Trade in 2010-10-13

1. INDUSIND BANK 2QFY11: Strong core operating performance; Margin and CASA improvement continues; Not Rated

IndusInd Bank (IIB IN, Mkt Cap US$2.8b, CMP Rs275, Not Rated) reported 71% YoY growth in 2QFY11 net profit to Rs1.3b (up 12% QoQ). Strong growth in profits was driven by:

(1) 58% growth in NII to Rs3.3b as loans grew 33% YoY and margin expanded 55bp YoY (9bp QoQ),

(2) Strong core fee income growth of 34% YoY due to traction in trade and investment banking related fees, and

(3) Fall in cost to income ratio to 48% vs 54% a year ago.

Stellar performance on margins continues

– NII grew ~58% YoY and ~12% QoQ to ~Rs3.3b, led by sequential expansion in margins and continued traction in loan growth.

– Reported NIMs improved 9bp QoQ and 55bp YoY to 3.41%. While yield on loans declined 8bp QoQ to 12.1%, improvement in yield on investments by 26bp QoQ to 6.16% and stable cost of deposits at 5.99% led to sequential improvement in NIMs.

– Management expects incremental yield on loans to be higher going forward as it has raised its PLR by 75bp and base rate by 50bp during 2QFY11; full effect of this will reflect in 3QFY11.

– Higher yields, strong growth in low cost deposits, and deployment of equity money (Rs12b raised in Sept-10) would keep NIMs healthy in near term.

Business growth remains strong

– Loan book grew 33% YoY and 9% QoQ to Rs235b. Growth in loans was led by traction in vehicle financing segment (CVs – up 11% QoQ, UVs – 8% QoQ, car loans – 13% QoQ). Overall, the consumer finance segment witnessed a growth of 9% QoQ (and 29% YoY). The share of vehicle finance in overall loans improved 40bp QoQ to 41.2%. Corporate and commercial banking segment grew by 8% QoQ (37% YoY).

– Deposits grew at a robust pace of 14% QoQ and 37% YoY to Rs313b. CASA deposits grew 19% QoQ (64% YoY) to ~Rs79.5b outpacing overall deposit growth. Current account deposits grew 21% QoQ and savings deposits by 16% QoQ. Consequently, CASA ratio expanded 110bp QoQ and 420bp YoY to 25.4%. (CASA deposits included Rs1.5b of float money on account of various equity issuances in primary market.)

– Branch additions and thrust on increasing CASA base would lead to gradual improvement in CASA deposits.

Strong fee income growth; stable C/I ratio

– IndusInd’s core fee income exhibited a growth of ~34% YoY to ~Rs1.6b led by trade and remittance related fees (up 57% YoY) and fee from investment banking Rs190m (v/s Rs70m in 2QFY10). Income from third party distribution also reported growth of 21% YoY to Rs400m (on a higher base). The bank booked lower treasury gains of Rs130m in 2QFY11 as against Rs160m in 2QFY10 (Rs286m in 1QFY11).

– Operating expenses were at ~Rs2.43b (up 31% YoY). Employee cost was up 21% YoY whereas other operating expenses increased 38% YoY. C/I ratio declined marginally to 48.1% from 49.5% in 1QFY11. Higher other operating cost is largely attributed to increase in branch network to 238 from 180 in 2QFY10 and 224 in 1QFY11.

– The management plans create a network of 300 branches by end FY11, 450 branches by FY12 and 600 by FY13.

Asset quality stable QoQ

– Gross slippages in 2QFY11 was at Rs750m (1.46% of loans – annualized). Additions were largely from consumer finance division.

– However with strong upgradations of Rs640m during the quarter, Gross NPAs remained stable at 1.21%. NNPA declined by 35bp YoY (stable QoQ) largely due to higher provisions made during the year.

– Quarterly credit cost stood at 14bp vs 22bp in 1QFY11. Management expects for the year credit cost to be in the range of 60-70bp.

– Restructured loans remain one of the lowest in the industry at 18bp of the outstanding loan book.

