Research Best Ideas Update
Relative Call - Replacing United Spirits with Colgate Palmolive,
Adding Tata Motors and Hero MotoCorp
Summary — We name Colgate Palmolive a Least Preferred stock relative to our
fundamental analyst coverage for the next three months, replacing United Spirits,
which we last selected on 01 Mar 2011.
Furthermore, we name Tata Motors a Most Preferred stock and Hero MotoCorp a
Least Preferred stock relative to our fundamental analyst coverage for the next
three months.
Colgate Palmolive (India)
(COLG.BO; Rs995.00; 3)
Catalyst and Thesis — After good stock outperformance over the past two
years, current valuations imply flawless execution and in our view don't price in dual
risks of decelerating growth and impact of higher tax rates. Risks of increasing
competition from Hindustan Unilever and Dabur can't be ruled out, as they
aggressively invest behind their oral care portfolio. The risk of P&G's entry - and the
subsequent de-rating - also appears not to be adequately priced in.
Hero MotoCorp
(HROM.BO; Rs1,998.60; 3)
Catalyst and Thesis — Valuations appear expensive at the current price levels.
Competitive intensity is expected to increase with Honda expanding capacity and a
more focused Bajaj Auto.
Tata Motors
(TAMO.BO; Rs180.25; 1)
Catalyst and Thesis — Tata Motors looks well positioned as a proxy for the India
infrastructure / capex story, given its dominant positioning in trucks. New Evoque
launch should boost volumes for JLR. Increasing China sales augers well for
profitability due to better product mix in China volumes.
Colgate Palmolive (India)
Valuation
We use a P/E based methodology to value Colgate India because of its steady
growth profile. Our target price of Rs935 is based on 25x FY13E earnings. Our
target P/E multiple of 25x is at the higher end of the average trailing three-year
historical trading range, which we believe is appropriate given Colgate's strong
brand equity, which will likely help it maintain a premium rating despite increasing
competition. Over the last five years, the stock has traded in a P/E range of 15x-
30x (average 21x). Colgate's relative PE to the broad market is currently at the
higher end of the last five-year range (0.8x-1.6x), thus the risk reward at current
levels appears unfavorable. At the current ~30x one-year forward P/E, we believe
that the stock fully captures the growth expectations - forecast ~12% EPS CAGR
over FY11-FY13E.
Risks
Key upside risks include: 1) Benign input cost environment onwards may support
margins to some extent; 2) Brand building spends remains key towards
profitability - Any major cutback in ad spends, due to easing competitive pressures
or lack of new product launches, may provide upside risk to our estimates; and 3)
better profitability driven by the amalgamation of various contract manufacturers. If
the impact of any of these upside risks is greater than we anticipate, the stock
could exceed our target price.
United Spirits
Valuation
Our target price of Rs1,168 is based on a two-part EV/EBITDA methodology. We
value the domestic operations at 12.5x Mar-13E EV/EBITDA. The multiple is at a
25% premium to international peers, which we view as merited given: a) Volume
growth in India continues at mid teen levels vs. nominal growth in developed
markets; b) With >55% market share, UNSP's market positioning in a high growth
market is attractive; and c) India's demographic story is attractive from a longer
term alcohol consumption story. We value the W&M EBITDA stream at 7.5x (a
~20% discount to the global majors, which we view as merited because of W&M's
status as a bulk scotch manufacturer). While over the longer term, we think that
W&M could re-rate, given management focus on building the branded business, it
is still early days - thus we maintain the discount given the execution risks. We
also ascribe Rs43/share to value the Bangalore IPL cricket team franchise at
investment.
Risks
Key downside risks to our target price include: 1) The liquor industry is highly
regulated and any change in policy increase in taxes, further control on
distribution, outright ban on liquor sales in some states etc.) could adversely
impact growth and profitability; 2) High interest expenses may impact earnings
growth, if United Spirits is unable to deleverage its balance sheet over the medium
term; 3) Concerns on group-related issues - promoter's pledged stake in UNSP
and airline business losses.
Key upside risks to our target price include: 1) Lower ENA costs than our current
estimates forecast; 2) Management ability to pare discretionary costs that may
buttress operating margins.
Tata Motors
Valuation
Our Rs228 target price for Tata Motors is based on a sum-of-the-parts valuation.
