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 Authoritys 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 the objectivity 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 US who are not registered/qualified as research analysts with FINRA. PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 155.
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
Summary of our Ratings, Price Targets and Earnings Estimates in this Report
Company Rating Old India Capital Goods ABB Ltd. (ABB IN / ABB.NS) Areva T&D India (ATD IN / AREV.NS) BGR Energy Systems Ltd. (BGRL IN / BGRE.NS) Bharat Heavy Electricals Ltd. (BHEL IN / BHEL.NS) Crompton Greaves Ltd. (CRG IN / CROM.NS) Cummins India Ltd. (KKC IN / CUMM.NS) Havells India Ltd. (HAVL IN / HVEL.NS) KEC International Ltd. (KECI IN / KECL.NS) Larsen & Toubro Ltd. (LT IN / LART.NS) Siemens Ltd. (SIEM IN / SIEM.NS) Thermax Ltd. (TMX IN / THMX.NS) Voltas Ltd. (VOLT IN / VOLT.NS) New Price 02-Dec-11 Old Price Target New EPS FY1 (E) EPS FY2 (E)
%Chg Old New %Chg Old New %Chg
0-NR 2-Neu N/A 3-UW N/A 2-EW N/A 3-UW N/A 3-UW N/A 1-OW N/A 1-OW N/A 1-OW N/A 1-OW N/A 1-OW N/A 3-UW N/A 3-UW N/A 3-UW 618.80 208.65 270.55 282.45 132.15 357.85 424.55 41.25 1310.75 723.35 469.70 92.10 N/A 494.00 N/A 193.00 N/A 241.00 N/A 230.00 N/A 147.00 N/A 428.00 N/A 502.00 N/A 72.00 N/A 8.50 N/A 7.60 N/A 42.00 N/A 27.00 N/A 6.90 N/A 18.40 N/A 27.80 N/A 5.70 N/A 66.20 N/A 27.90 N/A 32.00 N/A 6.40 N/A 19.80 N/A 9.70 N/A 40.30 N/A 28.30 N/A 9.10 N/A 20.40 N/A 34.90 N/A 7.10 N/A 73.00 N/A 32.10 N/A 32.60 N/A 6.60 -
N/A 1560.00 N/A 630.00 N/A 392.00 N/A 78.00
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
7 December 2011
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 governments 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

Investment cycle is decelerating and all end markets are now in a downturn
Our bottom-up analysis of more than 20 end markets suggests that Indias 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

For a new cycle to be created, constraints to ordering need to be removed
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.
7 December 2011
Figure 1:India Capital Goods sector derating has tracked changes to consensus earnings estimates
60% 40% 20% 0% -20% -40% -60% Aug-98 Mar-06 May-01 Aug-09 Dec-99 Sep-00 Sep-02 Feb-04 Nov-06 Dec-08 Nov-97 Oct-04 Jul-05 Jan-02 Apr-99 Jun-03 Jul-07 Apr-08 Apr-10 30.0 25.0 20.0 15.0 10.0 5.0 0.0
Change in 1 year fwd earnings estimates for the sector YoY

Source: Datastream, IBES consensus, Barclays Capital
12M fwd PE
Hyper-competition and margin risk

Key end markets going through a phase of hyper-competition
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
Our top picks are L&T, Cummins and Havells
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 Capitals outlook for key segments
Segment Power Boilers & Turbines Our outlook Our investment view
Segment in a downturn with more than 90% of planned Initiate on BHEL, BGR Energy and Thermax with 3-UW orders for Indias 12th five-year plan having already been ordered; expect 13th plan spend to commence, but several projects are still in the planning/approval phase 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 2EW and CRG and KEC with 1-OW
Transmission & Distribution Industrial Infrastructure
Expect market to remain weak with recovery now only in Siemens, ABB and L&T have exposure to industrial capex CY13 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
7 December 2011
Top picks
L&T 1-OW PT Rs1,560
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&Ts ability to grow its market share over the years is due to the companys 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 companys 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 companys site in Phaltan. End-market exposure is the best relative to peers, in our view, owing to the companys 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.
Havells 1-OW PT Rs502
Cummins 1-OW PT Rs428
Other 1-Overweight stocks

KEC International 1-OW PT Rs72
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 CRGs 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.
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Crompton Greaves 1-OW PT Rs147
7 December 2011
Figure 3: India Capital Goods summary of comparative valuations

Market Cap Ticker L&T BHEL Siemens Ltd. ABB Cummins Crompton Greaves Thermax Havells Areva T&D Voltas BGR Energy KEC International LT IN BHEL IN SIEM IN ABB IN KKC IN CRG IN THMX IN HAVL IN ATD IN VOLT IN BGRL IN KECI IN (US$ mn) 15,609 13,469 4,793 2,552 1,933 1,652 1,090 1,033 972 592 380 283 Liquidity Price Potential up/downside to PT (%) 19 -19 -13 -20 20 11 -17 18 -8 -15 -11 75 EPS (Rs) EPS growth P/E (x) P/B (x) EV/EBITDA ROE
US$mn/shr Rating Price target 69.4 29.1 3.4 1.8 2.8 12.6 1.6 3.6 0.8 3.4 4.8 0.3 1-OW 3-UW 3-UW 3-UW 1-OW 1-OW 3-UW 1-OW 2-EW 3-UW 3-UW 1-OW 1311 282 723 619 358 132 470 425 209 92 271 41 1560 230 630 494 428 147 392 502 193 78 241 72
FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E 66.9 27.0 27.9 8.5 18.4 6.9 32.0 27.8 7.6 6.4 42.0 5.7 73.8 28.3 32.1 19.8 20.4 9.1 32.6 34.9 9.7 6.6 40.3 7.2 15.0 9.9 11 184 -13.9 -52.1 -1 14.3 -3 -34 -6 -28 10.3 4.9 15 133 10.9 31.3 2 25.5 28 2 -4 25 19.6 10.5 26.0 72.9 19.5 19.1 14.7 15.3 27.6 14.3 6.4 7.3 17.8 10.0 22.5 31.3 17.6 14.5 14.4 12.2 21.6 14.0 6.7 5.8 3.2 2.8 5.4 5.1 4.9 2.3 3.7 5.4 4.4 1.9 1.7 1.0 2.8 2.3 4.6 4.4 4.3 2.1 3.2 3.8 3.8 1.7 1.4 0.9 12.7 5.4 14.8 31.3 15.6 9.2 7.4 8.6 13.4 18.5 4.3 5.9 11.5 5.3 13.0 16.6 13.9 8.0 7.1 7.3 10.9 17.6 4.3 5.0 16 27 21 7 25 12 25 35 16 13 26 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) Rs L&T BHEL Siemens Ltd. ABB Cummins Crompton Greaves Thermax Havells Areva T&D Voltas BGR Energy KEC International Max 47 36 38 48 25 31 33 25.9 33 35.3 27.6 19 Min 8 9 10 12 8 6 5 3.7 10 4.2 5.3 3 Average 21 19 24 28 17 17 17 14.2 20 16.0 13.1 11 Current 14 10 21 29 14 11 13 12 18 10 6 5 Rs 1560 230 630 494 428 147 392 502 193 78 241 72 Price target % diff from current price 19 -19 -13 -20 20 11 -17 18 -8 -15 -11 75 Rs 2488 350 900 900 499 182 625 697 300 132 337 86 Upside case % diff from current price 90% 24% 24% 45% 39% 38% 33% 64% 44% 43% 24% 107% Rs 817 208 334 247 204 91 171 278 97 28 88 36 Downside case % diff from current price -38% -26% -54% -60% -43% -31% -64% -35% -54% -70% -67% -14%
Note: Prices as of the market close on 2 December 2011. Source: Datastream, IBES Consensus, Barclays Capital estimates
7 December 2011
3-Underweight stocks
BHEL 3-UW PT Rs230
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 companys ability to make margins in the boiler and turbine segment, as well as fund the substantial capex plans ahead. We believe BGRs 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 ABBs 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.
Voltas 3-UW PT Rs78
Thermax 3-UW PT Rs392
BGR Energy 3-UW PT Rs241
ABB 3-UW PT Rs494
7 December 2011
Siemens 3-UW PT Rs630
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&E 2-EW PT Rs193
Areva T&D (2-Equal Weight; PT Rs193): Our PT is based on 20x CY12E earnings. While Areva T&Ds 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 companys 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 Indias 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.
7 December 2011
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
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.
Infrastructure investment in India remains in a downcycle
Figure 5: India infrastructure investment activity has remained muted since FY09
35% 31% 30% 25% 19% 19% 18% 17%15%18% 17% 20% 15% 12% 11% 15% 13% 10% 8% 10% 5% 3% 5% 0% -5% -4% -10% -7% -7% -9% -10% -15% 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
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
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Figure 6: India infrastructure new project initiations continue to decelerate

250% 200% 150% 100% 50% 0% -50% -100% Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10 Project investments added during the quarter
Source: CMIE, Barclays Capital
Figure 7: India infrastructure sector returns correlate with overall project investment activity in the economy
150% 100% 50% 0% -50% -100% Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10 60% 50% 40% 30% 20% 10% 0% -10%
Sector index return relative to sensex Project investments outstd at the end of the quarter
Source: CMIE, Datastream, Barclays Capital
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 Indias 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.
IIP deceleration suggests weak ordering for sector ahead Stock prices track IIP and reflect a similar trend
Figure 8: India Capital Goods capital goods returns momentum correlates with trends in IIP
250% 200% 150% 100% 50% 0% -50% -100% Mar-95 Nov-96 Jul-98 Mar-00 Nov-01 Jul-03 Mar-05 Nov-06 Jul-08 Mar-10 Capgood index YoY
IIP = Indias Index of Industrial Production Source: MOSPI, Datastream, Barclays Capital
70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30%
IIP capgoods 3mma YoY (RHS)
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.
7 December 2011
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Figure 9: Boiler & Turbines segment has the weakest market growth 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
7 6 5 4 3 2 1 0 Defence T&D international Mining equipment Railways Buildings and factories Oil and Gas overseas lighting T&D domestic Construction equipment Roads Medical equipment Water/waste Boilers and turbines Wind Industrial Cement & Steel Fans Tower Airports/Ports HVAC BOP
12
End market cycle outlook

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 BHEL Thermax Cethar Vessels L&T ABB KEC Havells Areva T&D Management comments 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). Does not expect any major improvement in orders. Pace of finalisation of orders is very slow. Coal linkages impacting order inflows. Hasnt received any orders post SKS Ispat power order. Cautious on order inflows. Revised down its order inflow target to 5% y/y growth. Pricing environment for T&D orders remains weak. Does not expect any further deterioration in prices though. Positive on demand environment. 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. Continues to see Europe as a flattish market. Margin recovery on track. 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. Positive on ordering but believes competition is stiff. Some foreign competitors setting up manufacturing base in India. Has an order enquiry of Rs40-50bn although does not see acceleration in order intake. 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. 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. Revised down guidance for September quarter. Concerned about competition in low KVA segment and impact of diesel prices on demand. Positive on prospects in India. Plans to set up manufacturing facility in India. Several orders in pipeline but pace of finalization of orders slow. Ordering in steel and wind weak. Public sector ordering has weakened. Positive on BOP ordering. Has an order pipeline of more than Rs30bn. Also bidding for orders in waste heat recovery segment.
Hyosung Elecon Engg Voltas Cummins Kirloskar Oil Dongfang BGR Energy Shriram EPC Tecpro
Source: Company data, Barclays Capital
7 December 2011
AC
Power: More than 95% of ordering has already been completed

