Economy News. Corporate News OCTOBER 26, 2016

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1 OCTOBER 26, 2016 Economy News Asserting that the government is determined to implement GST from the next fiscal, Economic Affairs Secretary Shaktikanta Das expressed confidence that the revenue neutral rate structure will be decided in first week of November. (BS) The finance ministry is examining the possibility of cutting the corporation tax rate by one to two percentage points, even as the revenue department is set to kickstart Budget consultations with industry and consultants from the first week of November. (BS) The National Highways Authority of India (NHAI) awarded fewer contracts in the first six months of the current financial year, compared to the same period last year. Not only was the number of projects less this year, the total length (km) of these projects was also down 16 per cent. (BS) The media industry in India will cross Rs 2 trn in revenue by 2020 and Rs 4.6 trn by 2025.The sector is expected to reach Rs 1.31 trn in revenue in 2016 after growing 11 per cent every year since 2012, according to a report by the Confederation of Indian Industry (CII) and Boston Consultancy Group. (BS) Corporate News The government has won a major portion of the $1 billion arbitration with Reliance Industries and British firm BG Group over recovery of cost in western offshore Panna/Mukta and Tapti oil and gas fields. (BS) Mahindra & Mahindra announced an overhaul plan for its loss-making two-wheeler business. Mahindra Two Wheelers (MTWL), the bike and scooter unit of M&M, said it would infuse Rs bn in the business to resurrect BSA and Jawa brands, pushing Peugeot products into newer markets and to develop new products for domestic market.(bs) The Ruias of the heavily indebted Essar Group have told lenders that American hedge fund Farallon Capital Management has offered "bridge equity" to the tune of Rs 15 bn to help bolster efforts to revive Essar Steel said multiple sources aware of ongoing negotiations. Under the plan, Farallon is supposed to take a quasi-equity exposure in an offshore vehicle controlled by the Essar promoters. (ET) Idea Cellular Ltd, India's third largest telco, said it had not violated any norms in issuing points of interconnection (PoIs) to rival Reliance Jio Infocomm Ltd for which the telecom regulator has proposed a penalty of Rs9.50 bn. (Mint) Tata Power Co. Ltd plans to expand capacity by acquiring some of the underutilised plants instead of investing in expensive new facilities. (Reuters) Arvind Ltd announced that it is raising Rs7.40 bn by selling 10% stake in its brand business arm to private equity firm Multiples Private Equity. (Mint) Saregama India has signed a two-movie deal with Pen Movies for the acquisition of music rights of their upcoming Bollywood releases, which includes Kahaani 2 - Durga Rani Singh. This strategic partnership sees Saregama's return to film music acquisition after a six-year gap. (BL) Reliance Industries said it has raised a term loan of $ 573 million to part finance construction of six very large ethane carriers (VLECs). (BL) Equity % Chg 25 Oct 16 1 Day 1 Mth 3 Mths Indian Indices SENSEX Index 28,091 (0.3) (0.7) 0.4 NIFTY Index 8,691 (0.2) (0.4) 1.2 BANKEX Index 22, SPBSITIP Index 10,167 (0.8) (0.7) (5.8) BSETCG INDEX 14,921 (0.5) 0.0 (4.6) BSEOIL INDEX 12,381 (0.5) CNXMcap Index 15,991 (0.1) SPBSSIP Index 13, World Indices Dow Jones 18,169 (0.3) 0.4 (1.6) Nasdaq 5,283 (0.5) FTSE 7, NIKKEI 17, HANGSENG 23,565 (0.2) Value traded (Rs cr) 25 Oct 16 % Chg - Day Cash BSE 2,750 (10.3) Cash NSE 20, Derivatives 462, Net inflows (Rs cr) 24 Oct 16 % Chg MTD YTD FII (392) 77 (996) 49,009 Mutual Fund 527 (19) 5,287 19,238 FII open interest (Rs cr) 24 Oct 16 % Chg FII Index Futures 18, FII Index Options 77,023 (0.3) FII Stock Futures 64, FII Stock Options 8, Advances / Declines (BSE) 25 Oct 16 A B T Total % total Advances Declines Unchanged Commodity % Chg 25 Oct 16 1 Day 1 Mth 3 Mths Crude (US$/BBL) 49.3 (1.3) Gold (US$/OZ) 1, (4.8) (3.4) Silver (US$/OZ) (8.7) (9.2) Debt / forex market 25 Oct 16 1 Day 1 Mth 3 Mths 10 yr G-Sec yield % Re/US$ Sensex Source: ET = Economic Times, BS = Business Standard, FE = Financial Express, BL = Business Line, ToI: Times of India, BSE = Bombay Stock Exchange Oct-15 Jan-16 Apr-16 Jul-16 Oct-16

