INDIA DAILY November 15, 2010 India 12-Nov 1-day1-mo 3-mo

Transcription

1 Contents Results IOCL: Healthy 2QFY11 results, maintain positive view Tata Steel: Corus surprises positively INDIA DAILY November 15, 2010 India 12-Nov 1-day1-mo 3-mo Reliance Communications: Another weak quarter, on expected lines. SELL Sensex 20,157 (2.1) Nifty 6,072 (2.0) Global/Regional indices Dow Jones 11,193 (0.8) Nasdaq Composite 2,518 (1.5) FTSE 5,797 (0.3) Nikkie 9, Hang Seng 24,223 (1.9) KOSPI 1, Reliance Power: Rosa stabilizing Oil India: Good results; upgrade to ADD on reasonable valuations Tata Power: Improving coal realizations Value traded India Cash (NSE+BSE) Derivatives (NSE) 1, ,048 Deri. open interest 1,714 1,679 1,664 Reliance Infrastructure: Regulatory relief boosts standalone earnings Unitech: Revenue recognition subdued HPCL: Government compensation makes up for weak operational performance Lanco Infratech: Merchant dilemma IVRCL Infrastructures: Another disappointment; probably road projects have not picked execution yet India Cements: Breaching breakeven Balrampur Chini Mills: Weak quarter due to sales of high cost inventory Updates Economy: September IIP: Low on account of base effects and indices Banks/Financial Institutions: 2QFY11 review - Margins improve further; slippages remain high Forex/money market Change, basis points 12-Nov 1-day 1-mo 3-mo Rs/US$ (197) 10yr govt bond, % Net investment (US$mn) 11-Nov MTD CYTD FIIs 25 3,650 28,483 MFs (22) 154 (282) Top movers -3mo basis Change, % Best performers 12-Nov 1-day 1-mo 3-mo IDBI IN Equity (3.9) IBULL IN Equity NEST IN Equity ACEM IN Equity (1.7) HNDL IN Equity (4.6) Worst performers FTECH IN Equity (1.4) (4.5) (16.1) GMRI IN Equity 52.1 (2.3) (7.8) (15.8) HDIL IN Equity (4.0) (9.9) (14.4) IVRC IN Equity (3.8) (8.8) (13.7) EDSL IN Equity (8.6) (18.0) (12.7) For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES. REFER TO THE END OF THIS MATERIAL.

2 Indian Oil Corporation (IOCL) Energy Healthy 2QFY11 results, maintain positive view. IOCL reported better-thanexpected 2QFY11 (standalone) net income at `52.9 bn versus our estimate of `8.6 bn due to compensation of `72.2 bn from the government for 1HFY11 versus nil assumed by us. IOCL reported 2QFY11 refining margins at US$6.6/bbl versus US$3/bbl in 1QFY11 and US$3.5/bbl in 2QFY10. We maintain our ADD rating on the stock with a revised target price of `500 (`480 previously). We see (1) diesel deregulation and (2) positive government action on subsidy-sharing scheme before the proposed disinvestment as key triggers for the stock. ADD NOVEMBER 15, 2010 RESULT Coverage view: Cautious Price (Rs): 403 Target price (Rs): 500 BSE-30: 20,157 Company data and valuation summary Indian Oil Corporation Stock data Forecasts/Valuations E 2012E 52-week range (Rs) (high,low) EPS (Rs) Market Cap. (Rs bn) EPS growth (%) (21.4) 4.0 Shareholding pattern (%) P/E (X) Promoters 78.9 Sales (Rs bn) 2, , ,856.4 FIIs 1.0 Net profits (Rs bn) MFs 1.8 EBITDA (Rs bn) Price performance (%) 1M 3M 12M EV/EBITDA (X) Absolute (3.0) ROE (%) Rel. to BSE-30 (2.8) (5.3) 13.0 Div. Yield (%) Cash compensation from government boosts 2QFY11 earnings IOCL reported 2QFY11 EBITDA (standalone) at `68.9 bn versus `26.7 bn in 1QFY11 and `6.1 bn in 2QFY10; our estimate was at `5.6 bn. The stronger-than-expected performance was due to compensation of `72.2 bn from the government for 1HFY11 versus nil assumed by us. We note that IOCL has borne `43.9 bn as net under-recovery in 1HFY11. However, we would not extrapolate the subsidy-sharing arrangement for 1HFY11 to estimate FY2011E earnings as the final subsidy-sharing arrangement will not be known until 4QFY11 results. QUICK NUMBERS 1HFY11 EBITDA at `42.2 bn versus `56.1 bn in 1HFY10 Change of US$1/bbl in refining margin impacts EPS by 13% 24% potential upside to earnings assuming nil subsidy burden in FY2012E Refining margins improve; sales volumes increased 1% yoy IOCL s 2QFY11 refining margin improved significantly to US$6.6/bbl versus US$3/bbl in 1QFY11 and US$3.5/bbl in 2QFY10. 2QFY11 sales volumes increased 1% yoy to 15.7 mn tons. The modest yoy growth in sales despite strong growth in gasoline sales reflects (1) modest growth in diesel sales and (2) decline in sales of bitumen, fuel oil and naphtha. Earnings will depend on crude prices which have been extremely volatile in the near term The earnings of downstream companies will depend on crude prices which will, in turn determine the gross under-recoveries in the system and net under-recoveries to be borne by downstream companies. We would advise investors to take a view on crude prices based on fundamentals of demand and supply. Crude prices can swing sharply in the short term based on (1) speculative positions, (2) weekly changes in inventory positions, (3) disruption in a source of supply for a short period etc. In our view, short-term and medium-term fundamentals of crude oil do not support current level of crude oil prices given (1) ample OPEC spare capacity (6 mn b/d), (2) comfortable global inventories and (3) rising supply of alternative energy in CY E. Revised earnings; stock offering good upside to current target price Our revised target price is `500 (`480 previously) based on 11X FY2012E EPS plus value of investments. We have revised our FY E EPS to `39 (+2%), `40 (-4%) and `43 (-4%) to reflect (1) 2QFY11 results, (2) stronger rupee, (3) higher crude price and (4) other changes. For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.

