STRATEGY
August 26, 2020
Scouting for giants
Head of Research Author / Consultant Nitin Bhasin Ritika Mankar Mukherjee, CFA [email protected] [email protected] Tel: +91 22 6623 3241 Tel: +91 98333 49668
Research Analyst Nikhil Pillai [email protected] Tel: +91 22 6623 3265
[email protected] 2020-12-07 Monday 13:17:41 Strategy
CONTENTS Strategy: Scouting for giants ………………………………………………………………….3 Section1: India’s High GDP growth rate ≠ high revenue growth rates ………………..4 for listed firms! Section 2: Listed Indian firms’ susceptibility to dwarfism > EM peers ……………….11 Section 3: India’s High GDP growth rate ≠ high revenue growth for ………………..15 unlisted firms too Section 4: So why do Indian businesses suffer from scalability challenge? ………….20 Section 5: A deep-dive into five key sectors ……………………………………………..26 Section 5.1: Consumers – Market appears optically large! …………………………….27 Section 5.2: Pharma: High competition along with high capital intensity! …………..29 Section 5.3: IT - Only sector to present an organic scalability example! ……………..31 Section 5.4: Metals & Mining – High presence in the +1tn revenue club! ….33 Section 5.5: Oil & Gas – Maintaining leadership on ‘scale’ in India ………..35 for decades Section 5: Why check for scale? Scale quintiles persist but high ……………37 growth rarely Section 6: Highly probable scalable bets ……………………………………….42
COMPANIES
Aarti Industries (BUY): Leader in the making …………………………………..47 Aavas Financiers (NOT RATED): Wired to play in big league ……………….57 Amber Enterprises (BUY): Ride the import substitution wave ……………….63 APL Apollo Tubes (BUY): A ‘Structural’ Story ………………………………….73 Dixon Technologies (BUY): Riding on the electronic wave ……………………83 Hatsun Agro (NOT RATED): Milking scale and pricing power ………………..93 ICICI Lombard (BUY): Good things come at a price! ……………………….101 L&T Infotech (NOT RATED): Balancing growth and profitability …………….109 Mahindra CIE (BUY): Growing on internal accruals ………………………..121 Minda Industries (BUY): Scaling up profitably …………………………………131 Pidilite Industries (NOT RATED): Portfolio of opportunities ………………….141 Prestige Estates (NOT RATED): Set the floor to rise higher ………………….151 SBI CARDS (NOT RATED): Moving to the Premier League …………………..163 SBI Life Insurance (SELL): A true marathon runner! …………………………..175 Torrent Pharmaceuticals (SELL): An enviable M&A track record …………..183 Whirlpool of India (NOT RATED): David’s fight with new Goliaths ………..193
August 26, 2020 Ambit Capital Pvt. Ltd. Page 2
Strategy
THEMATIC August 26, 2020
Exhibit A: Majority of listed Indian Scouting for giants companies suffer from dwarfism
India’s GDP growth rate will hit an unprecedented air-pocket this year. FY11 FY19
This should be doubly worrying for Indian listed companies. This is 55% 41% because, even as India’s real GDP grew at a spectacular 7% for three decades, this growth rate did not distil into high revenue growth for its 3.2% 0.4% companies. An overwhelming 28% of listed firms (ex-BFSI) even today have revenues of Share Share of listed 100bn revenue range, a ratio that is distinctly higher in peer countries. - 1-6tn 0-1bn ex Given Indian companies’ inherent susceptibility to dwarfism and given 1-100bn that Covid-19 will disrupt business models in unimaginable ways, it 100bn-1tn becomes critical to identify companies that can overcome the scale Annual Sales (in Rs) challenge. We highlight 16 companies that in our view will able to Source: Capitaline, Ambit Capital research deliver consistent revenue growth over the next 5 years. Exhibit B: EM peers markedly less The mysterious malaise of dwarfism prone to this malaise Even as GDP growth in India will crash in CY20, average GDP growth over the India 6 EMs' Median last 3 decades has been spectacular (7% in real terms, 13% in nominal terms). It 64% would be logical to expect such a high growth economy to be characterized by 55% (1) a few small companies that are routinely scaling-up and (2) a rich eco-system of large companies. The reality however could not have been more contrasting. Of the 2,865 listed ex-BFSI companies in India as at FY19-end, (1) 28% were 28% BFSIcos. ultra-small i.e. had revenues of Introducing Ambit’s top scalability candidates Author/Consultant It’s apparent that India’s high GDP growth rate fails to distil itself into consistently Ritika Mankar Mukherjee, CFA high revenue growth for its companies. Now with Covid-19 crisis wreaking +91 98333 49668 havoc, carefully identifying mid-sized companies of today that can overcome dwarfism tomorrow becomes all the more critical. We highlight 12 non-BFSI and [email protected] 4 BFSI companies (see exhibit C for details) as our top scalability candidates. Research Analyst These medium sized companies today clear our corporate governance filters and, Nikhil Pillai possess the ability to efficiently sweat their brand and successfully boost their +91 22 6623 3265 scale over the next quinquennium. [email protected] Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Strategy Section1: India’s High GDP growth rate ≠ high revenue growth rates for listed firms! Summary: GDP growth in India will sink to an unprecedented low in FY21. However, it is worth noting that India has maintained an impressive average real GDP growth of +6% for four consecutive decades now. It would then be logical to expect businesses to be able to scale up their revenue base with a high degree of success. However, sales data relating to the listed universe suggests exactly the contrary. Despite the high GDP growth that India has maintained for decades on end, this has failed to translate into high sales growth for listed businesses. At one end of the spectrum, Ultra-small firms (i.e. firms with annual sales of less than Rs400mn) have shown a distinct inability to break into higher revenue buckets – a dynamic which has notably been exacerbated in the noughties. Consequently, Ultra-small listed companies account for an eye-watering 28% of non-BFSI listed companies today. Besides suffering from an unusually wide-base of Ultra-small companies, the Indian corporate landscape is characterized by an even larger ‘middle’ and then a narrow ‘peak’. Medium-sized companies (i.e. firms with sales of Rs100bn-Rs1tn) account for 55% of total non-BFSI listed companies in India. And when it comes to the top category of the largest firms, only 12 listed ex-BFSI Indian companies today have a revenue base of +Rs1tn. To make matters worse, not only are companies of world-class revenue size rare in India, they also appear to be concentrated in sectors like Oil & Gas, Metals & Mining or Automobiles; i.e. sectors that are arguably past their heyday . The Indian listed space – A few mature adults but mostly dwarfs and midgets India has maintained a lead of 450bps and 150bps as against the real GDP growth rate of G7 economies and EM peers respectively over the last three decades (see exhibit below). Exhibit 1: India’s GDP growth rate has been materially Exhibit 2: Ultra-small companies’ share in total listed higher than that of peers for the last three decades companies is high and it stopped declining by FY11 G7 EMs FY91 FY01 FY11 FY19 6.2% 58% 5.1% 44% 3.0% 27% 28% 2.1% (%) Sales 22% 1.8% 20% 1.3% listed of Share 15% 13% excess of& excess G7 (%) EM companies* by annual by annual companies* India's real GDP growth in growth GDP real India's FY91-00 FY01-10 FY11-19 0-400mn (Ultra Small) 400mn-1bn (Small) Source: IMF, Ambit Capital research Source: Bloomberg, Ambit Capital research; Note: 1. Annual sales are expressed in Rupees. 2. Listed companies* here refers to listed companies in India ex-BFSI. Additionally ~100 companies have been excluded owing to unavailability of Sales data. Despite this, nearly a third of listed Indian companies (ex-BFSI) today maintain annual revenues of Rs400mn or lower (see exhibit above). (Note: We hence refer to these companies with annual revenues of less than Rs400mn as Ultra-small companies). Furthermore, it appears that the pace at which Ultra-small companies were able to move into higher revenue buckets has ironically slowed down over time. The share of Ultra-small companies had been expectedly declining through the nineties and early noughties. But this process came to an abrupt halt by FY11. Even as India’s real GDP growth rate shot up to an average of ~7% over FY11-19, the ratio of Ultra-small August 26, 2020 Ambit Capital Pvt. Ltd. Page 4 Strategy companies in the listed space notably registered a small ‘increase’ over this period (see black arrow in exhibit above). Distinct from the dwarfism that has plagued Ultra-small companies in India, Medium- sized companies have struggled to increase their share in the listed space. Companies with annual sales amounting to Rs1-100bn (hence referred to as Medium-sized companies) rose rapidly right until FY11 but then actually fell by ~1% by FY19. Hence, even today, 55% of listed companies in India (ex-BFSI) have revenues of Rs1-100bn; i.e. a ratio that has worryingly ‘declined’ over the last decade (see black arrow in exhibit below). Exhibit 3: Medium-sized companies’ share in total listed Exhibit 4: ~80% of Medium-sized companies have companies stopped rising by FY11 revenues in the lowest range of Rs1-20bn FY91 FY01 FY11 FY19 90% 78% 56% sized 55% - 60% 36% Sales (%) Sales (%) 30% Share of listed listed of Share 22% 20% 20% 12% 15% 13% 5% 3% 2% companies* by Annual 0% Share of listed Mid listed of Share companies* by companies* Annual Sales 20- 40- 60- 80- 40bn 60bn 80bn 400mn-1bn (Small) 1bn-100bn (Medium) 100bn 1-20bn Source: Bloomberg, Ambit Capital research. Note: 1. Annual sales are Source: Bloomberg, Ambit Capital research. Note: 1.Annual sales expressed expressed in Rupees. 2. Listed companies here refers to listed companies in in Rupees. 2. Listed companies* here refers to listed companies in India ex- India ex-BFSI. Additionally, ~100 companies have been excluded owing to BFSI. Additionally, ~100 companies have been owing to unavailability of unavailability of Sales data. Sales data. In fact, within the universe of ~1600 Medium-sized companies, nearly 80% of firms were concentrated in the lowest range of revenues of Rs1-20bn (see exhibit above). Furthermore, within these ~1200 companies with revenues in the Rs1-20bn range, about 60% are situated in the lowest range of Rs1-5bn (see exhibit below). In other words, of the total ~2900 ex-BFSI listed companies that we analyzed, nearly 25% of companies have revenues of Rs1-5bn. Exhibit 5: ~60% of companies in the Rs1-20bn category of Exhibit 6: Large & Mature companies’ share in listed has revenues have revenues in the lowest range of Rs1-5bn been rising, but share remains low at ~4% 80% FY91 FY01 FY11 FY19 - 3.2% 58% 2.0% 40% Sales (%) Sales 20bn (%) 20bn 23% 19% Share of listed listed of Share 0.3% 0.4% companies* by Annual 0.3% with Annual with Annual Sales of 1 0.0% Share of listed companies* companies* listed of Share 0% 1-5bn 5-10bn 10-20bn 100bn-1tn (Large) 1tn-6tn (Mature) Source: Bloomberg, Ambit Capital research. Note: 1. Annual sales are Source: Bloomberg, Ambit Capital research. Note: 1. Annual sales expressed expressed in Rupees. 2. Listed companies here refers to listed companies in in Rupees. 2. Listed companies* here refers to listed companies in India ex- India ex-BFSI. Additionally, ~100 companies have been excluded owing to BFSI. Additionally, ~100 companies have been owing to unavailability of unavailability of sales data. sales data. India’s resolve to embrace greater liberalization since the nineties did however result in one important development. The noughties in India saw a fistful of Indian companies actually break into the +Rs100bn annual sales club – a scale of revenues that was hitherto unseen. August 26, 2020 Ambit Capital Pvt. Ltd. Page 5 Strategy However, here too it is worth noting that both Large (i.e. companies with annual sales of Rs100bn-1tn) and Mature companies’ (i.e. companies with annual sales of Rs1-6tn) share in the listed universe seems to be rising at a fairly slow pace. Consequently, these two categories of Large and Mature companies accounted for less than 4% of the listed universe (ex-BFSI) in FY19. And when it comes to the top category of the largest firms, only 12 listed ex-BFSI Indian companies today have a revenue base of +Rs1tn. However, not a single Indian non-BFSI listed company even today has revenues exceeding Rs6tn. The BFSI space – Same story of a few mature adults but mostly dwarfs The BFSI space today spanning lenders and insurance companies today is the largest listed sector. This sector accounts for 34% weightage of Nifty50 companies as at June 2020 which marks a significant increase from 20% in 1995. It is worth noting that structural scarcity of debt capital, has meant that this sector has grown rapidly over the noughties. Whilst the total number of banks in the listed space in India today stands at 40 as against 30 in FY01; the total number of listed NBFCs in India has burgeoned from 172 in FY01 to 466 in FY19. Despite this rapid growth of the Financial Sector, this space is also characterized by a handful of large companies and a multitude of smaller ones. In fact small companies’ share in the listed financial space is much greater than the occurrence of small companies in the non-financials space. The pyramid of listed lenders (i.e. Banks and NBFCs) in India appears to be characterized by a very wide base of Ultra-small companies. Ultra-small companies (i.e. lenders with advances of Rs0-500mn) account for 70% of lenders in India today (see exhibit below). Exhibit 7: Ultra-small lenders account for the lion’s share Exhibit 8: Small lenders’ share has been rising but of lenders in India today Medium lenders’ share has been falling in the noughties FY91 FY01 FY11 FY19 FY91 FY01 FY11 FY19 19% 89% 75% 15% 16% 70% 65% 12% 10% 9% 7% 19% 5% (in%) 15% (in%) 7% 9% 0-500mn (Ultra-small) 500mn-10bn (Small) 500mn-10bn (Small) 10bn-1tn (Medium) Share in total banks & NBFCs NBFCs banks & in Share total Advances range (in Rs) NBFCs banks & in Share total Advances range (in Rs) Source: Bloomberg, Ambit Capital research. Note: Listed Banks and NBFCs Source: Bloomberg, Ambit Capital research. Note: Listed Banks and NBFCs companies spans 506 companies as at FY19. companies spans 506 companies as at FY19. Whilst Small lenders (i.e. lenders with advances of Rs500-10bn) share in total lenders has been progressively rising, the share of Medium-sized lenders (i.e. lenders with advances of Rs10bn-1tn) has been declining through the noughties (see exhibit above). It is thus worrying to note that the pace at which Medium-sized lenders were able to move into higher revenue buckets has ironically slowed down over time. As is the case with listed ex-BFSI companies, the lending space is also characterized by an extremely narrow top comprising Large (i.e. lenders with advances of Rs1tn- 4tn) and Mature Companies (i.e. lenders with advances of +Rs4tn). Consequently, these two categories of Large and Mature lenders accounted for 0% listed lenders in FY91 – a ratio which has only risen to 5.1% in FY19 (see exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 6 [email protected] 2020-12-07 Monday 13:17:41 Strategy Exhibit 9: Large and Mature lenders’ share in total listed Exhibit 10: The Insurance sector in India is nascent with lenders today stands at 5.1% (amounts to 26 lenders) only 7 players FY01 FY11 FY19 3 2 3.4% 3.6% 1 1 1.6% FY19 (in%) 0.5% 0.2% 0-100bn 0.0% Share in total banks & NBFCs NBFCs banks & in Share total No. ofin companies insurance 1tn-4tn (Large) 4tn and above (Mature) 200bn-300bn 100bn-200bn 300bn & above 300bn Advances range (in Rs) Premium range (in Rs) Source: Bloomberg, Ambit Capital research. Note: Listed Banks and NBFCs Source: Bloomberg, Ambit Capital research companies spans 506 companies as at FY19. And hence when it comes to the top category of the largest lenders in India, 26 listed lenders today have an advances base of +Rs1tn (see exhibit above). Once again, liberalization paid off as the noughties in India saw a handful of Indian lenders grow their book beyond the +Rs1tn advances mark – a scale that was hitherto unseen. However, the industry structure still remains heavily skewed in the direction of small companies. Within the Financials space, Insurance on the other hand is a nascent sector in India with the first pure play life insurance company in India (namely Max Financial Services) being listed only in 2016. This sector cumulatively today has only 7 listed companies with 5 of these having a premium base of Rs200-400bn (see exhibit above). So then are India’s Large & Mature companies in the ‘right’ sectors? As shown above, not only do companies of world-class revenue size appear to be rare in India, they also appear to be concentrated in a handful of sectors that have arguably hit their peak. Three sectors account for 75% of the dozen Indian listed companies that have revenues in excess of Rs1tn (i.e. essentially Mature companies as per our classification). Basis FY19 full year data, these three sectors where the majority of truly large companies in India are concentrated include: . Oil & Gas (spanning Reliance Industries and four SOEs namely IOCL, ONGC, BPCL & HPCL); . Metals & Mining (spanning Tata Steel & Hindalco) and, . Autos (spanning Tata Motors & M&M). Rajesh Exports, TCS and L&T are the other three Indian non-BFSI companies characterized by revenues in excess of Rs1tn as at FY19. In fact, it is worth noting that these 12 non-BFSI +Rs1tn companies of India are often conglomerates (as opposed to being focused on a single core business), are mostly SOEs (as opposed to being private sector entities) and often have the presence of meaningful asset bases overseas. In specific, . Reliance Industries, L&T and M&M are conglomerates with presence across multiple business verticals spanning beyond their core business. . IOCL, ONGC, BPCL & HPCL are state-owned energy conglomerates. . Tata Steel, Hindalco, Tata Motors and Rajesh Exports own global assets which in some cases are larger than their India assets. August 26, 2020 Ambit Capital Pvt. Ltd. Page 7 Strategy This in turn leaves out TCS as the only organically grown private listed Indian ‘Mature’ business that has displayed a multi-decadal focus on a single business-line, i.e. IT. Moving one notch lower in terms of revenue buckets, the sectoral concentration that plagues India’s Mature business can be seen in its ‘Large’ companies too (i.e. companies with annual sales of Rs100bn-1tn which amount to 93 in number). Only a fistful of sectors account for the majority of 93 companies that have made it to the ‘Large’ bracket. IT companies along with capital-intensive businesses like Oil & Gas, Metals, Autos and E&C & Infra together account for the majority of Large companies in India (see exhibit below). In specific, sectors with the greatest presence in the ‘Large’, or Rs100bn-1tn revenue category, includes: . Oil & Gas (such as GAIL, MRPL & CPCL), . Autos (such as Maruti, Motherson Sumi & Hero Motocorp), . Metals & Mining (such as Coal India, Vedanta & SAIL), . E&C (such as Reliance Infra, NCC and Bharat Electronics), . Utilities (such as NTPC and Power Grid) and, . IT (such as like Infosys, HCL Tech & Wipro). Exhibit 11: Capital-intensive sectors & IT account for the Exhibit 12: Several prominent sectors have no majority of Large listed companies in India today representation amongst Mature listed Indian companies 100bn-1tn (Large) 1tn-6tn (Mature) 42% 8% 8% 6% 6% 6% 15%17% 17% 13% 3% 8% 8% 8% 5% 4% 0% 0% 0% 0% 0% 0% Share Share in total by companies Oil & Gas Auto & Metals & E&C and IT (%) Dec2019 at as size Sales Share Share in total by companies Sales size as at Dec2019 (in %) (in Dec2019 at as size Sales Auto Anc. Mining Infra Cap Goods Utilities Pharma 100bn-1tn (Large) 1tn-6tn (Mature) Telecom Consumer Chemicals Source: Bloomberg, Ambit Capital research; Note: 1. Annual sales expressed Source: Bloomberg, Ambit Capital research; Note: 1. Annual sales are in Rupees. 2. Listed companies here refers to listed companies in India ex- expressed in Rupees. 2. Listed companies here refers to listed companies in BFSI. Additionally ~100 companies have been excluded owing to India ex-BFSI. Additionally ~100 companies have been excluded owing to unavailability of Sales data. unavailability of Sales data. This concentration of ‘Large’ companies in a handful of sectors is perhaps the reason why several prominent sectors like Pharma, Chemicals or Consumers as well as capital-intensive sectors like Capital Goods, Utilities, Telecom, Aviation and Realty have no representation in the ‘Mature’ listed space in India. Taking a helicopter-view of both Large and Mature businesses in India, it is clear that ‘Natural Resource Processing’ (i.e. Oil & Gas as well as Metals & Mining) and ‘Automobiles’ account for the lion’s share of Large & Mature companies. Global experience suggests that these exact sectors have undergone deep disruptions over the last decade. More importantly, it appears like the peak demand for these sectors appears to be arguably behind us. This is turn means that Large & Mature companies in operating in these sectors in India today can only hope to deliver scalability through market share gains or re-investing their products disruptively. In fact, a McKinsey paper suggests that three of the most rapidly growing sectors globally are sectors that require low-to-medium capital intensity. These three rapidly growing sectors are ‘Pharmaceuticals’, ‘Medical products’ and ‘Internet, media & software’ (see exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 8 Strategy Exhibit 13: Pharma, Medical products and Internet, Media & Software are the fastest growing sectors of the world The McKinsey paper titled ‘Superstars’: The dynamics of firms, sectors, and cities leading the global economy) analyzed 5,750 companies globally with annual revenues +US$1bn and labelled the top 10% exhibiting the top economic profit performance as ‘superstars’. This study found that, “…70% of gains in gross value added and gross operating surplus have accrued to establishments in just a handful of sectors over the past 20 years. This is in contrast to previous decades, in which gains were spread over a wider range of sectors. While the superstar effect is not as strong for sectors as it is for firms, what we have identified as superstar sectors over the past 20 years include financial services, professional services, real estate, and two smaller (in gross value-added and gross operating-surplus terms) but rapidly gaining sectors: pharmaceuticals and medical products, and internet, media, and software.” Source: McKinsey, Ambit Capital research It is interesting to note that at a global level, capital-light businesses appear to be growing revenues most rapidly. This is in sharp contrast to the situation in India. In specific: . Capital-intensive businesses such as Oil & Gas, Metals & Mining as well as Autos account for the majority of Large and Mature businesses in India. . Capital-light businesses such as Pharma and IT account for a minority of Large and Mature businesses in India. It is clear to see that the top 12 mature companies in India have no meaningful presence in these global superstar sectors. In specific, . The largest listed Healthcare company in India is Sun Pharma with revenues of Rs290bn as of FY19 (i.e. falls in the ‘Medium’ revenue size category). . The largest listed Internet/Media/Software company in India is InfoEdge with revenues of Rs11bn as of FY19 (i.e. again falls in the ‘Medium’ revenue size category). The Mckinsey study quoted above also found that (1) ‘Internet, media and software’ (2) ‘Pharma & medical products’, (3) Banking and (4) Food, beverage and tobacco together accounted for 60% of the top-1% firms globally and 30% of the top-decile firms globally (see exhibit below). Exhibit 14: India’s weak footprint in sectors known to achieve a large scale globally is notable Representation in top Representation in top Largest listed and unlisted Indian firm in this space Sector decile firms globally 1% firms globally (with FY19 revenues in parentheses) (%) (%) . InfoEdge in the listed space (Rs11bn) Internet, media & Software 8% 19% . Flipkart in the unlisted space (Rs360bn) Pharma & medical . Sun Pharma in the listed space (Rs290bn) 8% 19% products . Mankind in the unlisted space (Rs47bn) . SBI in the listed space Banking 7% 12% . Largest unlisted BFSI companies are typically subsidiaries of listed banks . ITC in the listed space (Rs480bn) Food, beverage & tobacco 7% 10% . Amul in the unlisted space (Rs331bn) Source: Mckinsey report titled ‘Superstars’, Ambit Capital research Indian listed companies’ weak presence in each of these sectors that are likely to be characterised by growing demand over the next decade is once again unfortunate and notable (see the last column in the exhibit above). August 26, 2020 Ambit Capital Pvt. Ltd. Page 9 Strategy To conclude… This section clearly illustrates how India’s high GDP growth rate does not seem to be distilling itself into high revenue growth rates for the listed universe at large. . The pyramid of listed Indian companies in India (ex-BFSI) appears to be characterized by a very wide base of several Small to Mid-sized companies along with an extremely narrow top comprising Large & Mature Companies. . More worryingly, the movement of companies from small to larger revenue buckets seems to have categorically slowed down over FY11-19. . Even in the lending space, 70% of lenders are small and have advances in the range of Rs0-500mn. . Also, the data above suggests that the dozen-odd Indian listed ex-BFSI companies that have managed to establish scalability (i.e. have crossed the Rs1tn revenue mark) themselves are not located in the superstar sectors of tomorrow (such as Internet, Media, Software or Healthcare) but are operating in sectors of the past (Oil & Gas, Autos and Metals). So the next natural question that ought to be answered is: ‘Is the lack of scale and scalability an emerging market problem?’ August 26, 2020 Ambit Capital Pvt. Ltd. Page 10 Strategy Section 2: Listed Indian firms’ susceptibility to dwarfism > EM peers Summary: Optimists may argue that companies’ susceptibility to dwarfism is a natural phenomenon that most companies in any Emerging Market (EM) have to grapple with. However, comparing revenue-size data amongst EM peers suggests that Indian companies in particular appear vulnerable to this problem disproportionately. We compared India’s listed space to that of the listed space in the six largest EMs (with nominal GDPs indicated in parentheses) namely - China (US$14tn), Brazil (US$1.8tn), Russia (US$1.6tn), S Korea (US$1.6tn), Mexico (US$1.3tn) and Indonesia (US$1.1tn). Exhibit 15: Listed Indian firms are smaller in scale as compared to EM Peers Share of listed ex-BFSI firms in total firms (in %) India China Indonesia EM Median 0-400mn (Ultra Small) 28% 1% 12% 8% 400mn-1bn (Small) 13% 1% 11% 4% 1bn-100bn (Medium) 55% 84% 71% 64% 100bn-1tn (Large) 3% 14% 7% 14% +1tn (Mature) 0.4% 1% 0.2% 1% Total 100% 100% 100% 100% Source: Bloomberg, Ambit Capital research; Note: 1. Annual sales are measured in Rupees for all countries and data pertains to FY19/CY19 or 12 months trailing data if FY & CY basis data is not available. 2. Data spans ex-BFSI listed companies in China (3644), India (3780), Brazil (258), Russia (193), Indonesia (551), and Mexico (130) with numbers in parentheses indicating number of companies covered. As captured in the table above, it is worth noting that: . The median ratio of ‘Ultra Small companies’ as a share of total listed companies for these 6 EMs is 8% whilst the ratio stands at 28% for India; i.e. more than 3x the median ratio seen in peer countries. . Then the median ratio of ‘Mid-sized companies’ as a share of total listed companies for these 6 EMs stands at 64% whilst the ratio stands at a significantly lower proportion of 55% for India. . At the other end of the spectrum, the median proportion of ‘Large and Mature’ companies stands at a paltry 4% for India whilst the ratio is 14% for these EMs; i.e. more than 3x that of India! Read on for details of this phenomenon. Even amongst peers, India’s company-size pyramid is characterized by an unusually wide base and an unusually narrow top Cross-country evidence spanning six large EMs suggests that the dwarfism that plagues listed Indian companies (ex-BFSI) is largely an India-specific feature. For instance, 28% of listed Indian companies are Ultra-small, i.e. have annual revenues of Rs0-400mn. This is 3.6x the median ratio of 8% displayed by other EM peers (see exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 11 [email protected] 2020-12-07 Monday 13:17:41 Strategy Exhibit 16: The share of Ultra-small listed companies in Exhibit 17: The share of Small listed companies is India is India is unusually high also greater than most EM peers 28% 13% 11% 12% 6% 8% 8% 6% 3% 4% 6% 2% 1% 1% small* listed cos. as as a cos. listed small* of total cos %) cos (in oftotal - share of total cos %) cos (in of total share Small* listed cos. as as a cos. listed share Small* India India Ultra Brazil Brazil China China Russia Russia Mexico Mexico SKorea SKorea Indonesia Indonesia Source: Bloomberg, Ambit Capital research; Note: 1. Annual sales are Source: Bloomberg, Ambit Capital research; Note: Same data notes as the measured in Rupees for all countries and data pertains to FY19/CY19 or 12 adjacent chart apply here. months trailing data if FY & CY basis data is not available. 2. Data spans ex- BFSI listed companies in China (3644), India (3780), Brazil (258), Russia (193), Indonesia (551), and Mexico (130) with numbers in parentheses indicating number of companies covered. Likewise, 13% of listed Indian companies are Small, i.e. have annual revenues of Rs400mn-1bn. This is 3x the median ratio of 4% displayed by other EM peers (see exhibit above). Moving one notch higher, 55% of listed Indian companies are Medium-sized, i.e. have annual revenues of Rs1-100bn. This is lower than the median ratio of 64% displayed by other EM peers (see exhibit below). Exhibit 18: The share of Mid-sized companies in India is Exhibit 19: Large and Mature companies share in the listed lower than that of peers space in India is unusually low 84% 81% 71% 64% 64% 32% 55% 56% 25% 27% 14% 7% 8% 3.7% sized* listed cos. as a a as cos. listed sized* - share of total cos %) cos (in of total share Mid Large & Mature* listed cos. cos. listed Mature* & Large India India as a share of total cos %) cos (in of total a as share Brazil Brazil China China Russia Russia Mexico Mexico S Korea S Korea Indonesia Indonesia Source: Bloomberg, Ambit Capital research; Note: Same data notes as the Source: Bloomberg, Ambit Capital research; Note: Same data notes as Exhibit above apply here. the Exhibit above apply here. When it comes to Large and Mature companies (i.e. companies that have annual revenues of +Rs100bn), only 4% of listed Indian companies fall in this elite category. This is significantly lower than the median ratio of 14% displayed by other EM peers (see exhibit above). As highlighted in Section 1, only 12 Indian companies (ex-BFSI) have revenues in excess of Rs1tn. However, the comparable number of companies stands at 30 in China, 29 in Korea and Brazil too already has 8. In fact it is worth noting that China, Russia and South Korea are characterized by the existence of 2-3 listed companies with revenues exceeding Rs6tn. In specific: . In China these companies are China State Construction Engineering and SAIC Motors. . In Russia, Rosneft, Gazprom and Lukoil have revenues in excess of Rs6tn. . In South Korea, these companies are Samsung Electronics, Hyundai Motors and SK Holdings. August 26, 2020 Ambit Capital Pvt. Ltd. Page 12 Strategy However, the largest company by India is Reliance Industries which in fact falls short of the Rs6tn revenue mark as per FY19 revenue. Hence, it is no surprise that the combined revenue of the top 3 companies in India by market cap as at FY20-end (i.e. Reliance Industries, TCS & HUL) is significantly lower than the revenue of the top 3 listed companies by market cap of most EMs as well as developed countries (see exhibit below). Exhibit 20: The combined revenues of the top 3 Indian companies by market cap pale in comparison to EM peers as well as Developed Countries 806 667 423 370 408 222 108 112 128 136 20 (CY19, US$bn) (CY19, US India Brazil Japan China Russia France Mexico Top 3 listed cos. revenues Germany Indonesia South Korea Source: Ambit Capital research, Note: 1. Annual sales are measured in US$ for all countries and data pertains to FY19/CY19 or 12 months trailing data if FY & CY basis data is not available. 2. The top 3 companies are identified by measuring market capitalization values as at March 31, 2020. The table below highlights the names of the three non-BFSI companies with the largest market capitalization in each of these countries (see exhibit below). Exhibit 21: Companies (ex-BFSI) with the largest market cap in top 6 EMs Country Companies (ex-BFSI) with largest market cap as at 31 March 2020 India Reliance Indus. TCS HUL China Kweichow Moutaix Petro China China Petroleum & Chemical Corp South Korea Samsung Electronics SK Hynix Samsung Biologics Brazil Petroleo Brasileiro Vale Ambev Russia Gazprom Rosneft Oil Co LUKOIL Mexico America Movil Wal-Mart de Mexico Fomento Economico Mexicano Indonesia Telekomunikasi Indonesia Persero Unilever Indonesia Hanjaya Mandala Sampoerna US Microsoft Apple Inc Amazon.com Japan Toyota Motor NTT DOCOMO Nippon Telegraph & Telephone Corp Germany SAP SE Volkswagen AG Siemens AG France LVMH Moet Hennessy Louis Vuitton L'Oreal SA Sanofi Source: Bloomberg, Ambit Capital research, Note: The top 3 companies are identified by measuring market capitalization values as at March 31, 2020. Essentially, the top 3 Indian companies’ market-cap is 2.3x their revenues, with only developed countries like France and US have higher multiples (see exhibit below). Exhibit 22: Indian companies tend to enjoy far higher market-cap relative to revenues Market Cap to Revenue ratio for top 3 listed cos. (in %) 493% 327% 234% 233% 140% 93% 92% 90% 66% 47% 38% US India Brazil South Korea Japan China Russia France Mexico Germany Indonesia Source: Ambit Capital research, Note: 1. Annual sales are measured in US$ for all countries and data pertains to FY19/CY19 or 12 months trailing data if FY & CY basis data is not available.2. The top 3 companies are identified by measuring market capitalization values as at March 31, 2020. August 26, 2020 Ambit Capital Pvt. Ltd. Page 13 Strategy But more than the problem of Indian companies’ revenues being unusually small, once again, the more worrying development appears to be the fact that the pace of improvement in revenue size has slowed over the last decade. For instance, there seemed to exist a strong positive correlation between ‘nominal GDP growth rates’ and ‘pace of revenue growth for the top 3 listed companies’ over CY01-11 (see exhibit below). As is evident from the chart on the left side below, most notably, to India’s credit, it was one of the few countries where the pace of revenue growth of the top 3 listed companies was far higher than that implied by its nominal GDP growth over this period (see exhibit on the left side where location of the India bubble being below the black dotted line). Exhibit 23: India’s high GDP growth translated into high Exhibit 24: Transmission of India’s GDP growth into revenue growth for its top 3 listed companies over CY01-11 revenues of top 3 listed companies weakened in CY11-19 R² = 0.4178 30% 20% R² = 0.1728 China Brazil 10% 20% S Korea China Indonesia Indonesia India 19(% p.a.) US 11(% p.a.) Brazil - Mexico - India S Korea Russia Germany 10% Germany 0% France France Brazil Japan Mexico over CY11 over CY01 Japan -10% 0% US Avg. US$ nominal GDP growth GDP nominalUS$ Avg. -10% 0% 10% 20% Avg. US$ nominal GDP growth GDP nominalUS$ Avg. 0% 15% 30% 45% Top 3 listed cos. revenue growth over CY01-11 Top 3 cos. revenue growth over CY11-19 (% p.a.) (% p.a.) Source: Bloomberg, Ambit Capital research Note: Annual Sales are Source: Bloomberg, Ambit Capital research Note: Annual Sales are measured in US$ for all countries and data pertains to FY19/CY19 or 12 measured in US$ for all countries and data pertains to FY19/CY19 or 12 months trailing data if FY & CY basis data is not available. months trailing data if FY & CY basis data is not available. However, this progression ceased to exist over CY11-19 when not only did India’s GDP growth rate slow down drastically, but the pace of revenue growth of its top 3 listed companies fell to significantly lower levels than implied by its nominal GDP growth (see exhibit above and location of the India bubble which has now moved to above the black dotted line). To conclude… The charts above clearly illustrate how India’s high GDP growth rate does not uniquely translate into high revenue growth for India’s listed companies, and this is not an EM-specific ailment. In fact it is worth noting that: . The share of Ultra-small & Small companies in India in total companies is too large (as it stands at more than 3x the median for EM peers) whilst the share of Large & Mature companies is too small (stands at 0.3x the median for EM peers). . Hence it is no surprise that the combined revenue of the top 3 companies in India today by market cap is significantly lower than that of most EM peers. For instance, the combined revenues of HUL, TCS and Reliance Industries today is one-seventh of that of the combined revenues of China’s top 3 companies by market capitalization. . Most worryingly, this process of revenue scale-ups seems to be weakening for all Indian companies at large, and even for its top 3 listed companies. So then the next natural question that begs an answer is, ‘Is India’s high GDP growth rate translating into superior revenue growth outcomes for the unlisted space?’ August 26, 2020 Ambit Capital Pvt. Ltd. Page 14 Strategy Section 3: India’s High GDP growth rate ≠ high revenue growth for unlisted firms too Summary: Analyzing 2800 unlisted companies (see note below for details) suggests that this segment has undeniably showed a superior ‘pace’ of revenue scale-ups as compared to the listed space. For instance, the share of Ultra-small companies as a share of total unlisted companies has continued to decline through the noughties – and that too at an increasing pace. But despite this displayed scalability that the unlisted Indian space has shown, unlisted companies in India appear at least two decades away from reaching the absolute levels of revenues that listed companies show. For instance, Ultra-small companies today account for 48% of total unlisted companies we analyzed. Ultra- small companies accounted for such a high share of the listed space way back in the nineties with the ratio today at a significantly lower 28%. The only glimmer of hope here is presented by start-ups. As compared to the listed and unlisted universe, the start-up space in India has shown greater promise when it comes to scale. In fact, USA and China appear to be the only two countries with which Indian start-ups can be compared. Data note: 1. According to the Ministry of Corporate Affairs (MCA), there are more than ~1.1mn private, unlisted companies in India. However, financial data for a majority of such companies is not readily available in the public domain. Hence for the purpose of this analysis, we have used the unlisted company financials available in the Indian database of Capitaline which seems to have complete financial data on a smaller sample of ~2800 ex-BFSI companies. The combined revenues of these 2800 companies amounts to Rs23tn which compares to the total revenue of the ex-BFSI 2865 listed companies of Rs82tn. Also whilst the median revenue of a listed company in India stood at ~Rs1.8bn in FY19, the corresponding number for the unlisted space stood at ~Rs0.5bn. 2. The data for unlisted companies that we have been able to access via Capitaline, as highlighted earlier, only represents a subset of the larger unlisted space in India. The unlisted space – Growing fast but a stunted population at large Unlike the listed space, Ultra-small companies’ (defined as companies with annual sales of Rs0-400mn) share in total unlisted companies in our universe has been declining not just in the nineties but well into the noughties as well (see exhibit below). But despite this displayed ability of Ultra-small unlisted companies to grow, an overwhelming 48% of unlisted Indian companies (ex-BFSI) even today maintain annual revenue of less than Rs400mn (see exhibit below). Ultra-small companies accounted for such a high share of the listed space way back in the nineties with the ratio today at a significantly lower 28%. Exhibit 25: Ultra-small companies’ share in total unlisted Exhibit 26: Medium-sized companies’ share in unlisted companies has been declining consistently and rapidly companies has been correspondingly rising steadily FY91 FY01 FY11 FY19 FY91 FY01 FY11 FY19 87% 77% 39% 62% 48% 26% Sales (%) Sales Sales (%) Sales 12% 12% 11% 11% Share Share of unlisted 12% 12% 11% Share of unlisted 7% 7% 6% companies* by Annual companies* by Annual 0-400mn (Ultra Small) 400mn-1bn (Small) 400mn-1bn (Small) 1bn-100bn (Medium) Source: Capitaline, Ambit Capital research Note: 1. Annual sales are Source: Capitaline, Ambit Capital research Note: 1. Annual sales are expressed in Rupees. 2. Unlisted companies* here refers to ~2800 ex-BFSI expressed in Rupees. 2. Unlisted companies* here refers to ~2800 ex-BFSI companies for which financial data is available on Capitaline. companies for which financial data is available on Capitaline. August 26, 2020 Ambit Capital Pvt. Ltd. Page 15 Strategy Medium-sized unlisted companies too have managed to increase their presence through the noughties, unlike listed Medium-sized companies whose share peaked out in FY11. The share of unlisted companies with annual sales of Rs1-100bn (hence referred to as Medium-sized companies) rose rapidly over the last four decades (see exhibit above). However, once again, despite this progression only 39% of unlisted companies in India have revenues of Rs1-100bn today (see exhibit above) as compared to 55% of listed companies being in the Medium category in the listed space. Much like in the listed space, India’s decision to open up its closed economy in the nineties meant that the noughties saw a few unlisted companies break into the elite club of companies with revenues exceeding Rs100bn. Whilst the combined share of Large and Mature companies in total unlisted companies did register an undeniable increase, even today these companies account for a negligible a smidgeon of the unlisted companies’ pie at 1.5% (see exhibit below). It is worth noting that this slice of the pie is once again slimmer than the 3.7% share that Large and Mature companies account for in the listed universe. Moreover, only one unlisted Indian company (namely Reliance Retail) could break into the big league of Mature companies with annual sales of Rs1-6tn which compares to a dozen listed companies that are part of the elite club. Exhibit 27: Large and Mature companies’ share in unlisted Exhibit 28: India’s start-up eco-system appears more companies rising far more slowly than in the listed space developed compared to EM peers ex-China FY91 FY01 FY11 FY19 25 20 1.5% 20 15 10 10 7 Sales (%) Sales 5 5 Share of unlisted 0 0 companies* by Annual 0.3% 0 0.1% India 0% of No. in unicorns Jan 2020 0.0% 0% 0% 0% Brazil Russia Mexico S Korea 100bn-1tn (Large) 1tn-6tn (Mature) Indonesia Source: Capitaline, Ambit Capital research; Note: 1. Annual sales are Source: CB Insights, Ambit Capital research, Note: Data pertains to January expressed in Rupees. 2. Unlisted companies* here refers to ~2800 ex-BFSI 2020. companies for which financial data is available on Capitaline. Start-ups: The only exception to the India corporate landscape that struggles with dwarfism Even as the susceptibility to dwarfism appears to be an India-specific problem affecting its listed and unlisted companies, it is worth noting that the start-up eco- system in India is young but has shown greater promise in terms of overcoming the scalability challenge. In October 2019, the Secretary at the Department for Promotion of Industry and Internal Trade of India, said in a statement that, “There are 50,000 registered startups in India, and there will be 50,000 more by 2024 at this pace.” According to media sources, India has the third-largest startup ecosystem in the world after the US and China. The start-up ecosystem in India raised US$550mn in CY10 and has reportedly raised US$14.5bn in CY19. In fact, the start-up ecosystem in India appears substantially more developed than EM peers ex-China. Whilst comparable data regarding revenue of start-ups is hard to find, using valuations as a proxy for scale suggests that India was home to 20 unicorns (i.e. start-ups with a valuation of +US$1bn) pre-Covid i.e. in January 2020. This number is substantially higher than the number of unicorns seen in EM peers like South Korea or Brazil (see exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 16 [email protected] 2020-12-07 Monday 13:17:41 Strategy Exhibit 29: The total number of unicorns in India is significantly higher than that of EM peers ex-China 25 20 20 15 10 10 7 5 5 0 0 No. of unicorns in Jan 2020 Jan in of unicorns No. 0 India S Korea Brazil Indonesia Russia Mexico Source: CB Insights, Ambit Capital research, Note: The top 3 start-ups in India by valuation as at January 2020 are One97 Communications, Oyo Rooms and Snapdeal Also, the sectoral constitution of India’s 20 unicorns appears to be in sectors that have potential for rapidly growing revenues such as Internet, Fin Tech and E- commerce (see exhibit below). This is in sharp contrast to the listed space where the majority of Mature companies are concentrated in the Oil & Gas, Metals & Mining and Auto, i.e. sectors arguably well past their prime (refer to Section 1 for details). Exhibit 30: The sectoral constitution of India’s start-up Exhibit 31: However, India’s start-up ecosystem is far less ecosystem appears well spread out developed than that of US or China USA China India Supply chain & logistics 217 Fin Tech Auto & Transport 149 E-commerce 119 Mobile & telecom 109 Internet software & services EdTech 33 Travel 20 in in sector Jan 2020 by Renewable Energy No. of of No. in unicorns Indian No. of unicorns Total valuation of top 3 unicorns 0 2 4 6 (in US$bn) Source: CB Insights, Ambit Capital research, Note: Data pertains to January Source: CB Insights, Ambit Capital research, Note: Data pertains to 2020. January 2020. Comparing India’s unicorns to that of the US and China, however, suggests that the number of unicorns in India are low at 20 as of January 2020 (as compared to 109 in China and 217 in USA). Also, the total valuation of the top 3 unicorns in India at US$33bn is substantially lower than that of the top 3 unicorns of China that are valued at US$149bn as well as USA where the top 3 unicorns are valued at US$119bn (see exhibit above). It is worth noting that the start-up ecosystem in India is less than a decade old but has shown greater promise in terms of overcoming the scalability challenge so far. However, it is critical to note that in the absence of accurate revenue data regarding the start-up ecosystem, we rely on ‘valuations’ as a proxy. Given that valuations are at the end of the day a grossly inadequate proxy of revenues as well as scalability, the said conclusion needs to be interpreted with due caution! August 26, 2020 Ambit Capital Pvt. Ltd. Page 17 Strategy To conclude… Thus it is fair to say that, whilst the unlisted space in India has seen a superior ‘pace’ of revenue scale-up as compared to the listed space, the maturity of the unlisted space is at least two decades behind that of the listed space. This is because: . The distribution of Ultra-small, Small, Medium, Large and Mature companies in the unlisted space today most closely resembles the distribution pattern seen in the listed space in FY01 (see exhibit below). . The unlisted company universe remains much smaller than the listed company universe. The combined revenues of the listed space in FY19 amounted to Rs82tn, which is more than 3x that of the unlisted space we analyzed. . The unlisted company universe appears to have been exposed to a massive bout of mortality in the noughties, causing the total number of unlisted companies (ex- BFSI) collapsing from 6700 to 2800 over FY11-19. This is unlike the listed space which has seen the total number of companies grow by 4% p.a. for the last three decades (see exhibit below). Exhibit 32: Size-wise distribution of companies in unlisted Exhibit 33: The total number of unlisted companies space today is more similar to listed companies in FY01 experienced a sharp decline over FY11 to FY19 Listed space in FY01 Unlisted space in FY19 Listed companies Unlisted companies 60% 48% 6,745 BFSI BFSI) - 44% - 39% 40% 36% 20% 3,269 20% 2,865 11% 2,685 2,784 companies (%) 2,008 0% 2% No. of companies (ex No.of companies 965 Share in total no.of in Share total ex 0% 204 0-400mn 400mn-1bn 1bn-100bn 100bn-6tn (Ultra Small) (Small) (Medium) (Large + Mature) FY91 FY01 FY11 FY19 Source: Capitaline, Ambit Capital research; Note: 1. Listed companies here Source: Capitaline, Ambit Capital research; Note: 1. Listed companies here refers to listed companies in India ex-BFSI. Additionally, ~100 companies refers to listed companies in India ex-BFSI. Additionally, ~100 companies have been owing to unavailability of Sales data. 2. Unlisted companies* here have been owing to unavailability of Sales data. 2. Unlisted companies* refers to ~2800 ex-BFSI companies for which financial data is available on here refers to ~2800 ex-BFSI companies for which financial data is Capitaline. available on Capitaline. August 26, 2020 Ambit Capital Pvt. Ltd. Page 18 Strategy Section 4: So why do Indian businesses suffer from scalability challenge? Summary: Whilst a multitude of factors can be attributed to Indian companies’ susceptibility to dwarfism, the most proximate reasons for Indian companies’ inability to scale-up appear to be: . Rapidly changing rules and regulations: The regulatory environment in India is unpredictable, thereby preventing business models from managing multi- decadal scalability. Hence, it is no surprise that only Indian businesses characterized by very long-term leadership stability have been able to manage multi-decadal survival and growth. Some of the largest companies in India today have either benefitted from the leadership of a long-serving patriarchal chairman (such as TCS, Tata Motors or L&T) or tend to be SOEs (e.g. IOCL, BPCL or HPCL). . India’s deceivingly small market size: The Indian market is vast but is a highly segmented market lacking homogeneity of tastes & preferences. Thus the Indian market is in fact more like Europe (large but segmented and heterogeneous) and less like USA (i.e. large and intergraded). To complicate matters, India’s underdeveloped exports footprint means that Indian companies’ ability to raise revenue from overseas is limited. Besides the above stated two factors, (1) the high cost of debt capital in India and (2) the shape of labour regulations in India act as barriers to rapid and continuous growth across decades. Reason#1: The high degrees of regulatory uncertainty mean that only companies with ‘very long-term leadership’ can survive India regulatory environment is unusually complex and subject to frequent and/or retrospective changes. As Manish Sabharwal, Chairman of the leading staffing company, Teamlease puts it, “There are many reasons why many of India's 63 million enterprises are dwarfs (small that stay small) rather than babies (small that grow). But one of them is surely regulatory cholesterol. We need massive rationalization, simplification, and digitization of the compliance universe captured below”. Exhibit 34: Doing business in India means complying with a vast variety of regulations Source: Teamlease, Ambit Capital research The multitude and complexity of regulations in India often mean that the judiciary needs to get involved in interpreting these rules and then often ends up changing the rules of the game drastically. Prominent examples of this dynamic include: . Telecom: The ongoing saga in the telecom space is a perfect illustration of this dynamic. As is well known now, the Government of India itself had transitioned the telecom sector to an Adjusted Gross Revenue (AGR)-based license fee & spectrum usage fee calculation in 1999. This was in fact done to provide relief to the sector from high fixed fees and to provide a tailwind to the nascent, newly liberalized sector. Two decades later, the contentious interpretation of the term AGR has spelt record business-related uncertainty for this sector. August 26, 2020 Ambit Capital Pvt. Ltd. Page 19 Strategy . Coal: In September 2014 the Supreme Court of India cancelled nearly all the 218 coal blocks that the Government had allocated between 1993 and 2010. The court said that the allocations were arbitrary, illegal and amounted to unfair distribution of national wealth. The decision adversely affected a number of power, metals and mining companies besides affecting banks that had lent to companies that purchased coal blocks. The high degrees of structural as well as cyclical regulatory uncertainty have in fact meant that mortality rates in heavily-regulated or capital-intensive sectors are higher than those seen in lightly regulated sectors. Lightly-regulated sectors such as Auto & Auto Ancillaries, Chemical and Consumers are characterized by distinctly lower mortality rates (see exhibit below). For instance, of the 164-odd listed Auto companies existing today nearly 32% (or a third) have managed to exist and scale-up for three decades. Exhibit 35: Lightly-regulated or sectors protected by Govt. Exhibit 36: Heavily-regulated or capital-intensive sectors have shown the greatest ability to survive & scale-up have typically been marred by the least ability to survive 32% 14% 26% 11% 23% 11% 17% 16% 8% 14% 6% %) %) 4% 2% 0% Survivorcos. as a share of total listed cos. in sector (in Survivorcos. as a share of total listed cos. in sector (in IT Cap Gas Autos. Goods Metals Oil & Textiles Realty Infra Utilities Pharma Aviation Telecom E&C and Consumer Chemicals Source: Bloomberg, Ambit Capital research; Note: Survivor companies refers Source: Bloomberg, Ambit Capital research; Note: 1. Annual Sales are to the only 390 listed ex-BFSI companies that have managed to exist from expressed in Rupees. 2. The 390 listed companies here refers to the only FY91 to FY19. listed ex-BFSI companies that have managed to exist from FY91 to FY19. At the other end of the spectrum, capital-intensive and/or heavily regulated sectors such as Aviation, Utilities, Realty, E&C and Infra emerge as sectors where the proportion of survivors in the total number of listed companies in that sector today is the lowest (see exhibit above). IT is a clear exception in this chart for industry specific reasons highlighted in Section 5. A prime manifestation of the high degrees of regulatory uncertainty in India is that only companies that are characterized by long-term stability in leadership are able to overcome the scalability challenge. It is clear to see that companies that have been able to achieve the highest magnitude of scale across time appear to be characterized by one of two types of leadership formats namely, (1) Government ownership or (2) Family owned businesses with leadership that has been in-charge for at least a decade (if not two). For instance, travelling back in time, a cursory look at the top-10 companies (ex-BFSI) in India by revenue size of FY11 showed the following characteristics: . 