Bulk of 12th plan orders awarded
Our bottom-up analysis of ordering for the past five years suggests that more than 95% of the planned orders for the Indian governments 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 Boilers and turbines Market size (Rs bn) Our Comments 20 Segment in a downturn with more than 90% of planned orders for Indias 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) T&D domestic substation 20 10 Expect strength in ordering for next 12 months followed by cyclical weakness. 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 Transmission tower Nuclear segment 100 4 8 Expect flattish growth. Some recovery in ordering for wind transformers. Flattish market expected. Ordering from most of the BOOT projects still pending. 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.
Expect market ordering to decelerate
Figure 12: India Capital Goods sector order inflow growth to decelerate
35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar12E YoY Mar13E 50% 0% -50% 17680 27047 30000 30000 30000 25000 20000 250% 200% 150% 100%
Industry ordering MW
Source: Company data, Barclays Capital estimates
7 December 2011
13
Figure 13: India Capital Goods more than 95GW of orders meant for 12th Five Year Plan already awarded
Plant Athena Chhattisgarh TPP Bajaj Hindustan - Lalitpur Barh II units 1 and 2/Barh TPP 1 Dainik Bhaskar East Coast TPP JPA Karchana, Prayagraj/Nigri Raichur Krishnapatnam 1/2 Mahagenco - Koradi Nagarjuna CC TPP 1 Rajpura TPP - Nabha Power Krishnapatnam/Chitrangi/Tilaya Thermal Powertech TPP 1 Tiroda/Kawai Amarkantak 3/4 Bellary TPS NTPC bulk tender GMR (SJK powergen) Shadol Vidharbha Mettur/Kalisindh Abhijit -/Adhunik Kaktiya TPP, Rayalseema Bina Power TPP Chandrapur TPP Dainik Bhaskar Power Ind Bharat TPP Indiabulls Amravati 1-2, Nashik 1-2 Jhabua Power TPP, Angul, Malwa TPP Jindal power Jindal TPP Kalisindh TPP KPCL - Bellary/Surana Power KVK Neelanchal TPP Marwah TPP unit 2 Mauda TPP/Ideal Energy Rihand TPP3, NTPC jhajar, DVC Bokaro RKM Powergen TPP Singareni Collieries Co Limited (SCCL) SKS Ispat Tuticorn JV Vindhyachal TPP 1V, Korba Visa Power - Raigarh Wardha TPP 1 Sagardighi Tori , Salay , Navbharat, Mahan Capacity MW (MW) configuration Technology 1320 1980 3300 1320 1320 4620 1600 1600 1320 1320 2100 9940 1320 1980 1320 700 7200 1320 1320 1980 1620 1200 500 1000 1200 700 5400 1950 2400 1200 1200 700/420 1000 1000 1590 1500 1440 1200 1200 1000 1600 1200 1800 1000 7920 660 660 660 660 660 660 800 800 660 660 660 800 660 660 660 660 800 660 660 660 270/540 600 250 500 600 350 270 300/500 600 600 600 700/420 500 500 525/540 500 360 600 600 500 500 600 600 500 600 Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Supercritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical Subcritical State Chhattisgarh Uttar Pradesh Bihar Madhya Pradesh Andhra Pradesh Various locations Karnataka Andhra Pradesh Maharashtra Andhra Pradesh Punjab Various locations Andhra Pradesh Maharashtra/Rajasthan Uttar Pradesh Karnataka Various locations Madhya Pradesh Madhya Pradesh Tamil Nadu/Rajasthan Jharkhand Andhra Pradesh Madhya Pradesh Maharashtra Chhattisgarh Orissa Amravati Madhya Pradesh Chhattisgarh Orissa Rajasthan Karnataka Orissa Chhattisgarh Maharashtra UP/Haryana/Jharkhand Chhattisgarh Andhra Pradesh Chhattisgarh Tamil nadu Madhya Pradesh Madhya Pradesh Chhattisgarh West Bengal Various locations GMR Lanco TNEB/RRVUNL Abhijit I/Adhunik Apgenco Bina Power Limited Mahagenco Dainik Bhaskar group Ind-Bharat Energy Utkal Ltd Indiabulls Power Jhabua Power/MPCL Jindal Power Jindal India TPL Rajya Vidyut Utpadan Nigam KPCL/Surana power KVK Nilanchal Chhattisgarh SEB GMR Energy/Ideal Energy NTPC/DVC RKM Powergen Corp SCCL SKS Ispat Power Projects Neyveli Lignite NTPC/Avantha Visa Power Wardha Power Limited WPCDL Essar Power Developer Athena Chhattisgarh Power Bajaj Hindusthan NTPC DB Power East Coast Energy Jaiprakash BHEL state JV APgenco Mahagenco NCC L&T R Power Thermal Powertech Corp Adani Power Lanco KPCL
Note: Supercritical: Sets above 660MW size; Subcritical = sets below 600 MW size. Source: CEA, Barclays Capital
7 December 2011
14
Order pipeline still in early stages of planning

Our analysis of more than 110GW of the order pipeline suggests that the projects are 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 Ramagundam Stage-IV Pudimadka Badarpur Expansion Kawas and Gandhar North Karanpura Vindhyachal-V Barethi Khargone Gadarwara Talcher Kaniha Talcher TPP Anta Stage II Marakkanam Singrauli III Feroze Gandhi Unchahar TPP Stage-IV Tanda Expansion Bilhaur Auraiya Capacity (MW) 1,000 4,000 1,050 1300 1,980 500 3,960 1,320 1320 500 1,320 1050 4,000 500 500 1,320 1,320 1400 State Status
Andhra Pradesh Under active consideration. Application for coal linkage put. Andhra Pradesh Project conceived in late 2010- Early stage (i.e. no land/coal) Delhi Gujarat Jharkhand Gas allocation awaited Gas projects. Tender floated in Apr 2011 Decision on location pending for over a decade. A three member panel set up by GOI to resolve the issue
Madhya Pradesh Bids invited (in Oct 2010) but no award as yet Madhya Pradesh DPR being prepared. Site specific clearances and in progress Madhya Pradesh Site selection work commenced. Coal linkage applied. Issue with land emerged in 2010 (largely compensation related) Madhya Pradesh TOR issued in Jan 2011. Was earlier a 2640MW project. Approvals awaited Orissa Orissa Rajasthan Tamil Nadu Tenders awaited Tenders awaited Gas allocation awaited , Approvals awaited NA
Uttar Pradesh Coal linkages applied and awaited Uttar Pradesh Moef clearance awaited (is an expansion of 1050MW project) Uttar Pradesh NA Uttar Pradesh Decision taken in Jan CY11 Uttar Pradesh Approvals awaited
Source: NTPC Ltd., Damodar Valley Corp., Barclays Capital
While more than 50GW of state projects are in the pipeline; Funding will be an issue. Some could convert to JVs
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 Yerasmus Edlapur Udangudi Latur Khandwa Orissa, AP, Tripura
Source: BHEL, Barclays Capital
Capacity JV partner Status 1,600 800 1,600 1,320 N/A KPCL KPCL TNEB MPCL N/A Order awarded in FY11. Coal linkage awaited Order awarded in FY11. Coal linkage awaited Order expected in 3Q/4Q FY12 Inducting a strategic partner Under discussions
1,320 Mahagenco Gas based project of 15GW in case coal becomes an issue. Land acquisition is taking place
7 December 2011
15
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 Latur ( BHEL JV) Buxar TPP Lakhisarai TPP PirpaintiTPP Kuchhadi TPP Sinor TPP Dahej TPP Kanpa TPP Gondia TPP Mendki TPP GNDTP Bhatinda Ext Stage-II Obra TPP Sonebhadra TPP Anpra TPP Adra TPP Godhna TPP (KPCL) Vadarevu TPP Stage-I Bunji Bundeli TPS Korba South TPP Vijayawada IGCC - BHEL Satupally TPS Udangudi- BHEL JV Ennore TPP Khandwa BHEL JV Shahpura TPP Jharsuguda Bhusawal TPS Nashik TPP Dhopawe TPP Dondaicha TPP Gidderbaha TPP Banswara TPP KaliSindh Phase-II Ennore TPP Katwa TPP Wanakbori TPP Extension. Yamuna Nagar Jewargi TPP Bakreswar State Maharashtra Bihar Bihar Bihar Gujarat Gujarat Gujarat Maharashtra Maharashtra Maharashtra Punjab Uttar Pradesh Uttar Pradesh Uttar Pradesh West Bengal Chattisgarh Andhra Pradesh Chattisgarh Chattisgarh Andhra Pradesh Andhra Pradesh Tamilnadu Tamilnadu Madhya Pradesh Madhya Pradesh Orissa Maharashtra Maharashtra Maharashtra Maharashtra Punjab Rajasthan Rajasthan Tamil nadu West Bengal Gujarat Haryana Karnataka West Bengal Status MOU for JV signed in Late CY10. Approval process commenced Approval awaited from CEA Approval awaited from CEA Approval awaited from CEA Project under planning stage Project under planning stage Project under planning stage Project under planning stage Project under planning stage Project under planning stage Coal linkage applied for and awaited Coal linkage applied for and awaited Awaiting approvals and linkage Awaiting approvals and linkage Awaiting approvals and linkage Awaiting clearance from Moef JV between NTPC and Railways Coal linkage has been applied. Coal linkage and approvals awaited Tender issued for DPR. Clearance to be taken later. Coal linkage applied for. Tender issued for DPR. Clearance to be taken later Coal linkage and others approvals awaited Water and coal linkage awaited Awaiting approvals and linkage Awaiting environment clearance. (EPC tender floated) Land acquisition in progress Clearances awaited Clearances awaited and land for ash disposal not yet obtained Land acquired Converted to supercritical from subcritical earlier Approval received Coal available for the first two units . Awaited for others. Project to be executed by NTPC and MoU signed in late 2010 NA DPR to commence Tender for EPC was floated. Now converted to supercritical hence delay in ordering. Project now with NTPC. Some land acquired NA NA NA NA Capacity (MW) 1,320 1,320 1,320 1,320 3,200 1,600 1,600 1,320 1,320 1,320 500 500 1980 1320 1320 1,320 1,600 1,600 500 1,000 182 600 1,600 1,600 1,600 1320 1,320 660 660 1,980 3,330 2640 1,320 1,320 1,600 1,600 800 660 1,320 660
GHTP Lehra Mohabbat Ext Stage-III Punjab
Source: CEA, state utilities, Barclays Capital
7 December 2011
16
Figure 17: India Capital Goods Among Indias Independent Power Producers, more than 40-50GW of orders are in the pipeline with several projects in the 12th plan already awarded
Name Adhunik Group Ahijit Infra Adhunik Group GMR Chhattisgarh KSK Narmada Moser Baer Chhattisgarh Adani-Bhadreshwar Dahej Dahej Expansion Mundra Phase-II Adhunik Jharkhand Phase II Indiabulls Jharkhand CPP (Tata Steel) Maithon Phase-II Tiruldih Gulbarga Power Plant Coastal Maharashtra Adani-Chindwara India Bulls-Chindwara Annupur Phase-II Dhenkanal TPP KS K Naraj Marthapur CPP Naraj Marthapur IPP Wardha Naini TPP Indiabulls Mansa TPP - Phase-I Bara Phase II Karchana Phase II CESC-Balagarh
Source: CEA, Company data, Barclays Capital
State Bihar Bihar Chhatisgarh Chhatisgarh Chhatisgarh Chhatisgarh Gujarat Gujarat Gujarat Gujarat Jharkhand Jharkhand Jharkhand Jharkhand Jharkhand Karnataka Mahrashtra.
Status Environment clearance awaited. Land in possession Environment approval awaited Environment clearance awaited. Land in possession Environmental issue has emerged Current in planning stage Pre-developmental work on NA NA NA In Planning stage Approvals/linkages obtained NA NA Under planning Land acquisition in progress BOOT model - Bids invited NA
Total expected capacity (MW) 1,320 2,640 1,320 1,370 1,800 1,320 3,300 1,980 660 1,600 540 1,320 500 1,320 1,980 1,320 2,400 1,320 2,640 1,320 1320 1,800 1,200 1,320 1,800 540 1,320 660 1320
Firm Adhunik Group Abhijit Group Adhunik Group GMR KSK Energy Moser Baer Adani Power Adani Power Adani Power TATA Power Adhunik Group Indiabulls Power TATA Power TATA Power TATA Power KPCL - BOOT TATA Power Adani Power Indiabulls Power Moser Baer CESC KSK Energy TATA Power TATA Power KSK Energy Indiabulls Power JVPL JVPL CESC
Madhya PradeshNA Madhya PradeshNA Madhya PradeshNA Orissa Orissa Orissa Orissa Orissa Punjab Coal linkage awaited Under planning NA Land acquisition in progress Planning stage NA
Uttar Pradesh Land yet to be acquired Uttar Pradesh Land not available as yet West Bengal Coal linkage awaited; targeted for 2016
7 December 2011
17
Coal a structural issue; risk for the sector

Coal approvals speeded up, but structural shortage difficult to resolve
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 2009 Progress on change in policy on no go areas for coal mining 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 Jul-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 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
We expect a shortfall in coal of more than 30% by FY15
Figure 19: India Capital Goods Supply and demand outlook for domestic coal
100% 80% 60% 40% 20% 0% FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E
Supply- Demand for domestic coal

Source: Coal Ministry, Coal India, Barclays Capital estimates
Companies have started booking orders without linkages

BHEL has booked several projects 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.
7 December 2011
18
Figure 20: India Capital Goods several orders booked by BHEL in FY11 do not have coal linkages
Plant Edlapur TPP Bellary TPS Yerasmus TPP Lalitpur power Sagardighi
Source: Coal Ministry, BHEL, Barclays Capital
Utility BHEL - KPCL JV KPCL BHEL - KPCL JV Bajaj Hindusthan WBPDCL
Supplier BHEL BHEL BHEL BHEL BHEL
Capacity (MW) 800 700 1,600 1,980 1,000
Figure 21: India Capital Goods cases in which LOA were cancelled. BHEL is implementing these plants
Project Muzaffarpur TPP Stage II Farakka Stage III Bokaro TPS A
Source: Coal ministry, BHEL, Barclays Capital
Utility NTPC NTPC DVC
Capacity (MW) 390 500 500
Location Bihar West Bengal Jharkhand
BTG BHEL BHEL BHEL
Date of award 2010 2008 2009
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
20 18 16 14 12 10 8 6 4 2 0 19 13 10 6 4 2 3 1 4 2 7 5 3 2 2Q-2011 3Q-2011 4Q-2011 1Q-2012 2Q-2012 7 7 10 9
Figure 23: India Capital Goods Sharp increase in substation tenders

16 14 12 10 8 6 4 2 0 14 11 9 6 4 4 4 3 4 2 7 7 7 6 9 9 7 5
1Q-2008 2Q-2008 3Q-2008
4Q-2008 1Q-2009 2Q-2009 3Q-2009 4Q-2009 1Q-2010
2Q-2010 3Q-2010 4Q-2010 1Q-2011 2Q-2011 3Q-2011
1Q-2008 2Q-2008 3Q-2008 4Q-2008
1Q-2009 2Q-2009 3Q-2009 4Q-2009 1Q-2010 2Q-2010 3Q-2010 4Q-2010 1Q-2011
Transformer or Reactor- No of tenders

Source: Powergrid Corporation, Barclays Capital
Substation EPC- No of tenders

Source: Powergrid Corporation, Barclays Capital
7 December 2011
4Q-2011 1Q-2012 2Q-2012

