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STRATEGY

November 2016

Year 1

Year 10

The Coffee Can Portfolio 2016


Research Analysts:
Karan Khanna, CFA
karan.khanna@ambit.co
Tel: +91 22 3043 3251
Nitin Bhasin
nitin.bhasin@ambit.co
Prashant Mittal, CFA
prashant.mittal@ambit.co

Rakshit Ranjan, CFA


rakshit.ranjan@ambit.co

Sagar Rastogi
sagar.rastogi@ambit.co

Anuj Bansal
anuj.bansal@ambit.co

Aadesh Mehta, CFA


aadesh.mehta@ambit.co

Paresh Dave, CFA


paresh.dave@ambit.co

Ashvin Shetty, CFA


ashvin.shetty@ambit.co

Ravi Singh
ravi.singh@ambit.co

Abhishek Ranganathan, CFA


abhishek.r@ambit.co

Nikhil Pillai
nikhil.pillai@ambit.co

Strategy

CONTENTS
SECTOR
The Coffee Can Portfolio 2016 .3
Executive Summary 4
The case for a Coffee Can portfolio .9
A framework for constructing the Indian Coffee Can portfolio .13
Does the approach work? Results from our back-testing ..15
Performance of the Coffee Can portfolios launched in .18
2014 and 2015
Optimal way to deploy fresh funds each year .21
The ideal life of a Coffee Can portfolio .24
Todays Coffee Can for 2016-2026 ..26
Appendix 1: How the Coffee Can is different to our 131
other portfolio constructs
Appendix 2: Performance of the 14 back-tested ..133
Coffee Can portfolios
Appendix 3: John Kays IBAS Framework ..150

COMPANIES
HDFC Bank (SELL): Flawless execution ..27
Axis Bank (BUY): A strong core 33
HCL Technologies (BUY): Set to surf the IoT wave ..39
Asian Paints (BUY): A legend built over several decades ..45
Lupin (BUY): Dukes have castellated the fort ...51
Cadila (BUY): Inches make champions .57
Britannia (SELL): On a steady growth path ...63
LIC Housing Finance (SELL): The old lady of housing finance ..69
Page Industries (BUY): Inner Strength .75
Amara Raja Batteries (SELL): Competitive edge under threat ..81
GRUH Finance (NOT RATED): Will it stand the test of time? 89
Dr Lal PathLabs (NOT RATED): Long-term growth path .95
eClerx (SELL): No room for error ..101
Astral Poly (NOT RATED): A fanatic challenger 107
Relaxo Footwears (NOT RATED): The nimble footed giant 113
REPCO Home Finance (NOT RATED): Swimming against the tide 119
Cera Sanitaryware (NOT RATED): A super-efficient Superbrand ..125
November 17, 2016

Ambit Capital Pvt. Ltd.

Page 2

Strategy
THEMATIC

November 17, 2016

The Coffee Can Portfolio 2016

The Indian Coffee Can Portfolio 2016

In this annual update of our coffee can portfolio, we further augment the
case for this unique construct. The previous editions of the coffee can
portfolio (CCP) have done remarkably well, with 18.4% outperformance
and 9.6% outperformance (in CAGR terms) for the two iterations since
publication in Nov 14 and Nov 15 respectively. That said, our analysis
suggests for the true potential of the coffee can construct to play out, the
portfolio should be left untouched for a decade. Asian Paints, HDFC
Bank, Page and Astral are some prominent stocks that again appear in
this years portfolio. Relaxo, Repco and Dr Lal are the new entrants.

HDFC Bank

Our stance: SELL

Mcap (US$ bn): 47.6

ADV - 6m (US$ mn): 25.9

Axis Bank

Our stance: BUY

Mcap (US$ bn): 17.5

ADV - 6m (US$ mn): 85.8

HCL Technologies

Our stance: BUY

Mcap (US$ bn): 16.6

ADV - 6m (US$ mn): 27.4

Asian Paints

Our stance: BUY

Mcap (US$ bn): 15.2

ADV - 6m (US$ mn): 17.6

The case for a Coffee Can Portfolio


The coffee can construct hinges on investing in high quality franchises (which
have a superior track record of financial performance over the preceding decade)
for a very long period of time a decade to be precise. The virtues of such a
construct include: (a) significantly raising the probability of making returns; (b)
reducing costs by avoiding churn; (c) allowing the power of compounding to work
its magic; and (d) removing the negatives of noise.
Back-tests prove the potential of the CCP to beat the benchmark
Both on a live basis as well as in back-tests, the previous 16 iterations of the
Coffee Can Portfolio have handsomely outperformed the Sensex as well as
broader market indices, such as the BSE200 index. Further, on a total returns
basis (i.e. including dividends), the Coffee Can Portfolios returns are +1% to
+3.7% points higher than the returns under a share price only scenario.

Lupin

Our stance: BUY

Mcap (US$ bn): 10.4

ADV - 6m (US$ mn): 30.1

Cadila Health.

Our stance: BUY

Mcap (US$ bn): 5.9

ADV - 6m (US$ mn): 5.1

Britannia Inds.

Our stance: SELL

Mcap (US$ bn): 5.6

ADV - 6m (US$ mn): 10.0

LIC Housing Fin.

Our stance: SELL

Mcap (US$ bn): 4.0

ADV - 6m (US$ mn): 18.1

Page Industries

Our stance: BUY

Mcap (US$ bn): 2.7

ADV - 6m (US$ mn): 2.4

Amara Raja Batt.

Our stance: SELL

True potential of the CCP is realised over the long term


Whilst the portfolio continues to do well even over a shorter duration (say, five
years), terminating it at the end of year 5 (and investing the proceeds in the CCP
for year 5) results in a loss of potential alpha of ~3.3% points (in CAGR terms).
That said, in case the need for fresh deployment of funds arises, we also
showcase that doing so in successive coffee can iterations also leads to
benchmark-beating returns (8-9% excess IRRS under various scenarios).

Mcap (US$ bn): 2.6

ADV - 6m (US$ mn): 5.0

GRUH Finance

Our stance: NR

Mcap (US$ bn): 1.7

ADV - 6m (US$ mn): 1.5

Dr Lal PathLabs

Our stance: NR

Mcap (US$ bn): 1.5

ADV - 6m (US$ mn): 1.8

eClerx Services

Our stance: SELL

Todays Coffee Can for 2016-2026


Six stocks from the previous CCP do not make it to this years portfolio: ITC,
Marico, GSK Consumer, Colgate Palmolive, Berger and V-Guard Inds.
Fresh additions to this years portfolio are Relaxo, Repco and Dr. Lal
PathLabs. Whilst we do not advocate annual rebalancing of the portfolio, clients
who are interested in the 2016 CCP should refer to the exhibit on the right.

Mcap (US$ bn): 0.9

ADV - 6m (US$ mn): 1.0

Astral Poly

Our stance: NR

Mcap (US$ bn): 0.8

ADV - 6m (US$ mn): 0.4

Relaxo Footwear

Our stance: NR

Mcap (US$ bn): 0.7

ADV - 6m (US$ mn): 0.2

Repco Home Fin

Our stance: NR

Mcap (US$ bn): 0.6

ADV - 6m (US$ mn): 1.0

Cera Sanitary.

Our stance: NR

Mcap (US$ bn): 0.5

ADV - 6m (US$ mn): 0.6

Sixteen iterations of the Coffee Can Portfolio have outperformed the Sensex
Kick-off
year*

All-cap
CCP (start)

All-cap
CCP (end)

CAGR
return

Outperformance
relative to Sensex

2000

500

3,831

22.6%

6.6%

2001

600

9,802

32.2%

11.7%

2002

800

7,709

25.4%

5.1%

2003

900

10,175

27.4%

7.2%

2004

1,000

16,849

32.6%

12.7%

2005

900

6,643

22.1%

6.0%

Karan Khanna, CFA

2006

1,000

6,376

20.4%

9.0%

2007

1,500

7,828

19.5%

10.8%

+91 22 3043 3251

2008

1,100

5,724

22.1%

11.2%

2009

1,100

4,843

22.7%

11.5%

2010

700

2,042

18.7%

9.5%

2011

1,400

2,550

12.1%

2.7%

2012

2,200

5,356

23.3%

9.9%

2013

1,800

4,762

34.8%

21.4%

Prashant Mittal, CFA

2014

1,600

2,331

22.2%

21.0%

+91 22 3043 3218

2015

2,000

2,387

19.3%

13.4%

prashant.mittal@ambit.co

Source: Bloomberg, Ambit Capital research. Note: *Returns for 10 year-period from 2000-2006 (starting 30th June); CAGR
returns for portfolios since 2007 until 30th Sep16 (except for live portfolios for 2014 and 2015 for which CAGR returns and
absolute returns have been calculated since these portfolios were launched in Nov 15 and Nov 16 respectively).

Source: Bloomberg, Ambit Capital research. Note: Mcap as of


15 November 2016

Research Analysts

karan.khanna@ambit.co
Nitin Bhasin
+91 22 3043 3241
nitin.bhasin@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Strategy

Executive Summary
The case for a Coffee Can Portfolio
We first introduced the Coffee Can Portfolio in our 17 November 2014 thematic: The
Indian Coffee Can Portfolio for investors who have the ability to hold stocks for very
long periods of time (i.e. for ten years or more). The coffee can construct essentially
hinges on investing in quality franchises with superior long-term historical track
records of financial performance over longer periods of time.
We believe at the portfolio level, there are four factors that work in favour of the
coffee can construct. These are:

Higher probability of returns over the long term: Over longer periods of
time (for example, the last 30 years), the Sensex has returned ~15% CAGR. That
said there have been intermittent periods of unusually high drawdowns. For
example, an investor entering the market near the peak in early Jan 08 would
have lost over 60% of value in just about fourteen months of investing. Thus,
whilst over longer time horizons, the odds of profiting from equity investments are
very high; the same cannot be said of shorter time horizons.

A longer time horizon allows the power of compounding to work its


magic: Holding a portfolio of stocks for periods as long as 10 years or more
allows the power of compounding to play out its magic. Over the longer term, the
portfolio gets dominated by the winning stocks whilst underperforming stocks
keep declining and eventually become inconsequential. Thus, the positive
contribution of the winners disproportionately outweighs the negative
contribution of the losers to eventually help the portfolio compound handsomely.

Neutralising the negatives of noise: Empirically, investing and holding for


the long term has been the most effective way of killing noise that interferes
with the investment process.
Using Lupins illustration in the note we show that one of the reasons the coffee
can construct works well is because the ability to hold on to a great franchise for
a long period of time allows you to let fundamentals drive your investment
decision rather than noise.

No churn: Finally, the coffee can construct allows an investor to hold a portfolio
of stocks for over 10 years without any churn. With no churn, the coffee can
approach reduces transaction costs which add to the overall portfolio
performance over the long term.

Laying a framework for constructing the Indian Coffee Can Portfolio


To identify stocks for our Coffee Can Portfolio, we start with the basic principles of
investing. At the very basic level, a company doing well would mean that it is
profitable and is growing. These twin filters of growth and profitability, in our view,
are sufficient to assess the success of a franchise.
We, therefore, select stocks with a long-term track record of delivery on revenue
growth and RoCE. For financial services stocks, we modify these filters slightly and
look for a long-term track record of delivery on loan book growth and RoE.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 4

Strategy
Note that even our work suggests a combination of superior RoCE and revenue
growth has been a winner in the Indian context (see exhibit 1 below):
Exhibit 1: A combination of superior RoCE and revenue growth is a winner in the
Indian context*
Average outperformance, 10-year CAGR
11.1%

12.0%
10.0%
8.0%
6.0%
4.0%

4.9%
2.6%

2.0%
0.0%
Superior on Revenue
growth

Superior on RoCE

Superior on both

Source: Bloomberg, Ambit Capital research. Note: * The universe is 2006s BSE200 firms (ex-financials);
performance relative to the BSE200 Index; the chart is based on price data from 31 March 2006 to 31 March
2016. The red bars denote the 10-yr share price performance of top quartile stocks on revenue growth, RoCE as
well as a combination of both from the BSE200 universe.

For the Coffee Can Portfolio, we therefore look for firms that have delivered a
minimum pre-tax RoCE of 15% or more and sales growth of at least 10% or more
over ten consecutive years. For financial services stocks, we seek to identify firms that
have delivered a minimum RoE of 16% and loan book growth of at least 10% or more
for ten consecutive years.
Back-test proves the potential of the coffee can construct to beat the
benchmark
Using the filters discussed above, we run back-tests of the framework for each of the
last 16 years. Results from our back-test suggest that each of the previous 16 coffee
can portfolios has comprehensively outperformed the benchmark Sensex index both
on an absolute as well as on a risk-adjusted basis.
Further, even if we were to use broader market indices, such as the BSE200 index,
each of the previous sixteen iterations of the coffee can portfolios still beat the
benchmark BSE200 index quite comprehensively.
Performance of the live Coffee Can Portfolio launched in 2014 and 2015
We launched the first Coffee Can Portfolio for investors in our 17 November 2014
thematic: The Indian Coffee Can Portfolio (to be held from 2014-2024). We
followed this up with the second Coffee Can Portfolio that was launched in our 02
November 2015 thematic: The Coffee Can Portfoliothe coffee works!
Since publication in November 2014, the first Coffee Can Portfolio has generated
total CAGR returns of 17.6% vs total CAGR returns of -0.8% for the benchmark
Sensex index. Similarly, the second Coffee Can Portfolio that was launched in 2015
has generated total CAGR returns of 11.7% vs total CAGR returns of 2.1% for the
benchmark Sensex index since initiation.
That said both these portfolios have witnessed a churn of 30-35%. With reasonably
high levels of churn, the obvious question one would ask is whether to rebalance the
2014 and 2015 portfolios to include stocks that feature in this years iteration?
We advise investors to refrain from rebalancing the coffee can portfolios. A Coffee
Can Portfolio that is rebalanced every year underperforms the Coffee Can Portfolio
that is left untouched for a decade by ~5.3% points (on a median basis; in CAGR
terms, see exhibit 2 below):

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 5

Strategy
Exhibit 2: Share price CAGR returns over 10-year period for CCP with and without
rebalancing

CCP without rebalancing

20002010

20012011

20022012

20032013

20042014

20052015

Median
CAGR

19.3%

28.5%

22.4%

25.4%

30.8%

20.5%

23.9%

CCP with rebalancing


18.5%
22.6%
22.0%
17.0%
18.7%
13.5%
18.6%
Difference (w/o minus with
0.8%
5.9%
0.4%
8.4%
12.0%
6.9%
5.3%
rebalancing)
Source: Bloomberg, Ambit Capital Research Note: Dates refer to the first year and last year of the ten-year
holding period. Performance has been measured over a 10-yr period starting from June of the first year and
ending with June of the last year. This exhibit has been reproduced without any changes from our 02 November
2015 thematic: The Coffee Can Portfoliothe coffee works!

An optimal way to deploy fresh funds each year


The coffee can construct advocates the buy and hold approach. That said one of the
challenges investors face is how to deploy the fresh fund inflows that are received
every year.
Here we evaluate two scenarios: (1) where the fresh fund inflows that are received
every year are assumed to remain constant; and (2) where the fresh fund inflows that
are received every year are assumed to increase by 20% each year. We further
assume that every year as an investor receives fresh fund inflows, these funds are
deployed in the Coffee Can Portfolio for that particular year.
Our analysis suggests that under both the scenarios, the IRR for the Coffee Can
Portfolio is significantly higher than the IRR for Sensex. Further, whilst the number of
stocks in the portfolio are high (~43 stocks on an average for the seven completed
coffee can portfolios), the top ~23% of the stocks comprise 65-75% of the total
portfolio value by the end of year 10 under both the scenarios.
We believe this brings out a very important aspect of the coffee can construct which is
that allowing the power of compounding to work its magic is a much more important
driver of long-term returns than the most ideal stock selection itself. Thus, even whilst
the number of stocks in the portfolios is fairly high, over time the losing stocks
become insignificant while the portfolio returns are gradually dominated by the
winners.
An ideal life of a Coffee Can Portfolio
Historically, we have advocated a minimum holding period of ten years for the Coffee
Can Portfolio as we believe that the benefits of the coffee can construct can only be
realised by investing in quality franchises with a superior long-term track record of
financial performance, over longer periods of time. That said one of the questions
several investors have asked us is how do the returns as well as risk profile fare over
a shorter period of time (such as five years)?
Results from our analysis reveal that each of the previous sixteen iterations of the
Coffee Can Portfolio has handsomely outperformed the benchmark Sensex index over
a shorter time horizon (i.e. five years). So, given the outperformance even over a
shorter time period, would the investor be better off if he terminates the Coffee Can
Portfolio at the end of 5 years instead of 10 years?
Our analysis suggests for the coffee can construct to work its magic, the portfolio
should be left untouched for the decade. Whilst the Coffee Can Portfolio over a
shorter time horizon does indeed outperform the benchmark Sensex index,
terminating the portfolio at the end of, say, 5 years (and investing the funds from the
exiting stocks in fresh stocks that make it to the Coffee Can Portfolio in year five)
results in ~3.3% points lower alpha for the portfolio vs keeping the portfolio
untouched for a decade.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 6

Strategy
Todays coffee can for 2016-26
Having discussed the virtues of the coffee can construct and establishing the ideal life
for a Coffee Can Portfolio, we screen the entire spectrum of listed companies with
market-cap greater than `1bn using our twin filters of growth and profitability.
The list of firms that makes it to this years edition of our Coffee Can Portfolio has
been summarised in exhibit 3 below. The coffee can continues to feature some of
Indias most successful franchises as well as the most-compelling investment themes.
Using John Kays IBAS (Innovation, Brand, Architecture and Strategic Assets)
framework, we evaluate these companies in the ensuing sections of the note.
Appendix 3 of the note gives you more colour regarding John Kays IBAS framework
and Ambits bestselling book, The Unusual Billionaires, gives you details regarding
just how successful the coffee can companies have been over years.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 7

Strategy
Exhibit 3: Summary of the 2016 Coffee Can Portfolio
Company

Ticker

Mcap

Free Float
Mcap

($mn)

($mn)

ADV-6m
(Median) Accounting
Decile
($mn)

Greatness
Score
(%)

Ambit
Stance

Comments

Credible execution track record driving consistent high earnings


HDFC Bank
HDFCB IN
47,610
35,232
23.2
N/A
N/A
SELL
growth while maintaining asset quality
Despite facing asset quality stress, capability to generate strong
Axis Bank
AXSB IN
17,489
11,368
68.3
N/A
N/A
BUY
operating profits provides comfort
Set to capitalise on competitive advantages in IMS and ES to build
HCL Tech.
HCLT IN
16,641
6,490
20.6
D2
92%
BUY
a strong IOT offering
Deserve high valuation due to a) resilient repainting cycle in weak
Asian Paints
APNT IN
15,151
7,121
15.0
D1
50%
BUY
macro, b) greater pricing power and c) ability to successfully drive
transition to value added services in home improvement category
Ability to adapt to changing environment and be successful is the
Lupin
LPC IN
10,365
5,493
22.7
D6
100%
BUY
secret sauce to Lupin
Early investments in innovation like biosimilars, NCEs/NDDS are
Cadila Health.
CDH IN
5,907
1,477
3.8
D5
46%
BUY
provide competitive edge in EMs/regulated markets
Will play on the width of the portfolio and leverage its cost
Britannia Inds.
BRIT IN
5,633
2,760
8.0
D2
83%
SELL
efficiencies vs peers
LICs support is key strategic asset. But earnings momentum
LIC Housing Fin. LICHF IN
3,987
2,392
15.0
N/A
N/A
SELL
should decline due to declining real estate prices and competitive
headwinds.
Will grow due a) aspirational brand b) in-house manufacturing
Page Inds.
PAG IN
2,702
1,324
2.0
D3
88%
BUY
and c) control on distribution channel
Low cost advantage with Johnson Controls' parentage to continue
Amara Raja Batt. AMRJ IN
2,552
1,225
3.9
D3
83%
SELL
driving market share gains market share gains albeit at lower
pace than before
Best play in affordable housing due to innovative credit scoring,
GRUH Finance
GRHF IN
1,705
699
0.8
N/A
N/A
NR
strong local knowledge and support of the parent HDFC
Set to enjoy long growth ramp driven by market share gains from
Dr Lal Pathlabs
DLPL IN
1,477
177
0.7
N/A
N/A
NR
unorganised, acquisitions and socio economic tailwinds driving
penetration
Competitive advantage a thing of past as regulatory driven
eClerx Services
ECLX IN
874
437
0.4
D2
42%
SELL
challenges in BFSI and rise of automation threaten business model
Transitioning from a pipes manufacturer to a larger building
Astral Poly
ASTRA IN
758
303
0.2
D1
58%
NR
materials franchise; capitalising the brand recall and replicating its
architecture to become a challenger brand in adhesives
Focus on brand building and premiumisation provide Relaxo the
Relaxo Footwear RLXF IN
727
182
0.1
D1
92%
NR
pricing power in a value offering without compromising on volume
growth
Strong positioning in affordable housing due to local area
Repco Home Fin. REPCO IN
626
388
0.6
N/A
N/A
NR
knowledge and an innovative origination strategy
Second largest in scale but the most profitable sanitaryware
Cera Sanitary.
CRS IN
490
221
0.2
D5
67%
NR
manufacturer. With competition rising, Cera has plugged gaps in
its product portfolio, now catering to all market segments
Source: Bloomberg, Capitaline, Ambit Capital Research. Note: *RoA for BFSI stocks. Mcap data as of 15 November 2016.

November 17, 2016

Ambit Capital Pvt. Ltd.

P/E

RoCE*

P/B

FY16

FY17E

FY16

FY17E

FY16

25.6

21.5

4.4

3.8

1.9

13.9

28.2

2.2

2.1

1.7

19.7

13.7

4.1

3.4

34.2

58.4

47.3

18.0

15.1

47.2

30.3

23.1

6.3

5.1

24.6

25.8

25.0

7.3

6.0

29.0

46.5

39.2

21.2

15.9

71.9

15.9

12.4

2.9

2.4

1.4

77.3

61.0

35.6

27.7

54.7

34.7

29.8

8.1

6.7

35.8

46.6

38.6

13.6

11.3

2.4

73.8

59.1

19.3

15.2

31.5

15.9

15.2

5.3

4.5

51.5

49.8

35.6

6.5

5.6

18.2

40.2

36.3

10.1

DNA

29.7

27.7

22.0

4.4

3.7

2.2

39.1

30.5

7.7

6.4

25.1

Page 8

Strategy

The case for a Coffee Can Portfolio


The coffee can approach to portfolio construction
In our 17 November 2014 thematic: The Indian Coffee Can Portfolio, we introduced
the Coffee Can Portfolio for investors who have the ability to hold stocks for very long
periods of time (for ten years or more). For investors who are not familiar with the
coffee can construct, the term coffee can was coined by Robert G Kirby of Capital
Guardian, who in his 1984 note (click here for the note) narrated an incident
involving his clients husband who had purchased stocks recommended by Kirby in
US$5000 denomination each but did not ever sell anything from the portfolio. This
process led to enormous wealth creation for the client over a period of about 10
years mainly on account of one position transforming to a jumbo holding worth over
US$800,000 which came from a zillion shares of Xerox. Impressed by this approach
of buy and forget followed by this gentleman, Kirby coined the term Coffee Can
Portfolio - the concept harkens back to the Wild West, when Americans, before the
widespread advent of banks, saved their valuables in a coffee can and kept it under a
mattress.

Robert Kirby of Capital Guardian


introduced the concept of Coffee
Can Portfolio in 1984

Why does the approach work?


The simplicity of the coffee can approach to portfolio construction rests in four factors
that work in favour of longer investment horizons at the portfolio level:

Higher probability of returns over the long term: As is well understood,


equities as an asset class are prone to extreme movements in the short term. For
example, whilst the Sensex has returned ~15% CAGR returns over the last 30
years, there have been intermittent periods of unusually high drawdowns. In Jan
08, for instance, an investor entering the market near the peak in January would
have lost over 60% of value in just about fourteen months of investing. Thus,
whilst over longer time horizons, the odds of profiting from equity investments are
very high; the same cannot be said of shorter time frames.

Four factors work in favour of the


Coffee Can approach to portfolio
construction

In his book, More than you know, Michael Mauboussin illustrates this concept
using simple math in the context of US equities. We use that illustration and apply
it in the context of Indian equities here.
We note that the Sensexs returns over the past 30 years have been ~14% on a
CAGR basis, whilst the standard deviation of returns has been ~29%. Now using
these values of returns and standard deviation and assuming a normal
distribution of returns (a simplifying assumption), the probability of generating
positive returns over a one-day time horizon works out to ~51.1%.

Firstly,
the
probability
of
generating
positive
returns
increases disproportionately with
increase in holding horizons

Note, however, that as the time horizon increases, the probability of generating
positive returns goes up. The probability of generating positive returns goes up to
~68% if the time horizon increases to one year; the probability tends towards
100% if the time horizon is increased to 10 years (see Exhibit 4 below).
Exhibit 4: Probability of gains from equity investing
disproportionately with increase in holding horizon

in

India

increases

Probability of gains

100%
90%
80%
70%
60%
50%
1 Hour

1 Day

1 Week

1 Month

1 Year

10 Year 100 Years

Years
Source: Bloomberg, Ambit Capital research. Note: This chart has been inspired by similar work done by Michael
Mauboussin in the Western context.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 9

Strategy

Power of compounding: Holding a portfolio of stocks for periods as long as 10


years or more allows the power of compounding to play out its magic. Over the
longer term, the portfolio comes to be dominated by the winning stocks whilst
losing stocks keep declining to eventually become inconsequential. Thus, the
positive contribution of the winners disproportionately outweighs the negative
contribution of losers to eventually help the portfolio compound handsomely.
We elaborate the power of this powerful phenomenon in much greater details in
the ensuing sections of the note as well as Appendix 2 (Performance of the 14
back-tested Coffee Can Portfolio) using historical case studies. We will illustrate
the point using simple mathematics here.
Lets consider a hypothetical portfolio that consists only of two stocks. One of
these stocks, stock A, grows at 26% per annum whilst the other, say stock B,
declines at the same rate, i.e. at 26% per annum. Overall, not only do we assume
a 50-50 strike rate, we also assume symmetry around the magnitude of positive
and negative returns generated by the winner and the loser respectively.
In Exhibit 5 below, we track the progress of this portfolio over a 10-year holding
horizon. As time progresses, stock B declines to irrelevance while the portfolio
value starts converging to the value of holding in stock A. Even with the assumed
50% strike rate with symmetry around the magnitude of winning and losing
returns, the portfolio compounds at a healthy 17.6% per annum over this 10-year
period, a pretty healthy rate of return. This example demonstrates how powerful
compounding can be for investor portfolios if only sufficient time is allowed for it
to work its magic.

Secondly, compounding results in a


natural rebalancing of winners and
losers in a portfolio

Exhibit 5: A hypothetical portfolio with 50% strike rate and symmetry around positive
and negative returns
10 yr CAGR

600
500

Stock A

26%

Stock B

-26%

Portfolio

17.6%

400
300
200
100
0
0

10

Source: Ambit Capital research

Neutralising the negatives of noise: Empirically, investing and holding for


the long term have been the most effective way of killing noise that interferes
with the investment process. This has also been corroborated by Robert G.
Hagstrom in his recent book, Investing The Last Liberal Art (2nd edition, 2013).
In this book, the author talks about the chaotic environment, with so much
rumour, miscalculation, and bad information swirling. Such an environment was
labelled noise by Fischer Black, the inventor of the Black-Scholes formula.
Hagstrom goes on to say:
Is there a solution for noise in the market? Can we distinguish between noise
prices and fundamental prices? The obvious answer is to know the economic
fundamentals of your investment so you can rightly observe when prices have
moved above or below your companys intrinsic value. It is the same lesson
preached by Ben Graham and Warren Buffett. But all too often, deep-rooted
psychological issues outweigh this commonsensical advice. It is easy to say we
should ignore noise in the market but quite another thing to master the
psychological effects of that noise. What investors need is a process that allows
them to reduce the noise, which then makes it easier to make rational decisions.

November 17, 2016

Ambit Capital Pvt. Ltd.

Thirdly, by its design, the CCP is


indifferent to short-term trends,
sectors, themes, and approaches
such as chasing earnings or
momentum

Page 10

Strategy
As an example, we highlight how, over the long term, Lupins stock price has
withstood short-term disappointments to eventually compound at an impressive
29% CAGR since Jan04 (see Exhibit 6 below).
Exhibit 6: Lupins stock has compounded at an impressive 29% CAGR since Jan 04
3,500
3,000
2,500
2,000
1,500
1,000
500
Apr-16

Sep-15

Feb-15

Jul-14

Dec-13

May-13

Oct-12

Mar-12

Aug-11

Jan-11

Jun-10

Nov-09

Apr-09

Feb-08

Sep-08

Jul-07

Dec-06

May-06

Oct-05

Mar-05

Aug-04

Jan-04

Source: Bloomberg, Ambit Capital research

However, the chart shown above also highlights that over the past 13 years, there
have been several extended time periods when Lupins share price has not gone
anywhere such as from Jan 04 to Mar 08, Nov 10 to Feb 13 and more
recently since Mar 15. In spite of remaining flat over these periods, Lupin has
performed so well in the remaining five years that the 13-year CAGR for the stock
is 29%. At its simplest, this is why the concept of investing for longer time
horizons works once you have identified a great franchise and you have the
ability to hold on it for a long period time, there is no point trying to be too
precise about timing your entry or your exit. As soon as you try to time that
entry/exit, you run the risk of noise rather than fundamentals driving our
investment decisions.
To further demonstrate how churn and turn destroy return, we quote again
from Investing: The Last Liberal Art by Hagstrom. In this book, the author refers
to an interesting experiment conducted by a behavioural economist at the
University of California. We reproduce the extract below:
In 1997, Terence Odean, a behavioral economist at the University of California,
published a paper titled, Why do Investors Trade Too Much? To answer his
question, he reviewed the performance of 10,000 anonymous investors.
Over a seven-year period (1987-1993), Odean tracked 97,483 trades among ten
thousand randomly selected accounts of a major discount brokerage. The first thing
he learned was that the investors sold and repurchased almost 80 percent of their
portfolios each year (78 percent turnover ratio). Then he compared the portfolios to
the market average over three different time periods (4 months, 1 year and 2
years). In every case, he found two amazing trends: (1) the stocks that the investors
bought consistently trailed the market, and (2) the stocks that they sold actually
beat the market 1.
Odean wanted to look deeper, so he next examined the trading behavior and
performance results of 6,465 households. In a paper titled, Trading Is Hazardous
to Your Wealth (2000), Odean, along with Brad Barber, professor of finance at
University of California, Davis, compared the records of people who traded
frequently versus people who traded less often. They found that, on average, the
most active traders had the poorest results, while those who traded the least earned
the highest returns 2. The implication here is that people who might have suffered
the most from myopic loss aversion and acted upon it by selling stocks did less well
much less well than those who were able to resist the natural impulse and
instead hold their ground.
1

Terence Odean, Do investors trade too much?, American Economic Review (December
1999)

Terence Odean and Brad Barber, "Trading Is Hazardous to Your Wealth: The Common Stock
Investment Performance of Individual Investors," Journal of Finance 55, no. 2 (April 2000)
November 17, 2016

Ambit Capital Pvt. Ltd.

Page 11

Strategy

No churn: Finally, by holding a portfolio of stocks for over ten years, a fund
manager resists the temptation to buy/sell in the short term. With no churn, this
approach reduces transaction costs which add to the overall portfolio
performance over the long term. We illustrate this with an example below.
Assume that you invest US$100mn in a hypothetical portfolio on 30 June 2006.
Assume further that you churn this portfolio by 50% per annum (implying that a
typical position is held for two years) and this portfolio compounds at the rate of
Sensex Index. Assuming a total price impact cost and brokerage cost of 100bps
for every trade done over a ten-year period, this portfolio would generate CAGR
returns of 8.8%. Left untouched, however, the same portfolio would have Finally, churn has a significant
generated CAGR returns of 9.8%. This implies ~8.6% of the final corpus impact on overall portfolio returns
(~US$22mn in value terms) is lost to churn over the ten-year period. Thus, a
US$100mn portfolio that would have grown to US$252mn over the ten-year
period (30 June 2006 - 30 June 2016) in effect grows to US$230mn due to high
churn.

Having built the case for a coffee can construct, in the next section we discuss the
framework we use to identify stocks for the Coffee Can Portfolio.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 12

Strategy

A framework for constructing the Indian


Coffee Can Portfolio
There are multiple rule-based approaches that one can use for portfolio construction.
For example, Joel Greenblatts Magic Formula and Joseph Piotroskis F-score
screener are some of the well-known approaches that can be used for portfolio
construction. Even at Ambit, we use our proprietary greatness framework to identify
quality franchises that have consistently been showing an improvement in their
financial performance over a six-year period. [Note: We have now made both our
proprietary greatness and accounting frameworks available for access to our
clients using HAWK. Please contact your sales representative if you are yet to receive
your login credentials for access to the HAWK platform.]
Thus, whilst there are multiple rule-based approaches for portfolio construction most
of these rule-based approaches however usually require a periodic rebalance of the
portfolio and will, hence, not be directly useful for the coffee can construct.
We, therefore, start with the basic principles of investing for our stock selection. At the
very basic level, a company doing well would mean that it is profitable and is
growing. The twin filters of growth and profitability, in our view, are sufficient to
assess the success of a franchise. Our tests of stock selection, therefore, center
around a long-term track record of delivery on revenue growth and RoCE generation.

We start with the basic investing


principles for our stock selection

Exhibit 7: A combination of superior RoCE and revenue growth is a winner in the


Indian context*
Average outperformance - 10-year CAGR
11.1%

12.0%
10.0%
8.0%
6.0%
4.0%

4.9%
2.6%

2.0%
0.0%
Superior on Revenue
growth

Superior on RoCE

Superior on both

Source: Bloomberg, Ambit Capital research. Note: * The universe is 2006s BSE200 firms (ex-financials);
performance relative to the BSE200 Index; the chart is based on price data from 31 March 2006 to 31 March
2016. The red bars denote the 10-yr share price performance of top quartile stocks on revenue growth, RoCE as
well as a combination of both from the BSE200 universe.

Specifically, we use the following filters.

Pre-tax return on capital employed of 15% for each of the last ten years
Why pre-tax RoCE? Whilst management teams have a natural desire for growth
and scale, growth creates shareholder value only when the returns on capital Stocks with superior RoCE have
exceed the cost of capital. RoCE, therefore, is of utmost importance in assessing a outperformed their peers over the
firms performance. Our empirical work on the share price performance of Indian last ten-year period
companies also supports the primacy of RoCE as a share price driver (see the
exhibit above). As shown in the exhibit above, BSE200 firms (ex-BFSI) with
superior revenue growth (in the top quartile) during the 10-year period over
FY06-16 outperformed the BSE200 Index by 2.6% on a CAGR basis. However,
firms with a superior RoCE growth gave a higher outperformance of 4.9%. The
best outperformance during this period was given by firms that were superior on
both revenue growth and RoCE at 11.1%.
Why 15%? The weighted average cost of capital (before taxes) for Indian
15% RoCE is the minimum return
companies is around 13-14% (assuming an equal mix of debt and equity; ~11%
required to beat the cost of capital
cost of debt and ~15% cost of equity). Adding the risk-free rate (7.5-8% in India)
in India
and an equity risk premium of 6-6.5% too gives a cost of capital broadly in that

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 13

Strategy
range. The equity risk premium, in turn, is calculated as 4% (the long-term US
equity risk premium) plus 250bps to account for Indias rating (BBB- as per S&P).
We, thus, use 15% as a minimum because we believe that that is the bare
minimum return required to beat the cost of capital which for the vast majority of
listed companies is at least 14%.
Further, from our earlier discussions, we note that over the past 30 years, the
Sensex has delivered returns of around 15% per annum, validating our point of
view that 15% is a sensible figure to use as a minimum RoCE (pre-tax) criteria.

Revenue growth of 10% every year for each of the last ten years: Indias
nominal GDP growth rate has averaged 15% over the past ten years (FY05-14). A
firm operating in India should, therefore, be able to deliver sales growth of at
least 15% per annum. However, very few listed companies (only 8 out of the
~1,480 firms run under our screen), have managed to achieve this! Therefore,
we reduce this filter rate modestly to 10%; i.e. we look for companies that have
delivered revenue growth of 10% per annum every year for ten consecutive years.

Very few listed companies manage


to achieve a sales growth that
matches Indias nominal GDP
growth rate of 15%

In summary, our filters focus on a minimum pre-tax RoCE of 15% or more and sales
growth of 10% for more over ten consecutive years.
For financial services stocks, we modify the filters on RoE and sales growth as
follows:

Return on equity of 16% for each of the last ten years: We prefer return on
We use RoE of 16% and loan
equity over return on assets because it is a fairer measure of the banks ability to
growth of 15% as filters to screen
generate higher income efficiently on a given equity capital base over time.
BFSI stocks
We use 16% as a minimum because we believe that is the bare minimum return
required to meet the cost of equity for Indian lenders (for the vast majority of
Indian lenders, cost of equity is at least 15%).

Loan growth of 15% every year for each of the last ten years: We believe
loan growth of 15% is an indication of a banks ability to lend over business
cycles. Strong lenders ride the downcycle better as competitive advantages
surrounding their origination, appraisal and collection process ensure that they
continue their growth profitably either through market-share improvements or
upping the ante in sectors which are resilient during a downturn.

Finally, for all the stocks considered for the Coffee Can Portfolio, we put a marketcap threshold of `1bn. India is the least liquid among the worlds 15 largest equity
markets. Thus, for institutional clients, we believe a market capitalisation of `1bn is
the bare minimum to take a position in the stock. Stocks smaller than this tend to be
illiquid and create high impact costs.

We use a market-cap threshold of


`1bn

Whilst these twin filters of revenue growth and RoCE may appear simplistic in nature,
through our approach we are not looking for optimal candidates with the highest
growth and highest RoCE, as reversion to mean is an accepted fact in corporate life.
Instead, we base our selection on a system of guard rails which helps us assess which
firms have what it takes to protect themselves and march ahead through good as well
as bad times. This approach is also different to that taken in our other portfolio
constructs that focus on comparatively shorter holding periods, where we are more
focused on directional progress. More details on these can be found in the Appendix
1 - How the Coffee Can is different to our other portfolio constructs.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 14

Strategy

Does the approach work? Results from our


back-testing
Having built a case for the coffee can construct and a framework for identifying these
coffee can stocks, we now discuss results from our back-testing of the framework.

We back-test the framework and


the results are revealing

Using the twin filters of growth and profitability discussed in the previous section, we
ran back-tests of the CCP over the last sixteen years (i.e. portfolios initiated annually
from 2000 to 2015), including seven portfolios that have run their entire course of
ten-years (2000-2010, 2001-2011, 2002-2012, 2003-2013, 2004-2014, 20052015 and 2006-2016) and nine portfolios (starting 2007) which have not yet
completed their 10 years. We also show the performance of a separate large-cap
CCP consisting solely of stocks that were in the top-100 stocks by market cap (at the
start of the period under consideration).
We have also stress-tested these results for maximum drawdown to test the strength
of the portfolio during periods of market volatility:
First, we calculate CAGR returns for each of the 16 portfolios and the Sensex;

Next, we compute the maximum drawdown (defined as the maximum drop in


cumulative returns from the highest peak to the lowest subsequent trough); and

Finally, we calculate the risk-adjusted returns; i.e. returns in excess of the riskfree rate (assumed at 8%, comparable to the last ten year average 10-yr
Government bond yield of 7.9%) divided by the absolute maximum drawdown.

Performance of the previous coffee can portfolios vs Sensex using share price
returns
In the exhibit below, we have shown the performance of each of the preceding 16
coffee can portfolios vs Sensex based on share price returns (without including any
dividends):
Exhibit 8: Back-testing results of sixteen iterations of the Coffee Can Portfolio (vs Sensex index) using share price returns
Kick-off
year*

All-cap
CCP (start)

All-cap
CCP (end)

CAGR
return

Outperformance
relative to Sensex

Large-cap
CCP (start)

Large-cap
CCP (end)

CAGR
return

Outperformance
relative to Sensex

2000

500

2,923

2001

600

7,366

19.3%

5.3%

400

2,602

20.6%

6.5%

28.5%

10.0%

300

2,685

24.5%

6.0%

2002

800

6,057

22.4%

4.1%

500

3,348

20.9%

2.6%

2003

900

8,668

25.4%

7.1%

600

6,754

27.4%

9.1%

2004

1,000

14,618

30.8%

12.6%

500

3,097

20.0%

1.9%

2005

900

5,795

20.5%

6.0%

500

2,517

17.5%

3.1%

2006

1,000

5,414

18.4%

8.6%

600

2,524

15.4%

5.7%

2007

1,500

6,697

17.5%

10.3%

1,000

3,892

15.8%

8.6%

2008

1,100

5,167

20.6%

11.4%

800

3,136

18.0%

8.8%

2009

1,100

4,431

21.2%

11.7%

900

2,780

16.8%

7.4%

2010

700

1,892

17.2%

9.7%

300

903

19.3%

11.7%

2011

1,400

2,361

10.5%

2.7%

400

860

15.7%

8.0%

2012

2,200

5,118

21.9%

10.3%

500

1,018

18.2%

6.5%

2013

1,800

4,564

33.1%

21.3%

600

1,234

24.8%

13.0%

2014

1,600

2,290

21.0%

21.4%

700

950

17.6%

18.0%

2015

2,000

2,366

18.3%

13.8%

1,200

1,308

9.0%

4.5%

Source: Bloomberg, Capitaline, Ambit Capital research. Note: Portfolio at start denotes an equal allocation of `100 for the stocks qualifying to be in the CCP for
that year. *The Portfolio kicks off on 30th June of every year. CAGR returns for all the portfolios since 2007 have been calculated until 30th Sep16 (except for the
live portfolios for the years 2014 and 2015 for which CAGR returns and absolute returns have been calculated since these portfolios were launched in Nov 15 and
Nov 16 respectively).

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 15

Strategy
Performance of the previous coffee can portfolios vs Sensex using total
shareholder returns
In the exhibit below, we have shown the performance of each of the preceding 16
coffee can portfolios vs Sensex using the total shareholder returns (i.e. assuming that
dividends are reinvested back into the same stock on the ex-dividend date).
We summarise the results of each of these 16 iterations in the table below. For
details on the portfolio constituents, please refer to the Appendix 2.
Exhibit 9: Back-testing results of 16 iterations of the Coffee Can Portfolio (vs Sensex index) using total shareholder returns
Kick-off
year*

All-cap
CCP (start)

All-cap
CCP (end)

CAGR
return

Outperformance
relative to Sensex

Large-cap
CCP (start)

Large-cap
CCP (end)

CAGR
return

Outperformance
relative to Sensex

2000

500

3,831

22.6%

6.6%

400

3,338

23.6%

7.6%

2001

600

9,802

32.2%

11.7%

300

3,622

28.3%

7.8%

2002

800

7,709

25.4%

5.1%

500

4,182

23.7%

3.3%

2003

900

10,175

27.4%

7.2%

600

7,791

29.2%

9.0%

2004

1,000

16,849

32.6%

12.7%

500

3,679

22.1%

2.1%

2005

900

6,643

22.1%

6.0%

500

2,968

19.5%

3.4%

2006

1,000

6,376

20.4%

9.0%

600

2,918

17.1%

5.7%

2007

1,500

7,828

19.5%

10.8%

1,000

4,426

17.4%

8.7%

2008

1,100

5,724

22.1%

11.2%

800

3,444

19.3%

8.5%

2009

1,100

4,843

22.7%

11.5%

900

3,054

18.3%

7.2%

2010

700

2,042

18.7%

9.5%

300

959

20.4%

11.2%

2011

1,400

2,550

12.1%

2.7%

400

914

17.0%

7.6%

2012

2,200

5,356

23.3%

9.9%

500

1,066

19.5%

6.1%

2013

1,800

4,762

34.8%

21.4%

600

1,286

26.4%

12.9%

2014

1,600

2,331

22.2%

21.0%

700

969

18.9%

17.8%

2015

2,000

2,387

19.3%

13.4%

1,200

1,323

10.3%

4.3%

Source: Bloomberg, Capitaline, Ambit Capital research. Note: Portfolio at start denotes an equal allocation of `100 for the stocks qualifying to be in the CCP for
that year. *The Portfolio kicks off on 30th June of every year. CAGR returns for all the portfolios since 2007 have been calculated until 30th Sep16 (except for the
live portfolios for the years 2014 and 2015 for which CAGR returns and absolute returns have been calculated since these portfolios were launched in Nov 15 and
Nov 16 respectively).

The results are revealing and can be summarised as follows:


Each of the 16 CCPs has comprehensively outperformed the benchmark
Sensex index.

Even the sub-set of the CCP, i.e. the large-cap version of the CCP has been
successful in beating the Sensex on all 16 occasions.

On a risk-adjusted basis (where we define risk as maximum drawdown), all the


16 iterations of the all-cap portfolio as well as the large-cap portfolio have
outperformed the Sensex.

The large-cap versions of the CCP have outperformed the all-cap versions in
2000, 2003, 2010 and 2011 (both on an absolute basis as well as risk-adjusted
basis). In the other versions, however, the all-cap version of the CCP has
delivered superior returns as compared to the respective large-cap versions on an
absolute basis.

Using total shareholder returns, the total portfolio returns improve by +1% to
+3.7% points (average 1.9% points) versus using only the share price returns.

November 17, 2016

Ambit Capital Pvt. Ltd.

16 iterations of the CCP that we


initiated from 2000 to 2015 prove
the potential of the CCP to beat the
Sensex and the BSE200

Page 16

Strategy
Performance of the previous coffee can portfolios vs BSE200 index using total
shareholder returns
From exhibits 8 and 9 above we note that the previous sixteen iterations of the coffee
can portfolios have comprehensively outperformed the benchmark Sensex index in all
the iterations. Further, using total shareholder returns versus only the share price
returns, the total returns for the portfolio improve by +1% to +3.7% points.
In exhibit 10 below, we now plot the performance of these portfolios vs broader
market indices, such as the BSE200 index. The results, however, remain the same
with all the sixteen all-cap coffee can portfolios and fifteen of the sixteen large-cap
coffee can portfolios managing to beat the benchmark BSE200 index
comprehensively (see Exhibit 10 below):
Exhibit 10: Back-testing results of sixteen iterations of the Coffee Can Portfolio (vs BSE200 index)
Kick-off
year*

All-cap
CCP (start)

All-cap
CCP (end)

CAGR
return

Outperformance
relative to BSE200

Large-cap
CCP (start)

Large-cap
CCP (end)

CAGR
Outperformance
return relative to BSE200

2000

500

3,831

22.6%

5.1%

400

3,338

23.6%

6.1%

2001

600

9,802

32.2%

9.8%

300

3,622

28.3%

5.9%

2002

800

7,709

25.4%

4.9%

500

4,182

23.7%

3.2%

2003

900

10,175

27.4%

7.7%

600

7,791

29.2%

9.5%

2004

1,000

16,849

32.6%

13.4%

500

3,679

22.1%

2.8%

2005

900

6,643

22.1%

6.2%

500

2,968

19.5%

3.6%

2006

1,000

6,376

20.4%

8.1%

600

2,918

17.1%

4.9%

2007

1,500

7,828

19.5%

9.9%

1,000

4,426

17.4%

7.8%

2008

1,100

5,724

22.1%

10.1%

800

3,444

19.3%

7.3%

2009

1,100

4,843

22.7%

10.2%

900

3,054

18.3%

5.9%

2010

700

2,042

18.7%

8.6%

300

959

20.4%

10.4%

2011

1,400

2,550

12.1%

0.9%

400

914

17.0%

5.9%

2012

2,200

5,356

23.3%

7.6%

500

1,066

19.5%

3.8%

2013

1,800

4,762

34.8%

17.5%

600

1,286

26.4%

9.1%

2014

1,600

2,331

22.2%

16.5%

700

969

18.9%

13.2%

2015

2,000

2,387

19.3%

8.7%

1,200

1,323

10.3%

-0.4%

Source: Bloomberg, Capitaline, Ambit Capital research. Note: Portfolio at start denotes an equal allocation of `100 for the stocks qualifying to be in the CCP for
that year. *The Portfolio kicks off on 30th June of every year. CAGR returns for all the portfolios since 2007 have been calculated until 30th Sep16 (except for the
live portfolios for the years 2014 and 2015 for which CAGR returns and absolute returns have been calculated since these portfolios were launched in Nov 15 and
Nov 16 respectively).

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 17

Strategy

Performance of the coffee can portfolios


launched in 2014 and 2015
In our 17 November 2014 thematic: The Indian Coffee Can Portfolio, we had
launched the first Coffee Can Portfolio for investors (to be held from 2014-2024). We
followed this up with the second Coffee Can Portfolio that was launched in our 02
November 2015 thematic: The Coffee Can Portfoliothe coffee works!

We launched the first two iterations


of the Coffee Can Portfolio in Nov
15 and Nov 16

Whilst the whole premise of our Coffee Can Portfolio is based on holding the
portfolio stocks for a period of 10 years without being perturbed by the short-term
fluctuations in the share prices, a look at the performance of these portfolios suggests
that both these portfolios have done extremely well vs. the Sensex.
The Coffee Can Portfolio launched in 2014 has generated total returns of 17.6% (on
a CAGR basis) vs total CAGR returns of -0.8% for the benchmark Sensex index since
initiation.
Similarly, the Coffee Can Portfolio launched in 2015 has generated total CAGR
returns of 11.7% vs total CAGR returns of 2.1% for the benchmark Sensex index since
initiation (see Exhibits 11 and 12 below):

Both these portfolios have done


extremely well vs the Sensex index

Exhibit 11: Performance of the 2014 Coffee Can Portfolio since initiation
Value at start
(`)

Value at end
(`)

14-Nov-14

11-Nov-16

ITC

100

103

2%

Asian Paints

100

145

21%

Godrej Consumer

100

149

22%

Marico

100

153

24%

Ipca Labs.

100

82

-9%

Berger Paints

100

170

31%

Page Industries

100

149

22%

Balkrishna Inds

100

147

21%

eClerx Services

100

148

22%

Mayur Uniquote

100

100

0%

V-Guard Inds.

100

220

49%

HCL Technologies

100

100

0%

HDFC Bank

100

139

18%

Axis Bank

100

106

3%

City Union Bank

100

168

30%

GRUH Finance

100

131

15%

1,600

2,212

17.6%

100

98

-0.8%

Company
Date from/to

Portfolio*
Sensex
Outperformance

Total return
CAGR

18.4%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `1,600 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period (11 November 2016). Thus, for this period, the value of the portfolio rose from `1,600 at the start to
`2,212 at the end.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 18

Strategy
Exhibit 12: Performance of the 2015 Coffee Can Portfolio since initiation
Company

Value at start (`)

Value at end (`)

01-Nov-15

11-Nov-16

Total return
CAGR

HCL Technologies

100

90

-9%

ITC

100

111

11%

Lupin

100

76

-23%

Asian Paints

100

117

16%

Cadila Health.

100

92

-8%

Britannia Inds.

100

96

-4%

Marico

100

129

28%

GlaxoSmith C H L

100

90

-10%

Colgate-Palm.

100

101

1%

Amara Raja Batt.

100

107

7%

Page Industries

100

101

1%

Berger Paints

100

137

36%

eClerx Services

100

103

3%

Astral Poly

100

101

1%

V-Guard Inds.

100

222

117%

Cera Sanitary.

100

115

15%

HDFC Bank

100

117

16%

Axis Bank

100

106

6%

LIC Housing Fin.

100

110

9%

GRUH Finance

100

119

18%

2,000

2,241

11.7%

100

102

Date from/to

Portfolio*
Sensex
Outperformance

2.1%
9.6%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `2,000 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period (11 November 2016). Thus, for this period, the value of the portfolio rose from `2,000 at the start to
`2,241 at the end.

Note that amongst the stocks in our Coffee Can Portfolio 2014, five stocks missed out
on making it to the Coffee Can Portfolio for the year 2015. These were Godrej
Consumer, Ipca Labs, Balkrishna Industries, Mayur Uniquoters and City Union Bank.
Similarly, from our Coffee Can Portfolio for the year 2015, 6 stocks miss out on
making it to this years Coffee Can Portfolio. Please see the section on Todays
Coffee Can for 2016-2016 on Pg 19 for details on this years candidates. The stocks
that do not make it to this years portfolio are:

6 stocks miss out on making it to


this years Coffee Can Portfolio

Exhibit 13: Stocks that do not make it to this years iteration of the Coffee Can
Portfolio
Company name

Reasons for exclusion

ITC delivered sales growth of 2% in FY16; hence does not clear the coffee can filter
on ten consecutive years of sales growth in excess of 10%
Marico delivered sales growth of 7% in FY16; hence does not clear the coffee can
Marico
filter on ten consecutive years of sales growth in excess of 10%
GSK Consumer's sales have been flat in FY16; hence does not clear the coffee can
GSK Consumer
filter on ten consecutive years of sales growth in excess of 10%
Colgate Palmolive delivered sales growth of ~4.5% in FY16; hence does not clear
Colgate Palmolive
the coffee can filter on ten consecutive years of sales growth in excess of 10%
Berger Paints delivered sales growth of ~7.2% in FY16; hence does not clear the
Berger Paints
coffee can filter on ten consecutive years of sales growth in excess of 10%
V-Guard Industries delivered sales growth of ~6.7% in FY16; hence does not clear
V-Guard Industries
the coffee can filter on ten consecutive years of sales growth in excess of 10%
Source: Company filings, Ambit Capital research
ITC

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 19

Strategy
Should investors rebalance the coffee can portfolios for the years 2014 and
2015?
With 6 out of last years 20 stocks not featuring in this years Coffee Can Portfolio,
the obvious question one would ask is whether to rebalance the 2014 and 2015
portfolios to include the stocks figuring in this years iteration.
Here we point investors to our 02 November 2015 thematic: The Coffee Can
Portfoliothe coffee works! In our 02 November 2015 note, we compared the
results of a buy and hold strategy vs an annual rebalancing strategy of the Coffee
Can Portfolio over six ten-year iterations starting year 2000.