3 Indian Oil Corporation Energy Key financial and operating details of 2QFY11 results Exhibit 1 gives key highlights of IOCL s 2QFY11 results and compares the same on yoy and qoq basis. We do not see merit in a comparison of quarterly results given the high volatility in the timing and quantum of compensation from government and upstream companies. Interim results of Indian Oil Corp., March fiscal year-ends (` mn) (% chg.) yoy 2QFY11 2QFY11E 2QFY10 1QFY11 2QFY11E 2QFY10 1QFY11 1HFY11 1HFY10 (% chg.) 2011E Net sales (a) 773, , , ,245 (2.2) ,492,602 1,201, ,667,029 Total expenditure (704,457) (796,368) (603,559) (745,901) (11.5) 16.7 (5.6) (1,450,358) (1,145,365) 26.6 (3,490,507) Increase/(Decrease) in stocks 24,494 43,816 1,660 26,154 48,915 Purchase of products/crude for resale (363,973) (388,134) (309,012) (361,367) (6.2) (725,340) (568,324) 27.6 (1,843,883) Consumption of raw materials (313,634) (380,361) (294,499) (347,950) (17.5) 6.5 (9.9) (661,585) (540,884) 22.3 (1,537,275) Staff cost (16,004) (10,833) (11,195) (9,832) (25,836) (21,110) 22.4 (48,946) Other expenditure (a) (35,339) (17,040) (32,670) (28,412) (63,751) (63,961) (0.3) (60,403) EBITDA 68,901 (5,633) 6,138 (26,657) (1,323.1) 1,022.5 (358.5) 42,244 56,128 (24.7) 176,522 Other income 8,619 14,378 8,481 8,830 (40.1) 1.6 (2.4) 17,449 23,525 (25.8) 31,243 Interest (5,079) (5,210) (3,477) (5,712) (2.5) 46.1 (11.1) (10,791) (6,817) 58.3 (23,341) Depreciation (11,178) (10,575) (7,805) (10,346) (21,524) (15,403) 39.7 (45,476) Pretax profits 61,262 (7,040) 3,337 (33,884) (970.2) 1,736.1 (280.8) 27,378 57,432 (52.3) 138,949 Previous years arrears/extraordinary income Tax 1,403 (493) (15,791) (35,385) Deferred tax (8,323) (2,956) (8,323) (1,969) (10,771) Net income 52,940 (8,593) 2,844 (33,884) (716.0) 1,761.7 (256.2) 19,056 39,672 (52.0) 92,793 EPS (Rs) 21.8 (3.5) 1.2 (14.0) Tax rate (%) 13.6 (22.1) Volume data Crude throughput (mn tons) (2.2) (8.6) Domestic sales (mn tons) (9.1) Export sales (mn tons) Pipelines throughput (mn tons) (5.7) Refining margin (US$/bbl) (13.1) 5.3 Inventory gain/(loss)-products (Rs mn) (351) 750 (1,260) 5,171 4,820 16,070 9,320 Subsidy gain/(loss) (Rs mn) (64,066) (67,515) (59,735) (110,139) (174,205) (91,637) (338,142) Receipt from upstream companies (Rs mn) 21,355 22,505 17,991 36,713 58,068 20, ,714 Oil bonds/cash from government (Rs mn) 72,200 72, ,050 Net under-recovery 29,489 (45,010) (41,744) (73,426) (43,937) (71,355) (34,378) Exchange gain/(loss) (Rs mn) 6,435 4,628 (260) (4,675) 1,760 6,268 2,238 (a) Reported sales and other expenditure include freight costs and local taxes. Our estimates are without the same. Source: Company, Kotak Institutional Equities estimates Refining margins improved qoq in 2QFY11. IOCL s 2QFY11 refining margin improved sharply to US$6.6/bbl versus US$3/bbl in 1QFY11 and US$3.5/bbl in 2QFY10. This is better than qoq improvement of US$0.5-1/bbl in global benchmark margins. Compensation (cash) from the government and discounts from the upstream oil companies. IOCL received `72.2 bn as compensation from the government for 1HFY11. IOCL received `21.4 bn of discounts from the upstream companies in 2QFY11 compared to `18 bn in 2QFY10 and `36.7 bn in 1QFY11. Its net under-recovery was `43.9 bn in 1HFY11 compared to under-recovery of `71.4 bn in 1HFY10. Refining throughput and sales volumes. IOCL s refineries processed 12.1 mn tons of crude in 2QFY11 compared to 13.3 mn tons in 1QFY11 and 12.4 mn tons in 2QFY10. IOCL s sales volume (domestic sales) was 15.7 mn tons (-9.1% qoq, +0.9% yoy). Petchem EBIT negative. IOCL reported a negative EBIT of `5 bn from sale of petrochemical products versus a gain `1.3 bn in 2QFY10 and -`4.8 bn in 1QFY11. The qoq decline in performance despite significantly higher sales due to ramp-up of Panipat cracker reflects correction in global chemical margins qoq. KOTAK INSTITUTIONAL EQUITIES RESEARCH 3

