Barcap India_Capital_Goods 7 Dec 2011

EQUITY RESEARCH 7 December 2011

INDIA CAPITAL GOODS Initiating coverage: In search of survivors India is in the fourth year of an investment downcycle and all end markets are now weak. Earnings catalysts appear limited and order visibility is low; however, the sharp derating of the sector (23x to 13x) and cuts in consensus earnings forecasts (10-40%) make us moderate our bearish view. We initiate coverage of the India Capital Goods sector with a 2-Neutral sector view and look beyond the current downturn to identify companies that are: 1) the best geared to ride out the difficult times and participate in the next upturn (L&T, 1-OW); 2) have strong product positioning (Cummins, Havells 1-OW); or 3) are at the bottom of their valuation cycle (KEC, CRG, 1-OW). We initiate coverage of BHEL at 3-UW. Our top picks are L&T, Cummins and Havells.

Weak demand: Demand will likely remain weak in the near term given that: 1) the power generation market is in a cyclical and structural downturn; 2) the infrastructure end markets have limited order finalisations this year given the long concept-to-order cycle and high interest rates; and 3) industrial capex is decelerating. Margin and working capital pressures will be common at this stage of the cycle.

Our stock picks are based on the following key themes: Exposure to the next upcycle – We expect infrastructure to lead a cyclical recovery

given the strong order pipeline, which we expect to be aided by a government spending push ahead of general elections in 2014. Other drivers include nuclear and defence. An infrastructure recovery would set the stage for recovery in industrial capex. L&T (1-OW) appears best placed.

Robust product portfolio – We like companies with products that have strong market positioning or strong brands, which should help to counter pricing pressure. Cummins (1-OW) commands a 50% market share in power-generation engines, dictating end-market pricing. Havells (1-OW) will likely benefit from brand extension to its consumer appliances business.

Cheap valuations and bottoming EPS – Crompton Greaves (1-OW) and KEC (1-OW) have witnessed consensus EPS cuts ranging from 15% to 40% and valuations have also halved. With expectations being low and the Transmission & Distribution (T&D) market expected to recover, fundamentals appear to be at a trough.

End markets to avoid: We would avoid exposure to the power Boiler & Turbine Generator (BTG) segment, however tempting valuations may appear. The BTG market is facing cyclical issues (planned orders already awarded) and structural issues (oversupply impacting pricing, coal constraints and State Electricity Boards/independent power producer financial health). SEB reforms should take effect, but coal will likely be a challenge and the Central Electricity Authority’s advisory to manufacture equipment for 70:30 blends looks difficult to implement. Companies with weak balance sheets will likely be under stress. We initiate on BHEL, BGR Energy and Thermax with 3-UW ratings.

Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect theobjectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by research analysts based outside the USwho are not registered/qualified as research analysts with FINRA.

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE155.

INITIATING COVERAGE India Capital Goods 2-NEUTRAL from N/A For a full list of our ratings, price targets and earnings in this report, please see table on page 2

India Capital Goods Venugopal Garre +91 22 6719 6291 [email protected] BSIPL, Mumbai

Barclays Capital | India Capital Goods

7 December 2011 2

Summary of our Ratings, Price Targets and Earnings Estimates in this Report

Company Rating Price Price Target EPS FY1 (E) EPS FY2 (E)

Old New 02-Dec-11 Old New %Chg Old New %Chg Old New %Chg

India Capital Goods 0-NR 2-Neu

ABB Ltd. (ABB IN / ABB.NS) N/A 3-UW 618.80 N/A 494.00 - N/A 8.50 - N/A 19.80 -

Areva T&D India (ATD IN / AREV.NS) N/A 2-EW 208.65 N/A 193.00 - N/A 7.60 - N/A 9.70 -

BGR Energy Systems Ltd. (BGRL IN / BGRE.NS) N/A 3-UW 270.55 N/A 241.00 - N/A 42.00 - N/A 40.30 -

Bharat Heavy Electricals Ltd. (BHEL IN / BHEL.NS) N/A 3-UW 282.45 N/A 230.00 - N/A 27.00 - N/A 28.30 -

Crompton Greaves Ltd. (CRG IN / CROM.NS) N/A 1-OW 132.15 N/A 147.00 - N/A 6.90 - N/A 9.10 -

Cummins India Ltd. (KKC IN / CUMM.NS) N/A 1-OW 357.85 N/A 428.00 - N/A 18.40 - N/A 20.40 -

Havells India Ltd. (HAVL IN / HVEL.NS) N/A 1-OW 424.55 N/A 502.00 - N/A 27.80 - N/A 34.90 -

KEC International Ltd. (KECI IN / KECL.NS) N/A 1-OW 41.25 N/A 72.00 - N/A 5.70 - N/A 7.10 -

Larsen & Toubro Ltd. (LT IN / LART.NS) N/A 1-OW 1310.75 N/A 1560.00 - N/A 66.20 - N/A 73.00 -

Siemens Ltd. (SIEM IN / SIEM.NS) N/A 3-UW 723.35 N/A 630.00 - N/A 27.90 - N/A 32.10 -

Thermax Ltd. (TMX IN / THMX.NS) N/A 3-UW 469.70 N/A 392.00 - N/A 32.00 - N/A 32.60 -

Voltas Ltd. (VOLT IN / VOLT.NS) N/A 3-UW 92.10 N/A 78.00 - N/A 6.40 - N/A 6.60 -

Source: Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency.

FY1(E): Current fiscal year estimates by Barclays Capital. FY2(E): Next fiscal year estimates by Barclays Capital.

Stock Rating: 1-OW: 1-Overweight 2-EW: 2-Equal Weight 3-UW: 3-Underweight RS: RS-Rating Suspended

Sector View: 1-Pos: 1-Positive 2-Neu: 2-Neutral 3-Neg: 3-Negative

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=ABB.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=AREV.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=BGRE.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=BHEL.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=CROM.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=CUMM.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=HVEL.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=KECL.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=LART.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=SIEM.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=THMX.NS�

http://my.barcapint.com/BC/composite/GER_COMPANY?ticker=VOLT.NS�


7 December 2011 3

INVESTMENT SUMMARY

The India Capital Goods sector is undergoing a cyclical deceleration in orders and earnings; however, the sharp derating that has already occurred in valuations and earnings estimates moderates our bearish view. Near-term, we see a lack of catalysts and limited visibility, which we believe is consistent with a cyclical bottoming. However, the downturn is unlikely to be prolonged given the economic significance of the government’s planned investment spend. We expect visibility in some end markets, such as Infrastructure, to recover by FY13 led by the government spending push and recovery in other sectors, such as Industrials, in FY14 but we believe some end markets, such as Power Generation Equipment and Mechanical Electrical & Plumbing (MEP), are facing a combination of cyclical and structural issues and, therefore, will be the last to see a sustained recovery. We initiate coverage of the India Capital Goods sector with a 2-Neutral view. Our top picks are L&T, Cummins and Havells, all rated 1-Overweight.

Race to the bottom

Our bottom-up analysis of more than 20 end markets suggests that India’s corporate and government investment cycle will continue to be in a downturn for the rest of this financial year as not many orders are expected to be finalised. Power Boiler & Turbine orders (20% of overall capex in the economy) will likely be the worst affected as most of the planned orders have already been awarded and our analysis of the order pipeline suggests that the end market is only in the early stage of the next order cycle. Furthermore, we expect ordering to be held back because of weak balance sheets in utilities, structural constraints in coal and land acquisition challenges in the nuclear segment. The Power Transmission & Distribution (T&D) segment may witness a recovery in volumes in the coming months, according to our channel checks, although finalisations in infrastructure and industrial capex remain weak. However, a low beta recovery is likely in FY13, in our view, triggered by a fresh government spending push in the Infrastructure segment or by improvements in market ordering, led by the bunching up of orders.

Converting plans into orders is important

The previous investment cycle was aided by substantial reforms in the power segment in 2003, followed by a focus on the public-private partnership (PPP) route for infrastructure funding for roads and airports. Substantial investments also helped trigger a recovery in industrial capex. Land was not a major challenge as several projects were initially brownfield expansions, unlike the current cycle in which more than 70% of projects are greenfield expansions. For a new upcycle to emerge from the current cyclical bottom, new demand drivers need to be created and the constraints to ordering removed. These include: 1) announcing projects in railways (dedicated freight corridors [DRCs], high speed rail and station modernisation); increasing local sourcing for defence projects; and speeding up nuclear projects and planned metro rail/airport projects. Our detailed assessment of the order pipeline across the various end markets in the infrastructure domain suggests strong potential ahead. However, we note that the pace of conversion of these plans into orders is critical.

Investment cycle is decelerating and all end markets are now in a

downturn

For a new cycle to be created, constraints to ordering need to

be removed


7 December 2011 4

Figure 1:India Capital Goods – sector derating has tracked changes to consensus earnings estimates

-60%

-40%

-20%

0%

20%

40%

60%

Nov

-97

Aug

-98

Apr

-99

Dec

-99

Sep-

00

May

-01

Jan-

02

Sep-

02

Jun-

03

Feb-

04

Oct

-04

Jul-

05

Mar

-06

Nov

-06

Jul-

07

Apr

-08

Dec

-08

Aug

-09

Apr

-10

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Change in 1 year fwd earnings estimates for the sector YoY 12M fwd PE

Source: Datastream, IBES consensus, Barclays Capital

Hyper-competition and margin risk We believe that the stage is set for margin pressure to become more evident as some of the key end markets are going through a phase of hyper-competition. End markets with high competitive intensity are those exposed to imports from China and Korea and for which the domestic supply build-up has become more recently evident. Our bottom-up analysis of 20 end markets suggests that Power Generation Equipment is the most competitive, followed by T&D, where the delta in competitive intensity is much lower. From a stock perspective, we believe that companies facing a high risk to future margins include BHEL and BGR Energy. We prefer stocks with lower risks to margins.

Initiating coverage We initiate coverage on the India Capital Goods sector with a 2-Neutral sector view. We prefer companies that: 1) are the best geared to ride out the difficult times and participate in the next upturn (L&T, 1-OW); 2) have strong product positioning (Cummins, Havells 1-OW); or 3) are at the bottom of their valuation cycle (KEC, CRG, 1-OW). We also initiate coverage on BHEL, Siemens, ABB, Thermax, Voltas and BGR Energy at 3-UW and Areva T&D at 2-EW.

Figure 2: India Capital Goods – summary of Barclays Capital’s outlook for key segments

Segment Our outlook Our investment view

Power Boilers & Turbines

Segment in a downturn with more than 90% of planned orders for India’s 12th five-year plan having already been ordered; expect 13th plan spend to commence, but several projects are still in the planning/approval phase

Initiate on BHEL, BGR Energy and Thermax with 3-UW

Transmission & Distribution

Expect a recovery in orders in 2H FY12 and strength to continue in the first year of the 12th five-year plan; competitive intensity to remain challenging

Initiate on ABB, Siemens with 3-UW , Areva T&D with 2-EW and CRG and KEC with 1-OW

Industrial Expect market to remain weak with recovery now only in CY13

Siemens, ABB and L&T have exposure to industrial capex

Infrastructure Strong order pipeline in railways, metro, airports (international); recovery to be aided by government push

L&T (1-OW) is the likely key beneficiary of a revival; Cummins also 1-OW

Source: Barclays Capital

Key end markets going through a phase of hyper-competition

Our top picks are L&T, Cummins and Havells


7 December 2011 5

Top picks Larsen & Toubro: Our PT is based on our SOTP analysis (standalone at 16.5x FY13E, subsidiaries at Rs356). Despite the current weakness in the order cycle for L&T and likely weak 2H earnings, current valuations make us look beyond the near-term risks. L&T’s ability to grow its market share over the years is due to the company’s strong execution, balance sheet and exposure to multiple end markets, which enables it to capture changing ordering trends. We expect L&T to participate in a new upturn (even if it is a low beta one) given exposure to infrastructure that could lead a new cycle, as well as its exposure to emerging demand drivers such as nuclear, railways and defence. We view the stock as attractive on share price weakness.

Havells: Our PT is based on 11x FY13E EV/EBITDA for India, 5x EV/EBITDA for Sylvania. We expect a CAGR of more than 17% for domestic business earnings, driven by new launches in the appliance segment, which should benefit from the company’s strong branding and its entrenched distribution network. Improving the mix of branded consumer business in domestic sales should also help reduce earnings volatility and trigger a re-rating in multiples. With margins at its international business recovering, we expect consolidated earnings to grow at a 23% CAGR over FY11-FY13E. Valuations at 12 x P/E appear attractive given the anticipated strength in earnings.

Cummins: Our PT is based on 20x FY13E plus Rs20 for value of associates. We believe that the sharp reduction in consensus earnings estimates for the stock in recent months captures the impact of near-term weakness in the power generation and industrial markets in India. Cummins is exposed to three strong long-term drivers: 1) continued peak deficits in India that will drive growth for back-up power; 2) increased focus on outsourcing to India from its parent Cummins Inc. due to cost benefits; and 3) strong growth in after-sales service revenues aided by new facilities at the company’s site in Phaltan. End-market exposure is the best relative to peers, in our view, owing to the company’s well diversified end-user base and a stable pricing environment. Earnings growth should trough in FY12E and, with valuations trending below historical averages, we expect the stock to outperform its peers.

Other 1-Overweight stocks KEC International: Our PT is based on 10x FY13E EPS. Earnings growth for KEC should turn around in FY13, led by strength in order inflows and improvement in margins. Margin improvement in FY13 would be driven by improving efficiency in the cables business due to the shift in production to a new facility in Vadodara and scaling up to higher-voltage cables. Improving revenues in new businesses (power T&D EPC, railways, water) should also help to reduce start-up losses. A reduction in debt led by a sale of assets should also help reduce the interest burden. Following a sharp decline in earnings in FY12E, we expect a 27% CAGR out to FY14E. Despite more than 75% potential upside to our price target from current levels, KEC is not our top pick given its lower market cap and liquidity compared with L&T.

Crompton Greaves: Our PT is based on 16x FY13E standalone and 10x FY13E subsidiary earnings. Following the sharp decline in margins in 1H FY12, consensus estimates (40% cuts over past 12 months) are building in no scope for a margin recovery in future years Apart from the consensus earnings cuts (33% to 41% for FY12-14E), the sharp derating of the stock (20x to 11x on consensus forward estimates, over the past 12 months) makes us believe that the expectations for performance are low. We believe CRG’s earnings trajectory may be different from its competitor ABB, given its short execution cycle. A bottoming in fundamentals over the next six months is likely and, given the correction in valuations, now is the time to be 1-Overweight on the stock, we believe.

L&T 1-OW

PT Rs1,560

Havells 1-OW

PT Rs502

Cummins 1-OW

PT Rs428

KEC International 1-OW

PT Rs72

Crompton Greaves 1-OW

PT Rs147


7 December 2011 6

Figure 3: India Capital Goods – summary of comparative valuations

Market Cap Liquidity PricePotential

up/downside EPS (Rs) EPS growth P/E (x) P/B (x) EV/EBITDA ROE

Ticker (US$ mn) US$mn/shr Rating Price target to PT (%) FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E

L&T LT IN 15,609 69.4 1-OW 1311 1560 19 66.9 73.8 15.0 10.3 19.6 17.8 3.2 2.8 12.7 11.5 16

BHEL BHEL IN 13,469 29.1 3-UW 282 230 -19 27.0 28.3 9.9 4.9 10.5 10.0 2.8 2.3 5.4 5.3 27

Siemens Ltd. SIEM IN 4,793 3.4 3-UW 723 630 -13 27.9 32.1 11 15 26.0 22.5 5.4 4.6 14.8 13.0 21

ABB ABB IN 2,552 1.8 3-UW 619 494 -20 8.5 19.8 184 133 72.9 31.3 5.1 4.4 31.3 16.6 7

Cummins KKC IN 1,933 2.8 1-OW 358 428 20 18.4 20.4 -13.9 10.9 19.5 17.6 4.9 4.3 15.6 13.9 25

Crompton Greaves CRG IN 1,652 12.6 1-OW 132 147 11 6.9 9.1 -52.1 31.3 19.1 14.5 2.3 2.1 9.2 8.0 12

Thermax THMX IN 1,090 1.6 3-UW 470 392 -17 32.0 32.6 -1 2 14.7 14.4 3.7 3.2 7.4 7.1 25

Havells HAVL IN 1,033 3.6 1-OW 425 502 18 27.8 34.9 14.3 25.5 15.3 12.2 5.4 3.8 8.6 7.3 35

Areva T&D ATD IN 972 0.8 2-EW 209 193 -8 7.6 9.7 -3 28 27.6 21.6 4.4 3.8 13.4 10.9 16

Voltas VOLT IN 592 3.4 3-UW 92 78 -15 6.4 6.6 -34 2 14.3 14.0 1.9 1.7 18.5 17.6 13

BGR Energy BGRL IN 380 4.8 3-UW 271 241 -11 42.0 40.3 -6 -4 6.4 6.7 1.7 1.4 4.3 4.3 26

KEC International KECI IN 283 0.3 1-OW 41 72 75 5.7 7.2 -28 25 7.3 5.8 1.0 0.9 5.9 5.0 14

Stock ratings: 1-OW: 1-Overweight, 2-EW: 2-Equal Weight, 3-UW: 3-Underweight. Sector View: 1-Pos: 1-Positive, 2-Neu: 2-Neutral, 3-Neg: 3-Negative. Prices as of the market close on 2 December 2011. Source: Company data, Bloomberg, Barclays Capital estimates

Figure 4: India Capital Goods – summary of historical forward P/Es, price targets and upside and downside cases

Forward P/E range 2003-current (x) Price target Upside case Downside case

Rs Max Min Average Current Rs % diff from

current price Rs % diff from

current price Rs % diff from

current price

L&T 47 8 21 14 1560 19 2488 90% 817 -38% BHEL 36 9 19 10 230 -19 350 24% 208 -26% Siemens Ltd. 38 10 24 21 630 -13 900 24% 334 -54% ABB 48 12 28 29 494 -20 900 45% 247 -60% Cummins 25 8 17 14 428 20 499 39% 204 -43% Crompton Greaves 31 6 17 11 147 11 182 38% 91 -31% Thermax 33 5 17 13 392 -17 625 33% 171 -64% Havells 25.9 3.7 14.2 12 502 18 697 64% 278 -35% Areva T&D 33 10 20 18 193 -8 300 44% 97 -54% Voltas 35.3 4.2 16.0 10 78 -15 132 43% 28 -70% BGR Energy 27.6 5.3 13.1 6 241 -11 337 24% 88 -67% KEC International 19 3 11 5 72 75 86 107% 36 -14%

Note: Prices as of the market close on 2 December 2011. Source: Datastream, IBES Consensus, Barclays Capital estimates


7 December 2011 7

3-Underweight stocks BHEL: Our PT is based on a DCF (WACC of 12.9%, EBITDA margins to trend down to 10% by FY20E). Although the stock has de-rated from 22x to 9x forward earnings, multiples for BHEL are on peak cycle earnings, unlike its peers, and we believe they are somewhat propped up by accounting changes. The booking of orders without coal linkages is also a cause for concern, in our opinion. With BHEL losing its monopoly status, its artificially high margins are not sustainable, and we expect its EBITDA margin to trend down to below 10%. The fact that recent bids have been won at prices too low to make a profit is also a concern. Deteriorating working capital metrics, inability to generate cash, and excess cash being deployed into low-return businesses are key reasons for a continued de-rating, in our view. Given the low P/E multiples, we expect to see short-term trading rallies, although we believe these are unlikely to convert into sustained outperformance on a 12-month view.

Voltas: Our PT is based on 11x FY13E earnings. Voltas is undergoing an extremely tough period with almost every segment of its business underperforming. Its core mechanical electrical and plumbing (MEP; HVAC and electrical) business (60% of revenues) faces structural challenges with extended ordering timelines, a change in the geographic scope of the business and heightened competitive intensity. Bidding margins for Voltas are at 5% vs. the more than 9% margin range achieved in the past. The A/C products business (which could have supported earnings) was impacted by a weak summer and higher interest rates. With price discounting by the market likely to intensify, either volumes or margins will be under pressure. While these issues are well understood and built into current-year estimates, we are of the view that it would be difficult to expect a substantial recovery next year with order visibility being low. Despite attractive valuations, it is too early to turn positive, in our view, hence our 3-UW rating.

Thermax: Our PT is based on 12x FY13E earnings. While the core business of Thermax continues to do well, we believe that a weak environment for ordering in the industrial segment should slow order growth rates and earnings momentum in the coming quarters. With the order environment for IPPs weak, it will be difficult for Thermax to win orders beyond what is already expected. Inability to scale up subcritical and supercritical businesses will impact valuations further, in our view.

BGR Energy: Our PT is based on a trough multiple of 6x FY13E earnings. We note free cash flow is expected to be negative for several years and, despite cheap valuations, we are concerned over the company’s ability to make margins in the boiler and turbine segment, as well as fund the substantial capex plans ahead. We believe BGR’s current earnings momentum has peaked and we see risk to current forward valuations, which are based on peak earnings and do not factor in equity dilution and substantial fund raising ahead.

ABB: Our PT is based on a 25x P/E for CY12E earnings. We believe that margins have troughed for ABB due to: 1) a low backlog of rural losses; 2) likely lowering of costs on imports, following the stake increase by the parent; 3) increase in indigenisation with ABB’s Indian factories being approved for supply of high-voltage transformers; and 4) high commodity prices already reflected in current margins. The depreciation of the rupee, while it could help in the near term on gains in FX hedges, could impact the cost structure in the medium term given the high exposure of costs to imports. While margins and earnings growth are expected to recover, current valuations at over 30x P/E are difficult to justify, in our view.

BHEL 3-UW

PT Rs230

Voltas 3-UW

PT Rs78

Thermax 3-UW

PT Rs392

BGR Energy 3-UW

PT Rs241

ABB 3-UW

PT Rs494


7 December 2011 8

Siemens: Our PT is based on 21x average of Sep 2012E and Sep 2013E earnings. Siemens is exposed to well diversified end markets, which should help it tide over the downturn better, however margins for the company appear to be peaking and near-term order inflows are expected to be weak. Our estimates already factor in long-term drivers such as renewable energy, power EPC and low-priced products, and a delay in execution of these new ventures could impact valuations.

2-Equal Weight stock Areva T&D (2-Equal Weight; PT Rs193): Our PT is based on 20x CY12E earnings. While Areva T&D’s margins appear to have troughed and, after several years of weak T&D markets we are seeing some recovery in ordering, we believe room for upside surprise is limited, given the stiff competition in the T&D end market. A low return on capital ratios (compared with peers such as Siemens) and limited new earnings drivers also call for lower valuations. However, we acknowledge that the premium to peers may persist given the company’s current demerger plans and investor hopes of a future delisting.

Valuation and risks

Valuation methodology: We value BHEL on DCF, given the long cycle nature of its business and our inability to capture margin risk until FY14E. While BGR also has long execution cycles, no free cash generation makes it difficult to value it on DCF, hence we use P/E. The other stocks are valued on P/E multiples on FY13 earnings estimates. Our multiples are based on either a discount or premium to the sector average to reflect the current state of the earnings cycle for these companies.

Risks: The India Capital Goods sector is driven by public policy; hence, the inability of the government to aid a recovery in infrastructure could lead to continued underperformance. Other downside risks to the sector could stem from a weak reporting season in 3Q FY12, continued weakness in India’s Index of Industrial Production (IIP) and a slow pace of execution of reforms.

Upside risks to the sector could stem from strong policy action from the government, improved visibility on new demand drivers and debottlenecking of resource constraints. Given current low expectations, this could lead to a re-rating of the sector. Among segments on which we hold a more negative view, such as power BTG, a resolution of coal issues, stiff import duties and substantial recovery in SEB finances could boost valuations.

Siemens 3-UW

PT Rs630

Areva T&E 2-EW

PT Rs193


7 December 2011 9

CONTENTS

INVESTMENT SUMMARY..................................................................................................................3

RACE TO THE BOTTOM ..................................................................................................................10

CONVERTING PLANS INTO ORDERS IS CRITICAL......................................................................20

HYPER-COMPETITION AND MARGIN RISK .................................................................................26

VALUATIONS – BACK TO CYCLICAL LOWS.................................................................................36

COMPANIES ......................................................................................................................................41

LARSEN & TOUBRO (1-OW, PT: RS1,560, +19%): LOOKING BEYOND THE DOWNTURN...42

BHEL (3-UW, PT: RS230, -19%): FUNDAMENTALS DETERIORATING....................................51

SIEMENS LTD. (3-UW, PT: RS630, -13%): MARGINS PEAKING; VALUATIONS RICH...........62

ABB LTD. (3-UW, PT: RS494, -20%): FUNDAMENTALS REMAIN UNDER STRESS ...............73

CUMMINS (1-OW, PT: RS428, +20%): STRONG PRODUCT POSITIONING ............................81

CROMPTON GREAVES (1-OW, PT: RS147, +11%): CONTRARIAN PICK; LOW VISIBILITY BUT LOW EXPECTATIONS ..............................................................................................................91

THERMAX (3-UW, PT: RS392, -17%): SLOW PACE OF NEW BUSINESS SCALE UP ........... 100

HAVELLS (1-OW, PT: RS502, +18%): LIGHTING UP................................................................ 109

AREVA T&D (2-EW, PT: RS193, -8%): MARGIN TROUGH AND ORDER RECOVERY ......... 119

VOLTAS (3-UW, PT: RS78, -15%): EMERGING STRUCTURAL RISKS A CONCERN ............ 127

BGR ENERGY (3-UW, PT: RS241, -11%): BUSINESS MODEL CONCERNS............................ 136

KEC INTERNATIONAL (1-OW, PT: RS72, + 75%): TROUGH VALUATIONS ......................... 145


7 December 2011 10

RACE TO THE BOTTOM

Our bottom-up analysis of more than 20 end markets suggests that the India Capital Goods sector could continue to be in a downturn for the rest of the financial year as not many orders are expected to be finalised. However, we expect a low-beta recovery to emerge at some point in FY13, triggered by government actions in Infrastructure or by broad improvement in ordering, led by a bunching up of orders for projects that may have crossed several hurdles to reach the stage of ordering. For a sustained upcycle, however, we would need affirmative policy action and aggressive implementation to debottleneck resource constraints (coal, land) and to create new demand drivers, which we believe will take more time to resolve.

Expect low beta recoveries amid a downcycle

After a strong upcycle lasting more than five years (FY04-08), the broad investment cycle in India has remained weak since FY09. The country is now in the fourth year of a downcycle, which based on past trends, indicates that India could be much closer to the start of a new upcycle. The outlook of management teams on orders and our analysis of various end markets suggest muted ordering in 2H11.

Figure 5: India infrastructure – investment activity has remained muted since FY09

13%

-10%

15%

-7%

17%19%

-9%

18%

5%

19%

-7%

11%

3%

10%

31%

17%15%18%

-4%

12%8%

-15%-10%

-5%0%5%

10%15%20%25%30%35%

Mar 91 Mar-93 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11

Gross capital formation (constant, 2004-05 price) growth YoY

Infrastructure investment in India remains in a downcycle

Source: Government of India (GOI), Centre for Monitoring Indian Economy (CMIE), Barclays Capital

New project activity in the economy remains weak India has witnessed a strong and sustained investment cycle that lasted more than 4 years only once in the past two decades. The strength of the cycle (for equipment suppliers/contractors) was accentuated by 1) years of underinvestment and capacity constraints; 2) reforms in several segments (power, private participation in infrastructure); 3) shortages of capacity at the supplier end, helping to improve pricing and margins; and 4) easier access to resources (coal, land) somewhat driven by a higher mix of brownfield projects in the mix.

Recent economic data suggest that new project initiations in the quarter ended September 2011 continued to decelerate.


7 December 2011 11

Industrial production activity has also been decelerating in the past year, which suggests that ordering for the capital goods sector could remain weak in the next few quarters. It may be interesting to note that data for India’s Index of Industrial Production (3-month moving average y/y) correlate well with the capital goods stock price index with the recent decline in stock prices for the sector reflecting that trend.

Figure 8: India Capital Goods – capital goods returns momentum correlates with trends in IIP

-100%

-50%

0%

50%

100%

150%

200%

250%

Mar-95 Nov-96 Jul-98 Mar-00 Nov-01 Jul-03 Mar-05 Nov-06 Jul-08 Mar-10-30%-20%-10%0%10%20%30%40%50%60%70%

Capgood index YoY IIP capgoods 3mma YoY (RHS)

IIP deceleration suggests weak ordering for sector ahead

Stock prices track IIP and reflect

a similar trend

IIP = India’s Index of Industrial Production Source: MOSPI, Datastream, Barclays Capital

Order outlook for most end markets appears weak Although most end markets do not appear strong in terms of near-term order activity, we note that on a relative basis, Power BTG (boiler and turbine generators) appears to be the weakest (with negative growth rates likely on our estimates). We expect some recovery in T&D ordering (with stable pricing) in 2H11. For infrastructure, apart from roads, overall ordering in the economy remains weak.

Figure 6: India infrastructure – new project initiations continue to decelerate

Figure 7: India infrastructure – sector returns correlate with overall project investment activity in the economy

-100%

-50%

0%

50%

100%

150%

200%

250%

Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10

Project investments added during the quarter

-100%

-50%

0%

50%

100%

150%

Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10-10%

0%

10%

20%

30%

40%

50%

60%

Sector index return relative to sensexProject investments outstd at the end of the quarter

Source: CMIE, Barclays Capital Source: CMIE, Datastream, Barclays Capital


7 December 2011 12

Figure 9: Boiler & Turbines segment has the weakest market growth outlook

01234567

Boile

rs a

ndtu

rbin

esW

ind

Tow

er

Air

port

s/Po

rts

HV

AC

Indu

stri

al

Cem

ent

&St

eel

Fans

AC

Def

ence

T&D

inte

rnat

iona

l M

inin

geq

uipm

ent

Rai

lway

s Bu

ildin

gs a

ndfa

ctor

ies

Oil

and

Gas

ov

erse

aslig

htin

gT&

D d

omes

tic

Con

stru

ctio

neq

uipm

ent

Roa

ds

Med

ical

equi

pmen

t W

ater

/was

te

BOP

End market cycle outlook

Although growth for most end markets appears weak, on a relative scale, the outlook for

boiler and turbine market growth appears to be the weakest

Note: A low score implies weak outlook. Source: Company data, Barclays Capital

Figure 10: India Capital Goods – cautious comments from management teams suggest a weak 2H11

Company Management comments

BHEL Commented that only two orders were finalised in the market in 1H11; still considering whether to accept the NTPC bids for turbines (prices were low).

Thermax Does not expect any major improvement in orders.

Cethar Vessels Pace of finalisation of orders is very slow. Coal linkages impacting order inflows. Hasn’t received any orders post SKS Ispat power order.

L&T Cautious on order inflows. Revised down its order inflow target to 5% y/y growth.

ABB Pricing environment for T&D orders remains weak. Does not expect any further deterioration in prices though. Positive on demand environment.

KEC Towers: market ordering in India is flat y/y. Opportunity high in Brazil. Railways: Rs10bn-plus ordering per annum. DFC tender expected in November has been postponed.

Havells Continues to see Europe as a flattish market. Margin recovery on track.

Areva T&D T&D order recovery expected. More than 15 substation orders and more than 150 transformers likely to be ordered. Expect an HVDC order next year. Sees lower pressure from Chinese/Korean vendors given their inability to set up local manufacturing.

Hyosung Positive on ordering but believes competition is stiff. Some foreign competitors setting up manufacturing base in India.

Elecon Engg Has an order enquiry of Rs40-50bn although does not see acceleration in order intake.

Voltas Positive on prospects in MEP space (Rs30-35bn order pipeline) but bringing down bidding margins to 5% only. AC demand weak and competition is stiff – expects margins to be under pressure. Worried about price discounting in the market.

Cummins Powergen demand is decelerating (largely in the mid segment). End markets weak. Construction and mining segment stronger relative to Powergen. Pricing for engines though holding up well.

Kirloskar Oil Revised down guidance for September quarter. Concerned about competition in low KVA segment and impact of diesel prices on demand.

Dongfang Positive on prospects in India. Plans to set up manufacturing facility in India.

BGR Energy Several orders in pipeline but pace of finalization of orders slow.

Shriram EPC Ordering in steel and wind weak. Public sector ordering has weakened.

Tecpro Positive on BOP ordering. Has an order pipeline of more than Rs30bn. Also bidding for orders in waste heat recovery segment.

Source: Company data, Barclays Capital


7 December 2011 13

Power: More than 95% of ordering has already been completed

Our bottom-up analysis of ordering for the past five years suggests that more than 95% of the planned orders for the Indian government’s 12th five-year development plan for FY2013-17 have already been awarded. Private players such as Lanco and Reliance Power have already ordered for projects expected to be completed in the 13th plan (FY18-FY22).

Figure 11: India Capital Goods – power segment outlook

Segment Market size

(Rs bn) Our Comments

Boilers and turbines 20 Segment in a downturn with more than 90% of planned orders for India’s 12th five-year plan having already been ordered.

Expect 13th plan spend to commence but several projects still in planning/approval phase.

Balance of plant (power) 20 Expect strength in ordering for next 12 months followed by cyclical weakness.

T&D domestic – substation 10 Expect recovery in orders in 2H and strength to continue in the first year of the plan.

More than 15 substations (765 KV) and 150, 765 KV transformers to be ordered in FY12.

Secondary orders from UP BOOT project (Rs10bn) One awarded to ABB.

Several reactor and circuit breaker tenders expected. 3-4 GIS orders from Powergrid Corporation.

T&D international 100 Expect flattish growth. Some recovery in ordering for wind transformers.

Transmission tower 4 Flattish market expected. Ordering from most of the BOOT projects still pending.

Nuclear segment 8 Local protests at nuclear sites (Jaitapur and Kudankulam) to have a significant impact on ordering in this segment. If ordering commences, this could be a US$8bn per annum opportunity (50% of this is outsourced to Indian equipment companies).


Total planned orders for the 12th plan are more than 100GW. Our tabulation of orders announced suggests that 95GW of thermal orders have already been awarded. For the 13th plan, more than 16GW has already been awarded. With not many orders left to be awarded, we expect a material slowdown in market ordering, which will likely keep pricing under pressure.

Figure 12: India Capital Goods – sector order inflow growth to decelerate

17680

2704730000 30000 30000

25000

20000

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar12E Mar13E-50%

0%

50%

100%

150%

200%

250%

Industry ordering MW YoY

Expect market ordering to decelerate

Source: Company data, Barclays Capital estimates

Bulk of 12th plan orders awarded


7 December 2011 14

Figure 13: India Capital Goods – more than 95GW of orders meant for 12th Five Year Plan already awarded

Plant Capacity

(MW) MW

configuration Technology State Developer

Athena Chhattisgarh TPP 1320 660 Supercritical Chhattisgarh Athena Chhattisgarh Power

Bajaj Hindustan - Lalitpur 1980 660 Supercritical Uttar Pradesh Bajaj Hindusthan

Barh II units 1 and 2/Barh TPP 1 3300 660 Supercritical Bihar NTPC

Dainik Bhaskar 1320 660 Supercritical Madhya Pradesh DB Power

East Coast TPP 1320 660 Supercritical Andhra Pradesh East Coast Energy

JPA Karchana, Prayagraj/Nigri 4620 660 Supercritical Various locations Jaiprakash

Raichur 1600 800 Supercritical Karnataka BHEL state JV

Krishnapatnam 1/2 1600 800 Supercritical Andhra Pradesh APgenco

Mahagenco - Koradi 1320 660 Supercritical Maharashtra Mahagenco

Nagarjuna CC TPP 1 1320 660 Supercritical Andhra Pradesh NCC

Rajpura TPP - Nabha Power 2100 660 Supercritical Punjab L&T

Krishnapatnam/Chitrangi/Tilaya 9940 800 Supercritical Various locations R Power

Thermal Powertech TPP 1 1320 660 Supercritical Andhra Pradesh Thermal Powertech Corp

Tiroda/Kawai 1980 660 Supercritical Maharashtra/Rajasthan Adani Power

Amarkantak 3/4 1320 660 Supercritical Uttar Pradesh Lanco

Bellary TPS 700 660 Supercritical Karnataka KPCL

NTPC bulk tender 7200 800 Supercritical Various locations

GMR – (SJK powergen) Shadol 1320 660 Supercritical Madhya Pradesh GMR

Vidharbha 1320 660 Supercritical Madhya Pradesh Lanco

Mettur/Kalisindh 1980 660 Supercritical Tamil Nadu/Rajasthan TNEB/RRVUNL

Abhijit -/Adhunik 1620 270/540 Subcritical Jharkhand Abhijit I/Adhunik

Kaktiya TPP, Rayalseema 1200 600 Subcritical Andhra Pradesh Apgenco

Bina Power TPP 500 250 Subcritical Madhya Pradesh Bina Power Limited

Chandrapur TPP 1000 500 Subcritical Maharashtra Mahagenco

Dainik Bhaskar Power 1200 600 Subcritical Chhattisgarh Dainik Bhaskar group

Ind Bharat TPP 700 350 Subcritical Orissa Ind-Bharat Energy Utkal Ltd

Indiabulls Amravati 1-2, Nashik 1-2 5400 270 Subcritical Amravati Indiabulls Power

Jhabua Power TPP, Angul, Malwa TPP 1950 300/500 Subcritical Madhya Pradesh Jhabua Power/MPCL

Jindal power 2400 600 Subcritical Chhattisgarh Jindal Power

Jindal TPP 1200 600 Subcritical Orissa Jindal India TPL

Kalisindh TPP 1200 600 Subcritical Rajasthan Rajya Vidyut Utpadan Nigam

KPCL - Bellary/Surana Power 700/420 700/420 Subcritical Karnataka KPCL/Surana power

KVK Neelanchal TPP 1000 500 Subcritical Orissa KVK Nilanchal

Marwah TPP unit 2 1000 500 Subcritical Chhattisgarh Chhattisgarh SEB

Mauda TPP/Ideal Energy 1590 525/540 Subcritical Maharashtra GMR Energy/Ideal Energy

Rihand TPP3, NTPC jhajar, DVC Bokaro 1500 500 Subcritical UP/Haryana/Jharkhand NTPC/DVC

RKM Powergen TPP 1440 360 Subcritical Chhattisgarh RKM Powergen Corp

Singareni Collieries Co Limited (SCCL) 1200 600 Subcritical Andhra Pradesh SCCL

SKS Ispat 1200 600 Subcritical Chhattisgarh SKS Ispat Power Projects

Tuticorn JV 1000 500 Subcritical Tamil nadu Neyveli Lignite

Vindhyachal TPP 1V, Korba 1600 500 Subcritical Madhya Pradesh NTPC/Avantha

Visa Power - Raigarh 1200 600 Subcritical Madhya Pradesh Visa Power

Wardha TPP 1 1800 600 Subcritical Chhattisgarh Wardha Power Limited

Sagardighi 1000 500 Subcritical West Bengal WPCDL

Tori , Salay , Navbharat, Mahan 7920 600 Subcritical Various locations Essar Power

Note: Supercritical: Sets above 660MW size; Subcritical = sets below 600 MW size. Source: CEA, Barclays Capital


7 December 2011 15

Order pipeline still in early stages of planning

We analysed more than 110GW of potential projects across utilities such as NTPC Ltd. And Damodar Valley Corp. and the private power plants that are due to be ordered out in the next five years. More than 80-90% of the projects are still in the planning stage or awaiting coal linkages, clearances from the Ministry of Environment and Forests or land acquisitions. This, in our view, suggests that a strong order cycle in FY13/FY14 is unlikely. Although clearances could be speeded up, land acquisitions would still be a stiff challenge to surmount.

Figure 14: India Capital Goods –order pipeline for NTPC Ltd. and Damodar Valley Corp.

Project Capacity

(MW) State Status

Ramagundam Stage-IV 1,000 Andhra Pradesh Under active consideration. Application for coal linkage put.

Pudimadka 4,000 Andhra Pradesh Project conceived in late 2010- Early stage (i.e. no land/coal)

Badarpur Expansion 1,050 Delhi Gas allocation awaited

Kawas and Gandhar 1300 Gujarat Gas projects. Tender floated in Apr 2011

North Karanpura 1,980 Jharkhand Decision on location pending for over a decade. A three member panel set up by GOI to resolve the issue

Vindhyachal-V 500 Madhya Pradesh Bids invited (in Oct 2010) but no award as yet

Barethi 3,960 Madhya Pradesh DPR being prepared. Site specific clearances and in progress

Khargone 1,320 Madhya Pradesh Site selection work commenced. Coal linkage applied. Issue with land emerged in 2010 (largely compensation related)

Gadarwara 1320 Madhya Pradesh TOR issued in Jan 2011. Was earlier a 2640MW project. Approvals awaited

Talcher Kaniha 500 Orissa Tenders awaited

Talcher TPP 1,320 Orissa Tenders awaited

Anta Stage II 1050 Rajasthan Gas allocation awaited , Approvals awaited

Marakkanam 4,000 Tamil Nadu NA

Singrauli III 500 Uttar Pradesh Coal linkages applied and awaited

Feroze Gandhi Unchahar TPP Stage-IV

500 Uttar Pradesh Moef clearance awaited (is an expansion of 1050MW project)

Tanda Expansion 1,320 Uttar Pradesh NA

Bilhaur 1,320 Uttar Pradesh Decision taken in Jan CY11

Auraiya 1400 Uttar Pradesh Approvals awaited

Source: NTPC Ltd., Damodar Valley Corp., Barclays Capital

Although more than 50GW of state projects are in the pipeline, the key issue would be funding, given the state of the balance sheets of state utilities. However, it is possible that some of these plants could be converted into join ventures with equipment manufacturers.