2 RESULT UPDATE Ritwik Rai Summary table (Rs mn) FY16 FY17E FY18E Sales 58,515 66,406 70,142 Growth (%) EBITDA 15,095 19,131 23,552 EBITDA margin (%) PBT 16,147 17,253 24,926 PAT 10,601 11,315 16,327 EPS Growth (%) CEPS (Rs) BV (Rs/share) Dividend/share (Rs) ROE (%) ROCE (%) Net cash (debt) 12,144 22,962 35,669 NW Capital (Days) P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) Source: Company, Kotak Securities - Private Client Research ZEE ENTERTAINMENT ENTERPRISES LTD PRICE: RS.515 RECOMMENDATION: SELL TARGET PRICE: RS.476 FY18E P/E: 30.2X ZEEL has reported robust results from operations in 2QFY17, with EBITDA for the quarter coming in 4% ahead of estimates. However, there are signs of weakening adex growth in the industry, as also indications that weakness in Zee TV is beginning to have an impact on the company's growth. Management comments indicate that a revival in Zee TV ratings could be one quarter away (programming likely to be revamped in 4QFY17). At the present point, Zee TV ranks #5 in the Hindi GEC (Urban) data. In our opinion, ZEEL faces significant risks across its revenue streams over the medium-term. Further, we believe that entrenched incumbents could be the worst hit on potential changes in interconnect regulations (draft regulations released recently). We downgrade the stock to SELL (REDUCE earlier) with a price target of Rs 476 (maintained). Results Summary (Rs mn) 2QFY17 2QFY16 % chg y/y 1QFY17 % chg q/q Income from operations % Advertising Revenues % Subscription Revenues % Other Sales % Expenses % Operating Cost % Employee Expenses % Advertising and Publicity % Other Expenses % EBITDA % Margin Depreciation and Amortzn % EBIT % Other Income % Financial Expenses % Fair Value through P&L % PBT % Exceptional Item NM NM PBT after exceptional items % Tax % Net Profit for the period % Associate/ Minority % PAT after Minority/ Associate % Other Comprehensive Income % Total Comprehensive Income % Source: Company Zee Entertainment's 2QFY17 revenues came in 1.5% ahead of estimates, as a modest miss on advertising revenues was offset by higher growth in subscription revenues. Domestic subscription revenues registered 11% q/q growth, and likely contain some catch-up revenues. Other sales, in line with estimates, registered strong growth on account of the release of "Rustom" and syndication sales (sports). Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 2

3 The company has noted that there was a moderation in advertising spends especially from e-commerce segment; and also indicated that the advertising revenues of the company were impacted by the slight drop in viewership of Zee TV in the previous quarter. Expenses rose broadly in line with estimates. EBITDA registered growth of 36.4% y/y. Reported EBITDA was 4% ahead of estimates. Items below the EBITDA line surprised negatively, and PAT came in lower than estimates. Sports business losses for the quarter were Rs 168mn, lower than our estimates (positive surprise). In the quarter, ZEEL has added three channels to its domestic offerings, including Zee Anmol Cinema (FTA, Hindi Cinema), Zee Yuva (youth Marathi GEC), and Zee Cinemalu (Telugu Cinema). The company has made some changes in its organizational structure, dividing its business into five verticals - broadcasting, movies, music, live events, and digital. On the conference call, the management commented on the weak performance of Zee TV, and said that the weakness was a result of poor implementation and program selection. The channels has a new head in place (joined a few months ago), and the company has a strong pipeline of new shows (to be launched in 4QFY17). The management has expressed hope that ratings shall pick up consequently. The management believes that the changes in regulation, if draft regulations of TRAI on interconnect agreements are implemented, shall be a medium-long term positive for the company. We recommend SELL on Zee Entertainment Enterprises Ltd with a price target of Rs.476 Outlook and Investment View Going forward, we think ZEEL's stock performance shall be dependent on two broad factors: a/ ratings of key channels, which shall determine the advertising revenue growth of the company, and b/ regulations, which will determine the subscription revenues that ZEEL earns and the relative advantage that ZEEL continues to have over other broadcasters. In the context of 'a' above, we note that Zee Entertainment channels have seen competitive position deteriorate in several genres, of which the most glaring is the Hindi GEC space. In the most recent week, Zee TV, the flagship Hindi GEC of the company ranks #5 in the Hindi GEC (Urban) viewership. In the context of 'b' above, we note that ZEEL is amongst the most entrenched incumbents in the Indian broadcasting space, and could be a likely loser (relatively, if not in absolute terms) of interconnect regulations that threaten to alter the power of broadcasters to sell bouquets. We have made changes to our estimates to reflect: a/ higher earnings from reduction in sports losses (sale of the business) and b/ lower advertising revenue growth in non-sports channels as a result of weaker competitive position of the company's channels, c/ higher MTM losses on RPS. Net-net, our EPS estimates are revised -5%/+7% for FY17/FY18. Valuations of the stock continue to be rich, post recent correction from historical highs, and given the context discussed above. Further, we think that the earnings could see significant downside if the subscription revenues stream is impacted by regulation (not accounted for in the estimates). We think that the stock should be valued at 28X FY18E PER, or Rs 476 (cut from 30X FY18E, on account of higher possibility of regulations in the near-term, and weak competitive position of Zee TV). In view of the downside implied in the fair value, we downgrade the stock to SELL (REDUCE earlier), while we maintain price target of Rs 476. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 3