4 Energy Indian Oil Corporation Staff expenses rose sharply 63% qoq and 43% yoy. IOCL s staff expenses rose sharply to `16 bn (+63% qoq and +43% yoy), significantly above our estimated `10.8 bn. The management highlighted that a one-time provision was made in this quarter for settlement of employee s dues. Other income seems to be quite low at `8.6 bn as it includes FX-related gains of `6.4 bn. Adventitious loss. IOCL s reported an adventitious loss of `351 mn versus a gain of `5.2 bn in 1QFY11 and loss of `1.3 bn in 2QFY10. Earnings revisions and key assumptions behind earnings model We have revised FY2011E, FY2012E and FY2013E EPS estimates to `38.6, `40.2 and `42.9 from `37.9, `41.9 and `44.7. We discuss key assumptions behind our earnings model below. Refining margins. We model refining margin (standalone) for IOCL at US$5.3/bbl in FY2011E, US$5.9/bbl in FY2012E and US$6.3/bbl in FY2013E compared to US$4.5/bbl in FY2010. The improvement in refining margins reflects likely improvement in global supply-demand balance with new refining capacity additions and new NGL supply in CY E likely to lag increase of 3.5 mn b/d in global oil demand. We assume adventitious gains at `9.3 bn in FY2011E in line with 1HFY11 s `4.8 bn and nil gains or losses for the future years. Crude throughput. We model crude throughput at 51.7 mn tons, 54.6 mn tons and 54.6 mn tons in FY2011E, FY2012E and FY2013E versus 50.7 mn tons in FY2010. The yoy jump in crude throughput in FY2011E reflects a full year of operation of Panipat s expanded capacity (15 mtpa). Marketing margins. We model marketing margin on gasoline and diesel at `2,093/ton and `1,307/ton in FY2011E and `1,900/ton and `1,700/ton in FY2012E compared to `3,929/ton and `1,113/ton and in FY2010. We expect diesel prices to be deregulated by April 1, 2011 with the easing of inflationary concerns. We do not assume any increase in LPG and kerosene retail prices throughout our forecast period. Compensation from government and discount from upstream companies. For FY E, we assume the government will restrict the amount of net under-recoveries at around `63 bn (higher than `56 bn in FY2010) for the downstream oil companies and will give sufficient compensation to maintain the profitability of downstream companies at a certain level. We model IOCL to receive compensation of `191 bn, `113 bn and `131 bn from the government in FY2011E, FY2012E and FY2013E. We assume IOCL to receive a discount of `113 bn for FY2011E, `74 bn for FY2012E and `82 bn for FY2013E from the upstream companies. We assume net under-recoveries at `34 bn, `35 bn and `34 bn for FY2011E, FY2012E and FY2013E. Exchange rate. We now assume `/US$ exchange rate for FY2011E, FY2012E and FY2013E at `45.5/US$, `44.5/US$ and `44.5/US$ versus `46/US$, `46/US$ and `46/US$ previously. A stronger rupee is moderately negative for earnings of IOCL for the refining segment although it is positive for marketing margins of controlled products in that under-recoveries will be likely lower. CPCL 2QFY11 results higher refining margins qoq boost earnings CPCL reported 2QFY11 net income of `978 mn compared to -`553 mn in 1QFY11 and Rs1.4 bn in 2QFY10. The qoq increase in net income reflects high refining margins of US$4.1/bbl versus US$1.8/bbl in 1QFY11. The qoq increase in margins is due to (1) increase in global refining margins, (2) higher throughput at 2.78 mn tons versus 2.33 mn tons in 1QFY11 and (2) adventitious gains. 4 KOTAK INSTITUTIONAL EQUITIES RESEARCH

5 Indian Oil Corporation Energy We model FY2011E and FY2012E EPS at `12.6 (`1.9 bn net income) and `29.3 (`4.4 bn net income). We model FY2011E and FY2012E refining margin at US$3.6/bbl and US$4.8/bbl versus US$3.1/bbl in 1HFY11; all figures include adventitious gains/losses. The yoy decline in FY2011E net income reflects (1) lower refining margins and (2) stronger rupee. Stock offers 24% upside to our fair valuation of IOCL Fair valuation of IOCL (`) Valuation based on P/E multiple Profit after tax for FY2012E (Rs mn) 95,298 Less: income from investment valued separately (Rs mn) 9,749 Adjusted profit after tax for FY2012E (Rs mn) 85,549 Adjusted EPS for FY2012E 35 P/E multiple (X) 11 Fair value on P/E (without value of investments) (A) 388 Add: Value of investments (Rs mn) 272,777 Oil and Natural Gas Corp. 197,377 Chennai Petroleum Corp. 19,239 Gas Authority of India 13,845 Oil India Ltd. 13,910 IOC treasury shares (IBP Co.) 14,841 Petronet LNG Ltd. 6,750 Other equity 6,815 Value of investments (Rs) (B) 112 Total equity value (A) + (B) 500 Current stock price 403 Potential upside (%) 24 Source: Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 5

6 Energy Indian Oil Corporation IOCL earnings model assumptions, March fiscal year-ends, E E 2012E 2013E 2014E Rs/US$ Weighted average duty on products (%) Import duty on crude (%) Effective 'import duty' on domestic crude (%) Effective duty protection (%) Refinery yield (US$/bbl) Cost of crude (US$/bbl) Domestic - Northeast Gujarat Rest of India Imported Landed cost of crude (US$/bbl) Net refining margin (US$/bbl) Crude throughput (mn tons) Domestic - Northeast Gujarat Rest of India Imported Other products Fuel and loss Production of main products Fuel and loss (%) Sales volume (mn tons) Marketing margin (Rs/ton) 26 (633) (2,203) (5,253) 874 (437) 1,792 1,776 1,775 Source: Company, Kotak Institutional Equities estimates Earnings sensitivity of IOC (standalone) to refining margins and marketing margins (` mn) Fiscal 2011E Fiscal 2012E Fiscal 2013E Downside Base case Upside Downside Base case Upside Downside Base case Upside Refining margins Refining margins (US$/bbl) Net profits (Rs mn) 80,858 92, ,729 82,948 95, ,649 89, , ,527 EPS (Rs) % upside/(downside) (12.9) 12.9 (13.0) 13.0 (12.1) 12.1 Marketing margins Transportation fuels margins (Rs/ton) (1585) (1435) (1285) Net profits (Rs mn) 92,394 92,793 93,193 91,117 95,298 99,480 97, , ,623 EPS (Rs) % upside/(downside) (0.4) 0.4 (4.4) 4.4 (4.4) 4.4 Source: Kotak Institutional Equities estimates 6 KOTAK INSTITUTIONAL EQUITIES RESEARCH