60% of the constituents of the top-10 revenue club in India in FY11 were ‘new entrants’ into the top-10 revenue club (see column 1 in exhibit below). These 6 companies were IOCL, BPCL, HPCL, ONGC, MMTC and Coal India. All of these 6 new entrants were in fact SOEs (see column 2 in exhibit below) and were listed as part of the Government’s privatization/disinvestment drive initiated by the NDA-I Government. . The four private sector players that were part of the top-10 revenue club in India in FY11 i.e. Reliance Industries, Tata Motors, Tata Steel and Hindalco Industries were Family Owned Businesses (FOBs). Hence, they had the benefit of multi- decadal leadership stability (see column 3 in exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 20 Strategy Exhibit 37: The top-10 companies by revenue in India in FY11 were with either SOEs or FOBs If private, then has the Did co. exist as a 10 largest Is the co. an SOE? company had a bout of long Sector Revenue listed co. in FY01? companies in FY11 (Column 2) term stable leadership? (Column 1) (Column 3) (By revenue size) Name (Rs tn in FY11) Yes/No Yes/No Yes/No/NA I O C L Oil & Gas 3.1 No Yes NA Reliance Inds. Oil & Gas 2.7 Yes No Yes B P C L Oil & Gas 1.5 No Yes NA H P C L Oil & Gas 1.4 No Yes NA Tata Motors Auto & Auto Anc. 1.2 Yes No Yes O N G C Oil & Gas 1.2 No Yes NA Tata Steel Metals & Mining 1.2 Yes No Yes Hindalco Inds. Metals & Mining 0.7 Yes No Yes MMTC Others 0.7 No Yes NA Coal India Metals & Mining 0.6 No Yes NA Source: Capitaline, Bloomberg, Ambit Capital research Note: The top-10 revenue club is defined as the 30 listed ex-BFSI companies with the highest annual revenue in FY11. Then travelling forward in time by a decade, a look at the top-10 companies (ex-BFSI) in India by revenue size of FY19 re-confirms the importance of leadership stability in overcoming headwinds posed by tempestuous policy changes. In specific: . The two new star entrants into the top-10 revenue club in FY19 were TCS and L&T. Both these companies benefitted from the existence of long-serving Chairmen, namely Ratan Tata and AM Naik respectively at the helm of their affairs (see column 1 and 3 in the exhibit below). . Meanwhile Reliance Industries, Tata Motors and Tata Steel, i.e. the three other private companies in the top-10 club that had been around in the listed space for more than a decade each, managed to continue scaling up their revenues under the leadership of their own long-serving chairmen (see column 3 in the exhibit below). . The presence of SOEs in the top-10 revenue club diminished by FY19 but four SOEs (with all 4 operating in the Oil & Gas sector) retained their membership to this elite club with all four operating in the heavily regulated Oil & Gas sector (see column 2 in the exhibit below). Exhibit 38: The top 10 companies in India by revenue today are either SOEs or have had a bout of stable top leadership lasting +25 years If private, then has the Did co. exist in the top 10 largest Is the co. an SOE? company had a bout of Sector Revenue 10 club in FY11? companies in FY19 (Column 2) long term stable leadership? (Column 1) (Column 3) (By revenue size) Name (Rs tn in FY19) Yes/No Yes/No Yes/No/NA Reliance Inds. Oil & Gas 5.7 Yes No Yes I O C L Oil & Gas 5.3 Yes Yes NA O N G C Oil & Gas 4.2 Yes Yes NA Tata Motors Auto & Auto Anc. 3.0 Yes No Yes B P C L Oil & Gas 3.0 Yes Yes NA H P C L Oil & Gas 2.8 Yes Yes NA Rajesh Exports Others 1.8 No No No Tata Steel Metals & Mining 1.6 Yes No Yes TCS IT 1.5 No No Yes Larsen & Toubro E&C and Infra 1.4 No No Yes Source: Capitaline, Bloomberg, Ambit Capital research, Note: Top-10 revenue club defined as 30 listed ex-BFSI companies with highest annual revenue in FY19. In fact India’s corporate history suggests that most large Family Owned Businesses (FOBs) in India with long-serving leaders have almost always ended up having presence in the top-30 revenue club in India (see exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 21 [email protected] 2020-12-07 Monday 13:17:41 Strategy Exhibit 39: FOBs with long serving corporate leaders almost always end up being present in the top revenue club of India Is the group/co. present Tenure Duration Name of companies present in Business group Chairman in the top-30 revenue (From- To) (in years) the top-30 revenue club of FY19 club*? Tatas JRD Tata 1938-88 50 Yes Tata Motors, Tata Steel, TCS Mahindras Keshub Mahindra 1963-12 49 Yes M&M Ambanis Dhirubai Ambani 1977-02 25 Yes Reliance Industries Wadias Nusli Wadia 1977-present 43 No NA Infosys NR Narayan Murthy 1981-11 30 Yes Infosys Hero Moto Brijmohan Munjal 1984-15 31 No NA Tatas Ratan Tata 1991-12 21 Yes Tata Motors, Tata Steel, TCS Mittals Sunil Mittal 1995-present 25 Yes Bharti Airtel AV Birla Group KM Birla 1995-present 25 Yes Hindalco Larsen & Toubro AM Naik 2003-17 14 Yes L&T ITC YC Deveshwar 1996-17 21 No ITC Source: Business Standard, Company, Ambit Capital research. Note: The top-30 revenue club is defined as the 30 listed ex-BFSI companies with the highest annual revenue in FY19. Thus, India’s corporate history clearly suggests the regulatory environment is unpredictable, preventing business models to manage multi-decadal scalability. In such an environment, only businesses blessed with very long-term leadership stability (either in the form of a long-serving chairman or in the form of Government ownership) appear to be most likely to maintain multi-decadal survival and growth. Reason#2: India’s deceivingly small market size “Europe’s current situation is partly due to a structural disadvantage: its fragmented markets and governance. While the EU domestic market, with 500 million citizens, is larger than the United States’, it is less homogenous than both China and the United States, despite the European Union’s efforts to create a single market. Linguistic and cultural diversity are a core strength for Europe but also inhibit rapid scaling; trade and labor markets are integrated, but businesses still must deal with different corporate and individual tax regimes (for example, 81 different value-added taxation regimes across Europe).” - McKinsey report titled, ‘How purpose-led missions can help Europe innovate at scale’, December 2019 India too potentially suffers from the same problem as Europe, whereby despite having an aggregate market size which is large, the market is not an integrated one. The language barrier and the multitude of tastes/preferences that exist in India are potentially responsible for making India a less integrated market. The case of HUL’s operations in India illustrates this point most clearly. HUL is the largest listed corporate in India operating in the Staples space. HUL’s ability to scale up can be mainly attributed to its ability to build brands straddling across the consumer income spectrum and being able to constantly refresh them. Over and above India’s market size being segmented, the other reason why Indian companies fail to scale up meaningfully is simply because of India’s underdeveloped exports footprint. For instance, the top 5 listed ex-BFSI companies in India in fact have a domestic revenue base which is comparable to EMs like S Korea and Brazil as well as more developed markets such as France and Germany. Despite this, the top 5 listed companies have significantly higher ‘total revenues’ owing to a significantly better developed export footprint (i.e. the summation of export and domestic revenue) (see exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 22 Strategy Exhibit 40: Domestic revenues of India’s top 5 companies comparable to peers but India lags on exports’ revenue Total revenues Export revenue Domestic revenue 781 520 502 482 428 319 317 306 (un US$bn) (un 261 272 230 227 213 164 112 94119 Revenues of top 5 cos. 79 Germany France South Korea Russia India Brazil Source: Bloomberg, Ambit Capital research 1.Revenue data pertains to FY19/CY19 and is denominated in US$ 2. The following companies are covered as part of this analysis: Germany – Volkswagen, Daimler, BMW, Siemens & Deutsche Telecom. France – Total SA, Carrefour, Peugeot, EDF & Airbus. S Korea – Samsung, Hyundai, SK Holdings, POSCO & LG. Russia – Rosneft, Gazprom, LUKOIL, Gazprom Neft & Surgutneftegas. India – Reliance Industries, IOC, ONGC, Tata Motors & BPCL. Brazil - Petroleo Brasileiro, JBS, Vale, Petrobras Distribuidora and Ultrapar Participacoes. This is mainly because the top companies in this region have been able to break into the exports market of their sectors besides capturing a large market share in the domestic market as well. Consequently for this cluster of countries whose top 5 companies have domestic revenues in the range of US$100-300bn, the export revenue component varies from being 1x to 3x the domestic revenue component whilst for India this ratio stands at 0.3x (see exhibit above). A few other reasons that prevent rapid scalability of Indian businesses Besides the existence of high degree of regulatory uncertainty in India which is partially responsible for the inability of businesses to scale up, it is also worth noting that the shape of labour regulations in India also explicitly disincentivizes the existence of large businesses. The Economic Survey of India for FY19 published by the Ministry of Finance itself noted that, “India has a plethora of labour laws, regulations and rules, both at the centre and the state levels that govern the employer-employee relationship. Each of these legislations exempts smaller firms from complying with these legislations....Given the transaction costs inherent in complying with such regulations, naturally a large majority of firms would prefer to be below the threshold of 100 employees. Thus, such labour legislation creates perverse incentives for firms to remain small. In this sense, labour legislation complements other benefits provided to small firms in providing such perverse incentives.” Exhibit 41: The web of Indian regulations by design is more onerous for firms hiring more than 100 employees Labour Act Applicability of establishments Industrial Disputes Act,1947, Chapter V relating to strikes, lockouts, Employing 100 or more workers retrenchment, layoff Trade Union Act, 2001-Registration of trade unions Membership of 10 per cent or 100 workmen whichever is less Industrial Employment (Standing Orders) Act, 1946 100 or more workmen Factories Act,1948 10 or more workers with power and 20 or more workers without power Contract Labour (Regulation & Abolition) Act, 1970 20 or more workers engaged as contract labour The Minimum Wages Act, 1948 Employment in the schedule having more than 1000 workers in the State Employees’ State Insurance Act,1948 - ESI Scheme 10 or more workers and employees monthly wage does not exceed `21000 Employees’ Provident Fund & Miscellaneous Provisions Act, 1952 20 or more workers Source: Economic Survey of FY19, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 23 Strategy Even as a few states like Uttar Pradesh, Gujarat and Madhya Pradesh have announced drastic changes in labour laws following the outbreak of Covid19, it is unclear if these changes will be legally tenable given that labour as a subject is on the concurrent list and hence changes here require Presidential assent. Finally, scalability is a challenge in India since the cost of debt capital facing a sub- AAA corporate is unusually high. . For instance, 5-year G-Sec yield in India has been recorded at a 5-year average of 7%. . During this period, the 5-year average bond yield on an AAA corporate bond was recorded at 7.8%, i.e. implying an 80bps spread as against the corresponding G- Sec yield. . Moving one notch lower on the credit rating spectrum, the 5-year average bond yield on an AA corporate bond was recorded at 8.4%, i.e. implying another 60bps spread as against the corresponding AAA bond yield. . Moving one more notch lower, the 5-year average bond yield on an A corporate bond was recorded at 9.8%, i.e. implying a 140bps spread as against the corresponding AA bond yield. The cost of debt capital thus facing sub-AAA corporates tends to be high and rises disproportionately as one moves down to credit quality spectrum (see exhibit below for details). Exhibit 42: AAA bond yields are higher Exhibit 43: AA bond yields are higher Exhibit 44: A bond yields are higher than G-Sec yields by 80-100bps than AAA yields by 50-60bps than AA yields by 110-140bps! 5yr avg 10yr avg 5yr avg 10yr avg 5yr avg 10yr avg Sec - 1.4 1.4 1.0 1.0 1.3 1.0 0.9 0.9 0.6 1.1 1.1 0.8 0.6 0.5 1.1 0.50.5 0.5 bond yield (in %) (in yield bond AA %) (in yield AA bond Spread Spread betweenG yield & AAA (in AAA & yield %) bond Spread between AAA Spread betweenAAA & Spread between AA A AA & between Spread 1yr Paper 5yr Paper 10yr Paper 1yr Paper 5yr Paper 10yr Paper 1yr Paper 5yr Paper 10yr Paper Source: Bloomberg, Ambit Capital research; Note: Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research 5yr data spans 2QFY16 to 1QFY21 whilst 10yr data spans 2QFY11 to 1QFy21. Besides the shortage of debt capital, another factor could also be the inadequacy of equity capital availability in the country and which in turn causes Indian corporates to remain debt focused. But the shortage of debt capital essentially means that just when a small Indian company needs capital to scale up into the mid-sized segment, it often struggles to maintain a weighted average cost of capital (WACC) which is below its return on invested capital. We have now articulated two critical pieces namely, . Uncovering the precise nature of dwarfism that Indian corporates are susceptible to (with Section 1 covering the listed companies perspective, Section 2 covering the cross-country perspective and Section 3 covering the unlisted space perspective) and, . Identifying the most proximate factors responsible for this malaise (covered in Section 4); We now move closer to the most critical piece, i.e. ‘what frameworks can be used to identify companies that are likely to be able to overcome the scalability challenge’? But before we dive into this segment, in the subsequent segment we answer two key questions with respect to the largest sectors in India namely: . What has been the scalability experience of this key sector in India? . What have been the key challenges confronted by this sector in overcoming the scalability challenge? August 26, 2020 Ambit Capital Pvt. Ltd. Page 24 Strategy Section 5: A deep-dive into five key sectors As illustrated in Section 1 of this note, only 12 Indian listed ex-BFSI companies have managed to scale up their revenues into the +Rs1tn realm. Then in the section above we highlighted ‘macro factors’ that prevent India’s high GDP growth rate from distilling itself into high revenue growth rate for listed companies. In this segment, we now analyze why only a fistful of sectors front (such as Oil & Gas, Metals & Mining and IT) have managed to establish their footprint on the scale front whilst some sectors that are known to have high revenues in developed countries (such as Consumers and Pharma) have failed to make their presence felt in the elite +Rs1tn revenue club in India. The table below presents a summary of the findings and the rest of this section elaborates on granularities relating to each of these sectors. Exhibit 45: ‘Metals & Mining’ and ‘Oil & Gas’ are the main sectors that have managed to establish meaningful presence in the +Rs1tn revenue club Did Mid-sized companies’ Scalability Sector’s presence in +Rs1tn share increase significantly Key challenge to scalability experienced by sector metrics revenue club? in sector since CY90? Weak Yes The very wide spectrum of local tastes and heterogeneity prevent a Consumer (with ‘zero’ presence) (Share rose from 20% to 60%) single brand to take very high share across categories. Continuous spend on R&D and commensurate capex in an environment Weak Yes of pervasive pricing pressure limits scalability. Limited bargaining power Pharma (with ‘zero’ presence) (Share rose from 14% to 56%) versus the channel in the US, intense competition and weak regulatory framework in the domestic market. Moderate Not-so-much Since scale begets more scale in the sector, smaller IT players suffer IT (with TCS present) (Share rose from 8% to 39%) disadvantages such as limited client reach and lower pricing power. High Limited access to capital, combatting sharp regulatory changes and Metals & Yes (with Tata Steel & ability to finish projects on time prevents smaller companies from Mining (Share rose from 22% to 64%) Hindalco present) scaling-up. High No In a heavily regulated sector, medium-sized firms are not scalable as Oil & Gas (with Reliance, ONGC, they were set up for specific strategic reasons. Also, given large capital HPCL, IOCL and BPCL (Share rose from 40% to 45%) requirements Mid-sized firms ‘chose’ not to scale up. present) Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 25 Strategy Section 5.1: Consumers – Market appears optically large! The Indian Consumer sector perhaps presents the most interesting case study in the current context. Despite being capital-light, labour-light, requiring low technological input and being subject to low levels of regulation, this sector has not been able to make its presence felt in the +Rs1tn club. However, it is worth noting that this sector internally has seen a fairly high proportion of companies graduate from the ‘Small and Ultra-small’ categories into the Medium-sized category. Scroll below for a tabular representation of the reasons behind the evolution of this sector on the scale front, over the last three decades. Exhibit 46: What have been the challenges faced by Indian Consumer firms that failed to scale up? Stylized questions Details Overview Is the capital intensity of the sector High, Medium or Low? LOW: Capital intensity for a business operating in this sector is low. Is the labour intensity of the sector High, Medium or Low? MEDIUM: Labour intensity for a business operating in this sector is medium. Is the tech/knowledge intensity of the sector High, Medium or MEDIUM: Tech/knowledge intensity required for a business operating in this sector is Low? medium. Is regulatory change a meaningful variable that affects the It is largely a business of creating brands and widening distribution. Regulatory changes prospects of this sector? don’t make much of a difference barring small changes in margins. What proportion of total revenues at a sectoral level arises The split amounts to 90% from India and 10% from overseas in broad terms at a sector from India and what proportion can be attributed to foreign level. Some large companies like GCPL derive 50% of their revenues from international markets? businesses, which were acquired. Getting shelf space in general trade is the biggest challenge. The only sustainable way to build scalability is by creating consumer pull through product innovation and advertising backed by aggressive distribution expansion. Besides the above stated factors, what is the key variable that affects the scalability of firms in this sector? Another factor in India is that shelf space never got organized with the local mom n pop shops dominating the consumption source. In the coming years smaller new entrants may be able to use online channels to build brand visibility – which could be another reason for more dwarfs to emerge before any potential consolidation. Best example of a business that has shown scalability in this sector Hindustan Unilever with revenues of Rs0.4tn today is the best example in this regard. It Which company provides the best example of scaling-up has been able to deliver a 5-yr and 10-year revenue CAGR of 4.5% and 8.4% successfully in this sector? respectively. HUL’s ability to build brands straddling across the consumer income spectrum and its What are the two defining features of HUL’s business that ability to adapt to disruptions (spanning Demon, GST, the rise of digital media and allowed this firm to scale-up over the last 5 years? competing with e-Commerce) have been the two defining features of HUL’s business that allowed this firm to scale-up over the last 5 years. Challenges to scaling up Notably, no Indian Consumer company today has revenues in The key challenge that prevents the Indian consumer firms from graduating to the excess of Rs1tn. This is confounding given that: +Rs1tn revenue category is the fact that even as India is seen as a single market with . In India, capital-light sectors like IT have managed to find 1.3bn consumers; the very wide spectrum of local tastes and heterogeneity prevent a representation in this elite club. single brand to take very high share across categories. . Globally, Consumers has meaningful representation amongst the top firms by revenues. Also, it is worth noting that India’s purchasing power is still evolving and the share of What are the two key challenges that prevent Indian consumer premium brands still remains low. firms from graduating to the +Rs1tn revenue category? The problems associated with building a pan-India distribution network and limited 60% of companies in this sector today are in the Medium access to quality talent are the two key challenges that prevent Medium-sized category (i.e. revenues of Rs1-100bn). What are the two key companies from graduating into a higher revenue category. challenges that prevent these firms from graduating to a higher Also, brands’ limited ability to replicate success across multiple product categories acts revenue category? as a constraint. Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 26 [email protected] 2020-12-07 Monday 13:17:41 Strategy Exhibit 47: Stylized facts about the Indian Consumer Industry and its scale Stylized questions Details Overview What proportion of listed companies do Consumer companies In the listed universe in India (ex-BFSI) spanning 2,865 companies, Consumer companies in India account for? account for 195 or 7% of the companies. What are the top-3 Consumer companies in India today as ITC (Rs0.5tn), HUL (Rs0.4tn) and Nestle (Rs0.1tn). per FY19 revenues? Survivorship 33 Consumer companies have existed in the listed space from CY90 to CY19. What is the total number of Consumer companies that have existed in the listed space from CY90 to CY19? This includes all the major heavyweights in the sector, including ITC, HUL, Nestle and Britannia. Of the total 390 ex-BFSI companies in India that have In the listed universe in India (ex-BFSI) spanning 390 survivors, Consumer companies managed to survive from CY90 to CY19, what proportion are account for 33 or 8.5% of survivors. Consumer companies? Entry & exit Which decade saw the highest number of entry of firms into The decade spanning FY91-01 saw 85 firms enter into the listed Consumer space in this sector? India. Which decade saw the highest number of exit of firms from The decade spanning FY01-11 saw 4 firms exit from the listed Consumer space in India. this sector? Size Which revenue buckets account for the largest proportion of The Ultra Small (i.e. revenues of Rs0-400mn) and Medium category (i.e. revenues of Rs1- Indian Consumer firms? 100bn) account for 47% and 39% of Indian Consumer firms today. How many companies in the Consumer sector have revenues Only 5 companies in the listed consumer sector have revenues in excess of Rs100bn. in excess of Rs100bn? These are ITC, HUL, Nestle, Britannia and Godrej Consumer. Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 48: No listed Consumer company has managed to break into the +Rs1tn revenue club Total number of firms (by annual revenues in rupees) FY90 FY00 FY10 FY19 0-400mn (Ultra Small) 67 82 50 46 400mn-1bn (Small) 22 39 24 27 1bn-100bn (Medium) 22 73 113 117 100bn-1tn (Large) - 1 4 5 1tn-6tn (Mature) - - - - TOTAL 111 195 191 195 Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 49: Smaller companies in the Consumer sector managed to graduate to higher revenue categories in the noughties Total number of firms (by annual revenues in rupees) CY90 CY00 CY10 CY19 0-400mn (Ultra Small) 60% 42% 26% 24% 400mn-1bn (Small) 20% 20% 13% 14% 1bn-100bn (Medium) 20% 37% 59% 60% 100bn-1tn (Large) 0% 1% 2% 3% 1tn-6tn (Mature) 0% 0% 0% 0% Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 27 Strategy Section 5.2: Pharma: High competition along with high capital intensity! The Indian Pharmaceutical sector presents another noteworthy case study in the context of scalability (or the lack of it). Despite being capital-light and despite the fact that globally Pharmaceuticals account for some of the largest revenue heavyweights, this sector has not been able to make a mark in the +Rs1tn club. However, it is worth noting that this sector, much like Consumers, has seen a fairly high proportion of companies consistently move from the Small and Ultra-small categories to the Medium-sized category. Scroll below for a tabular representation of the reasons behind the evolution of this sector on the scale front over the last three decades. Exhibit 50: What have been the challenges faced by Indian Pharma firms that failed to scale up? Stylized questions Details Overview HIGH. Contrary to popular belief, growth sustenance in the US requires considerable Is the capital intensity of the sector High, Medium or Low? spend on R&D, while pricing pressure is pervasive. CE turns are in the range 0.8-1.2x for most US exposed large cap companies in the space. MEDIUM. Technical complexity of plants is high, but labour requirement is not very Is the labour intensity of the sector High, Medium or Low? intense. Is the tech/knowledge intensity of the sector High, Medium or HIGH. R&D spend for US exposed names is generally in the range 7-10% of sales. Low? Is regulatory change a meaningful variable that affects the Yes. Domestic pricing caps, USFDA compliance issues and delayed approvals for prospects of this sector? complex products are the usual regulatory issues. What proportion of total revenues at a sectoral level arises from For large Pharma players, about 40% of revenues arise from domestic sales whilst about India and what proportion can be attributed to foreign markets? 60% is export driven. In the US, a consolidated channel has led to bargaining power of manufacturers turning Besides the above stated factors, what is the key variable that adverse over the last 5-7 years which impedes scalability. Meanwhile, lax regulations affects the scalability of firms in this sector? results in hyper-fragmentation in the domestic market which impedes scalability. Best example of a business that has shown scalability in this sector Sun Pharma with revenues of Rs313bn today is one of the best examples in this regard. Which company provides the best example of scaling-up It has been able to deliver a 5-year and 10-year revenue CAGR of 12% and 20% successfully in this sector? respectively though quite a bit of this growth has stemmed from inorganic pursuits (e.g., Ranbaxy, Taro acquisitions). What are the two defining features of Sun’s business that Acquisitions (Taro, Ranbaxy) have complemented Sun’s early-mover advantage in allowed this firm to scale up over the last 10 years? India/US, whilst promoter’s risk appetite on the litigation front has been high in the US. Challenges to scaling-up Notably, no Indian Pharma company today has revenues in excess of Rs1tn. This is confounding given that globally, Pharma Entry barriers are limited in generics, leading to accentuated competition. Also, has meaningful representation amongst the top firms by innovator molecule capabilities are sub-par with respect to development and revenues. What are the two key challenges that prevent Indian commercialization. pharma firms from graduating to the +Rs1tn revenue category? Most pharma companies have core competencies in certain niche areas, for instance – 56% of companies in this sector today are in the Medium (i) Eris: domestic anti-diabetes; (ii) Laurus: ARV APIs; (iii) Natco: US complex generics; category (i.e. revenues of Rs1-100bn). What are the two key and (iv) IPCA: domestic pain management. challenges that prevent these firms from graduating to a higher revenue category? Continuous spend into R&D and commensurate capex, but in a pervasive pricing pressure construct limits scalability for such companies outside of core competencies. Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 28 Strategy Exhibit 51: Stylized facts about the Indian Pharma Industry and its scale Stylized questions Details Overview What proportion of listed companies do Pharma companies in In the listed universe in India (ex-BFSI) spanning 2,865 companies, Pharma companies India account for? account for 148 or 5% of the companies. What are the top-3 Pharma companies in India today as per Sun Pharma (Rs0.3tn), Aurobindo Pharma (Rs0.2tn) and Lupin (Rs0.2tn). FY19 revenues? Survivorship What is the total number of Pharma companies that have 17 companies have existed in the listed space from CY90 to CY19. existed in the listed space from CY90 to CY19? This includes Cipla, Dr. Reddy’s Labs and Piramal Enterprises. Of the 390 ex-BFSI companies in India that have managed to In the listed universe in India (ex-BFSI) spanning 390 survivors, Pharma companies exist in the listed space from CY90 to CY19, what proportion account for 17 or 4% of survivors. are Pharma companies? Entry & exit Which decade saw the highest number of entry of firms into The decade spanning FY91-01 saw 87 firms enter into the listed Pharma space in this sector? India. No decade has seen the total number of Pharma companies in India decline. The Which decade saw the highest number of exit of firms from decade spanning FY11-19 saw no change in the total number of listed Pharma this sector? companies in India. Size Which revenue buckets account for the largest proportion of The Medium category (i.e. revenues of Rs1-100bn) accounts for 56% of Indian Pharma Indian Pharma firms? firms today. How many companies in the Pharma sector have revenues in Only 7 companies in the listed pharma sector have revenues in excess of Rs100bn. excess of Rs100bn? Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 52: No single Pharma company in India has managed to break into the +Rs1tn revenue club Total number of firms CY90 CY00 CY10 CY19 (by annual revenues in rupees) 0-400mn (Ultra Small) 24 68 47 26 400mn-1bn (Small) 14 18 15 32 1bn-100bn (Medium) 6 45 86 83 100bn-1tn (Large) - - - 7 1tn-6tn (Mature) - - - - TOTAL 44 131 148 148 Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 53: Several Small companies in the Pharma sector have managed to graduate into higher revenue categories Total number of firms CY90 CY00 CY10 CY19 (by annual revenues in rupees) 0-400mn (Ultra Small) 55% 52% 32% 18% 400mn-1bn (Small) 32% 14% 10% 22% 1bn-100bn (Medium) 14% 34% 58% 56% 100bn-1tn (Large) 0% 0% 0% 5% 1tn-6tn (Mature) 0% 0% 0% 0% Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 29 Strategy Section 5.3: IT - Only sector to present an organic scalability example! The scale perspective highlights why the Indian IT sector deserves the halo that it is often credited with. Unlike Metals or Oil & Gas companies or conglomerates like L&T (which are capital intensive and/or have managed to scale up through acquisitions), the IT sector has managed to make its mark in the +Rs1tn revenue club mainly through organic growth with a focus on a single business line. However, it is worth noting that this sector has not seen a high proportion of companies graduate from the ‘Small and Ultra-small categories’ into the Medium-sized category. Scroll below for a tabular representation of the reasons behind the evolution of this sector on the scale front over the last three decades. Exhibit 54: What have been the challenges faced by Indian IT firms that failed to scale up? Stylized questions Details Overview LOW: Capital intensity for a business operating in this sector is low. Typically 2-3% of Is the capital intensity of the sector High, Medium or Low? sales is the capex of IT companies. HIGH: Labour intensity for a business operating in this sector is high. Employee cost is Is the labour intensity of the sector High, Medium or Low? between 55-60% of sales. Is the tech/knowledge intensity of the sector High, Medium or HIGH: Tech/knowledge intensity required for a business operating in this sector is high. Low? Training, reskilling and adaptation to technology changes are key to scalability. Is regulatory change a meaningful variable that affects the Domestic regulation has low relevance for the sector, but developed market prospects of this sector? immigration policies have impacts on fulfillment and cost for the sector. What proportion of total revenues at a sectoral level arises The split amounts to 15% from India and 85% from overseas in broad terms at a sector from India and what proportion can be attributed to foreign level. markets? Other factors affecting sector scalability are: (1) Management continuity and depth – TCS which had a seamless transition for its last three CEOs has scale better compared to Infosys, Wipro and Cognizant where there have been management discontinuities, (2) Industry dynamics supporting scale players – Business used to be empanelment based, with larger existing relationships valued more than new smaller players. This put mid cap IT at a disadvantage, Besides the above stated factors, what is the key variable that affects the scalability of firms in this sector? (3) Ability to expand target markets and differentiate offerings: Most mid cap players were generic copies or large cap players with limited differentiation. Players like TCS expanded target markets across geographies (LATAM, Japan, Continental Europe) and segments (Insurance platforms, UK public services, Healthcare) which aided scale up and, (4) Inability to take short term pain to gain long term: HCLT is a prime example wherein it hurt margins in the interim to gain a foothold in IMS which is now near 40% of their revenues and more profitable than their IT business. Best example of a business that has shown scalability in this sector Which company provides the best example of scalability in this TCS with revenues of Rs1.6tn today is the best example in this regard. It has been able sector? to deliver a 5-year and 10-year revenue CAGR of 10.8% and 18.4% respectively. Ability to marry capabilities to stitch up large deals and also expansion of target What are the two defining features of TCS’s business that markets across Japan, Latin America, Europe and Insurance platform BPO has allowed allowed this firm to scale-up over the last 5 years? TCS to manage entry into the +Rs1tn revenue club. Challenges to scaling-up Me-too positioning is one of the problems and also scale begets more scale in the 47% of companies in this sector today are in the Ultra Small sector. Hence, smaller IT players have been largely replicas of larger IT players with (i.e. revenues of Rs0-400mn) category. What are the two key limited differentiation and competency gaps versus larger players. challenges that prevent these firms from graduating to a Further, smaller scale has been a disadvantage in terms of client reach, ability to invest higher revenue category? given lower margins, lower pricing power and higher client concentration risks. Thus, historically, smaller scale was an impediment to faster growth. Capabilities limited to a few areas and competency levels not at par or better than the larger players: Smaller players typically were largely application development and 39% of companies in this sector today are in the Medium maintenance players, without strong capabilities in enterprise solutions, BPO, category (i.e. revenues of Rs1-100bn). What are the two key infrastructure management and ER&D services. This prevents them from becoming full challenges that prevent these firms from graduating to a service plays. Further, on competency levels, they are still challengers and not exactly higher revenue category? near the larger players in these service lines. Thus, their play has been largely higher responsiveness and lower pricing to drive growth. Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 30 Strategy Exhibit 55: Stylized facts about the Indian IT Industry and its scale Stylized questions Details Overview What proportion of listed companies do IT companies in India In the listed universe in India (ex-BFSI) spanning 2,865 companies; IT companies account for? account for 184 or 6% of the companies. What are the top-3 IT companies in India today as per FY19 TCS (Rs1.4tn), Infosys (Rs0.8tn) and HCL Tech (Rs0.6tn). revenues? Survivorship What is the total number of IT companies that have existed in 3 companies have existed in the listed space from CY90 to CY19. the listed space from CY90 to CY19? This includes Wipro, Zensar Tech and Rolta India. Of the 390 ex-BFSI companies in India that have managed to In the listed universe in India (ex-BFSI) spanning 390 survivors, IT companies account exist in the listed space from CY90 to CY19, what proportion for 3 or 0.8% of survivors. are IT companies? Entry & exit Which decade saw the highest number of entry of firms into The decade spanning FY91-01 saw 156 firms enter into the listed IT space in India. this sector? Which decade saw the highest number of exit of firms from The decade spanning FY11-19 saw 25 firms exit from the listed IT space in India. this sector? Size Which revenue buckets account for the largest proportion of The Ultra Small (i.e. revenues of Rs0-400mn) and Medium categories (i.e. revenues of Indian IT firms? Rs1-100bn) respectively account for 47% and 39% of Indian IT firms today. How many companies in the IT sector have revenues in excess Only 5 companies in the listed IT sector have revenues in excess of Rs100bn with TCS of Rs100bn? being characterized by revenues in excess of Rs1tn. Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 56: IT is a capital-light sector which has managed to record revenues in excess of Rs1tn Total number of firms CY90 CY00 CY10 CY19 (by annual revenues in rupees) 0-400mn (Ultra Small) 7 116 84 86 400mn-1bn (Small) 4 17 27 22 1bn-100bn (Medium) 1 35 93 71 100bn-1tn (Large) - - 5 4 1tn-6tn (Mature) - - - 1 TOTAL 12 168 209 184 Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 57: The pace of graduation of Small companies into Mid-sized ones suffered a setback over the last decade Total number of firms CY90 CY00 CY10 CY19 (by Annual Revenues in Rupees) 0-400mn (Ultra Small) 58% 69% 40% 47% 400mn-1bn (Small) 33% 10% 13% 12% 1bn-100bn (Medium) 8% 21% 44% 39% 100bn-1tn (Large) 0% 0% 2% 2% 1tn-6tn (Mature) 0% 0% 0% 1% Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 31 [email protected] 2020-12-07 Monday 13:17:41 Strategy Section 5.4: Metals & Mining – High presence in the +1tn revenue club! The existence of strong promoter groups that have been able to deliver superior access to capital has meant that the Metals & Mining sector has had meaningful presence in the top 10 revenue league of India since 1991. Whilst Steel Authority of India Ltd (SAIL) was the largest listed Metals & Mining Company in India by revenue in FY01, Tata Steel and Hindalco became the two largest companies by revenue in this sector by FY11. These two companies retained their leadership position and are both characterized by revenues in excess of Rs1tn today. Also it is worth noting that both these companies owe their scale to inorganic expansions. Additionally, it is worth noting that this sector has seen a fairly high proportion of companies consistently graduate from the Small and Ultra-small categories into the Medium- sized category. Scroll below for a tabular representation of the reasons behind the evolution of this sector on the scale front over the last three decades. Exhibit 58: What have been the challenges faced by Indian Metals & Mining firms that failed to scale-up? Stylized questions Details Overview HIGH: Capital intensity for a business operating in this sector is high. It takes Is the capital intensity of the sector High, Medium or Low? +Rs50,000/tonne of capital to set up greenfield steel plant and the intensity is high for other metals as well. HIGH: Labour intensity for a business operating in this sector is high. Some of the European Is the labour intensity of the sector High, Medium or Low? countries have more automation, but in India it is more labour intensive given access to cheap labour. MEDIUM: Tech/knowledge intensity required for a business operating in this sector is high- Is the tech/knowledge intensity of the sector High, Medium need geological/metallurgical expertise to find the right deposit/mix in furnaces. However, or Low? knowledge intensity in India is significantly lower than western countries that produce more specialized/value-added products. Is regulatory change a meaningful variable that affects the Absolutely. Regulations relating to mineral royalties, auctions, land acquisition, pricing (for prospects of this sector? Coal India), import/export duties & anti-dumping duties are important considerations. What proportion of total revenues at a sectoral level arises from India and what proportion can be attributed to Varies mineral to mineral, and company to company. foreign markets? Availability of raw materials, expertise in setting up/expanding projects on time and within budgetary constraints. Two other factors are responsible for only a fistful of Indian companies being able to break into the top revenue categories in the Metals space in India. Firstly, the sector is extremely cyclical in nature and hence smaller companies take on debt for expansion but get financially stressed in a downturn. And banks are naturally reluctant to Besides the above stated factors, what is the key variable lend further support to such companies during a downturn. This is the reason why large that affects the scalability of firms in this sector? companies with financial clout have a markedly superior capability to ride out a downturn and even acquire stressed companies. Secondly the sector is high on capital intensity. For instance it takes broadly speaking US$1bn to setup a 1 million tonne steel plant and US$5bn to setup a 1 million tonne aluminum plant. This degree of initial capital investment requires acts as a big entry barrier. Best example of a business that has shown scalability in this sector Which company provides the best example of scaling up JSW Steel. With revenues of Rs0.8tn today is the best example in this regard. It has been able successfully in this sector? to deliver a 5-year of 7%. Excellent project management team, disciplined and prudent acquisitions and ability to What are the two defining features of JSW Steel’s business turnaround stressed units acquired. For instance, JSW has in-house project management that allowed this firm to scale up over the last 5 years? team-completing Dolvi expansion more or less on time and also turned around Ispat acquisition. Challenges to scaling-up 64% of companies in this sector today are in the Medium category (i.e. revenues of Rs1-100bn). What are the two Access to capital, ability to time the cycle and finish projects on time and within budget (many key challenges that prevent these firms from graduating to companies tried getting bigger but ended up in IBC) a higher revenue category? Strong promoter groups and access to capital have allowed Tata Steel and Hindalco to scale up revenues to this extent. Metals & Mining as a sector is well-represented in the Both raised funds through rights offering, preferential warrants, and leveraged strong +Rs1tn revenue category. What are the factors that banking relationships and tapped into diversified, global sources of funding. Both also got allowed 2 private sector companies namely Tata Steel & bigger through overseas acquisitions, i.e. Tata Steel through Corus and Hindalco through Hindalco to increase revenues to this extent? Novelis. However, it is important to note that companies may get higher revenue through acquisitions but often dilute their EBITDA margin or EV/tonne. Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 32 Strategy Exhibit 59: Stylized facts about the Indian Metals & Mining Industry and its scale Stylized questions Details Overview What proportion of listed companies do Metals & Mining In the listed universe in India (ex-BFSI) spanning 2,865 companies, Metals & Mining companies in India account for? companies account for 183 or 6% of the companies. What are the top 3 Metals & Mining companies in India today Tata Steel (Rs1.6tn total revenues of which 600bn India revenues), Hindalco (Rs1.3tn of as per FY19 revenues? which 400bn India revenues) and Coal India (Rs1.0tn). Survivorship 25 companies have existed in the listed space from CY90 to CY19. What is the total number of Metals & Mining companies that have existed in the listed space from CY90 to CY19? This includes two of the largest Metal & Mining companies in India, i.e. Tata Steel and Hindalco. Others include Vedanta and Jindal Saw as well. Of the 390 ex-BFSI companies in India that have managed to In the listed universe in India (ex-BFSI) spanning 390 survivors, Metals & Mining exist in the listed space from CY90 to CY19, what proportion companies account for 25 or 6% of survivors. are Metals & Mining companies? Entry & exit Which decade saw the highest number of entry of firms into As the global commodities super-cycle unfolded, the decade spanning FY01-11 saw 72 this sector? firms enter into the listed Metals & Mining space in India. Which decade saw the highest number of exits of firms from The sector is yet to see exits on a decadal basis. The decade spanning FY11-19 saw the this sector? least number of entries at ‘2 firms’ into the listed Metals & Mining space in India. Size Which revenue buckets account for the largest proportion of The Medium category (i.e. revenues of Rs1-100bn) accounts for 64% of Indian Metals & Indian Metals & Mining firms? Mining firms today. How many companies in the Metals & Mining sector have A respectable number, i.e. 14 companies in the listed Metals & Mining sector have revenues in excess of Rs100bn? revenues in excess of Rs100bn. Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 60: Two companies namely Tata Steel and Hindalco have managed to break into the +Rs1tn revenue club Total number of firms CY90 CY00 CY10 CY19 (by annual revenues in rupees) 0-400mn (Ultra Small) 47 30 26 33 400mn-1bn (Small) 27 28 19 18 1bn-100bn (Medium) 21 50 126 118 100bn-1tn (Large) - 1 9 12 1tn-6tn (Mature) - - 1 2 TOTAL 95 109 181 183 Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 61: Much like IT, growing share of Mid-sized companies in the Metals space suffered a setback in the last decade Total number of firms CY90 CY00 CY10 CY19 (by annual revenues in rupees) 0-400mn (Ultra Small) 49% 28% 14% 18% 400mn-1bn (Small) 28% 26% 10% 10% 1bn-100bn (Medium) 22% 46% 70% 64% 100bn-1tn (Large) 0% 1% 5% 7% 1tn-6tn (Mature) 0% 0% 1% 1% Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 33 Strategy Section 5.5: Oil & Gas – Maintaining leadership on ‘scale’ in India for decades Much like the Metals & Mining sector, the Oil & Gas sector in India has had meaningful presence in the top 10 revenue league of India since 1991. Kochi Refineries was the largest listed Oil & Gas company in FY91 and was eventually acquired by BPCL in FY00. FY01 then marked the entry of IOCL, HPCL, BPCL, ONGC and Reliance Industries into the elite club of India’s top 10 companies by revenue. For the subsequent two decades, these 6 companies managed to retain their position in this top-10 revenue club with each of these 6 companies being characterized by revenues in excess of Rs1tn by FY19. Also, as regards the scalability of experience of smaller Oil & Gas companies, it is worth noting a unique feature of this sector - the total number of listed players in this sector has largely stayed range-bound at 20-30 for the last two decades as has the size categorization of companies in this sector. Scroll below for a tabular representation of the reasons behind the evolution of this sector on the scale front over the last three decades. Exhibit 62: What have been the challenges faced by Indian Oil & Gas firms that failed to scale up? Stylized questions Details Overview HIGH: Capital intensity for a business operating in this sector is high. Upstream energy firms like Is the capital intensity of the sector High, Medium or ONGC have depleting assets that are hard to replace given uncertainty of oil and gas find; mid Low? and stream firms like OMCs, GAIL, CGDs and Petronet LNG usually set up large installations to benefit from economies of scale. LOW: Labour intensity for a business operating in this sector is low. Capital is the most important Is the labour intensity of the sector High, Medium or variable and there is a high degree of automation in the extraction and processing of oil and Low? gas. MEDIUM: Tech/knowledge intensity required for a business operating in this sector is medium. Is the tech/knowledge intensity of the sector High, Seismic data analysis skills are vital in the upstream sector but other segments don’t require such Medium or Low? specialized know-how. Yes. Regulations affect the pricing of inputs/licenses to explore, access to raw material and/or Is regulatory change a meaningful variable that affects intermediate/retail tariffs and are hence the key determinant of return ratios that energy the prospects of this sector? companies generate. What proportion of total revenues at a sectoral level The split amounts to ~80% from India and the remainder overseas in broad terms at a sector arises from India and what proportion can be level. attributed to foreign markets? Given the restrictive regulatory environment and high taxation that is due to low affordability of Besides the above stated factors, what is the key energy consumers and the Government’s fiscal constraints, the sector’s participants are unable variable that affects the scalability of firms in this to generate predictable returns exceeding cost of capital. This affects scalability. Companies that sector? have reinvested cash flows from their energy business into unregulated business lines have scaled up meaningfully. Best example of a business that has shown scalability in this sector Which company provides the best example of scaling Reliance Industries (RIL) with revenues of Rs6.1tn in FY19 is the best example in this regard. It up successfully in this sector? has been able to deliver a 5-year and 10-year revenue CAGR of 7% and 15% respectively. In its oil-to-chemicals business, RIL had succeeded with its strategy of vertical integration along What are the two defining features of RIL’s business with a focus on economies of scale. Over the last five years, it replicated this strategy in that allowed this firm to scale up over the last 5 years? consumer businesses like telecom and retail. Challenges to scaling-up As compared to sectors like Metals & Mining or E&C Given the Government’s involvement and vast capital requirements to avail scale benefits, this and Infra, the total number of companies in the Oil & sector hasn’t attracted private capital in a major way. Directed by the Government, several Gas space has been unusually low in India. What is companies have folded into larger ones like Bongaigaon Refinery and CPCL into IOCL and MRPL the reason behind +150 companies existing in the and HPCL into ONGC. But in the gas sector, given conducive Government policies for demand former two sectors with the number being sub-30 and mid-stream infrastructure creation, the sector is attracting private and foreign capital. The across decades for the Oil & Gas sector? Government’s act of BPCL’s divestment and easing norms for fuel retailing will also help. Despite the existence of few firms in this sector, 45% of Government policies that spawned medium-sized firms are not scalable as they were set up for companies in this sector today are in the Medium strategic reasons like distribution of oil infrastructure in far flung areas or keeping in mind geo- category (i.e. revenues of Rs1-100bn). What are the political considerations. two key challenges that prevent these firms from Additionally, large capital requirements and sub-par economics are reasons why firms chose not graduating to a higher revenue category? to scale up. Instead, they focused predominantly on sweating their existing infrastructure. Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 34 Strategy Exhibit 63: Stylized facts about the Indian Oil & Gas industry and its scale Stylized questions Details Overview What proportion of listed companies do Oil & Gas companies In the listed universe in India (ex-BFSI) spanning 2,865 companies, Oil & Gas in India account for? companies account for 22 or 1% of the companies. What are the top-3 Oil & Gas companies in India today as per Reliance Industries (Rs5.7tn), IOCL (Rs5.3tn) and ONGC (Rs4.2tn). FY19 revenues? Survivorship Only 3 companies have existed in the listed space from CY90 to CY19. What is the total number of Oil & Gas companies that have This includes Reliance Industries, Aban Offshore and Jindal Drilling. existed in the listed space from CY90 to CY19? Of the 390 ex-BFSI companies in India that have managed to In the listed universe in India (ex-BFSI) spanning 390 survivors, Oil & Gas companies exist in the listed space from CY90 to CY19, what proportion account for 3 or 0.8% of survivors. are Oil & Gas companies? Entry & exit Which decade saw the highest number of entry of firms into The decade spanning FY91-01 saw 19 firms enter into the listed Oil & Gas space in this sector? India. Which decade saw the highest number of exit of firms from The decade spanning FY11-19 saw 5 firms exit from the listed Oil & Gas space in India. this sector? Size Which revenue buckets account for the largest proportion of The Medium category (i.e. revenues of Rs1-100bn) accounts for 45% of Indian Oil & Indian Oil & Gas firms? Gas firms today. How many companies in the Oil & Gas sector have revenues 10 companies in the listed Oil & Gas sector have revenues in excess of Rs100bn. in excess of Rs100bn? Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 64: The noughties saw 5 Oil & Gas companies break into the +Rs1tn revenue club Total number of firms CY90 CY00 CY10 CY19 (by annual revenues in rupees) 0-400mn (Ultra Small) 3 6 3 1 400mn-1bn (Small) - 3 3 1 1bn-100bn (Medium) 2 9 9 10 100bn-1tn (Large) - 5 7 5 1tn-6tn (Mature) - 1 5 5 TOTAL 5 24 27 22 Source: Bloomberg, Capitaline, Ambit Capital research Exhibit 65: Share of Mid-sized firms in the Oil & Gas sector has risen slowly whilst the Large category has grown rapidly Total number of firms CY90 CY00 CY10 CY19 (by annual revenues in rupees) 0-400mn (Ultra Small) 60% 25% 11% 5% 400mn-1bn (Small) 0% 13% 11% 5% 1bn-100bn (Medium) 40% 38% 33% 45% 100bn-1tn (Large) 0% 21% 26% 23% 1tn-6tn (Mature) 0% 4% 19% 23% Source: Bloomberg, Capitaline, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 35 Strategy Section 6: Why check for scale? Scale quintiles persist but high growth rarely In this section, we show how revenue quintiles have been stable across the cross-section of firms at any point in time in the cycle, i.e firms tend to persist as high (or low) revenue companies over long periods of time. Firms with higher absolute revenue have also enjoyed relatively higher revenue growth in the past and this has subsequently translated into higher returns historically; but our analysis suggests that the magnitude of revenue growth has been decelerating gradually, and this has been more pronounced for the intersection of firms with high revenues as well as high growth. Along with this there has been a significant decrease in the number of companies that have delivered high growth, and a gradual reduction in the overall returns from the high revenue growth cohort. Decelerating growth and a reducing number of high growth companies could make lower returns a new normal. Hence, making it more important for investors to find determined management teams building a business with good economics, in an industry full of opportunity; these companies can get lucky along the way. For that, read on after this section. Persistence of absolute revenue quintiles To check persistence of Revenue quintiles on a 5, 10 and 15-year rolling basis, we divided the listed universe of stocks (ex BFSI) every year into quintiles in the decreasing order of absolute revenue. Then we compare this every year with the revenue quintiles in the subsequent 5/10/15 years on a rolling basis. The results of this analysis can be observed in the exhibits below. The results suggest that firms have a higher probability to persist in the quintile they were in at the start of the period (denoted by the higher probability values along the diagonal). Firms in ‘Q1’, or the highest in terms of absolute revenue, have the highest probability of remaining in ‘Q1’ after 5/10/15 years. Similarly, companies with the lowest revenues (i.e. denoted by ‘Q5’), also have a higher probability of remaining in the same quintile over the next 5/10/15 years. Exhibit 66: Persistence of Revenue quintiles (5-year) Quintiles - Yr 'X+5' Q1 Q2 Q3 Q4 Q5 Q1 76% 14% 1% 0% 0% Yr 'X' Q2 16% 57% 21% 3% 1% - Q3 1% 17% 46% 23% 5% Q4 0% 4% 22% 46% 22% Q5 0% 0% 5% 21% 68% Quintiles Quintiles Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with absolute Revenue in the decreasing order. Persistence is calculated as percent of companies from a quintile in Year ‘x’ remaining in the same quintile after five years; e.g. 76% indicates the median of all 15 five year iterations from 2000-2014 of the number of companies in ‘Q1’ remaining in ‘Q1’ after five years. Persistence has been calculated across 4699 observations over 2000-2014. Exhibit 67: Persistence of Revenue quintiles (10-year) Quintiles - Yr 'X+10' Q1 Q2 Q3 Q4 Q5 Q1 68% 17% 4% 0% 0% Yr 'X' Q2 17% 45% 25% 5% 0% - Q3 3% 22% 33% 27% 6% Q4 1% 5% 20% 37% 25% Q5 0% 1% 7% 22% 55% Quintiles Quintiles Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with absolute Revenue in the decreasing order. Persistence is calculated as percent of companies from a quintile in Year ‘x’ remaining in the same quintile after ten years; e.g. 68% indicates the median of all 10 ten year iterations from 2000-2009 of the number of companies in ‘Q1’ remaining in ‘Q1’ after ten years. Persistence has been calculated across 2583 observations over 2000-2009. August 26, 2020 Ambit Capital Pvt. Ltd. Page 36 [email protected] 2020-12-07 Monday 13:17:41 Strategy Exhibit 68: Persistence of Revenue quintiles (15-year) Quintiles - Yr 'X+15' Q1 Q2 Q3 Q4 Q5 Q1 62% 19% 0% 3% 3% Yr 'X' Q2 13% 39% 26% 8% 0% Q3 5% 24% 25% 25% 10% Q4 3% 3% 17% 30% 26% Quintiles - Quintiles Q5 0% 0% 12% 16% 43% Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with absolute Revenue in the decreasing order. Persistence is calculated as percent of companies from a quintile in Year ‘x’ remaining in the same quintile after fifteen years; e.g. 62% indicates the median of all 5 fifteen year iterations from 2000-2004 of the number of companies in ‘Q1’ remaining in ‘Q1’ after fifteen years. Persistence has been calculated across 740 observations over 2000-2004. Persistence of Revenue growth quintiles is less probable On similar lines, we also checked persistence on the basis of revenue growth on a 5, 10 and 15-year rolling basis. The results in the exhibits below suggest that although the persistence is not as high as that of absolute revenue in the three exhibits above, firms have a somewhat higher probability to persist in the quintile they were in at the start of the period (denoted by the higher probability values along the diagonal). Exhibit 69: Persistence of Revenue growth quintiles (5-year) Quintiles - Yr 'X+5' Q1 Q2 Q3 Q4 Q5 Q1 21% 17% 14% 14% 24% Yr 'X' Q2 19% 22% 22% 16% 17% Q3 18% 23% 19% 20% 17% Q4 16% 20% 22% 19% 17% Quintiles - Quintiles Q5 20% 15% 18% 21% 21% Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with Revenue growth in the decreasing order. Persistence is calculated as percent of companies from a quintile in Year ‘x’ remaining in the same quintile after five years; e.g. 21% indicates the median of all 15 five year iterations from 2000-2014 of the number of companies in ‘Q1’ remaining in ‘Q1’ after five years. Persistence has been calculated across 4681 observations over 2000-2014. Exhibit 70: Persistence of Revenue growth quintiles (10-year) Quintiles - Yr 'X+10' Q1 Q2 Q3 Q4 Q5 Q1 17% 15% 10% 16% 21% Yr 'X' Q2 18% 11% 18% 16% 17% Q3 16% 21% 22% 16% 16% Q4 16% 22% 22% 19% 13% Quintiles - Quintiles Q5 18% 16% 14% 18% 18% Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with Revenue growth in the decreasing order. Persistence is calculated as percent of companies from a quintile in Year ‘x’ remaining in the same quintile after ten years; e.g. 17% indicates the median of all 10 ten year iterations from 2000-2009 of the number of companies in ‘Q1’ remaining in ‘Q1’ after ten years. Persistence has been calculated across 2569 observations over 2000-2009. August 26, 2020 Ambit Capital Pvt. Ltd. Page 37 Strategy Exhibit 71: Persistence of Revenue growth quintiles (15-year) Quintiles - Yr 'X+15' Q1 Q2 Q3 Q4 Q5 Q1 22% 14% 8% 17% 16% Yr 'X' Q2 17% 21% 19% 13% 13% Q3 16% 22% 16% 16% 14% Q4 21% 17% 22% 19% 14% Quintiles - Quintiles Q5 13% 5% 14% 23% 27% Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with Revenue growth in the decreasing order. Persistence is calculated as percent of companies from a quintile in Year ‘x’ remaining in the same quintile after fifteen years; e.g. 22% indicates the median of all 5 fifteen year iterations from 2000-2004 of the number of companies in ‘Q1’ remaining in ‘Q1’ after fifteen years. Persistence has been calculated across 733 observations over 2000-2004. Revenue growth across the board has fallen - higher revenue cohorts have seen the highest deceleration in revenue growth Further, we analyzed the trend of revenue growth within the revenue quintiles by looking at the median revenue growth every year of each quintile. Exhibit below shows that revenue growth across the board has fallen significantly over the past decade (i.e. FY11-19) as compared to the previous decade (i.e. FY00-10). Exhibit 72: Revenue growth across quintiles has fallen over the years Revenue Median revenue growth of Revenue and revenue growth quintiles quintiles ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 ‘16 ‘17 ‘18 ‘19 Q1 (High 23% 18% 6% 17% 20% 30% 24% 30% 19% 22% 11% 23% 24% 13% 9% 8% 1% 8% 12% 16% Rev.) Q2 13% 11% 13% 25% 16% 20% 21% 29% 25% 20% 10% 19% 19% 12% 12% 10% 3% 5% 10% 17% Q3 17% 19% 11% 12% 16% 21% 20% 30% 29% 22% 15% 22% 20% 14% 14% 10% 8% 7% 11% 14% Q4 23% 17% 17% 12% 23% 19% 27% 31% 26% 27% 14% 22% 19% 14% 13% 12% 7% 5% 13% 14% Q5 (Low 45% 34% 10% 12% 11% 22% 29% 42% 41% 19% 12% 20% 14% 15% 13% 12% 6% 6% 9% 12% Rev.) Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with absolute Revenue in the decreasing order. To paint a clearer picture, we further we took median revenue growth over blocks of five year periods of the above data. It can be seen clearly from the exhibit below that companies with higher revenue have seen the highest deceleration in revenue growth. Exhibit 73: Revenue growth across quintiles has fallen over the years Revenue Median revenue growth Change quintiles FY00-04 FY05-09 FY10-14 FY15-19 (abs.) Q1 (High Rev.) 18% 24% 13% 8% -9% Q2 13% 21% 12% 10% -2% Q3 16% 22% 15% 10% -6% Q4 17% 27% 14% 12% -6% Q5 (Low Rev.) 12% 29% 14% 9% -3% Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with absolute Revenue in the decreasing order. August 26, 2020 Ambit Capital Pvt. Ltd. Page 38 Strategy High revenue and high revenue growth that has seen the most deceleration in revenue growth over the years Adding a layer of revenue growth on the above analysis gives further clarity. As can be seen in the exhibit below, it is the intersection of high revenue and high revenue growth that has seen the most deceleration in revenue growth over the years. Exhibit 74: Revenue growth across quintiles has fallen over the years Median revenue growth Revenue Rev. growth Change quintiles quintiles FY00-04 FY05-09 FY10-14 FY15-19 (abs.) Q1 54% 76% 36% 30% -24% Q2 27% 34% 22% 15% -12% Q1 (High 15% 24% 14% 10% -5% Revenue) Q3 Q4 7% 16% 8% 5% -2% Q5 -3% 3% -5% -8% -5% Q1 72% 71% 40% 32% -41% Q2 30% 34% 23% 15% -15% Q2 Q3 15% 24% 12% 11% -5% Q4 7% 14% 7% 3% -3% Q5 -7% 4% -3% -4% 3% Q1 78% 70% 41% 26% -52% Q2 30% 37% 23% 15% -15% Q3 Q3 17% 23% 14% 10% -7% Q4 6% 14% 9% 5% -2% Q5 -1% 2% -5% -4% -4% Q1 74% 64% 50% 29% -45% Q2 30% 37% 25% 16% -14% Q4 Q3 16% 25% 14% 11% -5% Q4 9% 14% 5% 4% -5% Q5 -5% 1% -5% -11% -6% Q1 76% 96% 44% 28% -48% Q2 29% 36% 22% 17% -12% Q5 (Low 16% 26% 13% 10% -5% Revenue) Q3 Q4 8% 15% 7% 4% -4% Q5 -18% -3% -13% -6% 12% Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. Q1-Q5 indicates quintiles of listed companies with absolute Revenue and Revenue growth in the decreasing order. August 26, 2020 Ambit Capital Pvt. Ltd. Page 39 Strategy Revenue growth trend explains past returns To understand how growth in revenue and returns go hand in hand, we analysed the rolling ten year revenue growth along with the ten year price performance over the same period. Quite evidently, as can be seen from the exhibit below, it is the companies with the higher revenue growth that have also given significantly better returns. Exhibit 75: Companies with higher revenue growth have provided higher returns… Median 10yr CAGR Price Performance Rev Growth ‘00-10 ‘01-11 ‘02-12 ‘03-13 ‘04-14 ‘05-15 ‘06-16 ‘07-17 ‘08-18 ‘09-19 ‘10-20 ‘11-20* >18% 15% 23% 23% 24% 19% 16% 10% 11% 13% 18% 10% 11% 15%-18% 17% 26% 20% 20% 14% 22% 9% 10% 16% 23% 12% 16% 12%-15% 10% 20% 17% 12% 9% 12% 10% 16% 17% 24% 2% 11% 8%-12% 10% 17% 14% 20% 9% 8% 4% 10% 10% 13% 7% 9% <8% -4% -3% 3% 3% 2% 1% -6% -3% -6% 4% -11% -2% Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. The universe of stocks is divided into cohorts based on 10yr revenue CAGR and 10yr median price performance has been calculated over the same period. * indicates the revenue CAGR has been calculated upto FY20 and price performance has been calculated upto 20th Aug’20. No of companies in the high revenue cohort has been reducing; look for steady growth companies which can scale up Although, the companies in the highest cohort on the basis of revenue growth have historically given higher returns, from the exhibit above it can also be observed that the returns for the top cohort have been gradually reducing. The overall number of companies with higher revenue growth have also been sharply falling over time (see exhibit below). Exhibit 76: …but the percent of companies providing higher returns have been dwindling over the years 10 yr No. cos in the revenue growth cohorts as a % of total Revenue growth ‘00-10 ‘01-11 ‘02-12 ‘03-13 ‘04-14 ‘05-15 ‘06-16 ‘07-17 ‘08-18 ‘09-19 ‘10-20 ‘11-20 >18% 36% 41% 41% 41% 39% 33% 22% 15% 13% 11% 9% 7% 15%-18% 9% 9% 11% 19% 17% 12% 11% 12% 6% 9% 5% 4% 12%-15% 18% 15% 18% 10% 14% 18% 17% 14% 13% 13% 10% 6% 8%-12% 12% 18% 19% 18% 19% 19% 19% 18% 19% 18% 20% 21% <8% 26% 18% 12% 13% 11% 19% 30% 42% 48% 48% 55% 62% Source: Capitaline, Ambit Capital research; Note: Universe is listed universe (ex financials) for every year starting since 2000 with a minimum market capitalisation of Rs3,750mn and increased every year by 7%. The universe of stocks is divided into cohorts based on 10yr revenue CAGR. With lesser number of companies being able to deliver higher revenue growth and as discussed earlier, with significant deceleration of revenue growth especially within the intersection of high revenue and high revenue growth companies, a lower quantum of overall returns could be expected going ahead. August 26, 2020 Ambit Capital Pvt. Ltd. Page 40 Strategy Section 7: Highly probable scalable bets Summary: The previous sections highlight how and why, even when India’s high GDP growth rate is high, its translation into revenue growth for the listed universe has been poor. Given Indian companies’ inherent susceptibility to dwarfism and given that Covid-19 will disrupt business models in unimaginable ways, it now becomes critical to identify companies that can overcome the scale challenge. Against this backdrop, in this section we highlight the names of 16 companies that in our view will able to deliver consistent revenue growth over the next 5 years. We hence deem this list of 16 companies as Ambit’s top scalability candidates (see exhibits below). Ambit’s list of top 16 scalability candidates We highlight names of 16 companies that in our view present the highest probably of scaling up over the next quinquennium. These companies in our view are likely to be able to sustain high revenue growth over the next five years such that the growth rate is higher than the country’s nominal GDP growth rate and/or is greater than the growth rate exhibited by the market that they operate in. Exhibit 77: Ambit’s Candidates FF 3m RoCE (pre- Company Ticker Mcap Ambit Acctg Greatness 5yr CAGR (FY15-20) (%) RoE (%) P/E P/B Mcap MDVT tax) (%)* (US$ (US$ 5 Yr 5 Yr (US$ mn) Stance Decile Score (%) Revenue* EBITDA* PAT FY20 FY20 FY21 FY22 FY21 FY22 mn) mn) Avg Avg SBI Life Insur. SBILIFE IN 11,421 4,488 14.9 SELL N/A N/A 26 24 20 1.0 0.9 20 20 40.8 34.6 2.8 2.4 SBI Cards SBICARD IN 10,464 3,188 19.6 NR N/A N/A 39 36 36 4.6 5.5 25 29 68.1 40.5 12.5 10.0 Pidilite Inds. PIDI IN 10,091 3,008 15.5 NR D9 67 8 15 17 37 33 28 26 70.3 52.9 14.7 12.8 ICICI Lombard ICICIGI IN 7,746 3,727 7.8 BUY N/A N/A 17 22 17 16 19 18 21 43.4 34.7 8.7 7.4 Torrent Pharma TRP IN 6,392 1,838 19.1 SELL D6 8 11 16 5 20 14 27 20 42.7 35.0 8.5 7.2 L&T Infotech LTI IN 5,505 1,403 3.8 NR D2 75 17 13 15 43 36 35 30 24.4 21.0 6.4 5.4 Whirlpool of India WHIRL IN 3,849 962 1.6 NR D2 100 9 15 18 33 27 22 21 71.6 46.5 9.9 8.4 Aarti Inds. ARTO IN 2,681 1,409 5.6 BUY D8 75 10 16 21 19 17 23 19 34.9 25.8 5.8 4.9 Aavas Financiers AAVAS IN 1,590 740 0.8 NR N/A N/A 59 60 67 3.1 3.8 10 13 47.4 37.4 5.1 4.5 Dixon Technologies DIXON IN 1,281 818 5.2 BUY D7 83 30 47 56 30 32 28 26 59.1 38.3 13.9 10.5 Minda Inds. MNDA IN 1,275 372 1.0 BUY D8 75 20 32 18 15 10 18 10 318.3 27.8 4.7 4.2 Prestige Estates Proj. PEPL IN 1,269 438 2.2 NR D9 67 19 18 4 11 14 8 8 30.9 23.2 1.7 1.6 APL Apollo Tubes APAT IN 821 506 1.3 BUY D6 58 20 21 30 21 19 21 22 27.9 17.9 3.7 3.0 Amber Enterprises AMBER IN 772 432 1.3 BUY D3 50 26 24 41 15 16 10 16 93.9 37.9 4.8 4.4 Mahindra CIE MACA IN 737 225 0.2 BUY D4 42 7 17 19 10 10 8 8 499.4 25.3 1.2 1.1 Source: Bloomberg, Capitaline, Ambit Capital research, Note: *For BFSI companies, RoCE indicates RoA, EBITDA indicates Operating Profit, Revenue indicates Premium earned for insurance & Operating Income for NBFC cos, Ambit extimates have been used for companies under coverage, else consensus estimates have been used The rest of the section highlights the process followed to identify these companies and then is followed by a deep-dive into the specifics of each of these 16 companies. August 26, 2020 Ambit Capital Pvt. Ltd. Page 41 [email protected] 2020-12-07 Monday 13:17:41 Strategy Identifying scalability candidates in the Ex-BFSI space The flowchart below illustrates the process we followed to have our analysts think of stocks and sectors in the ex-BFSI space to identify scalability candidates. Exhibit 78: Filtration process followed to arrive at Ambit’s 12 scalability candidates in the non-BFSI space Identified listed ex-BFSI Retained companies from this list companies in India in the with high ‘scalability potential’. Mid-sized category i.e. Analyzed this potential using four companies with revenues parameters namely: spanning Rs1-100bn. (1) Source of scalability (i.e. sweating brand and/or building scale); (2) Route to scalability (i.e. growth in market and/or market share); (3) Geography of scalability (i.e. growth in India and/or exports) and, (4) Threat to scalability (i.e. ruling out risk of obsolescence and risk of rising capital intensity)). Arrived at Ambit’s list of 12 Eliminated companies with poor scalability candidates in the HAWK* scores and/or corporate non-BFSI space. governance concerns. Source: Ambit Capital research, Note: HAWK refers to Ambit’s proprietary model capturing accounting and greatness scores for ~1400 companies. Identifying scalability candidates in the BFSI space As regards the Financials space we picked four candidates from this pool spanning three insurance provides and SBI cards. In the financials space, ex-NBFCs we have only selected SBI Cards. The rationale for this is threefold namely: . Credit cards are still a relatively smaller part of payment systems in India with outstanding credit card rated balances being just ~7% of outstanding debit card balances. . SBI cards appears to be well poised to benefit from the rising share of digital payments in India (~67% in 1QFY20 vs 42% in 1QFY17), increasing acceptance of cards at merchant locations (No of POS CAGR of 35% over FY15-FY20) and the under-penetration of credit cards (with only 4 credit cards per 100 population vs 337 for US). . Lastly, strong support from parent SBI will allow SBI Cards to steadily scale up. The advantages come in the form of brand, trust, access to vast customer base (tapping the existing liability customers), distribution strength (~33k sales force and 22k branches of SBI) and sourcing (new credit card sourced from SBI has grown at 60% CAGR in FY17-FY20 vs just 38% CAGR from other sources). Apart from this, high operating leverage (with the cost to income ratio down ~600bps between FY17-FY20) and controlled asset quality (GNPA between 2.0%-2.8%) being the main drivers of its high growth/RoE. It is additionally worth highlighting that the reason we have not picked up any Banks in this framework as potential scalability candidates is simply because lending is no longer an underpenetrated industry in India with India’s debt to GDP at +70% . Moreover, barring a couple of banks, maintaining profitability whilst scaling up businesses has been a challenge for Banks. Most banks that attempted to scale up August 26, 2020 Ambit Capital Pvt. Ltd. Page 42 Strategy business too fast have seen asset quality and profitability challenges in later years with Yes Bank being an example of this phenomenon. On other hand, Banks that have been focused on profitability and asset quality have found it difficult to scale-up business at a fast enough pace. In the NBFC space we picked three candidates namely SBI Life, ICICI Lombard and Aavas Financiers. . SBI Life enjoys irreplaceable pseudo-sovereign identity, largest and most entrenched distribution network of >22k bank branches in the country and an unparalleled cross-sell potential. This makes us believe SBI Life would clock 4-5% faster premium growth than the industry on a sustainable basis. . ICICI Lombard should continue its strong run within the fastest growing BFSI segment in the country. Best suited candidate when it comes to longevity of profitable growth. Leadership (largest private insurer with ~7% market share) should consolidate given operating leverage, ramp-up in retail business, investment in technology, and no legacy baggage given adequate claim reserving. Regulatory tailwinds (long-term motor TP policies) and growth headroom with PSUs ceding share (~38% vs 51% in FY14) enlarge opportunity. . Aavas Financiers is all set to ramp up and benefit from its presence in the underpenetrated and underserved low-cost housing segment. When compared to peers it stands out given best-in-class management execution and ability to hit above its weight (industry leading risk & data analytics) which make it future- proof. Scalability hinges on niche positioning, technology-backed processes and people. Why have we mostly picked small/mid caps in the ex- BFSI space? It is worth noting that India’s high GDP growth rate seldom translates into high revenue growth for its companies. Some of the largest businesses in India, be it SOEs or private sector businesses, have ended-up maintaining revenue growth rates that are lower than the nominal GDP growth rate (see exhibits below). Exhibit 79: Several of India’s largest SOEs have maintained Exhibit 80: …as is the case with some of India’s largest revenue CAGR < India’s nominal GDP growth rate… private businesses by revenue as well 20% FY09-14 FY14-19 15% FY09-14 FY14-19 15% 10% 10% (% p.a.) (% p.a.) 5% 5% CAGR in Revenue growth Revenue in CAGR CAGR in Revenue growth Revenue in CAGR 0% 0% S A I L H P C L B P C L I O C L Hindalco Inds. Wipro Tata Steel Source: Bloomberg, CEIC, Ambit Capital research; Note: Largest companies Source: Bloomberg, CEIC, Ambit Capital research; Note: Largest companies refers to the top 30 ex-BFSI companies as per FY19 revenues. refers to the top 30 ex-BFSI companies as per FY19 revenues. More worryingly this process - of GDP growth translating into high revenue growth for large listed businesses - has been slowing over time. As highlighted in our note dated 12 August 2020, focusing on the 30 largest ex-BFSI companies in India by revenues suggests that even the top companies in India have seen their revenue growth rates being distinctly lower than the nominal GDP growth rate (see exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 43 Strategy Exhibit 81: India’s 30 largest* companies’ revenue growth Exhibit 82: Of India’s 30 largest* companies, the majority has been lower than its nominal GDP growth rate are unable to grow revenues faster than GDP growth Nominal GDP Sum of revs. of 30 largest cos. 21 20% 15% 15% 15% 14 11% 10% 7% growth (% p.a.) (% growth CAGR in Revenue in CAGR 5% growth/Nominal GDP revs. v/s nominal GDP 2 No. of 30 largest cos. that that cos. largest 30 of No. 0% of CAGR lower maintained FY09-14 FY14-19 FY04-09 FY09-14 FY14-19 Source: Bloomberg, CEIC, Ambit Capital research; Note: Largest companies Source: Bloomberg, CEIC, Ambit Capital research; Note: Largest companies refers to the top 30 ex-BFSI companies as per FY19 revenues. refers to the top 30 ex-BFSI companies as per FY19 revenues. Does scale entail superior returns’ performance? This time we check our revenue cohorts over the years. Before the turn of the century, larger companies’ returns performance was distinctly superior to that of Ultra-small companies. In specific Medium, Large and Mature companies delivered higher returns as compared to both Small and Ultra-small companies over FY96-01 (see exhibit below). Exhibit 83: Larger companies delivered distinctly higher returns over FY96-01 22.2% 21.3% 20.8% 01 19.9% - 17.1% 15.4% (in %) Nifty 1tn-6tn 100bn-1tn 1bn-100bn 400mn-1bn 0-400mn (Ultra Avg. CAGR over FY96 over CAGR Avg. (Mature) (Large) (Medium) (Small) Small) Revenue range (in Rs) Source: Bloomberg, Ambit Capital research: Note: Data refers to ex-BFSI listed companies. The leadership position maintained by larger companies relative to smaller companies was then maintained through the noughties. In specific Mature, Small and Medium sized companies delivered higher returns as compared to Ultra-small companies over FY01-11 (see exhibit below). August 26, 2020 Ambit Capital Pvt. Ltd. Page 44 Strategy Exhibit 84: Mature, Medium and Small companies delivered superior returns over FY01-11 7.1% 11 5.0% - 0.3% (in %) -0.9% -2.6% -4.6% Avg. CAGR over FY01 over CAGR Avg. Nifty 1tn-6tn 100bn-1tn 1bn-100bn 400mn-1bn 0-400mn (Mature) (Large) (Medium) (Small) (Ultra Small) Revenue range (in Rs) Source: Bloomberg, Ambit Capital research: Note: Data refers to ex-BFSI listed companies. To be fair, the performance superiority maintained by larger companies was then lost in the decade that followed. In specific, over FY11-19 Ultra-small companies’ performance was now significantly superior to that of larger companies (see exhibit below). Exhibit 85: Ultra-small companies delivered superior Exhibit 86: But Large companies offered return in excess of returns over FY11-19 Nifty, whilst also entailing lower volatility over FY11-19 65.8% 400% 19 - 41.1% 26.0% 9.6% 200% 19 (in %) 19 (in - (in %) -7.6% 0% -17.2% Nifty Nifty (Medium) Avg. CAGR over FY11 over CAGR Avg. over FY11 over Small) 1bn-100bn 0-400mn(Ultra Standard deviation of returns deviation Standard 1tn-6tn(Mature) 100bn-1tn(Large) 1tn-6tn(Mature) 400mn-1bn(Small) 100bn-1tn(Large) 400mn-1bn(Small) 1bn-100bn(Medium) 0-400mn(Ultra Small) Revenue range (in Rs) Revenue range (in Rs) Source: Bloomberg, Ambit Capital research: Note: Data refers to ex-BFSI Source: Bloomberg, Ambit Capital research: Note: Data refers to ex-BFSI listed companies. listed companies. However it is worth noting that the superior performance of Ultra-small companies was accompanied by very high levels of volatility (see exhibit above). To conclude, India’s stock market history clearly suggests that Medium and Small sized companies offer possibly the best investment proposition for an investor who is looking to maximize returns in the Indian equity markets whilst trying avoid unusually high levels of volatility. But as highlighted earlier, investors can find determined management teams building a business with good economics, in an industry full of opportunity; these companies can get lucky along the way as we are noticing in present times. August 26, 2020 Ambit Capital Pvt. Ltd. Page 45 Strategy This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 46 [email protected] 2020-12-07 Monday 13:17:41 Ratings 1 (lowest conviction) to 5 (highest conviction) across parameters Source to Source to Scalability/ Geography of Route to Geography Threat to Sector Route to Scalability Threat to Scalability Forensic Greatness Scalability/ Moat Scalability Scalability of Scalability Scalability Moat Buidling scale from basic Exposure to multiple end Export led and blocks to downstream sectors; Pharma biz led; Oil to Chemicals; Attrition of Aarti Chemicals import D8 75% 5 4 4 3 products; sweating of new adjacencies; mgmt senior management substitution assets depth Underpenetrated Standardization; opex Domestic; from segment, niche positioning management; risk Aavas Financials regional to pan Cost of funds and liquidity N/A N/A 5 4 3 2 and technology-backed management and India processes leverage upsizing Penetration led; cost Domestic first; Competition from foreign ODM Buidling scale; sweating of arbitrage; ODM first Amber EMS export potential players; Inability to break into D3 50% 3 4 4 3 assets and then brandex model; econ of scale; high in long run brands for component offering import subs regulation led Building brand and scale; Legacy replacement and APL Apollo Building Rise of competitive intensity from sweating of asets with VAP/ innovation led + Domestic led D6 58% 3.5 4 4 2 Tubes Materials larger players higher cap util SKU growth Penetration led; cost arbitrage; OEM/ ODM Domestic first; Rise in competitive intensity from Buidling scale; sweating of balanced; client export potential domestic/international EMS Dixon EMS D7 83% 4 3 4 3 assets and then brandex partnerships; econ of high in medium players; inability of GOI to deliver scale; import subs run on PLI regulation led Building scale on Farmer subsidies from Domestic; pan procurement; sweating Farmer engagement, government that disrupt fair price Hatsun Consumer region to pan D6 58% 5 5 3 3 assets and supply chain logistics dominance discovery during milk India dominance procurement Fastest growing BFSI Prolonged pricing pressure from segment, profitable Channel diversification, new enterants and life insurers ICICIGI Insurance product mix, regulatory pricing power, innovation Domestic led N/A N/A 4 5 4 2 allowed to self indemnity health tailwind and PSU ceding and leadership position offering market share Mgmt depth; Digital first, Higher churn in senior tuck in acq led; potential Overseas first; Brand and Technology management; weakness in BFSI LTI Tech merger with MTCL a huge domestic business D2 75% 5 4 3 3 prowess (~45% revenues); Value growth (products/ services to consolidate destructive acquisitions + geography) driver Transition from forging to Mahindra Asset sweating; building components; Export led; ASEAN Higher cost of acquisitions, Auto D4 42% 5 4 4 3 CIE scale deleveraging; wider OEM entry slower adoption of EV parts relationships Ambit Capital Pvt Ltd Source to Source to Scalability/ Geography of Route to Geography Threat to Sector Route to Scalability Threat to Scalability Forensic Greatness Scalability/ Moat Scalability Scalability of Scalability Scalability Moat Diversifying portfolio; Asset sweating; building rising kit value per vehicle; Higher cost of acquisitions, Minda Auto Domestic led D8 75% 5 4 3 2 scale; tech-led VAP SKUs; R&D and inability to get tech partners innovation Increasing competitive intensity in penetration and products Brand led channel construction chemicals from Paint Pidilite BMAT led; consolidate existing Domestic led D9 67% 5 4 4 3 ownership companies; attrition of senior TAM, build new TAM management Domestic led; new micro Stress to remain in residential Prestige Capex and consolidation New segments; new Real Estate markets/ regions segment. Further, success in new D9 67% 5 4 4 3 Estates led micromarkets (curr. S India micromarkets to be delayed. dominated) Increasing share of digital payments, Under Strong distribution, High Stagnating spends, cap on MDR & SBICARD Financials penetration of credit Op Lev, controlled asset Domestic led severe deterioration in asset N/A N/A 5 4 5 3 cards, Brand led, strong quality issues quality parentage Most entrenched Strong brand and Regulatory change in distribution netwrok parentage, growing need shareholding limit on banks and SBILIFE Insurance (largest), strong cross-sell Domestic led N/A N/A 5 5 5 3 for insurance products and SBI Bank adoptin open potential and cost of fund pseudo soverign identity architecture advantage Domestic strong; Rise in NLEM mix, increased Inorganic growth record; Torrent Branding and R&D led; US+ Germany/ competition in chornic, exports Pharma market share stickiness; D6 8% 4 3 3.5 3 Pharma chronic dominance Brazil to drive regulatory issues, value- lower NLEM mix yet growth destructive M&A Penetration story; Rising competitive intensity; Whirlpool Durables Brand led; building scale innovation; SKUs rising Domestic led inability to manage change in D2 100% 2 3 3 4 with focus on core management Ambit Capital Pvt Ltd Aarti Industries BUY SCALABILITY ARTO IN EQUITY August 26, 2020 Leader in the making CHEMICALS Aarti is the most scalable specialty chemicals company in India given a Recommendation credible second generation (25% earnings CAGR over last decade, 14% Mcap (bn): `199/US$2.7 average post-tax RoCE), isomer balancing strengths, diversified presence across agri/pharma/industrials/pigments, backward-integrated product 3M ADV (mn): `679/US$9.1 chain and asset efficiencies. Expansion into benzene chain, addition of CMP: `1,142 toluene derivatives, ramp-up of pharma-API/intermediate business and TP (12 mths): `1,150 transition to IP-led contract manufacturing are growth levers for the next Upside (%): 0 decade. Technocrat promoters (from IIT/UDCT) have focused on QSHE and professional management teams. We expect Aarti to grow Flags revenue/EBITDA/PAT at 15%/15%/17% CAGR over FY20-30 with RoCE improvement to 17%. ~50% exposure to non-agri and pharma sectors Accounting: AMBER could cause earnings growth weakness in FY21. Oil to Chemicals (OTC) Predictability: AMBER and professional mgmt. attrition are key risks for long term scalability. Earnings Momentum: AMBER COMPETITIVE position: STRONG Changes to this position: POSITIVE Performance Expertise built over decades ARTO IN SENSEX 180 A leading benzene player, Aarti is among the top four global companies in 75% of its products. Focus on integrated value chain, strengths in isomer balancing 160 and expansion into multiple chemistry areas enabled it to offer a wide range of 140 products while maintaining scale and cost efficiencies. Technocrat promoters 120 successfully transitioned themselves from license-raj era to a credible supplier to 100 MNCs. They focused on increasing the opportunity size while scale/cost efficiency 80 helped gain market share. Aarti has almost doubled its earnings every three 60 years over FY11-20 through aggressive investments across its assets (gross block Jul-20 Jan-20 >5x over FY11-20) alongside 18%+ pre-tax RoCE. Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-19 Nov-19 May-20 Created formidable entry barriers Aarti’s scale came through its consistent forward/backward integration in more Source: Bloomberg, Ambit Capital research than 70+ products, making it the market leader in most. Increased focus on R&D helped it widen its portfolio and enter more value-added products. Significant Aarti has delivered 14% CAGR over investments on QSHE (~20% of FY16-20 capex) and R&D (new design centre in FY05-20 Vadodara and R&D centre in Mumbai) add to the ability to expand into newer 50 46.2 chemistries and boost contract manufacturing revenues. Self-sufficient value chain (no RM dependence on China), wide customer relationships (agri, pharma, 40 29.1 polymer, FMCG, pigments) and continuous capability development have created 30 bn formidable entry barriers. ` 20 13 Aarti poised to become integrated chemical giant in the next decade 10 6.9 Aarti is poised to benefit from import substitution and shift of manufacturing from China. Growth over the next decade would be driven by: a) higher number of 0 downstream benzene derivatives; b) deepening of capabilities in toluene FY05 FY10 FY15 FY20 derivatives; c) ramp-up of contract manufacturing revenues; and d) expansion of pharma given new API launches/import substitution. Significant capability Source: Company, Ambit Capital research development (human resource, infrastructure, distribution network) has already been done in the past decade. This is likely to get strengthened further. Aarti is on path to become integrated chemical giant starting from basic blocks to value- added products over the next decade. Near-term weakness provides a good entry point Research Analysts We build in relatively linear growth over the next decade with revenue/EBITDA/PAT CAGR of 15%/15%/19% over FY20-30 along with ~200bps Ritesh Gupta, CFA RoCE improvement. Potential upsides to our estimates through new contract wins, [email protected] expansion in pharma and entry into new verticals are likely. Near-term outlook Tel: +91 22 6623 3242 will likely remain subdued due to COVID and recent termination of one of its Prasenjit Bhuiya contract manufacturing projects. Maintain BUY with 12M TP of `1,150, implying [email protected] 26x FY22 P/E. Tel: +91 22 6623 3132 Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Aarti Industries Exhibit 1: Aarti posted marked improvement in QSHE/R&D spend and significant uptick in capex towards the end (FY18-20) of the last decade FY10-13: Increased focus on FY14-17: Investments on R&D, human FY18-20: Significant uptick in capex exports. RoCE continued to resource and QSHE. RoCE in this period for toluene derivatives and contract improve as share of high value continued to improve as pharma segment mfg. RoCE dropped as utilisation of 50 profitability increased new capacity remain low. 22% 45 21% 40 35 20% bn 30 ` 19% 25 20 18% 15 17% 10 16% 5 - 15% FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Spcialty Chemicals Pharmaceuticals HPC Pre-tax RoCE Note: HPC demerged in FY19; Source: Company, Ambit Capital Research Exhibit 2: Increase in capability building and QSHE helped Aarti build relationships with global innovators Time period Phase Key developments . Aarti increased its focus on exports, leading to 30% CAGR in exports over FY10-13. Contribution of exports FY10-FY13 Focus on exports to total revenues increased to 51% in FY13 from 37% in FY10. . Pre-tax RoCE improved to 20.6% in FY17 from 18.5% in FY13. . Realising importance of QSHE for global partnerships, Aarti started significant investments on QSHE. Capability building 15% of capex during this period was on QSHE. Employee costs increased at 25% CAGR over FY14-17. FY14-FY17 . (R&D, QSHE) . Investments in QSHE/R&D helped Aarti get more value-added products, driving 400bps improvement in EBITDA margin. . Capex of `26bn over FY18-20 (~2/3rd of FY20 gross block). Aarti won two big contracts from two global innovators – one worth `40bn spread over 10 years and the Significant uptick in . FY18-20 other `100bn over 20 years. However, recently the `40bn project got terminated and ‘take or pay’ contract Capex for future growth was enforced. . Revenue/EBITDA clocked 13%/14% CAGR over FY17-20. Source: Company, Ambit Capital Research Exhibit 3: Key financial parameters over the last decade (` mn) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues 14,530 16,733 20,962 26,325 29,080 27,796 31,635 38,061 47,055 46,207 Revenue growth (%) 12% 15% 25% 26% 10% -4% 14% 20% 24% -2% Net profits 733 900 1,330 1,521 1,937 2,681 3,275 3,461 5,042 5,468 EPS 5.7 6.5 8.5 9.2 11.6 15.4 19.2 21.3 30.2 30.8 CFO 610 1,208 2,298 3,149 3,395 5,736 4,701 3,349 7,287 11,021 CFO-EBITDA 0.3 0.5 0.6 0.8 0.7 1.0 0.7 0.5 0.8 1.1 FCF (80) (123) (50) 240 364 1,071 (602) (2,799) (713) (512) Debt equity (x) 0.8 0.8 0.9 0.9 0.9 1.1 1.0 1.2 0.5 0.5 CE turnover 1.5 1.5 1.5 1.6 1.5 1.3 1.2 1.2 1.1 1.0 GB Turnover 1.9 2.0 2.0 1.9 1.8 1.5 1.3 1.3 1.4 1.2 RoE (%) 15% 16% 20% 19% 21% 25% 26% 24% 23% 19% ROCE* (%) 11% 13% 15% 14% 15% 16% 16% 14% 16% 13% Source: Company, Ambit Capital research. Note: * Pre-tax RoCE August 26, 2020 Ambit Capital Pvt. Ltd. Page 48 Aarti Industries Exhibit 4: Competitive mapping of Aarti Industries with peers like PI, SRF, Atul, Vinati and NFIL Pre-tax CFO/ Sub-segment FY20 Revenue EBITDA Pre-tax Capex/ CFO Company EBITDA Positioning Revenue CAGR FY11-20 Margin (FY20) RoCE (FY20) (FY11-20) (FY11-20) PI Industries 1 32,882 18% 21.8% 23% 0.94 0.83 Navin Fluorine 2 10,616 11% 24.8% 18% 0.83 0.69 Aarti Industries 3 46,207 14% 21.2% 17% 0.92 1.07 SRF 4 72,094 8% 20.2% 14% 0.94 1.06 Vinati Organics 6 10,289 14% 40.2% 34% 0.83 0.52 Atul 5 40,931 11% 22.0% 24% 0.95 0.59 Source: Company, Ambit Capital Research Exhibit 5: Mapping Aarti vs peers on IBAS Strategic Overall Company Innovation Brand Architecture Comments asset rank PI has perfected the business model. Has chemistry capabilities, engineering skills, strong capital allocation, wide talent base, PI Ind ambitious promoter, and a strong set of guiding principles. Widening client base beyond agrochemicals will drive long-term scalability. Specialized fluorination capabilities; is in pre-commercial stage Navin fluorinated products for pharma innovators. Works with global Fluorine agrochem innovators and a few pharma ones. Currently lacks scale when compared to its peers like SRF and PI. Strong at R&D and world class infrastructure at Dahej. Very strong brand amongst clients. Focused on professional management and SRF building right R&D teams since the beginning. Asset discipline is a weakness. Has been a good executor in a semi-commodity business and has gradually built value-added product portfolio. It has got a good Aarti reputation with a wide set of clients. Improvement in architecture will gradually create a stronger brand and boost relations with clients. Wide set of product capabilities and client base but somewhat less Atul aggressive to fully capitalise the growing number of opportunities. Focus on product vs chemistry. Innovation and green processes make Vinati Vinati a leader in the product it manufactures. Needs to focus more on building human capital and architecture for growth. Source: Company, Ambit Capital Research Exhibit 6: Aarti’s trailing P/E evolution Exhibit 7: Stock price performance vs relevant index Trailing 12m PE 3 year avg Aarti Share Price SENSEX 45.0 6,000 40.0 35.0 5,000 30.0 4,000 25.0 20.0 3,000 15.0 2,000 10.0 1,000 5.0 0.0 0 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jul-20 Jul-10 Jul-12 Jul-14 Jul-16 Jul-18 Jul-20 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Mar-11 Mar-13 Mar-15 Mar-17 Mar-19 Nov-11 Nov-13 Nov-15 Nov-17 Nov-19 Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 49 [email protected] 2020-12-07 Monday 13:17:41 Aarti Industries Exhibit 8: Aarti’s revenue has increased at 10% CAGR over Exhibit 9: Aarti’s gross margin has improved by 1,000bps FY14-20 over FY14-20 (23% CAGR in gross profit) HPC Pharmaceuticals Gross Margin EBITDA Margin Specialty 3 year revenue CAGR 50% 50 25% 45% 40 40% 20% 35% 30 30% bn 15% ` 20 25% 10% 20% 10 15% 0 5% 10% FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company Ambit Capital Research Source: Company, Ambit Capital Research Exhibit 10: Aarti’s FCFF has been negative as capex Exhibit 11: GB turnover has declined due to investments intensity has significantly increased in toluene and capacity expansions in benzene block CFO FCFF Net D/E Gross block turnover WC turnover 13,000 1.4 6.0 11,000 1.2 9,000 5.0 1.0 7,000 mn 4.0 0.8 ` 5,000 0.6 3,000 3.0 0.4 1,000 2.0 (1,000) 0.2 (3,000) - 1.0 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital Research Source: Company, Ambit Capital Research Exhibit 12: RoCE will improve as utilization for toluene Exhibit 13: Aarti has increased its hiring resulting in drop capacities starts increasing in EBITDA per employee RoCE (pre-tax) RoE EBITDA (Rs mn) EBITDA/employee (Rs mn) 28.0% 12,000 2.4 26.0% 24.0% 10,000 2.2 22.0% 8,000 20.0% 2.0 6,000 18.0% 1.8 16.0% 4,000 14.0% 2,000 1.6 12.0% 10.0% - 1.4 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital Research Source: Company, Ambit Capital Research August 26, 2020 Ambit Capital Pvt. Ltd. Page 50 Aarti Industries Exhibit 14: Explanation for our flags Segment Score Comments Aarti is in the zone of darkness in our accounting decile primarily due to its high CWIP/gross block and change in reserves. Accounting AMBER Aarti’s CWIP is high given large investments over FY18-20. This will reduce as projects start getting commissioned. Change in reserves was largely due to the demerger of the HPC segment. We believe that these are not cause for concerns. Predictability AMBER Given multiple drivers for volumes of different products, volume growth over short periods of time is difficult to track. Earnings AMBER Earnings have seen cut after the recent termination of one of its contract manufacturing orders. momentum Source: Ambit Capital research HAWK Scores Aarti currently features in ‘Zone of Darkness’ (D8) in our accounting decile. It scores lower than the median accounting score for both the universe and its sector. Aarti is in ‘Zone of Greatness’,(75%) in our greatness score. It scores higher than the universe and sector averages. Key contributors to accounting score and comparison to peers Aarti features in D8 decile on our accounting framework, which is a ‘Zone of Darkness’. Key contributors which pull down Aarti’s scores are its low cash yield, high CWIP/gross block and provisions for doubtful debtors. Aarti’s CWIP increased over FY17-19 given the increase in capex intensity and commissioning of two contract projects. We believe this will reduce as projects get commissioned. Aarti’s doubtful debtors are less than 1% of its revenues and as such we do not see any impact from low provisions. Cash flow to EBITDA is above average and will improve further given the improvement in FY20 to 113% from 90% in FY19. Overall, we expect Aarti’s score to improve in FY20 given improvement in cash conversion and low debtors of more than 180 days (~0% of revenues). FCFF will remain low given the continued capex by the company. We believe the new capex are going in high RoCE segments and won’t impact the return profile. Exhibit 15: Forensic accounting score contributors Exhibit 16: Forensic score percentiles Source: Ambit ‘HAWK’, Ambit Capital research Source: Ambit ‘HAWK’, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 51 Aarti Industries Comments on evolution of accounting scores Aarti’s score has dropped from 2015 when in was in D5 and is at D8 in 2019. Its best score was in 2016 at D4 and worst was in 2018 at D9. It is pertinent to note here that our framework consists of multiple ratios including CWIP/gross block, advances to related parties/CFO ratio which assess companies accounting quality on numerous fronts. Owing to the nature of the chemicals business, these companies might get inadvertently penalised on our framework, especially on CWIP/gross block and advances to related parties/CFO (needed for its subsidiaries outside India). Exhibit 17: Forensic score evolution Exhibit 18: Movement in accounting checks – FY20 score likely to be similar as FY19 Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 62% 90% 113% P&L check Volatility in depreciation rate 5% 5% 5% PFD % of debtors more 0% 0% 0% than six months Cash yield 0% 0% 0% Balance sheet Changes in reserves (ex 0% 0% 0% check sec prem)/PAT (ex-dividend) Cont liab as % of NW 10% 7% NA Miscellaneous expenses as % 0% 0% NA of total reserves Pilferage checks Adv to related parties/CFO 0% 0% 0% CWIP/Gross Block 0.16 0.27 0.36 CAGR in auditors' Audit quality checks 22% 24% NA remn/CAGR in cons Revs Source: HAWK, Ambit Capital Research Source: Company, Ambit Capital Research Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.). Aarti’s greatness score has remained at similar levels from 2015. Key contributors pulling down Aarti’s score are capital employed turnover and equity dilution. Continuous capex has led to low capital employed turnover. Aarti’s also undertook a QIP in FY19 to fund growing need of capex leading to equity dilution. Capital employed turnover will improve as share of specialty products increase and plants get commissioned. August 26, 2020 Ambit Capital Pvt. Ltd. Page 52 Aarti Industries Exhibit 19: Greatness score contributors Exhibit 20: Greatness score percentile vs sector and universe Source: HAWK, Ambit Capital Research Source: HAWK, Ambit Capital Research Exhibit 21: Exhibit XX: Greatness Score Evolution Exhibit 22: Movement in greatness checks – Can improve in FY20 FY18 FY19 FY20 Depreciation/Capex 24% 20% 16% Capital Employed turnover 1.2 1.1 1.0 EBIT margin 15% 17% 17% Equity dilution 0% 6.2% 0% Note: FY19 Equity dilution was due to QIP of `7.5bn. Source: Company, Ambit Capital Research Source: HAWK, Ambit Capital Research August 26, 2020 Ambit Capital Pvt. Ltd. Page 53 Aarti Industries Aarti: Balance Sheet Balance Sheet (` mn) FY18 FY19 FY20 FY21E FY22E FY23E Share capital 407 433 871 871 871 871 Reserves and surplus 15,378 27,188 28,917 33,473 39,638 50,733 Total Networth 16,555 28,544 30,734 35,291 41,456 52,550 Loans 19,208 21,356 18,105 24,041 28,357 25,802 Deferred tax liability (net) 1,774 2,003 2,110 2,110 2,110 2,110 Sources of funds 37,536 51,903 50,949 61,442 71,922 80,463 Net block 19,979 22,832 24,676 36,367 40,419 44,108 Capital work-in-progress 4,362 7,990 14,176 10,176 10,176 10,176 Investments 472 647 370 370 370 370 Total Current Assets 18,461 29,221 24,094 28,037 35,659 43,031 Current Liabilities 6,198 7,252 7,414 8,556 9,750 12,270 Provisions 310 439 399 399 399 399 Current liabilities and provisions 6,509 7,692 7,813 8,955 10,149 12,669 Net current assets 11,953 21,530 16,280 19,082 25,510 30,362 Application of funds 37,536 51,903 50,949 61,442 71,922 80,463 Source: Company, Ambit Capital Research Aarti: Profit and loss Profit and loss FY18 FY19 FY20 FY21E FY22E FY23E Revenue 36,993 47,055 46,207 46,572 58,681 75,803 yoy growth 17% 27% -2% 1% 26% 29% Total expenses 30,426 37,404 36,434 37,340 45,878 58,834 EBITDA 6,567 9,651 9,773 10,832 14,403 16,970 yoy growth 0% 47% 1% -6% 39% 33% Net depreciation / amortisation 1,358 1,627 1,852 2,309 2,947 3,311 EBIT 5,210 8,024 8,010 8,620 11,563 13,765 Net interest and financial charges 1,307 1,825 1,248 1,318 1,683 1,985 Other income 21 21 88 97 107 107 PBT 3,924 6,220 6,762 7,302 9,880 17,780 Provision for taxation 759 1,085 1,294 1,607 2,174 3,912 Adjusted PAT 3,165 5,135 5,468 5,696 7,706 13,869 yoy growth 6% 46% 8% 4% 35% 80% EPS (`) 21.3 30.2 30.8 32.7 44.2 79.6 Source: Company, Ambit Capital Research August 26, 2020 Ambit Capital Pvt. Ltd. Page 54 [email protected] 2020-12-07 Monday 13:17:41 Aarti Industries Aarti: Cashflow statement Cash flows (` mn) FY18 FY19 FY20 FY21E FY22E FY23E PBT 4,290 6,220 6,762 7,302 9,880 17,780 CFO before change in WC 1,704 7,280 13,286 10,321 7,426 17,312 Change in working capital (2,633) (1,186) 627 (256) (3,489) (2,829) Direct taxes paid (988) (1,178) (1,638) (1,607) (2,174) (3,912) CFO 3,349 7,287 11,021 8,970 8,741 16,229 Net capex (6,141) (8,000) (11,533) (10,000) (7,000) (7,000) Net investments 34 0 0 0 0 0 Interest received ------CFI (6,104) (7,979) (11,241) (9,903) (6,893) (6,893) Proceeds from borrowings 5,192 2,149 (3,032) 5,936 4,315 (2,554) Change in share capital (985) 7,500 - - - - Interest & finance charges paid (1,317) (1,825) (1,248) (1,318) (1,683) (1,985) Dividends paid (100) (252) (1,064) (1,139) (1,541) (2,774) CFF 2,791 7,571 (5,349) 3,479 1,091 (7,313) Source: Company, Ambit Capital Research Aarti: Ratio Analysis FY18 FY19 FY20 FY21E FY22E FY23E EBITDA margin (%) - ex. OI 17.8% 20.5% 21.2% 23.3% 24.5% 22.4% EBIT margin (%) - ex. OI 14.1% 17.1% 17.3% 18.5% 19.7% 18.2% PBT margin (%) 10.6% 13.2% 14.6% 15.7% 16.8% 23.5% Net profit margin 8.6% 10.9% 11.8% 12.2% 13.1% 18.3% Dividend payout ratio 2% 5% 15% 20% 20% 20% Net debt to Equity (x) 1.2 0.5 0.5 0.5 0.5 0.3 Working capital turnover 5.1 3.6 3.1 3.6 3.5 3.5 Gross block turnover 1.3 1.4 1.2 1.0 1.0 1.2 Pre-tax CFO/EBITDA 0.4 0.6 1.0 0.7 0.5 0.7 Capex/post-tax CFO 1.8 1.1 1.0 1.1 0.8 0.4 Pre-tax RoCE 19.6% 21.9% 17.7% 13.8% 17.1% 20.1% RoE 23.5% 23.2% 19.0% 17.8% 20.6% 30.1% Source: Company, Ambit Capital Research Aarti: Valuation parameters Valuation parameters FY18 FY19 FY20 FY21E FY22E FY23E EPS (`) 21.3 30.2 30.8 32.7 44.2 79.6 BVPS (`) 97.1 169.9 171.0 197.1 232.5 296.2 DPS (`) 0.5 1.6 4.7 6.5 8.8 15.9 P/E (x) 53.1 37.4 36.7 34.6 25.5 14.2 P/BV (x) 11.6 6.7 6.6 5.7 4.9 3.8 EV/EBITDA (x) 32.8 5.8 5.9 5.8 4.7 3.7 EV/EBIT (x) 41.4 22.3 22.1 19.9 15.0 12.7 Price/Sales (x) 5.0 3.9 4.3 4.2 3.4 2.6 Source: Company, Ambit Capital Research August 26, 2020 Ambit Capital Pvt. Ltd. Page 55 Aarti Industries This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 56 Aavas Financiers NOT RATED SCALABILITY THEMATIC AAVAS IN EQUITY August 26, 2020 Wired to play in big league BFSI Longevity of profitable growth in the underpenetrated low-cost housing Recommendation segment defines Aavas. Scalability hinges on niche positioning, Mcap (bn): `118/US$1.6 technology-backed processes and people. Its time-tested informal income assessment model, knowledge through local hires and in-house 3M ADV (mn): `89.1/US$1.2 souring strategy ensure impressive asset quality. Best-in-class CMP: `1505 management execution and ability to hit above its weight (industry TP (12 mths): NA leading risk & data analytics) make it future-proof. Prudent risk Downside (%): NA management DNA, liquidity cushion (~18% C&CE/AUM) and impressive collection infrastructure place it in a different orbit vs peers even in Flags periods of stress. It is well-placed to grow disbursements by >20% over the next 5 years. Desired combination of high-growth retail business Accounting: GREEN with low construction risk makes 16%+ RoE sustainable in the long term. Predictability: GREEN Valuation of 4.5x FY22E P/B vs 0.4x-2.0x for peers seems rich but Earnings Momentum: GREEN justified. Key risk: Absence of a long-term strategic shareholder. Competitive position: STRONG Changes to this position: STABLE Performance Bang for the buck! AAVAS IN EQUITY SENSEX 135 AUM/disbursements posted 72%/48% CAGR in FY13-20. Credit extended by 125 115 HFCs posted ~18% CAGR. Faster than system growth (despite small base) 105 helped Aavas capture ~0.9% of HFC share in nine years of inception. Even while 95 85 serving the informal segment, Aavas maintained impressive asset quality given 75 robust credit assessment module, in-house sourcing and full-scale collections 65 55 infra. Its credit costs/GNPAs remained <45bps/80bps each year since inception. Consistent growth while maintaining asset quality helped deliver superior RoA Jun-20 Apr-20 Oct-19 Feb-20 Dec-19 (>2.3%) across cycles. RoA of 3.1% (FY20) is amongst the highest in the sector. Aug-19 Aug-20 Designed to scale-up Aavas from inception was designed as a built-for-scale model. Its scalability Source: Bloomberg, Ambit Capital research prospects are propelled by: i) niche target segment (~65% self-employed with Aavas stacks up well compared to peers >60% first-time borrowers); ii) entrenched presence in underpenetrated (refer exhibit 5) geographies (beyond tier-2 cities); iii) proactive large investments across people, Entity Overall score processes and technology; and iv) capital cushion (leverage of 3.7x) with best-in- class execution track record. Its model entails all the levers to scale up quickly AAVAS and complete with larger incumbents whose regional-focussed models have CANFIN helped maintain tight opex ratios in addition to its cost of fund advantage. LICHF Opex management, standardization and positioning to drive growth Limited competition so far allowed Aavas to price risk for higher opex/potential REPCO credit costs. Heightened competition (>100 HFCs) with pursuit to maintain PNBHOUSI superior asset quality warrants Aavas will eventually move up the yield curve. This makes timeliness to move down the opex curve key to scale up. Multi-state Source: Ambit Capital research expansion strategy requires replicating appraisal mechanism while standardizing Note: - Strong; - Relatively Strong; - processes and reducing any key man risk. Our analysis (exhibit 1) suggests Average; - Relatively weak successful credit profiles operate in a high core pricing power of 2-3x with a leverage of >8x. Whilst Aavas scores well on pricing power (~4x), sub-optimal leverage restricts RoE expansion but adds firepower for the long run. Valuations reflect opportunity, longevity and execution premium Research Analysts Underpenetration, government financial/policy thrust, capital cushion and a Udit Kariwala, CFA platform equipped to handle growth will help Aavas grow disbursements by [email protected] >20% over the next 5 years. Margins would decline (up to 200bps) but offset by +91 22 6623 3197 reducing opex ratio. Resultant efficient capital deployment opportunities would Pankaj Agarwal, CFA help expand RoE to >16% and remain sustainable thereafter. Valuation of 4.5x FY22 P/B (Bloomberg) vs 0.4x-2.0x for peers seems rich but have to be seen in [email protected] the light of investors’ confidence on sustainability, execution and scalability. +91 22 6623 3206 Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Aavas Financiers Sweet spot for scalable businesses (HFCs) Our analysis suggests successful HFC credit profiles operate in a high core pricing power of 2-3x with leverage of >8x. Aavas commands the desired pricing power; sub-optimal leverage drags RoE but provides enough fire power for future growth. Exhibit 1: Positioning/pricing of housing finance companies 12 10 8 6 Leverage (x) Leverage 4 Aavas 2 0.0 1.0 2.0 3.0 4.0 5.0 -1.0 Pricing power: (NII-opex-cc)/avg. assets Source: Ace Equity, Ambit Capital research estimates. Note: HFCs with asset size of at least `2bn and maximum of `200bn have been considered for analysis. Bubble size indicates total assets The bright kid on the block! Aavas was incorporated as a retail affordable Housing Finance Company (private limited) at Jaipur, Rajasthan under the name of "AU Housing Finance Private Limited" on February 23, 2011. The company was initially promoted by AU Financiers (India) Limited, which is now known as AU Small Finance Bank Limited (AU SFB). In 2016, AU SFB sold 90% of its stake to Lake District Holdings (Kedaara Capital) to comply with regulatory requirements while pursuing the small finance bank licence. As at end-Mar’20, Lake District Holdings and Partners Group, the two promoters cumulatively hold ~53.5% stake in the company. Aavas primarily serves low/middle- income self-employed customers (~65%) in semi-urban/rural areas in India. Most of its customers have limited access to formal banking credit. Target customers are owners of small/medium size businesses like grocery shops, beauty parlours, tiffin services, transportation services using three-wheelers, agriculture-related business etc. Aavas has an in-house sourcing and execution model. Product offering consists of home loans for purchase, construction, extension and repair of existing housing units. Aavas is now present in 10 states covering Rajasthan, Maharashtra, Gujrat, Madhya Pradesh, Haryana, Uttar Pradesh, Chhattisgarh, Delhi, Uttarakhand and Punjab. As of Mar’20 its operations were spread across 250 branches. Its team strength is 4,581. Exhibit 2: Journey so far has been no less than of a poster boy of HFC’s Year Event 2011 Incorporated as AU Housing Finance and got registered as a non-deposit taking HFC with NHB 2012 Received its first rating 'BBB+/Stable' from CRISIL for long-term bank facilities of `1bn 2013 Converted into a public limited company. Received first refinancing assistance from NHB 2014 Issued first tranche of NCDs Entered into first pool buyout transaction in housing loan segment (priority sector) 2015 Got identified as a ‘financial institution’ under the SARFAESI Act, 2002 Received investment from Lake District Holdings (Kedaara Capital) and Partner Group 2016 ICRA assigned “A with a stable outlook’ rating for long term facilities of `5bn Received its first subsidy from NHB under ‘CLSS-PMAY’ Name changed to Aavas Financiers 2017 CARE assigned 'A+; Stable’ rating for long term bank facilities of `3.8bn and subordinated debt of `.0.5bn Entered into its first PTC transaction with IDBI Trusteeship Services CARE/CRISIL upgraded rating to 'A+; Positive', and 'A+/ Stable' for long term facilities 2018 ICRA assigned rating 'A+/ Positive' for bank limits and NCDs and 'A1+'for commercial paper 2019 Got listed on BSE & NSE in October 2018, rating upgraded by CARE to ‘AA-; Stable’ in March 2019 2020 Achieved footprint of 250 branches spread across 10 states Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 58 Aavas Financiers Exhibit 3: Key financial parameters over the last seven years (` mn) FY14 FY15 FY16 FY17 FY18 FY19 FY20 Net Interest Income 203 429 756 1,275 2,812 4,286 5,129 NII Growth (%) 111 76 69 121 52 20 Net Profit 63 191 328 571 931 1,759 2,491 EPS 2.0 5.5 8.2 11.1 15.9 22.5 31.8 AUM growth (%) 129 107 99 60 51 46 31 Gross NPAs (%) 0.22 0.52 0.55 0.79 0.46 0.47 0.46 Credit costs (% of AAUM) 0.34 0.38 0.31 0.43 0.09 0.22 0.28 Provisioning Coverage 16 18 23 24 16 22 26 Tier-1 (%) 24 21 27 46 56 65 54 Leverage (x) 7.1 8.2 9.2 6.4 4.4 3.8 4.1 ROA (%) 2.2 3.1 2.6 2.6 2.8 3.6 3.8 ROE (%) 15.0 24.3 21.5 14.8 10.3 11.6 12.7 Source: Company, Ambit Capital research Exhibit 4: Liquidity mapping - Aavas well-placed compared to peers Cash/cash ALM strength Overall score Ability to raise Entity equivalent as a % of /borrower’s ability (out of 4) on funds/parentage AUM to repay liquidity LICHF 3.0 AAVAS 2.5 CANFIN 2.3 PNBHOUSI 2.0 REPCO 1.3 Source: Ambit Capital research estimates; Note: - Strong; - Relatively Strong; - Average; - Relatively weak Exhibit 5: Aavas stacks up well compared to peers across most parameters Overall score Entity Credit rating Liquidity profile Asset quality profile Capital adequacy Profitability profile (out of 4) AAVAS AA- (stable) 3.4 CANFIN AA (stable) 2.8 LICHF AAA (stable) 2.6 REPCO AA- (stable) 2.5 PNBHOUSI AA (negative) 1.6 Source: Ambit Capital research estimates; Note: - Strong; - Relatively Strong; - Average; - Relatively weak Exhibit 6: A look at performance of Gruh when it was Aavas’s size; HDFC parentage aided in building liability franchise Tier-1 ratio Leverage Next 3 years CAGR (%) ` mn AUM PAT NIM (%) ROA (%) ROE (%) (%) (%) AUM PAT Gruh Finance FY14 70,090 1770 4.3 2.8 15 11 32 24 19 Aavas FY20 77,961 2491 7.5 3.8 54 4 13 Source: Company, Ambit Capital research estimates August 26, 2020 Ambit Capital Pvt. Ltd. Page 59 [email protected] 2020-12-07 Monday 13:17:41 Aavas Financiers Exhibit 7: Implied market valuations are currently trailing Exhibit 8: Post Covid-led correction, it yielded negative below 2-year average valuations returns (last 12 months) but outperformed Bankex One-yr fwd P/B 7.5 AAVAS IN BANKEX Index Par 2 year average one-year fwd P/B 6.5 135 5.5 4.5 115 3.5 95 2.5 1.5 75 0.5 Feb-19 Apr-19 Jun-19 Aug-19 Oct-19 Dec-19 Feb-20 Apr-20 Jun-20 Aug-20 55 Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-20 Aug-19 Nov-19 May-20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 9: Aavas’s AUM CAGR over the last 7 has been Exhibit 10: Robust AUM growth has been backed by strong at 72%; disbursements posted 48% CAGR granular assets, average HL ticket size of ~`0.9mn Other mortgage (Rsbn) Number of loan accounts (in 000') Housing (Rsbn) Avg. tick size: HL- RHS (Rsmn) AUM growth YoY (%) - RHS Avg. tick size: Others - RHS (Rsmn) Disbursement growth (%) - RHS 120 1.0 100 150 80 90 0.9 100 60 60 0.8 40 50 30 0.7 20 0 0 0 0.6 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 11: Decline in yields has been backed by reducing Exhibit 12: Asset quality has been impressive; credit CoF, ensuring spreads (pricing power) to remain intact costs/GNPAs remained <45bps/80bps since inception Yield on assets (%) Gross NPAs (%) Credit cost (%) Cost of borrowings (%) Interest spread (%) - RHS 0.9 0.8 NIMs (%)- RHS 20 9.5 0.7 0.5 0.6 8.5 0.5 0.5 0.5 15 0.5 7.5 0.2 6.5 0.3 10 5.5 0.1 5 4.5 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 60 Aavas Financiers Exhibit 13: GNPA across products maintained; declining Exhibit 14: Provision coverage stacks well among peers 1+dpd testament to robust collections infrastructure operating in similar segments HL: GNPA (%) Stage-3 provision coverage ratio (%) - FY20 Other Mortgage: GNPA (%) 48 50 44 1+DPD (%) - RHS 40 36 1.0 0.9 29 14 30 26 0.8 0.6 0.6 0.6 0.5 0.6 0.5 10 20 0.4 12 0.4 0.3 0.3 0.2 0.1 10 0.1 6 0.2 0.0 2 HDFC LICHF AAVAS REPCO* CANFIN PNBHOUSI FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research *PCR as of 3QFY19 Exhibit 15: Larger P&L cushion adds to the comfort Exhibit 16: Opex ratios to decline as Aavas scales up Opex to income (%) Opex to assets (%) - (RHS) Credit cost/AUM - (%) PPOP/AUM - (%) 60 5.0 5.0 4.0 55 4.5 3.0 50 4.0 2.0 45 3.5 1.0 3.0 0.0 40 35 2.5 FY19 FY20 FY19 FY20 FY19 FY20 FY19 FY20 AAVAS REPCO* CANFIN LICHF FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research *numbers as of 3QFY19 Source: Company, Ambit Capital research Exhibit 17: Aavas is well-capitalized for growth; RoE Exhibit 18: RoA remains one of the highest amongst curtailed given sub-optimal leverage peers; expect RoE to improve in tandem with leverage Tier 1 ratio Leverage (assets/equity) - (RHS) RoE (%) RoA (%) - RHS 24 60 54 12 25 4.0 21 50 10 3.5 40 8 20 30 20 25 6 3.0 15 15 17 15 20 12 4 15 13 2.5 10 2 12 10 10 2.0 HDFC LICHF AAVAS REPCO* CANFIN FY14 FY15 FY16 FY17 FY18 FY19 FY20 PNBHOUSI Source: Company, Ambit Capital research *numbers as of 3QFY19 Source: Company, Ambit Capital research Exhibit 19: Explanation of our flags on the front page Segment Score Comments We did not come across anything unusual in the reported financials and believe financials are a true representation Accounting GREEN of the health of the company. Aavas has reported fairly stable earnings growth and has also met its earnings and growth guidance over the last 12 Predictability GREEN months. The company’s disclosures provide adequate granularity on the business on a quarterly basis. Earnings momentum GREEN There have been no significant upgrades/downgrades to consensus numbers over last six months. Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 61 Aavas Financiers Financials Income Statement ` mn FY16 FY17 FY18 FY19 FY20 Net Interest Income 756 1,275 2,812 4,286 5,129 Interest Income 1,725 2,703 4,743 6,839 8,690 Interest Expense 969 1,428 1,931 2,554 3,561 Non Interest Income 184 352 201 270 341 Total Income 940 1,627 3,014 4,556 5,470 Operating expenses 405 673 1,645 1,890 2,296 Pre Provisioning Profit 535 953 1,369 2,666 3,174 Provisions 36 78 26 89 153 PBT 500 876 1,343 2,577 3,020 Less:Tax 172 304 412 818 529 Net Profit 328 571 931 1,759 2,491 Source: Ambit Capital research estimates Balance Sheet ` mn FY16 FY17 FY18 FY19 FY20 Networth 2,038 5,663 11,899 18,370 20,979 Borrowings 14,468 17,934 27,376 36,533 52,524 Other Liabilities 602 910 1,126 1,366 3,077 Total Sources of funds 17,108 24,507 40,401 56,268 76,580 Investments - 8 45 45 45 Loan Book 14,545 21,328 33,334 47,245 61,808 Other Assets 2,563 3,171 7,022 8,978 14,727 Total Application of funds 17,108 24,507 40,401 56,268 76,580 Source: Ambit Capital research estimates Key Ratios % FY16 FY17 FY18 FY19 FY20 AUM growth (%) 99.3 60.3 51.2 45.9 31.2 Dil Consol EPS growth (%) 48.7 34.7 43.2 41.6 41.2 Net interest margin (NIM) (%) 6.0 5.8 8.3 8.6 7.5 Cost to income (%) 43.1 41.4 54.6 41.5 42.0 Opex (% of AAUM) 3.21 3.08 4.86 3.77 3.34 Gross NPAs (%) 0.55 0.79 0.46 0.47 0.46 Credit costs (% of AAUM) 0.31 0.43 0.09 0.22 0.28 Provisioning Coverage 23.3 24.0 16.0 21.8 26.1 Capital adequacy (%) 27.5 46.9 61.6 67.8 56.0 Tier-1 (%) 26.7 46.2 55.9 65.4 53.9 Leverage (x) 9.2 6.4 4.4 3.8 4.1 Source: Ambit Capital research estimates Valuation Particulars FY16 FY17 FY18 FY19 FY20 BVPS (`) 51 110 203 235 268 Diluted EPS (`) 8.2 11.1 15.9 22.5 31.8 ROA (%) 2.6 2.6 2.8 3.6 3.8 ROE (%) 21.5 14.8 10.3 11.6 12.7 P/E 182.6 135.6 94.7 66.8 47.3 P/BV 29.4 13.7 7.4 6.4 5.6 Source: Ambit Capital research estimates August 26, 2020 Ambit Capital Pvt. Ltd. Page 62 Amber Enterprises BUY SCALABILITY THEMATIC AMBER IN EQUITY August 26, 2020 Ride the import substitution wave Consumer Durables Amber became leader of Indian AC EMS through: i) wide ODM range and Recommendation R&D; ii) backward integration + economies of scale (15 plants); and iii) Mcap (bn): `572/US$0.8 client relationships built on design and components-level solutions. Amber posted 24%/28% sales/EBITDA CAGR in FY13-20 on higher 3M ADV (mn): `1,320/US$1.77 outsourcing (40% in FY20) and new products (motors, electronics). Riding CMP: `1,820 industry tailwinds (given RAC penetration <10%) and low competition TP (24 mths): `2,504 (top2 players have 70% of ODM market), Amber would post 19%/20% Upide (%): 38 sales/EBITDA CAGR in FY20-30E with improving RoCE (>20% by FY25E) due to higher fixed asset turns of subsidiaries (Ever/IL Jin/Sidwal). ODM Flags business model provides confidence on higher competitive advantage period vs pure OEM players, negating concerns over low RoCE. Risks: Accounting: GREEN Import dependence (30% RM), demand seasonality & foreign ODM Predictability: AMBER players in long run. 2-year DCF-based TP of Rs2504, implies then 30x Earnings Momentum: AMBER one year forward eps. Performance Competitive position: STRONG Changes to this position: POSITIVE Leader in AC ODM solutions with significant cross-selling opportunities 190 140 Amber is leader in ODM solutions (22% domestic RAC share) with wide range of 90 IDUs, ODUs and window ACs. It has successfully created manufacturing 40 dependence for leading AC brands that prefer asset-light business models. Additional focus on components (33% FY20 sales) presents significant cross- Jun-20 Apr-20 Oct-19 lli i f AC d bl Feb-20 Dec-19 Backward integration and economies of scale are competitive strengths Aug-19 Aug-20 Amber Sensex Through 15 facilities in close proximity to clients, Amber has significant economies of scale to provide cost effective solutions. Going beyond backward integration on mechanical side (sheet-metal, plastic), Amber has invested in Source: Bloomberg, Ambit Capital research electronics (through subsidiaries Ever and IL Jin) and is now focusing on higher value-added products (e.g. inverter PCBs) that not only give it a heads-up over Amber’s forensic score analysis competition but also improves fixed asset turnover (10x for electronics vs 3x for standalone RAC manufacturing) Strong synergies from HVAC segment improves business model Sidwal acquisition provides entry into high RoCE (>40%) HVAC/commercial AC segments whilst also presenting new cross-selling opportunities (of higher Source: Ambit ‘HAWK’, Ambit Capital research tonnage) to existing clients. Sidwal contributed 6%/20% to FY20 sales/EBITDA and presents non-seasonal business opportunity to scale (2.5x order-book to Amber’s greatness score analysis FY20 sales) whilst providing strong cash flows to invest in other segments Long runway of growth + improving capital efficiency => BUY and hold Post Covid-19 challenges (20% sales dip in FY21E) mask long-term opportunity. Manufacturing dependence created in the industry (ODM model) implies Amber Source: Ambit ‘HAWK’, Ambit Capital research would enjoy a longer competitive advantage period (CAP). Coupled with low RAC penetration in India (<10%) and increasing outsourcing (>50% by FY23E), Amber could post 19%/21% sales/EBITDA CAGR over FY20-25E (RoCE >20% by Research Analysts FY25E) before reverting to industry-level growth over FY25-30E Nitin Bhasin +91 22 6623 3241 [email protected] Dhruv Jain +91 22 6623 3177 [email protected] Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Amber Enterprises Exhibit 1: Evolution of Amber Revenue growth - 21% CAGR Revenue growth - 34% CAGR 40 20% 32 16% 24 12% bn) ` ( 16 8% 8 4% 0 0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Sales pre-tax RoCE (Y1) EBITDA margin (Y1) Capital employed turnover (Y2) Source: Company, Ambit Capital research Exhibit 2: Key financial parameters over the last decade (Fig in Rs mn) FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenue 8,757 9,734 12,303 10,890 16,444 21,281 27,520 39,628 Revenue growth (%) 11% 26% -11% 51% 29% 29% 44% Net profit 197 222 288 241 279 623 952 1,641 EPS 12 11 13 11 13 23 30 52 CFO (pre-tax) 628 1,137 809 1,522 985 1,270 -631 2,882 CFO-EBITDA (Pre tax ) 114% 158% 88% 143% 84% 78% -16% 109% FCF -456 -39 -307 322 -23 -127 -1,606 1,509 Debt equity (x) 1.7 1.0 1.2 1.2 1.0 (0.0) 0.2 0.2 CE turnover 2.2 2.2 2.3 1.8 2.4 2.4 2.4 2.8 GB Turnover 3.0 3.0 3.1 2.2 2.9 3.1 3.4 4.1 RoE (%) 14.8% 13.0% 12.8% 9.6% 9.3% 10.2% 10.1% 15.5% ROCE* (%) 10.7% 12.7% 14.6% 13.9% 13.2% 15.3% 13.1% 16.1% Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total capital including cash in the denominator. Exhibit 3: The key things to note from the evolution Time period Phase Key developments . Amber benefited from the exit of Lloyd electric from the AC ODM space; thus becoming the largest AC ODM player in India FY13-FY18 Phase 1 . Acquisition of clients across the spectrum; brands that Amber caters to now contribute > 70% of overall market share . Acquired Ever, IlJin to enter the electronics space of components FY18-Current Phase 2 . Acquisition of Sidwal to enter mobility applications Source: Company, Ambit Capital research Exhibit 4: Competitive mapping of Amber with other comparable peers Pre-tax Pre-tax CFO/ Sub-segment FY20 Revenue CAGR EBITDA Capex/CFO Company RoCE EBITDA Positioning revenue FY16-20 Margin (FY20) (FY16-20) (FY20) (FY16-20) Dixon Technologies #1 44,001 33% 5.1% 29% 81% 83% Amber Enterprises #2 39,628 38% 7.8% 16% 76% 91% Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 64 [email protected] 2020-12-07 Monday 13:17:41 Amber Enterprises Exhibit 5: Mapping Amber and peers on IBAS Financial Metrics Operational metrics Capital Sales Return on Innov Archite Product Replacement Addressable Overall Comments Margins employed growth Capital ation cture range cycle market size turnover Dixon's diversification Dixon across segments and robust Technolog OEM/ODM mix make a ies robust EMS business model. Amber's concentration in Amber AC segment leads to Enterprises segment specific characteristics. Source: Company, Ambit Capital research Exhibit 6: Amber’s multiples have remained range-bound Exhibit 7: Stock’s price performance v/s relevant index 160 Amber Sensex Cons TTM PE(x) Cons EV/EBITDA(x) 140 50 Amber 45 40 120 35 30 100 25 20 80 15 10 60 5 0 40 Jul-18 Jul-19 Jul-20 Jan-18 Jan-19 Jan-20 Sep-18 Sep-19 Mar-18 Mar-19 Mar-20 Nov-18 Nov-19 May-18 May-19 May-20 Jun-19 Jun-20 Apr-19 Apr-20 Oct-18 Oct-19 Feb-19 Feb-20 Dec-18 Dec-19 Aug-18 Aug-19 Aug-20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 8: Revenue growth over the last 7 years for Amber has been robust Acquisition Investment in Investment in 50 in Sidwal 50% IlJin Ever 40 40% 30 30% bn) ` ( 20 20% 10 10% 0 0% FY14 FY15 FY16 FY17 FY18 FY19 FY20 RAC Components & mobile application Share of components (RHS) Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 65 Amber Enterprises Exhibit 9: Margins have now stabilized for last 4-5 years Exhibit 10: FCFF generation has been volatile owing to and should increase with the subsidiaries firing now high capex requirements and WC volatility 25.0% Gross margin (%) EBITDAM CFO (Rs mn) FCFF (Rs mn) Net D/E (RHS) 4,000 2.0 20.0% 3,000 1.5 15.0% 2,000 10.0% 1.0 1,000 5.0% 0.5 0 0.0% -1,000 - FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 -2,000 (0.5) Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 11: WC turnover has come off over the last 2 years Exhibit 12: RoCE has consistently been at ~20% over the last few years 14.0 Gross block T/O WC T/O 17% RoE (%) ROCE* (%) 12.0 15% 10.0 13% 8.0 11% 6.0 9% 4.0 7% 2.0 5% - FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research; * RoCE is pre-tax Exhibit 13: EBITDA/employee has been c oming off 4,500 EBITDA + Emp. Cost (LHS; Rs mn) EBITDA/Employee (RHS) 4 4,000 3.5 3,500 3 3,000 2.5 2,500 2 2,000 1.5 1,500 1,000 1 500 0.5 - 0 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 66 Amber Enterprises Exhibit 14: Explanation for our flags Segment Score Comments Amber’s accounting scores have improved on our HAWK metrics over the last few years. It has a reputed Accounting GREEN internationally affiliated auditor. It scores well on low contingent liability, low miscellaneous expenses to revenues and change in depreciation rate relative to revenues. Predictability is low due to ongoing Covid-19 pandemic. End-user demand may also vary due to seasonal factors Predictability AMBER and other industry characteristics. In the aftermath of Covid-19, users may curtail high discretionary spending and earnings are likely to be harder to predict. However, over a long period predictability is fairly high for the company. Earnings momentum has been mixed with earnings upgrade being seen till 1HFY20, but owing to Covid the stock Earnings Momentum AMBER has seen downgrades by consensus. Source: Ambit Capital research HAWK scores – Significant improvement over years Amber has improved its accounting scores significantly over FY15-20 where it now features in D3 – Zone of Safety. It scores higher than the median accounting score for its sector. Amber lies in the middle on our greatness parameters compared to peers and larger universe and features in ‘Good, not great category’ in FY19. It has remained largely in the same bucket since FY15. Key contributors to accounting score and comparison to peers Amber features in D3 decile on our accounting framework, which is also ‘Zone of Safety decile. Key contributors to its relatively better accounting score include low contingent liabilities, low change in deprecation rate, low misc. expenses as a % of revenues and low change in auditor’s remuneration as compared to revenue growth. However, CFO/EBITDA has been low due to volatile working capital requirements. Similarly CWIP to gross block has been high owing to high capex being done by the company in recent years. Advances to related party are advances to subsidiaries which are in normal course of business. FCF generation has been volatile owing to high capex and volatile WC. Exhibit 15: Forensic accounting score contributors Exhibit 16: Forensic score percentile to larger universe and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company. August 26, 2020 Ambit Capital Pvt. Ltd. Page 67 Amber Enterprises Comments on evolution of accounting score Amber has improved its accounting score from zone of darnkeness in FY15 to Zone of Safety in FY20 (i.e. D1 to D4 deciles) between FY15 to FY19. This is owing to improvement in FCF generation, lower misc. exps and improvement in contingent liability as a % of reveues. Exhibit 17: Forensic accounting score evaluation Exhibit 18: Movement in accounting checks – Likely to marginally deteriorate on accounting score in FY20 Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 78% -16% 109% P & L mis- Volatility in depreciation rate 0bps 0bps (20 bps) statement check PFD-% of Debtors more than 0% 0% 1% six months Balance sheet Cash yield 1.4% 2.5% 1.0% mis-statement Change in reserves (ex sec- 1.6 0.93 1.0 check prem)/(PAT ex dividend) Cont Liab-% of NW 9% 10% 6% Misc. exps-% of total revs 2.5% 2.3% 2.3% Adv. to related parties / CFO 611% -97% 7% Pilferage checks CWIP: Gross Block 8% 6% 6% Cum. FCF/median revs -1% -2% 0% Audit quality CAGR in auditor's remn/CAGR NA 0.3 0.4 check* in cons. Rev. Source: Ambit Capital research, Company Source: Ambit Capital research, Company. * Growth in auditor remuneration is insignificant; hence there is no concern Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc). Amber has been range bound on our greatness parameters. Greatness score contributors Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 68 Amber Enterprises Exhibit 19: Greatness score percentile to larger universe Exhibit 20: Greatness score evolution and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 69 [email protected] 2020-12-07 Monday 13:17:41 Amber Enterprises Balance sheet (consolidated)* Year to March (Rs mn) FY18 FY19 FY20 FY21E FY22E FY23E Shareholders' equity 314 314 314 314 314 314 Reserves & surpluses 8,613 9,547 10,970 11,519 12,837 14,564 Total networth 8,928 9,861 11,284 11,834 13,151 14,878 Minority interest 0 190 348 348 348 348 Borrowings 1,055 2,328 3,205 4,566 5,485 7,646 Other non-current liabilities 293 303 843 843 843 843 Deferred tax liability 347 469 697 697 697 697 Trade Payables 5,720 9,407 11,068 8,685 11,724 15,476 Other current liabilities 938 1,179 1,583 1,583 1,583 1,583 Total liabilities 17,280 23,739 29,028 28,556 33,831 41,471 Gross block 7,462 8,754 10,396 11,596 13,374 15,269 Net block 5,629 6,511 7,475 8,091 9,082 9,937 Capital work-in-progress 95 89 32 32 32 32 Intangible assets 1,471 1,584 3,584 3,438 3,241 2,981 Financial assets 177 332 370 370 370 370 Total non-current assets 7,372 8,515 11,460 11,931 12,725 13,320 Cash & equivalents 1,338 447 1,203 1,071 1,861 3,277 Debtors 3,786 7,872 8,542 7,817 9,967 13,156 Inventory 3,956 5,606 6,557 6,080 7,622 10,061 Current financial assets 152 462 453 453 453 453 Other current assets 676 838 814 1,205 1,205 1,205 Total current assets 9,908 15,224 17,568 16,625 21,107 28,151 Total assets 17,280 23,739 29,028 28,556 33,831 41,471 Source: Company, Ambit Capital research Income statement (consolidated)* Year to March (Rs mn) FY18 FY19 FY20E FY21E FY22E FY23E Operating income 21,281 27,520 39,628 31,703 42,798 56,495 % growth 29.4% 29.3% 44.0% -20.0% 35.0% 32.0% Operating profit 1,835 2,133 3,093 1,895 3,414 4,620 % growth 42.7% 16.2% 45.0% -38.7% 80.2% 35.3% Depreciation 490 623 848 729 984 1,299 EBIT 1,345 1,510 2,245 1,166 2,430 3,320 Interest expenditure 538 246 419 411 494 688 Non-operating income 87 99 82 65 88 116 Adjusted PBT 894 1,363 1,907 820 2,024 2,749 Tax 271 412 266 209 510 693 Adjusted PAT/ Net profit 1,641 1,514 2,056 623 952 611 % growth 123.3% 52.8% 72.4% -62.8% 147.8% 35.8% Extra Ordinary Items - - - Reported PAT / Net profit 623 952 1,641 611 1,514 2,056 Reported Consolidated net profit 1,641 1,514 2,056 623 952 611 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 70 Amber Enterprises Cashflow statement (consolidated) Year to March (Rs mn) FY18 FY19 FY20 FY21E FY22E FY23E PBT 894 1,363 1,907 820 2,024 2,749 Depreciation 490 623 848 729 984 1,299 Interest income (21) (14) - - - - Interest expense 538 246 419 411 494 688 Changes in working capital (530) (2,079) 432 (1,181) (652) (1,877) Taxes (168) (299) (488) (209) (510) (693) Others 67 (470) (236) - - - Cash flow from operations 1,270 (631) 2,882 570 2,340 2,167 Capex (1,024) (1,204) (1,449) (1,200) (1,778) (1,895) (Incr) / decr in investments (601) - (1,519) - - - Interest/Dividend Received 18 11 - - - - Others 0 0 (298) (391) - - Cash flow from investments (1,607) (1,193) (3,266) (1,591) (1,778) (1,895) Net borrowings (2,810) 1,176 1,759 1,361 918 2,161 Issuance of equity 4,747 - - - - - Interest expense (560) (245) (419) (411) (494) (688) Dividend paid - - (121) (61) (197) (329) Others Cash flow from financing 1,376 932 1,218 889 228 1,144 Net change in cash 1,028 (816) 250 (132) 790 1,416 Closing cash balance 1,194 401 700 568 1,358 2,774 Free cash flow 246 (1,835) 1,433 (630) 562 272 Source: Company, Ambit Capital research Ratio analysis (consolidated)* Year to March (%) FY18 FY19 FY20E FY21E FY22E FY23E EBITDA margin (%) 8.6% 7.8% 7.8% 6.0% 8.0% 8.2% EBIT margin (%) 6.3% 5.5% 5.7% 3.7% 5.7% 5.9% Net profit margin (%) 2.9% 3.5% 4.1% 1.9% 3.5% 3.6% Dividend payout ratio (%) 0.0% 0.0% 7.4% 10.0% 13.0% 16.0% Net debt: equity (x) (0.0) 0.2 0.2 0.3 0.3 0.3 Working capital turnover (x) 12.7 9.0 9.8 6.9 7.7 8.3 Gross block turnover (x) 3.1 3.4 4.1 2.7 3.2 3.7 RoCE (%) 15.3% 13.1% 16.1% 7.2% 13.3% 15.6% RoE (%) 10.2% 10.1% 15.5% 5.3% 12.1% 14.7% Source: Company, Ambit Capital research Valuation parameters (consolidated)* Year to March (Rs mn) FY18 FY19 FY20E FY21E FY22E FY23E EPS (Rs) 23.2 30.1 52.2 19.4 48.1 65.4 Diluted EPS (Rs) 23.2 30.1 52.2 19.4 48.1 65.4 Book value per share (Rs) 284.3 314.1 358.8 376.3 418.2 473.1 Dividend per share (Rs) - - 3.9 1.9 6.3 10.5 P/E (x) 79.1 60.8 35.1 94.3 38.1 28.0 P/BV (x) 6.4 5.8 5.1 4.9 4.4 3.9 EV/EBITDA (x) 31.1 27.8 19.3 32.2 17.9 13.4 EV/sales (x) 2.7 2.2 1.5 1.9 1.4 1.1 Price/Sales (x) 2.7 2.1 1.5 1.8 1.3 1.0 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 71 Amber Enterprises This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 72 APL Apollo Tubes BUY SCALABILITY THEMATIC APAT IN EQUITY August 26, 2020 A ‘Structural’ Story Home-building Over FY10-20, APAT increased its capacities/volumes by 6x/10x owing to Recommendation focus on innovative practices and expansion of SKU basket. Initially it Mcap (bn): `489/US$7.6 ran a leveraged balance sheet at very high WC days (76 days in FY10) 3M ADV (mn): `2,374/US$37.1 but has been able to reduce it over the last 10 years. In the next decade, CMP: `2,450 we believe that this scalability will continue as (1) APAT enters in Tricoat range of products, (2) Industry consolidates owing to weakening players TP (24 mths): `2902 and (3) Increasing usage of structural steel in India. We expect APAT to Upside (%): 18 grow at a minimum 13% CAGR over the next 10 years whilst keeping its margins stable. Current valuation of 28x FY22E P/E is at a steep discount Flags to other BM players; however rerating will be gradual as concerns over Accounting: AMBER corporate governance will subside gradually. Predictability: RED Competitive position: STRONG Changes to this position: POSITIVE Earnings Momentum: AMBER Over FY10-20: Capacity/volumes up 6x/10x; WC down by 61 days Performance APAT scaled its capacity from 0.4mn MT to 2.55mn/MT and volumes from 0.2mn MT to 1.6mn MT over FY10-20. Initially, APAT had a leveraged balance sheet APL Apollo Sensex (debt-equity of ~1x) and high WC (76 days in FY10). Management’s ‘innovative’ 210 thinking of introducing new processes/SKUs in a ‘commoditized’ business helped 160 APAT scale (asset turns of 1.6x in FY10 vs 2.5x in FY20). APAT was thus able to 110 increase bargaining power with suppliers, creating an RM price advantage which it passed on to consumers. However, margins have remained volatile (5-7% 60 EBITDAM); something APAT can improve ahead. Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-19 Scalability driven by innovative practices and expansion of SKUs Nov-19 May-20 APAT increased its SKU basket (300 SKUs in FY13 vs 1000 SKUS in FY20) and invested in warehouses/DFT technology ahead of competition. This enabled Source: Bloomberg, Ambit Capital research faster availability of goods to its customers (3 days delivery for APAT vs ~10 days for peers), which helped in increasing market share. This coupled with relentless APL Apollo’s forensic score analysis focus on costs (unitary costs down 23% over FY09-19) and passing the cost advantage to the customer helped APAT grow ahead of the industry. Next decade: VAP, consolidation and market expansion to drive growth APAT has multiple levers to fuel its growth engine: (1) APAT’s recent foray into ‘Tricoat’ range of products is likely to help expand margins (10-11% vs 7% of Source: Ambit ‘HAWK’, Ambit Capital research APAT); (2) Consolidation is inevitable in this industry with competitors reeling under debt (debt/equity of 0.8x-1.6x) and running at high WC (>50 days WC for APL Apollo’s greatness score analysis most peers); and (3) Currently , structural steel is close to 4% of overall steel market of India vs developed nations close to 10-12%; a push in overall infrastructure will lead to expansion of this market. Key risks: Any wrong capital allocation decision and aggravation of existing governance challenges. Near-term pain inevitable but scalability a certainty Covid-related near-term pain is inevitable with normalcy only returning post Source: Ambit ‘HAWK’, Ambit Capital research FY22E. However, APAT is currently working at ~60% capacity utilisation, hence capex requirement in the near term will be low. We believe APAT has the ability to improve its market share owing to evident supply consolidation in the industry. We expect APAT to post 20% CAGR over FY21-FY23. Over FY 20-30, we expect APAT to grow at 13% CAGR without factoring in the optionality of it Research Analyst getting into newer categories. Current valuation of 18x FY22E P/E is at a steep discount to other BM players, but re-rating will be gradual as concerns over Nitin Bhasin corporate governance will subside gradually. +91 22 6623 3241 [email protected] Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. APL Apollo Tubes Exhibit 1: Evolution of APL Apollo Tubes Phase 3 revenue 90 Phase 1 - revenue Phase 2 - revenue 35% 30% growth CAGR growth CAGR growth CAGR 80 22% 50% 30% 70 23% 22% 22% 21% 22% 22% 25% 60 20% 20% 19% 17% 17% 20% 50 16% 15% 16% 40 13% 10% 15% 30 10% 20 10 5% 0 0% FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Revenues (Rs bn) (LHS) ROCE (RHS) 9MFY20 Source: Company, Ambit Capital research Exhibit 2: Key financial parameters over the last decade (` mn) FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues 6,180 9,052 13,923 20,083 25,687 31,375 42,136 45,450 53,342 71,523 77,232 Revenue growth (%) 46% 54% 44% 28% 22% 34% 8% 17% 34% 8% Net profits 297 507 497 695 590 638 1,259 1,524 1,582 1,483 2,559 EPS 14 13 23 31 26 27 43 62 66 62 97 CFO 169 467 545 521 1,574 3,216 799 3,785 1,516 4,249 5,911 CFO-EBITDA (Pre tax ) 29% 52% 47% 33% 96% 177% 28% 114% 41% 108% 124% FCF (216) (446) (389) (563) 64 1,336 (741) 3,217 (765) 1,316 2,081 Debt equity (x) 0.7 1.0 1.0 1.2 1.2 1.0 1.1 0.8 0.9 0.8 0.6 CE turnover 1.8 2.2 2.6 2.8 2.9 3.3 3.9 3.6 3.6 4.2 3.9 GB Turnover 3.0 3.7 5.6 6.9 6.0 5.4 5.8 5.4 5.6 6.4 5.3 RoE (%) 17% 24% 19% 21% 15% 14% 24% 24% 20% 16% 22% ROCE* (%) 16% 20% 20% 21% 17% 17% 23% 22% 22% 19% 19% Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total capital including cash in the denominator. Exhibit 3: The key things to note from the evolution Time period Phase Key developments . Developed in-house Hollow Sections across a wide-range of sizes. First in India to launch pre- galvanised pipes FY04-FY09 Phase 1 . Acquired 100% stake in both Apollo Metalex Private Limited for `72mn . Acquired 100% stake in Shri Lakshmi Metal Udyog Limited in a share swap agreement at investment of `362mn . Acquired 100% stake in Shri Lakshmi Metal Udyog Limited in a share swap agreement at investment of `362mn FY10-13 Phase 2 . Commissioning of Hosur plant in Tamil Nadu with a capacity of 0.2mn tonnes. Started multiple warehouses across India. . First in India to achieve a capacity of 1MTPA in ERW pipes. . Established India’s first ever DFT (Direct Forming Technology) line in Hosur. FY14-Current Phase 3 . Acquired majority stake in Apollo Tricoat’. . Acquired Shankara’s Hyderabad facility. Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 74 [email protected] 2020-12-07 Monday 13:17:41 APL Apollo Tubes Exhibit 4: Competitive mapping of APL Apollo, with other comparable BM peers Revenue Pre-tax Pre-tax CFO/ Sub-segment FY20 Industry EBITDA Capex/CFO Company CAGR RoCE EBITDA Positioning revenue market share Margin (FY20) (FY10-20) FY10-20 (FY20) (FY10-20) Kajaria #1 28,080 15% ~11% 15% 18% 91% 81% Supreme #1 55,120 11% ~11% 15% 24% 97% 56% Astral #3 25,780 25% ~9% 17% 23% 90% 75% Cera #1 12,419 14% ~22% 15% 15% 84% 70% Century Ply #1 22,926 7% ~4% 15% 16% 94% 79% Source: Company, Ambit Capital research Exhibit 5: Mapping APL Apollo and peers on IBAS Brand Architecture Strategic Overall Company Innovation Mfg Dstrbn Comments Rural Urban asset rank reach reach APAT has been at the forefront of innovation and has introduced newer products like GP pipes, Tricoat etc. ahead of the industry. APAT has been able to develop APAT a deep urban and rural distribution network which puts it ahead of the industry. APAT has also developed a professional management team to manage the day to day operations. Ahead of competition in launching and building premium tile brand (glazed and double charged Kajaria polished vitrified tiles). It has the highest scale and strong distribution. Innovation in plastic pipes, first through creation of the CPVC market and then through launches of differentiated products of global majors in India. Astral Strongest CPVC brand in India but relatively weak in rural India. Relationships with real-estate developers /plumbers are its unique architecture Cera has a mid-segment brand recall and manufacturing is centred on a single location. Its Cera unique advantage is the access to administered gas, which is 30% cheaper than spot gas. Century has not displayed any major product innovation. It is the most premium ply brand in India Century Ply and has a widespread manufacturing reach and is strengthening distribution to reach micro-markets. Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 75 APL Apollo Tubes Exhibit 6: APAT has re-rated post FY14 Exhibit 7: Stock’s price performance v/s relevant index Cons TTM PE(x) Cross cycle avg. 40 Share price performance (indexed to 100 35 2000 Sensex APAT 30 25 1500 20 1000 15 10 500 5 0 0 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jul-20 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19 Aug-20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 8: Revenue growth over the last 8 years for APAT has been robust 100,000 Revenues (` mn; LHS) 60% 80,000 40% 60,000 40,000 20% 20,000 - 0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 MS Black Hollow sections GI Pipe GP Pipe DFT Tricoat 3 year avg. revenue CAGR Source: Company, Ambit Capital research Exhibit 9: Margins have been volatile for APAT over the Exhibit 10: FCFF generation has been volatile owing to years high capex requirements 18.0% EBITDAM (%) Gross Margin (%) CFO (Rs mn) FCFF (Rs mn) D/E (x) 16.0% 6,000 1.4 14.0% 5,000 1.2 12.0% 4,000 1.0 10.0% 3,000 0.8 8.0% 2,000 0.6 6.0% 1,000 0.4 4.0% - (1,000) 0.2 2.0% (2,000) - 0.0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 76 APL Apollo Tubes Exhibit 11: WC turnover has consistently increased over Exhibit 12: RoCE has consistently been at ~20% over the the last 8 years last few years 14 Gross block T/O WC T/O Pre-tax RoCE (%) RoE (%) 26% 12 24% 10 22% 8 20% 6 18% 4 16% 14% 2 12% 0 10% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 13: EBITDA/employee has been coming off 6,000 4.0 3.5 5,000 3.0 4,000 2.5 3,000 2.0 1.5 2,000 1.0 1,000 0.5 0 - FY15 FY16 FY17 FY18 FY19 FY20 EBITDA + Fixed Employee cost (LHS; Rs mn) EBITDA/employee Source: Company, Ambit Capital research Exhibit 14: Explanation for our flags Segment Score Comments Accounting AMBER Whilst AAT is audited by a Big 4 auditor, APAT features on ‘D6’ on our Hawk framework. Predictability RED Considering the volatile environment owing to pandemic, predictability is low Earnings AMBER Bloomberg shows downgrades owing to pandemic in the last 6 months. momentum Source: Ambit Capital research HAWK scores APAT has largely featured in Zone of Safety (ex. FY19), i.e. D1 to D5deciles, over the years (FY15-FY19); however it slipped a bit in FY19-end. It scores higher than the median accounting score for its sector. APAT scores well on our greatness parameters and features in ‘Good not great category’ in FY19. Its greatness score has remained steady over the last 5 years. Key contributors to accounting score and comparison to peers APAT features in D6 decile on our accounting framework, which is also a ‘Zone of Pain’ decile. Key contributors to its relatively weak accounting score include low or volatile cash conversion, high provision for debtors and high auditor remuneration vs revenue growth. Cash conversion has vastly improved in FY20 August 26, 2020 Ambit Capital Pvt. Ltd. Page 77 APL Apollo Tubes Exhibit 15: Forensic accounting score contributors Exhibit 16: Forensic score percentile to larger universe and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Comments on evolution of accounting score APAT has always featured in Zone of Safety (ex FY19) over FY15-19. It is pertinent to note here that our framework consists of a higher number of ratios which capture the cash generation abilities of the businesses. Lower cash conversion has impacted APAT’s accounting score in FY20. Exhibit 17: Forensic accounting score evaluation Exhibit 18: Movement in accounting checks – Likely to deteriorate on accounting score in FY20 Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 41% 108% 124% P & L mis- Volatility in (40bps) (20bps) 80bps% statement depreciation rate check PFD-% of Debtors 1.4% 1.2% NA more than six months Balance sheet Cash yield 57% 3% 4% Change in reserves (ex mis-statement sec-prem)/(PAT ex check 1.2 1.2 1.4 dividend) Cont Liab-% of NW 3% 2% NA Misc. exps-% of total 0.1% 0.1% NA revs Adv. to related parties 0% 0% NA Pilferage / CFO checks CWIP: Gross Block 5% 2% 1% Cum. FCF/median -0.2% 0.4% 1.1% revs Audit quality CAGR in auditor's check* remn/CAGR in cons. 0.80% 0.80% NA Rev. Source: Ambit Capital research, Company Source: Ambit Capital research, Company. * Growth in auditor remuneration is insignificant; hence there is no concern August 26, 2020 Ambit Capital Pvt. Ltd. Page 78 APL Apollo Tubes Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.). APAT has remained stable on our greatness framework over the years. Further, APAT has performed significantly well on ‘Greatness’ as compared to the larger universe or its sector peers. Exhibit 19: Greatness score contributors Source: Ambit Capital research, Company Exhibit 20: Greatness score percentile to larger universe Exhibit 21: Greatness score evolution and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 79 [email protected] 2020-12-07 Monday 13:17:41 APL Apollo Tubes Balance sheet (consolidated)* Particulars FY18 FY19 FY20 FY21E FY22E FY23E Net worth 8,378 9,641 13,562 15,837 19,145 23,454 Borrowings 7,751 8,581 8,279 3,279 779 500 Other liabilities 1,368 2,293 1,846 1,711 2,056 2,437 Trade Payables 3,793 6,989 7,644 6,877 8,296 9,849 Total liabilities 21,812 29,661 32,660 28,935 31,755 37,994 Fixed assets 9,286 10,611 17,158 13,939 14,266 15,949 Other non-current assets 1,142 2,748 1,002 1,793 1,730 2,054 Current assets 11,384 16,303 14,501 10,685 13,241 17,473 - Cash and cash equivalents 67 478 456 508 1,674 3,740 - Inventories 5,915 7,835 7,842 6,484 7,111 8,442 - Trade receivable 4,321 5,433 4,764 2,358 2,844 3,377 - Other Current assets 1,081 2,557 1,439 1,336 1,612 1,914 Total assets 21,812 29,661 32,660 28,935 31,755 37,994 Source: Company, Ambit Capital research Income statement (consolidated)* Particulars FY18 FY19 FY20 FY21E FY22E FY23E Total revenues 53,342 71,523 77,232 71,712 86,514 102,714 Gross profit 7,858 8,447 11,446 9,961 12,371 15,055 Other exps 4,148 4,518 6,674 5,418 6,558 7,986 EBITDA 3,711 3,929 4,772 4,543 5,813 7,069 Depreciation and amortization 534 643 959 1,112 1,173 1,317 EBIT 3,177 3,286 3,813 3,431 4,640 5,752 Net Finance costs 813 1,134 1,073 665 233 74 PBT 2,444 2,270 2,962 3,033 4,726 6,062 Tax expense 862 787 403 758 1,182 1,516 Restated profit/ (loss) 1,582 1,483 2,559 2,275 3,545 4,547 EPS 66 62 97 88 137 177 Source: Company, Ambit Capital research Cashflow statement (consolidated) Cash flow statement FY18 FY19 FY20 FY21E FY22E FY23E PBT 2,444 2,270 2,962 3,033 4,726 6,062 Depreciation 534 643 959 1,112 1,173 1,317 Interest exp 813 1,134 1,073 665 233 74 Tax paid (602) (673) (816) (758) (1,182) (1,516) WC Adjustment (2,342) 287 1,017 2,077 685 (282) CFO 914 3,577 5,095 5,863 5,317 5,272 Capex (1,679) (2,261) (3,014) (400) (1,500) (3,000) CFI (1,654) (2,639) (4,349) (134) (1,180) (2,616) Net borrowings 1,807 830 (948) (5,000) (2,500) (279) CFF 792 (528) (781) (5,665) (2,970) (590) FCF (741) 1,328 2,303 5,729 4,137 2,656 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 80 APL Apollo Tubes Ratio analysis (consolidated)* Ratios FY18 FY19 FY20 FY21E FY22E FY23E Gross margin 14.7% 11.8% 14.8% 13.9% 14.3% 14.7% EBITDA margin 7.0% 5.5% 6.2% 6.3% 6.7% 6.9% EBIT margin 6.0% 4.6% 4.9% 4.8% 5.4% 5.6% PBT margin 4.6% 3.2% 3.8% 4.2% 5.5% 5.9% PAT margin 3.0% 2.1% 3.3% 3.2% 4.1% 4.4% Asset turnover (x) 2.7 2.8 2.5 2.3 2.9 2.9 Working capital turnover (x) 8.9 10.1 12.2 17.7 28.6 22.0 Capital employed turnover (x) 3.6 4.2 3.9 3.5 4.4 4.7 Gross block turnover (x) 5.6 6.4 5.3 4.1 4.7 5.0 RoA 7.9% 5.8% 8.2% 7.4% 11.7% 13.0% Leverage 2.6 2.9 2.7 2.1 1.7 1.6 RoE 20.3% 16.5% 22.1% 15.5% 20.3% 21.3% RoCE (pre-tax) 21.7% 19.1% 19.0% 16.8% 23.8% 26.2% RoCE (post-tax) 15.8% 14.6% 17.0% 13.1% 17.7% 19.3% Debt/Equity ratio (net) 0.9 0.8 0.6 0.2 (0.0) (0.1) CFO/EBITDA 40.9% 108.1% 123.9% 145.7% 111.8% 96.0% Source: Company, Ambit Capital research Valuation parameters (consolidated)* Valuation ratios FY18 FY19 FY20 FY21E FY22E FY23E EPS 66 62 97 88 137 177 RoE 20% 16% 22% 15% 20% 21% P/E 37 39 25 28 18 14 P/B 6.9 6.0 4.3 3.7 3.0 2.5 P/S 1.1 0.8 0.8 0.8 0.7 0.6 EV/Sales 1.1 0.8 0.8 0.8 0.7 0.6 EV/EBITDA 15.8 14.9 12.3 12.9 10.1 8.3 EV/EBIT 18.4 17.8 15.4 17.1 12.6 10.2 EV/CFO 4.1 1.1 0.9 0.8 1.1 1.3 Dividend per share 14.0 14.0 - - 10.0 10.0 Dividend yield (%) 1% 1% 0% 0% 0% 0% EV (` mn) 58,565 58,565 58,565 58,565 58,565 58,565 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 81 APL Apollo Tubes This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 82 Dixon Technologies BUY SCALABILITY THEMATIC DIXON IN EQUITY August 26, 2020 Riding on the electronic wave Consumer Durables Dixon became leader of Indian EMS industry by entering multiple Recommendation segments, backward integration, focus on ODM solutions (33% 9MFY20 Mcap (bn): `95/US$1.2 sales), and addition of marquee clients. It posted 28%/39% sales/EBITDA 3M ADV (mn): `3,970/US$5.3 over FY13-20 led by strong domestic consumer electronics demand (12% CAGR, FY20-25E) and government incentives. Next decade, Dixon has CMP: `8225 significant scope to increase volume share (40-50%) in domestic TP (24 mths): `10,160 manufacturing across segments (TVs, WMs, mobiles) and become one of Upside (%): 12 the champion businesses driving the Indian EMS ecosystem. Over FY20- 30, we expect 30%/29% sales/PAT CAGR with 25%+ RoCE and high FCF Flags yield due to high CE turns (6x). Risks: High import dependence (65% RM Accounting: AMBER requirement) and payment risk in incentive of PLI scheme. Predictability: AMBER Competitive position: STRONG Changes to this position: POSITIVE Earnings Momentum: GREEN Diversified consumer durables play in the EMS industry Performance Dixon steadily added growth segments (WMs-2010, mobile-2016, CCTVs-2017). Besides cutting business risk, Dixon focused on supply chain efficiencies and Dixon Sensex cross-selling opportunities to diversified OEMs (Samsung, Xiaomi). This has 60000 meant increasing total addressable market and also using government incentives 40000 to become the lowest-cost manufacturer. Dixon scaled and proved its mettle in LED lighting (50% domestic volume share) and is now exploring export potential. 20000 Similar optionality to increase share of higher value-added products (fully- 0 automatic WMs, smartphones) is likely to drive growth in the near term. Jun-20 Apr-20 Oct-19 Feb-20 Strong internal processes + key client wins => scalable business Dec-19 Aug-19 Dixon has done well to incorporate best practices at par with global EMS players such that MNCs see value in outsourcing manufacturing. Through strong mid- Source: Bloomberg, Ambit Capital research tier management whose incentives are well-aligned with segment-wise RoCE, Dixon has cracked into many top tier OEMs such as Samsung and Xiaomi. Their Dixon’s forensic score analysis presence across categories has allowed significant cross-selling opportunities, such that scalability is a function of relationships rather than capex alone. Govt incentives limited peer set => advantage Dixon In an environment where global EMS players are fixated on high-end smartphones, Dixon can capture many gaps in the electronics assembly ecosystem (e.g. TVs, washing machines, low-end smartphones). Besides strong Source: Ambit ‘HAWK’, Ambit Capital research competition between brands that is accelerating the need for outsourcing, Dixon can also capitalize on government incentives (PLI scheme towards mobile Dixon’s greatness score analysis manufacturing in India) to grow with healthy RoCE (>25%). Scalability risks are few but souring relationship with clients would be a big negative. Long runway of growth + capital efficiency => BUY and hold Dixon has opportunity to replicate success in lighting (~50% volume share of domestic industry; exports expected to start in FY21) across other consumer electronic categories. Contribution from mobiles (13% FY20) is much lower than Source: Ambit ‘HAWK’ Ambit Capital research value share in industry (70%). We expect healthy ODM/OEM mix and Dixon’s 30%/29% sales/PAT CAGR over FY20-30E to be matched with high CE turnover Research Analysts (6x+) and high RoCE (25%+). Near-term valuations (59x FY21 PAT) do not capture the decade long opportunity to scale in electronics manufacturing, Nitin Bhasin driven particularly by increasing smartphone penetration. +91 22 6623 3241 [email protected] Dhruv Jain +91 22 6623 3177 [email protected] Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Dixon Technologies Exhibit 1: Evolution of Dixon Technologies Y1 Y2 48 50% 40 40% 32 30% . bn) ` ( 24 20% 16 8 10% 0 0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Consumer Electronics Lighting Home appliances Mobiles Reverse Logistics Security Systems EBITDA margin (Y2) RoCE (Y1) ODM share (Y1) Source: Company, Ambit Capital research Exhibit 2: Key financial parameters (` mn) FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues 7669 10937 12013 13894 24568 28416 29844 44001 Revenue growth (%) 43% 10% 16% 77% 16% 5% 48% Net profits 35 147 130 426 504 609 634 1205 EPS 11 47 42 137 46 55 55 103 CFO 449 104 445 423 546 679 -31 2373 pre-tax CFO/EBITDA 224% 57% 167% 90% 77% 79% 11% 126% FCF 362 19 224 152 155 -79 -837 1275 Debt equity (x) 1.4 1.2 0.9 0.6 0.2 0.1 0.3 0.0 CE turnover 5.0 6.9 7.1 7.4 10.7 9.3 6.7 7.5 GB Turnover 9.7 13.4 13.3 12.4 19.7 18.0 14.4 14.1 RoE (%) 6% 22% 16% 41% 31% 24% 18% 26% Pre-tax ROCE* (%) 10% 13% 15% 27% 35% 32% 25% 29% Source: Company, Ambit Capital research. Note: * This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total capital including cash in the denominator. Exhibit 3: Competitive mapping of Dixon Technologies with other listed EMS players Pre-tax Pre-tax CFO/ Sub-segment FY20 Revenue CAGR EBITDA Capex/CFO Company RoCE EBITDA Positioning revenue FY16-20 Margin (FY20) (FY16-20) (FY20) (FY16-20) Dixon Technologies #1 44,001 33% 5.1% 29% 81% 83% Amber Enterprises #2 39,628 38% 7.8% 16% 76% 91% Source: Company, Ambit Capital research Exhibit 4: Mapping EMS players on competitive strengths and financial performance Financial Metrics Operational metrics Addres Capital Return Sales Innova Architect Product Replacement sable Overall Comments Margins employed on growth tion ure range cycle market turnover Capital size Dixon's diversification across Dixon segments and robust Technologies OEM/ODM mix make a robust EMS business model. Amber's concentration in AC Amber segment leads to segment Enterprises specific characteristics. Source: Company, Ambit Capital research Note: - Strong; - Relatively Strong; - Average; - Relatively weak August 26, 2020 Ambit Capital Pvt. Ltd. Page 84 [email protected] 2020-12-07 Monday 13:17:41 Dixon Technologies Exhibit 5: Trailing P/E evolution Exhibit 6: Stock’s price performance v/s relevant index – Dixon has outperformed 310 Dixon Sensex Dixon 100 Cons TTM PE(x) Cons EV/EBITDA(x) 260 80 210 60 160 40 110 20 0 60 Jun-18 Jun-19 Jun-20 Sep-17 Sep-18 Sep-19 Dec-17 Dec-18 Dec-19 Mar-18 Mar-19 Mar-20 Feb-18 Feb-19 Feb-20 Aug-17 Aug-18 Aug-19 Aug-20 Nov-17 Nov-18 Nov-19 May-18 May-19 May-20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 7: Sales has grown at a healthy rate over FY14-20 Exhibit 8: EBITDA margins have trended upwards from backward integration and operating scale Revenues (Rs. Bn) 3-yr avg. sales growth (RHS) 16% 6% 50 40% 14% 5% 40 32% 12% 4% 30 24% 10% 3% 20 16% 8% 2% 10 8% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 0 0% Gross margin EBITDA margin (RHS) FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company Exhibit 9: FCF profile has turned positive post capex in Exhibit 10: Gross block turnover and working capital FY19; debt-equity ratio has improved significantly turnover are healthy CFO FCF Net debt:equity (RHS) GB turnover WC turnover (RHS) 3000 1.6 25 80 20 1.2 60 2000 15 0.8 40 1000 10 0.4 20 5 0 0.0 0 0 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 -1000 -0.4 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 85 Dixon Technologies Exhibit 11: Return ratios have remained healthy Exhibit 12: Dixon has maintained a healthy working capital cycle; OEM business allows higher payable days 50% RoE (%) pre-tax ROCE (%) Inventory days Receivable days Payable days Cash conversion cycle 40% 95 30% 75 20% 55 10% 35 15 0% -5 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company Exhibit 13: Explanation for our flags Segment Score Comments Dixon scores high on parameters related to cash yield, change in auditors' remuneration, change in depreciation rate and miscellaneous expenses. Other parameters that it scores low on in the HAWK framework are mostly Accounting AMBER related to increased working capital requirement and lower CFO (from strong sales growth from 2HFY19) and are thus not of significant concern. Predictability is low due to presence in multiple consumer durables and electronic segments. End-user demand may vary due to seasonal factors and other industry characteristics. In the aftermath of Covid-19, users may curtail high Predictability AMBER discretionary spending and earnings are likely to be harder to predict. Since listing, Dixon has met its earnings guidance shared during conference calls. Earnings momentum has been positive due to sales growth and increasing margin profile, on back on client Earnings Momentum GREEN additions, scale and operating leverage. However, on account of Covid-19 disruption we have seen downgrades over the last 6 months to the tune of 10%. Source: Ambit Capital research HAWK scores – Slipped in FY19 Dixon has largely featured in Zone of Safety (ex. FY19), i.e. D1 to D5 deciles, over the years (FY15-FY19) and D7 at FY19-end. It scores lower than the median accounting score for its sector. Dixon scores significantly well on our greatness parameters compared to peers and the larger universe, and featured in ‘Zone of Greatness’ in FY19. It has had consistent greatness scores since FY15. Key contributors to accounting score and comparison to peers Dixon features in D7 decile on our accounting framework, which is also a ‘Zone of Pain’. Key contributors to its relatively weak accounting score include low or volatile cash conversion and high contingent liabilities. However, we believe cash conversion has normalised and has improved in FY20. Contingent liabilities are caused by bank guarantees furnished by Dixon, a normal feature of this business. August 26, 2020 Ambit Capital Pvt. Ltd. Page 86 Dixon Technologies Exhibit 14: Forensic accounting score contributors Exhibit 15: Forensic score percentile to larger universe and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Comments on evolution of accounting score Dixon has always featured in Zone of Safety (i.e. D1 to D5 deciles) over FY15 to FY19. It is pertinent to note here that our framework consists of a higher number of ratios which capture the cash generation abilities of the businesses. Owing to the negative cash generation in FY20, Dixon got penalized. August 26, 2020 Ambit Capital Pvt. Ltd. Page 87 Dixon Technologies Exhibit 16: Forensic accounting score evaluation Exhibit 17: Movement in accounting checks – Likely to deteriorate on accounting score in FY20 Category Ratios FY18 FY19 FY20 (1) CFO/EBITDA 79% 11% 126% P&L (2) change in depreciation rate 20 bps 20 bps 160 bps misstatement (3) Provisions for doubtful checks debts as a proportion of 1.3% 0.7% NA debtors more than six months Cash yield 6.2% 5.3% 4.1% Change in reserves (excluding Balance sheet share premium) to net income 99.8% 95.6% 92.0% misstatement excluding dividends checks contingent liability as a 89% 129% NA proportion of net worth Adv. to related parties/CFO 0% 0% 0% Cash CWIP to gross block 6% 7% 2% pilferage checks Cumulative CFO plus CFI to 2% -2% 4% median revenues CAGR in auditor’s Audit quality remuneration to CAGR in 16% 23% NA checks consolidated revenues Source: Ambit Capital research, Company Source: Ambit Capital research, Company. * Growth in auditor remuneration is insignificant; hence there is no concern Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.). Dixon has consistently featured in the top decile of our greatness score since FY15. Exhibit 18: Greatness score contributors Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 88 Dixon Technologies Exhibit 19: Greatness score percentile to larger universe Exhibit 20: Greatness score evolution and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 89 [email protected] 2020-12-07 Monday 13:17:41 Dixon Technologies Balance sheet Year to March (` mn) FY18 FY19 FY20 FY21E FY22E FY23E Shareholders' equity 113 113 116 116 116 116 Reserves & surpluses 3,036 3,669 5,298 6,751 8,989 12,053 Total networth 3,150 3,782 5,414 6,867 9,105 12,169 Minority interest 0 0 0 0 0 0 Borrowings 406 1,361 828 2,384 3,788 5,544 Other non-current liabilities 36 1,630 949 1,630 1,630 