.dot SREI (SREI) Banks/Financial Institutions Buoyancy in infrastructure to drive business, upgrade to BUY. We find Srei s stock attractive at the current levels on account of (1) its inexpensive valuations, (2) the government s impetus to the infrastructure sector which expands Srei s business opportunities and (3) high unrealized gains on its investments. We are raising our price target to Rs115 (from Rs90) to factor higher value of Srei s infrastructure & construction equipment finance businesses and investment in Quippo Telecom. Upgrade to BUY. BUY OCTOBER 12, 2009 CHANGE IN RECO. Coverage view: Attractive Price (Rs): 74 Target price (Rs): 115 BSE-30: 16,643 Company data and valuation summary SREI Stock data Forecasts/Valuations 2009 2010E 2011E 52-week range (Rs) (high,low) 89-22 EPS (Rs) 7.0 8.7 8.4 Market Cap. (Rs bn) 8.6 EPS growth (%) (16.7) 23.4 (3.6) Shareholding pattern (%) P/E (X) 10.5 8.5 8.8 Promoters 30.0 NII (Rs bn) 2.8 3.8 3.7 FIIs 31.0 Net profits (Rs bn) 0.8 1.0 1.0 MFs 13.1 BVPS 88.9 102.8 109.7 Price performance (%) 1M 3M 12M P/B (X) 0.8 0.7 0.7 Absolute 2.1 31.3 34.5 ROE (%) 12.8 11.9 11.4 Rel. to BSE-30 (0.2) 6.6 (14.9) Div. Yield (%) 1.4 1.6 1.6 Significant value at current levels; upgrade to BUY We are raising our target price to Rs115 from Rs90 to factor in the higher value of Srei s core (infrastructure and construction equipment finance) businesses as well as the higher value of Srei s investment in Quippo telecom. QUICK NUMBERS Srei s core business (excluding value of Quippo telecom) is trading at 0.5X PBR FY2011E Our target price provides 55% upside from current levels Our fair value estimate, arrived using a residual growth model, for the core (infrastructure and construction equipment finance) businesses works out to Rs95/ share (0.9X PBR FY2011E) for long-term RoE of about 14-15%. We are raising our earnings estimates by 11-15% for FY2010E and FY2011E to factor higher loan growth, income from lending to Quippo Telecom (explained below) in the infrastructure (standalone) business, and somewhat better margins in the (construction equipment finance) business. Srei s infrastructure business (equity and debt investments and advisory to infrastructure projects) will be patchy and difficult to project. We are factoring income from short term lending to Quippo Telecom in FY2010E but are not assuming any episodic income in FY2011E the key reason for decline in our EPS estimate for FY2011E. We expect the company to report near-term RoEs at 10-12%, though the upside to our estimates remains high if infrastructure sector picks up and equity markets remain buoyant. Excluding the value of Srei s investments in Quippo Telecom, the core business is trading at 0.5X PBR FY2011E. We are valuing Srei s investments in Quippo telecom at Rs18/ share (up from Rs10/ share earlier). This is based on a valuation of Rs80 bn for Quippo Telecom. Our valuation estimate is based on enterprise value of Rs4 mn per tower for 25,000 towers (after the merger with telecom tower business of Tata Telecom and including the WIP towers). Our valuation estimate is lower than the value of Rs107 bn arrived during the merger. In another recent deal, Providence had valued the Indus towers at a higher benchmark - Rs10/ mn tower. Srei has economic interest of 2.5% in the merged entity (Srei had 1.5% economic interest in the merged entity and has recently picked-up additional 1% stake at ~Rs1 bn) as against 17% stake in Quippo Infrastructure. Exhibit 2 shows the pyramid structure of Srei s holding in Quippo Telecom. Nischint Chawathe nischint.chawathe@kotak.com Mumbai: +91-22-6634-1545 Manish Karwa manish.karwa@kotak.com Mumbai: +91-22-6634-1350 For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL. Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-6634-1100
Banks/Financial Institutions SREI Exhibit 1: Srei: Sum-of-parts-based valuation Stake Value of the firm Value per share (%) (Rs mn) (Rs) Valuation methodology Project related business and stake in subsidiary 95 Residual growth model assuming 14% cost of equity; 0.9X PBR FY2011E Investments in Quipo Quipo Telecom (post merger) 2.7% 80,000 19 25,000 telecom towers, assigning value of Rs3.1 mn/ tower Fair value estimate 113 Source: Kotak Institutional Equities Exhibit 2: Srei has a 2.7% stake in Quippo telecom Pyramid structure of Srei s economic holding in Quippo telecom Quippo Infra. (Srei's stake 17%) 38% Quippo Telecom (Srei's economic stake - 6.5%) 26% Quippo Telecom + WTTIL (merged entity) (Srei economic stake 1.7%) + 1% (direct holding) = 2.7% economic stake Source: Company Srei has equity investments of Rs3 bn in various road projects. We believe that the company has strong relationships with mid-tier construction companies that enable it to partner with them for bidding/ promoting infrastructure projects. The construction partners are responsible for the EPC contract while Srei arranges equity and debt funds for the projects. We have currently not quantified the value of these investments (though our long-term RoE assumption captures this to some extent) and capital gains thereon could provide upside. Businesses to gain traction in 2HFY10E We expect Srei s infrastructure and equipment finance business to gain traction in 2HFY10E on the back of pickup of activity in the infrastructure space. 2 KOTAK INSTITUTIONAL EQUITIES RESEARCH
