expedite NPA (non-performing assets) resolution but would also pave the way for long-buried private capex revival.

The quarter gone by has been quite interesting on the back of post-GST restocking and advancement of the festive season. The management commentary post earnings is also suggestive of early green shoots. While maintaining the overall defensive characteristics, we rejig our portfolio to make it more relevant to this changed reality.

We have two additions to the portfolio, NLC and ICICI Bank, which replace Power Grid and HDFC Bank.

While we are extremely convinced about the long-term moats of HDFC Bank, we perceive relatively greater value in ICICI Bank as the PSU bank recapitalisation stands to incrementally benefit private sector corporate lenders as well. We see the NPA pain persisting for ICICI Bank for a few more quarters and near normalization of credit costs by the second half of FY19. ICICI has built a robust low-cost deposit franchise (45 percent CASA) that positions it well in the MCLR-based lending regime. The bank is well capitalised and the retail book is sizeable and would be a growth driver along with a much de-risked corporate lending. The group derives substantial value from its strong subsidiaries (conservatively close to Rs 100 per share) that makes the valuation enticing.

The state run power utility, NLC, formerly known as Neyveli Lignite Corporation, has 1.3 times debt to equity and 20 times interest coverage ratio and has one of the best balance sheets in the power space. The company is generating close to Rs 1,000 crore of annual cash flow, which is now deployed for better growth. NLC has recently expanded its capacity by 1000 MW to 4280 MW, which will drive further growth. Interestingly, at current prices, the stock is trading at valuations of 1.4 times its book value and 7 times its FY17 earnings, offering an attractive dividend yield of close to 3 percent.

We see medium-term headwinds for Power Grid on account of increasing competition from the private sector and pressure on regulated yields.

For the rest of the stocks in the portfolio, we continue to repose faith in their growth journey.

Capacite keeps on delivering high growth with the company sitting on a huge unexecuted order book of close to Rs 4,705 crore, almost 5 times its sales. During the quarter, the company reported 48.5 percent increase in sales. While margins fell by about 300 basis points due to higher raw material and construction cost, company reported 81 percent growth in net profits in the absence of any increase in fixed cost such as depreciation and interest. Moreover, with the IPO money, the company hopes to increase execution, which will keep the earnings growth momentum.

Coal India’s share price recently saw a sharp rally post Supreme Court ruling banning the use of pet coke in three states for cement companies. Nevertheless, the offtake is increasing from most of the industries particularly power on the back of increasing PLFs (plant load factor). In Q2FY18 the company reported 4.2 percent increase in sales led by higher realisation and better volume.

Moreover, with the impact of grade slippages and employees cost easing, higher volumes and better realisation would translate to better earnings in the coming quarters. Interestingly, at 13 times its FY19 estimated earnings, the stock provides great comfort to hold.

Cochin Shipyard is sitting on cash and cash equivalent of close to Rs 2,700 crore (including the IPO money) or about 30 percent of its current market capitalisation. The company intends to use these funds for building capacities particularly in the ship repair segment. This will allow the company to undertake larger projects and at the same time speed up work on orders in hand. It is sitting on an order book of close to Rs 8,300 crore or about 4 times its sales. Moreover there is a strong pipeline of orders of about Rs 15,000-20,000 crore to be awarded by the government.

Cyient reported sequential revenue growth of 6.8 percent in USD terms (5.2 percent in constant currency), EBITDA margin was up 180 bps aided by both services (up 160 bps) and DLM (design led manufacturing, up 770 bps). Higher margins and other income led to 27 percent sequential jump in profitability. While order intake at USD 119 million in 2Q FY18 vs USD 160 million in 1Q FY18 was tad lower, management indicated some deals could spill over to 3Q and sounded confident of medium-term growth, based on its pipeline and conversations with the key accounts.

Himatsingka Seide delivered a steady but subdued quarter. A higher utilisation rate at the expanded sheeting unit from around 40-45 percent at present to the 50 percent mark by the end of FY19, coupled with commissioning of the terry towels facility, is expected to bolster its top-line in due course. The company hopes to derive operating leverage by increasing the proportion of private label brands to the total offerings, apart from operationalising its spinning facility by the end of Q3FY18.