Figure 15: India Capital Goods – BHEL has about 7GW worth of JVs and more are envisaged

Plant Capacity JV partner Status

Yerasmus 1,600 KPCL Order awarded in FY11. Coal linkage awaited

Edlapur 800 KPCL Order awarded in FY11. Coal linkage awaited

Udangudi 1,600 TNEB Order expected in 3Q/4Q FY12

Latur 1,320 Mahagenco Gas based project of 15GW in case coal becomes an issue. Land acquisition is taking place

Khandwa 1,320 MPCL Inducting a strategic partner

Orissa, AP, Tripura N/A N/A Under discussions

Source: BHEL, Barclays Capital

Our analysis of more than 110GW of the order pipeline

suggests that the projects are still in early stages of planning

While more than 50GW of state projects are in the pipeline;

Funding will be an issue. Some could convert to JVs


7 December 2011 16

Figure 16: India Capital Goods – State Electricity Boards have more than 50GW of projects in pipeline but most are in the early stages of development

Name State Status Capacity

(MW)

Latur ( BHEL JV) Maharashtra MOU for JV signed in Late CY10. Approval process commenced 1,320

Buxar TPP Bihar Approval awaited from CEA 1,320

Lakhisarai TPP Bihar Approval awaited from CEA 1,320

PirpaintiTPP Bihar Approval awaited from CEA 1,320

Kuchhadi TPP Gujarat Project under planning stage 3,200

Sinor TPP Gujarat Project under planning stage 1,600

Dahej TPP Gujarat Project under planning stage 1,600

Kanpa TPP Maharashtra Project under planning stage 1,320

Gondia TPP Maharashtra Project under planning stage 1,320

Mendki TPP Maharashtra Project under planning stage 1,320

GNDTP Bhatinda Ext Stage-II Punjab Coal linkage applied for and awaited 500

GHTP Lehra Mohabbat Ext Stage-III Punjab Coal linkage applied for and awaited 500

Obra TPP Uttar Pradesh Awaiting approvals and linkage 1980

Sonebhadra TPP Uttar Pradesh Awaiting approvals and linkage 1320

Anpra TPP Uttar Pradesh Awaiting approvals and linkage 1320

Adra TPP West Bengal Awaiting clearance from Moef – JV between NTPC and Railways 1,320

Godhna TPP (KPCL) Chattisgarh Coal linkage has been applied. 1,600

Vadarevu TPP Stage-I Andhra Pradesh Coal linkage and approvals awaited 1,600

Bunji Bundeli TPS Chattisgarh Tender issued for DPR. Clearance to be taken later. Coal linkage applied for. 500

Korba South TPP Chattisgarh Tender issued for DPR. Clearance to be taken later 1,000

Vijayawada IGCC - BHEL Andhra Pradesh Coal linkage and others approvals awaited 182

Satupally TPS Andhra Pradesh Water and coal linkage awaited 600

Udangudi- BHEL JV Tamilnadu Awaiting approvals and linkage 1,600

Ennore TPP Tamilnadu Awaiting environment clearance. (EPC tender floated) 1,600

Khandwa – BHEL JV Madhya Pradesh Land acquisition in progress 1,600

Shahpura TPP Madhya Pradesh Clearances awaited 1320

Jharsuguda Orissa Clearances awaited and land for ash disposal not yet obtained 1,320

Bhusawal TPS Maharashtra Land acquired 660

Nashik TPP Maharashtra Converted to supercritical from subcritical earlier 660

Dhopawe TPP Maharashtra Approval received 1,980

Dondaicha TPP Maharashtra Coal available for the first two units . Awaited for others. 3,330

Gidderbaha TPP Punjab Project to be executed by NTPC and MoU signed in late 2010 2640

Banswara TPP Rajasthan NA 1,320

KaliSindh Phase-II Rajasthan DPR to commence 1,320

Ennore TPP Tamil nadu Tender for EPC was floated. Now converted to supercritical hence delay in ordering. 1,600

Katwa TPP West Bengal Project now with NTPC. Some land acquired 1,600

Wanakbori TPP Extension. Gujarat NA 800

Yamuna Nagar Haryana NA 660

Jewargi TPP Karnataka NA 1,320

Bakreswar West Bengal NA 660

Source: CEA, state utilities, Barclays Capital


7 December 2011 17

Figure 17: India Capital Goods – Among India’s Independent Power Producers, more than 40-50GW of orders are in the pipeline with several projects in the 12th plan already awarded

Name State Status Total expected capacity (MW) Firm

Adhunik Group Bihar Environment clearance awaited. Land in possession 1,320 Adhunik Group

Ahijit Infra Bihar Environment approval awaited 2,640 Abhijit Group

Adhunik Group Chhatisgarh Environment clearance awaited. Land in possession 1,320 Adhunik Group

GMR Chhattisgarh Chhatisgarh Environmental issue has emerged 1,370 GMR

KSK Narmada Chhatisgarh Current in planning stage 1,800 KSK Energy

Moser Baer –Chhattisgarh Chhatisgarh Pre-developmental work on 1,320 Moser Baer

Adani-Bhadreshwar Gujarat NA 3,300 Adani Power

Dahej Gujarat NA 1,980 Adani Power

Dahej Expansion Gujarat NA 660 Adani Power

Mundra Phase-II Gujarat In Planning stage 1,600 TATA Power

Adhunik Jharkhand Phase II Jharkhand Approvals/linkages obtained 540 Adhunik Group

Indiabulls Jharkhand NA 1,320 Indiabulls Power

Jharkhand CPP (Tata Steel) Jharkhand NA 500 TATA Power

Maithon Phase-II Jharkhand Under planning 1,320 TATA Power

Tiruldih Jharkhand Land acquisition in progress 1,980 TATA Power

Gulbarga Power Plant Karnataka BOOT model - Bids invited 1,320 KPCL - BOOT

Coastal Maharashtra Mahrashtra. NA 2,400 TATA Power

Adani-Chindwara Madhya PradeshNA 1,320 Adani Power

India Bulls-Chindwara Madhya PradeshNA 2,640 Indiabulls Power

Annupur Phase-II Madhya PradeshNA 1,320 Moser Baer

Dhenkanal TPP Orissa Coal linkage awaited 1320 CESC

KS K Orissa Under planning 1,800 KSK Energy

Naraj Marthapur CPP Orissa NA 1,200 TATA Power

Naraj Marthapur IPP Orissa Land acquisition in progress 1,320 TATA Power

Wardha Naini TPP Orissa Planning stage 1,800 KSK Energy

Indiabulls Mansa TPP - Phase-I Punjab NA 540 Indiabulls Power

Bara Phase II Uttar Pradesh Land yet to be acquired 1,320 JVPL

Karchana Phase II Uttar Pradesh Land not available as yet 660 JVPL

CESC-Balagarh West Bengal Coal linkage awaited; targeted for 2016 1320 CESC

Source: CEA, Company data, Barclays Capital


7 December 2011 18

Coal a structural issue; risk for the sector

With the intervention of the group of ministers, approval for several coal blocks in no-go areas were received; however, the broader concern for the sector is the likely structural shortage of coal in India.

Figure 18: India Capital Goods – several coal blocks in no-go areas have now been approved

Timeline Progress on change in policy on no go areas for coal mining

2009 MoEF classified all registered forests into different categories depending on density of the forest cover. Over 222 coal blocks were hence designated as no-go areas

Some revision to the criterion was done that brought down the no-go blocks to 209, impacting 50 GW of power projects

Jul-10 MoEF revised forest areas under no-go zones and declared 36,000 hectares to be open for mining

Early 2011 GOM was set up to resolve the issue

Apr-11 Second meeting held; MoeF agreed to free more blocks based on a clustering and boundary modification approach. Now only 125 blocks were left as no go areas

Jul-11 MoeF awards Stage 1 approval to these blocks

Coal blocks associated with Bedabahal UMPP, NTPC Darlipalli project , OPGC's Ib valley project cleared

Jul-11 BK Chaturvedi panel report recommended that forest area classification for clearances to coal blocks is legally not tenable

Source: India Infrastructure, Barclays Capital

Figure 19: India Capital Goods – Supply and demand outlook for domestic coal

0%

20%

40%

60%

80%

100%

FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E

Supply- Demand for domestic coal

We expect a shortfall in coal of more than 30% by FY15

Source: Coal Ministry, Coal India, Barclays Capital estimates

Companies have started booking orders without linkages The slowdown in ordering in the power segment is making companies book orders ahead of the availability of coal linkages. This is concerning, in our view, because project execution cannot commence before firm linkages are obtained as the characteristics of coal are required before embarking on designing boilers. With revenue recognition not commencing as per norms, this distorts the relationship between order bookings and revenues. Execution periods of order books are hence set to lengthen. Our analysis of order books of various equipment manufacturers suggests that companies such as BHEL have booked several orders without linkages. While as a policy, BHEL books awards on receipt of advances, our concern is more about the futility of booking orders without linkages as execution trajectory would be much slower than what the order book may suggest.

Coal approvals speeded up, but structural shortage difficult to

resolve

BHEL has booked several projects without linkages


7 December 2011 19

Figure 20: India Capital Goods – several orders booked by BHEL in FY11 do not have coal linkages

Plant Utility Supplier Capacity (MW)

Edlapur TPP BHEL - KPCL JV BHEL 800

Bellary TPS KPCL BHEL 700

Yerasmus TPP BHEL - KPCL JV BHEL 1,600

Lalitpur power Bajaj Hindusthan BHEL 1,980

Sagardighi WBPDCL BHEL 1,000

Source: Coal Ministry, BHEL, Barclays Capital

Figure 21: India Capital Goods – cases in which LOA were cancelled. BHEL is implementing these plants

Project Utility Capacity (MW) Location BTG Date of award

Muzaffarpur TPP Stage II NTPC 390 Bihar BHEL 2010

Farakka Stage III NTPC 500 West Bengal BHEL 2008

Bokaro TPS A DVC 500 Jharkhand BHEL 2009

Source: Coal ministry, BHEL, Barclays Capital

T&D: Volume recovery likely

The pace of recovery in the T&D segment depends on the pace of commissioning of power generation projects. With the pace of commissioning expected to be stronger in FY12, we expect a recovery in T&D ordering. Channel checks suggests that in FY12 there is an expectation of more than 150 transformer awards (765KV) and more than 15 substation orders (765KV) and several tenders for circuit breakers and reactors. An HVDC order is also expected next year although the tender is expected to be divided into smaller contracts.

Figure 22: India Capital Goods – Volume of tenders higher than earlier years

Figure 23: India Capital Goods – Sharp increase in substation tenders

64

2 3

10

1

42

7

13

53 2

7

19

7

10 9

02468

101214161820

1Q-2

008

2Q-2

008

3Q-2

008

4Q-2

008

1Q-2

009

2Q-2

009

3Q-2

009

4Q-2

009

1Q-2

010

2Q-2

010

3Q-2

010

4Q-2

010

1Q-2

011

2Q-2

011

3Q-2

011

4Q-2

011

1Q-2

012

2Q-2

012

Transformer or Reactor- No of tenders

64 4 4

34

9

2

7 7 76

9 97

11

5

14

02468

10121416

1Q-2

008

2Q-2

008

3Q-2

008

4Q-2

008

1Q-2

009

2Q-2

009

3Q-2

009

4Q-2

009

1Q-2

010

2Q-2

010

3Q-2

010

4Q-2

010

1Q-2

011

2Q-2

011

3Q-2

011

4Q-2

011

1Q-2

012

2Q-2

012

Substation EPC- No of tenders

Source: Powergrid Corporation, Barclays Capital Source: Powergrid Corporation, Barclays Capital


7 December 2011 20

CONVERTING PLANS INTO ORDERS IS CRITICAL

The previous cycle was aided by substantial reforms in the power segment in 2003, followed by a focus on the public-private partnership (PPP) route for infrastructure funding for roads and airports. Substantial investments also helped trigger a recovery in industrial capex. Land was not a major challenge as several projects were initially brownfield expansions unlike the current cycle in which more than 70% of the projects are greenfield. For a new cycle to emerge, apart from removing the constraints to ordering, new demand drivers have to be created. These include announcing several projects in the railways segment (DFCs, high speed rail, station modernisation), increasing sourcing in defence projects from local manufacturers, speeding up nuclear power projects and speeding up the planned metro/mono rail/airport projects. Our analysis of the order pipeline across various end markets in the infrastructure domain suggests that a strong potential lies ahead but that the pace of conversion of these plans into orders is critical.

Infrastructure recovery likely to lead this next cycle: order pipeline encouraging

The Infrastructure segment will likely lead the recovery in this next cycle because capacity constraints are significant. India’s rail and port networks need to be strengthened to transport coal while urban infrastructure needs significant investments (metro rail, monorail). With the pipeline of orders being healthy, we believe that this is a segment for which an increased focus from the government can trigger an order recovery. A bottom-up survey of potential ordering in various segments suggests a healthy pipeline. Metro rail, railways, and defence are key segments for which we expect large investments.

Figure 24: Order pipeline in various end markets in the infrastructure segment

Market size

(US$bn) Comments

Railways 10 Overall slow pace of ordering. Typically US$2-3bn of civil engineering work/signalling work announced per annum.

DFC tendering has commenced, but pace of ordering is slow. One tender has already been released in which three consortiums have been qualified; however, a retendering of this is now likely. This was an Rs60bn tender.

Another tender expected to be released in November but has been delayed. These are large bulk tenders. Overall, Rs350-400bn worth of orders are to come from this segment.

Some JV's with private players expected to be finalized in FY12 (Loco JV, etc.).

Roads 13 Target of 7,300km of road awards vs. 5,000km awarded last year. Likely that only 5,000-5,500km gets bid out. Of the nine mega road projects, four have been ordered out.

Airports/ports 5 No major airport orders are expected this year. However, the pipeline is strong. The largest airport to be finalised next year will be that at Navi Mumbai (late FY13). A large airport in the Middle East is to be finalised next year.

Real estate/broad construction

30 The pace of ordering has been slower than before but no downturn as yet.

Mining equipment 0.4 Flattish trend; no major acceleration expected.

Construction equipment 2 Order growth decelerating due to weak infrastructure and real estate builds.

HVAC 25 Market remains weak in India (larger format retail and commercial real estate are weak areas). Order pipeline in Middle East strong but order finalisations slower than before.

Source: NHAI, Indian Railways, Barclays Capital

A strong potential lies ahead, but the pace of conversion of these

plans into orders is critical


7 December 2011 21

Metro investments

About Rs1,600bn in metro rail and monorail projects are being planned in various cities in India. These will largely be cash construction projects given they are not viable through a PPP route.

Figure 25: Metro Rail and Monorail – about Rs1,600bn in projects planned in India

City Project

type Cost

(Rs bn) Length

(km) Status

Hyderabad Metro 150 72 PPP awarded; secondary orders for coaches, electrification to be awarded in FY13

Mumbai Metro NA 40 In planning stage. Expected to be implemented over 2016-2021

Kochi Metro 30 26 ICB to be done for awarding project implementation work

Bangalore Mono Rail 36 60 Not ordered as yet. Project viability an issue.

Bangalore Airport Link 66 37 Not ordered as yet

Kozhikode Mono Rail 10 23 Proposed

Trivandrum Mono Rail 30 28 Proposed

Bangalore Metro phase 2 250 18 Process of preparation of DPR

Delhi Metro phase 3 280 105 Tendering has commenced

Jaipur Metro 20 Construction in progress. 35% of civil engineering work completed

Indore Mono Rail n.a. na Feasibility study commenced

Patna Mono Rail n.a na Ground survey to be conducted by RITES

Jodhpur Mono Rail n.a na Scomi to conduct feasibility study

Chennai Mono Rail n.a 111 Bidding commenced; 4 mono rail lines in first phase

Thane Mono Rail n.a 30 Under planning

Thane Metro na 10 Under planning

Ahmedabad Metro 70 40-50kms Work to commence in FY13 in two phases

Ahmedabad Metro link na na Planning stage

Ahmedabad Mono Rail 50 na Planning stage

Chandigarh Metro 150 52 In three corridors

Ludhiana Metro 87 29 In BOT route

Source: Various news reports, DMRC, India infrastructure, Barclays Capital

Railways

The key areas of spending in the rail segment will be on the dedicated freight corridors and modernising railway stations. An aggregate of Rs13,800bn spend is envisaged for the next seven years. Details of some key areas of spending are highlighted in Figure 22.

Figure 26: Railways – Vision 2020 envisages spending of Rs13,800bn to FY20

Rs bn Until FY12 From FY13-20

New lines 100 1,700

Doubling 60 1,240

Metropolitan transport 94.5 510

High-speed corridors 0 2,000

Upgrading of stations 12 stations 38 stations

Passenger coaches 110 714

Wagons 101 765

Diesel locomotives 72 487

Electric locomotives 67 581

Source: Indian Railways Vision 2020, Barclays Capital

Expect several metro projects to be executed in the coming years

Dedicated freight corridors and railway station modernization

are the key areas of spend


7 December 2011 22

Airport investments

More than Rs270bn worth Airports have been planned in India; however, the bulk of them are small projects. The only relevant project expected next year will be the Navi Mumbai Airport valued at more than Rs96bn that will be awarded through a BOOT model next year.

Figure 27: Indian Airports – Navi Mumbai Airport is the relevant airport planned for FY13

State City Cost

(Rs bn) Status

Maharashtra Navi Mumbai 96 Environmental clearance received in FY11; expected to be ordered in late FY13; EPC order may not be expected in FY13

Maharashtra Nagpur 26 Development work under way Maharashtra Sindhudurg 2 Already awarded to IRB Uttar Pradesh Kushinagar 8 Clearances obtained Uttar Pradesh Jewar Airport Noida 35 Awaiting approval; airport just 72 Kms from Delhi Airport is delaying the project as current rules

do not allow a new airport within 150kms radius of an existing one Punjab Ludhiana 30 NA Karnataka Shimoga 1.0 Land of about 660 acres acquired; work on project has commenced Karnataka Gulbarga 1.0 About 670acres of land acquired; construction work has commenced Karnataka Bijapur 1.0 About half of the land acquired (total 720 acres required) Karnataka Hassan 0.7 More than half of land acquired (total of 960 acres required) West Bengal Durgapur 3.5 Airport work will cost Rs1.6bn of which contracts worth Rs1bn has already been awarded Arunachal Itanagar 10 In planning stage Nagaland Cheitu 10 DPR approved by state government Madhya pradesh

Dabra Approval granted to Gwalior Agriculture Company; will be a cargo airport

Rajasthan Paladi Partnered with Fraport AG for airport development Goa Mopa 25 Through PPP route; bidding has not yet commenced Kerala Kannur 13 1280 acres of land acquired Andhra Pradesh Hyderabad 10 New terminal planned after FY15 Pondicherry Karaikal 2.5 Approval granted

Middle East A US$7bn airport project likely for bid next year

Source: India Infrastructure Journal, Airports Authority of India Economic Times, Times of India, Barclays Capital

Defence

We estimate the Ministry of Defence’s overall capex budget at more than US$80bn for the next five years with imports expected to account for 50% of the total. To increase sourcing from Indian firms a compulsory joint venture route could be deployed. Moreover, L&T, for example, has broad capabilities in building aircraft carriers, submarines, corvettes and frigates.

Figure 28: Ministry of Defence – plans for more than US$80bn in projects

Navy Air force

Items No. Value (US$bn) Items No. Value (US$bn)

Diesel submarines 6 21.0 Aircraft Su-30 MKI 140 9 Nuclear submarines "3-5" 9.0 Multirole combat Aircraft 126 10 Aircraft carriers 2 0.5 LCA (Tejas) 120 2.2 Corvettes 8 2.0 Fifth generation fighter aircraft 10 Destroyers 4 3.3 Medium and Heavy lift Helicopters 117 3.2 Frigates 7 8.0 Basic trainer Aircraft 181 6

Source: Confederation of Indian industry, Deloitte Touche Tohmatsu India, Barclays Capital

Largest Airport to be bid out next year is the one in Navi

Mumbai


7 December 2011 23

Recovery in industrial capex likely to be late in the cycle

A recovery in ordering in the industrial segment commenced in late FY10 with short-cycle product orders (refurbishment capex, small value items) seeing a recovery and management commentary post 2Q FY11 increasingly pointing at an imminent recovery in project ordering; however, excess supply vs. demand in the cement segment and resource constraints and delays in approvals in the steel segment affected the overall pace of ordering for the sector.

Near term, new orders for cement capex appear weak. For the steel segment, more than US$50bn in projects are in the pipeline; however, our channel checks suggest that tendering in the steel segment near term is weak. Key projects include Posco’s 12mtpa integrated steel facility in Orissa valued at Rs500bn, Arcelor Mittal’s 6mtpa project in Jharkhand and a 6mtpa project in Karnataka with an investment of more than Rs500bn, Bhushan Steel’s project in Bengal, and Tata Steel’s projects in Chhattisgarh and Karnataka.

Figure 29: Industrial Capex – spending like to come late in the cycle

Industrial

Market size

(US$bn) Comments

Cement and steel 2 Cement remains in oversupply; we expect muted ordering activity

For steel, near-term ordering activity is weak, but the project pipeline for the next three years is encouraging. Several pending SAIL projects already awarded. Pace of tendering is now slow. Live projects include ones at SAIL, JSPL, NMDC, Tata Steel.

Oil and gas 7 Ordering in the Middle East continues. Some projects in Southeast Asia. Ordering in India continues (Rs150bn orders from ONGC in 2H likely) but not a strong growth market

Consumer/others

Medical equipment 0.7 We expect mid-teen growth

Lighting 75.0 Continues to remain strong; we expect mid-teens growth

Overseas lighting 0.4 No deterioration in pricing or volumes; we expect growth to be flat

Fans 0.8 Sharp slowdown in demand this year; market growth in single digits

Air conditioners Market growth has sharply moderated due to weak summers and increase in interest rates

Defence 8 Do not expect any increase in ordering to private Indian vendors

Wind 35 Increase in interest rates to impact ordering in domestic market; pricing to decline in India


Progress on reforms There have been some improvements in reform activity in the past six months, in our view, with a new land reforms bill being introduced, some no-go areas being allowed for mining, new infrastructure lending norms for setting up of debt funds, increasing noise on the likely imposition of import duties and increase in power tariffs by various SEBs.

Land: The land reforms bill is likely to be cleared this year. It would give a benchmark for fair compensation (4x the current land value), which would allow the government to acquire land on behalf of private players for public projects. However, a provision for the life-long rehabilitation of the affected landowners is being raised as an issue by potential private investors. We believe that given the fragmented ownership of land in India, acquiring land could still be a challenge and a time-consuming process. What we believe is required is a reform to allow the speedy acquisition of land by the government for public projects much ahead of the actual project starts based on the long-term plans for potential projects.

Industrial capex recovery will emerge after infra recovery pans

out


7 December 2011 24

Coal: Although some no-go areas have received clearance post the intervention of the Group of Ministers (GoM), the key issue is the long term availability of coal, the pace of approvals and the execution and building of a strong logistics network to help transport coal within the country and to help transport imported coal. The process of ordering for dedicated freight corridors has been slow due to land and financing issues, which could create a material bottleneck in future.

Funding: Recent news reports suggest that the Reserve Bank of India will announce norms on the setting up of infrastructure development debt funds, which could help ease lending constraints for the banking system.

Import duties: The delay in implementation of import duties by the government has already significantly affected market shares for domestic competitors. Several orders for 12th as well as 13th plan have already been given to Chinese vendors through bulk contracts. Although an import duty is closer to being finalised (5% duty, 4% special additional duty and a 10% CVD to counter excise), it be nothing more than an academic impact for the coming years. The T&D segment has witnessed a similar fate with more than 70% of its high voltage orders being won by Korean/Chinese vendors. Some form of domestic manufacturing requirements, however, has now been implemented by Powergrid Corporation in India (these include compulsory JVs with domestic manufacturers with at least one transformer being manufactured in India).

State Electricity Board reforms: Several SEBs have increased tariffs in the past 12 months, ranging from 10-20%. There are also proposals for further increases pending. Since the aggregate losses of SEBs are more than Rs635bn (Tamilnadu, Uttar Pradesh, Andhra Pradesh and Rajasthan are making the largest losses), a committee has been set up under B.K. Chaturvedi, a member of India’s national Planning Commission, with the secretaries of various states and the RBI’s deputy governor to look at the financial health of power distribution companies (discoms) in two phases and suggest likely reforms. The first phase will comprise Andhra Pradesh, Uttar Pradesh, Haryana, Tamilnadu, Rajasthan, Madhya Pradesh and Punjab.


7 December 2011 25

Figure 30: India’s State Electricity Boards – recent increases in power tariff for consumers

SEB Price increases

Andhra Pradesh Aug 2010: Prices increased for industries and 60 paisa for commercial establishments and railway traction. No change for domestic and agricultural segment.

Mar 2011: Tried increasing tariff but did not get approval from the chief minister of Andhra Pradesh for increasing prices for domestic consumers (slab of 201-300 units) and cottage industries. Average 8-10% hike.

Bihar June 2011: 15-20% hike (applied fuel surcharge again with retrospective impact)

Dec 2011: 10% hike

Orissa April 2011: 20% avg. hike

Delhi Aug 2011: 22% avg. hike

Chattisgarh April 2011: 15% hike (22% increase for domestic consumers and 12% for industrial)

Gujarat April 2010: Avg. 2.36% increase

Sep 2011: 4-5% avg. hike

Rajasthan Sep 2011: 20% avg. hike

Maharashtra Sep 2010: 3% hike (had sought 14%)

Nov 2011: 40 paisa increase; about 8-10%

Madhya Pradesh June 2010: 10.66% increase

May 2011: 40% hike requested

Delhi Aug 2010: 22% hike

Punjab April 2010: 13% hike.; was 10% earlier but ere asked to roll back; approved again in budget

May 2011: 10% hike; about 37 paisa increase

Haryana Oct 2010: About 15%-20% increase (7 paisa increase)

May 2011: 0.5% increase

Another hike being solicited

Karnataka Oct 2011: 7% avg. or 27 paisa

Dec 2010: Avg. hike of 22 paisa; was put on hold for some time

Tamilnadu Aug 2010: Hiked power price for first time in seven years in Aug 2010; increase ranging from 30 paisa to Rs1.1/unit. Increase for consumers using above 300 units and industrial consumers. Avg of 10% hike

Nov 2011: Applied for a 38% tariff hike (about 74-110% in some slabs) in Nov 2011

West Bengal April 2010: 10-15%

April 2011: 11% hike (about 38-46 paisa of avg. hike)

Dec 2011: Another hike likely and to be implemented from April 2012

Uttar Pradesh April 2010: 20% hike

Jharkhand 15-50 paisa plus increase in fixed tariff by 12-40 per month

Source: State utilities, Barclays Capital


7 December 2011 26

HYPER-COMPETITION AND MARGIN RISK

While revenue growth and order run rates for the sector have declined sharply, margins have still been holding up well, primarily on account of support from companies with long execution periods. However, we believe the stage is set for margin pressure to become more evident as we enter the second phase of the down-cycle, as some of the key end markets are now going through a period of hyper-competition. End markets with high competitive intensity are those exposed to imports from China and Korea and where domestic supply build up has become more evident in recent times. Our bottom-up analysis of 25 end markets suggests that power generation equipment is the most competitive, followed by power T&D. Our preferred stocks have lower exposure to hypercompetitive segments since lower risk to margins gives more certainty to estimates and multiples. Companies for which we see high margin risks include BHEL, BGR Energy and Siemens. Companies with low risk relative to our estimates are Havells, Cummins and KEC.

Margin pressures

The first phase of the downturn, which commenced in FY09, saw a decline in revenue growth for the sector (Figure 35) due to a sharp deterioration in order activity. Margins held up due to a previous backlog of orders with healthy margins, BHEL’s continued monopoly status (and flat pricing), a sharp decline in commodity prices benefitting Cummins, Crompton Greaves) and general unwillingness of companies to bid for orders at low margins given an already healthy order book.

The second phase of the downturn that commenced earlier this year will bring margin pressures, as pressure on pricing is evident in all end markets. Companies will have to either adjust to the new pricing environment or face significant declines in order book growth. We believe that companies with an inability to fend margin pressures by increasing price of their offerings or by a strategic shift in their order mix would be the most exposed.

In the first phase of the down cycle revenue growth was

impacted but margins held up due to a healthy order book

The second phase has started: we expect margin pressures due

to weak pricing in various end markets; companies with

dominant product positioning will be the least exposed

Figure 31: India Capital Goods – sector revenue growth impacted …

Figure 32: … but margins have been holding up well

6%

17%

-1%

-2%

9%14%

9%

30%33%31%

37%

28%

10%

20%15%

8%10%

-5%0%5%

10%15%20%25%30%35%40%

Mar

98

Mar

99

Mar

00

Mar

01

Mar

02

Mar

03

Mar

04

Mar

05

Mar

06 M

ar07

Mar

08

Mar

09

Mar

10

Mar

11

Mar

12 E

Mar

13

E

Mar

14 E

Revenue growth yoy

0%2%

4%6%8%

10%12%

14%16%

Mar

97M

ar98

Mar

99

Mar

00

Mar

01

Mar

02 M

ar03

Mar

04 M

ar05

Mar

06 M

ar07

Mar

08 M

ar 0

9 M

ar 1

0 M

ar11

Mar

12E

Mar

13E

Mar

14E

EBITDA Margin

Source: Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates


7 December 2011 27

Figure 33: End-market competitive outlook – a bottom-up analysis of the supply chain

End market Comments based on supply chain survey

Boilers and turbines Over 50GW of boiler and 35-40GW of domestic manufacturing capacity vs. demand of 30GW/annum

Competition from China/Korea is high; Doosan is setting up manufacturing capacity in India and so is Dongfang; this is enough to bring other manufacturers to India

Power BOP Capacity still constrained as labour availability is a key challenge; pricing is stable

T&D domestic Price competition to remain challenging. Chinese (TBEA) to set up capacity in India. ABB/Areva T&D and Siemens to have better cost structure in 765kV as they are eligible for using 100% domestic content. Substation EPC orders more competitive due to change in qualification requirements.

T&D international No major change in competitive intensity – Chinese actively participating in bids

Transmission tower Competitive intensity increased since FY10. From 5-7 bidders earlier, total number of bidders is more than 20 now. Expect some moderation in competitive intensity as Powergrid Corporation has been blacklisting companies with poor execution record. Some recent orders were awarded to KEC despite it not being the lowest bidder.

Power back up Pricing stable in mid-high KVA segment. Pricing went up earlier this year and not expected to decline as companies like Cummins hold a dominant position. Low KVA (sub 200KVA) is facing pressure from Chinese competition.

Mining equipment Competition restricted as Coal India largely orders from BEML. Expect pricing to remain stable. Competition for private sector orders though high (small portion of the market).

Construction equipment Engine pricing largely stable and although demand is decelerating, pace of decline lower than powergen. No major competition from Chinese also helps

Railways Largely EPC work where margins are usually sub 10%. Price trends stable

For Wagons pricing has been stable

For metro coaches price competition is high with several bidders: Alstom , BEML, Bombardier, CAF of Spain, Chinese companies like China CNR, China Southern Railways and Siemens, Mitsubishi and Kawasaki

Electrification: Pricing pressure not as intense

Roads Competition intense. Several small players have become active. Over 114 companies have applied for annual qualification for bidding for road projects. Companies such as L&T no longer bid for road construction work and prefer participating in that segment by bidding for projects (BOT)

Airports/ports Competition for BOT orders expected to be stiff.

Real estate/broad construction

Execution is considered critical; hence, pricing environment not deteriorating. Margins will still be below that of manufacturing/industrial orders (5-7% range).

HVAC Stiff competition for orders expected. Voltas has brought down bidding EBITDA margin targets to 5% vs. last year’s 9% margins in MEP segment.

Other industries General industrial ordering is a high margin business due to limited strong competitors in India. L&T is largely among the only E&C company that caters to E&C jobs for most industries in India.

Cement and steel Not many orders in Cement and Steel but price competition not irrational.

Oil & gas Stiff competition from international firms. With Punj Lloyd typically not getting qualified for ONGC platform projects competition for domestic firms-L&T and Afcons is largely with Singapore/Malaysian and Korean vendors.

Medical equipment Scope for product differentiation is high hence price competition not as intense

Lighting Pricing typically stable in the market. Warranties, life of product key differentiating factor.

Overseas lighting Stable pricing trends in Europe

Fans Competition stiff especially with market slowing down

Air conditioners Stiff competition. High inventory in the channel. Price discounting expected.

Defence Very few competitors in India. Pricing/margins stable

Wind Pricing trends stable this year. Expect pricing to deteriorate due to excess global capacity

Biomass Not much price competition

Water and waste Largely an unorganized market. Competition for BOOT – Desal projects stiff but general contracting work not as competitive



7 December 2011 28

Relative attractiveness of end markets

The Boilers & Turbine (BTG) end market is relatively worst placed, on our analysis, since at current pricing levels for orders it is difficult for companies to make profits.

Figure 34: India Capital Goods – BTG, HVAC and T&D are the end markets with the worst competitive outlook

01234567

Boile

rs a

nd

HV

AC

T&D

dom

esti

c

Tran

smis

sion

Oil

and

Gas

over

seas

ligh

ting

Roa

ds

AC

Win

d

BOP

T&D

inte

rnat

iona

l

Rai

lway

s

Air

port

s/Po

rts

Build

ings

/fac

tori

es

Med

ical

Ligh

ting

Fans

Wat

er/w

aste

Con

stru

ctio

n

Indu

stri

al

Min

ing

equi

pmen

t

Cem

ent

& S

teel

Def

ence

Biom

ass

Competitive outlook

High foreign competitionHigh Domestic competition

Pricing pressure highest in BTG segment, followed by HVAC

Note: Each end market is scored over 1-10 points based on the competitive intensity. Source: Barclays Capital estimates

Figure 35: India Capital Goods – end-market exposure of companies

0

5

10

15

20

25

30

BGR

BHEL

Vol

tas

Ther

max

Are

va &

D

KEC

ABB

L&T

Cro

mpt

onG

reav

es

Hav

ells

Siem

ens

Cum

min

s

Relative exposure to best end markets - High score= better exposure

BGR and BHEL have exposure to the worst placed end markets

Note: Company exposure to various end markets is then compared with the end market score. Source: Barclays Capital estimates

Margin risk for BHEL and BGR is high Three factors dictate margin performance for the companies we analyse: 1) pricing power – ie, the ability to transfer commodity price risk to either customers or vendors; 2) end market exposure – ie, whether the segment is at risk with exposure to low-cost imports and a deteriorating supply-demand environment; and 3) mix shift – whether there is an increase/decrease in exposure to low-margin segments due to a slower pace of ordering in high-margin end markets. In the following table we present our expectations for FY12 EBITDA margin for each company.


7 December 2011 29

Figure 36: Comparing EBITDA margin estimates for FY12E with past trends; BHEL, BGR Energy face risk of margin downside

Past 10 year EBITDA margin FY12E vs. FY12E vs. Potential risk of downside from

Maximum Average FY12E maximum Average current estimate

BHEL 20 18 19 -1 2 High

L&T 14 11 12 -2 1 Medium

ABB 12 9 6 -6 -2 Low

Siemens 14 10 13 -1 2 High

Crompton Greaves 17 11 9 -8 -2 Low

Thermax 13 11 11 -2 0 Low

Voltas 10 6 5 -4 -1 Low

Cummins 19 15 14 -4 -1 Low

Havells 13 8 10 -3 2 Medium

KEC 13 9 8 -5 -1 Medium

BGR 11 11 12 1 1 High

Areva T&D 18 11 9 -8 -2 Low


Figure 37: India Capital Goods – end-market exposure as a percentage of revenues

(%) End markets BHEL L&T ABB Siemens CGL Thermax Cummins Havells BGR Voltas Areva T&D KEC

Power 85 40 60 45 80 70 0 14 100 0 100 100

Industrial 15 32 40 45 10 20 55 20 0 10 0 0

Infrastructure 0 28 0 10 10 10 45 67 0 90 0 0

Boilers and turbines 60 20 50 80

Balance of plant 20 10 20 20

T&D domestic 5 10 60 30 35 14 100 0

T&D international 15 40 50

Transmission tower 50

Mining equipment 5

Construction equipment 2 5 5

Railways 5 5 5

Roads 7 5

Airports/ports 5 5 10

Real estate 5 20 10

HVAC 40

Other industries 15 17 30 30 10 10 35 20 10

Cement and steel 5 10 15 10 20

Oil and gas 10

Medical equipment 5

Lighting 8

Overseas lighting 50

Fans 10 8

Air conditioners 25

Defence 2

Wind 5

Water and waste 2 10



7 December 2011 30

Power generation equipment

We estimate more than 50GW of boiler manufacturing capacity in India, apart from the impact of imports of boilers from China and Korea. For turbines, we estimate domestic manufacturing capacity at more than 36GW per annum (excluding imports of turbines from China and Korea). This capacity compares with our estimate of demand in the range of 25-35GW pa over the next few years

We expect excess capacity in power generation equipment to continue to pressure pricing, ensuring that the cost of maintaining market share for incumbents will increase sharply. Import duties may not deter competitive activity from China/Korea given that bulk orders for implementation over the next 10 years have already been awarded. We see an increase in a long-term approach towards India by the incumbents.

Figure 38: Boilers – supply/demand assessment: supply to exceed demand

JV Investment Capacity (GW)

details (Rs mn) Technology FY10 FY11 FY12E FY13E FY14E FY15E Status

BHEL No JV Alstom 10,000 15,000 15,000 20,000 20,000 20,000 Expansion from 15-20GW under way

L&T MHI 51:49 MHI 0 4,000 4,000 4,000 4,000 4,000 Capacity already set up in Gujarat

Thermax 51:49 7,000 B&W 1,500 1,500 4,500 4,500 4,500 4,500 Capacity to be set up in Gujarat

BGR Energy 74:26 15,000 Hitachi 0 0 4,000 4,000 4,000 4,000 Capacity to be set up in TN. Land identified

Cethar Vessels No JV 5,000 Ansaldo Engg 0 8,000 8,000 8,000 12,000 12,000 8GW capacity already exists

Doosan Doosan-Babcock 0 0 0 0 3,000 3,000 To set up capacity in TN

GB Engg- Ansaldo Riley Power 1,000 1,000 1,000 1,000 2,000 2,000 In a court case with NTPC

Industry capacity 12,500 29,500 36,500 41,500 49,500 49,500

Capacity ex-Cethar/GB 11,500 20,500 27,500 32,500 35,500 35,500

Demand 30,000 30,000 25,000 20,000 25,000 30,000


Figure 39: Turbines – supply/demand assessment: supply to exceed demand

JV Investment Capacity (GW)

details (Rs mn) Technology FY10 FY11 FY12E FY13E FY14E FY15E Status

BHEL No JV Siemens 10,000 10,000 15,000 20,000 20,000 20,000

L&T MHI 51:49 MHI 0 4000 4000 4,000 4,000 4,000

Toshiba - JSW 74:26 8,000 Toshiba 0 0 0 3,600 3,600 3,600 Capacity set up in progress (near Chennai)

BharatForge - Alstom 24,000 Alstom 0 0 0 5,000 5,000 5,000 Capacity expected in Gujarat

BGR Energy - Hitachi 30,000 Hitachi 0 0 4000 4,000 4,000 4,000

Industry capacity 10,000 14,000 23,000 36600 36,600 36,600

Demand 30,000 30,000 25,000 20,000 25,000 30,000



7 December 2011 31

Pricing in a free fall; difficult to make margins at current prices The pricing for generation equipment projects in India prior to FY11 was Rs13-15mn/MW for supercritical turbines, Rs15-Rs20mn/MW for boilers (+ auxiliaries) and Rs50-55mn/MW for supercritical EPC projects. Until mid-FY11, pricing remained firm as competition was limited and market growth was strong.

Starting in FY10, Chinese equipment majors were affected by the introduction of visa restrictions (eg, restricted the number of project managers that could be sourced from China and also allowed only skilled labour to enter India). This increased uncertainty over their ability to implement projects in India. Domestic competitors that had announced capacity expansions were still at an early stage of implementation (BGR Energy-Hitachi JV and Thermax-B&W’s JVs were announced only in the middle of FY10).

Pricing started deteriorating in September 2010, with bulk orders being awarded to the Chinese manufacturers by private sector players in India (Figure 40). Thereafter, domestic competitors (eg, Bharat Forge, Toshiba-JSW) also started bidding for orders and this coincided with a slowdown in order inflows in the sector because of issues with availability of coal.

Price discovery at the recent (September 2011) bulk tender from NTPC (for 9 x 800 MW) indicated a further decline in prices, with turbine pricing seeing a more pronounced decline. The lowest bidder (BGR-Hitachi) quoted a price of Rs10mn/MW. There still remains a gap with pricing offered by the Chinese companies. Our checks with Cethar Vessels (an unlisted Indian boiler manufacturer) suggest that turbines can be obtained from China at Rs6-7mn/MW and boilers at less than Rs10mn/MW. In fact, Cethar Vessels itself quotes a price of Rs11-12mn/MW for supercritical boilers compared with the Rs16.5mn/MW bid put in by Doosan. (The quote given by Cethar Vessels may not, however, be including auxiliaries in the contract.)

Figure 40: Generation Equipment – pricing of orders 4Q FY08-4Q FY11: pricing has declined about 30% in the past year

Date Supplier MW

rating No of

sets NatureOrder value

(Rs mn)Rs

mn/MW Client

4Q FY08 BHEL 1320 2X660 Boiler 25,000 19 NTPC- Barh II 5-Aug-08 BHEL 1600 2X800 Boiler 25,000 16 APPGCL Krishnapatnam 30-Jun-08 L&T 1600 TG+Aux 15,570 10 APPDCL 23-Oct-08 BHEL 660 660 TG 14,740 22 NTPC 12-Aug-09 L&T 1320 2X660 BTG 40,000 30 Jaiprakash 3-Nov-09 L&T 1980 3X660 BTG 68,970 35 Mahagenco 24-Nov-09 BHEL 1920 3X660 BTG 56,000 29 Jaiprakash-Prayagraj Power

30-FY11BHEL 1980 3x660 BTG 54,500 28 Lalitpur Power Gen Co

5-Oct-11 BHEL 1320 2X660 BTG 37,829 29 Dainik Bhaskar Power(DBPL) NTPC bulk tender 4Q FY11 Bharat Forge-Alstom 7260 11X660 TG 33,000 12 Bharat Forge to get 5 sets,

BHEL 4 and Toshiba 2 sets 2Q FY12 Doosan heavy 7200 9X800 Boiler+Aux 66,000 17 Doosan to get 5 sets rest to BHEL 2Q FY12 BGR Energy-Hitachi 7200 9X800 TG 32,320 10 BGR to get 4 sets, BHEL to get 3 sets and 2

sets Chinese bids Abhijeet group Dongfang 6600 10X660 BTG 11,2500 17 Reliance Power Shanghai Electric 23760 36X660 BTG 3,73,500 16 Lanco Harbin Power 10560 16X660 BTG 68,300 6.5


Pricing was firm prior to FY11 due to visa restrictions that

impacted Chinese projects and limited competition from

domestic vendors

Pricing started deteriorating in September 2011

Prices have declined by more than 30% over past year


7 December 2011 32

Current pricing not profitable Based on our understanding of cost structure of both boiler and turbine manufacturers we calculated expected EBITDA, PBT and returns for manufactures at current prices. Our calculations are conservative and are based on the cost structure of BHEL (for calculating raw material prices and employee cost/other expense).

For turbine manufacturers, our calculations suggest that it would be difficult to make profits at the current average price of Rs9.5mn/MW. While we estimate EBITDA breakeven at the 40% utilisation level, PBT breakeven in the initial years appears difficult at even 65% utilisation. This is because of the high fixed asset intensive nature of turbine manufacturing. We wonder if any of the new turbine manufacturers will be able to return a PBT breakeven in the next five years as we do not expect most to operate at above 60% utilisation.

Figure 41: Cost structure for turbine manufacturers – scenario analysis based on different utilisation rates

Rs mn Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5

Capacity (MW) 4000 4000 4000 4000 4000Price (Rs mn/MW) 9.5 9.5 9.5 9.5 9.5Utilisation (%) 30% 35% 40% 45% 65%Revenue 11400 13300 15200 17100 24700Material cost 7200 8400 9600 10800 15600Employees cost 2400 2400 2400 2400 2400Other exp 2400 2800 3200 3600 5200OBITDA -600 -300 0 300 1500OBITDA margin -5.3% -2.3% 0.0% 1.8% 6.1%Interest 2520 2520 2520 2520 2520Depreciation 1500 1500 1500 1500 1500PBT -4620 -4320 -4020 -3720 -2520PBT margin -41% -32% -26% -22% -10%ROE (%) -36% -34% -31% -29% -20%

Note: We use a capacity cost of Rs35bn for a 4GW integrated turbine manufacturing plant. Source: Barclays Capital estimates

For boiler manufacturers though, a pricing of Rs15mn/MW is sufficient to achieve breakeven at the PBT level at 35% utilisation levels, on our analysis, but if pricing dips another 20% it would be difficult to make profits even if utilisation levels are very high.

Figure 42: Cost structure for boiler manufacturers – scenario analysis based on different pricing and utilisation rates

Rs mn Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5

Capacity (MW) 4000 4000 4000 4000 4000Price (Rs mn/MW) 15 15 14 14 12Utilisation (%) 20% 35% 30% 50% 100%Revenue 12000 21000 16800 28000 48000Material cost 7200 12600 10800 18000 36000Employees cost 2400 2400 2400 2400 2400Other exp 2400 4200 3600 6000 12000Operating EBITDA 0 1800 0 1600 -2400margin 0.0% 8.6% 0.0% 5.7% -5.0%Interest 1008 1008 1008 1008 1008Depreciation 600 600 600 600 600PBT -1608 192 -1608 -8 -4008PBT margin -13% 1% -10% 0% -8%ROE (%) -31% 4% -31% 0% -78%

Source: Barclays Capital estimates


7 December 2011 33

Need for coal blending increases implementation risk India’s Central Electricity Authority (CEA) in April 2011 advised all power developers and generating companies to plan equipment for coal blends of 70:30 (domestic/imported coal) when ordering equipment. Our discussions with several boiler designers suggest that although it is possible to design equipment for such blends, it is difficult to guarantee/predict performance of equipment post implementation (BHEL commented this was the case during trials with 80:20 blends at a plant in Karnataka). This is because coal blending itself is a complex process given the non-additive nature of several properties of coal, such as ash fusion temperature. This makes it difficult to predict performance.

Key concerns over usage of blended coals include boiler furnace fouling and slagging, which could impact boiler performance. Simply put, lower ash fusion temperatures could lead to deposition of ash on the boiler surface and tubes changing the heat transfer efficiency, and obstruction of flow of gas due to deposits increasing velocity of ash, as well as probably making exit gas temperatures higher. These factors lead to poor boiler efficiency.