7 Indian Oil Corporation Energy Consolidated profit model, balance sheet, cash model of IOCL, March fiscal year-ends, E (` mn) E 2012E 2013E 2014E Profit model (Rs mn) Net sales 1,729,474 2,149,428 2,444,378 3,041,265 2,660,338 3,667,029 3,856,416 4,212,542 4,400,909 EBITDA 82, , ,872 61, , , , , ,749 Other income 21,310 27,451 43,748 45,155 68,588 31,718 31,049 32,384 31,482 Interest (12,101) (17,058) (17,556) (41,758) (16,638) (25,007) (23,191) (21,615) (16,888) Depreciation (24,711) (28,686) (29,918) (31,389) (34,943) (48,093) (49,372) (53,518) (54,305) Pretax profits 66,542 92, ,145 33, , , , , ,038 Extraordinary items 5,590 24,757 5,374 (14,995) Tax (19,975) (25,834) (38,293) (13,316) (47,193) (36,521) (42,725) (49,177) (53,656) Deferred taxation (1,282) (8,040) (473) 1,435 5,556 (10,594) (6,874) (3,537) (1,166) Net profits 51,125 82,729 83,430 25, ,238 94,672 99, , ,217 Net profits after minority interests 45,331 62,702 74,517 27, ,128 93,767 97, , ,230 Earnings per share (Rs) Balance sheet (Rs mn) Total equity 317, , , , , , , , ,023 Deferred tax liability 50,602 59,859 60,331 58,876 54,072 63,915 70,789 74,326 75,492 Total borrowings 292, , , , , , , , ,514 Currrent liabilities 286, , , , , , , , ,268 Total liabilities and equity 947,691 1,058,981 1,280,322 1,370,888 1,572,389 1,747,237 1,773,859 1,804,714 1,807,296 Cash 8,080 9,385 8,413 8,076 13,501 5,347 7,015 8,781 4,843 Current assets 413, , , , , , , , ,871 Total fixed assets 383, , , , , , , , ,397 Investments 141, , , , , , , , ,184 Total assets 947,691 1,058,981 1,280,322 1,370,888 1,572,389 1,747,237 1,773,859 1,804,714 1,807,296 Free cash flow (Rs mn) Operating cash flow, excl. working capital (10,334) (44,660) (107,263) (345,677) 138, , , , ,335 Working capital changes (8,136) 2,237 (1,414) 76,881 (163,423) (86,655) (1,136) (38,445) 12,326 Capital expenditure (49,042) (50,969) (79,586) (135,923) (128,974) (84,591) (50,081) (22,019) (24,291) Investments (17,778) 99,768 92, , ,320 2,914 25, Other Income 10,317 13,582 18,253 16,413 24,515 28,032 30,445 31,709 30,713 Free cash flow (74,973) 19,958 (77,346) (88,896) 18,276 (18,311) 127, , ,932 Ratios (%) Debt/equity Net debt/equity RoAE RoACE Key assumptions (IOC standalone) Crude throughput (mn tons) Effective tariff protection (%) Net refining margin (US$/bbl) Sales volume (mn tons) Marketing margin (Rs/ton) 26 (633) (2,203) (5,253) 874 (437) 1,792 1,776 1,775 Subsidy under-recoveries (Rs mn) (47,740) (21,900) (97,738) (31,588) (34,378) (34,612) (33,781) (33,172) Source: Company, Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 7

8 Tata Steel (TATA) Metals Corus surprises positively. Tata Steel reported 2QFY11 consolidated EBITDA of Rs36.8 bn, 1.9% ahead of our estimate. Net income of Rs19.8 bn was 8.4% ahead of our estimate led by solid performance of Corus and lower-than-expected tax rate. EBITDA of US$56/ton for Corus was ahead of our estimate of US$45/ton, while profitability of the India business fell short of expectations. Tata Steel s brownfield expansion and investments in raw material projects can deliver significant value in the medium term. NR NOVEMBER 12, 2010 RESULT Coverage view: Cautious Price (Rs): 631 Target price (Rs): - BSE-30: 20,589 Company data and valuation summary Tata Steel Stock data Forecasts/Valuations E 2012E 52-week range (Rs) (high,low) EPS (Rs) (3.6) Market Cap. (Rs bn) EPS growth (%) (103.6) (2,048.1) 0.8 Shareholding pattern (%) P/E (X) (177.3) Promoters 32.5 Sales (Rs bn) 1, , ,155.1 FIIs 17.0 Net profits (Rs bn) (3.3) MFs 3.7 EBITDA (Rs bn) Price performance (%) 1M 3M 12M EV/EBITDA (X) Absolute (0.4) ROE (%) (1.5) Rel. to BSE-30 (1.6) Div. Yield (%) Consolidated performance ahead of our estimate Tata Steel reported consolidated EBITDA of Rs36.8 bn, 1.9% ahead of our estimate. The outperformance was led by solid performance of Corus, which reported EBITDA of US$197 mn, 18% ahead of our estimate. The performance of the India operations was 9% lower than our estimate. Tata Steel reported consolidated net income of Rs19.8 bn (+8.4% qoq, % yoy), 8.4% ahead of our estimate and helped by higher-than-expected other income and lower-thanexpected tax rates. Corus realizations improve sequentially but will be under pressure in 3QFY11E Corus reported 5% improvement in realization to US$1,108/ ton. This helped Corus report EBITDA/ton of US$55 despite 20% qoq increase in raw material cost/ton. Corus attributes this to a mix of factors including benefits of annual and quarterly steel contracts and good momentum on spot pricing that continued till July- August. On expected lines, profitability will come under pressure in 3Q on account of lag impact of raw material price increase and likely decline in realization. Profitability may improve again in 4QFY11E on lag benefit of raw material price decline. Proposals to raise Rs70 bn through various equity/debt instruments The Tata Steel board has passed a resolution to seek shareholder approval to raise additional longterm resources of up to Rs70 bn through equity issuance, GDRs, debentures, DVRs, FCCBs etc. Tata Steel indicated that the capital raised would be used for capex for brownfield expansion, raw material projects and upgrade of capex for the European markets. The company highlighted that it has adequate liquidity and that funds are not being raised for any scheduled repayment of debt but for long-term strategic investments/projects that can deliver significant value. Stock trades at 5.5X FY2011E and 5.2X FY2012E EBITDA Tata Steel trades at 5.5X FY2011E and 5.2X FY2012E EBITDA (adjusting for CWIP). This is at a discount to peers. In our view, FY2013E could be an important year for Tata Steel since (1) benefits from 2.9 mtpa capacity at expansion at Jamshedpur will fully reflect in financials and (2) investments in raw material security projects may start delivering results. For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.

