Morning Insight

Morning Insight
19 May 2015
For private circulation only
Global Economies and Equities
 Most Asian stock indices have gained this morning after the US equity indices hit fresh
record highs last night. The confidence among the US homebuilders unexpectedly fell in
May. Earlier retail sales data disappointed. Hence, the markets expect the FED to further
delay the hike in the benchmark rates to December. This has led to strengthening of
equities across the world;
 Brent oil price edged lower on Monday and is currently trading at ~$66 a barrel after
Saudi Arabia posted its highest level of monthly exports in nearly 10 years and an Iranian
official said OPEC would likely decide to keep production steady at its meeting next month;
Indian Economy and the Equity Markets
 After consolidating for second straight day, the domestic market climbed to a 3–week high,
after the IMD indicated early arrival of monsoon over the southern state of Kerala on May
30, six days sooner than last year. The Sensex gained 363 points to close at 27,687, while
the Nifty ended up by 111 points at 8,374. In the broader market, both the BSE Midcap and
Smallcap indices ended up nearly 1% each. The FIIs were net sellers of stock worth
Rs.202.12 crore while the DIIs were net buyers of stock worth Rs.618.54 crore;
 There are two significant proposals through the government initiatives – after the PM
visit, South Korea announces investing over $10 billion in Indian infrastructure
projects including smart-city projects; and the Union Minister says that the government
would initiate about Rs.3 lakh crore worth of road projects in 6 months. If both
initiatives materialize, they would have significant impact in turning around the domestic
economy;
 The rupee fell on Monday due to dollar demand from oil companies and lower foreign
inflows. The rupee closed at 63.72 per dollar, down 0.32% from its previous close of 63.52.
Since January this year, the rupee has lost 1.1%;
 Indian sovereign bonds rose, pushing the 10-year yield to a one-week low, on
speculation the central bank will add to two interest-rate cuts this year as inflation slows.
The yield on the 8.4% notes due July 2024 fell five basis points, to end at 7.90%- the
lowest close since May 11;
 Government has missed the overall revised tax collection target for both direct and
indirect taxes only by a small margin of Rs.2,288 crore (which is a short-fall of 0.18%)
in the financial year FY2015. “Gross Tax Collections at Rs.12,45,037 crore has shown a
growth of 9% (Rs.1,06,303 crore) as compared to FY2014. The gross tax collection is 9.8%
of GDP;
 Investments into Indian markets through participatory notes (P-Notes) have dropped to
Rs.2.68 lakh crore ($42 billion) at the end of April, after hitting over 7-year high of Rs.3.23
lakh crore in March 2015. Fear and uncertainty over the levy of Minimum Alternate Tax
(MAT) may have impacted investment sentiment in India;
 Domestic mutual funds have seen their holding in BSE 500 companies touch a fourand-half year high of 4% during March 2015 quarter as compared to 3.92% in
December 2014 quarter. Foreign institutional investors, on the other hand have seen their
ownership in BSE500 companies remain unchanged at 20.35% in March 2015 quarter as
compared to previous quarter;
Sector Developments
 Describing beer as 'fun, social drink', the All India Brewers Association (AIBA) wants state
governments to allow the beverage to be sold like FMCG products through retail shops.