We value Tata Motors' core business at Rs123/share (on a share count of 659m
shares), based on 7x Mar13E EV/EBITDA. We value subsidiaries and
investments at Rs17. We attribute around Rs88/share to JLR - we value this at 3x
Mar13E EV/EBITDA, which equates to around Rs120/share and then deduct the
total net debt which amounts to around Rs32/share. At our target price, TTMT
would trade at a consolidated price-to-book value of 2.8x / 2.1x (FY12/13E), which
appears reasonable when juxtaposed against ROEs of 32%, 28% in FY12E/13E
respectively. On a P/E basis, the stock would trade at ~8.6x and 7.5x FY12E/13E
EPS.
Risks
The key downside risks to our estimates that could prevent the shares from
reaching our target price emanate from: a) JLR is exposed to risks of a global
macro slowdown. Weaker-than-forecast demand conditions for luxury cars and
SUVs in Europe and the US could impact JLR volumes and EPS, given the high
leverage of this business to these geographies, b) increase in competitive
intensity from JLR's peer group (Mercedes, BMW, Audi) could result in lower-thanexpected volume growth, c) cyclical risks within the CV business are increasing-
our CV forecasts are predicated on our economist Rohini Malkani's view that
industrial growth should rebound in FY13, and d) we assume that the credit and
liquidity environment will remain stable. A credit 'crunch' could impact consumer
confidence and possibly JLR's sales (especially in developed markets). Given
TTMT's fairly leveraged balance sheet, this is a risk. Key upside risks to our target
price are as follows: a) better-than-forecast growth in the Range Rover / Land
Rover product portfolio, b) a turnaround of the passenger car business in India,
and c) a sharp upward climb in the CV cycle in India.
Hero MotoCorp
Valuation
Our target price of Rs1,673 is based on 13x March13 earnings. The multiple is at
a slight discount to the stock's long term historical average of ~13.8x, due to the
uncertainties regarding HMCL's market positioning, as well as R&D and brand
related issues, post its split with Honda. We have chosen to use the P/E valuation
metric to value Hero MotoCorp, given the company's high level of cash
generation, reflecting its strong balance sheet (around Rs 52bn in cash and liquid
investments).
Risks
The key upside risks to our target price include: 1) Lower than expected market
share losses, 2) Better margins, 3) Change in corporate structure (technical
collaboration, etc).The key downside risks that could impede the stock from
reaching our target price are: 1) Slower-than-forecast growth in the two-wheeler
industry, 2) Any substantial increase in interest rates and greater than forecast
increase in material costs; and 3) Greater than expected increase in the
competitive intensity
Relative Call - Replacing United Spirits with Colgate Palmolive,
Adding Tata Motors and Hero MotoCorp
Summary — We name Colgate Palmolive a Least Preferred stock relative to our
fundamental analyst coverage for the next three months, replacing United Spirits,
which we last selected on 01 Mar 2011.
Furthermore, we name Tata Motors a Most Preferred stock and Hero MotoCorp a
Least Preferred stock relative to our fundamental analyst coverage for the next
three months.
Colgate Palmolive (India)
(COLG.BO; Rs995.00; 3)
Catalyst and Thesis — After good stock outperformance over the past two
years, current valuations imply flawless execution and in our view don't price in dual
risks of decelerating growth and impact of higher tax rates. Risks of increasing
competition from Hindustan Unilever and Dabur can't be ruled out, as they
aggressively invest behind their oral care portfolio. The risk of P&G's entry - and the
subsequent de-rating - also appears not to be adequately priced in.
Hero MotoCorp
(HROM.BO; Rs1,998.60; 3)
Catalyst and Thesis — Valuations appear expensive at the current price levels.
Competitive intensity is expected to increase with Honda expanding capacity and a
more focused Bajaj Auto.
Tata Motors
(TAMO.BO; Rs180.25; 1)
Catalyst and Thesis — Tata Motors looks well positioned as a proxy for the India
infrastructure / capex story, given its dominant positioning in trucks. New Evoque
launch should boost volumes for JLR. Increasing China sales augers well for
profitability due to better product mix in China volumes.
Colgate Palmolive (India)
Valuation
We use a P/E based methodology to value Colgate India because of its steady
growth profile. Our target price of Rs935 is based on 25x FY13E earnings. Our
target P/E multiple of 25x is at the higher end of the average trailing three-year
historical trading range, which we believe is appropriate given Colgate's strong
brand equity, which will likely help it maintain a premium rating despite increasing
competition. Over the last five years, the stock has traded in a P/E range of 15x-
30x (average 21x). Colgate's relative PE to the broad market is currently at the
higher end of the last five-year range (0.8x-1.6x), thus the risk reward at current
levels appears unfavorable. At the current ~30x one-year forward P/E, we believe
that the stock fully captures the growth expectations - forecast ~12% EPS CAGR
over FY11-FY13E.