9 Tata Steel Metals High leverage still a concern; small but a few steps taken in the right direction Tata Steel has a high leveraged balance sheet. With US$3.5-4 bn of capex over the next two years, we believe that the absolute debt is unlikely to change meaningfully. Nonetheless, some of the recent steps taken are in the right direction, in our view. MOU for sale of Teeside Cast Products (TCP) will bring in US$500 mn. In addition, the company sold part of the holding in Tata Power and Tata Motors to Tata Sons. This sale will bring in further Rs6.5 bn. On the negative side, refinancing of 3.53 bn of Corus debt may lead to additional interest outgo of US$60 mn per annum. The new loan has been negotiated at Unibor+350 bps versus Unibor+220 bps earlier. Note that the increased interest was already built into our estimates. Proposed equity raising plan may also address leverage concerns. Update on various projects Tata Steel has announced 185 mn investments in rebuild of No4 blast furnace at Port Talbot Steelworks. Tata Steel reiterated the commissioning of 3 mtpa brownfield capacity expansion at Jamshedpur on schedule by Dec Tata Steel has already spent Rs57 bn till Sep 2010 and will invest additional Rs29 bn in 2HFY11E. The product mix will comprise 2.54 mtpa HRC and 0.3 mtpa of slab mill capacity. The company is also making reasonable progress on the Mozambique coking coal project. Increased working capital requirement eats into operating cash flow Tata Steel s net current assets increased by US$1.1 bn over end-fy2010, impacting cash flow from operations. Working capital increased primarily to fund high raw material prices for the European operations. Gross debt increased to US$12.5 bn from US$11.8 bn primarily on capex for India operations and higher working capital for European operations. Net debt stood at US$10.7 bn at end-september Pension surplus for European operations declined further to 159 mn from 455 mn in 2QFY10. Few changes to our estimates We build in our economist s revised Re/US$ forecast of Rs45.5, Rs44.5 and Rs44 for FY2011E, FY2012E and FY2013E, respectively, from Rs46 earlier. We have also fine-tuned our HRC price assumption for India business in the next two years. As a result, our EBITDA estimates reduce by 0.6%, 3.2% and 3.5% for FY2011E, FY2012E and FY2013E, respectively. Exhibit 1 details the key changes to our estimate. Exhibit 1: Tata Steel, change in estimates, March fiscal year-ends, E (Rs mn) Revised estimates Old estimates % change 2011E 2012E 2013E 2011E 2012E 2013E 2011E 2012E 2013E Earnings (consolidated) Net sales 1,149,759 1,155,111 1,198,700 1,156,506 1,186,293 1,227,582 (0.6) (2.6) (2.4) EBITDA 156, , , , , ,546 (0.6) (3.2) (3.5) Adj. PAT 63,411 63,914 74,608 60,828 63,967 75, (0.1) (1.1) EPS (Rs) (0.1) (1.1) Volumes India (mn tons) International operations (mn tons) (0.9) (0.9) (0.9) Pricing HRC price India (US$/ton) (0.3) (0.9) (0.8) HRC price Corus (US$/ton) 1,085 1,075 1,060 1,075 1,065 1, Source: Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 9

10 Metals Tata Steel Other details EBITDA for the India business declined 25% sequentially to US$332/ton. Shipment of 1.66 mn tons showed a significant improvement over 1QFY11. On expected line Corus shipments declined 5% qoq to 3.53 mn tons. Consolidated steel deliveries declined 1.4% qoq and 3.8% yoy to 5.82 mn tons. Benefit of carbon credit sales and certain one-offs EBITDA of Corus was offset by expensing of unamortized borrowing cost. Tata Steel realized Rs6.5 bn from sale of investments in Tata Motors and Tata Steel. Exhibit 2: Interim results of Tata Steel (standalone), March fiscal year-ends (Rs mn) (% chg.) 2QFY11 2QFY11E 2QFY10 1QFY11 2QFY11E 2QFY10 1QFY11 Net sales 71,068 73,612 56,921 65,515 (3.5) Expenditure (44,777) (44,726) (37,699) (36,350) Consumption of raw materials (15,637) (13,008) (14,217) (9,649) Staff Cost (6,837) (6,759) (5,221) (5,781) Power and fuel (3,615) (4,233) (2,979) (3,549) (14.6) Freight and handling (3,603) (4,202) (3,078) (3,522) (14.3) Other Expenditure (15,086) (16,523) (12,204) (13,849) (8.7) EBITDA 26,290 28,886 19,222 29,165 (9.0) 36.8 (9.9) OPM (%) Other income 7,327 6, ,412.8 Interest (3,425) (3,441) (3,920) (3,277) (0.5) (12.6) 4.5 Depreciation (2,815) (2,942) (2,564) (2,802) (4.3) Pretax profits 27,378 29,004 13,499 23,570 (5.6) Extraordinaries Tax (6,726) (9,571) (4,470) (7,776) (29.7) 50.5 (13.5) Net income 20,651 19,432 9,029 15, Ratios EBITDA margin (%) ETR (%) EPS (Rs) Segment revenue Steel business 64,971 51,937 59, Others 4,488 3,761 4, Segment EBIT Steel business 21,764 16,828 24, (12) Others (88) (88) Margins Steel business (18.6) Others (13.4) Source: Company, Kotak Institutional Equities estimates 10 KOTAK INSTITUTIONAL EQUITIES RESEARCH

