Economy News. Corporate News JANUARY 25, 2017

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1 JANUARY 25, 2017 Economy News Cabinet approved a two-month interest waiver on short-term crop loans taken from cooperative banks. The decision was announced by Prime Minister Narendra Modi on New Year's Eve as a relief measure to aid winter planting after demonetisation of high value banknotes in November led to a cash crunch in rural areas. (Mint) The Central Board of Direct Taxes (CBDT) issued the much-awaited "guiding principles" for determination of a Place of Effective Management (PoEM) of a company, scotching speculation that the Budget may see its removal from the statute book. (BL) Just days ahead of the Union Budget, a high-powered panel headed by Andhra Pradesh Chief Minister N Chandrababu Naidu recommended imposing tax on cash transactions of at least Rs 50,000 through banks to discourage the excessive use of cash and promote digital payments. (BS) Hoping to give a boost to the agriculture sector after its decision to demonetise high-value currency, the government allowed the National Bank for Agriculture and Rural Development to raise Rs. 200 bn for shortterm crop loans to farmers at lower rates. The funds will be raised by Nabard at the prevailing market rate and will be used for on-lending to cooperative banks at an interest of 4.5 per cent. (BL) Corporate News In a BSE filing, Lupin said, "It has launched its Norgestimate and Ethinyl Estradiol tablets USP, 0.25 mg/0.035 mg having received approval from the United States Food and Drug Administration (FDA) earlier to market a generic version of Janssen Pharmaceuticals Inc's Ortho-Cyclen 28 tablets.'' (BL) Amid stiff competition from Reliance Jio, telecom major Bharti Airtel has received its board approval to raise up to Rs 100 bn through nonconvertible debentures.(moneycontrol) Inox Leisure Ltd has emerged as the highest bidder for SRS Cinemas, the multiplex business of SRS Ltd, two people aware of the development said on condition of anonymity. Company has offered close to Rs2.25 bn for the theatre chain, one of the two people cited above said. (Mint) Global chemical major BASF has entered the Indian rice market by launching three products, to help manage major rice diseases, weeds, and pests. (BL) Hinduja Leyland Finance Ltd (HLF), the commercial vehicle financing unit of Ashok Leyland Ltd, has raised Rs 2.5 bn(about $37 million) from existing investors-hinduja group entities and private equity investor Everstone Capital-through a rights issue, two people aware of the development said.(mint) Sajjan Jindal-owned JSW Steel is close to finalising a deal with bankers to take over Bhushan Steel's debt of Rs bn and acquire majority stake in the company. (BL) Idea Cellular moved Delhi High Court against the telecom regulator's recommendation to impose a penalty of Rs 9.5 bn on it for not providing adequate interconnection to Reliance Jio Infocomm. (ET) Sluggish sales recorded in its Prestige Smart Kitchen stores over the last three years prompted TTK Prestige Ltd to partner with SME lending platform Innoviti Payment Solutions Ltd, a start-up backed by marquee investors including Titan Company, Catamaran Ventures and New India Investment Corporation, Canada. (BL) Source: ET = Economic Times, BS = Business Standard, FE = Financial Express, BL = Business Line, ToI: Times of India, BSE = Bombay Stock Exchange Equity % Chg 24 Jan 17 1 Day 1 Mth 3 Mths Indian Indices SENSEX Index 27, (2.5) NIFTY Index 8, (2.5) BANKEX Index 21, (4.6) SPBSITIP Index 9,877 (0.2) (0.2) (2.9) BSETCG INDEX 14, (2.2) BSEOIL INDEX 12, CNXMcap Index 15, (4.1) SPBSSIP Index 12, (4.4) World Indices Dow Jones 19, (0.1) 9.6 Nasdaq 5, FTSE 7,150 (0.0) NIKKEI 18,788 (0.5) (2.2) 9.4 HANGSENG 22, (2.5) Value traded (Rs cr) 24 Jan 17 % Chg - Day Cash BSE 3, Cash NSE 19, Derivatives 565, Net inflows (Rs cr) 23 Jan 17 % Chg MTD YTD FII (262) (887) (2,805) 15,978 Mutual Fund 58 (90) 3,284 50,527 FII open interest (Rs cr) 23 Jan 17 % Chg FII Index Futures 21, FII Index Options 73,482 (1.4) FII Stock Futures 73, FII Stock Options 7,367 (2.0) Advances / Declines (BSE) 24 Jan 17 A B T Total % total Advances Declines Unchanged Commodity % Chg 24 Jan 17 1 Day 1 Mth 3 Mths Crude (US$/BBL) 53.0 (0.3) (0.0) 6.1 Gold (US$/OZ) 1,212.7 (0.2) 6.6 (5.1) Silver (US$/OZ) (4.0) Debt / forex market 24 Jan 17 1 Day 1 Mth 3 Mths 10 yr G-Sec yield % Re/US$ Sensex Jan-16 Apr-16 Jul-16 Oct-16 Jan-17

