INDIA DAILY August 13, 2018 India 10-Aug 1-day 1-mo 3-mo Sensex 37,869 (0.4) 3.6 6.6 Nifty 11,430 (0.4) 3.7 5.8 Contents Global/Regional indices Dow Jones 25,313 (0.8) 1.2 1.9 Special Reports Nasdaq Composite 7,839 (0.7) 0.2 5.9 Strategy FTSE 7,667 (1.0) 0.1 (0.7) Nikkei 22,064 (1.0) (2.4) (3.1) Strategy: Valu(b)e and valu(be)able lessons from Castrol India stock Hang Seng 28,367 (0.8) (0.6) (8.9) Daily Alerts KOSPI 2,260 (1.0) (2.2) (8.8) Value traded – India Results Cash (NSE+BSE) 382 357 335 State Bank of India: NPL reversal cycle takes shape 11,46 Derivatives (NSE) 5,540 5,864 1 Coal India: Strong performance Deri. open interest 3,883 3,632 4,148 GAIL (India): Boon from bane Hindalco Industries: Aluminum earnings improve Forex/money market Aurobindo Pharma: Strong quarter for revenues Change, basis points DLF: Changing track 10-Aug 1-day 1-mo 3-mo Rs/US$ 69.1 4 65 144 Indraprastha Gas: Weak margins offset volume growth; limited success in CGD round 10yr govt bond, % 8.0 - (13) 8 Net investment (US$ mn) Voltas: Will margins rebound over time and market share gains sustain? 9-Aug MTD CYTD Jindal Steel and Power: Slower road to recovery FIIs 60 214 (200) Tata Communications: Disappointing run continues MFs 2 23 11,140 Top movers Amara Raja Batteries: Weak quarter; profitability disappoints Change, % Apollo Hospitals: Improving trends across segments Best performers 10-Aug 1-day 1-mo 3-mo Union Bank: Not yet but soon to be out of woods RCOM IN Equity 19 (3.0) 49.6 42.0 Dr Lal Pathlabs: Strong start to the year DABUR IN Equity 443 (0.7) 17.7 22.4 RIL IN Equity 1,204 (1.1) 9.5 21.7 Kaveri Seed: In-line results SBIN IN Equity 304 (4.1) 18.1 21.6 S H Kelkar and Company: Tightrope walk continues GCPL IN Equity 1,294 (0.3) (1.2) 19.9 Dhanuka Agritech: 1Q blip, expect better Worst performers JPA IN Equity 13 (7.0) (14.8) (29.0) Company alerts TTMT/A IN Equity 140 (2.3) (6.8) (28.3) HDFC Bank: Dy MD Sukthankar resigns TTMT IN Equity 250 (3.0) (5.1) (24.4) VEDL IN Equity 224 (3.0) 6.3 (22.0) Infosys: Infosys NDR takeaways AL IN Equity 128 (1.3) (3.7) (21.2) Economy alerts Economy: IIP: Continuing to signal gradual recovery For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES. REFER TO THE END OF THIS MATERIAL. INDIA Strategy India AUGUST 13, 2018 UPDATE BSE-30: 37,869 Valu(b)e and valu(be)able lessons from Castrol India stock. Investors may want to take cognizance of the flat performance of Castrol India stock over the past five years, understand the reasons for the stock’s de-rating over the past 2-3 years and see if certain expensive stocks in the branded and semi-branded categories can face a similar situation. In particular, we see two massive disruptions for branded and semi-branded products in the form of ‘standardization’ and ‘formalization’. Castrol India: A case of price-value proposition becoming too skewed perhaps? QUICK NUMBERS We wonder if Castrol stretched the price-value proposition too much over the past few years, Castrol stock has de- which allowed other players in a semi-branded space to offer better price-value proposition. rated from 40-45X Castrol’s volumes have been stagnant for the past several years (see Exhibit 1 for volume data forward P/E to 20- for CY2012-17 and 1HCY18); better-quality lubes and engines may have also contributed to 25X forward P/E longer ‘drain’ times. Castrol’s realizations went up moderately over the same period despite a sharp decline in raw material (base oil) prices (see Exhibit 2), which led to a sharp increase in Gross contribution is profitability (see Exhibit 3 for contribution/liter and EBITDA/liter). up to `88/liter in 1HCY18 from Or a case of market’s concerns about disruption from electric vehicles and terminal value? `64/liter in CY2012 The severe de-rating of Castrol stock (see Exhibit 4 for 12-month forward multiple) may reflect Quarterly volumes the market’s concerns about eventual uptake of electric vehicles (EVs) and consequent lower usage of lubes as the share of EVs in total vehicle population (stock of vehicles) reaches a stagnant at around sizeable figure. In other words, this raises questions about the terminal value of the business in 50 mn liters over a ‘disrupted’ future. Exhibit 5 summarizes possible sources of disruption in the future (see our CY2012-1HCY18 April 12, 2018 report titled Disruption ahead on disruption across sectors for more details). Price-value gap can close in several categories through new competition, standardization Investors may want to review the business moats of companies in the context of their products (gap between price and value) and business models. In our view, ‘standardization’ will be a powerful