We advise investors to refrain from


rebalancing
the
coffee
can
portfolios

The results from our analysis have been reproduced in Exhibit 14 below:
Exhibit 14: Share price CAGR returns over 10-year periods for CCP with and without
rebalancing

CCP without rebalancing

20002010

20012011

20022012

20032013

20042014

20052015

Median
CAGR

19.3%

28.5%

22.4%

25.4%

30.8%

20.5%

23.9%

CCP with rebalancing


18.5%
22.6%
22.0%
17.0%
18.7%
13.5%
18.6%
Difference (w/o minus with
0.8%
5.9%
0.4%
8.4%
12.0%
6.9%
5.3%
rebalancing)
Source: Bloomberg, Ambit Capital Research Note: Dates refer to the first year and last year of the ten-year
holding period. Performance has been measured over a 10-yr period starting from June of the first year and
ending with June of the last year. This exhibit has been reproduced without any changes from our 02 November
2015 thematic: The Coffee Can Portfoliothe coffee works!

As can be seen in the results above (Exhibit 14), the Coffee Can approach without
rebalancing has outperformed with rebalancing approach on all six occasions. The
median CAGR for CCP without rebalancing over these six iterations was 23.9% vs
18.6% for CCP with rebalancing. These results reaffirm the advantage of the buy
and hold approach over an annual rebalancing approach even with the weights of
repeating stocks unchanged in the portfolio.
How should investors deploy fresh capital received every year?
Whilst the coffee can construct advocates the buy and hold approach, we agree
that one of the challenges investors face is using the coffee can construct. How
should investors deploy fresh fund inflows that are received every year? We discuss
this aspect in the next section.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 20

Strategy

Optimal way to deploy fresh funds each


year
From our previous discussions, we note that the coffee can construct advocates the
buy and hold approach, i.e. once invested the portfolio should be kept untouched
for a decade. That said, we agree that as fund managers, one of the challenges
investors face is how the fresh fund inflows that are received every year should be
deployed.

How should investors deploy fresh


funds every year under the CCP
construct?

To address this, we discuss two scenarios:

We evaluate
scenarios

In Scenario 1, the fresh inflows every year are assumed to remain constant.

this

under

two

In Scenario 2, the fresh inflows received every year are assumed to grow at 20% each
year over the 10-year life of a particular Coffee Can Portfolio.
Scenario 1 - Fresh fund inflows every year are assumed to remain constant
In scenario 1, we assume that `100 is invested in the initial Coffee Can Portfolio (say
for example the Coffee Can Portfolio that was launched in Jun 00). We further
assume that the `100 invested in the initial coffee can is left untouched and is
allowed to compound over the subsequent ten years. Each year, as the investor gets
fresh fund inflows (the fresh fund inflows are assumed to remain constant at `100
each year; dividends declared during the year are invested in the portfolio for the
subsequent year), the funds received are deployed in that years Coffee Can Portfolio.
So, for example, in Jun 01, when an investor receives `100 more, these funds are
deployed in the Coffee Can Portfolio for the year 2001 (and allowed to compound
over the remaining 9 years of the initial coffee can). Any dividends that were declared
by any of the stocks in the initial Coffee Can Portfolio too are deployed in the Coffee
Can Portfolio for the year 2001. Similarly, in Jun 02, when the investor receives
another `100, these funds are deployed in the Coffee Can Portfolio for the year 2002
along with any dividend declared by stocks in the coffee can portfolios for the years
2000 and 2001 (and all these funds are allowed to compound over the remaining 8
years of the initial coffee can), and so on.

In scenario 1 we assume the fresh


fund inflows to be constant each
year

We repeat this exercise for each of the subsequent coffee can portfolios (i.e. the
coffee can portfolios for the years 2001-11, 2002-12, 2003-13, 2004-14, 2005-15
and finally for the years 2006-16).
The results from the analysis have been summarised in exhibit 15 below:
Exhibit 15: Portfolio returns assuming constant fund inflows every year
Weight in the portfolio (%):
Total stocks

Top 5 stocks

Next 5 stocks

Remaining
stocks

Overall

Portfolio IRR

Sensex IRR

Alpha (Portfolio
vs Sensex)

2000-10

30

62.33

23.70

13.96

100.00

29.7%

21.4%

8.3%

2001-11

31

57.78

24.44

17.79

100.00

29.5%

21.0%

8.5%

2002-12

36

53.14

26.56

20.30

100.00

25.1%

16.9%

8.2%

2003-13

46

54.65

24.29

21.05

100.00

23.3%

15.1%

8.1%

2004-14

48

53.88

17.50

28.63

100.00

25.6%

15.7%

9.9%

2005-15

50

49.15

18.10

32.76

100.00

21.6%

13.5%

8.1%

2006-16

57

46.48

15.66

37.86

100.00

19.9%

10.2%

9.7%

Average

43

53.92

21.46

24.62

100.00

25.0%

16.3%

8.7%

Median

46

53.88

23.70

21.05

100.00

25.1%

15.7%

8.3%

Source: Bloomberg, Ambit Capital research

Number of stocks: As can be seen in Exhibit 15 above, a typical portfolio,


assuming fresh funds received every year are invested in the Coffee Can Portfolio
for that particular year, has about 43 stocks.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 21

Strategy

Portfolio returns are significantly higher than Sensex returns for each of
the seven iterations: Not only has each of the seven portfolios delivered
healthy IRR (average IRR for the seven portfolios is ~25.0%), each of the
portfolios has quite comprehensively beaten the benchmark Sensex index (with
an average outperformance of ~8.7%).

Portfolio weight: Note that whilst the number of stocks in the portfolio is high,
the top 5 stocks (in terms of value of the stock in the portfolio by the end of year
10) comprise around 54% of the portfolio value by the end of year 10. Further,
the next 5 stocks constitute ~21.5% of the portfolio value by the end of year 10.
The more interesting thing to note, however, is that the remaining 33 stocks
comprise only the remaining 24.6% of the portfolio value at the end of year 10.
This means ~23% of the stocks comprise ~75% of the total portfolio value.

Scenario 2- Fresh fund inflows every year are assumed to grow at 20% each
year over the 10-year life of a particular Coffee Can Portfolio
In scenario 2, we assume that `100 is invested in the initial Coffee Can Portfolio (say
for example the Coffee Can Portfolio that was launched in Jun 00). Further, just like
the previous scenario, we assume that the `100 invested in the initial coffee can is
left untouched and is allowed to compound over the subsequent ten-year period. In
this scenario, however, we assume that the fresh fund flows received by the investor
grow at 20% each year. So, for example, in Jun 01, the investor receives fresh
inflows of `120 (i.e. a 20% increase over the `100 received in Jun 00), which is then
invested in the Coffee Can Portfolio for the year 2001 and is then allowed to
compound over the remaining 9 years of the initial coffee can. Here again we
assume that any dividends that were declared by any of the stocks in the initial
Coffee Can Portfolio are deployed in the Coffee Can Portfolio for the year 2001.
Similarly, in Jun 02, the investor receives `144 more (i.e. a 20% increase over the
`120 received in Jun 01), which along with any dividend declared by stocks in the
coffee can portfolios for the years 2000 and 2001, is then invested in the Coffee Can
Portfolio for the year 2002 and is allowed to compound over the remaining 8 years of
the initial coffee can; and so on.

In scenario 2, we assume the fresh


fund inflows to increase by 20%
each year

We repeat this exercise for each of the subsequent coffee can portfolios (starting with
the coffee can for the years 2001-11 and ending with the coffee can for the years
2006-16).
Exhibit 16 below summarises the results from our analysis.
Exhibit 16: Portfolio returns assuming fund inflows every year grow at 20%
Total stocks

Weight in the portfolio (%):


Top 5

Next 5

Others

Overall

Portfolio IRR

Sensex IRR

Alpha (Portfolio
vs Sensex)

2000-10

30

55.29

23.94

20.77

100.00

29.9%

21.4%

8.4%

2001-11

31

49.65

25.15

25.20

100.00

28.3%

19.7%

8.5%

2002-12

36

45.04

25.26

29.70

100.00

23.4%

14.3%

9.1%

2003-13

46

48.16

21.75

30.09

100.00

20.4%

13.0%

7.4%

2004-14

48

45.94

15.40

38.66

100.00

24.8%

15.3%

9.6%

2005-15

50

41.37

16.58

42.05

100.00

22.4%

13.5%

8.9%

2006-16

57

38.40

16.54

45.06

100.00

20.1%

9.9%

10.2%

Average

43

46.26

20.66

33.07

100.00

24.2%

15.3%

8.9%

Median

46

45.94

21.75

30.09

100.00

23.4%

14.3%

8.9%

Source: Bloomberg, Ambit Capital research

Exhibit 16 above suggests that whilst the total number of stocks in the portfolio would
remain the same, the top 5 stocks (in terms of value of the stock in the portfolio by
the end of year 10) comprise around 46% of the portfolio value by the end of year
10. Further, the next 5 stocks constitute ~21% of the portfolio value by the end of
year 10. The remaining 33 stocks, however, continue to comprise only ~33% of the
portfolio value by the end of year 10. Here again, the key thing to note is that ~23%
of the stocks comprise ~67% of the total portfolio value by the end of year 10. The
portfolio IRR remains healthy at ~24.2% (vs ~15.3% for the Sensex index).
November 17, 2016

Ambit Capital Pvt. Ltd.

Under both the scenarios, the


portfolio continues to generate
healthy IRRs vs the Sensex index

Page 22

Strategy
We believe exhibits 15 and 16 above bring out a very important aspect of the coffee
can construct; which is, allowing the power of compounding to work its magic is a
much more important driver of long-term returns than the most ideal stock selection
itself. This is also similar to what we had seen in Exhibit 5 on page 10, where even
with a 50% strike rate and perfect symmetry around the returns generated by winning
and losing stocks, the portfolio when left untouched for longer periods of time
compounds well. This is because over time the losing stocks become insignificant
while the portfolio returns are gradually dominated by the winners.

The more important thing to note is


that ~23% of the stocks comprise
65-75% of the end portfolio value

What is the ideal life for a Coffee Can Portfolio?


Having discussed the virtues of the coffee can construct, in the next section we will
discuss how the returns as well as risk profile for the Coffee Can Portfolio are over a
shorter time horizon. Further, using historical analysis, we will discuss whether an
investor should terminate the Coffee Can Portfolio over a shorter time horizon or
would he be better off keeping the portfolio untouched for a decade.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 23

Strategy

The ideal life of a Coffee Can Portfolio


The entire coffee can construct is premised on investing in quality franchises with a
long-term track record of superior financial performance over longer periods of time.
Further, as discussed in the preceding sections of the note, one of the reasons the
coffee can construct works well is because a longer period of time (usually ten years)
allows the power of compounding to play out its magic. Over the longer term, the
coffee can construct allows the portfolio to be dominated by the winning stocks whilst
losing stocks keep declining to eventually become inconsequential.
Performance of the coffee can portfolios over a shorter time horizon
Whilst, historically, we have advocated a 10-year holding period for the Coffee Can
Portfolio, one of the questions that several investors have asked us is how are the
returns as well as the risk profile over a shorter period of time (such as five years).
In that context, in exhibit 17 below, we have shown the returns as well as the risk
profile for each of the preceding 16 iterations of the Coffee Can Portfolio over a
shorter time horizon (i.e. 5 years).

We analyse the CCP returns over a


shorter time horizon

Exhibit 17: Performance of the previous 16 iterations of the Coffee Can Portfolio over a 5-year period
Kick-off
year*

All-cap
CCP (start)

All-cap
CCP (end)

CAGR
return

Outperformance
relative to Sensex

Large-cap
CCP (start)

Large-cap
CCP (end)

CAGR
return

Outperformance
relative to Sensex

2000

500

1,150

18.1%

7.3%

400

925

18.2%

7.4%

2001

600

2,409

32.1%

4.3%

300

1,320

34.5%

6.8%

2002

800

4,006

38.0%

0.1%

500

2,667

39.8%

1.8%

2003

900

3,771

33.2%

0.9%

600

3,089

38.8%

6.5%

2004

1,000

3,904

31.3%

4.7%

500

1,769

28.8%

2.2%

2005

900

2,525

22.9%

1.6%

500

1,606

26.3%

4.9%

2006

1,000

2,029

15.2%

1.5%

600

1,458

19.4%

5.7%

2007

1,500

2,685

12.3%

7.4%

1,000

1,968

14.5%

9.5%

2008

1,100

2,670

19.4%

10.2%

800

1,875

18.6%

9.3%

2009

1,100

3,529

26.3%

12.6%

900

2,203

19.6%

6.0%

2010

700

1,764

20.3%

9.2%

300

708

18.7%

7.6%

2011

1,400

2,335

10.8%

1.6%

400

828

15.6%

6.5%

2012

2,200

5,356

23.3%

9.9%

500

1,066

19.5%

6.1%

2013

1,800

4,762

34.8%

21.4%

600

1,286

26.4%

12.9%

2014

1,600

2,331

22.2%

21.0%

700

969

18.9%

17.8%

2015

2,000

2,387

19.3%

13.4%

1,200

1,323

10.3%

4.3%

Source: Bloomberg, Capitaline, Ambit Capital research. Note: Portfolio at start denotes an equal allocation of `100 for the stocks qualifying to be in the CCP for
that year. *The Portfolio kicks off on 30th June of every year. CAGR returns for all the portfolios since 2012 have been calculated until 30th Sep16 (except for the
live portfolios for the years 2014 and 2015 for which CAGR returns and absolute returns have been calculated since these portfolios were launched in Nov 15 and
Nov 16 respectively).

The results can be summarised as follows:


Even over shorter time horizons, each of the 16 CCPs has outperformed the
benchmark Sensex index.

Even the sub-set of the CCP i.e., the large-cap version of the CCP, has been
successful in beating the Sensex on all 16 occasions.

On a risk-adjusted basis (where we define risk as maximum drawdown), 14 out of


the 16 iterations of the all-cap portfolio as well as the large-cap portfolio
have outperformed the Sensex.

Even over shorter time horizons,


the 16 iterations of the CCP that
we initiate from 2000 to 2015
have beaten the benchmark
Sensex index

What is the optimal holding period for a Coffee Can Portfolio?


Exhibit 17 above suggests that each of the previous sixteen iterations of the Coffee
Can Portfolio has handsomely outperformed the benchmark Sensex index; both on
an absolute basis as well as on a risk-adjusted basis.
Given the outperformance for the coffee can portfolios even over a shorter time
period (i.e. 5 years), the obvious question one would ask is whether investors should
terminate the Coffee Can Portfolio after 5 years instead of 10 years.

November 17, 2016

Ambit Capital Pvt. Ltd.

Should investors terminate the CCP


after 5 years instead of 10 years?

Page 24

Strategy
To answer this, in exhibit 18 below, we have summarised the portfolio returns under
two different scenarios:
Scenario 1- Each of the seven completed coffee can portfolios are left untouched for
a decade.
Scenario 2- Each of these seven coffee can portfolios is allowed to compound for the
first 5 years of the life of the portfolio. At the end of year 5, the portfolio value of
stocks that does not clear our coffee can filters in year 5 is equally allocated to the
fresh stocks that meet the coffee can criteria in year 5. So, for example, from the
Coffee Can Portfolio for the year 2000, Cipla, Hero MotoCorp and HDFC continued
to meet the coffee can thresholds in 2005. NIIT and Swaraj Engines however failed to
meet the coffee can criteria in 2005. Hence, we allocate the portfolio value of NIIT
and Swaraj Engines at the end of year 5 equally to all the fresh stocks that meet our
coffee can thresholds in 2005 (in this case: Infosys, Container Corporation,
Geometric, Havells India, Ind-Swift and Munjal Showa). We repeat this exercise for
the periods of 2001-11, 2002-12, 2003-13, 2004-14, 2005-15 and 2006-16.
In both the scenarios we assume a total price impact cost plus brokerage cost of
100bps for every trade done over the ten year period. The portfolio attributes under
each of the two scenarios discussed above can be seen in exhibit 18 below:
Exhibit 18: Performance of the coffee can portfolios under the two scenarios
Scenario 1
Phase
2000-10

Scenario 2

Growth of `99
CAGR returns for
invested at the beg
the portfolio
of the period*
22.6%
759

Scenario 1 vs Scenario 2
Excess CAGR
Loss of terminal
returns under
portfolio value
Scenario 1
under Scenario 2
-0.2%
1%

Growth of `99
CAGR returns for
invested at the beg
the portfolio
of the period*
22.7%
769

2001-11

32.2%

1,617

24.9%

913

7.3%

-44%

2002-12

25.4%

954

23.3%

803

2.1%

-16%

2003-13

27.4%

1,119

25.7%

976

1.7%

-13%

2004-14

32.6%

1,668

28.6%

1,222

4.1%

-27%

2005-15

22.1%

731

21.4%

686

0.8%

-6%

2006-16

20.4%

631

13.3%

344

7.1%

-45%

Average

26.1%

3.3%

-21%

22.8%

Source: Bloomberg, Ambit Capital research. Note: * after considering Re 1 in terms of brokerage and price impact cost.

The results from our analysis (see exhibit 18 above) have been summarised
below:

Under scenario 1, if an investor invests `100 in each of the seven coffee can
portfolios, the average returns generated by the investor over the seven iterations
of the portfolio is ~26.1%.

Under scenario 2, if the same investor invests `100 in each of the seven coffee
can portfolios (but decides to replace the exiting stocks in year 5 with stocks that
clear the coffee can filters in year 5), the average returns generated by the
investor over the seven iterations is ~22.8%.

Points 1 and 2 above suggest that if an investor decides to run the Coffee Can
Portfolio over a shorter time horizon (i.e. 5 years instead of 10 years), the overall
investment returns are lower by ~3.3% points.

In six out of the seven iterations, the portfolio value at the end of year 10 is
higher if the initial Coffee Can Portfolio is kept untouched for the decade.

The more astounding thing to note is that in two of the iterations (i.e. 2001-11
and 2006-16), the portfolio value at the end of year 10 is lower by 44% and 45%
respectively if an investor decides to churn the portfolio in year 5.

The results from our analysis yet again bring out the point that for the coffee can
construct to deliver its magic, the portfolio should be left untouched for the decade. A
shorter time horizon does not allow the power of compounding to work its magic.

Our analysis suggests for the


coffee can construct to play its
magic, the CCP should be left
untouched for a decade

Which are the stocks that clear our Coffee Can filters for 2016-2026?
Having discussed the virtues of the coffee can construct and establishing the ideal
time horizon over which one should remain invested in a typical Coffee Can Portfolio,
we now introduce the Coffee Can candidates for 2016-2026 in the next section.
November 17, 2016

Ambit Capital Pvt. Ltd.

Page 25

Strategy

Todays Coffee Can for 2016-2026


Introducing the Coffee Can candidates for 2016-2026
We screened Indias listed universe of non-BFSI stocks with a market capitalisation of
more than `1bn that have delivered 10% sales growth and 15% RoCE (pre-tax) every
year for the past year. The list is mentioned in the exhibit below.
Exhibit 19: The short list of firms with superior RoCE (pre-tax) and superior sales
growth over the last ten years (FY06-16)
Share price performance
(ten-year CAGR rel. to Sensex) (%)

Mcap
(US$bn)

FY17
P/E

HCLT IN

17%

16.7

13.7

Asian Paints

APNT IN

30%

15.2

47.3

Lupin

LPC IN

31%

10.4

23.1

Cadila Health.

CDH IN

22%

5.9

25.0

Britannia Inds.

BRIT IN

22%

5.6

39.2

Page Industries

PAG IN

47%

2.7

61.0

Amara Raja Batt.

AMRJ IN

50%

2.6

29.8

Dr Lal PathLabs

DLPL IN

N/A

1.5

59.1

eClerx Services

ECLX IN

29%

0.9

15.2

Astral Poly

ASTRA IN

49%

0.8

35.6

Relaxo Footwear

RLXF IN

59%

0.7

36.5

Cera Sanitary.

CRS IN

47%

0.5

30.5

Superior on both

Ticker

HCL Technologies

Coffee Can 2016-2026 continues


to feature some of Indias mostsuccessful franchises as well as the
most-compelling
investment
themes

Source: Bloomberg, Capitaline, Ambit Capital research; Note: Share price performance has been measured over
a ten-year period (i.e. 31 March 2006 to 31 March 2016). In case of firms with a shorter listing history, the
performance has been measured over the shorter period (not less than 3 years). * Market-cap as on 10
November 2016. Page Industries, Dr. Lal PathLabs, eClerx Services, Astral Poly and Cera Sanitaryware were not
listed throughout the ten-year period and hence the financial data used is based on Draft Red Herring Prospectus
as provided by Capitaline, for periods prior to their IPOs.

As mentioned in the preceding sections, from our previous Coffee Can Portfolio,
stocks like Marico, GSK Consumer, Colgate Palmolive, Berger Paints, V-Guard
Industries and ITC do not find a place in this years coffee can.
The new additions this year include Dr. Lal PathLabs and Relaxo Footwear.
We run a similar filter for Indias listed BFSI stocks with a market-cap of more than
`1bn and: (a) an RoE of 16%; and (b) loan growth of 15% for every consecutive year Only 6 BFSI stocks meet our
for the past ten years. In a universe of 127 firms, a meagre 6 firms managed to pass screening filters
this test (representing a small fraction of ~5%). This handful of firms is shown in the
exhibit below.
Exhibit 20: The very short list of BFSI firms with superior RoE and superior loan book
growth (over FY05-15)
Share price performance
(Ten year CAGR rel. to Sensex) (%)
21%

Mcap
US$bn)
47.7

FY17
P/E
21.5

AXSB IN

20%

17.5

28.2

LICHF IN

29%

4.0

12.4

GRUH Finance

GRHF IN

40%

1.7

38.6

Repco Home Fin

REPCO IN

50%

0.6

22.0

Muthoot Cap. Serv

MTCS IN

30%

0.1

DNA

Superior on both

Ticker

HDFC Bank

HDFCB IN

Axis Bank
LIC Housing Fin.

Source: Bloomberg, Capitaline, Ambit Capital research; Note: Share price performance has been measured over
the last ten-year period (i.e. 31 March 2006 to 31 March 2016). In case of firms with a shorter listing history, the
performance has been measured over the shorter period (not less than 3 years). * Market-cap as on 10
November 2016. Repco Home Finance was not listed throughout the ten-year period and hence the financial
data used is based on Draft Red Herring Prospectus as provided by Capitaline, for periods prior to its IPO.

From the above list, we exclude Muthoot Capital Services due to its size.
Having identified the coffee can stocks for this years iteration of the Coffee Can
Portfolio, in the ensuing sections we will evaluate each of the companies forming part
of our Coffee Can Portfolio using John Kays IBAS framework.
John Kays IBAS framework has been discussed in greater details in Appendix 3: John
Kays IBAS Framework.
November 17, 2016

Ambit Capital Pvt. Ltd.

In the ensuing sections we evaluate


the stocks that feature in this years
CCP using John Kays IBAS
framework

Page 26

HDFC Bank
SELL
STRATEGY NOTE

HDFCB IN EQUITY

Flawless execution

BFSI

Changes to this position: STABLE

Banking on low-cost liabilities


Established in 1994, HDFC Bank is Indias largest private sector bank in terms of
assets. It holds ~4% market share in the total banking industry. The banks retail
loans form 51% of the loan book, with market-leading presence in most of the
retail product categories. Its corporate business has focused on working capital
financing. HDFC Bank has differentiated itself from its peers through its strategic
focus on granular low-cost franchise. Superior margins and controlled asset
quality have driven healthy average RoE of ~18% in the last ten years. A stable
management team and use of technology, since beginning, have further
facilitated the banks consistent performance.
Mastering the word execution
HDFC Bank focused on two key principles in its business building a stable and
low-cost liability base and winning clients by offering unique solutions (such as
technology-led capture of capital market floats). The bank has taken a long-term
approach of protecting its margins and asset quality rather than pursuing nearterm aggressive growth (e.g. avoided project finance-led growth in last six
years). Superior profitability has allowed HDFC Bank to sustain its capital
position mainly through internal profit generation without undue dilution of its
shareholders fund. The bank has made two acquisitions in the past, but its
recent focus has been on organic growth through accelerated branch network
expansion on a pan-India basis.

Recommendation
Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

`3,230/US$48.5
`1,798/US$27.0
`1,244
`1,225
2

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
GREEN
GREEN

Performance
130
120
110
100
90
80
70
Nov-15
Dec-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Jul-16
Aug-16
Sep-16
Oct-16

Since inception, HDFC Bank has focused on building a granular retail


franchise on both sides of the balance sheet. It has maintained a
conservative approach towards lending (gross NPA of 1.02%). With a
stable management team at the helm, the bank was able to expand its
retail offering on a pan-India basis and fill the gaps in its corporate
banking offering. However, the valuation premium over peers largely
captures superior earnings growth of the bank in the medium term (20%
EPS CAGR over FY17-18E). Further, with 20-odd new banks, we believe
that the competitive intensity will rise for low-cost liabilities and
customer data. We remain SELLers with a TP of `1,225 (15x one-year
forward EPS and 2.9x one-year forward BVPS).
Competitive position: STRONG

November 17, 2016

HDFC Bank

Sensex

Source: Bloomberg, Ambit Capital research

Going beyond IBAS framework


Risk-averse culture and ability to use technology (systems and processes) to
create a unique offering have been key differentiators. Despite the relatively low
advertising budget and lack of celebrity endorsements, its high level of brand
recall is a testimony of the banks strengths. HDFC Bank is known for its focus on
systems and processes; this has helped the bank in terms of business continuity.
The banks key strategic asset has been its low-cost funding franchise (cost of
funds of 5.5% vs peer average of 6.2%), which has helped it effectively compete
with other banks without taking higher asset quality risks.

Research Analysts
Pankaj Agarwal, CFA
Tel: +91 22 3043 3206

Premium valuation justified by robust growth

pankaj.agarwal@ambit.co

Over the years, HDFC Bank has moved in the right direction on most
parameters. HDFC Banks higher NIM (4.1%), improving cost-to-income ratio
(48%) and lower credit costs (40bps) are driving the current RoA of 1.8%.
However, with 20-odd new banks, we believe that the competitive intensity will
increase for low-cost liabilities and customer data. We expect earnings CAGR of
20% over FY17-18E and average RoE of 19.2% over FY17-18E for HDFC Bank.
We remain SELLers with a TP of `1,225 (2.9x one-year forward BVPS).

Ravi Singh
Tel: +91 22 3043 3181
ravi.singh@ambit.co
Rahil Shah
Tel: +91 22 3043 3217
rahil.shah@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

HDFC Bank
Exhibit 1: HDFC Bank loan book is diversifying towards retail
Home

Vehicle

Other retail

Non-retail

RoE (RHS)

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

25%
20%
15%
10%
5%
1HFY17

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

0%

Source: Company, Ambit Capital research

Exhibit 2: Key financial parameters over the last decade


Loan book (` bn)
Loan book growth (%)

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

582

792

989

1,258

1,600

1,954

2,397

3,030

3,655

FY16 1HFY17*
4,646

4,944

39.8%

36.1%

24.9%

27.3%

27.1%

22.2%

22.7%

26.4%

20.6%

27.1%

18.1%

Operating profits (` mn)

28,331

41,975

51,790

64,297

77,254

93,906

114,276

143,601

174,045

213,635

118,437

Net profits (` mn)

12,629

17,221

22,449

29,487

39,264

51,671

67,263

84,784

102,159

122,962

66,942

EPS (`)

6.5

8.1

10.6

12.9

16.9

22.0

28.3

35.3

42.1

48.6

26.4

Gross NPAs (%)

1.66%

1.81%

1.95%

1.43%

1.05%

1.01%

0.97%

0.98%

0.93%

0.94%

1.02%

Net NPAs (%)

0.59%

0.66%

0.63%

0.31%

0.19%

0.18%

0.20%

0.27%

0.25%

0.28%

0.30%

8.8%

10.2%

10.6%

13.3%

12.2%

11.6%

11.1%

11.8%

13.7%

13.2%

13.3%

RoA (%)

1.30%

1.28%

1.31%

1.45%

1.57%

1.68%

1.82%

1.90%

1.89%

1.89%

1.78%

RoE (%)

18.0%

16.7%

16.1%

16.1%

16.7%

18.7%

20.3%

21.3%

19.4%

18.3%

17.5%

Tier 1 (%)

Source: Company, Ambit Capital research. Note: *1HFY17 operating profits, net profits and EPS numbers not annualized

Exhibit 3: The key things to note from evolution


Time period

1994-1999

2000-2008

2009-Present

Phase

A corporate bank with


a difference

Building the retail


bank

Reaching the
hinterland and taking
on Silicon Valley

Key developments

The initial management team was built mostly by hiring young bankers from foreign banks like Citibank,
Bank of America and HSBC.

The bank focused on raising low-cost liabilities, finding gaps in the existing offerings of competing banks,
capturing transactional and cash management business from the corporates rather than lending money to
them.

The bank implemented a fully integrated online banking automation system as compared to other popular
offline systems which were used by other competitors.

In FY04, the bank struck a deal with its parent company (HDFC) to become a distributor of HDFCs home
loans for a fee of 0.7% of the loan and the right to buy back 70% of the loans originated by it.

Extensive focus on retail loans allowed the bank to post a retail loan book CAGR of 67% over FY00-08 and
contributed 57% of the loan book by FY08.

Focused on selling third-party products and acquiring point-of-sale terminals.

HDFC Bank focused on improving rural foot prints. The bank set up dedicated desks at semi-urban and rural
branches to cater to agriculture loans.

HDFC Bank started a major push towards digital banking. Various initiatives like PayZapp wallet, loans in
ten seconds, etc. were launched.

HDFC Bank acquired Centurion Bank of Punjab (CBOP) in May 2008. CBOP was one-fifth of HDFC Bank in
terms of balance sheet and half in terms of branches.

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 28

HDFC Bank
Exhibit 4: Competitive mapping of HDFC Bank with other comparable peers
Loan book ` bn (FY16)
14,637

Loan CAGR
(FY12-16)
14.1%

HDFC Bank

4,646

ICICI Bank

4,353

Axis Bank
Kotak Mahindra Bank

Company
State Bank of India

IndusInd Bank

CASA (FY16)

NIMs (FY16)

RoE (FY16)

42.6%

2.8%

7.3%

Net NPAs
(FY16)
3.81%

23.8%

43.2%

4.5%

18.3%

0.28%

13.2%

15.0%

45.8%

3.5%

11.4%

2.98%

13.1%

3,388

18.9%

47.3%

3.6%

16.8%

0.74%

12.5%

1,187

32.3%

38.1%

4.0%

9.2%

1.06%

15.3%

884

27.6%

35.2%

3.9%

17.3%

0.36%

14.9%

Tier 1(FY16)
9.9%

Source: Company, Ambit Capital research

Exhibit 5: Mapping HDFC Bank and its peers on IBAS


Company

Innovation

Brand Architecture

Strategic
asset

Overall
rank

Comments

HDFC Bank

The bank scores highly on all parameters: Innovation (origin as an upstart


bank, transaction banking, technology-led solution, capital markets
strategy to capture floats, forays in rural and digital banking); brand (wide
geographical and demographical reach); architecture (little churn in senior
management, highly focused on systems and processes, meeting unmet
demands of customers); and strategic assets (wide branch network, large
and sticky retail deposits franchise, strong asset quality and a good capital
raising track record)

ICICI Bank

The bank has mixed scores on IBAS: Innovation (present across all
segments of financial services, pioneer in using technology); brand (wide
geographical and demographical reach, but marred by negative asset
quality cycles); architecture (cyclical ups and downs on growth and asset
quality indicate inadequate quality of engagement with employees and
customers); and strategic assets (wide branch network, large and sticky
retail deposits franchise, leading franchises in most financial services
businesses)

Axis Bank

The bank scores highly on most parameters: Innovation (evolution of the


banks retail liabilities, retail assets, DCM business, SME banking and
wholesale banking in high quality leading franchises); brand (wide
geographical and demographical reach; successful transition from a quasiPSU brand to new-age banking brand); architecture (strong and
independent board, an employee-friendly environment and a flexible
culture open to changes with track record of seamlessly re-orienting under
three leaders with different management styles); and strategic assets (bestin-class franchise in areas of transaction banking, such as cash
management, payments, business banking and government businesses,
wide branch network, large and sticky retail deposits franchise).

Kotak
Mahindra
Bank

The bank scores highly on most parameters: Innovation (evolution from an


NBFC to a universal financial services conglomerate); brand (strong brand
but with limited reach, receive a fill up from ING Vysya Bank acquisition);
architecture (conservative corporate culture with high focus on costs and
risk pricing, even at the cost of growth); and strategic assets (leading
franchises in number of lending and non-lending financial service
businesses).

IndusInd Bank

The bank has mixed scores on IBAS: Innovation (overhauling of entire


corporate banking, and launching and scaling up of retail products under
new management); brand (strong niche brand in vehicle finance and other
niche segments, yet to evolve into a prominent high-street brand);
architecture (strong and well-knit senior management team; strong longterm relationship-based customer connect in vehicle finance); and strategic
assets (unmatched differentiated vehicle finance franchise, structured midmarket corporate banking franchise, rapidly expanding branch network).

State Bank of
India

The bank has mixed scores on IBAS: Innovation (has built presence across
all segments of financial services businesses over the long term, but
constraints linked with being PSU bank limit rapid innovations and
adopting best practices from peers); brand (wide geographical and
demographical reach, but underwhelming perception for standards of
customer service); architecture (poor alignment of employee-reward
programme with commercial success of the bank, HR practices are not
comparable with private sector peers); and strategic assets (wide branch
network, large and sticky retail deposits franchise and leading franchises in
most financial services businesses).

Source: Company, Ambit Capital research; Note:

November 17, 2016

- Strong;

- Relatively Strong;

- Average;

Ambit Capital Pvt. Ltd.

- Relatively weak.

Page 29

HDFC Bank

Loan growth

5%
0%

Net interest margins (RHS)

RoA

FY16

0.0%
FY07

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

4.1%

0.5%

FY15

4.2%

10%

FY14

4.3%

15%

1.0%

FY13

4.4%

20%

1.5%

FY12

4.5%

25%

FY11

4.6%

2.0%

FY10

4.7%

FY09

45%
40%
35%
30%
25%
20%
15%
10%
5%
0%

Exhibit 7: Due to efficiencies in operations, RoA of the bank


has improved over the years

FY08

Exhibit 6: Loan book growth has been stable at around


20% with improvement in NIM

RoE (RHS)

13.2%

11.8%
FY14

FY16

11.1%
FY13

13.7%

11.6%
FY12

FY15

12.2%

Tier 1

FY11

FY10

Provision coverage ratio (RHS)

FY09

Gross NPAs

FY08

0%

16%
14%
12%
10%
8%
6%
4%
2%
0%

FY07

0.0%
FY16

20%
FY15

0.5%
FY14

40%

FY13

1.0%

FY12

60%

FY11

1.5%

FY10

80%

FY09

2.0%

FY08

100%

FY07

2.5%

13.3%

Exhibit 9: Tier-1 ratio has been strong over past years

10.6%

Exhibit 8: Gross NPAs and provision coverage ratio has


shown healthy trends

10.2%

Source: Company, Ambit Capital research

8.8%

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 10: HDFC Bank is trading at its historical multiple

Exhibit 11: Share price performance v/s BSE Bankex

700

600
500

400

300
200

100

1
Sep-16

Dec-15

Mar-15

Jun-14

Sep-13

Dec-12

Mar-12

Jun-11

Sep-10

Dec-09

Mar-09

Jun-08

Sep-07

Dec-06

Mar-06

Jun-05

PB

Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Nov-09
May-10
Nov-10
May-11
Nov-11
May-12
Nov-12
May-13
Nov-13
May-14
Nov-14
May-15
Nov-15
May-16

HDFCB IN

Avg. PB

Source: Bloomberg, Company, Ambit Capital research

SENSEX

Source: Bloomberg, Company, Ambit Capital research

Exhibit 12: Explanation for our flags


Segment

Score

Accounting

GREEN

Predictability

GREEN

Earnings momentum

GREEN

Comments
Similar to all other Indian private sector banks, HDFC Bank uses intrinsic value of stock option to account ESOP
expense. However, the bank disclosed that if Black Scholes model-based fair valuation was used, net profit would
be adjusted lower by 10% in FY14, FY15 and FY16.
The bank has one of the best track records of long-term profitability. It has delivered on the guidance with very
little room in variation.
Consensus EPS estimates for FY17 and FY18 have been reduced by 6% and 7% respectively in past one year. We
expect 20% EPS CAGR over FY17-18E.

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 30

HDFC Bank
Balance sheet
Year to March (` mn)
Net worth
Deposits
Borrowings
Other liabilities

FY14

FY15

FY16

FY17E

FY18E

434,786

620,094

726,778

839,240

973,785

3,673,375

4,507,956

5,464,242

6,393,163

7,671,796

394,390

452,136

530,185

621,072

744,570

413,444

324,844

367,251

459,064

573,830

4,915,995

5,905,031

7,088,456

8,312,538

9,963,980

395,836

363,315

389,188

444,353

517,306

Investments

1,209,511

1,516,418

1,638,858

1,965,391

2,402,834

Advances

3,030,003

3,654,950

4,645,940

5,457,757

6,565,548

Total liabilities
Cash & balances with RBI & banks

Other assets

280,645

370,348

414,470

445,037

478,292

Total assets

4,915,995

5,905,031

7,088,456

8,312,538

9,963,980

FY14

FY15

FY16

FY17E

FY18E

Interest income

411,355

484,699

602,214

700,351

812,190

Interest expense

226,529

260,742

326,299

368,171

424,461

Net interest income

184,826

223,957

275,915

332,180

387,729

Source: Company, Ambit Capital research

Income statement
Year to March (` mn)

Total non-interest income

79,196

89,964

107,517

125,533

147,419

Total income

264,023

313,920

383,432

457,714

535,148

Total operating expenses

120,422

139,875

169,797

198,323

229,189

Employees expenses

41,790

47,510

57,022

67,504

76,131

Other operating expenses

78,632

92,366

112,775

130,819

153,058

Pre-provisioning profits

143,601

174,045

213,635

259,391

305,959

15,873

20,750

27,256

36,870

39,744

PBT

127,728

153,295

186,379

222,521

266,215

Tax

42,944

51,136

63,417

74,544

89,182

PAT

84,784

102,159

122,962

147,976

177,033

FY14

FY15

FY16

FY17E

FY18E

Credit-Deposit (%)

82.5%

81.1%

85.0%

85.4%

85.6%

CASA ratio (%)

45.6%

44.6%

43.8%

43.1%

41.8%

Cost/Income ratio (%)

45.6%

44.6%

44.3%

43.3%

42.8%

29,893

34,384

43,928

56,792

64,125

Gross NPA (%)

0.98%

0.93%

0.94%

1.03%

0.97%

Net NPA (` mn)

8,200

8,963

13,204

15,334

17,314

Net NPA (%)

0.27%

0.25%

0.28%

0.28%

0.26%

Provision coverage (%)

72.6%

73.9%

69.9%

73.0%

73.0%

NIMs (%)

4.39%

4.40%

4.52%

4.57%

4.47%

Tier-1 capital ratio (%)

11.8%

13.7%

13.2%

13.1%

12.7%

Provisions

Source: Company, Ambit Capital research

Key ratios
Year to March (` mn)

Gross NPA (` mn)

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 31

HDFC Bank
Du-pont analysis
Year to March

FY14

FY15

FY16

FY17E

FY18E

NII/Assets (%)

4.1%

4.1%

4.2%

4.3%

4.2%

Other income/Assets (%)

1.8%

1.7%

1.7%

1.6%

1.6%

Total Income/Assets (%)

5.9%

5.8%

5.9%

5.9%

5.9%

Cost to assets (%)

2.7%

2.6%

2.6%

2.6%

2.5%

PPP/Assets (%)

3.2%

3.2%

3.3%

3.4%

3.3%

Provisions/Assets (%)

0.4%

0.4%

0.4%

0.5%

0.4%

PBT/Assets (%)

2.9%

2.8%

2.9%

2.9%

2.9%

Tax rate (%)

33.6%

33.4%

34.0%

33.5%

33.5%

RoA (%)

1.90%

1.89%

1.89%

1.92%

1.94%

Leverage

11.2

10.3

9.6

9.8

10.1

21.3%

19.4%

18.3%

18.9%

19.5%

Year to March

FY14

FY15

FY16

FY17E

FY18E

EPS (`)

35.3

42.1

48.6

58.5

70.0

EPS growth (%)

25%

19%

16%

20%

20%

RoE (%)
Source: Company, Ambit Capital research

Valuation

BVPS (`)

181.2

247.4

287.5

332.0

385.2

P/E (x)

36.1

30.3

26.2

21.8

18.2

P/BV (x)

7.04

5.16

4.44

3.84

3.31

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 32

Axis Bank
BUY
STRATEGY NOTE

AXSB IN EQUITY

A strong core

BFSI

A strong and independent Board, an employee friendly culture, and a


DNA flexible to changes form the foundation of Axis Banks long-term
success. These strengths have helped the bank transform from a quasiPSU bank to a new-age universal bank over the past two decades under
three different leaders. The banks strength on both sides of the balance
sheet is visible in its strong operating profitability, which enables it to
absorb higher credit cost of ~200bps in FY17-18E and still deliver
average ROE of 13.2% and EPS CAGR of 13% over FY16-18E. Axis Bank is
trading at ~30% discount to peers despite superior steady-state ROE. We
are BUYers with TP of `600 (2.2x FY18 P/B). The key risks to our BUY
stance are a prolonged economic slowdown and continued deadlock in
the power sector. These could lead to higher asset quality risks due to
Axis Banks higher exposure to the power and SME sectors.
Competitive position: MODERATE

November 17, 2016

Changes to this position: STABLE

Recommendation
Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Upside (%):

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
AMBER
AMBER

Performance

A long term track-record on RoE and growth

150

In last ten years (FY07-16), Axis Banks RoA and RoE have averaged at 1.5% and
~19%, respectively, along with loan book CAGR of 31%. However, in 1HFY17,
the performance has taken a hit due to asset quality stress with RoA and RoE of
0.7% and ~7%, respectively. The underlying drivers of the banks long-term
performance are: (a) strong liability franchise (focus on branch/ATM network,
government business, SME banking supporting CASA in early years and focus on
a granular retail term deposits franchise in recent years); (b) superior fee-income
generation (average fee income to assets at 1.8% (FY07-16), and; (c) controlled
operating efficiency (average cost to fee income of 43% (FY07-16).

130

From strong retail liability franchise to a universal bank

`1,190/US$17.9
`7,049/US$106
`499
`600
20

110
90
Nov-15
Dec-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Jul-16
Aug-16
Sep-16
Oct-16

70

Axis Bank

Sensex

Source: Bloomberg, Ambit Capital research

Axis Banks journey in the noughties was mostly about building a low-cost
liability base (cost of funds of 5.7% now) by employing a well thought out branch
and ATM expansion, customer segmentation and sales model. Over the last five
years, the bank leveraged its retail liability base to build its retail asset franchise
(42% of total loans now; vs 20% in FY12). The acquisition of ENAM (equities and
investment banking business), international expansion, and a relationship-based
model strengthened the banks corporate banking franchise.
Ticking all boxes of IBAS framework
Multiple innovations were involved when the bank ramped up its low cost
deposit franchise during FY00-09 and when the bank ramped up its retail
franchise during Ms. Sharmas tenure (FY09-current). Transition of brand from
UTI Bank to Axis Bank was an exemplary success. A strong and independent
Board, an employee friendly culture and a flexible culture open to changes has
defined the success of Axis Bank, which has seamlessly reoriented itself under
three leaders with different management styles. Beyond plain-vanilla banking,
Axis Bank has best-in-class franchise in areas of transaction banking, such as
cash management, payments, business banking and government businesses.

Research Analysts
Pankaj Agarwal, CFA
Tel: +91 22 3043 3206

Significant discount to peers despite strong profitability

pankaj.agarwal@ambit.co

Asset quality challenges in the corporate loan book have led to a de-rating of
the stock. However, strong operating profitability (3.1% of assets) can more than
offset the average credit cost of 200bps over FY17-18E and can help generate
average ROE of 13.2% and EPS CAGR of 13% over FY17-18E. Axis Bank is
trading at 1.8x FY18 P/B, ~15% discount to its cross-cycle valuations and ~30%
discount to its peers despite better steady-state ROE. Our target price of `600
implies FY18E P/B of 2.2x and FY18E P/E of 13.7x (20% upside).

Ravi Singh
Tel: +91 22 3043 3181
ravi.singh@ambit.co
Rahil Shah
Tel: +91 22 3043 3217
rahil.shah@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Axis Bank
Exhibit 1: Axis Bank loan book is diversifying towards retail
Retail

Corporate

SME

Agri

RoE (RHS)

20%

60%

15%

40%

10%

20%

5%

0%

0%

FY14

FY15

FY16 1HFY17*

369

597

816

1,043

1,424

1,698

1,970

2,301

2,811

FY15

FY13

FY14

FY12

FY13
FY11

FY12
FY10

FY11
FY09

FY10
FY08

FY09
FY07

FY08

1HFY17

80%

FY16

25%

FY07

100%

Source: Company, Ambit Capital research

Exhibit 2: Key financial parameters over the last decade


Loan book (` bn)
Loan book growth (%)

3,388

3,532

65.3%

61.8%

36.7%

27.9%

36.5%

19.2%

16.0%

16.8%

22.2%

20.5%

18.5%

12,639

22,259

37,249

52,405

64,157

74,309

93,031

114,561

133,854

161,036

85,696

6,590

10,710

18,154

25,145

33,885

42,422

51,794

62,181

73,587

82,237

18,746

4.7

6.0

10.1

12.4

16.5

20.5

22.1

26.5

31.0

34.5

7.9

Gross NPAs (%)

1.13%

0.83%

1.09%

1.25%

1.11%

1.06%

1.20%

1.36%

1.45%

1.78%

4.53%

Net NPAs (%)

0.72%

0.42%

0.40%

0.40%

0.29%

0.28%

0.36%

0.45%

0.47%

0.74%

2.20%

6.4%

10.2%

9.3%

11.2%

9.4%

9.5%

12.2%

12.6%

12.1%

12.5%

12.0%

ROA (%)

1.07%

1.17%

1.41%

1.53%

1.60%

1.61%

1.65%

1.72%

1.74%

1.67%

0.70%

ROE (%)

21.0%

17.6%

19.1%

19.2%

19.3%

20.3%

18.5%

17.4%

17.8%

16.8%

6.9%

Operating profits (` mn)


Net profits (` mn)
EPS (`)

Tier 1 (%)

Source: Company, Ambit Capital research. Note: *1HFY17 operating profits, net profits and EPS numbers not annualized

Exhibit 3: The key things to note from evolution


Time period

Phase

Key developments

1994-1999

The early years a shaky start

2000-2009

The P Jayendra Nayak era An


unusual and inspirational banker
who transformed the
bank

2009-Present

The Shikha Sharma era


Seamless reorientation

Axis Bank framed initial strategy to leverage UTIs customer base, brand and branch
network.
Axis Banks strategy to lend to mid-corporates backfired in the late 1990s as the economic
slowdown led to a significant deterioration in asset quality by end FY2000.
Low investment in branches and ATMs meant that Axis Bank suffered on the liability side as
well with CASA ratio of just 17% by the end of FY2000.
Dr Nayak was able to win the confidence of senior management of Axis with his clarity of
thought and communication on the banks future plans and employee friendly policies.
Another major transformation, apart from starting ESOPs scheme, at the beginning of
Nayaks era was IT upgrade at the bank; all branches were brought on an online, realtime, centralised core banking platform.
Axis Bank aggressively expanded its branch and ATM networks between FY2000 and FY09,
the fastest rate amongst peers. Hence, Axis Banks CASA, EPS and ROE grew at a rapid
pace during Nayaks tenure.
Ms Sharma changed the business model from product-focused to customer-focused. She
hired some of her ex-colleagues to implement her vision.
Deterioration in corporate asset quality has been a sobering experiencing for the bank with
risks in infrastructure loan book emerging from unexpected areas, e.g., environmental and
judicial changes.
Use of technology has helped the bank in huge productivity gains in terms of reducing
branch sizes and better employee productivity.

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 34

Axis Bank
Exhibit 4: Competitive mapping of Axis Bank, with other comparable peers
Loan book ` bn (FY16)
14,637

Loan CAGR
(FY12-16)
14.1%

CASA
(FY16)
42.6%

NIMs
(FY16)
2.8%

RoE
(FY16)
7.3%

Net NPAs
(FY16)
3.81%

Tier 1
(FY16)
9.9%

HDFC Bank

4,646

23.8%

43.2%

4.5%

18.3%

0.28%

13.2%

ICICI Bank

4,353

15.0%

45.8%

3.5%

11.4%

2.98%

13.1%

Axis Bank

3,388

18.9%

47.3%

3.6%

16.8%

0.74%

12.5%

Kotak Mahindra Bank

1,187

32.3%

38.1%

4.0%

9.2%

1.06%

15.3%

884

27.6%

35.2%

3.9%

17.3%

0.36%

14.9%

Company
State Bank of India

IndusInd Bank
Source: Company, Ambit Capital research

Exhibit 5: Mapping HDFC Bank and its peers on IBAS


Company

Innovation

Brand Architecture

Strategic
asset

Overall
rank

Comments

HDFC Bank

The bank scores highly on all parameters: Innovation (origin as an upstart


bank, transaction banking, technology-led solution, capital markets
strategy to capture floats, forays in rural and digital banking); brand (wide
geographical and demographical reach); architecture (little churn in senior
management, highly focused on systems and processes, meeting unmet
demands of customers); and strategic assets (wide branch network, large
and sticky retail deposits franchise, strong asset quality and a good capital
raising track record)

ICICI Bank

The bank has mixed scores on IBAS: Innovation (present across all
segments of financial services, pioneer in using technology); brand (wide
geographical and demographical reach, but marred by negative asset
quality cycles); architecture (cyclical ups and downs on growth and asset
quality indicate inadequate quality of engagement with employees and
customers); and strategic assets (wide branch network, large and sticky
retail deposits franchise, leading franchises in most financial services
businesses)

Axis Bank

The bank scores highly on most parameters: Innovation (evolution of the


banks retail liabilities, retail assets, DCM business, SME banking and
wholesale banking in high quality leading franchises); brand (wide
geographical and demographical reach; successful transition from a quasiPSU brand to new-age banking brand); architecture (strong and
independent board, an employee-friendly environment and a flexible
culture open to changes with track record of seamlessly re-orienting under
three leaders with different management styles); and strategic assets (bestin-class franchise in areas of transaction banking, such as cash
management, payments, business banking and government businesses,
wide branch network, large and sticky retail deposits franchise).

Kotak
Mahindra
Bank

The bank scores highly on most parameters: Innovation (evolution from an


NBFC to a universal financial services conglomerate); brand (strong brand
but with limited reach, receive a fill up from ING Vysya Bank acquisition);
architecture (conservative corporate culture with high focus on costs and
risk pricing, even at the cost of growth); and strategic assets (leading
franchises in number of lending and non-lending financial service
businesses).

IndusInd Bank

The bank has mixed scores on IBAS: Innovation (overhauling of entire


corporate banking, and launching and scaling up of retail products under
new management); brand (strong niche brand in vehicle finance and other
niche segments, yet to evolve into a prominent high-street brand);
architecture (strong and well-knit senior management team; strong longterm relationship-based customer connect in vehicle finance); and strategic
assets (unmatched differentiated vehicle finance franchise, structured midmarket corporate banking franchise, rapidly expanding branch network).

State Bank of
India

The bank has mixed scores on IBAS: Innovation (has built presence across
all segments of financial services businesses over the long term, but
constraints linked with being PSU bank limit rapid innovations and
adopting best practices from peers); brand (wide geographical and
demographical reach, but underwhelming perception for standards of
customer service); architecture (poor alignment of employee-reward
programme with commercial success of the bank, HR practices are not
comparable with private sector peers); and strategic assets (wide branch
network, large and sticky retail deposits franchise and leading franchises in
most financial services businesses).

Source: Company, Ambit Capital research; Note:

November 17, 2016

- Strong;

- Relatively Strong;

- Average;

Ambit Capital Pvt. Ltd.

- Relatively weak.

Page 35

Axis Bank

10%

0%

Net interest margins (RHS)

RoA

FY16

0.0%
FY15

5%
FY14

0.5%

FY13

FY16

FY15

FY14

FY13

15%

1.0%

FY07

Loan growth

FY12

FY11

FY10

FY09

FY08

FY07

0%

20%

FY12

1%

1.5%

FY11

2%

25%

FY10

3%

2.0%

FY09

4%

70%
60%
50%
40%
30%
20%
10%
0%

Exhibit 7: Due to efficiencies in operations, RoA of the bank


is improving

FY08

Exhibit 6: Loan book growth has been stable at around


20% with improvement in NIMs

RoE (RHS)

Exhibit 8: Though the gross NPAs of the bank is increasing,


the provisioning coverage ratio is strong

Exhibit 9: Tier 1 ratio has been strong over the past four
years

1.0%
0.5%

FY16

12.1%

12.2%
9.5%

9.4%

11.2%

9.3%

10%
8%
6%
4%
2%

FY16

FY15

FY14

FY13

FY12

FY11

FY10

Provision coverage ratio (RHS)

FY09

0%
FY08

FY15

FY14

FY13

12%

FY07

Gross NPAs

FY12

FY11

FY10

FY09

FY08

FY07

0.0%

14%

10.2%

1.5%

Tier 1

6.4%

80%
70%
60%
50%
40%
30%
20%
10%
0%

2.0%

12.5%

Source: Company, Ambit Capital research

12.6%

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 10: Forward P/B evolution

Exhibit 11: Share price performance v/s BSE Bankex

700

600
500

400
300

200

100

PB

Oct-16

Mar-16

Aug-15

Jan-15

Jun-14

Nov-13

Apr-13

Sep-12

Feb-12

Jul-11

Dec-10

May-10

Oct-09

Mar-09

Aug-08

AXSB IN

Avg. PB

Source: Bloomberg, Company, Ambit Capital research

Jan-08

Jun-07

Nov-06

Jun-16

Sep-15

Dec-14

Mar-14

Jun-13

Sep-12

Dec-11

Mar-11

Jun-10

Sep-09

Dec-08

Mar-08

Jun-07

Sep-06

Dec-05

Mar-05

SENSEX

Source: Bloomberg, Company, Ambit Capital research

Exhibit 12: Explanation for our flags


Segment

Score

Accounting

GREEN

Predictability

AMBER

Earnings momentum

AMBER

Comments
Similar to all other Indian private sector banks, Axis Bank uses intrinsic value of stock option to account ESOP
expense. However, Axis Bank disclosed that if Black Scholes model based fair valuation was used, net profit would
be adjusted lower by 1% in FY14, FY15 and FY16. For fee income on letters of credit (LC), Axis Bank books the
income when due rather than amortising the income over the period of LC.
Due to uncertainty around the slippages in the corporate loan book it is difficult to predict exact trajectory of the
bank earnings. Over a long term, however, Axis Bank has reported stable operating performance.
FY17/FY18E consensus EPS estimates have been reduced by 52% and 32% respectively in past one year. We expect
13% EPS CAGR in FY16-18E.