AIBA, an industry body of breweries operating in India, is also demanding a separate
classification of beer from hard-drinks or spirits citing lesser alcohol content. If this
proposal is accepted (however, we doubt whether this government would accept it), it
would be positive for United Breweries Ltd. – a leader in the Indian beer market with
~51% market share;
Founder &
Managing Director
chokka.g@equinomics.in
Equinomics Research & Advisory Private Limited - Investment Adviser
19 May 2015
Equinomics
Morning Insight
|
Corporate Developments
 Cairn India has demanded a change in the pricing formula for crude oil from its prolific Rajasthan block saying the
current pricing mechanism does not capture the full value of oil. By revisiting the pricing formula government can
significantly get an upside and it will also give Cairn an opportunity to get better realisation at a time when crude
prices are significantly low;
 Styrolution ABS has posted quite impressive results yesterday- Net Sales for the quarter ended March 31
2015 declined 11% yoy to Rs.267.64 crore compared to Rs.299.26 crore. However, Net Profit for the quarter
grew by 53% yoy to Rs.9.21 crore. Lower raw material costs aided significant expansion of margin and robust
growth in net profits. EBITDA for the quarter grew by 109% yoy to Rs.19.89 crore compared to Rs.9.51 crore. We
suggest our investors to hold on to the stock and book profits around target price of Rs.800;
Review of Past Calls
We had initiated JB Chemicals & Pharmaceuticals on November 27, 2014 at a market price of Rs.206, with a target
price of Rs.256. On April 16, we revised our target price to Rs.285 as it breached our initial target price. The stock has
moved 22% from the date of imitation. We suggest that the long-term investors may hold on to the stock with our
revised target price of Rs.285 which is 17x its FY2016E EPS of Rs.16.80;
We reiterate our firm conviction in Tata Sponge Iron Ltd. (TSP)
We firmly believe that Tata Sponge Ltd (TSP) is one of our high conviction stocks for the following reasons:
 The stock price of TSP has corrected about 50% from its 52W High. This provides a lot of comfort on price point;
 Its net cash (as of March 2015) stands at Rs.459 crore, which is Rs.298/ per share and ~49% of its market
cap;
 CIBC, one of the most reputed research houses, provides quite interesting outlook on iron ore:
Commodity
Unit
2014
2015(f)
2016(f)
2017(f)
Iron Ore (62% Fe)
$/mt
97
59
63
62
Source: CIBC
It expects Iron Ore prices to remain subdued in the medium to long terms – it expects price to improve to $63
a tonne in 2016 but remain at more or less same level in 2017. During the years 2016 and 2017, it is expected
to be 36% lower than 2014-average price and about 59% lower than recent peak price of around $150 a tonne.
This will lead to lower raw material cost for TSP, which will further improve the margins going forward;
 Many small sponge iron units in the country have shutdown under severe raw material crises and low demand
from the domestic steel manufacturing units. This will be beneficial to large players like TSP, in gaining market
share;
Impressive Profile
Tata Sponge Iron is engaged in manufacturing high grade sponge iron through coal based method.
O TSP has reported consistent growth in its production volume on yoy basis. Though, international commodity
prices impacted per unit realization during past couple of years; however, company sustained output and grew the
sales volume at a CAGR of over 5.8% during past 10 years. Despite slowdown in commodity prices during past
several years, TTSP managed to improve per unit realization of its high grade sponge iron by the CAGR of 7.9%
since 2005. However, in FY2015 its performance has been impacted. Going forward, we expect its
performance to improve, considering shut down of many small units, cheap raw material costs and with
revival of domestic economy;
Equinomics Research & Advisory Private Ltd | For private circulation only
o Company has 26MW of two captive power units based on waste heat recovery, which enables the company
to reduce ‘Power & Fuel’ cost and aided operating margins;
Weak steel market, iron prices trampled Q4 Performance
Net profit of Tata Sponge Iron declined 78.8% to Rs.8.57 crore in the quarter ended March 2015 as against Rs.40.50
crore during the previous quarter ended March 2014. Sales declined 30% to Rs.159.85 crore in the quarter ended
March 2015 as against Rs.228.36 crore during the previous quarter ended March 2014, impacted by sluggish steel
market and sponge iron ore prices. For the full year, net profit declined 9.14% to Rs.91.94 crore in the year ended
March 2015 as against Rs.101.19 crore during the previous year ended March 2014. Sales rose 0.46% to Rs.766.23
crore in the year ended March 2015 as against Rs.762.72 crore during the previous year ended March 2014;
Continued on Next Page...
