Research Speak Week Ended – 19th June, 2010

Market Commentary
The Chinese authorities have signaled to the market that gradually the country will move out of the dollar peg
and would eventually have a currency which will reflect its personal demand supply scenario. This has been long
in demand by countries having significant current account deficits with China. This will help those countries (read
USA) in two direct ways. One, these countries will be now able sell their goods at a more competitive price in
Chinese currency, in China. Secondly, the Chinese goods sold in these countries will become more expensive and
hence would make domestic companies more competitive.

China’s decision to loosen the exchange rate and let the yuan appreciate has come as a positive surprise for the
global markets. Indian exports to EU and USA where China is a major competitor especially in categories like
textiles, engineering goods etc. would benefit. Indian capital goods companies like BHEL and L&T would be more
competitive for domestic orders in relation to Chinese companies as this sector is witnessing significant
competition from Chinese players. Flexible exchange policy has a positive impact on global commodity markets
with expectation of higher commodity imports from China and this should benefit major commodity players like
Sterlite, Sesa Goa where earnings are dependent upon higher commodity prices.

Our stance in our previous “Research Speak” recommending selective stock picking has been vindicated. In our
previous columns we had recommended investments in infrastructure and capital goods companies such as
BHEL, IVRCL, IRB infra etc. and these have shown good appreciation. Despite concerns on external front on the
back of negative new flow from Euro zone; Indian markets have given excellent returns with gains coming from
large cap stocks and few good quality midcap/small cap stocks. Indian markets have climbed the “wall of worry”
on the back of robust economic growth, expectation of good monsoon and improving fiscal situation. The recent
auction of 3G spectrums and wireless broadband would bring over Rs. 67,000 in the government’s kitty. This is
likely to reduce fiscal deficit as a percentage of GDP down by 0.8%. This will give significant elbow room for the
govt. take up planned fiscal expenditures resorting lower amounts of borrowings. This would keep the yields in
check and will make funds available for private players at a relatively lower cost.

There have been many steps taken by the govt. and proposals laid by planning commission and other govt.
authorities that can have a very positive effect on the creation of physical infrastructure of the country. We have
always been in dire need of physical infrastructure like roads, highways and power to support our growth, but
there has always been a problem of having proper funding schemes. Recently there was a proposal where foreign
funds can be directly infused in SPVs created for building up significant projects, which provides an alternative to
investing in companies executing these projects. This way investors can avoid risks like corporate governance,
funds diversion etc. There have also been talks where the projects will be put for bidding after making all the
regulatory clearance such that execution delays can be minimized.

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FIIs which were taking money out of India has again starting putting money in Indian markets and we would see
higher FII inflows during the year as India continues to perform on the economic front coupled with progress on
important policy reforms like Direct tax code, GST etc. We advise investors to stay invested and buy in every
correction.

Banking
Banking sector has been performing very well in the past few months. The run up has only faded in last week.
However, we still remain bullish on the financial sector where the prospects remain good and so are the
valuations. We continue to be bullish on well managed banks that have the scalability and capital to leverage
their return on assets to get the best possible ROE. We remain bullish on Bank of Baroda, PNB, Indian Bank, J&K
Bank, Federal Bank and South Indian Bank. These banks have healthy loan portfolio, less likely to throw up
uncomfortable surprises. The provision coverage remains at high levels, hence no significant hit would be felt on
the P&L. the return on assets has been good and is expected to improve once the demand for funds firm up. On
the cost front, a continuous focus on CASA would keep a check on the cost of funds. Moreover they have
garnered significant funds at lower rates and would finally reap the benefits in the form of higher NIMs. This
would help them to improve already high ROE of upwards of 20%. The valuations for these banks also remain
comfortable at levels less than 2 times. On the private banks front, we remain bullish about AXIS Bank which is
likely to expand its branches significantly which would shore up its CASA and reduce cost of deposits. It is also
making forays into asset management and insurance sector which would add up to the valuation. The
management is very competent and with Shikha Sharma at the top, we can expect a good performance from the
bank. The valuation might be a bit rich compared to other banks we discussed above, but being a private bank,
the valuation gap will persist.

Stock and Sector Update

Larsen and Tourbo

L&T’s significant presence in wide array of infrastructure sector activities makes it a proxy play on India’s
infrastructure opportunity. Likely spends in infrastructure is set to double in the XII plan to 1trillion$ from the
current envisaged 500 billion$ spend in the XI plan. Infrastructure investments are set to rise to 10% of GDP in
the XII plan period as against the 7.5% in the ongoing plan period. Rising infrastructure spends coupled with a
pickup in industrial capex will give a tremendous boost to the company’s engineering and construction business
in the next 5 years. We expect a high double digit growth in order inflows and order book growth in the next 2-3
years. Order inflows have been strong in FY10 (35% YoY growth), in particular Q4FY10(90% YoY growth) which
has resulted in a impressive 43% YoY growth in FY10 order book to Rs 1000 billion.

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Figures in Rs billion

Breakup of FY10 Order inflows and Order book

Source: Company Presentation.