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 36

Axis Bank
Balance sheet
Year to March (` mn)
Net worth
Deposits

FY14

FY15

FY16

FY17E

FY18E

382,205

446,765

531,649

574,973

661,393

2,809,446

3,224,419

3,579,676

4,224,017

5,111,061

Borrowings

502,909

797,583

992,264

1,235,895

1,455,223

Other Liabilities

137,889

150,557

151,088

181,305

217,566

3,832,449

4,619,324

5,254,676

6,216,190

7,445,243

282,387

360,990

333,254

387,729

466,920

Investments

1,135,484

1,175,502

1,220,062

1,409,171

1,697,661

Advances

2,300,668

2,810,830

3,387,737

4,068,902

4,920,197

Other Assets

113,910

272,001

313,623

350,388

360,464

Total Assets

3,832,449

4,619,324

5,254,676

6,216,190

7,445,243

FY14

FY15

FY16

FY17E

FY18E

306,412

354,786

409,880

451,432

522,096

Total Liabilities
Cash & Balances with RBI/Banks

Source: Company, Ambit Capital research

Income statement
Year to March (` mn)
Interest Income
Interest Expense

186,895

212,545

241,551

262,359

299,522

Net Interest Income

119,516

142,241

168,330

189,073

222,574

Total Non-Interest Income

74,052

83,650

93,715

113,523

125,306

193,569

225,892

262,044

302,596

347,880

Total Operating Expenses

79,008

92,037

101,008

119,518

139,366

Employees expenses

26,013

31,150

33,760

40,165

46,524

Other Operating Expenses

52,994

60,888

67,248

79,353

92,843

Pre Provisioning Profits

Total Income

114,561

133,854

161,036

183,078

208,514

Provisions

21,070

23,277

37,099

104,510

51,791

PBT

93,490

110,578

123,937

78,568

156,723

Tax

31,310

36,990

41,700

26,320

52,502

PAT

62,181

73,587

82,237

52,248

104,221

Source: Company, Ambit Capital research

Key ratios
Year to March (` mn)

FY14

FY15

FY16

FY17E

FY18E

Credit-Deposit (%)

81.9%

87.2%

94.6%

96.3%

96.3%

CASA ratio (%)

47.4%

45.5%

48.0%

47.5%

46.1%

Cost/Income ratio (%)


Gross NPA (` mn)

40.8%

40.7%

38.5%

39.5%

40.1%

31,464

41,102

60,875

170,029

132,092

Gross NPA (%)

1.36%

1.45%

1.78%

4.07%

2.64%

Net NPA (` mn)

10,246

13,167

25,221

59,510

39,628

Net NPA (%)

0.45%

0.47%

0.74%

1.46%

0.81%

Provision coverage (%)

67.4%

68.0%

58.6%

65.0%

70.0%

NIMs (%)

3.40%

3.53%

3.62%

3.50%

3.44%

Tier-1 capital ratio (%)

12.6%

12.1%

12.5%

11.3%

10.8%

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 37

Axis Bank
Du-pont analysis
Year to March (` mn)

FY14

FY15

FY16

FY17E

FY18E

NII / Assets (%)

3.3%

3.4%

3.4%

3.3%

3.3%

Other income / Assets (%)

2.0%

2.0%

1.9%

2.0%

1.8%

Total Income / Assets (%)

5.3%

5.3%

5.3%

5.3%

5.1%

Cost to Assets (%)

2.2%

2.2%

2.0%

2.1%

2.0%

PPP / Assets (%)

3.2%

3.2%

3.3%

3.2%

3.1%

Provisions / Assets (%)

0.6%

0.6%

0.8%

1.8%

0.8%

PBT / Assets (%)


Tax Rate (%)
ROA (%)
Leverage

2.6%

2.6%

2.5%

1.4%

2.3%

33.5%

33.5%

33.6%

33.5%

33.5%

1.7%

1.7%

1.7%

0.9%

1.5%

10.1

10.2

10.1

10.4

11.0

17.4%

17.8%

16.8%

9.4%

16.9%

Year to March

FY14

FY15

FY16

FY17E

FY18E

EPS (`)

26.5

31.0

34.5

21.9

43.7

EPS growth (%)

20%

17%

11%

-36%

99%

ROE (%)
Source: Company, Ambit Capital research

Valuation

BVPS (`)

162.7

188.5

223.1

241.3

277.6

P/E (x)

18.8

16.1

14.5

22.7

11.4

P/BV (x)

3.07

2.65

2.24

2.07

1.80

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 38

HCL Technologies
BUY
HCLT IN EQUITY

Set to surf the IoT wave


HCLTs prescient bets on infrastructure management services (IMS) and
engineering services (ES) have enabled it to deliver FY06-16 revenue
CAGR of 21% (USD) vs. 18% for larger peers. Strong capabilities in these
segments also position it well for the upcoming Internet-of-Things era,
as it is able to counter customer-spend deflation (30-40% at each deal
renewal). It has had a stellar capital allocation track record as is visible
from FY06-16 median RoCE of 21%; its large acquisition of Axon (55% of
overall capital invested, FY09) has been marquee deal in industry.
Current valuation of 12x FY18E EPS, implying 7% revenue CAGR over
FY16-26, vs 21% over FY06-16, offer margin of safety. We are BUYers
with a TP of `950, implying 15x FY18E EPS. Key risk: longevity of the
business, especially IMS which faces 30-40% deflation due to cloud.
Competitive position: MODERATE

Changes to this position: STABLE

One of the better performing large Indian IT services companies


Since FY08, performance of top firms has diverged in terms of revenue/earnings
growth due to differences in capital allocation, portfolio mix, operational
excellence and management quality. HCLT has been one of the better
performers on these metrics. Its bold bets on IMS and Axon have paid off.
Capabilities in IMS, Indian ITs fastest growing segment, continue to strengthen.
Finally, an excellent sales effort driven by Vineet Nayar (CEO from 2007-13) has
allowed it to penetrate and grow marquee clients. Over the past ten years,
HCLTs revenues and profits have grown at 21% CAGR (USD; vs 18% for larger
peers) and 25% CAGR (Re terms, vs 23% for larger peers).
Rode the IMS wave, now well-positioned for IoT
HCLT began as the R&D division of HCL Enterprise, which developed an
indigenous microcomputer in 1978. The inherited culture is a key ingredient of
its success in outsourced engineering services (#1 in India, top-5 globally). Over
1996-2003, HCL formed a JV with Perot Systems which gave it access to highvalue US clients. It missed out on the Y2K bug boom because management
thought it was temporary low-end work. However, since then, two large bets
paid off. It pioneered offshore delivery of IMS in 2003-04 (36% of FY16
revenues, no. 2 globally after IBM) and acquired Axon in 2009 (gave it
relationships with CXOs in large organizations). Its next big bet is on IoT, which
would require it to build on its capabilities in IMS and engineering services.
Second only to TCS on our IBAS framework
HCLT has consistently innovated to lower its cost structure. HCLT posted average
EBIT margin of 19% (FY06-16) despite offering 30-40% cost-savings to clients on
each deal renewal and steady wage inflation; depreciation of INR vs. USD would
have helped though. HCLT scores well on brand as it occupies a high client mind
share (source: third-party industry analyst reports) as well as a good reputation
among employees as is reflected in lower attrition of 17% (vs peer median of
19%). HCLTs decent positioning on architecture and strategic assets are based
on strong sales architecture it has built over years and client-connect.

November 17, 2016


Technology
Recommendation
Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Upside (%):

`1087/US$16
`1,515/US$23
`771
`950
23%

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
GREEN
AMBER

Performance
120
110
100
90
80
70
Nov-15
Dec-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Jul-16
Aug-16
Sep-16
Oct-16

STRATEGY NOTE

HCL Tech.

Sensex

Source: Bloomberg, Ambit Capital research

HCLTs forensic score analysis

Source: Ambit HAWK, Ambit Capital research

HCLTs greatness score analysis

Source: Ambit HAWK, Ambit Capital research

Low valuation (12x FY18 EPS) implies market concerns on longevity

Research Analysts

IMS (40% of Sep-16 revenues) is at risk of 30-40% deflation from the cloud.
However, there is significant room to gain share from high-cost vendors. All
Indian vendors together cater to less than 5% of global IMS spend. HCLTs
investments in moving up the value-chain (higher scale and complexity,
automation) position it well. Further, top-notch capabilities in IMS and
engineering will likely lead to leadership in the emerging IoT/automation era.
We expect 10%/11% revenue/NOPAT CAGR over FY16-26E.

Sagar Rastogi
+91 22 3043 3291
sagar.rastogi@ambit.co
Sudheer Guntupalli
+91 22 3043 3203
sudheer.guntupalli@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

HCL Technologies
Exhibit 1: Evolution of HCL Technologies
Cloud / IOT

Software services

Infrastructure services

FY16

FY15

FY14

50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
FY13

FY12

FY10

FY09

FY08

FY07

FY11

IMS and ES ramp up

6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500

BPO

Source: Ambit Capital research, company

Exhibit 2: Key financial parameters over the last decade


(` mn)
Revenues ($ mn)
Revenue growth (%)
Net profits

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

1,266

1,763

2,078

2,574

3,320

4,035

4,539

5,180

5,822

6,235

38%

39%

18%

24%

29%

22%

12%

14%

12%

7%

10,049

13,732

9,787

12,156

14,361

21,014

36,313

57,138

73,209

73,365

EPS

14.7

13.4

7.3

8.9

10.3

15.0

25.8

40.4

51.9

51.9

CFO

9,941

15,282

21,272

11,811

14,584

18,493

27,096

63,481

55,422

71,067

CFO pre-tax/ EBITDA

0.8

1.1

1.0

0.5

0.6

0.5

0.5

0.8

0.6

0.8

6,312

8,786

17,507

6,864

7,353

10,021

22,490

57,527

44,110

61,310

Debt equity (x)

0.00

0.70

0.42

0.31

0.20

0.11

0.05

0.02

0.03

RoE (%)

24%

26%

18%

21%

19%

22%

29%

35%

35%

29%

ROCE* (%)

37%

26%

27%

20%

24%

31%

41%

46%

40%

38%

FCF

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator.

Exhibit 3: The key things to note from evolution


Time period

Phase

FY07-15

HCLT pioneered global offshore delivery of IMS and ES starting in 2003-04. However, strong growth of IMS (36%
CAGR) and ES (21% CAGR) over FY06-16 helped HCLT maintain industry leading overall revenue growth (21%
CAGR vs 15% for Wipro, 16% for Infosys and 19% for TCS) during this period.
HCLT acquired Capital Stream, US based leader in providing comprehensive Straight through Processing (STP)
solutions to commercial banks and finance companies, for $40mn. In FY13, HCLT sold off a part of capital stream
IMS and ES ramp up
to Linedata for $45mn.
/ Inorganic growth
In FY09, HCLT announced the acquisition of Axon, to add SAP implementation capabilities. At an EV of $765mn,
Axon represented 55% of total capital invested by HCLT in FY09. This was also the largest buyout by an Indian IT
firm.
During FY11-15, the company slowed down its inorganic growth spending just 6% of its Free Cash Flows during
this period on acquisitions.

FY15-

Cloud/IoT

Key developments

In FY16 HCLT spent 19% of FCF on big ticket acquisitions like Volvos external IT business and end to end internal
outsourcing.
In FY17, the company announced that it will buy majority stake in Geometric in a share swap deal estimated at
$200mn to bolster its engineering and R&D practise. In addition to Volvo and Geometric, the company
announced seven other deals in the last eighteen months
To remain insulated from cloud disruption and build on IoT capabilities.

Source: Ambit Capital research, company

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 40

HCL Technologies
Exhibit 4: Competitive mapping of HCLT, TCS, Infosys, Wipro and TechM
Sub-Segment
positioning

FY16
revenue
($)

Revenue
CAGR
FY10-16

Industry
market
share

EBITDA
margin
(FY16)

Pre-tax
ROCE
(FY16)

Pre-tax
CFO/EBITDA
(FY10-16)

Capex/CFO
(FY10-16)

TCS

16,544

17%

38%

28%

53%

93%

16%

Infosys

9,501

12%

22%

27%

35%

97%

31%

Wipro

7,346

9%

17%

22%

23%

94%

26%

6,235

16%

14%

21%

38%

84%

20%

NA

4,038

27%

9%

16%

29%

67%

56%

Company

HCLT
TechM

Source: Company, Ambit Capital research

Exhibit 5: Mapping HCLT and peers on our IBAS framework


Company

Innovation

Reputation

Architecture

Strategic
asset

Overall
Comments
rank

TCS

Overall, TCS ranks on top of our IBAS framework. It has constantly


innovated in areas of offshoring, pyramid correction, code re-use and
moving up the value chain in terms of IT services (which is also reflected
in its industry leading EBIT margin 26.5%, FY16). TCS developed the
reputation of a value for money vendor which makes it a preferred
choice of clients especially for annuity kind of Run The Business (RTB)
projects. It also has the reputation of an employee friendly organization
which is reflected in its low attrition rate (15%, FY16). Focus on delivery,
unique organizational structure driving margin expansion makes TCS
score well on architecture aspect. Client connects ($50mn clients = 78
which is almost 2x of the nearest competitor), make it rank well on
strategic assets aspect.

Infosys

Infosys ranks second on our IBAS framework along with HCLT. The
company scores well in areas of offshoring, pyramid correction, code
re-use which is reflected in its high EBIT margins (25%, FY16). However,
it could not establish a niche for itself in any particular vertical or
service line which makes it an average scorer on reputation aspect. It
lags well behind TCS in terms of its organizational structure (issues
regarding placement of consulting practise in hierarchy) and strategic
assets (client connects).

Wipro

Wipro lags behind other four big players on (overall score of ) on our
IBAS framework. Wipro is not as successful as TCS/Infosys in terms of
pyramiding, code re-use which is also reflected in its lower EBIT margin
(19%, FY16). Though the company has been at the forefront of
adopting new technologies, it could not scale them up (and hence given
away market leadership to HCLT in IMS). Strategic assets (client
connects) are not strong (as in the case of TCS or Infosys) as it used to
rotate relationship managers every 18 months. Wipro runs a silo-ed
organizational structure which lacks vertical based selling experience.
These factors make the company score low on architecture and strategic
assets.

HCLT

HCLT ranks second on our IBAS framework along with Infosys. The
company maintained decent margins (20%, FY16) and ROCE (24%,
FY16) by keeping utilization (85%) high, pyramid correction and code
re-use. The company has built a strong reputation of being among top2 IMS vendors globally (ahead of all Indian peers) and top-5 ES vendors
(ahead of all Indian peers) globally which makes it score well on
Reputation. The company has built the architecture of an aggressive
sales led organization with client relationships in IMS and ES become
strategic assets to cross sell other services.

TechM

Though the current EBIT margins of TechM are significantly lower than
its peers (13.3%, FY16), this cannot be interpreted as weakness of the
company in terms of offshoring, pyramid correction and code re-use.
Margins of the company have taken a hit because of recent acquisitions
like LCC (normalized margin is 19.4% in FY14). The company has built
the reputation of being the strongest player in telecom segment (ahead
of all Indian peers). The company also has the DNA of successful
growth derived in inorganic route and marquee clients especially in
telecom segment. Overall, the company fits into above average bucket
on IBAS framework.

Source: Company, Ambit Capital research, Note:

November 17, 2016

- Strong;

- Relatively Strong;

- Average;

Ambit Capital Pvt. Ltd.

- Relatively weak

Page 41

HCL Technologies
Exhibit 6: Cash flow from operations was the significant
source of cash for the firm over last decade (FY06-16)

Exhibit 7: The company returned a significant part of its


cash flows to shareholders as dividends over FY06-16

4%
7%
16%
33%
60%
80%

CFO

Asset sale

Cash Flow from Financing

Dividend

Capex

Acquisitions

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 8: Valuations are at a discount to historical average

Exhibit 9: HCLTs share price performance vs Sensex


700
600
500
400
300
200
100
-

1 year forward P/E


(consensus)

16
14
12

P/E

Oct-16

Apr-16

Oct-15

Apr-15

Oct-14

Apr-14

Oct-13

Apr-13

Oct-12

Apr-12

Oct-11

10

Oct-06
May-07
Nov-07
May-08
Dec-08
Jun-09
Jan-10
Jul-10
Jan-11
Jul-11
Feb-12
Aug-12
Feb-13
Sep-13
Mar-14
Sep-14
Apr-15
Oct-15
May-16

18

SENSEX

Avg

Source: Company, Ambit Capital research

HCLT

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our flags


Segment

Score

Comments

Accounting

GREEN

Our proprietary forensic accounting tool Hawk places HCL Tech in Zone of safety in terms of accounting policies.

Predictability

GREEN

The management issues annual guidance and earnings surprises over the past eight quarters have averaged less
than 5%.

Earnings momentum

AMBER

Bloomberg shows downgrades to earnings estimates for the sector as a whole and even for HCLT on the back of
uncertainty over US presidential election and subsequent H-1B reforms.

Source: Ambit Capital research

Exhibit 11: Forensic score evolution

Exhibit 12: Greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 42

HCL Technologies
Balance sheet (consolidated)*
Balance sheet (` bn)
Net Worth

FY14

FY15

FY16

FY17E

FY18E

FY19E

183.3

229.7

277.5

320.6

368.5

428.2

Other Liabilities
Capital Employed
Net Block

24.7

18.0

22.2

25.2

25.1

25.1

208.1

247.7

299.6

345.8

393.6

453.3

81.4

85.5

106.4

148.5

175.5

204.6

Other Non-current Assets

23.7

29.6

40.0

40.0

40.0

40.0

179.3

215.1

247.4

272.6

305.4

353.1

Debtors

52.9

63.3

76.5

83.2

91.9

104.2

Unbilled revenues

21.4

29.5

29.7

27.2

30.0

34.0

Cash & Bank Balance

83.8

97.1

117.4

133.5

151.8

178.9

Other Current Assets

21.1

25.3

23.9

28.8

31.8

36.0

Current Liab. & Prov

76.3

82.5

94.2

115.3

127.3

144.4

Net Current Assets

103.0

132.6

153.3

157.3

178.1

208.8

Application of Funds

208.1

247.7

299.6

345.8

393.6

453.3

Current Assets

Source: Company, Ambit Capital research

Income statement (consolidated)*


Income statement (`bn)

FY14

FY15

FY16

FY17E

FY18E

5,180

5,822

6,235

6,934

7,662

Growth

14.1%

12.4%

7.1%

11.2%

10.5%

Revenue

314.7

357.9

409

464

513

Cost of goods sold

Revenue (US$ mn)

201.7

231.4

274.9

317.1

352.5

SG&A expanses

39.9

43.2

52.2

54.3

57.5

EBITDA

80.4

88.4

88

102

116

Depreciation
EBIT
EBIT Margin

7.2

5.1

5.7

9.1

13.9

73.2

83.4

82.1

92.8

102.5

23.3%

23.3%

20.1%

20.0%

20.0%

Other Income

(0.9)

8.5

10.1

9.0

9.2

PBT

72.3

91.9

92.2

101.8

111.7

Tax

15.2

18.7

18.8

21.6

24.0

Rate (%)

21.0%

20.3%

20.4%

21.3%

21.5%

Reported PAT

57.1

73.2

73.4

80.2

87.7

Diluted Adj EPS

40.4

51.9

52

57

62

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 43

HCL Technologies
Cash flow statement (consolidated)*
Cash flow (` bn)

FY14

FY15

FY16

FY17E

FY18E

Net Income

57.4

73.2

73.4

80.2

87.7

Depreciation

7.2

5.1

5.7

8.6

12.8

CF from Operations

64.2

73.4

73.5

88.5

101.6

Cash for Working Capital

(0.7)

(17.9)

(2.4)

9.0

(2.5)

Net Operating CF

63.5

55.4

71.1

97.5

99.1

Net Purchase of FA

(6.0)

(11.3)

(9.8)

(39.0)

(40.6)

Others

(37.5)

(17.2)

(33.1)

(4.1)

(0.5)

Net Cash from Invest.

(43.5)

(28.5)

(42.8)

(43.1)

(41.0)

0.3

0.2

0.0

Proceeds from Equity & other


Dividend Payments

(11.3)

(24.7)

(33.7)

(40.1)

(39.7)

Cash Flow from Fin.

(16.9)

(28.8)

(28.4)

(43.7)

(39.7)

Free Cash Flow

57.5

44.1

61.3

58.5

58.6

Opening cash balance

46.2

85.9

103.6

119.8

133.4

3.1

(1.9)

(0.1)

10.7

18.4

FY14

FY15

FY16

FY17E

FY18E

Revenue growth (US$)

14.1%

12.4%

7.1%

11.2%

10.5%

EBIT growth (`)

54.5%

13.9%

-1.5%

13.1%

10.4%

EPS growth (`)

57.0%

28.3%

0.1%

9.3%

9.4%

P/E

20.0

15.6

15.6

14.3

13.1

EV/EBITDA

13.0

11.8

11.9

10.3

9.0

Net Cash Flow


Source: Company, Ambit Capital research

Ratio analysis (consolidated)*


Growth

Valuation (x)

EV/Sales

3.3

2.9

2.6

2.3

2.0

14.3

12.6

12.8

11.3

10.2

6.2

5.0

4.1

3.6

3.1

1.0%

2.1%

2.7%

3.0%

3.0%

RoE

35%

35%

29%

27%

25%

RoCE

30%

29%

24%

23%

22%

ROIC

46%

48%

39%

37%

35%

Receivable days (Days)

86

95

95

87

87

Fixed Asset Turnover (x)

3.9

4.3

4.3

3.6

3.2

EV/NOPAT
Price/Book Value
Dividend Yield (%)
Return Ratios (%)

Turnover Ratios

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 44

Asian Paints
BUY
APNT IN EQUITY

Consumer Discretionary

Asian Paints is Indias largest decorative paints player with over 50%
organised market share. Its foundation is built around high quality
professionals, proactive use of technology, effective functioning of its
Board and strong dealer relationships. Current high valuations are
justified by a combination of: a) resilient repainting demand in a weak
macro: industry likely to deliver volume CAGR of ~12% over the next
decade; b) greater pricing power vs historical levels provides
sustainability to current higher levels of EBITDA margins; and c) ability
to successfully drive the next phase of evolution towards providing value
added services in the broader home improvement category. We expect
18%/23% revenue/EPS CAGR over FY16-FY20 amid 15%/12% decorative
paint industry revenue CAGR over FY15-25/FY25-35. Our DCF-based fair
value of `1,270 (32% upside) implies FY18E P/E of 43x.

Recommendation

Competitive position: STRONG

Performance

Asian Paints is a rare example of a large Indian company, held by multiple


promoters and yet run by a high-calibre, professional, management team. The
remarkable consistency in revenue growth (18-20% revenue CAGR in each of
the previous 6 decades), earnings growth (consistently rising PBT margin over
the past 40 years), and disciplined capital deployment (~32% average RoCE
over the past two decades) stands testimony to their calibre.

140
120
100
80

Asian Paints

Sep-16

Asian Paints has revenue and earnings with remarkable consistency

GREEN
GREEN
GREEN

160

Mar-16

Over FY06-16, Indias organised decorative paints industry has delivered


revenue CAGR of 16.4%. This has been driven by: a) shift from unorganised to
organised products; b) premiumisation from distempers to emulsions; c)
shrinking repainting cycles; and d) urbanisation. Asian Paints has reported 18%
revenue growth over this period, gaining 10% market share.

Accounting:
Predictability:
Earnings Momentum:

Jan-16

16.4% industry revenue CAGR over FY06-16; Asian Paints gaining share

`995/US$14.9
`1,109/US$16.6
`963
`1,270
32

Flags

Nov-15

Changes to this position: STABLE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

Jul-16

A legend built over several decades

November 17, 2016

May-16

STRATEGY NOTE

Sensex

Source: Bloomberg, Ambit Capital research

Asian Paints forensic score analysis

Asian Paints has built moats around supply chain, talent and IT
In a voluminous product category with over 1,800 SKUs, Asian Paints has built
impregnable competitive advantages around supply chain through extensive use
of the technology to forecast demand accurately, shorten product delivery times
and better manage working capital. Asian Paints has consistently led the
evolution of the paints industry by pioneering initiatives like supplying directly to
dealers rather than through distributors and using IT in demand forecasting. The
firms architecture is built around: a) nurturing professional talent in a unique
work culture; b) consistent use of technology for operating efficiency
improvements; and c) a truly independent and empowered Board of Directors.
Valuations whats the right multiple for an enduring franchise?
Asian Paints valuations have undergone a re-rating from 35x to 43x over the
past two years. Resilience of decorative paints category demand and higher
pricing power over the past two years vs a decade ago were the key factors.
However, the current valuations do NOT adequately factor in the likelihood of
Asian Paints transitioning from a decorative paints company to a provider of
value-added offerings in the broader home dcor sector. Our DCF factors in
longevity of Asian Paints growth profile given market share gains in paints. This
industry growth will be driven by decreasing repainting cycle (from 10.6 years
currently to 8.5/7.5 years by FY25/FY35) and a rise in the share of organised
sector. Our fair value of `1,270 implies 32% upside and 43x FY18E P/E.

Source: Ambit HAWK, Ambit Capital research

Asian Paints greatness score analysis

Source: Ambit HAWK, Ambit Capital research

Research Analysts
Rakshit Ranjan, CFA
+91 22 3043 3201
rakshit.ranjan@ambit.co
Dhiraj Mistry, CFA
+91 22 3043 3264
dhiraj.mistry@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Asian Paints
Exhibit 1: Evolution of Asian Paints
Renenue (Rs. bn)

175

Pre-tax ROCE (RHS)

80%

150
60%

125
100

40%

75
50

20%

25
0%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Source: Company, Ambit Capital research.

Exhibit 2: Key financial parameters over the last decade


(Fig in ` mn)
Revenues

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

36,700

44,072

54,632

66,809

77,062

96,322

109,707

127,148

141,828

155,341

21%

20%

24%

22%

15%

25%

14%

16%

12%

10%

2,886

4,365

4,230

8,828

8,814

10,205

11,595

12,727

14,549

18,317

Revenue growth (%)


Net profits
EPS
CFO

3.0

4.3

4.2

8.7

8.8

10.3

11.6

12.8

14.8

18.5

2,697

4,798

3,894

10,632

7,613

8,263

11,868

14,000

11,877

23,333

Pre-tax CFO / EBITDA

90%

101%

87%

112%

88%

83%

94%

94%

81%

112%

1,760

1,718

794

6,679

6,052

1,532

5,501

11,664

7,501

15,274

0.3

0.2

0.1

0.1

(0.2)

(0.1)

(0.2)

(0.2)

0.0

(0.0)

RoE (%)

40%

47%

37%

57%

43%

40%

36%

33%

32%

34%

Pre-tax ROCE (%)

46%

56%

47%

74%

59%

54%

50%

48%

45%

49%

FCF
Debt equity (x)

Source: Company, Ambit Capital research.

Exhibit 3: The key things to note from evolution


Time period

Phase

1942-1967

Founders take it to
the #1

1967-1997

Key developments

Professional
management helps
scale up operations

Asian Paints chose decorative paints instead of price driven industrial paints business
Asian Paints built its distribution starting with smaller cities and later expanded to larger cities
Asian Paints became Indias largest paints company in 1967
Started hiring professional from top business schools of India
Asian Paints strengthened system and processes across functions during 1967-1987
Joint venture company viz. Asian PPG Industries Pvt. Ltd was set up along with PPG Industries
In 1997 chairman Champaklal Choksey passes away; Atul Choksey resigns; Ashwin Choksi appointed as MD

1997-2016

Booz Allen Hamilton (consultant) helped improve operational efficiencies during 1998-2001
Business process re Market share increased from 38% in 1997 to 54% in 2015
engineering and
acceleration of
Appointed Mr. PM Murty as Managing Director & CEO in 2009
market share gains
Appointed Mr. KBS Anand as Managing Director & CEO in 2011
Acquisition of Sleek Group (modular kitchen) in 2013 and ESS ESS bathroom products in 2014

Source: Ambit Capital research

Exhibit 4: Competitive mapping of Asian Paints with other peers


Company

Sub-segment
Positioning

Revenue
FY16 revenue CAGR FY1016

Decorative
paint market
share

EBITDA
Margin
(FY16)

Pre-tax
RoCE
(FY16)

Pre-tax
CFO/EBITDA
(FY10-16)

Capex/CFO
(FY10-16)

Asian Paints

#1

155,341

15%

54%

18%

49%

95%

38%

Berger Paints

#2

46,341

16%

18%

14%

32%

84%

57%

Kansai Nerolac

#3

38,302

14%

16%

15%

27%

83%

31%

Akzo Nobel

#4

27,401

17%

10%

11%

30%

97%

49%

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 46

Asian Paints
Exhibit 5: Mapping Asian Paints and its peers on IBAS
Asian
Paints

Berger
Paints

Kansai
Nerolac

Akzo
Nobel

Comments

Innovation

Brand

Architecture

Strategic asset

Asian Paints has regularly innovated around products by staying close to its
customers
Empowerment of professionals to take control of middle and senior
management as early as 1969
Attempting a transition from a products company to a services company
(home dcor company)
Asian Paints has consistently maintained its focus on advertising from as early
as the 1950s
Asian Paints advertising expense is 1.3x of summation of other 3 competitors
Nurtured professional talent in a unique work culture by rapid career
progression for those who perform and allowing creativity
Proactive investments in technology
Independent board of directors are high quality professionals with relevant
experience
Asian Paints has created a network of factories and depots across the country
with 8 factories, 6 regional distribution centre and 125 depots
Deep rooted relationships with >35,000 dealers

Overall
Source: Company, Ambit Capital research, Note:

- Strong;

- Relatively Strong;

Exhibit 6: Sources of funds over the last decade

- Average;

- Relatively weak.

Exhibit 7: Application of funds over the last decade


Increase in
cash and
cash
equivalents
5%

Dividend
received,
5%

Purchase of
Investments
4%

Dividend
paid
38%
Net Capex
40%

Cash flows
from
operations,
96%

Interest paid
3%

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 8: Asian Paints forward P/E evolution

Exhibit 9: Asian Paints share price performance v/s Sensex

50

2,000
1,500

40

1,000

30
500

Source: Company, Ambit Capital research

November 17, 2016

Average of 5yr P/E

APNT

Oct 16

Oct 15

Oct 14

Oct 13

Oct 12

Oct 11

Oct 10

Oct 09

Oct 08

Oct 07

Oct 06

Oct-16

Jun-16

Feb-16

Oct-15

Jun-15

Feb-15

Jun-14

Asian Paints 1 year fwd P/E

Oct-14

Oct-13

Feb-14

Jun-13

Oct-12

Feb-13

Jun-12

Feb-12

Oct-11

20

Sensex

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 47

Asian Paints
Exhibit 10: Explanation for our flags
Segment

Score

Comments

Accounting

GREEN

Asian Paints scores well on cash conversion, related party advances and return on surplus cash; its working
capital cycle; RoE and provisions for debtors outstanding for more than six months are better than peers.

Predictability

GREEN

Predictability of earnings remains high for Asian Paints given: (a) high correlation of industry volume
growth rates with GDP; (b) strong correlation of raw material costs with crude and foreign exchange rates;
and (c) market share changes across various players in the industry.

Earnings Momentum

GREEN

On the back of higher-than-expected volume growth, Asian paints' consensus EPS estimates have been
upgraded by 4% for FY17 and FY18 over the past six months.

Source: Ambit Capital research

Exhibit 11: Forensic score evolution

Exhibit 12: Greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 48

Asian Paints
Balance sheet
Year to March (` mn)
Shareholders' equity

FY15

FY16

FY17E

FY18E

FY19E

959

959

959

959

959

Reserves & surpluses

46,464

55,093

66,344

81,032

99,467

Total networth

47,424

56,053

67,303

81,991

1,00,426

Minority Interest

2,637

2,942

3,552

4,254

5,061

Preference share capital


Debt
Deferred tax liability

4,099

3,060

3,060

3,060

3,060

1,799

2,176

2,176

2,176

2,176

Total liabilities

55,959

64,231

76,092

91,481

1,10,723

Gross block

41,123

51,105

57,105

59,105

61,105

Net block

26,600

34,031

36,642

34,994

33,216

1,960

1,108

1,000

1,000

1,000

15,878

20,982

20,982

20,982

20,982

2,044

4,204

7,561

22,622

41,329

Debtors

11,799

12,483

14,538

17,438

20,833

Inventory

22,585

20,640

28,106

33,714

40,277

5,404

4,683

5,815

6,975

8,333

CWIP
Investments
Cash & equivalents

Loans & advances


Other current assets

2,853

3,303

1,938

2,325

2,778

Total current assets

44,685

45,313

57,958

83,075

1,13,550

Current liabilities

25,573

28,326

32,253

38,688

46,219

Provisions

7,591

8,877

8,238

9,882

11,805

Total current liabilities

33,164

37,203

40,491

48,570

58,025

Net current assets

11,520

8,110

17,467

34,505

55,525

55,959

64,231

76,092

91,481

1,10,723

FY15

FY16

FY17E

FY18E

FY19E

1,41,828

1,55,341

1,76,877

2,12,167

2,53,468

11.5%

9.5%

13.9%

20.0%

19.5%

1,16,993

1,19,749

1,42,970

1,69,413

2,02,545

22,354

28,086

33,906

42,754

50,923

11.9%

25.6%

20.7%

26.1%

19.1%

Miscellaneous
Total assets
Source: Company, Ambit Capital research

Income statement
Year to March (` mn)
Operating income
% growth
Operating expenditure
Operating profit
% growth
Depreciation
EBIT
Interest expenditure
Non-operating income
Adjusted PBT
Tax

2,659

2,880

3,388

3,648

3,778

19,695

25,207

30,518

39,106

47,145

348

405

346

346

346

1,697

2,007

2,469

3,061

3,857

21,045

26,809

32,641

41,821

50,656

6,495

8,491

10,119

12,964

15,703

14,549

18,317

22,522

28,856

34,953

14%

26%

23%

28%

21%

14,549

18,317

22,522

28,856

34,953

322

531

610

702

807

Adjusted Consolidated net profit

14,227

17,787

21,912

28,155

34,146

Reported Consolidated net profit

14,227

17,787

21,912

28,155

34,146

Adjusted PAT/ Net profit


% growth
Prior Period Items
Reported PAT / Net profit
Minority Interest
Share of associates

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 49

Asian Paints
Cashflow statement
Year to March (` mn)
EBIT
Depreciation

FY15

FY16

FY17E

FY18E

FY19E

21,392

27,214

32,987

42,167

51,002

2,683

2,880

3,388

3,648

3,778

Others

(1,367)

(1,124)

Tax

(6,329)

(8,154)

(10,119)

(12,964)

(15,703)

(Incr) / decr in net working capital

(4,502)

2,517

(6,001)

(1,977)

(2,313)

Cash flow from operations

11,877

23,333

20,256

30,874

36,764

Capex

(4,377)

(8,059)

(5,892)

(2,000)

(2,000)

(Incr) / decr in investments

306

(832)

Other income (expenditure)

816

847

Others

(1,523)

(648)

Cash flow from investments

(4,778)

(8,691)

(5,892)

(2,000)

(2,000)

1,531

(1,139)

(345)

(401)

(346)

(346)

(346)

(6,947)

(7,642)

(10,661)

(13,467)

(15,711)

(5,761)

(9,182)

(11,007)

(13,813)

(16,057)

1,339

5,460

3,356

15,061

18,707

10,669

16,130

7,561

22,622

41,329

7,501

15,274

14,364

28,874

34,764

Net borrowings
Issuance of equity
Interest paid
Dividend paid
Others
Cash flow from financing
Net change in cash
Closing cash balance
Free cash flow
Source: Company, Ambit Capital research

Ratio analysis
Year to March (%)

FY15

FY16

FY17E

FY18E

FY19E

EBITDA margin (%)

15.8%

18.1%

19.2%

20.2%

20.1%

EBIT margin (%)

15.1%

17.5%

18.6%

19.9%

20.1%

Net profit margin (%)

10.3%

11.8%

12.7%

13.6%

13.8%

Dividend payout ratio (%)

50.0%

50.1%

48.7%

47.8%

46.0%

0.0

(0.0)

(0.1)

(0.2)

(0.4)

15.0

39.8

17.9

17.9

17.9

Net debt: equity (x)


Working capital turnover (x)
Gross block turnover (x)

3.8

3.5

3.4

3.8

4.4

Post-tax RoCE (%)

31.4%

32.7%

34.2%

36.5%

36.5%

Pre-tax RoCE (%)

45.4%

49.2%

51.0%

54.3%

54.1%

RoIC (%)

34.7%

34.9%

37.2%

44.3%

53.2%

RoE (%)

32.4%

34.4%

35.5%

37.7%

37.4%

Year to March (` mn)

FY15

FY16

FY17E

FY18E

FY19E

EPS (`)

14.8

18.5

22.8

29.4

35.6

Diluted EPS (`)

14.8

18.5

22.8

29.4

35.6

Book value per share (`)

49.4

58.4

70.2

85.5

104.7

Source: Company, Ambit Capital research

Valuation parameters

Dividend per share (`)

6.1

7.5

9.5

12.0

14.0

P/E (x)

64.9

51.9

42.2

32.8

27.1

P/BV (x)

21.0

17.8

14.8

12.2

9.9

EV/EBITDA (x)

41.6

33.3

27.5

21.8

18.3

EV/EBIT (x)

46.8

36.8

30.3

23.7

19.6

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 50

Lupin
BUY
LPC IN EQUITY

Lupin has championed the art of business evolution (from plain oral solids to
complex generics) without compromising on profitability and stakeholder
interests. Lupin transitioned from anti-TB company (more than 50% of revenues
in FY06) to higher growth CVS/Diabetes/CNS resulting in revenue CAGR of 23%
over FY06-16E. In the USA, Lupin evolved its revenue profile from plain oral
solids to filing for complex generics. Revenue per ANDA improved from
US$3.7mn in FY08 to US$6.5mn in FY16. Over the past couple of years, Lupins
investments in the USA have come to the fore as it has added differentiated
products and expect them to materialise in medium term.
From India to USA; journey from weak product portfolio to complex one

Flags
Accounting:
Predictability:
Earnings Momentum:

AMBER
AMBER
RED

Performance
120
110
100
90
80
70

Lupin

Sep-16

Vision to move from oral solids to complex generics materialises

`658/US$9.9
`1,824/US$27.4
`1,459
`1,851
27

Jul-16

Changes to this position: STABLE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Upside (%):

May-16

Competitive position: STRONG

Recommendation

Mar-16

Lupin transitioned from API to plain oral solids to complex generics due
to managements vision/agility in tapping changing dynamics. Lupin is
one of the biggest beneficiaries of GDUFA given presence in complex
generics and pipeline of ~150 ANDAs. Management is preparing for the
next leap through innovation. Success should be driven by (a) investment
in innovative pursuits in complex therapeutic areas; (b) industry-leading
R&D spends (12% of FY16 sales) and an experienced team; and (c)
previous experience in marketing branded products in the USA. Stock
trades at 16x FY18E EPS; material re-rating from present 16x (peers at
~20x) will be driven by earnings surprises (our estimates are 20% ahead
of consensus) as visibility improves. Risks: a) adverse pricing
environment in the USA; and b) failure in executing innovative projects.

Healthcare

Jan-16

Dukes have castellated the fort

November 17, 2016

Nov-15

STRATEGY NOTE

Sensex

Until FY07, Lupin had India-heavy revenue profile with product portfolio in slowgrowing acute therapies. The management realised changing trends in Indian
pharma consumption and switched to lifestyle disease chronic products which
grew faster than IPM. Similarly, in the US market, Lupins management realised
product-specific opportunities and capitalised during FY13-16 (US revenue
CAGR of 23%). Lupins capability to adapt to changing environment has led to
margin/RoCE expansion from 24%/22% in FY07 to 28%/25% in FY16. During
this period, while its peers focused on acquisition to grow, Lupin primarily grew
organically. Early entry into the Japanese market and investments in innovative
pursuits (NCEs/NDDS; R&D at 12% of sales) should provide the next big leap.

Source: Bloomberg, Ambit Capital research

Ranks 2nd on sector IBAS framework; brands and strategic asset fortified

Lupins greatness score analysis

Focus on creating strategic assets through investment in Japan, presence in


complex generics in the USA and de-risking of the US business through multiple
USFDA-approved facilities to strengthen its business mix. The company has
credible branded franchise in India with a broad-based product portfolio (Top 10
brands contribute only 20% of revenue). Limited key man risk is led by
decentralised decision making. Scope to improve MR productivity in India for top
rank.

Source: Ambit HAWK, Ambit Capital research

Lupins forensic score analysis

Source: Ambit HAWK, Ambit Capital research

Visibility on growth drivers lends comfort on valuations


Lupin trades at 16x FY18E EPS (20% discount to its peers and five-year average).
We believe valuations will improve, given: a) well-entrenched promoters; b)
strong balance sheet; and c) excellence in execution. Also, earnings momentum
is likely to sustain led due to a) unfolding of pipeline of ~150 ANDAs in the USA
and 25% net profit CAGR over FY16-18E; b) investments in longer-term growth
drivers like complex injectables, ophthalmics, respiratory and dermatology; and
c) high visibility of earnings through large pipeline in the USA and growth
acceleration in India.

Research Analyst
Paresh Dave, CFA
+91 22 3043 3212
paresh.dave@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Lupin
Exhibit 1: Evolution of Lupin

160
140

` Bn

120
100

Making in-raods in the US


business led by launch of plain oral
solids and enetering chronic space in
Indian business.

Indian business
driven growth with
India contributing
60% of overall
revenues

Benefits of patent cliff with


Lupin launching limited
competiion products in the US
market

30%
25%
20%

80

15%

60

10%

40

5%

20
0

0%
FY05

FY06

FY07

FY08

India

FY09

FY10

FY11

US generics

FY12

FY13

Others (RoW, API)

FY14

FY15

FY16

RoCE, RHS

Source: Company and Ambit Capital research. Note: RoCE is pre-tax RoCE.

Exhibit 2: Key financial parameters over the last decade


(` mn)
Revenues

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

21,509

28,709

38,296

48,708

58,195

70,829

96,413

112,866

127,700

142,085

33.5%

33.4%

27.2%

19.5%

21.7%

36.1%

17.1%

13.1%

11.3%

4,083

5,015

6,816

8,625

8,677

13,141

18,364

24,032

22,707

Revenue growth (%)


Net profits

3,086

EPS

7.0

9.2

12.0

15.6

19.2

19.4

29.3

40.8

53.5

50.4

CFO

1,779

2,585

4,695

6,764

7,969

5,592

12,510

20,040

27,331

-3,689

CFO (pre-tax)/ EBITDA

58.0%

58.4%

79.2%

85.7%

87.6%

70.2%

83.6%

90.9%

100.4%

44.1%

FCF

240

1,308

72

3,693

540

7,098

14,787

18,655

-61,435

1.0

0.9

0.9

0.4

0.4

0.4

0.2

0.1

0.1

0.7

RoE (%)

41.2%

37.9%

37.1%

34.1%

29.5%

23.8%

28.5%

30.3%

30.4%

22.9%

RoCE* (%)

23.9%

26.7%

24.9%

27.1%

25.0%

24.1%

32.2%

39.3%

37.5%

23.9%

Debt equity (x)

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator.

Exhibit 3: The key things to note from evolution


Time period

Phase

Key developments

Lupin derived 60% of its revenues from its Indian business comprising primarily of anti-TB portfolio
(contributing 50% of the Indian business).
Within its Indian business, the company relied on acute portfolio which is a low-margin business (consolidated
Indian business drives
FY05-FY07
EBITDA margins <20%). Its US business was negligible contributing ~15% of the overall revenues with
growth
products in plain vanilla oral solids and entering as follow-on generic player, garnering revenue per ANDA of
<US$3mn.
RoCE at <20% with investment in R&D at ~4% of sales. High debt to equity at 1x led to RoE at ~40%.
Revenue growth accelerated (25% CAGR over FY08-12) led by higher revenue contribution from the US
business (34% of overall revenues) led by the launch of limited competition generics. Revenue per ANDA
increased from US$4mn to US$5mn.
Indian business reported 22% CAGR over FY08-12 led by launch of chronic products. Improvement in sales
Making in-roads in
force efficiency led by chronic therapy (MR productivity increased from `2mn in FY08 to `4.3mn in FY12).
FY08-12
US market
Chronic therapies contribute ~45% of the Indian business.
Led by US business and chronic revenues in India, gross margins expanded from 58% in FY08 to 62% in
FY12, however EBITDA margins remained flat at 21% due to increase in R&D spends from 5% of sales in FY08
to 7.5% in FY12. The company reduced its debt-to-equity ratio to 0.4x. Entered Japanese market though
acquisition of Irom Pharma which also led to slip in RoCE from 22% in FY11 to 18% in FY12.
Led by launch of limited competition products in the US market, overall revenues reported 19% CAGR over
FY12-16. Its Indian business (now majority portfolio being of chronic therapy) grows at 16% CAGR.
Lupins presence in the Japanese market improved led by Irom acquisition and revenues grew by 12% CAGR
over FY12-16. As of FY16, Japan contributes 10% of the overall revenues. The company is also fortifying its
presence in RoW markets (specifically South Africa) through acquisition of Pharma dynamics. RoW market
US business gains
FY13 Current
reported 22% revenue CAGR over FY12-16.
momentum
Led by the US business, EBITDA margins improved from 21% in FY12 to 27.7% in FY16 despite increase in
R&D spends from 8% in FY12 to 12% in FY16. Acquisitions fuelled by FCF generation of `40bn over FY13-15.
RoCE improved from 18% in FY12 to 27% in FY15; dipped in FY16 to 16% due to acquisition of Gavis for
US$880mn.
Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 52

Lupin
Exhibit 4: Competitive mapping of Lupin, with other comparable generic pharma peers
Positioning

FY16
revenue

Revenue
CAGR
FY10-16

Revenue
per ANDA
(US$ mn)

EBITDA
Margin
(median
FY10-16)

Pre-tax
RoCE
(median
FY10-16)

Median
Pre-tax CFO/
EBITDA
(FY10-16)

Cumulative
R&D as % of
Sales
(FY10-16)

Sun Pharma

#1

282,697

38%

5.1

34%

25%

91%

7%

Lupin

#2

142,085

20%

7.3

24%

26%

86%

8%

Cadila

#5

98,376

18%

6.5

21%

24%

82%

7%

Torrent

#4

66,764

23%

2.2

22%

27%

91%

4%

Dr. Reddys

#3

156,978

14%

7.0

23%

23%

85%

8%

Cipla

#6

136,783

17%

1.9

21%

19%

92%

5%

Ipca

#8

28,850

10%

1.4

18%

24%

92%

4%

Aurobindo

#7

138,961

25%

4.1

22%

21%

65%

4%

Company

Source: Company, Ambit Capital research

Exhibit 5: Mapping Lupin and its peers on IBAS


Innovation

Brand

Architecture

Strategic
Asset

Overall Comments
Visionary management has built its business through acquisitions and fortified its
moats through innovative pursuits like MK3222. The company has strong brand
equity in India with base business reporting stellar growth over FY11-15.
Marginally lower than Sun Pharma but has the ability to scale up in the US market
through launch of complex generics. The company has focused on creating strategic
assets through investment in Japan and maintaining low-cost structure.
Need to look out for Cadila's innovative pursuits. Whilst the innovative revenues
would be from India and EMs in the near term, success in these geographies would
be incrementally positive for its regulated market expectations.
Torrent Pharmas biosimilar outlook coupled with improvement in productive MR in
the Indian business help to strengthen moats. However, the company entered late in
the US business and will have to use the inorganic route to improve its position. It
continues to be best in class in the EM markets and expect EM revenues to cushion
ventures in regulated markets.
Best in class innovation profile as it leads the pack in biosimilar evolution. However, it
falters on brands in India and EMs due to predominant presence in acute therapy in
India and volatility in its EM business.
Apart from inhalers, limited investment in innovation. Base business in India lags its
peers implying lower brand equity for its excising portfolio. Senior management churn
results in weak architecture.
Serious compliance issues at its faculties hamper its prospects in the US market. Yet to
prove capability in innovative pursuits. Low-cost structure is the only advantage for
the company.
Limited investment in innovation, no branded generic business and average cost
structure despite presence in complex generics lead to lowest position on IBAS.

Sun
Lupin
Cadila

Torrent

Dr. Reddys
Cipla
Ipca
Aurobindo

Source: Company, Ambit Capital research; Note:

- Strong;

- Relatively Strong;

Exhibit 6: Increase in debt towards funding of Gavis


acquisition in 2015

- Average;

- Relatively weak.

Exhibit 7: Lupin focused on organic growth through capex


in relevant markets (like Japan)

Proceeds
from
shares,
1.1%

Purchase of
investment,
17.4%
Debt
raised,
39.2%
CFO,
57.5%

Interest
received,
1.5%

Net Capex,
67.5%

November 17, 2016

Interest
paid, 2.4%
Increase in
cash and
cash
equivalent,
1.5%

Dividend
received,
0.8%
Source: Company, Ambit Capital research

Dividend
paid,
11.2%

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 53

Lupin
Exhibit 8: Re-rating driven by product approvals in USA
followed by decline in PE due to quality issues at Goa
45.0
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
-

Exhibit 9: Lupins share price performance v/s Sensex


3500

LPC - one-yr forward P/E chart

3000
2500

Five-year average PE = 22.1x

2000
1500
1000
500
Jan-16

Jan-15

Sensex

Jan-14

Jan-13

Jan-12

Lupin

Jan-11

Jan-10

Jan-09

Jan-08

Jan-07

Jan-06

Jan-05

Mar-16

Mar-15

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Mar-09

Mar-08

Mar-07

Mar-06

Mar-05

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our flags


Field

Score

Accounting

AMBER

Predictability

AMBER

Earnings momentum

RED

Source: Ambit Capital research, Note:

Comments
In our forensic analysis of 360 companies, Lupin scores above the pharma industry average (comprising 26
companies). Lupin scores high on ratios of: (a) CFO/EBITDA; (b) fixed asset turnover; (c) contingent liabilities; and
(d) audit fees as a percentage of standalone revenues. However, Lupin has weaker scores on: (a) volatility in
selling and distribution costs; and (b) cash yield.
Overall, the management made timely announcements in its earnings calls, meetings and interviews regarding
product filings, acquisitions and business outlook. However, the unpredictability of unknown large filings in the
USA, emerging markets and innovative projects makes us assign an AMBER flag on predictability.
Consensus FY17E and FY18E EBITDA and EPS estimates have been downgraded by 3-9% over the past three
months led by muted guidance for FY17E, increase in guidance for R&D spends to 12-15% of sales (vs 10% in
FY16) and lack of clarity on remediation at it Goa facility.
- Strong;

- Relatively Strong;

- Average;

- Relatively weak

Exhibit 11: Forensic score evolution

Exhibit 12: Greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 54

Lupin
Balance sheet (consolidated)
Year to Mar (` mn)

FY15

FY16

FY17E

FY18E

FY19E

Total assets

96,377

183,984

198,978

223,776

254,402

Fixed assets

32,961

86,379

95,231

103,107

105,171

Current assets (incl cash)

64,507

107,473

120,088

146,302

185,552

4,814

8,379

30,767

35,542

46,752

Cash
Investments

16,584

75

75

75

75

Total liabilities

96,377

183,984

198,978

223,776

254,402

Total networth

88,741

109,844

134,837

169,635

210,261

5,371

71,775

61,775

51,775

41,775

35,001

40,393

46,866

56,159

66,846

2,024

2,045

2,045

2,045

2,045

Total debt
Current liabilities
Deferred tax liability
Source: Company, Ambit Capital research;

Income statement (consolidated)


Year to March (` mn)

FY15

FY16

FY17E

FY18E

FY19E

Net revenues

127,700

142,085

175,355

220,382

278,723

Material costs

41,570

43,094

54,162

67,149

93,161

Employee costs

13,949

17,260

19,744

22,063

24,710

Other mfg. costs

35,985

44,196

54,501

68,636

87,553

Core EBITDA

36,196

37,535

46,948

62,534

73,299

Depreciation

4,347

4,635

6,149

7,124

7,936

Interest expense
Adjusted PBT
Tax
Net profit

98

446

1,669

1,419

1,169

34,149

34,331

40,538

56,351

65,794

9,705

11,536

10,945

15,215

17,764

24,032

22,707

29,367

40,886

47,733

Source: Company, Ambit Capital research

Cash flow statement (consolidated)


Year to March (` mn)

FY15

FY16

FY17E

FY18E

FY19E

34,149

34,331

40,538

56,351

65,794

4,347

4,635

6,149

7,124

7,936

Tax

(9,436)

(11,662)

(10,945)

(15,215)

(17,764)

Net working capital

(1,378)

(22,946)

9,856

(12,317)

(16,048)

PBT
Depreciation

Others
CFO
Capital expenditure
Investment and others
CFI
Issuance of equity
Inc/Dec in borrowings
Net dividends
Interest paid
Others

(351)

(8,047)

7,756

(124)

(1,153)

27,331

(3,689)

53,354

35,819

38,765

(14,970)

(70,028)

(15,000)

(15,000)

(10,000)

4,425

593

(10,545)

(69,435)

(15,000)

(15,000)

(10,000)

413

536

(700)

62,081

(10,000)

(10,000)

(10,000)

(1,573)

(4,055)

(4,071)

(4,374)

(6,088)

(109)

(436)

(1,669)

(1,419)

(1,169)

(226)

(250)

(297)

CFF

(1,969)

58,126

(15,966)

(16,043)

(17,554)

Net change in cash

14,817

(14,998)

22,387

4,776

11,210

4,814

8,379

30,767

35,542

46,752

12,361

(73,717)

38,354

20,819

28,765

Closing cash balance


FCFF
Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 55

Lupin
Ratio analysis (consolidated)
Year to March (` mn)

FY15

FY16

FY17E

FY18E

FY19E

Revenue growth

13.1

11.3

23.4

25.7

26.5

Core EBITDA growth

20.5

3.7

25.1

33.2

17.2

APAT growth

30.9

-5.5

29.3

39.2

16.7

EPS growth

31.1

-5.7

29.3

39.2

16.7

Core EBITDA margin

28.3

26.4

26.8

28.4

26.3

EBIT margin

24.9

23.2

23.3

25.1

23.5

Net profit margin

18.8

16.0

16.7

18.6

17.1

RoCE (%)

26.7

15.8

15.7

19.3

20.1

Reported RoE (%)

30.4

22.9

24.0

26.9

25.1

Debt-equity ratio (X)

0.1

0.7

0.5

0.3

0.2

Current ratio

1.8

2.7

2.6

2.6

2.8

Gross block turnover (x)

2.7

2.1

1.9

2.0

2.3

Working capital turnover (x)

3.7

2.9

2.5

2.7

2.7

CFO/EBITDA (x)

0.8

-0.1

1.1

0.6

0.5

FY15

FY16

FY17E

FY18E

FY19E

Source: Company, Ambit Capital research

Valuation parameters (consolidated)


Year to March (` mn)
EPS
Book value ( per share)
P/E (x)
P/BV (x)
EV/EBITDA(x)

53.5

50.4

65.2

90.7

105.9

197.4

243.8

299.3

376.5

466.6

28.1

29.8

23.0

16.5

14.2

7.6

6.2

5.0

4.0

3.2

18.6

19.7

15.1

11.1

9.2

EV/Sales (x)

5.3

5.2

4.0

3.1

2.4

EV/EBIT (x)

21.2

22.4

17.3

12.5

10.3

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 56

Cadila
BUY
CDH IN EQUITY

Cadila has missed opportunities that were leveraged by peers to create value for
stakeholders. However, if we discount the initial 43 years of its relatively passive
existence, Cadila seems to be a budding newbie. A deep dive into Cadilas
history suggests that the company has been proactive in acquiring capabilities
and product-related assets through alliances, JVs and acquisitions. However, its
financials suggest that the company is yet to extend these acquired assets
beyond the domestic market. We believe the extension of these assets and
capabilities beyond the home market would be a key trigger for value creation
and revaluation of Cadilas long-term growth prospects.
Niche product launches in the USA to drive near-term margins/RoCE
Cadila has been guilty of quality issues in past (FY12 and FY16), but the
management is closer to clearing its facility as majority remediation have been
done with and Form 483 has been cleared. Cadila should receive bunched up
product approvals and we build >75 product approvals for the USA in FY18/19;
most would be complex generics (modified release, topicals, transdermal
patches) implying lower competition and higher pricing. Over-dependence on
Moraiya facility will end with Baddi and SEZ facilities gaining scale. Normalised
margins (excluding one-off in HCQS revenues) should increase from ~18% in
FY16 to 21.4% in FY19E led by ramp-up in US generics (40% share). Positive
surprises can be from bolt-on acquisitions (in EMs) which are in gestation period
(losses).

