Sanju Verma picks SAIL; underweight on Bharti, Suzlon

The government's divestment agenda has gathered momentum and Sanju Verma MD & CEO of Violet Arch Capital Advisors prefers SAIL among the upcoming issues. She considers its valuations attractive and expects SAIL to give a healthy return. She is also hopeful that the company will achieve an earnings per share (EPS) of Rs 11 from the stock.

Besides, Verma advises investors to avoid Suzlon. In the midcap infra space, she favours Sadbhav Engineering and feels it is best to switch to asset owners from contractors. As far as the auto segment is concerned, Verma mentioned that the sales figure in February were well below street expectations. According to her, HMSI is gaining market share at the expense of listed peers. Besides, Mahindra and Mahindra’s standalone business will be driven by its SUV and diesel portfolio, she added. Due to capex concerns, she no longer prefers Tata Motors. She remains underweight on Bharti Airtel due to high debt and low Africa earnings.  Here is the edited transcript of the interview on CNBC-TV18. Q: Your thoughts on the next few government offerings which are coming up, Nalco, Steel Authority of India (SAIL) and Neyveli Lignite, would you pick up any of them? A: The performance of some of the offer for sale (OFS) issues in the last two and half months has been pretty much lackluster. Look at NMDC for instance, the OFS was done well below Rs 150, in the region of about Rs 146-Rs 147 per share. This was after the stock had already fallen 15 percent prior to the OFS. The stock has been hovering in and around the Rs 144-Rs 145 levels. The point I am trying to make is despite a steep fall prior to the OFS, the stock still haven't recovered. So there have been very few takers and ditto goes for Rashtriya Chemicals and Fertilizers (RCF). I think the OFS performances have left a lot to be desired. That said, between the three names Nalco, SAIL and Neyveli Lignite, if I had to pick one, I would actually go with SAIL. True, the performance for SAIL has not been very flattering either. About a year back every analyst on the street was talking of SAIL doing something like Rs 10-Rs 11 for FY13. For the first three quarters they have done earnings per share (EPS) of just about Rs 5. I will be happy if they end FY13 with an EPS of Rs 7. So, that speaks very little about the credibility of the earnings momentum for the company. That said, FY14 will be pretty superior for SAIL on conservative estimates. My analyst tells me they are well on their way to doing an EPS of Rs 11, if not more. So, at Rs 11 on FY14 estimates, at a price of Rs 70 or Rs 72 is where it has been hovering at for the better part of last few weeks. The stock is available to you on price to earnings at less than 7 times. Given that it has a decent amount of cash on its balance sheet, ex-cash the stock is available at less than 6 times or 5 times. So, valuation wise there is huge amount of cushion and comfort. What has been a problem with SAIL and where I would like to see greater clarity before I decide to take the plunge and then go the whole hog is some clarity on the EBITDA per tonne. Remember, this was a company till about 18 months back which was doing an EBITDA per tonne of something like USD130- USD135 and for the last two quarters, for the September quarter and then again for the December quarter, the EBITDA per tonne has come crashing down to somewhere in the region of just about USD 70 to USD 75. If they can go back to the USD 120-130 then I think you have a good story in the making which again is the function of the capex, where government policy intervention on the supportive side comes into the picture. Government policy intervention unfortunately has not been supportive, it has been quite contrary. Don’t forget that they have a current capacity of about 12 million tonne. They were slated to do something like 25 million tonne by the end of FY15. Now, I am told they will do 25 million tonne perhaps by the end of FY17 or even FY18. The expansion calendar was the big story for SAIL. The expansion calendar itself has been pushed back by two and half years. That is what has done the price in. But, if there is clarity on that front I think there is reason to believe that SAIL can outperform. Given that international coking coal prices have still been pretty much on the softer side and don’t forget coking coal prices was something like USD 325 a tonne two years back, USD 200 a tonne plus a year back, currently they are in the region of USD 180. So they will continue to benefit from lower commodity prices and even if there is a 5 percent uptick in finished product prices, they sell at about Rs 38,000 a tonne. If there is a 5 percent uptick given the huge elasticity of earnings to a small change in end products prices, SAIL stands to benefit. My analyst tells me that if there is a 5 percent change in key product prices, it actually increases SAIL’s EBITDA and net profit between 25 percent and 40 percent. That is the kind of elasticity impact it will gain from. I would like to believe that given a choice, I would some time stick my neck out for SAIL. The other two, I would let them go by. _PAGEBREAK_ Q: The stock that has been seeing a lot of attention and news flow is Suzlon Energy. Any thoughts on that and whether you would buy it? A: No. Suzlon is something I would clearly stay away from at this point in time. Within midcaps there is so much to pick and choose from, I don’t think there