AMBIT INSIGHTS 19 April 2017 DAILY Thematic Consumer Have money… spend prudently (Click here for detailed note) Updates Interglobe Aviation (SELL) Are we overestimating yield and passenger growth? Analyst Notes: Banks: RBI proposes higher provisioning for stressed sector exposure Ravi Singh, +91 22 3043 3181 The RBI has notified (https://goo.gl/aip6Tt) banks to consider higher standard asset provisioning over and above the regulatory minimum for exposures to stressed sectors. Beyond looking at company-specific stress, the RBI proposes to have board- approved policy to review sector-level stress each quarter by monitoring debt-burden, profitability ratios and policy issues of sectors. For the immediate future, it has asked banks to review telecom sector exposure by end-June 2017 and consider making higher provisions. While it is difficult to estimate what additional provisioning burden these proposals could cause, similar measures in Jan’14 for exposure to companies with unhedged foreign currency exposure prescribed additional provisions of up to 80bps. IndusInd Bank (4.7% of total exposure), Yes Bank (4.0%) and Kotak Mahindra Please refer to our website for Bank (3.7%) have higher exposure to telecom. In another notification complete coverage universe (https://goo.gl/V8ppU2), the RBI has tightened disclosure norms by asking banks to disclose material divergences in asset classification and provisioning from RBI norms http://research.ambitcapital.com (as discovered by the RBI) for FY16 along with their FY17 financial statements. Source: Ambit Capital research 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. Please refer to the Disclaimers at the end of this Report. Consumer NEGATIVE THEMATIC April 19, 2017 Have money… spend prudently Key Recommendations GCPL The international businesses of FMCG companies GCPL, Dabur and SELL Marico contribute 25-50% of consolidated sales. Contrary to Target Price: 1,060 Downside: 37% expectations, they failed to complement growth when the Indian businesses decelerated. Businesses in the Middle East and the Indian Marico SELL subcontinent have succeeded with high profitability and RoCE due to their ‘right to win’ there. However, businesses in Sub-Saharan Africa Target Price: 250 Downside: 17% have been the worst performers with single-digit sales growth and Dabur SELL RoCE. We prefer Dabur’s and Marico’s method of organically building businesses over GCPL’s acquisition-led approach. Reiterate SELL on Target Price: 245 Downside: 15% GCPL with possibility of its RoCE falling below 15% if further big-ticket Britannia acquisitions are pursued. SELL Emerging market MNC ambitions fuelled overseas acquisitions Target Price: 2,800 Downside: 18% Starting with export-led model in the late 1990s, Indian FMCG companies Asian Paints SELL GCPL, Dabur and Marico organically built international operations in the early 2000s in countries with Indian diaspora. Via a series of acquisitions over FY06- Target Price: 835 Downside: 23% 13, they entered relatively unknown and higher-risk geographies (geopolitical Berger Paints SELL and currency risk) like North and Sub-Saharan Africa and Latin America to rapidly increase overseas presence. Since FY13, Marico and Dabur have Target Price: 190 Downside: 24% focused on organic growth while GCPL has continued with acquisitions. Possibility of further reduction in GCPL’s No ‘right to win’ in Sub-Saharan Africa overseas RoCE while Marico and Dabur Companies setting up operations in the Middle East or Indian subcontinent (ex- are expected to show improvement India) had a ‘right to win’ given: a) cultural similarities helping product 100% acceptability; and b) presence of significant Indian diaspora enabling use of Dabur* existing Indian brand architecture. However, they had no ‘right to win’ in Sub- 75% Dabur Marico* Saharan Africa and LatAm due to completely new product categories and 50% Marico different consumer behaviour traits. Macro and geopolitical issues, poor 25% GCPL* GCPL infrastructure and foreign exchange losses added to their woes. 0% Organically built businesses doing better than acquisitions -25% Organically built businesses like Dabur’s Asia business (ex-India) and Marico’s buisness Organicof % 0% 10% 20% 30% ROCE of International business Bangladesh business (MBL) have sales of `15bn/`6bn with 25%/13% CAGR over FY12-16 and RoCE >50%. However, acquisitions like Dabur’s Namaste Source: Company, Ambit Capital research Note: Size of the bubble denotes the size of the international (0% sales CAGR) and GCPL’s Africa (10-11% sales CAGR) generate RoCE of business as % of total company sales, * denotes the <10% and are unable to