19
CONVERTING PLANS INTO ORDERS IS CRITICAL

A strong potential lies ahead, but the pace of conversion of these 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. Indias 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 Airports/ports 13 5 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. 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. The pace of ordering has been slower than before but no downturn as yet. Flattish trend; no major acceleration expected. Order growth decelerating due to weak infrastructure and real estate builds. 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.
Real estate/broad construction Mining equipment Construction equipment HVAC
30 0.4 2 25
Source: NHAI, Indian Railways, Barclays Capital
7 December 2011
20
Metro investments
Expect several metro projects to be executed in the coming years
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 Hyderabad Mumbai Kochi Bangalore Bangalore Kozhikode Trivandrum Bangalore Delhi Jaipur Indore Patna Jodhpur Chennai Thane Thane Ahmedabad Ahmedabad Ahmedabad Chandigarh Ludhiana Project type Metro Metro Metro Mono Rail Airport Link Mono Rail Mono Rail Metro phase 2 Metro phase 3 Metro Mono Rail Mono Rail Mono Rail Mono Rail Mono Rail Metro Metro Metro link Mono Rail Metro Metro Cost (Rs bn) 150 NA 30 36 66 10 30 250 280 20 n.a. n.a n.a n.a n.a na 70 na 50 150 87 na na na 111 30 10 40-50kms na na 52 29 Length (km) 72 40 26 60 37 23 28 18 105 Status PPP awarded; secondary orders for coaches, electrification to be awarded in FY13 In planning stage. Expected to be implemented over 2016-2021 ICB to be done for awarding project implementation work Not ordered as yet. Project viability an issue. Not ordered as yet Proposed Proposed Process of preparation of DPR Tendering has commenced Construction in progress. 35% of civil engineering work completed Feasibility study commenced Ground survey to be conducted by RITES Scomi to conduct feasibility study Bidding commenced; 4 mono rail lines in first phase Under planning Under planning Work to commence in FY13 in two phases Planning stage Planning stage In three corridors In BOT route
Source: Various news reports, DMRC, India infrastructure, Barclays Capital
Railways
Dedicated freight corridors and railway station modernization are the key areas of spend
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 New lines Doubling Metropolitan transport High-speed corridors Upgrading of stations Passenger coaches Wagons Diesel locomotives Electric locomotives
Source: Indian Railways Vision 2020, Barclays Capital
Until FY12 100 60 94.5 0 12 stations 110 101 72 67
From FY13-20 1,700 1,240 510 2,000 38 stations 714 765 487 581
7 December 2011
21
Airport investments
Largest Airport to be bid out next year is the one in Navi Mumbai
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 Maharashtra Maharashtra Maharashtra Uttar Pradesh Uttar Pradesh Punjab Karnataka Karnataka Karnataka Karnataka West Bengal Arunachal Nagaland Madhya pradesh Rajasthan Goa Kerala Andhra Pradesh Pondicherry Middle East City Navi Mumbai Nagpur Sindhudurg Kushinagar Jewar Airport Noida Ludhiana Shimoga Gulbarga Bijapur Hassan Durgapur Itanagar Cheitu Dabra Paladi Mopa Kannur Hyderabad Karaikal Cost (Rs bn) Status 96 Environmental clearance received in FY11; expected to be ordered in late FY13; EPC order may not be expected in FY13 26 Development work under way 2 Already awarded to IRB 8 Clearances obtained 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 30 NA 1.0 Land of about 660 acres acquired; work on project has commenced 1.0 About 670acres of land acquired; construction work has commenced 1.0 About half of the land acquired (total 720 acres required) 0.7 More than half of land acquired (total of 960 acres required) 3.5 Airport work will cost Rs1.6bn of which contracts worth Rs1bn has already been awarded 10 In planning stage 10 DPR approved by state government Approval granted to Gwalior Agriculture Company; will be a cargo airport Partnered with Fraport AG for airport development 25 Through PPP route; bidding has not yet commenced 13 1280 acres of land acquired 10 New terminal planned after FY15 2.5 Approval granted 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 Defences 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$80bn in projects
Navy Items Diesel submarines Nuclear submarines Aircraft carriers Corvettes Destroyers Frigates No. 6 "3-5" 2 8 4 7 Value (US$bn) 21.0 9.0 0.5 2.0 3.3 8.0 Items Aircraft Su-30 MKI Multirole combat Aircraft LCA (Tejas) Fifth generation fighter aircraft Medium and Heavy lift Helicopters Basic trainer Aircraft 117 181 Air force No. 140 126 120 Value (US$bn) 9 10 2.2 10 3.2 6
Source: Confederation of Indian industry, Deloitte Touche Tohmatsu India, Barclays Capital
7 December 2011
22
Recovery in industrial capex likely to be late in the cycle

Industrial capex recovery will emerge after infra recovery pans out
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$50bn in projects are in the pipeline; however, our channel checks suggest that tendering in the steel segment near term is weak. Key projects include Poscos 12mtpa integrated steel facility in Orissa valued at Rs500bn, Arcelor Mittals 6mtpa project in Jharkhand and a 6mtpa project in Karnataka with an investment of more than Rs500bn, Bhushan Steels project in Bengal, and Tata Steels projects in Chhattisgarh and Karnataka.
Figure 29: Industrial Capex spending like to come late in the cycle
Market size (US$bn) 2
Industrial Cement and steel
Comments 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 Consumer/others Medical equipment Lighting Overseas lighting Fans Air conditioners Defence Wind
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
0.7 75.0 0.4 0.8 8 35
We expect mid-teen growth Continues to remain strong; we expect mid-teens growth No deterioration in pricing or volumes; we expect growth to be flat Sharp slowdown in demand this year; market growth in single digits Market growth has sharply moderated due to weak summers and increase in interest rates Do not expect any increase in ordering to private Indian vendors 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.
7 December 2011 23
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 Indias national Planning Commission, with the secretaries of various states and the RBIs 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.
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24
Figure 30: Indias 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 Delhi Chattisgarh Gujarat April 2011: 20% avg. hike Aug 2011: 22% avg. hike April 2011: 15% hike (22% increase for domestic consumers and 12% for industrial) April 2010: Avg. 2.36% increase Sep 2011: 4-5% avg. hike Rajasthan Maharashtra Sep 2011: 20% avg. hike 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 Punjab Aug 2010: 22% hike 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 Jharkhand April 2010: 20% hike 15-50 paisa plus increase in fixed tariff by 12-40 per month
Source: State utilities, Barclays Capital
7 December 2011
25
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 bottomup 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
In the first phase of the down cycle revenue growth was impacted but margins held up due to a healthy order book
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, BHELs 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.
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

40% 37% 33% 35% 30% 31% 28% 30% 25% 20% 17% 20% 15% 14% 15% 10% 10% 9% 9% 8% 10% 6% 5% -1% 0% -5% -2% Mar98 Mar 99 Mar 00 Mar02 Mar03 Mar04 Mar05 Mar06 Mar07 Mar08 Mar 01 Mar 09 Mar 10 Mar11 Mar12 E Mar 13 E Mar14 E
Figure 32: but margins have been holding up well

16% 14% 12% 10% 8% 6% 4% 2% 0% Mar97 Mar98 Mar 99 Mar 00 Mar 01 Mar02 Mar03 Mar04 Mar05 Mar06 Mar07 Mar08 Mar 09 Mar 10 Mar11 Mar12E Mar13E Mar14E EBITDA Margin
Revenue growth yoy

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26
Figure 33: End-market competitive outlook a bottom-up analysis of the supply chain
End market Boilers and turbines Comments based on supply chain survey 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 T&D domestic Capacity still constrained as labour availability is a key challenge; pricing is stable 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. No major change in competitive intensity Chinese actively participating in bids 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. 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. 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). Engine pricing largely stable and although demand is decelerating, pace of decline lower than powergen. No major competition from Chinese also helps 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) Competition for BOT orders expected to be stiff. Execution is considered critical; hence, pricing environment not deteriorating. Margins will still be below that of manufacturing/industrial orders (5-7% range). Stiff competition for orders expected. Voltas has brought down bidding EBITDA margin targets to 5% vs. last years 9% margins in MEP segment. 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. Not many orders in Cement and Steel but price competition not irrational. 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. Scope for product differentiation is high hence price competition not as intense Pricing typically stable in the market. Warranties, life of product key differentiating factor. Stable pricing trends in Europe Competition stiff especially with market slowing down Stiff competition. High inventory in the channel. Price discounting expected. Very few competitors in India. Pricing/margins stable Pricing trends stable this year. Expect pricing to deteriorate due to excess global capacity Not much price competition Largely an unorganized market. Competition for BOOT Desal projects stiff but general contracting work not as competitive
T&D international Transmission tower
Power back up
Mining equipment Construction equipment Railways
Airports/ports Real estate/broad construction HVAC Other industries Cement and steel Oil & gas
Medical equipment Lighting Overseas lighting Fans Air conditioners Defence Wind Biomass Water and waste
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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
Pricing pressure highest in BTG segment, followed by HVAC
7 6 5 4 3 2 1 0 High Domestic competition High foreign competition
T&D domestic
Transmission
Water/waste
overseas lighting
Construction
Boilers and
Defence
HVAC
BOP
AC
Buildings/factories
Oil and Gas
Airports/Ports
Railways
Industrial
Lighting
Mining equipment
T&D international
Competitive outlook
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

BGR and BHEL have exposure to the worst placed end markets
30 25 20 15 10 5 0 L&T Crompton Greaves ABB Havells Areva &D Cummins
28
Voltas
Thermax
KEC
Relative exposure to best end markets - High score= better exposure

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
Siemens
BGR
BHEL
Cement & Steel
Biomass
Medical
Roads
Wind
Fans
Figure 36: Comparing EBITDA margin estimates for FY12E with past trends; BHEL, BGR Energy face risk of margin downside
Past 10 year EBITDA margin Maximum BHEL L&T ABB Siemens Crompton Greaves Thermax Voltas Cummins Havells KEC BGR Areva T&D 20 14 12 14 17 13 10 19 13 13 11 18 Average 18 11 9 10 11 11 6 15 8 9 11 11 FY12E 19 12 6 13 9 11 5 14 10 8 12 9 FY12E vs. maximum -1 -2 -6 -1 -8 -2 -4 -4 -3 -5 1 -8 FY12E vs. Average 2 1 -2 2 -2 0 -1 -1 2 -1 1 -2 Potential risk of downside from current estimate High Medium Low High Low Low Low Low Medium Medium High Low
Figure 37: India Capital Goods end-market exposure as a percentage of revenues

(%) End markets Power Industrial Infrastructure Boilers and turbines Balance of plant T&D domestic T&D international Transmission tower Mining equipment Construction equipment Railways Roads Airports/ports Real estate HVAC Other industries Cement and steel Oil and gas Medical equipment Lighting Overseas lighting Fans Air conditioners Defence Wind Water and waste
BHEL 85 15 0 60 20 5
L&T 40 32 28 20 10 10
ABB Siemens 60 40 0 45 45 10
CGL Thermax Cummins Havells 80 10 10 70 20 10 50 20 0 55 45 14 20 67
BGR 100 0 0 80 20
Voltas Areva T&D KEC 0 10 90 100 100 0 0 0 0
60
30 15
35 40 5
14
100
0 50 50
2 5 7 5 5 15 17 5 10 5 30 10 30 15 10 10 10 5
5 5 5 5 20 35 20 20
10 10 40 10
8 50 10 2 5 2 10 8 25
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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 2535GW 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 details BHEL L&T MHI Thermax BGR Energy Cethar Vessels Doosan GB Engg- Ansaldo Industry capacity Capacity ex-Cethar/GB Demand
Investment (Rs mn) Technology Alstom MHI 7,000 15,000 5,000 B&W Hitachi Ansaldo Engg Doosan-Babcock Riley Power
Capacity (GW) FY10 FY11 FY12E FY13E FY14E FY15E Status 10,000 15,000 15,000 20,000 20,000 20,000 Expansion from 15-20GW under way 0 4,000 4,000 4,000 4,000 4,000 Capacity already set up in Gujarat 1,500 1,500 4,500 4,500 4,500 4,500 Capacity to be set up in Gujarat 0 0 4,000 4,000 4,000 4,000 Capacity to be set up in TN. Land identified 0 0 0 3,000 3,000 To set up capacity in TN
No JV 51:49 51:49 74:26 No JV
0 8,000 8,000 8,000 12,000 12,000 8GW capacity already exists 0 1,000 1,000 1,000 1,000 2,000 2,000 In a court case with NTPC 12,500 29,500 36,500 41,500 49,500 49,500 11,500 20,500 27,500 32,500 35,500 35,500 30,000 30,000 25,000 20,000 25,000 30,000
Figure 39: Turbines supply/demand assessment: supply to exceed demand

JV details BHEL L&T MHI Toshiba - JSW BharatForge - Alstom BGR Energy - Hitachi Industry capacity Demand
Investment (Rs mn) Technology Siemens MHI 8,000 24,000 30,000 Toshiba Alstom Hitachi FY10
Capacity (GW) FY11 FY12E FY13E FY14E FY15E Status
No JV 51:49 74:26
10,000 10,000 15,000 20,000 20,000 20,000 0 0 0 0 4000 0 0 0 4000 0 0 4000 4,000 3,600 5,000 4,000 4,000 3,600 5,000 4,000 4,000 3,600 Capacity set up in progress (near Chennai) 5,000 Capacity expected in Gujarat 4,000
10,000 14,000 23,000 36600 36,600 36,600 30,000 30,000 25,000 20,000 25,000 30,000
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Pricing in a free fall; difficult to make margins at current prices