Changes at the equipment end to resolve these issues could involve implementation of larger furnaces in order to ensure that heat patterns are more uniform. This could potentially increase the cost of a boiler. Coal mill design may also have to be changed, increasing BOP (balance of plant) costs. With pricing of the product being dictated by competitive activity, such an increase in cost will have to be borne by the equipment manufacturer, in our view. Furthermore, risk of implementation (ie, ability to achieve guaranteed operational parameters) also rests with the boiler manufacturer and this could increase the costs associated with the warranty period. An extreme scenario would be the imposition of liquidation damages due to delay in implementing projects and/or inability to achieve desired performance levels.

T&D: excess capacity impacting pricing A combination of a slower pace of ordering in the past two years, excess domestic manufacturing capacity in India and the entry of foreign players has impacted pricing across voltage levels in India. Prices on an annual basis have declined 15-30% over the past three years. A 765KV transformer available previously at Rs200mn is now being bid at less than Rs80mn per transformer.

Foreign players entered the India market when two key factors made the opportunity (ie, margins) in India attractive:

Tender clauses for high-voltage products that required more than 66% of the tender to be supplied from a factory with a minimum two years’ experience in manufacturing the product.

Subsidiaries of MNCs in India, such as ABB, Siemens and Areva T&D, imported a significant amount of these products from their European factories, which increased the cost of the product.

Hyosung of Korea was the first to tap this opportunity and gained more than 70% of the 765KV transformer market in India (in FY08). The tender clauses were later (FY10) changed to 50% of product to be sourced from a factory with two years’ experience and, thereafter, compulsory JV clauses were introduced (at end-FY11). Despite the clauses requiring a JV to have an Indian partner, at least one transformer in each tender to be manufactured in India and the JV to be set up within six months of the award, competition continued to be tough


7 December 2011 34

during FY11 and new entrants such as Korea’s Hyundai and Ukraine’s ZTR (a JV with TRIL of India) managed to win tenders (4Q FY11). This impacted order inflows for Hyosung in India. We have seen recent activity from Chinese equipment manufacturers, in particular TBEA (Tebian Electric Apparatus Ltd), setting up manufacturing capacity in India.

Figure 43: Domestic capacity for transformers (MVA) – capacity more than doubled in the past five years

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

FY07 FY08 FY09 FY10 FY1150%

70%

90%

Industry transformer capacity Capacity utilisation RHS


Substation engineering procurement and construction (EPC) Excess capacity across the voltage level has put pressure on prices. Competitive intensity in substation EPC orders increased in FY09 as general contractors like L&T entered the market given weak ordering in industrial and infrastructure segments. Usually 5-10 EPC orders for 765KV are awarded by Powergrid corporation every year with each award being Rs2bn in size. A similar number of 400KV orders are awarded by various Indian states. In FY10, competitive intensity increased further with Powergrid Corporation relaxing the criteria for qualification for substation EPC orders. Powergrid Corporation removed circuit breakers from the substation contract making it easy for general contractors and other firms such as KEC, Jyoti Structures, Techno Electric to bid for these orders. In fact, each of these new contractors (in this segment) managed to garner an order each last year.

The near-term pricing environment remains challenging, according to our supply chain checks.


7 December 2011 35

Figure 44: High imports from Europe impacted cost structure and margins for subsidiaries of European MNCs in India (FY11)

28% 30%

20%

5%

0%

5%

10%

15%

20%

25%

30%

35%

ABB Siemens Areva T&D Crompton Greaves

Imports as % of sales


Figure 45: Most domestic manufacturers have lost share in Powergrid Corporation orders

0%1%2%3%4%5%6%7%8%9%

Cro

mpt

ongr

eave

s

Siem

ens

Ltd

Hyo

sung

TBEA

Are

vaT&

D

BHEL

Siem

ens

AG

Baod

ing

ABB

LTD

FY09 FY10 FY11 FY12

Note: Data exclude HVDC orders. Source: Powergrid Corporation, Barclays Capital estimates


7 December 2011 36

VALUATIONS – BACK TO CYCLICAL LOWS

Sector valuations have de-rated (from 23x in December 2010 to 13x currently) and are now closer to levels at which the previous upcycles commenced (in early CY04 and in early CY09). Furthermore, consensus expectations for sector earnings have been revised down by 10-40% (over the past 12 months). At this point, we believe the sector risk/reward is skewed more to the upside. Hence, our 2-Neutral sector view.

We prefer companies that: 1) are the best geared to ride out the difficult times and participate in the next upturn (L&T, 1-OW); 2) have strong product positioning (Cummins, Havells 1-OW); or 3) are at the bottom of their valuation cycle (KEC, CRG, 1-OW). We also initiate coverage of BHEL, BGR Energy, Thermax, ABB, Siemens and Voltas at 3-UW, and Areva T&D at 2-EW.

Sifting cyclical from structural The current de-rating of the sector is led by a weak order macro backdrop for most end markets; however, we believe that although some end markets are facing a cyclical slowdown (eg, infrastructure, industrial capex) others have structural issues that may take longer to resolve. For example, the BTG segment faces a cyclical slowdown in orders, as the bulk of the 12th plan projects are awarded; however, oversupply in the domestic market will impact margins for incumbents and this may not get resolved until order run rates are significantly higher than projections. We expect this may not happen until FY14-15. Similarly, the MEP (HVAC) segment for Voltas is facing a geographic shift following weakness in Dubai, and this is extending order finalisations and reducing bidding margins to as low as 5%. Hence we do not recommend exposure to the sector, even if valuations may appear attractive.

Figure 46: India Capital Goods – sector valuations close to 2009 previous cycle lows

5

10

15

20

25

30

35

Dec

-94

Oct

-95

Aug

-96

Jun-

97

Apr

-98

Feb-

99

Dec

-99

Oct

-00

Aug

-01

May

-02

Mar

-03

Jan-

04

Nov

-04

Sep-

05

Jul-

06

May

-07

Mar

-08

Jan-

09

Oct

-09

Aug

-10

Jun-

11

Aggregate sector fwd PE

13x

12x10 x

Source: Datastream, IBES Consensus, Barclays Capital

Sector trading at valuations close to levels at which the

previous upcycle had commenced

We favour companies facing a cyclical slowdown in end markets vs. exposure to

structurally weak end markets


7 December 2011 37

Figure 47: India Capital Goods – Sector derating led by consensus earnings estimate changes

-60%

-40%

-20%

0%

20%

40%

60%

Nov

-97

Aug

-98

Apr

-99

Dec

-99

Sep-

00

May

-01

Jan-

02

Sep-

02

Jun-

03

Feb-

04

Oct

-04

Jul-

05

Mar

-06

Nov

-06

Jul-

07

Apr

-08

Dec

-08

Aug

-09

Apr

-10

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Change in 1 year fwd earnings estimates for the sector YoY 12M fwd PE

Sector derating led by change in

consensus earnings estimates

Source: Datastream, IBES Consensus ,Barclays Capital

Figure 48: India Capital Goods – over 15% cut in consensus EPS expectations for the sector since May this year

-20%

-10%

0%10

%

Jun-10 Aug-10 Oct-10 Dec-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11

FY12 EPS YoY decline FY13 EPS YoY decline

Earnings cuts have accelerated since May, led by lower-than-

expected order intake in 1Q FY12 and margin pressures

Source: Datastream, IBES Consensus, Barclays Capital estimates

Figure 49: India Capital Goods – EPS revisions over past 12 months for FY12E and FY13E

-70%

-50%

-30%

-10%

10%

L&T

BHEL

Cro

mpt

onG

reav

es

Ther

max

Vol

tas

Cum

min

s

Hav

ells

KEC

inte

rnat

iona

l

ABB

Are

va T

&D

BGR

Ene

rgy

Siem

ens

FY12 FY13

Crompton Greaves, Voltas and ABB have seen the sharpest

earnings estimates cuts

Source: Datastream, IBES Consensus, Barclays Capital estimates


7 December 2011 38

In addition to assessing P/E multiples, we evaluate companies on four key factors: 1) exposure to end markets (order cycle and competition, risk of execution delays or order cancellations; 2) commodity and FX risk; 3) balance sheet (leverage); and 4) risk of earnings downgrades. We summarise our views in the following table.

Figure 50: India Capital Goods – Evaluation of companies on four factors: 1) state of end market, 2) commodity and forex risk, 3) balance sheet risk and 4) risk of EPS downgrades (continued on next page)

Factors BHEL L&T ABB Siemens Crompton Greaves Thermax

State of end-market

With 12th plan orders awarded, there will be a gap before ordering commences for 13th plan

Diversified business. Will be able to manage growth better than peers. Exposed to several end markets; hence, the ability to reduce risk

T&D volume cycle is recovering while industrial is already weak and should recover by FY14


T&D volume cycle is recovering.

Expect flattish growth for industrial core ordering but expect weak ordering in IPP sector; however, with low base of orders, impact is not likely very high

Risk of execution delays or order cancellations

BHEL has booked several orders without coal linkages/financial closure. This could impact pace of conversion of order book to revenues

See risk to Hyderabad metro project. JPA Karchana project still has land issues. Gas availability concerns could delay gas projects on book

See limited risk See limited risk See limited risk See limited risk on current order book

Exposed to competition and price pressures

Irrational competition. If current pricing continues there could be a sharp erosion in EBITDA margins

Competition high in only some segments such as power BTG, Oil and Gas. Other EPC work does not see irrational competition and if at all it is order specific and temporary in nature

High competition for T&D orders. Prices have though already declined at a 30% pa over the past three years. Competitive intensity more benign in industrial products and projects

High competition for T&D orders. Prices have though already declined at a 30% pa pace.

Very high competitive activity and irrational pricing exposure is about 15-20% of order book. Rest of the markets are competitive but base of margins are low so risk not very high

Core business can generate 10% EBITDA margins. Risk largely specific to new BTG business and here margins are unremunerative

Commodity price risk

Scale of risk is not very high as 70% of contracts have price variation clauses

Medium risk to margins as 70% of contracts have price variation clauses

Medium risk: 50% has price variation clauses

Medium-high risk as only 35% of contracts may have PV clauses

Only 20% of order book has price variation clauses. Commodity price increase will impact margins but will be the first to benefit from a decline

20-30% of order book has price variation clauses

Forex risks Risk limited to any imports (10% of costs)

Risk is very low. Have US$200mn of FCCBs outstanding and rupee depreciation could increase outflow

Imports 35% of its raw materials (and finished product) and rupee depreciation could impact cost

Imports 25-30% of the product; rupee depreciation to impact cost

Largely hedged as imports are about 10% of costs but exports 10-15% of product. Translation risk likely as 50% of revenues are from outside India

Limited exposure to forex risk

Risk of earrings downgrades

Limited risk for FY12/13 but significant risk to margins from FY14. Accounting changes supporting EPS

With L&T revising down guidance risk has lowered. On a relative scale downside risk should be about 5%

Consensus estimates for CY12 are too high – should see moderation

See margins risk on Siemens. EPS estimates appear achievable but have limited room for upgrades

Risk much lower than two quarters back. Overall risk limited to 10% further cuts. Our EPS estimates assume bear-case scenario

Inability to win order in IPP space can impact EPS estimates for FY14. FY13 numbers are largely a reflection of current order book

Leverage Low Medium Low Low Low Low


7 December 2011 39

Figure 50 (Continued): India Capital Goods – evaluation of companies on four factors: 1) state of end market, 2) commodity and forex risk, 3) balance sheet risk and 4) risk of EPS downgrades

Factors Cummins Havells BGR Voltas Areva T&D KEC

State of end-market

Demand in Power generation segment is decelerating but exposure to new products in exports to reduce downside risk.

Demand for consumer products remains strong in India. Fans segment is witnessing weak demand this year but appears to more of a cyclical issue.

With 12th plan orders already awarded there will be a phase of slow ordering

With Dubai market being weak, focus of ordering has shifted to Saudi Arabia and Qatar/Oman, etc, butpace of orders much slower although order pipeline appears encouraging


Flattish market growth for towers in FY13; however, exposure to Rail, water and substation segment plus acquisition of SAE Towers to help drive growth

Risk of execution delays and order cancellations

Low risk as it is a product business

Low risk as it is a product business

Limited risk on current order book

Limited risk as most projects in current order book under execution

Low risk Low risk. A very small portion of order book is slow moving ((Libya , Tunisia)

Exposed to competition and price pressures

Less risk. Cummins is a dominant player. Prices have gone up this year by 5-6% and are now stable

Competition not irrational - should be able to protect margins

Exposed to stiff competition. Cannot make margins in boiler/turbine (BTG) business

Exposed to high competition in both MEP business and in air-con products. While margins have deteriorated, we do not expect a recoveryin FY13

Exposed to high competition in T&D sector but current margins reflect the impact of weak pricing

High competition in India but exposure to orders outside India lowers the impact on margins

Commodity price risk

High commodity prices have already impacted margins. See low risk from here

Able to pass on increase in commodity prices with a lag

Limited risk now as new orders from NTPC will have price variation clauses

Risk is high as most projects fixed price in nature

Risk reflects in margins. Low risk though as over 60% of book has PV clauses

Over 60% of contracts are fixed price but high commodity prices already reflects in margin estimates

Forex risk Exports comprises about 25% of sales. Should benefit from rupee depreciation

Higher payout on foreign currency loans

Risk largely specific to contracts with Hitachi

Over 50% of revenues stems from Middle East. There could be risk of translation losses due to rupee depreciation

Only 10-15% of products and components are imported so risk is not very high

Rupee depreciation to re-price advances received in international locations and impacts financials. It is a non-cash loss though.

Risk of earnings downgrades

Limited risk post the recent earnings downgrades

Limited risk. A sharp recession in Europe could Impact margins. We continue to build in margin recovery at Sylvania

Substantial risk for FY14. With pricing in recent orders being low there is risk of sharp deterioration in EBITDA margins

Risk lower after recent downgrades but don’t see any scope for recovery in earnings

Less risk of EPS downgrades as margin/order expectations are not very high

Downside risk limited to 5-10% range, and this risk is also due tothe impact of translation losses.

Leverage Low Medium High Low Low Medium



7 December 2011 40

This page is intentionally left blank


7 December 2011 41

COMPANIES


7 December 2011 42

LARSEN & TOUBRO (1-OW, PT: RS1,560, +19%): LOOKING BEYOND THE DOWNTURN

We initiate coverage of L&T with a 1-Overweight rating and a 12-month price target of Rs1,560 (SOTP based, standalone at 16.5x FY13E, subsidiaries at Rs356). Despite the current weakness in the order cycle for L&T and likely weak 2H earnings, current valuations make us look beyond the near-term risks. L&T’s ability to grow its market share over the years is due to its strong execution, balance sheet and exposure to multiple end markets, which enables it to capture changing trends in orders. We expect L&T to participate in a new upcycle (even if it is a low beta one) given its exposure to infrastructure, as well as emerging demand drivers such as nuclear, railways and defence. We view the stock as attractive on share price weakness.

Well positioned to capture a new upcycle: L&T’s diversified skills, qualifications in several domains and a large balance sheet (compared with other contractors) helps it shift end markets in order to shield itself from a downturn in others. L&T hence tends to gain market share during downturns, and is also able to minimise y/y decline in growth during downturns. L&T is best positioned to capture an upturn in the capex cycle even if it is led by new drivers such as the railways, nuclear or defence industries. With the infrastructure sector being the key driver of a recovery in FY13E and industrial capex in FY14E, we believe that the order inflow trajectory for L&T will outperform relative to peers.

Guidance cut moderates expectations: L&T’s order and margin guidance cut (from 20% to 5% and a 50bs decline to 50-75 bps) post Sep quarter numbers has significantly lowered consensus expectations. A weak order environment is well acknowledged by consensus, in our view, thus we believe that a further moderation in estimates may not be a big surprise. We build in 9% moderation in inflows in FY12E and 11% growth in FY13e.

Looking through the weak near term: L&T’s valuation has witnessed a de-rating (from 23x P/E to 14x) and consensus earnings estimates cuts by 9-18% for FY12-14E. We believe the our bear case scenario suggests an ~35% downside as against a bull case scenario of 90% upside, tilting the risk-reward towards a 1-Overweight rating. L&T, in our view, has always performed best when bought during uncertain times, and while there is always a risk of near-term downside, the stock tends to outperform over the medium term. Our downside case share price of Rs817 suggests an order inflow CAGR of growth of 5% until FY20, margins to moderate to 8%, while our upside case share price of Rs2488 builds in 10% order CAGR and EBITDA margins to remain at 12% levels.

Figure 51: L&T (Standalone financials) – statistical abstract

Year to Net profit EPS EPS growth P/E P/B ROE Div. yield

Mar Rs mn Rs % (x) (x) (%) (%)

2011A 35,033 57.5 12.9 22.8 3.7 16.0 1.2

2012E 40,296 66.2 15.0 19.8 3.2 16.2 1.4

2013E 44,431 73.0 10.3 18.0 2.8 15.8 1.5

2014E 53,315 87.6 20.0 15.0 2.5 16.6 1.8

Source: Company data, Barclays Capital estimates, based on standalone financials

LT IN / LART.NS

Stock Rating 1-OVERWEIGHT

Sector View 2-NEUTRAL

Price Target INR 1560.00

Price (02-Dec-2011) INR 1310.75

Potential Upside/Downside +19%


7 December 2011 43

COMPANY SNAPSHOT

LARSEN AND TOUBRO INDIAN CAPITAL GOODS

Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 439,049 530,835 565,712 658,443 14.5% Stock Rating 1-OVERWEIGHTEBITDA 55,985 63,337 69,428 82,898 14.0% Sector View 2-NEUTRALEBIT 49,982 56,807 63,197 75,652 14.8% Price (02-Dec-2011) 1310Pre-tax income 57,940 60,979 67,622 81,068 11.8% Price Target 1560Net income 35,033 40,296 44,431 53,315 15.0% Ticker LART.BOEPS (R) 57.5 66.2 73.0 87.6 15.0%Diluted shares (mn) 609 609 609 609 0.0% Investment case

DPS (R) 14 17 18 22 15.0%

Margin and return data (%) AverageEBITDA margin 12.8 11.9 12.3 12.6 12.4EBIT margin 11.4 10.7 11.2 11.5 11.2Pre-tax margin 13.2 11.5 12.0 12.3 12.2Net margin 8.9 7.6 7.9 8.1 8.1ROIC 13.3 12.3 12.0 12.5 12.5ROA 11.9 11.0 10.7 11.3 11.2 Upside case 2488ROE 16.0 16.2 15.8 16.6 16.1

Balance sheet and cash flow (INRmn) CAGRFixed assets 72,370 75,839 79,609 82,363 4.4%Cash and equivalents 17,304 40,799 49,362 60,734 52.0%Total assets 295,571 366,090 414,409 472,389 16.9%Current liabilities 278,233 336,779 358,905 417,737 14.5%Long term liabilities 71,611 111,908 126,904 144,897 26.5% Downside case 817Total liabilities 349,844 448,687 485,809 562,634 17.2%Net debt/(funds) (14,505) 2,297 8,729 15,352 NAShareholders' equity 218,463 248,684 282,008 321,994 13.8%Change in working capital (2,772) (13,553) (5,987) (13,855) NACash flow from operations 38,613 29,100 40,250 41,290 2.3%Capital expenditure (15,468) (10,000) (10,000) (10,000) NAFree cash flow 23,145 19,100 30,250 31,290 10.6%

Upside/downside scenarios

Valuation and leverage metrics AverageP/E (x) 22.8 19.8 18.0 15.0 18.9 EV/EBITDA (x) 15.2 13.7 12.6 10.6 13.1 FCF yield (%) 2.9 2.4 3.8 3.9 3.3 EV/sales (x) 1.9 1.6 1.5 1.3 1.6 Price/BV (x) 3.7 3.2 2.8 2.5 3.0 Dividend yield (%) 1.1 1.3 1.4 1.7 1.4 Total debt/capital (%) 0.4 0.3 0.5 0.5 40.0Net debt/EBITDA (x) 1.0 1.1 1.1 1.0 1.1

Source: Thomson Reuters Datastream, Barclays Capital est.

Selected operating metrics Expect Order inflow growth to recoverOrder inflow 797,690 728,659 806,407 967,688 Order inflow growth (%) 14 -9 11 20Orderbook 13,027 15,002 17,340 20,353 Orderbook growth (%) 30 15 16 17

Source: Company data, Barclays Capital estimates Note: FY end Mar.

Why a 1-Overweight? Exposure to multiple endmarkets should enable L&T to capture changingordering trends. We expect L&T to participate in anew upturn given its exposure to infrastructure,which should lead the new cycle, and exposure toemerging demand drivers. Consensus EPS cuts andvaluation deratings have moderated expectations.

Our bullish case would be a general recovery in allend markets in India led by government reforms. Inour DCF, we assume margins to remain at 12% andmarket share in power orders at 15%. We valuesubsidiaries at Rs400/L&T share. Terminal growth at0%.

Our bear case would represent market share losses.In our DCF, we assume market share in non-powerorders declines to 11.5% from 15%. We expectpower orders at a market share of only 10% longterm and margins to fall to 8% by FY20. Terminalgrowth at 0%.

-20%-10%

0%10%20%30%40%

Mar10E Mar11E Mar12E Mar13E Mar14E

Order inflow growth

DownsideCase

INR817(-37.6%) Price

Target

INR1560(19.0%)

UpsideCase

INR2488(89.8%)

408

908

1408

1908

2408

2908

22-Dec-10 2-Dec-11

DownsideCase


Target

INR1560(19.0%)

UpsideCase

INR2488(89.8%)

408

908

1408

1908

2408

2908

22-Dec-10 2-Dec-11


7 December 2011 44

Expect order inflow momentum to trough in FY13E

We expect L&T to witness a decline in order inflows in FY12E (vs. guidance of 5% growth) given the slower pace of ordering in most of its end markets in India. We do, however, expect a recovery in infrastructure ordering in India in FY13E and industrial recovery in FY14E. Given the diversified skill sets of L&T, we believe the company should be able to drive a recovery in order inflows. Continued weakness in power BTG orders will however likely keep overall order inflow growth in check in FY13E.

Figure 54: L&T – Expect a recovery in FY14E led by recovery in industrial orders

Rs mn FY12 FY13 FY14 Comments

Power BTG 99,000 118,800 118,800 KPCL JV included in FY12. UMPP win can make a big difference

Power BOP 50,000 40,000 40,000 Expect ordering to weaken by FY14 – largely a cyclical event

Power T&D 60,000 50,000 50,000 Expect wins in substations in India and in middle east

Nuclear 20,000 20,000 40,000 Expect Nuclear orders to commence in FY14

Other utilities 10,000 10,000 20,000 Water/Gas to be the drivers

ONGC +GSPL 20,000 35,000 35,000 More a market share story. Expect flat ordering every year

Other hydrocarbons 20,000 20,000 35,000 More a market share story. Expect flat ordering every year

Metals 50,000 50,000 60,000 FY14 recovery is likely. Can present upside surprises

Cement 5,000 10,000 20,000 Building in moderate growth in FY14

Other industries 30,000 30,000 50,000 Expect ordering in other industries to revive

Short cycle product 80,000 80,000 120,000 Industrial recovery to drive FY14 numbers

Other infra 40,000 80,000 50,000 Ports. Bidding for a large port in East/West coast

Roads 30,000 30,000 30,000 Building in base case orders in this segment

Real estate/buildings 90,000 80,000 100,000 Continue to see strength in this segment

Defence 20,000 30,000 40,000 Expect to benefit from offsets

Ships 10,000 10,000 25,000 Shipyard to start getting traction in FY14

Railways 20,000 40,000 60,000 Expect Rail ordering to recover in FY14

Middle East 60,000 50,000 50,000 Led by infra projects

Order inflow 714,000 783,800 943,800


Figure 52: L&T – revenue by product: mix has always changed in response to market conditions

Figure 53: L&T – Market share over the years has increased

0%10%20%30%40%50%60%70%80%90%

100%

FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E

Infrastructure Power Hydrocarbons Process Others

5% 5%6%

7% 7% 7%9%

10%11%12%

16%14%

0%

2%

4%

6%

8%10%

12%

14%

16%

18%

Mar-00 Mar-02 Mar-04 Mar06 Mar08 Mar10E

L&T E&C market share



7 December 2011 45

Limited downside to EPS estimates

L&T’s FY12-14E consensus EPS has seen revisions of 9-18% over the past 12 months and, given management’s revision of guidance following the 2Q FY12 results, we see less risk of further EPS revisions from hereon.

Figure 55: L&T – Barclays Capital’s sensitivity analysis of margins and revenue growth suggests that a further cut in EPS estimates by 15% would represent a bearish scenario

FY12E FY13E

Revenue Growth

15% 18% 21% 25% 7% 10% 15% 20%

EPS forecasts (Rs)

10.8% 57.0 58.3 59.7 61.5 10.5% 62.15 64.00 66.69 69.38

11.9% 63.2 64.7 66.2 68.3 10.9% 64.60 66.52 69.33 72.13

12.8% 67.7 69.3 71.0 73.2 11.8% 70.09 72.19 75.26 78.32

13.5% 71.8 73.5 75.3 77.6 12.3% 72.98 75.17 78.37 81.57

14.0% 74.5 76.3 78.2 80.6 12.8% 76.03 78.32 81.66 85.01

Change from our current base case EPS forecasts

10.8% -14% -12% -10% -7% 10.5% -15% -12% -9% -5%

11.9% -5% -2% 0% 3% 10.9% -11% -9% -5% -1%

12.8% 2% 5% 7% 11% 11.8% -4% -1% 3% 7%

13.5% 8% 11% 14% 17% 12.3% 0% 3% 7% 12%

14.0% 13% 15% 18% 22% 12.8% 4% 7% 12% 16%

EPS growth rates

10.8% 2% 4% 6% 10% 10.5% -6% -3% 1% 5%

11.9% 13% 15% 18% 22% 10.9% -2% 1% 5% 9%

12.8% 21% 23% 26% 30% 11.8% 6% 9% 14% 18%

13.5% 28% 31% 34% 38% 12.3% 10% 14% 18% 23%

Mar

gin

14.0% 33% 36% 39% 44% 12.8% 15% 18% 23% 28%


Figure 56: L&T – history of current consensus EPS forecasts shows upward revisions have occurred during positive cycles (Rs)

Figure 57: L&T – history of current consensus EPS forecasts for FY12-14 shows estimates have been revised down 9-18% in past 12 months (Rs)

0

20

40

60

80

100

Nov

-05

Aug

-06

May

-07

Feb-

08

Nov

-08

Aug

-09

May

-10

Feb-

11

FY06 FY07 FY08 FY09FY10 FY11

60

80

100

120

140

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

FY12 FY13 FY14

Source: Datastream, IBES consensus estimates, Barclays Capital Source: Datastream, IBES consensus estimates, Barclays Capital


7 December 2011 46

Shares pricing in bearish prospects over the longer term

The current share price reflects a bearish view on L&T’s long-term prospects as per our cash flow analysis. We believe the current share price is reflecting an assumption that order inflows will decline 10% this year, grow only 4% next year and broadly grow at a CAGR of 7% from FY12E until FY20E, leading to revenue and EBITDA CAGRs of 12% and 9%, respectively. We assume a WACC of 13.7% and terminal cash flow growth of 0% as well as subsidiary value of Rs300 per share (i.e., we assign no value to the L&T-MHI JV or the new subsidiaries).

Figure 58: L&T – long-term cash flow analysis

Rs mn; March year-ends Mar-12 Mar13E Mar14E Mar15E Mar-16 Mar-17 Mar-18 Mar-19 Mar-20

GCF 4,671,192 5,138,311 5,652,142 6,499,964 7,474,958 8,596,202 9,885,632 11,368,477 13,073,749

YoY 0% 10% 10% 15% 15% 15% 15% 15% 15%

GCF US$bn 104 114 126 144 166 191 220 253 291

Market share 14% 14% 14% 13% 13% 13% 12% 11% 11%

Power-Industry ordering 25,000 20,000 20,000 30,000 35,000 35,000 35,000 35,000 35,000

L&T market share 10% 10% 10% 10% 10% 10% 10% 10% 10%

L&T MW orders 2,500 2,000 2,000 3,000 3,500 3,500 3,500 3,500 3,500

Order inflow- Power BTG 67,500 60,000 64,000 96,000 119,000 126,000 126,000 126,000 126,000

YoY -35% -11% 7% 50% 24% 6% 0% 0% 0%

Price per MW 27 30 32 32 34 36 36 36 36

Non power inflows 653,967 693,672 763,039 844,995 971,745 1,074,525 1,186,276 1,250,532 1,372,744

YoY -6% 6% 10% 10% 10% 10% 10% 10% 10%

Order inflow 721,467 753,672 827,039 940,995 1,090,745 1,200,525 1,312,276 1,376,532 1,498,744

YoY -10% 4% 10% 14% 16% 10% 9% 5% 9%

Orderbook 1,487,147 1,673,211 1,864,430 2,096,942 2,390,849 2,694,806 2,996,529 3,249,363 3,529,596

YoY 14% 13% 11% 12% 14% 13% 11% 8% 9%

Execution period, months 29 31 32 32 32 32 32 32 32

Sales/orderbook 41% 38% 38% 38% 38% 38% 38% 38% 38%

Gross sales 537,020 567,607 635,820 708,484 796,838 896,568 1,010,552 1,123,699 1,218,511

Net revenues 530,835 560,796 628,190 716,985 806,400 907,327 1,022,679 1,137,183 1,233,133

YoY 21% 6% 12% 14% 12% 13% 13% 11% 8%

EBITDA Margin 12% 12% 11% 11% 11% 11% 10% 10% 10%

EBITDA 63,337 66,174 69,101 78,868 88,704 99,806 102,268 113,718 123,313

Tax + Other income 11,366 12,439 14,537 (13,408) (13,306) (14,971) (15,340) (17,058) (18,497)

Capex (10,000) (10,000) (10,000) (10,000) (10,000) (10,000) (10,000) (10,000) (10,000)

Investments in JVs (15,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000)

Working capital 67,529 73,162 83,530 94,288 106,047 119,320 134,489 149,547 162,165

Days 46 48 49 48 48 48 48 48 48

Change in working capital (13,553) (5,633) (10,368) (10,759) (11,759) (13,273) (15,170) (15,058) (12,618)

FCFF 36,150 47,980 48,270 29,702 38,640 46,562 46,758 56,602 67,198

Present value 36,150 42,188 37,318 20,191 23,095 24,471 21,607 22,998 24,007

Source: Company Data, Barclays Capital


7 December 2011 47

Valuation

Our 12-month price target of Rs1,560 is based on our sum-of-the-parts (SOTP) analysis in which we value the company on a standalone at 16.5x our EPS estimate for FY13 and its subsidiaries at Rs356 per share. Our target P/E multiple for the standalone business is set at a 25% discount to the stock’s historical average for the past seven years as we do not assume a substantial uptick in all its end markets in FY13.

Figure 59: L&T – sum-of-the-parts valuation

Stake Methodology Multiple Value per share value Rs mn

L&T standalone P/E 16.5FY13 16.5 1,204 733,293

L&T Infotech P/E 12x FY12 12 79 48,029

L&T Finance 83% P/B 1.9x 1.9 85 51,960

L&T IDPL 100% P/B 2.0x 2.0 97 59,152

L&T MHI P/E 12x FY14 discounted 49 30,102

Other subsidiaries P/B 1.5x 1.5 45 27,624

Target price 1,560 950,161


L&T’s share is trading a close to its historical trough valuation (Figure 60).

Figure 60: L&T – historical 12-month forward P/E (x): close to historical trough

5

10

15

20

25

30

35

Dec

-94

Oct

-95

Aug

-96

Jun-

97

Apr

-98

Feb-

99

Dec

-99

Oct

-00

Aug

-01

May

-02

Mar

-03

Jan-

04

Nov

-04

Sep-

05

Jul-

06

May

-07

Mar

-08

Jan-

09

Oct

-09

Aug

-10

Jun-

11L&T

Source: Datastream,, IBES consensus estimates, Barclays Capital estimates

Risks

The key risks that could keep our price target from being achieved, in our view, include the following: 1) a sharper-than-expected contraction in margins for the company; 2) order inflow guidance of 5% growth for FY12 is also at risk given the weak ordering activity in various end markets; and 3) although earnings estimates have moderated to reflect near-term weakness, there could be volatility in the stock and some downside around quarterly result announcements in January 2012.


7 December 2011 48

Financials

Figure 61: L&T – consolidated financials

Rs mn FY11 FY12E FY13E FY14E

Standalone profit after tax 35033 40296 44431 53315

L&T Infotech 3130 3897 4287 4716

L&T Finance 2304 2012 2516 3144

L&T Infrastructure development projects 158 190 218 251

L&T infrastructure finance 2009 1619 1862 2141

Minorities, start-up losses on MHI JV -1003 -3000 -3000 -2500

Consolidated recurring profit after tax 41630 45015 50314 61068

Standalone EPS 58 66 73 88

y/y 13% 15% 10% 20%

Consolidated EPS 68 74 83 100

y/y 14% 8% 12% 21%


Figure 62: L&T – income statement, FY09-14E

Rs mn; years ending March FY09 FY10E FY11E FY12E FY13E FY14E

Net revenue 339,264 370,348 439,049 530,835 565,712 658,443

Change in stocks -1,051 4,230 -5,596 -4,235 - -

Material and mfg costs 263,372 280,306 339,912 409,837 430,128 503,358

% of sales 78% 76% 77% 77% 76% 76%

Staff costs 19,980 23,791 28,845 37,554 37,727 39,265

% of sales 6% 6% 7% 7% 7% 6%

Sales and admin expenses 18,640 13,866 19,903 24,343 28,429 32,922

% of sales 5% 4% 5% 5% 5% 5%

Total expenditure 300,940 322,193 383,064 467,498 496,284 575,545

OBITDA 38,323 48,156 55,985 63,337 69,428 82,898

OBITDA margin 11.3% 13.0% 12.8% 11.9% 12.3% 12.6%

Depreciation 2,630 3,850 5,769 6,530 6,231 7,246

Amortization of intangible assets 212 310 234 - - -

EBIT 35,482 43,997 49,982 56,807 63,197 75,652

EBIT margin 10% 12% 11% 11% 11% 11%

Interest -1,784 -5,053 -6,474 -7,193 -8,014 -9,121

Other Income 5,680 8,144 14,431 11,366 12,439 14,537

Recurring other income 5,658 8,144 10,121 11,366 12,439 14,537

Profit before tax 39,378 47,088 57,940 60,979 67,622 81,068

PBT margin 12% 13% 13% 11% 12% 12%

Tax -12,312 -16,409 -19,459 -20,684 -23,191 -27,753

Profit after tax before Extraordinary items 27,066 30,679 38,481 40,296 44,431 53,315

Profit on sale of business 7,725 12,105 708 - - -

Reported net income 34,790 42,784 39,189 40,296 44,431 53,315

Recurring profit after tax 27,048 30,679 35,033 40,296 44,431 53,315



7 December 2011 49

Figure 63: L&T – balance sheet, FY09-14E

Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E

Equity capital 1,171 1,204 1,218 1,218 1,218 1,218

Reserves and surplus 121,069 178,822 213,562 243,784 277,107 317,093

Loans 65,560 68,008 71,611 111,908 126,904 144,897

Deferred tax liability 4,352 3,893 5,497 5,497 5,497 5,497

Total sources 194,508 255,017 295,571 366,090 414,409 472,389

Net tangible assets 40,128 53,654 64,520 67,989 71,759 74,513

Capital WIP 10,410 8,577 7,850 7,850 7,850 7,850

Intangible assets 1,408 1,427 2,212 2,212 2,212 2,212

Investments 82,637 137,054 146,848 176,848 206,848 236,848

Deferred tax assets 3,867 3,119 2,863 2,863 2,863 2,863

Inventory 58,051 14,154 15,772 18,906 20,149 23,451

Debtors 100,555 111,637 124,276 152,706 164,289 193,023

Cash and bank deposits 7,753 14,319 17,304 40,799 49,362 60,734

Loans and advances plus other cash 67,906 123,507 192,160 232,695 247,983 288,632

Interest accrued on investments 216 0 0 0 0 0

Liabilities 147,759 190,545 255,898 309,775 330,128 384,242

Provisions 30,665 21,884 22,334 27,003 28,778 33,495

Net current assets 56,056 51,188 71,279 108,328 122,878 148,104

Miscellaneous expenses not written off 2 0 0 0 0 0

Assets 194,508 255,017 295,571 366,090 414,409 472,389


Figure 64: L&T – cash flow statement, FY09-14E


Profit before tax and exceptional items 39,404 58,807 58,329 60,979 67,622 81,068

Dividends paid/received -3,346 -2,586 -3,942 -11,366 -12,439 -14,537

Depreciation 3,060 4,146 5,992 6,530 6,231 7,246

Interest (net) 1,784 5,053 3,114 7,193 8,014 9,121

Others 3,102 -12,981 -2,072 0 0 0

Operating profit be working capital change 44,003 52,438 61,420 63,337 69,428 82,898

Change (inc.)/dec. in working capital -20,487 17,580 -2,772 -13,553 -5,987 -13,855

Tax paid -8,731 -15,193 -20,035 -20,684 -23,191 -27,753

Net cash from operations 14,786 54,825 38,613 29,100 40,250 41,290

Change in financing activities -19,798 -15,598 -15,468 -10,000 -10,000 -10,000

Change in Investments -5,284 -41,597 -6,109 -30,000 -30,000 -30,000

Others 4,169 -3,523 -2,871 11,366 12,439 14,537

Net cash from investing -44,297 -60,717 -24,448 -28,634 -27,561 -25,463

Change in capital 230 21,327 3,473 0 0 0

Change in loans 23,606 6,680 -1,615 40,297 14,995 17,994

Dividends paid -5,054 -6,170 -7,562 -10,074 -11,108 -13,329

Others(interest paid) -2,374 -9,381 -5,544 -7,193 -8,014 -9,121

Cash flow from financing activities 16,408 12,456 -11,248 23,030 -4,126 -4,456

Opening cash balance 9,645 6,569 14,319 17,304 40,799 49,362

Inc./dec during the year -1,887 6,563 2,985 23,496 8,563 11,372

Closing balance 7,753 14,319 17,304 40,799 49,362 60,734



7 December 2011 50

Figure 65: L&T – historical consolidated income statement, FY05-11

Rs mn; years ended March FY05 FY06 FY07 FY08 FY09 FY10 FY11

Gross revenues 145,993 167,474 207,005 295,611 406,079 438,542 519,785

Less: excise duty 2,200 2,472 3,645 3,626 4,209 3,407 4,264

Sales and services 143,793 165,002 203,360 291,985 401,870 435,136 515,520

Add: operational other inc 1,176 611 1,768 1,519 2,929 4,562 5,371

Revenue 144,969 165,613 205,129 293,504 404,799 439,698 520,891

Expenditures

Mfg cons other expenses 112,168 124,912 151,215 219,679 302,128 323,400 375,409

Staff costs 8,719 10,469 14,882 20,494 26,660 30,658 38,020

Sales and admin expenses 12,290 14,384 12,885 17,341 26,423 21,246 29,888

EBITDA 11,793 15,848 26,146 35,990 49,586 64,394 77,575

EBITDA margin 8% 10% 13% 12% 12% 15% 15%Depreciation 1,941 2,240 2,997 4,063 7,283 9,793 13,189

Amortization 181 195 452 1,035

Interest (net) -1,025 -1,303 -504 -896 -4,620 6,919 8,309

Recurring other income 1,350 2,063 3,174 2,947 5,754 8,630 9,191

Profit on sale of investments 4,057 2,510 4,683 1,243 149

Profit before tax 14,052 16,683 30,050 34,186 43,587 56,312 65,269

Exceptional items post tax 7,725 18,664 2,053

Taxation 2,775 4,313 7,327 11,471 14,257 20,388 23,554

Reported profit after tax 11,277 12,369 22,723 22,715 37,055 54,589 43,768

Adjusted profit after tax 7,250 10,467 18,655 22,259 30,034 36,009 41,630



7 December 2011 51

BHEL (3-UW, PT: RS230, -19%): FUNDAMENTALS DETERIORATING

We initiate coverage on BHEL with a 3-Underweight rating and a 12-month price target of Rs230. While the stock has de-rated (from 22x to 10x) unlike its peers, multiples for BHEL are on peak cycle earnings and somewhat propped by accounting changes. Booking of orders without coal linkages is also a cause for concern. With BHEL losing its monopoly status, the artificially high margins it sports are not sustainable and should trend down to below 10%. The fact that recent bids at prices where it is not possible to make profits is concerning. Deteriorating working capital metrics, inability to generate cash, more than 15% of order book with slow moving orders and excess cash being deployed into low return businesses are key reasons for the de-rating.

Exposed to a competitive end market: BHEL’s order inflow is exposed to the boiler and turbine segment, an end market that is the worst placed, in this cycle as per our analysis of over 20 end markets. The slow pace of diversification in the industrial segment, implies that the earlier street view of industrial business supporting decelerating power order inflows does not hold good. Furthermore, BHEL now has to compete for every order, whereas in the past it received orders on a negotiated basis or had price preference clauses during bids. Order growth rates are set to slow, in our view.

Order booking without coal linkages and financial closures: Our analysis of BHEL’s order book suggests that BHEL has booked several orders in FY11(~15% of orderbook) that have not received coal linkage (Figures 20 and 21). Without coal linkage, it is not possible to design a boiler, hence project execution does not commence. This is a concern as it extends order execution cycles.

Current margins unsustainable: BHEL has successfully managed to ward off margin pressures through accounting changes. Over 20% of FY11E profits and 8% of 2Q FY12E PAT was due to accounting changes. The piecemeal approach towards implementation of such changes has distorted earnings predictability, and is partially responsible for the de-rating of the stock. As such, we believe that BHEL will be unable to maintain EBITDA margins at the current 20% range. Margins post FY14E should trend down to around 15% and longer-term margins should be below 10%.

More de-rating likely: BHEL is trading at 10x peak year earnings; at these valuations the stock is pricing in cyclical concerns, but structural factors (i.e. coal shortage, and competition driving down margins) will continue to pressure the stock, in our view.

Figure 66: BHEL – statistical abstract


Mar Rs mn Rs % (x) (x) (%) (%)

2011A 60113 24.6 39.4 11.5 3.4 29.8 2.2

2012E 66089 27.0 9.9 10.5 2.8 26.7 2.5

2013E 69358 28.3 4.9 10.0 2.3 23.4 2.6

2014E 64169 26.2 -7.5 10.8 2.0 18.8 2.4

Source: Company data, Barclays Capita estimates

BHEL IN / BHEL.NS

Stock Rating 3-UNDERWEIGHT



Price (02-Dec-2011) INR 282.45

Potential Upside/Downside -19%


7 December 2011 52

COMPANY SNAPSHOT

BHEL INDIA CAPITAL GOODS

Income statement (INRmn) 2011A 2012E 2013E 2014E CAGRRevenue 422,466 476,781 500,629 493,826 5.3% Stock Rating 3-UNDERWEIGHTEBITDA 85,857 92,755 95,554 87,551 0.7% Sector View 2-NEUTRALEBIT 80,416 86,006 88,367 80,512 0.0% Price (02-Dec-2011) 283Pre-tax income 90,057 95,749 101,132 95,263 1.9% Price Target 230Net income 60,113 66,089 69,358 64,169 2.2% Ticker BHEL IN/BHEL.BOEPS (R) 24.6 27.0 28.3 26.2 2.2%Diluted shares (mn) 2,448 2,448 2,448 2,448 0.0% Investment case

DPS (R) 6 7 7 7 2.7%


Balance sheet and cash flow (INRmn) CAGRFixed assets 51,631 64,882 72,696 75,657 13.6%Cash and equivalents 96,302 120,742 153,675 204,473 28.5%Total assets 592,606 679,769 755,782 799,941 10.5%Current liabilities 389,434 429,735 457,197 456,437 5.4%Long term liabilities 1,634 1,634 1,634 1,634 0.0% Downside case 208Total liabilities 391,067 431,368 458,831 458,071 5.4%Net debt/(funds) (94,668) (119,108) (152,041) (202,839) NAShareholders' equity 201,538 247,801 296,352 341,270 19.2%Change in working capital (30,929) (4,171) (2,804) 13,841 NACash flow from operations 26,586 59,524 60,976 70,298 38.3%Capital expenditure (17,300) (20,000) (15,000) (10,000) NAFree cash flow 9,286 39,524 45,976 60,298 86.6%


Valuation and leverage metrics AverageP/E (x) 11.5 10.5 10.0 10.8 10.7 EV/EBITDA (x) 6.2 5.6 5.0 4.8 5.4 FCF yield (%) 1.3 5.7 6.7 8.7 5.6 EV/sales (x) 1.4 1.2 1.1 1.0 1.2 Price/BV (x) 3.4 2.8 2.3 2.0 2.6 Dividend yield (%) 2.2 2.5 2.6 2.4 2.4 Total debt/capital (%) 0.8 0.7 0.6 0.5 0.6 Net debt/EBITDA (x) -1.1 -1.3 -1.6 -2.3 -1.6


Selected operating metrics Order inflows expected to remain weakOrder inflow, Rs bn 6,051 5,336 4,545 5,473 Order inflow growth (%) 1.4 -11.8 -14.8 20.4Orderbook, Rs bn 16,211 16,705 16,131 16,555 Orderbook growth (%) 12.3 3.0 -3.4 2.6


Why a 3-Underweight? Power BTG sector is goingthrough a weak phase of ordering. Oversupply isimpacting pricing and margins. BHEL’s currentmargin trajectory is unsustainable. Whilefundamentals are weak, P/E at 10x is pricing in someof the weakness.