SREI Banks/Financial Institutions Increase in growth traction for equipment finance business. We are factoring about 15% loan growth in FY2010E and 23% in FY2011E on the back of a marginal decline reported in FY2010E and low growth (5% yoy) reported in 1QFY10. An uptick in infrastructure activity will push the demand of construction equipments thereby driving growth in 2H; 2QFY10 performance may however continue to remain subdued due to seasonal slackness and high base of 2QFY09. The company reported a 46% loan CAGR between FY2003 and FY2008; we believe that the company can potentially deliver higher-than-expected growth in 2HFY10 and FY2011E though longer-term traction will be lower due to the high base. The increase in activity will also improve collection efficiency and likely bring down Srei s NPL as well gross NPLs increased to 2.13% in 1QFY10 from 1.27% in 1QFY09. We are accordingly factoring a provisioning cost of 0.5% of average loans in FY2010E (down from 0.67% in FY2009); our assumption however remains above the average of 0.3-0.4% of average loans reported in the period FY2003-FY2008. Episodic business to support near-term earnings of infrastructure business. Srei has provided a short-term loan of Rs10 bn to Quippo Telecom to fund the acquisition of Tata Telcom s tower business (WTTIL). The company will earn an interest of over 16% (higher than 13-14% earned on other deals). Quippo proposes to list the merged entity and sell down stake to another private investor thus repaying this loan. The interest income from this loan will boost Srei s income over the next 1-2 quarters. Quippo s inability to sell a stake in the business in case capital markets dry up is a potential risk. We expect the infrastructure (standalone) business to report loan book growth of Rs21 bn by FY2010E (excluding the loan to Quipo), Rs29 bn in FY2011E (up from Rs26 bn assumed earlier). The company will earn moderate spreads of about 2% though income from advisory/ loan syndication and other non-fund based activities will also drive earnings. As highlighted earlier, we find it difficult to project the episodic income streams linked to these projects and hence our earnings estimates have upside risk if the infrastructure sector remains buoyancy and vice versa. Exhibit 3: Srei: Old and new estimates, March fiscal years, 2010-2011E (Rs mn) Old estimates New estimates % change 2010E 2011E 2010E 2011E 2010E 2011E Net interest income 3,535 3,666 3,660 3,560 4 (3) Loan growth (%) 19 22 19 27 Loan book (Rs bn) 87,010 105,743 86,761 110,237 AUMs (Rs bn) 112,534 140,854 107,161 135,737 NIM (%) 4.0 3.4 4.2 3.4 NPL provisions 383 411 345 348 (10) (15) Other income 418 527 424 548 1 4 Operating expenses 1,829 1,882 1,797 1,834 (2) (3) Employee 766 811 766 809 - (0) Others 1,063 1,072 1,031 1,025 (3) (4) PBT 1,734 1,892 1,933 1,918 11 1 Tax 537 636 653 626 22 (2) PAT 1,196 1,256 1,280 1,292 7 3 PAT (after minority interest) 870 787 964 918 11 17 Source: Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 3
Banks/Financial Institutions SREI Exhibit 4: SREI: Key ratios, March fiscal year-ends, 2007-2011E (%) 2007 2008 2009E 2010E 2011E Income statement growth (%) Net interest income 36 (8) 102 30 (3) Loan loss provisions/ writeoffs 99 70 135 (16) 1 Non-interest income 343 4,940 (8) (56) (11) Operating expenses 52 98 61 (0) (7) Balance sheet growth(%) Net loans 92 56 30 19 27 Net loans (incl securitised) 69 50 (3) 16 23 Asset management measures (%) Yield on average earning assets 12.0 17.1 22.7 12.2 12.5 Average cost of funds 8.6 14.4 21.6 10.2 11.3 Spreads 3.4 2.7 1.1 1.9 1.2 Net interest income/ea 5.1 2.8 4.0 4.2 3.4 Total credit cost/average net loans 0.4 0.4 0.6 0.4 0.4 Tax rate 7.6 5.0 27.8 33.8 29.0 Dividend payout ratio 13.7 12.8 10.3 10.9 10.8 Profitability measures (%) Net int. income/net total income 98.6 57.1 74.6 89.6 90.4 Operating expenses/total income 36.9 45.8 47.5 44.0 42.5 Payout ratio 13.7 12.8 10.3 10.9 10.8 Equity/assets (EoY) 11.7 39.6 12.8 12.0 10.2 Debt/ equity (X) 7.0 1.4 6.1 6.7 8.1 Du Pont Analysis (% of average assets) Net interest income 4.8 4.9 5.5 3.9 3.2 Loan loss provisions 0.3 0.6 0.8 0.4 0.3 Net other income 0.1 3.7 1.9 0.5 0.3 Gains on securitization 0.0 0.0 0.0 0.0 0.0 Operating expenses 1.8 4.0 3.5 1.9 1.5 (1- tax rate) 92.4 95.0 72.2 66.2 67.4 ROA 2.5 3.8 2.2 1.4 1.2 Average assets/average equity (x) 7.1 5.0 5.9 8.1 9.1 ROE 18.1 19.2 12.8 11.1 10.5 Source: Company, Kotak Institutional Equities estimates 4 KOTAK INSTITUTIONAL EQUITIES RESEARCH