Pricing was firm prior to FY11 due to visa restrictions that impacted Chinese projects and limited competition from domestic vendors
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&Ws 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 Rs67mn/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.)
Pricing started deteriorating in September 2011
Prices have declined by more than 30% over past year
Figure 40: Generation Equipment pricing of orders 4Q FY08-4Q FY11: pricing has declined about 30% in the past year
MW Date 4Q FY08 5-Aug-08 30-Jun-08 23-Oct-08 12-Aug-09 3-Nov-09 24-Nov-09 Supplier BHEL BHEL L&T BHEL L&T L&T BHEL 30-FY11 BHEL 5-Oct-11 NTPC bulk tender 4Q FY11 2Q FY12 2Q FY12 Chinese bids Abhijeet group Reliance Power Lanco Dongfang Shanghai Electric Harbin Power 6600 23760 10560 10X660 36X660 16X660 BTG BTG BTG 11,2500 3,73,500 68,300 17 16 6.5 Bharat Forge-Alstom Doosan heavy BGR Energy-Hitachi 7260 7200 7200 11X660 TG 33,000 66,000 32,320 12 Bharat Forge to get 5 sets, BHEL 4 and Toshiba 2 sets 9X800 Boiler+Aux 9X800 TG 17 Doosan to get 5 sets rest to BHEL 10 BGR to get 4 sets, BHEL to get 3 sets and 2 sets BHEL rating 1320 1600 1600 660 1320 1980 1920 1980 1320 660 2X660 3X660 3X660 3x660 2X660 No of sets 2X660 2X800 Nature Boiler Boiler TG+Aux TG BTG BTG BTG BTG BTG Order value (Rs mn) 25,000 25,000 15,570 14,740 40,000 68,970 56,000 54,500 37,829 Rs mn/MW Client 19 NTPC- Barh II 16 APPGCL Krishnapatnam 10 APPDCL 22 NTPC 30 Jaiprakash 35 Mahagenco 29 Jaiprakash-Prayagraj Power 28 Lalitpur Power Gen Co 29 Dainik Bhaskar Power(DBPL)
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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 Capacity (MW) Price (Rs mn/MW) Utilisation (%) Revenue Material cost Employees cost Other exp OBITDA OBITDA margin Interest Depreciation PBT PBT margin ROE (%) Scenario 1 4000 9.5 30% 11400 7200 2400 2400 -600 -5.3% 2520 1500 -4620 -41% -36% Scenario 2 4000 9.5 35% 13300 8400 2400 2800 -300 -2.3% 2520 1500 -4320 -32% -34% Scenario 3 4000 9.5 40% 15200 9600 2400 3200 0 0.0% 2520 1500 -4020 -26% -31% Scenario 4 4000 9.5 45% 17100 10800 2400 3600 300 1.8% 2520 1500 -3720 -22% -29% Scenario 5 4000 9.5 65% 24700 15600 2400 5200 1500 6.1% 2520 1500 -2520 -10% -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 Capacity (MW) Price (Rs mn/MW) Utilisation (%) Revenue Material cost Employees cost Other exp Operating EBITDA margin Interest Depreciation PBT PBT margin ROE (%)
Source: Barclays Capital estimates
Scenario 1 4000 15 20% 12000 7200 2400 2400 0 0.0% 1008 600 -1608 -13% -31%
Scenario 2 4000 15 35% 21000 12600 2400 4200 1800 8.6% 1008 600 192 1% 4%
Scenario 3 4000 14 30% 16800 10800 2400 3600 0 0.0% 1008 600 -1608 -10% -31%
Scenario 4 4000 14 50% 28000 18000 2400 6000 1600 5.7% 1008 600 -8 0% 0%
Scenario 5 4000 12 100% 48000 36000 2400 12000 -2400 -5.0% 1008 600 -4008 -8% -78%
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Need for coal blending increases implementation risk

Indias 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 33
during FY11 and new entrants such as Koreas Hyundai and Ukraines 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
160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 FY07 FY08 FY09 FY10 FY11 50% 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.
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Figure 44: High imports from Europe impacted cost structure and margins for subsidiaries of European MNCs in India (FY11)
35% 30% 25% 20% 15% 10% 5% 0% ABB Siemens Areva T&D Crompton Greaves 5% 28% 30%
20%
Imports as % of sales
Figure 45: Most domestic manufacturers have lost share in Powergrid Corporation orders
9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Crompton greaves Siemens Ltd Siemens AG Hyosung ABB LTD
35
TBEA
Areva T&D
FY09
FY10
FY11
FY12
Note: Data exclude HVDC orders. Source: Powergrid Corporation, Barclays Capital estimates
7 December 2011
Baoding
BHEL
VALUATIONS BACK TO CYCLICAL LOWS

Sector trading at valuations close to levels at which the previous upcycle had commenced
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

We favour companies facing a cyclical slowdown in end markets vs. exposure to structurally weak end markets
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
35 30 25 20 15 10 10 x 5 Mar-03 Feb-99 Dec-99 Aug-01 May-02 Jan-04 Sep-05 Jul-06 Mar-08 Aug-10 Oct-00 Nov-04 Jan-09 Dec-94 Aug-96 May-07 Oct-95 Oct-09 Jun-97 Apr-98 Jun-11
36
13x
12x
Aggregate sector fwd PE

Source: Datastream, IBES Consensus, Barclays Capital
7 December 2011
Sector derating led by change in consensus earnings estimates
Figure 47: India Capital Goods Sector derating led by consensus earnings estimate changes
60% 40% 20% 0% -20% -40% -60% May-01 Nov-97 Oct-04 Sep-00 Sep-02 Mar-06 Dec-99 Aug-98 Dec-08 Apr-99 Jun-03 Nov-06 Apr-08 Jul-05 Jul-07 Aug-09 Feb-04 Apr-10
Nov-11
BGR Energy
30.0 25.0 20.0 15.0 10.0 5.0 0.0 Jan-02
Change in 1 year fwd earnings estimates for the sector YoY

Source: Datastream, IBES Consensus ,Barclays Capital
12M fwd PE
Figure 48: India Capital Goods over 15% cut in consensus EPS expectations for the sector since May this year
Earnings cuts have accelerated since May, led by lower-thanand margin pressures
0% -20% -10% Jun-10 10%
expected order intake in 1Q FY12
Aug-10
Oct-10
Dec-10
Jan-11
Mar-11 May-11
Jul-11
Sep-11
FY12 EPS YoY decline
FY13 EPS YoY decline
Source: Datastream, IBES Consensus, Barclays Capital estimates
Figure 49: India Capital Goods EPS revisions over past 12 months for FY12E and FY13E
Crompton Greaves, Voltas and ABB have seen the sharpest earnings estimates cuts
10% -10% -30% -50% -70% Crompton Greaves L&T Thermax Cummins ABB KEC international Areva T&D Siemens Havells FY13 Voltas BHEL
FY12
Source: Datastream, IBES Consensus, Barclays Capital estimates
7 December 2011
37
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 Diversified business. Will be able to manage growth better than peers. Exposed to several end markets; hence, the ability to reduce risk ABB T&D volume cycle is recovering while industrial is already weak and should recover by FY14 Siemens Crompton Greaves Thermax 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 See limited risk on current order book
State of end- With 12th plan orders awarded, market there will be a gap before ordering commences for 13th plan
T&D volume cycle is T&D volume cycle is recovering while recovering. industrial is already weak and should recover by FY14
BHEL has booked Risk of several orders execution without coal delays or linkages/financial order cancellations closure. This could impact pace of conversion of order book to revenues Exposed to competition and price pressures Irrational competition. If current pricing continues there could be a sharp erosion in EBITDA margins
See risk to See limited risk Hyderabad metro project. JPA Karchana project still has land issues. Gas availability concerns could delay gas projects on book 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
See limited risk
See limited risk
High competition for T&D orders. Prices have though already declined at a 30% pa pace.
Very high Core business can competitive activity generate 10% and irrational pricing EBITDA margins. Risk exposure is about largely specific to 15-20% of order new BTG business book. Rest of the and here margins are markets are unremunerative competitive but base of margins are low so risk not very high Only 20% of order 20-30% of order book has price book has price variation clauses. variation clauses Commodity price increase will impact margins but will be the first to benefit from a decline Largely hedged as Limited exposure to imports are about forex risk 10% of costs but exports 10-15% of product. Translation risk likely as 50% of revenues are from outside India Risk much lower than two quarters back. Overall risk limited to 10% further cuts. Our EPS estimates assume bear-case scenario Low Inability to win order in IPP space can impact EPS estimates for FY14. FY13 numbers are largely a reflection of current order book Low
Commodity Scale of risk is not very high as 70% of price risk contracts have price variation clauses
Medium risk to Medium risk: 50% margins as 70% of has price variation contracts have price clauses variation clauses
Medium-high risk as only 35% of contracts may have PV clauses
Forex risks
Risk limited to any imports (10% of costs)
Risk is very low. Have Imports 35% of its Imports 25-30% of US$200mn of FCCBs raw materials (and the product; rupee outstanding and finished product) and depreciation to rupee depreciation rupee depreciation impact cost could increase could impact cost outflow
Limited risk for Risk of FY12/13 but earrings downgrades significant risk to margins from FY14. Accounting changes supporting EPS Leverage Low
With L&T revising down guidance risk has lowered. On a relative scale downside risk should be about 5% Medium
Consensus estimates See margins risk on for CY12 are too high Siemens. EPS should see estimates appear moderation achievable but have limited room for upgrades Low Low
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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 Flattish market growth for towers in FY13; however, exposure to Rail, water and substation segment plus acquisition of SAE Towers to help drive growth Low risk. A very small portion of order book is slow moving ((Libya , Tunisia) High competition in India but exposure to orders outside India lowers the impact on margins
State of end- Demand in Power generation segment market is decelerating but exposure to new products in exports to reduce downside risk.
Demand for With 12th plan With Dubai market T&D volume cycle is consumer products orders already being weak, focus of recovering while remains strong in awarded there will be ordering has shifted industrial is already India. Fans segment a phase of slow to Saudi Arabia and weak and should is witnessing weak ordering Qatar/Oman, etc, but recover by FY14 demand this year but pace of orders much appears to more of a slower although cyclical issue. order pipeline appears encouraging Low risk as it is a product business Limited risk on current order book Limited risk as most Low risk projects in current order book under execution Exposed to high Exposed to high competition in both competition in T&D MEP business and in sector but current air-con products. margins reflect the While margins have impact of weak deteriorated, we do pricing not expect a recovery in FY13
Low risk as it is a Risk of product business execution delays and order cancellations Exposed to competition and price pressures
Less risk. Cummins is Competition not a dominant player. irrational - should be Prices have gone up able to protect this year by 5-6% margins and are now stable
Exposed to stiff competition. Cannot make margins in boiler/turbine (BTG) business
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 Risk is high as most Risk reflects in new orders from projects fixed price in margins. Low risk NTPC will have price nature though as over 60% variation clauses of book has PV clauses 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
Over 60% of contracts are fixed price but high commodity prices already reflects in margin estimates Rupee depreciation to re-price advances received in international locations and impacts financials. It is a non-cash loss though. Downside risk limited to 5-10% range, and this risk is also due to the impact of translation losses.
Forex risk
Exports comprises Higher payout on about 25% of sales. foreign currency Should benefit from loans rupee depreciation
Limited risk post the Limited risk. A sharp Risk of recent earnings recession in Europe earnings could Impact downgrades downgrades margins. We continue to build in margin recovery at Sylvania Leverage Low Medium
Substantial risk for Risk lower after FY14. With pricing in recent downgrades recent orders being but dont see any low there is risk of scope for recovery in sharp deterioration in earnings EBITDA margins High Low
Less risk of EPS downgrades as margin/order expectations are not very high
Low
Medium
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COMPANIES
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LARSEN & TOUBRO (1-OW, PT: RS1,560, +19%): LOOKING BEYOND THE DOWNTURN
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
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&Ts 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&Ts 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&Ts 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&Ts 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 Mar 2011A 2012E 2013E 2014E Net profit Rs mn 35,033 40,296 44,431 53,315 EPS Rs 57.5 66.2 73.0 87.6 EPS growth % 12.9 15.0 10.3 20.0 P/E (x) 22.8 19.8 18.0 15.0 P/B (x) 3.7 3.2 2.8 2.5 ROE (%) 16.0 16.2 15.8 16.6 Div. yield (%) 1.2 1.4 1.5 1.8
+19%
Source: Company data, Barclays Capital estimates, based on standalone financials
7 December 2011
42
COMPANY SNAPSHOT LARSEN AND TOUBRO Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2010A 439,049 55,985 49,982 57,940 35,033 57.5 609 14 2011E 530,835 63,337 56,807 60,979 40,296 66.2 609 17 2012E 565,712 69,428 63,197 67,622 44,431 73.0 609 18 2013E 658,443 82,898 75,652 81,068 53,315 87.6 609 22 CAGR 14.5% 14.0% 14.8% 11.8% 15.0% 15.0% 0.0% 15.0% Average 12.4 11.2 12.2 8.1 12.5 11.2 16.1 CAGR 4.4% 52.0% 16.9% 14.5% 26.5% 17.2% NA 13.8% NA 2.3% NA 10.6% INDIAN CAPITAL GOODS
Stock Rating Sector View Price (02-Dec-2011) Price Target Ticker Investment case
1-OVERWEIGHT 2-NEUTRAL 1310 1560 LART.BO
12.8 11.4 13.2 8.9 13.3 11.9 16.0
11.9 10.7 11.5 7.6 12.3 11.0 16.2
12.3 11.2 12.0 7.9 12.0 10.7 15.8
12.6 11.5 12.3 8.1 12.5 11.3 16.6
Why a 1-Overweight? Exposure to multiple end markets should enable L&T to capture changing ordering trends. We expect L&T to participate in a new upturn given its exposure to infrastructure, which should lead the new cycle, and exposure to emerging demand drivers. Consensus EPS cuts and valuation deratings have moderated expectations. Upside case 2488 Our bullish case would be a general recovery in all end markets in India led by government reforms. In our DCF, we assume margins to remain at 12% and market share in power orders at 15%. We value subsidiaries at Rs400/L&T share. Terminal growth at 0%. Downside case 817 Our bear case would represent market share losses. In our DCF, we assume market share in non-power orders declines to 11.5% from 15%. We expect power orders at a market share of only 10% long term and margins to fall to 8% by FY20. Terminal growth at 0%. Upside/downside scenarios
Balance sheet and cash flow (INRmn) Fixed assets 72,370 Cash and equivalents 17,304 Total assets 295,571 Current liabilities 278,233 Long term liabilities 71,611 Total liabilities 349,844 Net debt/(funds) (14,505) Shareholders' equity 218,463 Change in working capital (2,772) Cash flow from operations 38,613 Capital expenditure (15,468) Free cash flow 23,145 Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
75,839 40,799 366,090 336,779 111,908 448,687 2,297 248,684 (13,553) 29,100 (10,000) 19,100
79,609 49,362 414,409 358,905 126,904 485,809 8,729 282,008 (5,987) 40,250 (10,000) 30,250
82,363 60,734 472,389 417,737 144,897 562,634 15,352 321,994 (13,855) 41,290 (10,000) 31,290
22.8 15.2 2.9 1.9 3.7 1.1 0.4 1.0
19.8 13.7 2.4 1.6 3.2 1.3 0.3 1.1
18.0 12.6 3.8 1.5 2.8 1.4 0.5 1.1
Average 15.0 18.9 10.6 13.1 3.9 3.3 1.3 1.6 2.5 3.0 1.7 1.4 0.5 40.0 1.0 1.1
2908 2408 1908 1408 908 408 22-Dec-10 2-Dec-11 INR817 INR817 (-37.6%) (-37.6%) Downside
Case
INR2488 (89.8%) INR1560 (19.0%)