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
AMBER
AMBER

Performance
120
110
100
90
80
70

Cadila Health.

Sep-16

Catching up with peers

`389/US$5.8
`314/US$4.7
`380
`430
13

Jul-16

Changes to this position: STABLE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Upside (%):

May-16

Competitive position: STRONG

Recommendation

Mar-16

Cadila, a late bloomer, is finally displaying abilities in the US market


and results from innovative pursuits (19% revenue CAGR over FY03-16).
Cadila is building capabilities in complex generics and innovative
pursuits inch by inch and moving up the value chain from plain vanilla
oral solids to complex generics like transdermals and modified release,
resulting in FY11-16 cumulative R&D spends of 7% of sales. Despite
quality compliance issues, Cadila is best placed to reap the benefits of
faster product approvals through GDUFA (~150 ANDAs pending
approval). US business should normalise as issues get resolved, facility is
cleared (Apr-17) and Cadila receives bunched up product approvals (US
revenue CAGR of 26% over FY16-19E). Cadila ranks third on our IBAS
framework led by realisation of novel products and biosimilars in India
and EMs.

Healthcare

Jan-16

Inches make champions

November 17, 2016

Nov-15

STRATEGY NOTE

Sensex

Source: Bloomberg, Ambit Capital research

Cadilas forensic score analysis

Source: Ambit HAWK, Ambit Capital research

Cadilas greatness score analysis

IBAS framework: Leads in innovative capabilities, India brand equity


Cadila is among the more successful innovation plays in Indian pharma. Whilst
innovatives revenues would emanate only from India/EMs in the near term,
success will set stage for regulated market forays. Its Indian business has a slowgrowing acute heavy portfolio, yet revenues have grown faster than IPM due
better execution (MR productivity at Rs6.5mn vs peers average of Rs4mn).

Source: Ambit HAWK, Ambit Capital research

Valuations to recover as concerns abate


Quality compliance issues at the Moraiya facility have affected valuations in the
past. The company is closer to clearing its facility, as per our analysis. Whilst
well-entrenched promoters, high R&D productivity and excellence in execution
lend comfort on valuations, earnings momentum is also likely to sustain (led by
the unfolding of the ANDA pipeline in the USA). We use a DCF-based
methodology to value Cadila with target price of Rs430/share, implying 19x
FY18E P/E vs current P/E of 17.2x, material discount to 20-21x average for last 2
years and peers at ~20x. Remediation at Moraiya will drive re-rating.

Research Analyst
Paresh Dave, CFA
+91 22 3043 3212
paresh.dave@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Cadila
Exhibit 1: Evolution of Cadila

120
100

Focus on US generics
with launch of limited
competition products
improving RoCEs

India business driven


growth with >70% of
revenue from slow-growing
acute therapy

Quality issues at its facility


hamper revenue growth though
limited comeptition opportunity in US
salvages RoCE

35%
30%
25%

80

20%

60

15%

40

10%

Revenue, LHS (Rs. Bn)

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

0%
FY07

0
FY06

5%
FY05

20

RoCE

Source: Company and Ambit Capital research. Note: RoCE is pre-tax RoCE

Exhibit 2: Key financial parameters over the last decade


(Rs mn)
Revenues

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

17,855

22,660

28,624

35,742

44,647

50,900

61,552

70,600

84,971

94,694

26.9%

26.3%

24.9%

24.9%

14.0%

20.9%

14.7%

20.4%

11.4%

2,338

2,576

3,031

5,051

7,110

6,526

6,536

8,036

11,506

15,226

3.7

4.1

3.0

4.9

6.9

6.4

6.4

7.8

11.2

14.9

Revenue growth (%)


Net profits
EPS
CFO

2,885

2,548

4,491

7,084

8,382

6,934

9,105

11,753

14,130

27,188

CFO (pre-tax)/EBITDA

78.9%

49.1%

44.1%

87.7%

73.2%

43.9%

62.1%

88.3%

78.6%

111.4%

645

-3074

-1,918

3050

1,464

-8881

-2,759

4,294

4,981

10,275

FCF
Debt equity (x)

0.5

0.8

1.0

0.7

0.5

0.9

1.0

0.8

0.6

0.5

RoE (%)

29.9%

26.7%

26.4%

35.3%

37.4%

27.5%

23.7%

25.2%

29.9%

31.7%

RoCE* (%)

26.8%

26.3%

22.4%

27.8%

31.9%

22.5%

17.8%

18.5%

25.9%

31.8%

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator.

Exhibit 3: The key things to note from evolution


Time period

FY05-FY07

FY08-12

FY13 Current

Phase

Key developments

Indian business
drives growth

Cadila derived 60% of its revenues from the Indian business over FY05-07 comprising primarily of acute
therapy (contributing >70% of Indian business).
The US business is at a nascent stage (8% of revenue), with focus on product development. As of FY07, the
company had 23 ANDAs approved (but only 9 launched) and 37 ANDAs filed and pending approval.
Margins were at 20% (vs FY16 at 25%) due slow moving and lower margin acute therapy portfolio in India.

Focus shifts to
US generics

Revenue growth accelerated (23% CAGR over FY08-12) led by higher revenue contribution from the US
business (24% of overall revenues) led by launch of limited competition generics. Revenue per ANDA
increased from <US$2mn to US$3.1mn.
The Indian business reported 12% CAGR over FY08-12 led by a gradual shift from acute therapy to chronic
products (chronic contributing 52% in FY12 vs 30% in FY07). Also, improvement in sales force efficiency led by
chronic therapy (MR productivity increases from Rs2mn in FY08 to Rs4.3mn in FY12). From FY09, the
management expanded its presence in emerging markets (though acquisitions) leading to 16% revenue CAGR
over FY07-12.
Led US business and chronic revenues in India, gross margins expanded from 64% in FY08 to 67% in FY12,
however EBITDA margins remained flat at 20% due to increase in R&D spends from 6% of sales in FY07 to 8%
in FY12.

Quality issues at its


facility stalls revenue
partially

Cadila received warning for its Moraiya facility in FY12 and FY16 leading to slowdown in pace of product
approvals in the US market. However, on the positive side, the launch of limited competition products
(Depakote ER and HCQS) led to flat gross margin (67% in FY12 vs 65% in FY16).
Improvement in revenue growth in emerging markets (26% revenue CAGR over FY12-16) but continue to
remain loss making for the company due to gestation period in establishing brand equity.
Increase in R&D spends (20% CAGR over FY12-16), losses in EM business and limited product approvals led to
EBITDA margins at 18% in FY16 vs 21% in FY12. RoCE improved to 23% in FY16 from 19% in FY12. Quality
issues raised at its Moraiya facility are expected to be cleared by the end of FY17.

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 58

Cadila
Exhibit 4: Competitive mapping of Lupin, with other comparable generic pharma peers
Positioning

FY16
revenue

Revenue
CAGR
FY10-16

Revenue
per ANDA
(US$mn)

EBITDA
Margin
(median
FY10-16)

Pre-tax
RoCE
(median
FY10-16)

Median
Pre-tax CFO/
EBITDA
(FY10-16)

Cumulative
R&D as % of
Sales
(FY10-16)

Sun Pharma

#1

282,697

38%

5.1

34%

25%

91%

7%

Lupin

#2

142,085

20%

7.3

24%

26%

86%

8%

Cadila

#5

98,376

18%

6.5

21%

24%

82%

7%

Torrent

#4

66,764

23%

2.2

22%

27%

91%

4%

Dr. Reddys

#3

156,978

14%

7.0

23%

23%

85%

8%

Cipla

#6

136,783

17%

1.9

21%

19%

92%

5%

Ipca

#8

28,850

10%

1.4

18%

24%

92%

4%

Aurobindo

#7

138,961

25%

4.1

22%

21%

65%

4%

Company

Source: Company, Ambit Capital research

Exhibit 5: Mapping Lupin and its peers on IBAS


Innovation

Brand

Architecture

Strategic
Asset

Overall Comments
Visionary management has built its business through acquisitions and fortified its
moats through innovative pursuits like MK3222. The company has strong brand equity
in India with base business reporting stellar growth over FY11-15.
Marginally lower than Sun Pharma but has the ability to scale up in the US market
through launch of complex generics. The company has focused on creating strategic
assets through investment in Japan and maintaining low-cost structure.
Need to look out for Cadila's innovative pursuits. Whilst the innovative revenues
would be from India and EMs in the near term, success in these geographies would be
incrementally positive for its regulated market expectations.
Torrent Pharmas biosimilar outlook coupled with improvement in productive MR in
the Indian business help strengthen moats. However, the company has entered late in
the US business and will have to use the inorganic route to improve its position. It
continues to be best in class in the EM markets and expect EM revenues to cushion
ventures in regulated markets.
Best in class innovation profile as it leads the pack in biosimilar evolution. However, it
falters on brands in India and EMs due to predominant presence in acute therapy in
India and volatility in its EM business.
Apart from inhalers, limited investment in innovation. Base business in India lags its
peers implying lower brand equity for its excising portfolio. Senior management churn
results in weak architecture.
Serious compliance issues at its faculties hamper its prospects in the US market. Yet to
prove capability in innovative pursuits. Low-cost structure is the only advantage for the
company.
Limited investment in innovation, no branded generic business and average cost
structure despite presence in complex generics lead to lowest position on IBAS.

Sun
Lupin
Cadila

Torrent

Dr. Reddys
Cipla
Ipca
Aurobindo

Source: Company, Ambit Capital research, Note:

- Strong;

- Relatively Strong;

Exhibit 6: CFO and some marginal debt were key sources


of funds over last decade (Rs112bn)

- Average;

- Relatively weak.

Exhibit 7: Capex and dividend were main uses of funds over


last decade (Rs76bn)
Purchase of
investment,
1.4%

Debt
raised,
15.3%

CFO,
81.0%

Interest
received,
3.3%

Net Capex,
62.6%

Dividend
received,
0.3%

Source: Company, Ambit Capital research

November 17, 2016

Dividend
paid,
20.7%
Interest
paid, 6.7%
Increase in
cash and
cash
equivalent,
8.6%

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 59

Cadila
Exhibit 8: Re-rating in 2008 driven by entry in USA
followed by de-rating in FY16 due to quality issues

Exhibit 9: Cadilas share price performance v/s Sensex


1400

(P/E)
CDH 1yr fwd P/E chart

35

1200
1000

30

800

25

600

20

400

15

200

Cadila

Jan-16

Jan-15

Jan-14

Jan-13

Jan-12

Jan-11

Jan-10

Jan-09

Jan-08

Jan-07

Mar-16

Mar-15

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Mar-09

Mar-08

Mar-07

Mar-06

Mar-05

0
Jan-06

Five yr PE average = 20.0x

Jan-05

10

Sensex

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our flags


Field

Score

Accounting

GREEN

Predictability

AMBER

Earnings momentum

AMBER

Comments
In our forensic analysis of 360 companies, Cadila scores in line with the average of the pharma industry
(comprising 26 companies). Cadila scores high on ratios of: (a) gross block conversion; (b) change in
depreciation rates; (c) audit fees; and (d) non-operating expenses. However, Cadila has weaker scores on: (a)
cash yield; and (b) volatility in sales and distribution costs.
Overall, the management has made timely announcements in its earnings calls, meetings and interviews
regarding product filings, acquisitions and business outlook. However, the unpredictability of unknown large
filings in the USA, emerging markets and innovative projects makes us assign an AMBER flag on predictability.
Consensus FY17E and FY18E EBITDA and EPS estimates have been flat over the past three months and have
seen material downgrades in the six-month period led by concerns around remediation at Moraiya facility.

Source: Ambit Capital research

Exhibit 11: Forensic score evolution

Exhibit 12: Greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 60

Cadila
Balance sheet (consolidated)
Year to Mar (Rs mn)

FY15

FY16

FY17E

FY18E

FY19E

Total assets

71,304

79,904

93,094

110,238

128,277

Fixed assets

41,501

47,896

54,165

59,868

65,004

Current assets (incl cash)

47,426

49,604

63,529

80,705

96,360

6,699

6,953

15,651

22,892

32,973

Cash
Investments
Total liabilities
Shareholders' equity

1,544

2,663

2,663

2,663

2,663

71,304

79,904

93,094

110,238

128,277

1,024

1,024

1,024

1,024

1,024

Reserves & surplus

41,492

52,495

65,685

82,829

100,868

Total networth

42,516

53,519

66,709

83,853

101,892

Total debt

26,513

24,420

24,420

24,420

24,420

Current liabilities

19,167

20,259

27,263

32,997

35,750

586

611

611

611

611

Deferred tax liability


Source: Company, Ambit Capital research;

Income statement (consolidated)


Year to March (Rs mn)

FY15

FY16

FY17E

FY18E

FY19E

Net revenues

84,971

94,694

111,864

140,601

156,573

Material cost

31,966

32,770

40,790

53,200

59,824

General expenses

31,382

34,240

37,907

44,656

49,601

R&D expenses

5,608

7,537

9,421

12,530

15,663

Core EBITDA

17,557

23,829

25,617

32,555

34,054

2,873

3,022

3,731

4,297

4,864

679

486

661

661

661

14,455

21,237

22,250

28,919

30,428

2,594

5,711

4,450

5,784

6,086

11,506

15,226

17,800

23,135

24,342

Depreciation
Interest expense
Adjusted PBT
Tax
Reported net profit
Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 61

Cadila
Cash flow statement (consolidated)
Year to March (Rs mn)

FY15

FY16

FY17E

FY18E

FY19E

14,455

21,237

22,250

28,919

30,428

Depreciation

2,873

3,022

3,731

4,297

4,864

Tax

2,594

5,711

4,450

5,784

6,086

(3,770)

2,656

(2,833)

(5,582)

(3,135)

PBT

Net working capital


CFO
Capital expenditure
Investment

9,936

19,938

18,698

21,851

26,072

(4,955)

(9,663)

(10,000)

(10,000)

(10,000)

308

624

(4,647)

(9,039)

(10,000)

(10,000)

(10,000)

Other investments
CFI
Issuance of equity

Inc/Dec in borrowings

(1,162)

(2,558)

Net dividends

(2,349)

(6,969)

(4,610)

(5,991)

(3,511)

(9,527)

(4,610)

(5,991)

Net change in cash

1,778

1,372

8,698

7,241

10,081

Closing cash balance

6,699

6,953

15,651

22,892

32,973

FCFF

4,981

10,275

8,698

11,851

16,072

Year to March (Rs mn)

FY15

FY16

FY17E

FY18E

FY19E

Revenue growth

20.4

11.4

18.1

25.7

11.4

Core EBITDA growth

46.3

35.7

7.5

27.1

4.6

APAT growth

43.2

32.3

16.9

30.0

5.2

EPS growth

41.4

31.4

16.7

30.0

5.2

Core EBITDA margin

20.7

25.2

22.9

23.2

21.7

EBIT margin

17.3

22.0

19.6

20.1

18.6

Net profit margin

13.5

16.1

15.9

16.5

15.5

RoCE (%)

23.4

29.6

27.1

29.7

26.5

Reported RoE (%)

29.9

31.7

29.6

30.7

26.2

Debt equity ratio (X)

0.6

0.5

0.4

0.3

0.2

Net Debt Equity ratio (X)

0.5

0.3

0.1

0.0

(0.1)

CFO/EBITDA (x)

0.6

0.8

0.7

0.7

0.8

Gross block turnover (x)

2.1

2.1

2.2

2.5

2.5

Working capital turnover (x)

3.3

3.3

3.4

3.3

2.9

Current ratio

2.5

2.4

2.3

2.4

2.7

Year to March (Rs mn)

FY15

FY16

FY17E

FY18E

FY19E

EPS

11.3

14.9

17.4

22.6

23.8

Book Value ( per share)

41.5

52.3

65.2

81.9

99.5

P/E (x)

34.4

26.2

22.4

17.3

16.4

9.4

7.5

6.0

4.8

3.9

Other financing activities


CFF

Source: Company, Ambit Capital research

Ratio analysis (consolidated)

Source: Company, Ambit Capital research

Valuation parameters (consolidated)

P/BV (x)
EV/EBITDA(x)

23.9

17.5

15.9

12.3

11.5

EV/Sales (x)

4.9

4.4

3.6

2.9

2.5

EV/EBIT (x)

28.5

20.0

18.6

14.2

13.4

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 62

Britannia
SELL
BRIT IN EQUITY

Britannia derives ~76% of its sales from biscuits with remainder from cakes, rusk
and dairy products. In the biscuit segment, Britannia derives majority of its
revenues from the mid-to-premium segment with dominant market share in the
cookies segment (~26% of the market) through the Good Day brand. It is a
distant second in the mass market glucose segment (~19% of the market) and a
close #3 in the creams segment (~23% of the market) which is dominated by
ITC (#1) at the premium end and Parle (#2) in the mass end. Britannia has
leveraged the brand equity of legacy brands like Good Day, Cream Treat and
Tiger to maintain its dominance in the biscuit market.
Renewed dominance since FY13 under the new CEO
During FY07-12, the company barely maintained its biscuit market share due to
severe competition from ITC. The company did not have any successful product
launches and its diversification attempts into the snacks and breakfast category
failed. Over FY13-16, under Varun Berry the company focused on: a) widening
and deepening its distribution; b) product innovation and renovation; and c)
several cost cutting initiatives (Click here for detailed note_16Dec2014). This
helped the company regain its market leadership from Parle in FY16. Along with
input cost tailwinds, the cost cutting initiatives helped increase EBITDA margin
from 5.7% in FY12 to 14% in FY16 with PAT growing at ~46% CAGR over
FY13-16.
Leveraging strong brands and distribution to gain scale advantages

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
AMBER
AMBER

Performance
130
120
110
100
90
80

Britannia Inds.

Sep-16

Biscuit market leader with legacy brands

`396/US$5.9
`668/US$10.0
`3,080
`2,700
12

Jul-16

Changes to this position: STABLE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

May-16

Competitive position: MODERATE

Recommendation

Mar-16

Britannia is the value market leader in Indias biscuit market; delivered


sales/PAT CAGR of 18%/19% over FY07-16. During the first half of the
last decade, it faced intense competition from ITC resulting in marketshare loss. Since FY13, under its new CEO Varun Berry, EBITDA margin
expanded from 6.8% to 14.1% in FY16 and it regained market
leadership. The companys increased focus on systems and processes
and a stronger diverse portfolio have made it more capable than a
decade ago to weather key threats of input cost inflation and intense
competitive action. With limited scope for margin expansion and
market-share increase we value Britannia at 30x FY18E EPS, at lower
end of FMCG average.

Consumer Staples

Jan-16

On a steady growth path

November 17, 2016

Nov-15

STRATEGY NOTE

Sensex

Source: Bloomberg, Ambit Capital research

Britannias forensic score analysis

Source: Ambit HAWK, Ambit Capital research

Britannias greatness score analysis

Biscuits sales in India is a low-margin commodity-like business as the category is


mostly dominated by basic variants like glucose and cookies. Unlike its peers
which have only 1-2 strong brands, Britannia has positioned itself in the mid and
premium segment through bouquet of strong brands (Good Day, Tiger, Marie,
Treat, 50-50, Milk Bikis and Nutri Choice) positioned across biscuit subcategories. Britannia has the second largest distribution reach in the biscuits
category which has been going deeper and wider in the last 5 years. These
strengths have been leveraged to gain scale and drive investment in technology
to further bring down costs and keep growing ahead of its peers.

Source: Ambit HAWK, Ambit Capital research

Trades at a marginal premium

rakshit.ranjan@ambit.co

Our bullishness around gains in market share and EBITDA margin is capped by:
(a) aggressive approach to product development by peers like ITC and Parle;
and (b) increasing input prices, leaving lower potential for EBITDA margin
expansion. We expect Britannia to deliver revenue/earnings CAGR of 14%/17%
over FY16-20E. Our DCF-based fair value of `2,700 (12% downside) implies
FY18P/E of 30x.

Ritesh Vaidya, CFA

Research Analysts
Rakshit Ranjan, CFA
+91 22 3043 3201

+91 22 3043 3246


ritesh.vaidya@ambit.co
Dhiraj Mistry, CFA
+91 22 3043 3264
dhiraj.mistry@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Britannia
Exhibit 1: Tale of two halves over the last decade
Varun Berry era deepeing of distribution,
product renovation
driving share gains

Vinita Bali era several failed product


innovations and diversifications resulting in
market share loss to ITC and Parle

100
80

80%
60%

60

40%

40

20%

20
-

0%
FY04

FY05

FY06

FY07

FY08

FY09

Biscuits revenue (Rs bn, LHS)

FY10

FY11

FY12

FY13

Other revenue (Rs bn, LHS)

FY14

FY15

FY16

Pre-tax ROCE (RHS)

Source: Ambit capital research

Exhibit 2: Key financial parameters over the last decade


(` mn)
Revenues
Revenue growth (%)
Net profits

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

27,763

34,212

37,729

46,052

54,854

61,854

69,127

78,584

86,789

23%

23%

10%

22%

19%

13%

12%

14%

10%

1,699

1,335

1,338

1,343

1,996

2,595

3,954

5,426

8,164

EPS

14.2

11.1

11.1

11.2

16.6

21.6

32.9

45.2

68.0

CFO

522

2,926

2,396

2,591

6,802

711

5,979

6,231

6,630

Pre-tax CFO-EBITDA

40%

145%

151%

133%

240%

40%

123%

102%

86%

FCF

(4)

145

167

204

104

572

631

712

Debt equity (x)

0.4

(0.2)

0.9

0.5

(0.3)

0.2

(0.2)

(0.5)

(0.4)

RoE (%)

27%

19%

27%

44%

54%

54%

58%

53%

54%

Pre-tax RoCE (%)

27%

21%

17%

25%

40%

53%

62%

70%

75%

Source: Company, Ambit Capital research.

Exhibit 3: The key things to note from evolution


Time period

Pre 2003

Phase

Sunil Alagh era

Key developments

2004-2013

Vinita Bali Taking


step backward

Post 2013

Varun Berry Biscuits


back in focus

Key brands like Good Day (1986), 50-50 and Little Hearts (1993), Milk Bikis (1996) was launched
Entered into JV with Fonterra for dairy business
In 1993, Danone and Wadia bought controlling stake in Britannia Industries.
Strengthened Brand Britannia through aggressive marketing campaign in late 1990s with Eat Healthy,
Think Better and Cricket World Cup 1999 and 2003 campaign of Britannia Khao, World Cup Jao
In 2005, Vinita Bali was appointed as new CEO
Despite shift of focus from brand building to increasing operating efficiency, EBITDA margin decreased from
11.4% in FY04 to 6.8% in FY13
Market-share loss to Parle and ITC
New product launches intensity decreased
Wadia bought out Danones stake (25.5%) in the company
Wadia bought out Fonterras stake in the Joint Venture entity
Varun Berry was appointed VP and COO in 2013
Vinita Bali quits; Varun Berry was appointed as MD
Distribution efficiency was brought by: a) resolving supply chain inefficiencies to reduce damages; b)
implementing new IT infrastructure for better MIS; and c) restructuring of sales force by giving more decision
making power to junior sales person
New product launch intensity increased in premium brands and superior/innovative packaging for existing
premium brands
Increased advertising spends from 7.6% in FY12 to 8.5% in FY16
EBITDA margin improved from 6.8% in FY13 to 14% in FY16 by a) improving operating efficiency; b) inhouse manufacturing (increasing from 33% in FY13 to 50% in FY16; c) supply chain efficiency; and d)
reducing trade promotions
Britannia became the market leader in biscuits by end of FY16

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 64

Britannia
Exhibit 4: Competitive mapping of Britannia
FY16 revenue
(` bn)

Revenue
CAGR
FY10-16

Industry
market
share

EBITDA
Margin
(FY16)

Pre-tax
RoCE
(FY16)

Pre-tax CFO/
EBITDA
(FY10-16)

Capex/CFO
(FY10-16)

#1

86.8

15%

~29%

14%

40%

125%

35%

#3

97.0

18%

~13%

3%

NA

NA

NA

#2

~83.0

19%

~28%

9%

26%

73%

41%

Company

Sub-segment
Positioning

Britannia
ITC FMCG division
Parle Biscuits

Source: Company, Ambit Capital research; Note: For ITC we have taken the FMCG segment revenues

Exhibit 5: Mapping Britannia and its peers on IBAS


Britannia

Parle

ITC

Comments
Introduction of mini pack to increase penetration
First to focus on nutrition biscuits with the launch of NutriChoice
However, Britannia has poor track record of successful product innovation over the last
decade
Britannia has built strong brands across categories and price points through popular
marketing campaigns like Eat Healthy, Think Better in the last 1990s and the Cricket
World Cup 1999 campaign with a tagline of Britannia Khao, World Cup Jao
ITC and Parle havent been able to create strong sub-brands
Britannia has the second largest distribution outreach in the biscuit category next only to
Parle
Britannia has increased its network of factories and brought them closer to the end
market thus reducing the logistics cost. It has focused on bring manufacturing in-house
to improve product quality and produce more value-added products.
Parle also has an extensive network of factories but these are mostly outsourced
manufacturers.
In a low profit margin category, Britannias scale is a key strategic asset
Britannia has also successfully created strong sub-brands at different price points which
it has used to capture the current consumption trend. For e.g. it has used Good Day to
ride the cookies wave and NutriChoice to tap into consumer demand for health biscuits
Amongst its peers, Britannia is best placed on the IBAS framework. However, the other
two players are a close second to Britannia

Innovation

Branding

Architecture

Strategic assets

Overall
Source: Company, Ambit Capital research; Note:

- Strong;

- Relatively Strong;

Exhibit 6: Britannias sources of fund over the last decade

- Average;

Exhibit 7: Britannias application of funds over the last


decade
Purchase
of
Investmen
ts
23%

Dividend
received
6%

Decrease
in cash
5%
Proceeds
from
shares
0%

- Relatively weak.

Net Capex
29%
CFO
89%

Source: Company, Ambit Capital research

November 17, 2016

Debt
repayment
15%

Dividend
paid
28%
Interest
paid
5%

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 65

Britannia
Exhibit 7: Most of the re-rating happened over last 2 years

Exhibit 8: After doing nothing, the stock performed with the


change in the management

50

2,000

40

1,500

30

1,000

20
500

BRIT

Average of 5yr P/E


Source: Company, Ambit Capital research

Oct 16

Oct 15

Oct 14

Oct 13

Oct 12

Oct 11

Oct 10

Oct 09

Oct 08

Britannia 1 year fwd P/E

Oct 07

Oct 06

Oct-16

Jun-16

Feb-16

Jun-15

Oct-15

Feb-15

Jun-14

Oct-14

Oct-13

Feb-14

Jun-13

Feb-13

Jun-12

Oct-12

Oct-11

Feb-12

10

Sensex

Source: Company, Ambit Capital research

Exhibit 9: Explanation for our forensic accounting scores


Segment

Score

Comments

Accounting

GREEN

Britannia has, in the past, reported high cash conversion and efficient management of working capital and it
ranks in the top quartile of our forensic accounting checks for FMCG. Consequently, we give a high rating to the
quality of its accounting.

Predictability

AMBER

Due to a combination of its presence across products, categories and SKUs, and predominant exposure to
consumer-activity-led sector of the economy, revenues show stability. However, the current economic environment
and volatility in raw material prices can lead to some volatility in earnings.

Earnings Momentum

AMBER

End of tailwinds around raw material cost has led to consensus downgrading its EPS forecast for Britannia by ~5%
for both FY17 and FY18 over the past six months.

Source: Ambit Capital research

Exhibit 10: Forensic score evolution

Exhibit 11: Greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 66

Britannia
Balance sheet
Year to March (` mn)
Shareholders' equity

FY15

FY16

FY17E

FY18E

FY19E

240

240

240

240

240

Reserves & surpluses

12,211

17,453

21,971

27,346

33,903

Total networth

12,451

17,693

22,211

27,586

34,143

Minority Interest

24

25

22

20

16

1,402

1,270

408

408

408

(234)

(277)

(277)

(277)

(277)

Total liabilities

13,644

18,711

22,365

27,736

34,291

Gross block

15,989

18,067

21,067

24,067

25,567

Net block

7,334

8,343

9,876

11,183

10,822

Debt
Deferred tax liability

CWIP
Goodwill
Investments

484

901

901

901

901

1,107

1,159

1,159

1,159

1,159

771

3,564

3,564

3,564

3,564

Cash & equivalents

6,672

4,841

6,975

11,055

17,989

Debtors

1,358

1,706

1,926

2,198

2,528

Inventory

4,040

4,407

4,974

5,677

6,530

Loans & advances

5,563

8,995

10,154

11,588

13,329

Other current assets


Total current assets
Current liabilities
Provisions
Total current liabilities
Net current assets
Total assets

372

378

427

487

560

18,005

20,327

24,456

31,004

40,937

9,828

10,491

11,843

13,515

15,546

4,228

5,092

5,748

6,560

7,546

14,056

15,583

17,591

20,075

23,092

3,949

4,744

6,865

10,929

17,845

13,644

18,711

22,365

27,736

34,291

FY15

FY16

FY17E

FY18E

FY19E

78,584

86,789

97,971

1,11,804

1,28,606

Source: Company, Ambit Capital research

Income statement
Year to March (` mn)
Operating income
% growth

13.7%

10.4%

12.9%

14.1%

15.0%

69,945

74,523

84,186

95,363

1,09,317

EBITDA

8,639

12,265

13,786

16,441

19,289

% growth

37.7%

42.0%

12.4%

19.3%

17.3%

Depreciation

1,445

1,134

1,468

1,693

1,861

EBIT

7,194

11,131

12,318

14,749

17,428

39

49

50

24

12

Operating expenditure

Interest expenditure
Non-operating income

880

1,000

1,233

1,082

1,574

Adjusted PBT

8,035

12,082

13,500

15,806

18,989

Tax

2,611

3,920

4,380

5,128

6,160

Adjusted PAT/ Net profit

5,424

8,163

9,121

10,678

12,829

% growth

37.2%

50.5%

11.7%

17.1%

20.1%

Extraordinaries

1,461

(103)

Reported PAT / Net profit

3,964

8,266

9,121

10,678

12,829

(2)

(2)

(2)

(3)

(4)

Minority Interest
Share of associates

Adjusted Consolidated net profit

3,965

8,268

9,123

10,681

12,832

Reported Consolidated net profit

3,965

8,268

9,123

10,681

12,832

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 67

Britannia
Cash flow statement
Year to March (` mn)

FY15

FY16

FY17E

FY18E

FY19E

EBIT

8,074

12,131

13,551

15,830

19,002

Depreciation

1,445

1,134

1,468

1,693

1,861

Others

(320)

(42)

(0)

(0)

(2,611)

(3,920)

(4,380)

(5,128)

(6,160)

Tax
(Incr) / decr in net working capital

(318)

(2,626)

13

16

19

6,231

6,630

10,601

12,386

14,709

Capex

(786)

(2,561)

(3,000)

(3,000)

(1,500)

(Incr) / decr in investments

(457)

(2,846)

-1,243

-5,406

-3,000

-3,000

-1,500

(80)

(133)

(861)

Cash flow from operations

Others
Cash flow from investments
Net borrowings
Issuance of equity
Interest paid
Dividend paid
Others

(39)

(49)

(50)

(24)

(12)

(2,238)

(2,888)

(4,105)

(4,806)

(5,775)

1,282

(34)

(500)

(500)

(500)

(1,074)

(3,103)

(5,517)

(5,331)

(6,287)

Net change in cash

3,914

(1,880)

2,084

4,055

6,922

Closing cash balance

6,672

4,841

6,975

11,055

17,989

Free cash flow

5,446

4,069

7,601

9,386

13,209

FY15

FY16

FY17E

FY18E

FY19E

Gross margin (%)

40.3%

42.4%

42.4%

43.0%

43.3%

EBITDA margin (%)

11.0%

14.1%

14.1%

14.7%

15.0%

EBIT margin(%)

10.3%

14.0%

13.8%

14.2%

14.8%

6.9%

9.4%

9.3%

9.6%

10.0%

41.2%

35.4%

45.0%

45.0%

45.0%

Net debt: equity (x)

(0.4)

(0.2)

(0.3)

(0.4)

(0.5)

Working capital days

(13)

(0)

(0)

(0)

(0)

Cash flow from financing

Source: Company, Ambit Capital research

Ratio analysis
Year to March

Net profit margin(%)


Dividend payout ratio(%)

Gross block turnover (x)

4.9

4.8

4.7

4.6

5.0

RoCE(%)

47.0%

50.7%

44.6%

42.7%

41.4%

RoE(%)

53.1%

54.2%

45.7%

42.9%

41.6%

Year to March

FY15

FY16

FY17E

FY18E

FY19E

EPS (`)

45.2

68.0

76.0

89.0

106.9

Diluted EPS (`)

45.2

68.0

76.0

89.0

106.9

Source: Company, Ambit Capital research

Valuation parameters

Book value per share (`)

104.2

148.1

185.9

230.9

285.8

Dividend per share (`)

16.0

20.0

34.2

40.1

48.1

P/E (x)

68.1

45.3

40.5

34.6

28.8

P/BV (x)

29.5

20.8

16.6

13.3

10.8

EV/EBITDA (x)

42.2

29.8

26.3

21.8

18.2

Price/Sales (x)

4.7

4.3

3.8

3.3

2.9

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 68

LIC Housing Finance


SELL
LICHF IN EQUITY

Growth and RoE slowed despite realignment of assets and liabilities


LICHFs strong growth and profitability during FY06-12 (27% AUM CAGR;
median RoE of 23%) were driven by benign regulatory and moderate competitive
environment. But from FY12, regulatory and competitive headwinds put intense
pressure on LICHFs growth and profitability. Growth moderated to 19% CAGR
over FY12-16 and RoE slowed to 18% over FY12-16. This was despite a
meaningful realignment in liability mix (share of cheaper bond borrowings rose
from 58% in FY12 to 77% in FY16) and loan mix (share of higher yielding LAP
rose from 0% in FY12 to 9% in FY16). Growth in line with RoE implied that
dividend payout ratio was a reasonable ~21% over FY12-16.

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
AMBER
GREEN

Performance
140
120
100
80

LIC Housing Fin.

Sep-16

Strong focus on the salaried and urban segments


Promoted by state-owned life insurance giant, Life Insurance Corporation of India
(LIC), LICHF is Indias second-biggest HFC with a `1.3tn loan book. LICHF
focuses on home loans (88% of loan book) and more specifically on the salaried
segment (84% of home loans) and metros (46% of home loans).

`242/US$3.6
`1367/US$20
`511
`420
18

Jul-16

Changes to this position: NEGATIVE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

May-16

Competitive position: MODERATE

Recommendation

Mar-16

LICHFs prolonged strong performance 22% EPS CAGR, 24% AUM CAGR,
and median RoE of 19% over FY06-16 was supported by a decadal rally
in real estate prices and its parent LICs support. LICs support ensures
access to cheaper liabilities (no liquidity crunch even during Lehmann
crisis) and ease in customer acquisition (access to LICs strong brand and
1mn agents). Going forward, declining real estate prices and rising
competitive intensity should moderate its earnings growth and RoE; we
estimate 12% EPS CAGR over FY16-19E (vs 18% CAGR over FY13-16) and
17.5% RoE, which should de-rate the multiples. Our TP of `420, implies
1.9x 1-year fwd P/B. Rapidly moderating cost of funds is a near-term risk.

BFSI

Jan-16

The old lady of housing finance

November 17, 2016

Nov-15

STRATEGY NOTE

Sensex

Source: Bloomberg, Ambit Capital research

Parent LICs support is the strategic asset


LICs support has helped LICHF get cheap and convenient access to wholesale
markets. This was tested during the Lehman crisis, when LIC was able to access
funds rather effortlessly and sustained growth even as other lenders struggled for
funding. Moreover, beyond liabilities, LICs support has also driven customer
acquisition for LICHF through: i) branding: LICHFs approval on a home loan of a
under-construction project is perceived by customers as having minimal legal and
execution risks; and ii) origination: LICHF has access to ~1mn LIC agents, who
currently contribute ~60% of its origination.
A turn in the decade-long dream run
A decadal surge in real estate prices combined with strong support from parent
LIC drove LICHFs earnings momentum of 22% CAGR over FY06-16. However,
with declining real estate prices and high competitive intensity, LICHFs already
moderate loan growth and profitability should decelerate further (due to
pressures on margins and asset quality). So, we estimate LICHFs earnings
growth to continue moderating from 18% CAGR over FY13-16 to 12% CAGR
over FY16-19E. Moreover, HFCs are exposed to the looming regulatory risk of
convergence of loan pricing to a more transparent and objectively calculated
base rate (which is followed by banks). LICHF stock trades at 2.3x 1-year forward
P/B, which is at a 27% premium to 5-year average.

Research Analysts
Pankaj Agarwal, CFA
+91 22 3043 3206
pankaj.agarwal@ambit.co
Aadesh Mehta, CFA
+91 22 3043 3239
aadesh.mehta@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

LIC Housing Finance


Exhibit 1: LICHFs growth has moderated due to increasing competition
Moderation in growth and
profitability
AUM Growth 19%
RoAs 1.5%

Strong growth period


AUM CAGR 27%
RoAs 1.9%

1,300
1,100

30%
25%

900
700

20%

500
300

15%

100
(100)

FY06

FY07

FY08

FY09

FY10

FY11

FY12

AUM (Rs bn)

FY13

FY14

FY15

10%

FY16

RoEs (RHS, %)

Source: Company, Ambit Capital research

Exhibit 2: LICHF key financial parameters over the last decade


(Fig in ` mn)

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Interest Income

9.1%

10.2%

11.0%

10.0%

10.2%

10.8%

10.9%

11.0%

10.9%

10.9%

Interest Expense

6.7%

7.4%

8.1%

7.3%

7.1%

8.3%

8.6%

8.7%

8.6%

8.3%

Net Interest Income

2.4%

2.8%

2.9%

2.7%

3.1%

2.5%

2.2%

2.3%

2.3%

2.6%

Non-Interest Income

0.5%

0.7%

0.6%

0.6%

0.5%

0.4%

0.3%

0.3%

0.3%

0.2%

Total Income

2.9%

3.4%

3.6%

3.3%

3.7%

2.9%

2.5%

2.6%

2.6%

2.8%

Operating Expenses

0.6%

0.7%

0.62%

0.58%

0.49%

0.43%

0.41%

0.38%

0.39%

0.42%

Pre Provisioning Profit

2.2%

2.8%

2.9%

2.7%

3.2%

2.5%

2.1%

2.2%

2.2%

2.4%

Loan loss provisions

0.08%

0.12%

0.02%

-0.09%

0.09%

0.20%

0.12%

0.03%

0.01%

0.13%

Profit Before tax (PBT)

2.1%

2.7%

2.9%

2.8%

3.1%

2.5%

2.0%

2.2%

2.2%

2.3%

Taxes

0.5%

0.7%

0.8%

0.8%

0.9%

0.7%

0.5%

0.6%

0.6%

0.8%

RoA

1.7%

1.9%

2.1%

2.0%

2.2%

1.6%

1.5%

1.6%

1.4%

1.5%

Leverage

11.3

11.7

12.1

11.5

11.5

11.3

11.3

11.8

12.6

13.2

19.3%

22.7%

25.8%

23.2%

25.5%

18.5%

16.8%

18.8%

18.1%

19.6%

AUM growth (%, YoY)

19%

21%

22%

34%

38%

28%

25%

18%

19%

15%

EPS growth (%, YoY)

35%

39%

37%

16%

40%

-6%

5%

29%

5%

20%

RoE

Source: Company, Ambit Capital research.

Exhibit 3: LICHFs growth and profitability has meaningfully moderated since FY12
Time period

Strong growth
period

Moderation in
growth and
profitability

Phase

Key developments

LICHFs robust growth (27% CAGR) during this period was driven by both increasing customer acquisition (due to
benign competition in the small ticket segment and increasing ticket size per loan (due to rapid increase in real estate
prices).

Regulatory and competitive environment remained benign. Consequently both growth and profitability remained high
during this period (AUM CAGR of 27% and RoA of 1.9%).

Regulatory headwinds emerged FY11 onwards such as introduction of base rate system (which led to increasing cost
of funds) and removal of prepayment penalties (leading to higher churn in the loan book and reduction in feeincome).

Moreover, during this period, HFCs have seen hyper-competition from banks in home loans due to: i) lack of any
opportunities in corporate loans due to slowdown; and ii) regulators incentivising affordable housing in FY15 by
reduction of risk weights and exemption on SLR/CRR and PSL requirements. Decline in real estate prices have also let
to moderation in ticket size growth (which used to drive 50-60% of growth of HFCs).

Consequently LICHFs growth has moderated to 19% CAGR over FY12-16 versus 27% CAGR in FY06-12. However,
LICHF was able to sustain such pressure on profitability and growth by: i) increasing the share of higher-yielding
albeit risky LAP (from 0% in FY12 to ~9% in FY16); and ii) shift in liability mix towards cheaper bond borrowings (from
58% in FY12 to 77% in FY16). This somewhat offset the lower profitability from the business and enabled it to still
deliver moderate RoAs of 1.5% during this period.

FY06-12

FY12Current

Source: Ambit Capital research.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 70

LIC Housing Finance


Exhibit 4: Competitive mapping of HFCs LICHFs growth has moderated despite its small-ticket positioning
Key metrics
(FY16)
LICHF

Avg. ticket
size (` mn)
1.2

AUM
(` bn)
1,252

AUM CAGR
(FY13-16)
17%

Gross
NPA (%)
0.45%

RoA

RoE

2.6%

Opex/
AUM
0.4%

1.5%

NIMs

19.6%

Branches
(#)
234

Employees
(#)
1,726
619

Repco

1.1

77

29%

4.9%

1.0%

1.30%

2.2%

17.0%

150

GRUH

0.5

111

27%

4.2%

0.8%

0.32%

2.3%

31.5%

179

618

HDFC

2.5

2,908

16%

3.1%

0.3%

0.70%

2.4%

21.8%

401

2,196

CANFIN

1.7

106

38%

3.1%

0.7%

0.19%

1.6%

19.0%

140

553

DEWAN

1.2

695

24%

3.0%

0.9%

0.93%

0.9%

11.9%

353

2,625

PNBHF

3.7

272

60%

3.8%

1.2%

0.22%

1.4%

17.6%

47

752

Source: Company, Ambit Capital research

Exhibit 5: Mapping GRUH and its peers on IBAS


Particulars

GRUH

HDFC

LICHF

REPCO CNFIN

DHFL

PNBHF

Comments

Innovation

Innovation in terms of ability to appraise a non-salaried borrower is


key to gain penetration in the under-served low-income segment.
GRUH scores best in the metric due to its innovative products and
appraisal techniques. GRUHs product innovation is exemplified from
the fact that it structures customised EMIs to match the cash flows of
the low-income borrowers and has flexible repayment plan as per
daily, monthly or yearly amortising. Moreover, GRUH was the first HFC
to introduce a formal credit score methodology for the low-income
category of borrowers. Repco comes closest to GRUH in replicating
this. Moreover Repcos origination strategy is also innovative as it
sources only through loan melas and referrals and avoids sourcing
through DSAs unlike other HFCs.

Brand

Brand for the home loan borrower will depend on the perceived
customer service and the perceived project financing abilities by the
lender. Whilst HFCs score lower than banks on all these metrics, HDFC
enjoys the best brand amongst the HFCs due to superior perception on
the above metrics, followed closely by GRUH. LICHF, CNFIN and
PNBHF also score high due to their PSU parentage.

Architecture

A robust branch network with decentralised decision making is the key


to gain penetration in small ticket housing finance. HDFC with ~400
branches and a decentralised decision making has one of the best
architectures amongst peers, closely followed by DHFL and GRUH.
Whilst REPCO has marginally lower branches than GRUH, it also
scores highly due to a decentralised decision making process.

Strategic asset

Support of the parent, strong credit rating and a granular retail deposit
franchise are the key strategic assets for HFCs in times of liquidity
crunch. LICHF is best placed in this metric due to strong support from
its parent on the above mentioned metrics.

Overall rank

GRUH comes out as one the strongest HFCs versus its peers due to its
strengths in innovation, brand, architecture and strategic assets.

Source: Company, Ambit Capital research Note:

- Strong;

- Relatively Strong;

Exhibit 6: LICHFs AUM is dominated by home loans

- Average;

- Relatively weak.

Exhibit 7: Salaried segment dominate LICHFs home loans


LICHF's customer profile

3%
Salaried

Home loans

9%

16%
LAP

88%

Source: Company, Ambit Capital research

November 17, 2016

84%

Developer

Self-employed
& others

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 71

LIC Housing Finance


Exhibit 8: LICHFs liability mix is tilted towards bonds

2.5%

Banks
13%

2.0%
NCD

1.5%

NHB

1.0%

Deposits

0.5%

Gross NPA

FY16

FY15

FY14

FY13

FY12

FY11

-0.5%

FY10

Others

FY09

0.0%

80%

FY08

3%

3.0%
2%

FY07

3%

Exhibit 9: LICHFs asset quality has remained in control

Credit costs

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 10: LICHF is trading at a 27% premium to its


cross-cycle average P/B

Exhibit 11: LICHFs share price performance versus Sensex

3.5

2,500

3.0

2,000

2.5
2.0

1,500

1.5

1,000

1.0

500

SENSEX

+1 SD

Apr-16

Apr-15

Apr-14

Apr-13

Apr-12

Apr-11

Apr-10

Apr-09

Mar-16

Source: Bloomberg, Ambit Capital research

Mar-15

-1 SD

Mar-14

Mar-13

Avg. PB

Mar-12

Mar-11

Mar-10

Mar-09

Mar-08

Mar-07

Mar-06

Mar-05

PB

Apr-08

0.0

Apr-07

0.5

LICHF

Source: Bloomberg, Ambit Capital research

Exhibit 12: Explanation for our flags


Segment

Score

Comments

Accounting

GREEN

LICHFs revenue and expense recognition policies are by far the most conservative amongst the peers. We do
not come across any instance wherein the reported profitability of the company is materially different from its
true profitability.

Predictability

AMBER

Volatile bond yields and frequent base rate cuts by banks have made it difficult to predict the earnings of
LICHF. Moreover, the management guidance has been off-mark both in times of earnings decline and
recovery.

Earnings momentum

GREEN

Consensus has marginally upgraded in FY17/18 estimates by 1% over the past 3-4 months

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 72

LIC Housing Finance


Income statement
Net Interest Income
Interest Income
Interest Expense

FY15

FY16

FY17E

FY18E

FY19E

22,364

29,441

33,730

35,663

40,692

105,467

122,508

139,409

155,950

177,080

83,102

93,068

105,679

120,287

136,388

Non Interest Income


Total Income

2,520

2,346

2,575

2,825

3,102

24,884

31,787

36,305

38,487

43,794

3,792

4,687

5,849

6,835

7,664

21,092

27,100

30,456

31,652

36,130

73

1,465

2,087

1,405

1,556

21,020

25,635

28,369

30,247

34,574

7,158

9,028

9,362

9,982

11,409

13,862

16,608

19,007

20,265

23,164

FY16

FY17E

FY18E

FY19E

Operating expenses
Pre Provisioning Profit
Provisions
PBT
Less:Tax
Net Profit

Source: Company, Ambit Capital research

Balance sheet
FY15
Networth

78,184

91,460

106,666

122,878

141,410

965,470

1,109,360

1,265,452

1,437,619

1,627,282

Total Sources of funds

1,043,654

1,200,820

1,372,118

1,560,497

1,768,692

Loan Book

1,083,610

1,251,730

1,430,290

1,626,657

1,843,678

- Individual

1,056,300

1,217,310

1,390,186

1,579,252

1,787,224

Borrowings

- Developer
Other Assets
Total Application of funds

27,310

34,420

40,104

47,405

56,454

(39,956)

(50,910)

(58,173)

(66,159)

(74,986)

1,043,654

1,200,820

1,372,118

1,560,497

1,768,692

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 73

LIC Housing Finance


Key ratios
FY15

FY16

FY17E

FY18E

FY19E

18.6

15.5

14.3

13.7

13.3

Dil Consol EPS growth (%)

5.2

19.8

14.4

6.6

14.3

Net interest margin (NIM) (%)

2.3

2.6

2.5

2.3

2.3

Cost to income (%)

15.2

14.7

16.1

17.8

17.5

Opex (% of AAUM)

0.39

0.41

0.44

0.45

0.44

0.5

0.5

0.6

0.6

0.6

Credit costs (% of AAUM)

0.01

0.13

0.16

0.09

0.09

Provisioning Coverage

52.2

51.1

55.0

55.0

55.0

Capital adequacy (%)

16.5

17.0

17.0

17.0

17.0

Tier-1 (%)

12.5

13.9

13.9

13.9

13.9

Leverage (x)

12.6

13.2

13.0

12.8

12.6

FY15

FY16

FY17E

FY18E

FY19E

AUM growth (%)

Gross NPAs (%)

Source: Company, Ambit Capital research

Valuation parameters
BVPS (`)

155

181

211

243

280

Diluted EPS (`)

27.5

32.9

37.7

40.2

45.9

ROA (%)

1.6

1.5

1.5

1.4

1.4

ROE (%)

18.1

19.6

19.2

17.7

17.5

P/E

18.6

15.5

13.6

12.7

11.1

P/BV

3.3

2.8

2.4

2.1

1.8

Dividend yield (%)

1.0

1.1

1.3

1.3

1.5

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 74

Page Industries
BUY
PAG IN EQUITY

Inner Strength

Consumer Discretionary

Page has focused intently on Jockey/Speedo, and capital discipline


Pages foundation is built on: a) 60-year association with Jockey and Speedo;
b) strong focus on capital allocation and RoCE; and c) incentivisation and
empowerment of professionals to achieve scale with operating efficiencies.
Some of the key strategic decisions Page has implemented over the past
decade include: a) extending Jockeys product portfolio to leisurewear
segments like thermals, loungewear, t-shirts, shapewear etc; b) maintaining
capital allocation discipline with 0.5-0.7x debt/equity ratio, leveraging on
benefits under Technology Upgradation Funds Scheme for textile sector, and
ensuring payout of surplus capital each year as dividends to shareholders.

Flags
Accounting:
Predictability:
Greatness:

GREEN
GREEN
GREEN

Performance (%)
150
130
110
90

Page Inds.