11 Tata Steel Metals Exhibit 3: Interim results of Tata Steel (consolidated), March fiscal year-ends (Rs mn) (% chg.) 2QFY11 1QFY11E 2QFY10 1QFY11 1QFY11E 2QFY10 1QFY11 Net sales 286, , , , Expenditure (249,739) (225,898) (250,232) (227,622) 10.6 (0.2) 9.7 Consumption of raw materials (124,064) (108,308) (118,589) (103,481) Staff Cost (38,275) (37,017) (43,608) (37,771) 3.4 (12.2) 1.3 Power and fuel (9,967) (9,726) (10,128) (9,713) 2.5 (1.6) 2.6 Freight and handling (14,676) (13,706) (14,580) (15,861) (7.5) Other Expenditure (62,757) (57,141) (63,328) (60,796) 9.8 (0.9) 3.2 EBITDA 36,723 36,034 3,718 44, (17.2) OPM (%) Other income 8,143 6, , ,269.2 Interest (6,637) (5,916) (7,172) (5,976) 12.2 (7.5) 11.1 Depreciation (10,781) (10,753) (11,535) (10,439) 0.3 (6.5) 3.3 Pretax profits 27,448 26,165 (14,810) 28, (3.7) Extraordinaries (316) (599) (9,113) (599) (47.3) (96.5) (47.3) Tax (7,450) (7,670) (3,275) (10,005) (2.9) (25.5) Net income 19,682 17,896 (27,198) 17, Minority interest (174) 416 (75.3) (158.9) (75.3) Share of profit from associates 3 (65) 300 (65) (104.9) (98.9) (104.9) PAT after minority interest 19,788 18,247 (27,073) 18, Adjusted PAT 19,998 18,495 (18,085) 18, Income tax rate (%) (13.7) 35.9 Ratios EBITDA margin (%) ETR (%) (13.7) 35.9 EPS (Rs) (29.6) 20.0 Segment revenue Steel business 273, , , (7.4) Others 30,067 26,220 28, Segment EBIT Steel business 31,391 (6,567) 32,824 (578.0) (4.4) Others 2,340 2,304 3, (28.6) Segment capital employed Steel business 535, , , Others 48,788 39,350 45, Margins Steel business 11.5 (2.4) 11.1 (573.4) 3.3 Others (11.4) (31.9) Source: Company, Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 11

12 Metals Tata Steel Exhibit 4: Tata Steel, Quarterly analysis of cost-structure, March fiscal year-ends (US$/ton) 2Q Q Q Q Q Q Q Q Q 2011 Tata Steel India Steel business Average realization 1, Steel EBIT Realization (US$/ ton) 1, , Raw material cost Employee cost Power and fuel cost Freight and handling Other expenditure EBITDA/ ton Tata Steel (Consolidated) Average realization 1,314 1, ,003 1,068 1,010 Steel EBIT (40) (37) (22) Steel EBITDA (12) (3) Realization (US$/ ton) 1,278 1, ,059 Raw material cost Employee cost Power and fuel cost Freight and handling Other expenditure EBITDA/ ton (1) Source: Company, Kotak Institutional Equities estimates 12 KOTAK INSTITUTIONAL EQUITIES RESEARCH

13 Tata Steel Metals Exhibit 5: Valuation parameters, consolidated, March fiscal year ends, FY E E 2012E 2013E Valuation ratios P/E (X) (170.5) EV/EBITDA (X) P/B (X) EV/ Revenues (X) P/FCF (X) (26.5) FCF Yield (%) (3.8) P/CEPS EV/Invested Capital Dividend Yield (%) Return ratios ROE (year-end) (%) (1.4) ROE (average) (%) (1.5) ROIC (year-end) (%) (43.0) ROIC (average) (%) (37.7) ROCE (year-end) (%) (39.4) ROCE (average) (%) (34.8) Leverage ratios Debt/ Equity (X) Net debt/ Equity (X) Debt/ Capitalization (X) Net debt/ EBITDA (X) Other ratios Revenues/Average gross block (X) Working capital cycle (days of sales) Book value per share FCF per share (Rs) (22.9) Cash EPS (Rs) Source: Company, Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 13

14 Metals Tata Steel Exhibit 6: Tata Steel (standalone), Profit model, balance sheet and cash flow model, March fiscal year-ends, E (Rs mn) E 2012E 2013E Profit model (Rs mn) Net sales 196, , , , , ,151 EBITDA 80,138 91,334 89, , , ,544 Other income 2,428 3,083 8,538 13,081 6,244 6,499 Interest (7,865) (11,527) (15,084) (15,554) (14,952) (12,424) Depreciation (8,346) (9,734) (10,832) (11,934) (14,045) (18,153) Profit before tax 66,355 73,156 72,143 96,191 89, ,467 Extraordinaries 4,309 20,700 Taxes (23,793) (21,139) (21,675) (34,833) (26,895) (30,440) Profit after tax 46,870 52,017 50,468 82,057 62,756 71,027 Fully diluted EPS (Rs) Balance sheet (Rs mn) Equity 218, , , , , ,888 Deferred tax liability 6,818 5,857 8,677 9,612 10,508 11,523 Total Borrowings 234, , , , , ,392 Current liabilities 78, ,077 99,568 87,904 90, ,043 Total liabilities 538, , , , , ,846 Net fixed assets 82, , , , , ,503 Capital work in progress 43,675 34,877 38,436 93,436 93,436 23,436 Investments 41, , , , , ,097 Cash 4,650 15,906 32,341 28,096 10,285 34,432 Other current assets 364,974 86,945 90, , , ,380 Miscellaneous expenditure 1,551 1,051 Total assets 538, , , , , ,846 Free cash flow (Rs mn) Operating cash flow excl. working capita 60,778 66,599 71,874 94,926 77,697 90,194 Working capital changes 1,764 7,373 11,818 (3,112) (949) 1,522 Capital expenditure (23,951) (27,711) (20,237) (70,000) (56,000) (29,010) Free cash flow 38,591 46,261 63,455 21,814 20,748 62,706 Ratios EBITDA margin (%) EBT margin (%) Debt/equity (X) Net debt/equity (X) Net debt/ebitda (X) RoAE (%) RoACE (%) Source: Company, Kotak Institutional Equities estimates 14 KOTAK INSTITUTIONAL EQUITIES RESEARCH