A recovery in BTG market led by resolution of coalcrisis, improved financial health of utilities andreduction in competition in India could help drivemultiples. Upside case assumptions: market sharelong term at 45%, margins at 16% by FY20, terminalgrowth of 5%.

Our bearish case estimates assume a market sharelong term of 35%. Margins to fall to 10% by FY20.Terminal growth at 3%.

-20%

-10%

0%

10%

20%

30%

Mar-10 Mar11 Mar12E Mar13E Mar14E

Order inflow growth rates

DownsideCase

INR208(-26.5%)

PriceTarget

INR230(-18.7%)

UpsideCase

INR350(23.6%)

104

204

304

404

504

16-Dec-10 2-Dec-11

INR208(-26.5%)Downside

Case

INR230(-18.7%)

PriceTarget

INR350(23.6%)

UpsideCase

0

100

200

300

400

500

16-Dec-10 2-Dec-11


7 December 2011 53

Current margins unsustainable; accounting changes impacting quality of earnings

We see significant margins risk ahead for BHEL due to 1) the increase in competitive activity which is impacting pricing of new projects, 2) likely increase in mix of EPC projects and 3) increase in the mix of supercritical projects under execution. Margin risk emerges from FY14E, as we expect execution of high margin orders in the backlog to support margins in the near term.

Figure 67: BHEL – EBITDA margins at ~20% are unsustainable

23%22%21%

11%10%

14%

18%17%

13%15%

9%

14%15%16%17%

19%20%

19%

16%18%

20%19%19%18%

0

0

0

0

0

0

Mar91E Mar-94 Mar-97 Mar-00 Mar-03 Mar-06 Mar-09 Mar12E

Operating Ebitda margin

Current EBITDA margins for BHEL are unsustainable, in our

view. We believe that downside post FY14E could be higher than

expected


Figure 68: BHEL – accounting changes support margins – PBT increased by ~ 20% in Mar-11 and over 8% in Sep-11

Quarter Sales

(Rs mn) PBT

(Rs mn) %

of PBT Changes

Dec-11 4440 880 4% Changed accounting policy with respect to provision for warranties. As against creation of provision for warranties at 2.5% of contract value on trial operation, the company has revised it and provides warranty cost at 2.5% of revenue progressively as and when it recognized the revenue and maintains same throughout the warranty period. This is against the earlier policy of deferring warranty provisions and corresponding revenues till the completion of trial operation

Mar1111

23288 8950 21% Cumulative impact of the three accounting changes in the Mar quarter

23288 6075 Change in accounting policy of provisioning during trial operation

468 Cranes used at site have been classified as general plant and machinery as against erection equipment and accordingly depreciation rate has been changed from 20% to 8% with retrospective effect.

2408 As against creation of leaves on accrual basis, it has been changed to actuarial valuation basis treating the same as other long-term benefits based on behavioural patterns.

Sep-11 1660 8% Company has accounted for leave encashment expenditure with 30 days per month as base for computation of encashment leave as per specific instructions by DP/E on this subject. This is compared with earlier formula of computation of leave based on 26 days a month


Execution of supercritical projects: Supercritical projects will have lower margins in the initial stages due to higher import content. We expect over 36% of FY13E and 57% of FY14E revenues to stem from supercritical projects, which should have an impact on blended margins. The impact though will not be pronounced as these supercritical projects were obtained at a higher price compared with recent trends.


7 December 2011 54

Earnings momentum to decelerate

A combination of slower ordering for equipment (as over 95% of 12th plan orders have already been awarded, coal availability issues delaying project ordering) and competitive activity (market share moderation) will impact order inflow growth for BHEL, in our view. While we expect BHEL’s state JVs to support order inflow, this would however impact the company’s returns ratio.

Weak order inflow momentum will start impacting sales growth from FY13E, in our view, and in turn earnings growth. Even in the near term, we expect the high base of 2HFY11 to impact earnings growth in the coming quarters. While we are still building in a modest single-digit growth in earnings for both December and March quarters, it is likely that BHEL may report negative growth rates. If BHEL manages to implement some more accounting changes it is likely that the deterioration in earnings growth could be lower than our expectations.

Figure 69: BHEL – earnings momentum to deteriorate sharply in 2H FY12

64

78

62

85

38

58

3322

91

16

(3)

33

(10)

2

21 22

39 3642 42

33 31

47

22 24

4 4

-20

0

20

40

60

80

100

Sep-

05

Jun-

06

Mar

-07

Dec

-07

Sep-

08

Jun-

09

Mar

-10

Dec

-10

Sep-

11

Quarterly EPS YoY

Watch out for sharp decline in EPS momentum in 2H FY12


With EPS likely to decline sharply should one expect more

accounting changes?

Figure 70: BHEL – order inflows to deteriorate sharply

Figure 71: BHEL – sales growth to single digits by FY14

-40%

-20%

0%

20%

40%

60%

80%

100%

Mar-95 Mar-99 Mar-03 Mar-07 Mar-11

Order inflow YoY

10th plan9th plan8th plan 12th plan11th plan

-10%-5%0%5%

10%15%20%25%30%35%40%

Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar12E

Sales YoY

10th plan9th plan8th plan 12th plan11th plan

Source: : Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates


7 December 2011 55

Working capital under stress

BHEL’s cash flow generation has been affected by deterioration in the working capital situation with receivables days expanding sharply. Furthermore, a slowdown in order inflow growth has also impacted growth in advances received. Management, in a recent quarterly conference call, has highlighted that they are monitoring receivables/collections and that there have been some delays in payments. We believe that this could be largely due to the weak financial situation of the SEBs.

Figure 74: BHEL – net current asset (less cash) days more than doubled in the past year

Sep-10 Sep-11

Capital 4,895 4,895

Reserves and surplus 172,378 218,919

Loan funds 4,170 14,801

Fixed assets 41,159 53,793

Investments 4,284 4,617

Deferred tax assets 15,175 23,656

Inventories 107,081 131,586

Inventory days 117 116

Sundry Debtors 221,039 305,693

Debtor days 242 270

Cash and bank balances 86,770 79,491

Other current assets 2,587 3,087

Loans and advances 38,882 34,102

Current liabilities 295,584 328,381

Current liability days 323 290

Provisions 39,950 69,029

As days of sales 44 61

Net current assets 120,826 156,548

Net current assets less cash 34,056 77,057

Days of sales 37 68


Cash generation affected by deteriorating receivable days

Figure 72: BHEL – Working capital days starting to deteriorate

Figure 73: BHEL – Working capital changes (Rs mn)

-50

0

50

100

150

200

Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10

Net current asset days

-40,000

-30,000

-20,000

-10,000

0

10,000

20,000

30,000

Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10

Change in working capital

Source: Company data, Barclays Capital Source: Company data, Barclays Capital


7 December 2011 56

Not much value at current price

Although BHEL’s P/E has corrected from 22x to 10x in the past year, our long-term cash flow projections suggest that the current share price builds in the market orders of 140GW in both the 11th and 12th plans, BHEL has a long-term market share of 40%, margins will remain steady near-term and decline to 14% by FY20E, WACC of 12.9%, and terminal cash flow growth of 3%.

Figure 75: BHEL – cash flow analysis: share price builds in a long-term market share of 40% and margins trending down to 14% by FY20E

Mar (Rs m) Mar-11 Mar-12 Mar13E Mar14E Mar15E Mar-16 Mar-17 Mar-18 Mar-19 Mar-20

Industry ordering 30,000 25,000 20,000 20,000 30,000 35,000 35,000 35,000 35,000 35,000

BHEL orders in GW 16,500 15,000 11,000 9,000 13,500 14,000 14,000 14,000 14,000 14,000

BHEL market share 55% 60% 55% 45% 45% 40% 40% 40% 40% 40%

Order inflow- Power 463,930 427,750 330,000 270,000 432,000 448,000 448,000 448,000 448,000 448,000

YoY 11% -8% -23% -18% 60% 4% 0% 0% 0% 0%

Price per MW 28 29 30 30 32 32 32 32 32 32

Order inflow- Industry + Others

141,140 192,488 148,500 121,500 216,000 246,400 246,400 246,400 246,400 246,400

YoY -17% 36% -23% -18% 78% 14% 0% 0% 0% 0%

as % of power inflow 30% 45% 45% 45% 50% 55% 55% 55% 55% 55%

Order inflow 605,070 620,238 478,500 391,500 648,000 694,400 694,400 694,400 694,400 694,400

YoY 2% 3% -23% -18% 66% 7% 0% 0% 0% 0%

Gross Revenues 418,419 486,323 515,466 504,377 470,514 523,760 574,952 610,786 635,870 653,429

Orderbook 1,621,076 1,718,222 1,681,255 1,568,379 1,745,865 1,916,506 2,035,954 2,119,568 2,178,097 2,219,068

Execution period, mth 41 40 40 40 40 40 40 40 40 40

Gross sales 418,419 486,323 515,466 504,377 470,514 523,760 574,952 610,786 635,870 653,429

Excise Duty (18,011) (21,050) (22,312) (21,832) (20,366) (22,671) (24,887) (26,438) (27,523) (28,283)

Excise as % of sales -4% -4% -4% -4% -4% -4% -4% -4% -4% -4%

Net revenues 400,408 465,272 493,155 482,545 450,148 501,089 550,065 584,349 608,347 625,146

YoY 27% 16% 6% -2% -7% 11% 10% 6% 4% 3%

EBITDA Margin 20% 20% 18% 17% 17% 17% 15% 16% 15% 14%

EBITDA 81,436 92,538 86,652 82,033 76,525 85,185 82,510 93,496 91,252 87,520

Tax + Other income (19,738) (23,135) (21,663) (20,508) (18,366) (20,444) (19,802) (22,439) (21,900) (21,005)

Others as % of EBITDA -24% -25% -25% -25% -24% -24% -24% -24% -24% -24%

Capex (17,300) (15,000) (10,000) (7,000) (7,000) (7,000) (7,000) (7,000) (7,000) (7,000)

Investments in JVs (5,000) (10,000) (10,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000)

Working capital 29,212 34,417 36,480 33,051 30,832 34,321 37,676 40,024 41,668 42,818

Days 27 27 27 25 25 25 25 25 25 25

Change in working capital

(22,182) (5,205) (2,063) 3,429 2,219 (3,489) (3,355) (2,348) (1,644) (1,151)

FCFF 18,622 44,199 42,926 47,953 38,378 39,252 37,353 46,709 45,708 43,365

Discount factor 1.0 0.9 0.8 0.7 0.6 0.5 0.5 0.4 0.4

Present value of cash flows 44,199 38,022 37,621 26,669 24,159 20,364 22,555 19,549 16,428

Source: Company Data, Barclays Capital estimates


7 December 2011 57

Valuation

Our 12-month price target of Rs230 for BHEL is based on our discounted cash flow valuation analysis because we believe estimates for the next two years do not capture the impact of current pricing trends on margins.

Our assumptions appear to be a bit aggressive but capture long-term margin concerns:

Assume 140GW ordering in 12th and 13th plan. Execution period of 40 months. Healthy industry order book of over Rs200bn post FY16.

EBITDA margin to trend down to 14% from FY16 and 10% by FY20. Terminal growth of 3%. We value JVs at 1.2x P/B.

Figure 76: BHEL – discounted cash flow valuation analysis

Mar (Rs m) Mar-11 Mar-12 Mar13E Mar14E Mar15E Mar-16 Mar-17 Mar-18 Mar-19 Mar-20

Industry ordering 30,000 25,000 20,000 20,000 30,000 35,000 35,000 35,000 35,000 35,000

BHEL orders in GW 16,500 15,000 11,000 9,000 12,000 14,000 14,000 14,000 14,000 14,000

BHEL market share 55% 60% 55% 45% 40% 40% 40% 40% 40% 40%

Order inflow- Power 463,930 371,250 300,000 337,500 384,000 448,000 448,000 448,000 448,000 448,000

YoY 11% -20% -19% 13% 14% 17% 0% 0% 0% 0%

Price per MW 28 29 30 30 32 32 32 32 32 32

Order inflow - Industry + Others 141,140 162,311 184,508 209,819 192,000 224,000 224,000 224,000 246,400 246,400

YoY -17% 15% 14% 14% -8% 17% 0% 0% 10% 0%

as % of power inflow 30% 45% 45% 45% 50% 50% 50% 50% 55% 55%

Order inflow 605,070 533,561 484,508 547,319 576,000 672,000 672,000 672,000 694,400 694,400

YoY 2% -12% -9% 13% 5% 17% 0% 0% 3% 0%

Gross Revenues 418,419 474,450 505,527 502,075 502,212 524,348 568,644 599,651 621,355 643,269

Orderbook 1,621,076 1,670,464 1,639,084 1,674,039 1,747,827 1,895,479 1,998,835 2,071,185 2,144,229 2,195,361

Execution period, months 41 40 40 40 40 40 40 40 40 40

Gross sales 418,419 474,450 505,527 502,075 502,212 524,348 568,644 599,651 621,355 643,269

Excise Duty -17,709 -7,158 -11,089 -11,013 -21,738 -22,696 -24,614 -25,956 -26,895 -27,844

Excise as % of sales -4% -4% -4% -4% -4% -4% -4% -4% -4% -4%

Net revenues 400,711 467,292 494,438 491,061 480,474 501,652 544,030 573,695 594,460 615,425

YoY 27% 17% 6% -1% -2% 4% 8% 5% 4% 4%

EBITDA Margin 20% 19% 19% 18% 16% 14% 14% 14% 12% 10%

EBITDA 81,436 90,909 94,390 87,058 76,876 70,231 76,164 80,317 71,335 61,543

Tax + Other income -19,738 -19,516 -18,905 -16,432 -15,375 -14,046 -15,233 -16,063 -14,267 -12,309

Others as % of EBITDA -24% -21% -20% -19% -20% -20% -20% -20% -20% -20%

Capex -17,300 -20,000 -15,000 -10,000 -7,000 -7,000 -7,000 -7,000 -7,000 -7,000

Investments in JVs -3,594 -5,000 -5,000 -10,000 -15,000 -20,000 -20,000 -20,000 -15,000 -15,000

Working capital 29,212 33,383 37,114 36,325 35,542 37,109 40,243 42,438 43,974 45,525

Days 27 26 27 27 27 27 27 27 27 27

Change in working capital -22,182 -4,171 -3,731 789 783 -1,567 -3,135 -2,194 -1,536 -1,551

FCFF 18,622 42,222 51,754 51,415 40,284 27,618 30,797 35,059 33,532 25,683

Present value of cash flows 42,222 45,841 40,337 27,993 16,999 16,789 16,929 14,342 9,730

Source: Company Data, Barclays Capital estimates


7 December 2011 58

Figure 77: BHEL – historical 12-month forward P/E (x): close to historical trough

5

10

15

20

25

30

35

Dec

-94

Oct

-95

Aug

-96

Jun-

97

Apr

-98

Feb-

99

Dec

-99

Oct

-00

Aug

-01

May

-02

Mar

-03

Jan-

04

Nov

-04

Sep-

05

Jul-

06

May

-07

Mar

-08

Jan-

09

Oct

-09

Aug

-10

Jun-

11

BHEL

Valuations for BHEL are on peak EPS; hence, despite its decline, the stock may not outperform

Source: Datastream, Barclays Capital

Risks The key risks that could keep our price target from being achieved, in our view, include a recovery in order inflows in the power segment led by the government’s positive policy action in solving the coal issue and issue with financials of state electricity boards. Stiff import duties would also help limit competition for local players. Shift in ordering to EPC will help reduce competition as only BHEL, L&T and BGR will then qualify for orders. Continued sustenance of margins and improved pricing trends in the market would support the share price, in our view.

Figure 78: BHEL – history of consensus EPS forecasts shows consensus earnings predictability has been high in the past (Rs)

Figure 79: BHEL – history of current consensus EPS forecasts for FY12-14 shows estimates have remained steady given a healthy order book

0

5

10

15

20

25

30

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

FY06 FY07 FY08 FY09

FY10 FY11

2526272829303132333435

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

FY12 FY13 FY14

Source: Datastream, IBES consensus estimates, Barclays Capital Source: Datastream, IBES consensus estimates ,Barclays Capital estimates


7 December 2011 59

Figure 80: BHEL – income statement, FY09-14E

Rs mn; years ending 31 March FY09 FY10 FY11 FY12E FY13E FY14E

Net revenue 267,268 333,545 422,466 476,781 500,629 493,826

Raw material expenses adjusted for inventory 164,685 198,856 230,817 289,894 304,678 305,515

% of sales 62% 60% 55% 61% 61% 62%

Staff cost 29,837 65,395 53,967 54,340 57,582 58,480

% of sales 11% 20% 13% 11% 12% 12%

Provisions for expenses 12,810 (9,342) 27,151 4,768 5,006 4,938

% of sales 5% -3% 6% 1% 1% 1%

Other expenses 17,746 19,438 24,674 35,024 37,810 37,342

% of sales 7% 6% 6% 7% 8% 8%

OBITDA 42,190 59,198 85,857 92,755 95,554 87,551

Operating margin 16% 18% 20% 19% 19% 18%

Depreciation and amortization 3,343 4,580 5,441 6,749 7,187 7,039

Interest expenses 307 335 547 401 423 423

Interest and other miscellaneous income 9,829 11,552 10,206 10,144 13,188 15,175

Other extraordinary items - (73) 18 - - -


Profit before tax margin 18% 20% 21% 20% 20% 19%

Tax 17,106 22,800 29,945 29,660 31,774 31,094

Profit after tax 31,994 43,107 60,113 66,089 69,358 64,169

Profit after tax margin 12% 13% 14% 14% 14% 13%

Adjusted profit after tax 31,994 43,165 53,709 66,089 69,358 64,169

Adjusted profit after tax margin 12% 13% 13% 14% 14% 13%



7 December 2011 60

Figure 81: BHEL – balance sheet, FY09-14E


Share capital 4,895 4,895 4,895 4,895 4,895 4,895


Shareholder funds 129,388 159,174 201,538 247,801 296,352 341,270

Total debt 1,494 1,278 1,634 1,634 1,634 1,634

Capital employed 130,882 160,451 203,172 249,435 297,985 342,904

Net fixed assets 14,704 24,154 34,009 47,261 55,074 58,035

Capital WIP 11,570 15,296 17,622 17,622 17,622 17,622

Investments 523 798 4,392 9,392 14,392 19,392

Deferred tax and others 18,403 15,272 21,636 21,636 21,636 21,636

Cash and bank balance 103,147 97,901 96,302 120,742 153,675 204,473

Receivables 159,755 206,888 273,546 308,275 323,695 311,178

Receivable days 218 226 236 236 236 230

Inventories 78,370 92,355 109,630 124,094 137,159 135,295

Inventory days 107 101 95 95 100 100

Loans and advances 24,237 28,137 32,373 27,653 29,037 28,642

Others 3,502 4,069 3,096 3,096 3,494 3,669

Current liabilities 233,573 280,237 313,466 353,767 371,462 366,414

Current liabilities days 319 307 271 271 271 271

Provisions 49,756 44,180 75,968 75,968 85,735 90,023


Total assets 130,882 160,451 203,172 250,035 298,585 343,504



7 December 2011 61

Figure 82: BHEL – cash flow statement, FY09-14



Depreciation 3,343 4,580 5,441 6,749 7,187 7,039

Others (8,448) (8,175) 665 (9,143) (12,765) (14,751)

Operating cash before working capital 43,995 62,313 96,163 93,355 95,554 87,551

Change in receivables (49,110) (52,089) (74,073) (34,728) (15,420) 12,517

Change in inventories (21,006) (13,984) (17,380) (14,463) (13,065) 1,864

Change in other assets - - - 4,720 (1,781) 220

Change in current liabilities and provisions 82,102 38,645 60,524 40,301 27,462 (760)

Change in working capital 11,986 (27,428) (30,929) (4,171) (2,804) 13,841

Tax paid (23,069) (19,035) (38,648) (29,660) (31,774) (31,094)

Cash flow from operations 32,912 15,851 26,586 59,524 60,976 70,298

Change in fixed assets (13,236) (17,137) (17,237) (20,000) (15,000) (10,000)

Change in investments (441) (275) (3,594) (5,000) (5,000) (5,000)

Others 8,549 7,746 7,403 - - -

Cash flow from investing activities (5,128) 9,666 (13,428) (25,000) (20,000) (15,000)

Inc./(dec.) in debt 526 (215) 351 - - -

Issue of share capital - - - - - -

Others (9,023) (11,214) (15,108) (10,084) (8,042) (4,499)

Cash flow from financing activities (8,498) (11,429) (14,757) (10,084) (8,042) (4,499)


Increase/(decrease) during the year 19,286 (5,246) (1,599) 24,440 32,933 50,798

Closing balance 103,147 97,901 96,302 120,742 153,675 204,473



7 December 2011 62

SIEMENS LTD. (3-UW, PT: RS630, -13%): MARGINS PEAKING; VALUATIONS RICH

We initiate coverage of Siemens Ltd. with a 3-Underweight rating and a 12-month price target of Rs630 (based on 21x average FY12-13E earnings). Siemens is exposed to well diversified end markets, which should help it endure the downturn; however, margins for the company appear to be peaking and near-term order inflows are expected to be weak. Our estimates factor in long-term drivers such as renewable energy, power EPC and low-priced products.

End market exposure attractive: Siemens’ end market exposure is attractive. Gearing to powergen, renewable, T&D, medical products, building automation products and industrial, as well as exports, makes its exposure the most versatile among the peer group. This is the primary reason for Siemens rarely suffering negative growth in order inflows in the past. We estimate a modest 15% CAGR in inflows until September 2014; however, the near term is expected to be weak due to slowing industrial capex and few order finalisations in infrastructure. Order trajectory could be volatile – and lumpy – but the exposure of the company to segments such as metro and railways provided, sufficient opportunities for growth over the longer term.

Strong long-term drivers: Expansion initiatives by Siemens were announced in February 2010 when management highlighted plans to invest Rs16bn over three years to set up a wind manufacturing facility and expand its presence in low-priced products. The company’s target from these initiatives is to achieve revenues of Rs65bn per annum by 2020. The six hubs planned are for setting up centres of competence for: 1) low-end signalling systems; 2) ring main units; 3) steam turbine generators above 45MW; and 4) iron and steel making equipment; 5) wind turbine manufacturing; and 6) EPC execution for power plants.

Valuations rich: Siemens will continue to enjoy a premium to sector multiples on account of expectations of strong growth over the longer term given its new initiatives and strong balance sheet. Current valuations are, however, rich. Given the likely peaking of margins and weak order inflow, we expect the derating of multiples to continue through 2012. We value Siemens at a 15% discount to its average historical P/E multiples over 2004-11.

Figure 83: Siemens Ltd – statistical abstract


Sept Rs mn Rs % (x) (x) (%) (%)

2011A 8,454 25.0 2 28.8 6.4 22.2 0.9

2012E 9,390 27.9 11 26.0 5.4 20.7 1.0

2013E 10,831 32.1 15 22.5 4.6 20.2 1.1

2014E 12,548 37.2 16 19.4 3.9 19.9 1.3

Source: Company data, Barclays Capita estimates

SIEM IN / SIEM.NS




Price (02-Dec-2011) INR 723.35



7 December 2011 63

COMPANY SNAPSHOT

Siemens INDIA CAPITAL GOODS

Income statement (INRmn) 2011A 2012E 2013E 2014E CAGRRevenue 119,419 123,008 139,864 160,238 10.3% Stock Rating 3-UNDERWEIGHTEBITDA 13,496 14,907 16,940 19,404 12.9% Sector View 2-NEUTRALEBIT 11,974 13,344 15,162 17,367 13.2% Price (02-Dec-2011) 723.35Pre-tax income 12,750 14,297 16,491 19,105 14.4% Price Target 630Net income 8,454 9,390 10,831 12,548 14.1% Ticker SIEM IN/SIEM.BOEPS (R) 25.07 27.85 32.13 37.22 14.1%Diluted shares (mn) 337.16 337.16 337.16 337.16 0.0% Investment case

DPS (R) 6.06 6.68 7.71 8.93 13.8%


Balance sheet and cash flow (INRmn) CAGRFixed assets 14,183 14,120 13,843 12,806 -3.3%Cash and equivalents 12,750 23,660 31,398 40,600 47.1%Total assets 101,577 110,620 127,803 148,158 13.4%Current liabilities 63,415 65,321 74,272 85,091 10.3%Long term liabilities - - - - NA Downside case 334Total liabilities 101,577 110,619 127,802 148,158 13.4%Net debt/(funds) (12,750) (23,660) (31,398) (40,600) NAShareholders' equity 38,162 45,298 53,530 63,067 18.2%Change in working capital (8,097) 3,710 (771) (1,371) NACash flow from operations 1,124 13,784 10,508 11,475 117%Capital expenditure (5,900) (1,500) (1,500) (1,000) NAFree cash flow (4,776) 12,284 9,008 10,475 NA


Valuation and leverage metrics AverageP/E (x) 28.8 26.0 22.5 19.4 24.2 EV/EBITDA (x) 17.1 14.8 12.5 10.5 13.7 FCF yield (%) -2.0 5.0 3.7 4.3 2.8EV/sales (x) 1.9 1.8 1.5 1.3 1.6 Price/BV (x) 6.4 5.4 4.6 3.9 5.0 Dividend yield (%) 0.2 0.3 0.3 0.4 0.3Total debt/capital (%) 0.0 0.0 0.0 0.0 0.0Net debt/EBITDA (x) -0.3 -0.5 -0.6 -0.6 -0.5


Selected operating metrics High risk to marginsOrder inflow 122,886 141,319 162,517 186,894 Order inflow growth (%) -1 15 15 15Orderbook 139,213 157,524 180,176 206,832 Orderbook growth (%) 7 13 14 15

Source: Company data, Barclays Capital estimates Note: FY end Sep.

Why a 3-Underweight? The stock’s valuation at 25xFY12E appears rich especially given only 2% PATgrowth in Sep-11 and a 14% EPS CAGR. Risks to thedownside for our estimates are high as we arebuilding in margin growth, which could be difficultgiven pricing pressure in various end markets

A bullish case for Siemens would be theannouncement of a delisting, which could lead to thestock heading to at least its previous open offer price

An earnings shock led by margin compression couldlead to the stock heading to its historical low P/E of10x

0%

5%

10%

15%

Sep0

6

Sep0

7

Sep0

8

Sep0

9

Sep1

0

"Sep

11

Sep1

2E

Sep1

3E

Sep1

4E

EBITDA margin

DownsideCase


Target

INR630(-12.9%)

UpsideCase

INR900(24.4%)

167

367

567

767

967

1167

16-Dec-10 28-Nov-11

DownsideCase


Target

INR630(-12.9%)

UpsideCase

INR900(24.4%)

100

300

500

700

900

1100

16-Dec-10 28-Nov-11


7 December 2011 64

End market exposure attractive

Siemens has seen a sharp increase in order inflows in the past two years, largely led by large order wins in Qatar (transmission projects) and Powergen EPC orders (gas-based EPC projects). While we build a modest 15% growth in inflows over Sep12-14E into our model, we see risk to our estimates in the near term given low order finalisations. Long-term growth is attractive given new initiatives, including announcements of: a JV in railways; orders in the new rolling stock business and a tie-up with BEML Ltd to jointly manufacture and market stainless steel coaches; exposure to powergen markets through EPCs of gas-based projects; exposure to several new products (including manufacturing of wind turbines of 250MW capacity by 2013) and outsourcing from its parent for such products.

Figure 84: Siemens – order inflows (Rs mn): inflow have grown at a CAGR of 20% since September 2005

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

Sep99 Sep01 Sep03 Sep05 Sep07 Sep09 Sep-11-20%

0%

20%

40%

60%

80%

100%

120%

Order inflow YoY

Order inflows grow in steps; growth not just dictated by trends in economy but also

driven by expansion initiatives and success in winning

international projects


Figure 85: Siemens – annual order inflows: rate of growth has rarely declined in the past decade

52.0%

-5.3% -10%

7%

45%

80%

37%

99%

17%

-8%

0%

41%

-1%

-20%

0%

20%

40%

60%

80%

100%

120%

Sep99 Sep01 Sep03 Sep05 Sep07 Sep09 Sep-11

YoY

Order inflows have rarely declined due to exposure to

many segments

Note: Order inflow decline in Sep-08 largely due to divestment of automotive business. Source: Company data, Barclays Capital

New expansion initiatives to drive growth


7 December 2011 65

Progress on these initiatives has been good. Siemens has expanded manufacturing capacity for its steam turbine and compressor manufacturing facility in Vadodara. The facility can manufacture turbines up to 150MW now. Siemens has also introduced a new direct drive-based wind turbine for low wind speed locations such as India; production is expected to commence in 2013. Annual capacity of this facility is expected to be 250MW initially and expanded to 500MW pa by 2015. Siemens is also investing in R&D at its facility in Vadodara.

Figure 86: Siemens – sales by end markets, September 2011: diversified exposure

Industrial Solutions and

Services9%

Transport6%

Generation 4%

Automation and Drives19%

Transmission 27% Oil gas

11%

Real Estate0%

Building Technologies

7%Healthcare and other services

8%

Distribution 9%

Well diversified company


Strong balance sheet and cash generation ability

Siemens has typically been efficient in its working capital management, although working capital metrics deteriorated in FY11 (ending September 2011) due to the lower pace of growth in advances (no order inflow growth). Siemens continues to have no debt on its balance sheet.

Figure 87: Siemens – cash generation (Rs mn): growth has been below our expectations

-4,000

0

4,000

8,000

12,000

16,000

Sep99 Sep01 Sep03 Sep05 Sep07 Sep09 Sep11E

PBT after exp Cash for operations

Cash generation was weak last year



7 December 2011 66

Increase in exports could counter rupee depreciation impact

While Siemens is a net importer and has seen forex gains and losses every year, we believe that the long-term risk may be limited given increasing indigenisation that can help reduce the level of imports and improve the ability to increase exports. Management highlighted that the company is also an exporter of products/projects and, hence, further depreciation of the rupee could make sourcing from India attractive. It would also make the case for the Indian entity becoming a sourcing hub for more products.

Figure 88: Siemens – rupee depreciation could have a medium-term impact as Siemens is a net importer

Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10

Export of goods 955 2,287 2,368 4033 2,570 1,996

Project business 2,056 6,692 23,557 26,377 17,304 13,459

Commission 387 399 490 452 520 446

Service charges and others 789 1,174 301 94 144 116

Exports 4,187 10,553 26,716 30,957 20,538 16,017

As % of sales 9% 14% 32% 37% 22% 13%

Expenditure in foreign currency 745 4,195 8,435 11,896 5312 7,398

as % of sales 2% 5% 10% 14% 6% 6%

RM imports 8,792 13,758 3,340 4,432 26,398 33,960

Capital goods 92 682 14,492 19,950 529 819

Imports 8,884 14,440 17,832 24,382 26,926 34,779

As % of sales 20% 19% 22% 29% 29% 29%

Net imports 12% 11% -1% 6% 13% 22%

Forex loss 286 -141 -1,085 -2,017 83 676

as % of sales 1.1% -0.3% -1.4% -2.4% 0.1% 0.7%

Adjusted EBITDA margin 11.5% 8.7% 8.2% 7.0% 12.4% 14.7%

Reported EBITDA margin 10.1% 8.9% 9.5% 9.3% 12.1% 13.8%

Source: Company Data, Barclays Capital

Siemens can increase exports to counter Rs depreciation; it is a

net importer


7 December 2011 67

Figure 89: Siemens – net imports: company is a net importer of products

12%11%

-1%

6%

13%

22%

1085

2017

-83

-676

141-286

-5%

0%

5%

10%

15%

20%

25%

Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10-1000

-500

0

500

1000

1500

2000

2500

Net imports as % of sales Forex gains/losses, Rs mn

Rupee depreciation could have a medium-term impact as Siemens

is a net importer


Valuation Our 12-month price target of Rs630 for Siemens is based on a P/E of 21x applied to an average of our EPS estimates for FY12 and FY13. We use average earnings as we are valuing peers on earnings for financial years ending in March 2013. Our multiple of 21x is set at a 15% discount to its historical 12-month forward P/E multiple for the past seven years given risk to margins, which appear to be peaking.

With the financial performance for Siemens in FY11 being modest on our estimates and the recent quarter margins impacted by forex losses, valuations have been tempered and now are close to historical averages. We believe that current valuations are rich and the stock should trade at a discount to its historical average given modest growth in the near term and peaking margins.

Figure 90: Siemens – historical 12-month forward P/E (x): stock trading below average

5

10

15

20

25

30

35

Mar

-04

Aug

-04

Dec

-04

Apr

-05

Sep-

05

Jan-

06

Jun-

06

Oct

-06

Feb-

07

Jul-

07

Nov

-07

Mar

-08

Aug

-08

Dec

-08

May

-09

Sep-

09

Jan-

10

Jun-

10

Oct

-10

Feb-

11

Jul-

11

Nov

-11

Siemens Linear (Siemens)

SISL /SIPS stake sale

Stock trading below historical average multiples but valuations

appear rich


Current valuations are rich


7 December 2011 68

ABB trading at a premium to Siemens While we have 3-Underweight ratings on both Siemens and ABB, we note that Siemens is trading at a steep discount to ABB despite better diversification, better cash generation and return ratios (Figure 91).

Figure 91: Siemens – ABB is trading at a historical premium to Siemens

0.60.70.80.91.01.11.21.31.41.51.6

Aug

-02

Jan-

03

Jul-

03

Dec

-03

Jun-

04

Nov

-04

May

-05

Oct

-05

Apr

-06

Sep-

06

Mar

-07

Aug

-07

Feb-

08

Aug

-08

Jan-

09

Jul-

09

Dec

-09

Jun-

10

Nov

-10

May

-11

Oct

-11

ABB 12M fwd PE as a ratio of Siemens 12M Fwd PE

ABB is trading at a 50% premium to Siemens, highest over the past

decade


Figure 92: Siemens – historical performance has been significantly superior to that of ABB

FY05 FY06 FY07 FY08 FY09 FY10 FY11E CAGR

Order inflows (Rs mn)

ABB 37,645 56,236 76,682 86,008 93,977 63,489 98,208 17%

Siemens 41,233 82,026 95,720 87,722 87,960 124,304 122,886 20%

Profit after tax (Rs mn)

ABB 2,187 3,403 4,917 5,474 3,546 632 1,798 -3%

Siemens 2,548 3,602 5,968 5,954 10,449 8,272 8,454 22%

Net working capital (days)

ABB 20 22 29 55 64 58 na

Siemens -38 -62 4 -5 6 5 29

ROE (%)

ABB 20% 24% 27% 21% 13% 0% 7% 14%

Siemens 33% 33% 34% 25% 23% 24% 22% 21%



7 December 2011 69

Risks

The key risks that could keep our price target from being achieved, in our view, include large order wins in the Rail segment or in Power EPC market as well as forex gains or increases in core margins.

Figure 93: Siemens – history of current consensus EPS forecasts shows estimates after the strong period of 2005-2006 were moderated due to losses in some projects (Rs)

Figure 94: Siemens – history of current consensus EPS forecasts for FY12-14 shows estimates upgrades in recent years (Rs)

0

10

20

30

40

50

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Sep-06 Sep-07 Sep-08

Sep-09 Sep-10

05

1015202530354045

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

Sep-11 Sep-12 Sep-13

Source: Datastream Barclays Capital Source: Datastream, Barclays Capital


7 December 2011 70

Figure 95: Siemens – income statement, FY08-14E

Rs mn; years ending September FY08 FY09 FY10 FY11E FY12E FY13E FY14E

Net sales 82,504 83,367 92,707 119,419 123,008 139,864 160,238

Other operating income plus commissions 1,074 1217 1294 1,645 1,623 1,846 2,115

Raw material expenses adj for inventory 67,972 63,977 68,474 90,267 91,972 104,581 119,817

% of sales 82% 77% 74% 76% 75% 75% 75%

Staff cost 4,476 5,499 6,325 9,174 9,496 10,796 12,369

% of sales 5% 6.6% 6.8% 7.7% 7.7% 7.7% 7.7%

Other expenses 3,339 4,878 6,269 8,127 8,257 9,394 10,764

% of sales 4% 6% 7% 7% 7% 7% 7%

OBITDA 7,791 10,231 12,932 13,496 14,907 16,940 19,404

OBITDA margin 9% 12% 14% 11% 12% 12% 12%

Depreciation and amortization 637 778 1,015 1,522 1,563 1,778 2,037

Interest income net 472 465 670 755 879 1,329 1,738

Other income 67 2,341 0 21 74 0 0

Other extraordinary items 1,246 2,059 0 0 0 0 0


Profit before tax margin 11% 17% 14% 11% 12% 12% 12%

Tax 2,984 3,870 4,315 4,295 4,907 5,660 6,557

Reported profit after tax 5,954 10,449 8,272 8,454 9,390 10,831 12,548

Adjusted profit after tax 5,124 6,731 8,272 8,454 9,390 10,831 12,548

Adjusted profit after tax margin 6.2% 8.1% 8.9% 7.1% 7.6% 7.7% 7.8%



7 December 2011 71

Figure 96: Siemens – balance sheet, FY08-14E


Share capital 674 674 674 681 681 681 681

Reserves and surplus 20,017 28,492 34,103 37,481 44,618 52,850 62,386

Shareholder funds 20,691 29,166 34,778 38,162 45,298 53,530 63,067

Total debt 11 6 2 0 0 0 0

Capital employed 20,701 29,172 34,780 38,162 45,298 53,530 63,067

Net fixed assets 5,572 6,295 7,340 11,718 11,655 11,378 10,341

Capital WIP 870 1,057 2,465 2,465 2,465 2,465 2,465

Investments 5,236 4,770 3,885 1 1 1 1

Deferred tax and others 910 1,119 1,313 1,889 1,889 1,889 1,889

Cash and bank balance 9,131 14,449 18,534 12,750 23,660 31,398 40,600

Receivables 34,328 34,583 33,023 41,733 42,988 48,878 55,998

Receivable days 152 151 130 128 128 128 128

Inventories 7,621 9,722 15,335 16,961 13,480 15,328 17,999

Inventory days 34 43 60 52 40 40 41

Loans & advances 6,173 10,458 12,449 14,060 14,483 16,467 18,866

as % of sales 7% 13% 13% 12% 12% 12% 12%

Current liabilities 41,868 40,585 43,892 45,376 46,740 53,145 60,887

Current liabilities days 185 178 173 139 139 139 139

Provisions 7,272 12,695 15,672 18,039 18,581 21,127 24,204

Provisions as % of current liabilities 32 56 62 55 55 55 55

Net current assets -1,018 1,482 1,243 9,340 5,630 6,401 7,773

Total assets 20,701 29,172 34,780 38,162 45,299 53,531 63,067



7 December 2011 72

Figure 97: Siemens – cash flow statement, FY08-14E



Depreciation 637 778 1,015 1,522 1,563 1,778 2,037

Others -1,255 -6,006 -349 -755 -879 -1,329 -1,738

Operating cash before working capital 8,300 9,091 13,253 13,516 14,981 16,940 19,404

Change in receivables -10,569 -1,261 588 -10,321 -1,677 -7,875 -9,519

Change in inventories -396 -2,101 -5,187 -1,626 3,481 -1,847 -2,672

Change in current liabilities and provisions 12,208 3,371 6,169 3,850 1,906 8,951 10,819

Change in working capital 1,243 9 1,570 -8,097 3,710 -771 -1,371

Restructuring costs 0 0 0 0 0 0 0

Taxes paid -3,970 -5,631 -4,812 -4,295 -4,907 -5,660 -6,557

Cash flow from operations 5,574 3,468 10,012 1,124 13,784 10,508 11,475

Discontinued operations -105 0 0 0 0 0 0

Change in fixed assets -1,657 -1,451 -2,577 -5,900 -1,500 -1,500 -1,000

Change in investments -467 1,320 -703 -3,884 0 0 0

Others

Cash flow from investing activities -108 2,140 -4,413 -9,029 -621 -171 738

Discontinued operations -42 0 0 0 0 0 0

Inc./(dec.) in debt -5 -5 -3 -2 0 0 0

Issue of share capital 0 0 0 0 0 0 0

Others

Cash flow from financing activities -971 -290 -2,007 -2,044 -2,254 -2,600 -3,012

0 0 0 0 0 0 0

Opening cash balance 4,636 9,131 14,449 18,534 12,750 23,660 31,398

Increase/decrease during the year 4,495 5,318 3,592 -9,949 10,909 7,738 9,202

Closing balance 9,131 14,449 18,534 12,750 23,660 31,398 40,600



7 December 2011 73

ABB LTD. (3-UW, PT: RS494, -20%): FUNDAMENTALS REMAIN UNDER STRESS

We initiate coverage of ABB Ltd. with a 3-UW rating and a 12-month price target of Rs494 (based on a 25x P/E for CY12E earnings). We believe that margins have troughed for ABB due to: 1) a low backlog of rural losses; 2) likely lowering of costs on imports, following the stake increase by the parent; 3) increase in indigenisation, with ABB’s Indian factories being approved for supply of high-voltage transformers; and 4) high commodity prices already reflected in current margins. The depreciation of the rupee, while it could help in the near term on gains in forex hedges, could impact the cost structure in the medium term given the high exposure of costs to imports. While margins and earnings growth are expected to recover, current valuations at over 30x P/E (on recovered earnings) appear rich and difficult to justify, in our view.

Margins at trough levels: ABB’s cost structure and execution skills have come under scrutiny, especially following the sharp deterioration in margins and project-specific losses. Exit from rural electrification projects and market share losses due to high costs have substantially affected financial performance. Margins are expected to recover next year, however. More than 35% of the company’s costs are exposed to imports therefore the current depreciation of the rupee will have a long-term cost impact; we note that in the near term there could be forex gains on hedges. The sharp increase in royalty cost (46% y/y in CY10 is also worth noting, especially given weak financials last year.

Order recovery in power, industrials to weaken: We believe that improving ordering in the T&D segment and the recent HVDC project win (worth Rs10bn) will help support order growth in the coming quarters. However, industrial business (projects and products) should weaken given limited recovery in project ordering. With refurbishment capex that supported short cycle orders already behind, it is likely that product ordering should also weaken. We expect a recovery in this segment at end-CY12, coinciding with a likely recovery in ordering from the infrastructure segment.

Rich valuations: ABB’s current valuations at 30x forward earnings are rich, in our view, especially given that they are based on consensus estimates that we believe are building in a substantial recovery in earnings. A continued weakness in margins would imply that actual valuations are much higher. We value ABB at 25x P/E (25x is the average multiple since 2003), giving us a price target of Rs494.