disruption theme. If consumers were to have confidence about the basic quality of a product, the gap between price and value may close dramatically through (1) acceptance of new products with lower price points with similar value and/or (2) down-trading to products that may offer better price-value proposition. Semi-branded businesses (building components for example) will be first to see the disruption from ‘standardization’ of products. Private labels of organized players (e-commerce and physical) may even disrupt the stranglehold of FMCG companies, a possible outcome of ‘formalization’ of retailing in India. Sanjeev Prasad The higher the P/E, the more one should worry about terminal value A high P/E of a stock reflects the market’s confidence about strong growth in cash flows of the Anindya Bhowmik company for a very long period of time (and terminal value), which in turn reflects very high confidence in the business models of companies and their ability to withstand disruption (many Sunita Baldawa of which may be even unknown now). We can only marvel at the confidence of investors about certain stocks (looking at the high P/Es or P/Bs of so many stocks these days). Exhibit 6 provides a sample list while Exhibits 7-8 show the expansion in gross and EBITDA margins of automobile and consumer staple stocks over the few years. For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL. Strategy India Exhibit 1: Castrol’s volumes have been stagnant for the past several years Trend of quarterly sales volume of Castrol India, calendar year-ends, 2012-18 (mn liters) Sales volumes (mn liter) 60 50 40 30 20 10 0 1QCY12 2QCY12 3QCY12 4QCY12 1QCY13 2QCY13 3QCY13 4QCY13 1QCY14 2QCY14 3QCY14 4QCY14 1QCY15 2QCY15 3QCY15 4QCY15 1QCY16 2QCY16 3QCY16 4QCY16 1QCY17 2QCY17 3QCY17 4QCY17 1QCY18 2QCY18 Source: Company, Kotak Institutional Equities Exhibit 2: Castrol’s realizations went up moderately over CY2012-17 despite a sharp decline in raw material (base oil) prices Trend of quarterly gross realizations and raw material cost of Castrol India, calendar year-ends, 2012-18 (Rs/liter) Gross realization (Rs/liter) Raw material cost (Rs/liter) 200 160 120 80 40 0 1QCY12 2QCY12 3QCY12 4QCY12 1QCY13 2QCY13 3QCY13 4QCY13 1QCY14 2QCY14 3QCY14 4QCY14 1QCY15 2QCY15 3QCY15 4QCY15 1QCY16 2QCY16 3QCY16 4QCY16 1QCY17 2QCY17 3QCY17 4QCY17 1QCY18 2QCY18 Source: Company, Kotak Institutional Equities KOTAK INSTITUTIONAL EQUITIES RESEARCH 3 India Strategy Exhibit 3: Profitability increased sharply over CY2012-1HCY18 Trend of quarterly gross contribution/liter and EBITDA/liter of Castrol, calendar year-ends, 2012-18 (Rs/liter) Gross contribution/liter (Rs) EBITDA/liter (Rs) 120 80 40 0 1QCY12 2QCY12 3QCY12 4QCY12 1QCY13 2QCY13 3QCY13 4QCY13 1QCY14 2QCY14 3QCY14 4QCY14 1QCY15 2QCY15 3QCY15 4QCY15 1QCY16 2QCY16 3QCY16 4QCY16 1QCY17 2QCY17 3QCY17 4QCY17 1QCY18 2QCY18 Source: Company, Kotak Institutional Equities Exhibit 4: Castrol stock has seen sharp de-rating over the past two years 12-month forward P/E for Castrol India (X) CSTRL 12-month forward P/E 50 45 40 35 30 25 20 15 10 5 - Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Source: Bloomberg, Kotak Institutional Equities estimates 4 KOTAK INSTITUTIONAL EQUITIES RESEARCH Strategy India Exhibit 5: Long-term themes that will shape the Indian economy Key themes for the Indian market and the sectors impacted by them Consumption Disruption Consumer Privatization Technological Corporate de- Demographics Financialization Environment Formalization Standardization leveraging (indirect) disruption leveraging Favorable Large FCF (steel demographics, Private banks will Technological companies) and Households to Financial savings rising income gain further share advancement will sale of assets increase debt should increase on Clean air and Shift from levels, from PSU banks Products will be lead to disruption (power) to levels for account of high higher share of unorganized to urbanization will (currently have more generic/ of business improve the consumption led real interest rate renewables in organized will lead to higher around70% share standardized models along with balance-sheet of by easy availability and growing India's energy mix gather pace penetration of in deposits & increasing distressed of retail finance financial inclusion various goods and loans); Airlines productivity companies and services their lenders Key beneficiaries: Consumer Key beneficiaries: companies in Consumer Key beneficiaries: Key beneficiaries: Key beneficiaries: sectors with high Key beneficiaries: businesses Automobiles, Banks, NBFCs, Natural gas, share of Key beneficiaries: Adaptive Key beneficiaries: (durable and non-