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SECTOR UPDATE
Telecommunications
Quarterly revenue market share performance
The Telecom Regulatory Authority of India has come out with the revenue numbers of the domestic telecommunications (telecom) companies for Q2FY2013.
Key points
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The overall all-India adjusted gross revenue (AGR) stayed flat on a quarter-on-quarter (Q-o-Q) basis at Rs25,772.5 crore. On a year-on-year (Y-o-Y) basis the overall revenues increased by 7.1%.
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On an all-India basis, only the metro circle stayed in the positive territory, with its AGR growing marginally by 2.8% quarter on quarter (QoQ) to Rs4,323.3 crore.
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Bharti Airtel and Reliance Communications (RCom) were the major gainers during the quarter whereas Vodafone and Idea Cellular were the losers in the quarter.
Valuations: Bharti Airtel's strategy to cut down on the discount offers and focus on the competitive pricing policy was reflected in market share gain in the quarter. Further, RCom has finally gained on the RMS front after several quarters of a declining trend. On the other hand, Vodafone and Idea Cellular lost some ground in the September quarter. Overall, we maintain our cautious optimism on the telecom sector in view of the easing of the regulatory scene and a shift of focus towards the quality of revenue rather than subscriber addition which would benefit the operating metrics in the coming year. We have a Hold rating on Bharti Airtel with a price target of Rs340.
VIEWPOINT
Cipla
Long-term synergy likely from Cipla Medpro Key points
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Cipla prepares to acquire Medpro: Cipla is in preliminary discussions with South Africa-based company, Cipla Medpro South Africa (Cipla Medpro), to acquire a 51% stake in the latter at an initial offer price of 8.55 rands per share, totaling $220 million (or Rs1,200 crore). The offer values Cipla Medpro at $430 million, which is 15x estimated earnings for CY2012. Cipla Medpro has been linked to Cipla by virtue of a marketing tie-up under which Cipla supplied a range of generic products to be marketed in the South African region. A substantial portion of the products sold by Cipla Medpro is supplied by Cipla from its India based manufacturing plants. This is the first overseas acquisition by Cipla in its 75-year-old history. Therefore, it is viewed as a major shift in the business strategy of the company.
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Strategic fit for Cipla: Cipla is among a few Indian pharmaceutical companies that are expanding through the organic route. Most of its international businesses have been based on the partnership model under which Cipla supplies finished products to global partners, who distribute the products at wholesaler and retailer levels. However, recent actions of the company's management suggest a major transition in the business strategy, which now includes establishing a front-end presence in the key markets and expanding the presence in the regulated markets like the USA and Europe. Apart from the long-term strategic importance, we believe, the acquisition of a majority stake in Cipla Medpro will have a positive impact on Cipla's financials in the long term.
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Latest performance of Cipla Medpro is impressive: Cipla Medpro is the third largest player in South Africa and among the fastest growing pharmaceutical players in the country. In H1CY2012, Cipla Medipro recorded a 28% year-on-year (Y-o-Y) rise in revenues to 1,080 million rands (Rs669 crore) and a gross margin of 53.6%. The net profit at 126 million rands (Rs75.7 crore) was down 36% year on year (YoY), mainly due to an exceptional income in H1CY2011. However, the adjusted profit grew by 31% YoY during this period.
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Long-term positive for Cipla: Though Cipla Medpro is currently earning a better gross profit margin than Cipla (Cipla's gross profit margin was 51% in H1FY2013), but higher equity base and capital employed by Cipla Medpro translate into lower return on equity (RoE) and return on capital employed (RoCE). Cipla Medpro recorded RoE and RoCE of 14.6% and 17.7% respectively during CY2011 as compared with Cipla's RoE and RoCE of 16% and 19% respectively in FY2012. Therefore, we believe the consolidated numbers may not be earnings accretive immediately. Cipla will gain a synergetic benefit in the long run by way of an improved margin on the front-end sales of its products. Currently Cipla has 278 dossiers with Medicine Control Center, South Africa which are pending registration, and would be marketed in the next two years through Cipla Medpro. The acquisition at the current offer price will cause Rs1,200 crore of cash outflow from the Rs1,300-crore-plus kitty of Cipla. Therefore, there would not be any strain on the balance sheet of Cipla due to this acquisition.
Outlook
Cipla is changing its way of doing business in the international market. Doing away with the partnership-based model, which gives a thin margin, it is keen to set up its own front-end facilities and is looking to independently file abbreviated new drug applications and market the drugs in the USA. Besides, niche products like inhalers, combination drugs, ant-malarial drugs and first-to-file (FTF) opportunities are set to improve the margin scenario for the company. It is likely to launch Dymista in Q3FY2012 (the drug is estimated to contribute $25-30 million to its earnings). It has two FTF opportunities to be monetised in the next two years. It also has a couple of products under development in the fields of biosimilars and stem cell. It is going to launch at least four inhaler-based products in Europe in the next couple of quarters.
Escorts
Tractor margin continues to improve Promoters tighten grip on the company by consolidating group entities
Escorts has amalgamated three group entities, ECEL, Escotrac and EFILL, with itself. This has resulted in a 16% increase in the outstanding shares and a rise in the effective promoter stake in the consolidated entity from 32.5% to 42.5%. The corporate action has averted a possible take-over threat even though several minority shareholders have opposed the amalgamation move.
Improved demand scenario for tractors
The tractor industry witnessed a double-digit decline in volumes in Q4FY2012 on account of delayed rains that affected the kharif crop. The industry ended FY2012 with flat volumes. The tractor volumes are likely to recover on the back of an improved rabi crop outlook. Also, the government has increased the minimum support price for the rabi crops which augurs well for the tractor industry.
Tractor market share intact with improved mix
Escorts' market share remained constant at 10.3%. The lower end of the tractor segment, the 21-30HP range forming 13-15% of the mix, has seen its contribution dropping to merely 2%. The 31-40HP segment has seen its market share increase at the expense of the lower range. This segment currently contributes 45% of the overall volumes. Also, the core 41-50HP segment contributing 55% of the volumes saw a drop in the mix. With new launches in the over 50HP range, the company has managed to migrate customers up the value chain.
Valuation
Escorts has merged three group entities resulting in equity dilution of 16%. We have incorporated the effect of the financials of the three amalgamated entities in our FY2013 estimates. In view of the improved outlook for tractors, we have estimated an 11% growth in the revenues for FY2013. The margins are expected to improve on the back of improved tractor volumes and continuous cost controls. We estimate a 120-basis-point margin improvement in FY2013. The stock trades at 6.3x FY2013 earnings estimate. Given the completion of the merger process and revival in the tractor business, we are positive on the company. Currently, the stock is not under our active coverage.
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