Valuations and view

– Having depicted their execution capabilities in terms of improvement in NIMs, increasing CASA mix, strengthening asset quality and higher return ratios, focus going ahead would be on increasing franchise network, maintaining 25-30% growth rates and operating parameters

– Rapid branch network expansion, acquisition of new customers and deepening of existing customer relationships would help ensure that its asset growth remains higher than industry and would also strengthen liability profile.

– Bank has recently raised Rs12b through QIP (at a price of Rs234 per share) leading to increase in CAR to 16.2% (Tier I 12.2%). Thus, we believe capital would not be a constraint for achieving higher growth.

– We estimate 42% CAGR in PAT over FY10-12E and RoAs to improve to 1.4%+. On account of recent equity raising, RoEs would be subdued at ~ 18% for FY12E.

– The stock trades at 3.3x FY11E BV and 2.9x FY12E BV. Not Rated.

2. SOUTH INDIAN BANK: Met management; Business growth remains strong; Target of 25% CAGR till FY13; Buy

We met the management of South Indian Bank (SIB IN, Mkt Cap US$660m, CMP Rs27, Buy) to get an update about business growth, margins and asset quality. Key takeaways:

– Management remains confident of achieving loans CAGR of 25%+ and deposits CAGR of 23%+ over FY10-13. Margins are expected to be at 2.8% with an upward bias.

– It is targeting to increase the share of corporate fee income and third party distribution income.

– The bank expects to increase its branch network by ~10% every year and is targeting to reach to 750 branches by FY13 (from 580 as of 1QFY11).

– Asset quality is a non-issue; the management remains confident of maintaining GNPA ratio at ~1.3% and NNPA at ~0.4% with PCR of ~70%.

– Overall, on track to achieve RoA of ~1% and RoE of ~18%. Maintain Buy.

Business growth to remain strong

– Management expects to achieve business growth of 25-28% YoY to Rs480-500b in FY11. Loans are expected to grow 25%+ YoY to Rs200b and deposits 23%+ YoY to Rs280b. We expect loans to grow 25% YoY and deposit to grow 24% YoY in FY11.

– FY13 business target of Rs750b, 750 branches and ATM and 7,500 employees remains intact. The management remains confident of achieving its targets ahead of schedule.

– As of 1QFY11, loans grew 5% QoQ and 34% YoY to Rs169b while deposits grew 1% QoQ and 25% YoY to Rs233b.

– Gold loans, SME and Corporate loans will remain key drivers of loan growth going forward.

– Management expects to maintain CASA growth in line with overall deposits growth and CASA ratio is expected to remain stable at ~25%. However, in 1QFY11, CASA growth of 28% YoY outpaced overall deposits growth. CASA ratio had improved to 25.1% vs 23.3% for FY10 and 24.5% for 1QFY10.

Margin guidance of 2.8% with an upward bias

– NIMs for 1QFY11 were 2.83% compared to 2.76% (adjusted) for 1QFY10 and 2.77% for FY10.

– Management expects to maintain margins at 2.8%+. Increase in cost of deposits is likely to be compensated by increasing share of gold loans and SME loans which are high yielding.

– Improving share of CASA deposits and higher proportion of NRE deposit (~14% of deposits) coupled with improvement in CD ratio (72% as of 1QFY11) will help the bank maintain margins.

Fee income to accelerate; branch expansion to limit C/I ratio improvement

– Fee income growth remained muted for SIB over last few quarters, however, mgmt expects it to improve with increased focus on corporate fees and third party distribution

– Branch expansion picked up during 2QFY11. Management expects to reach 625+ branches by December 2010 (vs 580 branches as on 1QFY11).

– On back of higher branch expansion C/I ratio to remain at ~50%. However, improving branch and employee productivity coupled with incremental branches coming up in semi urban and rural areas, C/I ratio can provide positive surprise.

Trades at P/BV of 1.6x FY12E; RoA of ~1% and RoE of ~18%; Buy

– While our business growth figures are in line with management’s internal targets, PAT growth of 12% YoY is lower than management guidance of ~20% YoY.