Figure 98: ABB – statistical abstract


Dec Rs mn Rs % (x) (x) (%) (%)

2010A 632 3.0 -82 196.1 5.1 2.6 0.3

2011E 1,798 8.5 184 68.9 4.8 7.0 0.1

2012E 4,191 19.8 133 29.6 4.2 14.2 0.3

2013E 4,337 20.5 3 30.2 3.9 13.0 0.3


ABB IN / ABB.NS




Price (02-Dec-2011) INR 618.80



7 December 2011 74

COMPANY SNAPSHOT

ABB Limited INDIAN CAPITAL GOODS

Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 62,871 74,884 88,207 90,554 12.9% Stock Rating 3-UNDERWEIGHTEBITDA 838 3,934 7,432 7,724 110% Sector View 2-NEUTRALEBIT 319 3,098 6,557 6,828 178% Price (02-Dec-2011) 618.8Pre-tax income 1,002 3,025 6,378 6,601 87.4% Price Target 494Net income 632 1,798 4,191 4,337 90.0% Ticker ABB IN/ABB.BOEPS (R) 2.98 8.49 19.78 20.47 90.0%Diluted shares (mn) 212 212 212 212 0.0% Investment case

DPS (R) 2.00 0.80 1.88 1.94 -1.0%


Balance sheet and cash flow (INRmn) CAGRFixed assets 8,238 9,402 10,527 10,631 8.9%Cash and equivalents 5,871 922 573 3,605 -15.0%Total assets 57,714 60,256 70,361 75,564 9.4%Current liabilities 33,477 34,419 40,797 42,142 8.0%Long term liabilities - - - - NA Downside case 247Total liabilities 57,714 60,256 70,361 75,564 9.4%Net debt/(funds) (5,871) (922) (573) (3,605) NAShareholders' equity 24,237 25,837 29,564 33,422 11.3%Change in working capital 785 (5,384) (2,952) (722) NACash flow from operations 2,207 (2,564) 2,351 4,799 29.6%Capital expenditure (1,044) (2,000) (2,000) (1,000) NAFree cash flow 1,162 (4,564) 351 3,799 48.4%


Valuation and leverage metrics AverageP/E (x) 196.1 68.9 29.6 30.2 81.2 EV/EBITDA (x) 141.0 31.3 16.6 16.5 51.3 FCF yield (%) 0.9 -3.7 0.3 2.9 0.1EV/sales (x) 1.9 1.6 1.4 1.4 1.6 Price/BV (x) 5.1 4.8 4.2 3.9 4.5 Dividend yield (%) 0.3 0.1 0.3 0.3 0.3Total debt/capital (%) 0.0 0.0 0.0 0.0 0.0Net debt/EBITDA (x) -24 -4 -2 -11 -10


Selected operating metrics High exposure to imports a risk to marginsOrder inflow 63,489 98,208 88,387 97,226 Order inflow growth (%) -32 55 -10 10Orderbook 85,723 107,770 107,950 114,622 Orderbook growth (%) 0 20 0 6

Source: Company data, Barclays Capital estimates Note: FY end Dec.

Why a 3-Underweight? ABB is exposed to highcompetitive pressures in its T&D business, and this isimpacting margins. Furthermore, industrial markets(40% of mix) is decelerating. Margins could recoveroff the lows in Dec-10 but we believe that currentvaluations adequately capture the growth.

Our bull case for ABB is premised on non-fundamental facors. ABB's parent has alreadyincreased its stake in ABB Ltd to 75%. A futuredelisting could lead to the stock heading to itsprevious open offer price.

No recovery in margins next year and weak orderinflows in 2H could lead to a de-rating of the stock.Expect the stock to head to its historical trough P/Eof 12x.

0%

10%

20%

30%

40%

50%

Dec05 Dec06 Dec07 Dec08 Dec09 Dec10E

Imports as % of material costs

DownsideCase


Target

INR494(-20.1%) Upside

Case

INR900(45.3%)

100

300

500

700

900

1100

15-Dec-10 25-Nov-11

DownsideCase

INR247(-60.0%)

PriceTarget

INR494(-20.1%)

UpsideCase

INR900(45.3%)

0

200

400

600

800

1000

15-Dec-10 25-Nov-11


7 December 2011 75

Margin decline

ABB’s quarterly EBITDA margins have fallen from a peak of 14% in December 2007 to 3.6% now. A collapse in power systems margins due to execution issues in rural electrification projects was the key driver; however, margins in most segments have deteriorated over the past year suggesting that these are not project-specific losses. Lower margins could be either attributed to price competition in the market or due to the impact of commodity price rises. There is evidence that margins have, however, started recovering on a y/y basis and we model margins to head towards the high single digits in CY12.

Figure 99: ABB – power systems and products margins

-15%

-10%

-5%

0%

5%

10%

15%

20%M

ar-0

5

Sep-

05

Mar

-06

Sep-

06

Mar

07

Sep0

7

Mar

08

Sep0

8

Mar

09

Sep0

9

Mar

-10

Sep-

10

Mar

-11

Sep-

11

Power products margin Power systems margin

Margins at power systems division were first to collapse; power products segment has

also declined


Figure 100: ABB – margins in automation segment have also moderated

-5%

0%

5%

10%

15%

20%

25%

Mar

-05

Sep-

05

Mar

-06

Sep-

06

Mar

07

Sep0

7

Mar

08

Sep0

8

Mar

09

Sep0

9

Mar

-10

Sep-

10

Mar

-11

Sep-

11

Automation products margin Power automation margin

While margins for automation business have been holding up

well relative to power, there has been a sharp deceleration in profits even in this segment


Royalty rates up 46% in the worst year at ABB

ABB imports more than 35-40% of its material costs and these high-cost imports – which also increase the impact of forex volatility, and some of which are from parent factories outside India – are part of the reason for the company’s’ structural decline in margins. While ABB was earlier able to charge a premium on these imported products as new technology items got introduced to India, commoditisation of the industry and thin margins in the India

Margins have deteriorated in all segments

High import content one of the key reasons for weak margins

and high margin volatility


7 December 2011 76

business mean margins are now impacted. Interestingly, in one of the toughest years for ABB, there was an increase in royalty expenditure by about 46% y/y (representing 2% of sales as of CY10).

With margins in the India business being weak and the poor cost structure impacting order wins, ABB was forced to announce an open offer for purchasing a 20% stake in its Indian subsidiary at steep valuations.

Figure 103: ABB – EPS (Rs) vs. EBITDA Margin: recovery expected to be led by margins normalising to high single digits

1 2 34

32 2 3 3

4 57

10

16

2326

17

3

8

20

0

5

10

15

20

25

30

Dec93 Dec95 Dec97 Dec99 Dec01 Dec03 Dec05 Dec07 Dec09 Dec11E0%

2%

4%

6%

8%

10%

12%

14%

Adjusted EPS Ebitda margin RHS

We expect EPS to recover in CY12 led by normalising of

margins; margin recovery could be led by completion of rural

projects, lower transfer price on products imported


Figure 101: ABB – royalties as percentage of sales: increase rose more than 46% y/y in (CY10E)

Figure 102: ABB – imports a percentage of material costs: continues to be high

0.0%

0.5%

1.0%

1.5%

2.0%


Royalty as % of sales

0%5%

10%15%20%25%30%35%40%45%50%


Imports as % of mateial costs



7 December 2011 77

Valuation

Our 12-month price target of Rs494 is based on an average 25x P/E. Our target multiple is the stock’s historical average 12-month forward P/E since 2003. Despite the recent moderation in valuations, ABB still trades at 30x forward earnings. The reason for the stock trading at such a high multiple we believe is the market’s expectation of a possible delisting of the stock and a lower cost of capital from the parent being used in cash flow valuations. However, we use a higher target P/E multiple for ABB compared with that used for peers as the cost of capital being used for any cash flow calculations will be that of its parent. This is because the recent open offer done by ABB’s parent for purchasing 20% of shares in ABB India at steep valuations were justified largely on account of lower cost of capital of its parent. Valuations will remain high relative to peers also due to expectations of a delisting in future as ABB’s parent’s stake has increased to 75% now.

Figure 104: ABB – Stock still appears rich on P/E valuation (x)

5

10

15

20

25

30

35

Dec

-94

Oct

-95

Aug

-96

Jun-

97

Apr

-98

Feb-

99

Dec

-99

Oct

-00

Aug

-01

May

-02

Mar

-03

Jan-

04

Nov

-04

Sep-

05

Jul-

06

May

-07

Mar

-08

Jan-

09

Oct

-09

Aug

-10

Jun-

11

ABB

ABB still trading at the upper end of its valuation band


Rich valuations pricing in a recovery

Figure 105: ABB – history of current consensus EPS forecasts shows stock has seen downgrades in estimates every year since CY07 (Rs)

Figure 106: ABB – history of current consensus EPS forecasts for FY12-14 shows estimates have been cut but still appear high in the context of current margins (Rs)

0

10

20

30

40

50

60

Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10

CY05 CY06 CY07 CY08

CY09 CY10

0

5

1015

20

25

3035

40

45

Jun-09 Jun-10 Jun-11

CY11 CY12

Source: Datastream, IBES consensus estimates, Barclays Capital Source: Datastream, IBES consensus, Barclays Capital


7 December 2011 78

Risks

The key risks that could keep our price target from being achieved, in our view, include: 1) a faster-than-expected uptick in margins; 2) a sharp recovery in the T&D market and market share gains for ABB; and 3) announcement of a delisting by parent at substantially higher valuations.

Figure 107: ABB – income statement, 2007-2013E

Rs mn; years ending December 2007 2008E 2009E 2010E 2011E 2012E 2013E

Sales and services (Net) 59,303 68,370 62,372 62,871 74,884 88,207 90,554

YoY 39% 15% -9% 1% 19% 18% 3%

Cost of materials and erection services 42,920 49,504 45,179 48,021 55,362 63,155 64,841

% of sales 72% 72% 72% 76% 74% 72% 72%

Personnel expenses 3,061 4,030 3,892 4,901 5,694 6,206 6,361

% of sales 5% 6% 6% 8% 8% 7% 7%

Other expenses 6,076 7,183 8,042 9,111 9,894 11,415 11,628

% of sales 10% 11% 13% 14% 13% 13% 13%

EBITDA 7,246 7,654 5,259 838 3,934 7,432 7,724

EBITDA Margin 12% 11% 8% 1% 5% 8% 9%

Other income 710 1,304 726 855 170 87 90

Depreciation and amortisation 327 369 488 519 836 874 896

Interest expenses 68 347 256 174 243 266 317


Profit before tax margin % 13% 12% 8% 2% 4% 7% 7%

Tax 2,648 2,858 1,728 370 1,226 2,188 2,264

Tax rate 35% 34% 33% 37% 41% 34% 34%

Reported profit after tax 4,917 5,474 3,546 632 1,798 4,191 4,337

Margin 8% 8% 6% 1% 2% 5% 5%

Adjusted profit after tax 4,917 5,474 3,546 632 1,798 4,191 4,337

Margin 8% 8% 6% 1% 2% 5% 5%

Source: Company reports, Barclays Capital estimates


7 December 2011 79

Figure 108: ABB – balance sheet, 2007-13E

Rs mn; years ending December 2007 2008E 2009E 2010E 2011E 2012E 2013E

Share capital 424 424 424 424 424 424 424

Reserves and surplus 15,840 20,766 23,814 23,813 25,413 29,140 32,998

Shareholder funds 16,263 21,190 24,237 24,237 25,837 29,564 33,422

Total loans 6 0 0 0 0 0 0

Deferred tax liability 128 38 0 0 0 0 0

Total liabilities 16,397 21,228 24,237 24,237 25,837 29,564 33,422

Net block 3,519 5,458 6,731 7,661 8,825 9,950 10,054

Capital WIP 1,059 1,375 1,163 577 577 577 577

Deferred tax assets 46 46 46 46

Investments 705 611 169 168 168 168 168

Inventories 4,887 6,427 7,294 6,979 8,206 9,908 10,420

Inventory days 30 34 43 40 40 41 42

Sundry debtors 24,236 29,759 28,577 29,260 33,852 40,116 41,432

Debtor days 149 159 167 165 165 166 167

Cash and bank balances 6,429 3,482 5,241 5,871 922 573 3,605

Other current assets 2,754 3,813 3,203 3,611 3,846 4,530 4,650

as % of sales 5% 6% 5% 5% 5% 5% 5%

Loans and advances 2,802 3,518 3,177 3,542 3,814 4,493 4,612

as % of sales 5% 5% 5% 5% 5% 5% 5%

Current liabilities 29,315 31,619 29,869 31,630 32,826 38,908 40,191

Days of sales 180 169 175 160 160 161 162

Provisions 678 1,596 1,450 1,846 1,594 1,889 1,951

% of Current liabilities 2% 5% 5% 5% 5% 5% 5%

Net current assets 11,114 13,783 16,174 15,785 16,221 18,823 22,577

Total assets 16,397 21,228 24,237 24,237 25,837 29,564 33,422



7 December 2011 80

Figure 109: ABB – cash flow statement, 2007-13E

Rs mn; years ending December 2007 2008 2009 2010 2011E 2012E 2013E


Depreciation and amortisation 324 367 485 517 836 874 896

Operating profit be working capital 7,679 9,060 5,829 2,004 4,047 7,490 7,784

Change in sundry debtors -8,533 -5,453 1,172 -715 -4,592 -6,264 -1,316

Change in inventories -1,340 -1,539 -868 316 -1,228 -1,702 -512

Change in other current assets -1,264 -1,194 599 -407 -234 -684 -121

Change in loans and advances -928 -1,075 1,065 -160 -273 -679 -120

Change in current liabilities and provisions 9,820 2,777 -1,566 1,751 943 6,377 1,346

Others 0 0 0 0 0 0 0

Change in working capital -2,245 -6,484 403 785 -5,384 -2,952 -722

Direct taxes paid (net of refund) -2,759 -2,378 -2,687 -582 -1,226 -2,188 -2,264

Net cash from operating activities 2,676 197 3,545 2,207 -2,564 2,351 4,799

Change in fixed assets -1,470 -2,639 -1,633 -1,044 -2,000 -2,000 -1,000

Change in investments 69 117 439 1 0 0 0

Others 262 275 194 114 57 29 30

Net cash from investing activities -1,139 -2,247 -986 -929 -1,943 -1,971 -970

Change in shares 0 0 0 0 0 0 0

Change in loans -10 -5 0 0 0 0 0

Others -563 -891 -800 -648 -442 -729 -797

Net cash from financing activities -573 -896 -800 -648 -442 -729 -797

Increase/decrease in cash and equivalent 964 -2,946 1,759 630 -4,949 -350 3,032

Opening cash 5,464 6,429 3,482 5,241 5,871 922 573

Closing cash 6,429 3,482 5,241 5,871 922 573 3,605



7 December 2011 81

CUMMINS (1-OW, PT: RS428, +20%): STRONG PRODUCT POSITIONING

We initiate coverage of Cummins India with a 1-Overweight rating and a 12-month price target of Rs428 (20x FY13E plus Rs20 for value of associates). We believe the sharp reduction in consensus earnings estimates for the stock captures the impact of near-term weakness in the powergen and industrial markets in India. Cummins is exposed to three strong long-term drivers: 1) continued peak deficits in India that will driver growth for back-up power; 2) an increased focus on outsourcing to India from Cummins Inc. due to cost benefits; and 3) strong growth in after-sales service, aided by new facilities at the site in Phaltan. We view end-market exposure as the best relative to peers, due to a well-diversified end-user base and a stable pricing environment. Earnings growth should trough in FY12 and, with valuations trending below historical averages, the stock should outperform, in our view.

Near-term cyclical pressures: long-term drivers intact: With demand for powergen and industrial segments slowing and also impacted by stiff base comparison, management has revised down guidance for y/y sales growth in FY12 from 20% to single digits. Peers such as Kirloskar Oil Engines have also given a cautious commentary on demand and revised down sales guidance to flat y/y. With weak end-market demand, there has been an inventory correction at the OEM end, which has impacted sales sharply. While we expect demand to be weak in the near term, exports and growth from Cummins sales and services business will likely damp the impact. We expect modest 6% y/y growth in sales in FY12E followed by a recovery (14% y/y) next year. Note that past trends suggest that sales growth of less than 5% is usually a rare event for Cummins.

Long-term drivers intact: Long-term drivers for Cummins are promising and are the key reason for our positive view. A continued shortage of peak power as well as regulations, (change in emission norms in 2014) will continue to drive demand for power back-up generators. Furthermore, with Cummins Inc. intent on expanding outsourcing from India, owing to cost benefits, it is likely that base level exports will continue to grow.

Dominant positioning to support pricing: Cummins sports over 50% market share in the mid-high KVA segment and dictates price trends in the market. Cummins increased prices by 3-4% this year, in order to manage commodity pressure, and management is intent on keeping prices at current levels, ensuring that downside risk to margins is reduced.

Derating captures near-term concerns: Cummins stock has de-rated from 20x to 12x forward earnings (based on consensus estimates) and estimates have been revised down by 17-23% for FY12-14. With valuations below historical growth rates and modest earnings forecasts, we believe the stock offers a good investment opportunity on a long-term view.

Figure 110: Cummins – statistical abstract


31 Mar Rs mn Rs % (x) (x) (%) (%)

2011A 5,911 21.3 33.8 15.7 5.1 32.7 3.4

2012E 5,088 18.4 (13.9) 18.3 4.5 24.9 2.9

2013E 5,642 20.4 10.9 16.5 4.0 24.4 3.2

2014E 7,570 27.3 34.2 12.3 3.5 28.4 4.3


KKC IN / CUMM.NS




Price (02-Dec-2011) INR 357.85



7 December 2011 82

COMPANY SNAPSHOT

CUMMINS Ltd INDIAN CAPITAL GOODS

Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 39,454 41,665 47,313 61,002 15.6% Stock Rating 1-OVERWEIGHTEBITDA 6,636 5,923 6,679 9,272 11.8% Sector View 2-NEUTRALEBIT 4,102 4,291 4,736 5,763 12.0% Price (02-Dec-2011) 357.9Pre-tax income 8,024 7,144 7,925 10,624 9.8% Price Target 428Net income 5,911 5,088 5,642 7,570 8.6% Ticker KKC IN/CUMM.BOEPS (R) 21.32 18.36 20.35 27.31 8.6%Diluted shares (mn) 277.20 277.20 277.20 277.20 0.0% Investment case

DPS (R) 11.32 9.74 10.80 14.49 8.6%


Balance sheet and cash flow (INRmn) CAGRFixed assets 16,805 18,201 20,947 27,564 17.9%Cash and equivalents 1,038 525 874 1,684 17.5%Total assets 28,657 31,641 35,781 43,116 14.6%Current liabilities 10,412 11,008 12,500 16,283 16.1%Long term liabilities 183 - - - NA Downside case 204Total liabilities 28,657 31,641 35,781 43,116 14.6%Net debt/(funds) (855) (342) (691) (1,501) NAShareholders' equity 18,063 20,450 23,098 26,650 13.8%Change in working capital (1,053) (1,314) (904) (2,024) NACash flow from operations 3,470 2,554 3,492 4,194 6.5%Capital expenditure (1,500) (2,000) (2,000) (1,500) NAFree cash flow 1,970 554 1,492 2,694 11.0%


Valuation and leverage metrics AverageP/E (x) 15.7 18.3 16.5 12.3 15.7 EV/EBITDA (x) 13.9 15.6 13.8 9.9 13.3 FCF yield (%) 2.0 0.6 1.5 2.7 1.7EV/sales (x) 2.3 2.2 1.9 1.5 2.0 Price/BV (x) 5.1 4.5 4.0 3.5 4.3 Dividend yield (%) 3.2 2.7 3.0 4.1 3.2Total debt/capital (%) 1.0 0.9 0.8 0.7 0.8Net debt/EBITDA (x) - 0.0 - 0.0 - 0.0 - 0.0 - 0.0


Selected operating metrics Capacity utilisation decline reflected in estimatesICE capaicty 53,300 83,300 83,300 83,300 Capacity utilisation 72.8 48.5 50.0 70.0Domestic sales ex CSS 23,677 24,310 27,168 37,291 Exports 10,230 11,253 13,128 15,641


Why a 1-Overweight? Dominant positioning inpowergen products should help the company tosustain pricing despite weak market ordering. Long-term drivers for its business are intact with peakshortages expected to continue until FY17. We valueit at 15% premium to its historical average.

A recovery in domestic ordering , improvement inmargins (if commodity prices start declining) as wellas strength in exports could lead to the stockheading to peak P/E of 25x.

Continued weakness in revenues and marginsespecially for exports could lead to the stock tradingcloser to its recent trough P/E of about 10x.

0%20%40%60%80%

100%120%

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

EM

ar-1

3E

Mar

14E

Capacity utilisation

DownsideCase


Target

INR428(19.6%)

UpsideCase

INR499(39.4%)

102

202

302

402

502

602

702

22-Dec-10 2-Dec-11

DownsideCase


Target

INR428(19.6%)

UpsideCase

INR499(39.4%)

0

100

200

300

400

500

600

22-Dec-10 2-Dec-11


7 December 2011 83

Near-term cyclical pressures evident

It is now apparent that FY12 will be a weak year for growth, with management guiding for single-digit growth in sales in the domestic market (overall sales guidance was for 20% y/y growth, which was reduced to 15% after 1Q). For exports, management says it is not witnessing any unusual slowdown but base comparisons remain a challenge, in our view. In the domestic market, management is of the view that a slowdown in various end markets in the past six months has impacted demand and this has led to an inventory overhang at OEMs (Powerica, among others), which in turn has impacted demand for products.

Demand for powergen was decelerating at a faster pace than the industrials segment, according to our checks with management. In the industrials sector, demand from the water well segment fell sharply largely due to cyclical factors. On pricing trends, management is of the view that after two price hikes this year, prices should remain firm at current levels. Management also noted that it does not expect weak demand to lead to a price cut in the market.

Weak demand will impact capacity utilisation for Cummins and, given the ramp up of medium KVA engines at Phaltan, capacity is increasing. A combination of lower capacity utilisation and a high price of raw materials (pig iron) will continue to impact margins, leading management to expect a further 1% decline over the next two quarters. Our estimates reflect this scenario.

Figure 111: Cummins – capacity utilisation: we expect a fall, in turn, affecting margins

We expect capacity utilisation to decline given weak demand and

an increase in capacity for medium KVA engines 83%

102%94%

109%

53% 55%

73%

49% 50%

70%

0%

20%

40%

60%

80%

100%

120%

Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar14E

Capacity utilisation


Cautious view from Kirloskar Oil management We find Kirloskar Oil Engines (KOEL) view on the market useful, as it helps to get a good read on demand trends for powergen engines and engines for construction equipment. KOEL is a competitor of Cummins and we believe its sales are a leading indicator for sales trends at Cummins , in our view. This could be because of its higher gearing to the low KVA segment, which may be the first to see the impact of a slowdown in the market.

KOEL management has been negative on trends in the powergen market since the December quarter. In December, management was of the view that old engines from the

Sales guidance has been cut from 20% y/y at start of the year

to single-digit growth

Powergen demand decelerating at a faster pace than industrial

Management expects EBITDA margins to decline by another

1% over the next two quarters

Peers such as Kirloskar Oil engines have also given a

cautious view on sales growth


7 December 2011 84

Commonwealth Games came out for sale in the market in 3Q FY11, after the event was over, and this increased supply in the market.

After 4Q/FY11 management guided for 15-20% sales growth in FY12 (as the market slowdown was still not evident in the mid- to high-end segment) on the hope that successes in the mid-high KVA segment would help drive sales. After 1Q FY12, however, a weaker-than-expected market led to a downward revision to guidance (to 10% y/y growth). After 2Q FY12, the guidance was further revised down to 0% growth. Management commented that powergen demand was weak due to good overall availability of power.

KOEL management appeared more positive on the high KVA segment (recent entrant) as competition from Chinese players was high in the low KVA segment and demand from some key segments such as telecom remained weak. Management was of the view that the implementation of CPCB pollution norms for diesel generation sets from October 2013 should help reduce competitive intensity as not all players will have engines that will fulfil the emission standards.

While KOEL has a dominant market share in the construction equipment segment, this was affected by the shift of JCB to its own engines. We note that the impact on Cummins would have been much lower given the lower mix of sales to JCB. Overall, though, management was of the view that high interest rates are impacting demand in this segment.

Figure 112: Cummins – KOEL’s sales growth trends are a leading indicator for Cummins

-25%-20%-15%-10%

-5%0%5%

10%15%20%25%

Jun-

07

Sep-

07

Dec

-07

Mar

-08

Jun-

08

Sep-

08

Dec

-08

Mar

-09

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

-40%

-20%

0%

20%

40%

60%

80%

100%

Kirloskar oil engines quarterly sales YoY Cummins quarterly sales growth YoY

KOEL’s sales trends are a good leading indicator of trends at

Cummins


Weak earnings in the near term and risk of consensus EPS cuts Management is guiding for single-digit growth in domestic sales and, for exports, while management does note expect any unusual slowdown, base comparison remains a challenge, in our view.

We are building in 6% y/y sales growth for FY12E and 14% growth for FY13 (largely led by exports as we expect the new 200KVA facility to start contributing next year).

KOEL decreased guidance from 15-20% sales growth to 10%

Management appeared more concerned over low KVA

compared with medium-high KVA engines

EPS estimates now reflect weak demand; we expect 6% growth

in sales in FY12E followed by 14% growth in FY13E


7 December 2011 85

Figure 113: Cummins – sales: we expect only 6% sales growth in FY12E

Rs mn FY11 FY12E FY13E Mar14E

Domestic 23,677 24,310 27,168 37,291

y/y 24% 3% 12% 37%

Overseas 10,230 11,253 13,128 15,641

y/y 137% 8% 17% 19%

Cummins sales and services 5,547 6,102 7,017 8,070

y/y 15% 10% 15% 15%

Total 39,454 41,665 47,313 61,002


Earnings may have troughed in September quarter

Quarterly earnings growth for Cummins may have already troughed, in our view, but it will likely remain at low levels until 1HCY12. An easy base comparison, coupled with a contribution from the low KVA facility at Phaltan should help drive a y/y recovery in sales, in our view.

Long-term drivers intact

Key drivers of demand for Cummins include: 1) continued peak deficits in India ensuring that demand for power remains strong; 2) growth in exports; 3) likely strength in demand for mining and construction equipment (cycles are more pronounced though); 4) changing emission norms that drive replacement/upgrade demand; and 5) increase in supply of alternate fuel sources such as natural gas.

Cummins’ business model remains strong given the structural shortfall of power in India – and what matters to Cummins, we believe, is a shortage of peak power as its generators are used primarily for standby application. While the addition of over 200GW of power capacity until FY17 should reduce the overall power deficit, the peak deficit is envisaged to still remain above 15%, according to Cummins’ management.

Quarterly earnings momentum at historical lows; we expect

momentum to improve next year led by easy y/y comps

Figure 114: Cummins – Annual sales growth was below 10% in only 5 of the past 20 years

Figure 115: Cummins – Earnings growth close to trough on quarterly basis; expect improvement from 2H FY13E

21

1014

33

2122

(7)(13)

28

4

(14)

1212

282326 27

40

(13)

39

6

-20

-10

0

10

20

30

40

50

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

Mar

-10

Mar

-12

Annual revenue growth YoY

0%

5%

10%

15%

20%

25%Ju

n-02

Jun-

03

Jun-

04

Jun-

05

Jun-

06

Jun-

07

Jun-

08

Jun-

09

Jun-

10

Jun-

11

Jun-

12

-60%

-30%

0%

30%

60%

90%

120%

EBITDA Margin EPS YoY growth (RHS)


Continued peak deficits for India, growth in exports, cyclical

improvement in demand for construction/mining engines

should help drive a recovery in the medium term


7 December 2011 86

Figure 116: Cummins – management expects peak deficit to continue at 15%

79 82 106 117171 20253 27

82 31

129 54

0

50

100

150

200

250

300

350

Demand Availablesupply



Demand Supply

2009 20172012

Peak defecit :17%Base surplus : 4%

Peak defecit :15%Base surplus : 18%

Peak defecit :22%Base surplus : 8 %

132 GW109 GW

190 GW 148 GW

300 GW 256 GW

GWPeak shortages are expected to

fall but remain at 15% levels until FY17


Exports will continue to be a driver for Cummins in the long term as outsourcing to India is being expanded from the largely high-HP power-gen segment to the less than 200KVA segment

Strong market positioning Cummins has a high share (50-60%)of the mid-high KVA powergen market in India ,(as per management estimates) due to its strong product quality, after sales services and well entrenched presence in India. Cummins’ competitors in India sell at a discount to Cummins but it has nevertheless been able to hold onto its market share because of strong quality and service . Cummins is now also expanding its presence in the lower KVA segment in India and the export market. KOEL dominates the low KVA segment in India. Strong and dominant market positioning helps Cummins protect pricing during downturns, which helps support margins.

Valuation

Our 12-month price target of Rs428 for Cummins is based on a P/E of 20x applied to our EPS forecast for FY13E plus Rs20 for the value of associates. Our target P/E for the core business is at a multiple set at a 10% premium to the average of the past eight years’ P/E valuation. Since we have already cut earnings estimates to capture the cyclical weakness, we are using average P/E multiples. We give a premium of 10% because of the company’s well developed sales and service business and the likely higher mix of exports that could offset the impact of a weak domestic market in the coming year. In addition, we also value the 50% stakes in Valvoline Cummins and Cummins Research & Technology India at Rs20 per share based on 18x FY13E. We are not factoring in upside risk to the current stock price if the parent of Cummins in the US decides to do an open offer.

The company’s weak earnings momentum has led to a derating of Cummins share price in the past 12 months. The stock is trading below its historical average valuations. We believe that the cyclical pressures are largely reflected in the valuations.

With Cummins introducing new product lines for exports, long-

term potential remains high

Strong and dominant market positioning helps protect pricing

Cyclical weakness captured in valuations


7 December 2011 87

Figure 117: Cummins – historical 12-month forward P/E (x): valuations have witnessed a sharp correction

4

8

12

16

20

24

Jan-

95

Nov

-95

Sep-

96

Jul-

97

May

-98

Feb-

99

Dec

-99

Oct

-00

Aug

-01

Jun-

02

Apr

-03

Feb-

04

Dec

-04

Sep-

05

Jul-

06

May

-07

Mar

-08

Jan-

09

Nov

-09

Sep-

10

Jul-

11

Cummins Linear (Cummins)

Valuations are below historical averages; further derating likely

only in a deep recession


Risks The key risks that could keep our price target from being achieved, in our view, include the following: 1) a recession in export markets impacting sourcing from India; 2) further deceleration in domestic markets; and 3) price discounting in the market that could impact margins. In addition, any further shift among its customers in construction and mining equipment to their own engines would be a concern. And some competitors such as KOEL are scaling up their business in India and their ability to win customers could impact the dominant position of Cummins.

Figure 118: Cummins – history of consensus EPS forecasts shows estimates have often been underestimated

Figure 119: Cummins – history of current consensus EPS forecasts for FY12-14 shows recent sharp estimates cuts (20-23% for FY12-14) should capture the cyclical downturn

0

5

10

15

20

25

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

FY06 FY07 FY08 FY09

FY10 FY11

15

20

25

30

35

40

45

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

FY12 FY13 FY14

Source: Datastream, IBES consensus, Barclays Capital Source: Datastream, IBES consensus, Barclays Capital


7 December 2011 88

Figure 120: Cummins – income statement, FY09-14E


Net sales 32,741 28,449 39,454 41,665 47,313 61,002

YoY 40% -13% 39% 6% 14% 29%

Expenditure 27,968 23,174 32,818 35,741 40,634 51,730

Total material costs 22,338 18,552 25,803 27,881 31,809 40,847

% of sales 68% 65% 65% 67% 67% 67%

Employee costs 2,130 1,953 2,546 3,157 3,484 4,339

% of sales 7% 7% 6% 8% 7% 7%

Other costs 3,501 2,670 4,469 4,704 5,342 6,544

OBITDA 4,772 5,275 6,636 5,923 6,679 9,272

OBITDA margin 15% 19% 17% 14% 14% 15%

Other income plus other operating income 1,507 1,216 1,774 1,657 1,876 2,157

Depreciation 456 381 367 413 606 781

Interest 26 21 19 23 24 24

Pre-tax exceptional items 192 0 0 0 0 0


Profit before tax Margin 18% 21% 20% 17% 17% 17%

Tax 1,654 1,670 2,114 2,056 2,283 3,054

Tax rate 28% 27% 26% 29% 29% 29%

Post-tax exceptional items 0 0 0 0 0 0

Profit after tax – reported 4,337 4,419 5,911 5,088 5,642 7,570

Profit after tax – adjusted 4,202 4,419 5,911 5,088 5,642 7,570



7 December 2011 89

Figure 121: Cummins – balance sheet, FY09-14E


Share capital 396 396 396 396 396 396


Shareholders equity 13,947 15,610 18,063 20,450 23,098 26,650

Secured loans 212 86 183 - - -

Unsecured loans 0 0 - - - -

Loan funds 212 86 183 183 183 183

Finance lease liability 17 - - - - -

Total sources of funds 14,176 15,696 18,246 20,633 23,281 26,833

Gross block 7,414 8,041 9,144 11,144 13,144 14,644

Less: depreciation 4,324 4,704 4,733 5,146 5,752 6,534

Net block 3,090 3,337 4,411 5,997 7,391 8,110

Investments 3,993 7,329 7,255 7,255 7,255 7,255

Deferred tax net 231 169 187 187 187 187

Inventories 4,680 4,098 5,190 5,936 6,741 8,691

Inventory days 52 53 52 52 52 52

Debtors 6,821 5,229 7,182 7,658 8,696 11,212

Debtor days 76 67 67 67 67 67

Cash and bank 323 559 1,038 525 874 1,684

Other current assets 83 93 99 136 154 199

as % of sales 0 0 0 0 0 0


as % of sales 0 0 0 0 0 0



Provisions 1,732 2,634 3,303 3,424 3,889 5,181

Number of days net sales 19 34 33 30 30 31


No of days net sales 77 62 62 62 62 62

Total application of funds 14,176 15,696 18,246 20,633 23,281 26,833



7 December 2011 90

Figure 122: Cummins – cash flow statement, FY09-14E



Depreciation 456 361 367 413 606 781

Cash flow from operations excluding working capital 6,085 5,872 6,636 5,923 6,679 9,272

Changes in working capital (2,023) 1,436 (1,053) (1,314) (904) (2,024)

Cash flow from operations 4,062 7,309 5,584 4,609 5,775 7,248

Tax paid (1,850) (1,550) (2,114) (2,056) (2,283) (3,054)

Cash flow from operating activities 2,212 5,759 3,470 2,554 3,492 4,194

Purchase of fixed assets (908) (665) (1,500) (2,000) (2,000) (1,500)

Sale of fixed assets 312 46 - - - -

Purchase of investments (17,092) (17,146) - - - -

Sale of investments 17,504 13,806 - - - -

Cash flow from investing activities 104 (3,368) 274 (343) (124) 657

Change in debt (107) (126) 97 - - -

Interest paid (26) (21) (19) (23) (24) (24)

Dividend paid (2,099) (1,192) (3,137) (2,701) (2,995) (4,018)

Cash flow from financing activities (2,231) (2,155) (3,059) (2,724) (3,019) (4,042)

Change in cash and cash equivalents 84 236 685 (513) 349 810

Opening cash and cash equivalents 239 323 559 1,038 525 874

Closing cash and cash equivalents 323 559 1,038 525 874 1,684



7 December 2011 91

CROMPTON GREAVES (1-OW, PT: RS147, +11%): CONTRARIAN PICK; LOW VISIBILITY BUT LOW EXPECTATIONS

We initiate coverage of Crompton Greaves (CRG) with a 1-Overweight rating and a 12-month price target of Rs147, based on 16x FY13E standalone and 12x FY13E subsidiary earnings. Following the sharp decline in margins in 1H/FY12, consensus estimates (40% cuts over the past 12 months) are building in no scope for a margin recovery in future years. We take a non-consensus view of this stock and believe there is scope for margin recovery given the product nature of the business, which ensures low correlation between yearly margins. Apart from the earnings cuts, the sharp derating of the stock (20x to 11x over the past 12 months) makes us believe that the expectations for performance are low. A bottoming in fundamentals over the next six months and weak quarterly earnings support our view that now is the time to be 1-Overweight on the stock.

Margin trough likely in FY12: We believe the reasons for CRG’s margin increase last year and the current decline across most segments remain unclear in the market. We believe the current margin decline arises from a combination of the impact of commodity price increases and pressures at some projects being executed by subsidiaries. With CRG’s exposure to an extremely tough pricing environment in the domestic T&D segment (limited to 15% of order book on our estimates), we believe that any unusual weakness in margins should be limited to that portion of business only. In recent discussions, the company’s new CEO indicated management’s intent is to purge costs over the longer term, with new initiatives such as sourcing from China.

Downgrade cycle nearing an end: Another weak quarter should lead to the last round of earnings downgrades, in our view, but the key point to ponder is whether a further 10-15% decline in EPS estimates will impact the stock price. We note that there have been cuts of more than 40% – and not just for FY12 estimates, but also for FY13 and FY14, even though there is little relationship between margins year to year for CRG as it is a product business, and the stock has de-rated from a P/E of 20x forward earnings to 11x currently. We think the impact of continued weakness in near-term earnings will be temporary.

Trading at a steep discount to ABB and Siemens: . The current 50-60% discount to ABB and Siemens valuations are not justified, in our view given a better earnings track record for CRG.

Figure 123: Crompton Greaves – statistical abstract


Mar Rs mn Rs % (x) (x) (%) (%)

2011A 9,268 14.4 13.5 9.1 2.6 28.1 1.8

2012E 4,441 6.9 -52.1 19.1 2.3 12.3 1.3

2013E 5,833 9.1 31.3 14.5 2.1 14.3 1.3

2014E 7,031 11.0 20.5 12.1 1.8 15.1 1.5


CRG IN / CROM.NS




Price (02-Dec-2011) INR 132.15



7 December 2011 92

COMPANY SNAPSHOT

Crompton Greaves INDIA CAPITAL GOODS

Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 100,051 94,185 94,272 102,619 0.8% Stock Rating 1-OVERWEIGHTEBITDA 13,438 8,074 9,219 10,900 -6.7% Sector View 2-NEUTRALEBIT 11,502 6,003 7,590 9,189 -7.2% Price (02-Dec-2011) 132.15Pre-tax income 12,291 6,425 8,217 9,858 -7.1% Price Target 147Net income 9,268 4,441 5,833 7,031 -8.8% Ticker CRG INEPS (R) 14.45 6.92 9.09 10.96 -8.8%Diluted shares (mn) 641.52 641.52 641.52 641.52 0.0% Investment case

DPS (R) 2.20 1.55 1.62 1.88 -5.2%


Balance sheet and cash flow (INRmn) CAGRFixed assets 19,417 19,845 20,715 21,504 3.5%Cash and equivalents 2,984 9,655 12,873 17,025 78.7%Total assets 71,500 75,644 80,465 89,026 7.6%Current liabilities 33,892 34,370 34,369 37,066 3.0%Long term liabilities 4,703 4,922 4,922 4,923 1.5% Downside case 91Total liabilities 71,500 75,637 80,458 89,019 7.6%Net debt/(funds) 1,719 (4,733) (7,951) (12,102) NAShareholders' equity 32,747 36,206 41,028 46,891 12.7%Change in working capital (5,133) 4,156 16 (172) NACash flow from operations 5,605 10,267 6,878 7,935 12.3%Capital expenditure (7,592) (2,500) (2,500) (2,500) NAFree cash flow (1,987) 7,767 4,378 5,435 NA


Valuation and leverage metrics AverageP/E (x) 9.1 19.1 14.5 12.1 13.7 EV/EBITDA (x) 6.4 9.9 8.3 6.7 7.8 FCF yield (%) -2.3 9.2 5.2 6.4 4.6EV/sales (x) 0.9 0.8 0.8 0.7 0.8 Price/BV (x) 2.6 2.3 2.1 1.8 2.2 Dividend yield (%) 1.7 1.2 1.2 1.4 1.4Total debt/capital (%) 12.5 11.9 10.7 9.5 11.1Net debt/EBITDA (x) 0.1 -0.1 -0.2 -0.3 -0.1


Selected operating metrics EPS expected to recover in FY13Order inflow 109,620 92,445 98,128 116,192 Order inflow growth (%) 7 -16 6 18Orderbook 71,690 68,571 69,718 80,151 Orderbook growth (%) 12 -4 2 15


Why a 1-Overweight? After our cuts of more than 35-40% for EPS for FY12-14 and stock multiplescoming down from over 22x to 12x, we believe thatweak fundamentals are priced in. We modelconservative EPS and value Crompton on a P/E of14x.

A recovery in margins especially at the subsidiairescould take its P/E back to 25x, which is closer to thesector average P/E.

Continued weakness could lead to the stock trending back to sector trough P/E of 10x. Continuedweakness could lead to stock trending back to sectortrough P/E of 10x.

-60%-40%-20%

0%20%40%60%

Mar10 Mar11 Mar12E Mar13E Mar14E

EPS growth

DownsideCase

INR91(-31.1%)

PriceTarget

INR147(11.2%)

UpsideCase

INR181(36.9%)

050

100150200250300350

15-Dec-10 2-Dec-11

DownsideCase

INR91(-31.1%)

PriceTarget

INR147(11.2%)

UpsideCase

INR182(37.7%)

050

100150200250300350

15-Dec-10 2-Dec-11


7 December 2011 93

Margin recovery the key driver

CRG’s margins have fallen to significantly lower levels that in the past, due to losses at subsidiaries and a moderation in margins in India. While CRG may have benefitted from lower commodity prices in 2009, which may have helped increase margins in all segments until late FY11, we believe that this does not explain the sharp deterioration in margins at the subsidiaries. We believe there is a possibility of project-specific losses that may have been booked. The losses could be in the 765KV orders being manufactured in Ganz (we would get more clarity only from the FY12 annual report) as the revenue booking for these projects was expected to commence in 4Q FY10 or 1Q FY12. If the losses were specific to certain projects then margins could retrace back by 200-300bps, in the coming quarters, on our estimates. Commodity price increases and product price declines in the market will continue to pressure margins, in our view.

Figure 126: Crompton Greaves – Consolidated EBITDA margin: recent margins of 7-8% are significantly lower than in the past

10% 11%

14%

10%11% 11%

13%

11%

14% 14%16%

13%14% 14%

13%

7%8%

0%2%4%6%8%

10%12%14%16%18%

Sep-

07

Dec

-07

Mar

-08

Jun-

08

Sep-

08

Dec

-08

Mar

-09

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

OBITDA Margins

Source:: Company data, Barclays Capital

Margin decline could have been led by commodity price

increases and project-specific losses at its subsidiaries

Figure 124: Crompton Greaves – operating margin: standalone margins have moderated

Figure 125: Crompton Greaves – operating margin: subsidiaries made a loss in the June quarter

0%

2%

4%

6%

8%10%

12%

14%

16%

18%

Sep0

3

Jun0

4

Mar

05

Dec

05

Sep0

6

Jun0

7

Mar

08

Dec

08

Sep0

9

Jun-

10

Mar

-11

Operating margins

-4%

0%

4%

8%

12%

16%

Sep

07

Mar

-08

Sep-

08

Mar

-09

Sep-

09

Mar

-10

Sep-

10

Mar

-11

Sep-

11

Operating margins

Source: Company data, Barclays Capital Source: . Company data, Barclays Capital


7 December 2011 94

Building conservative estimates

We have taken a conservative stance on both order inflows and margins while building our estimates. We expect flattish sales in FY13 but a 31% growth in PAT in FY13E given the low base. Absolute PAT in FY13E would still be lower than achieved in FY10.

