India Logistics Clear road ahead November 26, 2018 Alok Deshpande +91 22 6620 3163 Edelweiss Securities Limited [email protected] Logistics Executive Summary On the cusp of transformation: In the ensuing decade, we envisage a potent mix of drivers to transform the large (USD220bn plus), yet inefficient, Indian logistics sector. We estimate a confluence of favourable (Click here for factors—GST tailwinds, reducing transit times, warehouse consolidation, video clip) infrastructure status and rapid adoption of technology—to drive sector growth to 12-13% p.a. Nearly one-third of India’s logistics costs is transport and storage related inefficiencies. We expect these inefficiencies to reduce in coming years, which will boost logistics spending. Large opportunities to become larger: We estimate growth rates ranging from 7-18% for various sub-segments. Transportation, pegged at USD150bn plus, is a huge segment and growing at 9-10%, with road as the dominant mode—USD100bn plus in size (~10% growth). We estimate India’s container rail sector to post 12-13% CAGR over the next five-seven years. Niche markets such as road express and third party logistics (3PL) can potentially clock ~18% CAGR till FY25E. Cost economics favour organised pockets: We estimate robust margin (10% plus) and return profiles (20-40%) for the more organised pockets such as express and 3PL, where entry barriers & pricing power are high and the industry structure is not fragmented. On the other hand, almost ~90% of road transport suffers from low pricing power, fragmented ownership and hence <10% RoCE. Our preferred segments to play: We like the niche road express segment (USD2bn), which is posting 17-18% CAGR and can be an USD7bn opportunity by FY25E. We also estimate the USD6bn 3PL market to clock 17-18% CAGR and potentially become an USD17bn market by FY25E. To us, these segments appear to be multi-year structural growth plays with long growth runways. Top picks: Within 3PL, we like Mahindra Logistics (BUY) and TCI (BUY; has a 3PL division) as they have a proven track record, strong market positioning and large client base. In the express market, we like TCI Express (BUY), one of the market leaders in B2B road express, which has a robust branch and sorting centre network. We are negative on Blue Dart Express (REDUCE) as air is losing market share to road express and the company’s profitability is likely to be challenged in the medium term in a rising cost environment. We are neutral on Container Corp (HOLD), where Dedicated Freight Corridors (DFC) will boost volumes and efficiency meaningfully, but majority of upside is baked into current valuation. Valuation and risks: For capturing the structural long-term opportunity and value of the 3PL market, we value MLL, TCI Express and TCI’s 3PL division on DCF. While we estimate that current valuations imply FY18-28 EBITDA CAGR of 17-18%, realistically EBITDA CAGR of 20- 21% is achievable. For other stocks such as Blue Dart, Concor and VRL, which are semi- structural, we rely on PE or EV/EBITDA-based relative valuations—based on their growth and return profiles. Key risks to our thesis are: slower-than-expected implementation of GST, rising oil prices and hence rising fuel costs, depreciating INR and disruptive tech business models. 1 Edelweiss Securities Limited Logistics Contents Executive Summary ......................................................................................................... 1 Investment Thesis ........................................................................................................... 3 An opportunity in inefficiency... ...................................................................................... 3 3PL: An USD17bn opportunity by FY25 ......................................................................... 19 Express Sector: Niche, Structural And High Growth ..................................................... 27 Transportation: Road to Remain Dominant .................................................................. 35 Valuations: How much to pay for growth? ................................................................... 46 Companies Mahindra Logistics ................................................................................................. 53 TCI Express ............................................................................................................. 73 Transport Corporation of India .............................................................................. 93 Blue Dart Express ................................................................................................. 115 Container Corporation of India ............................................................................ 