2 RESULT UPDATE Dipen Shah Summary table (Rs mn) FY16 * FY17E FY18E Sales 311, , ,069 Growth (%) EBITDA 68, , ,128 EBITDA margin (%) PBT 71, , ,498 Net profit 56,670 83,214 93,662 EPS (Rs) Growth (%) CEPS (Rs) BV (Rs/share) Dividend / share (Rs) ROE (%) ROCE (%) Net cash (debt) 108, , ,537 NW Capital (Days) P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) Source: Company, Kotak Securities - Private Client Research; * FY16 is a 9 month period HCL TECHNOLOGIES LTD (HCLT) PRICE: RS.849 RECOMMENDATION: REDUCE TARGET PRICE: RS.873 FY18E P/E: 12.8X HCLT's results were marginally ahead of expectations on both, revenues (3% CC growth) and profitability (30bps rise in margins). Excluding the IPR sharing deal, revenue growth was lower at about 2%, we believe. HCLT is making efforts to increase its relatively lower presence in the Digital / Platforms & Products space through the IBP IPR deal. While this is expected to reap dividends, we will watch out for the same. sustainability of the same. We maintain that, the competition in IMS market is set to intensify with several players now focusing more on this segment. We also believe that, HCLT continues to face profitability challenges, in a bid to sustain high growth (SG&A spends at about 11.7% and 84.6% employee utilization rates (incl trainees). HCLT has maintained its guidance of a 12%-14% CC revenue growth guidance (ex-acquisitions; includes only Volvo Deal). Organic CC growth guidance is at about 10%, we estimate. EBIT margin guidance stands at 19.5% %. We tweak our EPS estimates for FY17 and FY18 to Rs.58.9 (Rs.58.4, earlier) and Rs.66.3 (Rs.65.6). Our FY18-based PT stands revised to Rs.873 (Rs.863, earlier), based on target valuations of about 13x FY18 earnings. With limited upsides from current levels, we maintain REDUCE and will wait for better prices to turn buyers in the stock. 3QFY17 - marginally better-than-expected (Rs mn) 3QFY17 2QFY17 QoQ (%) 3QFY16* YoY (%) Revenues Expenditure Operating Profit Depreciation Gross Profit Interest Other Income PBT Tax PAT Adj. PAT Shares (mns) EPS (Rs) OPM (%) GPM (%) NPM (%) Source: Company FY17 guidance maintained - CC revenue growth of 12% - 14%, EBIT margins at 19.5% % HCLT, has maintained its revenue and margin guidance for FY17. The company expects CC revenue growth of about 13% (midpoint of 12% and 14%) for FY17. This excludes acquisitions announced after September 2016 viz. IPR deal (one more signed in January 2017; total 3 deals), Butler and Geometric. These are expected to bring in 0.6% - 1% of revenues in FY17. 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 IP sharing deals, which HCLT entered into in FY17, is expected to yield about $45mn - $50mn in the first year of operation post which, the annualized revenue potential is about $160mn, according to the management. The Butler acquisition will likely add about $24mn in 4QFY17. We have assumed Geometric acquisition to add about $35mn in 4Q. Thus, the 13% guidance likely includes only the Volvo business acquisition. We believe that, the consolidation of Volvo revenues (WEF April 2016) will add 2.75% to revenues in FY17 (about $160mn). Thus, on an organic basis HCLT is guiding for a growth of about 10% in CC terms for FY17. While the guidance is muted, it is marginally higher v/s the expected growth for Infosys in FY17. To that extent, growth rates are comparable for these companies. Wipro is expected to grow at a much slower pace in FY17. NASSCOM has already reduced the FY17 growth guidance to 8% - 10%. After discontinuing margin guidance in 4QFY16, citing consolidation of the Volvo business and investments required in the business, HCLT had guided for an EBIT margin range of 19.5% % for FY17. The company has maintained the margin guidance of 19.5% % for FY17, despite the acquisitions, which may have a slight impact on the profitability. The company achieved EBIT margins of 20.4% in 3QFY17. Going ahead, 4Q will see remaining salary hikes, which may have an impact of about 10bps in 4Q. The impact of these is expected to be offset by steady state margins in past deals and other operational efficiencies. We have factored in EBIT margins in of around 20.4% in FY17 and in FY18. We have assumed the Rupee to average 67.3/USD in FY17 and 66.5 / USD in FY18 v/s 67.5/USD in FY16. HCLT and TCS are operating at high utilization levels whereas Infosys and Wipro have more space to use this lever to improve margins. HCLT's SG&A expenses are also lower at 11.7% of revenues, providing little scope for further moderation. IP sharing deal - Efforts to get into Digital / Products & Platforms HCLT had entered into an IP sharing deal in 1Q with a global major wherein, it has acquired rights to use the IP of that company. HCLT will also be able to further develop the IPs, which will be the property of HCLT. It has, subsequently, entered into two more deals with IBM, taking up rights for more products. HCLT is looking at increasing its presence in the products / platforms space through these deals. The initial deal was for increasing presence in the legacy services and bringing in more automation in the same (Mode 1 : Application services, Business services, IMS and Engineering services). The latter two deals are for products which will enhance presence in the Mode 2 types of services viz. Digital, IoT, Cloud and Security and Mode 3 services which is platforms and products. The IPs can be used in areas like work-load automation, which are becoming necessary in areas like hybrid cloud development. HCLT will also develop various other services around the IPs. Thus, HCLT has done away with the gestation period for developing these IPs. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 3