4 RESULT UPDATE Amit Agarwal ADANI PORTS & SPECIAL ECONOMIC ZONE LTD (APZ) PRICE: RS.310 RECOMMENDATION: ACCUMULATE TARGET PRICE: RS.340 FY18E P/E: 16.0X Strong quarter - Future ready Highest ever volume at 43 mn tonnes (19% YoY) reflects (1) strong growth in containers and crude, with recovery of coal volumes; (2) Strong contribution from subsidiary ports (3) healthy consolidated EBITDA margin, (4) higher non-recurring income and rationalization of interest cost that boosted PAT. The company's good FY17 volume growth guidance, led by commissioning of new ports, new cargo sourcing and market share gains, is a positive. Management also intends to reverse the Loans & Advances of Rs 25 bn extended till date in FY17 and we see this as healthy corporate governance from the company. Broadly, we estimate volume to grow at 12% CAGR over FY16 to FY18E driven by volumes at Dhamra, Hazira, Dahej and container volumes at Mundra leading to earnings CAGR of 16% with ROE of 20%. Recommend ACCUMULATE (from BUY) with an increased TP of 340 (from Rs 305) Summary table (Rs mn) FY16 FY17E FY18E Sales 72,558 83,042 95,083 Growth (%) EBITDA 47,560 55,300 62,184 EBITDA margin (%) PBT 31,377 36,899 41,796 Net profit 28,108 34,619 39,149 EPS (Rs) Growth (%) CEPS (Rs) BV (Rs/share) Dividend/share (Rs) ROE (%) ROCE (%) Net cash (debt) (188,187) (208,077) (225,979) Net WC (Days) EV/EBITDA (x) P/E (x) P/Cash Earnings P/BV (x) Source: Company, Kotak Securities - Private Client Research Quarterly snapshot (Consolidated) (Rs mn) Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Net Sales 18,423 17,179 19,472 18,266 21,830 OPEX 4, , ,529 Employee cost Admn cost , EBIDTA 12,576 10,794 12,543 11,699 14,515 EBIDTA (%) Other Income 1,436 1,779 2,145 2,571 2,337 Depreciation 2,756 2,877 2,555 2,810 2,823 Gross interest 3,644 2,637 2,781 2,903 2,967 PBT 7,612 7,059 9,352 8,557 11,062 Taxes , Effective tax rate (%) Share of Associates/MI Reported PAT 7,034 6,478 8,048 8,127 10,308 Extraordinary Adjusted PAT 6,510 6,451 9,141 8,358 10,907 Source: Company Financial Highlights: Company has reported its highest ever volume at 43 mn tonnes (19% YoY) Sales was reported at 21.8 bn (21% YoY). Sales got marginally impacted due to poor off take of SEZ sales, but got more than compensated by healthy volume growth. EBIDTA was reported at Rs bn translating into healthy Ebidta margin of 66.5% Company was able to bring down its interest cost to Rs 2.97 bn from Rs 3.64 bn YoY Consequently PAT was reported at healthy Rs bn (+67% YoY) well ahead of our expectation of Rs 8.45 bn and ahead of consensus estimate Rs 8.6 bn APZ continues to outperform other ports of India Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 4

5 Details of subsidiary port projects of Adani port Long term strategy of the company APZ made major announcements in the last 12 months with respect to new port projects including development of a new port at Vizhinjam, acquisition of Kattupalli port in Tamil Nadu from L&T Shipbuilding Limited, transshipment hub at Mundra, expansion of Dhamra, creating LPG storage in Mundra and acquisition of Abbot Point Bulk coal Ltd (APB). It has also raised Rs 45 bn via NCDs and USD 650 mn through dollar bonds to repay high cost short term debt and facilitate the development of the new port projects PAN India. This expansion strategy will make APZ the largest port in the country with PAN India presence. We estimate the expansion to be EPS accretive for APZ with improvement in cash flows. The expansion also (1) De-risks Adani port from any concentration risk and any specific commodity risk and (2) lends greater credibility to our estimates. Details of port projects of APZ Adani Ports now has 10 ports in its fold. The key Mundra Port has already created significant value for the company. We estimate the next phase of growth for the company to come from subsidiary ports, especially the ports of Hazira, Dahej and Dhamra ports. The growth would be primarily led by both market growth and market share gains (lower government revenue share to help). Large value creation from some ports is less likely given higher revenue share to government (Vizag and Ennore) or likely lower rate of growth in cargo volumes given the emerging domestic supply economics (Kandla). The other big value creator could be SEZ land sale/lease where transactions have picked up in FY16 and is likely to sustain at high levels over the next 2-3 years (LNG terminal, CT4 and possibly CT5, potential IOCL refinery transaction, etc.) Port Dahej Mormugao Dhamra Hazira Kandla Vizag Ennore Vizhinjam Stake of Adani (%) Capacity (mt) Under construction (mt) Expansion room (Upto mt) Source: Company, Kotak Quarterly performance of APZ and for its subsidiaries Coastal volume was reported at 1 mn tonnes and the company is targeting to do 4 mn tonne in FY17 Coal volume was reported at 15.9 mn tonnes (flat QoQ). Management indicated coal volumes to only improve from here led by captive volumes. Container reported healthy growth at 1.19 mn TEUs (+30% YoY). Container now constitute almost 36% of the total cargo (increased from 29% YoY) Dhamra has started handling iron ore with APZ now developing facilities to handle fertilizer at Dhamra as well at Dahej Management indicated that the key subsidiary ports of Hazira and Dahej have done well in the quarter. Dhamra has disappointed in the quarter, but the company is optimistic about the prospects of Dhamra. Kattupalli has started contributing in a healthy way to the total cargo.(32,000 TEUS in Q2FY17 vs. 30,000 in Q1FY17) Management indicated that new services have started contributing to container volumes at Mundra, Hazira and Kattupalli The company has started with its trial run at Container terminal IV. This terminal is estimated to start contributing to volumes from Q3FY17. Operations at Ennore port is likely to commence during Q4FY17. Company is also constructing LPG storage tanks at Mundra and should start contributing to revenues from FY19 Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 5