Sep-16

70
Jul-16

Page controls the master franchise of Jockey (innerwear) and Speedo


(swimwear) in India. Over the past 10 years, Page has delivered 33%/34%
revenue/earnings growth with 35% average RoCE. Longevity of Pages growth
is led by: (a) only ~50% penetration of mid-premium innerwear in SEC A/B
households even in 2020; (b) sustainability of competitive advantages driving
market-share gains in mid-to-premium innerwear to 38% overall (including
65% in mens segment) by FY30; and (c) unexplored sub-segments in
categories like kidswear and loungewear.

`176/US$2.6
`151/US$2.3
`14,177
`16,400
16

May-16

Page possesses strong and sustainable growth drivers

Mcap (bn):
6M ADV (mn):
CMP:
TP (12 mths):
Upside (%):

Mar-16

Changes to this position: STABLE

Recommendation

Jan-16

With laser-like focus on innerwear and associated categories, the


Genomals have leveraged their experience in the Philippines to fortify
Pages moats around: a) product differentiation given in-house
manufacturing; b) aspirational brand recall; and c) tight control on the
distribution channel. Hence, new entrants offering either international
brand recall, or affordable price, struggle to break Jockeys customer
loyalty which is built on a combination of quality, affordability and
brand. Weakness in revenue growth momentum in FY16 is temporary
and macro-driven. We expect 28%/34% CAGR in revenue/earnings over
FY16-21 with average RoE of 58% and a high dividend payout of >55%.
Our DCF-based fair value of `16,400 implies 44x FY18E EPS.
Competitive position: STRONG

November 17, 2016

Nov-15

STRATEGY NOTE

Sensex

Source: Bloomberg, Ambit Capital Research

Pages forensic score analysis

Page has built a fortress with its competitive moats


Pages competitive advantages are centered on: a) in-house manufacturing to
deliver product differentiation in a labour-intensive industry; b) maintaining
aspirational connect with consumers; and c) an entrenched distribution channel
spanning hosiery stores to exclusive brand outlets through distributors. Threats
to Pages leadership are low given: a) incumbents like Rupa/Maxwell sell
through the wholesale channels with outsourced manufacturing and hence lack
control of both manufacturing and distribution; b) given lack of in-house
manufacturing, new entrants like FCUK, USPA, CK or regional players cant
offer affordability with good product quality.

Source: Ambit HAWK, Ambit Capital research

Page deserves one of the highest P/E multiples in the consumer space

Source: Ambit HAWK, Ambit Capital research

Besides overall macro improvement, Pages growth revival will be driven by


benefits from recent initiatives like: a) new products (kids innerwear,
hoodies/lounge pants and towels); b) new IT platform aimed at improving
working capital management, closer monitoring of the sales team and
distributors performance; and c) expanding Speedos footprint in India.
Exemplary financials (33% EPS CAGR over FY16-21E and ~57% RoCE) support
the valuation premium to most consumer names. Key risk: Inability to manage
growth given labour-intensive manufacturing and wide range of SKUs.

Pages greatness score analysis

Research Analysts
Rakshit Ranjan, CFA
+91 22 3043 3201
rakshit.ranjan@ambit.co
Dhiraj Mistry, CFA
+91 22 3043 3264
dhiraj.mistry@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Page Industries
Exhibit 1: Evolution of Page Industries
in ` bn
20
15

90%

Phase IV - Beating the


competition

Phase III Gearing up for


competition

80%
70%

10

60%
50%

40%

Others

Liesurewear

Women

Men

*Innerwear (Men + Women)

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

FY06

FY05

FY04

FY03

FY02

FY01

30%

Pre-tax ROCE (RHS)

Source: Ambit Capital research, * Split of men and women innerwear is available since FY10.

Exhibit 2: Pages key financial parameters over the last decade


(` mn)

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

1,375

1,945

2,584

3,441

4,977

6,966

8,758

11,876

15,430

17,834

Revenue growth

35%

42%

33%

33%

45%

40%

26%

36%

30%

16%

Net profits

170

238

316

396

585

900

1,125

1,537

1,960

2,327

15

21

28

36

52

81

101

138

176

209

Revenues

EPS (`)
CFO

91

112

315

298

(2)

1,226

871

740

1,670

2,165

CFO (pre-tax)/EBITDA

63%

58%

84%

70%

31%

113%

79%

59%

83%

85%

FCF

(45)

(90)

43

62

(275)

959

430

280

1,139

1,902

Debt equity (x)

0.4

0.5

0.5

0.6

0.9

0.5

0.5

0.6

0.3

0.1

RoE

42%

33%

39%

43%

53%

62%

59%

61%

58%

52%

Pre-tax RoCE

47%

36%

42%

44%

48%

60%

64%

65%

64%

65%

Source: Company, Ambit Capital research

Exhibit 3: The key things to note from the evolution of Page


Time period Phase

Key developments/ initiatives

Establishing Jockeys
leadership
in the Philippines

Genomal Vehromal (father of Sunder Genomal) got the licence to manufacture Jockey in the Philippines in
1959
Genomals got the master franchise of brand Speedo in Philippines in 1988
Jockey entered India in 1962 with Associated Apparels, and exited in 1973
Several innerwear brands expanded during 1980s and 1990s in India Rupa, Amul, Lux Cozi, Neva,
Bodycare, Softy, Lady Care, Little Lacy, Red Rose etc.

1993-1997

Jockey re-enters India


through Page

1997-2003

Gearing up for
competition

Competition intensified Rupa and VIP were 7-8x larger than Jockey in sales
TTK Tantex and Associated Apparel (Liberty/Libertina) fell prey to labour strikes
In FY03, Page crossed `500mn in sales with a retail network of 10,000 outlets

2004-2015

Page delivered 35% sales CAGR with at least one new product launch every year
Some key new product launches sub-brand Jockey Zone for mens in 2004, brassieres in 2005, No panty
line promise in 2006, sub-brand USA Originals in 2014, Kids innerwear in 2015, Towels in 2016
Beating the competition In 2007, Page raised `1bn from an IPO
Brand campaign launch - Just Jockeying (2010) and Jockey or Nothing (2015)
Speedos licence for India signed up in 2011
UAE was added as a new territory in 2011

1959-1992

Page Apparel Manufacturing was incorporated in Nov 1994 in Bengaluru


Mens innerwear products launched in November 1995
First exclusive brand outlet launched in Bengalurus Commercial Street in 1995
Between 1995 and 1997, core team was hired (incl. Vedji Tiku and Pius Thomas)
Competition for Jockey included strong brands like Liberty, Libertina and Tantex

Source: Ambit Capital Research, Company

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 76

Page Industries
Exhibit 4: Competitive mapping of the company with its key peers
Revenues
of FY16
(` mn)

3 yr
Revenue
CAGR

Avg 3 yr
EBITDA
margin

Avg 3 yr
CFO /
EBITDA

Avg 3 yr
CFO/
Capex

Page

17,834

27%

21%

76%

5.0

43% Distributor-based only

Rupa

10,148

9%

15%

38%

1.3

26% Wholesale largely

VIP

1,946

3%

10%

82%

0.9

Lovable

1,725

7%

19%

22%

5.4

11% Wholesale largely


Wholesale +
15%
Distributors

Avg 3yr Distribution


ROCE channel type

Segment presence
Men and women innerwear;
leisurewear, sportswear, swim wear
Men innerwear, men leisurewear,
thermal wear
Men and women innerwear
Women innerwear, women sportswear

Source: Company, Ambit Capital research

Exhibit 5: Mapping Page and its peers on IBAS


Page

Rupa

VIP

Lovable

Comments

Innovation

Jockey (Parent) provides technology related innovation


Page has 20 member R&D team to understand local consumer preferences
Whilst Page launches one new product every year, product portfolio of peers largely
remains unchanged for 3-5 years in a row

Brand

Jockey has maintained an aspirational recall as an international brand


Page doesnt allow price discounts on its products, unlike others
Page maintains premium look and feel of its stores, display racks and packaging

Architecture

Page uses in-house manufacturing with strong labour relationships vs outsourced


manufacturing for peers
Page sells through distributor channel vs wholesale for Rupa/VIP
Page follows a process-oriented approach towards operations management
Page's HR philosophy includes empowerment of professionals and attractive incentive
structures for senior managers

Strategic Asset

Page has over 60 years of experience in expanding Jockey in the Philippines


Access to Jockey's international experience and technology is a key strategic asset

Overall
Source: Ambit Capital research; Note:

- Strong;

Exhibit 6: Sources of funds over FY07-16

- Relatively Strong;

- Average;

- Relatively weak.

Exhibit 7: Application of funds over FY07-16


Increase in
cash and
cash
equivalents,
14%

Interest
received,
1%
Debt raised,
24%
Proceeds
from shares,
4%

Debt
repayment,
5%

Net Capex,
30%

Cash flow
from
operations,
71%

Dividend
paid, 45%

Interest
paid, 7%
Source: Company, Ambit Capital research

November 17, 2016

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 77

Page Industries
Exhibit 8: Band chart of Page one-year forward P/E

Exhibit 9: Pages share price performance vs Sensex

80

7,000

70

6,000

60

5,000
4,000

50

3,000

40

2,000

30

1,000
Mar 07
Sep 07
Mar 08
Sep 08
Mar 09
Sep 09
Mar 10
Sep 10
Mar 11
Sep 11
Mar 12
Sep 12
Mar 13
Sep 13
Mar 14
Sep 14
Mar 15
Sep 15
Mar 16
Sep 16

Oct-16

Jun-16

Feb-16

Jun-15

Oct-15

Oct-14

Page 1 year fwd P/E

Feb-15

Jun-14

Oct-13

Feb-14

Jun-13

Feb-13

Jun-12

Oct-12

Oct-11

Feb-12

20

Average of 5yr P/E

Source: Company, Ambit Capital research

Page

Sensex

Source: Company, Ambit Capital research; Note: price are rebased to 100

Exhibit 10: Explanation for our flags


Segment

Score

Comments

Accounting

GREEN

Page Industries' cash conversion has remained healthy and this has resulted in cumulative CFO (pretax)/EBITDA of above 70% in FY07-16. Page has maintained effective control on the working capital cycle, and
hence despite high sales growth, WC days have increased marginally from 63 days in FY09 to 71 days in FY16.

Predictability

AMBER

Since FY16, Page Industries has twice beaten or missed consensus revenue estimates by more than 4%. The
company has twice missed consensus net profit estimates by more than 4% and beaten once by more than 4%.

Earnings momentum

GREEN

In the last six months, consensus earnings forecasts for Page have been upgraded by ~3.5% for FY17 and FY18

Source: Ambit Capital research

Exhibit 11: Pages forensic score has remained in zone of


safety over 2011-15

Exhibit 12: Pages greatness score has improved from 40 in


2011 to 95 in 2015

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 78

Page Industries

Abridged financial summary


Balance sheet
Year to March (` mn)
Shareholders' equity

FY15

FY16

FY17E

FY18E

FY19E

112

112

112

112

112

Reserves & surplus

3,756

4,941

6,203

7,850

10,050

Total net worth

3,868

5,052

6,315

7,961

10,162

Loan funds

1,344

734

734

484

234

114

110

110

110

110

5,326

5,897

7,159

8,556

10,506

Deferred tax liability


Total liabilities
Gross block

3,059

3,251

3,941

4,672

5,446

Net block

2,173

2,132

2,555

2,968

3,368

CWIP

Investments

4,435

5,393

4,939

6,182

8,063

884

1,034

1,190

1,545

2,016

44

86

1,145

1,358

1,649

Loans & Advances

509

705

595

773

1,008

Other current assets

189

93

397

487

608

6,061

7,312

8,266

10,345

13,343

Creditors

821

941

1,071

1,391

1,814

Deposits from Dealers

556

735

869

1,128

1,472

1,028

1,234

1,369

1,777

2,318

504

640

357

464

605

2,909

3,550

3,665

4,760

6,209

Inventories
Debtors
Cash and cash equivalents

Total current assets

Other current liabilities


Provisions
Total current liabilities
Net current assets

3,152

3,762

4,600

5,585

7,135

Total assets

5,326

5,897

7,159

8,556

10,506

FY15

FY16

FY17E

FY18E

FY19E

Net Sales

15,430

17,834

21,718

28,204

36,788

% growth

29.9%

15.6%

21.8%

29.9%

30.4%

Raw materials Cost

7,121

8,133

10,230

13,397

17,474

Employees cost

Source: Ambit Capital research

Income statement
Year to March (` mn)

2,585

3,130

3,670

4,231

5,564

Royalty expenses

846

994

1,210

1,571

2,050

Advertisement expenses

714

670

903

1,044

1,324

Other Admin, S&D expenses

974

1,137

1,387

1,713

2,108

Total operating expenses

12,240

14,063

17,400

21,956

28,520

EBITDA

3,190

3,771

4,318

6,248

8,267

% growth

27.0%

18.2%

14.5%

44.7%

32.3%

Depreciation
EBIT
Non-operating Income
Interest expenditure
PBT
Tax expenses

176

238

266

318

374

3,014

3,533

4,052

5,930

7,893

86

62

130

169

221

167

153

57

44

25

2,933

3,443

4,125

6,055

8,089

973

1,116

1,320

1,938

2,588

Adjusted PAT

1,960

2,327

2,805

4,117

5,500

% growth

27.5%

18.7%

20.6%

46.8%

33.6%

Extraordinary items
Reported PAT / Net profit

1,960

2,327

2,805

4,117

5,500

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 79

Page Industries
Cash flow statement
Year to March (` mn)
PBT
Depreciation
Others
Tax

FY15

FY16

FY17E

FY18E

FY19E

2,933

3,443

4,125

6,055

8,089

176

238

266

318

374

96

102

(73)

(125)

(196)

(966)

(1,046)

(1,320)

(1,938)

(2,588)

(Increase)/Decrease in working capital

(569)

(572)

220

(772)

(1,258)

Cash flow from operating activities

1,670

2,165

3,218

3,538

4,421

Capex

(534)

(263)

(689)

(731)

(775)

(Increase)/Decrease in investments

Interest income

Others
Cash flow from investing activities
Net borrowings

130

169

221

(531)

(258)

(559)

(562)

(554)

(59)

(624)

(250)

(250)

Interest paid

(171)

(152)

(57)

(44)

(25)

Dividend paid

(899)

(1,087)

(1,543)

(2,470)

(3,300)

(1,129)

(1,864)

(1,600)

(2,765)

(3,575)

10

43

1,059

212

291

Cash flow from financing activities


Net change in cash
Closing cash balance
Free cash flow

43

86

1,145

1,358

1,649

1,139

1,902

2,659

2,977

3,867

Source: Ambit Capital research

Ratio analysis
Year to March

FY15

FY16

FY17E

FY18E

FY19E

Gross margin (%)

53.8

54.4

52.9

52.5

52.5

EBITDA margin (%)

20.7

21.1

19.9

22.2

22.5

EBIT margin (%)

19.5

19.8

18.7

21.0

21.5

Net profit margin (%)

12.7

13.0

12.9

14.6

15.0

Dividend payout ratio (%)

49

49

55

60

60

Net debt/equity (x)

0.3

0.1

(0.1)

(0.1)

(0.1)

Asset turnover excluding cash (x)

3.2

3.2

3.4

3.7

3.9

Working capital turnover (x)

5.1

5.2

5.2

5.6

5.8

Gross block turnover (x)

5.6

5.7

6.0

6.5

7.3

Post-tax RoCE (%)

42.6

44.2

44.3

53.5

58.6

Pre-tax RoCE (%)

63.7

65.4

65.2

78.7

86.1

ROE (%)

58.0

52.2

49.4

57.7

60.7

FY15

FY16

FY17E

FY18E

FY19E

175.7

208.6

251.5

369.1

493.1

Source: Ambit Capital research

Valuation parameters
Year to March
EPS (`)
Book value per share (`)

347

453

566

714

911

Dividend per share (`)

72.0

85.0

118.2

189.3

252.9

P/E (x)

79.8

67.2

55.8

38.0

28.4

P/BV (x)

40.4

31.0

24.8

19.6

15.4

EV/EBITDA (x)

49.4

41.6

36.1

24.9

18.7

Price/Sales (x)

10.1

8.8

7.2

5.5

4.3

0.5

0.6

0.8

1.4

1.8

Dividend yield (%)


Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 80

Amara Raja Batteries


SELL
AMRJ IN EQUITY

Competitive edge under threat


Amara Raja has made rapid market gains in automotive battery
segments (4W and 2Ws) led by Johnson Controls (JCI) parentage (lowcost manufacturing knowledge; hence, competitive pricing vs Exide) and
innovation surrounding products/advertising. We expect market share
gains for AMRJ to slow as Exide attempts comeback through aggressive
pricing/cost cutting. The current expensive valuation multiples (25x
FY19E net earnings) do not appear sustainable as long-term RoCE will
moderate due to rising capital intensity for investments in new
technologies and changes to business model from Lithium-ion adoption.
Competitive position: STRONG

Changes to this position: POSITIVE

Second-largest battery player in India


AMRJ is a JV between the Galla family and JCI (worlds largest lead acid battery
player). AMRJs automotive segment (~56% of FY16 revenues) is a play on
automotive volume recovery (at 18/1,000 people, India has among the lowest
PV penetrations). The key growth drivers are market share gain from
unorganised segment and market leader Exide. The Industrial segment is,
however, very dependent on telecom segment (slowly shifting to lithium-ion) and
recovery in industrial activity.
JCI provides strategic edge
AMRJ started as an Industrial battery player (in 1975), ventured into the
Automotive battery segment, with a JV with JCI in 2000. Driven by competitive
pricing, aggressive warranty terms and distribution expansion, it gained
significant market share across both 4W OEM (30% market share) and
replacement (41% market share). Despite late entry, it now commands 15% and
28% market share in 2W OEM and replacement. Over the last 10 years, AMRJ
has grown its revenue and EBITDA by 26% and 29% CAGR respectively.

November 17, 2016


Auto & Auto ancillaries
Recommendation
Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

`165/US$2.4
`406/US$6.1
`960
`763
20

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
AMBER
AMBER

Performance
130
120
110
100
90
80
Nov-15
Dec-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Jul-16
Aug-16
Sep-16
Oct-16

STRATEGY NOTE

Amara Raja Batt.

Sensex

Source: Bloomberg, Ambit Capital research

Amara Rajas forensic score analysis

Market share gains to slow down


AMRJs tie-up with JCI imparts superior technology, lower production cost and
competitive pricing over Exide. Further, it also scores over Exide on innovative
advertisement/communication. As battery technologies such as lithium-ion
evolve, strategic global partnerships and low-cost architecture will play a key
role. However, AMRJs cost advantage is under threat from Exides growing focus
on cost control. This should slow AMRJs market-share gains, particularly in the
lucrative auto replacement segment (1,600bps over FY09-16).

Source: Ambit HAWK, Ambit Capital research

Amara
analysis

Rajas

greatness

score

Current valuation akin to a consumer company is unjustified


We are concerned about slowdown in: (1) the lucrative automotive replacement
battery industry (30% of AMRJs revenue) given muted OEM volume across
vehicle categories over FY12-16 and Exides increased focus on cost
control/technology upgrade; and (2) telecom battery segment (24% of AMRJs
revenue) due to lower tower addition over FY12-16. So, we expect revenue and
EBITDA to grow at a slower pace of 12% and 11% CAGR respectively over the
next 10 years. JCIs parentage does provide better long-term visibility but
technology changes (lithium-ion, advances in lead-acid) over the next decade
could erode some key competitive advantages. Current multiples seem rich and
akin to consumer stocks though battery business drivers are not as sustainable.
We are SELLers of the stock with a target price of `763, implying 20x one-year
forward net earnings. The stock currently trades at 27.4x FY18E net earnings.

Source: Ambit HAWK, Ambit Capital research

Research Analyst Details


Ashvin Shetty, CFA
+91 22 3042 3285
ashvin.shetty@ambit.co
Gaurav Khandelwal, CFA
+91 22 3042 3132
gaurav.khandelwal@ambit.co
Ritu Modi
+91 22 3042 3292
ritu.modi@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Amara Raja Batteries


Exhibit 1: Amara Raja has emerged as a formidable player in the automotive battery segment
52

`. billion

42

Phase I- Emergence as a
strong industrial battery
player

Phase II- Foray into automotive


segment through JV with Johnson
Controls

120%

Phase III- Finding success across various


automotive battery segments.

100%
80%

32
22

Launched
4W battery

12

60%

Launched CV and
Tractor battery

Launched
2W battery

40%

Won OE orders from


Maruti and Hyundai

20%

0%
FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

(8)

Revenue CAGR: 32%


Median RoCE: 13.2%

Revenue CAGR: 32%


Median RoCE: 84.4%

-20%

Revenue CAGR: 20%


Median RoCE: 42.1%

AMRJ's Revenues (LHS)

AMRJ's ROCE % (Pre-tax) (LHS)

Source: Company, Ambit Capital research

Exhibit 2: through better quality products at a lower price


Phase

Time period

Key developments

Phase-I

FY1996-2000

Phase-II

FY01-08

Phase-III

FY09-16

Emerged as a major player in the industrial battery segment


Won several prestigious contracts from industrial customers like DoT (for rural telecommunication programme)
and ONGC (power supplies on offshore platforms)
Entry into automotive segment in 2000 through JV with Johnson Controls
Started with the more lucrative 4W aftermarket segment
Later won OEM contracts with key players like Maruti and Hyundai
Gained significant share in automotive segment from Exide
Amara Rajas better technology, lower price, expanding distribution contributed to share gains
Exides complacency (lack of capacities/shortage in replacement market)/capital allocation issues (foray into
insurance business) helped Amara Raja

Source: Company, Ambit capital research

Exhibit 3: allowing it to earn superior returns


(Fig in ` mn)

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

5,958

10,833

13,132

14,645

17,611

23,645

29,614

34,367

42,113

46,907

Revenue growth (%)

64%

82%

21%

12%

20%

34%

25%

16%

23%

11%

Net profits

479

909

1,115

1,550

1,479

2,024

2,898

3,621

4,125

4,768

Revenues

EPS

4.2

8.0

6.5

9.1

8.7

11.8

17.0

21.2

24.1

27.9

CFO (pre-tax)

(146)

328

2,776

2,927

1,638

4,011

4,721

4,394

5,872

7,729

CFO (pre-tax)/EBITDA

-18%

18%

138%

101%

63%

118%

104%

78%

83%

95%

(1,056)

(1,333)

1,335

1,627

195

2,176

1,892

(943)

(112)

643

0.5

0.8

0.5

0.1

0.1

(0.2)

(0.3)

(0.2)

(0.1)

(0.0)

RoE (%)

19.6%

27.3%

27.5%

28.5%

22.9%

24.6%

27.3%

26.6%

24.3%

23.7%

ROCE* (%)

23.2%

31.9%

27.7%

40.7%

32.3%

40.4%

51.5%

49.3%

40.6%

36.4%

FCF
Net-debt equity (x)

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 82

Amara Raja Batteries


Exhibit 4: Amara Raja has been able to gain the scale required to generate healthy returns
Particulars
Aftermarket network

Amara
Raja
>30,000

Exide
Comments
Industries
38,500

Amara Raja has established a network size of more than 30,000 in 15 years as
compared Exides 38,500 developed over decades.

Number of plants

Market share in four-wheeler OEM

31%

Market share in four-wheeler


replacement

41%

Revenues (FY16 ` mn)

46,907

59% Amara Raja has gained significant market share across both 4W OEM and
replacement driven by competitive pricing, aggressive warranty terms and
56% distribution expansion.
68,246

Revenue CAGR FY11-16

EBITDA margin (FY16)


Change in EBITDA Margin (FY11FY16)

34%

17.4%
(+)290 bps

Amara Raja's plants are relatively new and more efficient compared to Exides
old plants which are operating with old equipment.
Amara Rajas both plants are located in close vicinity of each other, as
compared to Exide plants which are spread across India. This has helped Amara
Raja operate its plant at lower overheads vs Exide.

16%

From FY11-16, Amara Raja has gained significant market share in both OE and
aftermarket segments from Exide due to its better quality product and lower
price (enabled by lower cost of manufacturing).
Shortage of capacity at Exide Industries also benefited Amara Raja. During
2009-10, automobile volumes picked up sharply and Exide took a strategic
decision to cater to the full requirement of the OE customers thereby
underplaying the more profitable aftermarket. This enabled Amara Raja to
become a major player in the aftermarket through its Amaron brand. Amara
Rajas market share in the 4W aftermarket segment improved to 41% in FY16,
an increase of 1600 bps over FY09-16.

15.0% Amara Raja benefited from improving product mix with rising contribution from the
higher-margin replacement segment, increasing utilisation levels and more cost
efficient operations (deployed best manufacturing practices of Johnson Controls). As
(-)430bps against this, Exide suffered market share loss in profitable 4W replacement market
and rising overheads.

Pre-tax CFO/ EBITDA (Average


FY11-16)

90%

96% Lower working capital levels have helped cash conversion for both the companies.

Capex to CFO (Average FY11-16)

79%

47%

Capex and Investments to CFO


(Average FY11-16)

79%

63%

Post-tax RoCE (Average FY11-16)

28%

23%

Amara Raja has been continuously investing over the years to expand its 4W
and 2W capacities. It also invested in UPS capacities which were earlier sourced
from outside.
Exide on the other part made significant investment in FY15/16 (`8bn) to
upgrade their technology and plants & machinery. Apart from this, Exide also
made significant investments in the insurance business which now represents
53% of its FY16-end capital employed.

Higher margins and lower capex enabled Amara Raja to generate higher returns vs
Exide.

Source: Company, Ambit Capital

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 83

Amara Raja Batteries


Exhibit 5: Strong Innovation capabilities and Brand places Amara Raja on top in our IBAS framework
Parameters

Amara Raja

Exide

JV with Johnson
Controls Inc.

Technological
agreement
Hitachi, Japan

Yes

Yes

Remarks

Innovation
A) Does the company have an
agreement with a foreign partner for
technology?

Rank
B) Was the company first to innovate
and have competitors copy it?

Rank
Overall position in Innovation

AMRJ brought zero maintenance batteries (Amaron Hi-Life)


into the Indian market, which was a key differentiator from
the batteries which required regular maintenance and topups. Similarly, it pioneered the introduction of VRLA batteries
for the 2W segment (Amaron Pro-bike rider) in May 2008,
which was suited for rising power needs of 2Ws due to
adoption of self-start bikes.
AMRJ offered aggressive warranty terms; for instance, it
introduced Amaron Pro-range of automotive batteries in
FY2005 with a first of its kind 48 month warranty.

Brands/Reputation
A) What is the ranking of the company
in the industry?

Market
Challenger in a
Duopoly industry

Market Leader in
a Duopoly
industry

Rank
B) Does the company spend more than
industry level on advertising, sales
promotion, publicity?

1.2% of sales

AMRJ has emerged as a strong challenger to Exide over the


years and closed the difference in brand perception to a
significant extent. However, build upon its decades of
presence in India and a large number of installations in the
existing car park, Exide still commands a greater brand recall.

AMRJ employs superior manufacturing practices through its


business alliance with JCI. AMRJ commands low
rejections/higher yield which is one of the reasons for its
higher gross margin despite pricing its products cheaper than
Exide.
AMRJ has had consistently low employee and overhead costs
compared to that of Exide mainly because of its concentrated
manufacturing plants.

0.8% of sales

Rank
Overall position in Brands
Architecture
Does the company employ superior
manufacturing practices?
Rank

Overall position in Architecture


Strategic Asset
A) Has the company demonstrated cost
competitive edge over competition?

Yes

No

2 mfg. facilities

7 mfg. facilities

Rank
B) Does the company have more
manufacturing facilities in India than
its competition?

Rank
Overall position in Strategic Asset

Overall Score in IBAS


Source: Company, Ambit Capital.

November 17, 2016

Rank 1;

JCI commands a much dominant position in the global leadacid battery industry with significantly higher R&D spends.
JCIs parentage provides an edge to AMRJ. It also helps that
JCI owns 26% equity stake in AMRJ. On the other hand, while
Exide has technical tie-ups with East Penn, Shin-Kobe
(Hitachi) and Furukawa, there is no equity participation.
Captive smelters have historically lent significant cost
advantage to Exide. However, recycling of lead has increased
in India over the years and the price of the used batteries
(that dealers pay to customers) has witnessed a spike,
somewhat negating Exides cost advantage on this front.
Strong Innovation capabilities, Improving brand perception
and better cost control places Amara Raja ahead of Exide
Industries in our IBAS framework.

Rank 2

Ambit Capital Pvt. Ltd.

Page 84

Amara Raja Batteries


Exhibit 6: Cash generated over the years...

Exhibit 7: ... has largely been used to fund expansion

Interest &
dividend
received
4%

Finance
charges
1%

Change in
net debt
4%

Dividends
17%

Capex
78%

CFO
96%

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 8: Stock trades at 27.4x one-year forward net


earnings, 50% premium to five-year average multiples

Exhibit 9: AMRJ has multiplied ~37x in the last 10 years as


compared to ~2x by Sensex
4,000

30

3,500

Return percentage

35

25
20
15
10
5

3,000
2,500
2,000
1,500
1,000
500
Mar-16

Jul-15

Nov-14

Jul-13

Mar-14

Nov-12

Jul-11

Mar-12

Mar-10

Nov-10

Jul-09

Nov-08

Amara Raja

5 yr Average P/E

Source: Company, Ambit Capital research

Jul-07

Nov-06

May-16

Jan-16

Sep-15

Jan-15

May-15

Sep-14

May-14

Jan-14

Sep-13

May-13

Jan-13

Sep-12

May-12

Jan-12

Sep-11

1 yr forward P/E (x)

Mar-08

Sensex index

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our flags


Segment

Score

Accounting

GREEN

Predictability

AMBER

Earnings momentum

AMBER

Comments
AMRJs scores relatively well in our accounting and forensic framework. AMRJs key accounting ratios such as cash
yield, CFO-EBITDA conversion, miscellaneous expenditure (as a % of sales) was much higher than other listed peers.
On Ambits forensic accounting, AMRJ is categorised in the 3rd decile of the Auto ancillary universe.
The OEM business (15% of the revenue) tends to be volatile. However, the replacement demand (35% of the
revenue) is more stable as battery required replacement in 2-3 years. Industrial volumes (44% of the revenue) are
also volatile and linked to telecom sector performance and industrial activity.
Moreover, Lead (and lead alloys) which is a volatile commodity is the key raw material in battery manufacturing and
constitutes 60-65% of the material cost (35%-40% of the sales revenue). However, Lead price is a pass-through for
~65% of the sales (auto OEM and Industrial).
Bloomberg shows no significant upgrades/downgrades to consensus numbers in recent weeks.

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 85

Amara Raja Batteries


Exhibit 11: AMRJ scores high in our forensic framework...

Exhibit 12: and greatness framework

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 86

Amara Raja Batteries


Balance sheet (standalone)
Year to March (` mn)
Share capital

FY15

FY16

FY17E

FY18E

FY19E

171

171

171

171

171

Reserves and surplus

16,825

19,974

24,283

29,209

34,857

Total Networth

16,996

20,145

24,453

29,380

35,027

Loans

759

741

678

615

552

Deferred tax liability

368

588

588

588

588

Sources of funds

18,123

21,475

25,720

30,584

36,168

Net block (inc CWIP)

10,785

14,485

16,339

16,839

17,438

161

161

161

161

161

Cash and bank balances

2,221

1,498

3,173

6,839

11,021

Sundry debtors

5,541

5,921

6,664

7,458

8,373

Inventories

4,181

6,016

6,771

7,577

8,507

992

1,002

1,127

1,262

1,416

12,935

14,437

17,735

23,136

29,318

Investments

Loans and advances


Current assets
Current liabilities and provisions

5,757

7,608

8,514

9,552

10,749

Net current assets

7,178

6,829

9,220

13,584

18,569

18,123

21,475

25,720

30,584

36,168

Application of funds
Source: Company, Ambit Capital research

Income statement (standalone)


Year to March (` mn)

FY15

FY16

FY17E

FY18E

FY19E

Revenue

42,113

46,907

52,787

59,077

66,327

% growth

22.5%

11.4%

12.5%

11.9%

12.3%

Total expenses

35,005

38,738

43,594

48,789

54,776

% growth

21.8%

10.7%

12.5%

11.9%

12.3%

EBITDA

7,108

8,169

9,193

10,288

11,550

Net depreciation

1,260

1,399

1,746

2,000

2,222

EBIT

5,849

6,770

7,447

8,288

9,329

Interest

273

330

358

531

779

PBT after EO

6,115

7,095

7,799

8,814

10,103

Provision for taxation

1,990

2,327

2,558

2,821

3,233

Adjusted PAT

4,125

4,768

5,241

5,994

6,870

% growth

13.9%

15.6%

9.9%

14.4%

14.6%

Reported PAT

4,104

4,894

5,241

5,994

6,870

24.1

27.9

30.7

35.1

40.2

Other Income

Adjusted EPS diluted (`)


Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 87

Amara Raja Batteries


Cash flow statement (standalone)
Year to March (` mn)
EBIT
Depreciation

FY15

FY16

FY17E

FY18E

FY19E

6,099

7,222

7,799

8,814

10,103

648

1,340

1,399

1,746

2,000

(305)

(116)

(215)

(353)

(526)

Direct taxes paid

(1,606)

(1,922)

(2,181)

(2,558)

(2,821)

Change in working capital

(1,315)

(1,450)

(677)

(778)

(832)

3,519

5,074

6,125

6,871

7,924

(3,731)

(4,062)

(4,904)

(3,600)

(2,500)

282

182

190

358

531

(3,448)

(3,880)

(4,714)

(3,242)

(1,969)

(27)

(97)

(18)

(63)

(63)

(0)

(2)

(5)

(5)

(5)

Others

CFO
Capex
Other expenses
CFI
Proceeds from borrowings
Interest paid
Dividends paid

(504)

(645)

(1,614)

(871)

(933)

CFF

(531)

(745)

(1,637)

(939)

(1,001)

Change in cash

(460)

448

(226)

2,690

4,955

Closing cash

746

1,498

3,173

6,839

11,021

(112)

643

2,257

4,136

4,538

Year to March

FY15

FY16

FY17E

FY18E

FY19E

EBITDA margin

16.9%

17.4%

17.4%

17.4%

17.4%

EBIT margin

13.9%

14.4%

14.1%

14.0%

14.1%

9.8%

10.2%

9.9%

10.1%

10.4%

Free cash flow


Source: Company, Ambit Capital research

Ratio analysis (standalone)

Net profit margin


Net debt: equity (x)

(0.1)

(0.0)

(0.1)

(0.2)

(0.3)

RoCE (pre-tax)

40.6%

36.4%

33.8%

34.6%

36.7%

RoCE (post-tax)

27.4%

24.5%

22.7%

23.5%

24.9%

RoE

24.3%

23.7%

21.4%

20.4%

19.6%

Year to March

FY15

FY16

FY17E

FY18E

FY19E

EPS (`.)

24.1

27.9

30.7

35.1

40.2

Diluted EPS (`.)

24.1

27.9

30.7

35.1

40.2

Book value per share (`.)

100

118

143

172

205

Source: Company, Ambit Capital research

Valuation parameters (standalone)

Dividend per share (`.)

3.6

4.3

4.6

5.2

6.0

39.8

34.4

31.3

27.4

23.9

9.6

8.1

6.7

5.6

4.7

EV/EBITDA (x)

23.0

20.0

17.8

15.9

14.1

EV/EBIT (x)

27.9

24.1

21.9

19.7

17.5

P/E (x)
P/BV (x)

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 88

GRUH Finance
NOT RATED
GRHF IN EQUITY

Set up in 1986, GRUH is a subsidiary of HDFC (owns 59%). It provides housing


loans in rural and semi-urban areas, operating primarily in the Gujarat and
Maharashtra, which account for ~70% of its loan book. With a modest loan
book of ~`120bn, GRUH accounts for less than 1% market share in mortgages
and has averaged loan growth of ~27% over FY06-16, making it a promising
play on the rural mortgage opportunity in India.
Strong focus in informal segment has driven robust growth and RoE
Since the stressful period of 1996-98, GRUH has moved away from the
developer loan segment to individual home loans where asset quality and
profitability were higher. Hence, share of individual home loans increased from
61% of loan book in FY97 to 97% by FY02, resulting in RoE improving from 3%
in FY98 to 22% in FY04. Since then RoE has never dipped below 24% as it has
single-mindedly focused on small-ticket home loans to informal segments. High
RoE over the past ten years (average RoE of ~30%) implied that it didnt need to
raise capital despite growing at 27% CAGR and simultaneously sustaining a
generous dividend payout of ~43% during the same period.

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
GREEN
AMBER

Performance
160
140
120
100
80

GRUH Finance

Sep-16

Play on the rural mortgage opportunity

`103/US$1.5
`143/US$2.1
`282
NA
NA

Jul-16

Changes to this position: NEGATIVE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

May-16

Competitive position: STRONG

Recommendation

Mar-16

GRUH has the strongest positioning in the affordable housing finance


due to its innovative credit scoring (first to credit score low-income
borrowers), strong local knowledge (well penetrated and decentralized
branches) and backing of the behemoth HDFC. Combined with a decadal
surge in real-estate prices, such strengths have driven GRUHs superior
profitability and growth over FY06-16 (avg. RoE of 30% and AUM CAGR
of 26%). However, declining real estate prices and increasing
competition in affordable housing finance have led to moderation in
earnings growth (EPS growth of 20% in FY16 versus 28% CAGR over
FY10-15). GRUHs lofty valuations (10x 1-year fwd P/B, 100% premium to
its peers) will be tested by such declining earnings momentum.

BFSI

Jan-16

Will it stand the test of time?

November 17, 2016

Nov-15

STRATEGY NOTE

Sensex

Source: Bloomberg, Ambit Capital research

Innovation and architecture drive competitive advantages


GRUH is one of the strongest HFCs on the IBAS framework due to: (i) its
innovative products and appraisal techniques (first HFC to introduce credit
scoring for low-income borrowers); ii) a well penetrated and decentralized
branch architecture underpinning its strong local area knowledge and superior
sourcing of low-ticket customers (despite low ticket sizes, credit costs have been
minimal at average of ~20bps over past ten years); iii) HDFCs parentage,
which enables it to get a better cost of funding, credit appraisal process and
management quality; and (iv) strong local reputation owing to its superior and
transparent customer service relative to peers. However, regulatory and
competitive headwinds pose risk to its earnings growth.
Valuations could be tested by declining earnings momentum
Mortgage financers have re-rated over the past two years at the cost of
corporate lenders due to the latters shaky earnings trajectory due to asset
quality concerns. A combination of such fundamental and sentimental factors
underpins GRUHs premium valuations. However, such peak valuations could be
tested by a declining earnings momentum (EPS growth of 20% in FY16 versus
28% CAGR over FY10-15) due to slower growth (24% in FY16 versus 30% CAGR
over FY10-15) caused by declining real estate prices and increasing competitive
intensity in the small-ticket housing finance. Moreover, HFCs are exposed to the
looming regulatory risk of convergence of loan pricing to a more transparent
and objectively calculated base rate (which is followed by banks).

Research Analysts
Aadesh Mehta, CFA
+91 22 3043 3239
aadesh.mehta@ambit.co
Pankaj Agarwal, CFA
+91 22 3043 3206
pankaj.agarwal@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

GRUH Finance
Exhibit 1: Evolution of GRUH good times have ended due to competitive and regulatory headwinds
Headwinds emerge
AUM Growth 24% 45%
NIMs 4.2%
40%
RoAs 2.3%

The good times


AUM CAGR 28%
NIMs 4.5%
RoAs 2.5%

160
140
120
100
80
60
40
20
-

35%
30%
25%
20%
FY05

FY06

FY07

FY08

FY09

FY10

FY11

AUM (Rs bn)

FY12

FY13

FY14

FY15

FY16

RoEs (RHS, %)

Source: Company, Ambit Capital research

Exhibit 2: GRUH key financial parameters over the last decade


(Fig in ` mn)
Interest Income

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

10.0%

10.8%

12.3%

11.1%

11.0%

12.3%

12.3%

12.2%

12.0%

11.4%

Interest Expense

6.2%

6.7%

8.6%

6.7%

6.4%

7.7%

7.8%

8.2%

7.9%

7.5%

Net Interest Income

3.8%

4.1%

3.7%

4.3%

4.6%

4.6%

4.5%

4.1%

4.0%

3.9%

Non-Interest Income

0.4%

0.4%

0.3%

0.5%

0.4%

0.4%

0.3%

0.5%

0.5%

0.4%

Total Income

4.2%

4.5%

4.0%

4.8%

5.0%

5.1%

4.7%

4.5%

4.5%

4.4%

Operating Expenses

1.0%

1.0%

0.9%

0.9%

1.0%

1.0%

0.9%

0.8%

0.8%

0.8%

Employee Expenses

0.4%

0.4%

0.5%

0.5%

0.5%

0.5%

0.5%

0.5%

0.4%

0.4%

Admin Expenses

0.6%

0.5%

0.4%

0.5%

0.5%

0.5%

0.4%

0.4%

0.4%

0.4%

Pre Provisioning Profit

3.2%

3.5%

3.1%

3.8%

4.1%

4.1%

3.9%

3.7%

3.7%

3.6%

Loan loss provisions

0.5%

0.2%

0.1%

0.3%

0.1%

0.1%

0.1%

0.04%

0.2%

0.2%

Profit Before tax (PBT)

2.7%

3.3%

3.0%

3.5%

4.0%

4.0%

3.8%

3.7%

3.5%

3.4%

Taxes

0.5%

1.0%

0.8%

1.0%

1.1%

1.1%

1.0%

1.0%

1.1%

1.1%

RoA

2.2%

2.3%

2.1%

2.6%

2.9%

3.0%

2.9%

2.7%

2.4%

2.3%

Leverage

11.0

10.2

11.4

11.0

10.8

11.5

11.8

12.1

12.9

13.9

23.9%

23.7%

24.3%

28.4%

31.4%

34.2%

34.2%

32.2%

30.9%

31.5%

AUM growth (%, YoY)

29%

29%

18%

18%

29%

28%

33%

29%

28%

24%

EPS growth (%, YoY)

16%

30%

19%

37%

31%

31%

20%

20%

14%

19%

RoE

Source: Company, Ambit Capital research.

Exhibit 3: Emerging regulatory & competitive headwinds led to slower growth and lower profitability recently
Time period

Phase

The good times FY05-14

Headwinds
emerge

FY14Current

Key developments

GRUHs robust growth (28% CAGR) during this period was driven by both increasing customer acquisition (due to
benign competition) and increasing ticket size per loan (due to real estate prices).

Regulatory headwinds emerged FY11 onwards such as introduction of base rate system (which led to increasing cost
of funds) and removal of prepayment penalties (leading to higher churn in the loan book and reduction in feeincome). However, GRUH was able to price in such increased costs to its customers due to benign competition and
relatively small market share in key geographies. Its RoAs sustained at 2.5% during this period.

During this period, HFCs have seen hyper-competition from banks in home loans due to: i) lack of any opportunities
in corporate loans due to slowdown; and ii) regulators incentivising affordable housing in FY15 by reduction of risk
weights and exemption on SLR/CRR and PSL requirements. Moreover decline in real estate prices have also let to
moderation in ticket size growth (which used to drive 50-60% of growth of HFCs).

Such headwinds mentioned above led to slowdown in growth as well as pressure in profitability for HFCs including
GRUH. GRUHs growth has slowed down to 24% YoY in FY16 (versus 28% CAGR in FY05-14) and RoAs moderating to
2.3% from an average of 2.5% in FY05-14.

Source: Ambit Capital research.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 90

GRUH Finance
Exhibit 4: Competitive mapping of HFCs GRUHs small-ticket positioning makes drives its superior profitability
Key metrics
(FY16)

Avg. ticket
size (` mn)

AUM (` bn)

AUM CAGR
(FY13-16)

Gross
NPA (%)

RoA

RoE

GRUH

0.5

111

27%

4.2%

0.8%

0.32%

2.3%

31.5%

179

618

HDFC

2.5

2,908

16%

3.1%

0.3%

0.70%

2.4%

21.8%

401

2,196

LICHF

1.2

1,252

REPCO

1.1

77

17%

2.6%

0.4%

0.45%

1.5%

19.6%

234

1,726

29%

4.9%

1.0%

1.30%

2.2%

17.0%

150

619

CANFIN

1.7

DEWAN

1.2

106

38%

3.1%

0.7%

0.19%

1.6%

19.0%

140

553

695

24%

3.0%

0.9%

0.93%

0.9%

11.9%

353

2,625

PNBHF

3.7

272

60%

3.8%

1.2%

0.22%

1.4%

17.6%

47

752

NIMs Opex/AUM

Branches Employees
(#)
(#)

Source: Company, Ambit Capital research

Exhibit 5: Mapping GRUH and its peers on IBAS


Particulars

GRUH

HDFC

LICHF

REPCO CNFIN

DHFL

PNBHF

Comments

Innovation

Innovation in terms of ability to appraise a non-salaried borrower is


key to gain penetration in the under-served low-income segment.
GRUH scores best in the metric due to its innovative products and
appraisal techniques. GRUHs product innovation is exemplified from
the fact that it structures customised EMIs to match the cash flows of
the low-income borrowers and has flexible repayment plan as per
daily, monthly or yearly amortising. Moreover, GRUH was the first HFC
to introduce a formal credit score methodology for the low-income
category of borrowers. Repco comes closest to GRUH in replicating
this. Moreover Repcos origination strategy is also innovative as it
sources only through loan melas and referrals and avoids sourcing
through DSAs unlike other HFCs.

Brand

Brand for the home loan borrower will depend on the perceived
customer service and the perceived project financing abilities by the
lender. Whilst HFCs score lower than banks on all these metrics, HDFC
enjoys the best brand amongst the HFCs due to superior perception on
the above metrics, followed closely by GRUH. LICHF, CNFIN and
PNBHF also score high due to their PSU parentage.

Architecture

A robust branch network with decentralised decision making is the key


to gain penetration in small ticket housing finance. HDFC with ~400
branches and a decentralised decision making has one of the best
architectures amongst peers, closely followed by DHFL and GRUH.
Whilst REPCO has marginally lower branches than GRUH, it also
scores highly due to a decentralised decision making process.

Strategic asset

Support of the parent, strong credit rating and a granular retail deposit
franchise are the key strategic assets for HFCs in times of liquidity
crunch. LICHF is best placed in this metric due to strong support from
its parent on the above mentioned metrics.

Overall rank

GRUH comes out as one the strongest HFCs versus its peers due to its
strengths in innovation, brand, architecture and strategic assets.

Source: Company, Ambit Capital research; Note:

- Strong;

- Relatively Strong;

Exhibit 6: AUM mix

- Average;

- Relatively weak.

Exhibit 7: Liability mix


Home loan - Salaried

3% 4%

Home loan - Self


employed

11%

NHB

9%
14%

LAP - Residential

39%

Bank loans

52%
29%

LAP - Non Residential

38%

Others

Construction Loans
Source: Company, Ambit Capital research

November 17, 2016

Public deposits

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 91

GRUH Finance
Exhibit 8: NIMs are declining due to competitive pressures
5.4%

Exhibit 9: Asset quality is worsening


2.0%

NIM

Gross NPA

5.2%
1.5%

5.0%
4.8%

1.0%

4.6%
4.4%

0.5%

4.2%

-1 SD

FY16

FY15

FY14

FY13

FY12

FY10

FY11

SENSEX

+1 SD

Apr-16

Apr-15

Apr-14

Apr-13

Apr-12

Apr-11

Apr-07

Jul-16

Feb-16

Sep-15

Apr-15

0.0
Nov-14

500
Jun-14

2.0
Jan-14

1,000

Aug-13

4.0

Mar-13

1,500

Oct-12

6.0

May-12

2,000

Dec-11

8.0

Jul-11

2,500

Feb-11

10.0

Apr-10

3,000

Sep-10

12.0

Apr-10

Exhibit 11: GRUH share price performance versus sensex

Apr-09

its

Apr-08

Exhibit 10: GRUH is trading at 60% premium to


cross-cycle average P/B

Avg. PB

FY09

FY07

FY16

FY15

FY14

FY13

FY11

FY10

FY09

FY08

FY07

FY12

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

PB

FY08

0.0%

4.0%

GRUH

Source: Bloomberg, Ambit Capital research

Source: Bloomberg, Ambit Capital research

Exhibit 12: Explanation for our flags


Segment

Score

Accounting

GREEN

Predictability

GREEN

Earnings momentum

AMBER

Comments
GRUHs revenue and expense recognition policies are by far the most conservative amongst the peers. We do not
come across any instance wherein the reported profitability of the company is materially different from its true
profitability.
GRUHs earnings trajectory has been fairly predictable. It has delivered a clockwork 20% earnings growth for at
least past 18 quarters.
Pressure on AUM growth and profitability has led to GRUHs earnings growth moderating from 30% PAT CAGR
over FY07-14 to 20% PAT CAGR over FY14-16.

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 92

GRUH Finance
Income statement
Year to March (` mn)
NII (inclu. Securitisation)

FY12

FY13

FY14

FY15

FY16

1,871

2,311

2,707

3,437

4,212

Other income

170

149

319

389

468

Total income

2,041

2,460

3,025

3,826

4,680

Operating expenditure
Pre-provisioning profit
Provisions
Profit before tax
Tax
Consol. PAT

392

463

556

661

844

1,649

1,997

2,469

3,165

3,836

22

29

24

157

219

1,627

1,968

2,445

3,008

3,617

424

509

675

970

1,181

1,202

1,500

1,770

2,038

2,436

Source: Company, Ambit Capital research

Balance sheet
Year to March (` mn)

FY12

FY13

FY14

FY15

FY16

3,856

4,910

6,072

7,115

8,353

38,330

49,145

64,475

67,453

102,444

Net-worth
Borrowings - on balance sheet
Borrowings - off balance sheet

Total liabilities

42,186

54,055

70,547

74,568

110,797

AUM

40,774

54,378

70,090

89,544

111,146

652

530

798

1,429

1,410

(974)

(73)

(15,775)

(350)

28,134

36,990

46,431

59,165

74,927

Cash and equivalents


Net Current Assets
Total assets

Source: Company, Ambit Capital research

Key ratios
Year to March (` mn)

FY12

FY13

FY14

FY15

FY16

NIM % (on AUM)

5.2%

4.9%

4.3%

4.3%

4.2%

AUM Growth

28%

33%

29%

28%

24%

Opex as % of AAUM

1.08%

0.97%

0.89%

0.83%

0.84%

Credit costs as a % of AUM

0.06%

0.06%

0.04%

0.20%

0.22%

CAR (%)

14.0%

14.6%

16.4%

15.4%

17.8%

FY12

FY13

FY14

FY15

FY16

3.4

8.2

4.9

5.6

6.7

Source: Company, Ambit Capital research

Valuation parameters
Year to March (` mn)
Dil EPS Consol (`)
BVPS (`.)

11

14

17

20

23

ROA (%)

3.0%

2.9%

2.7%

2.4%

2.3%

ROE (%)

34.2%

34.2%

32.2%

30.9%

31.5%

P/B (x)

25.8

20.6

16.7

14.4

12.3

P/E (x)

82.6

34.4

57.4

50.3

42.1

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 93

GRUH Finance

This page has been intentionally left blank

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 94

Dr Lal PathLabs
NOT RATED
DLPL IN EQUITY

Long-term growth path


Dr Lal PathLabs is the largest diagnostics chain in India by revenues; it
recorded 35% sales CAGR and 78% PAT CAGR over FY07-16 driven by: 1)
aggressive geographical expansion; 2) acquisition of smaller labs; 3)
market-share gain from low-quality unorganised players (48% share
now); and 4) acquiring customers through branding, not commissionbased referrals by doctors. Sales growth of mid-to-high teens with
steady margins and return ratios will continue given: 1) low penetration
rate of healthcare; 2) socio-economic tailwinds; and 3) continued
market-share gains from unorganised players. Valuation at 61x FY18E
P/E is at a 100% premium to FMCG sector justified by potentially higher
growth rates while delivering FMCG-like EBITDA margins and RoIC. Key
risks: Price disruption and increased competition from other labs.

Healthcare
Recommendation
Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

`93/US$1.4
`188/US$2.8
`1,135
NA
NA

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
AMBER
GREEN

Changes to this position: STABLE

Focus on quality is helping to grow market share


Diagnostics in India is highly fragmented (unorganised hold 48% market share).
Organised chains hold only 15% of revenues. Dr Lal, the largest player, has only
2% market share. Though globally, the industry is fragmented, market leaders
tend to have 10-20% market share (e.g. Quest in USA has 10% share, Miraca in
Japan has 21% share, DAAS in Brazil has 18% share, and Sonic in Australia has
43% market share). Dr Lal can continue to consolidate its market-leading due to:
1) shifting of sales from unorganised to organised; 2) geographical expansion
beyond North and East; and 3) acquiring smaller/regional labs.

280
230
180
130

Dr Lal Pathlabs

Oct-16

Sep-16

Jul-16

Aug-16

Jun-16

May-16

Apr-16

80
Mar-16

Dr Lal started operations in 1949 and is one of the pioneers in the diagnostics
industry in India. It is highly focused on technology to provide high quality
customer experience, faster turnaround time and wider array of tests with higher
accuracy vs unorganised peers. More than 20 labs of Dr Lal are certified by
National Accreditation Board. With `7.9bn in revenues (FY16), 175 labs, 1,500
patient service centres and annual throughput of 26mn+ samples, Dr Lal is the
largest diagnostics chain in India. Dr Lals 35% sales CAGR (last 10 years) is
unlikely to sustain given high base but a higher-than-industry growth rate of
mid-to-high teens is possible.