SREI Banks/Financial Institutions Exhibit 5: SREI: Income statement and balance sheet, March fiscal years 2007-2011E (%) 2007 2008 2009E 2010E 2011E Income statement Interest income 3,669 4,427 11,163 11,217 13,818 Interest expenses 2,155 3,031 8,340 7,558 10,258 Net interest income 1,514 1,396 2,822 3,660 3,560 Provisions and write/off 103 175 411 345 348 Net interest income (after prov.) 1,411 1,221 2,411 3,315 3,212 Other income 21 1,048 960 424 379 Operating expenses 567 1,120 1,798 1,797 1,673 Employee expenses 223 370 680 766 744 Admin and other expenses 264 389 1,023 944 838 Depreciation 22 361 37 28 32 Pretax income 858 1,143 1,565 1,933 1,910 Tax provisions 65 57 434 435 441 Deferred Tax 217 182 Net Profit 792 1,086 1,130 1,280 1,287 Net Profit after minority interest 792 1,086 818 964 917 EPS (Rs) 7 9 7 8 8 BPS (Rs) 43 57 96 102 109 Balance sheet Construction equipment finance 30,447 47,419 60,193 65,627 80,650 Project finance 5,373 8,368 12,512 21,134 29,587 Net loans 35,820 55,787 72,705 86,761 110,237 Total Investments 1,467 3,282 4,580 4,523 4,523 Cash & deposits 753 842 6,090 4,087 4,625 Other advances recoverable in cash & 1,712 3,759 3,082 3,365 3,676 Net fixed assets 257 44 358 375 408 Total assets 40,124 16,621 86,888 99,332 123,740 Total Borrowings 33,035 8,942 68,226 79,391 102,632 Current liabilities 1,079 894 1,680 1,703 1,728 Provisions 656 204 1,051 1,068 1,086 Deferred tax liability 645 0 537 537 537 Total liabilities 35,414 10,040 71,494 82,698 105,983 Share capital 1,091 1,163 1,163 1,163 1,163 Reserves 3,679 5,418 9,947 10,743 11,492 Shareholders fund 4,710 6,581 11,110 11,906 12,655 Minority interest 4,411 4,728 5,103 Source: Company, Kotak Institutional Equities estimates KOTAK INSTITUTIONAL EQUITIES RESEARCH 5
Disclosures "I, Nischint Chawathe, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report." Kotak Institutional Equities Research coverage universe Distribution of ratings/investment banking relationships 70% 60% 50% Percentage of companies covered by Kotak Institutional Equities, within the specified category. Percentage of companies within each category for which Kotak Institutional Equities and or its affiliates has provided investment banking services within the previous 12 months. 40% 30% 20% 10% 0% 31.9% 29.7% 26.8% 11.6% 0.7% 2.9% 0.7% 0.7% BUY ADD REDUCE SELL * The above categories are defined as follows: Buy = We expect this stock to outperform the BSE Sensex by 10% over the next 12 months; Add = We expect this stock to outperform the BSE Sensex by 0-10% over the next 12 months; Reduce = We expect this stock to underperform the BSE Sensex by 0-10% over the next 12 months; Sell = We expect this stock to underperform the BSE Sensex by more then 10% over the next 12 months. These ratings are used illustratively to comply with applicable regulations. As of 30/6/2009 Kotak Institutional Equities Investment Research had investment ratings on 138 equity securities. Source: Kotak Institutional Equities As of June 30, 2009 Ratings and other definitions/identifiers Definitions of ratings BUY. We expect this stock to outperform the BSE Sensex by 10% over the next 12 months. ADD. We expect this stock to outperform the BSE Sensex by 0-10% over the next 12 months. REDUCE. We expect this stock to underperform the BSE Sensex by 0-10% over the next 12 months. SELL. We expect this stock to underperform the BSE Sensex by more than 10% over the next 12 months. Our target price are also on 12-month horizon basis. Other definitions Coverage view. The coverage view represents each analyst s overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious. Other ratings/identifiers NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. CS = Coverage Suspended. Kotak Securities has suspended coverage of this company. NC = Not Covered. Kotak Securities does not cover this company. RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA = Not Available or Not Applicable. The information is not available for display or is not applicable. NM = Not Meaningful. The information is not meaningful and is therefore excluded. 6 KOTAK INSTITUTIONAL EQUITIES RESEARCH
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