– SIB has shown consistent improvement in its operating performance. We expect its ROAs to sustain at ~1% whereas increase in leverage would help drive ROEs to ~18% by FY12E.

– SIB is planning to add 60 new branches to its existing network of 580 branches. Of this, roughly 30 would be in southern India (without RBI license requirement) which would further strengthen its presence in that region.

– Stock trades at FY12 P/BV of 1.6x and PE of 9.4x. Maintain Buy.

3. KPIT CUMMINS: No further uptick in quarterly run-rate from Cummins for FY11; Revolo progress on track; Margins to recover in 2HFY11; Not Rated

We met with the management of KPIT Cummins (KPIT IN, CMP Rs163, MCap US$0.3b, Not Rated). Following are the key highlights:

– Quarterly run-rate from Cummins is expected to be in the range US$11-12m and an uptick from these levels is only anticipated from the onset of FY12. Revenues from Cummins saw a constant decline from US$17.7m in 2QFY09 to US$10.7m in 4QFY10, and stand at US$11m in 1QFY11.

– Expects incremental business from existing reputed clientele in the manufacturing segment to drive growth; surge in demand for auto electronics in China and acceleration in SAP practice post the acquisition of Sparta in 3QFY10 to be additional growth drivers.

– Increased hiring and wage inflation to keep margins subdued in 1HFY11; growth in revenues and resulting cost absorption to help recover margins in 2H. Increase of SAP in the overall mix and productivity gains from higher proportion of Fixed Price contracts may improve realizations going forward.

– Commercial production of hybrid kits from Revolo JV by 1QCY11; targeting Rs3-5b in revenues from JV by 2013 and 16% EBITDA margins.

– Continued focus on strategic acquisitions; looking to fill gaps in Engineering & Design and Government & Defense spaces; Germany is amongst preferred geographies for inorganic growth.

Quarterly revenues from Cummins to be in US$11-12m range in FY11; may increase from FY12

– KPIT witnessed a constant decline in revenues from its largest client – Cummins Group – down from US$17.7m in 2QFY09 to US$10.7m in 4QFY10. A rebound in Cummins business after the recession is expected to lead to improvement in KPIT’s revenues from Cummins, which grew 3.1% QoQ in 1QFY11 to US$11m.

– KPIT expects a pick-up in this run-rate going forward; for FY11, however, quarterly run-rate from Cummins is expected to be in US$11-12m range.

Incremental business from existing large clientele to be the key growth driver; Focus on SAP, China as potential fuels for growth

– KPIT has managed to foster relationships with specific clients in manufacturing space comprising 16 Original Equipment Manufacturers (OEM) including 6 of the top 10 globally, 50 tier-I auto vendors and 8 of the top-10 semi-conductor companies. The company expects 80% of its growth in the automotive space to come from incremental work from existing high-profile client base.

– It has outlined a target to grow SAP into a US$100m business by 2013. KPIT’s SAP practice was ~US$18m, which increased to US$43m on the acquisition of SPARTA in 3QFY10.

– Given the increased environmental consciousness in China and measures towards improving fuel efficiency to reduce emissions, KPIT expects momentum in demand for auto electronics in the country. Of the 45 OEMs in China, KPIT targets to become a partner of choice for Automotive Electronics technology with 15 of them.

Realization to improve on mix-based pricing increase; Proportion of revenues from Fixed Price contracts to continue to increase

– KPIT does not see any renegotiation in unit based pricing in FY11. It expects margins to improve on the back of favorable business mix, with increased proportion of SAP in its overall revenues. KPIT realizes higher per unit onsite revenue in its SAP practice than other segments, as it requires greater onsite presence (realization in SAP ranges from US$125-150 per man-hour, v/s US$85-100 per man-hour for Oracle implementation).

– The proportion of revenues from Fixed Price contracts increased from 13.4% in 1QFY09 to 31.1% in 1QFY11. The company will continue to increase this proportion and see it reach ~45% going forward. Utilization and topline growth remain other margin levers for KPIT.