is any particular reason at this point in time to go ahead and buy Suzlon. If I have to stick my neck out and buy something within the capital good space, within the midcap arena, I would rather go and buy Sadbhav Engineering where there has been positive news flow last week. They have got land and environmental clearances for some of their projects. We had also taken out a report last June where we were targeting something like Rs 179 for the stock. It is a different story that the stock thereafter has been hovering in the region of Rs 111 to Rs 115. But, what if it were to go back to Rs 150 or Rs 160 in a year from now? It would be trading at less than 8 times one year forward. I have always maintained that within the capital good space, which includes infra players, power players, it is time now to shift from players who are into the contracting business to asset owners and there I think players like Sadbhav Engineering tend to score. While it is true that the government has awarded a fraction of the 9500 kilometers odd that it was to award by way of road projects and it would have benefited something like Sadbhav Engineering. I am inclined to believe that in the first half of the coming fiscal, if not 3,000 kilometers which is what the finance minister said in the Budget, even if we do half of that which is 1500 kilometers, then asset owners like Sadbhav Engineering certainly stand to benefit. This is one of the few midcap players which actually have an return on equity (ROE) and Return on invested capital (ROIC) of something like 18 to 20 percent which is very comforting. They have a road portfolio of something like 700 to 750 kilometers and the CAGR growth that we are talking about in terms of toll receipts for the next two to three years should easily be 50 to 60 percent on conservative estimates. But, within the midcap space at this point in time, that is one story that I am tracking closely and that is one stock that I am particularly bullish on. Q: The one stock which has been intensely debated over the last few days in the market is Titan. It used to be a traditional favourite and suddenly it is down 20-25 percent and there all sorts of questions on the gold part of its business model. Would you buy it here after the correction? A: I would refrain to comment because we are doing something there. So I will let it pass. Q: Let me ask you about autos, the sector that you track. There has been a lot of pessimism on that given the recent numbers that have come in. If you still had to stick your neck out and buy one auto stock in the midst of this gloom what would it be? A: That is a very tough one. The 26 percent fall in sales in February was well below the most pessimistic expectations. Not only a Maruti which saw a volume decline of 9 percent in February, domestically though the export side of their business did slightly well and hence, the overall sales growth came in at 2.8 percent. I would clearly stay away from two wheelers because the growth in two wheelers, say in Bajaj Auto for instance in FY14, I will be surprised if they do a top-line or a volume growth in excess of 7-8 percent which is well below the five year industry trend of 12 to 13 percent. If I had to buy a two wheeler stock it would have been Honda Motorcycle and Scooter India (HMSI) which has bucked the trend and grown by 33 percent in February when all the three, Hero MotoCorp, Bajaj Auto and TVS have actually de-grown by 1 to 4 percent. But, unfortunately that is not listed. So, let us not speak about that and get into that territory which means the choice boils down to four wheelers. Within four wheelers at this point in time, if I have to pick and choose one, it would have to be Mahindra and Mahindra. The consolidated numbers for M&M have not been particularly good, with the top-line and earnings momentum coming in between 10 to 11 percent for the December quarter. That is likely to be the case. Don’t forget that the fourth quarter maybe particularly soft because the losses with respective to acquisition of Navistar or hiking the stake in Navistar will be booked. SsangYong is not going to make money for Mahindra till about end of FY15. Maybe they will cash break even and put their head above water only come FY16. Their two-wheeler business is not going great guns either. Therefore, the consolidated picture for M&M does not look pretty. The standalone business is looking pretty good. Don’t forget that M&M has been running only one leg. The tractor business despite having EBITDA margins of 15 percent or thereabouts, has done little. Every quarter, for the last three quarters or four quarters, they have not been able to sell more than 60,000 to 62,000 tractors. If they were able to up this number to 70,000 to 75,000 tractors a quarter, they are home with respect to keeping their head above the water on the tractor side of the business. Clearly, M&M is a story which has rested on this stupendous growth in the automotive segment. The automotive segment has been growing at 15 percent plus for them and whether it will continue or not, I am not sure. Maybe the growth will be 15 to 20 percent, maybe it will be 8 to 12 percent, but I am pretty confident that they will end up doing an EPS of something like Rs 56 to Rs 57 in FY14. It means they will end up showing an earnings growth of 9 to 10 percent which is good in the overall context of the earnings de-growth for the larger pack. Even in February M&M was perhaps the only Indian company which showed a