Sharekhan Top Picks

With the major event of the general election results ahead, the
equity market has turned volatile and lost most of the gains
registered in the first three weeks of April this year. Consequently,
the benchmark indices, Nifty and Sensex, have closed flat since
our last revision in the Top Picks basket whereas the Top Picks
basket itself has ended the month with a marginal gain of 0.5%.
This month, we are replacing Sun Pharmaceutical Industries (Sun
Pharma) with another large-cap, ITC. Sun Pharma appreciated
sharply (by close to 10%) in the last month on the back of an
initiative to acquire majority interest in Ranbaxy Laboratories.
On the other hand, ITC has underperformed and corrected by
close to 6% since we downgraded the stock at Rs362 and removed
it from the Top Picks basket at Rs354.
Having added ITC from the fast moving consumer goods (FMCG)
space, we are removing Jyothy Laboratories (a mid-cap FMCG
May 02, 2014 Visit us at www.sharekhan.com
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Absolute outperformance
Constantly beating Nifty and Sensex (cumulative returns) since April 2009
Name CMP* PER (x) RoE (%) Price Upside
(Rs) FY13 FY14E FY15E FY13 FY14E FY15E target (Rs)# (%)
Apollo Tyres 163 13.8 9.5 8.9 19.1 22.8 19.9 189 16
Crompton Greaves 165 126.9 42.3 20.4 -1.0 6.7 12.7 ** -
Federal Bank 92 9.4 9.4 8.1 13.9 12.6 13.3 110 20
HCL Tech 1,426 25.0 16.2 14.2 35.6 40.0 34.7 1,700 19
ICICI Bank 1,252 17.3 14.7 13.2 13.1 14.0 14.2 1,425 14
ITC 340 36.2 31.5 26.2 35.4 35.8 34.7 369 9
Larsen & Toubro 1,263 26.1 23.8 20.5 14.4 14.1 14.7 1,385 10
Lupin 1,010 34.4 24.7 21.6 25.3 26.9 24.0 ** -
Reliance Industries 928 14.3 13.3 12.3 11.3 11.0 11.0 1,060 14
Zee Entertainment 269 35.9 28.6 24.9 19.6 21.3 21.7 335 25
*CMP as on May 02, 2014 # Price target for next 6-12 months ** Under review (will revise in post result update)
Consistent outperformance (absolute returns; not annualised) (%)
1 month 3 months 6 months 1 year 3 years 5 years
Top Picks 0.5 9.1 12.6 25.3 40.7 176.2
Sensex 0.1 9.3 5.7 15.0 21.5 87.6
Nifty -0.1 10.0 5.9 12.9 21.5 85.4
CNX Mid-cap 2.5 17.0 15.8 12.9 9.2 118.9
stock) from the Top Picks folio and adding Crompton Greaves to
maintain the weightage of the FMCG sector and increase the folios
exposure to the cyclical sector. We have been positive on
Crompton Greaves fundamentally due to the reduction in the
losses of its overseas subsidiaries and the expectations of an
improvement in the domestic business environment. On the other
hand, the slowdown in demand for consumer products, forecast
of a below-average monsoon and rising input cost pressure could
limit the upside in the mid-cap FMCG stocks.
Lastly, we are booking profit in Selan Exploration Technology
(which has gained 70% in the last six months; which was added to
the Top Picks folio at Rs308) to generate some cash before the
major event (election outcome) ahead. We would use this cash
to make an intra-month addition to the portfolio depending upon
the evolving scenario.
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sharekhan top picks
2 Sharekhan
May 2014
Name CMP PER (x) RoE (%) Price Upside
(Rs) FY13 FY14E FY15E FY13 FY14E FY15E target (Rs) (%)
Apollo Tyres 163 13.8 9.5 8.9 19.1 22.8 19.9 189 16
Remarks: Apollo Tyres is one of the leading tyre manufacturers in India having a strong presence in the truck & bus as well
as the passenger car tyre segment. Its European subsidiary, ie Vredeistein, operating out of the Netherlands, is a
renowned brand in the winter passenger car tyre segment. The company had a consolidated turnover of over
Rs12,500 crore in FY2013.