Price Target Upside Case
Source: Thomson Reuters Datastream, Barclays Capital est.
Expect Order inflow growth to recover 797,690 14 13,027 30 728,659 -9 15,002 15 806,407 11 17,340 16 967,688 20 20,353 17
40% 30% 20% 10% 0% -10% -20% Order inflow growth
Mar10E Mar11E Mar12E Mar13E Mar14E Source: Company data, Barclays Capital estimates Note: FY end Mar.
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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 52: L&T revenue by product: mix has always changed in response to market conditions
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E Infrastructure Power Hydrocarbons Process Others
Figure 53: L&T Market share over the years has increased
18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Mar-00 Mar-02 Mar-04 Mar06 Mar08 5% 5% 9% 6% 7% 7% 7% 10% 11% 12%
16% 14%
Mar10E
L&T E&C market share

Figure 54: L&T Expect a recovery in FY14E led by recovery in industrial orders
Rs mn Power BTG Power BOP Power T&D Nuclear Other utilities ONGC +GSPL Other hydrocarbons Metals Cement Other industries Short cycle product Other infra Roads Real estate/buildings Defence Ships Railways Middle East Order inflow FY12 99,000 50,000 60,000 20,000 10,000 20,000 20,000 50,000 5,000 30,000 80,000 40,000 30,000 90,000 20,000 10,000 20,000 60,000 714,000 FY13 118,800 40,000 50,000 20,000 10,000 35,000 20,000 50,000 10,000 30,000 80,000 80,000 30,000 80,000 30,000 10,000 40,000 50,000 783,800 FY14 118,800 40,000 50,000 40,000 20,000 35,000 35,000 60,000 20,000 50,000 120,000 50,000 30,000 100,000 40,000 25,000 60,000 50,000 943,800 Comments KPCL JV included in FY12. UMPP win can make a big difference Expect ordering to weaken by FY14 largely a cyclical event Expect wins in substations in India and in middle east Expect Nuclear orders to commence in FY14 Water/Gas to be the drivers More a market share story. Expect flat ordering every year More a market share story. Expect flat ordering every year FY14 recovery is likely. Can present upside surprises Building in moderate growth in FY14 Expect ordering in other industries to revive Industrial recovery to drive FY14 numbers Ports. Bidding for a large port in East/West coast Building in base case orders in this segment Continue to see strength in this segment Expect to benefit from offsets Shipyard to start getting traction in FY14 Expect Rail ordering to recover in FY14 Led by infra projects
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Limited downside to EPS estimates

L&Ts FY12-14E consensus EPS has seen revisions of 9-18% over the past 12 months and, given managements revision of guidance following the 2Q FY12 results, we see less risk of further EPS revisions from hereon. Figure 55: L&T Barclays Capitals sensitivity analysis of margins and revenue growth suggests that a further cut in EPS estimates by 15% would represent a bearish scenario
FY12E Revenue Growth 15% 10.8% 11.9% 12.8% 13.5% 14.0% Margin 10.8% 11.9% 12.8% 13.5% 14.0% 10.8% 11.9% 12.8% 13.5% 14.0% 57.0 63.2 67.7 71.8 74.5 -14% -5% 2% 8% 13% 2% 13% 21% 28% 33% 18% 58.3 64.7 69.3 73.5 76.3 -12% -2% 5% 11% 15% 4% 15% 23% 31% 36% 21% 59.7 66.2 71.0 75.3 78.2 -10% 0% 7% 14% 18% 6% 18% 26% 34% 39% 25% 61.5 68.3 73.2 77.6 80.6 -7% 3% 11% 17% 22% 10% 22% 30% 38% 44% 10.5% 10.9% 11.8% 12.3% 12.8% 10.5% 10.9% 11.8% 12.3% 12.8% 10.5% 10.9% 11.8% 12.3% 12.8% 7% EPS forecasts (Rs) 62.15 64.60 70.09 72.98 76.03 -15% -11% -4% 0% 4% -6% -2% 6% 10% 15% 64.00 66.52 72.19 75.17 78.32 -12% -9% -1% 3% 7% -3% 1% 9% 14% 18% 66.69 69.33 75.26 78.37 81.66 -9% -5% 3% 7% 12% 1% 5% 14% 18% 23% 69.38 72.13 78.32 81.57 85.01 -5% -1% 7% 12% 16% 5% 9% 18% 23% 28% 10% 15% 20% FY13E
Change from our current base case EPS forecasts
EPS growth rates
Figure 56: L&T history of current consensus EPS forecasts shows upward revisions have occurred during positive cycles (Rs)
100 80 60
Figure 57: L&T history of current consensus EPS forecasts for FY12-14 shows estimates have been revised down 918% in past 12 months (Rs)
140 120 100
40 20 0 Aug-09 Aug-06 Feb-08 May-07 May-10 Nov-05 Nov-08 Feb-11 80 60 Jun-11 Dec-10 Sep-10 Mar-10 Mar-11 Dec-09 Sep-09 Sep-11
45
FY06 FY10
FY07 FY11
FY08
FY09 FY12 FY13 FY14
Source: Datastream, IBES consensus estimates, Barclays Capital
7 December 2011
Jun-09
Jun-10
Shares pricing in bearish prospects over the longer term

The current share price reflects a bearish view on L&Ts 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 GCF YoY GCF US$bn Market share Power-Industry ordering L&T market share L&T MW orders Order inflow- Power BTG YoY Price per MW Non power inflows YoY Order inflow YoY Orderbook YoY Execution period, months Sales/orderbook Gross sales Net revenues YoY EBITDA Margin EBITDA Tax + Other income Capex Investments in JVs Working capital Days Change in working capital FCFF Present value Mar-12 4,671,192 0% 104 14% 25,000 10% 2,500 67,500 -35% 27 653,967 -6% 721,467 -10% 1,487,147 14% 29 41% 537,020 530,835 21% 12% 63,337 11,366 (10,000) (15,000) 67,529 46 (13,553) 36,150 36,150 Mar13E 5,138,311 10% 114 14% 20,000 10% 2,000 60,000 -11% 30 693,672 6% 753,672 4% 1,673,211 13% 31 38% 567,607 560,796 6% 12% 66,174 12,439 (10,000) (15,000) 73,162 48 (5,633) 47,980 42,188 Mar14E 5,652,142 10% 126 14% 20,000 10% 2,000 64,000 7% 32 763,039 10% 827,039 10% 1,864,430 11% 32 38% 635,820 628,190 12% 11% 69,101 14,537 (10,000) (15,000) 83,530 49 (10,368) 48,270 37,318 Mar15E 6,499,964 15% 144 13% 30,000 10% 3,000 96,000 50% 32 844,995 10% 940,995 14% 2,096,942 12% 32 38% 708,484 716,985 14% 11% 78,868 (13,408) (10,000) (15,000) 94,288 48 (10,759) 29,702 20,191 Mar-16 7,474,958 15% 166 13% 35,000 10% 3,500 119,000 24% 34 971,745 10% 1,090,745 16% 2,390,849 14% 32 38% 796,838 806,400 12% 11% 88,704 (13,306) (10,000) (15,000) 106,047 48 (11,759) 38,640 23,095 Mar-17 8,596,202 15% 191 13% 35,000 10% 3,500 126,000 6% 36 1,074,525 10% 1,200,525 10% 2,694,806 13% 32 38% 896,568 907,327 13% 11% 99,806 (14,971) (10,000) (15,000) 119,320 48 (13,273) 46,562 24,471 Mar-18 Mar-19 Mar-20
9,885,632 11,368,477 13,073,749 15% 220 12% 35,000 10% 3,500 126,000 0% 36 1,186,276 10% 1,312,276 9% 2,996,529 11% 32 38% 1,010,552 1,022,679 13% 10% 102,268 (15,340) (10,000) (15,000) 134,489 48 (15,170) 46,758 21,607 15% 253 11% 35,000 10% 3,500 126,000 0% 36 1,250,532 10% 1,376,532 5% 3,249,363 8% 32 38% 1,123,699 1,137,183 11% 10% 113,718 (17,058) (10,000) (15,000) 149,547 48 (15,058) 56,602 22,998 15% 291 11% 35,000 10% 3,500 126,000 0% 36 1,372,744 10% 1,498,744 9% 3,529,596 9% 32 38% 1,218,511 1,233,133 8% 10% 123,313 (18,497) (10,000) (15,000) 162,165 48 (12,618) 67,198 24,007
Source: Company Data, Barclays Capital
7 December 2011
46
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 stocks 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 L&T standalone L&T Infotech L&T Finance L&T IDPL L&T MHI Other subsidiaries Target price
Methodology P/E P/E 16.5FY13 12x FY12 1.9x 2.0x 12x FY14 discounted 1.5x
Multiple Value per share value Rs mn 16.5 12 1.9 2.0 1.5 1,204 79 85 97 49 45 1,560 733,293 48,029 51,960 59,152 30,102 27,624 950,161
83% 100%
P/B P/B P/E P/B
L&Ts 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
35 30 25 20 15 10 5 May-07 Mar-08 Nov-04 Oct-09 May-02 Mar-03 Aug-96 Aug-01 Aug-10 Feb-99 Oct-95 Apr-98 Dec-94 Dec-99 Oct-00 Sep-05 Jan-09 Jun-97 Jan-04 Jun-11
47
L&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 nearterm weakness, there could be volatility in the stock and some downside around quarterly result announcements in January 2012.
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Jul-06
Financials
Figure 61: L&T consolidated financials
Rs mn Standalone profit after tax L&T Infotech L&T Finance L&T Infrastructure development projects L&T infrastructure finance Minorities, start-up losses on MHI JV Consolidated recurring profit after tax Standalone EPS y/y Consolidated EPS y/y
FY11 35033 3130 2304 158 2009 -1003 41630 58 13% 68 14%
FY12E 40296 3897 2012 190 1619 -3000 45015 66 15% 74 8%
FY13E 44431 4287 2516 218 1862 -3000 50314 73 10% 83 12%
FY14E 53315 4716 3144 251 2141 -2500 61068 88 20% 100 21%
Figure 62: L&T income statement, FY09-14E

Rs mn; years ending March Net revenue Change in stocks Material and mfg costs % of sales Staff costs % of sales Sales and admin expenses % of sales Total expenditure OBITDA OBITDA margin Depreciation Amortization of intangible assets EBIT EBIT margin Interest Other Income Recurring other income Profit before tax PBT margin Tax Profit after tax before Extraordinary items Profit on sale of business Reported net income Recurring profit after tax
FY09 339,264 -1,051 263,372 78% 19,980 6% 18,640 5% 300,940 38,323 11.3% 2,630 212 35,482 10% -1,784 5,680 5,658 39,378 12% -12,312 27,066 7,725 34,790 27,048
FY10E 370,348 4,230 280,306 76% 23,791 6% 13,866 4% 322,193 48,156 13.0% 3,850 310 43,997 12% -5,053 8,144 8,144 47,088 13% -16,409 30,679 12,105 42,784 30,679
FY11E 439,049 -5,596 339,912 77% 28,845 7% 19,903 5% 383,064 55,985 12.8% 5,769 234 49,982 11% -6,474 14,431 10,121 57,940 13% -19,459 38,481 708 39,189 35,033
FY12E 530,835 -4,235 409,837 77% 37,554 7% 24,343 5% 467,498 63,337 11.9% 6,530 56,807 11% -7,193 11,366 11,366 60,979 11% -20,684 40,296 40,296 40,296
FY13E 565,712 430,128 76% 37,727 7% 28,429 5% 496,284 69,428 12.3% 6,231 63,197 11% -8,014 12,439 12,439 67,622 12% -23,191 44,431 44,431 44,431
FY14E 658,443 503,358 76% 39,265 6% 32,922 5% 575,545 82,898 12.6% 7,246 75,652 11% -9,121 14,537 14,537 81,068 12% -27,753 53,315 53,315 53,315
7 December 2011
48
Figure 63: L&T balance sheet, FY09-14E