6 Quarterly volumes for APZ Mn tonnes Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Cargo at Mundra Consolidated cargo QoQ% YoY% Source: Company, Kotak Securities - Private Client Research Volume growth for APZ and for its subsidiaries Port FY14 FY15 FY16 F17E F18E Coal at Mundra Other bulk at Mundra Containers at Mundra Crude/POL Total at Mundra Dahej Hazira Mormugao Vizag Kandla Dhamra Ennore Grand Total Source: Company, Kotak Securities - Private Client Research APZ to operate Abbot Point Coal Terminal in Australia In Q2FY17, APZ entered into an agreement to acquire 100% ownership of Abbot Point Bulk coal Ltd (APB), an Australian company performing the operational activities in the bulk segment for Abbot Point for a price of AUD mn (USD 14.5 mn). Management indicated that the intention to go for an international venture was to gain experience in handling an international terminal and be prepared for any international foray as and when opportunities come-up. The operational rights would give APZ access to operate 50 mtpa capacity on a cost-plus 10 percent markup basis with no capital investments. Though the right to operate APB looks value accretive on the face of it, we feel the deal is very insignificant relative to Adani Ports net worth (USD $2 bn as on March 2016) and current market cap (USD $9 bn as on today). With tax rate of 30%, we estimate the contribution towards earnings to be very negligible at around AUD 3 mn per annum or Rs 150 mn or 0.04 per share. APZ has now completed the acquisition of APB and would consolidate the acquisition from Q3FY17. Loans and Advances (L&A) to completely reverse in FY17 The sharp increase in Loans & Advances (L&A) to Rs 100 bn YoY was led by (1) increase in related parties' transaction by Rs 3.4 bn to Rs 25.3 bn on loans extended to Mundra Solar Techno Park as a sponsor and accrual of interests in certain other loans, (2) increase in deposits by Rs 12.8 bn to Rs 18.5 bn led by deposits given for consultancy for new projects and locations, advance income tax and balances with statutory authorities. Of the above, Management has taken note of investors' concerns with respect to related part transactions and expressed its strong desire to reverse the same by end of FY17.(already reversed Rs bn in H1FY17) Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 6

7 Loans and Advances for APZ in Rs bn Particulars FY15 FY16 Change Remark Related party loans Reversed Rs bn in H1FY17 Other loans Deposits Capital advances Advances to suppliers MAT credit entitlement Total Source: Company Capex of Rs 35 bn FY17 to FY19E APZ has outlined its near-term capex plans: (1) capacity expansion at Mundra CT-4 (Rs 5 bn for 1.3 mn TEU capacity), (2) capacity expansion at Dahej (Rs 5 bn for taking capacity to 24 mn tonnes), (3) capacity expansion at Dhamra (Rs 10 bn for adding two berths), (4) capex at Ennore (Rs 3 bn); (5) acquisition of Kattupalli port (10 bn - already spent in H1FY17), (6) Construction of LPG storage (Rs 2 bn) and (7) maintenance capex (Rs 2-3 bn per annum). Most of these capex would get incurred over the next 2-3 years. Focusing to bring down the cost of capital Adani Ports had raised USD 650 mn through dollar bonds at a yield of 3.59% and utilized the proceeds partly to repay rupee debt of Rs 100 bn (total debt of Rs 201 bn) on the Balance sheet. And now it is planning to raise Rs 100 bn through long term debentures and equity to repay high cost short term debt. The intent of the management is to bring down the cost of capital while it pursues its capex programme. However the huge debt of Rs 201 bn on the BS remains on overhang on the stock. Recent debt raising by the company Type of debt Amount Yield Date Dollar bonds Rs 44 bn (USD 650 mn) 3.59% Q1FY16 Debentures Rs 100 bn not known To be announced Source: Company, Kotak Securities - Private Client Research We recommend ACCUMULATE on Adani Ports & Special Economic Zone Ltd with a price target of Rs.340 Valuation and recommendation We believe that the company has diversified product wise, geographically, making efforts to enhance non-port revenues, taking measures to bring down cost of debt and other cost and have taken cognizance of investor concerns with respect to third party transactions. We estimate the benefits of these efforts to accrue to APZ from FY17 onwards. We estimate the consolidated entity to report volume CAGR of 12% over FY16 to FY18E with the new ports of Dhamra, Hazira and Dahej and the container volume at Mundra contributing the maximum. We increase FY17/FY18E earnings estimates by ~3%/5% respectively with increased future volume assumptions and arrive at a TP of Rs 340 for the stock (from Rs 305). Recommend investors to Accumulate this strategic asset which would deliver earnings CAGR of 18% and ROE of ~21%, despite a tough global trade environment. Our TP is based on SOTP valuation with a weighted average cost of capital (WACC) of 12.5% and book values for other investments. The APZ parent value includes Mundra Port for a 50-year concession period and the SEZ business also for a 50-year concession period. Dhamra, Dahej, Hazira, Mormugao, Kandla, Vizag, Ennore, Mundra, Container Terminals 3, 4 and 5, and Adani Logistics Ltd are valued on a DCF basis while the other investments are at book values. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 7