Natural rubber prices have continued to soften and are currently quoting at about Rs140/kg, which is a five-year
low. The soft rubber prices translated into a 160-BPS margin expansion in M9FY2014 despite an increase in the
prices of the other raw materials such as carbon black and tyre cord. We expect the low natural rubber prices to
continue to boost profitability in H1FY2015.
The company has revived plans for a greenfield expansion in light of the failure of the Cooper Tire deal and is
looking at Eastern Europe and South East Asia for expansion. Its European operations are currently running at 90%
plus utilisation rate. Hence, a new plant in Eastern Europe would aid volume growth going forward.
The stock is currently trading at 7.7x FY2016E earnings of Rs20.9. Given the prolonged weakness in natural
rubber prices we continue to remain positive on the stock with a Buy recommendation and a price target of
Rs189.
Crompton Greaves 165 126.9 42.3 20.4 -1.0 6.7 12.7 ** -
Remarks: Crompton Greaves deals in industrial and power systems, which hold high potential, given the investment
opportunities in the power transmission & distribution sector. It also has a strong presence in domestic consumer
products and the business is expected to witness a high growth, thanks to brand leverage and stable demand.
Though the power system business in the USA and the subsidiaries in Canada are still not out of the woods, the
overall performance of the international subsidiaries would improve backed by a recovery in the European business,
which was hit by a restructuring exercise. A reversal in the outlook for domestic demand would improve sentiment.
Consequently, we expect a sharp improvement in its margin, earnings and return ratios which would be the key
driver of a re-rating. We remain positive on the stock.
3 May 2014
Sharekhan
sharekhan top picks
Name CMP PER (x) RoE (%) Price Upside
(Rs) FY13 FY14E FY15E FY13 FY14E FY15E target (Rs) (%)
Federal Bank 92 9.4 9.4 8.1 13.9 12.6 13.3 110 20
Remarks: Federal Bank had turned cautious in view of a slowdown in the economy (advances growth was below the industry
average) and preferred to strengthen its balance sheet. In the mean time the bank undertook structural changes
in the balance sheet, viz increasing the proportion of the better rated assets and the retail deposit base. As the
economy is gradually showing signs of a revival, the bank is much better capitalised (tier-1 capital adequacy ratio
of 14%) compared with its peer banks to expand the balance sheet.
In the recent quarters the non-performing assets (NPAs) declined and the slippages from small medium enterprises
(SME) and retail sectors have also been significantly lower in the past three to four quarters. Higher provision
coverage of 84% and a possibility of recovery from one large-ticket account (likely in the next two to three
quarters) would further increase the comfort on asset quality.
The valuation of 0.9x FY2016 BV is attractive when compared with the regional banks and other old private
banks. The expansion in the return on equity (RoE) led by a better than industry growth (FY2014-16) will lead to
an expansion in the valuation multiple. We have a Buy rating on the stock with a price target of Rs110.
HCL Tech 1,426 25.0 16.2 14.2 35.6 40.0 34.7 1,700 19
Remarks: HCL Technologies (HCL Tech) is an information technology (IT) services company providing software-led IT solutions,
remote infrastructure management services and business process outsourcing (BPO) services. The company has a
leading position in remote infrastructure management services which has helped it win large IT outsourcing
contracts. Through the Axon PLC acquisition, the company has gained a strong SAP consulting footing.
In the current environment, we believe HCL Tech is well placed in terms of its business strategy of consciously
targeting the re-bid market. The results of the same are evident in its consistent outperformance in terms of
volume and revenue growth. The company has allayed the apprehensions on the margin front by consistently
improving its margins despite head winds.
The management acknowledged the potential threat of the impending US immigration bill and expressed concern
over the outplacement clause in the current form (we, therefore, hope for some dilution in the final bill).
Nevertheless, among the top four IT companies, HCL Tech is relatively better placed, as around 50% of its total
workforce in the USA holds the H1-L1 visa against a higher percentage of such visa holders for TCS, Infosys and
Wipro.
In view of an improved operating environment coupled with decent earnings predictability driven by a $4-billion-
plus order book, stable margins and sustainable momentum in the IMS vertical, we continue to recommend a Buy
on it with a price target of Rs1,700.