15 Tata Steel Metals Exhibit 7: Tata Steel (consolidated), Profit model, balance sheet and cash flow model, March fiscal year-ends, E (Rs mn) E 2012E 2013E Profit model (Rs mn) Net sales 1,315,336 1,473,293 1,023,931 1,149,759 1,155,111 1,198,700 EBITDA 177, ,277 80, , , ,753 Other income 4,759 2,657 11,859 14,169 7,757 8,168 Interest (40,854) (32,902) (30,221) (33,989) (35,155) (35,513) Depreciation (41,370) (42,654) (44,917) (45,437) (47,015) (51,009) Profit before tax 100, ,378 17,147 90,950 90, ,398 Extraordinaries 63,351 (40,945) (16,837) 20,700 Taxes (40,493) (18,940) (21,518) (34,388) (27,732) (32,452) Profit after tax 123,218 48,492 (21,208) 77,262 63,192 73,947 Minority interest (1,399) 409 (152) (525) (604) (664) Share in profit/(loss) of associates 1, ,269 1,205 1,326 1,326 Reported net income 123,500 49,509 (20,092) 77,942 63,914 74,608 Adjusted net income 110,441 61,750 (3,255) 63,411 63,914 74,608 Fully diluted EPS (Rs) (3.6) Balance sheet (Rs mn) Equity 287, , , , , ,053 Deferred tax liability 24,545 17,094 16,541 17,658 18,112 18,644 Total Borrowings 590, , , , , ,004 Current liabilities 339, , , , , ,767 Minority interest 8,327 8,949 8,841 9,366 9,969 10,634 Total liabilities 1,250,022 1,210,583 1,096,232 1,191,282 1,219,678 1,267,102 Net fixed assets 331, , , , , ,321 Capital work in progress 88,476 88,880 92, , ,206 59,206 Goodwill 180, , , , , ,418 Investments 33,675 64,111 54,178 55,383 56,709 58,034 Cash 42,319 61,484 67,878 65,104 48,935 79,234 Other current assets 572, , , , , ,888 Miscellaneous expenditure 1,556 1,055 Total assets 1,250,022 1,210,583 1,096,232 1,191,282 1,219,678 1,267,102 Free cash flow (Rs mn) Operating cash flow excl. working capita 117, ,077 25, , , ,320 Working capital changes (22,227) 2,254 46,465 (37,088) 339 (3,211) Capital expenditure (79,967) (83,608) (69,472) (92,000) (88,610) (53,420) Free cash flow 15,578 34,723 2,577 (20,903) 14,633 60,690 Ratios EBITDA margin (%) EBIT margin (%) Debt/equity (X) Net debt/equity (X) Net debt/ebitda (X) RoAE (%) (1.5) RoACE (%) (34.8) Source: Company, Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 15

16 Li Reliance Communications (RCOM) Telecom Another weak quarter, on expected lines. SELL. RCOM s struggle to grow revenues (across wireless and non-wireless business lines) continued in 2QFY11 with the company reporting flat qoq overall revenues (down 10% yoy), 3% below estimates. Aggressive cost control aided the company meet our EBITDA estimate and tax writeback led to better-than-expected PAT. A stretched balance sheet (net debt to TTM EBITDA now at 4.3X) in addition to revenue woes keep us negative on the stock. SELL. SELL NOVEMBER 12, 2010 RESULT Coverage view: Cautious Price (Rs): 176 Target price (Rs): 125 BSE-30: 20,589 Company data and valuation summary Reliance Communications Stock data Forecasts/Valuations E 2012E 52-week range (Rs) (high,low) EPS (Rs) Market Cap. (Rs bn) EPS growth (%) (30.2) (72.8) 56.1 Shareholding pattern (%) P/E (X) Promoters 67.7 Sales (Rs bn) FIIs 9.0 Net profits (Rs bn) MFs 1.0 EBITDA (Rs bn) Price performance (%) 1M 3M 12M EV/EBITDA (X) Absolute (5.6) ROE (%) Rel. to BSE-30 (6.8) (10.8) (17.4) Div. Yield (%) Weak 2QFY11; revenue growth challenge continues RCOM reported revenues, EBITDA, and net income of Rs51.2 bn (3% below estimate, +0.2% qoq, -10% yoy), Rs16.6 bn (in line with estimate, +2% qoq, -18% yoy), and Rs4.5 bn (37% above estimate, -40% yoy) for 2QFY11. Even as the company managed to meet our EBITDA estimate despite revenue miss through aggressive cost controls (overall costs declined in absolute terms), tax write-back of Rs661 mn led to the reported net income outperformance. Revenue performance disappointed across the board wireless segment revenues were flat qoq at Rs41.6 bn (+3.8% yoy). Minutes growth trend (+0.2% qoq to 94.6 bn) was in line with Bharti, Idea, and Vodafone reflecting weak seasonality and some loss of minutes market share. We do note that RCOM s minutes trend is not 100% a reflection of industry trends on account of additional pressure from declining PCO base and struggling CDMA segment. The company missed revenue estimates in the LD and BB segments as well. Balance sheet remains stretched Exhibit 2 depicts the end-sep 2010 balance sheet of RCOM net debt to ttm EBITDA now stands at 4.3X, while net debt to annualized Sep quarter EBITDA is at 4.4X, stretched in our view. The company has announced steps and made attempts to reduce balance sheet leverage through asset sale as well as fresh equity infusion at the parent company level, without success so far. We also note that fresh capital infusion into the company could turn out to be only a temporary relief unless the company improves on execution and delivers better turnover of its massive asset base. Reiterate SELL; will review estimates and target price post the earnings call We shall review our EPS estimates post the company s earnings call. We continue to find RCOM in a very challenging situation battle for India s wireless business share continues to be fierce and the company is saddled with a stretched balance sheet and network disadvantage (lower # of cell sites, and a 1,800 MHz spectrum in most circles) versus leading incumbents. Valuations do not yet lend comfort in the wake of structural risks facing the industry and the company s weak balance sheet. We maintain our SELL recommendation on the stock. For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.