Q4FY10 AND FY10 Result Summary.

Rs billion Q4FY10 Q4FY09 % chg FY10 FY09 % chg

Net sales 133.75 104.69 27.76% 366.75 336.47 9.00%
Total operational costs 115.34 91.21 26.46% 322.19 300.16 7.34%
EBIDTA 20.51 14.84 38.21% 48.16 39.22 22.79%
EBIDTA (%) 15.1 14 13 11.6
PAT 14.38 9.99 43.94% 43.76 34.82 25.67%

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Segment (Rs crore) Q4FY10 Q4FY09 % chg.
Engineering & Construction
Revenues 12109 9438 28%
EBIDTA 1847 1420 30%
EBIDTA margin(%) 15.2 15
Electrical & Electronics
Revenues 988 790 25%
EBIDTA 133 89 49%
EBIDTA margin(%) 13.4 11.3
MaChinery and Industrial Products
Revenues 682 621 10%
EBIDTA 143 109 31%
EBIDTA margin(%) 21 17.6

Q4FY10 saw better growth in sales of around 28% compared to growth seen in FY10 (9%) on account of better
execution. Despite higher manufacturing an operational costs, The company was able to improve it EBIDTA
margin by 1% to 15% due to higher operating leverage.

Robust order inflows in Q4FY10(90% YoY) and 43% YoY growth in FY10 order book( Rs 1 billion- almost 3x FY10
revenue) gives us confidence for strong earnings growth in the next two years. Higher sales growth of Q4FY10
indicates robust revenue growth in the medium term as execution picks up. We remain optimistic on the
prospects of the company given the high earnings visibility and the improved outlook of the infrastructure sector
. We advise long term investors to buy the stock on dips.

Infrast ructure Meet – Bangalore – Key Takeaways

Business Standard in association with IVRCL Assets & Holdings organized an Infrastructure Meet in Bangalore on
15th June 2010. The following were the honorable speakers:

? Mr. S. Jaipal Reddy, Union Urban Development Minister.

? Mr. Saumitra Chaudhuri, Planning Commission Member.
? Mr. V Madhu, Principal Secretary Infrastructure Development in Karnataka.
? Mr. B V N Rao, Chairman of GMR Energy
? Mr. S. Ramachandran, Managing Director of IVRCL Assets & Holdings Ltd.

The following were the highlights of the event:

? There are 300 million people living in urban areas as of now. The number is expected to reach 800 million
in the next 25 years. In this scenario, an enabling policy environment at both the state and central level is
required to match the growing urban need

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 ? There is a need for huge investment in the infrastructure sector that can’t be funded only by a state or
the central government. So, the public-private partnership (PPP) model is the answer to India’s emerging
need in infrastructure sector.
? Infrastructure spending, which is expected to be close to 9 per cent of the gross domestic product by the
end of the 11th Five-Year Plan, throws immense opportunities for the private sector for participation in
this emerging growth story.
? Land acquisition, rehabilitation and resettlement issues, water and other raw material linkage are some
of the issues that should be taken care of by the government for smooth execution of infrastructure
projects.
? S Ramachandran, managing director of IVRCL Assets and Holding Company, said the government should
show more preparedness before implementing projects. “Bids should be invited after land acquisition,
water linkage and other raw material sourcing provisions for smooth execution of any infrastructure
project,” he said.

Our View

We must appreciate the fact that the current government has made some remarkable progress in addressing the
issues and bottlenecks of infrastructure development in the country. But the fact remains the same that India still
need a lot of development in infrastructure. The deficit in infrastructure can only be filled with collaboration of
government and private players. PPP model has been put in place for a long time. But rather than being an
answer it has put forward a fresh set of questions and problems. Individual infrastructure companies, with strong
capabilities and technology, would continue to strive albeit all the bottlenecks. Their performance and earnings
would surely get reflected in their stock price . But Infrastructure development story is still a farfetched dream
and there is a long way to go.

IRB Infra and IVRCL Infra are the two stocks under our coverage. We continue to be bullish on the same.

Commodities Outlook
Steel

Global steel prices continued to weaken owing to we ak demand and shaky market sentiments. For the coming
few months, the expectations are that the sentiment is likely to remain pessimistic. Chinese demand might
decline further along with slowing of restocking activity. In addition to this, exchange rates would also remain
uncertain adding to the woes of the industry. The implications are that current crude steel production is well in
excess of immediate needs and that mills should close furnaces and delay re-openings. Already in Europe, Arcelor
Mittal is idling several blast furnaces, although others are still proposing restarts. Beltrame too is idling a number
of EAFs, while Riva is temporarily halting some rolling operations. In the US, Severstal North America has
temporarily halted steelmaking at one of its mills.

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Flat Products

Prices continued to weaken in most parts of the world, once again barring the European market. The demand
remained sluggish, with uncertainty in the currency market adding to the skepticism. The buyers were unwilling
to buy apart from immediate needs.