Figure 127: Crompton Greaves – revenue by product segment: building in modest estimates

Rs mn, years ending March FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E

Power systems 17,750 19,633 22,585 25,103 25,542 21,353 20,053 22,684

Growth 46% 11% 15% 11% 2% -16% -6% 13%

Industrial systems 8,874 11,246 10,943 11,780 14,066 12,642 10,981 13,485

Growth 29% 27% -3% 8% 19% -10% -13% 23%

Consumer products 9,940 11,002 13,384 16,120 20,212 21,729 24,988 28,736

Growth (y/y) 22% 11% 22% 20% 25% 8% 15% 15%


Figure 128: Crompton Greaves – forecasts by segment: expect margin recovery in FY13E

Rs mn; years ending March FY10 FY11E FY12E FY13E FY14E

Standalone

Order inflow 64,271 65,100 56,829 62,512 77,015

y/y 7% 1% -13% 10% 23%

Order book 34,000 34,860 34,686 38,466 47,436

y/y 23% 3% 0% 11% 23%

Net sales 52,840 59,515 55,631 56,022 64,905

y/y 15% 13% -7% 1% 16%

EBITDA margin 16.2% 15.7% 11.8% 11.9% 11.9%

Net Income 5,613 6,724 4,610 4,807 5,468

y/y 41% 20% -31% 4% 14%

Subsidiaries

Order inflow 37,940 44,520 35,616 35,616 39,178

y/y 0% 17% -20% 0% 10%

Order book 30,000 36,830 33,886 31,252 32,715

y/y -21% 23% -8% -8% 5%

Net sales 38,569 40,536 38,560 38,250 37,714

y/y -7% 5% -5% -1% -1%

EBITDA Margin 10.9% 10.1% 4.0% 6.6% 8.4%

Net Income 2,550 2,545 -156 1,054 1,593

y/y 43% 0% -106% -777% 51%

Consolidated

Order inflow 102,211 109,620 92,445 98,128 116,192

y/y 4% 7% -16% 6% 18%

Order book 64,000 71,690 68,571 69,718 80,151

y/y -3% 12% -4% 2% 15%

Net sales 91,409 100,051 94,185 94,272 102,619

y/y 5% 9% -6% 0% 9%

EBITDA Margin 14.0% 13.4% 8.6% 9.8% 10.6%

Net Income 8,162 9,268 4,441 5,833 7,031

y/y 42% 14% -52% 31% 21%


We expect flattish sales in FY13 but more than31% growth in

PAT


7 December 2011 95

Shares are pricing in a weak near term

After a 40% cut in forward estimates and a derating of the stock from over 20x to 11x, we believe that near-term margin pressures are reflected in valuations. A recovery in earnings in Q3/Q4 could be the key driver of a stock rebound, in our view

Valuation

Our 12-month price target of Rs147 for CRG is based on 16x standalone FY13E earnings of Rs7.50 and 12x subsidiary earnings of Rs1.69. Our multiples are set at historical average multiples for the past seven years for CRG despite the recent sharp increase in consensus earnings estimates.

CRG’s estimates have seen a 40% revision for FY12-14, the highest decline among peers

Figure 129: Crompton Greaves – history of current consensus EPS forecasts shows estimates typically were revised up for FY06-11 (Rs)

Figure 130: Crompton Greaves – history of current consensus EPS forecasts for FY12-14 shows weak 1Q/2Q FY12E led to 40% cuts in estimates (Rs)

02468

10121416

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

FY06 FY07 FY08 FY09

FY10 FY11

579

1113151719212325

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

FY12 FY13 FY14

Source: Datastream, IBES consensus estimates, Barclays Capital Source: Datastream, IBES consensus estimates, Barclays Capital

Initiate at 1-Overweight

Figure 131: Crompton Greaves – Stock trading at close to historical P/E lows (x)

Figure 132: Crompton Greaves – EV/order book close to historical lows (x)

0

5

10

15

20

25

30

Dec

-94

Mar

-96

Jun-

97

Sep-

98

Dec

-99

Mar

-01

Jun-

02

Sep-

03

Dec

-04

Mar

-06

Jun-

07

Sep-

08

Dec

-09

Mar

-11

Crompton

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Mar

-95

Jun-

96

Sep-

97

Dec

-98

Mar

-00

Jun-

01

Sep-

02

Dec

-03

Mar

-05

Jun-

06

Sep-

07

Dec

-08

Mar

-10

Jun-

11

EV/orderbook

Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital


7 December 2011 96

Figure 135: Crompton Greaves – cash flow generation has typically been strong

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Mar03 Mar04 Mar05 Mar06 Mar07 Mar08 Mar09 Mar10 Mar11

Operating profit before WC changes Cash flow from operating activities, Rs mn

Source:: Company data, Barclays Capital

Risks

The key risks that could keep our price target from being achieved, in our view, include a higher-than-expected decline in order inflows due to stiff competitive pressures in the domestic market and continued price declines and risks could emerge from weak demand for T&D products from Europe since CRG derives more than 50% of revenues from international geographies.

Figure 133: Crompton Greaves – Trading at a steep P/E discount to ABB (x) …

Figure 134: … and Siemens (P/E x)

0.00.10.20.30.40.50.60.70.80.9

Dec

-94

Apr

-96

Jul-

97

Oct

-98

Jan-

00

Apr

-01

Aug

-02

Nov

-03

Feb-

05

May

-06

Aug

-07

Nov

-08

Mar

-10

Jun-

11CRG over ABB

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Dec

-94

Apr

-96

Jul-

97

Oct

-98

Jan-

00

Apr

-01

Aug

-02

Nov

-03

Feb-

05

May

-06

Aug

-07

Nov

-08

Mar

-10

Jun-

11

CRG over Siemens'

Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital


7 December 2011 97

Figure 136: Crompton Greaves – income statement, FY09-14E


Net sales 87,373 91,409 100,051 94,185 94,272 102,619

YoY 28% 5% 9% -6% 0% 9%

Materials, manufacturing and operating expenses 56,938 55,923 64,980 63,037 61,839 67586

% of sales 65% 61% 65% 67% 66% 66%

Staff cost 10,627 11,131 11,811 11,706 11,849 11,885

% of sales 12% 12% 12% 12% 13% 12%

Sales and administrative expenses 9,852 11,585 451,175 11,368 11,365 12,248

% of sales 11% 13% 451% 12% 12% 12%

Expenditure 77,418 78,640 527,967 86,111 85,053 91,718

% of sales 89% 86% 528% 91% 90% 89%

OBITDA 9,955 12,769 13,438 8,074 9,219 10,900

OBITDA margin 11.4% 14.0% 13.4% 8.6% 9.8% 10.6%

Other income 740 1,100 1,142 758 879 920

Depreciation 1,216 1,551 1,936 2,072 1,630 1,711

Interest 655 265 209 336 251 251

Exceptional items 0 0 0 0 0 0


Total taxation 3,047 3,650 3,100 1,971 2,357 2,794

Tax rate 35% 30% 25% 31% 29% 28%

Profit after tax before minority interests 5,777 8,403 9,192 4,454 5,860 7,064

Minority interests 17 -26 -4 -14 -29 -35

Share of profits of associates -9 32 80 1 2 3

Reported profit after tax 5,751 8,409 9,268 4,441 5,833 7,031



YoY 0% 42% 14% -52% 31% 21%



7 December 2011 98

Figure 137: Crompton Greaves – balance sheet, FY09-14E


Share capital 733 1,283 1,283 1,283 1,283 1,284


Total shareholder equity 18,310 25,043 32,747 36,206 41,028 46,891

Minority interest 139 43 157 139 139 139

Secured loans 6,923 4,766 4,554 4,802 4,802 4,802

Unsecured loans 260 244 149 149 149 149

Total loans 7,182 5,010 4,703 4,922 4,922 4,923


Application of funds

Gross block 30,289 29,858 37,805 40,305 42,805 45,305


Net block 13,248 12,623 18,314 18,743 19,613 20,402

Capital WIP 537 1,137 1,102 1,102 1,102 1,102

Total fixed assets 13,785 13,760 19,417 19,845 20,715 21,504

Investments 1,672 5,536 6,747 7,497 8,247 8,997

Deferred tax assets net 482 -49 -160 -160 -160 -160

Inventory 10,949 10,412 11,893 10,848 10,811 11,250


Debtors 20,556 21,463 25,427 22,205 22,213 24,054

Debtor days 86 86 86 86 86 87

Cash and bank 5,656 6,688 2,984 9,622 12,839 16,992


Days of sales 19 19 19 19 19 19

Total current assets 41,699 41,018 45,496 48,455 51,655 58,677


Current liability days 109 106 115 115 115 116

Provisions 5,986 3,603 4,298 6,436 6,444 7,041

Provision days 25 14 14 14 14 14

Total current liabilities and provisions 32,008 30,170 33,892 34,370 34,369 37,066


Net current assets excluding cash 4,035 4,161 8,620 4,463 4,448 4,620

Days of sales 17 17 31 17 17 16

Miscellaneous expenditures 0 0 0 0 0 0




7 December 2011 99

Figure 138: Crompton Greaves – cash flow statement, FY09-14E



Depreciation 1,216 1,551 1,936 2,072 1,630 1,711

Others 1,689 -509 -223 -422 -628 -669

Operating profit before working capital changes 11,577 12,932 14,004 8,074 9,219 10,900

Debtors -3,147 -664 -6,276 3,222 -8 -1,841

Inventory -251 726 -1,692 1,045 36 -438

Trade and other payables 3,228 407 2,989 478 -1 2,697

Others 228 74 -155 -588 -12 -590

Operating cash flow 11,635 13,475 8,871 12,231 9,235 10,728

Taxation -2,165 -2,920 -3,266 -1971 -2,357 -2,794


Change in fixed assets -1,977 -2,070 -7,592 -2,500 -2,500 -2,500

Change in investments -714 21,330 -1,200 -750 -750 -750

Others -652 -25,010 1,411 758 879 920

Cash flow from investing activities -3,343 -5,751 -7,382 -2,492 -2,371 -2,330

Change in equity

Change in loans -1,374 -2,169 -379 219 0 1

Dividend paid and tax thereon -814 -1,159 -1,195 -996 -1,038 -1,203

Others -702 -451 -354 -354 -251 -249

Cash flow from financing activities -2,890 -3,778 -1,927 -1,131 -1,290 -1,451

Net change in cash and cash equivalents 3,238 1,032 -3,704 6,637 3,217 4,153

Opening balance of cash and equivalents 2,445 5,656 6,688 2,985 9,622 12,839

Closing balance of cash and equivalents 5,682 6,688 2,985 9,622 12,839 16,992



7 December 2011 100

THERMAX (3-UW, PT: RS392, -17%): SLOW PACE OF NEW BUSINESS SCALE UP

We initiate coverage on Thermax with a 3-Underweight rating and a 12-month price target of Rs392 (P/E of 12 for FY13E). Although its core business continues to do well, we believe that a weak environment for ordering in the industrial segment should slow of Thermax’s order growth rates and earnings momentum in the coming quarters. With the order environment for IPPs weak, we believe it would be difficult for Thermax to win orders beyond what is already in the pipeline. The company’s potential inability to scale up subcritical and supercritical businesses would likely impact the stock’s valuations further.

Earnings momentum to decelerate: We expect earnings growth rates for Thermax to head into negative territory in the coming quarters given declining order book growth (down 7% in September quarter). We expect single-digit growth in earnings (3% y/y) and revenue next year due to weak order growth this year. Thermax has not won another subcritical utility order since the contract for Rs10bn for the Meenakshi power projects in FY10, which we believe is the result of depleting market ordering and stiff competition. The lack of new subcritical orders is the key reason for weak order growth in FY12.

Option value: Given the large market sizes of the new businesses that Thermax is venturing into, it would be prudent to expect some large wins in the coming year and some of these wins could have a substantial impact on order inflow growth for the company. We estimate a single supercritical 660MW EPC order win would double the order book for the company. The consensus forecasts, however, do not yet reflect that value, which we believe is because competition has decreased margins on new orders and hence the potential impact of a win is much lower than we thought earlier.

Core business priced in: Our analysis of four scenarios for ordering – 1) orders from core business only, 2) core business of Rs10bn-plus from subcritical wins, 3) core Rs20bn-plus wins, and 4) core Rs20bn-plus subcritical wins and Rs15bn-plus supercritical wins – suggests a price target range of Rs304-625. Therefore, the current stock price appears to be building in normal growth in the core business (ie, no recession) and some modest subcritical wins. We believe that given a weak industrial environment, which could impact the core business and likely create an inability to win modest subcritical orders, there is downside to the current stock price. Hence, we initiate coverage with a 3-Underweight rating. Given our positive view on management’s performance and the company’s strong execution skills, we would revisit the stock at levels below the core value (ie, Rs308).

Figure 139: Thermax – statistical abstract


Mar Rs mn Rs % (x) (x) (%) (%)

2011A 3,831 32 70.8 14.6 4.3 29.6 2.4

2012E 3,812 32 -0.5 14.7 3.7 25.1 2.9

2013E 3,889 33 2.0 14.4 3.2 22.2 2.9

2014E 4,671 39 20.1 12.0 2.8 23.0 3.5


TMX IN / THMX.NS




Price (02-Dec-2011) INR 469.70



7 December 2011 101

COMPANY SNAPSHOT

THERMAX INDIA CAPITAL GOODS

Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 48,832 51,072 52,376 62,767 8.7% Stock Rating 3-UNDERWEIGHTEBITDA 5,668 5,544 5,688 6,815 6.3% Sector View 2-NEUTRALEBIT 5,236 5,001 5,046 6,049 4.9% Price (02-Dec-2011) 469.7Pre-tax income 5,737 5,616 5,775 6,939 6.5% Price Target 392Net income 3,831 3,812 3,889 4,671 6.8% Ticker THMX.BO/TMX INEPS (R) 32.15 31.99 32.64 39.20 6.8%Diluted shares (mn) 119.15 119.15 119.15 119.15 0.0% Investment case

DPS (R) 10.46 12.80 13.06 15.68 14.4%


Balance sheet and cash flow (INRmn) CAGRFixed assets 5,163 5,121 5,229 5,213 0.3%Cash and equivalents 6,566 7,664 8,939 11,651 21.1%Total assets 35,928 39,239 42,168 49,721 11.4%Current liabilities 22,323 23,346 23,943 28,693 8.7%Long term liabilities 682 682 682 682 0.0% Downside case 171Total liabilities 35,928 39,239 42,168 49,721 11.4%Net debt/(funds) (6,085) (7,183) (8,458) (11,170) NAShareholders' equity 12,923 15,210 17,544 20,347 16.3%Change in working capital (1,161) (232) 49 394 NACash flow from operations 1,142 3,508 3,856 4,949 63.0%Capital expenditure (572) (500) (750) (750) NAFree cash flow 570 3,008 3,106 4,199 94.6%


Valuation and leverage metrics AverageP/E (x) 14.6 14.7 14.4 12.0 13.9 EV/EBITDA (x) 8.1 7.9 7.4 5.8 7.3 FCF yield (%) 1.0 5.4 5.5 7.5 4.9EV/sales (x) 1.0 1.0 0.9 0.7 0.9 Price/BV (x) 4.3 3.7 3.2 2.8 3.5 Dividend yield (%) 2.2 2.7 2.8 3.3 2.8Total debt/capital (%) 3.5 3.0 2.6 2.3 2.9Net debt/EBITDA (x) -1.1 -1.3 -1.5 -1.6 -1.4


Selected operating metrics Expect Rs20bn worth of IPP wins until FY14Order inflow 53,180 53,180 63,339 74,537 Order inflow growth (%) -5 0 19 18Orderbook 56,050 58,158 69,121 80,891 Orderbook growth (%) 4 4 19 17


Why a 3-Underweight? Weak investment cycle toimpact industrial ordering. Expect earningsmomentum to weaken. With order environment forIPP’s weak, Thermax may find it difficult to scale upsub/supercritical businesses which would impactvaluations further, in our view.

We see an upside to our estimates for FY14 andbeyond on order wins of over Rs20bn in the IPPsegment. A large supercritical win could reratemultiples. Assuming supercritical wins andsubcritical wins of Rs20bn, stock could trend up toP/E of 18x and forward EPS of Rs33.

Core business in a normal cycle supports a valuationof Rs308. We believe that weak industrial cycletypically leads to order cancellations and in thatscenario there is a likelihood of stock going down totrough P/E.

10000

0 0

7500

12500

0

5000

10000

15000

Mar-10 Mar-12E Mar-14E

0%5%10%15%20%

Power sector IPP inflow (Rs mn)Power IPP inflow as % of total inflow

INR171(-63.5%)Downside

Case

INR392(-16.5%)

PriceTarget

INR625(33.0%)

UpsideCase

0

170

340

510

680

850

15-Dec-10 2-Dec-11

INR171(-63.5%)

DownsideCase

INR392(-16.5%)

PriceTarget

INR625(33.0%)

UpsideCase

0100200300400500600700800

15-Dec-10 2-Dec-11


7 December 2011 102

Near-term momentum weak but there is an option value

Thermax has been attempting to scale up its business from an industrial captive power boiler/boiler manufacturer and industrial solutions providers (water, air pollution control) to a manufacturer of subcritical utility boiler/EPC and supercritical boilers. Thermax has partnered with Babcock and Wilcox for both ventures. For supercritical boilers, however, it is in the form of a joint venture with Thermax holding a majority stake.

While Thermax is now exposed to businesses with significantly bigger market sizes than earlier (revenue of Rs1,000bn pa vs. Rs200bn), it has won only one order in the LPP (large power plant) subcritical segment while in the supercritical business, bidding has just commenced. The potential upside surprise, however, would likely come from an ability to convert even a few orders or a market share of only 5% in the initial years, which we believe would be sufficient to double the current order book. Given that Thermax has all the capabilities and manufacturing facilities (in India) to set up this business, it is likely that some orders will come through. In our revenue forecast for FY13, we include an estimate of Rs12.5bn for such orders.

Figure 140: Thermax – IPP order wins, FY10-14E (Rs mn)

1250010000

7500

0

5000

10000

15000

Mar-10 Mar-11 Mar-12E Mar13E Mar14E0%

4%

8%

12%

16%

20%

Power sector IPP inflow Power IPP inflows as % of overall inflows

We forecast Rs20bn in order wins for FY13-14 for Thermax


Figure 141: Thermax – Earnings growth rates, June 2005-September 2012E

-40%-20%

0%20%40%60%80%

100%120%140%160%

Jun0

5

Dec

05

Jun0

6

Dec

06

Jun0

7

Dec

07

Jun0

8

Dec

08

Jun0

9

Dec

-09

Jun1

0

Dec

10

Jun1

1

Dec

11E

Jun1

2E

Earnings growth YoY

Earnings growth to head to negative territory

We expect earnings momentum to weaken



7 December 2011 103

Balance sheet over growth

Thermax sports a negative working capital (advances) and has no leverage. Management has typically been unwilling to take projects with unfavourable terms (that could impact balance sheet) or have exposure to companies with weak balance sheets (state utilities).

With the order environment for the power segment challenging and competition high, we believe that the terms of new contracts will not be as favourable for vendors as before, and from that perspective, Thermax will likely have to either accept balance sheet risk or decide not to take such orders. We believe that given the large size of power contracts. it would be prudent for Thermax to protect its balance sheet (only Rs12bn). Therefore, we expect order inflow to be lower than guidance. That said, unlike BGR Energy, Thermax appears to have sufficient cash reserves to set up new capacity without any equity dilution.

Figure 142: Thermax – net working capital days, March 1994-March 2011: now negative

33

61

116

90100

89 91 92

53

2212

-4-25

-37-21

1

-48

-16

-60-40-20

020406080

100120140

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Net working capital days

The working capital cycle is negative, and Thermax intends to maintain such a trend, in our

view


Figure 143: Thermax – Cash flow generation (Rs bn), March 2003-March 2011

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11

Operating profit before WC changes Pre tax cash flow post WC changes

Cash flow generation has been strong in the past


Focus on balance sheet protection is good, in our view,

but it will impact growth as there are no good projects in the

market


7 December 2011 104

Understanding the value of the core business

If we were to take a view that Thermax will not be able to win orders in the new businesses, then how much support can the core business lend to valuations? Essentially, we are stripping core from the new and trying to understand what the stock price currently implies. In order to calculate this we have made assumption on order inflows based on various scenarios and calculated fwd EPS. We also use different P/E ranges for each scenario as we believe that while a win in supercritical order does not impact EPS in the near term it would lead to a rerating of P/E as investors will start valuing the supercritical JV.

Figure 144: Thermax – estimates of value of core business plus value accretion led by various additional contract wins (Rs/share)

625

587442308

0

100

200

300

400

500

600

700

800

Core Subcritical wins ofRs10bn

Subcritical wins ofRs20bn

Subcritcial+supercriticalwin

Order inflow: Rs44bn, P/E of 12x, EPS of Rs26



Inflow: Rs80bn, Add value of supercritical JV, EPS of Rs33

Core business supports a valuation of Rs308, on our

estimate, and a stock price above that appears to build in

success in new businesses


Valuation

Our 12-month price target of Rs392 for Thermax is based on 12x our earnings estimate for FY13. Our target P/E multiple is set at a 30% discount to its historical average for the past seven years as the average multiples have been propped, in our view, by the expectation of success in the subcritical and supercritical IPP foray. We are modelling only core industrial business and modest wins in subcritical space and hence the discount.

Our valuations build in modest wins in the subcritical IPP space of Rs12.5bn in FY13 and hence are pegged between the first (core) and second scenarios as shown in Figure 144.


7 December 2011 105

Figure 145: Thermax – historical 12-month forward P/E, 1994-2011E

5

10

15

20

25

30

35

Dec

-94

Oct

-95

Aug

-96

Jun-

97

Apr

-98

Feb-

99

Dec

-99

Oct

-00

Aug

-01

May

-02

Mar

-03

Jan-

04

Nov

-04

Sep-

05

Jul-

06

May

-07

Mar

-08

Jan-

09

Oct

-09

Aug

-10

Jun-

11

Thermax

Stock has de-rated due to low visibility on order wins in

subcritical space

Valuations have compressed but 12-month forward P/E is base on

peak cycle earnings


Risks The key risks that could keep our price target from being achieved, in our view, include the following: 1) Given the large scale of the new businesses that Thermax has ventured into, any large order wins in either subcritical or supercritical businesses at a good pricing could re-rate the stock. 2) Continued strength in core industrial business could also lead to earnings surprises, 3) A faster-than-expected scaling up of new business ventures in the solar and geothermal segments could also help multiples.

Figure 146: Thermax – history of consensus EPS forecasts shows that estimates typically get cut in downturns (Rs)

Figure 147: Thermax – history of consensus EPS forecasts for FY12-14E shows some moderation in FY13 earnings estimates (Rs)

0

10

20

30

40

50

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

FY06 FY07 FY08 FY09

FY10 FY11

20

25

30

35

40

45

50

55

60

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

FY12E FY13E FY14E

Source: Datastream, IBES consensus, Barclays Capita Source: Datastream, IBES consensus, Barclays Capital


7 December 2011 106

Figure 148: Thermax – income statement, FY09-14E


Net sales 32,644 31,855 48,832 51,072 52,376 62,767

Material costs 20,976 20,585 34,159 36,207 37,201 44,590

% of sales 64% 65% 70% 71% 71% 71%

Personnel costs 2,546 2,927 3,686 3,675 3,706 4,433

% of sales 8% 9% 8% 7% 7% 7%

Other expenses 4,953 4,477 5,320 5,646 5,781 6,928

% of sales 15% 14% 11% 11% 11% 11%

Operating profits 4,168 3,866 5,668 5,544 5,688 6,815

OBITDA margin 13% 12% 12% 11% 11% 11%

EBITDA 4,556 4,363 6,190 6,198 6,459 7,752

EBITDA margin 14% 14% 13% 12% 12% 12%

Depreciation 321 404 432 542 642 766

Interest 33 15 22 39 46 55

Other income 388 498 523 654 771 937

Profit before tax and extraordinary items 4,202 3,944 5,737 5,616 5,771 6,931

Extraordinary items -14 -1,149 0 0 4 8



Taxation 1,319 1,356 1,906 1,804 1,882 2,260

Tax rate 31% 49% 33% 32% 33% 33%

Profit after tax 2,896 1,439 3,831 3,812 3,889 4,671







7 December 2011 107

Figure 149: Thermax – balance sheet, FY09-14E


Ordinary share capital 238 238 238 238 238 238

Preference share capital 0 0 0 0 0 0



Loan funds 0 0 481 481 481 481

Net deferred tax liability 181 172 201 201 201 201

Total funds employed 9,799 10,680 13,605 15,892 18,226 21,028

Gross fixed assets 6,029 6,884 7,171 7,671 8,421 9,171

Depreciation 1,630 1,946 2,305 2,848 3,490 4,256

Net fixed assets 4,399 4,939 4,866 4,824 4,931 4,916

Capital WIP 177 112 297 297 297 297

Investments 1,765 3,782 4,044 5,044 6,044 6,544

Inventory 2,664 2,464 2,823 3,498 3,587 4,299


Contracts in progress 2,269 2,762 3,571 3,498 3,587 4,299

Number of days of sales 25 32 27 25 25 25

Receivables 5,408 7,471 10,013 10,494 10,762 12,897

Receivable days 60 86 75 75 75 75

Cash and bank 3,408 6,056 6,566 7,664 8,939 11,651


% of sales 1% 2% 1% 1% 1% 1%


% of sales 6% 9% 6% 6% 6% 6%



Contracts in progress 559 674 1,014 1,060 1,087 1,303

Days of sales 6 8 8 8 8 8

Provisions 949 975 1,621 1,695 1,739 2,083

Days of sales 11 11 12 12 12 12


Misc. expenditure not written off 0 0 0 0 0 0

Total assets 9,799 10,680 13,605 15,892 18,226 21,028



7 December 2011 108

Figure 150: Thermax – cash flow statement, FY09-14E


Net profit before tax 4,179 3,919 5,730 5,616 5,771 6,931

Depreciation and amortization 321 404 432 542 642 766

Others -147 -201 -503 -615 -725 -881


Change in receivables 771 1,385 -3,179 -482 -268 -2,135

Change in inventory -669 201 -360 -774 -279 -2,221

Change in trade payables -260 2,033 2,846 903 526 4,189

Change in contracts in progress -1,318 -378 -469 121 70 561

Total changes in working capital -1,476 3,240 -1,161 -232 49 394


Direct taxes -1,393 -1,346 -1,799 -1,804 -1,882 -2,260


Change in fixed assets -1,595 -880 -572 -500 -750 -750

Change in investments 4,189 -2,010 -260 -1,000 -1,000 -500

Others 201 417 435 654 771 937

Cash flow from investing activities 2,795 -2,474 -397 -846 -979 -313

Change in share capital 0 0 0 0 0 0

Change in loans 0 0 481 0 0 0

Change in preference shares 0 0 0 0 0 0

Dividend paid -1,114 -696 -695 -1,525 -1,556 -1,868

Others -33 -15 -22 -39 -46 -55

Cash flow from financing activities -1,147 -712 -236 -1,564 -1,602 -1,924

Net change in cash flows 3,129 2,648 510 1,098 1,275 2,712

Opening cash 279 3,408 6,056 6,566 7,664 8,939

Closing cash 3,408 6,056 6,566 7,664 8,939 11,651



7 December 2011 109

HAVELLS (1-OW, PT: RS502, +18%): LIGHTING UP

We initiate coverage of Havells with a 1-Overweight rating and a 12-month price target of Rs502 (11x FY13E EV/EBITDA for India, 5x EV/EBITDA for Sylvania). We expect a CAGR of over 17% for domestic business earnings, driven by the new launches in the appliance sector, which should benefit from Havells’ strong branding and its well-entrenched distribution network. The improving mix of branded consumer business for domestic sales should also help damp earnings volatility and rerate multiples. With margins at Sylvania recovering, we expect consolidated earnings to grow at a 23% CAGR over FY11-13E. Valuations at 12x appear attractive, given the strength in earnings.

Consumer business new growth driver: We expect a domestic PAT growth CAGR at over 23% out to FY14E, with growth stemming from success of its new consumer initiatives. Havells is considered a strong brand in India with an efficient and loyal distribution network. The growth in PAT is due to its 17% CAGR for sales, which is modest compared with past trends and factors in the fact that over 60% of the business stems from new build. Given the slower growth in project starts, we expect slower growth in segments such as cables and wires and switchgears. Overall, we believe that Havells will continue to grow market share in most segments and this will help it grow at a faster pace than peers.

Business in Europe stable; should support earnings growth: While overall growth in Europe remains flattish, pricing is firm as per management comments. While we expect Havells to be able to hold up margins, this is primarily led by our view of an increase in the mix shift to faster-growth and higher-margin geographies. What Sylvania has given Havells is a global brand and a scale that helps it reduce costs through outsourcing. We also expect Havells to utilise its design capabilities and increase mix of the fixtures business in Europe.

Case for a rerating: Havells is trading at a forward P/E of 12x, despite the strong 23% CAGR in earnings expected. A key reason for the lower P/E appears to be due to the high revenue mix of commodity/industrial businesses and gearing to international business through Sylvania. The structure of growth for Havells, however, suggests that the mix of the consumer business and the contribution from high-growth geographies will increase. The change in mix will help the stock rerate, in our view.

Figure 151: Havells – statistical abstract


Mar Rs mn Rs % (x) (x) (%) (%)

2011A 3035 24.3 335.9 17.5 8.1 46.4 0.7

2012E 3467 27.8 14.3 15.3 5.4 35.5 0.5

2013E 4351 34.9 25.5 12.2 3.8 31.4 0.6

2014E 5147 41.2 18.3 10.3 2.8 27.6 0.7


HAVL IN / HVEL.NS




Price (02-Dec-2011) INR 424.55



7 December 2011 110

COMPANY SNAPSHOT

HAVELLS INDIA CAPITAL GOODS

Income statement (INRmn) 2011A 2012E 2013E 2014E CAGRRevenue 56,126 64,133 71,684 80,526 12.8% Stock Rating 1-OVERWEIGHTEBITDA 5,571 6,401 7,538 8,586 15.5% Sector View 2-NEUTRALEBIT 4,766 5,512 6,551 7,490 16.3% Price (02-Dec-2011) 424.55Pre-tax income 4,066 4,660 6,017 7,127 20.6% Price Target 502Net income 3,035 3,467 4,351 5,147 19.3% Ticker HAVL IN/HVLE.BOEPS (R) 24.32 27.79 34.87 41.25 19.3%Diluted shares (mn) 124.78 124.78 124.78 124.78 0.0% Investment case

DPS (R) 2.91 1.86 2.26 2.64 -3.1%


Balance sheet and cash flow (INRmn) CAGRFixed assets 10,204 10,115 9,928 9,631 -1.9%Cash and equivalents 1,779 5,287 8,774 13,992 98.9%Total assets 35,635 38,383 43,732 51,134 12.8%Current liabilities 17,361 18,746 20,953 23,538 10.7%Long term liabilities 11,173 9,300 8,372 8,372 -9.2% Downside case 278Total liabilities 35,635 38,383 43,732 51,134 12.8%Net debt/(funds) 9,395 4,013 (402) (5,620) NAShareholders' equity 6,537 9,773 13,843 18,660 41.9%Change in working capital (2,013) 1,721 (143) (168) NACash flow from operations 3,426 7,952 7,395 8,418 34.9%Capital expenditure (1,887) (800) (800) (799) NAFree cash flow 1,540 7,152 6,595 7,619 70.4%


Valuation and leverage metrics AverageP/E (x) 17.5 15.3 12.2 10.3 13.8 EV/EBITDA (x) 11.2 8.9 7.0 5.5 8.1 FCF yield (%) 2.9 13.5 12.4 14.4 10.8EV/sales (x) 1.1 0.9 0.7 0.6 0.8 Price/BV (x) 8.1 5.4 3.8 2.8 5.0 Dividend yield (%) 0.7 0.4 0.5 0.6 0.6Total debt/capital (%) 61.1 47.4 36.8 30.3 43.9Net debt/EBITDA (x) 1.7 0.6 - 0.1 - 0.7 0.4


Selected operating metrics EBITDA margin expected to remain steadyRevenues for new business 300.0 900.0 2,000.0 3,500.0 Sylvania revenues Eumn 27,836 30,352 32,141 34,418 Sylvania ebitda margins 5.8 7.9 8.4 8.6 Europe revenue growth -4.8 0.7 0.0 0.0


Why a 1-Overweight? We forecast a CAGR of morethan 23% in PAT for FY11-14 due to strength in thedomestic business aided by new consumer launchand improving margins at Sylvania. The increasingmix of the consumer business should help dampvolatility and boost valuations.

Continued strength in domestic market and Sylvaniamargins could lead to the stock heading to sectoraverage P/E of 20x.

In a rare scenario, if Sylvania starts making losses, itis likely that the stock could head to a sector troughP/E of 10x on current year earnings.

5.0%6.0%7.0%8.0%9.0%

10.0%11.0%

FY11 FY12E FY13E FY14E

EBITDA margin

DownsideCase

INR278(-34.5%)

PriceTarget

INR502(18.2%)

UpsideCase

INR697(64.1%)

100

300

500

700

900

16-Dec-10 2-Dec-11

DownsideCase

INR278(-34.5%)

PriceTarget

INR502(18.2%)

UpsideCase

INR697(64.1%)

0

300

600

900

16-Dec-10 2-Dec-11


7 December 2011 111

Consumer business new growth driver

We expect domestic revenues and profits to grow at a CAGR of 17% until FY14, led largely by strong growth in the consumer segment (40% of revenues). Our forecast growth rate for Havells is much slower than what Havells has achieved in the past, and this is because over 60% of its business is driven by new build (new build in real estate-housing, retail malls, commercial construction, etc), in our view, and given the slower pace of new builds in the past two years, we believe that Havells’ growth will be impacted with a lag. Continued market-share gains led by strong branding and increasing distribution reach will, however, enable the company to outperform peers, in our view.

Figure 152: Havells – growth expectations for various sub-segments

FY08-11 CAGR FY11-14E CAGR

Switchgears 12% 11% Management expects 12-15% growth

Cables and wires 10% 13% Expect 8-10% volume growth; value growth could be higher as prices have increased y/y

Lighting and fixtures 17% 18% Expect 20% growth for the market

Electrical consumer durables 26% 30% Fans- expect 10-12% value growth in FY12 and 15% in FY13; new business: Geysers and appliance target of Rs1bn revenue each


Figure 153: Havells – market growth and Havell’s positioning

Estimated market

size (Rs mn) CAGR

FY11-14E FY12E FY13E FY14E

Domestic switchgear 15,680 12% Market growth 12% 12% 12%

Market share 28% 28% 28%

Industrials switchgear 32,100 7% Market growth 7% 7% 7%


Switches modular 13,200 12% Market growth 10% 12% 15%


Motors 27,563 8% Market growth 5% 10% 10%


Cables 110,000 9% Market growth 10% 8% 8%


Wires 66,000 10% Market growth 10% 10% 10%


Lights-CFL 17,250 15% Market growth 15% 15% 15%


Fixtures 30,000 20% Market growth 20% 20% 20%


Fans 35,000 10% Market growth 0% 15% 15%


Geysers and other products 33,600 20% Market growth 20% 25% 25%



Expect domestic profits to grow at a CAGR of 17% until FY14, led

by strong growth in the consumer segment


7 December 2011 112

Consumer appliances business launched in FY12 Havells entered the geysers business in FY11 and thereafter entered the consumer appliance business in mid-FY12. The consumer appliances business is targeted to generate revenues of Rs500mn in FY12 and Rs1bn in FY13. The consumer appliance launch helps Havells target a market of over Rs20bn pa where Bajaj and Philips are the key competitors. Havells has launched products such as steam iron, toasters, ovens, juicer mixer grinders etc (See Figure89).

Business in Europe stable; to support earnings growth

Margin recovery at Sylvania continues to be strong and although market volumes remain flattish in Europe, pricing remains firm. Attempts to increase the mix of fixtures in sales could also help support margins. LatAm and Asia continue to be growth markets and given entry into new geographies, we continue to see strong growth (35-40% of revenue stems from these geographies).

Figure 156: Havells –sales and gross margin by region: strong recovery in margins in Europe was a key surprise

euro mn; March 1Q FY11 2Q FY11 3Q FY11 4Q FY11 1Q FY12 2Q FY12

Europe sales 66 65 74 73 64 69

Margin 2.8% 3.0% 4.5% 4.9% 6.1% 6.5%

Americas sales 33 38 36 36 36 40

Margin 8% 8% 9% 9% 10% 10%

Asia sales 5 6 5 5 7 7

Margin 3.3% 4.0% 5.0% 5.4% 5.8% 6.2%


Figure 154: Havells – Switchgears and cables to comprise more than 60% of revenues, FY12E

Figure 155: Havells – Expect higher profits from the consumer segment, FY12E

Switchgears24%

Cables and wires42%

Lighting and fixtures

16%

Others0.2%

Electrical consumer durables

18%

Switchgears46%

Cables and wires18%

Lighting and fixtures

18%

Electrical consumer durables

18%


Havells launched its new consumer appliances business in

mid-FY12; we expect success in this business to drive growth and

also help increase the mix of consumer business in sales

Margins at Sylvania are expected to remain in a recovery mode;

An increasing mix of Americas and Asia led by expansion of its

geographic presence should also help margins


7 December 2011 113

Valuation Our 12-month price target of Rs502 for Havells is based on forward EV/EBITDA multiples of 5x for Sylvania, taking conservative valuations due to exposure to Europe, and 11x for the domestic business. Our target price implies a P/E of 15.8x for FY13E. Our target multiples are set at the historical average for the past seven years.

Havells is still viewed as an industrial stock given that more than 60% of its domestic revenue stems from segments such as switchgears and cables/wires, which are considered a commodity business and prone to sharp cyclical swings in revenues as well as margins. Its consumer business, however, is growing at a faster pace than the industrials business, and this should ensure that the business mix will change in favour of consumer business in the coming years. Given the branded nature of the business, it is expected to render stability to revenues and margins. Multiples should hence rerate for the stock over the longer term. At a consolidated level, consumer business already comprises more than 70% of revenue; however, low profitability at Sylvania and the exposure to international business (slower growth) keeps multiples under check.

Figure 157: Havells – Sylvania’s EBITDA margins expected to recover to over 8% in FY13E

Figure 158: Havells – Consolidated EBITDA margins to be supported by improvements at Sylvania

5.3%

2.8%2.1%

5.8%

7.9% 8.4% 8.6%

0%1%2%3%4%5%6%7%8%9%

FY08 FY09 FY10 FY11 FY12 FY13 FY14

EBITDA margin

6.9%

5.3%5.9%

9.9% 10.0% 10.5% 10.7%

0%

2%

4%

6%

8%

10%

12%

FY08 FY09 FY10 FY11 FY12E FY13E FY14E

EBITDA margin


Figure 159: Havells – Country exposure in Europe (FY11)

Figure 160: Havells – Strong presence in LatAm (FY11)

France21%

UK18%

Germany and Austria

14%

Spain 9%

East Europe5%

Others33%

Colombia24%

Brazil21%

Argentina7%

Mexixo10%

USA13%

Others25%



7 December 2011 114

Figure 163: Havells – Valuation methodology

Rs mn FY12E FY13E FY14E Multiple

Standalone EBITDA 4,837 18% 20% 17% 11x

Sylvania EBITDA 2,701 47% 13% 9% 5x

EV 66,713

Net debt 4,106

Equity value 62,607

Share count (Mn shares) 125

Price target (Rs) 502


Figure 164: Havells – historical 12-month forward P/E (x): trading at the lower end

0

5

10

15

20

25

30

Jan-08 May-08 Oct-08 Feb-09 Jul-09 Dec-09 Apr-10 Sep-10 Jan-11 Jun-11 Nov-11

12 M fwd PE

The sharp correction in valuations in early 2009 was led

by Sylvania’s weak financial position

Source: Datastream, IBES consensus estimates, Barclays Capital estimates

Figure 161: Havells – consumer accounts for 33% of domestic sales …

Figure 162: …and 29% of segment profitability

24%29%

33%37% 39%

0%5%

10%15%20%

25%30%35%

40%45%

FY08 FY09 FY10 FY11 FY12E

Revenue from consumer segments

25% 25%29%

32%34%

0%

5%

10%

15%

20%

25%

30%

35%

40%

FY08 FY09 FY10 FY11 FY12E

profit from consumer statement


We see significant upside for Havells despite factoring in

conservative multiples


7 December 2011 115

Risks

The key risks that could keep our price target from being achieved, in our view, include a weak margin performance at Sylvania, any failure to scale up new consumer launches; and sharp increase in commodity pricing could also impact numbers.

Figure 165: Havells – history of consensus EPS forecasts shows estimates were impacted in 2009 due to losses at Sylvania

Figure 166: Havells – history of current consensus EPS forecasts for FY12-14 shows that the strong recovery at Sylvania has led to estimates upgrades

-10

-5

0

5

10

15

20

25

30

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11


15

20

25

30

35

40

45

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

FY12 FY13 FY14

Source: Datastream, IBES consensus estimates ,Barclays Capital Source: Datastream, IBES consensus estimates , Barclays Capital


7 December 2011 116

Figure 167: Havells – income statement, FY09-14E


Net sales 54,775 54,315 56,126 64,133 71,684 80,526

Total material costs 30,070 29,180 32,556 32,207 35,999 40,439

% of sales 55% 54% 58% 50% 50% 50%

Employee costs 8,452 7,602 6,319 6,953 7,772 8,730

% of sales 15% 14% 11% 11% 11% 11%

Other costs 10,701 11,062 8,484 18,572 20,376 22,770

EBITDA 2,886 3,222 5,571 6,401 7,538 8586

OBITDA margin 5% 6% 10% 10% 11% 11%

Other income plus other operating income 86 222 237 202 87 87

Depreciation 905 837 804 889 987 1,096

Interest 1,253 979 902 884 620 450

Pre-tax exceptional items -1,986 0 -36 -170 0 0

Profit before tax -1,172 1,628 4,066 4,660 6,017 7,127

Profit before tax margin -2% 3% 7% 7% 8% 9%

Tax 429 932 1,031 1,192 1,666 1,980

Tax rate -37% 57% 25% 26% 28% 28%

Post-tax exceptional items

Profit after tax - reported -1,601 696 3,035 3,467 4,351 5,147

Profit after tax - adjusted -1,601 696 3,035 3,467 4,351 5,147

Profit after tax margin -3% 1% 5% 5% 6% 6%



7 December 2011 117

Figure 168: Havells – balance sheet, FY09-14E


Share capital 301 312 624 624 624 624


Shareholders equity 6,147 4,004 6,537 9,773 13,843 18,660

Secured loans 10,624 9,963 9,933 0 0 0

Unsecured loans 1,654 700 1,240 0 0 0

Loan funds 12,278 10,664 11,173 9,300 8,372 8,372


Gross block 28,961 26,963 28,454 29,254 30,054 30,853


Net block 8,534 8,874 9,955 9,866 9,679 9,382

Investments 0 0 0 0 0 0

Deferred tax net 0 -266 -559 -559 -559 -559

Inventories 7,947 8,246 10,860 9,736 10,883 12,225


Debtors 7,573 6,982 7,724 8,244 9,215 10,352

Debtor days 50 47 47 47 47 47

Cash and bank 2,473 1,481 1,779 5,287 8,774 13,992


as % of sales 0 0 0 0 0 0


as % of sales 0 0 0 0 0 0



Provisions 567 321 639 379 424 476

as % of sales 1% 1% 1% 1% 1% 1%





7 December 2011 118

Figure 169: Havells – cash flow statement, FY09-14E


Profit before tax -1,172 1,628 4,066 4,660 6,017 7,127

Depreciation 905 837 804 889 987 1,096

Trade and other receivables 414 1,232 -564 -788 -1,204 -1,410

Inventories 2,472 -139 -2,751 1,124 -1,146 -1,342

Trade payables -1,232 226 1,923 1,645 2,163 2,532

Other liabilities 514 1,224 -621 -260 45 52

Direct taxes paid -400 -699 -851 -1,192 -1,666 -1,980

Others 698 -1,396 569 683 534 363

Net cash from operating activities 2,199 2,913 2,575 6,760 5,729 6,439

Purchase of fixed assets -1,403 -1,536 -1,887 -800 -800 -799

Sale of investment 33 0 63 0 0 0

Addition of goodwill -233 367 -142 335 302 272

Sale of fixed assets 53 92 239 0 0 0

Others -75 16 8 202 87 87

Net cash used in investing activities -1,626 -1,061 -1,719 -263 -411 -441

Issue of preferential equity shares 11 0 0 0 0 0

Receipt of share premium 1,386 0 0 0 0 0

Proceeds from borrowings 217 -631 45 0 0 0

Repayment of borrowings -1,873 -176 -131 0 0 0

Interest paid -1,084 -871 -819 -884 -620 -450

Dividends paid -145 -226 -207 -231 -282 -330

Others 971 -954 540 -1,873 -928 0

Net cash from financing activities -515 -2,858 -572 -2,989 -1,830 -779

Net increase in cash 57 -1,006 285 3,508 3,487 5,219

Cash at the beginning of the year 2,358 2,425 1,471 1,779 5,287 8,774

Cash at the close of the year 2,415 1,481 1,779 5,287 8,774 13,992



7 December 2011 119

AREVA T&D (2-EW, PT: RS193, -8%): MARGIN TROUGH AND ORDER RECOVERY

We initiate coverage on Areva T&D with a 2-Equal Weight rating and a 12-month price target of Rs193 (20x CY12E). Although Areva T&D’s margins appear to have troughed, and, after several years of weakness in the power transmission and distribution equipment (T&D) market, we are seeing some recovery in ordering, we believe that room for upside surprises are limited given the stiff competition in the T&D end market. Low returns on capital ratios (compared with peers such as Siemens) and limited new earnings drivers also do not help justify such rich valuations, in our view. However, we acknowledge that the premium may continue given the current demerger of the company and the hope of a future delisting.