double digit growth in sale driven by its SUV and diesel portfolio. A 3 percent hike in excise is not great news but, the SUV hike will impact the premium side of the market, not the mass end of the market. Don’t forget that in the mass end of the market, M&M Bolero still has a 30 percent market share and is rock steady. In a way, M&M stands to benefit if the excise hike is limited to the premium end of the market and not to the mass end of the market. Not withstanding the fact that you will have competition from Ford’s Ecosport and Maruti’s Alpha and GM’s Enjoy, it will be SUV offerings over the next 12 to 18 months. At Rs 56 EPS for FY14, the stock is not necessary cheap at about 15 to 16 times one year forward. But one has to buy M&M looking at FY15. If they end up doing Rs 68 to Rs 69 EPS, which is what I am targeting for FY15, that translates into 23 percent odd upside over FY14 and the stock would be available on FY15 at just about 13 times. Then it does make sense to look at this story. At this point in time, it is only M&M and Maruti and nothing from the two wheeler space. Not even Tata Motors which used to be a favourite because their capex of 2.75 billion pounds rather than 2 billion pounds, which they were talking about till three months back has come as a surprise. I don’t think you are going to see 14 percent margins on JLR in a hurry. Margins will continue to trend downwards and the domestic side of the business is under tremendous pressure, not to mention the fact that both their Sanand and Pune plants are operating at just 40 to 50 percent of their actual capacities. The story there is not looking pretty. So maybe go short on Tata Motors and incrementally put 60 to 70 percent of your money in M&M and have a little bit of Maruti as well. Q: You track telecom as well and that is going through a period of flux right now, how would you approach those stocks, is it time to buy Bharti Airtel or not quite yet? A: Unfortunately, in telecom there is hardly any choice. If you recall, we had a conversation on telecoms and particularly on Bharti Airtel about 8-9 months back. As a pure telecom story, Bharti Airtel has a lot going for it but that is all going to pan out for them only over the next 18-20 months. They are planning to sell their direct-to-home (DTH) business. They are valuing that at USD 1 billion. So, if they sell 25 percent stake, they are likely to rope in something like Rs 1,400-1,500 crore. But, what will Rs 1,400-1,500 crore do for a company which has a debt of something like USD 14 billion. The cash and cash equivalents currently for Bharti Airtel is just about a billion dollar. A lot has been written about the fact that they did this USD 1 billion offering recently at an interest rate, at a coupon of just about more than 5 percent. But, that is a lot of hogwash because do not forget that 19 percent of Bharti Airtel’s debt is unsecured. 90 percent of their debt is floating rate and again 68-70 percent of their debt is dollar denominated. Taking a call on Bharti Airtel currently means taking a huge call on which way the dollar-rupee movement will pan itself out. Secondly, their African operations have been very abysmal with respect to performance. I do not think the African operations will do USD 2 billion by way of EBITDA, which is what they were targeting for FY13. Even if they do that in FY14, it will be a positive. But, I have my doubts because the ARPUs in Africa are barely USD 6 odd. While making the acquisition Bharti Airtel thought that they will grow this market from 15 percent to something like 20-25 percent. Unfortunately, this market has started growing at just about 8-10 percent and not 15 percent odd which will be trend level. So it has been growing at below trend. That is again discomforting. Most importantly, I think there is no clarity at all from the government’s end with respect to intra-circle roaming. There was a news yesterday that Bharti Airtel will have to give back some of its circles in which it was offering 3G services. Secondly, there is no clarity on the cost of refarming. Do not forget, Bharti’s spectrum license comes up for renewal in FY14. The big telecom story putting it contextually in the next couple of years will be Reliance. The government has taken a huge step forward by allowing a voice to be offered on broadband airwaves, which I think will do a whole lot of good to somebody like Reliance. The government has categorically said that they will not allow auction in the 700 and 2,300 megahertz (MHz) spectrum. It means Reliance has a two-three year lead before anyone else comes in and gives them competition in the 4G airwaves. Reliance has got a backdoor entry, if that is what you want to call it, in terms of offering voice services because now they can use their pan-India broadband wireless access (BWA) license to offer voice and data after what the telecom commission said last week, for an additional Rs 1,658 crore. So net-net, by taking the first step towards making internet telephone history in India, Reliance has taken a huge leap of faith forward. This will be the one big telecom story to watch out for. Of course, it is going to be a long haul. It will play itself out over the next four-five years but, I think the firm beginnings have already been made with respect to that. Bharti Airtel is perhaps the only stock as a pure telecom play currently. But, I would buy it because of lack of choices and not because I am particularly positive about this space as such.