The domestic market thus remained in the grip of a downward trend owing to lack of buyer support. China may
cut or cancel export tax rebates on some steel products. Rebates for hot-rolled coil of 9 percent may be
eliminated and those for cold-rolled coil and galvanized products may be cut to 9 percent from 13 percent, the
official said. Chinese prices remained weak although the market stocks declined. Baosteel cut its July ex -works
prices sharply. It has cut HRC prices by RMB 300-500 per ton ($44-73 per ton), cold rolled coil prices by RMB 500-
1,000 per ton ($73-146 per ton) and hot-dip galvanized coil prices by RMB 300-800 per ton ($44-117 per ton), in
reflection of weak order bookings for its July delivery. As result, Baosteel’s Q235 5.5mm HRC ex-works price is
RMB 4,342 per ton ($636 per ton) non-VAT, while its SPCC 1.0mm CRC exworks price is RMB 5,525 per ton ($809
per ton) non-VAT.

Long Products

The long products market remained weak owing to weakness in demand and falling scrap prices. Stockists and
end users were concerned over the future market direction, which is leading to cautious and very little
speculative buying. The Indian market was marked by weak buying. The market sentiment is pessimistic and the
buyers bought to fulfill their immediate requirements. As per market sources, the prices have almost bottomed
out and a further fall would result in production cuts. However, some of the traders tried to push sales by
lowering their offers but the overall prices were more or less stable. Moreover, with the onset of monsoon, the
already slow construction activities would be even quieter. Thus, any recovery is unlikely before August, when
the construction activities will resume post monsoons. The Chine se market was on the weaker side. Although the
Chinese wire rod prices have remained relatively stable, market players doubt this will lead to a price recovery.
They cite the current weak buying activity and uncertainty in economic situations in China and abroad.

Steel to regain its lusture post Chinese yuan revaluation Announcement……………

As we have been discussing in the previous paragraphs that from the demand side there is slight lull in the both
domestic and international market as far as steel consumption is concerned. However, we feel post the
announcement by the Chinese central bank that it will allow a more flexible yuan, signaling an end to the
currency’s two-year-old peg to the dollar, it will bring in a paradigm shift in the sentiment for traders and
investors alike for all base metals.

The Chinese government has made it clear that it will progress slowly in relaxing the peg of yuan against the
dollar gradually over a period of time, this has several implications attached to it regarding the way china is
perceiving the growth in both the domestic and international market. With Yuan appreciating it would mean that
the import for China for goods denominated in US Dollar would become cheaper and Chinese export would
become relatively less competitive. This announcement indicate s that the Chinese authorities are consciously
trying to address the domestic inflation problem which was reported at 3.1 percent in May, which jumped to a

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19-month high. The bubble in the property market would also come down significantly as money in circulation is
likely to come down somewhat. On the same note it also means that the Chinese authorities are trying to boost
the domestic economy and reduce their exposure to international market. Thus going forward it is expected that
the country is going to give more emphasis on enhancing domestic consumption and try and increase the general
standard of living and per capital income so that the domestic consumption story becomes sustainable.

So far China has been an infrastructure led growth story, now the country requires to shift from capital formation
to capital utilisation and hence consumption. As such in the long term sectors like consumer durables,
Automobile, Real Estate, FMCG, Agriculture, etc., are going to be the sectors that are going to get thrust from the
government. Thus, with import becoming cheaper it would be generally good for all commodities and steel is not
going to be an exception. Thus, following this news development we expect the international commodities
market to remain buoyant as the sentiments in the international market is going to change favorably.

Impact of Chinese Revaluation of Yuan on Indian Steel Industry………………….

There are several factors that are going to keep Chine se Steel prices on the higher side. 1) Abolishion of export
tax rebate would mean the imported steel from China is going to be comparatively more expensive in the
international market, 2) yuan revaluation is going to make Chinese manufactured goods comparatively expensive
in the international market and steel is not going to remain an exception, 3) higher domestic consumption of
commodities by china is going to keep raw material prices on the higher side as the country strives to boost its
internal consumption which in turn means the finished goods prices are going to remain buoyant in the
international market.

Keeping these factors in mind it is expected that the domestic integrated steel players are going to be extremely
benefited from this move as imports from china is going to come down somewhat and by the virtue of being
backwardly integrated the cost of production is also going to remain under check. This would also make
domestically produced steel more competitive in the international market.

In light of the present development we once again have turned positive on the sector after having taken a call
to reduce exposure on the sector 1.5 months ago following the Chinese monetary tightening and Greece and
Euro Crisis.

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DISCLAIMER:
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Analyst Team

Analyst Name Sectors E-mail Contact Number

Samudrajit Gohain Oil & Gas, Engineering [email protected] +91- 9748860335
Kinshuk Acharya Steel, Agriculture [email protected] +91- 9681478735
Md. Riazuddin, FRM Banking, Economy, Power [email protected] +91- 9903062346
Rajiv Agarwal Auto, Tea, Sugar [email protected] +91- 9903076345
Ankit Kanodia Infrastructure [email protected] +91- 9163278562

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