4 However, these IPs are mature and have been implemented across major global corporations. Thus, HCLT will have to further develop these mature IPs in order to earn significant revenues from the same. The deals are worth $550mn. HCLT has already paid about 60% of the same and the balance is to be paid over the next fiscal. This amount of is expected to be amortised over a minimum period of 15 years. It expects revenues of about $45mn - 50mn from these deals in the first year. However, this is expected to increase to an annual run-rate of $160mn, going ahead. The deal has been EBIT margin accretive in 3Q. However, we believe that, these will be dilutive at the net levels. CC growth of 3% was marginally higher than estimates Revenues grew by 3% in CC terms (2.8% in 2QFY17, 3.5% in 1Q. This was higher than our expectations of 2.2% growth. Revenue growth was also higher than the 2% growth reported by TCS and 0.3% reported by Infosys. Excluding revenues from the IBM deal, growth was about 2%, we believe. Except in 2QFY15, the revenue growth rates have been relatively lower for HCLT, despite winning several large deals over the past few quarters. Engineering services grew by 7% QoQ; Applications / IMS revenues up by about 2% Engineering services reported a 7% QoQ growth in 3Q. While this is high, we believe that, growth rates were helped by the accrual of revenues from the IPR deal. HCLT is favourably placed in the Engineering vertical. Its focus on Manufacturing, Transport, automotive, aviation, etc gives it a head-start over peers, we believe. HCLT is seeing several M&A opportunities in this business and has been beefing up its capabilities through this route. The acquisitions of Butler / Geometric are cases in point. However, we also note that, this is also a project-based business, which may take time to become annuity based through larger and longer term projects. To that extent, we expect volatility in this business to also continue and scale-up may take time. Application services revenues grew by 2% QoQ. It had reported CC growth rates of 1.9% QoQ in 2Q and 0.5% in 3QFY16 (FY16 was a 9-month fiscal). The business had grown at a rate of sub-2% QoQ for several quarters in the past three years. HCLT has lagged behind peers in this service line and will have to strengthen its offerings significantly to compete with larger peers. HCLT is witnessing stress in the new ERP implementation business with most ERP OEMs increasingly focusing on Cloud. On the other hand, Digital is witnessing significant traction with organisations across manufacturing, BFSI, Retail, etc looking to digitize parts of their businesses. HCLT is making investments in Digital and has seen traction in its integrated offerings like Next-Gen ITO, BEYONDigital and IoT WoRKS. These offerings are in emerging areas like Internet of Things, cloud, automation and artificial intelligence. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 4

5 Digital revenues currently form 20% of HCLT's Applications business. On an overall basis, the contribution to revenues is much lower, we believe. However, we believe that, HCLT needs to invest further in Digital, to support the growth in Applications services. IMS, which has been the growth engine for HCLT for the past several quarters, reported a 2.1% growth in 3Q (4.4% growth in 2Q and 10% organic growth in 1Q) While the annual growth in IMS over the past two years is encouraging and has been led by the leadership position of HCLT in the re-bid market, the dependence on this business is high. IMS contributed about 40% of HCLT's 3QFY17 revenues. We have been concerned about this over the past few quarters. The IMS re-bid market is now facing higher degree of competition, with other large peers also increasing focus on the same. Several of HCLT's contracts may come up for re-bid and face increased participation from peers. To that extent, we believe that, it is important for HCLT to start improving the growth of the other businesses. Business services reported 2.9% growth. Services - Constant Currency Growth QoQ (%) 2QFY16 3QFY16 1QFY17 2QFY17 3QFY17 Application Services Infrastructure Services Business Services 8.00 (4.10) (15.90) Engg & R&D Services (1.50) Source : Company EBIT margins rose by 30bps QoQ; but may face headwinds EBIT margins rose by 30bps QoQ, and came above our estimates. Margins rose despite the impact of about 70bps due to salary increments. They rose on the back of increased deployment of automation tools across projects, increase in FP projects and other cost optimization initiatives. HCLT is increasingly focusing on automation and the DryICE platform has now been implemented in over 200 projects. Once again, SG&A expenses have surprisingly fallen QoQ by 10bps, as a percentage of revenues. The management has indicated that, while S&M expenses are increasing, G&A expenses are being rationalized, partly due to converting leased property into owned. However, these are expected to stabilize at around 12%, the management said. We have been concerned over the past few quarters that, S&M expenses will not be a margin lever and even G&A expenses may increase in line with the additional spends which the company has made and will need to make towards in Digital services and the applications portfolio. We maintain that, SG&A expenses, which are 11.7% of revenues, may not be a big driver of margins, going ahead. Moreover, the employee utilization levels (including trainees) are at 84.6%. This is a relatively high level and the company may find it difficult to increase this significantly from the current levels, especially in the backdrop of the 18% attrition rate in IT services. Thus, the company will find it difficult to squeeze further margin benefits out of the same, we believe. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 5