Operating metrics recovering: The operating margin for Areva T&D has shrunk more than 800bps since its peak five years back. The greater mix of EPC projects, competitive end market and decrease in capacity utilisation were the key drivers. A likely improvement in order growth and an improved cost structure (lower imports due to the ability to use 100% domestic content from Indian factories) should help arrest the decline in margins and ensure that the current margins are sustainable, in our view.

Order momentum improving: The T&D market has witnessed several years of single-digit growth rates in ordering, and sharp price declines have also impacted value growth. With the T&D market expected to witness some recovery in volumes in the current year (as evident from improvement in tendering activity), we expect order growth rates for Areva T&D to improve. Continued pressure on pricing could, however, be a damper.

Key catalysts: Recovery in earnings growth and continued strength in inflows would serve as the key catalyst for the stock, in our view.

Valuations and rating: The three local arms of multinational T&D companies trade at steep valuations to peers, largely due to the perception on their ability to drive their long-term growth through their strong technology backing. Furthermore, the parents of all three companies – Siemens Ltd, Areva T&D India and ABB Ltd – have announced open offers in the past at steep valuations (due to strategic benefit of acquisition and lower cost of capital). Furthermore, a reduction in free floats has also helped support valuations. We believe that Areva T&D’s return ratios and growth expectations do not justify such steep valuations, but given the ongoing demerger and hopes of delisting at a future date, the artificially high multiples could be sustained. Therefore, we value Areva T&D at a P/E of 20x (avg P/E), and given limited downside to current price, we initiate with a 2-Equal Weight rating.

Figure 170: Areva T&D – statistical abstract


Dec Rs mn Rs % (x) (x) (%) (%)

2010A 1,868 7.8 -2.8 26.7 5.0 18.6 0.9

2011E 1,810 7.6 -3.1 27.6 4.4 15.9 0.8

2012E 2,312 9.7 27.7 21.6 3.8 17.5 1.0

2013E 2,598 10.9 12.4 17.9 3.3 18.2 1.1


ATD IN / AREV.NS

Stock Rating 2-EQUAL WEIGHT



Price (02-Dec-2011) INR 208.65



7 December 2011 120

COMPANY SNAPSHOT

AREVA T&D INDIAN CAPITAL GOODS SECTOR

Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 40,200 44,991 50,131 57,991 13.0% Stock Rating 2-EQUAL WEIGHTEBITDA 4,238 4,220 5,183 6,061 12.7% Sector View 2-NEUTRALEBIT 3,302 3,257 4,107 4,821 13.4% Price (02-Dec-2011) 208.65Pre-tax income 2,816 2,711 3,469 4,183 14.1% Price Target 193Net income 1,868 1,810 2,312 2,788 14.3% Ticker ATD IN/AREV.NSEPS (R) 7.81 7.57 9.67 11.67 14.3%Diluted shares (mn) 239.00 239.00 239.00 239.00 0.0% Investment case

DPS (R) 1.80 1.51 1.93 2.33 9.0%


Balance sheet and cash flow (INRmn) CAGRFixed assets 8,939 8,976 8,401 8,161 -3.0%Cash and equivalents 1,199 109 667 478 -26.4%Total assets 44,681 44,314 48,321 54,134 6.6%Current liabilities 25,662 23,909 26,645 30,823 6.3%Long term liabilities 8,957 8,957 8,457 7,957 -3.9% Downside case 97Total liabilities 44,681 44,314 48,321 54,135 6.6%Net debt/(funds) 7,758 8,848 7,790 7,479 -1.2%Shareholders' equity 10,024 11,410 13,181 15,317 15.2%Change in working capital (3,519) (2,440) (1,289) (2,065) NACash flow from operations 1,075 879 2,737 2,602 34.2%Capital expenditure (1,131) (1,000) (500) (1,000) NAFree cash flow (56) (121) 2,237 1,602 NA


Valuation and leverage metrics AverageP/E (x) 26.7 27.6 21.6 17.1 23.2 EV/EBITDA (x) 13.6 13.9 11.1 9.5 12.0 FCF yield (%) -0.1 -0.3 4.7 3.4 1.9EV/sales (x) 1.4 1.3 1.2 1.0 1.2 Price/BV (x) 5.0 4.4 3.8 3.3 4.1 Dividend yield (%) 0.9 0.8 1.0 1.2 0.9Total debt/capital (%) 47.1 43.9 39.0 34.1 41.0Net debt/EBITDA (x) 0.8 0.8 0.6 0.5 0.7


Selected operating metrics Ebita margins expected to stabilise nowOrder inflow 41,848 48,858 57,200 70,356 Order inflow growth (%) -69 1,675 1,707 2,300Orderbook 49,365 53,232 60,300 72,665 Orderbook growth (%) 345 783 1,328 2,051

Source: Company data, Barclays Capital estimates Note: FY end Dec.

Why a 2-Equal weight? While margins havetroughed and orders are recovering, room for upsidesurprises appear limited given stiff competition in the sector. With valuations being rich (vs expectations),we believe that the stock is pricing in a recovery.

If a delisting is announced the stock could head to itsprevious open offer price. Fundamental upside canbe driven by higher-than-expected order wins inpowergrid orders at good pricing.

In a worst case scenario, stock could head to itshistoric trough P/E of 10x. This would happen only ifpricing pressure continues in powergrid orders andorder book starts shrinking.

0%

5%

10%

15%

20%

Dec-08 Dec-09 Dec-10 Dec11E Dec12E Dec13E

EBITDA margins

DownsideCase

INR97(-53.5%) Price

Target

INR193(-7.50%)

UpsideCase

INR300(43.7%)

48

148

248

348

15-Dec-10 25-Nov-11

DownsideCase

INR97(-53.5%)

PriceTarget

INR193(-7.50%)

UpsideCase

INR300(43.7%)

0

100

200

300

400

15-Dec-10 25-Nov-11


7 December 2011 121

Operating metrics set to recover

Areva T&D suffered a sharp deterioration in margins from Dec-08 due to weak order inflows, a significant decline in pricing in the market, lower capacity utilisation (as capacity increased sharply to cater to higher voltage products) and high import content. Areva was also not able to utilise its new factories as they were unable to win significant orders in the 765kV transformer and reactor space given tender clauses that required procurement of at least 66% of the tender from factories with two years of experience in supplying the product. We believe that margins may have bottomed out and that they should stabilise at the current levels due to 1) stable pricing in the market as entry-level pricing has impacted margins for incumbents, 2) new tender clauses that require compulsory JVs and domestic content, 3) factories approved for 100% domestic content, which should help reduce high cost imports, and 4) likely improvement in order momentum.

Figure 171: Areva T&D – transformer/reactor capacity utilisation has improved

Figure 172: Areva T&D – capacity utilisation in switchgears still low

94%

81%

98%

49% 49%

96%

0%

20%

40%

60%

80%

100%

120%

CY05 CY06 CY07 CY08 CY09 CY10

Capacity utilisation- transformers

87%

107%

89% 90%77%

0%

20%

40%

60%

80%

100%

120%

CY06 CY07 CY08 CY09 CY10

Switchgear-capacity utilisation


Figure 173: Areva T&D – high cost imports as percentage of costs reducing

Figure 174: Areva – EBITDA margins recovering

14%

20% 19%

14%

0%

5%

10%

15%

20%

25%

CY07 CY08 CY09 CY10

import as % of sales

13%

18%

15%

11% 11%9%

11% 11%

0%

4%

8%

12%

16%

20%

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

EBITDA Margin

Source: Company data, Barclays Capital Source: Company data, Barclays Capital estimates


7 December 2011 122

Order momentum improving

We expect an improvement in ordering (volumes) in the T&D segment led by a combination of recovery in Powergrid Corporation orders and ordering from various BOOT projects awarded this year. Areva T&D’s order inflows in 3Q FY11 were strong and led largely by wins in the 765kV segment (Figure 176).

Figure 175: Areva T&D – strong order wins in F3Q11

Client Product Order value

Rs mn

RRVPNL 765 kV substation package 4,000

Powergrid Corporation 765 kV transformer at Bareilly 850

Sterlite Technology 765 kV substation package 2,200

BHEL GIS package for SJVNL Rampur 580

Reliance Infrastructure 220 kV substation for Rajasthan Solar 400

OPTCL 63 MVA power transformer package 340

Aditya Aluminium ETC package 300

Lanco Infratech Substation package at Anuppur 300

NEEPCO 132 kV switchyard 250

India projects 180


Figure 176: Areva T&D – order inflows expected to improve after three years of weak ordering (Y/Y growth)

58

21

40

3 (1)

17 1723

5346 49

17

38

1321

-10

0

10

20

30

40

50

60

70

Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13

Order inflow YoY Orderbook YoY


Valuation Our 12-month price target of Rs193 for Areva T&D is based on a target P/E of 20x applied to our EPS forecast for 2012. The stock’s valuations are like its other MNC T&D peers, Siemens and ABB, which have typically been rich with an average forward P/E multiple of more than 20x. Our target multiple of 20x is set at the historical average multiple for the past seven years. The demerger process for Areva T&D (Areva T&D has been sold globally to Alstom and Schneider) has also been approved, and there could be a renewed interest in the stock during the period of the demerger, in our opinion.

Order recovery for the market and stable pricing should help

drive order inflow growth for the company

MNC stocks typically trade at a steep premium to peers in India.

We value Areva T&D at a forward P/E of 20x at the historical average values


7 December 2011 123

Figure 177: Areva T&D – historical 12-month forward P/E

0

5

10

15

20

25

30

35

May

-08

Jul-

08

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-

09

Sep-

09

Nov

-09

Jan-

10

Apr

-10

Jun-

10

Aug

-10

Oct

-10

Dec

-10

Feb-

11

Apr

-11

Jun-

11

Aug

-11

Oct

-11

Areva T&D Linear (Areva T&D)

Areva T&D’s valuation multiples have derated from a peak of 35x

to 19x now

Given risk to earnings, we do not expect a re-rating of the stock

near term


Figure 180: Areva T&D – stock price vs. EBITDA margin

0

100

200

300

400

500

600

Jan-

05

May

-05

Sep-

05

Jan-

06

Jun-

06

Oct

-06

Feb-

07

Jun-

07

Oct

-07

Feb-

08

Jun-

08

Oct

-08

Mar

-09

Jul-

09

Nov

-09

Mar

-10

Jul-

10

Nov

-10

Apr

-11

Aug

-11

0%

5%

10%

15%

20%

25%

Price EBITDA margins

Areva T&D’s stock price has tracked trends in its EBITDA margin. With our forecast of

EBITDA margins to remain at current levels, room for EPS

upgrades and a stock rerating appears limited.

Source: Datastream, Barclays Capital estimates

Figure 178: Areva T&D – history of consensus EPS forecasts shows that estimates were sharply revised down largely due to a sharp compression in margins

Figure 179: Areva T&D – history of consensus EPS forecasts shows for 2012-14 that consensus numbers post the recent cuts are expecting margins and order volumes to improve

0

5

10

15

20

25

Jun-

08

Sep-

08

Dec

-08

Mar

-09

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

CY08 CY09 CY10

6

8

10

12

14

16

18

20

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

CY11 CY12

Source: Datastream, IBES consensus estimates , Barclays Capital Source: Datastream, IBES consensus estimates , Barclays Capital


7 December 2011 124

Risks

The key risks that could keep our price target from being achieved, in our view, include the following: 1) Continued pressure on pricing from competitors and setting up of domestic manufacturing by Chinese or Korean firms could lead to a further deterioration in margins. 2) The change in substation tendering clauses have increased competitive intensity in that segment and inability to win orders (market share losses) could impact our view of recovery in order inflows for the company. And 3) execution delays in power projects and subsequent delays in ordering for T&D projects could impact market ordering.

Figure 181: Areva T&D – income statement, 2008-13E

Rs mn; years ending December 2008 2009 2010 2011E 2012E 2013E

Net sales 26,412 35,659 40,200 44,991 50,131 57,991

Materials, manufacturing and operating expenses 17,141 24,926 27,531 30,950 34,466 39,828

% of sales 65% 70% 68% 69% 69% 69%

Staff cost 2,091 2,924 3,460 3,681 4,303 4,970

% of sales 8% 8% 9% 8% 9% 9%

Sales and administrative expenses 2,928 3,794 4,971 6,140 6,179 7,132

% of sales 11% 11% 12% 14% 12% 12%

Expenditure 22,557 31,711 35,962 40,771 44,949 51,930

% of sales 85% 89% 89% 91% 90% 90%

OBITDA 3,855 3,947 4,238 4,220 5,183 6,061

OBITDA margin 15% 11% 11% 9% 10% 10%

Depreciation 340 611 936 963 1,075 1,240

Other income 142 173 169 82 - -

Interest 302 579 655 628 638 638


Total taxation 1,196 1,010 949 901 1,157 1,395

Tax rate 36% 34% 34% 33% 33% 33%






7 December 2011 125

Figure 182: Areva T&D – balance sheet, 2008-13E

Rs mn; years ending December 2008 2009 2010 2011E 2012E 2013E

Share capital 478 478 478 478 478 478



Unsecured loans 4,692 7,676 8,957 8,957 8,457 7,957

Total loans 4,692 7,676 8,957 8,957 8,457 7,957


Application of funds

Adjusted gross block 4,062 10,839 11,949 12,949 13,449 14,449


Net block 1,971 8,384 8,715 8,752 8,177 7,937

Capital WIP 4,500 519 224 224 224 224

Investments 0 0 2 1 1 -

Deferred tax assets net 387 100 - - - -

Inventory 3,862 3,790 4,808 6,579 7,330 8,421


Debtors 11,889 15,994 21,400 20,253 22,567 26,056

Debtor days 164 164 164 164 164 164

Cash and bank 451 1,325 1,199 109 667 478




Current liability days

Provisions 1,111 1,099 1,027 2,468 2,747 3,178

Provision days

Total current liabilities and provisions 16,516 21,420 25,662 23,909 26,645 30,823


Net current assets excluding cash 4,634 6,014 8,878 11,319 12,607 14,673




7 December 2011 126

Figure 183: Areva T&D – cash flow statement, 2008-13E

Rs mn; years ending December Dec-08 Dec-09 Dec-10 Dec11E Dec12E Dec13E

PBT 3,470 2,931 2,816 2,711 3,469 4,183

Depreciation 340 611 936 963 1,075 1,240

Others 839 1,230 1,437 545 638 639


Debtors (5,815) (6,376) (6,705) 1,084 (3,273) (5,153)

Inventory (1,133) 72 (1,018) (1,771) (752) (1,090)

Trade and other payables 5,362 5,093 4,204 (1,753) 2,736 4,178

Others


Taxation (1,521) (1,282) (595) (901) (1,157) (1,395)

Cash flow from operating activities 1,543 2,280 1,075 879 2,737 2,602

Change in fixed assets (4,217) (3,201) (1,131) (1,000) (500) (1,000)

Change in investments 118 16 - - - -

Others 3 1 2 82 - -

Cash flow from investing activities (4,096) (3,185) (1,129) (918) (500) (1,000)

Change in equity - - - - - -

Change in loans 3,543 2,873 1,079 - (500) (500)

Dividend paid and tax thereon (500) (499) (500) (424) (541) (652)

Others (272) (595) (650) (628) (638) (638)

Cash flow from financing activities 2,771 1,779 (71) (1,051) (1,679) (1,791)

Net change in cash and cash equivalents 217 874 (125) (1,090) 558 (189)

Opening balance of cash and equivalents 223 451 1,325 1,199 109 667

Closing balance of cash and equivalents 441 1,325 1,199 109 667 478



7 December 2011 127

VOLTAS (3-UW, PT: RS78, -15%): EMERGING STRUCTURAL RISKS A CONCERN

We initiate coverage on Voltas with a 3-Underweight rating and a 12-month price target of Rs78 (11x FY13E). Voltas is undergoing an extremely tough patch, in our view, with almost every segment of its business underperforming. The core Mechanical and Electrical Projects (MEP) business (60% of revenue) faces structural challenges with extended ordering timelines, changes in geographic scope and heightened competition. Bidding margins for Voltas are at 5% vs. more than 9% in the past. The A/C products business, which could have supported earnings (30% of segment profits), was affected by cooler summers and higher interest rates. With price discounting by the market likely to intensity, either volumes or margins could be under pressure. Although these issues appear well understood and reflected in current-year consensus estimates, we still do not expect a substantial recovery next year with order visibility being low. Despite the attractive valuations, it may be too early to bottom fish, in our view.

Structural and cyclical concerns: The fundamental issues that Voltas is facing are not just a reflection of a weak cycle, in our view. The core MEP segment thrives on demand from the Middle East, where after the problems in Dubai market, contractors were forced to search for new geographies. Voltas has hence been targeting Qatar and Saudi Arabia, but the pace of order wins in those countries has been disappointing. With competition intensifying, management plans to bid for projects using a margin of 5% vs. 9% for this segment in FY10-11. The product business that was experiencing strong growth rates is also witnessing a decline in growth rates, largely attributed to cooler summers and higher interest rates.

Low visibility on earnings: Apart from the weak order inflow momentum, we note that Voltas has been impacted by losses at Rohini Electricals as well as losses and execution issues at the two projects in Qatar. This has materially affected margins in the MEP business (0.7% for the September quarter vs. 8% for the previous year). With bidding margins now as low as 5%, the business is becoming more sensitive to project-specific execution issues. For the products business, we expect competition in the AC business to further shrink the already low margins in this segment.

Heading to cyclical lows: We expect earnings growth to remain muted in FY13 and decelerate at a CAGR of 14% for FY11- FY14. While the order book gives visibility into the next 1.5 years of revenue, we believe that despite taking a conservative view on order inflows, our numbers build in Rs22bn of MEP orders in 2HFY12, which given the current environment, may prove difficult, implying that more downgrades could follow.

Figure 184: Voltas – statistical abstract


Mar Rs mn Rs % (x) (x) (%) (%)

2011A 3,234 9.8 -12.1 9.4 2.2 23.8 1.4

2012E 2,130 6.4 -34.1 14.3 1.9 13.4 1.1

2013E 2,180 6.6 2.4 14.0 1.7 12.4 0.8

2014E 2,068 6.2 -5.2 14.7 1.6 10.7 0.7


VOLT IN / VOLT.NS




Price (02-Dec-2011) INR 92.10



7 December 2011 128

COMPANY SNAPSHOT

VOLTAS INDIA CAPITAL GOODS

Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 51,768 50,287 51,127 57,257 3.4% Stock Rating 3-UNDERWEIGHTEBITDA 4,408 2,666 2,798 2,660 -15.5% Sector View 2-NEUTRALEBIT 4,198 2,370 2,582 2,420 -16.8% Price (02-Dec-2011) 92.1Pre-tax income 4,843 4,123 3,160 2,998 -14.8% Price Target 78.0Net income 3,234 2,130 2,180 2,068 -13.8% Ticker VOLT IN/VOLT.BOEPS (R) 9.78 6.44 6.59 6.25 -13.9%Diluted shares (mn) 330.74 330.74 330.74 331.00 0.0% Investment case

DPS (R) 2.32 1.74 1.31 1.24 -18.8%


Balance sheet and cash flow (INRmn) CAGRFixed assets 2,458 2,661 2,945 3,206 9.3%Cash and equivalents 4,980 6,746 7,621 7,971 17.0%Total assets 41,466 43,067 45,219 49,921 6.4%Current liabilities 26,232 25,481 25,907 29,013 3.4%Long term liabilities 1,381 1,432 1,412 1,351 -0.7% Downside case 28Total liabilities 41,466 43,067 45,219 49,921 6.4%Net debt/(funds) (3,599) (5,313) (6,209) (6,621) NAShareholders' equity 13,617 15,915 17,649 19,293 12.3%Change in working capital (3,317) 117 (67) (485) NACash flow from operations 392 3,583 2,600 2,095 74.8%Capital expenditure (446) (500) (500) (500) NAFree cash flow (54) 3,083 2,100 1,595 NA


Valuation and leverage metrics AverageP/E (x) 9.4 14.3 14.0 14.7 13.1 EV/EBITDA (x) 6.1 9.4 8.7 9.0 8.3 FCF yield (%) -0.2 10.1 6.9 5.2 5.5EV/sales (x) 0.5 0.5 0.5 0.4 0.5 Price/BV (x) 2.2 1.9 1.7 1.6 1.9 Dividend yield (%) 2.5 1.9 1.4 1.3 1.8Total debt/capital (%) 9.1 8.1 7.3 6.5 7.7Net debt/EBITDA (x) -0.8 -2.0 -2.2 -2.5 -1.9


Selected operating metrics Order inflows continue to remain weak Order inflow 32,091 32,091 33,696 38,750 Order inflow growth (%) -15 0 5 15Orderbook 48,880 50,230 53,586 59,516 Orderbook growth (%) 4 3 7 11


Why a 3-Underweight? Voltas is facing issues in allits areas of operation. 1) MEP business has seen alarge geographic shift and increase in competitiveintensity; bidding margins are now only 5%. 2) ACmarket also going through cyclical issues.

A recovery in MEP business through large order winsin Middle East could help multiples recover to 20x -close to sector trading averages.

Continued weakness in margins and inability to evenmatch last year's inflows could lead to the stockmoving back to its trough P/E of ~5x.

-40%

-20%

0%

20%

40%

Mar 09 Mar11 Mar13E

Order inflow growth

INR28(-69.5%)

DownsideCase

INR78(-15.3%)

PriceTarget

INR132(43.3%)

UpsideCase

0

50

100

150

200

22-Dec-10 2-Dec-11

DownsideCase

INR28(-69.5%) Price

Target

INR78(-15.3%)

UpsideCase

INR132(43.3%)

0

50

100

150

200

22-Dec-10 2-Dec-11


7 December 2011 129

Cyclical and structural issues

We expect all three segments – Mechanical and Electrical Projects, Engineering and Cooling Products – to witness a sharp deterioration in revenue and margins due to the weak ordering environment and significant increases in competition.

Figure 185: Voltas – management views on demand and competition not encouraging

Volume Competition Our view

Mechanical and Electrical Projects

Order volumes slow in established geographies

Profitability impacted by rising input costs, restrictive visa conditions and setbacks in cash flows amplified by higher capital engagement.

With bidding margins now at 5%, we believe that this leaves limited scope for errors in execution. We remain concerned on the medium-term outlook for this segment.

Rohini Order book at Rs2.6bn, up 13% y/y in 2Q FY12. Loss of Rs353mn in FY11. Management has set up a dedicated team to focus on business development, and this should help increase inflows.

Margins impacted by the slow progress of some orders (including a high-value rural electrification job). Receivables expanding and a concern.

Voltas continues to face integration challenges with Rohini Electricals. We do not expect significant improvements in the medium term. Receivable write offs could also impact goodwill in this business and remains a risk

Engineering Economic slowdown, inflation and high interest rates have significantly impacted investment sentiment and forward visibility is limited. In textile segment, pace of order inflows slowed down due to significant profitability concerns in the user industry. While TUF may continue beyond 2012, environmental problems at Tirupur and the change in business confidence and investment sentiment could impact inflows in the coming quarters

There has been a consolidation amongst global equipment manufacturers with Bucyrus and Letourneau (erstwhile principals) being taken over by Caterpillar and Joy respectively. Voltas faces tough competition from entrenched Indian distributors of the acquirers

We expect industrial segments to remain weak until FY14 and, hence, expect no recovery in revenues or margins next year

Air Conditions Market volumes impacted due to unfavourable weather conditions.

Competitive intensity increasing with market fragmenting. Several players (MNCs) stepping up ad spends and reducing prices in the market.

We are positive on long=term prospects of this market but do not expect significant volume recovery in FY12. In addition, margins will be under tremendous pressure due to price discounting by peers.



7 December 2011 130

Earnings momentum likely to remain weak

With Voltas bidding at 5% margins in the MEP segment and competitive activity in the cooling product segment likely to temper margins for Voltas, we believe that earnings growth for Voltas will remain weak for the next two years.

Figure 188: Voltas –EPS growth rate likely to remain weak

19%32%

41%

89%66%

21% 27%

56%

-12%

-34%

2%

-5%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

12E

Mar

13E

Mar

14 E

EPS growth YoY


Figure 186: Voltas – revenue mix, FY11: skewed towards MEP segment; slower ordering and low margins on new wins will likely impact earnings growth

Figure 187: Voltas – Profit mix, FY11: margins in key segments of MEP and cooling products to sharply deteriorate

MEP59%

Engineering 11%

Cooling products

30%

Others 0%

EMP48%

Engineering 20%

Cooling products

32%

Others 0%



7 December 2011 131

Figure 189: Voltas – segment revenues and profitability

Rs mn FY03 FY04 FY05 FY06 FY07 FY08 FY09 Mar10 Mar11 Mar12E Mar13E Mar14E

Segmental revenues

Electro-mechanical projects 7,017 7,778 8,556 11,897 14,383 17,449 27,668 31,134 30,411 30,741 30,340 32,820

y/y 11% 10% 39% 21% 21% 59% 13% -2.3% 1.1% -1.3% 8.2%

Engineering 649 837 1,591 2528 4,162 5,535 5,422 4,680 5,638 5,084 4,597 5,012

y/y 29% 90% 59% 65% 33% -2% -14% 20% -10% -10% 9%

Unitary cooling products 4561 4,596 4,617 5,006 5957 8,259 9,223 11,871 15,608 14,108 15,771 18,962

y/y 1% 0% 8% 19% 39% 12% 29% 31% -10% 12% 20%

Segmental profits

Electro-mechanical projects 341 216 460 673 685 1,170 2,134 3,091 2,393 830 1,196 1,081

Margin 4.9% 2.8% 5.4% 5.7% 4.8% 6.7% 7.7% 9.9% 7.9% 2.7% 3.9% 3.3%

Engineering 216 275 401 697 984 1,136 626 768 1,030 742 626 622

Margin 33% 33% 25% 28% 24% 21% 12% 16.4% 18.3% 14.6% 13.6% 12.4%

Unitary cooling 24 86 -53 -337 26 553 550 1,203 1,600 971 808 1,138

Margin 1% 2% -1% -7% 0% 7% 6.0% 10.1% 10.3% 6.9% 5.1% 6.0%


Significant risk to consensus estimates Although consensus earnings estimates have been revised down by 20-35% for FY12-13, we believe that the current numbers do not adequately capture the impact of likely weak margins in the key segments.

Figure 190: Voltas – history of consensus EPS forecasts shows that estimates typically get cut in downturns (Rs)

Figure 191: Voltas –history of consensus EPS forecasts for FY12-14 shows some moderation in FY13 earnings estimates (Rs)

0

2

4

6

8

10

12

14

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11


02468

1012141618

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

FY12 FY13 FY14

Source: IBES consensus, Barclays Capital Source: IBES consensus, Barclays Capital


7 December 2011 132

Valuation

Our 12-month price target of Rs78 for Voltas is based on a P/E of 11 applied to our estimate for FY13. We set our P/E multiple of 11x at a 30% discount to the stocks historical average for the past seven years as 1) the MEP business has seen a large geographic shift and an increase in competitive intensity with bidding margins are now only 5% and 2) the AC market is also going through cyclical issues, seeing high competitive intensity.

Figure 192: Voltas – historical 12-month forward P/Es

05

101520

2530

3540

Sep-

04

Jan-

05

Jun-

05

Oct

-05

Feb-

06

Jun-

06

Oct

-06

Feb-

07

Jun-

07

Nov

-07

Mar

-08

Jul-

08

Nov

-08

Mar

-09

Jul-

09

Nov

-09

Apr

-10

Aug

-10

Dec

-10

Apr

-11

Aug

-11

Voltas 12M fwd PE


Risks

The key risks that could keep our price target from being achieved, in our view, include large order wins in the MEP segment in the Middle East and a recovery in the AC market next year.


7 December 2011 133

Figure 193: Voltas – income statement, FY09-14E


Net sales 43,252 47,575 51,768 50,287 51,127 57,257

Change in stock in trade -1,557 -596 -,645

Cost of materials 33,243 32,876 36,808 36,886 37,310 42,253

% of sales 73% 68% 68% 73% 73% 74%

Staff expenses 4,656 4,922 5,019 5,953 6,275 7,014

% of sales 11% 10% 10% 12% 12% 12%

Other expenses 4,087 5,777 7,178 4,781 4,744 5,331

% of sales 9% 12% 14% 10% 9% 9%

OBITDA 2,824 4,596 4,408 2,666 2,798 2,660

OBITDA margin 7% 10% 9% 5% 5% 5%

Interest 110 98 165 296 284 284

Other income 945 785 810 988 862 862

Depreciation 210 214 210 297 216 239



Extraordinary income/expenses 261 250 402 1,065 0 0


Tax 1,172 1,472 1,729 1,248 979 929

Tax rate 32% 28% 33% 30% 31% 31%

Profit after tax 2,545 3,846 3,515 2,875 2,180 2,068





7 December 2011 134

Figure 194: Voltas – balance sheet, FY09-14E


Share capital 331 331 331 331 331 331


Total shareholder funds 7,897 10,852 13,617 15,915 17,649 19,293

Minority interest 159 139 218 220 234 246

Secured loans 1,688 306 1,280 1,331 1,311 1,249

Unsecured loans 127 45 101 101 101 101

Total debt 1,814 352 1,381 1,432 1,412 1,351

Deferred tax liability - 1 18 18 18 18


Gross fixed assets 3,986 3,890 4,410 4,910 5,410 5,910

Depreciation 1,839 1,821 1,987 2,284 2,500 2,739

Net fixed assets 2,148 2,069 2,422 2,626 2,910 3,171

Change WIP 132 193 36 36 36 36

Goodwill on consolidation 675 764 916 916 916 916

Investments 1,562 2,339 2,613 3,113 3,613 4,113

Inventories 11,194 6,579 8,224 7,989 8,122 9,096


Sundry debtors 9,521 9,555 11,705 11,370 11,560 12,946

Debtor days 80 77 83 83 83 83

Cash and bank balances 4,571 4,689 4,980 6,746 7,621 7,971

Other current assets - 4,866 7,961 7,733 7,862 8,805

Loans and advances 2,203 -7 2,440 2,370 2,409 2,698




Provisions 2,645 2,645 3,157 3,067 3,118 3,492


Current liabilities and provisions 22,360 22,475 26,232 25,481 25,907 29,013


Deferred tax assets 224 204 170 170 170 170

Total usage of funds 9,871 11,343 15,234 17,585 19,312 20,908

Source: Source: Company data, Barclays Capital estimates


7 December 2011 135

Figure 195: Voltas – cash flow statement, FY09-14E



Depreciation 210 214 210 297 216 239

Operating profit before working capital 3,780 5,023 5,023 4,713 3,647 3,509

Change in inventories -4,618 -247 -4,737 235 -134 -974

Change in trade and other receivables -2,994 -411 -1,488 335 -190 -1,386

Change in loans and advances -507 263 -204 298 -169 -1,232

Change in advances from customers 1,813 579 438 -660 375 2,733

Change in trade payables 4,546 -442 2,673 -90 51 374

Change in working capital -1,760 -89 -3,317 117 - 67 -485

Others -1,487 - - -

Tax 1,048 1,611 1,879 1,248 979 929

Cash from operating activities 973 3,065 392 3,583 2,600 2,095

Purchase of fixed assets -439 -317 -446 -500 -500 -500

Sale of fixed assets 72 350 442 - - -

Purchase of investments -9,082 -1,664 -21,997 -500 -500 -500

Sale of investments 10,158 889 21,726 - - -

Cash from investing activities 649 -764 -288 -1,296 -1,284 -1,284

Repayment of loans -152 -1,463 1,029 51 - 20 - 61

Dividend paid -520 -615 -768 -575 -433 -411

Others 619 -99 -166 3 13 13

Net cash used in financing activities - 53 -2,177 96 -521 -441 -460

Net increase in cash and equivalents 1,569 124 200 1,766 875 350


Closing cash balance 4,571 4,695 4,980 6,746 7,621 7,971

Cash added on acquisition of subsidiaries 100



7 December 2011 136

BGR ENERGY (3-UW, PT: RS241, -11%): BUSINESS MODEL CONCERNS

We initiate coverage on BGR Energy with a 3- Underweight rating and a 12-month price target of Rs241 (P/E of 6x for FY13E earnings). Despite its cheap forward valuations on our estimates, our concern on BGR Energy is its ability to make margins in the Boiler & Turbine end market and its ability to fund its substantial capex plans. BGR’s current earnings momentum appears to have peaked and its current forward valuations could have more downside as they are based on peak earnings, in our view, and do not factor in equity dilution and substantial fund raising.

Business model concerns: BGR Energy’s business model has changed over the years. From being a strong player in EPC for the balance of plants for power equipment, BGR has scaled up its business to subcritical EPC largely for state electricity utilities. Equipment was sourced from its Chinese collaborator, Dongfang Electric, and in the process, BGR Energy locked in a healthy 10% EBITDA margin. The business model, however, is set to change as the introduction of domestic manufacturing clauses in government contracts prompted it to set up a joint venture with Hitachi. Although a shift from EPC to a manufacturing focus is good, in our view, the timing may not be the best given the oversupply in the equipment space, weak order cycle until at least FY14 and current pricing at which margins are difficult to make.

Earnings concerns: We believe that BGR Energy’s earnings may have peaked. We expect a healthy FY13 followed by a collapse in earnings in FY14. Earnings for BGR Energy will likely be affected by rising interest rates, a gap in order inflows that will impact sales growth in the coming quarters and a new order wins that come with low margins. Cash flow generation has typically been weak and lumpy, and receivables days have extended further in the September quarter due to retention money getting delayed in some contracts (Vijayawada BOP contract by more than eight months).

Funding and dilution: We expect BGR Energy to spend about Rs35bn in the next three years to set up a boiler and turbine manufacturing facility. Or analysis of cash flows suggests a funding gap of about Rs24bn. With leverage already being high (Rs17bn, D/E of 1.5x), we believe that the funding will have to be through equity fund raising, which indicates a potential dilution ahead.

Underperformance to continue: BGR Energy’s stock has derated to 7x FY13 earnings and may appear cheap on historical comparisons, but these valuations are based on peak cycle earnings and do not reflect potential dilution. Any valuations methodology for BGR Energy will have to capture the likely weak margins post FY14 (or even losses) and dilution. We value BGR Energy at 6x (trough valuations) on FY13 (peak cycle earnings) and obtain a price target of Rs241.

Figure 196: BGR Energy – statistical abstract


Mar Rs mn Rs % (x) (x) (%) (%)

2011A 3,230 45 60 6.0 2.1 33.9 3.8

2012E 3,034 42 -6 6.4 1.7 25.8 3.5

2013E 2,906 40 -4 6.7 1.4 20.9 3.3

2014E 1,215 17 -58 16.1 1.3 8.2 1.4


BGRL IN / BGRE.NS




Price (02-Dec-2011) INR 270.55



7 December 2011 137

COMPANY SNAPSHOT

BGR ENERGY INDIA CAPITAL GOODS

Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 47,498 45,979 49,860 53,718 4.2% Stock Rating 3-UNDERWEIGHTEBITDA 5,363 5,536 5,593 4,445 -6.1% Sector View 2-NEUTRALEBIT 5,190 5,334 5,373 4,209 -6.7% Price (02-Dec-2011) 270.55Pre-tax income 4,808 4,431 4,196 1,685 -29.5% Price Target 241Net income 3,230 3,034 2,906 1,215 -27.8% Ticker BGRL IN/BGRE.BOEPS (R) 44.77 42.05 40.27 16.83 -27.8%Diluted shares (mn) 72.16 72.16 72.16 72.16 0.0% Investment case

DPS (R) 10.01 9.25 8.86 3.70 -28.2%


Balance sheet and cash flow (INRmn) CAGRFixed assets 2,840 3,637 8,417 38,181 138%Cash and equivalents 10,449 12,743 13,353 5,316 -20.2%Total assets 54,006 59,672 68,715 94,074 20.3%Current liabilities 27,516 26,636 28,884 31,120 4.2%Long term liabilities 9,520 11,776 13,936 14,840 15.9% Downside case 88Total liabilities 54,006 59,672 68,715 94,074 20.3%Net debt/(funds) 2,925 4,921 8,945 39,203 138%Shareholders' equity 9,520 11,776 13,936 14,840 15.9%Change in working capital (7,138) (3,455) (1,405) (1,397) NACash flow from operations (1,297) 685 2,898 2,578 NACapital expenditure (700) (1,000) (5,000) (30,000) NAFree cash flow (1,997) (315) (2,102) (27,422) NA


Valuation and leverage metrics AverageP/E (x) 6.0 6.4 6.7 16.1 8.8 EV/EBITDA (x) 4.2 4.4 5.1 13.2 6.7 FCF yield (%) -10.2 -1.6 -10.8 -140.5 - 0.4 EV/sales (x) 0.5 0.5 0.6 1.1 0.7 Price/BV (x) 2.1 1.7 1.4 1.3 1.6 Dividend yield (%) 3.7 3.4 3.3 1.4 2.9Total debt/capital (%) 50.5 53.5 56.0 70.7 57.7Net debt/EBITDA (x) 0.5 0.9 1.6 8.8 3.0


Selected operating metrics Leverage expected to increaseOrder inflow 29,410 118,125 63,000 84,000 Order inflow growth (%) -20 302 -47 33Orderbook 79,710 151,856 164,996 195,277 Orderbook growth (%) -22 91 9 18


Why a 3-Underweight? Recent bids suggest that it isdifficult to make margins in the BTG sector. WithBGR set to spend over US$1bn on capex to set up itsBGR facilities we are concerned on its ability togenerate returns on this business.

Bull case for BGR Energy is a recovery in powermarket led by reforms in coal . In that case visibilityof orders improve and fwd valuations trend up to20x (avg of BHEL's P/E) on FY14 earnings. FY14captures the impact of weak margins

Bear case is that future wins for BGR Energy happenat prices which are perceived to be low. Street couldthen value it at trough P/E on FY14 earnings.

0.0

1.0

2.0

3.0

4.0


Debt to equity ratio

DownsideCase

INR88(-67.4%)

PriceTarget

INR241(-10.9%)

UpsideCase

INR337(24.5%)

44

244

444

644

844

22-Dec-10 2-Dec-11

DownsideCase

INR88(-67.4%) Price

Target

INR241(-10.9%)

UpsideCase

INR337(24.5%)

0

100

200

300

400

500

600

22-Dec-10 2-Dec-11


7 December 2011 138

Funding concerns: weak cash generation and high capex plans

BGR Energy’s cash flow generation has usually been weak given the EPC nature of business and the fact that advances were not taken on some contracts (as these were interest bearing, e.g.- TNEB contract).Since FY08, aggregate cash generation has been less than 10% of overall profit generated. Working capital metrics deteriorated further in the Sep quarter with debtor days at over 440 days and delayed receivables (retention money) at some projects. Retention funds at Vijayawada BOP project are expected to be delayed by 9-12 months as per management comments.

Figure 197: BGR Energy – Sharp deterioration in working capital metrics; debt levels rising (Rs mn) Sep-10 FY11 Sep-11

Loan funds 14,224 13,363 23,074Debtor days 232 173 464Liability days 165 131 268Provision days 21 19 39Net current assets ex cash 13,312 13,391 23,744Working capital days 107 74 280


Funding capex could be a challenge

The BGR Energy-Hitachi join venture is set to invest more than Rs45bn in the boiler and turbine joint venture of which BGR’s contribution is to be Rs34bn. Our analysis of cash flows for the next three years when this capex is likely to be incurred suggests that there would be a funding gap of Rs23bn. This funding gap will have to be bridged by raising debt or equity. We note that raising these funds through debt would be difficult as that would raise the company’s overall debt/equity ratio to more than 3.0x by FY14 and its interest burden pa could range to Rs3-4bn (depending on interest rate) as compared with our estimate of an EBITDA of Rs4-5bn pa. Since raising the entire gap through debt will not be possible, we believe that either BGR Energy will have to scale down its capex plans or extend the period of implementation of the project or raise equity. Given the negative outlook on power equipment sector, equity fund raising would be difficult, in our view.

BGR Energy’s cash flow generation has usually been

weak. Receivable days in Sep quarter has expanded to over

440 days

Figure 198: BGR Energy – net cash from operating activities: cash flow generation has usually been weak (Rs mn)

Figure 199: BGR Energy – net current assets ex-cash days: its business is working capital intensive (days)

-463

-1696

773

3299

-1297-2,000

-1,000

0

1,000

2,000

3,000

4,000


Net cash from operating activities

134

120 119

73

101

0

20

40

60

80

100

120

140

160


Net current assets ex cash days


We expect a funding gap of more than Rs24bn, which has to

be bridged though equity fund raising


7 December 2011 139

Figure 200: BGR Energy –funding for capex plan appears difficult Calculations Rs bn

Current debt/equity ratio 1.40Current debt 13,373Current cash balance 10,449Cash generation (FY12-14) 6,256Cash tied up in working capital 6,415Total cash for capex 10,290Capex planned 33,750Cash required 23,460Debt at end of FY14E 36,833New debt/equity ratio 2.5Annual interest outflow Rs3-4bnEBIDTA 4,250


Figure 201: BGR Energy – debt/equity at consolidated level: set to increase to 3.0x

05,000

10,000

15,00020,00025,00030,00035,000

40,00045,00050,000

FY08 FY09 FY10 FY11 FY12 E FY13 E FY14 E0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Total Debt D/E


Earnings peaking; margins to deteriorate

BGR’s business model has changed. It was earlier an EPC contractor thriving on two end markets, 1) BOP EPC and 2) subcritical EPC largely for state electricity boards. The model was unique given that BOP was a strong volume and stable margin business and with several utilities shifting to ordering BOP packages to a single contractor instead of tendering out several packages separately. This was largely done to ensure that there are no delays in the implementation of the BOP packages. In the BTG space, BGR had a unique business model as it had partnered with Dongfang Electric for supplies of boilers and turbines while EPC, and BOP were implemented by BGR Energy. This benefitted the Chinese vendors as they were able to participate in orders for which ordering was for the entire EPC of the project. Visa issues and difficulty in managing several local contractors was the key issue that Chinese vendors were facing while bidding for EPC contracts. Given the pricing of Chinese equipment and limited competition in state utility orders, BGR was able to achieve EBITDA margins of more than 10% for these contracts.

BGR Energy’s business model has changed now to manufacturing of boiler and turbines in a new JV with Hitachi (announced last year). This change was largely dictated by introduction

Business model is changing now to a manufacturer of BTG

equipment; however, oversupply in the BTG markets could impact viability of new business venture


7 December 2011 140

of domestic manufacturing clauses in NTPC orders and an advisory sent to all state utilities to also implement domestic manufacturing clauses in future tenders. With large IPPs directly obtain boilers and turbines from China, this was a segment that BGR could not have targeted. While BGR Energy’s shift to manufacturing is a positive, our concern largely stems from the company’s ability to sustain current margins in the new business model. We believe that until indigenisation levels are increased (could take over 3-4 years), the business could be unprofitable. Furthermore, at the price levels in recent orders, it is difficult to generate returns at even very high indigenisation levels. Turbine manufacturing is capex intensive, and at the current pricing utilisation levels need to be higher than 60% to break even pre-taxes. We wonder if BGR Energy would be able to run at 60% or higher utilisation levels in its turbine business given the current excess capacity in the market.

Figure 202: BGR Energy – operating EBITDA margins could get severely affected

10.2% 10.8% 11.2% 11.3%12.0%

11.2%

8.3%

0%

2%

4%

6%

8%

10%

12%

14%

FY08 FY09 FY10 FY11 FY12 E FY13 E FY14 E

EBITDA margin

Our margin estimates could be aggressive. BGR Energy could be

generating losses in FY14


BGR Energy’s sales growth may have peaked in FY12. We expect the execution period to extend as BGR Energy has not won orders for several quarters. While the NTPC orders are expected to be booked in January, revenue recognition may not commence until 3Q FY12.