1,630 Deferred tax liability 41 160 160 160 160 160 Trade Payables 5,147 7,397 9,391 12,432 20,039 29,553 Other current liabilities 875 594 230 230 230 230 Total liabilities 9,655 14,924 16,972 23,703 34,952 49,285 Gross block 2,048 2,826 3,943 5,090 8,204 12,626 Net block 1,788 2,362 3,114 3,772 6,099 9,359 Capital work-in-progress 125 188 96 96 96 96 Intangible assets 2 47 126 126 126 126 Financial assets 163 1,618 271 271 271 271 Total non-current assets 2,079 4,215 3,607 4,265 6,592 9,852 Cash & equivalents 552 443 1,002 2,478 2,389 2,193 Debtors 2,985 5,167 5,151 7,196 11,599 17,105 Inventory 3,223 4,084 4,978 7,530 12,138 17,901 Current financial assets 166 205 313 313 313 313 Other current assets 615 794 15 15 15 15 Total current assets 7,542 10,694 11,459 17,532 26,454 37,528 Total assets 9,655 14,924 16,972 23,702 34,951 49,284 Source: Company, Ambit Capital research Income statement Year to March (` mn) FY18 FY19 FY20 FY21E FY22E FY23E Operating income 28,416 29,844 44,001 61,080 98,453 145,197 % growth 15.7% 5.0% 48.0% 38.8% 61.2% 47.5% Operating profit 1,120 1,349 2,230 2,763 4,294 5,977 % growth 23.5% 20.4% 65.3% 23.9% 55.4% 39.2% Depreciation 152 217 365 489 788 1,162 EBIT 968 1,132 1,865 2,274 3,506 4,815 Interest expenditure 128 250 350 238 379 554 Non-operating income 42 56 52 122 197 290 Adjusted PBT 882 938 1,567 2,158 3,324 4,551 Tax 273 305 362 544 838 1,147 Adjusted PAT/ Net profit 609 634 1,205 1,614 2,487 3,404 % growth 20.9% 4.0% 90.2% 34.0% 54.0% 36.9% Extra Ordinary Items - - - - Reported PAT / Net profit 609 634 1,205 1,614 2,487 3,404 Reported Consolidated net profit 609 634 1,205 1,614 2,487 3,404 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 90 Dixon Technologies Cashflow statement Year to March (` mn) FY18 FY19 FY20 FY21E FY22E FY23E PBT 882 938 1,567 2,158 3,324 4,551 Depreciation 152 217 365 489 788 1,162 Interest income (25) (22) - - - - Interest expense 128 250 350 238 379 554 Changes in working capital (495) (693) 964 (1,556) (1,404) (1,756) Taxes (201) (183) (429) (544) (838) (1,147) Others 238 (538) (444) 681 - - Cash flow from operations 679 (31) 2,373 1,466 2,249 3,364 Capex (758) (806) (1,098) (1,147) (3,114) (4,421) (Incr) / decr in investments (111) 92 (270) - - - Interest/Dividend Received 25 22 28 - - - Others 1 3 330 - - - Cash flow from investments (843) (689) (1,010) (1,147) (3,114) (4,421) Net borrowings (25) 964 (570) 1,556 1,404 1,756 Issuance of equity 571 - 457 - - - Interest expense (128) (251) (378) (238) (379) (554) Dividend paid - (23) (83) (161) (249) (340) Others Cash flow from financing 418 691 (574) 1,156 776 861 Net change in cash 100 18 806 1,476 (89) (196) Closing cash balance 127 144 957 2,433 2,344 2,148 Free cash flow (79) (837) 1,275 320 (865) (1,057) Source: Company, Ambit Capital research Ratio analysis Year to March (%) FY18 FY19 FY20 FY21E FY22E FY23E EBITDA margin (%) 3.9% 4.5% 5.1% 4.5% 4.4% 4.1% EBIT margin (%) 3.4% 3.8% 4.2% 3.7% 3.6% 3.3% Net profit margin (%) 2.1% 2.1% 2.7% 2.6% 2.5% 2.3% Dividend payout ratio (%) 0.0% 3.5% 6.8% 10.0% 10.0% 10.0% Net debt: equity (x) 0.1 0.3 0.2 (0.0) (0.0) 0.3 Working capital turnover (x) 34.8 20.5 33.9 40.3 32.9 31.7 Gross block turnover (x) 16.1 12.2 13.0 12.0 12.0 11.5 pre-tax CFO/EBITDA 79% 11% 126% 73% 72% 75% pre-tax RoCE (%) 31.7% 25.4% 31.9% 28.8% 31.2% 31.1% RoE (%) 23.8% 18.3% 26.2% 26.3% 31.1% 32.0% Source: Company, Ambit Capital research Valuation parameters Year to March (` mn) FY18 FY19 FY20 FY21E FY22E FY23E EPS (`) 54.5 55.9 105.5 139.2 214.4 293.5 Diluted EPS (`) 54.5 55.9 105.5 139.2 214.4 293.5 Book value per share (`) 271.5 326.0 466.7 592.0 784.9 1,049.0 Dividend per share (`) - 2.0 7.2 13.9 21.4 29.3 P/E (x) 150.8 146.9 77.9 59.1 38.3 28.0 P/BV (x) 30.3 25.2 17.6 13.9 10.5 7.8 EV/EBITDA (x) 85.1 70.3 42.6 34.4 22.5 16.5 EV/Sales (x) 3.4 3.2 2.2 1.6 1.0 0.7 Price/Sales (x) 3.4 3.2 2.2 1.6 1.0 0.7 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 91 Dixon Technologies This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 92 Hatsun Agro NOT RATED SCALABILITY THEMATIC HTSMF IN EQUITY August 26, 2020 Milking scale and pricing power Dairy Hatsun has emerged as the largest private dairy company in India Recommendation thorough the differentiated approach of: i) direct milk procurement and farmer engagement; ii) penetration into lesser tapped markets (70% Mcap (bn): `137/US$1.8 revenue from non-tier 1 markets); and iii) product innovation across 3M ADV (mn): `36/US$0.48 categories. Whilst changing industry structure implies increasing access CMP: `808 to milk commodity, Hatsun’s focus on brand-building in fresh VAPs TP (12 mths): NA would lead to pricing power over the next decade. GM expansion is Downside (%): NA already underway (550bps expansion, FY13-20) and with increased utilization we expect EBITDAM to expand further. A high likelihood of Flags ~15%/~20-25%% sales/PAT growth over FY20-30, we believe near-term multiples are not the right way to set multiples for Hatsun. Key risks: Accounting: GREEN Milk subsidies may distort level playing field and key man risk. Predictability: AMBER Competitive position: STRONG Changes to this position: POSITIVE Earnings Momentum: AMBER Scope for penetration in adjacent geographies and product segments Performance Hatsun has scaled from increased penetration in home markets of TN, whilst 140 also focusing on newer geographies such as AP, Karnataka and Maharashtra. Sensex Hatsun Agro Introduction of newer brands such as IBACO, Oyalo and Santosa have 120 diversified product offerings. Combined with capex (27bn over FY13-20) and 100 increased backward integration, Hatsun has focused on both market share gains and increased profitability (EBITDA margin expansion 360bps over FY13-20) 80 from change in product mix. 60 Farmer engagement + logistical efficiency + pricing power => scale Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-19 Nov-19 Hatsun’s scale is a function of organic expansion into adjacent markets and May-20 deeper penetration in tier 2/3 cities. We like Hatsun for its i) direct procurement network, ii) transparent pricing for framers, and iii) tight control on supply chain Source: Bloomberg, Ambit Capital research that translates lower logistic costs and healthy RoCE (>20%). Global best practices and mid-level management that focuses on farmer engagement lead Hatsun’s forensic score analysis to sustainable business practices, whilst increasing focus on brandex (~2.5% of sales) and VAPs such as curd and ice-cream increase pricing power (gross margin expansion of ~550bps over FY13-20). Long runway of growth for efficient and quality conscious dairy player Hatsun’s business model is anti-fragile compared to competitive but highly unorganized sector (60% of total milk consumption in India). Hatsun’s focus on fresh dairy products implies short working capital cycle (<15 days) and robust Source: Ambit ‘HAWK’, Ambit Capital research cash conversion that is not prone to supply/demand disruptions. Our estimate is that Hatsun handles ~1% of total milk supply in India (in comparison, Amul Hatsun’s greatness score analysis handles ~6%), providing long runway of growth from market share gains. Structural growth + margin expansion Current valuation (117x FY20 PAT) does not adequately capture multiplier effect from sales growth and improved profitability. Whilst sales growth over FY17-20 has been disappointing (8% CAGR), we believe this was due to external factors such as high SMP inventory in global markets and unseasonal weather. With the Source: Ambit ‘HAWK’, Ambit Capital research shakeout in post-Covid world, Hatsun is likely to gain market share on the back Research Analysts of backward integration projects undertaken over FY17-20, even as FCF profile turns positive. We believe Hatsun can clock sales/PAT CAGR of 14-15% and 20- Nitin Bhasin 25% over FY20-30. By FY30, Hatsun would have transformed into multi- +91 22 6623 3241 product/geographically diversified dairy company (similar to Amul) with sales [email protected] growth >10% CAGR and pre-tax RoCE>30%. Dhruv Jain +91 22 6623 3177 [email protected] Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Hatsun Agro Exhibit 1: Evolution of Hatsun Agro 60 Sales pre-tax RoCE (RHS) 35% 50 28% 40 21% (Rs bn) 30 14% 20 7% 10 0 0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Exhibit 2: Key financial parameters over the last decade (` mn) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues 13557 16035 21650 24935 29331 34446 41976 42874 47603 53083 Revenue growth (%) 19% 18% 35% 15% 18% 17% 22% 2% 11% 12% Net profits 187 266 447 817 392 604 1,354 908 1,148 1,123 EPS 5.2 2.4 4.1 7.5 3.6 5.6 8.9 6.0 7.1 6.9 CFO 743 516 1428 2001 615 2186 4328 2771 3959 5519 pre-tax CFO/EBITDA 82% 52% 104% 126% 37% 82% 124% 83% 100% 108% FCF 277 7 154 -431 -672 783 -1405 -2555 41 2019 Debt equity (x) 2.5 2.5 3.1 2.8 2.8 2.9 2.6 3.6 1.2 1.0 CE turnover 3.8 4.2 4.5 4.0 3.7 3.8 3.8 2.9 2.7 2.9 GB Turnover 3.9 4.5 5.8 5.5 5.1 5.3 5.2 3.9 3.6 3.4 RoE (%) 20% 27% 38% 53% 20% 27% 47% 25% 20% 14% ROCE* (%) 16% 18% 20% 18% 13% 22% 21% 13% 14% 14% Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total capital including cash in the denominator. Exhibit 3: Mapping Hatsun Agro and its peers on IBAS Direct Product Strategic Financial Company Overall rank Comments Procurement Portfolio Assets metrics Hatsun scores well on all metrics. Slowdown in sales growth over FY17-20 Hatsun Agro and reduced returns are aberration due to external factors. We like Heritage's focus on fresh dairy. However, operations suffer due to poorer backward integration, and weaker product Heritage Foods portfolio compared to Hatsun. This is visible is lower gross margin, translating to poor profitability. Parag's focus on Western VAPs implies lower returns due to higher capital Parag Milk Foods intensity. However Parag's brand equity especially in modern trade is noteworthy. Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 94 [email protected] 2020-12-07 Monday 13:17:41 Hatsun Agro Exhibit 4: 1-yr forward P/E evolution chart indicates that Exhibit 5: Hastun has significantly outperformed Sensex, Hatsun enjoys punchy valuations growing at 43% CAGR over the last 10 years Hatsun 1 yr fwd adj P/E (x) 150 Sensex Hatsun Agro 3-yr rolling average P/E (x) 4,000 120 3,200 90 2,400 60 1,600 30 800 0 - May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18 May-19 May-20 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 6: Sales growth was adversely impacted in FY18 Exhibit 7: Both gross margin and EBITDA margin have due to unseasonal weather trended upwards on improved sales mix Revenues (Rs. Bn) 3-yr avg. sales growth (RHS) Gross margin EBITDA margin (RHS) 32% 12% 60 25% 11% 50 20% 29% 40 10% 15% 30 26% 9% 10% 20 8% 23% 10 5% 7% 0 0% 20% 6% FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company Exhibit 8: FCF profile is likely to turn positive post capex in Exhibit 9: Gross block turnover has trended downwards recent years; debt:equity ratio has improved significantly with significant backward integration over recent years; working capital turnover remains healthy CFO FCF Gross debt:equity (RHS) GB turnover WC turnover (RHS) 6000 4.0 6.0 60 5.5 50 4500 3.0 5.0 40 3000 4.5 30 (Rs mn) 1500 2.0 4.0 20 0 1.0 3.5 10 -1500 FY14 FY15 FY16 FY17 FY18 FY19 FY20 3.0 0 -3000 0.0 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 95 Hatsun Agro Exhibit 10: Return ratios have remained healthy Exhibit 11: Hatsun has spent significantly on brandex that has translated into gross margin gains Gross margin (RHS) 60% RoE (%) pre-tax ROCE (%) 4.0% Brandex (as % of sales) 32% Employee cost (as % of sales) 50% 3.5% 40% 30% 3.0% 30% 28% 20% 2.5% 26% 10% 2.0% 0% 1.5% 24% FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company Exhibit 12: Explanation for our flags Segment Score Comments Hatsun scores well on cash conversion, related-party transactions, RoE and working capital cycle compared to Accounting GREEN peers. Debt to equity has been lowered significantly post rights issue in FY19. Predictability AMBER Predictability of earnings for milk business is low due to high depreciation and lower operating profitability. There is limited coverage on this stock by analysts. Earnings momentum reversed in FY18 due to higher Earnings momentum AMBER interest outgo and higher depreciation. However, in FY19 higher sales growth and improvement in EBITDA margins led to positive earnings momentum once again. Source: Ambit Capital research HAWK scores HTSMF has largely featured in Zone of Safety (ex. FY15 and FY19 and scores similar to median accounting score for its sector. Similarly it scores similarly to universe on our greatness parameters and features in ‘Good, not great’ category in FY19. Key contributors to accounting score and comparison to peers HTSMF features in D6 decile on our accounting framework, which is also a ‘Zone of Pain’ decile. Key contributors to its relatively weak accounting score include low cash yields, low FCF and high CWIP/gross block ratio. However, we believe low FCF is on the back of higher capex over prior three years as HTSMF has focused on backward integration projects and scale. Deterioration in CWIP/gross block due to delayed capex is key reason for downgrade from D5 to D6 in FY19. In comparison to peers, HTSMF scores similar to median accounting score. August 26, 2020 Ambit Capital Pvt. Ltd. Page 96 Hatsun Agro Exhibit 13: Forensic accounting score contributors Exhibit 14: Forensic score percentile to larger universe and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Comments on evolution of accounting score HTSMF has featured consistently in ‘Zone of Safety’ and only in FY19 featured in ‘Zone of Pain’ due to higher CWIP/gross block ratio. Exhibit 15: Forensic accounting score evaluation Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 97 Hatsun Agro Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.). HTSMF capital employed turnover has suffered due to incremental capex that has not yet converted into higher sales, whilst it is further penalized for rights issue that led to dilution of equity in FY19. Exhibit 16: Greatness score contributors Source: Ambit Capital research, Company Exhibit 17: Greatness score percentile to larger universe Exhibit 18: Greatness score evolution and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 98 Hatsun Agro Balance sheet Year to March (` mn) FY16 FY17 FY18 FY19 FY20 Shareholders' equity 109 152 152 160 162 Reserves & surpluses 2,198 3,334 3,503 7,887 8,883 Total networth 2,307 3,486 3,655 8,047 9,045 Borrowings 6,715 9,196 12,989 9,590 9,108 Deferred tax liability 261 275 2,113 2,229 2,384 Trade Payables 1,433 1,700 1,714 1,776 1,421 Other current liabilities 859 1,196 1,669 2,643 5,186 Total liabilities 11,575 15,877 20,316 22,458 27,143 Gross block 11,322 10,836 14,371 18,289 24,733 Net block 6,372 9,799 12,051 13,953 15,122 Capital work-in-progress 325 903 2,593 2,332 3,546 Intangible assets 100 115 115 125 2,436 Financial assets 11 859 707 641 1,056 Total non-current assets 6,808 11,676 15,466 17,051 22,160 Cash & equivalents 294 553 328 364 407 Debtors 149 410 71 83 146 Inventory 3,468 2,965 3,837 4,034 3,740 Current financial assets 0 18 37 85 242 Other current assets 35 256 576 841 409 Total current assets 3,946 4,201 4,850 5,407 4,943 Total assets 11,575 15,877 20,316 22,458 27,144 Source: Company, Ambit Capital research Income statement Year to March (` mn) FY16 FY17 FY18 FY19 FY20 Operating income 34,446 41,976 42,874 47,603 53,083 % growth 17.4% 21.9% 2.1% 11.0% 11.5% Operating profit 3,046 3,780 3,716 4,415 5,501 % growth 225.6% 287.2% -1.7% 18.8% 24.6% Depreciation 1,071 1,429 1,736 2,006 2,965 EBIT 1,975 2,351 1,980 2,409 2,536 Interest expenditure 676 702 876 857 1,059 Non-operating income 40 68 83 60 87 Adjusted PBT 1,339 1,717 1,187 1,612 1,564 Tax 735 363 278 463 441 Adjusted PAT/ Net profit 604 1,354 908 1,148 1,123 % growth 90.8% 255.7% -32.9% 26.4% -2.2% Extra Ordinary Items - Reported PAT / Net profit 604 1,354 908 1,148 1,123 Minority Interest - - - - - Share of associates - - - - - Adjusted Consolidated net profit 604 1,354 908 1,148 1,123 Reported Consolidated net profit 604 1,354 908 1,148 1,123 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 99 [email protected] 2020-12-07 Monday 13:17:41 Hatsun Agro Cashflow statement Year to March (` mn) FY16 FY17 FY18 FY19 FY20 PBT 1,340 1,717 1,187 1,612 1,564 Depreciation 1,071 1,429 1,736 2,006 2,965 Interest income (6) (18) (27) - - Interest expense 660 691 - 857 1,059 Changes in working capital (410) 176 (649) (147) (124) Taxes (327) (372) (313) (463) (441) Others (138) 705 837 94 497 Cash flow from operations 2,190 4,328 2,771 3,959 5,519 Capex (1,403) (5,732) (5,326) (3,918) (3,500) (Incr) / decr in investments 5 21 73 - - Interest/Dividend Received 6 18 27 - - Others (0) 4 (3) - - Cash flow from investments (1,391) (5,689) (5,229) (3,918) (5,371) Net borrowings 551 2,881 3,799 (3,400) 1,279 Issuance of equity - - - 4,223 - Interest expense (662) (703) (838) (857) (1,059) Dividend paid (560) (183) (733) (647) (674) Others Cash flow from financing (671) 1,995 2,229 (681) (68) Net change in cash 59 261 (229) 36 80 Closing cash balance 292 544 315 364 445 Free cash flow 787 (1,405) (2,555) 41 2,019 Source: Company, Ambit Capital research Ratio analysis Year to March (%) FY16 FY17 FY18 FY19 FY20 EBITDA margin (%) 8.8% 9.0% 8.7% 9.3% 10.4% EBIT margin (%) 5.7% 5.6% 4.6% 5.1% 4.8% Net profit margin (%) 1.8% 3.2% 2.1% 2.4% 2.1% Dividend payout ratio (%) 71.9% 45.0% 67.0% 56.3% 60.0% Net debt: equity (x) 2.8 2.5 3.5 1.1 1.0 Working capital turnover (x) 18.1 21.8 22.2 21.0 22.1 Gross block turnover (x) 3.2 3.8 3.4 2.9 2.5 RoCE (%) 22.0% 21.1% 13.3% 13.8% 13.8% RoE (%) 26.7% 46.7% 25.4% 19.6% 13.5% Source: Company, Ambit Capital research Valuation parameters Year to March (` mn) FY16 FY17 FY18 FY19 FY20 EPS (`) 5.6 8.9 6.0 7.1 6.9 Diluted EPS (`) 5.6 8.9 6.0 7.1 6.9 Book value per share (`) 21.2 22.9 24.0 49.8 55.9 Dividend per share (`) 4.0 4.0 4.0 4.0 4.2 P/E (x) 153.4 68.4 135.4 113.7 116.3 P/BV (x) 38.1 35.3 33.6 16.2 14.4 EV/EBITDA (x) 32.5 26.7 36.4 31.6 25.2 Price/Sales (x) 2.7 2.2 2.9 2.7 2.5 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 100 ICICI Lombard BUY SCALABILITY THEMATIC ICICIGI IN EQUITY August 26, 2020 Good things come at a price! BFSI Longevity of profitable growth in fastest growing BFSI segment defines Recommendation ICICILB (largest private general insurer, ~7% share). Leadership should consolidate given operating leverage, ramp-up in retail business, Mcap (bn): `575/US$7.7 investment in technology, and no legacy baggage given adequate claim 3M ADV (mn): `1,324/US$17.8 reserving. Regulatory tailwinds (long-term motor TP policies) and growth CMP: `1,265 headroom with PSUs ceding share (~38% vs 51% in FY14) enlarge the TP (12 mths): `1,463 opportunity. Desired combination of retail-focused business and high Upside (%): 16 interest rates (7-8%) makes 18%+ RoE possible even at zero underwriting profit. Implied valuation of 8.6x FY22E P/B is 6-7% higher Flags vs life insurers under coverage. It factors higher growth/lower product substitution risk. TP of `1,463 implies 16% upside. Risk: Prolonged Accounting: GREEN pricing pressure from new entrants. Predictability: AMBER Earnings Momentum: AMBER Competitive position: STRONG Changes to this position: STABLE Retains leadership position while maintaining profitability Performance ICICILB is the fifth-largest general insurer in India and the leader of private ICICIGI IN SENSEX general insurers, commanding a market share of ~7% as of Mar’20. It clocked a 130 premium CAGR of 14% over FY11-20 driven by retail and SME segments. Motor 120 110 TP has been the fastest growing segment for ICICILB, clocking 25% CAGR in 100 FY11-20. Sharp upward revision in TP prices (FY15-20 CAGR of 12-24% for 90 most segments) led to robust growth in the segment. Historically (FY14-20), it 80 has consistently maintained its market share upwards of 8% (FY14-20 average 70 of 8%) while maintaining profitability (FY14-20 average RoE is 19%). Jun-20 Apr-20 Oct-19 Feb-20 Dec-19 Right strategy and sector tailwinds ensure robust growth trajectory Aug-19 Aug-20 Strong OEM/dealer presence (95%+ OEMs and 55-60% dealerships) and structural distribution advantages with strong bancassurance tie-ups with ICICI Source: Bloomberg, Ambit Capital research Bank (5,324 branches as of FY20) have ensured ICICILB’s growth in key segments of motor/health (51%/21% of GDPI). Strategy to underwrite granular profitable business with a track record of superior underwriting has ensured its growth trajectory. It has always been cautious while underwriting high-risk lower-margin corporate businesses. Additionally, consistent decline in market share of PSU insurers (~38% in FY20 vs 51% in FY14) has propelled ICICILB’s growth and continues to present ample growth opportunities. Clear growth runway for a long period We expect ICICILB’s GDPI to grow at 17% CAGR over FY20-30, faster than our industry growth expectation of 15%. Structural advantages in core segments like motor and health (~72% of GDPI) benefit ICICILB. We estimate motor/health to expand ~4.5x/6.5x at CAGR of 16%/21% over the next 10 years. Majority (~53%) of motor TP premiums for ICICILB comes from states with high under- penetration, giving it first-mover advantage. Growth in motor OD in the medium term would be hit amid rising competition from new entrants (long-term intact). ‘Premium’ growth potential spurs premium valuations! Expect premium/EPS CAGR of >10%/27% in FY20-25. Focus on profitable growth with operating efficiencies given scale will keep capital asks low/nil in the medium term. Valuations of 8.6x P/B and 40x P/E (FY22E) seem rich but Research Analysts justified. Factors distinguishing it from other BFSI favorites: i) rare combination of Udit Kariwala, CFA clear growth runway for an extended period (>15% CAGR over next 15 years) [email protected] and low/nil capital requirement; ii) ample growth opportunities even at current level of penetration as PSU insurers cede market share; iii) low-risk granular +91 22 6623 3197 prepaid business with strong management team; and iv) low product substitution Pankaj Agarwal, CFA risk. Potential to outpace global peers’ premium growth by ~5x justifies 5x P/B [email protected] exit multiple in FY30E, implying 13-14% IRR at current valuations. +91 22 6623 3206 Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. ICICI Lombard Exhibit 1: ICICILB – Largest private general insurer with ~15% private market share Year Event Incorporated with ICICI Bank and Lombard Canada (a nominee of Fairfax) holding 74% and 26% 2000 of the company's capital respectively 2001 Commenced non-life Insurance operations 2004 Became the largest private sector general insurer 2005 First to develop an online sales channel 2006 Crossed the mark of 1mn policies and receipt of `10bn of GDPI 2010 Settled more than 5mn claims 2014 Number of policies issued crossed 10mn, PAT crossed `5bn 2015 Investment book size crossed `100bn mark 2017 First pure play general insurance company in India to list on the stock exchanges 2019 Settled 99.9% health insurance claims and 93.14% motor OD claims within 30 days of claim filing Source: Company, Ambit Capital research Exhibit 2: Four phases and key characteristics of ICICILB’s evolution ICICI Lombard Industry GDPI Combined GDPI Combined Market Share Phase Period growth ratio Market Share as growth ratio at the end of the period CAGR Average CAGR Average Private PSU Phase I – opening the sector to private sector players FY02-FY07 154% 11% 17% 119% 33% 67% Phase II – de-tariffing products and rising competition FY08-FY12 12% 113% 9% 17% 121% 41% 59% Phase III- consolidation FY13-FY17 15% 105% 8% 17% 114% 47% 53% Phase IV – hardening wholesale prices and FY17-20 7% 101% 7% 14% 115% 62% 38% introduction of long term TP policies Source: IRDAI, Company, Ambit Capital research estimates Exhibit 3: Health and motor TP segments to drive growth for ICICILB Mix as of GDPI CAGR GDPI CAGR Product Category Rationale Mar’20 FY16-20 FY20-30 Expect ICICI Lombard to gain market share in health segment with expected traction in Health incl. PA 25% 19% 21% the group health segment. This should propel health segment to clock 21% CAGR over FY20-30, faster than 17% for the industry. Competition in this segment to remain high, putting downward pressure on prices in the short-medium term. Nevertheless, in the long run we expect ICICILB to benefit from its Motor OD 28% 10% 13% entrenched OEM/dealer tie-up to increase its segment market share from current level of 13%. We also factor in ICICI Lombard’s philosophy to underwrite profitable business and its investment in technology to create price differentiation. Introduction of mandatory long-term third-party policies to benefit. We also factor in historical passivity to underwrite higher loss ratio commercial vehicle segment. Factoring Motor TP 23% 17% 19% this, we expect ICICILB to clock growth of 19% over the next 10 years in the segment with growth front-ended for the first five years. Higher growth expectation on account of upward price revision by GIC across multiple occupancies in FY20 enabling longer-term price discipline in the sector. Additionally, Fire 12% 25% 18% improving insurance penetration levels for SMEs backed by rising awareness would also benefit. Practically discontinued on account of increase in re-insurance charges. We have not Crop 0% -63% - factored any crop insurance premium for the next 10 years. This segment should grow in line with our long-term nominal GDP estimate of 10-11% Others 12% 12% 10% over the next 10 years. Source: Ambit Capital research estimates Exhibit 4: Key financial parameters over the last decade (` bn) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY19 FY20 FY21 FY22 FY23 GDPI (` bn) 33 34 33 43 52 61 69 67 145 133 142 171 199 NEP (` bn) 16 20 22 29 35 40 44 42 84 94 95 102 122 Net Profit (` bn) 1.0 0.2 1.4 (0.8) (4.2) 3.1 5.1 5.4 10.5 11.9 13.2 16.6 21.2 Diluted EPS (`) 2.7 0.6 3.6 -2 -9.5 7 11.5 12 23.1 26.3 29.1 36.4 46.8 Combined ratio 102% 114% 114% 116% 121% 104% 105% 104% 99% 100% 103% 99% 97% Investment leverage 1.3 1.4 1.5 1.5 1.5 1.7 2 2.3 2.4 2.5 3.0 3.3 3.3 RoAA (%) 10% 2% 9% -4% -22% 16% 23% 19% 18% 19% 20% 22% 24% RoAE (%) 11% 2% 9% -5% -24% 16% 23% 19% 19% 21% 22% 23% 25% Solvency 203% 203% 207% 156% 136% 155% 172% 195% 224% 217% 252% 247% 253% Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 102 ICICI Lombard Exhibit 5: General insurance has the competitive edge among sub-segments of the Indian financial services sector Industry Bargaining Bargaining Valuations Competitive Substitution Threat of new Overall Growth power of power of (P/B, FY19) intensity threat entrants Score Potential suppliers buyers Private Banks 3.2 PSU Banks 0.7 NBFCs/HFCs 2.0 Life Insurance 12.9 General Insurance 4.7 Source: Ambit Capital research estimates; Note: - Strong; - Relatively Strong; - Average; - Relatively weak Exhibit 6: Competitive mapping of ICICI Lombard with comparable peers GDPI Combined Investment Claim Market growth Distribution Average Ratio leverage reserving share (FY15-20) ICICILB 3.7 HDFC ERGO 3.5 BAGIC 2.8 TATA AIG 2.5 IFFCO Tokio 2.2 New India 2.2 Source: Ambit Capital research estimate ;Note: - Strong; - Relatively Strong; - Average; - Relatively weak Exhibit 7: SWOT analysis shows stunning business economics make ICICILB a true market leader STRENGTHS WEAKNESS Strong dealer/OEM tie-ups: It has: 1) well-managed Legacy book: ICICILB is the largest private insurer in India. To make any relationships with most of the big OEM/dealers in India, and 2) new changes in systems and processes would be comparatively much presence across 95% OEMs and 55-60% dealerships. more difficult to implement than any new-age insurer. Retail-focussed player: Largely retail-focussed franchise with lower risk and higher profitability. Agency channel needs attention: Individual agents only contribute Large distribution franchise and a strong brand name: ~11% of premiums vs 17% in FY13. This channel needs attention Exclusive tie-up with India’s 2nd largest private bank (ICICI Bank especially to grow retail health business. Competition from SAHI is strong exclusively sells general insurance policies of ICICILB). Other bank with regulatory arbitrage in their favour. Additionally, ICICILB has stayed tie-ups include (Standard Chartered Bank, RBL Bank, and Karur away from large online aggregators like Policybazaar. This could hamper Vysya Bank and SCB). Name sharing advantage with ICICI Bank. growth in the long-term if others are able to exploit this channel to their Timely customer service: Best claims settlement with ~94% claims advantage. getting settled within a month of reporting (both Motor OD and Health segments). Efficient risk planning: Lower exposure to TP claim prone states such as Tamil Nadu, Kerala and Karnataka. Also, provides the higher reserving against NEP vs. most other insurers. No defaults in the fixed income investment book since inception with better quality credits. OPPORTUNITIES THREATS Pricing differentiation through technology: Indian general Pricing risk: Intense price competition especially from the new-age insurers’ pricing mechanism more often than not lacks behavioural general insurers (fin techs) in the motor OD segment. New-age players pricing. E.g.: Price differentiation in motor insurance premium for a could give heavy discounts and higher commissions, hampering ICICILB’s frequently-driven vehicle vs a seldom-driven vehicle. growth in this large segment. Product innovation: Opportunity to come out with newer and Life insurers starting to sell indemnity health policies: Current simpler products. Indian general insurance market lacks product regulations only allow life insurers to sell benefit-based health insurance innovation. Dental segment could be one great opportunity. policies. Any change in regulation allowing life insurers in the indemnity Regulatory advantage: ICICILB could exploit new regulation for segment could be detrimental for the growth in the health insurance mandatory long-term motor TP policies to its benefit. It can optimise segment. Life insurers enjoy a much more entrenched distribution network its large presence across OEMs/dealers. Moreover, implementation compared to general insurers in India. of Motor Vehicle Act, 2019 may result in a reduction of TP claims and improve loss ratios due to the narrowing of the window of claim intimation to 6 months. This presents ICICILB an opportunity to expand its market share in the motor TP segment which is low at 7%. Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 103 ICICI Lombard Exhibit 8: Implied market valuations have improved since Exhibit 9: Stock return of ICICILB much higher than Bankex inception over the past 28 months Trailing P/B(x) 12M Forward P/B(x) ICICILB BankEx 14 200 12 150 10 8 100 6 50 4 Feb-18 Feb-19 Feb-20 Aug-17 Aug-18 Aug-19 Aug-20 Nov-17 Nov-18 Nov-19 May-18 May-19 May-20 Jun-19 Jun-20 Apr-19 Apr-20 Oct-18 Oct-19 Feb-19 Feb-20 Dec-18 Dec-19 Aug-18 Aug-19 Aug-20 Source: Bloomberg, Company, Ambit Capital Research estimates Source: Bloomberg, Ambit Capital Research Exhibit 10: GDPI to decline to -3%; ex-crop growth to be Exhibit 11: Best-in-class combined ratio with sharp robust at ~16% YoY improvement over last three years Motor Health (incl. PA) Crop Fire FY16 FY19 Others YoY growth - (RHS) 137 140 135 200 35% 124 120 108 150 25% 107 99 99 100 97 100 15% 80 50 5% United 0 -5% BAGIC ICICILB Oriental TATA AIG TATA New India HDFC Ergo HDFC IFFCO Tokio FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20E FY21E FY22E Source: Company, Ambit Capital research estimates Source: Company, Ambit Capital research Exhibit 12: Loss ratios: Motor TP and Health aided in Exhibit 13: Focus on granular retail offering; has improving combined ratio practically stopped underwriting crop insurance FY18 FY19 1HFY20 Marine 150% ICICILB: Product mix -FY20 Cargo, 3% 125% Marine 100% Hull, 1% Crop, 0% 75% Motor OD, 28% Others, 50% 12% 25% Fire, 12% 0% Fire Crop Others Marine Motor TP & PA Motor OD Motor TP, Health, Engineering Health,travel 23% 21% Source: Company, Ambit Capital research Source: Company, IRDAI, General Insurance Council Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 104 [email protected] 2020-12-07 Monday 13:17:41 ICICI Lombard Exhibit 14: Investment leverage stacks up favorably Exhibit 15: Improvement in combined ratios has driven compared to global peers RoE higher, expect to deliver 20%+ RoE 5.6 4.6 4.6 RoE % Combined Ratio-%- (RHS) 4.1 3.3 25 110 2.9 2.6 1.8 1.8 1.5 1.4 1.3 20 105 15 100 IAG (AUS)* IAG Chubb (US) Fairfax (US) Fairfax Markel (US) Ping An(HK) 10 95 BAGIC (IND)* Travelers (US) Travelers ICICILB (IND)* Direct (UK) Line Direct Progressive (US) Progressive FY14 FY15 FY16 FY17 FY18 FY19 FY20 HDFCErgo (IND)* China Pacific (HK)China Pacific FY21E FY22E FY23E Source: Bloomberg, Ambit Capital research. *Figures for ICICILB, HDFC Source: Company, Ambit Capital research estimates Ergo, BAGIC and IAG are for FY19, for all other insurers they are as of FY18 Exhibit 16: Explanation for our flags Segment Score Comments Claim reserving has been strong; first one to report loss triangles. We did not find anything unusual in the Accounting GREEN accounting practices of ICICILB. With multiple regulatory changes over the past 12-18 months, we expect some uncertainty around Predictability AMBER investment leverage. There have been no significant upgrades/downgrades to consensus numbers over last six months Earnings momentum AMBER Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 105 ICICI Lombard Financials Income Statement (in ` bn) FY18 FY19 FY20 FY21E FY22E FY23E Premium from Direct Business written 124 145 133 142 171 199 Premium earned - Net 69 84 94 95 102 122 Income other than premium 12 14 16 19 22 25 Total Income 81 98 111 114 123 148 Total Claims Incurred (Net) 53 63 69 71 77 92 Net Commission (2.8) 2.2 3.6 2.4 3.0 3.7 Operating expenses 21 20 23 24 23 26 Total Expenses 71 85 95 97 103 122 Operating profit/(Loss) 9.2 12.3 15.4 16.4 20.4 26.1 Underwriting Profit/(Loss) (2.3) (1.7) (1.1) (2.3) (1.4) 0.6 Income from Investments 4.1 4.6 3.9 4.9 5.6 6.5 Other income – misc. income 0.1 0.1 0.2 - - - Total Income 13.4 17.1 19.5 21.3 26.0 32.6 Provisions (Other than taxation) 0.7 (0.4) 1.7 - - - Other Expenses 0.7 1.5 1.6 - - - Total Expenses 1.4 1.1 3.3 3.7 4.0 4.3 Profit Before Tax 12.0 16.0 17.0 17.7 22.1 28.3 Tax 3.3 5.5 5.0 4.4 5.5 7.1 Profit After Tax 8.6 10.5 11.9 13.2 16.6 21.2 Source: Ambit Capital research estimates Balance Sheet (in ` bn) FY18 FY19 FY20 FY21E FY22E FY23E Sources of funds - Share capital 4.5 4.5 4.5 4.5 4.5 4.5 - Reserves and surplus 48 52 53 66 77 91 Net worth 53 57 57 70 81 96 - Borrowings 4.9 4.9 4.9 4.9 4.9 4.9 Total liabilities 58 61 62 71 82 96 Application of funds Investments – Shareholders’ 47 53 59 69 83 99 Investments – Policyholders’ 135 169 205 243 289 345 Total investments 182 222 263 312 372 444 Fixed assets 4.1 4.7 6.8 9.8 14.3 20.8 Cash and bank balances 5.9 4.0 0.3 0.4 0.5 0.6 Advances and other assets 103 100 97 104 106 107 Current Liabilities (195) (216) (250) (289) (333) (385) Provisions (45) (56) (59) (70) (81) (93) Total assets 58 61 62 71 82 96 Source: Ambit Capital research estimates August 26, 2020 Ambit Capital Pvt. Ltd. Page 106 ICICI Lombard Key Ratios (%) FY18 FY19 FY20 FY21E FY22E FY23E Premium from Direct Business Written Growth 15% 17% -8% 7% 20% 17% Net Premium Growth 19% 22% 1% -4% 22% 19% Loss Ratio 77% 75% 73% 75% 76% 75% Commission Ratio -4% 2% 4% 3% 3% 3% Expense Ratio 27% 21% 24% 26% 20% 19% Combined Ratio 100% 98.8% 100% 103.0% 98.6% 97% Underwriting Profit/(Loss) Ratio -3% -2% -1% -2% -1% 1% Solvency Ratio 205% 224% 217% 252% 247% 253% Investment Yield 9.5% 9.3% 8.8% 8.5% 8.7% 8.5% Tax Rate 28% 34% 30% 25% 25% 25% Dividend Pay-out Ratio 11% 27% 32% 32% 32% 32% Source: Ambit Capital research estimates Net written premiums – Mix (%) FY18 FY19 FY20 FY21E FY22E FY23E Motor - OD 33% 32% 33% 31% 29% 28% Motor - TP 27% 28% 32% 32% 34% 34% Personal Accident 3% 4% 5% 3% 3% 4% Health Insurance 16% 20% 19% 23% 24% 25% Fire 2% 2% 3% 3% 3% 3% Marine 3% 3% 3% 2% 2% 2% Crop Insurance 8% 7% 0% 0% 0% 0% Others 8% 5% 5% 5% 5% 4% Source: Ambit Capital research estimates Valuations Particulars FY18 FY19 FY20 FY21E FY22E FY23E Underwriting Loss Ratio (%) -3% -2% -1% -2% -1% 1% Investment Leverage (asset to NEP) 2.3 2.4 2.5 3.0 3.3 3.3 Investment Income to Premium (%) 22% 22% 22% 25% 29% 28% PAT to NEP (%) 12% 13% 13% 14% 16% 17% EPS (`.) 19.0 23.1 26.3 29.1 36.4 46.8 Dividend Yield (%) 0.1% 0.4% 0.6% 0.7% 0.9% 1.2% BPS (`.) 100 117 135 145 170 201 P/BV 12.6 10.8 9.4 8.7 7.4 6.3 P/E 66.6 54.8 48.2 43.4 34.7 27.1 P/GDPI 4.6 4.0 4.3 4.0 3.4 2.9 RoAE (%) 18% 19% 21% 22% 23% 25% Source: Ambit Capital research estimates August 26, 2020 Ambit Capital Pvt. Ltd. Page 107 ICICI Lombard This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 108 L&T Infotech NOT RATED SCALABILITY THEMATIC LTI IN EQUITY August 26, 2020 Balancing growth and profitability Technology LTI is a strong challenger to tier-1 IT with a full services offering. Its focus Recommendation on acquiring deep capabilities in next-gen technologies, client centricity Mcap (bn): 409/US$5.5 and disciplined execution has helped it create a differentiated 3M ADV (mn): 389/US$5.2 positioning. This has driven industry leading USD revenue CAGR of 13.4% (vs 10.9% at tier-2) and strong PAT CAGR of 16.3% over FY15-20, CMP: 2,344 aided by 120bps EBITDA margin improvement (vs 80bps at tier-2). Over TP (12 mths): NA a period, likely consolidation with Mindtree could create a player of half Downside (%): NA the scale of TECHM overall (~75% of TECHM’s business in US) based on 1QFY21 annualized revenue. Since its IPO, the company’s performance Flags has been rewarded by stock appreciation of 235% vs 67% return on Accounting: GREEN CNXIT. Strong leadership, digital strength and focused execution should Predictability: AMBER help drive 10-15% revenue CAGR over the next 10 years. The stock currently trades at 23x/21x 1-year fwd/FY22E P/E, based on consensus Earnings Momentum: AMBER estimates, implying ~15% discount to TCS on our estimates. Competitive position: STRONG Changes to this position: POSITIVE Performance Broad-based growth and focus on next-gen technologies LTI CNXIT 350 LTI has driven industry leading growth led by broad-based traction across key 250 verticals (BFSI, Retail, Manufacturing, Telecom, Energy) over the last 5 years. This 150 was aided by focus on next-gen (Digital) technologies like AI, analytics, IOT, automation and cloud. Digital is 42% of LTI revenues and has grown at 32% 50 CAGR over last 3 years. This could remain a strong growth driver for LTI. Frost & Sullivan expects overall Digital market to post 20.2% CAGR over 2018-25. Jul-16 Jul-17 Jul-18 Jul-19 Jul-20 Top ranked player within tier 2 IT in our Digital mapping framework In our digital competency mapping of tier-2 IT, LTI ranks number one overall and Source: Bloomberg, Ambit Capital research is the strongest challenger to tier-1 IT. The company ranks favorably in Digital Strategy & Experience (Rank 1); Enterprise Solutions & SaaS, Analytics & IoT LTI FY15-20 revenue (USD mn) (Rank 2); Cloud & Infra, Automation and App Modernization (Rank 3). LTI has complemented its organic capabilities with tuck-in acquisitions across areas like 1,800 big-data analytics (Lymbyc; AugmentIQ), cloud (Powerupcloud), automation 1,300 (Ruletronics) and verticalized offerings in BFSI/Healthcare/CPG (Syncordis; N+P). 800 Sound operating philosophy and strategy focused on client centricity 300 LTI’s operating philosophy is focused on 1) Operate to transform – Do less, do fast, do more and do better, 2) Data-driven enterprise – Leveraging all elements FY15 FY16 FY17 FY18 FY19 FY20 of data to help drive decision making at clients, 3) Experience transformation and 4) Digitizing the core – focus on app modernization and automation. Client centricity is a key focus area with decentralized decision making (e.g. pricing Source: Company, Ambit Capital research decisions made by Chief Business Officers and respective teams) enabling better client-connect, giving top management bandwidth to drive growth and LTI’s greatness score analysis differentiation. To tide over the near-term Covid crisis, LTI is partnering with clients to (i) reduce total cost of ownership in the medium term; (ii) enable cloud transformation, while conserving cash and reducing discretionary expenditure. Strongest management team within tier 2 IT Strong leadership of CEO Sanjay Jalona and experienced management team helped create a differentiated positioning for LTI and drove high client satisfaction scores. This has driven the strong scale-up of LTI, and increased investments in top-50 accounts should help sustain this momentum. Strong Research Analyst leadership, Digital strength and focused execution should help drive 10-15% Ashwin Mehta, CFA revenue CAGR over the next 10 years. The stock trades at 23x/21x 1-year +91 22 6623 3295 fwd/FY22E P/E, based on consensus, implying ~15% discount to TCS on our [email protected] estimates. Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. [email protected] 2020-12-07 Monday 13:17:41 L&T Infotech Exhibit 1: Evolution of LTI – Segment revenue (USD mn) and RoE 1,800 70% Period of consistent management churn. Sanjay Jalona (ex-Infosys, Global head of hi-tech, 1,600 Both Joint CEOs and COO quit during manufacturing and engineering at Infosys) was 65% 1,400 this period citing decision-making appointed as MD & CEO. The current management 60% team was put in place under his leadership 1,200 constraints after remaining in their roles 55% for 24 months and 15 months 1,000 respectively 50% 800 45% 600 40% 400 35% 200 30% - 25% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Services Industrials Telecom ROE (ex-cash & investments) - RHS Source: Company, Ambit Capital research. Note: Telecom segment consists of Product Engineering Services, which was divested to LTTS in Jan 2014. Services and industrials cluster classification as per our estimates based on last reported numbers. Services cluster consists of BFS, Insurance, Media& Entertainment, Travel & Logistics and Healthcare. Industrials cluster includes Hi Tech and Consumer Electronics, Consumer, Retail & Pharma, Energy & Process, Automobile & Aerospace, Plant Equipment & Industrial Machinery, Utilities and Engineering & Construction Exhibit 2: The key things to note from evolution Time period Phase Key developments . Commenced operations in 1997 as a fully-owned subsidiary of L&T . In 2004, the company won its first large multi-year contract from a global energy company . The company acquired GDA technologies in 2007 (LTI’s first ever acquisition). GDA technologies had expertise in Silicon intellectual Pre FY13 Under L&T’s cover property (SIP) solution and electronic design services . In 2011, as part of its 2nd acquisition, the company acquired Transfer agency business unit of Citigroup fund services, Canada . In April 2011, Sudip Banerjee stepped down from his role as CEO in less than 3 years of his appointment . In Sep 2012, the company appointed Mukesh Aghi and Vivek Chopra as Joint CEOs and reorganized the company into 2 clusters (Industrial and Services) . In 2014, the company divested its Telecom business to LTTS as part of restructuring activity within L&T IT subsidiaries Consistent management churn . In 2015, the company acquired ISRC from Otis - IT service provider FY13-FY16 and reorganization of core business services for Otis and UTC companies . LTI experienced significant management churn during this period with both Joint CEOs and COO stepping down in 2HCY15 within 24 months and 15 months of their appointment. . Revenue growth (from continuing businesses) declined to high single digits in FY15 (8% from 16% in FY13) . The company appointed Sanjay Jalona as MD&CEO (Global head of Hi-tech, manufacturing and engineering at Infosys) and current leadership was put in place . The company was listed in Jul 2016with L&T selling ~11% of its stake . The company made 6 acquisitions during this period to further Post IPO - focus on acquiring deepen its capabilities in traditionally strong areas like banking and next-gen capability while being FY16-till date augmenting skills in Analytics, AI, cloud consulting, DevOps etc. The client centric and improving company acquired AugmentIQ, Syncordis, Ruletronics, N+P, Lymbyc profitability and Powerupcloud, in that order. . LTI is among 16 global strategic services partners of SAP and the only Indian tier-2 player to achieve this status . Delivered revenue growth of 13% CAGR and 120bps EBITDA margin expansion over the last 5 years leading to improvement in ROE (ex- cash & investments) to 53% in FY20 from 39% in FY16 Source: Company, Ambit Capital research, Media articles - Apr-11, Oct-14, Aug-15 August 26, 2020 Ambit Capital Pvt. Ltd. Page 110 L&T Infotech Exhibit 3: Key financial parameters ` mn FY15 FY16 FY17 FY18 FY19 FY20 Revenues (USD mn) 812 887 970 1,132 1,349 1,525 Revenue growth (%) 0% 9% 9% 17% 19% 13% Net profits 7,718 8,369 9,709 11,611 15,157 16,426 EPS (INR) 46 49 56 66 86 87 CFO 6,423 8,633 11,796 8,436 13,955 16,431 CFO/EBITDA 55% 84% 96% 68% 74% 81% FCF 4,484 7,491 11,108 7,454 12,424 14,005 Debt equity (x) 0.1 0.0 0.0 0.0 0.0 0.1 CE turnover 2.4 2.6 2.4 2.0 2.1 1.9 GB Turnover 6.9 9.4 12.2 10.7 11.0 9.3 RoE (%) 42% 40% 37% 33% 35% 32% ROCE* (%) 41% 38% 39% 30% 38% 33% Source: Company, Ambit Capital research. Note: *Pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total capital including cash in the denominator. Revenue growth ex-telecom was 8% in FY15 Exhibit 4: LTI has better EBIT margin compared to tier-2 peer average due to higher offshore revenue contribution and revenue per employee Margins & drivers FY20 Mindtree LTTS LTI Mphasis Hexaware NIIT Tech Gross Margin (%) 31.0% 32.9% 32.4% 28.7% 32.7% 34.2% SG&A (%) 16.9% 13.1% 13.7% 10.2% 17.3% 16.4% EBITDA (%) 14.0% 19.8% 18.7% 18.7% 15.4% 17.8% Depreciation (%) 3.5% 3.3% 2.5% 2.6% 1.9% 4.1% EBIT (%) 10.5% 16.5% 16.1% 16.1% 13.6% 13.7% Employee cost (%) 65.2% 58.6% 59.9% 55.8% 54.2% 58.6% Travel cost (%) 4.2% 1.6% 3.3% 2.3% 2.0% 3.2% Sub-contractor costs (%) 8.0% 3.9% 8.2% 13.9% 15.5% 8.2% Utilization (%) 76.6% 78.6% 79.5% 83.0% 79.3% 79.7% Offshore revenue (%)* ~45% 55.2% 50.5% 42.1% 35.6% 36.0% Revenue per employee (USD) 51,608 49,108 51,156 48,713 43,824 54,933 Employee cost per employee (USD) 33,664 28,767 30,644 27,180 23,770 30,668 Source: Company, Ambit Capital research. Note: LTI and LTTS Travel and Sub-con costs based on FY19; NIIT Tech Employee, Travel and Sub-con costs based on FY19. FY20 corresponds to CY19 for Hexaware.* Offshore revenue contribution for Mindtree is our est. as company has discontinued this metric. Mindtree Gross margins and SGA as per IFRS figures. All other numbers in the report for Mindtree are Ind-AS numbers. August 26, 2020 Ambit Capital Pvt. Ltd. Page 111 L&T Infotech Exhibit 5: Ranking based on weighted average scores for Digital skills across companies, using third-party industry research vendor assessment – LTI ranks at the top of tier-2 IT peers Digital Automation Enterprise Analytics, Cloud & Overall Strategy & and App Solutions & IoT & Comments Infra Experience Modernization SaaS E&RD . Among top 3 players in tier 2 IT across Digital skills. LTI 1 3 1 3 2 2 Rates well across most categories. . Digital strategy & experience core strength of Mindtree, coupled with Enterprise solutions & SaaS (augmented by BlueFin & Magnet 360 acquisitions). Mindtree 2 5 3 5 1 4 . Lags Tier-2 IT peers in Cloud & Infra and app modernisation – two strong demand drivers post Covid in our view. . Strong cloud capabilities, with aid from Stelligent Mphasis 3 1 4 4 7 5 acquisition (a AWS platinum partner) . Enterprise solutions and SaaS are weak links. . Strong performance in Digital and app modernisation/automation skills Hexaware 4 4 2 2 3 7 . Scope for improvement with Mobiquity acquisition and Gold level partner status (second highest tier) in Pega partner program . Strong capabilities in Automation and App Modernization EPAM 5 8 6 1 4 3 . Very strong in front-end Digital areas, but lacks offerings on the back-end . Clear mismatch between actual performance and rankings especially in Cloud & Infra. Zensar 6 2 5 8 5 8 . Increasingly coming in the charts in Digital & cloud/infra . Pure play ER&D company in India with comparable capabilities with tier-1 IT LTTS 7 10 10 7 10 1 . Whether it can collaborate with its sister concerns to drive end-to-end enterprise business is a key monitorable Virtusa 8 5 9 9 6 6 . Lags tier-2 IT except in cloud & infra space . Decent Agile and ADM skills but gaps remain in other capabilities NIIT Tech 9 7 8 6 9 9 . Along with Globant, competency rankings do not do justice with growth being superior over last 3 years. . Reasonable Digital and SaaS competencies but limited offerings in other areas. Globant 10 9 7 10 7 10 . Focus on front-end Digital and vertical strengths drive best in class growth. Clear mismatch between ratings and growth performance Source: Company releases citing vendor assessments by Gartner, IDC, Forrester, ISG, Everest, Zinnov, Avasant, Ambit Capital Research August 26, 2020 Ambit Capital Pvt. Ltd. Page 112 L&T Infotech Exhibit 6: Rerating in 1-year fwd P/E since IPO has been Exhibit 7: LTI share price has appreciated by ~235% vs driven by superior execution among tier-2 peers ~67% return on CNXIT since IPO in Jul-16 30 1 yr fwd PE Average 400 LTI CNXIT 25 350 300 20 250 15 200 10 150 5 100 0 50 Jul-16 Jul-17 Jul-18 Jul-19 Jul-20 Jan-17 Jan-18 Jan-19 Jan-20 Apr-17 Apr-18 Apr-19 Apr-20 Oct-16 Oct-17 Oct-18 Oct-19 Jun-17 Jun-18 Jun-19 Jun-20 Sep-16 Sep-17 Sep-18 Sep-19 Dec-16 Dec-17 Dec-18 Dec-19 Mar-17 Mar-18 Mar-19 Mar-20 Source: Bloomberg, Ambit Capital research. Source: Bloomberg, Ambit Capital research Exhibit 8: LTI has delivered strong revenue growth of 16% Exhibit 9: …while maintaining over17% EBITDA margin CAGR… during 2017-20 100% 20% EBITDA margin (%) - RHS Gross margin (%) 15% 43% 26% 41% 24% 10% 50% 39% 22% 37% 20% 5% 35% 18% 33% 16% 0% 0% 31% FY15 FY16 FY17 FY18 FY19 FY20 29% 14% BFS Insurance 27% 12% Manufacturing Energy 25% 10% CPG/retail & Pharma Hi-tech & Media FY15 FY16 FY17 FY18 FY19 FY20 Others 3 yr revenue CAGR Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 10: Cash conversion and gearing remain at healthy Exhibit 11: …and working capital turnover has improved levels… CFO/EBITDA FCF/PAT Gearing ratio [RHS] Gross Block (INRm) WC turnover [RHS] 140% 11% 16,000 8 120% 9% 14,000 100% 12,000 7% 6 80% 10,000 5% 8,000 60% 3% 6,000 40% 4 4,000 1% 20% 2,000 0% -1% - 2 FY15 FY16 FY17 FY18 FY19 FY20 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research. Note: CFO ex acquisitions Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 113 L&T Infotech Exhibit 12: RoE moderation due to increasing cash & Exhibit 13: EBITDA/employee shows progressive investments; RoIC has improved from FY16 levels improvement since FY16 RoE (%) ROIC (%) - RHS SG&A (INRm) 45% 55% EBITDA (INRm) EBITDA/Employee (000s) - RHS 50% 40,000 800 40% 45% 30,000 600 35% 40% 20,000 400 30% 35% 10,000 200 25% 30% FY15 FY16 FY17 FY18 FY19 FY20 0 - FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research. Source: Company, Ambit Capital research. Ambit’s HAWK analysis LTI has significantly improved its forensic score from D6 (Zone of pain) in FY16 to D2 (Zone of safety) in FY19. It is placed well above median in the sector. In addition, LTI is placed in the top quintile in our analysis of greatness parameters and was placed in ‘Zone of Greatness’ in FY19, which is an improvement compared to FY18 driven by better capital employed turnover and lower potential equity dilution (due to reduced number of ESOPs awarded). Key contributors to accounting score and comparison to peers LTI features in D2 (Zone of greatness) decile on our accounting framework. Key contributors to LTI’s accounting score include (i) High cum. FCF/ Median revenue; (ii) Low advances to related parties/CFO; (iii) Strong cash conversion (CFO/EBITDA); (iv) Lower contingent liabilities and (v) Lower volatility in depreciation rate. While miscellaneous expenses/revenue is higher, we note that it has declined by 10bps in FY20, which would aid in improvement of accounting score. Another factor impacting accounting score would be lower cash yield. However, we note that the company follows a long-term hedging policy which would minimize any material impact from exchange rate fluctuations. August 26, 2020 Ambit Capital Pvt. Ltd. Page 114 [email protected] 2020-12-07 Monday 13:17:41 L&T Infotech Exhibit 14: Forensic accounting score contributors Exhibit 15: Forensic score percentile in larger universe and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company Comments on evolution of accounting score LTI’s accounting score has improved from ‘Zone of Pain’ (D6) in FY16 to ‘Zone of Safety’ (D2) in FY19. The improvement since FY15 has been driven by (i) improvement in cash conversion driven by lower outstanding debtors and lower capital work-in-progress as % of gross block and (ii) declining contingent liabilities as % of net worth We expect LTI’s forensic score to sustain driven by improvement in cash conversion, lower miscellaneous expenses and contingent liabilities as % of net worth largely at similar levels. August 26, 2020 Ambit Capital Pvt. Ltd. Page 115 L&T Infotech Exhibit 16: Forensic accounting score evolution Exhibit 17: Movement in accounting checks Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 68% 74% 81% P&L mis- Volatility in statement depreciation rate (bps) -60 -58 95 check PFD-% of Debtors more than six months NA NA NA Cash yield 6.4% 7.2% 5.1% Balance Change in reserves (ex sheet mis- sec-prem)/(PAT ex statement dividend) check 1.00 1.11 0.55 Cont Liab-% of NW 6.4% 5.1% 5.3% Misc. exps-% of total revs 0.6% 0.6% 0.5% Adv. to related parties / Pilferage CFO 0% 0% 0% checks CWIP / Gross Block 0% 0% 3% Cum. FCF/median revs 40% 42% 36% CAGR in auditor's Audit quality remn/ CAGR in check Revenue -1.1 -1.1 1.7 Source: Ambit Capital research, Company Source: Ambit Capital research, Company Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.). LTI’s greatness score has improved from ‘Good, not great’ (~50%) in FY17-18 to “Zone of Greatness” (~80%) in FY19 (similar to FY15 levels). LTI’s greatness score is higher than ~88% of the sector peer set. Key contributors to high greatness score include strong revenue growth, high capital turnover and robust cash flow. Exhibit 18: Greatness score contributors Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 116 L&T Infotech Exhibit 19: Greatness score percentile in larger universe Exhibit 20: Greatness score evolution and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company Exhibit 21: Explanation of our flags on the front page Segment Score Comments LTI’s cash conversion ratio (CFO/EBITDA) has been healthy at 81% in FY20, an improvement from 55% in FY15. On Accounting GREEN Ambit’s forensic accounting, LTI is categorised in the 2nd decile – Zone of safety, an improvement from 6th decile in FY15. LTI has higher revenue contribution from top 20 clients (58% in 1QFY21). Although this has reduced from 68% in FY17, Predictability AMBER higher client concentration would impact the business in case of client-specific issues arising (revenue growth moderated in 1HFY20 due to issues at couple of top clients). Earnings Bloomberg consensus estimates have been revised upwards by 6/9% for FY22E/23E over the past 3 months but are still AMBER momentum lower by 4% for FY22E compared to 6 months ago Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 117 L&T Infotech Income statement (` mn) FY16 FY17 FY18 FY19 FY20 Revenue (US$ mn) 887 970 1,132 1,349 1,525 Revenue growth 9% 9% 17% 19% 13% Revenue (INR) 58,463 65,009 73,065 94,458 108,786 Revenue growth 17% 11% 12% 29% 15% Cost of Revenue 38,212 42,123 48,505 61,643 73,589 Gross Profit 20,251 22,886 24,560 32,815 35,197 Gross margin 35% 35% 34% 35% 32% SG&A expenses 10,000 10,584 12,065 13,980 14,905 EBITDA 10,251 12,302 12,495 18,835 20,292 Depreciation 1,738 1,780 1,563 1,471 2,731 EBIT 8,513 10,522 10,932 17,364 17,561 EBIT margin 15% 16% 15% 18% 16% Other Income 1,838 1,835 4,101 2,915 2,463 PBT 10,351 12,357 15,033 20,279 20,024 Tax 1,982 2,648 3,422 5,122 3,598 Tax Rate (%) 19% 21% 23% 25% 18% PAT 8,369 9,709 11,611 15,157 16,426 Share from associates/Minority interest - - - - - Adjusted PAT 8,369 9,709 11,611 15,157 16,426 PAT margin 14% 15% 16% 16% 15% Extraordinary items - - - - - Reported PAT 8,369 9,709 11,611 15,157 16,426 EPS 49.4 56.1 66.4 86.4 86.6 DPS 0 16.6 21.5 28.0 28.0 Source: Company, Ambit Capital research. Balance sheet (` mn) FY16 FY17 FY18 FY19 FY20 Net Worth 21,251 31,452 38,611 48,946 54,051 Loan Funds - - - - 320 Other Liabilities 483 456 1,454 1,283 3,194 Capital Employed 21,734 31,908 40,065 50,229 57,565 Net Block 2,799 2,587 2,518 3,084 4,412 Investments 429 9,406 12,644 17,402 22,186 Other Non current Assets 8,620 8,473 9,384 11,907 12,855 Debtors & Unbilled revenue 15,449 16,420 22,327 23,845 27,541 Cash & Bank Balance 2,035 3,795 3,633 4,150 5,252 Other Current Assets 2,290 3,665 3,042 6,304 8,311 Current Liabilities. & Provisions 9,888 12,438 13,483 16,463 22,992 Net Current Assets 9,886 11,442 15,519 17,836 18,112 Application of Funds 21,734 31,908 40,065 50,229 57,565 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 118 L&T Infotech Cashflow statement (` mn) FY16 FY17 FY18 FY19 FY20 CF from Operations 9,569 12,105 12,344 16,798 18,744 Changes in Working Capital (936) (305) (3,908) (2,843) (2,313) Net Operating CF 8,633 11,799 8,436 13,955 16,431 Net Purchase of FA (1,142) (688) (982) (1,531) (2,426) Acquisition spend - (71) (1,146) (2,157) (591) Payment towards investments 701 (8,751) (2,478) (3,751) (3,503) Net Cash from Invest. (441) (9,510) (4,606) (7,439) (6,520) Proceeds from Equity & other 69 4 3 4 - Dividend Payments (6,516) (1,888) (3,533) (5,346) (5,678) Change in debt and liabilities (1,721) 1,448 (546) (605) (1,825) Others - (94) 81 (54) (1,308) Cash Flow from Fin. (8,167) (530) (3,995) (6,002) (8,811) Free Cash Flow 7,491 11,108 7,454 12,424 14,005 Opening Cash 2,009 2,035 3,795 3,633 4,150 Net Cash Flow 24 1,760 (162) 516 1,102 Closing Cash Balance 2,035 3,795 3,633 4,150 5,252 Source: Company, Ambit Capital research Ratio analysis (` mn) FY16 FY17 FY18 FY19 FY20 P/E 47.6 41.9 35.0 27.0 25.8 P/B 18.7 12.9 10.7 8.4 7.6 EV/EBITDA 38.1 31.7 31.3 20.7 19.2 EV/EBIT 45.9 37.1 35.7 22.5 22.2 EV/Sales 6.7 6.0 5.3 4.1 3.6 Return Ratios (%) RoE 40.3% 36.9% 33.5% 34.8% 31.0% RoCE (pre-tax) 37.9% 39.2% 30.4% 38.5% 32.6% ROIC 34.9% 43.5% 39.8% 49.5% 45.9% Turnover Ratios Receivable days (Days) 96 92 112 92 92 Fixed Asset Turnover (x) 21 24 29 34 29 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 119 [email protected] 2020-12-07 Monday 13:17:41 L&T Infotech This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 120 Mahindra CIE BUY SCALABILITY THEMATIC MACA IN EQUITY August 26, 2020 Growing on internal accruals Auto Ancillaries In CY10-19 MACA’s revenue grew ~6x and net-debt/equity fell to 0.3x vs Recommendation 0.8x in FY10. It diversified beyond traditional low-margin EU/India truck forgings to PV components in India/EU and 2W components in India. Mcap (bn): `55/US$0.7 MACA took inorganic route by acquiring Bill Forge and Aurangabad 3M ADV (mn): `33/US$0.45 Electricals, adding customers like Maruti and Bajaj Auto. MACA is CMP: `144 building a scalable business, targeting domestic CVs/tractors/PVs/2W TP (12 mths): `166 and CVs/PVs in EU by allocating its CFO, keeping a steady capital Upside (%): 15 structure. We expect MACA to organically double revenue in CY20-25E to `112bn. Also, we see scope of adding ~50% to revenue through M&As using internal accruals. Target areas of growth are light-weighting Flags components and ASEAN markets. Our DCF-based TP of `166 (`143 Accounting: AMBER earlier) implies ~15x CY22E EPS. Risks: EU slowdown, wrong acquisition, Predictability: RED and inability to tap EV component market. Earnings Momentum: RED Competitive position: STRONG Changes to this position: POSITIVE Moving in the right track by scaling up and diversification Performance In CY16-18, amid single-digit growth of OEMs both in India and EU, MACA grew Sensex MACA revenue ~50% to `80bn through BFL and AEL addition. Thus, PAT grew ~3x to 125 `5.5bn and balance sheet size by ~30% to `59bn. This expansion was amidst 100 reduction in net-debt/equity from 0.4x to 0.2x. This signifies MACA is moving in 75 the direction of expansion+ diversification while keeping tab on financial 50 leverage through disciplined capital allocation. In CY20, with EBITDA being 25 under pressure due to Covid disruption, MACA would keep capex at 4-5% of sales vs normal levels of ~7-8% and remain FCF positive. Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-20 Aug-19 Nov-19 Scale boosted by addressing a wider segment of OEMs May-20 MACA is on an acquisition-led diversification path, covering newer customers and segments. After being a CV/tractor component supplier a decade back, it Source: Bloomberg, Ambit Capital research has diversified to PV components for leading OEMs in India/EU through CIE and MACA’s revenue grew ~6x in the last BFL. It added 2W client Bajaj Auto through AEL, in turn adding die casting products to portfolio besides forgings, composites and stampings. Best-in-class 10 years operational/financial practices from CIE Spain coming into the Indian entity have 100 been instrumental in the transformation over the past 6 years. 79 75 56 Addition of CIE assets + entry into ASEAN markets the next target bn 50 MACA has been doing M&A depending on its OCF generation. It targets adding ` two more CIE assets (China and Brazil, currently three in EU) besides expanding 25 13 2 base in ASEAN markets. Though EU business (~50% mix) would grow at 4-5% 0 CAGR, we believe MACA would deliver 16% organic revenue CAGR over next 5 FY06 FY10 FY15 CY19 years through customer additions/wallet share gains. Thus, we expect MACA to achieve ~2x CY20E revenue in CY25E, organically, funded by internal accruals by adding light weighting products and EV related components. Source: Company, Ambit Capital research Improving scale+ mix= higher EBITDAM, R0CE and valuation multiples MACA improved EBITDAM from ~10% to ~12% in CY16-19. In CY20-25E, we expect MACA to improve EBITDAM back to ~14%, deliver organic revenue CAGR of ~16%, and ramp up pre-tax RoCE to ~16% (vs ~12% in CY19). Thus MACA is poised for disciplined allocation of FCF across years and in turn grow business, Research Analysts benefit from operating leverage, improve RoCE and in turn trade at superior Basudeb Banerjee earnings multiples of 15-18x (now 10-12x). With primary focus of parent CIE [email protected] being on delivering stable and superior RoE of 15-20%, we are confident MACA is well on track towards that target. We retain BUY on MACA with DCF based PT Tel: +91 22 6623 3141 of `166 (earlier `143), implying ~15x CY22E EPS. Increase in PT is led by Karan Kokane factoring ~16% revenue CAGR in CY20-25E vs. ~15% earlier (CY20-21E [email protected] estimates unchanged) on improving demand outlook and earnings rollover. Tel: +91 22 6623 3028 Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Mahindra CIE Exhibit 1: Rising revenue with improving margins & RoCE post entry of CIE in FY14; CY20E weakness led by Covid outbreak MACA: CY15 MACA CY18 revenue: AEL revenue: India BFL:~11%, India-ex Inclusion MACA: FY13 revenue: India ~31%, CIE:~26, BFL:~31%, CIE:26%, and down ~20%, MFE (Germany & UK): 119 EU-ex-CIE: ~43% EU ex-CIE: 32% cycle across 30% ~80% CIE Inclusion BFL Inclusion India & EU 25% 102 80 79 20% 85 56 64 65 15% 68 53 53 10% 51 39 26 5% 34 23 22 24 22 13 19 0% 17 2 2 -5% 0 -10% FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 CY16 CY17 CY18 CY19 CY20E CY21E Consolidated revenue (Rs bn) pre-tax ROCE (%) (RHS) EBITDA margin (%) (RHS) CY15 (9m) CY15 Source: Company, Ambit Capital research Exhibit 2: Evolution of MCIE through shift in business mix towards higher margin and higher RoCE businesses Time period Phase Key developments . Mahindra Forgings Ltd. (MFL) began operations in FY06 with the acquisition of the forging business of Amforge Ind. Ltd. (AIL). In order to become a global forgings player, MFL acquired three European forging entities, thus Pre-FY13 Part of Mahindra Systech . forming MF Europe (MFE). . Losses at MFL despite ~8% EBITDAM and MFE EBITDAM at ~3% along with exposure to EU CV cyclicality meant RoCE of ~2% in FY08-13 and urgent need for change in business mix. . Mahindra group and CIE Automotive S.A. (Spain) announced the signing of a global alliance agreement. Entry of CIE Automotive S.A (Spain) MCIE benefitted from CIE’s portfolio, customers and market diversification other than its financial FY14-16 . discipline and M&A skills. . With CIE contributing ~25-30%/~35% of revenue/EBITDA, stability of cash flows improved and RoCE inched up to ~7-8%. . MCIE added Bill Forge Ltd. (BFL) in CY16, an entity with ~20%+ revenue growth and ~18-20% operating margin. This helped improve India business EBITDAM from ~8-10% to ~12-14% and Further improvement in business further improve stability of cash flows. FY16-present mix through acquisition of BFL and . Aurangabad Electricals Ltd. (AEL) was added in CY19, which had similar EBITDA margin as MCIE AEL India and large exposure to Bajaj Auto (~75% revenue mix). . Thus, directionally, MCIE has been shifting its business mix towards high margin/RoCE businesses with stable cash flows to gradually scale up. Source: Company, Ambit Capital research Exhibit 3: Key financial parameters over the last decade ` mn FY11 FY12 FY13 FY14 FY15 CY15 (9m) CY16 CY17 CY18 CY19 Revenue 19,179 24,403 22,164 25,908 55,699 38,612 53,199 64,279 80,315 79,078 Growth YoY (%) 44% 27% -9% 17% 115% -31% 38% 21% 25% -2% Net profit 118 527 (1,128) (732) 1,479 1,651 1,780 3,736 5,485 3,584 EPS (`) 0 6 (12) (9) (2) 3 4 10 14 9 CFO 160 3,286 (12) 1,587 1,153 7,153 861 6,006 6,961 7,702 CFO-EBITDA (%) 9% 158% -3% 146% 26% 189% 16% 74% 66% 80% FCF (507) 1,223 (616) (2,768) (31,942) 4,041 (13,190) 919 2,186 (6,424) Debt equity (x) 0.9 0.6 0.7 0.9 0.7 0.5 0.4 0.3 0.2 0.3 CE turnover (x) 1.4 1.8 1.7 2.0 2.5 1.3 1.5 1.4 1.5 1.3 GB Turnover (x) 0.8 0.9 0.8 0.8 1.2 0.6 1.6 1.6 0.9 0.8 RoE (%) 1% 6% -14% -10% 12% 8% 7% 11% 14% 8% ROCE* (%) 4% 7% -5% 0% 11% 7% 9% 12% 15% 11% Capex 667 2,064 603 4,355 33,095 3,112 14,050 5,087 4,775 14,126 Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total capital including cash in the denominator. August 26, 2020 Ambit Capital Pvt. Ltd. Page 122 Mahindra CIE Exhibit 4: Mapping Mahindra CIE and its peers on IBAS Strategic Overall Company Innovation Brand Architecture Comments asset rank MCIE is too small to get established on the IBAS framework as it is still in its evolution stage since its creation in FY14. MCIE has been focussing on acquisition-led growth and has thus been obtaining new Mahindra technologies/products by paying goodwill. Further, access to CIE's CIE processes/product technologies and manpower expertise provides MCIE with unique advantage of bringing in best-in-class practices to drive RoCE. Thus, MCIE is all set to scale up into a diversified components player with superior technical knowhow. BHFC is India’s largest manufacturer and exporter of forging components with a global forging capacity of 625ktons/annum and manufacturing facilities spread across India, Germany, Sweden and the US. Over the years, BHFC has diversified its exposure from CV Bharat Forge forging to PV, O&G, railway, industrial forging etc. to increase stability in its business. However, its exposure to cyclical segments remains at ~65% even today. Strong relationships with OEMs, access to superior technology and vertically integrated capabilities would aid BHFC in maintaining its leadership in the forgings space. MNDA’s revenue has grown at 2-4x OEM volume growth over the last decade by adopting the strategy of continuous portfolio enrichment via organic/inorganic additions to drive higher kit value/vehicle. MNDA will continue to invest in sunrise products and benefit with increase in scale, thus maintaining post-tax RoCE above 18%. MNDA Minda Ind. will continue to benefit from its superior R&D capabilities (~4% of sales vs peers at ~1%) along with diversified presence across 2W/4Ws and leadership in automotive switches, acoustics and 4W alloy wheels. We expect premiumisation, regulatory changes, emission control and electrification to drive growth for MNDA. Strong relationships with global marquee OEMs and leadership in key business segments of domestic wiring harness (~65% market share), mirrors (~30% of global rear-view mirrors) and plastics (~10-30% of Motherson polymer products in Europe) are some of MSS’s key strengths. Sumi Additionally, strong R&D capabilities at SMRPBV (~3% of revenue) results in ~2% R&D/sales at consolidated level (vs peers at ~1%) signifying thrust on innovation. SFL’s ability to maintain cross-cyclical RoCE at ~18%+ through stringent cost control and focus on quality is amongst the best in the industry. With ~60% of manpower being temporary, SFL has the capability to maintain EBITDAM across cycles. Further, continuation of shift in mix towards higher value-added products like specialized Sundram fasteners along with diversification into newer products/markets Fasteners (management plans to derive ~20% of annual revenue from new products/customers) is expected to drive higher revenue and EBITDAM for SFL. SFL plans to increase exports to ~50% of revenue in 2-3 years (~33% now) by offering new products to existing customers in the US and diversifying from US (~85% of exports now) to Europe and other geographies. Varroc’s globally diversified pool of plants in low-cost countries, each focussed on cost and quality, are its key strategic assets. Strong relationship with marquee global OEMs like Tesla, Daimler, JLR, VW etc. and leading 2W players in India (Bajaj Auto contributes >50% revenue of India business) besides focus on R&D and innovation make Varroc it a preferred supplier. With the capex cycle now almost complete, VLS Engineering is set to benefit from rise in scale in FY22 post the pandemic disruption. Introduction of BS6-led products like catalytic convertors, electronic fuel injection systems (EFIs), magnetos etc. is set to benefit its India business other than diversification of customer base and cross-selling of products. Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 123 Mahindra CIE Exhibit 5: P/B for MCIE on an upward trajectory of late post Exhibit 6: MCIE’s focus on increasing mix of stable and high witnessing sharp correction led by Covid-19 disruptions RoCE business like AEL, BFL to drive outperformance ahead Trailing P/B (x) 2.5 350 NSE Auto Index MACA 2.0 300 250 1.5 200 1.0 150 100 0.5 50 0.0 - Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-20 Aug-19 Nov-19 May-20 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19 Aug-20 Source: Company, Ambit Capital research, Bloomberg Source: Company, Ambit Capital research, Bloomberg Exhibit 7: Competitive mapping of Mahindra CIE with domestic auto ancillary players Pre-tax Pre-tax CFO/ FY20 Revenue CAGR EBITDA Capex/CFO Company RoCE EBITDA revenue FY11-20 Margin (FY20) (FY11-20) (FY20) (FY11-20) Motherson Sumi 635,369 25% 8% 10% 111% 90% Bharat Forge 80,558 9% 14% 8% 69% 77% Sundram Fasteners 37,232 8% 16% 15% 63% 86% Minda Ind. 54,651 24% 11% 13% 89% 133% Mahindra CIE 79,078 20% 12% 11% 74% 235% Varroc Engineering 111,219 15%* 7% 3% 106%* 88%* Source: Company, Ambit Capital research. * FY13-20 due to recent IPO Exhibit 8: MCIE’s revenue has grown at ~20% CAGR in Exhibit 9: EBITDA margin has been consistently improving FY14-CY19 with entry of CIE and acquisition of BFL and AEL AEL revenue BFL revenue EBITDA margin Gross margin (RHS) Revenue ex-AEL/BFL 14% 62% 100 40% 12% 60% 58% 75 30% 10% 56% 8% bn 50 20% 54% ` 6% 52% 25 10% 4% 50% 0 0% FY14 FY15 CY16 CY17 CY18 CY19 (9m) FY14 FY15 CY15 (9m) CY15 CY15 CY16 CY17 CY18 CY19 Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 124 [email protected] 2020-12-07 Monday 13:17:41 Mahindra CIE Exhibit 10: Scaling up without increasing debt on books; Exhibit 11: GB turnover rose from ~0.8x in FY14 to ~1.6x net-debt/equity down to 0.3x in CY19 from 0.9x in FY14 in CY17 before declining to ~0.8x in the current slowdown CFO (Rs mn) GB turnover WC turnover (RHS) FCF (Rs mn) Net debt/equity (x) (RHS) 1.8 0 10,000 1.0 1.6 1.4 -50 0 0.8 1.2 1.0 -100 0.8 -150 FY14 FY15 (10,000) CY16 CY17 CY18 CY19 0.6 0.6 0.4 -200 (20,000) (9m) CY15 0.4 0.2 0.0 -250 (30,000) 0.2 FY14 FY15 CY16 CY17 CY18 CY19 (40,000) 0.0 (9m) CY15 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 12: RoCE steadily improving with addition of Exhibit 13: EBITDA/employee rising with improving higher margin businesses and steady cash flows employee efficiency through better technology 20% pre-tax RoCE (%) RoE (%) EBITDA (Rs bn) EBITDA/employee ('000 Rs) (RHS) 15% 12.0 3,500 10.0 3,000 10% 8.0 2,500 2,000 5% 6.0 1,500 4.0 0% 1,000 2.0 500 -5% FY14 FY15 0.0 0 CY16 CY17 CY18 CY19 -10% FY14 FY15 CY15 (9m) CY15 CY16 CY17 CY18 CY19 -15% (9m) CY15 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 14: Explanation for our flags Field Score Comments MACA’s current accounting score decile (Ambit framework) is D4. In CY15, it was D2 and it fell to D7 in CY16 likely due to BFL acquisition. However, post that it has been steadily improving with higher asset utilization Accounting AMBER and steady cash flows with inclusion of more stable businesses like BFL. MCIE scores higher on miscellaneous expenses % of total revenue and CWIP/gross block while it scores lower on advance to related parties/CFO. We assign Amber flag. With demand recovering both in India and Europe with partial easing of lockdowns, we expect MACA’s profitability to gradually improve on a sequential basis. However, we still expect a sharp ~33% decline in Predictability RED CY20 revenue given the impact of Covid-19 on demand. Further, given rising cases of Covid-19 in India, we cannot rule out the possibility of another lockdown playing spoilsport for earnings generation, contributing to uncertainty. Thus, we assign a Red flag. Consensus EPS estimates for CY20 have declined by ~60% in the past 6 months due to the impact of Covid- Earnings momentum RED 19 both in India and EU and might worsen further if there is a second wave. Thus, we assign a Red flag. Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 125 Mahindra CIE HAWK scores While MACA’s forensic score has improved from “Zone of Safety” in CY14 (D5) to “Zone of Safety” in CY18 (D4), its greatness score has deteriorated from “Zone of Greatness” (~75%) in CY14 to “Zone of Mediocrity” (~42%) in CY18. Key contributors to accounting score and comparison to peers MACA features in the D4 decile on our accounting framework, or the ‘Zone of Safety decile. Key contributors to its relatively strong accounting score mainly include: 1) low miscellaneous expenses as % of total revenue and 2) low CWIP to gross block. In comparison to peers, MACA’s scores higher than median accounting score, with score better than ~61% of the larger universe and ~76% of the sector. Exhibit 15: Forensic accounting score contributors Exhibit 16: Forensic score percentile vs sector and universe Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Comments on evolution of accounting score MACA’s forensic score has improved from “Zone of Safety” in CY14 (D5) to “Zone of Safety” in CY18 (D4). While the accounting score deteriorated to “Zone of Pain” in CY16 (D7) from “Zone of Safety” in CY15 (D2), it has steadily improved thereon to “Zone of Safety” in CY18 (D4). August 26, 2020 Ambit Capital Pvt. Ltd. Page 126 Mahindra CIE Exhibit 17: Forensic accounting score evaluation Exhibit 18: Movement in accounting checks Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 99% 92% 106% Volatility in depreciation P & L mis-statement 48bps 37bps -60bps checks rate PFD-% of Debtors more N.M. N.M. N.M. than six months Cash yield 5% 5% 8% Balance sheet Change in reserves (ex mis-statement sec-prem)/(PAT ex 1.0 1.0 1.0 checks dividend) Cont Liab-% of NW 7% 5% 6% Misc. exps-% of total revs 1% 0% 1% Adv. to related parties / 16% 9% 6% Pilferage checks CFO CWIP: Gross Block 1% 1% 1% Cum. FCF/median revs 10% 4% 9% Audit quality CAGR in auditor's 0.8 0.2 0.4 checks remn/CAGR in cons. Rev. Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.) MACA’s greatness score has deteriorated from “Zone of Greatness” (~75%) in CY14 to “Zone of Mediocrity” (~100%) in CY18. MACA’s greatness score is higher than ~28% of the sector peer set. Key contributors to the low greatness score include low CFO and lower asset-turns in recent years. Exhibit 19: Greatness score contributors Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 127 Mahindra CIE Exhibit 20: Greatness score percentile vs sector and universe Exhibit 21: Greatness score evolution Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 128 Mahindra CIE Balance sheet Year to March (` mn) CY17 CY18 CY19 CY20E CY21E CY22E Shareholders' equity 3,784 3,788 3,790 3,790 3,790 3,790 Reserves & surpluses 33,372 39,103 42,548 42,657 44,819 48,661 Total networth 37,156 42,891 46,338 46,448 48,609 52,451 Minority Interest ------Debt 11,969 16,134 14,691 12,691 10,691 8,691 Total liabilities 49,125 59,025 61,029 59,139 59,300 61,142 Gross block 88,662 93,079 107,623 110,266 113,515 118,014 Net block 47,503 49,052 60,436 59,810 59,702 60,729 CWIP 602 960 542 542 542 542 Investments (non-current) 550 6,808 955 955 955 955 Deferred Tax Assets 1,630 1,565 (912) (912) (912) (912) Cash & equivalents 719 1,127 1,499 899 1,545 3,294 Debtors 5,984 7,414 7,368 5,213 6,409 6,780 Inventory 9,898 12,286 10,566 7,530 9,258 10,272 Loans & advances 8,103 5,106 4,122 4,361 4,615 4,884 Total current assets 24,705 25,933 23,555 18,003 21,827 25,229 Current liabilities 23,106 22,396 20,359 15,482 18,742 21,037 Provisions 2,759 2,897 3,187 3,778 4,072 4,363 Total current liabilities 25,865 25,294 23,546 19,260 22,814 25,400 Net current assets (1,161) 639 8 (1,256) (987) (171) Total assets 49,125 59,025 61,029 59,139 59,300 61,142 Source: Company, Ambit Capital research Income statement (consolidated) Year to March (` mn) CY17 CY18 CY19 CY20E CY21E CY22E Net Sales 64,279 80,315 79,078 52,856 64,982 74,985 % growth 21% 25% -2% -33% 23% 15% Raw material (RM) expenditure 28,162 36,315 37,487 23,785 29,242 33,743 RM/Sales 44% 45% 47% 45% 45% 45% Staff cost 11,527 13,297 13,080 8,985 10,397 11,998 Staff cost/Sales 18% 17% 17% 17% 16% 16% Other expenses 16,447 20,192 18,834 16,399 18,829 19,943 Other expenses/Sales 26% 25% 24% 31% 29% 27% Operating expenditure 56,136 69,805 69,401 49,169 58,468 65,685 EBITDA 8,143 10,511 9,677 3,686 6,514 9,301 % growth 53% 29% -8% -62% 77% 43% Depreciation 2,683 2,867 3,161 3,268 3,357 3,473 EBIT 5,460 7,643 6,516 418 3,157 5,828 Interest expenditure 510 502 523 493 421 349 Non-operating income 268 387 331 225 225 225 Reported PBT 5,149 7,529 6,279 150 2,961 5,704 Tax 1,483 2,043 2,741 41 799 1,483 Reported PAT 3,667 5,485 3,538 110 2,162 4,221 Exceptionals (69) - (46) - - - Adjusted PAT 3,736 5,485 3,584 110 2,162 4,221 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 129 [email protected] 2020-12-07 Monday 13:17:41 Mahindra CIE Cashflow statement (consolidated) Year to March (` mn) CY17 CY18 CY19 CY20E CY21E CY22E Reported PAT 3,667 5,485 3,538 110 2,162 4,221 Depreciation 2,683 2,867 3,161 3,268 3,357 3,473 Deferred Taxes ------(Incr) / decr in net working capital (344) (1,392) 1,003 664 377 933 Cash flow from operations 6,006 6,961 7,702 4,042 5,896 8,627 Capex (net) (5,087) (4,775) (14,126) (2,643) (3,249) (4,499) (Incr) / decrease in investments (161) (6,257) 5,853 - - - Cash flow from investments (5,248) (11,032) (8,273) (2,643) (3,249) (4,499) Dividend paid - - - - - (379) Net borrowings (1,652) 4,165 (1,442) (2,000) (2,000) (2,000) Issue of Equity 3 4 2 - - - Other items 630 310 2,384 - - - Cash flow from financing (1,019) 4,479 944 (2,000) (2,000) (2,379) Net change in cash (262) 408 372 (601) 647 1,748 Free cash flow 919 2,186 (6,424) 1,399 2,647 4,128 Source: Company, Ambit Capital research Ratio analysis (consolidated) Year to March (%) CY17 CY18 CY19 CY20E CY21E CY22E Gross margin 56.2% 54.8% 52.6% 55.0% 55.0% 55.0% EBITDA margin 12.7% 13.1% 12.2% 7.0% 10.0% 12.4% EBIT margin 8.5% 9.5% 8.2% 0.8% 4.9% 7.8% Net profit margin 5.7% 6.8% 4.5% 0.2% 3.3% 5.6% Net debt: equity (x) 0.3 0.2 0.3 0.2 0.2 0.1 RoCE (pre-tax) 12.4% 15.3% 11.5% 1.1% 5.6% 9.9% RoCE (post-tax) 9% 11% 6% 1% 4% 7% RoE 10.7% 13.7% 8.0% 0.2% 4.5% 8.4% Fixed Asset Turnover (x) 0.7 0.9 0.8 0.5 0.6 0.6 Asset Turnover (x) 0.9 1.0 0.9 0.6 0.8 0.9 Working Capital days 0.8 13 15 22 18 13 DPS (`) 0.0 0.0 0.0 0.0 0.0 1.00 Payout Ratio 0.0% 0.0% 0.0% 0.0% 0.0% 9.0% Source: Company, Ambit Capital research Valuation parameters (consolidated) Year to March CY17 CY18 CY19 CY20E CY21E CY22E EPS (`) 10 14 9 0 6 11 Book value per share (`) 98 113 122 123 128 138 P/S (x) 0.7 0.7 1.0 0.8 0.7 P/E (x) 15 10 15 N.M. 25 13 P/BV (x) 1.5 1.3 1.2 1.2 1.1 1.0 EV/Sales (x) 0.8 0.9 1.3 1.0 0.9 EV/EBITDA (x) 8.3 6.4 7.0 18.3 10.4 7.3 EV/EBIT (x) 12.4 8.8 10.4 N.M. 21.4 11.6 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 130 Minda Industries BUY SCALABILITY THEMATIC MNDA IN EQUITY August 26, 2020 Scaling up profitably Auto Ancillary Minda scaled up revenue ~9x in the last decade, ~4x OEM volume CAGR Recommendation of ~6% led by increase in kit value/vehicle (organically and M&A/JVs). It Mcap (bn): `95/US$1.3 focusses on sunrise products with lower penetration, gets access to technology and briskly expands by making affordable solutions. Minda 3M ADV (mn): `133/US$1.8 achieved this while maintaining net-debt/equity at sub-0.5x consistently, CMP: `361 which is commendable, in addition to improving RoE to ~25% in FY19 TP (12 mths): `394 from sub-10% pre-FY10. We expect Minda to focus on themes of safety, Upside (%): 9 premiumisation, emission standards, car connectivity and EVs to drive outperformance over OEM growth in the coming decade. Portfolio Flags additions like LED lightings, sensors, seatings etc. would drive revenue outperformance over OEMs in FY21-24E. TP of `394 implies ~21x FY23E Accounting: AMBER earnings. Risks: Wrong acquisitions and higher competition. Predictability: RED Competitive position: STRONG Changes to this position: POSITIVE Earnings Momentum: RED Seamless scaling up with improved capital efficiency Performance Minda expanded revenue ~9x in FY10-20 led by continuous improvement in kit Sensex MNDA value/vehicle (~100bps increase/year), driving ~24% revenue CAGR vs OEM 150 volume CAGR of ~6%. Along with strong revenue growth, MNDA was able to 125 increase EBITDAM ~400bps having first mover advantage and leadership across 100 key sunrise products. Thus having scale and pricing power it is able to quickly stabilize profitability in new businesses. MNDA with net-debt/equity sub-0.5x, 75 improved ROE from sub-10% to ~20-25% and grew net worth ~8x over FY09- 50 Continued focus on diversifying portfolio; increasing kit value/vehicle Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-19 Aug-20 Nov-19 Minda has continued to focus on diversifying portfolio of offerings based on May-20 strategy of pillars of premiumisation, emission, safety and EVs/car connectivity. Thus over and above ~7.5% domestic OEM volume CAGR in FY21-31E, MNDA would target ~10% kit value/vehicle CAGR via product additions. This was led Source: Bloomberg, Ambit Capital research by M&A/JVs to get access to technology, briskly indigenizing the products, MNDA revenue up ~9x in FY10-20 making them affordable and scaling them up. Thus in addition to commoditized legacy offerings of automotive switches, horns and halogen lightings, Minda’s 60 55 portfolio transitioned to products like sensors/telematics, LEDs, air-bags, alloy- 50 40 wheels etc. 30 22 bn Scaling up having a domino effect on pricing, profitability and cash flows ` 20 6 A new product takes 12-18 months for Minda to scale up and then deliver target 10 3 profitability post achieving desirable operating leverage. Thus scale, pricing and 0 profitability are pretty well inter-related for Minda, giving advantage in terms of FY06 FY10 FY15 FY20 ability to come out with new products at affordable prices. This we believed resulted in Minda scaling up revenue by 9x in past decade along with improving EBITDAM from ~6% to ~12% and subsequently ROE from ~sub-10% to ~25% in FY19. Going ahead, we expect Minda to follow the same principle of scaling Source: Company, Ambit Capital research up size using internal accruals (both organic/M&As) and keep debt/equity under 0.5x. Strong growth+ healthy balance sheet = premium valuation multiples Over FY21-25, we expect revenue to post ~22% CAGR, EBITDAM to revive ~450bps to ~13%, and pre-tax RoCE to reach ~26% (attained last in FY18). Research Analysts Minda is focused towards diversifying portfolio by bringing in new components in order to benefit from needs generated by premiumisation, safety, emission Basudeb Banerjee and EVs. With controlled capital allocation and well managed capital structure, [email protected] Minda has the capability to scale up and remain resilient in terms of capital Tel: +91 22 6623 3141 efficiency, justifying Minda’s premium earnings multiples (20-25x vs 16x median Karan Kokane for auto component peers). We have a BUY on Minda with DCF based PT of [email protected] `394, implying ~21x FY23E earnings vs. earnings CAGR of ~50% in FY20-23E. Tel: +91 22 6623 3028 Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Minda Industries Exhibit 1: High growth rate with rising RoCE led by improvement in kit value/vehicle through steady portfolio enrichment MNDA consolidated revenue (Rs bn) Growth (RHS) Adding new products like alloy-wheels, air-bags, 82 75 60% Gradually gaining wallet sensors 72 A commoditized diversified 50% component supplier to share and doing small ticket 59 62 55 54 40% domestic OEMs acquisitions 52 45 30% 42 34 20% 32 22 25 10% 17 22 13 0% 9 12 12 3 3 4 4 6 -10% 2 -20% FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E Source: Company, Ambit Capital research Exhibit 2: Key stages of Minda’s evolution; wallet share gains and JVs/acquisitions key elements of growth Time period Phase Key developments . Minda group started its auto parts business in 1958 as a supplier of ammeters to Royal Enfield and by 1995 had diversified into switches, lights and horns. A commoditized portfolio with Post separating into two businesses, under the banner of Uno Minda (MNDA) and Spark Pre-FY09 . OEM-driven growth Minda (Minda Corp), MNDA slowly diversified into automotive batteries, blow moulding and CNG kits. . In this phase it was largely an OEM driven entity with a commoditized portfolio. . In this phase, MNDA consolidated its portfolio with focus on gaining wallet share of key customers like Maruti Suzuki, Toyota, Honda 2Ws, RE etc. It also added exports, 2W LED Started gaining wallet share and lighting /4W alloy wheels to its portfolio in this stage. FY10-15 undertook diversification exercise . Despite mid-single digit growth of key OEM customers, MNDA was able to report ~22% revenue CAGR. EBITDA margin improved ~400bps to ~10% led by higher scale and better mix. MNDA entered the fast track growth trajectory led by 1) higher scale of its highly profitable Higher focus on new products . FY16-present 4W alloy wheels business 2) addition of 4W switch business 3) addition of JVs/tie-ups related through JVs/acquisitions to sensors (RPAS), airbags, telematics etc. Source: Company, Ambit Capital research Exhibit 3: Key financial parameters ` mn FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenue 11,575 13,168 16,726 21,795 25,273 33,863 44,706 59,081 54,651 Growth YoY (%) 24% 14% 27% 30% 16% 34% 32% 32% -7% Net profit 287 282 72 680 1,111 1,652 3,102 2,856 1,550 EPS (`) 1.2 1.2 0.3 2.9 4.7 6.9 11.9 10.9 5.9 CFO 1,504 945 45 938 2,209 3,042 3,223 3,209 10,504 CFO-EBITDA (%) 198% 101% 6% 61% 93% 81% 60% 44% 170% FCF 373 (309) (877) 638 (1,541) (1,613) (3,647) (3,499) 2,067 Net debt/equity (x) 0.3 0.4 0.7 0.5 0.7 0.1 0.3 0.5 0.4 CE turnover (x) 2.7 3.0 3.3 3.9 3.8 3.7 2.9 2.6 2.0 GB Turnover (x) 2.4 2.6 2.1 2.1 2.1 2.2 2.6 2.9 2.0 RoE (%) 10% 9% 2% 19% 26% 27% 29% 18% 9% ROCE* (%) 11% 12% 7% 16% 22% 25% 26% 23% 13% Capex 1,131 1,254 922 300 3,750 4,655 6,870 6,708 8,436 Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total capital including cash in the denominator. August 26, 2020 Ambit Capital Pvt. Ltd. Page 132 Minda Industries Exhibit 4: Mapping Minda industries and peers on IBAS Strategic Overall Company Innovation Brand Architecture Comments asset rank Strong relationships with global marquee OEMs and leadership in key business segments of domestic wiring harness (~65% market share), mirrors (~30% of global rear- view mirrors) and plastics (~10-30% of polymer products in Motherson Sumi Europe) are some of MSS’s key strengths. Additionally, strong R&D capabilities at SMRPBV (~3% of revenue) results in ~2% R&D/sales at consolidated level (vs peers at ~1%) signifying thrust on innovation. BHFC is India’s largest manufacturer and exporter of forging components with a global forging capacity of ~625ktons p.a. and manufacturing facilities spread across India, Germany, Sweden and the US. Over the years, BHFC has diversified its exposure from CV forging to PV, O&G, railway, industrial Bharat Forge forging etc. to increase stability in its business. However, its exposure to cyclical segments remains at ~65% even today. Strong relationships with OEMs, access to superior technology and vertically integrated capabilities would aid BHFC in maintaining its leadership in the forgings space. SFL’s ability to maintain cross-cyclical RoCE at ~18%+ through stringent cost control and focus on quality is amongst the best in the industry. With ~60% of manpower being temporary, SFL has the capability to maintain EBITDAM across cycles. Further, continuation of shift in mix towards higher value-added products like specialized fasteners along with Sundram diversification into newer products/markets (management Fasteners plans to derive ~20% of annual revenue from new products/customers) is expected to drive higher revenue and EBITDAM for SFL. SFL plans to increase exports to ~50% of revenue in 2-3 years (~33% now) by offering new products to existing customers in the US and diversifying from US (~85% of exports now) to Europe and other geographies. MNDA’s revenue has grown at 2-4x OEM volume growth over the last decade by adopting the strategy of continuous portfolio enrichment via organic/inorganic additions to drive higher kit value/vehicle. MNDA will continue to invest in sunrise products and benefit with increase in scale, thus Minda Ind. maintaining post-tax RoCE above 18%. MNDA will continue to benefit from its superior R&D capabilities (~4% of sales vs peers at ~1%) along with diversified presence across 2W/4Ws and leadership in automotive switches, acoustics and 4W alloy wheels. We expect premiumisation, regulatory changes, emission control and electrification to drive growth for MNDA. MCIE is too small to get established on the IBAS framework as it is still in its evolution stage since its creation in FY14. MCIE has been focussing on acquisition-led growth and has thus been obtaining new technologies/products by paying Mahindra CIE goodwill. Further, access to CIE's processes/product technologies and manpower expertise provides MCIE with unique advantage of bringing in best-in-class practices to drive RoCE. Thus, MCIE is all set to scale up into a diversified components player with superior technical knowhow. Varroc’s globally diversified pool of plants in low-cost countries, each focussed on cost and quality, are its key strategic assets. Strong relationship with marquee global OEMs like Tesla, Daimler, JLR, VW etc. and leading 2W players in India (Bajaj Auto contributes >50% revenue of India Varroc business) besides focus on R&D and innovation make it a Engineering preferred supplier. With the capex cycle now almost complete, VLS is set to benefit from rise in scale in FY22 post the pandemic disruption. Introduction of BS6-led products like catalytic convertors, electronic fuel injection systems (EFIs), magnetos etc. is set to benefit its India business other than diversification of customer base and cross-selling of products. Source: Company, Ambit Capital research Note: - Strong; - Relatively Strong; - Average; - Relatively weak August 26, 2020 Ambit Capital Pvt. Ltd. Page 133 Minda Industries Exhibit 5: Competitive mapping of Minda with domestic auto ancillary players Pre-tax Pre-tax CFO/ FY20 Revenue CAGR EBITDA Capex/CFO Company RoCE EBITDA revenue FY11-20 Margin (FY20) (FY11-20) (FY20) (FY11-20) Motherson Sumi 635,369 25% 8% 10% 111% 90% Bharat Forge 80,558 9% 14% 8% 69% 77% Sundram Fasteners 37,232 8% 16% 15% 63% 86% Minda Ind. 54,651 24% 11% 13% 89% 133% Mahindra CIE 79,078 20% 12% 11% 74% 235% Varroc Engineering 111,219 15%* 7% 3% 106%* 88%* Source: Company, Ambit Capital research* FY13-20 due to recent IPO Exhibit 6: P/B on a downward trend recently due to the Exhibit 7: Minda has significantly outperformed NSE Auto lockdown; now way below 3-year rolling average Index due to ability to briskly scale up JVs/acquisitions 16 Trailing P/B (x) 3-yr rol. P/B NSE Auto Index MNDA 14 2,500 12 2,000 10 8 1,500 6 1,000 4 2 500 0 - Apr-15 Apr-16 Apr-17 Apr-18 Apr-19 Apr-20 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19 Aug-20 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19 Aug-20 Source: Company, Ambit Capital research, Bloomberg Source: Company, Ambit Capital research, Bloomberg Exhibit 8: Revenue posted ~21% CAGR in FY12-20 led by Exhibit 9: Improving scale and ability to swiftly ramp-up product portfolio expansion via acquisitions/JVs target companies have driven EBITDAM growth Ex-standalone revenue (Rs bn) Standalone revenue (Rs bn) EBITDA margin Gross margin (RHS) 3-yr roll rev CAGR (RHS) 80 30% 14% 45% 25% 12% 60 40% 20% 10% 40 15% 35% 8% 10% 20 30% 5% 6% 0 0% 4% 25% FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 134 [email protected] 2020-12-07 Monday 13:17:41 Minda Industries Exhibit 10: Scaling up without increasing debt on books; Exhibit 11: GB turnover rose from ~2.1x in FY14 to ~2.9x net-debt/equity down to ~0.4x in FY20 from ~0.7x in FY14 in FY19 before declining to ~2x in the current slowdown CFO (Rs bn) FCF (Rs bn) GB Turnover (x) WC turnover (x) (RHS) Net debt equity (x) (RHS) 15 0.8 3.5 40 35 3.0 10 0.6 30 2.5 5 0.4 25 2.0 20 0 0.2 1.5 15 FY14 FY15 FY16 FY17 FY18 FY19 FY20 (5) - FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 12: RoCE up ~1600bps in FY14-19; drop in RoCE in Exhibit 13: EBITDA/employee rising with improvement in FY20 led by fall in asset turns due to weak demand employee efficiency and cost control pre-tax ROCE (%) RoE (%) EBITDA (Rs bn) EBITDA/employee (Rs '000) (RHS) 35% 8 2,000 30% 25% 6 1,500 20% 4 1,000 15% 10% 2 500 5% 0% 0 0 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 14: Explanation for our flags Field Score Comments Minda’s accounting score decile (Ambit framework) is currently D8. While it has improved from D9 in FY18, it is still lower than D3 assigned in FY15. The factors which drag the decile rating are: 1) weak Accounting AMBER FCF/cumulative revenue for the last six years led by higher capex in recent years and lower margin in earlier years, 2) Higher advances to related parties/CFO. We assign an Amber Flag. Addition of 2W alloy wheels plant, brisk scale-up of Delvis acquisition and orders from key Japanese OEMs, and addition of Harita seats from 2HFY21 will limit earnings decline. However, uncertainty due to Predictability RED Covid-19 persists, and if further lockdowns are imposed given rising cases in India, asset utilization and RoCE may be significantly hit. Thus, we assign a Red flag. Consensus EPS estimates for FY21 have declined by ~59% in the past 6 months led by the impact of Earnings momentum RED Covid-19 lockdown in India further weakening demand outlook. Thus, we assign a Red flag. Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 135 Minda Industries HAWK scores While Minda’s forensic score has weakened from “Zone of Safety” in FY15 (D3) to “Zone of Darkness” in FY19 (D8), its greatness score has improved from “Good, not great” (~58%) in FY15 to “Zone of Greatness” (~75%) in FY19. Key contributors to accounting score and comparison to peers Minda features in the D8 decile on our accounting framework, or the ‘Zone of Darkness’ decile. Key contributors to its relatively weak accounting score include: 1) low cumulative FCF/median revenue 2) high advances to related parties/CFO. We expect cumulative FCF/median revenue to improve sharply from FY22E on a low base of FY21E led by rising production of key OEMs, controlled capex other than the structural cost savings initiatives resulting in leaner cost structure. In comparison to peers, Minda scores lower than median accounting score, with score better than ~29% of the larger universe and ~20% of the sector. Exhibit 15: Forensic accounting score contributors Exhibit 16: Forensic score percentile vs sector and universe Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Comments on evolution of accounting score Minda’s forensic score has weakened from “Zone of Safety” in FY15 (D3) to “Zone of Darkness” in FY19 (D8). However, we expect improvement in Minda’s forensic score from FY22E led by improvement in cumulative FCF to median revenue ratio with revival in demand for key automotive customers along with improved FCF. August 26, 2020 Ambit Capital Pvt. Ltd. Page 136 Minda Industries Exhibit 17: Forensic accounting score evaluation Exhibit 18: Movement in accounting checks Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 60% 44% 170% Volatility in depreciation P & L mis-statement 106bps 221bps -44bps checks rate PFD-% of Debtors more N.A. N.A. N.A. than six months Cash yield 5% 4% 4% Balance sheet Change in reserves (ex mis-statement sec-prem)/(PAT ex 2.1 0.9 0.6 checks dividend) Cont Liab-% of NW 0% 0% 1% Misc. exps-% of total revs 1% 1% 1% Adv. to related parties / 0% 0% 0% Pilferage checks CFO CWIP: Gross Block 13% 6% 12% Cum. FCF/median revs -29% -33% -18% Audit quality CAGR in auditor's 0.0 -0.3 0.1 checks remn/CAGR in cons. Rev. Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.) Minda’s greatness score has improved from “Good not great” (~58%) in FY15 to “Zone of Greatness” (~75%) in FY19. Minda’s greatness score is higher than ~74% of the sector and ~83% of the larger universe. Key contributors to high greatness include robust topline growth, strong operating margin and a low net-debt/equity. Exhibit 19: Greatness score contributors Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 137 Minda Industries Exhibit 20: Greatness score percentile vs sector and universe Exhibit 21: Greatness score evolution Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 138 Minda Industries Balance sheet (consolidated) Year to March (` mn) FY18 FY19 FY20 FY21E FY22E FY23E Shareholders' equity 174 524 524 544 544 544 Reserves & surpluses 13,743 16,517 17,633 20,201 23,062 27,512 Total networth 13,917 17,042 18,157 20,746 23,606 28,056 Minority Interest 2,110 2,667 2,828 2,928 3,278 3,678 Debt 5,429 9,555 9,975 9,975 7,975 4,975 Deferred tax liability (186) 6 135 135 135 135 Total liabilities 21,269 29,270 31,096 33,784 34,995 36,845 Gross block 16,528 23,842 30,209 38,209 42,709 48,209 Net block 13,505 18,612 21,960 26,138 26,188 26,687 CWIP 2,108 1,501 3,571 3,571 3,571 3,571 Investments (non-current) 1,552 3,556 3,722 3,722 3,722 3,722 Cash & equivalents 1,595 1,101 3,278 1,499 2,123 3,087 Debtors 7,899 8,992 7,264 7,101 9,595 11,514 Inventory 4,175 5,610 5,553 5,030 6,737 8,084 Loans & advances 2,633 2,935 3,042 3,289 3,556 3,844 Total current assets 16,302 18,638 19,137 16,918 22,010 26,529 Current liabilities 10,768 11,607 16,156 15,317 19,127 22,162 Provisions 1,430 1,430 1,137 1,247 1,368 1,501 Total current liabilities 12,198 13,037 17,293 16,564 20,495 23,663 Net current assets 4,104 5,601 1,844 354 1,515 2,865 Total assets 21,269 29,270 31,096 33,784 34,995 36,845 Source: Company, Ambit Capital research Income statement (consolidated) Year to March (` mn) FY18 FY19 FY20 FY21E FY22E FY23E Net Sales 44,706 59,081 54,651 53,995 74,513 89,416 % growth 32% 32% -7% -1% 38% 20% Raw material (RM) expenditure 27,632 36,225 32,841 31,444 44,544 54,038 RM/Sales 62% 61% 60% 58% 60% 60% Staff cost 5,868 7,913 8,468 9,738 11,199 12,878 Staff cost/Sales 13.1% 13.4% 15.5% 18.0% 15.0% 14.4% Other expenses 5,868 7,691 7,151 8,223 9,457 10,874 Other expenses/Sales 13.1% 13.0% 13.1% 15.2% 12.7% 12.2% Operating expenditure 39,367 51,829 48,460 49,405 65,199 77,790 EBITDA 5,338 7,252 6,192 4,590 9,314 11,625 % growth 43% 36% -15% -26% 103% 25% Depreciation 1,649 2,344 3,019 3,821 4,450 5,000 EBIT 3,690 4,908 3,173 768 4,864 6,625 Interest expenditure 351 632 902 698 558 323 Non-operating income 334 270 252 350 400 500 Reported PBT 3,672 4,547 2,522 420 4,705 6,802 Tax 977 1,341 775 111 1,176 1,700 Reported PAT/ Net profit 2,695 3,206 1,747 309 3,529 5,101 before MI Minority Interest/Share of JVs 24 (350) (198) (50) - 100 Reported PAT/ Net profit after 2,720 2,856 1,550 259 3,529 5,201 MI Exceptionals 382 - - - - - Adjusted PAT/ Net profit after 3,102 2,856 1,550 259 3,529 5,201 MI Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 139 [email protected] 2020-12-07 Monday 13:17:41 Minda Industries Cashflow statement (consolidated) Year to March (` mn) FY18 FY19 FY20 FY21E FY22E FY23E Net Profit Before Tax 3,672 4,547 2,522 420 4,705 6,802 Depreciation 1,649 2,344 3,019 3,821 4,450 5,000 Others 407 (350) (198) (50) - 100 Tax (977) (1,341) (775) (111) (1,176) (1,700) (Incr) / decr in net working capital (1,528) (1,991) 5,935 (289) (537) (386) Cash flow from operations 3,223 3,209 10,504 3,791 7,442 9,815 Capex (net) (6,870) (6,708) (8,436) (8,000) (4,500) (5,500) (Incr) / decrease in investments (441) (2,004) (166) - - - Cash flow from investments (7,311) (8,711) (8,602) (8,000) (4,500) (5,500) Net borrowings 1,044 4,126 420 - (2,000) (3,000) Interest paid Dividend paid (265) (337) (123) - (318) (350) Others 1,161 2,512 (3,777) - - - Issue of Equity 1 - - 2,430 - - Cash flow from financing 1,941 6,301 (3,480) 2,430 (2,318) (3,350) Net change in cash (2,147) 799 (1,579) (1,779) 624 965 Free cash flow (3,647) (3,499) 2,067 (4,209) 2,942 4,315 Source: Company, Ambit Capital research Ratio analysis (consolidated) Year to March (%) FY18 FY19 FY20 FY21E FY22E FY23E EBITDA margin 11.9% 12.3% 11.3% 8.5% 12.5% 13.0% EBIT margin 8.3% 8.3% 5.8% 1.4% 6.5% 7.4% Net profit margin 6.0% 5.4% 3.2% 0.6% 4.7% 5.7% Net debt: equity (x) 0.3 0.5 0.4 0.4 0.2 0.1 RoCE (pre-tax) 26% 23% 13% 4% 17% 22% RoCE (post-tax) 19% 16% 9% 3% 13% 16% RoE 29% 18% 9% 1% 16% 20% Fixed Asset Turnover (x) 2.55 2.93 2.02 1.58 1.84 1.97 Asset Turnover (x) 2.4 2.3 1.8 1.7 2.2 2.5 Working Capital days 20.5 27.8 (9.6) (7.7) (3.0) (0.9) Gross margin 38.2% 38.7% 39.9% 41.8% 40.2% 39.6% DPS (`) 0.9 1.1 0.4 - 1.0 1.1 Payout Ratio 7.8% 10.1% 6.8% 0.0% 7.7% 5.8% Source: Company, Ambit Capital research Valuation parameters (consolidated) Year to March FY18 FY19 FY20 FY21E FY22E FY23E EPS (`) 11.9 10.9 5.9 1.0 13.0 19.1 Diluted EPS (`) 12 11 6 1 13 19 Book value per share (`) 53.3 65.0 69.2 76.2 86.7 103.1 Dividend per share (`) 0.9 1.1 0.4 - 1.0 1.1 P/E (x) 30.4 33.1 61.1 N.M. 27.8 18.9 P/BV (x) 6.8 5.6 5.2 4.7 4.2 3.5 EV/EBITDA (x) 18.5 13.6 16.0 21.6 10.6 8.5 EV/EBIT (x) 26.8 20.2 31.2 N.M. 20.3 14.9 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 140 Pidilite Industries NOT RATED SCALABILITY THEMATIC PIDI IN EQUITY August 26, 2020 Portfolio of opportunities Consumer Discretionary Pidilite’s core strength lies in building innovative products and backing Recommendation them with right amount of advertising, user education and engagement, Mcap (bn): `743/US$10.0 and right distribution channel. Pidilite’s strength in: a) adhesives and waterproofing categories which can grow 1-2x of GDP and 2-4x of GDP 3M ADV (mn): `1,502/US$20.2 respectively, b) forays into new categories in construction materials CMP: `1,463 category, and c) deepening distribution in rural, B2B and international TP (12 mths): NOT RATED markets could help it replicate 15% EBITDA CAGR over last decade in Upside (%): NA next too. A professionalized management team should act as a catalyst. Covid brings new challenges to already under pressure real estate/home Flags building market growth, impacting near-term growth rate but long-term scalability is not a challenge. 1-year forward consensus P/E of 61x is at Accounting: AMBER 22% premium to last 3-year average 1-year fwd P/E despite bleak Predictability: AMBER revenue/EPS CAGR of 8%/11% (consensus) over FY20-23. Earnings Momentum: RED Competitive position: STRONG Changes to this position: NEUTRAL Performance Healthy consistent growth Pidilite SENSEX Pidilite cultivated umbrella brands in adhesives (Fevicol), waterproofing (Fixit) 140 and art materials (Fevicryl) and drove multiple variants under those which 120 worked well. Until 2007, the franchise was largely family-run and Fevicol (and 100 extensions) dominant. Bringing in Bharat Puri on the Board and hiring 80 experienced professional talent (2008) aided scalability. Forays into international 60 geographies and set-up of multiple JVs with technology partners (though a 40 mixed bag) have added new growth drivers. This led to sales/EBITDA CAGR of Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 13%/15% over last decade; margins improved led by better pricing power of Sep-19 Dec-19 Mar-20 Aug-19 Nov-19 May-20 these brands also drove RoCE from 20% to 22%. Scalability: Right solutions, advertising and right influencer engagement Source: Bloomberg, Ambit Capital research Strong brand equity, consistent user engagement, high stake performance products alongside distribution reach drive scalability. From inception, Pidilite Pidilite’s revenue reported 16% built exceptional brand recall via advertising (~4% of sales in last decade) across CAGR during FY05-20 brands. Customer education on waterproofing and engagement with 80 carpenters/masons/painters on right adhesive/waterproofing are differentiators 70 that made Pidilite market leader on both waterproofing as well as adhesives. 60 Addressable market is expanding 50 bn 40 Key growth drivers over the next decade: a) increase in penetration through ` 30 distribution expansion into rural India and India-like international markets, b) 20 driving growth in adhesives categories with functional variants and new innovations (like Fevispray), b) driving adoption of waterproofing with Fixit (can 10 grow 2-4x GDP growth) and B2B forays in waterproofing services through - FY05 FY10 FY15 FY20 Nina/Percept, and c) creating new categories through innovative products such as WD40, Roof, Tenax, etc. Low penetration/consumption per capita in both waterproofing (1:20 vs. China) and adhesives (1:6 vs. China) provide long Source: Company, Ambit Capital research growth runway for both businesses. These can help replicate the previous decade’s revenue CAGR and potentially better if economic growth accelerates. Near term a challenge apart from margin tailwinds Research Analysts Weaker economic growth/real estate demand hit growth over the past few years. Covid-19 aggravates this pain and could keep near-term growth in check. Ritesh Gupta, CFA Crude-linked RM (VAM) prices decline could drive EBITDAM to the higher end of [email protected] management’s guided band of 20-24%. Lower penetration across core Tel: +91 22 6623 3242 categories and pick-up in revenues from Pioneer categories should keep growth Ashish Kanodia, CFA consistent as in the previous decade over the longer term. Valuation of 63x FY20 [email protected] EPS (consensus) is in line with that of peers like Asian Paints and may be ripe for Tel: +91 22 6623 3264 correction in line with other peers amidst slowing consumption. Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Pidilite Industries Exhibit 1: Pidilite’s last decade has seen foray into multiple new categories/businesses and professionalization of management Improvement in operational Acquired Percept, Nina Fortressing in domestic consumer efficiencies drove shift in waterproofing (B2B services). Hired facing business, acquires stake in EBITDA margins; sharp Mr. Bharat Puri, first professional Pepperfry, Homelane. New JVs to 70 60% increase in employee base CEO in Pidilite's history in 2015 (he enter new product categories and professionalizing entered board in 2008) 60 55% 50% 50 45% 40 bn 40% ` 30 35% 20 30% 10 25% - 20% FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Consumer & Bazaar Business to Business Others Pre-tax RoCE Source: Company, Ambit Capital research Exhibit 2: Over the last decade, Pidilite has institutionalized the business and is now moving towards being more consumer centric brand Time Phase Key developments period . Sharp increase in employee base and professionalizing management Institutionalizing the . Mr. Bharat Puri joins the board in 2008 FY11-14 business . Construction of Synthetic Elastomer Plant started and subsequently suspended . Entered into waterproofing application services by acquiring the business of Percept Engineers . Hired Mr. Bharat Puri - the first professional CEO in Pidilite's history . Acquired the adhesive business of Bluecoat and Nina Waterproofing Systems . Manufacturing facility at Guwahati to produce Fevikwik and M-seal commissioned Focusing on domestic FY15-17 . Initiated “Project Runway” with the objective of "preserve “what’s working well”, drive growth across businesses opportunities and address chokepoints and create strong platform for future growth." . Embarked on cost excellence program “Project Parivartan”, with an aim to review entire supply chain cost structure from manufacturing to distribution and warehousing . Made digital initiatives deeper through social media and performance marketing campaigns. Increased the use of digital videos, in the form of pre-roll YouTube ads. FY18- Being consumer centric . Invested in online furniture retailer Pepperfry and online interior design company Home Lane current . Entered into a technical collaboration with Jowat SE aimed at providing comprehensive range of Thermoplastic Hot Melt adhesives for catering to the requirements of joineries and industrial consumers Source: Company, Ambit Capital research Exhibit 3: Key financial parameters over the last decade (` mn) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues 26,439 32,849 38,979 42,832 48,441 53,612 56,168 60,784 70,787 72,945 Revenue growth (%) 21% 24% 19% 10% 13% 11% 5% 8% 16% 3% Net profits 3,100 4,828 6,419 4,564 5,303 8,028 8,600 9,624 9,249 11,186 EPS 6.0 9.4 12.5 8.9 10.3 15.7 16.8 19.0 18.2 22.0 CFO 3,218 3,671 5,175 3,939 5,520 9,075 7,938 7,964 8,448 12,796 CFO-EBITDA 0.7 0.6 0.6 0.6 0.7 0.8 0.6 0.6 0.6 0.8 FCF 1,930 2,117 3,716 2,046 1,429 7,416 6,714 6,204 5,910 8,356 Debt equity (x) 0.1 (0.0) (0.2) (0.2) (0.1) (0.2) (0.4) (0.3) (0.3) (0.2) CE turnover 1.9 2.1 2.2 2.2 2.2 2.0 1.7 1.6 1.7 1.5 GB Turnover 2.6 2.9 3.2 3.2 3.0 3.0 2.9 3.0 3.3 3.0 RoE (%) 32% 40% 43% 25% 25% 40% 31% 32% 27% 29% ROCE* (%) 31% 39% 47% 33% 32% 44% 38% 35% 32% 33% Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE August 26, 2020 Ambit Capital Pvt. Ltd. Page 142 Pidilite Industries Exhibit 4: Competitive mapping of Pidilite with peers like Asian Paints, Havells, Cera and Supreme FY20 revenue Revenue CAGR EBITDA Pre-tax Pre-Tax CFO/ Capex/CFO Company (` mn) FY11-20 Margin (FY20) RoCE (FY20) EBITDA (FY11-20) (FY11-20) Pidilite 72,945 12% 22% 33% 93% 33% Asian Paints 205,156 11% 22% 32% 90% 41% Havells 95,537 14% 12% 22% 99% 59% Cera 12,419 20% 14% 15% 84% 74% Supreme 55,113 9% 15% 24% 93% 56% Source: Company, Ambit Capital research Exhibit 5: Mapping Pidilite and its peers on IBAS Brand Architecture Strategic Overall Company Innovation Manufacturing Distribution Comments Rural Urban asset rank reach reach Pidilite has been the pioneer in new category creation Pidilite and increasing its total addressable market with track record of building successful brands. Asian Paints is moving from a paints-centric company Asian to an overall home décor company. However, it is yet Paints to prove its dominance in the new categories. Havells is present across product categories (white goods as well as brown goods) and have presence across B2B and B2C segments with multiple sub- Havells brands. Its distribution and retail reach is one of the best amongst its peers and is second only to Bajaj Electricals. Cera has a mid-segment brand recall and manufacturing is centred on a single location. Its Cera unique advantage is the access to administered gas, which is 30% cheaper than spot gas. Supreme has built a deep distribution network and enjoys a great brand-recall in rural as well as urban Supreme market. Innovation on products like Silpaulin has been the key differentiating innovations. However, succession uncertainty remains a concern. Source: Company, Ambit Capital research Note: - Strong; - Relatively Strong; - Average; - Relatively weak Exhibit 6: Pidilite’s Trailing P/E evolution Exhibit 7: Pidilite’s price performance v/s Sensex TTM P/E 3yr avg Pidilite Share Price SENSEX 90 1,400 80 1,200 70 60 1,000 50 800 40 600 30 400 20 10 200 0 - Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19 Aug-20 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19 Aug-20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 143 Pidilite Industries Exhibit 8: Pidilite’s revenue CAGR was 9% during FY14-20 Exhibit 9: Pidilite’s GM/EBITDAM has improved by 8.5ppt/5.9ppt over FY14-20 Consumer & Bazaar Business to Business Others 3yr revenue CAGR Gross margin (LHS) EBITDA margin (RHS) 70 20% 55% 24% 60 22% 15% 52% 50 20% 40 49% 18% bn 10% ` 30 46% 16% 20 5% 14% 43% 10 12% - 0% 40% 10% FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company Exhibit 10: Pidilite has consistently generated positive FCFF Exhibit 11: WC turnover has declined led by increase in during FY14-20 cash conversion days Gross block turnover WC turnover CFO FCFF Net D/E 12 14 - 10 12 (0.1) (0.1) 10 8 (0.2) 8 (0.2) 6 bn ` 6 (0.3) (0.3) 4 4 (0.4) 2 2 (0.4) 0 (0.5) 0 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company Exhibit 12: RoCE and RoE have moderated due to mixed Exhibit 13: Employee productivity has improved led by performance of new JVs and international forays shift in EBITDA margins band RoCE (pre-tax) RoE EBITDA (LHS) EBITDA/employee (RHS) 50% 18 3.0 45% 16 2.5 40% 14 12 2.0 35% 10 mn 1.5 mn 30% ` 8 ` 25% 6 1.0 4 20% 0.5 2 15% - - FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 144 [email protected] 2020-12-07 Monday 13:17:41 Pidilite Industries Exhibit 14: Explanation for our flags Segment Score Comments Pidilite falls in zone of darkness in our accounting decile primarily due to its high CWIP/Gross Block, high miscellaneous Accounting AMBER expense and low cash conversion. Pidilite’s revenue is closely linked to growth in real estate sector along with discretionary spending by consumers. Given Predictability AMBER current scenario of economic slowdown and tepid consumer sentiment, revenue growth over short periods of time is difficult to track. Earnings RED Consensus has revised EPS for FY21/FY22 by -26%/-15% in the last 6 months. momentum Source: Ambit Capital research HAWK scores – Below sector average Pidilite featured in the Zone of Darkness (D9 deciles) from FY17 to FY19 after slipping from Zone of Safety (D5 decile) in FY16. Pidilite also scores lower than the median accounting score for its sector. It scores higher on our greatness parameters as well compared to peers and larger universe and have consistently featured in the ‘Zone of Greatness’ during FY15-19. It posted a slight deterioration in greatness score in FY17 and since then has remained constant. Key contributors to accounting score and comparison to peers Pidilite features in D9 decile on our accounting framework, which is also a ‘Zone of Darkness’ decile. Key contributors to its relatively weak accounting score include low cash flow conversion (CFO/EBITDA), high CWIP/gross block, high CAGR in auditor’s remuneration vis-à-vis revenue CAGR, high miscellaneous expense as % of revenue and low cash yields. Pidilite’s accounting ratios on CWIP/gross block, cash flow conversion (CFO/EBITDA), miscellaneous expense as % of revenue and cumulative FCF as a percentage of median revenue improved in FY20 vs FY19. Exhibit 15: Forensic accounting score contributors Exhibit 16: Forensic score percentile to larger universe and sector Source: Ambit Capital research Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 145 Pidilite Industries Comments on evolution of accounting score Pidilite has featured in the Zone of Darkness (D9 deciles) from FY17 to FY19 after slipping from Zone of Safety (D5 decile) in FY16. It is pertinent to note here that our framework consists of a higher number of ratios which capture the cash generation abilities of the businesses. Owing to rapid expansion and capacity building, cash flow conversion has been impacted, which penalised Pidilite on our framework. Exhibit 17: Forensic accounting score evaluation Exhibit 18: Movement in accounting checks – Likely to improve on accounting score in FY20 Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 91% 92% 106% P & L mis- Volatility in depreciation -18 31 83 statement rate (bps) check PFD - % for debtors NA NA NA beyond credit period Cash yield 10.5% 8.4% 7.9% Balance sheet Change in reserves (ex mis-statement sec-prem)/(PAT ex 0.3 1.1 1.0 checks dividend) Cont Liab-% of NW 7.3% 7.5% 7.7% Misc. exps-% of total revs 3.3% 3.5% 3.0% Adv. to related parties / 0% 0% 0% Pilferage CFO checks CWIP/Gross Block 11% 11% 10% Cum. FCF/median revs 54% 54% 62% Audit quality CAGR in auditor's 1.1 0.8 1.2 checks remn/CAGR in Rev. Source: Ambit Capital research, Company Source: Ambit Capital research, Company Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover, etc.). Pidilite has been consistently ranked in the Zone of Greatness over the years and has performed significantly better on ‘Greatness’ as compared to the larger universe or its sector peers. Exhibit 19: Greatness score contributors Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 146 Pidilite Industries Exhibit 20: Greatness score percentile to larger universe Exhibit 21: Greatness score evolution and sector Source: Ambit Capital research Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 147 Pidilite Industries Balance sheet (consolidated) ` mn unless mentioned FY16 FY17 FY18 FY19 FY20 Share capital 513 513 508 508 508 Reserves and surplus 25,867 34,196 35,233 40,973 44,048 Total Networth 26,380 34,709 35,740 41,481 44,556 Loans 800 975 1,226 1,111 1,691 Lease liability - - - - 1,115 Minority Interest 434 1,273 1,750 2,072 2,157 Deferred tax liability (net) 753 877 1,107 1,201 693 Sources of funds 28,367 37,835 39,823 45,864 50,211 Net block 10,040 11,411 11,648 12,626 14,757 Lease asset - - - - 1,470 Goodwill 1,334 1,338 1,774 1,850 1,840 Capital work-in-progress 1,581 1,480 2,277 2,421 2,593 Investments 7,055 14,431 12,459 15,477 11,862 Cash and bank balances 1,317 999 1,636 1,904 7,033 Total Current Assets 15,811 18,044 22,250 24,866 25,672 Current liabilities and provisions 8,772 9,870 12,222 13,281 15,016 Net current assets 7,039 8,175 10,028 11,586 10,657 Application of funds 28,367 37,835 39,823 45,864 50,211 Source: Company, Ambit Capital research Income statement (consolidated) ` mn unless mentioned FY16 FY17 FY18 FY19 FY20 Revenue 53,694 56,168 60,784 70,787 72,945 yoy growth 11% 5% 8% 16% 3% Total expenses 41,893 43,570 47,372 57,105 57,185 EBITDA 13,494 12,598 13,412 13,682 15,760 yoy growth 72% -7% 6% 2% 15% Depreciation 1,005 1,151 1,199 1,327 1,699 EBIT 12,489 11,447 12,213 12,355 14,061 Interest and financial charges 133 139 155 261 336 Other income 778 1,123 1,484 1,466 1,494 Adj PBT 13,134 12,430 13,542 13,560 15,219 Provision for taxation 3,335 3,851 3,927 4,132 3,477 Adjusted PAT 9,807 8,596 9,628 9,384 11,619 yoy growth 86% -12% 12% -3% 24% Reported PAT 9,831 8,600 9,624 9,249 11,186 EPS basic (`) 19.2 16.8 19.0 18.2 22.0 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 148 Pidilite Industries Cash flow statement (consolidated) ` mn unless mentioned FY16 FY17 FY18 FY19 FY20 PBT 11,408 12,483 13,542 13,380 14,698 Depreciation 1,005 1,151 1,199 1,327 1,699 Interest paid 133 139 155 261 336 CFO before change in WC 12,227 13,069 14,014 14,332 16,161 Change in working capital (12) (1,398) (1,774) (1,791) 565 Direct taxes paid (3,140) (3,733) (4,276) (4,093) (3,931) CFO 9,075 7,938 7,964 8,448 12,796 Net capex (1,659) (1,224) (1,760) (2,538) (4,439) Net investments (3,296) (7,690) 2,952 (2,848) 4,713 Interest received 43 59 74 93 125 CFI (4,911) (8,790) 393 (5,131) 1,029 Proceeds from borrowings 50 (7) 39 11 (120) Change in share capital 339 807 (4,808) 287 28 Interest & finance charges paid (133) (139) (155) (167) (254) Dividends paid (4,032) (316) (2,930) (3,635) (8,254) CFF (3,710) 407 (7,898) (3,606) (8,492) Net increase in cash 453 (445) 459 (289) 5,333 FCF 7,416 6,714 6,204 5,910 8,356 Source: Company, Ambit Capital research Ratio analysis (consolidated) FY16 FY17 FY18 FY19 FY20 EBITDA margin (%) - ex. OI 25.1% 22.4% 22.1% 19.3% 21.6% EBIT margin (%) - ex. OI 23.3% 20.4% 20.1% 17.5% 19.3% PBT margin (%) 24.5% 22.2% 22.4% 19.0% 20.1% Net profit margin 18.3% 15.3% 15.8% 13.3% 15.9% Net debt to Equity (x) (0.2) (0.4) (0.3) (0.3) (0.2) Working capital turnover 8.8 7.3 6.7 6.6 6.6 Gross block turnover 2.9 3.1 3.3 3.5 3.2 Pre-tax CFO/EBITDA (%) 91% 93% 91% 92% 106% Capex/post-tax CFO 19% 17% 22% 31% 37% Pre-tax RoCE 41% 40% 31% 29% 30% RoE 40% 31% 32% 27% 29% Source: Company, Ambit Capital research Valuation parameters (consolidated) Valuation parameters FY16 FY17 FY18 FY19 FY20 EPS (`) 19.2 16.8 19.0 18.2 22.0 BVPS (`) 51.5 67.7 70.4 81.7 87.7 P/E (x) 76.8 87.8 77.7 80.8 66.9 P/BV (x) 28.6 21.7 20.9 18.0 16.8 EV/EBITDA (x) 54.7 58.6 55.0 54.0 46.8 EV/EBIT (x) 59.1 64.5 60.4 59.7 52.5 Price/Sales (x) 13.9 13.3 12.3 10.6 10.3 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 149 [email protected] 2020-12-07 Monday 13:17:41 Pidilite Industries This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 150 Prestige Estates NOT RATED SCALABILITY THEMATIC PEPL IN EQUITY August 26, 2020 Set the floor to rise higher Real Estate Incorporated in 1986, Prestige is one of the leading South-based RE Recommendation developers. It has completed >245 projects covering 134msf across Mcap (bn): `94/US$1.3 residential, commercial, retail, hospitality and plotted development. Over the last decade, Prestige has forayed into other micro-markets (ex- 3M ADV (mn): `211/US$2.81 South) like MMR/NCR to expand its portfolio. In the next decade, we CMP: `235 believe this scalability will continue given: (i) industry consolidation in TP (12 mths): NA favour of large developers; (ii) ongoing/under-planning projects include Downside (%): NA exposure to new micro-markets; and (iii) optimistic long-term outlook for commercial RE (>30% of ongoing + upcoming projects). PEPL trades at Flags 7.4x TTM EV/EBITDA (40% below past 3-year average) given Covid disruption, implying favourable valuations. Key risk: Delay in sales and Accounting: AMBER UC projects due to Covid; micro-market concentration risks. Predictability: AMBER Earnings Momentum: AMBER Competitive position: STRONG Changes to this position: POSITIVE Scalability driven by brand recall, strong architecture Performance: Prestige Estate vs Commencing operations in Bengaluru (1986), Prestige successfully extended its Sensex expertise in other South micro-markets including Kochi, Chennai and Hyderabad Sensex Prestige Estates in 2007. Within the segment, Prestige also expanded its portfolio in line with 160 140 industry trends (entered affordable housing in FY18 vs luxury/mid-segment 120 100 earlier). Presence of several Fortune 500 tenants in the commercial portfolio 80 60 demonstrates Grade A asset quality. Retail malls witnessed healthy traction given 40 presence of several domestic/international brands and >75mn footfalls in FY20. Tie-ups with global brands (Hilton, Sheraton, Marriott, Oakwood) implies best-in Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-19 Nov-19 class hospitality services. Average net D/E remained 1x (FY10-20) with significant May-20 portfolio expansion, implying success across projects. Expanded into new segments/ micro-markets over the last decade Source: Bloomberg, Ambit Capital research Since listing in 2010, Prestige has significantly increased focus on annuity Prestige Estate’s revenue grew at business. This led to stable cash flows with cumulative pre-tax CFO/EBITDA over 24% CAGR over FY05-20 FY16-20 at 92% vs 11% over FY11-15. Prestige expanded its brand within annuity business across segments with operational portfolio (Prestige’s share) of 100 Prestige Estate' revenue 9.9msf commercial, 3.4msf of retail and 1,123 hotel keys. This provided 80 23%/27% revenue/EBITDA CAGR over FY10-20. Over the last five years, Prestige 60 bn forayed into new micro-markets (ex-South) including Ahmedabad, Pune, Mumbai ` and NCR. 40 20 UC/planned projects + land bank + consolidation = growth headroom 0 We believe Prestige would be able to scale-up across projects and micro-markets amid ~110msf of ongoing and upcoming project area. Further, this is spread FY05 FY10 FY15 FY20 across residential (54%), commercial (34%), retail (6%), hospitality (4%) and plotted development segment (3%). With improving cash flows amid stable Source: Company Ambit Capital research revenue from annuity business and net D/E at 1.4x (FY20), we believe Prestige has enough headroom for growth over the next decade. Ongoing/upcoming projects are spread across >10 cities/micro-markets, implying scale-up across existing and newer markets. Moreover, Prestige has land bank of 27msf, which coupled with industry consolidation implies further growth optionality. Research Analysts Favourable valuations amid near-term uncertainty Karan Khanna, CFA Covid-induced uncertainties resulted in significant impact on +91 22 6623 3251 residential/hospitality segments amid declining sales/occupancies, resulting in [email protected] negative cash flows. This led to sharp ~50% correction in valuations over the past five months to 7.4x TTM EV/EBITDA (40% discount to last 3-year average). Amandeep Singh Grover With upcoming project pipeline, coupled with consolidation opportunities and +91 22 6623 3082 market expansion, Prestige should be able to grow at mid-to-high-teen CAGR [email protected] over the next decade, implying favourable valuations. Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Prestige Estates Exhibit 1: Over the years, Prestige has increased its focus on annuity business with expansion into new micro-markets Phase 1 - Revenue CAGR Phase 2 - Increasing focus Phase 3 - Increasing focus on of 25% over FY05-10 on annuity; revenue CAGR annuity + expansion into new 90 of 27% over FY10-15 micro-markets; revenue CAGR of 14% 19% over FY15-20 80 12% 70 10% 60 bn 8% ` 50 40 6% 30 4% 20 10 2% 0 0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Net Sales pre-tax RoCE (%, RHS) Source: Ace Equity, Company, Ambit Capital research Exhibit 2: Till date, Prestige has completed projects of 134msf, with ongoing/upcoming projects of 109msf and land bank of 27msf Plotted Area in msf Residential Commercial Retail Hospitality Total development Completed Projects 81 36 7 3 7 134 Ongoing Projects 31 15 3 3 1 53 Upcoming Projects 28 22 4 1 2 56 Land Bank/Deal pipeline - - - - - 27 Total 140 73 13 6 11 270 Source: Company, Ambit Capital research Exhibit 3: Key financial parameters over the last decade (` mn) FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues 10,244 15,431 10,523 19,476 25,492 34,198 55,310 47,745 54,986 51,719 81,248 Revenue growth (%) 20% 51% -32% 85% 31% 34% 62% -14% 15% -6% 57% Consolidated net 1,502 1,710 826 2,860 3,143 3,324 6,098 2,649 3,713 4,156 4,031 profits EPS (`) 5.7 5.2 2.5 8.2 9.0 8.9 16.3 7.1 9.9 11.1 10.6 CFO (2,872) (2,996) 2,269 1,061 1,479 (4,780) 4,351 5,141 10,716 7,621 22,263 CFO-EBITDA (%) -129% -80% 76% 18% 21% -48% 41% 56% 84% 52% 94% FCF (4,416) (6,231) (1,700) (4,827) (3,303) (8,750) (4,868) (3,531) 4,863 (31) 6,812 Debt equity (x) 1.5 0.5 0.7 0.8 0.9 0.9 1.2 1.2 1.4 1.9 1.5 CE turnover (x) 0.4 0.5 0.3 0.4 0.4 0.5 0.6 0.5 0.5 0.4 0.6 GB Turnover (x) 0.8 1.2 0.6 0.9 1.0 1.0 2.4 4.6 3.9 2.3 2.7 RoE (%) 22% 12% 4% 12% 11% 10% 15% 6% 8% 9% 8% ROCE* (%) 8% 10% 6% 11% 11% 12% 11% 8% 10% 9% 13% Source: Ace Equity, Company, Ambit Capital research. Note: *This is pre-tax RoCE August 26, 2020 Ambit Capital Pvt. Ltd. Page 152 Prestige Estates Exhibit 4: Share of annuity business increased significantly coupled with expansion into new micro-markets (ex-South) Time Rev/ EBITDA Key developments period CAGR (%) - Commenced operations in 1986 (Bengaluru); - 1988: Completed 1st commercial development and 1st project; - 1995: Inaugurated 1st plotted development; 25%/ 49% - 1996: Forayed into property management services; Upto FY10 over FY05-10 - 2000: Inaugurated luxury residential project; - 2001: Forayed into hospitality segment; - 2004: Prestige’s first retail project and Bengaluru’s first fully-fledged mall opens; - 2007: Entered other South Indian markets of Kochi, Chennai and Hyderabad. - Got listed in 2010; 27%/ 35% - Scaled-up/ increased focus on annuity portfolio including commercial, retail, hospitality; FY10-15 over FY10-15 - Share of annuity business in upcoming projects increased to 25% in FY15 (9msf) vs 19% in FY11 (7msf). - FY16: Forayed into new markets of Pune and Ahmedabad; - FY18: Entered into affordable segment; FY15- 19%/ 19% - FY19: Signed two deals in Mumbai’s prime localities (Worli and BKC); also ventured into the National current over FY15-20 Capital Region (NCR) to establish presence in the North Indian market; - Share of annuity business in upcoming projects increased to 46% in FY20 (27msf) vs 25% in FY15 (9msf). Source: Company, Ambit Capital research Exhibit 5: Competitive mapping of Prestige Estates with other real estate developers FY20 Sub-segment Revenue CAGR Cum. pre-tax CFO/ Cum. capex/CFO Company Revenue Pre-tax positioning EBITDAM (%) FY10-20 EBITDA (FY10-20) (FY10-20) (` mn) RoCE (%) Prestige Estates #2 81,248 29% 13% 23% 64% 159% DLF #1 60,828 19% 2% -2% 85% 99% Sobha #2 37,539 30% 20% 13% 60% 24% Brigade Enterprises #2 26,322 25% 8% 22% 50% 218% Embassy REIT* #1 21,449 78% 3% 11% 108% 85% Phoenix Mills #1 19,411 50% 8% 32% 105% 125% Source: Ace Equity, Company, Ambit Capital research; Note: *data over FY16-20 as per availability. August 26, 2020 Ambit Capital Pvt. Ltd. Page 153 Prestige Estates Exhibit 6: Prestige scores high on IBAS Strategic Overall Company Innovation Brand Architecture Remarks asset rank - With experience of >3 decades, Prestige has completed >240 projects covering 134msf across residential, commercial, retail, hospitality and plotted development; - Within residential, Prestige catered to luxury and mid-segment earlier, now also entered into affordable housing (in-line with market trends); Prestige Estates successfully ramped-up Grade-A commercial portfolio and with retail assets; has tie-ups with global brands for the hospitality segment (Hilton, Sheraton, Marriott, Oakwood); - Experienced management with South Indian micro-market expertise; - Prestige has been extending its brand to other business verticals, sub- segments and micro-markets. - Co-sponsored by Blackstone/Embassy, Embassy REIT is India’s first and Asia’s largest REIT in sq.ft. (~33msf under management); - Fortune 500/MNCs contributing to 42%/78% of rental obligations Embassy REIT (Mar’20) implies quality Grade A assets; - Embassy REIT has external manager; cumulative senior management experience exceeds 10 decades. - Embassy Manyata is the strategic asset for the REIT. - Phoenix has successfully transitioned from a real estate, entertainment hub, shopping destination developer-operator to an owner-operator of India’s largest mixed-use retail development portfolio; - Google rating data indicates strong customer visitor satisfaction for Phoenix Malls as is evidenced by higher rating across malls (4.4 average our of 5) versus nearby vicinity malls (4.1 average); Phoenix Mills - Phoenix has unique architecture of strong and an experienced senior management (cum. experience >25 decades) along with experienced individuals even at the mall-level (associated with the company for >3 decades cumulatively); - Successful in other segments (commercial, hospitality, residential); - HSP and Palladium, Mumbai is the strategic asset for PML. - DLF has been successfully able to make market leadership positioning in North across segments, which gives DLF a competitive edge over peers in the micro-market it operates; - DLF has the advantage of better micro-market expertise as evidence by DLF change in formats of DLF (DLF Avenue Saket) and Inorbit (Pune), which earlier faced issues of tenant exists amid lower footfalls in the past. Whilst the former revamped its mall, the later converted the mall into commercial. - DLF Cyber city is the strategic asset of the developer. - Brigade has been successfully extend its brand into other verticals like Brigade commercial, retail and hospitality; Enterprises - Experienced management with South Indian micro-market expertise. - Better quality amid own construction, implying healthy brand recall, also corroborated by contract manufacturing business (grew 25% CAGR over Sobha FY16-20); - Experienced management with South micro-market expertise; however, yet to make any significant in-roads in annuity portfolio. Source: Company, Ambit Capital research; Note: - Strong; - Average; - Relatively weak; - Weak. Exhibit 7: PEPL is trading at 40% discount to historical Exhibit 8: Prestige has outperformed S&P BSE Realty index valuations over the last decade since listing PEPL S&P BSE Realty Index PEPL TTM EV/ EBITDA (x) 3 yr. rolling avg. (x) 200 20 150 15 100 10 5 50 0 0 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Apr-19 Apr-20 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19 Aug-20 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18 Oct-19 Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research; Note: price indexed to 100. August 26, 2020 Ambit Capital Pvt. Ltd. Page 154 [email protected] 2020-12-07 Monday 13:17:41 Prestige Estates Exhibit 9: Growth of annuity business remained high over the last decade 90 60% 60 40% bn ` 30 20% 0 0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Other operating income Sale of services (room rentals, f&B, others) Property rental, facilities and hire charges Sale of real estate (resi + commercial) 3 yr avg. revenue CAGR (%, RHS) Source: Ace Equity, Company, Ambit Capital research Exhibit 10: Volatile EBITDAM amid residential business; Exhibit 11: Stable CFO amid increasing share of annuity expect to stabilize with increasing annuity business business 31% EBITDAM (%) CFO FCF D/E (x, RHS) 29% 25 2.0 20 27% 15 1.5 25% 10 23% bn 5 1.0 ` 21% 0 19% -5 0.5 17% -10 15% -15 0.0 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ace Equity, Company, Ambit Capital research Source: Ace Equity, Company, Ambit Capital research Exhibit 12: Low WC turnover amid higher inventory of Exhibit 13: Pre-tax RoCE/RoE averaged at 10% over the under-construction projects last decade WC t/o (x) 16% pre-tax RoCE (%) RoE (%) 14% 1.2 WC t/o (x) 12% 1.0 10% 0.8 8% 0.6 6% 0.4 4% 0.2 2% 0.0 0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ace Equity, Company, Ambit Capital research Source: Ace Equity, Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 155 Prestige Estates Exhibit 14: EBITDA/employee cost has increased over the last decade EBITDA + fixed employee cost EBITDA/ employee cost (x, RHS) 30 6 25 5 bn 20 4 ` 15 3 10 2 5 1 0 0 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Ace Equity, Company, Ambit Capital research Exhibit 15: Healthy long-term growth prospects across Exhibit 16: …imply historical scalability would be further segments… achievable Likely Expected . Continued traction towards Grade-A assets would revenue (` mn) CAGR over Comments range in continue to drive growth in the CRE segment. FY20-30E FY30E (` bn) . Increasing penetration of retail space amidst rising FY20 revenue (`81bn) discretionary spends would drive growth for the retail Expect challenges in residential segment to sustain. portfolio. Bear case 8-10% 175-210 Further, success in newer . Increasing preference towards organised hotel markets to be delayed. chains, coupled with consolidation would drive Expect residential segment to normalise over next 2-3 years Base case 10-12% 210-250 growth for the hospitality segment. with Prestige successfully expanding in newer markets. . Consolidation in the residential space, coupled with Consolidation narrative in the preference towards credible developers would drive favour of large developers, growth for the residential portfolio. increasing preference towards credible developers and Bull case 12-15% 250-330 . However, given increasing traction by PE Funds, successful market expansion Prestige could also look for monetizing its annuity across real-estate segments could drive 12-15% revenue portfolio. growth over the next decade. Source: Ambit Capital research Source: Company, Ambit Capital research Exhibit 17: Explanation for our flags Segment Score Comments Whilst Prestige is audited by a Big 4 auditor, it features on ‘D9’ i.e. ‘ Zone of Darkness’ on our Hawk framework largely Accounting AMBER due to low score on CFO/EBITDA, contingent liabilities and FCF. Considering the volatile environment owing to the pandemic, predictability is low on sale (residential/ commercial) and Predictability AMBER hospitality revenues. Earnings AMBER Consensus has downgraded estimates over the last 3-6 months amid Covid-induced uncertainties. momentum Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 156 Prestige Estates HAWK scores Whilst Prestige is audited by a Big 4 auditor, it features on ‘D9’ i.e. ‘ Zone of Darkness’ on our Hawk accounting framework largely due to low score on CFO/EBITDA, contingent liabilities and FCF. Further, on Greatness score, Prestige scores ‘67%’ and features in ‘Zone of Greatness’. Key contributors to accounting score Prestige Estates features in the ‘D9’ decile i.e. ‘Zone of Darkness’ on our Hawk accounting framework. Key contributors to its relatively weak accounting score mainly include: 1) low score on cumulative CFO/EBITDA, 2) high contingent liabilities (% of net-worth) and 3) low cumulative FCF/median revenue. However, note that >80% of contingent liabilities in FY19 were towards corporate guarantees given on behalf of other related entities. Exhibit 18: Forensic accounting score contributors Exhibit 19: Forensic score percentile vs sector and universe Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Comments on evolution of accounting score Prestige’s forensic score has weakened from “Zone of Pain” in FY16 (D7) to “Zone of Darkness” in FY19 (D9). August 26, 2020 Ambit Capital Pvt. Ltd. Page 157 Prestige Estates Exhibit 20: Forensic accounting score evaluation Exhibit 21: Movement in accounting checks Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 84% 52% 94% Volatility in depreciation P & L mis-statement -503bps 341bps DNA rate checks PFD-% of Debtors more DNA DNA DNA than six months Cash yield 9% 10% DNA Balance sheet mis- Change in reserves (ex sec- 0.9 (1.4) DNA statement checks prem)/(PAT ex dividend) Cont Liab-% of NW 38% 28% DNA Misc. exps-% of total revs 0% 1% DNA Adv. to related parties / 11% 3% DNA Pilferage checks CFO CWIP: Gross Block 140% 60% DNA Cum. FCF/median revs -50% -31% -10% CAGR in auditor's Audit quality checks 0.5 0.5 DNA remn/CAGR in cons. Rev. Source: Ambit Capital research, Company Source: Ambit Capital research, Company; Note: DNA stands for data not available. Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.) Prestige Estate’s greatness score has improved from “Good not great” (50%) in FY17 to “Zone of Greatness” (67%) in FY19. Prestige’s greatness score is higher than ~92% of the sector and ~72% universally. Key contributors to high greatness score include better CE turnover, healthy operational cash flows and relatively better net debt/equity ratio. Exhibit 22: Greatness score contributors Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 158 Prestige Estates Exhibit 23: Greatness score percentile vs sector and universe Exhibit 24: Greatness score evolution Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 159 [email protected] 2020-12-07 Monday 13:17:41 Prestige Estates Key financials Balance sheet (consolidated) Year to March (`mn) FY16 FY17 FY18 FY19 FY20 Networth 41,999 44,148 47,327 42,266 53,602 Minority Interest 2,266 2,027 2,300 1,120 2,284 Debt 52,364 56,410 69,078 82,108 86,269 Other liabilities 67,967 65,717 70,320 155,114 155,561 Sources of funds 164,596 168,302 189,025 280,608 297,716 Net block (incl. CWIP) 19,138 27,145 40,999 39,476 44,265 Investments 32,955 30,581 39,776 52,082 74,915 Other non current assets 15,295 15,772 17,931 17,995 27,865 Current assets (ex cash) 92,604 90,940 82,934 163,932 141,163 Cash 4,604 3,864 7,385 7,123 9,508 Application of funds 164,596 168,302 189,025 280,608 297,716 Source: Ace Equity, Company, Ambit Capital research Income statement (consolidated) Year to March (`mn) FY16 FY17 FY18 FY19 FY20 Revenue 55,310 47,745 54,986 51,719 81,248 Operating expenses 44,648 38,547 42,216 37,181 57,688 EBITDA 10,662 9,198 12,770 14,538 23,560 Depreciation 1,274 1,637 1,547 3,229 6,667 EBIT 9,388 7,561 11,223 11,309 16,893 Interest expense 3,462 3,160 5,657 7,228 10,233 Other income 2,831 872 679 1,122 1,185 PBT 8,757 5,273 6,245 5,203 7,845 Provision for taxation 2,291 1,660 2,135 1,985 2,783 Extraordinaries - - - 894 380 PAT 6,466 3,613 4,110 4,112 5,442 Share of associates 67 121 136 307 44 Share of minority (435) (1,085) (533) (263) (1,455) Consolidated adj PAT 6,098 2,649 3,713 4,156 4,031 EPS diluted (`) 16.3 7.1 9.9 11.1 10.6 Source: Ace Equity, Company, Ambit Capital research Cashflow statement (consolidated) Year to March (`mn) FY16 FY17 FY18 FY19 FY20 PBT 8,824 5,394 6,381 6,404 8,269 WC changes (3,365) (967) 664 (4,804) 1,433 CFO 4,351 5,141 10,716 7,621 22,263 Capex (9,219) (8,672) (5,853) (7,652) (15,451) CFI (7,367) (5,218) (20,054) (6,276) (23,496) CFF 2,251 (797) 9,596 870 2,520 FCF (CFO - capex) (4,868) (3,531) 4,863 (31) 6,812 Source: Ace Equity, Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 160 Prestige Estates Ratio analysis and valuations (consolidated) Year to March FY16 FY17 FY18 FY19 FY20 Revenue growth (%) 62% -14% 15% -6% 57% EBITDA margin (%) 19.3% 19.3% 23.2% 28.1% 29.0% EBIT margin (%) 17.0% 15.8% 20.4% 21.9% 20.8% Consol. PAT margin (%) 11.0% 5.5% 6.8% 8.0% 5.0% ROCE pre-tax (%) 11% 8% 10% 9% 13% RoE (%) 15% 6% 8% 9% 8% pre-tax CFO/EBITDA (%) 71% 91% 106% 68% 107% pre-tax CFO/ Capital employed (%) 8% 8% 11% 8% 18% Net debt/ equity (x) 1.1 1.1 1.2 1.7 1.4 P/E (x) 14.5 33.3 23.7 21.2 22.1 P/B (x) 2.1 2.0 1.9 2.2 1.7 EV/Sales (x) 3.3 3.8 3.3 3.5 2.2 EV/EBITDA (x) 16.9 19.6 14.1 12.4 7.7 Source: Ace Equity, Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 161 Prestige Estates This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 162 SBI CARDS NOT RATED SCALABILITY THEMATIC SBI CARD IN EQUITY August 26, 2020 Moving to the Premier League BFSI SBI Cards is the only listed pure play credit card company in India that Recommendation delivered 49% PAT CAGR and 29% average RoE over FY17-20. Credit card Mcap (bn): `777/US$10.5 industry has high growth potential due to low penetration and increasing share & acceptance of digital payments. Low penetration in SBI’s customer 3M ADV (mn): `1,950/US$26.2 base and strong distribution imply SBI’s card base can post ~20% CAGR CMP: `827 over FY20-24 and possibly only slightly lower for next half a decade. TP (12 mths): NR Increased focus on EMI products can drive faster loan book CAGR of Downside (%): N/A ~50%, leading to >25% CAGR in revenues/PAT in FY20-24. Whilst asset quality has held up so far, economic slowdown due to COVID-19 can Performance increase NPAs in the near term. Current valuation of 15x/62x FY20 BVPS/EPS looks expensive but in the long term this can be a high SBICARD IN SENSEX (RHS) growth/RoE model. Stagnating spends, potential regulatory cap on MDR 920 40,000 840 charges and worsening of asset quality are key risks. 760 30,000 680 20,000 Competitive position: STRONG Changes to this position: STABLE 600 10,000 High growth, high RoE business 520 440 - SBI Cards’ outstanding card base has posted 26% CAGR over FY15-1QFY21 (industry at 21%) with market share of ~18% in 1QFY21. Alongside, PAT growth Jul-20 Jun-20 Jun-20 Apr-20 Apr-20 Mar-20 Aug-20 Aug-20 and RoE have also been higher. During FY17-FY20, SBI Cards’ PAT CAGR was May-20 49% driven by 33% CAGR in balance sheet size and RoA expansion from 4% in FY17 to 5.5% in FY20. The key drivers of higher profitability have been consistent Source: Bloomberg, Ambit Capital research growth in NII/fee income, high operating leverage and controlled credit cost. Multiple factors behind high growth and RoE Combination of industry and company-specific tailwinds is fueling this high growth. Increasing share of digital payments (~67% in 1QFY20 vs 42% in 1QFY17), rising acceptance of cards at merchant locations (PoS CAGR of 33% over FY15-1QFY21), under-penetration of credit cards (only 4 credit cards per 100 vs 337 for US) aid industry growth. Strong brand, extensive distribution network (~33k sales force, 22k branches of SBI), high operating leverage (cost to income ratio down ~600bps in FY17-20), controlled asset quality and support from parent SBI at company level are drivers of high growth/RoE. Long-term drivers intact, pressure in the near term Interest earning loan book has potential to post 50% CAGR (20% for cards) in FY20-24E if the loan book/trailing 3-month spends ratio of SBI Cards converges with leader HDFC Bank (70%/110% for SBI Cards/HDFCB at FY20). In the near term, low consumer spends (card spends are still 75% of pre-Covid levels) could slow revenue growth. SBI Cards’ gross NPA ratio and credit cost remained in the narrow range of 2-2.8% and 6%-6.4%, respectively over FY18-20. However, the asset quality in FY21/22E should remain under pressure due to weak GDP/job losses driven by COVID-19. Valuations expensive but worth watching from a long-term perspective SBI Cards is currently trading at ~15x/62x FY20 BVPS/EPS, which looks expensive Research Analysts from a near-term perspective. However, high growth potential of the credit card Pankaj Agarwal, CFA industry, SBI’s strong positioning in the segment and high entry barriers in the Tel: +91 22 6623 3206 business implies that bottom line of the company grow at ~20% CAGR over the [email protected] next decade. Given industry structure and country landscape, loan book and fee Ajit Kumar, CFA income can grow at ~30%/25% CAGR over the next decade. In FY21/22E, asset Tel: +91 22 6623 3252 quality and fee income could be a drag on its earnings due to COVID-19 driving low RoE. However, RoE should bounce back to original levels from FY23E onwards [email protected] once the COVID-19 crisis subsides. Stagnating spends, potential regulatory cap on Shreya Khandelwal MDR and severe deterioration in asset quality remains the key risks. Tel: +91 22 6623 3292 [email protected] Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. SBI CARDS Exhibit 1: Evolution of SBI Cards Year Key events/milestones . The company was incorporated as “SBI Cards and Payment Services Private Limited” as a result of JV between SBI and GE Capital Mauritius Overseas Investment 1998 . The company was registered as Non-Deposit accepting Systemically Important Non-Banking Financial Company (NBFC-ND-SI) with the Reserve bank of India (RBI) 2005 . The company was registered as corporate agent (composite) by the IRDAI 2017 . GE Capital exited from the company and its stake was acquired by both, the SBI and CA Rover (Carlyle group) . Amalgamation of “SBI Business Process and Management Services Limited” (SBIBPMSL) with the company 2019 . The company got converted into “Public Limited” from “Private Limited” and name changed to “SBI Cards and Payment Services Limited” . Successful IPO led to decrease in stake of SBI (69% from 74%) & Carlyle group (14% from 24%) Source: Company, Ambit Capital research Exhibit 2: Increasing market share over the years… No of outstanding cards No of credit card transactions Value of credit card transactions 22% 20% 20% 18%19% 18% 16% 14% 12% 10% FY15 FY16 FY17 FY18 FY19 FY20 1QFY21 Source: RBI, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 164 [email protected] 2020-12-07 Monday 13:17:41 SBI CARDS Exhibit 3: Financial Snapshot – Key financial parameters over last few years Rs mn FY17 FY18 FY19 FY20 1QFY21 FY18 FY19 FY20 Income Statement YoY growth (%) Net Interest Income 13,597 20,485 25,585 35,404 11,370 51% 25% 38% Non-Interest Income 15,829 26,102 37,111 49,110 7,830 65% 42% 32% Net Income Opex 18,390 29,393 37,903 47,815 9,070 60% 29% 26% Operating Profit 11,036 17,194 24,793 36,699 10,130 56% 44% 48% Provisions and write-offs 5,320 8,001 11,477 19,402 4,850 50% 43% 69% PBT 5,716 9,193 13,316 17,296 5,280 61% 45% 30% Taxes 1,988 3,182 4,689 4,848 1,350 60% 47% 3% PAT 3,729 6,011 8,627 12,448 3,930 61% 44% 44% Balance sheet 14,488 23,531 35,817 53,412 56,510 Networth 62% 52% 49% Borrowings (Incl. Debt securities) 77,295 104,148 124,537 161,183 170,250 35% 20% 29% Advances 99,829 140,455 179,087 228,116 219,210 41% 28% 27% Total assets 107,650 156,860 202,396 253,028 242,590 46% 29% 25% Du Pont analysis Interest Income 20.9% 19.9% 21.3% 22.8% Interest Expenses 5.4% 5.7% 5.7% 4.4% Net Interest Income 15.5% 14.2% 15.5% 18.4% Other Income 19.7% 20.7% 21.6% 12.6% Total Income 35.2% 34.9% 37.1% 31.0% Employee expenses 1.5% 2.2% 2.1% 1.8% Operating expenses 20.8% 18.9% 18.4% 12.3% Total operating expenses 22.2% 21.1% 21.0% 14.6% Pre Provisioning profits 13.0% 13.8% 16.1% 16.4% Provisions 6.0% 6.4% 8.5% 7.8% PBT 7.0% 7.4% 7.6% 8.5% Tax 2.4% 2.6% 2.1% 2.2% RoA (calculated) 4.5% 4.8% 5.5% 6.3% Leverage (x) 7.0 6.1 5.1 4.5 RoE (calculated) 31.6% 29.1% 27.9% 28.6% Reported ratios FY17 FY18 FY19 FY20 1QFY21 Yield on loans 21.3% 22.2% 21.6% 22.7% 23.9% Cost of Funds 7.4% 7.2% 8.1% 8.4% 6.6% NIM 15.3% 16.5% 15.5% 16.6% 19.2% Cost to Income Ratio (%) 62.5% 63.1% 60.5% 56.6% 47.2% Gross NPA (%) 2.3% 2.8% 2.4% 2.0% 1.4% Net NPA (%) 0.8% 0.9% 0.8% 0.7% NA Tier I ratio 11.3% 12.4% 14.7% 17.7% 20.1% CAR 15.7% 18.3% 20.0% 22.4% 24.4% Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 165 SBI CARDS Exhibit 4: Competitive mapping of SBI Cards – Second-largest player across major parameters No of No of ATM – No of Outstanding POS Spends 1QFY21 transactions- transactions- withdrawals credit cards (value) ATM POS (value) HDFCB 25% 26% 29% 34% 31% SBI Cards 18% 19% 19% 15% 20% ICICIBC 16% 4% 16% 4% 13% AXSB 12% 6% 8% 6% 8% RBK 5% 15% 4% 10% 5% KMB 4% 0% 3% 0% 3% IIB 2% 2% 2% 3% 3% Source: RBI, Ambit Capital research Exhibit 5: Share of digital transaction in volume terms is increasing in the system Physical Digital 42% 43% 55% 58% 58% 57% 60% 61% 62% 62% 62% 63% 67% 58% 57% 45% 42% 43% 43% 40% 40% 38% 38% 38% 37% 34% 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 Source: RBI, Ambit Capital research Note: Physical transactions include ATM and cheques/paper clearing while digital transactions include RTGS/ECS/NEFT/NACH/IMPS/Credit cards/Debit cards/Prepaid payment instruments Exhibit 6: No of PoS machines is increasing in the system 6.0 No of POS (mn) Y-o-Y growth 90% 5.1 5.0 80% 5.0 70% 4.0 3.7 60% 3.1 50% 3.0 2.5 40% 2.0 30% 1.4 1.1 20% 1.0 10% 0.0 0% FY15 FY16 FY17 FY18 FY19 FY20 1QFY21 Source: RBI, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 166 SBI CARDS Exhibit 7: Outstanding credit cards at system level have Exhibit 8: SBI Cards has recorded a higher 26% CAGR grown at CAGR of 21% over FY15-1QFY21 growth in FY15-1QFY21 No of outstanding credit cards (mn) No of outstanding credit cards (mn) YoY growth (RHS) YoY growth (RHS) 70 40% 12 40% 11 11 57 60 58 35% 10 35% 8 30% 30% 50 47 8 6 37 25% 25% 40 6 5 30 20% 4 20% 30 25 4 3 21 15% 15% 20 10% 2 10% 10 5% 0 5% FY15 FY16 FY17 FY18 FY19 FY20 FY15 FY16 FY17 FY18 FY19 FY20 1QFY21 1QFY21 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 9: Outstanding loans at system level have grown at Exhibit 10: SBI Cards has recorded a higher 29% CAGR CAGR of 21% over FY17-1QFY21 growth in loan outstanding in FY17-1QFY21 Credit cards- loan book (Rs bn) Gross loan (Rs bn) YoY growth (RHS) YoY growth (RHS) 300 45% 1,200 1,081 50% 40% 976 241 233 1,000 250 883 40% 35% 200 185 30% 800 686 30% 146 25% 600 521 150 20% 20% 103 400 100 15% 10% 10% 200 50 5% 0 0% 0 0% FY17 FY18 FY19 FY20 1QFY21 FY17 FY18 FY19 FY20 1QFY21 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 11: Number of credit cards per 100 people for major economies (2018) 337 260 225 214 160 94 85 81 49 7 6 4 US UK India Japan China France Canada Australia Germany Singapore Hong Kong Switzerland Source: BIS, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 167 SBI CARDS Exhibit 12: Outstanding number of various financial products (FY19, in million) 1,643 248 204 82 81 57 36 21 14 11 Demat Savings Current accounts accounts accounts MFfolios policies accounts Insurance accounts Autoloans accounts Credit cards Credit Homeloans TDaccounts Personalloans Source: RBI, SEBI, AMFI, IRDA, CRISIL, Ambit Capital research Note: 1HFY20 numbers for personal, auto and home loans and 1QFY21 numbers for credit cards Exhibit 13: Credit cards outstanding are only ~7% of debit Exhibit 14: Lowest share of credit to debit cards for SBI cards outstanding in the system Cards implies strong growth potential from SBI customers Credit card to debit Card ratio 7.0% 6.8% FY17 FY20 300% 5.1% 250% 239% 4.4% 200% 3.8% 3.7% 3.5% 150% 100% 48% 41% 36% 27% 23% 22% 21% 17% 17% 50% 17% 14% 12% 6% 0% IIB YES RBK KMB AXSB HDFCB FY15 FY16 FY17 FY18 FY19 FY20 1QFY21 ICICIBC Source: RBI, Ambit Capital research Source: RBI, Ambit Capital research Exhibit 15: India - Rising share of working age population Exhibit 16: Indian credit card industry – Increasing proportion of credit card origination among millennials (aged <30 years) 0-14 years 15-29 years 30-59 years 60+ years >40 years 31-40 years 26-30 years <=25 years 1% 2% 4% 7% 10% 7% 8% 10% 18% 22% 23% 24% 25% 31% 34% 37% 48% 45% 41% 40% 28% 28% 38% 26% 35% 31% 28% 33% 31% 32% 29% 27% 2000 2010 2020E FY15 FY16 FY17 FY18 FY19 Source: Company, CRISIL, Ambit Capital research Source: Company, CRISIL, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 168 SBI CARDS Exhibit 17: India - Rising share of urban population Exhibit 18: India - Rising retail leverage as well 35% Retail loans (including NBFCs) as a % of 16.6% 31% nominal GDP 16.4% 28% 26% 15.3% 23% 14.6% 20% 18% 17% 13.7% 14% 13.0% 12% 12.8% 11% 10% 11% 12.2% 11.8% 10.7% 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011 2021 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Source: RBI, Ambit Capital research Source: RBI, Ambit Capital research Exhibit 19: Proportion of new accounts opened in Exhibit 20: …self-employed cardholders for SBI Cards is non-metros and… increasing Others Tier III metropolitan areas Self-employed cardholders (%) Salaried cardholders (%) Tier II metropolitan areas Top-eight metropolitan areas 4% 10% 11% 14% 13% 10% 26% 17% 15% 19% 13% 11% 19% 14% 18% 33% 90% 67% 89% 54% 87% 85% 43% 38% FY17 FY18 FY19 1QFY21 FY17 FY18 FY19 1QFY21 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 21: Number of cards sourced from SBI Bank Exhibit 22: …and market share of bank distribution distribution network has been increasing… channel showing support from parent No of cards sourced from SBI (mn) YoY growth (RHS) Retail Co-brand 2.0 180% Bank distribution channel (SBI) Corporate distribution channel 1.8 1.8 160% 1.6 100% 1% 0% 0% 0% 1.6 140% 1.4 80% 35% 1.2 120% 45% 48% 1.2 55% 100% 1.0 60% 80% 0.8 28% 60% 40% 26% 0.6 0.4 35% 30% 0.4 40% 20% 35% 0.2 20% 28% 15% channel Open 16% 0.0 0% 0% FY17 FY18 FY19 FY20 FY17 FY18 FY19 9MFY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 169 [email protected] 2020-12-07 Monday 13:17:41 SBI CARDS Exhibit 23: Rollover rate (loan as % of 3M spend) lower for SBI Cards FY17 FY18 FY19 FY20 1QFY21 250% 220% 186% 184% 200% 151% 150% 128% 118% 115% 110% 100% 84% 70% 67% 63% 50% 0% RBK HDFCB AXSB SBI Cards IIB ICICIBC Source: RBI, Company, Ambit Capital research Exhibit 24: Interest earning portion of the loan book can grow at 50% CAGR (FY20-24E) if its rollover rate increases FY15 FY16 FY17 FY18 FY19 FY20 FY20-24E CAGR No. of credit cards (mn) 3.2 3.6 4.6 6.3 8.3 10.5 21.9 YoY growth (RHS) 10% 15% 26% 37% 32% 28% 20% Total spend (Rs mn) 208,863 287,272 434,355 764,702 1,029,702 1,307,965 3,296,692 YoY growth 38% 51% 76% 35% 27% 26% Spend per card (Rs) 66,137 79,356 95,065 122,189 124,489 124,007 150,731 YoY growth 20% 20% 29% 2% 0% 5% Loans 99,829 140,455 179,087 228,116 989,008 YoY growth 41% 28% 27% 44% 12m -rollover rate 23% 18% 17% 17% 30% Interest earnings loans 66,557 92,901 120,054 162,263 823,025 YoY growth 40% 29% 35% 50% Interest earnings loans (%) 67% 66% 67% 71% 83% Source: Company, Ambit Capital research Exhibit 25: Cost-to-income ratio has been falling 80% Opex to avg. loans Cost to Income 70% 63% 60% 60% 57% 50% 47% 40% 30% 24% 24% 23% 20% 16% 10% FY18 FY19 FY20 1QFY21 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 170 SBI CARDS Exhibit 26: NPA ratio broadly stable Exhibit 27: Credit cost (provision as % of average assets) spiked in FY20 due to COVID-19 provision Gross NPA (%) Net NPA (%) 9.1% 3.0% 2.8% 8.2% 2.4% 2.3% 2.3% 6.9% 2.5% 6.4% 2.0% 5.2% 1.5% 1.4% 1.0% 0.5% 0.0% FY17 FY18 FY19 FY20 1QFY21 FY17 FY18 FY19 FY20 1QFY21 Source: Company, Ambit Capital research *Net NPA for 1QFY21 has not been provided Source: Company, Ambit Capital research Exhibit 29: Forward P/B evolution Exhibit 28: Exhibit 30: Stock price performance vs Sensex 12.0 1 Yr fwd PB Avg. PB SBICARD IN SENSEX (RHS) 920 40,000 11.0 840 30,000 10.0 760 680 20,000 9.0 600 10,000 8.0 520 440 - Jul-20 Jun-20 Apr-20 Aug-20 May-20 Jul-20 Jun-20 Jun-20 Apr-20 Apr-20 Mar-20 Aug-20 Aug-20 May-20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 171 SBI CARDS Summary financials Balance sheet Year to March (Rs mn) FY17 FY18 FY19 FY20 Net worth 14,488 23,531 35,817 53,412 Borrowings 77,295 104,148 124,537 161,183 Other Liabilities 15,866 29,182 42,042 38,433 Total Liabilities 107,650 156,860 202,396 253,028 Cash & Balances with RBI & Banks 2,829 4,727 7,768 6,760 Investments 0 0 15 15 Advances 99,829 140,455 179,087 228,116 Other Assets 4,992 11,678 15,527 18,137 Total Assets 107,650 156,860 202,396 253,028 Source: Company, Ambit Capital research Income statement Year to March (Rs mn) FY17 FY18 FY19 FY20 Interest Income 18,882 27,600 35,757 48,413 Interest expenses 5,284 7,115 10,172 13,009 Net Interest Income 13,597 20,485 25,585 35,404 Total Non-Interest Income 15,829 26,102 37,111 49,110 Total Income 29,426 46,587 62,696 84,514 Total Operating Expenses 18,390 29,393 37,903 47,815 Employees expenses 953 1,931 3,904 4,684 Other Operating Expenses 17,437 27,462 33,999 43,131 Pre Provisioning Profits 11,036 17,194 24,793 36,699 Provisions 5,320 8,001 11,477 19,402 PBT 5,716 9,193 13,316 17,296 Tax 1,988 3,182 4,689 4,848 PAT 3,729 6,011 8,627 12,448 Source: Company, Ambit Capital research Key ratios Year to March FY17 FY18 FY19 FY20 Cost/Income ratio (%) 62.5% 63.1% 60.5% 56.6% Gross NPA (Rs mn) 2,409 4,125 4,529 4,852 Gross NPA (%) 2.34% 2.83% 2.44% 2.03% Net NPA (Rs mn) 773 1,348 1,518 1,592 Net NPA (%) 0.76% 0.94% 0.83% 0.68% Provision coverage (%) 67.9% 67.3% 66.5% 67.2% Yield on loans (%) 21.3% 22.2% 21.6% 22.7% Cost of funds 7.4% 7.2% 8.1% 8.4% NIMs (%) 15.3% 16.5% 15.5% 16.6% Tier-1 capital ratio (%) 11.3% 12.4% 14.7% 17.7% CAR (%) 15.7% 18.3% 20.0% 22.4% Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 172 SBI CARDS Du-pont analysis Year to March FY18 FY19 FY20 NII / Assets (%) 15.5% 14.2% 15.5% Other income / Assets (%) 19.7% 20.7% 21.6% Total Income / Assets (%) 35.2% 34.9% 37.1% Cost to Assets (%) 22.2% 21.1% 21.0% PPP / Assets (%) 13.0% 13.8% 16.1% Provisions / Assets (%) 6.0% 6.4% 8.5% PBT / Assets (%) 7.0% 7.4% 7.6% Tax Rate (%) 2.4% 2.6% 2.1% RoA (%) 4.5% 4.80% 5.47% Leverage 7.0 6.1 5.1 RoE (%) 31.6% 29.1% 27.9% Source: Company, Ambit Capital research Valuation* Year to March FY17 FY18 FY19 FY20 EPS - annualized (Rs) 4.8 7.4 9.4 13.4 EPS growth (%) 56% 27% 42% BVPS (Rs) 18.5 29.8 39.9 56.9 P/E (x) 146.8 94.2 73.9 53.1 P/B (x) 37.8 23.4 17.5 12.5 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 173 SBI CARDS This page has been intentionally left blank August 26, 2020 Ambit Capital Pvt. Ltd. Page 174 [email protected] 2020-12-07 Monday 13:17:41 SBI Life Insurance SELL SCALABILITY THEMATIC SBILIFE IN EQUITY August 26, 2020 A true marathon runner! BFSI A non-replicable pseudo-sovereign identity, entrenched distribution Recommendation network of >22k bank branches and unparalleled cross-sell potential are SBIL’s unique competitive strengths. This makes it the most scalable Mcap (bn): `848/US$11.4 and fastest growing non-lender. Riding on these, SBIL has grown to 3M ADV (mn): `1,336/US$18.0 become the largest private life insurer basis APE, with 24% CAGR over CMP: `848 FY15-19 vs 17% for the private sector. Improvement in banca-branch TP (12 mths): `728 productivity and penetration would drive APE growth over the medium Downside (%): 14 term. Improving protection mix will aid in at least 100bps margin expansion each year over the next 4-5 years. Longevity of growth Flags potential and expectation of sustained superior operating matrices are key valuation drivers. SBI adopting open architecture is the key risk to Accounting: GREEN our industry exceeding growth estimates. Predictability: AMBER Earnings Momentum: AMBER Competitive position: MODERATE Changes to this position: STABLE Fastest growing life insurer Performance SBIL is the largest private insurer basis APE and grew fastest at 24% CAGR over SBILIFE IN SENSEX FY15-20. Market share (private) increased by 640bps to 20.5%. APE growth over 130 FY15-20 was driven by increase in share of ULIPs, which grew faster, at CAGR of 120 29% vs 10-11% for peers. Whilst premium growth over the last 3-4 years has 110 100 been robust and consistent, rise in profitability has been modest. Its VNB 90 margins increased only gradually from 14.2% in FY16 to 18.7% in FY20 on 80 account of faster growth in lower-margin-linked businesses and reduction in 70 protection APE (10.3% in FY16 to 8.9% in FY20). Jun-20 Apr-20 Oct-19 Feb-20 Dec-19 Largest distribution franchise backed by strong brand-propelled growth Aug-19 Aug-20 Strong distribution network (>22k bank branches), 2nd largest private agency force of 108K agents (FY18) with best-in-class productivity (FY18: 0.26mn vs Source: Bloomberg, Ambit Capital research private sector average of ~0.15mn) and pseudo-sovereign identity give SBIL a unique advantage over peers. Industry-leading growth was driven by strong push towards galvanizing bancassurance sales force to capitalize on the large cross-sell opportunity. Bancassurance channel APE share went up by >12% over FY15-20 to 65%. Lowest operating cost (FY20: 10% vs 14-17% for peers) helps drive operating efficiency. Growth only a function of quality execution Given the large captive customer base of SBI (~316mn customers), best-in-class distribution franchise and strong brand name, we expect SBIL to grow 200- 300bps faster than long-term industry growth pegged at 1-1.2x of long-term GDP growth. In absolute terms, ULIP would continue to drive the lion’s share of growth but share of protection APE would increase on the back of cross-sell potential and management focus to increase protection share. Given SBI’s large retail franchise and renewed focus on cross-sell, potential for margin improvement remains large. Valuations leave no room for error; structural potential in place Our conviction on SBIL emanates from its structural and potential for growth Research Analysts longevity backed by one of the largest distribution networks, huge cross-sell Udit Kariwala, CFA potential and superior operating matrices. We expect VNB CAGR of 9% over the [email protected] next 20 years on a sustainable basis. Nevertheless, near-team disruptions and +91 22 6623 3197 current high valuations (FY21E: P/EV of 2.8) leave little fundamentals-based upside today for investors. Hence our outlook in the near term remains negative. Pankaj Agarwal, CFA We value SBIL using appraisal value methodology, wherein we add NPV of VNB [email protected] profits over FY21-42 to EV at FY21E to arrive at TP of `728 (implied valuation of +91 22 6623 3206 FY21EV + 35x 1-year forward VNB and 2.4x FY21 EV). Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. SBI Life Exhibit 1: Evolution of SBI LIFE Established in October 2000, SBI Life Insurance Company Limited (SBIL) is a joint venture between State Bank of India (SBI), India’s largest bank, and BNP Paribas Cardif, a leading global insurance company (life and property & casualty insurance arm of BNP Paribas). Exhibit 2: Progression of SBIL to `1tn+ AUM player Year Event 2000 Commenced operation in October 2000, as a JV between SBI and BNP Paribas Cardif S.A 2006 First private sector life insurer to declare profit (`20mn) within six years of incorporation 2008 Achieved the breakeven mark, wiping out all accumulated losses 2010 Crossed gross written premium of `100bn 2011 Achieved a scale of >500 branches 2012 Declared its first dividend with PAT crossing `5bn 2013 Achieved a scale of >750 branches with AUM exceeding `500 billion 2016 Gross written premium crosses `150bn mark 2017 Gross written premium crosses `200bn mark 2017 Gets listed on October 03, 2017 at `733, a premium of 4.75% over issue price of `700 2018 Achieves AUM of `1tn 2019 BNP Paribas Cardif sells 2.5% stake in SBI Life for `16.3bn Source: Company, Ambit Capital research SBIL has grown (basis new business premium – NBP) at a CAGR of 14% over FY07- 20; faster than 9% CAGR growth during the period for industry. FY07-10 was a growth phase where SBIL grew at a very rapid pace of 40% CAGR due to popularity of unit-linked plans and buoyed equity markets. This was followed by a declining phase where NBP for SBIL declined at a rate of 8% CAGR over FY11-15 due to multiple regulatory changes which forced the SBIL and industry to redesign their products. The pace picked up recently as the industry entered the revival phase between FY16-20. In this period SBIL has grown at CAGR of 24% (fastest in the industry) vs industry CAGR of 17% led by financialisation of savings in India and new product launches. From FY16, the company started to aggressively gain market share and is currently the largest private sector life insurer with ~21% market share in retail new business premiums. Exhibit 3: Growth trends in first-year insurance premiums indicate a recovery; SBIL leads the way SBIL NBP (Rs bn) SBIL NBP YoY growth (%) - RHS Industry NBP YoY growth (%) - RHS 200 75 Growth phase led by ULIPs; Declining phase led by change Revival phase led by increase in market share by FY10: 6.4% ULIP regulations; market share by financialisation of savings; market 160 FY15: 4.9% share by FY20: 6.4% 50 120 25 80 0 40 0 -25 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: IRDAI; Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 176 SBI Life Exhibit 4: SBIL has consistently clocked robust growth Exhibit 5: Share of ULIP has been consistently rising 40% APE Growth % VNB Growth % ULIPs Par Protection Non-par savings Group Savings 30% 5% 10% 6% 7% 9% 17% 19% 24% 11% 20% 31% 10% 71% 67% 71% 70% 53% 0% FY18 FY19 FY20 FY21E FY22E FY23E FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 6: Key financial parameters Particulars FY18 FY19 FY20 FY21E FY22E FY23E APE (` mn) 85,500 97,000 107,400 107,400 120,288 134,723 Embedded Value (` mn) 190,700 224,010 262,810 304,797 355,228 415,500 VNB (` mn) 13,850 17,190 20,100 20,762 24,486 30,166 VNB Margin* 18.4% 19.8% 20.7% 21.3% 22.4% 24.4% RoEV (%) 17.9% 17.4% 20.5% 16.0% 16.5% 17.0% EPS (`.) 