8 Investment risks Risks include trade weakness, viability of imported coal, shift of cargo to Mumbai ports on the start of DFC from FY20CL and slow capex at SEZs. Valuation table Project Value of equity Share of APZ APZ value (Rs mn) % (Rs Mn) Mundra 303, ,632 Mundra SEZ 87, ,842 Dhamra 119, ,840 Hazira 104, ,160 Dahej 34, ,255 Mormugao 13, ,830 Ennore 10, ,692 Kandla 2, ,394 Container terminal 3 7, ,724 Container terminal 4 7, ,724 Container terminal 5 7, ,724 Vizag 7, ,448 Adani Logistics 22, ,500 Total 704,764 Shares OS 2,071 Value per share 340 Source: Kotak Securities - Private Client Research Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 8

9 RESULT UPDATE Amit Agarwal ASIAN PAINTS LTD (APL) PRICE: RS.1150 RECOMMENDATION: SELL TARGET PRICE: RS.1075 FY18E P/E: 47.7X Low double digit volume growth in the decorative paint segment, improved performance in the industrial and auto OEM segment has led to revenue of Rs 42.3 bn (+12% YoY), but higher raw material cost has translated into lower Ebidta margin of 16.9% (-320 bps QoQ) and lower earnings of Rs 4.95 bn (-10% QoQ) vs. our expectation of Rs 5.5 bn. Overseas performance is a mixed bag, while home improvement segment (Sleek International) continue to disappoint despite receiving attention and investments from the parent. We interpret the performance as weak from a market leader in a competitive market with stable demand environment, especially when the stock is trading at high valuation. We continue to value the stock at 45x FY18E EPS (premium to medium sized paint companies) and arrive at a TP of Rs 1075 (from Rs 1125) and recommend SELL (from Accumulate) Summary table (Rs mn) FY16 FY17E FY18E Sales 1,55,3411,74,0561,89,109 Growth (%) EBITDA 28,090 31,912 34,540 EBITDA margin (%) PBT 26,813 30,872 33,480 Net profit 18,317 21,110 22,936 EPS (Rs) Growth (%) CEPS (Rs) BV (Rs/share) Dividend / share (Rs) ROE (%) ROCE (%) Net cash (debt) 37,075 50,392 65,623 NW Capital (Days) EV/EBITDA (x) P/E (x) P/Cash Earnings P/BV (x) Source: Company, Kotak Securities - Private Client Research Quarterly consolidated (Rs mn) Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Sales 37,794 41,600 39,712 40,821 42,326 QoQ (%) YoY (%) Raw Material 20,321 22,004 20,269 23,637 25,566 Employee 2,466 2,469 2,766 2,775 2,794 Other expenses 8,797 9,121 9,640 6,206 6,834 Total operating expenses 31,584 33,594 32,675 32,618 35,194 EBIDTA 6,210 8,006 7,037 8,203 7,132 EBIDTA margin Depreciation EBIT 5,501 7,281 6,284 7,348 6,289 Interest other income Exceptional PBT 5,984 7,039 6,476 8,003 7,020 Taxes 1,836 2,288 2,253 2,603 2,207 PAT 4,148 4,751 4,223 5,400 4,813 Minority /Associate APAT 3,992 4,634 4,088 5,525 4,951 Equity EPS (Rs) Source: Company Highlights of the quarter: Low double digit volume growth in the decorative paint segment, improved performance in the industrial and auto OEM segment has enabled APL to report healthy revenue of Rs 42.3 bn (+12% YoY). Management indicated that there was no change in product mix in the quarter Management also indicated that the company is experiencing increase in raw material prices since the last 4 months Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 9

10 The higher raw material cost has translated into lower Ebidta margin of 16.9% (-250 bps YoY) in the quarter Management indicated that the business environment continues to be challenging, but has improved in the current quarter. International business (especially Middle East) and Bangladesh continue to do well for APL while Nepal continues to recover from the Earthquake. Sleek International continue to underperform.. Consequently PAT was reported Rs 495 mn (-10% QoQ) below our expectation of Rs 552 mn Sales was driven by all the segments Management indicated the sales performance of Q2FY17 could be attributed to: Double digit volume growth in the decorative segment Improved demand in the industrial and auto OEM segment Healthy performance of the international business aided by contribution from the units in Middle East and Bangladesh. Growth has been slower than expected in the home improvement segment Decorative segment trends for APL The decorative segment (domestic + international) contribute around 93% of APL's overall business Management of APL indicated that the demand gained momentum in the current quarter registering low double digit volume growth. Management indicated growth from Tier II and Tier III markets continued to outpace the Tier I market growth In terms of geographic mix, South India witnessed slower demand growth vs. rest of the markets. In terms of product mix, economy segment continues to grow at a faster pace. APL continues to strengthen its product portfolio and introduced various new products every financial year APL is expecting healthy volume growth in the decorative segment on the back of normal monsoon, payout to government employees under the seventh pay commission and various government initiatives We believe the company added another 500 dealers in Q2FY17.APL continues to add ~2000 dealers (per annum) to its dealer base currently at above 40K. Current Product portfolio of APL Range Premium Mid-range Economy Exterior Interior Wood finish Waterproofing Products Royal Brand, Emulsion, Enamel Apcolite, Apex Tractor, Acrylic, Lusture Safari, Dune Synthetic, Distemper Ultima, ACE Supreme, Duracast Infinitex, Royale Atmos, Royale Play" Wood décor, genie polish Smartcare range Source: Company Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 10