6 Robust growth in Europe business Geographically, growth was led by Europe, with revenues growing by 6.8% QoQ in CC terms after a de-growth of 2% seen in previous quarter. Revenues from US grew by 1.7% whereas, ROW revenues fell marginally QoQ, in CC terms. The management has said that, it has not felt any impact of Brexit and the Deutsche Bank account is also scaling up as per plan. However, there is uncertainty on these issues and any adverse fallout may have an impact on HCLT's revenues. We note that, the revenue growth from US and Europe has been very volatile across quarters and we need to see some stability in the same in future quarters. Geography - Constant Currency Growth QoQ (%) 2QFY16 3QFY16 1QFY17 2QFY17 3QFY17 USA Europe (2.4) (2.4) 16.9 (2.1) 6.8 ROW (3.4) (0.5) Source: Company Financial services, Manufacturing grow at a solid pace; Retail / Life Sciences / Telecom drag Financial services continued to report strong growth and grew by 4.5% QoQ in 3Q. Manufacturing also reported a strong 8.3% growth, likely due to the Volvo business. However, retail / CPG, telecom and life sciences reported de-growth in CC terms. Verticals - Constant Currency Growth QoQ (%) 2QFY16 3QFY16 1QFY17 2QFY17 3QFY17 Financial Services 1.9 (1.3) (0.1) Manufacturing (1.3) (0.9) 8.3 Retail / CPG 10.3 (1.2) (6.9) Tele/Media/publis/ Entertainment (3.3) Life S / Healthcare (1.0) 8.2 (2.9) Public Services (3.7) 5.6 Source: Company HCLT won 9 transformational deals during the quarter. The order booking for HCLT has consistently remained above the $1bn mark for the past several quarters. However, the revenue growth has not reflected the full impact of these large deals, and we need to see traction in revenues in the future quarters. Future prospects HCLT has changed the fiscal year-ending from June to March WEF FY17, in line with the statutory requirements. Thus, FY16 was 9-month fiscal. Revenues are expected to rise by 11.7% in FY17 and 13.6% in FY18, in USD terms. The Volvo financials have been consolidated WEF April 2016 and the IP deal revenues from 3QFY17. The Butler acquisition and Geometric acquisition will be consolidated WEF 4QFY17. Excluding these, we expect about 10.2% growth in FY17. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 6

7 FY18 will be the first full year post these acquisitions. Excluding these, we expect growth to be 11.5% in FY18. We expect the rupee to average about 67.3 / USD in FY17 and 66.5 / USD in FY18. Margins are expected to be marginally lower in FY17 / FY18, as compared to FY16. The consolidation of acquisitions and salary increments are expected to be offset by higher offshore proportion, cost optimization initiatives and improved profitability in the current low-margin projects. We expect the company to report an EPS of Rs.58.9 in FY17 (Rs.58.4, earlier) and Rs.66.3 in FY18 (Rs.65.6 earlier). We maintain REDUCE on HCL Technolgies Ltd with a price target of Rs.873 Valuations HCLT's 9mFY17 results have beaten estimates. The company has given a guidance for FY17, which reflects the revenue visibility it has for FY17. However, the organic growth will likely be at about 10%, which likely reflects the headwinds faced by the company, especially in the applications business. HCLT is making efforts to increase its relatively lower presence in the Digital / Products & Platforms spaces through the IBM IPR deal. We will watch out for the success and sustainability of the same. On the other hand, HCLT's margins are lower as compared to most of the larger industry peers. We believe that, SG&A leverage is likely to have a muted impact, going ahead. Utilization levels including trainees at about 84.6% also provide little scope of improvement. Thus, we accord a suitable valuations discount as compared to Infosys and TCS. We maintain REDUCE with a FY18-based PT of Rs.873 (Rs.863, earlier). At our TP, FY18 estimates will be discounted by about 13x. We will watch out for the sustainability and improvement of growth rates, going ahead. Concerns A delayed recovery in major user economies may impact our projections. A sharp acceleration in the rupee from our assumed levels may impact our earnings estimates for the company. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 7

8 RESULT UPDATE Amit Agarwal ASIAN PAINTS LTD (APL) PRICE: RS.970 RECOMMENDATION: ACCUMULATE TARGET PRICE: RS.1050 FY18E P/E: 40.3X Defies Demonetisation 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 39.4 bn (+2.6% YoY) despite 52 days of demonetisation in the 92 days of Q3FY17. Higher raw material prices (+1.5% QoQ) and weak performance of the home improvement segment eroded margins by 70 bps YoY to 17.8%, but is still healthy for the company under the current circumstance. Fiji, Nepal and Middle East contributed to good performance of international operations. We interpret the numbers as strong for the company, with the company reporting PAT of Rs 4.89 bn, well above consensus estimate of Rs 4.7 bn. We maintain our estimates and value the stock at 44x FY18E EPS (premium to medium sized paint companies) and Recommend ACCUMULATE (from SELL) with a TP of Rs 1050 (from 1075) for the stock. Summary table (Rs mn) FY16 FY17E FY18E Sales 155, , ,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) Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Net Sales 38,356 36,698 36,374 37,635 39,370 QoQ (%) YoY (%) Raw Material 21,719 20,050 19,190 20,875 22,045 Employee 2,417 2,683 2,775 2,794 2,643 Other expenses 6,364 6,987 6,206 6,834 6,918 Total operating expenses 30,500 29,720 28,171 30,503 31,606 EBIDTA 7,856 6,978 8,203 7,132 7,764 EBIDTA margin Depreciation EBIT 7,162 6,257 7,348 6,289 6,909 Interest Other income Exceptional PBT 6,982 6,575 8,003 7,020 7,231 Taxes 2,274 2,279 2,603 2,207 2,465 PAT 4,708 4,296 5,400 4,813 4,766 Minority /Associate Reported PAT 4,822 4,345 5,525 4,951 4,893 Equity EPS (Rs) 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 8