133 VRL Logistics ......................................................................................................... 153 2 Edelweiss Securities Limited Logistics Investment Thesis An opportunity in inefficiency Nearly one-third of India’s logistic cost (~4% of GDP) is due to inefficiency such as lower road & rail speeds, higher inventory levels and theft & damages. We see several factors combining to reduce these inefficiencies over the next decade. A favourable confluence of GST tailwinds, reducing transit times, warehouse consolidation, the new infrastructure status and rapid adoption of technology solutions are estimated to drive sector growth to 12-13% p.a. Dominance of road transport, despite being the costliest mode, is likely to sustain due to expanding road infrastructure. We like niche segments such as 3PL and road express which are structural multi-year opportunities and clearly stand out based on long-term growth potential, margins and return profiles. Chart 1: Logistics inefficiency worth 4% of GDP likely to fall Chart 2: Road, despite higher cost, will remain dominant 5.0 3.5 4.0 1.1 2.8 3.0 1.1 2.1 2.0 4.0 (% of (% GDP) 0.3 0.3 1.0 1.4 1.2 0.0 (INR per ton perkm) perton (INR 0.7 Longer Total inv share distances inefficiency 0.0 Higher Road Lower speedLower Higher transit Higher Road Rail Coastal Causes of inefficiency & DamageTheft Chart 3: 3PL & Road Express stand out on growth & RoCE Fig. 1: Logistics—Key demand drivers & supply drivers 35% Road Express Emergence Stable economic 28% Air of demand growth and fast centres growing demand Sea (Tier 2/3/4 from MSMEs Rapid 21% 3PL cities) adoption of technology Less than Rail (RoCE) 14% Truck Load Indian Rapid rise in 7% Logistics: Regulatory Full Truck internet reforms penetration USD450bn Load by 2025? such as GST, 0% E-Way, etc 0% 5% 10% 15% 20% Segment CAGR FY18-25E Source: Edelweiss research Note: Bubble size represents the segment size 3 Edelweiss Securities Limited 1 Logistics Backing asset light aggregators, steering clear of asset-heavy models In our view, business models that are aggregation based with an asset light or partnering approach will be key beneficiaries in coming years. While asset-light models seem an easy entry option, the partnering asset owners (vehicle or warehouse owner) generally tie-up with only established players. As a result, asset-light model aggregators have a natural moat through high entry barriers. Road transporters (especially small FTL operators) and general warehouse owners continue to suffer from low pricing power due to fragmented ownership in India. This strengthens our preference for 3PL and road express players which follow an asset light and aggregation model. Table 1: Growth prospects, cost economics, size of opportunities and financial metrics by sub-sector TRANSPORTATION (USD150b+) WAREHOUSING / Container Domestic Coastal / 3PL (USD6b) STORAGE (USD100bn+ Broad segment Road Transport (USD110bn+) Rail Air Express Seaways (End to End that includes mostly high (USD17b) (USD0.8b) (USD10b) solutions) inventory costs) Sub-segment FTL LTL Express Growth prospects FY18-25E CAGR 10% 10% 17% 12% 7% 8-10% 18% 12% Current size (USD b) 90 10 2 17 0.8 10 5.8 100 2025e size(USD b) 165 18 6.5 37.6 1.3 17 17.3 180 Nature of growth Cyclical Semi-cyclical Structural Cyclical Semi- Cyclical Structural Cyclical Competitive landscape cyclical Industry structure Fragmented Moderate Organised Organised Organised Organised Organised Fragmented Entry barriers Low Mod to High High High High High High Low to Mod Pricing power Low Mod to High High Moderate Moderate Moderate High Low to Mod Proposition to customer INR 15-20 per INR 60-80 INR 2-3 per INR 5-8 per INR 1-2 per INR 1 per Cost to consumer ton km; per ton km; NA INR 15-25 per sq ft ton km ton km ton km ton km INR14-16/kg INR60-70/kg Delivery time (hours) 96 - 120 72-96 < 72 24-72 24-72 96 - 120+ Continuous NA Margin & Return profile EBITDA margin (%) 2-4% 8-11% 10-12% 16-18% 9-13% 25-35% 5-15% 10-25% RoCE (%) 10-12% 15-16% 30-45% 13-15% 30-35% 20-22% 25-35% 10-20% Source: Edelweiss research Table 2: Presence in business segments by company TRANSPORTATION (USD150b+) 3PL (USD6b) Broad segment Road Transport (USD110b+) Domestic Air Coastal / Warehousing / (End to End Container Rail Express Seaways Storage Sub-segment FTL LTL Express solutions) (USD0.8b) (USD10b) Mahindra Logistics Future Supply Chain Container Corporation Blue Dart VRL Logistics Transport Corp of India TCI Express Gati Navkar Aegis Logistics All Cargo Gateway Source: Company, Edelweiss research 4 Edelweiss Securities Limited Logistics India’s 3PL market size can reach ~USD17bn by FY25E India’s 3PL market, currently pegged at ~USD6bn, can potentially reach ~USD17bn by FY25, in our view. We see two key growth