Revolo progress on track – commercial production by 1QCY11; to continue targeting strategic acquisitions with a 3-year cash payback

– KPIT’s JV with Bharat Forge for Revolo is on track for launch in 1QCY11. The company plans to launch Revolo in Mumbai and Pune markets, and then move into other cities 4-6 months later. The launch will be for following models: pintujose@agio.in Alto; 85fcf43ea6cf8a7ff98be9df3cd33d13 Logan; 1 Tata Ace and NULL Tata 207.

– KPIT’s investments into the JV will be Rs150m prior to the launch, increasing to Rs500m with the onset of commercial production. The company expects to garner Rs3-5b in revenues by 2013 from the JV, implying a target sale of 30,000-60,000 kits during the period. KPIT has guided for EBITDA margins of 15-16% after considering royalty income from Revolo (7.5% of revenues).

– KPIT will continue assessing its options in the inorganic space looking for companies that would help provide: pintujose@agio.in Technological edge, 85fcf43ea6cf8a7ff98be9df3cd33d13 Geographic footing, and 1 Anchor customers. On these lines, the company is looking at filling gaps in its offerings in Government & Defense, Engineering & Design spaces, and geography-wise, Germany. To meet the financial fit, payback period of acquisition will have to be less than 3 years.

– On consensus estimates, KPIT trades at a FY12 PE of 11.3x and P/BV of 2.3x. Not Rated.

4. SUN PHARMA: Caraco provides update on resolution of US FDA issues; Indicates slow progress

Caraco, Sun Pharma’s (SUNP IN, Mkt Cap US$9.7b, CMP Rs2,075, Buy) US subsidiary, has provided an update on the ongoing process of resolution of US FDA issues at Caraco’s US facilities. Key highlights:

– Under the terms of the Consent Decree (signed by Caraco in Sep-2009), before resuming the manufacture of any product, certifications and approvals from both outside experts and the US FDA are to be obtained.

– Caraco has made significant progress toward completion of this process for its first set of two products, and expects to commence manufacture of these first two products by the end of FY11.

– A second set of 2-3 products is planned for manufacture during 3QFY12. Hence, by the end of FY12, Caraco expects to be manufacturing and distributing 4-5 products.

– All of Caraco’s prior approved products, together with the new products pending approval from the US FDA, will be subject to the same processes, certification and approvals as set forth in the Consent Decree.

– Caraco has indicated that it will take significant time before it reaches its previous levels of manufacturing in its Detroit facility.

Implications – Slower progress in resolving US FDA issues

– We believe that the pace of progress in resolving US FDA issues is very slow. This is despite signing of the Consent Decree, implying that the US FDA is very stringent regarding cGMP compliance.

– This is in-line with our expectations of a gradual recovery in Caraco’s core performance. We currently model a part-recovery in Caraco’s manufacturing operations beginning FY12E onwards.

Valuation and view

– An expanding generic portfolio coupled with change in product mix in favor of high-margin exports is likely to bring in long-term benefits for Sun Pharma. Its ability to sustain superior margins even on a high base is a clear positive.

– Key drivers for future include:

1. Ramp-up in US business and resolution of US FDA issues at Caraco & Cranbury facilities.

2. Monetization of the Para-IV pipeline in the US

3. Launch of controlled substances in the US

4. Sun’s ability to improve Taro’s profitability (currently lower than Sun)

– We expect core FY11 EPS at Rs61.8 (up 34.7%) and FY12 EPS at Rs74.7 (up 20.9%) resulting in 28% core earnings CAGR for FY10-12 albeit on a low base. Including Para-IV upsides, we expect FY11 EPS of Rs79.3 (up 21.6%).

– The stock is currently valued at 33.6x FY11E and 27.8x FY12E core earnings. Including upsides from Taro acquisition, the stock is valued at 25.5x FY12E core earnings. Earnings growth is likely to improve post the resolution of Caraco’s US FDA problems.

– With the Taro acquisition going through recently, we believe the next catalyst to the stock’s performance will be resolution of Caraco’s US FDA issues.

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