9 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 39.4 bn (+2.6% YoY). Management indicated that there was no change in product mix in the quarter North and East India got more impacted to West and Southern Indian markets due to demonetisation Management also indicated that the raw material prices have firmed up in the last 2 months with the company experiencing 1.5% sequential increase in raw material prices Increasing raw material prices in the quarter and weak performance of the home improvement segment eroded margins by 70 bps YoY to 17.8% Fiji, Nepal and Middle East contributed to good performance of international operations There was an exceptional loss Rs 103 mn due to devaluation of currency in the key international market of Egypt Home improvement segment continue to be weak for Asian Paints Consequently company reported PAT of Rs 4.89 bn which was above our expectation of Rs 4.4 bn and consensus estimate of Rs 4.7 bn We interpret the numbers as strong for the company despite 52 days of demonetisation in the 92 days of the quarter Sales was driven by all the segments Management indicated the sales performance of Q3FY17 could be attributed to: Low single digit volume growth in the decorative segment Improved demand in the industrial and auto OEM segment Two wheeler segment has not done well in the quarter primarily due to demonetisation Healthy performance of the international business aided by contribution from the units in Fiji, Nepal and Middle East. Growth has been slower than expected in the home improvement segment Unfavourable Raw material situation OPECs decision to limit production, backed by Russia, Kazakhstan and a few other countries has led to increase in Brent crude prices by more than 15% in the last 2 months and increase in price of key raw material - Titanium Dioxide (TIO2) by 14% (with a lag). We expect crude to remain firm in near term which is estimated to put pressure on margins of paints companies including APL. Management of APL indicated that, in case of sustained elevated prices of crude and TIO2, companies would be forced to pass on the increase in raw material to customers, which would protect the margins of paint companies. It is important to see whether crude touches $60 per barrel and sustain at that level with US companies including Shale expected to increase crude production at higher prices for crude. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 9

10 Brent crude (US$/barrel) TiO2 (USD/MT) Source: Bloomberg Source: Bloomberg Management of APL indicated that the company had experienced 1.5% QoQ increase in raw material prices which is estimated to aggravate in Q4FY17. With strong volume growth expected on the back of low per-capita consumption of paints in the country, strong urbanization trends, shortening re-painting cycles, up-trading and with paints forming just 15 to 20% of the overall painting cost, we expect APL to be able to pass on any increase in raw material cost to customers on real time basis and maintain margins. Current capacities and capex APL is setting up paint manufacturing facilities in Mysore and Vizag. APL is currently doing civil works in Mysore and ground leveling at Vizag. The capacities at both these manufacturing facilities will be built in a phased manner by APL (over the next 5 to 6 years) starting FY17, to cater to the future demand. Plus, APL is also upgrading and expanding its capacity at Ankleshwar Gujarat involving an investment of Rs 6.5 bn over the next 4 years.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 Vizag Mysore Ankleshwar Capacity (lakh Kilo Litre) ,000 Investment (Rs bn) Estimated over FY17 to FY22 Source: Company We recommend ACCUMULATE on Asian Paints Ltd with a price target of Rs.1050 Valuation Current quarter's performance indicate the market leader is highly immune to external factors. Management also indicated that the volume trends have picked up in December 2016 and January 2017 over November 2017.For APL, we remain confident of 11% overall volume CAGR over FY16 to FY18E with stable margins, earnings CAGR of 12% with ROE of 34% and ROCE of 45%. 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 value the stock at 44x FY18E EPS (premium to medium sized paint companies) and arrive at a TP of Rs 1050 (from Rs 1075) and recommend ACCUMULATE (from SELL). Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 10

11 RESULT UPDATE Teena Virmani KAJARIA CERAMICS LTD PRICE: RS.585 TARGET PRICE: RS.627 RECOMMENDATION: ACCUMULATE FY18E P/E: 28X Summary table (Rs mn) FY16 FY17E FY18E Sales 24,088 24,882 29,758 Growth (%) 10% 3% 20% EBITDA 4,537 4,753 5,981 EBITDA margin (%) PBT 3,577 3,806 5,136 Net profit 2,292 2,459 3,319 EPS(Rs) Growth(%) 31% 7% 35% CEPS(Rs) BVPS(Rs) DPS (Rs) ROE (%) ROCE (%) Net debt(cash) 1, (1,944) NW capital(days) P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) Source: Company, Kotak Securities - Private Client Research Revenues for Q3FY17 were ahead of our estimates and impact of demonetization was much lesser than our expectations. Operating margins were under pressure due to higher operational costs on account of low capacity utilization at its plants. Net profit came ahead than estimates due to better than expected revenues. Lower gas prices has helped in cost reduction and would help in aiding margins going forward. We believe that company would continue to benefit on market share due to its enhanced presence in Tier 2/3/4 cities as well as enhanced dealer network. Most of its dealers have shifted towards other means of transactions such as cheque, credit card and company expects the shift to be much faster going ahead. We revise our estimates to factor in better than expected performance in Q3FY17 and over medium term. We arrive at a revised price target of Rs 627 as against Rs 533 earlier on FY18 estimates. Owing to limited upside from current levels, we now recommend ACCUMULATE rating on the stock (BUY earlier). We would advise investors to look for better entry points to enter into the stock. Consolidated Financial highlights (Rs mn) Q3FY17 Q3FY16 YoY (%) Net Sales % Total Expenditure % (Increase) / Decrease In Stocks Cost of Services & Raw Materials As % of sales Purchase of Finished Goods As % of sales Operating & Manufacturing Expenses As % of sales Electricity, Power & Fuel Cost As % of sales Employee Cost As % of sales EBITDA % EBITDA (%) Depreciation EBIT % Interest EBT(exc other income) % Other Income PBT % Tax Tax (%) 36.0% 35.0% PAT % Minority Interest Consolidated Net Profit % NPM (%) 9.1% 9.6% Equity Capital Face Value (In Rs) Basic EPS before Extraordinary Items % 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 11