Rs mn; years ending March Equity capital Reserves and surplus Loans Deferred tax liability Total sources Net tangible assets Capital WIP Intangible assets Investments Deferred tax assets Inventory Debtors Cash and bank deposits Loans and advances plus other cash Interest accrued on investments Liabilities Provisions Net current assets Miscellaneous expenses not written off Assets
FY09 1,171 121,069 65,560 4,352 194,508 40,128 10,410 1,408 82,637 3,867 58,051 100,555 7,753 67,906 216 147,759 30,665 56,056 2 194,508
FY10 1,204 178,822 68,008 3,893 255,017 53,654 8,577 1,427 137,054 3,119 14,154 111,637 14,319 123,507 0 190,545 21,884 51,188 0 255,017
FY11 1,218 213,562 71,611 5,497 295,571 64,520 7,850 2,212 146,848 2,863 15,772 124,276 17,304 192,160 0 255,898 22,334 71,279 0 295,571
FY12E 1,218 243,784 111,908 5,497 366,090 67,989 7,850 2,212 176,848 2,863 18,906 152,706 40,799 232,695 0 309,775 27,003 108,328 0 366,090
FY13E 1,218 277,107 126,904 5,497 414,409 71,759 7,850 2,212 206,848 2,863 20,149 164,289 49,362 247,983 0 330,128 28,778 122,878 0 414,409
FY14E 1,218 317,093 144,897 5,497 472,389 74,513 7,850 2,212 236,848 2,863 23,451 193,023 60,734 288,632 0 384,242 33,495 148,104 0 472,389
Figure 64: L&T cash flow statement, FY09-14E

Rs mn; years ending March Profit before tax and exceptional items Dividends paid/received Depreciation Interest (net) Others Operating profit be working capital change Change (inc.)/dec. in working capital Tax paid Net cash from operations Change in financing activities Change in Investments Others Net cash from investing Change in capital Change in loans Dividends paid Others(interest paid) Cash flow from financing activities Opening cash balance Inc./dec during the year Closing balance
FY09 39,404 -3,346 3,060 1,784 3,102 44,003 -20,487 -8,731 14,786 -19,798 -5,284 4,169 -44,297 230 23,606 -5,054 -2,374 16,408 9,645 -1,887 7,753
FY10 58,807 -2,586 4,146 5,053 -12,981 52,438 17,580 -15,193 54,825 -15,598 -41,597 -3,523 -60,717 21,327 6,680 -6,170 -9,381 12,456 6,569 6,563 14,319
FY11 58,329 -3,942 5,992 3,114 -2,072 61,420 -2,772 -20,035 38,613 -15,468 -6,109 -2,871 -24,448 3,473 -1,615 -7,562 -5,544 -11,248 14,319 2,985 17,304
FY12E 60,979 -11,366 6,530 7,193 0 63,337 -13,553 -20,684 29,100 -10,000 -30,000 11,366 -28,634 0 40,297 -10,074 -7,193 23,030 17,304 23,496 40,799
FY13E 67,622 -12,439 6,231 8,014 0 69,428 -5,987 -23,191 40,250 -10,000 -30,000 12,439 -27,561 0 14,995 -11,108 -8,014 -4,126 40,799 8,563 49,362
FY14E 81,068 -14,537 7,246 9,121 0 82,898 -13,855 -27,753 41,290 -10,000 -30,000 14,537 -25,463 0 17,994 -13,329 -9,121 -4,456 49,362 11,372 60,734
7 December 2011
49
Figure 65: L&T historical consolidated income statement, FY05-11

Rs mn; years ended March Gross revenues Less: excise duty Sales and services Add: operational other inc Revenue FY05 145,993 2,200 143,793 1,176 144,969 FY06 167,474 2,472 165,002 611 165,613 FY07 207,005 3,645 203,360 1,768 205,129 FY08 295,611 3,626 291,985 1,519 293,504 FY09 406,079 4,209 401,870 2,929 404,799 FY10 438,542 3,407 435,136 4,562 439,698 FY11 519,785 4,264 515,520 5,371 520,891
Expenditures Mfg cons other expenses Staff costs Sales and admin expenses EBITDA EBITDA margin Depreciation Amortization Interest (net) Recurring other income Profit on sale of investments Profit before tax Exceptional items post tax Taxation Reported profit after tax Adjusted profit after tax 2,775 11,277 7,250 4,313 12,369 10,467 7,327 22,723 18,655 11,471 22,715 22,259 112,168 8,719 12,290 11,793 124,912 10,469 14,384 15,848 151,215 14,882 12,885 26,146 219,679 20,494 17,341 35,990 302,128 26,660 26,423 49,586 323,400 30,658 21,246 64,394 375,409 38,020 29,888 77,575
8%
1,941 181 -1,025 1,350 4,057 14,052
10%
2,240 195 -1,303 2,063 2,510 16,683
13%
2,997 452 -504 3,174 4,683 30,050
12%
4,063 1,035 -896 2,947 1,243 34,186
12%
7,283 -4,620 5,754 149 43,587 7,725 14,257 37,055 30,034
15%
9,793 6,919 8,630
15%
13,189 8,309 9,191
56,312 18,664 20,388 54,589 36,009
65,269 2,053 23,554 43,768 41,630
7 December 2011
50
BHEL (3-UW, PT: RS230, -19%): FUNDAMENTALS DETERIORATING

BHEL IN / BHEL.NS Stock Rating
3-UNDERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 230.00
Price (02-Dec-2011)
INR 282.45
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: BHELs 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 BHELs 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 derating 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
Year to Mar 2011A 2012E 2013E 2014E Net profit Rs mn 60113 66089 69358 64169 EPS Rs 24.6 27.0 28.3 26.2 EPS growth % 39.4 9.9 4.9 -7.5 P/E (x) 11.5 10.5 10.0 10.8 P/B (x) 3.4 2.8 2.3 2.0 ROE (%) 29.8 26.7 23.4 18.8 Div. yield (%) 2.2 2.5 2.6 2.4
-19%
Source: Company data, Barclays Capita estimates
7 December 2011
51
COMPANY SNAPSHOT BHEL Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2011A 422,466 85,857 80,416 90,057 60,113 24.6 2,448 6 2012E 476,781 92,755 86,006 95,749 66,089 27.0 2,448 7 2013E 500,629 95,554 88,367 101,132 69,358 28.3 2,448 7 2014E 493,826 87,551 80,512 95,263 64,169 26.2 2,448 7 CAGR 5.3% 0.7% 0.0% 1.9% 2.2% 2.2% 0.0% 2.7% Average 19.1 17.8 20.2 13.7 27.0 24.5 24.7 CAGR 13.6% 28.5% 10.5% 5.4% 0.0% 5.4% NA 19.2% NA 38.3% NA 86.6% INDIA CAPITAL GOODS
3-UNDERWEIGHT 2-NEUTRAL 283 230 BHEL IN/BHEL.BO
20.3 19.0 21.3 14.2 26.6 29.6 29.8
19.5 18.0 20.1 13.9 31.5 26.4 26.7
19.1 17.7 20.2 13.9 27.5 23.2 23.4
17.7 16.3 19.3 13.0 22.6 18.7 18.8
Why a 3-Underweight? Power BTG sector is going through a weak phase of ordering. Oversupply is impacting pricing and margins. BHELs current margin trajectory is unsustainable. While fundamentals are weak, P/E at 10x is pricing in some of the weakness.
Balance sheet and cash flow (INRmn) Fixed assets 51,631 64,882 72,696 75,657 Cash and equivalents 96,302 120,742 153,675 204,473 Total assets 592,606 679,769 755,782 799,941 Current liabilities 389,434 429,735 457,197 456,437 Long term liabilities 1,634 1,634 1,634 1,634 Total liabilities 391,067 431,368 458,831 458,071 Net debt/(funds) (94,668) (119,108) (152,041) (202,839) Shareholders' equity 201,538 247,801 296,352 341,270 Change in working capital (30,929) (4,171) (2,804) 13,841 Cash flow from operations 26,586 59,524 60,976 70,298 Capital expenditure (17,300) (20,000) (15,000) (10,000) Free cash flow 9,286 39,524 45,976 60,298 Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow, Rs bn Order inflow growth (%) Orderbook, Rs bn Orderbook growth (%)
Upside case 350 A recovery in BTG market led by resolution of coal crisis, improved financial health of utilities and reduction in competition in India could help drive multiples. Upside case assumptions: market share long term at 45%, margins at 16% by FY20, terminal growth of 5%. Downside case 208 Our bearish case estimates assume a market share long term of 35%. Margins to fall to 10% by FY20. Terminal growth at 3%.
Upside/downside scenarios 11.5 6.2 1.3 1.4 3.4 2.2 0.8 -1.1 10.5 5.6 5.7 1.2 2.8 2.5 0.7 -1.3 10.0 5.0 6.7 1.1 2.3 2.6 0.6 -1.6 Average 10.8 10.7 4.8 5.4 8.7 5.6 1.0 1.2 2.0 2.6 2.4 2.4 0.5 0.6 -2.3 -1.6
500 504 400 404 300 304 200 204 100 0 104 16-Dec-10 INR350 (23.6%) INR230 INR350 INR208 (-18.7%) (23.6%) (-26.5%) INR230 INR208 Upside Downside (-18.7%) (-26.5%) Upside Price Case
Case Downside Case Price Target Target Case
2-Dec-11
Order inflows expected to remain weak 6,051 1.4 16,211 12.3 5,336 -11.8 16,705 3.0 4,545 -14.8 16,131 -3.4 5,473 20.4 16,555 2.6
30% 20% 10% 0% -10% -20% Mar-10 Mar11 Mar12E Mar13E Mar14E Order inflow growth rates
Note: FY end Mar.
7 December 2011
52
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
Current EBITDA margins for BHEL are unsustainable, in our view. We believe that downside post FY14E could be higher than expected
0 23% 22% 21% 0 0 0 0 0 Mar91E 18% 17% 14% 11% 10% 15% 13% 20% 20% 19% 19% 19% 19% 18% 18% 17% 16% 16% 15% 14%
9%
Mar-94
Mar-97
Mar-00
Mar-03
Mar-06
Mar-09
Mar12E
Operating Ebitda margin

Figure 68: BHEL accounting changes support margins PBT increased by ~ 20% in Mar-11 and over 8% in Sep-11
Quarter Dec-11 Sales (Rs mn) 4440 PBT (Rs mn) 880 % of PBT Changes 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 21% Cumulative impact of the three accounting changes in the Mar quarter Change in accounting policy of provisioning during trial operation 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. 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. 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
Mar111 1
23288 23288
8950 6075 468
2408 Sep-11 1660
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 53
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 BHELs state JVs to support order inflow, this would however impact the companys returns ratio.
With EPS likely to decline sharply should one expect more accounting changes?
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
Watch out for sharp decline in EPS momentum in 2H FY12

100 78 80 60 38 40 20 0 -20 Jun-06 Sep-05 Dec-07 Mar-07 (3) (10) Sep-08 Jun-09 Mar-10 Dec-10 Sep-11
12th plan
85 62 58 33 22
91
64
33 16 2 21 22
47 39 36 42 42 33 31
22 24 4 4
Quarterly EPS YoY

Figure 70: BHEL order inflows to deteriorate sharply

100% 80% 60% 40% 20% 0% -20% -40% Mar-95 Mar-99 Mar-03 Mar-07 Mar-11
8th plan 9th plan 10th plan 11th plan 12th plan
Figure 71: BHEL sales growth to single digits by FY14

40% 8th plan 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% Mar-92 Mar-96
9th plan 10th plan 11th plan
Mar-00 Mar-04 Mar-08 Mar12E Sales YoY
Order inflow YoY

Source: : Company data, Barclays Capital estimates
7 December 2011
54
Working capital under stress

Cash generation affected by deteriorating receivable days
BHELs 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 73: BHEL Working capital changes (Rs mn)
Figure 72: BHEL Working capital days starting to deteriorate

200 150 100 50 0 -50 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Net current asset days
30,000 20,000 10,000 0 -10,000 -20,000 -30,000 -40,000
Mar-10
Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Change in working capital

Figure 74: BHEL net current asset (less cash) days more than doubled in the past year
Sep-10 Capital Reserves and surplus Loan funds Fixed assets Investments Deferred tax assets Inventories Inventory days Sundry Debtors Debtor days Cash and bank balances Other current assets Loans and advances Current liabilities Current liability days Provisions As days of sales Net current assets Net current assets less cash Days of sales
Sep-11 4,895 218,919 14,801 53,793 4,617 23,656 131,586 116 305,693 270 79,491 3,087 34,102 328,381 290 69,029 61 156,548 77,057 68
4,895 172,378 4,170 41,159 4,284 15,175 107,081 117 221,039 242 86,770 2,587 38,882 295,584 323 39,950 44 120,826 34,056 37
7 December 2011
55
Not much value at current price