Interglobe Aviation (IndiGo), the market leader in domestic skies, retained its mojo as is evident from a strong set of 2QFY18 numbers. IndiGo posted a very strong all-round performance with revenue from operations clocking a growth of 27 percent (YoY) led by increase in volume (15.4 percent) supported by a rise in yield (8.9 percent). IndiGo was able to post EBITDAR margin of 29.9 percent, up 643bps over the same quarter last year. We continue to like the business on the back of operational efficiencies, capacity addition plans, and multiple growth drivers.

In Q2 2018, ITC’s core FMCG business posted a comparable sales growth of 10 percent aided by strong performance in branded packaged foods and personal care businesses. Improving retail offtake and premiumization adds to ITC’s increasing exposure to non-cigarette business. Its focus on integrating value chain from farm to consumer in the perishable segment aids its medium term growth trajectory. This is also expected to benefit from government’s recent initiatives for food processing industry and logistic supply chain. Additionally, ITC is currently trading close to multiyear low valuation multiple and provides an attractive level to enter, in our view.

Portfolio

Recent quarterly results of Dabur (a key client for JHS Svendgaard) adds to improving earnings visibility for JHS Svendgaard. Dabur’s oral care segment witnessed a significant improvement of 22.8 percent YoY growth aided by e-commerce campaign and market share gain. Further, JHS’s recent capacity expansion of toothpaste manufacturing to 175 million tubes (from 90 million tubes) along with newer contracts from Patanjali should continue to aid its earnings growth. Q2 results underline an improving EBITDA margin profile (+370 bps YoY), which is assuring to us. At the same time, recent run up in the stock does not take away valuation comfort, in our opinion.

NBCC is probably the most expensive stock in the construction space trading at about 40 times its FY19 estimated earnings. However, considering the earnings visibility and growth, one would be better off holding. The company continues to get new orders with the order book swelling to almost Rs 75,000 crore or 12 times its trailing revenue. In Q2FY18, revenue fell by about 9 percent on year-on-year basis but this was largely on account of GST. Thankfully, due to improvement in margins, it was able to post 10 percent growth in net profit. Pace of construction is expected to recover over the next two quarters, thus driving earnings higher.

Petronet LNG reported a stellar performance in Q2FY18 mainly on account of an uptick in volumes and high operating leverage with improved capacity utilization. With continued shortage of LNG domestically, capacity expansion at Dahej, resumption of operations at Dhabol and full commissioning of Kochi terminal scheduled by December 18, we see future uptick in volumes and earnings.

After an operationally good quarter, Reliance Industries stands to gain in the medium term as it is almost at the end of an aggressive capex cycle. Most investment projects have either stabilized or are getting commissioned. This should lift the return on capital employed in the coming years. We believe that Jio will be able to sustain the current momentum, on the back of innovative strategies and huge unmet potential available in India. With the resumption of the oil marketing business, we expect greater vertical integration which would bring in better margins in the coming quarters.

Sun Pharmaceutical reported Q2 FY18 numbers that were in line with the subdued expectations. India business is gradually getting back on track. However, the continued pricing pressure in US generics business and Sun’s investment in building a speciality business marred the performance. The management maintained its earlier guidance of single-digit revenue decline in FY18 and better EBITDA margin performance in the second half. While FY18 remains to be prima facie a year of no gains, FY19 could be a tad better (contingent on US FDA clearing its key facility of Halol). Early signs of contribution of speciality business will only be visible from FY20 onwards.

Tata Motors (TTMT) reported an excellent set of numbers for the 2QFY18, driven by a turnaround of its domestic business, and improved profitability of Jaguar Land Rover (JLR). JLR posted a volume growth of 5 percent (YoY) and EBITDA margin expansion of 660bps (YoY). The domestic business saw growth in operating revenues backed by strong volume growth complemented by a favourable product mix. In addition, the accelerated cost reduction efforts also helped in 360bps expansion in the EBITDA margin. We continue to like the business on the back of reasonable valuations, growth prospects of JLR and the focus of Tata Group’s top management on domestic business revival.

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