Performance

Jan-16

Sustained quality leadership in Indian diagnostics space

Feb-16

Competitive position: MODERATE

November 17, 2016

Dec-15

STRATEGY NOTE

Sensex

Source: Bloomberg, Ambit Capital research

Investing for growth to ensure competitive advantage sustains


We believe, given the high base and rising competition from national and
regional chains, Dr Lal will have to continue investing in growth. Steps being
taken to maintain market leadership in terms of growth and quality are: 1)
setting up of two reference labs for capex of `1bn; 2) continuous expansion of
an array of tests, including for latest epidemics like the Zika virus; 3) pricing
discipline with annual hikes averaging 2-3%, which is much lower than inflation;
4) addition of satellite labs in new cities to enhance reach; and 5) acquisition of
smaller/regional labs. While these steps will drive growth, RoIC will be hit.
However, given high RoIC (50%+), we are not overly worried about this.
Valuation is rich as investors are focusing on long-term growth
Trading at 61x FY18 consensus P/E, Dr Lal appears rich. However, we believe Dr
Lal combines the higher growth potential of the consumer discretionary sector
but at the economics of the consumer staples sector. This combination of higher
growth and healthy profitability, return ratios and cash generation is unique and
justifies the 100% premium over consumer staples and 33% premium over the
consumer discretionary basket.

Research Analyst
Anuj Bansal
+91 22 3043 3122
anuj.bansal@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Dr Lal PathLabs
Exhibit 1: Tale of two halves over the last decade
130%

45%

Phase 1: With penetration rates


low, rapid geographic expansion,
share gains and acquisition of
smaller labs for lower price helped
strong revenue growth while
driving up RoCE

90%

Phase 2: As base
expanded, smaller players
became organised,
valuations for M&A moved
up scope for revenue
growth moderated and
incremental RoIC for this
growth became lower

50%

35%

25%

15%

10%
FY07

FY08

FY09

FY10

FY11

Pre-tax ROCE (%)

FY12

FY13

FY14

FY15

FY16

Revenue growth (RHS, %)

Source: Ambit capital research

Exhibit 2: Key financial parameters over the last decade


(` mn)

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Revenues

945

1,230

1,670

2,373

3,422

4,517

5,579

6,596

7,913

Revenue growth (%)

24%

30%

36%

42%

44%

32%

24%

18%

20%

Net profits

86

128

252

295

452

557

803

964

1,059

EPS

1.6

2.4

4.5

3.6

5.6

6.8

9.7

11.6

16.1

CFO

522

2,926

2,396

2,591

6,802

711

5,979

6,231

6,630

144%

105%

151%

135%

136%

95%

177%

111%

125%

63

103

234

438

559

380

974

700

904

Pre-tax CFO-EBITDA
FCF
Debt equity (x)

0.0

0.0

0.0

0.2

0.0

0.0

0.0

RoE (%)

13%

16%

26%

32%

43%

40%

41%

34%

25%

Pre-tax RoCE (%)

31%

46%

83%

49%

73%

90%

127%

110%

92%

Source: Company, Ambit Capital research.

Exhibit 3: The key things to note from evolution


Time period

Phase

Pre 2005

Dr S.K Lal and Dr Arvind


Lal run the company as a
family business

2005-2014

Dr Om Manchanda joins
as COO and promoted
to CEO in 2008

Post 2014

Growth is strong but at a


higher cost

Key developments
Business started in 1949 by Dr Major S.K. Lal
Dr Arvind Lal (son of Dr S.K. Lal) took over as the Chairman of Dr Lal PathLabs in 1977
Under his leadership the company modernised and adopted Information and Communication Technology
(ICT). The company also expanded beyond Delhi NCR.
In 2004, Dr Lal PathLabs became first Indian Diagnostic chain to get into a Public Private Partnership with
Government of Tripura
Helped convert a family run business into a professional entity
Revenues grew 11x in 10 years at a 30% CAGR mainly driven by rapid geographic expansion and
acquisition of smaller labs
Profitability improved significantly, going up from `10mn to `1.8bn over FY06 to FY16
Level of investments set to rise to ensure growth levels are maintained. This should cap profitability and
return ratios going forward
With two new reference labs coming up, quality of service should improve further
Focus will be firmly on growing in North and East with West and South to be tapped either inorganically or
through selected clusters

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 96

Dr Lal PathLabs
Exhibit 4: Competitive mapping of Britannia
Sub-segment
Positioning

Company

FY16 revenue
(` bn)

Revenue
CAGR
FY11-16

Industry
market
share

EBITDA
Margin
(FY16)

Pre-tax
RoCE
(FY16)

Pre-tax CFO/
EBITDA
(FY11-16)

Capex/CFO
(FY11-16)

Dr Lal

#1

79.1

27%

~2%

23%

92%

130%

15%

SRL

#2

77.4

14%

~2%

24%

NA

NA

NA

Thyrocare

#4

23.5

25%

~1%

40%

74%

108%

30%

Source: Company, Ambit Capital research; Note: For ITC we have taken the FMCG segment revenues

Exhibit 5: Mapping Dr Lal and its peers on IBAS


Dr Lal

SRL

Thyrocare

Metropolis Comments

Innovation

Branding

Architecture

Strategic Assets

Overall

In terms of back-end systems or sample collection and logistics, all four are fairly
well placed.
Key difference is range of tests provided where Dr Lal leads (4,600) followed by SRL
(3,500) and Metropolis (4,500).
Thyrocare has a limited test portfolio (200 tests) and focuses just on basics.
SRL has a well-established brand with presence across pan-India (revenue split is
even).
Dr Lal (North and East) and Metropolis (West) are also strong brands but with
limited geographic reach.
Thyrocare is better known for Thyroid tests and its Aarogyam brand for preventive
health check-ups is still work in progress
SRL through higher presence in hospitals, more accredited labs (37) and more
doctors (700) has a better ecosystem.
Dr Lal is largely dependent on franchisees which have high churn rate of 15-20%
and fewer certified labs (20) and doctors (175).
Thyrocare also has a weaker ecosystem which is completely dependent on
franchisees which compromises customer experience and quality

High class reference lab for Dr Lal in Delhi.


Synergies with Fortis Hospitals for SRL provide better branding and customer reach
Thyrocare's reference lab is relatively limited in its ability due to limited number of
tests supported by it.

Dr Lal is a strongly competing player though SRL due to its parentage with Fortis
Hospitals has an edge.
Thyrocare clearly needs to enhance focus on moving up the quality chain

Source: Company, Ambit Capital research

Exhibit 6: CFO

was

the

main

source

of

funds

Exhibit 7: Post capex, large sums of money available for


liquid investments

Debt
4%

Others
9%
Dividend
14%

Share
Capital
17%

Capex
57%
Investments
20%

CFO
79%

Source: Company, Ambit Capital research

November 17, 2016

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 97

Dr Lal PathLabs
Exhibit 9: Strong outperformance vs Sensex

Dr Lal

1- yr average

Dr Lal

Source: Company, Ambit Capital research

Oct 16

Sep 16

Aug 16

Jul 16

Jun 16

May 16

Nov-16

Oct-16

Sep-16

Aug-16

Jul-16

Jun-16

May-16

Apr-16

Mar-16

Feb-16

Jan-16

40

Apr 16

50

Mar 16

60

Feb 16

70

160
150
140
130
120
110
100
90
80
Jan 16

80

Dec 15

Exhibit 8: Sharp re-rating since listing in Dec15

Sensex

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our forensic accounting scores


Segment

Score

Comments

Accounting

GREEN

There are no significant issues with Dr Lals accounting policy. High CFO/EBITDA and steady working capital are
positives. Historically ESOPs have been at an elevated level but have been accounted for fairly.

Predictability

AMBER

Earnings swing due to extent of onset of seasonal diseases is fairly high. While structural growth over medium term
is fairly predictable, near-term volatility can be high. Actual performance has often beaten management guidance.

Earnings Momentum

GREEN

Earnings momentum has been positive for Dr Lal with consistent earnings beat vs expectations since listing.

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 98

Dr Lal PathLabs
Balance sheet
Year to March (` mn)
Shareholders' equity
Reserves & surpluses

FY12

FY13

FY14

FY15

FY16

163

164

803

1,108

1,243

996

1,457

1,512

2,303

3,831

Total networth

1,160

1,621

2,315

3,411

5,074

Minority Interest

11

16

18

23

29

Debt

(27)

(127)

(196)

(254)

(121)

Total liabilities

1,171

1,640

2,342

3,434

5,102

Gross block

1,245

1,466

1,676

1,995

2,340

Net block

1,145

1,271

1,400

1,510

1,697

Deferred tax liability

Investments

48

548

86

379

643

Cash & equivalents

134

215

1,057

1,482

2,296

Debtors

143

198

252

310

363

62

86

117

143

145

180

203

347

597

882

Inventory
Loans & advances
Other current assets

29

41

62

79

105

Total current assets

415

528

776

1,128

1,495

Current liabilities

394

898

1,038

1,127

838

Provisions

204

150

135

192

312

Total current liabilities

598

1,048

1,173

1,319

1,150

Net current assets

(183)

(520)

(397)

(192)

345

Total assets

1,171

1,640

2,342

3,434

5,102

FY12

FY13

FY14

FY15

FY16

3,422

4,517

5,579

6,596

7,913

32%

24%

18%

20%

3,540

4,194

5,036

6,090

977

1,386

1,560

1,824

13%

42%

13%

17%

Source: Company, Ambit Capital research

Income statement
Year to March (` mn)
Revenues
% growth
Operating expenditure
EBITDA

2,557
865

% growth
Depreciation

198

204

272

282

283

EBIT

667

773

1,113

1,278

1,541

11

(1)

(56)

(90)

(142)

Interest expenditure
Non-operating income

28

22

29

50

Adjusted PBT

664

802

1,192

1,397

1,734

Tax

213

245

389

433

675

Adjusted PAT/ Net profit

452

557

803

964

1,059

23%

44%

20%

10%

% growth
Extraordinaries

(274)

Minority Interest

10

447

552

796

957

1,322

Reported PAT / Net profit


Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 99

Dr Lal PathLabs
Cash flow statement
Year to March (` mn)

FY12

FY13

FY14

FY15

FY16

PAT

452

557

803

964

1,059

Depreciation

198

204

272

282

283

250

155

242

239

213

245

389

433

675

78

(337)

123

205

537

947

919

1,743

2,126

2,792

Others ESOPs
Tax
(Incr) / decr in net working capital
Cash flow from operations
Capex

194

368

400

372

400

Cash flow from investments

194

368

400

372

400

(183)

(9)

Net borrowings
Issuance of equity

(66)

640

305

135

Dividend paid

150

91

100

150

196

Cash flow from financing

(399)

(87)

545

146

(61)

Closing cash balance

134

215

1,057

1,482

2,296

Free cash flow

380

974

700

904

907

FY12

FY13

FY14

FY15

FY16

Gross margin (%)

77.7%

78.5%

78.9%

78.9%

78.1%

EBITDA margin (%)

25.3%

21.6%

24.8%

23.6%

23.0%

EBIT margin (%)

19.5%

17.1%

20.0%

19.4%

19.5%

Net profit margin (%)

13.2%

12.3%

14.4%

14.6%

13.4%

Dividend payout ratio (%)

33.5%

16.4%

12.6%

15.7%

18.5%

Net debt: equity (x)

-0.2

-0.5

-0.5

-0.5

-0.6

Working capital days

-20

-42

-26

-11

16

Source: Company, Ambit Capital research

Ratio analysis
Year to March

Gross block turnover (x)

2.75

3.08

3.33

3.31

3.38

Post-tax RoCE(%)

49.3%

62.6%

85.5%

75.9%

56.0%

RoE(%)

43.3%

40.1%

40.8%

33.7%

25.0%

Source: Company, Ambit Capital research

Valuation parameters
Year to March

FY12

FY13

FY14

FY15

FY16

EPS (`)

5.6

6.8

9.7

11.6

12.9

Diluted EPS (`)

5.6

6.8

9.7

11.6

12.9

14.4

20.0

28.3

41.5

61.7

1.9

1.1

1.2

1.8

2.4

198.6

162.3

113.3

94.7

68.6

76.6

55.3

38.9

26.6

14.3

EV/EBITDA (x)

102.5

90.9

64.2

56.9

48.1

Price/Sales (x)

26.0

19.8

16.2

13.7

9.2

Book value per share (`)


Dividend per share (`)
P/E (x)
P/BV (x)

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 100

eClerx
SELL
ECLX IN EQUITY

No room for error

Technology

Impeccable capital allocation, exemplary growth


The founders have made no mistake in either strategy or execution since
founding in 2000. eClerx has focused on large corporate customers, small &
complex processes and annuity-like revenue. Its key competitive advantages
have been its internal processes (knowledge management, training), deep
domain expertise and superior sales engine (higher-quality talent). The capital
allocation track record is also impeccable. 41% of profits were returned to
shareholders over FY06-16. After examining hundreds of potential targets,
eClerx has made just three niche acquisitions (in FY08, FY13 and FY15), each of
which has been successful (EPS-accretive from day-1, continued to grow post
deal).
Architecture built around domain expertise, talent and clients
eClerx scores most highly on the architecture aspect of the IBAS framework. The
founders network (both were Wharton MBA graduates) and sales ability enabled
marquee wins (e.g. Dell, Lehman Brothers). This, in turn, not only allowed eClerx
attract and retain high-calibre employees (a generous ESOP and listing in 2007
also helped) but also resulted in significant growth headroom. Focus on lowvolume and complex processes have resulted in better pricing (low competition)
and also high utilisation (just-in-time hiring). All of these combine to deliver high
customer satisfaction despite relying on low-cost, junior, offshore labour, which
in turn generates high profitability (average EBIT margin of 35% over FY06-16).
Trading at par with Infosys; threats from regulation and automation
The regulatory-driven shift of trading OTC derivatives to the exchanges and the
higher proportion of newer, smaller-duration projects are hurting eClerxs
competitive advantages in the financial services segment (~40% of revenues in
FY14). Robotic process automation is another threat. Although the management
has a good track record of overcoming challenges and it could potentially add
new revenue streams, current valuations leave no room for error. eClerx trades
at 15x FY18E EPS, on par with Infosys (15x) which is a better franchise (much
larger scale, full-service offering).

Accounting:
Predictability:
Earnings Momentum:

GREEN
AMBER
AMBER

Performance

eClerx Services

Sensex

Source: Bloomberg, Ambit Capital research

eClerxs forensic score analysis

Source: Ambit HAWK, Ambit Capital research

eClerxs greatness score analysis

A b

AW

A b

Sep-16

Aug-16

Jul-16

Jun-16

Apr-16

May-16

130
120
110
100
90
80
Mar-16

eClerx business has three segments: financial services (~40% of FY16 revenues),
digital marketing (~40%) and cable & telecom (~20%). Examples of processes in
each: handling documentation related to OTC derivatives for a global
investment bank, optimising an e-commerce website catalog to boost sales and
using analytics to improve customer-service for a large US-based cable
company. Revenue and operating cash flow posted 40% and 30% CAGR over
FY06-16.

`57/US$0.8
`77.8/US$1.2
`1,399
`1,425
1.8%

Flags

Jan-16

Specialises in low-volume, highly complex, offshore BPO

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Upside (%):

Feb-16

Changes to this position: NEGATIVE

Recommendation

Dec-15

eClerx has built formidable moats around its niche of low-volume, highcomplexity BPO, reflected in high pre-tax median RoCE of 57% (FY06-16).
Its internal processes, deep domain expertise and superior sales engine
have helped it offset competition (from larger peers, offshore captives)
to deliver 40%/30% revenue/operating cash flow CAGR (FY06-16). The
promoters have also demonstrated an impeccable capital allocation
track record over the past 10 years 41% of profits have been returned
to shareholders over the past 10 years and each of the three acquisitions
has been successful. However, regulatory-driven challenges in BFSI (40%
of revenue) and the rise of robotic process automation tools threaten its
business model. Current valuation of 15x FY18E EPS (vs. 15x for Infosys)
leave no room for error. We are SELLers with a TP of `1,425, implying
14x FY18E EPS.
Competitive position: STRONG

November 17, 2016

Nov-15

STRATEGY NOTE

Research Analysts
Sagar Rastogi
+91 22 3043 3291
sagar.rastogi@ambit.co
Sudheer Guntupalli
+91 22 3043 3203
sudheer.guntupalli@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

eClerx
Exhibit 1: eClerx has executed the same play book (mine customers, make sensible acquisitions)
200%
180%
200

Executing the same play book over last decade

160%

Pre-Tax RoCE

Revenue (US$mn)

250

140%

150

120%
100%

100

80%
60%

50

40%
-

Revenue (US$mn)

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

20%

Pre-tax RoCE

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator.

Exhibit 2: Key financial parameters over the last decade


(` mn)

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

20

31

42

55

76

98

122

138

154

199

91%

56%

39%

30%

37%

29%

25%

14%

11%

29%

Revenues ($ mn)
Revenue growth (%)
Net profits

397

446

618

735

1,328

1,599

1,716

2,555

2,297

3,630

EPS

13.9

15.6

21.7

18.8

30.8

39.8

42.7

62.8

55.7

87.7

CFO

358

330

412

606

1,020

1,721

1,533

1,950

2,432

4,254

CFO-EBITDA

82%

67%

51%

60%

76%

91%

60%

55%

77%

87%

FCF

330

177

284

517

780

1,470

451

1,503

1,822

2,583

Debt equity (x)

0.0

RoE (%)

135%

34%

37%

37%

56%

55%

44%

50%

35%

40%

RoCE* (%)

193%

61%

46%

45%

68%

69%

54%

65%

46%

53%

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator.

Exhibit 3: since it was founded in 2000


Phase

Time Period

Key developments

Founded by P D Mundhra and Anjan Malik, batch-mates at the Wharton MBA programme. After graduation, PD
worked at Citibank and Anjan worked at Lehman Brothers. They founded the company in 2000.

Initially most of the revenues from the investment banking segment with also some revenues from retail and
manufacturing segments.

Phase- I

2000-now

It listed on the stock exchanges in 2007 through an IPO.


In 2007, it acquired Igentica which added clients in the digital marketing segment.
In 2008, Lehman Brothers, which was one of its top clients, went bankrupt but eventually revenues resumed from the
successor entity.

In 2012, it acquired Agilyst, which added the cable and telecom segment.
In 2015, it acquired CLX, which added capabilities in content marketing.
Source: Ambit Capital research, company

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 102

eClerx
Exhibit 4: Competitive mapping of eClerx, HGS and WNS Global

199

Hinduja Global
Solutions (HGS)
507

Revenue growth (US$ terms, last 5 years)

21.0%

15.8%

(2)%

FY16 EBIT Margin (%)

33.2%

9.0%

11.0%

Last 5 FY EBIT Margin (%)

34.0%

11.3%

9.9%

CFO/EBITDA

56.0%

50.7%

118%

CFO/CAPEX

1.23

0.63

3.8

Metric

eClerx

FY16 Revenues (US$mn)

WNS Global
562

RoE

36.0%

9.0%

15.0%

RoCE

53.0%

10.0%

15.0%

NA

16

Client Metrics
US$5m+ clients
US$1m+ clients
Top 10 clients' revenue (%)
Revenue per employee ('000 $)

17

NA

57

76.0%

60.6%

45.5%

22

12.7

17.3

1.1

2.0

EBIT per employee ('000 $)


Source: Company, Ambit Capital research

Exhibit 5: Mapping eClerx and peers on our IBAS framework


Component

eClerx

HGS

WNS Global Comment


The ability of the management to identify sweet spots (high value work that can be done by
relatively low-cost employees) is a key innovation. Though peers like HGS and WNS Global
were quick to capitalise on the BPO opportunity which evolved as a logical extension to ITO,
eClerx went a step ahead and started offering solutions which are more critical than a typical
BPO. It kept moving up the value chain over a period of time, becoming a key strategic partner
to its clients. The companys average EBIT margin (35%) is significantly higher than that of
peers (HGS - 9%, WNS Global 19%) indicating the complexity of processes (pricing power)
that eClerx executes.
eClerx occupies high mindshare of clients in its niche despite many competitors/captives now
providing, such services. This reflects in the fact that it has not lost a single client so far despite
intense competition from larger peers.
eClerx focuses on low-volume, highly complex processes. This insulates the company from
competition from its larger peers like TCS, Infosys etc. since BPO divisions of these companies
prefer high volume and simple processes. Captives are not able to match its cost structure or
its knowledge management and training processes. In fact, most of its clients use eClerxs
training material to train their own employees!
eClerxs deep understanding of the clients processes, and relationship with marquee
customers are the key strategic assets.
The brand image, architecture and strategic assets that eClerx has built in its business makes it
less vulnerable to upcoming technologies like robotic process automation when compared to
peers like HGS and WNS Global which are into low-end BPO services. Clients can easily
automate low-value offerings like claims and payroll processing, which is not the case with
complex offerings (such as trade confirmations and settlements) that eClerx provides.

Innovation

Brand (Reputation)

Architecture

Strategic Assets

Overall

Source: Company, Ambit Capital research, Note:

- Strong;

- Relatively Strong;

Exhibit 6: Cash generated over the years


Equity
Issuance
7%

- Average;

Exhibit 7: largely used to fund dividends

Total Outflow:
`18bn

Acquistions
14%

CFO (exWC)
93%

Source: Company, Ambit Capital research

November 17, 2016

- Relatively weak

WC
investments
34%

Capital
Expenditure
15%

Total Outflow:
`17bn

Dividends
37%

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 103

eClerx
Exhibit 8: Valuations at premium to historic average
20

Exhibit 9: eClerx share price performance v/s Sensex


3,500

1 year forward P/E


(consensus)

18

3,000

16

2,500

14

2,000
1,500

12

1,000

10

500

P/E

Avg

Source: Company, Ambit Capital research

SENSEX

Aug-16

Feb-16

Aug-15

Feb-15

Feb-14

Aug-14

Sep-13

Mar-13

Sep-12

Mar-12

Apr-11

Sep-11

Oct-10

Apr-10

Oct-09

Nov-08

May-09

Oct-16

Apr-16

Oct-15

Apr-15

Oct-14

Apr-14

Oct-13

Apr-13

Oct-12

Apr-12

Oct-11

Apr-11

Eclerx

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our flags


Segment

Score

Accounting

GREEN

Predictability

AMBER

Earnings momentum

AMBER

Comments
Our proprietary forensic accounting tool Hawk places eClerx in Zone of safety (D2 in FY15) in terms of
Accounting policies.
The management issues annual guidance and earnings surprises over past eight quarters have averaged more
than 5%.
Bloomberg shows downgrade to consensus numbers in last 8 weeks.

Source: Ambit Capital research

Exhibit 11: Forensic score evolution

Exhibit 12: Greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 104

eClerx
Balance sheet (consolidated)
(` mn)
Net worth
Other liabilities

FY15

FY16

FY17E

FY18E

FY19E

7,150

10,863

14,653

18,839

23,319

122

300

182

182

182

Capital employed

7,272

11,163

14,835

19,021

23,501

Net block

1,693

968

4,277

5,208

6,226

Goodwill

857.5

2,429.4

2,429.4

2,429.4

2,429.4

720

579

614

694

805

Curr. assets

7,190

8,677

9,177

12,568

16,204

Debtors

1,261

1,861

1,953

2,205

2,513

Cash & bank balance

4,419

5,459

5,786

8,736

11,803

Other current assets

505

1,357

1,439

1,626

1,888

Current liab. & prov

2,319

1,456

1,662

1,878

2,164

Other non-current assets

Net current assets

4,870

7,221

7,515

10,690

14,040

Application of funds

7,272

11,163

14,835

19,021

23,501

FY15

FY16

FY17E

FY18E

FY19E

154

199

207

234

266

Revenue

9,421

13,143

14,163

15,988

17,842

Cost of goods sold

3,964

5,514

6,040

7,017

8,129

Source: Company, Ambit Capital research

Income statement (consolidated)


(` mn)
Revenue (US$ mn)

SG&A expanses

2,801

3,268

3,469

3,712

4,104

EBITDA

3,156

4,868

5,177

5,909

6,393

500

507

524

649

783

Depreciation
EBIT

2,656

4,361

4,653

5,260

5,610

EBIT margin

28.2%

33.2%

32.9%

32.9%

31.4%

Other income
PBT
Tax
Rate (%)
Reported PAT
Diluted EPS

324

404

316

310

348

2,979

4,765

4,969

5,570

5,957

683

1,132

1,139

1,337

1,430

0.2

0.2

0.2

0.2

0.2

2,297

3,630

3,831

4,233

4,528

55.7

87.7

92.8

102.6

109.7

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 105

eClerx
Cash flow statement (consolidated)
(` mn)
PBT
Depreciation
CF from operations
Cash for working capital
Taxes
Net operating CF
Net purchase of FA
Net cash from invest.
Proceeds from equity & other
Equity distributions
Others
Cash flow from fin.

FY15

FY16

FY17E

FY18E

FY19E

2,979

4,765

4,969

5,570

5,957

500

507

524

649

783

3,272

5,179

5,216

5,909

6,393

121

(1,310)

32

(224)

(283)

(683)

(1,132)

(1,139)

(1,337)

(1,430)

2,710

2,738

4,110

4,349

4,679

(623)

(2,223)

(1,403)

(1,581)

(1,801)

(1,776)

(3,562)

(1,161)

(1,350)

(1,565)

104

(1,692)

(49)

(48)

(48)

(48)

103

207

(147)

(1,587)

263

(194)

(48)

(48)

Free cash flow

2,088

515

2,706

2,768

2,878

Net cash flow

(652)

(562)

2,754

2,951

3,067

FY15

FY16

FY17E

FY18E

FY19E

11%

29%

4%

13%

14%

-11%

57%

6%

11%

7%

P/E

29.5

18.7

17.7

16.0

15.0

EV/EBITDA

20.4

13.2

12.4

10.9

10.0

9.5

6.2

4.6

3.6

2.9

RoE

35%

40%

30%

25%

19%

RoCE

31%

36%

28%

24%

20%

Receivable days (Days)

48

51

51

51

51

Fixed asset turnover (x)

5.8

9.9

5.4

3.4

3.1

Source: Company, Ambit Capital research

Ratio analysis (consolidated)*


Growth
Revenue (US$)
EPS
Valuation

Price/Book value
Return ratios (%)

Turnover ratios

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 106

Astral Poly
NOT RATED
ASTRA IN EQUITY

A fanatic challenger

November 17, 2016


Building Materials

Astral evolved from a niche pipe maker (CPVC) to a pan-India plastic


pipe brand in less than a decade. Sales and EPS CAGR was 40% and
median ROCE was 22% over FY06-16. Focus on innovation (products and
processes) and strong relationships across ecosystem (suppliers, global
innovators and intermediaries) will support growth of the plastic pipe
business and building adhesives/construction chemicals business. Astral
can transition into an ace building material franchise (akin to legends
like Pidilite, Asian Paints) since: (a) both segments have significant room
for innovation/re-investments; and (b) management is fanatic, frugal
and focused. Valuations appear misleadingly expensive (25x FY18 EPS)
and should be seen in light of high growth rates beyond the next
decade. Consensus expects 39% EPS CAGR over FY16-18, higher than
most other new-age building material names.

Recommendation

Competitive position: MODERATE

Performance

GREEN
GREEN
AMBER

Astral Poly

Source: Bloomberg, Ambit Capital research

Astral created the CPVC pipes market in India through: (a) continuous launch of
differentiated products, (b) innovative communication to the influencers
(plumber trainings), and (c) branding (mass-media advertising in a seemingly
commoditized product). Throughout the last decade, the company maintained
focused capital allocation, with cash flows initially ploughed back to increase
capacities and then to de-leverage (0.2x D/E in FY16 vs 1.5x in FY05).
Establishment of Astrals brand and prudent capital allocation manifested in 40%
sales/EPS CAGR and average pre-tax RoCE of 22% over FY06-16.

Astrals forensic score analysis

Headline valuations can often be misleading


At 25x FY18 consensus EPS, Astral is one of the most expensive building material
franchises in India. However, Astrals valuation should be considered in light of:
(a) focused capital allocation history, and (b) ability and intent to reinvest cash in
RoCE-accretive products/segments to sustain the longevity of cash flow growth.
The growth phase in such businesses is longer than a 10-year DCF model gives
them credit for and, hence, a low terminal growth rate assumption leads to
misleading exit multiples (akin to Asian, Berger and Pidilite).

Source: Ambit HAWK, Ambit Capital research

Astrals greatness score analysis

Source: Ambit HAWK, Ambit Capital research

Research Analysts
Nitin Bhasin
+91 22 3043 3241
nitin.bhasin@ambit.co
Girisha Saraf
+91 22 3043 3211
girisha.saraf@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Sep-16

Jul-16

Sensex

From category creation to brand building to category extension

Innovation flows into products, branding and processes


Innovative, category-expanding product launches and processes set Astral apart
from peers. Strong relationships with Lubrizol and global pipe majors (Wavin,
Spears and IPSC) facilitated launch of differentiated products. Astrals unique
strategic assets are: (a) unparalleled CPVC/pipes brand (even without Lubrizol
support now), (b) relationships with plumbers, and (c) managements strong
reputation amongst channel. Acquisitions of well-established adhesive brands in
India/UK will add another leg to growth. Astral is slowly replicating its winning
formula of quality products, impactful communication, intermediary connect and
learning from leaders to build Indias 2nd largest adhesives franchise.

Aug-16

Jun-16

May-16

Mar-16

Jan-16

130
120
110
100
90
80
Feb-16

Despite a 16% 10-year revenue CAGR for top-5 companies, plastic pipes in
India have a long path to chart through: (a) replacement of GI pipes, (b)
increasing applications, and (c) innovation in plastic compounds and water
management systems. Current deflation in input prices (CPVC/PVC resin)
alongside scale and distribution ramp-up will support market share gains for
organized players (40% industry is unorganized). Astral is the 3rd largest and one
of the strongest plastic pipes brands and, hence, poised to gain share as the
market expands. Increasing competition has led to managements decision for
reinvesting capital and leveraging its brand/reach architecture.

Accounting:
Predictability:
Earnings Momentum:

Dec-15

Pipes a category with ample room for sustaining innovation

`50/US$0.8
`28.2/US$0.4
`418
n.a.
n.a.

Flags

Nov-15

Changes to this position: STABLE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

Apr-16

STRATEGY NOTE

Astral Poly Technik


Exhibit 1: Evolution of Astral Poly
(` mn)

Product Establishment
Sales CAGR: 65%
Pre-tax RoCE: 29%

16,000

(%)

Brand Building; start of


Adhesives
Sales CAGR: 31%
Pre-tax RoCE: 26%

Scale ramp-up
Sales CAGR: 43%
Pre-tax RoCE: 24%

45
40

12,000

35
30

8,000

25
20

4,000

15
10

FY03

FY04

FY05

FY06

FY07

FY08

FY09

Revenue

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Pre-tax RoCE (RHS)

Source: Company Ambit Capital research

Exhibit 2: Key financial parameters over the last decade (consolidated)


(Fig in ` mn)

FY07

Revenues

969

Revenue growth (%)

80%

Net profits

FY08
1,358

FY09
1,924

FY10
2,888

FY11
4,113

FY12
5,827

FY13
8,252

FY14
10,796

FY15
14,299

FY16
17,190

40%

42%

50%

42%

42%

42%

31%

32%

20%

91

171

140

277

328

395

610

793

782

1,024

EPS

CFO

29

101

167

245

501

851

648

672

1,170

2,303

CFO (pre-tax)/EBITDA

31%

60%

84%

71%

106%

114%

64%

58%

85%

127%

FCF

(72)

(35)

(316)

68

230

158

(42)

(286)

315

944

Gross debt equity (x)

0.4

0.4

0.4

0.4

0.3

0.5

0.4

0.5

0.3

0.3

RoE (%)

13%

23%

16%

26%

25%

24%

29%

28%

17%

15%

ROCE* (%)

14%

21%

17%

26%

26%

31%

32%

33%

20%

18%

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator;

Exhibit 3: The key things to note from evolution


Time period

Phase

Key developments

Established relationships with real-estate developers such as Rohan Lifescapes and Hiranandani and hotels in
Mumbai and Bangalore, which was the first proof of acceptance of CPVC pipes

FY03-07

Product
Establishment

Expanded product portfolio through launch of lead-free PVC pipes


Began plumber training and certifications aggressively to build brand recall with the intermediaries
Set-up a fitting manufacturing capacity in Baddi, HP, which was a significant step towards increasing revenue
scale and improving financial performance

FY08-12

FY13-17

Scale
ramp-up

Raised `340mn through an IPO and re-invested spare cash flows to increased its capacities 7x in this phase
Enhanced product portfolio through launch of large diameter pipes and sound-proof pipes
Ventured into Kenya through acquisition of a 26% stake in a JV
Incurred significant forex losses due to unhedged forex exposure in FY09, which wiped out 40% of its FY09 PBT
Improved working capital cycle to 48 days in FY12 as against 84 days in FY07
Aggressively started brand building initiatives and hired Salman Khan as the brand ambassador. Brandex
increased at a 50% CAGR in this phase

Expanded in South India and set-up a plant in Hosur in Feb-14. It also shut down its operations in Baddi
Expanded capacities in Gujarat. Installed capacities increased to ~120k tonnes as against 65k tonnes in FY12
Brand building and Acquisitions acquired Resinova in India and Seal-It in UK to establish its adhesive franchise. It raised `3bn
addition of new
segments

through a QIP to fund this acquisition.

Ended ties with Lubrizol for CPVC compound and technology in October 2016; setting up own compounding
facility and partnered with Japans Sekisui Chemical for CPVC resin.

Currently, bringing changes to Resinova (a) product packaging appearance and longevity, (b) go-to-market

strategy channel engagement and product reach, and (c) pricing strategy increasing prices and reducing cash
discounts to distributors; expected to increase branding for the adhesives business

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 108

Astral Poly Technik


Exhibit 4: Competitive mapping of Astral with its plastic piping peers
Company

Capacity
FY16
(tonnes)

FY16
revenue
(in `mn)

Revenue
CAGR
FY10-16

Supreme

4,00,000

23,069

18%

Plants

EBITDA
Margin
(FY16)

Pre-tax
RoCE
(FY16)

Plumbing and Agri

Maharashtra (3), UP (1), WB


(1), MP (2),

14.50%

29%

94%

58%

Gujarat (2), HP (1), TN (1)

11.90%

22%

93%

75%

Karnataka (2)

12.90%

30%

NA

NA

Maharashtra (2), Gujarat (1)

15.20%

29%

83%

28%

Dadra (2), Uttarakhand (1),


Maharashtra (1), Tamil
Nadu (1)

5.70%

11.10%

NA

NA

Plumbing, Agri and


Industrials
Plumbing, Agri and
Ashirvad*
1,08,000
14,002
33%
Industrials
Largely Agri, now
Finolex
2,80,000
17,822
14% getting into
plumbing
Largely Agri, now
Prince*
90,000
9,572
21% getting into
plumbing
Source: Company, Ambit Capital research;*Ashirwad & Prince numbers as of FY15
Astral

1,27,762

12,855

Pre-tax
CFO/ Capex/CFO
EBITDA (FY10-16)
(FY10-16)

Segments

28%

Exhibit 5: Mapping Astral and its peers on IBAS


Brand
Company

Innovation

Rural

Urban

Architecture
Mfg
reach

Dstrbn
reach

Strategic
asset

Overall
rank

Continued innovation in plastic processing with unique


products launches such as Silpaulin. The company has a
strong brand with the plumbers for PVC pipes and
farmers for agri pipes. Unmatched manufacturing and
distribution architecture, with plants at 18 locations.
Innovation in plastic pipes, first through creation of the
CPVC market and then through launches of differentiated
products of global majors in India. Strongest CPVC brand
in India but weak in rural India. Relationship with realestate developers and plumbers for retail pipes form its
unique architecture. Now with Lubrizol relationship
broken, Astrals own brand is the strategic asset which is
helping it maintain recall and also display strong
bargaining power with new CPVC resin supplier
Has not displayed innovation and does not have
differentiated products. A strong agri brand but still not
very strong in urban markets
Launched innovative products such as column pipes and
is now a part of one of the most innovative plastic pipes
company globally - Alliaxis. A strong brand, especially in
urban markets. Ashirvad also has relationships with
Lubrizol for raw material supply
No innovation of note in product launches or marketing.
Brand is reasonably strong but largely an institutional
seller
One of the slowest growing pipes companies. Largely an
agri pipe manufacturer but has been losing market share
to more aggressive peers

Supreme
Industries

Astral
PolyTechnik

Finolex
Industries
Ashirvad
Pipes

Prince
Jain
Irrigation
Source: Company, Ambit Capital research, Note:

November 17, 2016

Comments

- Strong;

- Relatively Strong;

- Average;

Ambit Capital Pvt. Ltd.

- Relatively weak.

Page 109

Astral Poly Technik


Exhibit 6: CFO and equity were the primary sources of
funds

Exhibit 7: Continuous capacity expansion and recent


acquisitions to build upon brand were the main uses
Dividend
paid, 3%

Net change
in cash, 5%

Interest
recd, 1%

Net
borrowings
, 11%

Interest
paid, 12%
Capex,
51%

Equity
raises,
29%

CFO, 59%

Investments
in sub/JV,
29%

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 8: After a strong re-rating valuations have


corrected as the company absorbs the new acquisitions

Exhibit 9: Astrals share price performance vs Sensex

70
60
50
40
30
20
10
0

6,000
5,000
4,000
3,000
2,000

1-year forward P/E (x)

6 yr avg P/E

Source: Company, Ambit Capital research

Astral

Mar-16

Jun-15

Sep-14

Dec-13

Mar-13

Jun-12

Sep-11

Dec-10

Mar-10

Jun-09

Sep-08

Dec-07

0
Mar-07

Nov-16

May-16

Nov-15

May-15

Nov-14

May-14

Nov-13

May-13

Nov-12

May-12

Nov-11

May-11

Nov-10

1,000

Sensex index

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our flags


Segment

Score

Comments

Accounting

GREEN

Astral falls in the top most decile (D1) in Ambits accounting framework; the companys (a) high cash yield (9%),
(b) low contingent liabilities as a % of net worth (1%), (c) negligible misc. expenses as a % of total revenues, and
(d) low volatility in non-operating income stand out.

Predictability

GREEN

Largely a predictable business. Management has been providing good indication of the progress of the business.
Excepting the sales of newly acquired Seal IT and Kenyan operations operating metrics are fairly predictable

Earnings momentum

AMBER

Consensus EPS downgraded by 4.7% and revenue by 2.5% over the past three months

Source: Ambit Capital research

Exhibit 11: Astrals forensic score evolution

Exhibit 12: Astrals greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 110

Astral Poly Technik


Balance sheet (consolidated)*
(` mn)

FY12

FY13

FY14

FY15

FY16

Shareholders' equity

112

112

112

118

120

Reserves & surpluses

1,728

2,301

3,041

6,069

7,696

Total networth

1,841

2,414

3,153

6,188

7,816

165

132

938

923

1,420

2,026

2,026

15

82

118

177

211

Total liabilities

2,793

3,422

4,698

8,556

10,185

Gross block

2,119

2,808

3,766

4,826

6,159

Net block

1,640

2,150

2,888

3,424

4,364

CWIP

130

120

82

268

165

Cash & Cash equivalents

355

115

10

115

542

Debtors

1,032

1,063

1,451

2,327

2,308

Inventory

1,271

1,505

1,950

2,656

2,804

368

486

554

702

759

Total current assets

2,679

3,057

3,959

5,701

5,896

Current liabilities

1,962

1,944

2,178

3,004

3,626

Minority Interest
Debt
Deferred tax liability

Loans & advances

Provisions
Total current liabilities
Net current assets
Total assets

48

76

67

93

29

2,010

2,020

2,245

3,097

3,654

668

1,037

1,714

2,604

2,241

2,793

3,422

4,698

8,556

10,185

Source: Company, Ambit Capital research; EPS adjusted for stock splits

Income statement (consolidated)*


(` mn)
Net Sales
% growth

FY12

FY13

FY14

FY15

FY16

5,827

8,252

10,796

14,299

17,190

42%

42%

31%

32%

20%

5,000

7,099

9,245

12,616

15,138

EBITDA

827

1,153

1,551

1,683

2,051

% growth

50%

39%

35%

8%

22%

Depreciation

138

181

219

364

423

EBIT

689

971

1,332

1,319

1,628

Interest expenditure

228

192

311

255

305

38

19

24

31

21

Adjusted PBT

500

798

1,045

1,095

1,344

Tax
Adjusted PAT before minority
interest
% growth

105

189

252

313

319

395

610

793

782

1,024

20%

55%

30%

-1%

31%

(4)

(4)

(23)

(10)

395

606

789

759

1,014

7%

7%

7%

5%

6%

Operating expenditure

Non-operating income

Minority Interest
Adjusted PAT after minority
interest
Reported PAT after minority interest
Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 111

Astral Poly Technik


Cashflow statement (consolidated)*
(` mn)

FY12

FY13

FY14

FY15

FY16

Net Profit Before Tax

500

798

1,045

1,095

1,335

Depreciation

138

181

219

364

423

Others

228

199

301

281

328

Tax

(91)

(91)

(229)

(264)

(292)

(Incr) / decr in net working capital


Cash flow from operations
Capex (net)

77

(440)

(665)

(306)

508

851

648

672

1,170

2,303

(696)

(681)

(920)

(854)

(1,359)

(Incr) / decr in investments

(2)

(7)

(2,591)

(696)

Other income (expenditure)

18

16

18

11

12

(680)

(665)

(909)

(3,435)

(2,043)

278

(48)

476

313

(27)

Cash flow from investments


Net borrowings
Issuance/buyback of equity
Interest paid
Dividend paid

2,359

590

(167)

(145)

(309)

(255)

(307)

(29)

(29)

(36)

(47)

(90)

82

(223)

131

2,371

166

253

(240)

(106)

106

426

Cash flow from financing


Net change in cash
Closing cash balance

355

115

10

115

542

Free cash flow

155

(33)

(248)

315

944

FY12

FY13

FY14

FY15

FY16

EBITDA margin (%)

14%

14%

14%

12%

12%

EBIT margin (%)

12%

12%

12%

9%

9%

7%

7%

7%

5%

6%

Source: Company, Ambit Capital research

Ratio analysis (consolidated)*


(` mn)

Net profit (bef min. int.) margin (%)


Dividend payout ratio (%)

6%

5%

5%

6%

5%

Net debt: equity (x)

0.3

0.3

0.4

0.3

0.2

Working capital turnover (x)

8.8

9.7

7.9

6.6

7.1

Gross block turnover (x)

3.3

3.4

3.3

3.3

3.1

RoCE (pre-tax) (%)

31%

32%

33%

20%

18%

RoIC (pre-tax) (%)

32%

34%

33%

20%

18%

RoE (%)

24%

29%

28%

17%

15%

FY12

FY13

FY14

FY15

FY16

EPS after minority interest (`)

3.5

5.4

7.0

6.4

8.4

Diluted EPS (`)

3.5

5.4

7.1

6.6

8.5

Book value per share (`)

16

21

28

52

65

Source: Company, Ambit Capital research

Valuation parameters (consolidated)*


(` mn)

Dividend per share (`)

0.2

0.3

0.3

0.4

0.4

121.6

78.7

60.5

64.7

50.3

P/BV (x)

26.1

19.9

15.2

8.2

6.5

EV/EBITDA (x)

63.6

45.7

33.9

31.3

25.6

EV/EBIT (x)

76.3

54.2

39.5

39.9

32.3

P/E (x)

Source: Company, Ambit Capital research; EPS adjusted for stock splits

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 112

Relaxo Footwears
NOT RATED
RLXF IN EQUITY
Retail

Relaxo has grown at anything but a relaxing pace with FY05-16 revenue
and PAT CAGR of 21% and 37%, respectively. It is a testament to brand
creation; brandex equalled capex since FY11 with ad spends averaging
8% of sales over the decade. The consistency and focus have provided
Relaxo pricing power (13% CAGR; FY05-16) in a value offering without
compromising volume growth (8% CAGR). Segmented brands (Sparx,
Flite, Bahamas, Schoolmate, Boston, etc.) and brand investments as
against distribution (only 250 stores) have driven asset turns (from 2.2x
in FY06 to 2.7x in FY16), driving RoE from 7% in FY06 to 28% in FY16.
Relaxo with an average selling price of `170/pair (just 4% market share
in volumes) could very well be the horse for the long haul. Relaxo trades
at 23x FY18E EPS (consensus), which is at a discount to Bata despite
superior RoCE/ improving brand equity.

Recommendation

Competitive position: MODERATE

Performance

From the humble Hawaii slippers to spring in the step


Relaxo has come a long way from a Hawaii slipper company to creating and
selling brands like Flite, Sparx, Boston and Bahamas. It began brand additions in
FY04 to give discerning customers premiumisation choices. In FY08, it identified
exports as an important market and grew it from `15mn to `300mn in FY15
(stagnant since FY12). In FY12, Relaxo introduced four major brand
ambassadors for four of its brands, which catapulted the brand perception of the
seeming value offering of rubber and rubber lookalike slippers. A point to note
is that unlike other parameters inventory days deteriorated from 67 days in FY10
to 138 days in FY16 partly due to premiumisation (lower turns).
Brand equity extends from customers to distributors
The strategy of premiumisation, consistent branding (8% of sales since FY04)
and brands across different price points (from `140 to `3,000) sets Relaxo apart.
Moreover, the company has demonstrated strong control over manufacturing
costs at its 8 plants by delivering 800bps improvement in EBITDA margins over
FY05-16. The fact that debtor days stand only at 3 weeks (as against 12-week
industry norm) indicate the strength of the brand and willingness of the
distributors to pay in time.

GREEN
AMBER
AMBER

Relaxo Footwear

Sensex

Source: Bloomberg, Ambit Capital research

Relaxos forensic score analysis

Source: Ambit HAWK, Ambit Capital research

Relaxos greatness score analysis

Valuations - Package of brand, value and RoE, yet at a discount!


The stock trades at 23x consensus FY18E EPS, a discount to Bata India (Ambit 29x FY18E EPS) despite superior RoE profile and brand-driven growth strategy as
against Batas distribution-driven strategy (see our report dated 09th Dec 2015).
The large opportunity at the bottom of the pyramid and a decade of brand
investment make Relaxo one of the best positioned companies in the branded
footwear category. FCF generation and maintaining value proposition of brands
such as Sparx are the risks which investors should watch out for.

Sep-16

Aug-16

Jul-16

Jun-16

Mar-16

Jan-16

120
110
100
90
80
70
Feb-16

Relaxo is one of the largest footwear companies in India selling over 129mn
pairs across its brands. It can sustain high growth as it is a leader in the largely
unorganised footwear market (at lower price points) with unique proposition of
value, durability and branding. Moreover, as the company expands its
distribution outside its dominant geographies (North and East), it will gain
market share. The company has room to premiumise its portfolio (realisation per
pair has moved from `36 in FY05 to `132 in FY16) as it adds more offerings
such as Sparx (35% of FY15 revenues) to the portfolio.

Accounting:
Predictability:
Earnings Momentum:

Dec-15

Unique combination of value proposition, quality and branding

`48/US$0.7
`7.2/US$0.1
`401
NA
NA

Flags

Nov-15

Changes to this position: STABLE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

Apr-16

The nimble footed giant

November 17, 2016

May-16

STRATEGY NOTE

Research Analysts
Abhishek Ranganathan, CFA
+91 22 3043 3085
abhishek.r@ambit.co
Mayank Porwal
+91 22 3043 3214
mayank.porwal@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Relaxo Footwears
Exhibit 1: Evolution of Relaxo Footwears The Flite from Hawaii slippers to Sparx and Bahamas

16
14
12

Undertook supply chain


initiatives
Revenue CAGR 19%
Sold 115mn pairs p.a. (avg.)

Catapulting new brands


Revenue CAGR 29%
Sold 83mn pairs p.a. (avg.)

18
The quiet period
Revenue CAGR 12%
Sold 56mn pairs p.a. (avg.)

35%
30%
25%

10

20%

15%

10%

5%

0%

FY05

FY06

FY07

FY08

FY09

FY10

FY11

Revenues (Rs bn) (LHS)

FY12

FY13

FY14

FY15

FY16

RoCE (RHS)

Source: Company, Ambit Capital research Note: RoCE is pre-tax.

Exhibit 2: Key financial parameters over the last decade


(Fig in ` mn)
Revenues
Revenue growth
Net profits
EPS (`)
CFO (post-tax)
CFO (pre-tax)-EBITDA
FCF
Debt equity (x)*
RoE
RoCE*

FY07
2,359
17%
61
1
205
97%
(67)
1.1
13%
16%

FY08
3,057
30%
105
1
306
121%
38
1.1
19%
20%

FY09
4,075
33%
142
1
411
116%
(183)
1.4
21%
22%

FY10
5,537
36%
377
3
719
104%
(206)
1.3
41%
30%

FY11
6,916
25%
268
2
437
72%
(190)
1.3
22%
18%

FY12
8,647
25%
399
3
727
87%
239
1.0
26%
22%

FY13
10,098
17%
448
4
540
68%
(298)
0.9
23%
22%

FY14
12,123
20%
656
5
1,249
104%
538
0.7
27%
26%

FY15
14,808
22%
1,031
9
1,075
72%
(238)
0.6
32%
30%

FY16
17,130
16%
1,203
10
1,594
89%
246
0.5
28%
30%

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator. Debt:equity used is Net debt:equity

Exhibit 3: Relaxos evolution calibrated and thoughtfully executed strategy


Time period Phase

Key developments

FY05-08

FY09-12

The quite period;


new brand
launches

Catapulting new
brands with strong

segmentation

FY13-16

Supply Chain

initiatives and debt

reduction

Production capacity during the period of 0.25 mn pairs from across 6 plants.
Revenues increased at a CAGR of 12% during this period and gross margins increased by 960bps; as a consequence EBIT
margins improved by 360bps.
Sold 56mn pairs per annum on an average during the period wherein realisation per pair increased from `36.2 to 47.6
(CAGR of 10%).
CFO (pre-tax) to EBITDA averaged 105%; net debt equity averaged 0.6.
Launched brand Sparx in 2005 and opened its first retail outlet by the name of Relaxo Retail Shoppe.
Brandex on an average formed 8% of sales and averaged 87% of capex during the period.
Production capacity during the period increased from 0.29mn pairs to 0.38mn pairs across 7 plants.
Own store network - 149
Revenues increased at a CAGR of 29% during this period and gross margins increased by 40bps. EBIT margins improved from
7.8% in FY09 to 11.1% in FY10 and dropped to 8.2% in FY12 due to pressure on raw material prices (natural rubber and
EVA).
Identified exports as an important market and grew it from `15mn to `300mn in FY12
CFO (pre-tax) to EBITDA averaged 95%; net debt equity averaged 0.9.
Sold 83 mn pairs per annum on an average during the period wherein realisation per pair increased from `58.9 to 92.5
(CAGR of 16%).
Brandex on an average formed 8% of sales and averaged 81% of capex during the period.
Production capacity was increased to close to 0.6mn pairs per day during the period across 8 plants.
Own store network - 250
Opened regional warehouses across India to strengthen supply chain management.
Revenues increased at a CAGR of 19% during this period and gross margins increased by 520bps. Raw material prices eased
during the period and as a consequence of the aforementioned and cost rationalisation, EBIT margins improved by 300bps.
Revenues from exports remained stagnant at `300mn per annum during this period as focus shifted to domestic market.
CFO (pre-tax) to EBITDA averaged 82%; net debt equity averaged 0.5.
Signed heavyweight brand ambassadors for Hawaii, Flite and Sparx brands spending ` 800 mn in FY13
Sold close to 115mn pairs per annum on an average during the period wherein realisation per pair increased from `100.4 to
`132.4 (CAGR of 10%).
Launched brand Bahamas in FY15.
Brandex on an average formed 8% of sales and averaged 100% of capex during the period.

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 114

Relaxo Footwears
Exhibit 4: Competitive mapping of Relaxo with other comparables
FY16
revenue

Revenue
CAGR
FY10-16

EBITDA
Margin
(FY16)

Pre-tax
RoCE
(FY16)

Pre-tax CFO/
EBITDA
(FY10-16)

Capex/CFO
(FY10-16)

Mid premium (ASP ` 500)

24,254

14%

11%

18%

91%

92%

Value (ASP ` 170)

17,130

21%

14%

29%

85%

66%

Liberty

Value (ASP ` 450)

4,542

9%

8%

10%

75%

85%

Metro

Premium (ASP ` 1,500)

7,020

24%

18%

46%

79%

59%

Company

Sub-segment
Positioning

Bata
Relaxo

Source: Company, Ambit Capital research. Note: Metro Shoes data is available only till FY15.

Exhibit 5: Mapping Relaxo and its peers on IBAS


Relaxo
Footwears

Metro
shoes

Bata
India

Liberty
shoes

Comments

Innovation is not the key source of competitive advantage in footwear sub-segment.


Innovation at best can be attributed to maintaining product quality and low cost
both of which can be replicated by peers.

While Bata is the oldest brand (in India for 85 years), Relaxo has a legacy of 40
years it started out as a slipper brand. However, as the customer has moved up,
Relaxos product launches and designs have kept pace along with consistent
branding.
Relaxo is one of the few major footwear brands to have created sub-brands at price
points (as low as `150), significantly lower than peers. So much so that original
brands of Relaxo and Hawaii are no longer the core brands and its additions such as
Flite, Sparx etc. have become part of the core brands.
It has backed these brands by consistent advertisement and brand ambassadors.
The aggregate ad spend of `5bn over last decade with consistent messaging of style,
quality and value is Relaxo's valued and strategic asset. Peers such as Bata have
missed this strategy and in contrast have sacrificed volumes in the endeavour to
premiumise.

Innovation

Brands and
reputation

Architecture

Strategic Assets
Overall

Relaxo enjoys strong terms of trade with distributors (a sign of popular brand) as is
evident in 21 debtor days. Similarly, it enjoys creditor days of 52.
Relaxo controls manufacturing (has 8 plants) whereas most peers outsource a
significant portion of their products.
Relaxo is available across 50,000 touch points (higher than Batas 30,000). While
Metro has lower reach its store productivity is lot superior to that of Batas and
hence in our framework scores as well as Bata and Relaxo.

Apart from Bata India, which has access to the know-how and designs of its parent,
there are no major strategic assets for the players.

Relaxo and Metro score highly given brand reputation and strong architecture driven
by distribution reach (Relaxo) and high throughput stores (`20,000 sales per sq ft).