Equinomics Research & Advisory Private Limited - Investment Adviser
19 May 2015
Equinomics
Morning
Insight
| Equinomics Research & Advisory Private Ltd
Morning
Insight
We reiterate our “BUY” recommendation on Tata Sponge Iron Ltd. (TSP) (Continued)
Sponge iron demand expected to revive aided by the new Foreign Trade Policy
With the import of ferrous scrap coming to a standstill as in the new Foreign Trade Policy (effective April 1), the
government made mandatory videography of loading of scrap containers in the source country which according to
importers is impossible. As such, the entire quantity of about 10 million tonnes (mt) of steel scrap import is likely to
be affected. Hence demand for sponge iron is expected to revive in the coming weeks, once existing stocks of scrap
are exhausted;
Government’s continued thrust on Development of Infrastructure and Manufacturing will help
review demand and production
The government's continued thrust on development of infrastructure and manufacturing will help steel demand in
the country to grow. Besides, higher support for the housing sector is a step in the positive direction. It is expected
the steel sector will grow 6.2% in 2015-16, against 4.3% in April 2014-February 2015. Owing to this, production
of sponge iron is likely to grow 6.4% in 2015-16;
Possible Productive Usage of cash pile
Tata Sponge Ltd’s net cash (as of March 2015) stands at Rs.459 crore (~Rs.298/share, 49% of marketcap). We
believe that the management may consider options for deploying cash such as i) additional sponge iron capacity (EC
approval of 2 additional sponge iron kilns exists), ii) pellet making capacities and iii) downstream facilities in
steelmaking (TMT);
MMDR Ordinance – Positive step, stable regime in mining expected
TSPs iron ore supplies from its parent Tata Steel are set to normalize from Q1FY16e as clearance of MMDR Bill has
paved the way for restart of Khandhbandh mine of Tata Steel which was supplying ore to TSP. Domestic iron ore
prices have corrected by 25-30% already in last few months and we see further weakness with restart of more mines.
Since TSPs iron ore pricing from Tata Steel is linked to market rates, we see sharply lower iron ore costs for TSP
going ahead;
Margin decline to be arrested as end product prices not falling out-of sync with Raw Material costs
Raw material prices in the domestic market have shown trends contrary to global prices led by iron ore prices that
have remained high due to tight supply in the domestic market (accentuated by capacity closures in
Odisha/Jharkhand). However, iron ore prices have started coming down in the last few months with NMDC taking
price cuts and likely to soften further in next few quarters as mining restarts in Odisha/Jharkhand. We see lower raw
material costs for TSP as domestic iron ore price will soften further while imported iron ore cost has also come down.
Imported coal costs are also coming down for TSP due to lower global coal prices. TSP is currently sourcing 25% of
its iron ore requirements from imports while coal requirements are almost completely met by imports;
Outlook & Valuations
Ongoing coal auctions and likely auctions of iron ore mines in FY2016E (as per new MMDR policy) would provide
opportunity for TSP to secure captive coal and iron ore mines without large upfront investment and we believe the
company will see larger fall in raw material costs vis-à-vis sponge iron prices thereby providing support to margins
and hence expect smart recovery in EBITDA in FY2016E/17E. Even TSP remains the most efficient sponge iron
player possibly at the doorstep of an upturn. At the current market price of Rs.603 the stock trades at 7.5x its
FY2017E EPS of Rs.80/. We firmly believe that the prospects of sponge iron industry would improve substantially
within 18 months and hence, we reiterate our ‘BUY’ on the stock with a target price of Rs.800, a potential upside of
33% from the current market price.
Disclosure: I, G.Chokkalingam, do not hold shares of Tata Sponge directly or indirectly through any friends,
relatives or proxies;
Equinomics
Morning Insight
Stock Disclosure: Whether Stock Held By:
Tata Sponge Iron Ltd.
G.Chokkalingam & Family
Equinomics
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Equinomics Research & Advisory Private Ltd
Investment Adviser
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G. Chokkalingam - Founder & Managing Director
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