4
May 2014
Sharekhan
sharekhan top picks
Name CMP PER (x) RoE (%) Price Upside
(Rs) FY13 FY14E FY15E FY13 FY14E FY15E target (Rs) (%)
ICICI Bank 1,252 17.3 14.7 13.2 13.1 14.0 14.2 1,425 14
Remarks: With an improvement in the liability profile, ICICI Bank is better positioned to expand its market share especially
in the retail segment. We expect its advances to grow at 18.5% compound annual growth rate (CAGR) over
FY2014-16 leading to a CAGR of 16.9% in the net interest income.
ICICI Banks asset quality has shown some stress in recent results due to rise in restructured loans. However, the
banks asset quality is significantly better than public sector banks (PSBs) and has improved in the past few
years. We believe the strong operating profits should help the bank to absorb the stress which anyways should be
within the manageable limits.
Led by a pick-up in the advance growth and a significant improvement in the margin, the RoE is likely to expand
to 15.5% by FY2016 while the return on assets (RoA) is likely to improve to 1.7%. This would be driven by a
15.2% growth (CAGR) in the profit over FY2014-16.
The stock trades at 1.6x FY2016E BV. Moreover, given the improvement in the profitability led by lower NPA
provisions, a healthy growth in the core income and improved operating metrics, we recommend a Buy with a
price target of Rs1,425.
ITC 340 36.2 31.5 26.2 35.4 35.8 34.7 369 9
Remarks: ITCs cigarette business, which contributes around 60% of revenues, continues to be the cash cow. ITC endeavours
to make a mark in the Indian FMCG market and with successful brands, such as Bingo, Sunfeast and Aashirwaad,
it is already reckoned among the best in the industry. With the new portfolio of personal care products gaining
market share, its FMCG business promises to compete with that of Hindustan Unilever and Procter & Gamble.
The government had increased the excise duty on cigarettes by about 20% in the finance budget for 2013-14. ITC
has already taken a price increase of about 18% in its cigarette portfolio which aided the cigarette business to
post margins above 30%. On the other hand, the central government and the governments of some of the key
states have not hiked the tax on cigarettes in their respective interim budgets for 2014-15. This will help improve
ITCs volumes in the near term.
ITCs other businesses of hotels, agri-products, and paper, paperboard and packaging are expected to provide a
good support to the revenues and profitability in the long run.
An increase in the taxation and the governments intention to curb the consumption of tobacco products remain
the key risks to ITCs cigarette business over the longer term.
We expect ITCs bottom line to grow at a CAGR of close to 18% over FY2013-16. At the current market price, the
stock trades at 21.3x its FY2016E earnings, which is lower than the current valuation of some of the mid-cap
FMCG stocks and a substantial discount to some of its closest large-cap peers. We like ITC from a longer-term
perspective and retain it as one of our top picks in the FMCG space.
5 May 2014
Sharekhan
sharekhan top picks
Lupin 1,010 34.4 24.7 21.6 25.3 26.9 24.0 ** -
Remarks: A vast geographical presence, focus on niche segments like oral contraceptives, ophthalmic products, para-IV
filings and branded business in the USA are the key elements of growth for Lupin. The company has remarkably
improved its brand equity in the domestic and international generic markets to occupy a significant position in
the branded formulation business. Its inorganic growth strategy has seen a stupendous success in the past.
Lupin is expected to see stronger traction in the US business on the back of the key generic launches in recent
months and a strong pipeline in the US generic business (over 91 abbreviated new drug approvals pending approval
including 86 first-to-files) to ensure the future growth. The key products that are going to provide a lucrative
generic opportunity for the company, include Nexium (market size $2.2 billion), Lunesta (market size $800
million) and Namenda (market size $1.75 billion) that will be going out of patent protection in FY2015.
While most of the geographies have recorded an impressive growth for the company, Japan (due to restructuring
at the step-down subsidiary, Irom Pharma) and India (due to the impact of the new drug pricing policy) saw a
weaker performance in M9FY2014. However, we expect the Indian business to bounce back, as the pricing related
issues are gradually getting settled.
The stock is currently trading at 24.7x and 21.6x earnings for FY2014E and FY2015E respectively.