pay down their own debt. Operating at debt:equity of positioning of the company after 5 years, for e.g. Marico* denotes the positioning of Marico after 5 ~5x, these businesses will continue to need equity infusion by the standalone years India business given their inability to generate internal accruals. Prefer Dabur’s and Marico’s organic growth to GCPL’s acquisitions Consistently significant FCF generation in an FMCG company makes capital allocation very important but also makes detecting management’s capital misallocations difficult. Prudent capital allocation ensures long-term wealth Research Analysts creation. Acquisitions have reduced RoCE of all three companies. However, Dabur and Marico corrected course and have halted acquisitions. GCPL’s Ritesh Vaidya, CFA continued focus on acquisitions despite RoCE falling from 65% in FY07 to 17% +91 22 3043 3246 in FY16 is a concern. Reiterate SELL on GCPL. [email protected] Mapping international businesses - Dabur, Marico placed higher than GCPL Anuj Bansal % of Business Geographical Resource Financial +91 22 3043 3122 Company international integration Overall spread allocation transparency [email protected] sales ability GCPL 45% Dhiraj Mistry, CFA Marico 22% +91 22 3043 3264 Dabur 32% [email protected] Source: Ambit Capital research Note: - Strong; - Relatively Strong; - Average; - Relatively weak. 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. AMBIT INSIGHTS Interglobe Aviation SELL Are we overestimating yield and passenger growth? Quick Insight The industry reported domestic passenger growth at 20%+ p.a. over FY16-17 driven by ~5-10% annual decrease in yields aided by weak fuel prices in Stock Information FY16 and margin decline in FY17. For Indigo, after a likely 55% YoY decline in Bloomberg Code: INDIGO IN PBT/ASK in FY17, a further 3-4% cut in yields at the cost of margins may make operations unprofitable in FY18. With a decline in yields unlikely, passenger CMP (Rs): 1092 growth may lag capacity growth of 16-17%. This implies that our/consensus TP (Rs): 760 expectations of a simultaneous 6% YoY increase in yields, ASK growth of 19% Mcap (Rs bn/US$ bn): 395/6.1 and stable utilisation of ~85% in FY18 may see significant downside risks. 3M ADV (Rs mn/US$ mn): 521/8.1 Our sensitivity analysis indicates that 1% lower-than-expected yields or utilisation would hit FY18E EPS by 10-12%. Even on our currently optimistic assumptions, Indigo trades at 20x FY18E P/E and 9x EV/EBITDAR, at a significant premium to global peer average of 11x P/E and 6x EV/EBITDAR. Stock Performance (%) 1M 3M 12M YTD Absolute 19 24 4 33 FY17 yields and margins much lower than expected Rel. to Sensex 19 16 (10) 22 Source: Bloomberg, Ambit Capital research We initiated Indigo with a SELL stance a year back as we expected margins to come under pressure to absorb mid-teen capacity growth (click here for our initiation note). Ambit Estimates (Rs mn) Valuations optimistically factored in sustained mid-teen ASK CAGR over FY17-26E and sustenance of peak unitary margin of Rs0.54/ASK seen in FY16 (2x FY10-15 FY16E FY17E FY18E average). However, both of these seem difficult due to planned capacity addition at Revenues 161,399 187,014 236,230 mid-teen levels, insufficient airport infrastructure, and need for decline in prices to EBITDA 30,025 21,047 27,675 keep passenger growth above 15%. In FY17: EPS (Rs) 55.2 44.2 53.0 . Decline in yields and margins sharper than expected: At the beginning of Source: Company, Ambit Capital research the year, we expected 3%/12% YoY decline in average yields/PBT per ASK in FY17 due to rising competition. As against this, in 9MFY17, yields declined by 12% and PBT/ASK declined by 53% – Rs0.54/ASK in FY16 to Rs0.24/ASK in FY17. ASK growth marginally higher than expectations: We expected 26% ASK growth in FY17 vs management’s initial guidance of 34%. Actual ASK growth in 11MFY17 was marginally higher, at ~29%. Market values of A320neo and A320 largely stable: Although our estimates and valuation did not factor in any decline in profits from sale and lease back, we saw possible risks to the quantum of Indigo’s cash incentives from sale and leaseback as the over 50% correction in crude makes fuel savings less attractive. However, market values of the A320 and the A320neo have remained largely stable at US$43mn and US$48mn respectively. Research Analyst Parita Ashar, CFA [email protected] Tel: +91 22 3043 3223 Ambit Capital Pvt Ltd 19 April 2017 AMBIT INSIGHTS Yield decline drives 20%+ passenger growth in FY16- 17 Over the last 10 years, India’s domestic airline passenger traffic has grown at a healthy 13% CAGR, implying an average GDP factor of 1.8x.