Figure 203: BGR Energy – execution period expected to lengthen and this will impact sales growth

20

36

26

21

37 37

0

5

10

15

20

25

30

35

40

FY09 FY10 FY11 FY12 E FY13 E FY14 E

Execution months

We expect execution period for BGR Energy to lengthen given the

gap in ordering and shift to longer lead time supercritical

projects



7 December 2011 141

Expect more consensus earnings downgrades

We calculate that consensus numbers are not building in a drop in earnings growth rates in FY13 as they continue to factor in 10% margins on supercritical contracts, which we believe is difficult to achieve given the likelihood of weak utilisation rates and low pricing in the current order.

Valuation

Our 12-month price target of Rs241 for BGR Energy is based a target P/E of 6x applied to our EPS forecast for FY13E given our view that FY13 broadly represents the peak of its earnings cycle. Our P/E target represents the stock’s recent trough valuation since the financial crisis.

Figure 206: BGR Energy – historical 12-month forward P/E

0

5

10

15

20

25

30

Mar

-08

Sep-

08

Mar

-09

Sep-

09

Mar

-10

Sep-

10

Mar

-11

Sep-

11

BGR Energy 12M fwd PE

Source: Datastream, IBES consensus estimates ,Barclays Capital estimates

We expect consensus earnings downgrades to continue

Figure 204: BGR Energy – history of consensus EPS forecasts shows that continued upward revisions led to a re-rating in FY11 (Rs)

Figure 205: BGR Energy – history of consensus EPS forecasts shows that the earnings downgrade cycle has just commenced; we expect more cuts (Rs)

05

101520253035404550

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

FY08 FY09 FY10 FY11

30

35

40

45

50

55

60

Jun-09 Dec-09 Jun-10 Dec-10 Jun-11

FY12 FY13 FY14



7 December 2011 142

Risks

The key risks that could keep our price target from being achieved, in our view, include a recovery in the power BTG market and an improved pricing on new orders. The ability to generate higher-than-expected cash flows through core operations would also help to reduce level of debt required for capex.

Figure 207: BGR Energy – income statement, FY09-14E


Net sales 19,303 30,734 47,498 45,979 49,860 53,718

Total expenditure 17214 27,292 42,136 40,443 44,266 49,274

Increase/decrease in WIP -11 25 -51 -2 0 0

Material and manufacturing cost 15,119 23,616 37,772 37,372 41,180 45,698

% of sales 78% 77% 80% 81% 83% 85%

Staff cost 731 1,248 1,431 1,613 1,564 1,822

% of sales 4% 4% 3% 4% 3% 3%

Administration, selling and general expenses 1,375 2,403 2,984 1,460 1,523 1,754

% of sales 7% 8% 6% 3% 3% 3%

OBITDA 2,089 3,442 5,363 5,536 5,593 4,445

OBITDA margin 11% 11% 11% 12% 11% 8%

Interest 579 538 605 945 1,221 2,541

Depreciation 75 103 173 202 220 236

Other income 317 250 223 42 44 18



Provision for taxation 586 1,037 1,577 1,397 1,290 470

Tax rate 33% 34% 33% 32% 31% 28%

Profit after tax 1,165 2,015 3,230 3,034 2,906 1,215




7 December 2011 143

Figure 208: BGR Energy – balance sheet, FY09-14E


Share capital 720 720 722 722 722 722

Employee stock options application money 0.00 0.00 0.04 0.04 0.04 0.04



Minority Interest 28 29 519 519 519 519

Secured loans 6,360 4,052 8,604 12,895 17,529 39,750

Unsecured loans 730 4,023 4,769 4,769 4,769 4,769

Total debt 7,090 8,075 13,373 17,664 22,298 44,519

Deferred tax liabilities 747 1,551 3,078 3,078 3,078 3,078

Total liabilities 13,504 16,717 26,490 33,036 39,831 62,954

Goodwill on consolidation of subsidiaries 6 6 6 6 6 6

Gross block 1,245 1,819 2,508 3,508 8,508 38,508

Less: depreciation and impairment 268 365 530 733 953 1,189

Net Block 977 1,454 1,978 2,775 7,555 37,319

CWIP (including capital advances) 54 104 862 862 862 862

Investments 5 5 5 5 5 5

Inventories 140 162 411 398 431 464

Sundry debtors 12,789 19,803 31,580 33,382 36,200 39,001

Debtor days 242 235 243 265 265 265

Cash and bank balances 6,152 9,019 10,449 12,743 13,353 5,316


OCA days 3 2 2 2 2 2

Loans and Advances 6,432 7,273 8,400 9,196 9,972 10,744

Current assets, loans and advances 25,690 36,438 51,155 56,024 60,286 55,882

Liabilities 12,326 18,955 23,971 23,204 25,163 27,110

Liability days 233 225 184 184 184 184

Provisions 903 2,334 3,545 3,432 3,722 4,010


Current liabilities and provisions 13,229 21,289 27,516 26,636 28,884 31,120


Total assets 13,504 16,717 26,490 33,036 39,831 62,954



7 December 2011 144

Figure 209: BGR Energy – cash flow statement, FY08-14E

Rs mn; years ending March FY08 FY09 FY10 FY11 FY12E FY13E FY14E

Net profit before tax and extraordinary items 1296 1,752 3,051 4,808 4,431 4,196 1,685

Depreciation and amortization 55 75 103 173 202 220 236

Operating profit before working capital changes 1,594 234 4,369 6,456 5,536 5,593 4,445

(Increase)/decrease in sundry debtors -3,672 -5,428 -7,079 -11,827 -1,803 -2,817 -2,802

(Increase)/decrease in inventories 146 10 -22 -249 13 -34 -33

(Increase)/decrease in other current assets -46 -92 -3 -134 10 -26 -26

(Increase)/decrease in loans and advances -1,807 -3,771 -841 -517 -795 -776 -772

Increase/(decrease) in trade payables 2,153 7,754 6,589 5,589 -880 2,248 2,235

Change in working capital -3,226 -1,528 -1,356 -7,138 -3,455 -1,405 -1,397

Cash generated from operations -1,632 -1,294 3,013 -681 2,082 4,189 3,048

Direct tax paid -64 -37 286 -616 -1,397 -1,290 -470

Net cash flow from operating activities -1,696 773 3,299 -1,297 685 2,898 2,578

Purchase of fixed assets -238 -544 -589 -700 -1,000 -5,000 -30,000

Sale of fixed assets 62 21 10 2 0 0 0

Purchase of investments -1,517 1,509 0 0 0 0 0

Net cash flow from investing activities -1,631 967 -629 -1,456 -958 -4,956 -29,982

Secured loans (repaid)/availed 23 60 230 51 4,291 4,634 22,220

Unsecured loans (repaid)/availed -24 695 3,293 746 0 0 0

Payment of dividend -32 -144 -216 -505 -668 -639 -267

Tax on dividend paid 2,564 1,307 -37 -86 -111 -106 -44

Net cash flow from financing activities 5,469 1,342 197 4,183 2,567 2,667 19,367

Net Increase in cash and cash equivalents 2,141 3,081 2,867 1,430 2,294 610 -8,037

Cash and cash equivalents (opening balance) 929 3,070 6,152 9,019 10,449 12,743 13,353

Cash and cash equivalents (closing balance) 3,070 6,152 9,019 10,449 12,743 13,353 5,316



7 December 2011 145

KEC INTERNATIONAL (1-OW, PT: RS72, + 75%): TROUGH VALUATIONS

We initiate coverage on KEC International with a 1-Overweight rating and a 12-month price target of Rs72 (based on 10x FY13E EPS). Earnings growth for KEC should turnaround in FY13, led by strength in order inflows and improvement in margins. Margin improvement in FY13, would be driven by improving efficiencies in the cables business due to the shift in production to a new facility in Vadodara and scale up to higher voltage cables. Improving revenues in new businesses will also help to reduce start up losses. A reduction in debt led by sale of assets should also help reducing interest burden. Post a sharp decline in earnings in FY12, we expect a 27% CAGR out to FY14.

Diversification key driver: KEC has outpaced peers in the transmission tower segment owing to success in winning orders in international markets and led by new initiatives such as substation EPC, Railways and Water. While the mix of rail and water business is currently small, the market size of these businesses are large, hence growth for KEC off a low base should be strong. We are though building in a modest mid teens growth rates in order inflows from FY13 and it is likely that new businesses provide an upside surprise.

Margins to trough in FY12 KEC international’s margins have been impacted due to forex losses as well as repricing of foreign advances due to rupee depreciation (these are non-cash expenses) and start-up losses in the rail business. We build in a trough in margins in FY12E and expect modest improvements thereafter as we expect: 1) margins in the cables business to improve due to the scaling up to higher-voltage lines and a shift in the manufacturing base from Thane to Vadodara; 2) improved margins in the railway and water segments, which are currently affected by the lower order book and entry-level pricing; and 3) strong growth at SAE, which should help given the higher margins. The impact of the increase in interest rates should get reflected in the base this year and should not impact y/y growth, and further cash flow from the sale of land at Vashi should help reduce debt.

Valuations at historical trough: KEC is trading at a P/E of 6x on our EPS estimate for FY13 and P/B of 0.9x, which are close to the historical troughs for the stock. We are unable to comprehend the reasons for such low valuations for KEC given that the company continues to be profitable. We expect the company to generate an ROE upwards of 15% even in a bear case. Moreover, the company does not typically raise dilutive funding. The current high gearing may be cited as a concern but is in fact a reflection of acquisition of SAE Towers last year.

Figure 210: KEC – statistical abstract


Mar Rs mn Rs % (x) (x) (%) (%)

2011A 2,057 8.0 4.4 5.2 1.1 21.7 3.1

2012E 1,472 5.7 -28.4 7.2 1.0 13.8 2.2

2013E 1,839 7.2 25.0 5.8 0.9 15.1 2.8

2014E 2,382 9.3 29.5 4.5 0.8 16.9 3.6


KECI IN / KECL.NS




Price (02-Dec-2011) INR 41.25



7 December 2011 146

COMPANY SNAPSHOT

KEC international INDIAN CAPITAL GOODS

Income statement (INRmn) 2011A 2012E 2013E 2014E CAGRRevenue 43,232 53,844 59,714 66,245 15.3% Stock Rating 1-OVERWEIGHTEBITDA 3,115 4,365 5,089 5,992 24.4% Sector View 2-NEUTRALEBIT 2,707 3,799 4,458 5,291 25.0% Price (02-Dec-2011) 41.25Pre-tax income 3,167 2,338 2,830 3,664 5.0% Price Target 72Net income 2,057 1,472 1,839 2,382 5.0% Ticker KECI INEPS (R) 8.00 5.72 7.15 9.26 5.0%Diluted shares (mn) 257.10 257.10 257.10 257.10 0.0% Investment case

DPS (R) 1.30 0.93 1.16 1.51 5.0%


Balance sheet and cash flow (INRmn) CAGRFixed assets 8,409 8,932 9,501 10,001 5.9%Cash and equivalents 1,614 1,723 929 449 -34.7%Total assets 47,094 56,137 61,216 66,483 12.2%Current liabilities 22,809 28,462 31,565 35,018 15.4%Long term liabilities 14,322 16,519 17,006 16,891 5.7% Downside case 36Total liabilities 47,094 56,136 61,215 66,482 12.2%Net debt/(funds) 12,708 14,796 16,077 16,442 9.0%Shareholders' equity 9,466 10,658 12,147 14,076 14.1%Change in working capital (2,297) (2,756) (2,202) (1,795) NACash flow from operations 1,694 853 1,904 2,920 19.9%Capital expenditure (780) (1,200) (1,200) (1,200) NAFree cash flow 914 (347) 704 1,720 23.5%


Valuation and leverage metrics AverageP/E (x) 5.2 7.2 5.8 4.5 5.6 EV/EBITDA (x) 7.5 5.8 5.2 4.5 5.8 FCF yield (%) 8.6 -3.3 6.6 16.2 7.0EV/sales (x) 0.5 0.5 0.4 0.4 0.5 Price/BV (x) 1.1 1.0 0.9 0.8 0.9 Dividend yield (%) 3.2 2.3 2.8 3.7 3.0Total debt/capital (%) 59.0 59.7 57.4 53.7 57.4Net debt/EBITDA (x) 4.1 3.4 3.2 2.7 3.3


Selected operating metrics EBITDA margins expected to recover in FY13Order inflow 63,626 62,405 70,206 78,396 Order inflow growth (%) 48 -2 13 12Orderbook 78,000 89,555 99,138 101,531 Orderbook growth (%) 42 15 11 2


Why a 1-Overweight? Earnings growth shouldrecover in FY13, led by strength in order inflows andmargins recovery. Margin improvements will likelybe aided by a shift in cable production to a newfacility that will bring in efficiencies and reduction instart up losses in new businesses.

Success in substation EPC wins in India, large wins inRail business could help re-rate valuations. Weexpect the stock to head closer to its near term peakP/E of 12x on improved order visibility and earningsperformance.

Continued weakness in earnings acccentuated byaccounting losses on account of translation offoreign currency advances (rupee dep) and a weak2H order inflow performance could lead to the stockheading to a P/E of 5x (close to trough P/E).

0%

5%

10%

15%


EBITDA margins

DownsideCase

INR36(-12.7%) Price

Target

INR72(74.5%)

UpsideCase

INR86(108.%)

18

38

58

78

98

118

15-Dec-10 25-Nov-11

DownsideCase

INR36(-12.7%)

PriceTarget

INR72(74.5%)

UpsideCase

INR86(108.%)

0

20

40

60

80

100

120

15-Dec-10 25-Nov-11


7 December 2011 147

Diversification key driver

KEC’s order inflows have been strong in the past two years despite flattish ordering in the domestic transmission tower segment due to strong wins in international orders, scaling up the value chain by order wins in high voltage substation (Kazakhstan), acquisition of SAE Towers and diversification into substation orders.

Figure 211: KEC – overview of businesses

Market size Order book

(Rs) Capability

Cables Current revenue of Rs120bn pa expected to increase to Rs200bn pa

1774 High-tension power cables: Installed capacity (Power Cables): 1,200km/annum

Power cables and telecom cables: Installed capacity of 10,000km/annum

Jelly-filled cables and optic fibre cables: 965,000km/annum

Low tension power cables: Installed capacity (power cables): 14,580km/annum.

Greenfield capacity being set up in Vadodara

Railways Orders in excess of Rs10bn pa. DFC orders of Rs400bn likely in next few years

3718 Civil infrastructure including bridges, tunnels, platform, workshop modernization, building of stations and facilities

Earthwork, new track laying and rehabilitation of existing tracks

Railway electrification and power systems

Signalling and telecommunication network

Water 11th plan allocation of US$50bn for irrigation, flood control and command area development

US$23bnfor urban water supply and sanitation projects

780 Irrigation and Hydroelectric construction

Embankment and Flood Control

Sewage and industrial effluent treatment

Potable water treatment and distribution


Figure 212: KEC – strong order inflows due to success in international geographies, acquisition of SAE and diversification (Rs mn)

Figure 213: KEC – revenue breakdown, FY12

-9%

56%

11%

-4%

48%

54%

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

FY06 FY07 FY08 FY09 FY10 FY11-20%

-10%

0%

10%

20%

30%

40%

50%

60%

Order inflows Y/Y growth

Intll. distribution

Domestic transmission

27%

Intll. Transmission

51%

Cable 2%

Telecom3%Domestic

distribution 10%

Railways 1%



7 December 2011 148

Margins to trough in FY12

We believe that margins for KEC International may have troughed in FY12. We expect improvements in FY13 led by improvements in margins for the cables segment given the shift to higher voltage lines as well as commencement of new factory in Vadodara, which should reduce costs and increase efficiency, improved margins in railway and water segments (facing low margins now due to lower order book and entry level pricing). SAE Towers should continue to support blended margins subject to the quantum of orders wins next year.

We also expect the impact of high interest rates to get reflected in interest costs this year and hence should not impact y/y profits next year. Note that more than 50% of the debt is in foreign currency and, hence, is not impacted by the increase in interest rates. Debt levels are also expected to come down next year with the likely sale of land in Vashi.

Figure 214: KEC – EBITDA margins; FY12 likely to be impacted due to commodity-related pressure in cables business and non-cash translation of forex losses

6.8%

12.1%

9.6% 9.4%

12.3% 12.6%

8.7%

10.4%

7.21%8.11% 8.5% 9.0%

0%

2%

4%

6%

8%

10%

12%

14%

FY03 FY05 FY07 FY09 FY11 FY13E

EBITDA Margin


Figure 215: KEC – revenue growth rates; expect some moderation in FY13 as we build in weaker order inflows in FY12 – our numbers could serve as the base case

45%

12%

51%

40%

18%

38%

22%

14%11%

25%

11% 11%

0%

10%

20%

30%

40%

50%

60%

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 E FY13E FY14E

Y/Y growth



7 December 2011 149

Valuation

Our 12-month price target of Rs72 for KEC is based on a target P/E of 10x applied to our EPS forecast for FY13. We set the multiple at a 10% discount to the historical average for the past seven years despite our view of less risk to earnings and our view that current estimates reflect a trough due to our expectation of lower margins and cash flows in this cycle. KEC is trading at 6x our FY13E estimates and 0.9x P/B, which are close to the historical troughs for the stock. We are unable to comprehend the reasons for such low valuations for KEC given that the company continues to be profitable and even under our worst-case scenario, we estimate it will generate an ROE of 15%, is able to generate cash to manage working capital and also does not typically raise dilutive funding. The company’s current high gearing may be cited as a concern, but this is in fact a reflection of acquisition of SAE Towers last year.

Figure 216: KEC – historical 12-month forward P/Es: close to historical lows

0

5

10

15

20

25

Jun-

06

Sep-

06

Dec

-06

Mar

-07

Jul-

07

Oct

-07

Jan-

08

Apr

-08

Aug

-08

Nov

-08

Feb-

09

May

-09

Aug

-09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Apr

-11

Jul-

11

Oct

-11

KEC

Source: Datastream, IBES consensus estimates

Pricing in a downturn

Figure 217: KEC – history of consensus EPS forecasts shows that estimates typically get cut in downturns (Rs)

Figure 218: KEC – history of consensus EPS forecasts shows that post the recent cuts, current estimates appear achievable

02468

10121416

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

FY06 FY07 FY08 FY09

FY10 FY11

56789

101112131415

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

FY12 FY13 FY14

Source: Datastream IBES consensus, Barclays Capital Source: Datastream IBES consensus, Barclays Capital


7 December 2011 150

Risks

The key risks that could keep our price target from being achieved, in our view, include execution delays or lower margins on the order book; weak order inflows due to high price competition in India; and inability to counter that with strong growth outside India. The company is currently highly leveraged, which is a concern in case it is unable to eventually reduce debt burden.

Figure 219: KEC – income statement, FY09-14E

Rs mn; years ending March FY09 FY10 FY11 FY12 E FY13E FY14E

Net sales 34,274 39,064 43,232 53,844 59,714 66,245

Y/Y growth 22% 14% 11% 25% 11% 11%

Cost of materials 19,758 20,127 22,552 28,486 31,727 34,855

% of sales 58% 52% 52% 53% 53% 53%

Erection and subcontracting expenses 5,750 9,581 9,806 11,235 12,490 13,856

% of sales 17% 25% 23% 21% 21% 21%

Personnel expenses 1,420 1,689 2,833 3,780 4,130 4,580

% of sales 4% 4% 7% 7% 7% 7%

Other expenses 4,350 3,616 4,926 5,978 6,277 6,963

% of sales 13% 9% 11% 11% 11% 11%

Total expenses 31,278 35,013 40,117 49,479 54,624 60,254

OBITDA 2,996 4,051 3,115 4,365 5,089 5,992

OBITDA margin 9% 10% 7% 8% 9% 9%

Depreciation and amortisation (net) 230 270 408 566 631 700

Other income 20 18 1,536 10 8 8

Interest 1,000 865 1,075 1,461 1,636 1,636

Profit after interest but before exceptional items 1,786 2,934 3,167 2,348 2,830 3,663

Exceptional items - - (85) (10) - 1



Tax 618 1,037 1,111 866 990 1,282

Tax rate 35% 35% 35% 37% 35% 35%

Profit after tax before extraordinary items 1,168 1,897 2,057 1,472 1,839 2,382




7 December 2011 151

Figure 220: KEC – balance sheet, FY09-14E


Share capital 493 493 514 514 514 514

Equity share suspense - 21 - - - -



Secured loans 5,839 7,755 14,296 - - -

Unsecured loans 379 112 11 - - -

Total debt 6,218 7,867 14,322 16,519 17,006 16,891

Deferred tax liability 298 461 497 497 497 497

Total 12,097 16,199 24,285 27,674 29,650 31,464

Fixed assets

Gross block 6,320 8,357 10,382 11,582 12,782 13,982

Less: Depreciation and amortisation 1,248 1,570 2,366 2,932 3,563 4,264

Net block 5,072 6,787 8,016 8,650 9,219 9,718

Capital work in progress 504 379 278 278 278 278

Advances for capital expenditure 10 4 4 4 4 4

Investments 30 30 - - - -

Deferred tax assets - - - - - -

Goodwill 2,813 2,813 2,813 2,813

Inventories 2,258 2,498 3,359 4,183 4,639 5,147


Sundry debtors 18,662 19,624 26,177 32,603 36,810 40,836

Inventory days 199 183 221 221 225 225

Cash and bank balances 1,411 698 1,614 1,723 929 449


as % of sales 0 0 0 0 0 0

Current assets 25,359 26,775 35,873 44,392 48,902 53,670

Liabilities 18,431 17,214 22,248 27,710 30,730 34,092


Provisions 445 562 561 753 835 926

as % of sales 0 0 0 0 0 0



Total assets 12,097 16,199 24,285 27,674 29,651 31,465



7 December 2011 152

Figure 221: KEC – cash flow statement, FY09-14E



Depreciation and amortisation (net) 230 270 408 566 631 700


Trade and other receivables (3,876) (367) (6,005) (7,585) (4,849) (4,740)

Inventories (204) 415 735 (824) (456) (507)

Trade and other payables 5,091 (2,567) 2,973 5,653 3,103 3,453

Miscellaneous expenditures - - - - - -

Cash from operations 4,407 1,125 2,373 1,719 2,894 4,200

Taxes (640) (778) (679) (866) (990) (1,282)

Others - - - - - 2

Net cash from operating activities 3,767 347 1,694 853 1,904 2,920

Change in financing activities (1,395) (588) (780) (1,200) (1,200) (1,200)

Change in investments - - - - - -

Interest received 14 80 60 - - -

Others - - (4,391) - - -

Cash used in investing (1,381) (509) (5,111) (1,200) (1,200) (1,200)

Change in equity/preferred equity (149) - - - - 1

Change in debt (205) 551 5,453 2,198 487 (115)

Interest paid (1,046) (944) (1,140) (1,461) (1,636) (1,636)

Dividends paid (287) (285) (354) (280) (350) (453)

Others - - - - - -

Change in financing (1,687) (678) 3,959 457 (1,499) (2,203)

Net change in cash equivalents 699 (840) 541 110 (795) (482)

Opening cash 690 1,410 698 1,614 1,723 929

Adjustments 21 130 - - 1 2

Closing cash 1,410 699 1,614 1,723 929 449



7 December 2011 153

Valuation Methodology and Risks

India Capital Goods

ABB Ltd. (ABB IN / ABB.NS)

Valuation Methodology: Our 12-month price target of Rs494 is based on an average 25x P/E. Our target multiple is the stock's historical average 12-month forward P/E since 2003. We use a higher P/E compared with that used for peers as the cost of capital being used for any cash flow calculations will be that of its parent. This is because the recent open offer done by ABB's parent for purchasing 20% of shares in ABB India at steep valuations were justified largely on account of lower cost of capital of its parent.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include: 1) a faster-than-expected uptick in margins; 2) a sharp recovery in the T&D market and market share gains for ABB; and 3) announcement of a delisting by parent at substantially higher valuations.

Areva T&D India (ATD IN / AREV.NS)

Valuation Methodology: Our 12-month price target of Rs193 for Areva T&D is based on a target P/E of 20x applied to our EPS forecast for 2012. The stock's valuations are like its other MNC T&D peers, Siemens and ABB, which have typically been rich with an average forward P/E multiple of more than 20x. Our target multiple of 20x is set at the historical average multiple for the past seven years.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include the following: 1) Continued pressure on pricing from competitors and setting up of domestic manufacturing by Chinese or Korean firms could lead to a further deterioration in margins. 2) The change in substation tendering clauses have increased competitive intensity in that segment and inability to win orders (market share losses) could impact our view of recovery in order inflows for the company. And 3) execution delays in power projects and subsequent delays in ordering for T&D projects could impact market ordering.

BGR Energy Systems Ltd. (BGRL IN / BGRE.NS)

Valuation Methodology: Our 12-month price target of Rs241 for BGR Energy is based a target P/E of 6x applied to our EPS forecast for FY13E given our view that FY13 broadly represents the peak of its earnings cycle. Our P/E target represents the stock's recent trough valuation since the financial crisis.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include a recovery in the power BTG market and an improved pricing on new orders. The ability to generate higher-than-expected cash flows through core operations would also help to reduce level of debt required for capex..

Bharat Heavy Electricals Ltd. (BHEL IN / BHEL.NS)

Valuation Methodology: Our 12-month price target of Rs230 for BHEL is based on our discounted cash flow valuation analysis because we believe estimates for the next two years do not capture the impact of current pricing trends on margins.Our assumptions appear to be a bit aggressive but capture long-term margin concerns. We assume 1) 140GW ordering in 12th and 13th plan, 2) execution period of 40 months and healthy industry order book of over Rs200bn post FY16. 3) EBITDA margin to trend down to 14% from FY16 and 10% by FY20. Terminal growth of 3%. We value JVs at 1.2x P/B.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include a recovery in order inflows in the power sector led by the government's positive policy action in solving the coal issue and issue with financials of state electricity boards. Stiff import duties would also help limit competition for local players. Shift in ordering to EPC will help reduce competition as only BHEL, L&T and BGR will then qualify for orders. Continued sustenance of margins and improved pricing trends in the market would support the share price, in our view.

Crompton Greaves Ltd. (CRG IN / CROM.NS)

Valuation Methodology: Our 12-month price target of Rs147 for CRG is based on 16x standalone FY13E earnings of Rs7.50 and 12x subsidiary earnings of Rs1.69. Our multiples are set at historical average multiples for the past seven years for CRG despite the recent sharp increase in consensus earnings estimates.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include a higher-than-expected decline in order inflows due to stiff competitive pressures in the domestic market and continued price declines and risks could emerge from weak demand for T&D products from Europe since CRG derives more than 50% of revenues from international geographies.

Cummins India Ltd. (KKC IN / CUMM.NS)

Valuation Methodology: Our 12-month price target of Rs428 for Cummins is based on a P/E of 20x applied to our EPS forecast for FY13E plus Rs20 for the value of associates. Our target P/E for the core business is at a multiple set at a 10% premium to the average of the past eight years' P/E valuation. Since we have already cut earnings estimates to capture the cyclical weakness, we are using average P/E multiples. We give a premium of 10% because of the company's well developed sales and service business and the likely higher mix of exports that could offset the impact of a weak domestic market in the coming year

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include the following: 1) a recession in export markets impacting sourcing from India; 2) further deceleration in domestic markets; and 3) price discounting in the market that could impact margins. In addition, any further shift among its customers in construction and mining equipment to their own engines would be a concern. And some competitors such as KOEL are scaling up their business in India and their ability to win customers could impact the dominant position of Cummins.

Havells India Ltd. (HAVL IN / HVEL.NS)


7 December 2011 154

Valuation Methodology and Risks

Valuation Methodology: Our 12-month price target of Rs502 for Havells is based on forward EV/EBITDA multiples of 5x for Sylvania, taking conservative valuations due to exposure to Europe, and 11x for the domestic business. Our target price implies a P/E of 15.8x for FY13E. Our target multiples are set at the historical average for the past seven years.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include a weak margin performance at Sylvania, any failure to scale up new consumer launches; and sharp increase in commodity pricing could also impact numbers.

KEC International Ltd. (KECI IN / KECL.NS)

Valuation Methodology: Our 12-month price target of Rs72 for KEC is based on a target P/E of 10x applied to our EPS forecast for FY13. We set the multiple at a 10% discount to the historical average for the past seven years despite of our view of less risk to earnings and our view that current estimates reflect a trough due to our expectation of lower margins and cash flows in this cycle.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include execution delays or lower margins on the order book; weak order inflows due to high price competition in India; and inability to counter that with strong growth outside India. The company is currently highly leveraged, which is a concern in case it is unable to eventually reduce debt burden.

Larsen & Toubro Ltd. (LT IN / LART.NS)

Valuation Methodology: Our 12-month price target of Rs1,560 is based on our sum-of-the-parts (SOTP) analysis in which we value the company on a standalone at 16.5x our EPS estimate for FY13 and its subsidiaries at Rs356 per share. Our target P/E multiple for the standalone business is set at a 25% discount to the stock's historical average for the past seven years as we do not assume a substantial uptick in all its end markets in FY13.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include the following: 1) a sharper-than-expected contraction in margins for the company; 2) order inflow guidance of 5% growth for FY12 is also at risk given the weak ordering activity in various end markets; and 3) although earnings estimates have moderated to reflect near-term weakness, there could be volatility in the stock and some downside around quarterly result announcements in January 2012.

Siemens Ltd. (SIEM IN / SIEM.NS)

Valuation Methodology: Our 12-month price target of Rs630 for Siemens is based on a P/E of 21x applied to an average of our EPS estimates for FY12 and FY13. We use average earnings as we are valuing peers on earnings for financial years ending in March 2013. Our multiple of 21x is set at a 15% discount to its historical 12-month forward P/E multiple for the past seven years given risk to margins, which appear to be peaking.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include large order wins in the Rail segment or in Power EPC market as well as forex gains or increases in core margins.

Thermax Ltd. (TMX IN / THMX.NS)

Valuation Methodology: Our 12-month price target of Rs392 for Thermax is based on 12x our earnings estimate for FY13. Our target P/E multiple is set at a 30% discount to its historical average for the past seven years as the average multiples have been propped, in our view, by the expectation of success in the subcritical and supercritical IPP foray. We are modelling only core industrial business and modest wins in subcritical space and hence the discount.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include the following: 1) Given the large scale of the new businesses that Thermax has ventured into, any large order wins in either subcritical or supercritical businesses at a good pricing could re-rate the stock. 2) Continued strength in core industrial business could also lead to earnings surprises, 3) A faster-than-expected scaling up of new business ventures in the solar and geothermal sectors could also help multiples.

Voltas Ltd. (VOLT IN / VOLT.NS)

Valuation Methodology: Our 12-month price target of Rs78 for Voltas is based on a P/E of 11 applied to our estimate for FY13. We set our P/E multiple of 11x at a 30% discount to the stocks historical average for the past seven years as 1) the MEP business has seen a large geographic shift and an increase in competitive intensity with bidding margins are now only 5% and 2) the AC market is also going through cyclical issues, seeing high competitive intensity.

Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include large order wins in the MEP segment in the Middle East and a recovery in the AC market next year.



7 December 2011 155

ANALYST(S) CERTIFICATION(S)

I, Venugopal Garre, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of thesubject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

IMPORTANT DISCLOSURES CONTINUED

For current important disclosures, including, where relevant, price target charts, regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer tohttp://publicresearch.barcap.com or call 1-212-526-1072.

The analysts responsible for preparing this research report have received compensation based upon various factors including the firm's totalrevenues, a portion of which is generated by investment banking activities.

Research analysts employed outside the US by affiliates of Barclays Capital Inc. are not registered/qualified as research analysts with FINRA.These analysts may not be associated persons of the member firm and therefore may not be subject to NASD Rule 2711 and incorporated NYSERule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst’saccount.

Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in othertypes of research products, whether as a result of differing time horizons, methodologies, or otherwise.

Primary Stocks (Ticker, Date, Price)

ABB Ltd. (ABB.NS, 02-Dec-2011, INR 618.80), 3-Underweight/2-Neutral

Areva T&D India (AREV.NS, 02-Dec-2011, INR 208.65), 2-Equal Weight/2-Neutral

BGR Energy Systems Ltd. (BGRE.NS, 02-Dec-2011, INR 270.55), 3-Underweight/2-Neutral

Bharat Heavy Electricals Ltd. (BHEL.NS, 02-Dec-2011, INR 282.45), 3-Underweight/2-Neutral

Crompton Greaves Ltd. (CROM.NS, 02-Dec-2011, INR 132.15), 1-Overweight/2-Neutral

Cummins India Ltd. (CUMM.NS, 02-Dec-2011, INR 357.85), 1-Overweight/2-Neutral

Havells India Ltd. (HVEL.NS, 02-Dec-2011, INR 424.55), 1-Overweight/2-Neutral

KEC International Ltd. (KECL.NS, 02-Dec-2011, INR 41.25), 1-Overweight/2-Neutral

Larsen & Toubro Ltd. (LART.NS, 02-Dec-2011, INR 1310.75), 1-Overweight/2-Neutral

Siemens Ltd. (SIEM.NS, 02-Dec-2011, INR 723.35), 3-Underweight/2-Neutral

Thermax Ltd. (THMX.NS, 02-Dec-2011, INR 469.70), 3-Underweight/2-Neutral

Voltas Ltd. (VOLT.NS, 02-Dec-2011, INR 92.10), 3-Underweight/2-Neutral

Guide to the Barclays Capital Fundamental Equity Research Rating System:

Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the "sector coverage universe").

In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investorsshould carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.

Stock Rating

1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

2-Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable orto comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting in an advisorycapacity in a merger or strategic transaction involving the company.

Sector View

1-Positive - sector coverage universe fundamentals/valuations are improving.

2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.


7 December 2011 156

IMPORTANT DISCLOSURES CONTINUED

3-Negative - sector coverage universe fundamentals/valuations are deteriorating.

Below is the list of companies that constitute the "sector coverage universe":

India Capital Goods

ABB Ltd. (ABB.NS) Areva T&D India (AREV.NS) BGR Energy Systems Ltd. (BGRE.NS)

Bharat Heavy Electricals Ltd. (BHEL.NS) Crompton Greaves Ltd. (CROM.NS) Cummins India Ltd. (CUMM.NS)

Havells India Ltd. (HVEL.NS) KEC International Ltd. (KECL.NS) Larsen & Toubro Ltd. (LART.NS)

Siemens Ltd. (SIEM.NS) Thermax Ltd. (THMX.NS) Voltas Ltd. (VOLT.NS)

Distribution of Ratings:

Barclays Capital Inc. Equity Research has 2045 companies under coverage.

44% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 56% of companies with this rating are investment banking clients of the Firm.

41% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 50% ofcompanies with this rating are investment banking clients of the Firm.

12% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 38% ofcompanies with this rating are investment banking clients of the Firm.

Guide to the Barclays Capital Price Target:

Each analyst has a single price target on the stocks that they cover. The price target represents that analyst's expectation of where the stock willtrade in the next 12 months. Upside/downside scenarios, where provided, represent potential upside/potential downside to each analyst's price target over the same 12-month period.

Barclays Capital offices involved in the production of equity research:

London

Barclays Capital, the investment banking division of Barclays Bank PLC (Barclays Capital, London)

New York

Barclays Capital Inc. (BCI, New York)

Tokyo

Barclays Capital Japan Limited (BCJL, Tokyo)

São Paulo

Banco Barclays S.A. (BBSA, São Paulo)

Hong Kong

Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong)

Toronto

Barclays Capital Canada Inc. (BCC, Toronto)

Johannesburg

Absa Capital, a division of Absa Bank Limited (Absa Capital, Johannesburg)

Mexico City

Barclays Bank Mexico, S.A. (BBMX, Mexico City)

Taiwan

Barclays Capital Securities Taiwan Limited (BCSTW, Taiwan)

Seoul

Barclays Capital Securities Limited (BCSL, Seoul)

Mumbai

Barclays Securities (India) Private Limited (BSIPL, Mumbai)

Singapore

Barclays Bank PLC, Singapore branch (Barclays Bank, Singapore)

DISCLAIMER:

This publication has been prepared by Barclays Capital, the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates as provided below. It isprovided to our clients for information purposes only, and Barclays Capital makes no express or implied warranties, and expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with respect to any data included in this publication. Barclays Capital will not treat unauthorized recipients ofthis report as its clients. Prices shown are indicative and Barclays Capital is not offering to buy or sell or soliciting offers to buy or sell any financial instrument.

Without limiting any of the foregoing and to the extent permitted by law, in no event shall Barclays Capital, nor any affiliate, nor any of their respective officers, directors, partners, or employees have any liability for (a) any special, punitive, indirect, or consequential damages; or (b) any lost profits, lost revenue, loss of anticipated savingsor loss of opportunity or other financial loss, even if notified of the possibility of such damages, arising from any use of this publication or its contents.

Other than disclosures relating to Barclays Capital, the information contained in this publication has been obtained from sources that Barclays Capital believes to be reliable, but Barclays Capital does not represent or warrant that it is accurate or complete. The views in this publication are those of Barclays Capital and are subject tochange, and Barclays Capital has no obligation to update its opinions or the information in this publication.

The analyst recommendations in this publication reflect solely and exclusively those of the author(s), and such opinions were prepared independently of any otherinterests, including those of Barclays Capital and/or its affiliates. This publication does not constitute personal investment advice or take into account the individualfinancial circumstances or objectives of the clients who receive it. The securities discussed herein may not be suitable for all investors. Barclays Capital recommends that investors independently evaluate each issuer, security or instrument discussed herein and consult any independent advisors they believe necessary. The value of andincome from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). Theinformation herein is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results.

This communication is being made available in the UK and Europe primarily to persons who are investment professionals as that term is defined in Article 19 of theFinancial Services and Markets Act 2000 (Financial Promotion Order) 2005. It is directed at, and therefore should only be relied upon by, persons who have professionalexperience in matters relating to investments. The investments to which it relates are available only to such persons and will be entered into only with such persons. Barclays Capital is authorized and regulated by the Financial Services Authority ('FSA') and member of the London Stock Exchange.

Barclays Capital Inc., U.S. registered broker/dealer and member of FINRA (www.finra.org), is distributing this material in the United States and, in connection therewith accepts responsibility for its contents. Any U.S. person wishing to effect a transaction in any security discussed herein should do so only by contacting a representativeof Barclays Capital Inc. in the U.S. at 745 Seventh Avenue, New York, New York 10019.

Non-U.S. persons should contact and execute transactions through a Barclays Bank PLC branch or affiliate in their home jurisdiction unless local regulations permitotherwise.

This material is distributed in Canada by Barclays Capital Canada Inc., a registered investment dealer and member of IIROC (www.iiroc.ca). To access Barclays Capitalpolicy on the dissemination of research reports, please go to http://www.barcap.com/Client+offering/Research/Research+Policy.

Subject to the conditions of this publication as set out above, Absa Capital, the Investment Banking Division of Absa Bank Limited, an authorised financial servicesprovider (Registration No.: 1986/004794/06), is distributing this material in South Africa. Absa Bank Limited is regulated by the South African Reserve Bank. Thispublication is not, nor is it intended to be, advice as defined and/or contemplated in the (South African) Financial Advisory and Intermediary Services Act, 37 of 2002, or any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever. Any South African person orentity wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Absa Capital in South Africa, 15 Alice Lane,Sandton, Johannesburg, Gauteng 2196. Absa Capital is an affiliate of Barclays Capital.

In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed to institutionalinvestors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan with registered office of 6-10-1 Roppongi, Minato-ku, Tokyo 106-6131, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firm regulated by the Financial ServicesAgency of Japan. Registered Number: Kanto Zaimukyokucho (kinsho) No. 143.

Barclays Bank PLC, Hong Kong Branch is distributing this material in Hong Kong as an authorised institution regulated by the Hong Kong Monetary Authority.Registered Office: 41/F, Cheung Kong Center, 2 Queen's Road Central, Hong Kong.

This material is issued in Taiwan by Barclays Capital Securities Taiwan Limited. This material on securities not traded in Taiwan is not to be construed as'recommendation' in Taiwan. Barclays Capital Securities Taiwan Limited does not accept orders from clients to trade in such securities. This material may not be distributed to the public media or used by the public media without prior written consent of Barclays Capital.

This material is distributed in South Korea by Barclays Capital Securities Limited, Seoul Branch.

All equity research material is distributed in India by Barclays Securities (India) Private Limited (SEBI Registration No: INB/INF 231292732 (NSE), INB/INF 011292738(BSE), Registered Office: 208 | Ceejay House | Dr. Annie Besant Road | Shivsagar Estate | Worli | Mumbai - 400 018 | India, Phone: + 91 22 67196363). Other research reports are distributed in India by Barclays Bank PLC, India Branch.

Barclays Bank PLC Frankfurt Branch distributes this material in Germany under the supervision of Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin).

This material is distributed in Malaysia by Barclays Capital Markets Malaysia Sdn Bhd.

This material is distributed in Brazil by Banco Barclays S.A.

This material is distributed in Mexico by Barclays Bank Mexico, S.A.

Barclays Bank PLC in the Dubai International Financial Centre (Registered No. 0060) is regulated by the Dubai Financial Services Authority (DFSA). Barclays Bank PLC-DIFC Branch, may only undertake the financial services activities that fall within the scope of its existing DFSA licence.

Barclays Bank PLC in the UAE is regulated by the Central Bank of the UAE and is licensed to conduct business activities as a branch of a commercial bank incorporatedoutside the UAE in Dubai (Licence No.: 13/1844/2008, Registered Office: Building No. 6, Burj Dubai Business Hub, Sheikh Zayed Road, Dubai City) and Abu Dhabi(Licence No.: 13/952/2008, Registered Office: Al Jazira Towers, Hamdan Street, PO Box 2734, Abu Dhabi).

Barclays Bank PLC in the Qatar Financial Centre (Registered No. 00018) is authorised by the Qatar Financial Centre Regulatory Authority (QFCRA). Barclays Bank PLC-QFC Branch may only undertake the regulated activities that fall within the scope of its existing QFCRA licence. Principal place of business in Qatar: Qatar FinancialCentre, Office 1002, 10th Floor, QFC Tower, Diplomatic Area, West Bay, PO Box 15891, Doha, Qatar.

This material is distributed in Dubai, the UAE and Qatar by Barclays Bank PLC. Related financial products or services are only available to Professional Clients as defined by the DFSA, and Business Customers as defined by the QFCRA.

This material is distributed in Saudi Arabia by Barclays Saudi Arabia ('BSA'). It is not the intention of the Publication to be used or deemed as recommendation, option oradvice for any action (s) that may take place in future. Barclays Saudi Arabia is a Closed Joint Stock Company, (CMA License No. 09141-37). Registered office Al Faisaliah Tower | Level 18 | Riyadh 11311 | Kingdom of Saudi Arabia. Authorised and regulated by the Capital Market Authority, Commercial Registration Number: 1010283024.

This material is distributed in Russia by OOO Barclays Capital, affiliated company of Barclays Bank PLC, registered and regulated in Russia by the FSFM. Broker License#177-11850-100000; Dealer License #177-11855-010000. Registered address in Russia: 125047 Moscow, 1st Tverskaya-Yamskaya str. 21.

This material is distributed in Singapore by the Singapore branch of Barclays Bank PLC, a bank licensed in Singapore by the Monetary Authority of Singapore. For matters in connection with this report, recipients in Singapore may contact the Singapore branch of Barclays Bank PLC, whose registered address is One Raffles QuayLevel 28, South Tower, Singapore 048583.

Barclays Bank PLC, Australia Branch (ARBN 062 449 585, AFSL 246617) is distributing this material in Australia. It is directed at 'wholesale clients' as defined byAustralian Corporations Act 2001.

IRS Circular 230 Prepared Materials Disclaimer: Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should be construed to be tax advice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot beused, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other mattersaddressed herein. Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor.

Barclays Capital is not responsible for, and makes no warranties whatsoever as to, the content of any third-party web site accessed via a hyperlink in this publication and such information is not incorporated by reference.

© Copyright Barclays Bank PLC (2011). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of BarclaysCapital or any of its affiliates. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London, E14 5HP. Additional information regarding this publication will be furnished upon request.

US08-000001

Barcap India_Capital_Goods 7 Dec 2011

Documents

Transcript of Barcap India_Capital_Goods 7 Dec 2011