Although BHELs 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) Industry ordering BHEL orders in GW BHEL market share Order inflow- Power YoY Price per MW Order inflow- Industry + Others YoY as % of power inflow Order inflow YoY Gross Revenues Orderbook Execution period, mth Gross sales Excise Duty Excise as % of sales Net revenues YoY EBITDA Margin EBITDA Tax + Other income Others as % of EBITDA Capex Investments in JVs Working capital Days Change in working capital 29,212 27 (22,182) Mar-11 30,000 16,500 55% 463,930 11% 28 141,140 -17% 30% 605,070 2% 418,419 Mar-12 25,000 15,000 60% 427,750 -8% 29 192,488 36% 45% 620,238 3% 486,323 Mar13E 20,000 11,000 55% 330,000 -23% 30 148,500 -23% 45% 478,500 -23% 515,466 Mar14E 20,000 9,000 45% 270,000 -18% 30 121,500 -18% 45% 391,500 -18% 504,377 Mar15E 30,000 13,500 45% 432,000 60% 32 216,000 78% 50% 648,000 66% 470,514 Mar-16 35,000 14,000 40% 448,000 4% 32 246,400 14% 55% 694,400 7% 523,760 Mar-17 35,000 14,000 40% 448,000 0% 32 246,400 0% 55% 694,400 0% 574,952 Mar-18 35,000 14,000 40% 448,000 0% 32 246,400 0% 55% 694,400 0% 610,786 Mar-19 35,000 14,000 40% 448,000 0% 32 246,400 0% 55% 694,400 0% 635,870 Mar-20 35,000 14,000 40% 448,000 0% 32 246,400 0% 55% 694,400 0% 653,429
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 41 418,419 (18,011) -4% 400,408 27% 20% 81,436 (19,738) -24% (17,300) 40 486,323 (21,050) -4% 465,272 16% 20% 92,538 (23,135) -25% (15,000) (5,000) 34,417 27 (5,205) 40 515,466 (22,312) -4% 493,155 6% 18% 86,652 (21,663) -25% (10,000) (10,000) 36,480 27 (2,063) 40 504,377 (21,832) -4% 482,545 -2% 17% 82,033 (20,508) -25% (7,000) (10,000) 33,051 25 3,429 40 470,514 (20,366) -4% 450,148 -7% 17% 76,525 (18,366) -24% (7,000) (15,000) 30,832 25 2,219 40 523,760 (22,671) -4% 501,089 11% 17% 85,185 (20,444) -24% (7,000) (15,000) 34,321 25 (3,489) 40 574,952 (24,887) -4% 550,065 10% 15% 82,510 (19,802) -24% (7,000) (15,000) 37,676 25 (3,355) 40 610,786 (26,438) -4% 584,349 6% 16% 93,496 (22,439) -24% (7,000) (15,000) 40,024 25 (2,348) 40 635,870 (27,523) -4% 608,347 4% 15% 91,252 (21,900) -24% (7,000) (15,000) 41,668 25 (1,644) 40 653,429 (28,283) -4% 625,146 3% 14% 87,520 (21,005) -24% (7,000) (15,000) 42,818 25 (1,151)
FCFF Discount factor Present value of cash flows
18,622
44,199 1.0 44,199
42,926 0.9 38,022
47,953 0.8 37,621
38,378 0.7 26,669
39,252 0.6 24,159
37,353 0.5 20,364
46,709 0.5 22,555
45,708 0.4 19,549
43,365 0.4 16,428
Source: Company Data, Barclays Capital estimates
7 December 2011
56
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) Industry ordering BHEL orders in GW BHEL market share Order inflow- Power YoY Price per MW Order inflow - Industry + Others YoY as % of power inflow Order inflow YoY Gross Revenues Orderbook Execution period, months Gross sales Excise Duty Excise as % of sales Net revenues YoY EBITDA Margin EBITDA Tax + Other income Others as % of EBITDA Capex Investments in JVs Working capital Days Change in working capital FCFF Present value of cash flows Mar-11 30,000 16,500 55% 463,930 11% 28 141,140 -17% 30% 605,070 2% 418,419 Mar-12 25,000 15,000 60% 371,250 -20% 29 162,311 15% 45% 533,561 -12% 474,450 Mar13E 20,000 11,000 55% 300,000 -19% 30 184,508 14% 45% 484,508 -9% 505,527 Mar14E 20,000 9,000 45% 337,500 13% 30 209,819 14% 45% 547,319 13% 502,075 Mar15E 30,000 12,000 40% 384,000 14% 32 192,000 -8% 50% 576,000 5% 502,212 Mar-16 35,000 14,000 40% 448,000 17% 32 224,000 17% 50% 672,000 17% 524,348 Mar-17 35,000 14,000 40% 448,000 0% 32 224,000 0% 50% 672,000 0% 568,644 Mar-18 35,000 14,000 40% 448,000 0% 32 224,000 0% 50% 672,000 0% 599,651 Mar-19 35,000 14,000 40% 448,000 0% 32 246,400 10% 55% 694,400 3% 621,355 Mar-20 35,000 14,000 40% 448,000 0% 32 246,400 0% 55% 694,400 0% 643,269
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 41 418,419 -17,709 -4% 400,711 27% 20% 81,436 -19,738 -24% -17,300 -3,594 29,212 27 -22,182 18,622 40 474,450 -7,158 -4% 467,292 17% 19% 90,909 -19,516 -21% -20,000 -5,000 33,383 26 -4,171 42,222 42,222 40 505,527 -11,089 -4% 494,438 6% 19% 94,390 -18,905 -20% -15,000 -5,000 37,114 27 -3,731 51,754 45,841 40 502,075 -11,013 -4% 491,061 -1% 18% 87,058 -16,432 -19% -10,000 -10,000 36,325 27 789 51,415 40,337 40 502,212 -21,738 -4% 480,474 -2% 16% 76,876 -15,375 -20% -7,000 -15,000 35,542 27 783 40,284 27,993 40 524,348 -22,696 -4% 501,652 4% 14% 70,231 -14,046 -20% -7,000 -20,000 37,109 27 -1,567 27,618 16,999 40 568,644 -24,614 -4% 544,030 8% 14% 76,164 -15,233 -20% -7,000 -20,000 40,243 27 -3,135 30,797 16,789 40 599,651 -25,956 -4% 573,695 5% 14% 80,317 -16,063 -20% -7,000 -20,000 42,438 27 -2,194 35,059 16,929 40 621,355 -26,895 -4% 594,460 4% 12% 71,335 -14,267 -20% -7,000 -15,000 43,974 27 -1,536 33,532 14,342 40 643,269 -27,844 -4% 615,425 4% 10% 61,543 -12,309 -20% -7,000 -15,000 45,525 27 -1,551 25,683 9,730
Source: Company Data, Barclays Capital estimates
7 December 2011
57
Figure 77: BHEL historical 12-month forward P/E (x): close to historical trough
Valuations for BHEL are on peak EPS; hence, despite its decline, the stock may not outperform
35 30 25 20 15 10 5 May-07 Mar-08 Nov-04 Oct-09 May-02 Mar-03 Aug-96 Aug-01 Aug-10 Dec-94 Oct-95 Apr-98 Dec-99 Oct-00 Sep-05 Jul-06 Jan-09 Feb-99 Jun-97 Jan-04 Jun-11
BHEL
Source: Datastream, Barclays Capital
Figure 78: BHEL history of consensus EPS forecasts shows consensus earnings predictability has been high in the past (Rs)
30 25 20 15 10 5 0 May-06 May-07 May-08 May-09 May-10 May-11 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10
Figure 79: BHEL history of current consensus EPS forecasts for FY12-14 shows estimates have remained steady given a healthy order book
35 34 33 32 31 30 29 28 27 26 25 Jun-11 Dec-10 Sep-10 Mar-10 Mar-11 Dec-09 Sep-09 Sep-11
58
FY06 FY10
FY07 FY11
FY08
FY09 FY12 FY13 FY14
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 a recovery in order inflows in the power segment led by the governments 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.
7 December 2011
Jun-09
Jun-10
Figure 80: BHEL income statement, FY09-14E

Rs mn; years ending 31 March Net revenue Raw material expenses adjusted for inventory % of sales Staff cost % of sales Provisions for expenses % of sales Other expenses % of sales OBITDA Operating margin Depreciation and amortization Interest expenses Interest and other miscellaneous income Other extraordinary items Profit before tax Profit before tax margin Tax Profit after tax Profit after tax margin Adjusted profit after tax Adjusted profit after tax margin
FY09 267,268 164,685 62% 29,837 11% 12,810 5% 17,746 7% 42,190 16% 3,343 307 9,829 49,100 18% 17,106 31,994 12% 31,994 12%
FY10 333,545 198,856 60% 65,395 20% (9,342) -3% 19,438 6% 59,198 18% 4,580 335 11,552 (73) 65,907 20% 22,800 43,107 13% 43,165 13%
FY11 422,466 230,817 55% 53,967 13% 27,151 6% 24,674 6% 85,857 20% 5,441 547 10,206 18 90,057 21% 29,945 60,113 14% 53,709 13%
FY12E 476,781 289,894 61% 54,340 11% 4,768 1% 35,024 7% 92,755 19% 6,749 401 10,144 95,749 20% 29,660 66,089 14% 66,089 14%
FY13E 500,629 304,678 61% 57,582 12% 5,006 1% 37,810 8% 95,554 19% 7,187 423 13,188 101,132 20% 31,774 69,358 14% 69,358 14%
FY14E 493,826 305,515 62% 58,480 12% 4,938 1% 37,342 8% 87,551 18% 7,039 423 15,175 95,263 19% 31,094 64,169 13% 64,169 13%
7 December 2011
59
Figure 81: BHEL balance sheet, FY09-14E

Rs mn; years ending March Share capital Reserves and surplus Shareholder funds Total debt Capital employed FY09 4,895 124,493 129,388 1,494 130,882 FY10 4,895 154,278 159,174 1,278 160,451 FY11 4,895 196,643 201,538 1,634 203,172 FY12E 4,895 242,906 247,801 1,634 249,435 FY13E 4,895 291,456 296,352 1,634 297,985 FY14E 4,895 336,375 341,270 1,634 342,904
Net fixed assets Capital WIP Investments Deferred tax and others Cash and bank balance Receivables Receivable days Inventories Inventory days Loans and advances Others Current liabilities Current liabilities days Provisions Net current assets Total assets
14,704 11,570 523 18,403 103,147 159,755 218 78,370 107 24,237 3,502 233,573 319 49,756 85,682 130,882
24,154 15,296 798 15,272 97,901 206,888 226 92,355 101 28,137 4,069 280,237 307 44,180 104,931 160,451
34,009 17,622 4,392 21,636 96,302 273,546 236 109,630 95 32,373 3,096 313,466 271 75,968 125,514 203,172
47,261 17,622 9,392 21,636 120,742 308,275 236 124,094 95 27,653 3,096 353,767 271 75,968 154,125 250,035
55,074 17,622 14,392 21,636 153,675 323,695 236 137,159 100 29,037 3,494 371,462 271 85,735 189,862 298,585
58,035 17,622 19,392 21,636 204,473 311,178 230 135,295 100 28,642 3,669 366,414 271 90,023 226,819 343,504
7 December 2011
60
Figure 82: BHEL cash flow statement, FY09-14

Rs mn; years ending March Profit before tax Depreciation Others Operating cash before working capital Change in receivables Change in inventories Change in other assets Change in current liabilities and provisions Change in working capital Tax paid Cash flow from operations FY09 49,100 3,343 (8,448) 43,995 (49,110) (21,006) 82,102 11,986 (23,069) 32,912 FY10 65,907 4,580 (8,175) 62,313 (52,089) (13,984) 38,645 (27,428) (19,035) 15,851 FY11 90,057 5,441 665 96,163 (74,073) (17,380) 60,524 (30,929) (38,648) 26,586 FY12E 95,749 6,749 (9,143) 93,355 (34,728) (14,463) 4,720 40,301 (4,171) (29,660) 59,524 FY13E 101,132 7,187 (12,765) 95,554 (15,420) (13,065) (1,781) 27,462 (2,804) (31,774) 60,976 FY14E 95,263 7,039 (14,751) 87,551 12,517 1,864 220 (760) 13,841 (31,094) 70,298
Change in fixed assets Change in investments Others Cash flow from investing activities
(13,236) (441) 8,549 (5,128)
(17,137) (275) 7,746 9,666
(17,237) (3,594) 7,403 (13,428)
(20,000) (5,000) (25,000)
(15,000) (5,000) (20,000)
(10,000) (5,000) (15,000)
Inc./(dec.) in debt Issue of share capital Others Cash flow from financing activities
526 (9,023) (8,498)
(215) (11,214) (11,429)
351 (15,108) (14,757)
(10,084) (10,084)
(8,042) (8,042)
(4,499) (4,499)
Opening cash balance Increase/(decrease) during the year Closing balance