17 Reliance Communications Telecom Exhibit 1: RCOM - 2QFY11 performance, March fiscal year-ends (Rs mn) (Rs mn) 2QFY10 1QFY11 2QFY11 qoq (%) yoy (%) 2QFY11E Deviation %) Consolidated results Revenues 57,026 51,092 51, (10.3) 52,833 (3.1) Operating costs (36,827) (34,772) (34,580) (0.6) (6.1) (36,191) (4.5) EBITDA 20,198 16,320 16, (17.8) 16,642 (0.3) EBITDA margin (%) Depreciation and Amortization (7,144) (9,648) (9,550) (1.0) 33.7 (9,798) (2.5) EBIT 13,055 6,672 7, (46.0) 6, EBIT margin (%) Net finance (cost)/income (6,551) (4,396) (2,800) (36.3) (57.3) (3,089) (9.4) PBT 6,503 2,276 4, (34.6) 3, Tax provision 1, (8.2) (62.1) (281) (334.8) PAT before minority interest 8,243 2,995 4, (40.4) 3, Minority interest (811) (486) (450) (7.4) (44.5) (223) Extraoridnaries (29) Reported net income 7,403 2,509 4, (39.8) 3, EPS (Rs/share) Segmental performance Wireless Revenues 40,100 41,528 41, ,878 (3.0) EBITDA 13,132 11,989 12, (7.9) 12,220 (1.0) OPM (%) ARPU (Rs/sub/month) (6.5) (24.5) 125 (2.9) MOU (min/sub/month) (6.3) (18.7) 286 (3.4) RPM (Rs/min) (0.2) (7.1) EPM (Rs/min) (17.7) Total minutes (bn) (3.6) Long distance segment Revenues 22,643 18,137 18, (18.8) 18,434 (0.2) EBITDA 5,227 3,317 3, (35.1) 3, OPM (%) Broadband segment Revenues 7,700 6,763 6,620 (2.1) (14.0) 6,898 (4.0) EBITDA 3,199 2,477 2, (22.5) 2,587 (4.1) OPM (%) Others Revenues 2,760 3,348 3, , EBITDA (1,244) (1,350) (1,340) (0.7) 7.7 (1,338) 0.1 OPM (%) (45.1) (40.3) (33.7) (35.0) Source: Company, Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 17

18 Telecom Reliance Communications Exhibit 2: RCOM's balance sheet for the most recent quarters (Rs mn) Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Equity Share capital 10,320 10,320 10,320 10,320 10,320 10,320 10,320 10,320 10,320 10,320 Reserves and surprlus 253, , , , , , , , , ,902 Equity 264, , , , , , , , , ,222 Minority interest 18,707 11,621 11,014 8,228 7,001 8,688 9,212 7,472 7,360 7,578 Debt 207, , , , , , , , , ,044 Current liabilities 238, , , , , , , , , ,725 Provisions 44,011 40,680 36,954 39,162 39,312 37,685 39,680 39,121 39,423 39,310 Total capital 772, , , , , , , , , ,879 Assets Cash 77,654 88,478 80, ,577 93,001 43,873 60,639 48,585 47,349 86,148 Inventories 4,330 4,408 5,111 5,427 5,390 5,494 5,210 5,446 5,441 5,414 Debtors 26,617 33,803 47,441 54,785 53,797 45,117 37,703 33,380 32,438 32,538 Other current assets 26,121 29,346 32,167 16,912 21,679 20,575 20,691 22,455 20,487 19,321 Loans and advances 56,118 53,368 64,911 59,859 71,071 71,471 61,796 54,286 53,871 57,691 Gross block 503, , , , , , , , , ,503 Less: Depreciation 102, , , , , , , , , ,864 Depreciation for the quarter 8,638 9,180 10,069 11,426 11,144 7,144 8,331 10,647 9,648 9,550 Net block 401, , , , , , , , , ,639 Capital work in progress 178, , , , , , , , , ,938 Net fixed assets incl CWIP 580, , , , , , , , , ,577 Goodwill Investments 1,533 1,614 2,818 2,857 1,298 1,365 1,327 1,199 1,229 1,190 Total assets 772, , , , , , , , , ,879 Net debt 128, , , , , , , , , ,706 Source: Company, Kotak Institutional Equities 18 KOTAK INSTITUTIONAL EQUITIES RESEARCH

19 Reliance Communications Telecom Exhibit 3: RCOM's condensed financial statements, March year ends, E E 2012E 2013E 2014E 2015E 2016E 2017E Profit model (Rs mn) Revenue 229, , , , , , , , ,000 EBITDA 92,976 78,870 67,679 82,829 99, , , , ,929 EBIT 56,899 41,404 27,689 37,176 50,040 59,938 65,732 70,246 74,483 Net interest income / (expense) 12,049 11,863 (12,357) (12,213) (13,680) (12,855) (10,447) (8,362) (6,542) Tax 518 (4,454) (1,406) (3,742) (5,679) (7,502) (8,896) (12,517) (14,547) Net profit 67,430 47,385 12,810 19,992 29,391 38,226 44,967 47,873 51,826 Fully diluted EPS Balance sheet (Rs mn) Cash 16,829 48,585 67,275 57,548 61,124 58,359 50,471 61,691 77,384 Other current assets 130, , , , , , , , ,096 Fixed assets 727, , , , , , , , ,860 Other long term assets 0 1,919 2,419 2,919 3,419 3,919 1,919 0 Short tem debt (33,110) 29,754 61,348 61,348 41,348 (1,199) (1,199) (1,199) (1,199) Other current liabilities 200, , , , , , , , ,222 Long term debt 329, , , , , , , , ,101 Other long term liabilities ,081 Shareholders funds (incl. minorities) 429, , , , , , , , ,135 Net (debt)/ cash (374,794) (198,888) (294,347) (304,075) (280,499) (240,716) (190,630) (154,411) (118,717) Free cash flow (Rs mn) EBITDA 92,976 78,870 67,679 82,829 99, , , , ,929 Change in working capital (38,059) 40,097 (31,601) (10,366) (469) 440 (394) (749) (863) Cash tax (paid) (328) (5,454) (2,606) (4,242) (6,179) (8,002) (9,396) (10,517) (11,547) Cash interest (paid) (10,711) (21,284) (22,333) (20,958) (22,240) (21,440) (18,712) (16,727) (15,715) Capex on PP&E and intangibles (194,168) (41,621) (116,575) (65,735) (55,402) (52,165) (50,885) (50,470) (50,965) Miscallenous (6,981) (376) (0) Free cash flow (157,271) 50,232 (105,435) (18,472) 15,015 31,199 41,821 50,258 56,838 Ratios (%) Sales growth 20.3 (3.0) (3.8) EBITDA growth 13.4 (15.2) (14.2) EPS growth 19.4 (30.2) (72.8) FCF growth NM NM NM NM NM EBITDA margin Net margin FCF margin (68.6) 22.6 (49.3) (7.3) RoAE ROAE (excl. cash and int. income RoACE ROACE (excl. cash and int. incom Net debt/ebitda (X) Net debt/equity (X) Total debt/capital (X) Tax rate (%) Source: Company, Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 19