12 Revenue ahead of our estimates Revenue growth of the company during the quarter was impacted by demonetization but the impact of demonetization was much less than our expectations. For Q3FY17, consolidated revenues reported a growth of 1.5% YoY. Volumes witnessed a growth of 0.5% YoY but declined by 4.2% QoQ. Average realizations improved by 1% YoY and 0.5% QoQ. Company had witnessed a decline of 5-6% YoY in the month of November post demonetization but month of December witnessed volume gain of 6-7% YoY as more and more dealers started shifting to credit card payments. Revenues from own production improved by 9.5% YoY while revenues from JVs declined by 17.2% YoY. Sales from imports has surprisingly gone up by 26.4% YoY. Sanitaryware and faucets division has reported 23.1% YoY improvement in revenues. Volumes are likely to improve going forward as liquidity improves in the system. Company has mentioned that demand environment is slowly improving and December sales were much better than November itself. Also with focus of the government on low cost housing, sanitation for all should help reviving the demand in medium to long term. With change in the mode of payments, now as many as 60% of its dealers have installed credit card swipe machines and since Dec, nearly only 20% of the transactions are being done in cash as against 80% cash transactions before demonetization. However, with demonetization, cash based players in Morbi have been impacted badly and are forced to shut shops. Organized players are likely to benefit from this shift in the demand which would augur well for revenue growth going forward. Realizations improved from own manufacturing plants on yearly basis but have witnessed a decline for imports and JV plants. Realizations from own production stood at Rs 373 per sq m, up 3.7% YoY; realizations from JV plants stood at Rs 372 per sq m, down 0.2% YoY and realizations from imported products stood at Rs 300 per sq m, down 9.7% YoY. Average realizations for the company on the whole during quarter stood at Rs 380 per sq m, up 1% YoY. Sales and volume break up (mn sq m) Revenues (Rs mn) Own manufacturing JV Imports/outsourced Own manufacturing JV Imports/outsourced Sanitaryware Q3FY17 Q3FY Q3FY17 Q3FY16 Source: Company Source: Company Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 12

13 Capacity utilizations across its JV plants have declined due to lack of demand. Soriso ceramic plant's capacity utilization stood at 40% (77% in Q1FY17) while Jaxx vitrified plant operated at 87% capacity utilization(79% in Q1FY17). Cosa Ceramics has operated at 79% (91% in Q1FY17) capacity utilization in Q3FY17 while Vennar Ceramics operated at full capacity utilization during the quarter. Taurus Tiles expansion which commenced production during June 15, was shut due to lack of demand (60% capacity utilization during Q2FY17). Company has an annual capacity of 68.6 mn sq meter. Post the expansion at Floera Ceramics for polished vitrified tiles for 5.7MSM in AP by FY18, company's capacity is likely to get enhanced to 74.3 MSM. We revise our estimates upwards to factor in better than expected performance in Q3FY17 and expect revenues to grow at a CAGR of 11% between FY (earlier estimated CAGR of 7% between FY16-18) Operating margins impacted by higher operational expenses Operating margins for the quarter stood at 18.4 % vs 18.6% for Q3FY16. Margins were impacted due to higher operational expenses as the operations of its JV plants was impacted owing to lack of demand. We maintain our estimates and expect margins of 19.1% and 20.1% for FY17/18 respectively. Net profit performance stood ahead of our estimates Net profit witnessed a decline of 3.6% YoY but stood ahead of our estimates due to improved performance on revenue front. We revise our estimates and expect net profits to grow at a CAGR of 20% between FY (earlier estimated CAGR of 14% between FY16-18) We recommend ACCUMULATE on Kajaria Ceramics Ltd with a price target of Rs.627 Valuation and recommendation The Stock is currently trading at valuations of 37.8x and 28x P/E on FY17 and FY18 estimates respectively. We believe that company would continue to benefit on market share due to its enhanced presence in Tier 2/3/4 cities as well as enhanced dealer network. Most of its dealers have shifted towards other means of transactions such as cheque, credit card and company expects the shift to be much faster going ahead. We revise our estimates to factor in better than expected performance in Q3FY17 and going forward. We arrive at a revised price target of Rs 627 (30x FY18 estimates) as against Rs 533 based on 28x FY18 estimates earlier. Owing to limited upside from current levels, we now recommend ACCUMULATE rating on the stock (BUY earlier). We would advise investors to look for better entry points to enter into the stock. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 13