Name CMP PER (x) RoE (%) Price Upside
(Rs) FY13 FY14E FY15E FY13 FY14E FY15E target (Rs) (%)
Larsen & Toubro 1,263 26.1 23.8 20.5 14.4 14.1 14.7 1,385 10
Remarks: Larsen & Toubro (L&T), the largest engineering and construction company in India, is a direct beneficiary of the
strong domestic infrastructure development and industrial capital expenditure (capex) boom.
L&T continues to impress us with its good execution skills, reporting decent numbers throughout despite the
slowdown in the industrial capex cycle. Also, we have seen order inflow traction in recent quarters which enhances
the revenue visibility.
As the economy is looking up, we believe a player like L&T would be a major beneficiary. Moreover, monetisation
of assets would help the company to improve the RoE.
A sound execution track record, a healthy order book and a strong performance of its subsidiaries reinforce our
faith in L&T.
At the current market price (CMP), the stock is trading at 20.5x its FY2015E stand-alone earnings and it is one of
the best bets to play the cyclicals now.
6
May 2014
Sharekhan
sharekhan top picks
Name CMP PER (x) RoE (%) Price Upside
(Rs) FY13 FY14E FY15E FY13 FY14E FY15E target (Rs) (%)
Reliance Industries 928 14.3 13.3 12.3 11.3 11.0 11.0 1,060 14
Remarks: Reliance Industries Ltd (RIL) has a strong presence in the refining, petrochemical and upstream exploration
businesses. The refining division of the company is the highest contributor to the companys earnings and is
operating efficiently with a better gross refining margin (GRM) compared with its peers in the domestic market
due to the ability of its plant to refine more of heavier crude. However, the gas production from the Krishna-
Godavari-D6 (KG-D6) field has fallen significantly in the last two years. With the government approval for additional
capex in its allocated gas fields; we believe production will improve going ahead.
Though there is uncertainty prevailing on gas production and pricing of gas from the KG-D6, the traction in
volume from shale gas assets is playing positively for the company. Moreover, the upcoming incremental capacities
in the petrochemical and refinery businesses are going to drive the earnings growth in future as the downstream
businesses are in the driving seat and contributing the lions share of the profitability. Hence, the uncertainty
related to the domestic gas production and pricing is likely to limit the impact.
In recent past there have been signs of improvement in the benchmark GRM, which suggests that there could be
a healthy improvement in the GRM of RIL too in the coming quarter.
At the CMP the stock is trading at a PE of 12.3x FY2015E earnings per share (EPS).
Zee Entertainment 269 35.9 28.6 24.9 19.6 21.3 21.7 335 25
Remarks: Among the key stakeholders of the domestic TV industry, we expect the broadcasters to be the prime beneficiary
of the mandatory digitisation process initiated by the government. The broadcasters would benefit from higher
subscription revenues at the least incremental capex as the subscriber declaration improves in the cable industry.
On completion of 20 years of operations, Zee Entertainment Enterprises Ltd (ZEEL) has issued redeemable
preference shares (RPS) aggregating Rs2,000 crore (6% preference dividend) for eight years. The RPS will be
issued at a ratio of 21 RPS for every equity share. The RPS will be redeemable from the fourth year till the eighth
year.
ZEELs management acknowledged that the recent Telecom Regulatory Authority of India (TRAI) recommendation
of capping the advertisement time at 12 minutes per hour would have an adverse impact on its advertisement
volume. The company will take adequate hikes in the advertisement rates in order to negate the impact of
reduced volumes. Thus, we expect a very minimal impact on the blended advertisement growth in FY2014 and
FY2015.
The recent demerger of the media business of Diligent Media Corporation Ltd (DMCL; a publishing joint venture
between DB Corp and Essel Group) and the vesting of the business with ZEEL is a positive development for the
company. First, the demerger scheme will provide ZEEL with an additional GEC licence (obtaining a GEC licence
is cumbersome) with a minimal pay-out of Rs2.6 crore related to the preferential allotment. Second, DMCLs
balance sheet has deferred tax assets to the tune of Rs314 crore which over the next two to three years will
ultimately help ZEEL to lower its effective tax rate from 33% currently.
We believe ZEEL will be the major beneficiary of the digitisation process in the years to come which coupled with
a strong balance sheet and high return ratios makes it a compelling long-term growth story. We maintain our Buy
rating on ZEEL with a price target of Rs335.
7 May 2014
Sharekhan
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