Risks
Key upside risks include: 1) Benign input cost environment onwards may support
margins to some extent; 2) Brand building spends remains key towards
profitability - Any major cutback in ad spends, due to easing competitive pressures
or lack of new product launches, may provide upside risk to our estimates; and 3)
better profitability driven by the amalgamation of various contract manufacturers. If
the impact of any of these upside risks is greater than we anticipate, the stock
could exceed our target price.
United Spirits
Valuation
Our target price of Rs1,168 is based on a two-part EV/EBITDA methodology. We
value the domestic operations at 12.5x Mar-13E EV/EBITDA. The multiple is at a
25% premium to international peers, which we view as merited given: a) Volume
growth in India continues at mid teen levels vs. nominal growth in developed
markets; b) With >55% market share, UNSP's market positioning in a high growth
market is attractive; and c) India's demographic story is attractive from a longer
term alcohol consumption story. We value the W&M EBITDA stream at 7.5x (a
~20% discount to the global majors, which we view as merited because of W&M's
status as a bulk scotch manufacturer). While over the longer term, we think that
W&M could re-rate, given management focus on building the branded business, it
is still early days - thus we maintain the discount given the execution risks. We
also ascribe Rs43/share to value the Bangalore IPL cricket team franchise at
investment.
Risks
Key downside risks to our target price include: 1) The liquor industry is highly
regulated and any change in policy increase in taxes, further control on
distribution, outright ban on liquor sales in some states etc.) could adversely
impact growth and profitability; 2) High interest expenses may impact earnings
growth, if United Spirits is unable to deleverage its balance sheet over the medium
term; 3) Concerns on group-related issues - promoter's pledged stake in UNSP
and airline business losses.
Key upside risks to our target price include: 1) Lower ENA costs than our current
estimates forecast; 2) Management ability to pare discretionary costs that may
buttress operating margins.
Tata Motors
Valuation
Our Rs228 target price for Tata Motors is based on a sum-of-the-parts valuation.
We value Tata Motors' core business at Rs123/share (on a share count of 659m
shares), based on 7x Mar13E EV/EBITDA. We value subsidiaries and
investments at Rs17. We attribute around Rs88/share to JLR - we value this at 3x
Mar13E EV/EBITDA, which equates to around Rs120/share and then deduct the
total net debt which amounts to around Rs32/share. At our target price, TTMT
would trade at a consolidated price-to-book value of 2.8x / 2.1x (FY12/13E), which
appears reasonable when juxtaposed against ROEs of 32%, 28% in FY12E/13E
respectively. On a P/E basis, the stock would trade at ~8.6x and 7.5x FY12E/13E
EPS.
Risks
The key downside risks to our estimates that could prevent the shares from
reaching our target price emanate from: a) JLR is exposed to risks of a global
macro slowdown. Weaker-than-forecast demand conditions for luxury cars and
SUVs in Europe and the US could impact JLR volumes and EPS, given the high
leverage of this business to these geographies, b) increase in competitive
intensity from JLR's peer group (Mercedes, BMW, Audi) could result in lower-thanexpected volume growth, c) cyclical risks within the CV business are increasing-
our CV forecasts are predicated on our economist Rohini Malkani's view that
industrial growth should rebound in FY13, and d) we assume that the credit and
liquidity environment will remain stable. A credit 'crunch' could impact consumer
confidence and possibly JLR's sales (especially in developed markets). Given
TTMT's fairly leveraged balance sheet, this is a risk. Key upside risks to our target
price are as follows: a) better-than-forecast growth in the Range Rover / Land
Rover product portfolio, b) a turnaround of the passenger car business in India,
and c) a sharp upward climb in the CV cycle in India.
Hero MotoCorp
Valuation
Our target price of Rs1,673 is based on 13x March13 earnings. The multiple is at
a slight discount to the stock's long term historical average of ~13.8x, due to the
uncertainties regarding HMCL's market positioning, as well as R&D and brand
related issues, post its split with Honda. We have chosen to use the P/E valuation
metric to value Hero MotoCorp, given the company's high level of cash
generation, reflecting its strong balance sheet (around Rs 52bn in cash and liquid
investments).
Risks
The key upside risks to our target price include: 1) Lower than expected market
share losses, 2) Better margins, 3) Change in corporate structure (technical
collaboration, etc).The key downside risks that could impede the stock from
reaching our target price are: 1) Slower-than-forecast growth in the two-wheeler
industry, 2) Any substantial increase in interest rates and greater than forecast
increase in material costs; and 3) Greater than expected increase in the
competitive intensity
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