11 Industrial segment Industrial segment presence for APL is through two Joint ventures: 1. Automotive Coatings: PPG Asian Paints Private Limited (PPG-AP) 2. Non-Auto Industrial Coatings: Asian Paints PPG Private Limited (AP-PPG) Industrial segment contributes ~7% to APL's revenues with automotive segment contributing 80% of the industrial segment revenues. Most auto companies have launched new models in the last one year, which has helped these Auto companies to report overall ~5.9% improvement in volumes in FY16 and 12% in H1FY17. Passenger car sales (domestic +exports) FY11 FY12 FY13 FY14 FY15 FY16 Q1FY17 H1FY17 Total 2,946,379 3,125,800 3,236,568 3,092,783 3,222,946 3,413, ,177 1,846,737 % Growth Source; SIAM Going forward, the following developments is going to keep demand for passenger cars healthy including 1) Further new launches 2) Seventh pay commission pay-out 3) Normal monsoon In Automotive segment, management of APL expects current demand trends to sustain over FY16 to FY18E and we are in agreement with the management. Non-paints forays APL also aspires to be a one-stop shop for home décor, which would help the company diversify its product offering and also give some push to its paint volumes. The company in the last 2 years have taken the following steps to step-up its non-paint offering including: Retailing of Adhesive category APL entered the retail segment of the adhesives category with a distribution arrangement with Henkel Adhesives Technologies, Germany. Under this arrangement, APL will sell the Loctite brand of adhesives under a co-branding initiative. Paint application tools under TruCare APL has also launched a range of paint application tools like power sanders, water jet washer, spray machine for putty and paint and putty mixer, all under a new brand "TruCare". EssEss bathroom products - Sanitary ware range APL had acquired the entire front end sales business including brands, network and sales infrastructure of EssEss Bathroom Products Private Limited effective 1st June, 2014 for a consideration of Rs 365 mn. Acquisition of Sleek International (51% Subsidiary) - Kitchen segment The company had acquired 51% stake in Sleek Group for a consideration of Rs1.2 bn in FY14 with a total of 30 showrooms including shop-in-shops and a network of 250+ dealers. We believe the diversification strategy of APL has 2 phases: 1) Increasing the share of non-paint category in the overall revenues to stay ahead of the competition and 2) Make itself a fully integrated home décor company Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 11

12 International markets for APL - contribute about 13% of overall revenues APL has a big international presence (through more than 30 subsidiaries) in countries like Nepal, Bangladesh, Trinidad, Sri-Lanka, Indonesia, Middle East, Singapore, UK and Vanuatu. International business (especially Middle East) and Bangladesh continue to do well for APL while Nepal continues to recover from the Earthquake. Management stated that a new state-of-the-art manufacturing facility is inaugurated in Oman with an annual capacity of 21,000 KL. The company had got all the regulatory approvals for its Greenfield project in Indonesia and work has begun for the same. Management hinted that availability of foreign exchange might impact business conditions in Egypt & Ethiopia. Nepal could witness growth in FY17 on the hope of post-earthquake reconstruction push. Margins to remain flat over FY16 to FY18E Crude linked derivatives forms 50 % of the raw material (down 11 % in the last 2 years and crude down 45% in the last 2 years) and Tio2 forms 25% of the raw material (down 6% in the last 2 years). But, from here we estimate crude prices to increase on the back of decline in production from US and possible cut in production by OPEC. We have already seen crude prices strengthening from $47/barrel to $ 51/ barrel in the last one month. Increasing crude prices would translate in higher prices of crude derivatives and even TI02 which would put pressure on margins of paints companies including APL. Strong volume growth on the back of festive season, seventh pay commission and OROP pay-out and strong momentum in auto sales would enable APL to maintain margins in an increasing raw material environment. Brent crude (US$/bbls) Tio2 (Rs/kg) Source: Bloomberg Source: Bloomberg Current capacities and capex APL completed its expansion project at Rohtak plant in Haryana from 200,000 KL per annum to 400,000 in FY16 which increased the total installed capacity for APL from 10 to 12 lakh KL. Currently the company is operating at 70% capacity and can go upto optimum level of 85% and hence we believe that the current capacities are sufficient for APL for growth for the next 2 to 3 years. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 12

13 APL is further planning to set up paint manufacturing facilities in the states of Karnataka and Andhra Pradesh. APL has already completed the land procurement and possession process in both these states in FY16. The capacities at both these manufacturing facilities will be built in a phased manner by APL (over the next 6 years) starting FY17, to cater to the future demand. Apart from these fixed capital investments, we estimate the company to spend Rs 3 bn per annum towards maintenance capex, translating to an approximate total capex of Rs 10 bn per annum. Investment in new facilities by APL Area Vishakhapatnam Mysore Capacity (lakh Kilo Litre) Investment (Rs bn) Estimated over FY16 to FY22 Source: Company We recommend SELL on Asian Paints Ltd with a price target of Rs.1075 Valuation Consensus EPS for APL for FY18 is at Rs 25.6 translating into earnings of 16% CAGR over FY16 to FY18E led by lower raw material prices, stable rupee and pick up in volumes. However we are slightly conservative here due to uncertainty over demand and increasing raw material prices. For APL, we remain confident of 12% decorative segment (mainstay of APL) volume CAGR over FY16 to FY18E with stable margins and return ratios. We have decreased our earnings estimate by 4% each for FY17E and FY18E to incorporate higher raw material prices than earlier estimated. We would want to give a small premium valuation to APL over other players in the industry for its leadership position, healthy pay-out ratio, better margins and superior return ratios. We continue to value the stock at 45x FY18E EPS (premium to medium sized paint companies) and arrive at a TP of Rs 1075 (from Rs 1125) and recommend SELL (from Accumulate). We are negative on the stock primarily on account of stretched valuation. Risk to our call Key triggers for the stock Upside risk Down side risk a) Healthy volume growth especially in the a) Fall in crude prices a) Increase in crude prices decorative segment b) Benign raw material environment b) Strong GDP growth b) Weak GDP growth c) Fruitful Investments in newer segments c) Normal monsoon c) Weak monsoon and geographies Source: Company d) Potentially EPS dilutive acquisition Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 13