14 RESULT UPDATE Teena Virmani Summary table (Rs mn) FY16 FY17E FY18E Sales 16,561 16,202 18,236 Growth (%) EBITDA 2,440 2,414 2,827 EBITDA margin (%) PBT 1,713 1,692 1,979 Net profit 1,292 1,235 1,445 EPS(Rs) Growth(%) CEPS(Rs) BVPS(Rs) DPS (Rs) ROE (%) ROCE (%) Net debt 2,466 1,752 4,750 NW capital (Days) P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) Source: Company, Kotak Securities - Private Client Research GREENPLY INDUSTRIES LTD PRICE: RS.255 RECOMMENDATION: REDUCE TARGET PRICE: RS.259 FY18E P/E: 21.6X Revenues for Q3FY17 were in line with our estimates and the impact of demonetization was felt more on MDF as against plywood. Net profit performance also came in line with our estimates led by better than expected margins despite higher tax rate. Plywood demand was facing challenges due to slowdown in real estate but post demonetization, demand from individual home buyers from tier 2 and tier 3 cities was impacted quite badly. Demand is likely to remain weak for next few quarters. However, plywood volumes have started improving from the lows of December and company expects Q4FY17 to be better than Q3FY17. We also believe that company is likely to be positively benefited with implementation of GST. GST implementation would improve the competitiveness of organized players and would help organized players to gain market share. Along with this, finalization of GST rate is also important for the sector as organized players are already paying 12.5% excise and 12.5% VAT. We revise our estimates downwards to factor in prolonged slowdown in real estate due to demonetization and arrive at a revised price target of Rs 259 based on 22x FY18 estimates. (Rs 299 earlier on 22x FY18 earnings, ACCUMULATE). Based on limited upside from the current levels, we now recommend REDUCE on the stock as the stock price is currently factoring in the positives related to demand/volume/margin improvement. We would look for better entry points to look into the stock. Financial highlights (Rs mn) Q3FY17 Q3FY16 YoY (%) Net Sales Total Expenditure EBITDA EBITDA margins (%) Depreciation EBIT Interest EBT (Exc other income) Other operating income Other Income EBT Tax Tax (%) Profit After Tax Other comprehensive income Net profit Equity Capital Face Value (In Rs) EPS (Rs) 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 Revenues in line with our estimates Revenues for the company reported a decline of 15% YoY led by 10% YoY decline in plywood division and 26% YoY decline in MDF division. Demonetization impact was not much visible in the plywood segment. Plywood division sales stood at 11 msm comprising of 7.7 msm from own manufactured plants while 3.3 msm from outsourcing. Decline of 4-5% in plywood volumes was led by demonetization while 3% decline was led by excise benefits getting over at its Uttarakhand plant. Capacity utilization in the plywood segment stood at 95% during the quarter. Average net realization of plywood however declined by 4% YoY to Rs 233 per sqm. Drop in realization in plywood is on account of excise benefits getting over for its Uttarakhand plant. Though plywood volumes were down in the month of November and December but volumes have started improving from January onwards. Demonetization has impacted MDF sales quite badly during the quarter. MDF volumes were down by 23% YoY. MDF Utilizations stood at 93% during Q3FY17 due to lack of demand. The company's volumes in MDF segment stood at cubic meter vs cubic meter in Q3FY16, depicting a decline of 23% YoY. Average realizations of MDF declined by 4% to Rs per CBM due to higher competition. Also, MDF realization are lower as exports have increased which have lower realization than the domestic market. During the quarter, exports were at 2002 CBM at an average rate of Rs per CBM. Export is the conscious strategy of the company to create a new market of MDF for its upcoming AP plant. Demand environment is still sluggish and overall industry growth may remain stagnant. However, plywood volumes have started improving from the lows of December and company expects Q4FY17 to be better than Q3FY17. We revise our volume estimates downwards to factor in prolonged slowdown in real estate for FY17/FY18 and expect revenues to grow at a CAGR of 5% between FY (earlier CAGR of 10.5% expected between FY16-18) Segment wise performance Plywood volumes Q3FY17 Q3FY16 YoY (%) Production mn sq m Outsourcing mn sq m Total Sales mn sq m Realization per mn sq m Plywood Revenues (Rs mn) 2, MDF Total Sales (CBM) 37, Realization per CBM 25, MDF Revenues (Rs mn) Plywood margins (%) MDF margins (%) Source: Company Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 15

16 Operating margins better than estimates due to jump in plywood margins Operating margins stood at 13.3% for Q3FY17 vs 15.4% for Q3FY16 and the fall in margins was mainly due to sharp fall in MDF margins. During Q3FY17, plywood margins stood at 12.6% vs 9.4% during Q3FY16. Plywood division margins have also improved sequentially. This was due to better product mix, improvement in yield and fall in raw material prices like core veneer. Company plans to improve product mix further in plywood through products like Green Defender, Green Gold Prima and Natural Veneers. MDF division margins stood at 20.3% vs 28.8% for Q3FY16. This fall was mainly due to sharp decline in demand and realizations. We maintain our margin estimates and expect margins of 14.9%/15.5% for FY17/18 respectively. Net profit performance in line with our estimates Net profit performance came in line with our estimates. MDF capacity expansion in AP is going on track to expand its capacity by CBM at a planned capex of Rs Bn to be invested over FY16-FY19. Effective tax rate is likely to move up to 27-28% for FY17/18 as the tax exemption at Uttarakhand plant is over. We revise our estimates downwards and expect net profits to grow at a CAGR of 5.2% between FY (13% estimated earlier) We recommend REDUCE on Greenply Industries Ltd with a price target of Rs.259 Valuation and recommendation At current price of Rs 255, stock is trading at 25.3x and 21.6x P/E and 13.5x and 12.6x EV/EBITDA on FY17 and FY18 estimates respectively. We revise our estimates downwards to factor in prolonged slowdown in real estate due to demonetization and arrive at a revised price target of Rs 259 based on 22x FY18 estimates. (Rs 299 earlier on 22x FY18 earnings). Based on limited upside from the current levels, we now recommend REDUCE on the stock as the stock price is currently factoring in the positives related to demand/volume/margin improvement. We would look for better entry points to look into the stock. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 16