11.5 13.3 14.2 12.4 16.7 22.9 BPS (`.) 65.3 75.8 87.4 101.2 118.0 140.9 P/EV 4.4 3.8 3.2 2.8 2.4 2.0 ROA (%) 1.1% 1.0% 0.9% 0.7% 0.8% 0.9% ROE (%) 19.0% 18.8% 17.4% 13.1% 15.3% 17.7% Source: Company, Ambit Capital research;* on effective tax rate basis Exhibit 7: SBIL’s comparison with peers HDFCL SBIL IPRU Relatively less diversified Improving mix towards higher- Quality of product mix (basis APE) Most diversified product mix product mix margin protection products Share of higher margin protection products 17% 9% 15% Share of lower margin ULIP products 23% 70% 65% Share of other Non linked saving products 60% 21% 20% Acquisition expense (% of total premium) Highest cost player Best in class Balanced cost structure Expense ratio (incl. commissions) 17.6% 9.9% 13.3% Persistency Broadly Stable Improving trend Declining trend 13th month 88% 86% 85% 61st month 54% 60% 57% Overall profitability Highest Lowest Moderate VNB margin 25.9% 20.7%* 21.7% Source:- Company, Ambit Capital research; * considered post incorporating benefit for the effective tax rate( for apple to apple comparison)-data-4QFY20 August 26, 2020 Ambit Capital Pvt. Ltd. Page 177 SBI Life Exhibit 8: Large insurers benefit from inherent competitive advantages Parameters LIC SBIL IPRU MaxL BajA Strength of the brand Cross sell potential Direct channel evolution Cost/productivity Product suit/innovation Overall score Source: Ambit Capital research Note: - Strong; - Relatively Strong; - Average; - Relatively weak Exhibit 9: SBIL – SWOT analysis, best-placed to capture cross-sell opportunities STRENGTHS WEAKNESS Largest distribution franchise: Access to >22k branch Not the most affluent customer segment: SBI’s (primary banca network of SBI with pan-India presence. Entrenched branch network with a large captive customer base. Footprint of >8k partner) customer segment is not as affluent as that of other private branches in Metropolitan and Urban areas. banks. Weaker ability to cross-sell (credit card/debit card ratio of 2.6% vs 15-46% for large peers). Best in class agent productivity: Second-largest agent workforce among private players with ~135k agents. Most Virtually non-existent direct channel: Direct channel contributed productive agent workforce, FY19 per agent productivity: <1% (FY19) of individual NBP vs ~17-31% for large peers. Result is a `0.25mn pa vs private average of `0.12mn. least evolved retail protection channel. Prior to FY19 retail protection channel contributed <1% to overall APE; the share increased to 3.8% Lowest operating cost player: Total expense ratio of 10% in FY19, almost entirely on the back of cross-sell to SBI customers. (FY20) vs 14-17% for peers. Lower opex on account of SBI Lacks a clear strategy: Not a market leader in any product charging lower (FY19: group banca channel expense of ~9% vs segment. Lags peers on innovation. 20-26% for peers) commissions compared to banca partners of other large peers. Geographically the most diversified business mix: Top 5 and top 10 states account for 38% and 66% of individual NBP (FY19) vs 50-58% and 76-81% respectively for large peers. 70% of SBILs NBP is from individual segments. OPPORTUNITIES THREATS Large cross-selling opportunity: In FY16-19 banca-branch productivity (retail banca NBP/branch) increased by ~2.3x to Sensitivity to increase in corporate tax rate to 25%: Among large `3mn, still lower than large peers (~`7-9 mn). SBI has almost peers, SBIL is most sensitive to increase in corporate tax rate (FY19, 4x of metro + urban branches then other large peers, and EV: 9% and VNB: 17% vs EV: 4%-6.6% and VNB: 7.5-13.8% for large largest customer base spread across the country. This presents a peers). large cross-sell opportunity. SBI embracing open architecture: We do not expect SBI to Momentum in business growth: SBIL’s APE growth has been embrace open architecture in the near to medium term. If it does, it the highest among private peers 24% (CAGR FY15-FY20) vs 12- could impact SBIL disproportionally compared to large peers. This is 17% for large peers. Growth is largely in the individual segment because the bancassurance channel contributes largest for SBI (FY20: with ULIP contributing the highest proportion (ULIP APE ~65% of APE vs 56-64% for large peers). Disproportionally large contribution increased to ~70% in FY20 vs ~53% in FY15). With proportion compared to large peers of banca channel business is only the focus now shifting towards credit protect and annuity depended on SBI (primarily banca partner). segment (single premium products), we expect this momentum to reflect in the NBP as well. Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 178 SBI Life Exhibit 10: Valuations have come off the peak, structural Exhibit 11: SBIL has outperformed Nifty over last 12 strengths intact months; backed by strong NBP growth Trailing P/EV 1 year Forward-PEV SBILIFE IN NIFTY Par 4.0 125 3.5 105 3.0 85 2.5 2.0 65 Jul-20 Jan-20 Jun-20 Apr-20 Feb-18 Feb-19 Feb-20 Oct-19 Feb-20 Sep-19 Dec-19 Aug-17 Aug-18 Aug-19 Aug-20 Mar-20 Nov-17 Nov-18 Nov-19 Aug-20 Aug-19 Nov-19 May-18 May-19 May-20 May-20 Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research Exhibit 12: SBI, India’s largest bank, is SBIL’s exclusive Exhibit 13: Untapped bancassurance potential – SBIL has bancassurance partner; unmatched distribution franchise lowest banca-branch productivity among top 3 Number of metro plus urban branches - FY14 FY15 FY16 FY17 FY18 FY19 FY19 10 Retail banca NBP/branch (Rs bn) 8,130 9 8 7 6 5 4 2,404 2,429 3 2 1 0 HDFC bank ICICI bank SBI SBI HDFC ICICI Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 14: VNB to grow at a CAGR of ~14% over FY20-23 Exhibit 15: Best-in-class and improving agent productivity on the back of ~368bps VNB margin expansion to aid operational efficiency VNB- Rs bn VNB margin - (RHS) 5 4 35 24% 30 22% 3 25 20% 2 20 18% 1 15 16% 0 10 14% 5 12% FY14 FY15 FY16 FY17 FY18 - 10% HDFCL IPRU MaxL FY16 FY17 FY18 FY19 FY20 SBIL Pvt. Avg. LIC FY21E FY22E FY23E Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 179 [email protected] 2020-12-07 Monday 13:17:41 SBI Life Exhibit 16: Lowest operating expense across peers driven Exhibit 17: SBIL is geographically most diversified among by lower distribution cost in bancassurance channel top 4 players (basis individual NBP) Top 5 states Top 10 states 19.0% Expense Ratio 90% 79% 81% 17.0% 80% 76% 66% 15.0% 70% 57% 60% 55% 13.0% 50% 50% 40% 11.0% 40% 30% 9.0% 20% FY15 FY16 FY17 FY18 FY19 FY20 10% 0% SBIL HDFCL IPRU SBIL MaxL IPRU HDFCL Source: Company, Ambit Capital research Source: Company, Ambit Capital research. Data is for FY20 Exhibit 18: Explanation for our flags Segment Score Comments Accounting GREEN We did not find anything unusual in accounting practices of SBIL. With anticipated regulatory changes around product regulations, surrender charges and tax rationalization, we expect Predictability AMBER uncertainty around premium growth and profitability. Earnings In the past 12 months, premium momentum (APE growth of ~11%) has been slower than the past year though not AMBER Momentum materially different than long-term estimate of ~14.5%. Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 180 SBI Life Financials Exhibit 19: Policyholders Account (` mn) FY19 FY20 FY21E FY22E FY23E First year premium 90,572 98,288 98,288 110,082 123,292 Renewal premium 191,974 240,422 274,684 302,469 334,565 Single premium 47,348 67,637 67,637 75,753 84,844 Gross Written Premiums 329,894 406,347 440,609 488,305 542,701 Net Premiums Earned 328,904 403,240 437,239 484,571 538,552 Investment Income 112,081 29,968 151,044 184,393 222,332 Total Income 442,612 438,428 588,566 669,278 761,231 Commission Expenses 13,769 16,249 17,024 18,875 18,875 Operating expenses 20,930 24,131 31,631 35,539 39,942 Benefits paid (Net) 152,331 161,753 187,309 226,987 270,464 Change in valuation of policy liabilities 235,917 206,049 334,256 365,598 404,010 Total Expenses 429,058 415,715 576,443 653,819 740,780 Surplus/(deficit) after tax 10,866 18,946 10,112 12,894 17,059 Transfer to Shareholders' account 9,985 14,627 5,792 8,574 12,738 Source: Ambit Capital research Shareholders’ Account (` mn) FY19 FY20 FY21E FY22E FY23E Amounts transferred from 9,985 14,627 5,792 8,574 12,738 Policyholders' account Income from investments 5,057 4,767 6,828 8,500 10,606 Total Income 15,177 19,461 12,688 17,142 23,413 Total Expenses 1,448 5,326 367 496 677 Profit before Tax 13,729 14,135 12,320 16,646 22,735 PAT 13,268 14,222 12,396 16,747 22,874 Source: Ambit Capital research Balance Sheet (` mn) FY19 FY20 FY21E FY22E FY23E Sources of Funds Share capital 10,000 10,000 10,000 10,000 10,000 Reserve and surplus 64,601 78,839 91,235 107,982 130,856 Networth 75,764 87,431 101,235 117,982 140,856 Policyholders' funds 1,351,399 1,531,011 1,910,779 2,294,123 2,717,563 Funds For Future Appropriations 2,816 7,137 11,457 15,778 20,098 Total Liabilities 1,429,978 1,625,579 2,023,470 2,427,883 2,878,516 Applications of Funds Shareholders’ investments 57,232 68,279 84,996 106,063 133,258 Policyholders’ investments 644,724 734,199 843,934 953,963 1,077,969 Total Investments 701,956 802,479 928,929 1,060,026 1,211,227 Asset held to cover linked liabilities 691,291 785,653 1,055,896 1,327,948 1,625,790 Total Assets 1,429,978 1,625,579 2,023,470 2,427,883 2,878,516 Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 181 SBI Life Valuation Particulars FY19 FY20 FY21E FY22E FY23E Embedded Value (` mn) 224,010 262,810 304,797 355,228 415,500 VNB (` mn) 17,190 20,100 20,762 24,486 30,166 VNB Margin* 19.8% 20.7% 21.3% 22.4% 24.4% RoEV (%) 17.4% 20.5% 16.0% 16.5% 17.0% EPS (`.) 13.3 14.2 12.4 16.7 22.9 BPS (`.) 75.8 87.4 101.2 118.0 140.9 P/EV 3.8 3.2 2.8 2.4 2.0 ROA (%) 1.0% 0.93% 0.68% 0.75% 0.86% ROE (%) 18.8% 17.4% 13.1% 15.3% 17.7% Source: Ambit Capital research* On Effective tax rate basis August 26, 2020 Ambit Capital Pvt. Ltd. Page 182 Torrent Pharmaceuticals SELL SCALABILITY THEMATIC TRP IN EQUITY August 26, 2020 An enviable M&A track record Pharmaceuticals Torrent clocked 15%/18% sales/EBITDA CAGR in the last 10 years with Recommendation inorganic pursuits. Acquisitions like Elder’s 30 brands and Unichem’s Mcap (bn): `475/US$6.4 India portfolio boosted market share by 1ppt to 3%. Brand recall and 3M ADV (mn): `2,437/US$32.8 superior reach ensured acquired brands’ growth turnaround, with CMP: `2,804 Shelcal/Chymoral recording 18% sales CAGR over the last 5 years. 52% chronic sales exposure would ensure market leading growth in the next 5 TP (12 mths): `2,166 years. Other markets’ FY20-22 topline development would be a mixed Downside (%): 23 bag given compliance issues in the US. Issues ex-India drive our skeptical stance as current 21x 1-year forward EV/EBITDA is at 34% premium to Flags last 3-year average and fully captures domestic market competitive edge. Accounting: AMBER Risks: Extended USFDA regulatory issues, unforeseen price caps. Torrent Predictability: AMBER would continue to scale-up in chronic areas over the next 10-years, especially with SGLT2 inhibitors (e.g., remogliflozin) in the portfolio now. Earnings Momentum: AMBER Competitive position: STRONG Changes to this position: NEUTRAL Performance Inorganic pursuits have been core to Torrent’s sharp scale-up Torrent Nifty Pharma Sales grew 15% CAGR to `79bn over FY10-20, helped by inorganic pursuits, 200 especially in India. Torrent allocated `55-58bn (FY20 capital employed: `107bn) 170 towards acquisitions over FY14-19. Brand recall and superior reach ensured 140 acquired brands’ growth turnaround, which has countered any punchy target (3- 110 6x trailing EV/sales) valuation concerns. EBITDA margin improved 5ppt to 27% 80 over FY10-20 as it generated operational synergies post acquisitions. Net Jul-19 Jul-20 Jan-20 Jun-20 Apr-20 Oct-19 Feb-20 Sep-19 Dec-19 Mar-20 Aug-19 Aug-20 Nov-19 debt/EBIDA shot up to 4.1x following Unichem acquisition in end-FY18. But May-20 healthy FCF generation would ensure this ratio moves to 1.1x by FY22. Superior domestic brand recall and reach – key moats Source: Bloomberg, Ambit Capital research Consistent top quartile MR productivity and high brand recall in cardiac (#2 in Torrent’s revenue has grown at 20% IPM; 31% India revenue share) exhibit branding capabilities. This combined with CAGR over FY03-20 wider reach vs peers ensures an efficient sales force setup. Other differentiating factors are high chronic exposure (52% vs. 33% for IPM) and lower NLEM impact. 100 Low base ensured US sales quadrupling over FY13-20, while coverage expansion Torrent's sales 80 has been the key growth driver in Germany. Presence in high-growth chronic 60 therapies and branding strength has aided Brazilian scale-up. Rs bn 40 Further scale-up hinges on sweating resilient mix and branding setup 20 A superior portfolio offers long-term market leading growth certainty, while - incremental scale-up is usually EBITDA margin-accretive. Torrent’s EBITDA margin expanded by 462bps over FY18-20 despite USFDA compliance issues impacting FY03 FY05 FY10 FY15 FY20 US sales. We expect Torrent’s next 5-year capital allocation to be focused on India. Superior branding capabilities offer it the scope to introduce new products such as SGLT2 inhibitors (e.g., remogliflozin). Continued scale-up in higher Source: Company, Ambit Capital research margin chronic areas backs our next 10-year 14% FCFF CAGR. Near-term valuation concerns overpower an otherwise steady narrative Other markets’ FY20-22 topline development would be a mixed bag as: (i) US is facing structural compliance issues; and (ii) German sales would stabilize in FY21 post internal restructuring, but Covid-19 and weak currency would drag Brazilian Research Analysts segment. This would be partly countered by domestic business strengthening on Nikhil Mathur, CFA counts of further upgradation of operational efficiencies via virtual doctor +91 22 6623 3220 connect, limited MR addition need and new product launches. Still, issues ex- India put a cap on near-term re-rating potential from 21x EV/EBITDA (34% [email protected] premium to last 3-year average). Kushagra Bhattar +91 22 6623 3062 [email protected] Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Torrent Pharmaceuticals Exhibit 1: A common thread in Torrent’s growth pursuits across markets has been its reliance on acquisitions Phase II: FY13-19 Phase III: FY20 Phase I: prior FY07 to FY12 FY14 - Acquired Elder’s domestic business and UK products portfolio onwards FY05 - Acquired Heumann of Cipla/Actavis WL for Indrad/Levittown; Pharma OAI for Dahej FY16 - Acquired Glochem US API facility; exceptional gAbilify 90 55% FY10 - Expanded reach in tier II- contribution; Dahej plant batches commenced 80 IV domestic market cities; Rs bn substantial expansion of Indrad 70 FY17 - Unichem acquisition; acquired Novartis' women healthcare 45% plant brands Regestrone/Pregachieve 60 FY11 – Commissioned Sikkim 35% 50 plant; invested into establishing 40 Dahej plant 25% 30 20 15% 10 - 5% FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 India US Germany Brazil RoW CRAMs & others Pre-tax RoCE % (RHS) Source: Company, Ambit Capital research. Exhibit 2: Considerable growth in sales and cash generation recorded over the last decade, but recent Unichem acquisition has dampened pre-tax RoCE to <20% levels (` mn) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues 21,955 26,937 32,058 41,800 46,463 66,669 58,148 59,380 76,730 79,390 Revenue growth (%) 15% 23% 19% 30% 11% 43% -13% 2% 29% 3% Net profits 2,702 3,362 4,608 6,639 7,509 18,765 9,336 6,779 7,186 9,425 EPS 16 20 27 39 44 111 55 40 42 56 CFO 3,950 5,073 1,535 5,994 8,102 27,481 10,088 8,942 17,981 13,920 CFO-EBITDA 124% 118% 41% 91% 85% 122% 101% 87% 105% 77% FCF 1,300 3,371 (1,394) 1,993 5,676 21,490 5,220 1,029 11,353 9,860 Debt equity (x) 0.4 0.4 0.4 0.5 0.9 0.8 0.7 1.5 1.3 1.1 CE turnover 1.5 1.7 1.7 1.7 1.1 1.2 1.0 0.7 0.7 0.7 GB Turnover 2.6 2.6 2.7 3.3 3.4 4.4 2.8 2.0 2.1 2.0 RoE (%) 29% 30% 35% 40% 33% 61% 24% 15% 15% 20% ROCE* (%) 22% 26% 32% 35% 20% 46% 18% 11% 13% 14% Source: Company, Ambit Capital research. Note: *Pre-tax RoCE; CFO-EBITDA is pre-tax CFO to EBITDA ratio. Exhibit 3: Acquisitions and plant setups have been key initiatives across different markets over the last 10-12 years Time period Phase Key developments . FY05: Acquired Huemann Pharma in Germany with 315 product approvals/34 filings Capacity expansion and Prior FY07 to FY12 FY10: Expanded reach in tier II-IV domestic market cities; substantial expansion of Indrad plant organic growth pursuits . . FY11: Commissioned formulation facility at Sikkim; invested towards establishing Dahej plant . FY14: Acquired Elder Pharma's domestic formulation business; Acquired portfolio of products from Cipla/Actavis in the UK . FY15: Acquired Zyg Pharma (CMO - contract mfg.) for Apotex and several MNCs in India for derma . FY16: Acquired Glochem API facility in US; Dahej plant batches commenced; exceptional Inorganic pursuits core to FY13-19 contribution from gAbilify growth strategy . FY17: Unichem acquisition; acquired Novartis' women healthcare brands Regestrone and Pregachieve; Vertical integration via USFDA approved API facility acquisition . FY18: Biopharma acquisition in US for manufacturing and R&D presence in the US and capability to manufacture controlled substances . FY19: Biopharma acquisition write-off; voluntary recall for Losartan/Losartan-H Better execution led organic FY20 onwards Warning letter for Indrad and Levittown facility; OAI for Dahej growth . Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 184 [email protected] 2020-12-07 Monday 13:17:41 Torrent Pharmaceuticals Exhibit 4: Capex intensity of India heavy names like Cipla/Alkem/Eris is usually towards the lower end of the spectrum; Torrent’s capex intensity is higher due to acquisitions Pre-tax Cumu. FY20 Domestic Revenue CAGR EBITDA margin Pre-tax RoCE Company name FY20 revenue CFO/EBITDA Investments/CFO market share FY14-20 (FY20) (FY20) (FY14-20) (FY14-20) Sun 8.5% 323,252 12% 20% 10% 95% 52% Cadila 4.0% 142,531 12% 20% 12% 81% 117% Cipla 4.6% 171,320 9% 19% 11% 88% 64% Lupin 3.9% 153,748 5% 15% 7% 92% 101% Alkem 3.4% 83,444 18% 18% 19% 92% 79% Torrent 3.2% 79,390 11% 27% 14% 87% 107% Dr. Reddy's 2.5% 174,600 5% 21% 27% 88% 78% Eris 1.0% 10,741 13% 34% 30% 94% 76% Source: Company, Ambit Capital research; Note:*investments include capex and acquisitions Exhibit 5: Sun ranks highest on IBAS framework; Torrent’s lack of innovation focus and limited backward integration capabilities lead to a lower score Architecture Strategic Overall Company Innovation Brand Distribution Comments Manufacturing assets rank reach Largest US specialty portfolio amongst Indian companies demonstrates its innovation capabilities. Sun has built a best-in-class domestic pharma business with 8% market share on the back of: (i) superior brand recall; (ii) top ranked MR productivity; and (iii) wide Sun reach. Halol plant compliance issues drags its manufacturing score, while Ilumya out-licensing deals and API capabilities ensure high rank on strategic assets. Domestic respiratory franchise, certain in-licensing deals and rising inhalers penetration in the US are its key competitive advantages. Cipla Recent Goa sterile unit compliance violation tempers its overall score. US’ specialty franchise, inhalation pipeline build-up and certain NCE out-licensing deals demonstrate its innovation capabilities. Key issue Lupin is manufacturing compliance, with five plants currently under regulatory glare. High chronic share and in-licensing deals resulted in sustained market-leading domestic growth. Management overhaul under new leadership, backward integration capabilities, and out-licensing of proprietary products to players in the US are strategic assets. Domestic business is strengthening via Dr. Reddy's both organic and inorganic initiatives, with base still low to record market leading next 5-year growth. Compliance issues are also currently under control as all plants have attained clearance. Domestic branding capabilities are superior to Sun, while successful acquisitions have boosted its mix. Overall score is low owing to Torrent three plants currently under USFDA compliance woes and sub-par backward integration setup. Cadila’s innovation initiatives are quite prominent both in the US and India, though scale-up is yet to materialize. Compliance issue at Cadila Moraiya is a concern, with US sales concentration also quite high. Backward integration into APIs is a key strategic asset. Overall score suffers from high acute share in the mix and lack of strategic assets like API investments. But, clean current regulatory Alkem track record and high brand recall in domestic acute segment are key advantages for the company. Eris has built a domestic franchise focused on specialists and super- specialists in the past 10 years in India. The firm gets penalised as Eris most of its brands are not in top 3, which we suspect drags MR productivity. Source: Ambit Capital research; Note: - Strong; - Relatively strong; - Average; - Relatively weak August 26, 2020 Ambit Capital Pvt. Ltd. Page 185 Torrent Pharmaceuticals Exhibit 6: Torrent is currently trading at 21x EV/EBITDA, Exhibit 7: Outperformance has largely resulted from implying 34% premium to its last 3-year average growth in higher share domestic segment 23 Torrent's 1-yr fwd EV/EBITDA multiple 1800 Stock price performance indexed to 100 21 1600 19 1400 17 1200 15 1000 13 800 11 600 9 400 7 200 5 0 Jul-20 Jul-16 Jul-13 Jan-20 Jan-17 Jan-13 Jan-10 Jun-19 Jun-16 Apr-18 Apr-15 Oct-18 Oct-14 Oct-11 Feb-17 Feb-14 Sep-17 Sep-14 Dec-19 Dec-15 Dec-12 Mar-18 Mar-14 Mar-11 Aug-20 Aug-17 Aug-13 Aug-10 Nov-18 Nov-15 May-19 May-15 May-12 Torrent 3-yr roll. avg. Torrent Nifty Pharma Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research Exhibit 8: Domestic represents 44% of total sales, while US’ Exhibit 9: Revenue/cost synergies from acquisitions contribution currently is 19% resulted in considerable EBITDA margin uptrend 100 30% 77% 45% 80 75% 40% 20% 60 73% 35% Rs bn 40 10% 71% 30% 20 - 0% 69% 25% 67% 20% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 CRAMs/others 65% 15% Brazil Germany US FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 India Sales 3-yr roll CAGR (RHS) Gross margin % EBITDA margin % (RHS) Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 10: Torrent is currently in a de-leveraging phase Exhibit 11: Lower US bargaining power and compliance following Unichem acquisition in end-FY19 issues drag both asset and working capital turns 30 1.6 5 14 25 1.4 12 4 20 1.2 10 1.0 15 3 8 Rs bn 0.8 10 6 0.6 2 4 5 0.4 - 0.2 1 2 (5) - FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 CFO FCF Debt-equity (RHS) Gross block turns WC turns (RHS) Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 186 Torrent Pharmaceuticals Exhibit 12: Superior FCF generation over FY20-22 would Exhibit 13: …which would partly result from uptrend in result in improvement of return rations… operating efficiency metrics like EBITDA/employee 70% 40 3.0 60% 2.5 30 50% 2.0 40% Rs bn 20 1.5 mn 30% ` 20% 1.0 10 10% 0.5 0% - - FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Pre-tax RoCE RoE Fixed cost EBITDA EBITDA/employee (RHS) Source: Company, Ambit Capital research Source: Company, Ambit Capital research HAWK Scores Marginally above sector average On our proprietary forensic score framework, Torrent appears in the Zone of “Pain” in 2019. Torrent improved its score to D6 in 2019 vs. D7 in 2018. The company scores higher than the median accounting score for its sector but scores below median accounting score for the large universe (BSE500 companies). On greatness, Torrent’s score deteriorated to 8% in 2019 vs. 58% YoY. Torrent’s greatness score has been above-50% over 2015-2018 but declined substantially in 2019. Consequently its greatness score percentile is significantly lower than the median score for its sector as well as the larger universe (BSE500 companies). Key contributors to accounting score and comparison to peers Torrent features in D6 decile on our accounting framework, which is the Zone of “Pain”. Key contributors to its marginally above-average accounting score include: (i) higher CFO to EBITDA ratio; (ii) relatively lower contingent liabilities; and (iii) lower CWIP to gross block ratio. In comparison with peers, Torrent scores marginally above median accounting score, indicating above par accounting quality vs. peers. We note that Torrent scores low on few parameters including: (i) volatile depreciation rate; (ii) lower FCF to sales ratio; (iii) relatively higher advances to related parties; and (iv) lower cash yield. Torrent’s accounting score is below median when compared with the large universe (BSE500 companies). August 26, 2020 Ambit Capital Pvt. Ltd. Page 187 Torrent Pharmaceuticals Exhibit 14: Forensic accounting score contributors Exhibit 15: Forensic score percentile to larger universe and sector Source: Ambit HAWK Source: Ambit HAWK Comments on evolution of accounting score Torrent’s score has largely been in the Zone of “Pain” (i.e. D6 to D7 deciles) over 2015-19. It is pertinent to note here that our framework consists of multiple ratios including CWIP/gross block, cumulative FCF/median sales which assess companies accounting quality capital deployment front. Owing to the nature of the pharma business, these companies might get inadvertently penalised on our framework, especially on CWIP/gross block and cumulative FCF/median sales. August 26, 2020 Ambit Capital Pvt. Ltd. Page 188 Torrent Pharmaceuticals Exhibit 16: Forensic accounting score evaluation Exhibit 17: Movement in accounting checks Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 87% 105% 77% Volatility in depreciation P & L mis- -193bps 190bps 21bps statement check rate PFD-% of Debtors more 0% 0% 0% than six months Cash yield 0.5% 1% 1% Balance sheet Change in reserves (ex mis-statement sec-prem)/(PAT ex 0.7 1.5 0.3 check dividend) Cont Liab-% of NW 3% 3% 3% Misc. exps-% of total revs 7% 6% 6% Adv. to related parties / 13% 10% 6% Pilferage checks CFO CWIP: Gross Block 7% 6% 7% Cum. FCF/median revs -55% -27% -13% Audit quality CAGR in auditor's (2.4) (0.3) 3.4 check remn/CAGR in cons. Rev. Source: Ambit HAWK Source: Company, Ambit Capital research Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc.). Torrent’s greatness score has deteriorated in 2019 to 8% vs. 58% YoY. Torrent’s greatness score has been above-50% over 2015-18. Decline in greatness score emanated from: (i) high net-debt to equity; and (ii) low capital employed turnover. Consequently, Torrent’s performance has been subdued when compared to the larger universe (BSE500 companies) and its sector peers. Exhibit 18: Greatness score contributors Source: Ambit HAWK August 26, 2020 Ambit Capital Pvt. Ltd. Page 189 [email protected] 2020-12-07 Monday 13:17:41 Torrent Pharmaceuticals Exhibit 19: Greatness score percentile to larger universe Exhibit 20: Greatness score evolution and sector Source: Ambit HAWK Source: Ambit HAWK Exhibit 21: Explanation for our flags Segment Score Comments Located in D6 in Ambit Hawk due to, (i) higher CWIP to gross block ratio, (ii) volatile depreciation rates, and (iii) lower FCF Accounting AMBER to revenue ratio. Product recalls, USFDA regulatory issues, presence of limited competition opportunities in the US and currency volatility in Predictability AMBER emerging markets like Brazil hamper revenues and earnings predictability. Earnings Torrent’s estimates have witnessed downward revision in the near term. This is due to challenges pertaining to domestic AMBER momentum growth in FY21, subdued growth guidance for Brazil and delayed reduction in debt levels. Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 190 Torrent Pharmaceuticals Balance sheet (consolidated) Year to March (` mn) FY19 FY20 FY21E FY22E FY23E Shareholders' fund 47,240 48,240 56,014 65,518 76,533 Long term borrowings 39,130 33,040 24,040 18,040 18,040 Others 3,180 4,280 4,280 4,280 4,280 Non-current liabilities 42,310 37,320 28,320 22,320 22,320 Short term borrowings 9,340 10,910 9,910 8,910 8,910 Trade payables 20,980 20,760 20,999 23,060 25,511 Others 21,340 23,150 23,150 23,150 23,150 Current liabilities 51,660 54,820 54,059 55,120 57,571 Total equity & liabilities 141,210 140,380 138,393 142,959 156,424 Tangible assets 28,007 28,179 27,890 28,185 28,846 Capital work-in-progress 6,170 7,120 7,120 7,120 7,120 Intangible assets 49,470 45,798 41,751 37,753 34,100 Deferred tax assets 3,700 4,330 4,330 4,330 4,330 Investments & others 3,480 4,860 4,860 4,860 4,860 Non-current assets 90,827 90,287 85,951 82,248 79,256 Inventories 19,350 21,480 20,999 24,274 26,854 Trade receivables 14,360 16,490 16,578 16,992 18,798 Cash and cash equivalents 11,670 6,660 9,402 13,982 26,053 Loans & advances and others 5,000 5,460 5,460 5,460 5,460 Current assets 50,380 50,090 52,439 60,707 77,165 Total assets 141,207 140,380 138,393 142,959 156,424 Source: Company, Ambit Capital research Profit and loss (consolidated) Year to March (` mn) FY19 FY20 FY21E FY22E FY23E Net sales 76,730 79,390 82,329 90,410 100,020 Gross profit 54,540 57,720 60,307 66,203 73,482 Employee cost (ex. R&D) (12,426) (12,812) (13,452) (14,798) (16,503) R&D expenses (5,380) (4,928) (4,775) (5,425) (6,501) Other expenses (ex. R&D) (16,894) (18,281) (18,693) (20,342) (22,462) EBITDA (core) 19,840 21,700 23,386 25,639 28,015 EBITDA (underlying) 19,840 21,700 23,386 25,639 28,015 Depreciation (6,180) (6,540) (6,836) (6,867) (6,993) Interest expense (5,040) (4,510) (3,425) (2,525) (1,804) Other income 570 1,220 932 940 699 EO items (3,570) - - - - Tax provision (1,260) (1,620) (2,952) (3,609) (4,183) PAT (reported) 4,360 10,250 11,106 13,577 15,735 PAT (adjusted) 7,186 9,425 11,106 13,577 15,735 Source: Company, Ambit Capital research Per share data (consolidated) Year to March (`) FY19 FY20 FY21E FY22E FY23E No. of shares o/s (mn) 169 169 169 169 169 EPS (adjusted) basic 42 56 66 80 93 EPS (adjusted) diluted 42 56 66 80 93 DPS 13 32 20 24 28 Dividend payout (%) 31% 57% 30% 30% 30% Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 191 Torrent Pharmaceuticals Cash flow (consolidated) Year to March (` mn) FY19 FY20 FY21E FY22E FY23E PBT 5,617 11,870 14,058 17,187 19,918 Depreciation 8,352 6,540 6,836 6,867 6,993 Others 5,830 2,210 - 2,492 4,077 WC (build)/release 994 (4,480) - 632 (995) Tax (2,812) (2,840) (2,952) (3,609) (4,183) Cash flow from operations 17,981 13,300 17,942 23,569 25,809 Capex (net) (6,628) (4,060) (2,500) (3,164) (4,001) Investments (increase)/decrease 3,679 40 - - - Others income/(expenditure) 537 470 932 940 699 Cash flow from investments (2,413) (3,550) (1,568) (2,224) (3,302) Proceeds from borrowings (5,013) (3,130) (10,000) (7,000) - Issuance/buyback of equity - - - - - Interest paid (5,034) (4,850) (3,425) (2,525) (1,804) Dividend paid (3,097) (7,190) (3,332) (4,073) (4,721) Cash flow from financing (13,145) (15,170) (16,757) (13,598) (6,525) Net change in cash 2,424 (3,080) 2,742 4,580 12,071 FCF 11,353 9,860 18,566 17,238 17,897 Source: Company, Ambit Capital research Ratios (consolidated) Year to March FY19 FY20 FY21E FY22E FY23E Revenue growth (%) 29% 3% 4% 10% 11% EBITDA margin (%) 26% 27% 28% 28% 28% EBIT margin (%) 19% 21% 21% 22% 22% Net margin (%) 9% 12% 13% 15% 16% R&D as % of sales (%) 7% 6% 6% 6% 7% Gross block turnover (x) 2.1 2.0 2.0 2.1 2.1 RoCE pre-tax (%) 13% 14% 16% 18% 19% RoCE post-tax (%) 10% 12% 12% 14% 15% RoIC pre-tax (%) 15% 15% 17% 20% 23% RoE (%) 15% 20% 21% 22% 22% Receivable days 68 76 75 70 70 Inventory days 92 99 95 100 100 Payable days 100 95 95 95 95 Cash conversion cycle 61 79 75 75 75 Pre-tax CFO/EBITDA (%) 105% 77% 103% 94% 93% Net debt / Equity (x) 1.0 1.1 0.7 0.4 0.2 Source: Company, Ambit Capital research Valuation ratios (consolidated) Year to March FY19 FY20 FY21E FY22E FY23E P/E (x) 66.0 50.3 42.7 34.9 30.2 P/B (x) 10.0 9.8 8.5 7.2 6.2 EV/EBITDA(x) 26.5 24.3 22.5 20.5 18.8 EV/EBIT(x) 38.5 34.7 31.8 28.0 25.0 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 192 Whirlpool of India NOT RATED SCALABILITY THEMATICS WHIRL IN EQUITY August 26, 2020 David’s fight with new Goliaths Consumer Durables Whirlpool posted a healthy 13%/22% revenue/EBITDA CAGR over FY14- Recommendation 20 owing to change in leadership and down-trading its core categories (WM and Ref) in order to gain market share lost by Videocon. Over the Mcap (bn): `286/US$3.5 years, Whirlpool has been able to establish a deep distribution network 3M ADV (mn): `1,674/US$2.23 coupled with innovation on SKUs and branding. Going forward Whirlpool CMP: `2,252 is set to face headwinds of (1) high competitive intensity with likes of TP (12 mths): NA Voltas Becko, Bosche and Electrolux entering the market and (2) Change Upside (%): NA in the top leadership. In the past Whirlpool has been able to withstand competition and grow in its core categories, can it do so again? Current Flags valuations of 91x TTM PE are punchy even though core categories remain under-penetrated. Going forward, Whirlpool needs to reinvest its cash Accounting: GREEN (like it did in FY20) to deepen its position in core categories and grow in Predictability: RED newer categories in the wake of competition. Earnings Momentum: AMBER Competitive position: STRONG Changes to this position: NEGATIVE Washing machine and refrigerators have driven growth Performance Over the last decade, Whirlpool’s revenue/EBITDA grew at a modest 11%/13% 210 Whirlpool Sensex CAGR. However the real change in its fortunes only happened after the leadership change in the company FY14; post which it posted a high 13%/22% 160 revenue/EBITDA growth over FY14-20. Whilst akin to its global strategy Whirlpool 110 tried venturing into other categories (Microwaves, AC and kitchen appliances), it found limited success there; growth came from core categories such as 60 refrigerator and washing machine which grew at ~14% CAGR over FY14-19. Growth in its core categories can be attributed to Whirlpool’s focus on Jul-20 Jan-20 Jun-20 Oct-19 Apr-20 Feb-20 Sep-19 Dec-19 Mar-20 Aug-19 Nov-19 distribution and its continuous innovation in both these product categories. May-20 Revenue growth at the cost of Videocon and expansion of distribution Source: Bloomberg, Ambit Capital research Owing to high upfront capital costs for refrigerators and washing machine, Whirlpool had a natural entry barrier here. Whirlpool’s effort to broad-base its Whirlpool’s forensic analysis distribution in Tier-2 and Tier-3 cites through multiple dealer meets/campaigns helped it to penetrate the non-urban markets. This coupled with Whirlpool’s strategy to capture Videocon’s lost market share through down-trading its products in to more value for money category helped the company. Whilst other businesses/exports also saw modest growth at 13% CAGR, albeit this came at a very low base. Whirlpool hasn’t been able to scale any of these businesses substantially owing to the high competitive intensity seen in these businesses Source: Ambit ‘HAWK’, Ambit Capital research Multiple Goliaths to enter market, can this David remain unaffected? Over FY10-20 Whirlpool was able to increase its market share in WM/Ref owing Whirlpool’s greatness score analysis to exit of Videocon/other Indian players whilst sustaining the competitive intensity from Korean brands. With giants like Voltas Becko, resurgent Haier, Bosche and RIL backed Kelvinator entering its core market, Whirlpool will face an uphill task. To add to its woes, Whirlpool has only recently seen the departure of its MD; who led the company during its successful growth period. Can Whirlpool overcome these dual blows to come out on the top in next decade? Source: Ambit ‘HAWK’, Ambit Capital research Valuations punchy; multiple headwinds ahead Whirlpool undertook highest ever capex to the tune of ` 3bn (vs usual run-rate of `1-1.5bn) in FY20 indicating its intention to rev up manufacturing in India. It Research Analysts needs to continue this reinvestment of cash its core business to continue growth owing to anticipated competitive intensity ahead. Currently the stock is trading at Nitin Bhasin 91x TTM PE (life high valuations).Whilst industry growth potential is high owing to +91 22 6623 3241 the low level of penetration of its core categories (33% for ref/12% for WM); [email protected] Whirlpool’s growth can come under-threat owing to high competitive intensity Dhruv Jain and change in management. Add to this need for capex and declining RoCE. +91 22 6623 3177 [email protected] Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. Whirlpool of India Exhibit 1: Evolution of Whirlpool over the last 15 years 70 60% Phase 1: 7% revenue CAGR Phase 1: 14% revenue 60 CAGR 50% 50 40% 40 30% 30 20% 20 10 10% 0 0% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues (Rs bn; LHS) Pre-tax RoCE (%; RHS) Source: Company, Ambit Capital research Exhibit 2: Key financial parameters over the last decade (Fig in ` mn) FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Revenues 22,149 27,028 26,579 27,727 28,346 32,938 34,399 39,408 48,319 53,977 59,925 Revenue growth (%) 22% -2% 4% 2% 16% 4% 15% 23% 12% 11% Net profits 1,450 1,660 1,237 1,277 1,229 2,105 2,400 3,105 3,507 4,070 4,762 EPS 5.7 12.3 9.6 10.1 9.7 16.6 18.9 24.5 27.6 32.3 38.6 CFO (before tax) 2,245 2,588 2,608 1,817 2,423 3,846 4,606 5,640 5,881 6,384 5,866 CFO-EBITDA (Pre tax ) 97% 99% 117% 84% 115% 116% 120% 115% 105% 99% 87% FCF 1,536 1,388 1,025 712 1,340 2,445 3,128 3,406 2,286 2,161 753 Debt equity (x) (0.17) (0.12) (0.18) (0.25) (0.39) (0.58) (0.73) (0.71) (0.55) (0.55) (0.56) CE turnover 6.4 6.8 5.6 4.8 4.0 3.9 3.3 3.0 3.1 2.6 2.4 GB Turnover 7.4 8.9 8.1 7.6 7.5 8.7 9.2 10.3 10.8 10.6 8.5 RoE (%) 43% 42% 27% 23% 18% 25% 23% 23% 23% 19% 19% ROCE* (%) 55% 54% 36% 27% 21% 31% 29% 30% 28% 27% 23% Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total capital including cash in the denominator. Exhibit 3: The key things to note from evolution Time period Phase Key developments . Deepened its distribution by expanding to Tier 2/Tier 3 towns FY09-FY13 Phase 1 . Focussed on branding by launching newer campaigns . Focussed on innovation of new products . Change in management in FY14 with Mr Salil D’Souza becoming MD FY14-Current Phase 2 . Down-trading of products, market share gain from Videcon in lower end category in Ref and WM Source: Company, Ambit Capital research Exhibit 4: Competitive mapping of Whirlpool, with other comparable BM peers Revenue Pre-tax Pre-tax CFO/ Sub-segment FY20 Industry EBITDA Capex/CFO Company CAGR RoCE EBITDA Positioning revenue market share Margin (FY20) (FY10-20) FY10-20 (FY20) (FY10-20) Whirlpool #1 28,080 15% ~11% 15% 18% 91% 81% Voltas #3 25,780 25% ~9% 17% 23% 90% 75% IFB #1 12,419 14% ~22% 15% 15% 84% 70% Lloyd #1 22,926 7% ~4% 15% 16% 94% 79% Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 194 [email protected] 2020-12-07 Monday 13:17:41 Whirlpool of India Exhibit 5: Mapping Whirlpool and its peers on IBAS Brand Architecture Strategic Overall Company Innovation Mfg Dstrbn Comments Rural Urban asset rank reach reach Whirlpool gains in innovation on the back of its foreign parentage and the know-how it receives from there. It enjoys a decent rural/urban brand on the back of its value Whirlpool for money proposition. It largely does its own in-house manufacturing and has been able to build a wide manufacturing reach. Hence, it ranks highly on our framework Voltas ranks low on innovation due to its reliance on ODM manufacturers. However, it has been able to create a Voltas unique brand in ACs and create a deep distribution network across the country. IFB ranks high on innovation owing to their technical knowhow of front loader WMs. However, it hasn’t been IFB able to create a deep brand in rural markets owing to limited reach of automatic WMs in rural areas. Its technical know-how is its key strategic asset Lloyd ranks low on innovation owing to its lack of any differentiated product/ODM manufacturing for fringe categories. Whilst it enjoys a strong rural brand, in urban Llloyd markets it is a lower end brand. Its in-house manufacturing it’s the key competitive advantage; however distribution remains a problem area. Source: Company, Ambit Capital research Exhibit 6: Whirlpools’s multiples have expanded Exhibit 7: Stock’s price performance – Whirlpool has consistently post FY14 significantly outpaced the index 70 2,000 60 50 1,500 40 1,000 30 20 500 10 0 - Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 Sep-10 Sep-12 Sep-14 Sep-16 Sep-18 May-11 May-13 May-15 May-17 May-19 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Apr-19 Apr-20 TTM PE(x) Cross cycle avg Whirlpool Sensex Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 8: Margins have largely been range bound over the Exhibit 9: Cash flow generation has been healthy for last decade Whirlpool and off late capex has been ramped up 50% 8,000 - 40% 6,000 (0.20) 30% 4,000 (0.40) 20% 2,000 (0.60) 10% 0% - (0.80) FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 CFO (before tax; Rs mn) FCF (Rs m) EBITDAM (%) Gross margin (%) Debt/equity (x; RHS) Source: Company, Ambit Capital research Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 195 Whirlpool of India Exhibit 10: WC turnover/ GB turnover has consistently Exhibit 11: RoCEs have been declining owing to reducing come off increased over the last 10 years capital allocation opportunities for Whirlpool GB turnover (x) WC turnover (x) 70 RoCE (Pre -tax ; %) RoE % 60 60% 50 50% 40 40% 30 30% 20 20% 10 10% 0 0% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Exhibit 12: EBITDA/employee has been flat for Whirlpool 12,000 6.0 10,000 5.0 8,000 4.0 6,000 3.0 4,000 2.0 2,000 1.0 - - FY15 FY16 FY17 FY18 FY19 FY20 EBITDA + emp. costs (Rs mn) EBITDA/employee (Rs mn; RHS) Source: Company, Ambit Capital research Exhibit 13: Explanation for our flags Segment Score Comments Accounting GREEN Whirlpool is audited by a reputed auditor, features on ‘D2’ on our Hawk framework. Predictability RED Considering the volatile environment owing to pandemic, predictability is low Earnings AMBER Bloomberg shows downgrades owing to pandemic in the last 6 months. momentum Source: Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 196 Whirlpool of India HAWK scores – In the top tier Whirlpool has consistently featured in the top tier of our framework which is in Zone of Safety. It also scores higher than the median accounting score for its sector. KECI scores significantly well on our greatness parameters compared to peers and larger universe and features in ‘Zone of Greatness’ in FY19. It has shown significant improvement in greatness scores since FY15. Key contributors to accounting score and comparison to peers Whirlpool has consistently featured in the top tier of our framework which is in Zone of Safety. Key contributors to its relatively strong accounting score include high cash flow generation, high FCF generation, low change in auditor remuneration. Weaker aspects include high contingent liability as a % of NW Exhibit 14: Forensic accounting score contributors Exhibit 15: Forensic score percentile to larger universe and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company. Comments on evolution of accounting score Whirlpool has always featured in Zone of Safety (i.e. D1 to D5deciles) between FY15 to FY19. It is pertinent to note here that our framework consists of a higher number of ratios which capture the cash generation abilities of the businesses. This consistent performance has been owing to strong cash flow generation and FCF generation over the years August 26, 2020 Ambit Capital Pvt. Ltd. Page 197 Whirlpool of India Exhibit 16: Forensic accounting score evaluation Exhibit 17: Movement in accounting checks – Likely to deteriorate on accounting score in FY20 Category Accounting ratios FY18 FY19 FY20 CFO/EBITDA 105% 99% 87% P & L mis-statement Volatility in - check depreciation rate -1.3% -1.3% 1.3% PFD-% of Debtors 2.7% 4.30% 4.6% more than six months Balance sheet Cash yield 6.2% 8.2% 7.6% Change in reserves (ex mis-statement check sec-prem)/(PAT ex 0.8 0.9 1 dividend) Cont Liab-% of NW 79% 69% 53% Misc. exps-% of total 1% 1% 1% revs Adv. to related parties Pilferage checks 0% 0% 0% / CFO CWIP: Gross Block 5% 5% 4% Cum. FCF/median revs 7% 6% 4% CAGR in auditor's Audit quality remn/CAGR in cons. (1.94) (4.11) 3.36 check* Rev. Source: Ambit Capital research, Company Source: Ambit Capital research, Company. * Growth in auditor remuneration is insignificant; hence there is no concern Evolution of greatness score Our greatness framework evaluates companies on drivers of ‘Greatness’ (e.g. cash generation, incremental capex, efficiency in capital employed turnover etc). Whirlpool has consistently improved in its greatness scores over the years. Exhibit 18: Greatness score contributors Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 198 Whirlpool of India Exhibit 19: Greatness score percentile to larger universe Exhibit 20: Greatness score evolution and sector Source: Ambit Capital research, Company Source: Ambit Capital research, Company August 26, 2020 Ambit Capital Pvt. Ltd. Page 199 [email protected] 2020-12-07 Monday 13:17:41 Whirlpool of India Balance sheet (consolidated)* Particulars (` mn) FY16 FY17 FY18 FY19 FY20 Total Networth 11,657 14,831 17,963 21,454 25,636 Sources of funds 11,657 14,831 17,963 21,454 25,636 Net block 3,662 3,978 4,459 5,082 7,035 Capital work-in-progress 367 295 331 929 929 Investments 0 1,297 4,563 6,590 5,671 Cash and bank balances 8,563 10,590 9,819 10,610 16,625 Sundry debtors 1,926 2,049 2,403 2,556 2,812 Inventories 6,835 8,888 8,101 8,886 11,989 Loans and advances 1,048 1,092 1,939 2,355 248 Other Current Assets 111 414 364 261 1,017 Total Current Assets 18,484 23,032 22,626 24,668 32,691 Current liabilities & 10,826 13,931 14,295 15,664 16,935 provisions Net current assets 7,658 9,101 8,332 9,004 15,756 Deferred tax (30) 159 279 (152) (3,755) liabiltiies/assets Application of funds 11,657 14,831 17,963 21,454 25,636 Source: Company, Ambit Capital research Income statement (consolidated)* Particulars (` mn) FY16 FY17 FY18 FY19 FY20 Net Sales 34,399 39,408 48,319 53,977 59,925 Reported EBITDA 3,835 4,888 5,600 6,422 6,733 Net depreciation / 769 875 1,015 1,113 1,293 amortisation EBIT 3,066 4,014 4,585 5,309 5,440 Interest Expense/(income) -502 -671 -823 -956 -1,088 PBT 3,568 4,685 5,408 6,265 6,528 Provision for taxation 1,167 1,580 1,902 2,194 1,766 PAT 2,400 3,105 3,507 4,070 4,762 Share of associates 0 0 0 27 139 Consolidated PAT 2,400 3,105 5,656 4,097 4,901 Consolidated EPS (`.) 19 24 28 32 39 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 200 Whirlpool of India Cashflow statement (consolidated) Particulars (` mn) FY16 FY17 FY18 FY19 FY20 PBT 3,560 4,685 5,408 6,265 6,668 Depreciation 769 875 1,015 1,113 1,293 Interest expense/ -502 -671 -823 -956 -1,088 (income) Direct taxes paid -1,168 -1,805 -2,039 -2,360 -2,064 CFO (before tax) 4,606 5,640 5,881 6,384 5,866 CFO 3,438 3,836 3,842 4,025 3,802 Purchase of fixed assets -787 -1,118 -1,557 -1,864 -3,049 CFI -284 -1,801 -4,151 -2,619 -720 CFF (9) (13) (465) (619) (720) Net Cash inflow / 3,145 2,022 (774) 787 2,211 (outflow) Free cash flow 3,128 3,406 2,286 2,161 753 Source: Company, Ambit Capital research Ratio analysis (consolidated)* Particulars FY16 FY17 FY18 FY19 FY20 Net debt/Equity (0.7) (0.7) (0.5) (0.5) (0.6) Working capital turnover 5.3 4.7 5.8 6.0 3.8 (x) Capital employed 3.3 3.0 3.1 2.6 2.4 turnover (x) Gross block turnover (x) 9.2 10.3 10.8 10.6 8.5 Post-tax RoCE 20% 20% 17% 18% 17% Pre-tax RoCE 29% 30% 28% 27% 23% ROE 23% 23% 23% 19% 19% Source: Company, Ambit Capital research Valuation parameters (consolidated)* Particulars FY16 FY17 FY18 FY19 FY20 Consolidated adjusted 19 24 28 32 39 EPS (`) BVPS 92 115 138 166 202 P/E (x) 117 91 80 69 58 P/B (x) 19 24 28 32 39 EV/EBITDA (x) 69 54 47 41 39 EV/EBIT (x) 86 66 57 50 48 Source: Company, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 201 Whirlpool of India Institutional Equities Team Research Analysts Name Industry Sectors Desk-Phone E-mail Nitin Bhasin - Head of Research Strategy / Cement / Home Building / Mid-Caps (022) 66233241 [email protected] Ajit Kumar, CFA, FRM Banking / Financial Services (022) 66233252 [email protected] Amandeep Singh Grover Mid-Caps / Hotels / Real Estate (022) 66233082 [email protected] Ashish Kanodia, CFA Consumer Discretionary (022) 66233264 [email protected] Ashwin Mehta, CFA Technology (022) 6623 3295 [email protected] Basudeb Banerjee Automobiles / Auto Ancillaries (022) 66233141 [email protected] Darshan Mehta E&C / Infrastructure / Aviation (022) 66233174 [email protected] Deep Shah Media / Telecom / Oil & Gas (022) 66233064 [email protected] Dhruv Jain Mid-Caps (022) 66233177 [email protected] Karan Khanna, CFA Mid-Caps / Hotels / Real Estate (022) 66233251 [email protected] Karan Kokane Automobiles / Auto Ancillaries (022) 66233028 [email protected] Kushagra Bhattar Healthcare (022) 66233062 [email protected] Nikhil Mathur, CFA Healthcare (022) 66233220 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 66233206 [email protected] Prasenjit Bhuiya Agri & Chemicals (022) 66233132 [email protected] Prateek Maheshwari Cement (022) 66233234 [email protected] Ritesh Gupta, CFA Consumer Discretionary / Agri & Chemicals (022) 66233242 [email protected] Satyadeep Jain, CFA Metals & Mining (022) 66233246 [email protected] Shreya Khandelwal Banking / Financial Services (022) 6623 3292 [email protected] Sumit Shekhar Economy / Strategy (022) 66233229 [email protected] Udit Kariwala, CFA Banking / Financial Services (022) 66233197 [email protected] Varun Ginodia, CFA E&C / Infrastructure / Aviation (022) 66233174 [email protected] Vinit Powle Strategy / Forensic Accounting (022) 66233149 [email protected] Vivekanand Subbaraman, CFA Media / Telecom / Oil & Gas (022) 66233261 [email protected] Sales Name Regions Desk-Phone E-mail Dhiraj Agarwal - MD & Head of Sales India (022) 66233253 [email protected] Bhavin Shah India (022) 66233186 [email protected] Dharmen Shah India / Asia (022) 66233289 [email protected] Abhishek Raichura UK & Europe (022) 66233287 [email protected] Pranav Verma Asia (022) 66233214 [email protected] USA / Canada Hitakshi Mehra Americas +1(646) 793 6751 [email protected] Achint Bhagat, CFA Americas +1(646) 793 6752 [email protected] Singapore Srinivas Radhakrishnan Singapore +65 6536 0481 [email protected] Sundeep Parate Singapore +65 6536 1918 [email protected] Production Sajid Merchant Production (022) 66233247 [email protected] Sharoz G Hussain Production (022) 66233183 [email protected] Jestin George Editor (022) 66233272 [email protected] Richard Mugutmal Editor (022) 66233273 [email protected] Nikhil Pillai Database (022) 66233265 [email protected] Babyson John Database (022) 66233209 [email protected] August 26, 2020 Ambit Capital Pvt. Ltd. Page 202 Whirlpool of India Aarti Industries Ltd (ARTO IN, BUY) APL Apollo Tubes Ltd (APAT IN, BUY) 1,200 2,900 1,000 2,400 800 1,900 600 1,400 400 900 200 400 0 Jun-17 Jun-18 Jun-19 Jun-20 Sep-17 Sep-18 Sep-19 Dec-17 Dec-18 Dec-19 Mar-18 Mar-19 Mar-20 Jun-17 Jun-18 Jun-19 Jun-20 Sep-17 Sep-18 Sep-19 Dec-17 Dec-18 Dec-19 Mar-18 Mar-19 Mar-20 Aarti Industries Ltd APL Apollo Tubes Ltd Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research Dixon Technologies India Ltd (DIXON IN, BUY) ICICI Lombard General Insurance (ICICIGI IN, BUY) 6,100 1,600 5,100 1,400 1,200 4,100 1,000 3,100 800 600 2,100 400 1,100 200 100 0 Feb-17 Feb-18 Feb-19 Feb-20 Aug-17 Aug-18 Aug-19 Nov-17 Nov-18 Nov-19 May-17 May-18 May-19 May-20 Jun-18 Jun-19 Jun-20 Apr-18 Apr-19 Apr-20 Oct-18 Oct-19 Feb-18 Feb-19 Feb-20 Dec-18 Dec-19 Aug-18 Aug-19 Dixon Technologies India Ltd ICICI Lombard General Insurance Co Ltd Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research Mahindra CIE Automotive Ltd (MACA IN, BUY) Minda Industries Ltd (MNDA IN, BUY) 350 500 300 400 250 200 300 150 200 100 100 50 0 0 Feb-20 Feb-20 Feb-19 Feb-19 Feb-18 Feb-18 Aug-20 Aug-20 Aug-19 Aug-19 Aug-18 Aug-18 Aug-17 Aug-17 Nov-19 Nov-19 Nov-18 Nov-18 Nov-17 Nov-17 May-20 May-20 May-19 May-19 May-18 May-18 Mahindra CIE Automotive Ltd Minda Industries Ltd Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 203 Whirlpool of India SBI Life Insurance Co Ltd (SBILIFE IN, SELL) Torrent Pharmaceuticals Ltd (TRP IN, SELL) 1,200 3,000 1,000 2,500 800 2,000 600 1,500 400 1,000 200 500 0 0 Jul-18 Jul-19 Jun-17 Jun-18 Jun-19 Jun-20 Sep-17 Sep-18 Sep-19 Dec-17 Dec-18 Dec-19 Jan-18 Jan-19 Jan-20 Apr-18 Apr-19 Apr-20 Oct-17 Oct-18 Oct-19 Mar-18 Mar-19 Mar-20 SBI Life Insurance Co Ltd Torrent Pharmaceuticals Ltd Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research Amber Enterprises India Ltd (AMBER IN, BUY) 1,900 1,700 1,500 1,300 1,100 900 700 500 300 100 Feb-18 Feb-19 Feb-20 Aug-18 Aug-19 Aug-20 Nov-18 Nov-19 May-18 May-19 May-20 Amber Enterprises India Ltd Source: Bloomberg, Ambit Capital research August 26, 2020 Ambit Capital Pvt. Ltd. Page 204 [email protected] 2020-12-07 Monday 13:17:41 Whirlpool of India Explanation of Investment Rating - Our target prices are with a 12-month perspective. Returns stated are our internal benchmark Investment Rating Expected return (over 12-month) BUY We expect this stock to deliver more than 10% returns over the next12 months SELL We expect this stock to deliver less than or equal to 10 % returns over the next 12 months UNDER REVIEW We have coverage on the stock but we have suspended our estimates, TP and recommendation for the time being NOT RATED We do not have any forward-looking estimates, valuation, or recommendation for the stock. POSITIVE We have a positive view on the sector and most of stocks under our coverage in the sector are BUYs NEGATIVE We have a negative view on the sector and most of stocks under our coverage in the sector are SELLs NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation Note: At certain times the Rating may not be in sync with the description above as the stock prices can be volatile and analysts can take time to react to development. 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