14 RESULT UPDATE Meeta Shetty, CFA ALEMBIC PHARMACEUTICALS LTD (ALPM) PRICE: RS.673 RECOMMENDATION: ACCUMULATE TARGET PRICE: RS.725 FY18E P/E: 22.2X The quarter was better than expected due to better than expected export formulations growth. ALPM had a strong quarter last year due to an exclusive opportunity (gabilify) and was booking certain profit share until Q1FY17 for gabilify. The opportunity was to cease from Q2FY17, however management indicated that some spillover has continued in the current quarter and will subside going ahead. Certain shift of US products from partner to own front end as well as certain drug shortage opportunity also aided export formulations growth. We have been optimistic on ALPM and continue to believe that it is one of the best bets in the mid cap pharma space. We tweak our EPS estimates for FY18 higher by 7% to factor better export formulations revenues driven by better traction in front end launches. We maintain our Accumulate rating on Alembic Pharma with a revised price target of Rs 725 (Rs 700 earlier), 24x FY18E EPS of Rs 30.3 (earlier Rs 28.3). Quarterly Financials - Snapshot (Rs mn) 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 YoY (%) QoQ (%) Net Revenues 10,078 9,210 6,170 7,270 8,787 (12.8) 20.9 Material Expenses 2,263 2,060 1,239 1,909 2, Other Operating Expenses 2,089 1,440 1,420 1,844 2, Excise duty Employee expenses 1,196 1, ,163 1,187 (0.8) 2.0 R&D expenses , , Operating income 3,751 3,839 1,416 1,559 1,771 (52.8) 13.6 Other operating income (25.0) (32.4) EBIDTA 3,760 3,846 1,426 1,570 1,778 (52.7) 13.3 Other Income Depreciation Interest expense (10.3) Exceptional items PBT 3,621 3,647 1,196 1,369 1,567 (56.7) 14.5 Tax (54.9) (0.4) Share of associates 1 (37.1) RPAT 2,885 2, ,037 1,198 (58.5) 15.5 Margin Analysis 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 YoY (bps) QoQ (bps) Material Expenses as % of Net Sales Other operating exp as % of Net Sales Employee expenses as % of Net sales (250) R&D expenses as % of Net sales EBIDTA Margin (%) (1,707) (130) APAT Margin (%) (1,706) (134) Tax Rate (%) (1,499) (63) Source: Company Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 14

15 Summary table (Rs mn) FY16 FY17E FY18E Sales 31,487 32,060 37,552 Growth (%) EBITDA 10,059 5,736 8,051 EBITDA margin (%) PBT 9,355 5,308 7,130 Net profit 7,195 4,247 5,704 Core EPS(Rs) Growth (%) CEPS (Rs) BVPS (Rs) DPS (Rs) ROE (%) ROCE (%) Net debt (3,183) 1, NWC (Days) Core P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) Source: Company, Kotak Securities - Private Client Research Key results highlights Domestic formulations growth was 17%, the branded segment posted growth of 19% whereas the generic segment remained flat. Within the segment, Acute posted 22% growth whereas the specialty posted 16% growth. Export formulations segment posted 38% de-growth YoY and 14% growth QoQ. The revenues are not reflective of the current pricing as well as competition in gabilify. ALPM reports revenues with a lag of 1-2 quarters and hence we expect the revenues for the segment to get impacted QoQ in coming quarters. API revenues for the quarter were higher by ~20% YoY and 28% QoQ. Quarterly - Segmental Mix (Rs mn) 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 YoY (%) QoQ (%) Domestic form revenues 3,097 3,083 2,961 2,991 3, Export form revenues 5,709 5,211 1,902 3,090 3,520 (38) 14 APIs 1,372 1,012 1,669 1,282 1, Gross revenues 10,177 9,306 6,532 7,363 8,790 (14) 19 Source: Company Key segmental / con-call highlights Though the quarter posted strong growth of 19% in Indian branded segment, the low base aided 6-7% of growth and the remaining 14-15% growth should be taken as actual growth. In the domestic segment, few therapies posted strong growth with cough & cold (up 35%), gynecology (up 34%) and anti-diabetic (up 28%). However, the derma and gastro segment growth was subdued. Company expects pick up in these segments in coming quarters. Usually company launches products in the Indian market every fiscal, but for the current year ALPM plans to launch higher number of brands (will be sharing details in later interactions). The US revenue for the quarter was at Rs 2.7bn against Rs 2.2bn in 1QFY17. Though there were no new launches, the growth was primarily driven by front end products as well as profit share of gabilify. Company expects soft revenues in US over 2HFY17. Company received only 2 tentative approvals from ANDA in 2QFY17, there were no new launches in 2QFY17. ALPM expects to launch 6-8 launches in US in this fiscal. ALPM had launched one ANDA in 1QFY17, lamotrigine chewable. ALPM has 33 pending ANDAs of which ~40% are Para 4s and a few are FTFs. The front end set up by the company is progressing well and already markets 23 products (transferred from partners). This re-launching of partnered products in US has driven export formulations sales as few products have picked up good market share whereas company could also capture certain shortage opportunities. Gross margins have increased by 100bps QoQ (YoY not comparable due to one off in base quarter) led by strong growth in domestic formulations as well as gabilify profit share contribution. Direct marketing of US products has also helped in better gross margins. Other expenses were higher for the quarter due to higher marketing spends in domestic market. The US front end expenses are also being captured in ALPM's expense line item (earlier there were partnered products) which is also leading to higher outgo. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 15