Source: Company, Ambit Capital research

Exhibit 6: Cash generated over the last 10 years

Sale of
investments
1%

Loans taken
21%

Exhibit 7: have been deployed to fund capex and service


interest

Dividend
paid
3%

Purchase of
assets
78%

CFO
78%

Source: Company, Ambit Capital research

November 17, 2016

Interest paid
19%

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 115

Relaxo Footwears
Exhibit 8: Relaxo is trading at a 40% premium to its 5-yr
average P/E

Exhibit 9: Relaxos share price performance v/s Sensex


20,000

70
60

15,000

50
40

10,000

30
20

5,000

10
Oct-15

Oct-14

Oct-13

Oct-12

Oct-11

Oct-10

Oct-09

Oct-08

RLXF

5-yr avg. P/E

Source: Company, Ambit Capital research

Oct-07

Oct-16

Jun-16

Oct-15

Feb-16

Jun-15

Feb-15

Oct-14

Jun-14

Oct-13

Feb-14

Jun-13

Feb-13

Oct-12

Jun-12

Oct-11

Feb-12

Relaxo's trailing P/E

Oct-06

SENSEX

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our flags


Segment

Score

Comments

Accounting

GREEN

Relaxo scores well on key accounting parameters like a low contingent liability proportion as a % of networth and
steady auditor remuneration. On Ambits forensic accounting, Relaxo is categorised in the 1st decile of the consumer
discretionary universe (comprising eleven companies).

Predictability

AMBER

The company does not provide any guidance on future estimates.

Earnings momentum

AMBER

Bloomberg shows no significant upgrades/downgrades to consensus numbers in recent weeks.

Source: Ambit Capital research

Exhibit 11: Forensic score evolution

Exhibit 12: Greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 116

Relaxo Footwears
Balance sheet (consolidated)
Year to March (` mn)
Shareholders' equity

FY12

FY13

FY14

FY15

FY16

60

60

60

60

120

Reserves & surpluses

1,664

2,084

2,706

3,618

4,680

Total networth

1,724

2,144

2,766

3,678

4,800

Minority Interest

1,455

2,049

1,627

2,110

2,026

220

241

264

249

270

Total liabilities

3,471

4,525

4,741

6,131

7,251

Gross block

3,785

4,572

5,256

6,678

7,712

Net block

2,713

3,267

3,658

4,717

5,305

202

237

242

21

282

11

30

57

45

24

Debt
Deferred tax liability

CWIP
Cash & Cash equivalents
Debtors

230

360

682

821

1,080

1,285

1,594

1,640

2,487

2,858

134

55

86

141

192

Total current assets

1,693

2,210

2,536

3,552

4,184

Current liabilities

1,133

1,295

1,660

2,060

2,405

Inventory
Loans & advances

Provisions
Total current liabilities
Net current assets
Total assets

142

50

168

221

312

1,276

1,345

1,828

2,281

2,716

417

865

708

1,271

1,468

3,471

4,525

4,741

6,131

7,251

Source: Company, Ambit Capital research.

Income statement
Year to March (` mn)
Net Sales
% growth

FY12

FY13

FY14

FY15

FY16

8,647

10,098

12,123

14,808

17,130

25%

17%

20%

22%

16%

3,112

4,306

5,141

6,344

7,640

EBITDA

943

1,098

1,470

2,009

2,411

% growth

31%

16%

34%

37%

20%

Depreciation

231

255

312

399

471

EBIT

712

843

1,159

1,610

1,940

Interest expenditure

187

177

227

185

229

11

11

23

23

Adjusted PBT

535

677

955

1,426

1,776

Tax
Adjusted PAT before minority
interest
% growth

136

229

299

396

573

399

448

656

1,031

1,203

49%

12%

46%

57%

17%

399

448

656

1,031

1,203

399

448

656

1,031

1,203

Operating expenditure

Non-operating income

Minority Interest
Adjusted PAT after minority
interest
Reported PAT after minority interest
Source: Company, Ambit Capital research.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 117

Relaxo Footwears
Cashflow statement
Year to March (` mn)

FY12

FY13

FY14

FY15

FY16

Net Profit Before Tax

535

677

955

1,426

1,776

Depreciation

231

255

312

399

471

Others

192

176

227

191

192

89

209

276

376

543

(142)

(359)

31

(566)

(302)

727

540

1,249

1,075

1,594

Tax
(Incr) / decr in net working capital
Cash flow from operations
Capex (net)

(471)

(827)

(706)

(1,302)

(1,344)

(Incr) / decr in investments

39

Other income (expenditure)

-470

-825

-697

-1,298

-1,303

(67)

502

(270)

410

(30)

Cash flow from investments


Net borrowings
Issuance/buyback of equity
Interest paid
Dividend paid
Cash flow from financing
Net change in cash
Closing cash balance

(187)

(177)

(227)

(164)

(216)

(14)

(18)

(24)

(30)

(60)

(268)

294

(513)

211

(313)

-11

10

39

-12

-21

11

17

56

44

22

257

-287

543

-227

250

FY12

FY13

FY14

FY15

FY16

11

11

12

14

14

EBIT margin (%)

10

11

11

Net profit (bef min. int.) margin (%)

Dividend payout ratio (%)

Net debt: equity (x)

23

16

15

15

13

Free cash flow


Source: Company, Ambit Capital research.

Ratio analysis
Year to March (%)
EBITDA margin (%)

Working capital turnover (x)


Gross block turnover (x)

RoCE (pre-tax) (%)

21

22

26

30

29

RoCE (post-tax)
RoIC (%) (post-tax)

16
18

15
15

18
19

22
23

20
21

RoE (%)

26

23

27

32

28

FY12

FY13

FY14

FY15

FY16

EPS after minority interest (`)

10

Diluted EPS (`)

10

144

179

46

61

40

122

109

74

47

41

Source: Company, Ambit Capital research.

Valuation parameters
Year to March

Book value per share (`)


Dividend per share (`)
P/E (x)
P/BV (x)

10

EV/EBITDA (x)

53

46

34

25

21

EV/EBIT (x)

71

60

44

32

26

Source: Company, Ambit Capital research.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 118

REPCO Home Finance


NOT RATED
REPCO IN EQUITY

Performance
140
120
100

Repco Home Fin.

Sensex

Source: Bloomberg, Ambit Capital research

Local knowhow and decentralized architecture are key strengths


A well-penetrated and decentralized branch architecture underpins strong local
area knowledge and superior sourcing of low-ticket customers (despite low ticket
sizes, credit costs have been reasonable at ~34bps over the past ten years).
Moreover, Repcos strong positioning in the informal housing finance is also led
by its innovative origination strategy (unlike other HFCs, it avoids sourcing
through DSAs and instead sources only through loan melas and referrals). That
said, a weak credit rating profile relative to its peers implies a weaker liability
franchise, making it susceptible to margin pressure during a liquidity crunch.
Further rerating doubtful due to macro headwinds
A decadal surge in real-estate prices combined with strong local knowhow and
decentralized decision making drove Repcos earnings momentum of 23% CAGR
over FY06-16. Simultaneously, mortgage financers have re-rated over the past 2
years at the cost of corporate lenders due to the latters shaky earnings
trajectory due to asset quality concerns. The combination of such fundamental
and sentimental factors underpins Repcos premium valuations (3.7x 1-year fwd
P/B, in line with peer average). Further re-rating hereon is doubtful as Repco
could find it difficult to sustain its current earnings momentum in light of
declining real estate prices and pressures on the informal economy due to
clampdown on the black economy. Moreover, HFCs are exposed to the looming
regulatory risk of convergence of loan pricing to a more transparent and
objectively calculated base rate (which is followed by banks).

Sep-16

Jul-16

80
Aug-16

Post capital infusion by Carlyle in FY08, Repcos growth was led by strong
growth in home loans (45% CAGR over FY08-12) driven by aggressive branch
expansion (from 25 in FY08 to 73 in FY13). But FY12 onwards, growth in home
loans moderated (26% CAGR over FY12-16) due to regulatory and competitive
headwinds. However, shifting gears to LAP ensured Repcos loan growth and
profitability remained respectable despite moderation. This led to Repco posting
at least 29% AUM CAGR and average RoA of 2.4% over FY12-16 (vs 45% AUM
CAGR and average RoA of 3% over FY06-12) as LAPs share in AUM increased
from 14% to 20% during the period. Growth being higher than RoE implied that
dividend payout ratio remained frugal at ~9% over FY12-16.

GREEN
GREEN
GREEN

Jun-16

Increasing LAP offset declining growth and profitability in home loans

Accounting:
Predictability:
Earnings Momentum:

Apr-16

Set up in 2000, Repco provides housing and LAP loans to the vastly
underpenetrated informal segment (non-salaried; 59% of loan book), with focus
on the four South Indian states (~90% of loan book). With a modest loan book
of ~`80bn, the bulk of it home loans, Repco has delivered ~27% loan book
CAGR of over FY06-16 with average RoE of 21%, making it a promising play on
housing finance to the informal segment in India.

Flags

May-16

Play on the under-penetrated informal segment

`33/US$0.5
`98.9/US$1.5
`532
NA
NA

Feb-16

Changes to this position: NEGATIVE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

Mar-16

Competitive position: MODERATE

Recommendation

Jan-16

Repcos decade-long earnings momentum (23% EPS CAGR, 26% AUM


CAGR, and average RoE of 22% over FY06-16) are underpinned by a
decadal rally in real estate prices and its strong positioning in the
informal segment. Its strengths are derived from strong local area
knowledge (validated by low credit costs) and an innovative origination
strategy (avoids sourcing through DSAs unlike other HFCs). Further
rerating of Repcos premium valuations (at 3.7x 1 year fwd P/B) depends
on its ability to further extend its current earnings momentum, which
seems doubtful in the light of declining real estate prices and pressures
on the informal economy.

BFSI

Dec-15

Swimming against the tide

November 17, 2016

Nov-15

STRATEGY NOTE

Research Analysts
Aadesh Mehta, CFA
+91 22 3043 3239
aadesh.mehta@ambit.co
Pankaj Agarwal, CFA
+91 22 3043 3206
pankaj.agarwal@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

REPCO Home Finance


Exhibit 1: Evolution of Repco Repcos growth has moderated as the base effect is now over
Growth moderation
AUM Growth 29%
Avg. RoA 2.4%

The honeymooon period


AUM CAGR 45%
Avg. RoA 3.0%

100
90
80
70
60
50
40
30
20
10
-

30%
25%
20%
15%
10%

FY06

FY07

FY08

FY09

FY10

FY11

AUM (Rs bn)

FY12

FY13

FY14

FY15

FY16

RoEs (RHS, %)

Source: Company, Ambit Capital research

Exhibit 2: Repco key financial parameters over the last decade


(Fig in ` mn)
Interest Income

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

10.8%

10.9%

12.4%

12.3%

11.9%

12.4%

11.8%

12.1%

12.8%

12.7%

Interest Expense

6.8%

7.1%

7.8%

7.2%

7.1%

8.2%

8.0%

7.6%

8.0%

7.9%

Net Interest Income

4.0%

3.8%

4.5%

5.2%

4.8%

4.2%

3.8%

4.5%

4.8%

4.8%

Non-Interest Income

1.0%

1.0%

0.6%

0.6%

0.7%

0.5%

0.4%

0.5%

0.0%

0.0%

Total Income

5.0%

4.9%

5.1%

5.8%

5.5%

4.7%

4.2%

5.0%

4.8%

4.8%

Operating Expenses

0.9%

1.2%

0.8%

0.7%

0.8%

0.8%

0.7%

0.9%

1.0%

0.9%

Employee Expenses

0.4%

0.4%

0.4%

0.4%

0.4%

0.4%

0.4%

0.5%

0.6%

0.6%

Admin Expenses

0.5%

0.8%

0.4%

0.4%

0.4%

0.3%

0.3%

0.4%

0.4%

0.4%

Pre Provisioning Profit

4.1%

3.7%

4.3%

5.1%

4.6%

3.9%

3.5%

4.0%

3.8%

3.9%

Loan loss provisions

0.3%

0.1%

0.3%

0.3%

0.3%

0.4%

0.3%

0.5%

0.4%

0.6%

Profit Before tax (PBT)

3.9%

3.6%

4.0%

4.8%

4.3%

3.5%

3.2%

3.5%

3.4%

3.3%

Taxes

0.8%

1.0%

1.1%

1.3%

1.2%

0.8%

0.8%

0.9%

1.2%

1.2%

RoA

3.1%

2.6%

2.8%

3.5%

3.2%

2.7%

2.4%

2.6%

2.3%

2.2%

Leverage

9.8

6.6

6.2

7.4

8.3

9.1

7.1

6.2

6.9

7.8

30.1%

17.4%

17.7%

25.7%

26.2%

24.7%

17.1%

16.0%

15.8%

17.0%

AUM growth (%, YoY)

47%

50%

52%

41%

47%

35%

26%

32%

29%

28%

EPS growth (%, YoY)

83%

35%

61%

75%

29%

19%

19%

38%

12%

22%

RoE

Source: Company, Ambit Capital research.

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 120

REPCO Home Finance


Exhibit 3: From a high growth phase of FY06-14, Repco is now going through a steady-state growth phase
Time period

Phase

Key developments
Repcos robust growth (45% CAGR) during this period was driven by both increasing customer acquisition (due to benign
competition in the small ticket segment and rapid branch expansion from 25 in FY08 to 73 in FY13) and increasing ticket
size per loan (due to rapid increase in real estate prices).
Such growth was supported by ~`1.1bn investment by Carlyle for a 49% stake in 2007. Such capital infusion helped
Repco to further scale up their growth quickly.
Regulatory and competitive environment remained benign in the relevant sub-segment Repco was operating.
Consequently both growth and profitability remained high during this period (AUM CAGR of 45% and RoA of 3%). Homeloans was the key growth and profitability driver, growing at 46% CAGR during this time period and accounting for 86% of
the AUM mix in FY12.

The
honeymoon
period

FY06-12

Regulatory headwinds emerged FY11 onwards such as introduction of base rate system (which led to increasing cost of
funds) and removal of prepayment penalties (leading to higher churn in the loan book and reduction in fee-income).
Moreover, during this period, HFCs have seen hyper-competition from banks in home loans due to: i) lack of any
opportunities in corporate loans due to slowdown; and ii) regulators incentivising affordable housing in FY15 by reduction
of risk weights and exemption on SLR/CRR and PSL requirements. Decline in real estate prices have also let to moderation
in ticket size growth (which used to drive 50-60% of growth of HFCs).
Consequently Repcos growth in the key segment of home loans moderated to 26% CAGR over FY12-16 versus 46%
CAGR in FY06-12. However, Repco was able to sustain such pressure on profitability and growth by increasing the share
of higher-yielding albeit risky LAP (from 14% in FY12 to 20% in FY16). This somewhat offset the lower profitability from the
business and enabled it to still deliver a respectable RoA of 2.5% during this period.

Growth
moderation

FY12Current

Source: Ambit Capital research.

Exhibit 4: Competitive mapping of HFCs Repcos small-ticket positioning drives its sustainable growth
Avg. ticket
size (` mn)

AUM
(` bn)

AUM CAGR
(FY13-16)

NIMs

Opex/
AUM

Gross
NPA (%)

RoA

RoE

Branches
(#)

Employees
(#)

Repco

1.1

77

29%

4.9%

1.0%

1.30%

2.2%

17.0%

150

619

GRUH

0.5

111

27%

4.2%

0.8%

0.32%

2.3%

31.5%

179

618

HDFC

2.5

2,908

16%

3.1%

0.3%

0.70%

2.4%

21.8%

401

2,196

LICHF

1.2

1,252

17%

2.6%

0.4%

0.45%

1.5%

19.6%

234

1,726

CANFIN

1.7

106

38%

3.1%

0.7%

0.19%

1.6%

19.0%

140

553

DEWAN

1.2

695

24%

3.0%

0.9%

0.93%

0.9%

11.9%

353

2,625

PNBHF

3.7

272

60%

3.8%

1.2%

0.22%

1.4%

17.6%

47

752

Key metrics (FY16)

Source: Company, Ambit Capital research

Exhibit 5: Mapping GRUH and its peers on IBAS


Particulars

GRUH

HDFC

LICHF

REPCO CNFIN

DHFL

PNBHF

Comments

Innovation

Innovation in terms of ability to appraise a non-salaried borrower is


key to gain penetration in the under-served low-income segment.
GRUH scores best in the metric due to its innovative products and
appraisal techniques. GRUHs product innovation is exemplified from
the fact that it structures customised EMIs to match the cash flows of
the low-income borrowers and has flexible repayment plan as per
daily, monthly or yearly amortising. Moreover, GRUH was the first HFC
to introduce a formal credit score methodology for the low-income
category of borrowers. Repco comes closest to GRUH in replicating
this. Moreover Repcos origination strategy is also innovative as it
sources only through loan melas and referrals and avoids sourcing
through DSAs unlike other HFCs.

Brand

Brand for the home loan borrower will depend on the perceived
customer service and the perceived project financing abilities by the
lender. Whilst HFCs score lower than banks on all these metrics, HDFC
enjoys the best brand amongst the HFCs due to superior perception on
the above metrics, followed closely by GRUH. LICHF, CNFIN and
PNBHF also score high due to their PSU parentage.

Architecture

A robust branch network with decentralised decision making is the key


to gain penetration in small ticket housing finance. HDFC with ~400
branches and a decentralised decision making has one of the best
architectures amongst peers, closely followed by DHFL and GRUH.
Whilst REPCO has marginally lower branches than GRUH, it also
scores highly due to a decentralised decision making process.

Strategic asset

Support of the parent, strong credit rating and a granular retail deposit
franchise are the key strategic assets for HFCs in times of liquidity
crunch. LICHF is best placed in this metric due to strong support from
its parent on the above mentioned metrics.

Overall rank

GRUH comes out as one the strongest HFCs versus its peers due to its
strengths in innovation, brand, architecture and strategic assets.

Source: Company, Ambit Capital research Note:

November 17, 2016

- Strong;

- Relatively Strong;

- Average;

Ambit Capital Pvt. Ltd.

- Relatively weak.

Page 121

REPCO Home Finance


Exhibit 6: Repco has delivered a robust loan book growth

AUM mix (%)

70%
60%

Exhibit 7: Increasing share of LAP has sustained growth


100%

57%
47%

50%

47%
35%

40%

26%

30%
20%

14%

16%

15%

14%

15%

19%

19%

20%

84%

85%

86%

85%

81%

81%

80%

FY10

FY11

FY12

FY13

FY14

FY15

FY16

80%

32%

29%
31%
28%

27%

60%
40%

12%

10%

20%

0%
FY11

FY12

FY13

FY14

Disbursements growth

FY15

FY16

0%

AUM growth

Mortgages

LAP

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 8: Repcos liability mix is tilted towards banks

Exhibit 9: Repcos asset quality has remained in control


1.3% 1.3%

0.6%

0.6%
0.3% 0.3% 0.3%

0.4%

0.4%

0.3%

Gross NPA (%)

FY16

FY15

NCDs

FY14

0.1%

FY13

72%

1.5% 1.5%

1.0%

FY08

Repco Bank

1.4%

FY12

Banks

1.2% 1.2%

FY11

14%

1.3%

FY10

6%

1.6%
1.4%
1.2%
1.0%
0.8%
0.6%
0.4%
0.2%
0.0%

FY09

8%

NHB
Refinancing

Credit Costs as a % of AUM

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 10: Repco is trading in line with its cross-cycle


average P/B

Exhibit 11: Repco share price performance versus sensex

5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0

600
500
400
300
200
100

+1 SD

SENSEX

Oct-16

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jan-15

Jul-14

Oct-14

Apr-14

Jan-14

Oct-13

Jul-13

Sep-16

Jun-16

Source: Bloomberg, Ambit Capital research

Mar-16

-1 SD

Dec-15

Sep-15

Avg. PB

Jun-15

Mar-15

Dec-14

Sep-14

Jun-14

Mar-14

Dec-13

Sep-13

Jun-13

PB

Apr-13

REPCO

Source: Bloomberg, Ambit Capital research

Exhibit 12: Explanation for our flags


Segment

Score

Accounting

GREEN

Predictability

GREEN

Earnings momentum

GREEN

Comments
Repcos revenue and expense recognition policies are by far the most conservative amongst the peers. We do not
come across any instance wherein the reported profitability of the company is materially different from its true
profitability.
Repcos earnings trajectory has been fairly predictable. It has delivered earnings growth of 16%+ for at least past
13 quarters.
Repcos recent earnings growth (20%+) has sustained at FY12-16 run-rate of 22% CAGR over FY12-16.

Source: Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 122

REPCO Home Finance


Income statement
Year to March (` mn)
NII (inclu. Securitisation)

FY12

FY13

FY14

FY15

FY16

1,033

1,255

1,909

2,604

3,327

Other income

128

147

198

12

Total income

1,161

1,402

2,106

2,612

3,339

Operating expenditure

191

242

388

547

642

Pre-provisioning profit

970

1,160

1,718

2,065

2,698

94

92

227

204

393

Profit before tax

875

1,068

1,491

1,861

2,304

Tax

201

268

390

632

800

Consol. PAT

674

801

1,101

1,229

1,505

Provisions

Source: Company, Ambit Capital research

Balance sheet
Year to March (` mn)

FY12

FY13

FY14

FY15

FY16

3,032

6,345

7,411

8,121

9,548

25,102

30,645

39,020

51,044

65,379

Net-worth
Borrowings - on balance
sheet
Borrowings - off balance
sheet
Total liabilities

28,134

36,990

46,431

59,165

74,927

AUM

28,022

35,447

46,619

60,129

76,912

175

2,101

219

175

200

Cash and equivalents


Net Current Assets
Total assets

(143)

(639)

(531)

(1,263)

(2,309)

28,134

36,990

46,431

59,165

74,927

Source: Company, Ambit Capital research

Key ratios
Year to March (` mn)

FY12

FY13

FY14

FY15

FY16

NIM % (on AUM)

4.2%

4.0%

4.7%

4.9%

4.9%

AUM Growth

35%

26%

32%

29%

28%

Opex as % of AAUM

0.78%

0.74%

0.93%

1.04%

0.96%

Credit costs as a % of AUM

0.39%

0.29%

0.55%

0.38%

0.57%

CAR (%)

16.5%

25.5%

25.5%

25.5%

20.7%

Source: Company, Ambit Capital research

Valuation parameters
Year to March (` mn)

FY12

FY13

FY14

FY15

FY16

Dil EPS Consol (`)

13.2

17.1

17.6

19.7

24.1

BVPS (`.)

66

102

119

130

153

ROA (%)

2.7%

2.4%

2.6%

2.3%

2.2%

ROE (%)

24.7%

17.1%

16.0%

15.8%

17.0%

P/B (x)

8.1

5.2

4.5

4.1

3.5

P/E (x)

40.3

31.2

30.2

27.0

22.1

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 123

REPCO Home Finance

This page has been intentionally left blank

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 124

Cera Sanitaryware
NOT RATED
CRS IN EQUITY

Accounting:
Predictability:
Earnings Momentum:

GREEN
GREEN
AMBER

Performance
160
140
120
100

Cera Sanitary.

Source: Bloomberg, Ambit Capital research

A decade back, Cera was 1/3rd the size of main peer HSIL; by FY16, it was
~90% of HSILs revenues and a lot more profitable (21.6% RoE vs 8.6% for
latter). Ceras secret sauce: (a) focus on gradually growing scale and segments
(lifestyle products, faucets, tiles) alongside maintaining strong balance sheet
(D/E within 1x in the last decade though capacity tripled); (b) significant
spending on brand (one of highest in building material space); (c) controlled
overheads; (d) expanding distribution. Faucets are 1.3x sanitaryware market size
at `52bn-55bn with 40% organised vs 60% in the case of sanitary ware.

Ceras forensic score analysis

Cera has launched several differentiated products like twin-flush and 4-litre WC
ahead of competition. Higher brandex than most peers has helped CERA
increase premium sales mix to ~40% of sales. It has the second-largest
sanitaryware manufacturing capacity (3mn units), strongest distribution network,
and a team of 200 in-house technicians for after-service. It is the only frontline
ceramic manufacturer with access to administered gas (30% cheaper than spot
gas) for ~30% of its production, which is a unique strategic asset.
Sustenance of rich valuations require a lot playing out in Ceras favor
Cera trades at 22x FY18 EPS, a marginal discount to Kajaria and at a premium
to Somany. Whilst Cera deserves credit for disciplined growth and good capital
allocation over the last decade, future free cash flows will depend on: (a) ability
to garner further market share, (b) reduce working capital intensity (78 days
now); and (c) discipline in deployment of capital in the tiles segment. Both of the
above could be difficult given aggressive expansions by competitors which make
us less comfortable on Cera given it rich valuations.

Sep-16

Jul-16

Sensex

A disciplined approach to usurp competition

Strong brand and low-cost manufacturing are key advantages

Aug-16

Jun-16

80
Apr-16

In the last decade Indian sanitaryware industry expanded at ~12% CAGR and
Cera posted 27% CAGR. Whilst poor sanitation quality/penetration in India
leaves ample scope for top brands to grow, our key concerns are: (a) market is
relatively small (`40bn vs `240bn for tiles), (b) organized players have sizable
market share (~60%); (c) new entrants (tile players, global majors); hence,
limited market share gains for Cera in future. Though tiles may get Cera
incremental sales, it is hard for Cera to build significant market share in this
segment; globally, we have not seen any sanitaryware brand succeed in tiles.

Flags

May-16

Can rising competition clog Ceras wheels?

`29/US$0.4
`54.7/US$0.8
`2,193
n.a.
n.a.

Feb-16

Changes to this position: STABLE

Mcap (bn):
3M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

Mar-16

Competitive position: MODERATE

Recommendation

Jan-16

Cera ranks second in scale but is the best-run Indian sanitaryware


company; it posted 27%/25% revenue/EBITDA CAGR and 24% median
RoE over FY07-16, significantly beating closest peer HSIL and tiles
players. Continuous capacity additions (first in sanitaryware, then faucets
and now tiles) and industry leading brandex (~4% of sales; FY05-16) led
to high growth and made it a Superbrand. Despite stellar history, our
concern emanates from rising competition in sanitaryware/faucets from
domestic tile manufacturers in low-mid range and global majors in
premium category. Stock isnt cheap at 22x FY18 EPS and value creation
depends on ability to: (a) improve working capital intensity (78 days,
highest among building materials) and gross block intensity (plateaued
at 3.1X); (b) gain market share (seems difficult, hence entry into new
segments); and (c) bring in further operating efficiencies.

Building Materials

Dec-15

A super-efficient Superbrand

November 17, 2016

Nov-15

STRATEGY NOTE

Source: Ambit HAWK, Ambit Capital research

Ceras greatness score analysis

Source: Ambit HAWK, Ambit Capital research

Research Analysts
Nitin Bhasin
+91 22 3043 3241
nitin.bhasin@ambit.co
Girisha Saraf
+91 22 3043 3211
girisha.saraf@ambit.co

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Cera Sanitaryware
Exhibit 1: Evolution of Cera Sanitaryware

1,000
900
800
700
600
500
400
300
200
100
-

Setting the base:


Sales CAGR: 26%
RoCE: 19%

Building premium brand:


Sales CAGR: 26%
RoCE: 31%

Product extensions:
Sales CAGR: 26%
RoCE: 27%

35%
30%
25%
20%
15%
10%
5%
0%

FY07

FY08

FY09

FY10

FY11

FY12

Revenues Rsbn (LHS)

FY13

FY14

FY15

FY16

RoCE pre-tax (%)

Source: Company, Ambit Capital research (RoCE for the above purpose implies Median RoCE for that period)

Exhibit 2: Key financial parameters over the last decade


(Fig in ` mn)
Revenues
Revenue growth (%)
Net profits
EPS

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

1,067

1,281

1,595

1,914

2,430

3,194

4,879

6,637

8,217

9,337

33%

20%

25%

20%

27%

31%

53%

36%

24%

14%

91

101

147

196

265

320

462

519

677

835

10

15

21

25

37

41

52

64

CFO

124

134

215

255

295

78

424

634

406

1,138

CFO (pre-tax)/ EBITDA

85%

79%

87%

97%

93%

44%

83%

91%

60%

102%

FCF

(98)

(86)

171

228

79

(166)

44

235

(426)

248

Gross debt/equity (x)

0.6

0.7

0.5

0.3

0.3

0.3

0.3

0.2

0.2

0.2

RoE (%)

19%

19%

23%

25%

27%

26%

29%

26%

24%

22%

ROCE* (%)

19%

19%

22%

26%

30%

29%

33%

32%

29%

27%

Source: Company, Ambit Capital research. Note: *This is pre-tax RoCE which includes interest and dividend income along with EBIT in the numerator and total
capital including cash in the denominator.

Exhibit 3: The key things to note from evolution


Time period

FY05-08

Phase

Key developments

Setting the
base

In this phase, the company was much smaller than the leader HSIL. To plug the gap, the company added
capacities (to 24,000 MT in FY08as against 16,000MT in FY05) and started expanding its distribution
Initial stages of building brand through adding Cera Bath studios (display centres)
Improved plant level efficiencies (leading to 20% increase in production) and also increased capacity of its
power capacities by installing a 1.25MW wind turbine generator in Gujarat
Increased manufacturing capacity by 33% to 2.7mn pieces in FY11. Also, tied up with Italian wellness major
Novellini, SPA for launching premium wellness products in India

FY08-12

FY13-17

Product
extensions

Building
premium
brand

Established a faucetware unit in FY11 to extend its products beyond sanitaryware. It further expanded its
product portfolio by adding kitchen sinks, mirrors and sensor products to its range under Bathware
Began plumber and architect influencing programmes, through adding sales manpower to build its
intermediary connect
Debt/Equity receded to 0.34x in FY12 as against 0.68x in FY08
Aggressively stared investing in the brand hired Bollywood celebrities (Sonam Kapoor and Dia Mirza) as
brand ambassadors.
Entered into the tiles business, first through outsourcing and has recently entered into a JV with Anjani Tiles in
Hyderabad. The tiles segment accounts for 13% of Cera revenue currently. The company also plans to enter
into a JV in Rajasthan
The company trebled its faucetware capacity to 2.34mn pieces in FY15. This segment now accounts for 20% of
the companys overall revenue
D/E reduced to 0.16x in FY16 as against 0.34x in FY13. The company also raised `700mn from Lighthouse
capital for capacity expansions
Entered the luxury sanitary ware segment through exclusive tie up with Italian luxury designer sanitary ware
brand, ISVEA, to market their luxury range of sanitary ware in India

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 126

Cera Sanitaryware
Exhibit 4: Competitive mapping
Sub-segment
Positioning

Company

FY16
revenue

CAGR
FY10-16

Industry
market share

EBITDA
Margin
(FY16)

Pre-tax
RoCE
(FY16)

Pre-tax CFO/
EBITDA
(FY10-16)

Capex/CFO
(FY10-16)

Kajaria

#1

23,073

18%

~10%

19%

37%

89%

81%

Somany

#2

14,975

31%

~7%

7%

20%

87%

94%

Berger

#2

14,010

33%

~20%

14%

33%

102%

50%

Astral

#2

16,938

15%

~7%

12%

16%

97%

71%

Cera

#1

12,000

14%

~23%

15%

29%

83%

74%

Century Ply

#1

11,628

2%

~9%

17%

26%

71%

69%

Source: Company, Ambit Capital research

Exhibit 5: Mapping Cera Sanitaryware and its peers on IBAS


Brand
Company

Innovation

Rural

Urban

Architecture
Mfg
reach

Dstrbn
reach

Strategic Overall
asset
rank

Comments

Kajaria

Ahead of competition in launching and building premium


tile brand (Glazed and Double charged polished vitrified
tiles). It is the only tile Super-brand in India and has the
highest scale, strong distribution and is now building a
professional management team

Somany

Somanys has innovated in products and launched


differentiated by launching tiles such as abrasion resistant
VC tiles. It has a strong ceramic brand and has significantly
improved its vitrified brand in the last few years. The
company is the third largest manufacturer and has been
investing in improving distribution. It is still way behind
Kajaria in professionalizing management

Berger

Promoters hands-off approach and flying under the radar


differentiates Berger from most other paint manufacturers.
Aggressive sub-brand creation such as Silk and Illusions.
Unique employee work culture which empowers and helps
improve execution. Widest network of manufacturing
locations 9 across the country

Astral

Innovation in plastic pipes, first through creation of the


CPVC market and then through launches of differentiated
products of global majors in India. Strongest CPVC brand
in India but weak in rural India. Relationships with Lubrizol
for raw materials and real-estate developers and plumbers
for retail pipes are it's unique architecture

Cera

Innovation in limited to a few products. It has a midsegment brand recall and manufacturing is centred on a
single location. Its unique advantage is the access to
administered gas, which is 30% cheaper than spot gas.

HSIL

We do not note any major innovation by HSIL which set it


apart from competition. The company has a strong brand
and manufacturing capability. We dont notice any unique
strategic assets which competitors do not enjoy.

Century Ply

Century has not displayed any major product innovation. It


is the most premium ply brand in India and has a wide
spread manufacturing reach (seven plants in India) and is
strengthening distribution to reach micro-markets. Access
to face veneer from Myanmar and Laos through its own
capacities, is its unique strategic asset.

Source: Company, Ambit Capital research, Note:

November 17, 2016

- Strong;

- Relatively Strong;

- Average;

Ambit Capital Pvt. Ltd.

- Relatively weak.

Page 127

Cera Sanitaryware
Exhibit 6: Mostly CFO and a small equity issuance were the
key sources (`4.7bn)
Net
borrowings
, 8%

Exhibit 7: Funds were mostly expended on capex (`3.5bn)

Interest
recd, 3%

Dividend
paid, 7%

Interest
paid, 8%
Investments
, 9%

Equity
issuance,
19%

Capex,
65%

Net
increase in
cash, 11%

CFO, 70%

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

Exhibit 8: Strengthening of franchise and high earnings


growth led to sharp re-rating

Exhibit 9: Ceras

40
30
20
10

1-year forward P/E (x)


Source: Company, Ambit Capital research

Nov-16

May-16

Nov-15

May-15

Nov-14

May-14

Nov-13

May-13

Nov-12

May-12

Nov-11

May-11

Nov-10

price

performance

vs

Sensex

4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
Nov-07
May-08
Nov-08
May-09
Nov-09
May-10
Nov-10
May-11
Nov-11
May-12
Nov-12
May-13
Nov-13
May-14
Nov-14
May-15
Nov-15
May-16
Nov-16

50

share

6 yr avg P/E

Cera

Sensex index

Source: Company, Ambit Capital research

Exhibit 10: Explanation for our flags


Segment

Score

Accounting

GREEN

Predictability

GREEN

Earnings momentum

AMBER

Comments
Cera falls into the 5th decile on the HAWK framework; in FY14 the forensic score evolved to zone of safety from
zone of pain. Whilst the company does well in terms of (a) low contingent liability as % of net worth (at 3%), (b)
low volatility in depreciation rate, (c) reasonable auditors remuneration and (d) low volatility in non-operating
income; we would like to flag that the company (a) does not provide for doubtful debts, and (b) has high
miscellaneous expenses as % of total revenue (at 3.6%).
Largely the business is fairly predictable excepting the demand related issues emanating from category specific
issues or overall discretionary consumption spending. Management has not surprised on guidance and discussed
business progress in detail at regular intervals
Bloomberg shows no significant upgrades/downgrades to consensus numbers in recent weeks.

Source: Ambit Capital research

Exhibit 11: Forensic score evolution

Exhibit 12: Greatness score evolution

Source: Ambit HAWK, Ambit Capital research

Source: Ambit HAWK, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 128

Cera Sanitaryware
Balance sheet (consolidated* in FY16)
(` mn)

FY12

FY13

FY14

FY15

FY16

Shareholders' equity

63

63

63

65

65

Reserves & surpluses

1,329

1,732

2,176

3,452

4,145

Total networth

1,392

1,795

2,240

3,517

4,210

164

Debt

476

610

483

682

667

Deferred tax liability

136

162

202

278

344

Total liabilities

2,004

2,568

2,924

4,477

5,384

Gross block

1,324

1,753

2,117

2,879

3,145

Net block

903

1,251

1,517

2,147

2,298

CWIP

109

43

52

77

651

Cash & Cash equivalents

313

404

307

295

600

Debtors

455

831

1,066

1,612

1,884

Inventory

918

940

1,046

1,259

1,357

Loans & advances

231

307

418

572

754

Minority Interest

Total current assets

1,923

2,489

2,842

3,741

4,612

Current liabilities

671

897

1,158

1,489

1,962

Provisions

271

332

450

477

689

Total current liabilities

942

1,229

1,608

1,965

2,651

Net current assets

981

1,260

1,234

1,776

1,961

2,004

2,568

2,924

4,477

5,384

Total assets
Source: Company, Ambit Capital research

Income statement (consolidated* in FY16)


(` mn)
Net Sales
% growth

FY12

FY13

FY14

FY15

FY16

3,194

4,879

6,637

8,217

9,337

31%

53%

36%

24%

14%

2,660

4,125

5,688

7,041

7,924

EBITDA

534

753

949

1,175

1,413

% growth

27%

16%

41%

26%

24%

77

94

122

155

163

Operating expenditure

Depreciation
EBIT

525

749

888

1,087

1,349

Interest expenditure

40

71

64

77

55

Non-operating income

68

90

62

66

100

Adjusted PBT

485

678

824

1,009

1,295

Tax
Adjusted PAT before minority
interest
% growth

165

216

305

333

460

320

462

519

677

835

21%

44%

12%

30%

23%

320

462

519

677

835

320

462

519

677

835

Minority Interest
Adjusted PAT after minority
interest
Reported PAT after minority interest
Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 129

Cera Sanitaryware
Cashflow statement (consolidated* in FY16)
(` mn)

FY12

FY13

FY14

FY15

FY16

485

678

824

1,009

1,295

Depreciation

77

94

122

155

163

Others

11

45

38

72

(2)

Tax

(155)

(200)

(233)

(296)

(300)

(Incr) / decr in net working capital

(340)

(194)

(118)

(535)

(18)

78

424

634

406

1,138

Net Profit Before Tax

Cash flow from operations


Capex (net)

(244)

(380)

(399)

(832)

(890)

(Incr) / decr in investments

69

(2)

(108)

(356)

17

Other income (expenditure)

25

26

26

15

41

(150)

(356)

(481)

(1,173)

(832)

98

134

(128)

199

(15)

Cash flow from investments


Net borrowings
Issuance/buyback of equity

706

164

Interest paid

(39)

(68)

(63)

(76)

(51)

Dividend paid

(37)

(44)

(59)

(74)

(98)

Cash flow from financing

23

22

(250)

755

(1)

(49)

91

(96)

(12)

305

313

404

307

295

600

(166)

44

235

(426)

248

FY12

FY13

FY14

FY15

FY16

EBITDA margin (%)

16.7%

15.4%

14.3%

14.3%

15.1%

EBIT margin (%)

16.4%

15.4%

13.4%

13.2%

14.5%

Net profit (bef min. int.) margin (%)

10.0%

9.5%

7.8%

8.2%

8.9%

Net change in cash


Closing cash balance
Free cash flow
Source: Company, Ambit Capital research

Ratio analysis (consolidated* in FY16)


(` mn)

Dividend payout ratio (%)

12%

11%

12%

12%

14%

Net debt: equity (x)

0.1

0.1

0.1

0.1

0.0

Working capital turnover (x)

6.3

6.4

7.4

6.8

6.6

Gross block turnover (x)

2.6

3.2

3.4

3.3

3.1

RoCE (pre-tax) (%)

29%

33%

32%

29%

27%

RoIC (pre-tax) (%)

31%

34%

35%

30%

28%

RoE (%)

26%

29%

26%

24%

22%

Source: Company, Ambit Capital research

Valuation parameters (consolidated* in FY16)


(` mn)

FY12

FY13

FY14

FY15

FY16

EPS after minority interest (`)

25.3

36.5

41.0

52.0

64.2

Diluted EPS (`)


Book value per share (`)
Dividend per share (`)

25.3

36.5

41.0

52.0

64.2

110.0

141.9

177.0

270.4

323.7

3.0

4.0

5.0

6.3

9.0

106.4

73.7

65.7

51.8

42.0

P/BV (x)

24.5

19.0

15.2

10.0

8.3

EV/EBITDA (x)

65.7

46.5

36.9

29.8

24.8

EV/EBIT (x)

66.8

46.8

39.5

32.3

26.0

P/E (x)

Source: Company, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

Page 130

Cera Sanitaryware

Appendix 1: How the Coffee Can is


different to our other portfolio constructs
"Forever is a good holding period."
Warren Buffett
Over the years, we have developed various portfolio constructions for investors based
on their outlook. We have summarised these below:
Good and Clean (G&C): We began this portfolio in 2011. The G&C portfolios are
constructed each quarter using: (i) a battery of financial tests based on the previous
fiscal years data; and (ii) our forensic accounting model. Each G&C portfolio typically
runs for a quarter before we revise it. Thus, we believe this portfolio is ideal for
investors aiming to beat benchmarks over the short term. The methodology is:

Within each sector, we first identify firms that do well on our greatness and
accounting frameworks;

We then overlay our macro outlook and valuation filters to identify sectors which
are placed favourably; and

The sector-level champions from step 1 (for the sectors identified in step 2)
constitute our G&C portfolio.

Our G&C portfolio is ideal for


investors
aiming
to
beat
benchmarks over the short term

Please click here for the latest G&C portfolio published on August 29, 2016.
Ten-bagger: We first unveiled this portfolio - built using our greatness framework in January 2012. (See our 19th January 2012 note - Tomorrows ten baggers - for
the framework behind this construct note; click here for the note.) This framework
studies a firms structural strengths by focusing not on absolutes but rather on
improvements over a period of time and the consistency of those improvements.
A basic sketch of the underlying process behind the making of a great firm has been
recaptured in Exhibit below.
Exhibit 13: The greatness framework
a. Investment (gross
block)

The ten-bagger framework studies


a firm's structural strength and
focuses on improvements over a
period of time and the consistency
of those improvements

b. Conversion of
investment to sales (asset
turnover, sales)

c. Pricing discipline (PBIT


margin)

e. Cash generation
(CFO)

d. Balance sheet discipline


(D/E, cash ratio)

Source: Ambit Capital Research

We rank the BSE500 universe of firms (excluding financial services firms and
excluding firms with insufficient data) on our greatness score, which consists of six
equally weighted headings investments, conversion to sales, pricing discipline,
balance sheet discipline, cash generation and EPS improvement, and return ratio
improvement. Under each of these six headings, we further look at two kinds of
improvements:

Percentage improvements in performance over FY13-15 vs FY10-12; and

Consistency in performance over FY10-15 i.e. improvements adjusted for


underlying volatility in financial data
November 17, 2016

Ambit Capital Pvt. Ltd.

Page 131

Cera Sanitaryware
A complete list of factors that are considered whilst quantifying greatness has been
mentioned in Exhibit below.
Exhibit 14: Factors used for quantifying greatness
Head
1 Investments
2 Conversion to sales

3 Pricing discipline
4 Balance sheet discipline

Cash generation and


5
PAT improvement

6 Return ratio improvement

Criteria
a.

Above median gross block increase (FY13-15 over FY10-12)*

b.

Above median gross block increase to standard deviation

a.
b.
c.

Improvement in asset turnover (FY13-15 over FY10-12)*


Positive improvement in asset turnover adjusted for standard
deviation
Above median sales increase (FY13-15 over FY10-12)*

d.

Above median sales increase to standard deviation

a.

Above median PBIT margin increase (FY13-15 over FY10-12)*

b.

Above median PBIT margin increase to standard deviation

a.

Below median debt-equity decline (FY13-15 over FY10-12)*

b.

Below median debt-equity decline to standard deviation

c.

Above median cash ratio increase (FY13-15 over FY10-12)*

d.

Above median cash ratio increase to standard deviation

a.

Above median CFO increase (FY13-15 over FY10-12)*

b.

Above median CFO increase to standard deviation

c.

Above median adj. PAT increase (FY13-15 over FY10-12)*

d.

Above median adj. PAT increase to standard deviation

a.

Improvement in RoE (FY13-15 over FY10-12)*

b.

Positive improvement in RoE adjusted for standard deviation

c.

Improvement in RoCE (FY13-15 over FY10-12)*

d.

Positive improvement in RoCE adjusted for standard deviation

Source: Ambit Capital research; Note: * Rather than comparing one annual endpoint to another annual endpoint
(say, FY10 to FY15), we prefer to average the data out over FY10-12 and compare that to the averaged data
from FY13-15. This gives a more consistent picture of performance (as opposed to simply comparing FY10 to
FY15).

The ten-bagger portfolio focuses on structural plays that are financially strong firms
(with credible management teams) and remain consistent performers on a crosscyclical basis. Companies are identified based on their relentless improvement in
financial performance over long periods of time (usually, six years). This portfolio is
ideal for conventional buy-and-hold investors with a 1-3 year horizon.
Adding the Coffee Can for long-term investors with a ten-year outlook
To this suite of portfolios, we add the Coffee Can which is ideal for long-term
investors with a ten-year outlook. In the table below, we summarise our portfolio
recommendations for investors.
Exhibit 15: Our suite of Portfolios for investors looking to invest in India
Type of Investor

Recommended Ambit
Portfolio

Short-term investor with quarterly


performance focus

Good and Clean Portfolio

Conventional buy-and-hold
investor with 1-3 year horizon

Ten-bagger portfolio

Long-term investor with ten-year


outlook
Source: Ambit Capital Research

November 17, 2016

Coffee Can Portfolio

Returns over recommended time


period
The 16 instalments of our Good &
Clean portfolios over the last five years
have delivered a staggering 4.1% alpha
on a CAGR basis
The five iterations of our ten-bagger
portfolios have generated over 10.2%
alpha on a CAGR basis over the past
five years
Average alpha of 8.3% over seven tenyear iterations using total returns

Ambit Capital Pvt. Ltd.

The Coffee Can Portfolio is ideal


for long-term investors with a tenyear outlook

Page 132

Cera Sanitaryware

Appendix 2: Performance of
back-tested Coffee Can Portfolio

the

14

Period 1: 2000-2010 (6.6% alpha relative to the


Sensex; 22.6% per annum absolute returns)
All-cap portfolio stocks: NIIT, Cipla, Hero MotoCorp, Swaraj Engines, HDFC
Large-cap portfolio stocks: NIIT, Cipla, Hero MotoCorp, HDFC
In the first iteration, both versions of the CCP outperformed the benchmark. Whilst
the all-cap CCP delivered a 22.6% return (6.6% alpha to the Sensex), the large-cap
portfolio delivered a 23.6% return (7.6% alpha to the Sensex). The maximum
drawdown for both the portfolios in this period was also less than the maximum
drawdown for the Sensex.
Exhibit 16: First iteration summary
2000-2010*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

22.6%

23.6%

16.0%

Maximum drawdown**

-35%

-30%

-56%

Excess returns

0.42

0.53

0.14

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2000. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2007 to February 2009 for the all-cap
CCP and Sensex and December 2007 to December 2008 for the large-cap CCP.

The five stocks that constituted the first iteration of the Coffee Can Portfolio consisted
of one IT company, one pharma company, one BFSI company and two companies
from the automobile/auto-ancillary sector. These were NIIT, Cipla, Hero MotoCorp
HDFC Ltd and Swaraj Engines. The star performers during this period were Hero
MotoCorp and HDFC which proved to be a ten-bagger whilst NIIT collapsed ~74% in
this period.
Exhibit 17: Portfolio performance during the first iteration
Value at start
(`)
30-Jun-00

Company
Date from/to

Value at end
(` bn)
30-Jun-10

Total return
CAGR

NIIT

100

26

-13%

Cipla

100

531

18%

Hero MotoCorp

100

1,499

31%

Swaraj Engines

100

493

17%

HDFC

100

1,283

29%

Portfolio

500

3,831

23%

Sensex

100

441

16%

Outperformance

6.6%

Source: Bloomberg, Ambit Capital research. Note: *Portfolio price at start of `500 denotes an equal allocation of
`100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `500 at the start to `3,831 at the end.

Exhibit 18: Hero and HDFC rose exponentially whilst NIIT collapsed in 2000-2010

Hero MotoCorp and HDFC were


the star performers, whilst NIIT was
the laggard in Period 1

5,000
4,000

Swaraj Engines

3,000

Hero Motocorp

2,000

Cipla

1,000

NIIT
HDFC

Value at start

Vaue at end

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `500 at the start to `3,831 at the end.

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Period 2: 2001-2011 (11.7% alpha relative to the


Sensex; 32.2% per annum absolute returns)
All-cap portfolio stocks: Cipla, Hero MotoCorp, Apollo Hospitals, Roofit Inds,
HDFC Ltd and LIC Housing Finance
Large-cap portfolio stocks: Cipla, Hero MotoCorp and HDFC
Both versions of the CCP performed well during the second iteration as well, beating
the Sensex. The all-cap and large-cap CCP gave an impressive alpha of 11.7% and
7.8% respectively for this iteration. The portfolio was remarkably steady as compared
to the maximum drawdown, delivering an excess return of 0.66-0.72x.
Exhibit 19: Second iteration summary
2001-2011*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

32.2%

28.3%

20.5%

Maximum drawdown**

-34%

-31%

-56%

Excess returns

0.72

0.66

0.23

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 29 June 2001. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2007 to November 2008 for the all-cap
CCP and the large-cap CCP and December 2007 to February 2009 for the Sensex.

During the second iteration, the Coffee Can Portfolio consisted of six stocks with three
repeats (Cipla, Hero MotoCorp and HDFC from Period 1) and three new entries
(Apollo Hospitals, Roofit Industries and LIC Housing Finance). During this period, note
that one of the stocks in the portfolio, Roofit Industries, was delisted during 20012011. Despite this, the portfolio performed admirably. The star performer was LIC
Housing Finance that delivered 46.7x returns whilst Cipla was a laggard at 3.0x.
Exhibit 20: Portfolio performance during the second iteration
Value at start
(`)

Value at end
(` bn)

30-Jun-01

30-Jun-11

Cipla

100

396

15%

Hero MotoCorp

100

1,985

35%

Apollo Hospitals

100

1,409

30%

Roofit Inds.

100

-27%

HDFC

100

1,242

29%

LIC Housing Fin.

100

4,767

47%

Portfolio

600

9,802

32%

Sensex

100

646

20%

Company
Date from/to

Total return
CAGR

Outperformance

LIC Housing Finance was the star


performer delivering ~47x total
returns in Period 2

11.7%

Source: Bloomberg, Ambit Capital research. Note: *Portfolio price at start of `600 denotes an equal allocation of
`100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `600 at the start to `9,802 at the end.

Exhibit 21: LIC Housing Finance was the stellar performer during 2001-2011
12,000
LIC Housing Fin.

10,000
8,000

HDFC

6,000

Roofit Inds.

4,000

Apollo Hospitals

2,000

Hero Motocorp

Value at start

Vaue at end

Cipla

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `600 at the start to `9,802 at the end.

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Period 3: 2002-2012 (5.1% alpha to the Sensex; 25.4%


per annum absolute returns)
All-cap portfolio stocks: Infosys, Hero MotoCorp, Cipla, Container Corporation
of India, Gujarat Gas, Aurobindo Pharma, HDFC and LIC Housing Finance
Large-cap portfolio stocks: Infosys, Hero MotoCorp, Cipla, Container
Corporation of India, HDFC
During the third iteration, the Coffee Can delivered an alpha of 5.1% whilst the
large-cap Coffee Can delivered an alpha of 3.3%. Both versions of the Coffee Can
performed well during maximum drawdown as well, delivering excess returns of
0.43x-0.49x.
Exhibit 22: Third iteration summary
2002-2012*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

25.4%

23.7%

20.3%

Maximum drawdown**

-41%

-32%

-56%

Excess returns

0.43

0.49

0.22

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 28 June 2002. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2007 to November 2008 for the all-cap
CCP, December 2007 to December 2008 for the large-cap CCP and December 2007 to February 2009 for the
Sensex.

The number of stocks making it to the 2002 edition of the Coffee Can Portfolio was
much higher than the previous two iterations. A total of eight stocks qualified to be
part of the Coffee Can Portfolio in the third iteration. Cipla, Hero MotoCorp, HDFC
Ltd and LIC Housing were repeated yet again whilst the other four stocks were
Infosys, Container Corporation, Gujarat Gas and Aurobindo Pharma.

LIC Housing Finance continued to


dominate portfolio returns in
period 3

Exhibit 23: Portfolio performance during the third iteration


Value at start
(`)
30-Jun-02

Company
Date from/to

Value at end
(` bn)
30-Jun-12

Total return
CAGR

Infosys

100

706

22%

Hero MotoCorp

100

1,038

26%

Cipla

100

461

16%

Container Corpn.

100

740

22%

Guj Gas Company

100

763

23%

Aurobindo Pharma

100

505

18%

HDFC

100

1,237

29%

LIC Housing Fin.

100

2,260

37%

Portfolio

800

7,709

25%

Sensex

100

637

Outperformance

20%
5.1%

Source: Bloomberg, Ambit Capital research. Note: *Portfolio price at start of `800 denotes an equal allocation of
`100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `800 at the start to `7,709 at the end.

Exhibit 24: Portfolios outperformance was led by LIC Housing Finance once again
LIC Housing Fin.

10,000

HDFC

8,000

Aurobindo Pharma

6,000

Guj Gas Company

4,000

Container Corpn.

2,000

Cipla
Hero Motocorp

Value at start

Vaue at end

Infosys

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `800 at the start to `7,709 at the end.

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Period 4: 2003-2013 (7.2% alpha to the Sensex; 27.4%


per annum absolute returns)
All-cap portfolio stocks: Infosys, Hero MotoCorp, Cipla, Sun Pharma,
Container Corporation of India, Gujarat Gas, Aurobindo Pharma, HDFC, LIC
Housing Finance
Large-cap portfolio stocks: Infosys, Hero
Corporation of India, Sun Pharma and HDFC

MotoCorp,

Cipla,

Container

Whilst the all-cap version of the portfolio delivered a 7.2% alpha, the large-cap
version gave a higher 9% alpha in the fourth iteration. In a maximum drawdown
situation, both versions remained steady and beat the Sensex, delivering excess
returns of 0.62-0.77x.
Exhibit 25: Fourth iteration summary
2003-2013*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

27.4%

29.2%

20.2%

Maximum drawdown**

-31%

-28%

-56%

Excess returns

0.62

0.77

0.22

Sun Pharma powered through to


be the best-performing stock in
Period 4

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2003. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2007 to November 2008 for the all-cap
CCP, December 2007 to December 2008 for the large-cap CCP and December 2007 to February 2009 for the
Sensex.