17 RESULT UPDATE Arun Agarwal TVS MOTORS (TVSM) PRICE: RS.400 RECOMMENDATION: SELL TARGET PRICE: RS.344 FY18E P/E: 23.3X TVSM's 3QFY17 results came on expected lines. Revenues during the quarter increased by 3% YoY, to Rs29.8bn, EBITDA margin remained stagnant YoY, at 7.3% and PAT grew by 10% YoY, partly supported by high growth in other income and lower tax rate. In terms of volume performance, the worst seems to be behind us and we expect gradual improvement in two wheeler demand in 4QFY17 and healthy volume growth in FY18. TVSM will likely continue to grow ahead of the industry and gain market share. We maintain our target price of Rs344 on the stock, valuing the company at 20x PER on FY18 earnings estimate. Given expensive valuations we recommend SELL rating (unchanged) on the stock. Standalone Result Highlight Summary table (Rs mn) FY16 FY17E FY18E Sales 112, , ,837 Growth (%) EBITDA 7,507 9,174 12,601 EBITDA margin (%) PBT 5,660 7,426 10,743 Adjusted Net profit 4,321 5,644 8,165 Adjusted EPS (Rs) Growth (%) Adjusted CEPS (Rs) BV (Rs/share) Dividend / share (Rs) ROE (%) ROCE (%) Net cash (debt) (8,916) (8,005) (2,447) NW Capital (Days) (1) (5) (8) P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) Source: Company, Kotak Securities - Private Client Research Quarterly performance (Rs mn) 3QFY17 3QFY16 YoY% 2QFY17 QoQ% Total Revenues 29,834 28, ,265 (12.9) Total expenditure 27,649 26, ,498 (12.2) RM consumed 21,491 20, ,777 (13.3) Employee cost 1,919 1, ,986 (3.4) Other expenses 4,239 4, ,736 (10.5) EBITDA 2,185 2, ,767 (21.0) EBITDA margin (%) Depreciation (0.6) Finance cost Other Income (11.2) Extraordinary income / (loss) - - PBT 1,698 1, ,340 (27.4) PBT margins (%) Tax (13.5) 567 (34.5) Tax rate (%) Reported PAT 1,327 1, ,774 (25.2) PAT margins (%) Other Comprehensive Income (67) Total Comprehensive Income 1,259 1,229-1,877 - Adjusted PAT 1,327 1, ,774 (25.2) Adjusted EPS (Rs) (25.2) Total Volumes (Nos) 718, , ,562 (11.9) Net Realization (Rs) 41,516 41, ,014 (1.2) RM cost per vehicle (Rs) 29,907 29, ,380 (1.6) Source: Company Per vehicle data (Rs) 3QFY17 3QFY16 YoY% 2QFY17 QoQ% Realization 41,516 41, ,014 (1.2) RM cost 29,907 29, ,380 (1.6) Employee cost 2,670 2, , Other expenses 5,899 5,941 (0.7) 5, 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

18 Revenues in 3QFY17 came in at Rs29.8bn (estimate was Rs29.9bn), 3% increase YoY. Volume growth during the quarter was hit by demand slowdown on the back of demonetization. Accordingly YoY volume growth in 3QFY17 was low at 2.4%. Average selling prices witnessed a marginal 0.6% increase YoY. On a QoQ basis, revenues declined by 13%, led by 12% fall in sales volumes. Over 2QFY17, volume decline was due to post festive season slowdown and demonetization impact on demand. Gross margin for the quarter stood at 28%, slight improvement over 3QFY16 and 2QFY17 gross margin of 27.7%. While commodity prices increased, company took price hike in September 2016 to off-set the same. Employee cost YoY increase largely pertains to annual increments. Other expenses in 3QFY17 remained largely under control. Over 2QFY17, employee cost and fixed cost declined due to lower volumes. EBITDA during the quarter grew by 3% YoY to Rs2.2bn, in line with our estimate of Rs2.1bn. Sequentially EBITDA declined by 21% due to 13% fall in revenues and negative operating leverage impact. EBITDA margins during the quarter came in at 7.3%, unchanged YoY, but 75bps lower QoQ. Depreciation for the quarter was higher by 16% YoY, but almost similar QoQ. Other income increased by 40% YoY to Rs348mn. Rise in other income is due to fair value of investments under IND AS. Tax rate for the quarter was on the lower side due to increase in investment income. TVSM's 3QFY17 PAT stood at Rs1.33bn, slightly above our estimates of Rs1.25bn. For the quarter, PAT growth was supported by increase in other income and lower tax rate. During the quarter, TVSM invested Rs334mn in equity shares of PT TVS Motor Company (Indonesia), Rs200mn in equity shares of Sundaram Auto Component, Rs33.5mn in equity shares of TVS Motor (Singapore) Pte and Rs400mn in equity shares of Emerald Haven Realty. Conference Call Highlights TVSM gained market share in 3QFY17. Company indicated that the company witnessed growth across segments during the festive season. Impact of demonetization has been higher in rural areas as compared with urban areas. Management indicated that demand is improving in January 2017, as compared with November/December In general, financed sales in two wheeler industry stands at 55% (40% organized and 15% unorganized). Growth in moped has largely been on the back of lower base (de-growth in past few years). Company do not expect any significant increase in moped's category share. Raw material prices witnessed marginal increase in 3QFY17 and the same were off-set by price hike in September TVSM also undertook marginal price hike in January In 4QFY17, TVSM do not expect any significant increase in input cost. Exports continue to suffer on account of forex availability issues and currency devaluation in certain export countries. Company expects exports to improve in FY18. Management further indicated that they have maintained/gained market share in various export countries and expects to further gain market share. Migration from BS3 to BS4 will increase two wheeler prices in the range of Rs500-Rs1,800 per vehicle. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 18