16 The capex incurred till now (1HFY17) stood at Rs 2.2bn. ALPM plans to spend Rs 6.0bn in capex for FY17 and Rs bn in FY18. The capex is largely towards the Onco Oral and Onco Injectable facility as well as general injectable and Derma facility. The Onco facility (both oral and Inj) will be ready by en d of FY17 and the general injectable and Derma facility will be ready by 1HFY18. ALPM also plans to start work on its new oral dosage facility in FY18. The filing will start post the stability of validation batches (which usually takes 6 months) after the facility is ready. Hence for Onco the filings will start from 2HFY18. The gross debt stands at Rs 1.45bn, at net levels ALPM is debt free. Though the management had indicated of increasing its R&D team, it still stands at 400 (same as earlier). Apart of the new capex which is ongoing, ALPM had few expansions at its existing plants (since last yr.), post which the overall capacity utilization stands at ~75%. We maintain ACCUMULATE rating on Alembic Pharmaceuticals Ltd with a price target of Rs.725 Outlook and Valuation The quarter was better than expected due to better than expected export formulations growth. ALPM had a strong quarter last year due to an exclusive opportunity (gabilify) and was booking certain profit share until last year for gabilify. The opportunity was to cease from this quarter, however management indicated that some spillover has continued in the current quarter and will subside going ahead. Certain shift of US products from partner to own front end as well as certain drug shortage opportunity also aided export formulations growth. Alembic is incurring huge capex as well as increasing its R&D expenses towards building a strong pipeline of complex products for the US markets which will drive its growth over the coming years. We have always maintained that ALPM is one of the best bets in the mid-cap pharma space given its focused approach as well as R&D capabilities, we believe the coming 2-3 quarters will be a phase of consolidation for the company but over the longer run we expect the company to come out as a strong growth company with stable margins and revenue visibility. We tweak our EPS estimates for FY18 higher by 7% to factor better export formulations revenues (FY18E revenues stand higher by 2%) driven by better traction in front end launches. We maintain our ACCUMULATE rating on Alembic Pharma with a revised price target of Rs 725 (Rs 700 earlier), 24x FY18E EPS of Rs 30.3 (earlier Rs 28.3). Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 16

17 RESULT UPDATE Meeta Shetty, CFA DR. REDDY'S LABORATORIES LTD PRICE: RS.3200 RECOMMENDATION: SELL TARGET PRICE: RS.2770 FY18E P/E: 24.0X Dr. Reddy's results were ahead of expectations on both revenues as well as PAT front. Revenues (including other operating income) came in at Rs 36.2bn, down 9% YoY. EBIDTA margins were at 17.8% for the quarter, down 1082bps YoY but up 543bps QoQ. PAT was down ~59% YoY. We have been cautious on DRL due to increasing competition in its key injectable products (40% of US revenues) and lack of big ticket launches. US, which is the largest revenue contributor at 48% to revenues has been the key driver in the past few years but going ahead the outlook looks weak. Moreover, the impending compliance issues at its plants will further delay the launch pipeline for DRL. Hence, we continue to maintain a cautious stance on DRL. We maintain our estimates for FY17E as well as FY18E. Maintain SELL with a target price of Rs Quarterly performance (Rs mn) 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 YoY (%) QoQ (%) Net Revenues 39,890 39,679 37,562 31,635 35,287 (11.5) 11.5 Other oper income Material Expenses 8,129 8,813 8,204 7,231 8, SG & A expenses 11,058 12,039 11,632 3,268 3,549 (67.9) 8.6 Other Operating Expenses 4,826 4,505 5,050 4,974 4,309 (10.7) (13.4) Employee expenses 8,050 8, R&D expenses 4,473 4,095 4,879 4,800 5, EBIDTA 11,404 10,227 7,797 3,902 6,270 (45.0) 60.7 Interest Cost (172) 401 2, (173.4) (14.9) Depreciation 2,466 2,771 3,032 2,436 2, Other Income (34.6) Exceptional items (388) 339 (4,309) - - PBT 9,041 7,516 (1,883) 1,988 3,960 (56.2) 99.2 Tax 1,879 1,788 1, (49.1) 81.7 Share from associates RPAT 7,219 5,792 (3,563) 1,535 3,089 (57.2) Adjustments 310 (271) 3, APAT 7,529 5,521 (116) 1,535 3,089 (59.0) AEPS (0.7) (59.0) Margin Analysis 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 YoY (bps) QoQ (bps) Raw mat expenses (%) SG & A expenses (%) (1,766) (27) Other Operating (%) (351) Employee exp (%) (232) R&D expenses (%) (44) EBIDTA margins (%) (1,082) 543 APAT Margin (%) (0.3) (1,012) 390 Tax Rate (%) (92.4) (232) Source: Company Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 17