Barring one addition (Sun Pharma), the Coffee Can Portfolio in its fourth iteration was
the same as that in the third iteration. Performance was driven by Sun Pharmas
stellar performance. However, the performance of the large-cap version was better
than the all-cap version of the Coffee Can Portfolio.
Exhibit 26: Portfolio performance during the fourth iteration
Value at start
(`)
30-Jun-03
100
100
100
100
100
100
100
100
100
900
100

Company
Date from/to
Infosys
Cipla
Hero MotoCorp
Sun Pharma
Container Corpn.
Aurobindo Pharma
Guj Gas Company
HDFC
LIC Housing Fin.
Portfolio
Sensex
Outperformance

Value at end
(` bn)
30-Jun-13
713
710
958
3,381
736
528
518
1,292
1,338
10,175
631

Total return
CAGR
22%
22%
25%
42%
22%
18%
18%
29%
30%
27%
20%
7.2%

Source: Bloomberg, Ambit Capital research. Note: *Portfolio price at start of `900 denotes an equal allocation of
`100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `900 at the start to `10,175 at the end.

Exhibit 27: Sun Pharma delivered a stellar performance in Period 4


12,000
10,000
8,000
6,000
4,000
2,000
Value at start

Vaue at end

LIC Housing Fin.


HDFC
Guj Gas Company
Aurobindo Pharma
Container Corpn.
Sun Pharma.Inds.
Hero Motocorp
Cipla
Infosys

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `900 at the start to `10,175 at the end.

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Period 5: 2004-2014 (12.7% alpha to the Sensex;


32.6% per annum absolute returns)
All-cap portfolio stocks: Infosys, Hero MotoCorp, Cipla, Container Corporation
of India, Gujarat Gas, Alok Industries, Munjal Showa and Havells India,
HDFC and LIC Housing Finance
Large-cap portfolio stocks: Infosys,
Corporation of India and HDFC

Hero

MotoCorp,

Cipla,

Container

The fifth iteration of our Coffee Can Portfolio yielded a whopping 12.7% alpha over
the Sensex. The portfolio was equally divided between large-caps and midcaps/small-caps. The higher share of the mid-caps/small-caps vs earlier iterations
was instrumental in delivering higher alpha during this period.
Exhibit 28: Fifth iteration summary
2004-2014*
CAGR returns
Maximum drawdown**
Excess returns

All-cap CCP
32.6%
-62%
0.40

Large-cap CCP
22.1%
-31%
0.45

Sensex
19.9%
-56%
0.21

The CCP delivered a whopping


12.7% to the Sensex, in Period 5

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2004. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2007 to November 2008 for the all-cap
CCP, December 2007 to December 2008 for the large-cap CCP and December 2007 to February 2009 for the
Sensex.

The performance amongst the mid-cap/small-cap stocks was extreme: Whilst Havells
delivered ~96.7x returns, Alok Industries on the other hand delivered -60% by the
end of the iteration. Given the phenomenal performance by Havells during the
period, the performance of the large-cap portfolio (22.1% CAGR) lagged that of the
all-cap portfolio (32.6% CAGR).
Exhibit 29: Portfolio performance during the fifth iteration
Value at start
(`)
30-Jun-04
100
100
100
100
100
100
100
100
100
100
1,000
100

Company
Date from/to
Infosys
Hero MotoCorp
Cipla
Container Corpn.
Guj Gas Company
Alok Inds.
Munjal Showa
Havells India
HDFC
LIC Housing Fin.
Portfolio
Sensex
Outperformance

Value at end
(` bn)
30-Jun-14
547
710
561
738
1,199
40
627
9,764
1,123
1,540
16,849
616

Total return
CAGR
19%
22%
19%
22%
28%
-9%
20%
58%
27%
31%
33%
20%
12.7%

Extreme price performance among


mid-cap/small-cap
stocks
sets
apart Period 5 from the earlier
iterations of the CCP

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `1000 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `1000 at the start to `16,849 at the end.

Exhibit 30: Havells India was the star performer in Period 5


20,000
15,000
10,000
5,000
Value at start

Vaue at end

LIC Housing Fin.


HDFC
Havells India
Munjal Showa
Alok Inds.
Guj Gas Company
Container Corpn.
Cipla
Hero Motocorp
Infosys

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `1000 at the start to `16,849 at the end.

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Period 6: 2005-2015 (6.0% alpha to the Sensex; 22.1%


per annum absolute returns)
All-cap portfolio stocks: Infosys, Hero MotoCorp, Cipla, Container Corporation
of India, Geometric, Havells India, Ind-Swift, Munjal Showa and HDFC
Large-cap portfolio stocks: Infosys, Hero MotoCorp, Cipla, Container
Corporation of India and HDFC
In the sixth iteration, our Coffee Can Portfolio again outperformed the Sensex with an
alpha of 6.0%. The large-cap version also outperformed the Sensex with an alpha of
3.4%. In this period, while the all-cap version generated a higher alpha than the
large-cap version on an absolute basis, on a risk-adjusted basis, large-cap version
beat all-cap version mainly on account of lower maximum drawdown (excess return
of 0.41x for large cap vs. 0.26x for all cap). Both versions, however, continued to
perform better than Sensex on riskadjusted basis as well.
Exhibit 31: Sixth iteration summary
2005-2015*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

22.1%

19.5%

16.1%

Maximum drawdown**

-54%

-28%

-56%

Excess returns

0.26

0.41

0.15

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2005. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2007 to February 2009 for the all-cap
CCP and Sensex; and from December 2007 to December 2008 for the large-cap CCP.

The extreme price performance among mid-cap/small-cap stocks continued during


this iteration as well: Havells delivered ~30.6x returns whilst Ind-Swift delivered
-92% returns by the end of the iteration.
Exhibit 32: Portfolio performance during the sixth iteration
Value at start
(`)
30-Jun-05
100
100
100
100
100
100
100
100
100
900
100

Company
Date from/to
Infosys
Hero MotoCorp
Cipla
Container Corpn.
Geometric
Havells India
Ind-Swift
Munjal Showa
HDFC
Portfolio
Sensex
Outperformance

Value at end
(` bn)
30-Jun-15
394
607
529
612
121
3,155
8
391
827
6,643
446

Extreme price performance among


mid-cap/small-cap
stocks
continued in period 6

Total return
CAGR
15%
20%
18%
20%
2%
41%
-22%
15%
24%
22%
16%
6.0%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `900 denotes an equal allocation of
`100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `900 at the start to `6,643 at the end.

Exhibit 33: Havells India continued being star performer in sixth iteration as well
7,000

HDFC

6,000

Munjal Showa

5,000

Ind-Swift

4,000

Havells India

3,000

Geometric

2,000

Container Corpn.

1,000

Cipla

Value at start

Vaue at end

Hero Motocorp

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `900 at the start to `6,643 at the end.

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Period 7: 2006-2016 (8.9% alpha to the Sensex; 20.3%


per annum absolute returns)
All-cap portfolio stocks: Infosys, Cipla, Hero MotoCorp, Container Corporation
of India, Geometric, Havells India, Suprajit Engineering, Munjal Showa, HDFC
and HDFC Bank
Large-cap portfolio stocks: Infosys, Hero
Corporation of India, HDFC and HDFC Bank

MotoCorp,

Cipla,

Container

In the seventh iteration, our Coffee Can Portfolio has again outperformed the Sensex
with an alpha of 8.9%. The large-cap version has also outperformed the Sensex with
an alpha of 5.7%. On a risk-adjusted basis, as well, both versions beat the Sensex
with excess return of 0.25-0.28x vs. 0.06x for the Sensex.
Exhibit 34: Seventh iteration summary
2006-2016*
CAGR returns
Maximum drawdown**
Excess returns

All-cap CCP
20.3%
-49%
0.25

Large-cap CCP
17.1%
-33%
0.28

Sensex
11.4%
-56%
0.06

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2006. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2007 to February 2009 for the all-cap
CCP and Sensex; and from December 2007 to November 2008 for the large-cap CCP.

Mid-cap/small-cap stocks again outperformed in this period with Havells and Suprajit
Engineering delivering 13.4x and 11.9x returns respectively.
Exhibit 35: Portfolio performance during the seventh iteration
Value at start
(`)
30-Jun-06
100
100
100
100
100
100
100
100
100
100
1,000
100

Company
Date from/to
Infosys
Cipla
Hero MotoCorp
Container Corpn.
Havells India
Geometric
Munjal Showa
Suprajit Engg.
HDFC
HDFC Bank
Portfolio
Sensex
Outperformance

Value at end
(` bn)
30-Jun-16
361
248
551
342
1,441
296
431
1,291
622
794
6,376
294

Mid-caps
continued
outperformance in the
iteration

their
seventh

Total return
CAGR
14%
10%
19%
13%
31%
11%
16%
29%
20%
23%
20%
11%
8.9%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `1,000 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `1,000 at the start to `6,376 at the end.

Exhibit 36: Mid-caps continued their outperformance in seventh iteration


7,000

HDFC Bank

6,000

HDFC

5,000

Suprajit Engg.

4,000

Munjal Showa
Geometric

3,000

Havells India

2,000

Container Corpn.

1,000

Hero Motocorp
Cipla

Value at start

Vaue at end

Infosys

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `1000 at the start to `6,376 at the end.

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Period 8: 2007-Present (10.8% alpha to the Sensex;


19.5% per annum absolute returns)
All-cap portfolio stocks: Infosys, Wipro, Cipla, Tech Mahindra, Hindalco, Hero
MotoCorp, Container Corporation of India, Asian Paints, Havells India,
Geometric, Aftek, Munjal Showa, Suprajit Engineering, HDFC and HDFC Bank
Large-cap portfolio stocks: Infosys, Wipro, Cipla, Tech Mahindra, Hindalco,
Hero MotoCorp, Container Corporation of India, Asian Paints, HDFD and
HDFC Bank
In the eighth iteration, our Coffee Can Portfolio continued its outperformance versus
the Sensex both on an absolute and risk adjusted basis. The large-cap CCP beat the
all-cap CCP on a risk adjusted basis (0.24x for large cap CCP vs. 0.22x for all-cap
CCP).
Exhibit 37: Eighth iteration summary
2007-2016*

All-cap CCP

Large-cap CCP

CAGR returns

Sensex

19.5%

17.4%

8.8%

Maximum drawdown**

-53%

-39%

-56%

Excess returns

0.22

0.24

0.01

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2007. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2007 to February 2009 for the all-cap
CCP, large-cap CCP and for the Sensex.

In this iteration, amongst large caps, Asian Paints lead the charge with almost 14.9x
returns. Extreme movements were seen in mid-cap stocks again with stocks like
Suprajit Engineering delivering almost 15.4x returns whereas Aftek delivered -96%
returns.

Suprajit Engineering and Asian


Paints have proven to be the star
performers in the eighth iteration
so far

Exhibit 38: Portfolio performance during the eighth iteration


Value at start
(`)

Value at end
(` bn)

30-Jun-07

30-Sep-16

Infosys

100

253

11%

Wipro

100

196

8%

Cipla

100

297

12%

Tech Mahindra

100

131

3%

Hindalco Inds.

100

116

2%

Hero MotoCorp

100

665

23%

Container Corpn.

100

202

8%

Asian Paints

100

1,587

35%

Havells India

100

952

28%

Geometric

100

221

9%

Aftek

100

-30%

Munjal Showa

100

591

21%

Suprajit Engg.

100

1,635

35%

HDFC

100

386

16%

HDFC Bank

100

592

21%

1,500

7,828

20%

100

218

9%

Company
Date from/to

Portfolio
Sensex
Outperformance

Total return
CAGR

10.8%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `1,500 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `1500 at the start to `7,828 until Sep 16.

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Exhibit 39: Suprajit Engineering and Asian Paints have been the star performers in
the eighth iteration
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Value at start

Vaue at end

HDFC Bank
HDFC
Suprajit Engg.
Munjal Showa
Aftek
Geometric
Havells India
Asian Paints
Container Corpn.
Hero Motocorp
Hindalco Inds.
Tech Mahindra
Cipla
Wipro
Infosys

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `1500 at the start to `7,828 until Sep 16.

Period 9: 2008-Present (11.2% alpha to the Sensex;


22.1% per annum absolute returns)
All-cap portfolio stocks: Infosys, Wipro, Cipla, Asian Paints, Tech Mahindra,
Havells India, Automotive Axles, Geometric, HDFC, HDFC Bank and Punjab
National Bank
Large-cap portfolio stocks: Infosys, Wipro, Cipla, Asian Paints,
Mahindra, HDFC, HDFC Bank and Punjab National Bank

Tech

Our ninth iteration that began in June 2008 is also outperforming the Sensex with an
alpha of 11.2%. The large-cap version too continues to beat the Sensex with an alpha
of 8.5%. The large-cap version on account of lower drawdown has the highest risk
adjusted return at 0.30x vs. 0.29x for all-cap version and 0.07x for the Sensex.
Exhibit 40: Ninth iteration summary
2008-2016*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

22.1%

19.3%

10.9%

Maximum drawdown**

-48%

-38%

-39%

Excess returns

0.29

0.30

0.07

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2008. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from July 2008 to February 2009 for the all-cap CCP,
large-cap CCP and for the Sensex.

Both large-caps and mid-caps shared the outperformance during this iteration with
Asian Paints and HDFC Bank delivering 10x and 5.7x returns respectively whilst
Havells India is continuing its dream run with 12.4x returns.

November 17, 2016

Ambit Capital Pvt. Ltd.

Both large-caps as well as midcaps


have
shared
the
outperformance during the ninth
iteration

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Cera Sanitaryware
Exhibit 41: Portfolio performance during the ninth iteration
Value at start
(`)

Value at end
(` bn)

30-Jun-08

30-Sep-16

Infosys

100

277

13%

Wipro

100

228

10%

Cipla

100

290

14%

Asian Paints

100

1,103

34%

Tech Mahindra

100

256

12%

Havells India

100

1,339

37%

Automotive Axles

100

355

17%

Geometric

100

585

24%

HDFC

100

395

18%

HDFC Bank

100

671

26%

Punjab Natl. Bank

100

226

10%

1,100

5,724

22%

100

235

11%

Company
Date from/to

Portfolio
Sensex

Total return
CAGR

Outperformance

11.2%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `1,100 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `1,100 at the start to `5,724 until Sep 16.

Exhibit 42: Large-caps and mid-caps shared outperformance in this iteration


7,000

Punjab Natl.Bank

6,000

HDFC Bank
HDFC

5,000

Geometric

4,000

Automotive Axles
Havells India

3,000

Tech Mahindra

2,000

Asian Paints

1,000

Cipla
Wipro

Value at start

Vaue at end

Infosys

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `1,100 at the start to `5,724 until Sep 16.

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Ambit Capital Pvt. Ltd.

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Period 10: 2009-present (11.5% alpha to the Sensex;


22.7% per annum absolute returns)
All-cap portfolio stocks: Infosys, Wipro, Jindal Steel, Cipla, Asian Paints,
Oracle Financial Services, Tech Mahindra, Motherson Sumi, HDFC, HDFC
Bank and Punjab National Bank
Large-cap portfolio stocks: Infosys, Wipro, Jindal Steel, Cipla, Asian Paints,
Oracle Financial Services, HDFC, HDFC Bank and Punjab National Bank
In the iteration beginning in 2009, both all-cap and large-cap CCP beat the Sensex
comprehensively again with alpha of 11.5% and 7.2% respectively. On a risk adjusted
basis, they gave a stable performance as well with excess returns of 0.56-0.69x.
Exhibit 43: Tenth iteration summary
2009-2016*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

22.7%

18.3%

11.1%

Maximum drawdown**

-21%

-19%

-24%

Excess returns

0.69

0.56

0.13

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2009. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from July 2015 to February 2016 for the all-cap CCP; and
December 2010 to December 2011 for the large-cap CCP and Sensex.

Motherson Sumi has been the star performer in this iteration having delivered
~14.4x returns during this period.
Exhibit 44: Portfolio performance during the tenth iteration
Value at start
(`)
30-Jun-09
100
100
100
100
100
100
100
100
100
100
100
1,100
100

Company
Date from/to
Infosys
Wipro
Jindal Steel
Cipla
Asian Paints
Oracle Fin. Serv.
Tech Mahindra
Motherson Sumi
HDFC Bank
HDFC
Punjab Natl. Bank
Portfolio
Sensex
Outperformance

Value at end
(` bn)
30-Sep-16
266
262
19
239
1,049
317
245
1,544
450
331
121
4,843
215

The returns for the tenth iteration


have largely been dominated by
Motherson Sumi and Asian Paints

Total return
CAGR
14%
14%
-21%
13%
38%
17%
13%
46%
23%
18%
3%
23%
11%
11.5%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `1,100 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `1,100 at the start to `4,843 until Sep 16.

Exhibit 45: Motherson Sumi has been the star performer in this iteration
6,000
5,000
4,000
3,000
2,000
1,000
Value at start

Vaue at end

Punjab Natl.Bank
HDFC
HDFC Bank
Motherson Sumi
Tech Mahindra
Oracle Fin.Serv.
Asian Paints
Cipla
Jindal Steel
Wipro
Infosys

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `1,100 at the start to `4,843 until Sep 16.

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Ambit Capital Pvt. Ltd.

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Period 11: 2010-Present (9.5% alpha to the Sensex;


18.7% per annum absolute returns)
All-cap portfolio stocks: Asian Paints, Amar Remedies, Motherson Sumi, Tulip
Telecom, HDFC Bank, Punjab National Bank and Dewan Housing Finance
Large-cap portfolio stocks: Asian Paints, HDFC Bank and Punjab National
Bank
This iteration of the Coffee Can Portfolio too continues to outperform the Sensex (with
an alpha of 9.5%). The large-cap version beat both the Sensex and the all-cap
version in this iteration with an outperformance of 11.2% and 1.8% respectively.
Exhibit 46: Eleventh iteration summary
2010-2016*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

18.7%

20.4%

9.2%

Maximum drawdown**

-26%

-20%

-24%

Excess returns

0.41

0.62

0.05

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2010. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from October 2010 to August 2013 for the all-cap CCP;
June 2011 to December 2011 for the large-cap CCP and December 2010 to December 2011 for the Sensex.

The performance of the portfolio in this iteration continues to be led by Motherson


Sumi and Asian Paints. In spite of suspension of trading in two of the constituent
stocks through the period (Amar Remedies and Tulip Telecom), the portfolio continues
to deliver a stellar performance with an 18.7% CAGR.

Even in the eleventh iteration


Motherson Sumi and Asian Paints
have dominated the portfolio
returns

Exhibit 47: Portfolio performance during the eleventh iteration


Value at start
(`)
30-Jun-10

Company
Date from/to

Value at end
(` bn)
30-Sep-16

Total return
CAGR

Amar Remedies

100

-33%

Asian Paints

100

534

31%

Motherson Sumi

100

789

39%

Tulip Telecom

100

-53%

HDFC Bank

100

348

22%

Punjab Natl. Bank

100

77

-4%

Dewan Hsg. Fin.

100

284

18%

Portfolio

700

2,042

19%

Sensex

100

173

Outperformance

9%
9.5%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `700 denotes an equal allocation of
`100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `700 at the start to `2,042 until Sep 16.

Exhibit 48: Motherson Sumi and Asian Paints continue to be the star performers in this
iteration
2,500
Dewan Hsg. Fin.

2,000

Punjab Natl.Bank

1,500

HDFC Bank
Tulip Telecom

1,000

Motherson Sumi
Asian Paints

500

Amar Remedies

Value at start

Vaue at end

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `700 at the start to `2,042 until Sep 16.

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Ambit Capital Pvt. Ltd.

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Cera Sanitaryware

Period 12: 2011-present (2.7% alpha to the Sensex;


12.1% per annum absolute returns)
All-cap portfolio stocks: ITC, Asian Paints, Motherson Sumi, Ipca Labs, Tulip
Telecom, Zylog Systems, Pratibha industries, Unity Infra, Amar Remedies,
Setco Automotive, HDFC Bank, Punjab National Bank, Dewan Housing and
City Union Bank
Large-cap portfolio stocks: ITC, Asian Paints, HDFC Bank and Punjab
National Bank
This iteration gave the weakest result in terms of both the absolute performance of
our Coffee Can Portfolio and the alpha generated versus the Sensex. The large-cap
version continued its outperformance in this iteration as well beating both the all-cap
version and the Sensex on both absolute and risk-adjusted return measures.
Exhibit 49: Twelfth iteration summary
2011-2016*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

12.1%

17.0%

9.4%

Maximum drawdown**

-27%

-16%

-21%

Excess returns

0.15

0.57

0.07

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2011. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from April 2012 to August 2013 for the all-cap CCP, July
2011 to December 2011 for the large-cap CCP and February 2015 to February 2016 for the Sensex.

Extreme price performance among mid-cap/small-cap stocks was seen during this
iteration. Motherson Sumi delivered 4.0x returns during this period whilst Zylog
Systems lost 99% of its value.

Extreme
price
performance
amongst small/mid-caps can be
seen in the twelfth iteration

Exhibit 50: Portfolio performance during the twelfth iteration


Value at start
(`)

Value at end
(` bn)

30-Jun-11

30-Sep-16

Total return
CAGR
5.26

ITC

100

196

14%

Asian Paints

100

382

29%

Motherson Sumi

100

505

36%

Ipca Labs.

100

179

12%

Tulip Telecom

100

-59%

Zylog Systems

100

-55%

Pratibha Inds.

100

34

-19%

Unity Infra.

100

18

-28%

Amar Remedies

100

-41%

Setco Automotive

100

222

16%

HDFC Bank

100

263

20%

Punjab Natl. Bank

100

72

-6%

Dewan Hsg. Fin.

100

296

23%

Company
Date from/to

City Union Bank


Portfolio
Sensex

100

375

29%

1,400

2,550

12%

100

161

9%

Outperformance

2.7%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `1,400 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `1,400 at the start to `2,550 until Sep 16.

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Cera Sanitaryware
Exhibit 51: Extreme price performance was seen in mid/small-caps in this iteration
3,000
2,500
2,000
1,500
1,000
500
Value at start

Vaue at end

City Union Bank


Dewan Hsg. Fin.
Punjab Natl.Bank
HDFC Bank
Setco Automotive
Amar Remedies
Unity Infra.
Pratibha Inds.
Zylog Systems
Tulip Telecom
Ipca Labs.
Motherson Sumi
Asian Paints
ITC

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `1,400 at the start to `2,550 until Sep 16.

Period 13: 2012- Present (9.9% alpha to the Sensex;


23.3% per annum absolute returns)
All-cap portfolio stocks: ITC, Asian Paints, Marico, Opto Circuits, Ipca Labs,
Berger Paints, Page Industries, Balkrishna Industries, Grindwell Norton,
Zylog Systems, Tecpro Systems, Pratibha Industries, Astral Poly Technik,
Amar Remedies, Unity Infra, Setco Automotive, HDFC Bank, Axis Bank,
Punjab National Bank, Allahabad Bank, Dewan Housing and City Union
Bank
Large-cap portfolio stocks: ITC, Asian Paints, HDFC Bank, Axis Bank and
Punjab National Bank
In the iteration beginning June 2012, the all-cap version again came to the fore,
beating both the Sensex and the large-cap CCP on both absolute basis and riskadjusted basis.
Exhibit 52: Thirteenth iteration summary
2012-2016*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

23.3%

19.5%

13.4%

Maximum drawdown**

-21%

-23%

-21%

Excess returns

0.72

0.50

0.26

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2012. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2012 to August 2013 for the all-cap CCP,
May 2013 to August 2013 for the large-cap CCP and from February 2015 to February 2016 for the Sensex.

With 22 companies making the cut in this iteration, this was the biggest Coffee Can
Portfolio in terms of number of constituent companies. Astral Poly Technik was the
star performer in this iteration with almost 9x returns. Zylog Systems and Tecpro
Systems, on the other hand, lost almost their entire value with a drop of 99% and
97% respectively.

November 17, 2016

Ambit Capital Pvt. Ltd.

The thirteenth iteration has been


the biggest CCP in terms of number
of stocks in the portfolio

Page 146

Cera Sanitaryware
Exhibit 53: Portfolio performance during the thirteenth iteration
Value at start
(`)

Value at end
(` bn)

30-Jun-12

30-Sep-16

ITC

100

151

10%

Asian Paints

100

310

30%

Marico

100

321

32%

Opto Circuits

100

-45%

Ipca Labs.

100

170

13%

Berger Paints

100

553

50%

Page Industries

100

546

49%

Balkrishna Inds

100

412

40%

Grindwell Norton

100

292

29%

Zylog Systems

100

-67%

Tecpro Systems

100

-57%

Pratibha Inds.

100

39

-20%

Astral Poly

100

991

71%

Amar Remedies

100

-52%

Unity Infra.

100

24

-29%

Setco Automotive

100

162

12%

HDFC Bank

100

233

22%

Axis Bank

100

278

27%

Punjab Natl. Bank

100

94

-1%

Allahabad Bank

100

56

-13%

Dewan Hsg. Fin.

100

391

38%

Company
Date from/to

City Union Bank


Portfolio
Sensex

Total return
CAGR

100

316

31%

2,200

5,356

23%

100

171

13%

Outperformance

9.9%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `2,200 denotes an equal allocation
of `100 in each stock at the start of the period. Thus, for this period, the value of the portfolio rose from `2,200
at the start to `5,356 until Sep 16.

Exhibit 54: Astral Poly Technik outperformed other stocks in this iteration
6,000
5,000
4,000
3,000
2,000
1,000
Value at start

Vaue at end

City Union Bank


Dewan Hsg. Fin.
Allahabad Bank
Punjab Natl.Bank
Axis Bank
HDFC Bank
Setco Automotive
Unity Infra.
Amar Remedies
Astral Poly
Pratibha Inds.
Tecpro Systems
Zylog Systems
Grindwell Norton
Balkrishna Inds
Page Industries
Berger Paints
Ipca Labs.
Opto Circuits
Marico
Asian Paints
ITC

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `2,200 at the start to `5,356 until Sep 16.

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Ambit Capital Pvt. Ltd.

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Period 14: 2013-present (21.4% alpha to the Sensex;


34.8% per annum absolute returns)
All-cap portfolio stocks: ITC, HCL Technologies, Asian Paints, Marico, Berger
Paints, Ipca, Page Industries, Balkrishna Industries, Solar Industries, Astral
Poly Technik, Pratibha Industries, Unity Infra, Sarla Performance Fibers,
HDFC Bank, Axis Bank, Indian Bank, City Union Bank and Dewan Housing
Large-cap portfolio stocks: ITC, HCL Technologies, Asian Paints, Marico, HDFC
Bank, Axis Bank
The June 2013 has given the best results thus far with a whopping return of 34.8% on
a CAGR basis. Sensex over the same period generated a CAGR return of 13.5%,
whereas the large-cap portfolio generated a CAGR return of 26.4%.
Exhibit 55: Fourteenth iteration summary
2013-2016*

All-cap CCP

Large-cap CCP

Sensex

CAGR returns

34.8%

26.4%

13.5%

Maximum drawdown**

-19%

-12%

-21%

Excess returns

1.40

1.53

0.27

Source: Bloomberg, Ambit Capital research. Note: * Portfolio kicks off on 30 June 2013. Excess returns have been
calculated as returns in excess of risk-free rate (assumed to be 8%) divided by absolute maximum drawdown.
Maximum drawdown is defined as the maximum drop in cumulative returns from the highest peak to the lowest
subsequent trough. ** Maximum drawdown took place from December 2015 to February 2016 for the all-cap
CCP, from July 2015 to February 2016 for the large-cap CCP and from February 2015 to February 2016 for the
Sensex.

Mid-cap stocks led the performance of the profile in this iteration with some of the
stocks prices rising 3-4 times since the beginning of this portfolio in June 2013.
These stocks included names like Astral Poly Technik, Balkrishna Industries, Page
Industries, Sarla Performance Fibers and Solar Industries. Unity Infraprojects and
Pratibha Industries on the other hand are amongst stocks that lost value in this
period.

Mid-caps
drove
the
outperformance for the fourteenth
iteration

Exhibit 56: Portfolio performance during the fourteenth iteration


Value at start
(`)
30-Jun-13

Value at end
(` bn)
30-Sep-16

ITC

100

119

5%

HCL Technologies

100

220

27%

Asian Paints

100

257

34%

Marico

100

283

38%

Berger Paints

100

327

44%

Ipca Labs.

100

93

-2%

Page Industries

100

379

51%

Balkrishna Inds

100

506

65%

Solar Inds.

100

360

48%

Astral Poly

100

397

53%

Pratibha Inds.

100

65

-12%

Unity Infra.

100

42

-23%

Sarla Performance

100

467

61%

HDFC Bank

100

195

23%

Axis Bank

100

213

26%

Indian Bank

100

198

23%

City Union Bank

100

248

32%

Company
Date from/to

Dewan Hsg. Fin.


Portfolio
Sensex

Total return
CAGR

100

393

52%

1,800

4,762

35%

100

151

Outperformance

13%
21.4%

Source: Bloomberg, Ambit Capital research. Note: * Portfolio price at start of `1,800 denotes an equal allocation
of `100 in each stock at the start of the period. Portfolio price at end is the value of the portfolio at the end of the
period. Thus, for this period, the value of the portfolio rose from `1,800 at the start to `4,762 until Sep 16.

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Exhibit 57: Mid-caps led the charge in this iteration driving most of the portfolio
returns
6,000
5,000
4,000
3,000
2,000
1,000
Value at start

Vaue at end

Dewan Hsg. Fin.


City Union Bank
Indian Bank
Axis Bank
HDFC Bank
Sarla Performanc
Unity Infra.
Pratibha Inds.
Astral Poly
Solar Inds.
Balkrishna Inds
Page Industries
Ipca Labs.
Berger Paints
Marico
Asian Paints
HCL Technologies
ITC

Source: Bloomberg, Ambit Capital research. Note: Value at start denotes an equal allocation of `100 in each
stock at the start of the period. Value at end is the value of each stock at the end of the period. Thus, for this
period, the value of the portfolio rose from `1,800 at the start to `4,762 until Sep 16.

November 17, 2016

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Cera Sanitaryware

Appendix 3: John Kays IBAS Framework


I dont want an easy business for competitors. I want a business with a moat around it.
I want a very valuable castle in the middle and I want the duke who is in charge of that
castle to be very honest and hardworking and able. Then I want a moat around that
castle. The moat can be various things. The moat around our auto insurance business,
GEICO, is low cost.
Warren Buffett
I always try and spend the last few minutes to touch on a competitor, or a company
they do business with, such as a supplier or a customer. Although not all managements
will talk about other companies, when they do, it can be very revealing. The ultimate
commendation is when a company talks positively about a competitor. I always put a
strong weight on such a view.
Anthony Bolton, the legendary fund manager who ran the Fidelity Special Situations
fund
Sustainable competitive advantages allow firms to add more value than their rivals
and to continue doing so over long periods of time. But where do these competitive
advantages come from? And why is it that certain firms seem to have more of these
advantages than others?

Sustainable
competitive
advantages allow firms to add
value and continue doing so over
long periods

In his 1993 book, Foundations of Corporate Success, John Kay, the British economist
and Financial Times columnist, wrote more comprehensibly and clearly about this
than any other business guru. John states that sustainable competitive advantage is
what helps a firm ensure that the value that it adds cannot be competed away by its
rivals. He goes on to state that sustainable competitive advantages can come from
two sources: distinctive capabilities or strategic assets. Whilst strategic assets can be
in the form of intellectual property (patents and proprietary know-how), legal rights
(licenses and concessions) or a natural monopoly, the distinctive capabilities are more
intangible in nature.
Distinctive capabilities, says Kay, are those relationships that a firm has with its
customers, suppliers or employees, which cannot be replicated by other competing
firms and which allow the firm to generate more value additions than its competitors.
He further divides distinctive capabilities into three categories:

Brands and reputation

Architecture

Innovation

Let us delve into these in more detail, as understanding them is at the core of
understanding the strength of a companys franchise.

John Kays framework focusses on


Innovation,
Brands,
Architecture and Strategic Assets
as
sources
of
sustainable
competitive advantage

Brands and reputation


"A product can be quickly outdated, but a successful brand is timeless."
Stephen King, American novelist, author & TV Producer
In many markets, product quality, in spite of being an important driver of the
purchase decision, can only be ascertained by a long-term experience of using that
product. Examples of such products are insurance policies and healthcare. In many
other markets, the ticket price of the product is high; hence, consumers are only able
to assess the quality of the product only after they have parted with their cash. A few
examples of such products would be cars and high-end TVs.

A product can be quickly


outdated, but a successful brand is
timeless

In both these markets, customers use the strength of the companys reputation as a
proxy for the quality of the product or the service. For example, we gravitate towards
the best hospital in town for critical surgery and we tend to prefer world-class brands
whilst buying expensive home entertainment equipment. Since the reputation for
such high-end services or expensive electronics takes many years to build, reputation
tends to be difficult and costly to create. This in turn makes it a very powerful source
for a competitive advantage.

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For products that we use daily, we tend to be generally aware of the strength of a
firms brand. In more niche products or B2B products (e.g. industrial cables, mining
equipment, municipal water purification, and semiconductors), investors often do not
have first-hand knowledge of the key brands in the relevant market. In such
instances, to assess the strength of the brand, they turn to:

Brand recognition surveys conducted by the trade press.

The length of the warranties offered by the firm (the longer the warranties, the
more unequivocal the statement it makes about the firms brand).

The amount of time the firm has been in that market (e.g. Established 1905 is a
fairly credible way of telling the world that since you have been in business for
over a century, your product must have something distinctive about it).

How much the firm spends on its marketing and publicity (a large marketing
spend figure, relative to the firms revenues, is usually a reassuring sign).
How much of a price premium the firm is able to charge vis-a-vis its peers.

One way to appreciate the power of brands and reputation to generate sustained
profits and, hence, shareholder returns, is to look at how Indias most-trusted brands,
according to an annual Economic Times survey, have fared over the last decade. As
can be seen in the table below, over the past decade, the listed companies with the
most powerful brands have comfortably beaten the most widely acknowledged
frontline stock market index by a comfortable margin on revenues, earnings and
share price movement.
Exhibit 58: Performance of listed companies with the most-trusted brands
#

Company

Trusted Brands*

ColgatePalmolive

Colgate (1)

Hindustan
Unilever

Nestle

4
5

Clinic Plus (4), Lifebuoy


(10), Rin (12), Surf (13),
Lux (14), Ponds, etc
Maggi (9), Nestle Milk
Chocolate (62), etc

GSK
Horlicks (16)
Consumer
Bharti Airtel
Airtel (18)
Average for the listed companies with
the top 5 brands
For the index, Nifty

10-year Growth (FY04-14) (% CAGR)**


Revenues

EPS

Share price***

14

17

27

10

15

15

16

23

15

21

33

33

18

15

18

16

22

12

13

14

Listed companies with the mosttrusted brands have beaten the


benchmark index on revenues,
earnings
and
share
price
performance

Source: Economic Times and Ambit Capital analysis using Bloomberg data. Note: * Figures in brackets indicate
the rank in the 2012 Economic Times brand equity survey to find the 100 most-trusted brands in India. ** The
FY14 data is based on Bloomberg consensus as on 7 April 2014. *** Share price performance has been
measured from Mar-04 to Mar-14

Architecture
A dream you dream alone is only a dream. A dream you dream together is reality.
John Lennon
Architecture refers to the network of contracts, formal and informal, that a firm has
with its employees, suppliers and customers. Thus, architecture would include the
formal employment contracts that a firm has with its employees and it would also
include the more informal obligation it has to provide ongoing training to its
employees. Similarly, architecture would include the firms legal obligation to pay its
suppliers on time and its more informal obligation to warn its suppliers in advance if
it were planning to cut production in three months.

Architecture refers to the network


of contracts, formal and informal,
that a firm has with its employees,
suppliers and customers

Such architecture is most often found in firms with a distinctive organisational style or
ethos, because such firms tend to have a well-organised and long-established set of
processes or routines for doing business. So, for example, if you have ever taken a
home loan in India, you will find a marked difference in the speed and
professionalism with which HDFC processes a home loan application as compared to
other lenders. The HDFC branch manager asks the applicant more specific questions
than other lenders do and this home loan providers due diligence on the applicant
and the property appears to be done more swiftly and thoroughly than most other
lenders in India.
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So, how can an investor assess whether the firm they are scrutinising has architecture
or not? In fact, whilst investors will often not know the exact processes or procedures
of the firm in question, they can assess whether a firm has such processes and
procedures by gauging the:

extent to which the employees of the firm co-operate with each other across
various departments and locations.

rate of staff attrition (sometimes given in the Annual Report).

extent to which the staff in different parts of the firm give the same message
when asked the same question.

extent to which the firm is able to generate innovations in its products or services
or production processes on an ongoing basis.

At the core of successful architecture is co-operation (within teams, across various


teams in a firm and between a firm and its suppliers) and sharing (of ideas,
information, customer insights and, ultimately, rewards). Built properly, architecture
allows a firm with ordinary people to produce extraordinary results.

HDFC and GCMMF are the most


striking
demonstrations
of
architecture in India

Perhaps the most striking demonstration of architecture in India is the unlisted nonprofit agricultural co-operative, Gujarat Cooperative Milk Marketing Federation Ltd
(GCMMF), better known to millions of Indians as Amul.
With its roots stretching back to Indias freedom movement, GCMMF was founded by
the legendary Verghese Kurien in 1973. This farmers co-operative generated
revenues of `137bn (around US$2.1bn) in FY13, thus making it significantly larger
than its main private sector competitor, Nestle (FY13 revenues of `91bn or around
US$1.5bn). Furthermore, GCMMFs revenues have grown over the past five years by
21% as opposed to Nestles 16% over the same period. In fact, GCMMFs revenue
growth is markedly superior to the vast majority of the top Indian brands shown in
exhibit 58.
GCMMFs daily milk procurement of 13 million litres from over 16,000 village milk
co-operative societies (which include 3.2 million milk producer members) has become
legendary. The way GCMMF aggregates the milk produced by over 3 million families
into the village co-operative dairy and then further aggregates that into the district
co-operative which in turn feeds into the mother dairy has been studied by numerous
management experts.
Not only does the GCMMF possess impressive logistical skills, its marketing acumen is
comparable to that of the multinational giants cited in the table shown above: In key
FMCG product categories such as butter, cheese and packaged milk, Amul has been
the longstanding market leader in the face of sustained efforts by the multinationals
to break its dominance. GCMMF is also Indias largest exporter of dairy products.
So how does GCMMF do it? How does it give a fair deal to farmers, its management
team (which includes the alumnus from Indias best business schools), its 5,000
dealers, its 1 million retailers and its hundreds of millions of customers? Although
numerous case studies have been written on GCMMF, at the core of this cooperatives success appears to be: (a) its 50-year old brand with its distinctive
imagery of the little girl in the polka red dotted dress; (b) the idea of a fair deal for
the small farmer and the linked idea of the disintermediation of the unfair middle
man; and (c) the spirit of Indian nationalism in an industry dominated by globe
girdling for-profit corporates.
Innovation
Learning is not compulsory neither is survival.
W Edwards Deming, American statistician, professor, author. The worlds most
famous prize for manufacturing excellence is named after him.
"Innovation distinguishes between a leader and a follower."

November 17, 2016

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Whilst innovation is often talked about as a source of competitive advantage,
especially in the Technology and Pharmaceutical sectors, it is actually the most
tenuous source of sustainable competitive advantage as:

Innovation is expensive.

Innovation is uncertain - the innovation process tends to be a hit or miss.

Innovation is hard to manage due to the random nature of the process.

Whilst
most
talked
about,
Innovation is also the most
tenuous source of sustainable
competitive advantage

Furthermore, even when the expensive innovation process yields a commercially


useful result, the benefits can be competed away, as other firms replicate the
innovator and/or employees who have driven the innovation process tend to extract
the benefits of innovation through higher compensation.
In fact, innovation is more powerful when it is twinned with the two other distinctive
capabilities we have described above reputation and architecture. Apple is the most
celebrated example of a contemporary firm which has clearly built a reputation for
innovation (think of the slew of products from Apple over the past decade which first
changed how we access music, then changed how we perceive our phones and
finally, how we use our personal computers).
Strategic assets
In contrast to the three distinctive capabilities discussed above, strategic assets are
easier to identify as sources of competitive advantages. Such assets can come in
different guises:

Intellectual property i.e. patents or proprietary know-how (e.g. the recipe for
Cokes famous syrup which is a closely held secret and kept in the companys
museum in Atlanta, Georgia);

Licenses and regulatory permissions to provide a certain service to the public,


e.g., telecom, power, gas or public transport;
Access to natural resources such as coal or iron-ore mines;

Political contacts either at the national, state or city level;

Sunk costs incurred by the first mover which result in other potential competitors
deciding to stay away from that market; e.g. given that there already is a
Mumbai-Pune highway operated by IRB, it does not make sense for anyone else
to set up a competing road; and

Natural monopolies i.e. sectors or markets which accommodate only one or two
firms; for example, the market for supplying power in Mumbai is restricted to one
firm, Tata Power.

Whilst strategic assets can come in different forms, all of them result in a lower per
unit cost of production for the firm owning the asset relative to its competitors. For
example, Tata Steels decades-old access to coal and iron-ore from its captive mines
allows it to make more money per tonne of steel produced than any other steel
manufacturer in India. According to Ambit Capitals analysts, on a tonne of steel
produced, Tata Steel earns `45,000 vs `39,000 for SAIL and `38,000 for JSW Steel.

strategic assets on the other


hand are easier to identify

Access to captive coal and iron ore


results in more money per tonne of
steel for Tata Steel vs its
competitors due to lower cost of
production

Unsurprisingly, therefore, among the top-50 companies by market cap in India since
the Nifty was launched in 1995, there is only one conglomerate Tata Sons - which
has had three companies which have been in the index more or less throughout this
period i.e., Tata Power, Tata Steel and Tata Motors.
Upon closer examination, the Tatas are an almost text book case of how to build
businesses which, without being the most innovative players in town, combine
architecture and brands to great effect, thereby creating robust sources of sustainable
competitive advantages. The group seems to have created at least three specific
mechanisms to ensure that these sources of competitive advantage endure:

The
Tatas
have
combined
architecture with brand to create
robust sources of sustainable
competitive advantages

Firstly, Tata Sons, an unlisted company (owned by several philanthropic trusts


endowed by members of the Tata family), is the promoter of the major operating Tata
companies and holds significant shareholdings in these companies. Tata Sons
patient, long-term orientation in terms of building large and robust businesses
gradually has played a major role in the stability of the listed Tata businesses.

November 17, 2016

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Secondly, Tata Quality Management Services (TQMS), a division of Tata Sons, assists
Tata companies in their business excellence initiatives through the Tata Business
Excellence Model, Management of Business Ethics and the Tata Code of
Conduct. TQMS, quite literally, provides the architecture to harmonise practices in
various parts of the Tata empire.
Thirdly, Tata Sons is also the owner of the Tata name and several Tata trademarks,
which are registered in India and around the world. These are used by various Tata
companies under a license from Tata Sons as part of their corporate name and/or in
relation to their products and services. The terms of use of the group mark and logo
by Tata companies are governed by the Brand Equity and Business Promotion
Agreement entered into between Tata Sons and Tata companies.

November 17, 2016

Ambit Capital Pvt. Ltd.

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Institutional Equities Team


Saurabh Mukherjea, CFA
Pramod Gubbi, CFA

CEO, Institutional Equities


Head of Equities

(022) 30433174
(022) 30433124

saurabh.mukherjea@ambit.co
pramod.gubbi@ambit.co

Research Analysts
Name

Industry Sectors

Nitin Bhasin - Head of Research


Aadesh Mehta, CFA
Abhishek Ranganathan, CFA
Anuj Bansal
Aditi Singh
Ashvin Shetty, CFA
Bhargav Buddhadev
Deepesh Agarwal, CFA
Dhiraj Mistry, CFA
Gaurav Khandelwal, CFA
Girisha Saraf
Karan Khanna, CFA
Mayank Porwal
Pankaj Agarwal, CFA
Paresh Dave, CFA
Parita Ashar, CFA
Prashant Mittal, CFA
Rahil Shah
Rakshit Ranjan, CFA
Ravi Singh
Ritesh Gupta, CFA
Ritesh Vaidya, CFA
Ritika Mankar Mukherjee, CFA
Ritu Modi
Sagar Rastogi
Sudheer Guntupalli
Sumit Shekhar
Utsav Mehta, CFA
Vivekanand Subbaraman, CFA

E&C / Infra / Cement / Industrials


Banking / Financial Services
Retail
Mid-caps
Economy / Strategy
Automobile
Power Utilities / Capital Goods
Power Utilities / Capital Goods
Consumer
Automobile
Mid-caps / Small-caps
Strategy
Retail
Banking / Financial Services
Healthcare
Metals & Mining / Aviation
Strategy / Derivatives
Banking / Financial Services
Consumer
Banking / Financial Services
Oil & Gas / Chemicals / Agri Inputs
Consumer
Economy / Strategy
Automobile
Technology
Technology
Economy / Strategy
E&C / Industrials
Media

Desk-Phone
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
(022)
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(022)

30433241
30433239
30433085
30433122
30433284
30433285
30433252
30433275
30433264
30433132
30433211
30433251
30433214
30433206
30433212
30433223
30433218
30433217
30433201
30433181
30433242
30433246
30433175
30433292
30433291
30433203
30433229
30433209
30433261

E-mail
nitin.bhasin@ambit.co
aadesh.mehta@ambit.co
abhishek.r@ambit.co
anuj.bansal@ambit.co
aditi.singh@ambit.co
ashvin.shetty@ambit.co
bhargav.buddhadev@ambit.co
deepesh.agarwal@ambit.co
dhiraj.mistry@ambit.co
gaurav.khandelwal@ambit.co
girisha.saraf@ambit.co
karan.khanna@ambit.co
mayank.porwal@ambit.co
pankaj.agarwal@ambit.co
paresh.dave@ambit.co
parita.ashar@ambit.co
prashant.mittal@ambit.co
rahil.shah@ambit.co
rakshit.ranjan@ambit.co
ravi.singh@ambit.co
ritesh.gupta@ambit.co
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ritika.mankar@ambit.co
ritu.modi@ambit.co
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sudheer.guntupalli@ambit.co
sumit.shekhar@ambit.co
utsav.mehta@ambit.co
vivekanand.s@ambit.co

Sales
Name

Regions

Sarojini Ramachandran - Head of Sales


Dharmen Shah
Dipti Mehta
Krishnan V
Nityam Shah, CFA
Parees Purohit, CFA
Punitraj Mehra, CFA
Shaleen Silori

UK
India / Asia
India
India / Asia
Europe
UK
India / Asia
India

Desk-Phone
+44 (0) 20 7886 2740
(022) 30433289
(022) 30433053
(022) 30433295
(022) 30433259
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(022) 30433256

E-mail
sarojini.r@ambit.co
dharmen.shah@ambit.co
dipti.mehta@ambit.co
krishnanv@ambit.co
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parees.purohit@ambit.co
punitraj.mehra@ambit.co
shaleen.silori@ambit.co

Singapore
Praveena Pattabiraman
Shashank Abhisheik

Singapore
Singapore

+65 6536 0481


+65 6536 1935

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shashankabhisheik@ambitpte.com

USA / Canada
Ravilochan Pola CEO
Hitakshi Mehra

Americas
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Production
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November 17, 2016

Production
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Database

(022)
(022)
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Ambit Capital Pvt. Ltd.

30433247
30433183
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30433273
30433265

sajid.merchant@ambit.co
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Page 155

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Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Jul-16

Oct-14

Jul-14

Jan-14

Oct-13

Apr-15

0
Jan-15

Oct-14

500
Jul-14

100

Oct-13

1,000

Apr-16

200

Jan-16

1,500

Oct-15

300

Jul-15

2,000

Apr-15

400

Jan-15

2,500

Apr-14

500

Apr-14

Lupin Ltd (LPC IN, BUY)

Jan-14

Cadila Healthcare Ltd (CDH IN, BUY)

Lupin Ltd

Cadila Healthcare Ltd

Source: Bloomberg, Ambit Capital research

Source: Bloomberg, Ambit Capital research

LIC Housing Finance Ltd (LICHF IN, SELL)

HDFC Bank Ltd (HDFCB IN, SELL)

LIC Housing Finance Ltd

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jan-15

Oct-14

Jul-14

Apr-14

Jan-14

Oct-13

Apr-15

100

Jan-15

200

Oct-14

300

Jul-14

400

Apr-14

500

Jan-14

600

Oct-13

1,400
1,200
1,000
800
600
400
200
0

700

HDFC Bank Ltd

Source: Bloomberg, Ambit Capital research

Source: Bloomberg, Ambit Capital research

HCL Technologies Ltd (HCLT IN, BUY)

Exhibit 59: eClerx Services Ltd (ECLX IN, SELL)

1,200

HCL Technologies Ltd


Source: Bloomberg, Ambit Capital research

November 17, 2016

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jan-15

Oct-14

Jul-14

Apr-14

Jan-14

Oct-13

Jan-15

200

Oct-14

400

Jul-14

600

Apr-14

800

Jan-14

1,000

Oct-13

1,800
1,600
1,400
1,200
1,000
800
600
400
200
0

eClerx Services Ltd


Source: Bloomberg, Ambit Capital research

Ambit Capital Pvt. Ltd.

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Asian Paints Ltd (APNT IN, BUY)

Exhibit 60: Britannia Industries Ltd (BRIT IN, SELL)

Asian Paints Ltd

Jul-16

Apr-16

Jan-16

Oct-15

Oct-13

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jan-15

Oct-14

Jul-14

Apr-14

Jan-14

Oct-13

Jul-15

200

Apr-15

400

Jan-15

600

Oct-14

800

Jul-14

1,000

Apr-14

1,200

Jan-14

4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0

1,400

Britannia Industries Ltd

Source: Bloomberg, Ambit Capital research

Source: Bloomberg, Ambit Capital research

Axis Bank Ltd (AXSB IN, BUY)

Exhibit 61: Page Industries Ltd (PAG IN, BUY)

700

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jan-15

Oct-14

Jul-14

Apr-14

Jan-14

Oct-13

Jan-15

100

Oct-14

200

Jul-14

300

Apr-14

400

Jan-14

500

Oct-13

18,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0

600

Page Industries Ltd

Axis Bank Ltd

Source: Bloomberg, Ambit Capital research

Source: Bloomberg, Ambit Capital research

Exhibit 62: Astral Poly Technik Ltd (ASTRA IN, NOT RATED)

Amara Raja Batteries Ltd (AMRJ IN, SELL)

600

1,200

500

1,000

400

800

300

600

200

400

100

200

Source: Bloomberg, Ambit Capital research

November 17, 2016

Aug-16

May-16

Feb-16

Nov-15

Aug-15

May-15

Feb-15

Nov-14

Aug-14

May-14

Feb-14

Jul-16

Apr-16

0
Nov-13

Astral Polytechnik Ltd

Jan-16

Oct-15

Jul-15

Apr-15

Jan-15

Oct-14

Jul-14

Apr-14

Jan-14

Oct-13

Amara Raja Batteries Ltd


Source: Bloomberg, Ambit Capital research

Ambit Capital Pvt. Ltd.

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GRUH Finance Ltd (GRHF IN, NOT RATED)

Dr Lal PathLabs Ltd (DLPL IN, NOT RATED)

GRUH Finance Ltd

Oct-16

Sep-16

Aug-16

Jul-16

Jun-16

May-16

Apr-16

Mar-16

Feb-16

Jan-16

Aug-16

May-16

Feb-16

Nov-15

Aug-15

May-15

Feb-15

Nov-14

Aug-14

May-14

Feb-14

Nov-13

Dec-15

1,300
1,200
1,100
1,000
900
800
700
600
500
400

400
350
300
250
200
150
100
50
0

Dr Lal PathLabs Ltd

Source: Bloomberg, Ambit Capital research

Source: Bloomberg, Ambit Capital research

Relaxo Footwears Ltd (RLXF IN, NOT RATED)

Repco Home Finance Ltd (REPCO IN, NOT RATED)


1,000

700
600

800

500
400

600

300

400

200

200

100

Relaxo Footwears Ltd

Aug-16

May-16

Feb-16

Nov-15

Aug-15

May-15

Feb-15

Nov-14

Aug-14

May-14

Feb-14

Nov-13

Aug-16

May-16

Feb-16

Nov-15

Aug-15

May-15

Feb-15

Nov-14

Aug-14

May-14

Feb-14

0
Nov-13

Repco Home Finance Ltd

Source: Bloomberg, Ambit Capital research

Source: Bloomberg, Ambit Capital research

Cera Sanitaryware Ltd (CRS IN, NOT RATED)


3,000
2,500
2,000
1,500
1,000
500
Aug-16

May-16

Feb-16

Nov-15

Aug-15

May-15

Feb-15

Nov-14

Aug-14

May-14

Feb-14

Nov-13

Cera Sanitaryware Ltd


Source: Bloomberg, Ambit Capital research

November 17, 2016

Ambit Capital Pvt. Ltd.

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Explanation of Investment Rating
Investment Rating

Expected return (over 12-month)

BUY

>10%

SELL
NO STANCE

<10%
We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW

We will revisit our recommendation, valuation and estimates on the stock following recent events

NOT RATED

We do not have any forward looking estimates, valuation or recommendation for the stock

POSITIVE

We have a positive view on the sector and most of stocks under our coverage in the sector are BUYs

NEGATIVE

We have a negative view on the sector and most of stocks under our coverage in the sector are SELLs

Disclaimer
This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically,
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Additional Disclaimer for U.S. Persons


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Additional Disclaimer for UK Persons
26. All of the recommendations and views about the securities and companies in this report accurately reflect the personal views of the research analyst named on the cover. No part of this research
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Disclosures
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report.
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