83,860 19,286 103,147
103,147 (5,246) 97,901
97,901 (1,599) 96,302
96,302 24,440 120,742
120,742 32,933 153,675
153,675 50,798 204,473
7 December 2011
61
SIEMENS LTD. (3-UW, PT: RS630, -13%): MARGINS PEAKING; VALUATIONS RICH
SIEM IN / SIEM.NS Stock Rating
3-UNDERWEIGHT
Sector View
2-NEUTRAL
Price Target
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 companys 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
Year to Sept 2011A 2012E 2013E 2014E Net profit Rs mn 8,454 9,390 10,831 12,548 EPS Rs 25.0 27.9 32.1 37.2 EPS growth % 2 11 15 16 P/E (x) 28.8 26.0 22.5 19.4 P/B (x) 6.4 5.4 4.6 3.9 ROE (%) 22.2 20.7 20.2 19.9 Div. yield (%) 0.9 1.0 1.1 1.3
INR 630.00
Price (02-Dec-2011)
INR 723.35
-13%
Source: Company data, Barclays Capita estimates
7 December 2011
62
COMPANY SNAPSHOT Siemens Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2011A 119,419 13,496 11,974 12,750 8,454 25.07 337.16 6.06 2012E 123,008 14,907 13,344 14,297 9,390 27.85 337.16 6.68 2013E 139,864 16,940 15,162 16,491 10,831 32.13 337.16 7.71 2014E 160,238 19,404 17,367 19,105 12,548 37.22 337.16 8.93 CAGR 10.3% 12.9% 13.2% 14.4% 14.1% 14.1% 0.0% 13.8% Average 11.9 10.6 11.5 7.6 20.8 20.8 20.8 CAGR -3.3% 47.1% 13.4% 10.3% NA 13.4% NA 18.2% NA 117% NA NA INDIA CAPITAL GOODS
3-UNDERWEIGHT 2-NEUTRAL 723.35 630 SIEM IN/SIEM.BO
11.3 10.0 10.7 7.1 22.2 22.2 22.2
12.1 10.8 11.6 7.6 20.7 20.7 20.7
12.1 10.8 11.8 7.7 20.2 20.2 20.2
12.1 10.8 11.9 7.8 19.9 19.9 19.9
Why a 3-Underweight? The stocks valuation at 25x FY12E appears rich especially given only 2% PAT growth in Sep-11 and a 14% EPS CAGR. Risks to the downside for our estimates are high as we are building in margin growth, which could be difficult given pricing pressure in various end markets
Balance sheet and cash flow (INRmn) Fixed assets 14,183 Cash and equivalents 12,750 Total assets 101,577 Current liabilities 63,415 Long term liabilities Total liabilities 101,577 Net debt/(funds) (12,750) Shareholders' equity 38,162 Change in working capital (8,097) Cash flow from operations 1,124 Capital expenditure (5,900) Free cash flow (4,776) Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
Upside case 900 A bullish case for Siemens would be the announcement of a delisting, which could lead to the stock heading to at least its previous open offer price
14,120 23,660 110,620 65,321 110,619 (23,660) 45,298 3,710 13,784 (1,500) 12,284
13,843 31,398 127,803 74,272 127,802 (31,398) 53,530 (771) 10,508 (1,500) 9,008
12,806 40,600 148,158 85,091 148,158 (40,600) 63,067 (1,371) 11,475 (1,000) 10,475
Downside case 334 An earnings shock led by margin compression could lead to the stock heading to its historical low P/E of 10x
Upside/downside scenarios 28.8 17.1 -2.0 1.9 6.4 0.2 0.0 -0.3 26.0 14.8 5.0 1.8 5.4 0.3 0.0 -0.5 22.5 12.5 3.7 1.5 4.6 0.3 0.0 -0.6 Average 19.4 24.2 10.5 13.7 4.3 2.8 1.3 1.6 3.9 5.0 0.4 0.3 0.0 0.0 -0.6 -0.5
1100 1167 900 967 700 767 500 567 300 367 100 167 16-Dec-10 INR334 INR334 (-53.8%) (-53.8%) Downside
Downside Case Case
INR900 INR900 (24.4%) INR630 (24.4%) INR630 (-12.9%) (-12.9%)

Price Price Target Target Upside Upside Case Case
28-Nov-11
High risk to margins 122,886 -1 139,213 7 141,319 15 157,524 13 162,517 15 180,176 14 186,894 15 206,832 15
15% 10% 5% 0% "Sep11 Sep06 Sep07 Sep08 Sep09 Sep10 Sep12E Sep13E Sep14E EBITDA margin
Note: FY end Sep.
7 December 2011
63
End market exposure attractive

New expansion initiatives to drive growth
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 gasbased 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
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
140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 Sep99 Sep01 Sep03 Sep05 Order inflow
120% 100% 80% 60% 40% 20% 0% -20% Sep07 YoY Sep09 Sep-11
Order inflows have rarely declined due to exposure to many segments
Figure 85: Siemens annual order inflows: rate of growth has rarely declined in the past decade
120% 99% 100% 80% 80% 60% 52.0% 40% 20% 0% -20% Sep99 -5.3% -10% Sep01 -8% Sep03 Sep05 YoY
Note: Order inflow decline in Sep-08 largely due to divestment of automotive business. Source: Company data, Barclays Capital
45%
37% 17%
41%
7%
0%
-1%
Sep07
Sep09
Sep-11
7 December 2011
64
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 drivebased 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
Well diversified company
Building Real Estate Technologies Healthcare and 0% 7% other services 8% Automation and Drives 19% Industrial Solutions and Services 9% Transport 6% Transmission 27% Generation 4% Oil gas 11%
Distribution 9%
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
Cash generation was weak last year
16,000 12,000 8,000 4,000 0 -4,000 Sep99 Sep01 Sep03 Sep05 PBT after exp
Sep07
Sep09
Sep11E
Cash for operations
7 December 2011
65
Increase in exports could counter rupee depreciation impact

Siemens can increase exports to counter Rs depreciation; it is a net importer
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 Export of goods Project business Commission Service charges and others Exports As % of sales Expenditure in foreign currency as % of sales RM imports Capital goods Imports As % of sales Net imports Forex loss as % of sales Adjusted EBITDA margin Reported EBITDA margin
Source: Company Data, Barclays Capital
Sep-06 2,287 6,692 399 1,174 10,553 14% 4,195 5% 13,758 682 14,440 19% 11% -141 -0.3% 8.7% 8.9%
Sep-07 2,368 23,557 490 301 26,716 32% 8,435 10% 3,340 14,492 17,832 22% -1% -1,085 -1.4% 8.2% 9.5%
Sep-08 4033 26,377 452 94 30,957 37% 11,896 14% 4,432 19,950 24,382 29% 6% -2,017 -2.4% 7.0% 9.3%
Sep-09 2,570 17,304 520 144 20,538 22% 5312 6% 26,398 529 26,926 29% 13% 83 0.1% 12.4% 12.1%
Sep-10 1,996 13,459 446 116 16,017 13% 7,398 6% 33,960 819 34,779 29% 22% 676 0.7% 14.7% 13.8%
955 2,056 387 789 4,187 9% 745 2% 8,792 92 8,884 20% 12% 286 1.1% 11.5% 10.1%
7 December 2011
66
Figure 89: Siemens net imports: company is a net importer of products

Rupee depreciation could have a medium-term impact as Siemens is a net importer
25% 20% 15% 10% 5% 0% -1% -5% Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Net imports as % of sales
22% 2017 12% 13% 11% 1085 6% -286 141 -83 -676
2500 2000 1500 1000 500 0 -500 -1000
Forex gains/losses, Rs mn
Valuation
Current valuations are rich
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.
Stock trading below historical average multiples but valuations appear rich
Figure 90: Siemens historical 12-month forward P/E (x): stock trading below average
35 30 25 20 15 10 5 Dec-04 Nov-07 Dec-08 Mar-04 Mar-08 May-09 Aug-04 Aug-08 Nov-11
67
SISL /SIPS stake sale
Oct-10
Sep-09
Jan-10
Jun-10
Apr-05
Feb-11
Sep-05
Jan-06
Jun-06
Oct-06
Feb-07
Siemens
Jul-07
Linear (Siemens)
7 December 2011
Jul-11
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).
ABB is trading at a 50% premium to Siemens, highest over the past decade
Figure 91: Siemens ABB is trading at a historical premium to Siemens

1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 Aug-02 Aug-07 Aug-08 Feb-08 Sep-06 Jul-03 May-05 Mar-07 Jul-09 May-11 Oct-05 Dec-03 Dec-09 Nov-04 Nov-10 Apr-06 Oct-11 Jun-04 Jun-10 Jan-03 Jan-09
ABB 12M fwd PE as a ratio of Siemens 12M Fwd PE

Figure 92: Siemens historical performance has been significantly superior to that of ABB
FY05 Order inflows (Rs mn) ABB Siemens Profit after tax (Rs mn) ABB Siemens Net working capital (days) ABB Siemens ROE (%) ABB Siemens
FY06
FY07
FY08
FY09
FY10
FY11E
CAGR
37,645 41,233 2,187 2,548 20 -38 20% 33%
56,236 82,026 3,403 3,602 22 -62 24% 33%
76,682 95,720 4,917 5,968 29 4 27% 34%
86,008 87,722 5,474 5,954 55 -5 21% 25%
93,977 87,960 3,546 10,449 64 6 13% 23%
63,489 124,304 632 8,272 58 5 0% 24%
98,208 122,886 1,798 8,454 na 29 7% 22%
17% 20% -3% 22%
14% 21%
7 December 2011
68
Figure 93: Siemens history of current consensus EPS forecasts shows estimates after the strong period of 20052006 were moderated due to losses in some projects (Rs)
50 40 30 20 10 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 May-06 May-07 May-08 May-09 May-10 Nov-10 May-11 0
Figure 94: Siemens history of current consensus EPS forecasts for FY12-14 shows estimates upgrades in recent years (Rs)
45 40 35 30 25 20 15 10 5 0
Dec-09
Dec-10
Jun-09
Jun-10
Sep-09
Sep-10
Jun-11
Mar-10
Sep-06 Sep-09
Source: Datastream Barclays Capital
Sep-07 Sep-10
Sep-08
Sep-11
Sep-12
Sep-13
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.
7 December 2011
Mar-11
Sep-11
69
Figure 95: Siemens income statement, FY08-14E

Rs mn; years ending September Net sales Other operating income plus commissions Raw material expenses adj for inventory % of sales Staff cost % of sales Other expenses % of sales OBITDA OBITDA margin Depreciation and amortization Interest income net Other income Other extraordinary items Profit before tax Profit before tax margin Tax Reported profit after tax Adjusted profit after tax Adjusted profit after tax margin
FY08 82,504 1,074 67,972 82% 4,476 5% 3,339 4% 7,791 9% 637 472 67 1,246 8,938 11% 2,984 5,954 5,124 6.2%
FY09 83,367 1217 63,977 77% 5,499 6.6% 4,878 6% 10,231 12% 778 465 2,341 2,059 14,319 17% 3,870 10,449 6,731 8.1%
FY10 92,707 1294 68,474 74% 6,325 6.8% 6,269 7% 12,932 14% 1,015 670 0 0 12,587 14% 4,315 8,272 8,272 8.9%
FY11E 119,419 1,645 90,267 76% 9,174 7.7% 8,127 7% 13,496 11% 1,522 755 21 0 12,750 11% 4,295 8,454 8,454 7.1%
FY12E 123,008 1,623 91,972 75% 9,496 7.7% 8,257 7% 14,907 12% 1,563 879 74 0 14,297 12% 4,907 9,390 9,390 7.6%
FY13E 139,864 1,846 104,581 75% 10,796 7.7% 9,394 7% 16,940 12% 1,778 1,329 0 0 16,491 12% 5,660 10,831 10,831 7.7%
FY14E 160,238 2,115 119,817 75% 12,369 7.7% 10,764 7% 19,404 12% 2,037 1,738 0 0 19,105 12% 6,557 12,548 12,548 7.8%
7 December 2011
70
Figure 96: Siemens balance sheet, FY08-14E

Rs mn; years ending September Share capital Reserves and surplus Shareholder funds Total debt Capital employed FY08 674 20,017 20,691 11 20,701 FY09 674 28,492 29,166 6 29,172 FY10 674 34,103 34,778 2 34,780 FY11E 681 37,481 38,162 0 38,162 FY12E 681 44,618 45,298 0 45,298 FY13E 681 52,850 53,530 0 53,530 FY14E 681 62,386 63,067 0 63,067
Net fixed assets Capital WIP Investments Deferred tax and others Cash and bank balance Receivables Receivable days Inventories Inventory days Loans & advances as % of sales Current liabilities Current liabilities days Provisions Provisions as % of current liabilities Net current assets Total assets
5,572 870 5,236 910 9,131 34,328 152 7,621 34 6,173 7% 41,868 185 7,272 32 -1,018 20,701
6,295 1,057 4,770 1,119 14,449 34,583 151 9,722 43 10,458 13% 40,585 178 12,695 56 1,482 29,172
7,340 2,465 3,885 1,313 18,534 33,023 130 15,335 60 12,449 13% 43,892 173 15,672 62 1,243 34,780
11,718 2,465 1 1,889 12,750 41,733 128 16,961 52 14,060 12% 45,376 139 18,039 55 9,340 38,162
11,655 2,465 1 1,889 23,660 42,988 128 13,480 40 14,483 12% 46,740 139 18,581 55 5,630 45,299
11,378 2,465 1 1,889 31,398 48,878 128 15,328 40 16,467 12% 53,145 139 21,127 55 6,401 53,531
10,341 2,465 1 1,889 40,600 55,998 128 17,999 41 18,866 12% 60,887 139 24,204 55 7,773 63,067
7 December 2011
71
Figure 97: Siemens cash flow statement, FY08-14E

Rs mn; years ending September Profit before tax Depreciation Others Operating cash before working capital Change in receivables Change in inventories Change in current liabilities and provisions Change in working capital Restructuring costs Taxes paid Cash flow from operations Discontinued operations FY08 8,918 637 -1,255 8,300 -10,569 -396 12,208 1,243 0 -3,970 5,574 -105 FY09 14,319 778 -6,006 9,091 -1,261 -2,101 3,371 9 0 -5,631 3,468 0 FY10 12,587 1,015 -349 13,253 588 -5,187 6,169 1,570 0 -4,812 10,012 0 FY11E 12,750 1,522 -755 13,516 -10,321 -1,626 3,850 -8,097 0 -4,295 1,124 0 FY12E 14,297 1,563 -879 14,981 -1,677 3,481 1,906 3,710 0 -4,907 13,784 0 FY13E 16,491 1,778 -1,329 16,940 -7,875 -1,847 8,951 -771 0 -5,660 10,508 0 FY14E 19,105 2,037 -1,738 19,404 -9,519 -2,672 10,819 -1,371 0 -6,557 11,475 0
Change in fixed assets Change in investments Others Cash flow from investing activities Discontinued operations Inc./(dec.) in debt Issue of share capital Others Cash flow from financing activities
-1,657 -467 -108 -42 -5 0 -971 0
-1,451 1,320 2,140 0 -5 0 -290 0 9,131 5,318 14,449
-2,577 -703 -4,413 0 -3 0 -2,007 0 14,449 3,592 18,534
-5,900 -3,884 -9,029 0 -2 0 -2,044 0 18,534 -9,949 12,750
-1,500 0 -621 0 0 0 -2,254 0 12,750 10,909 23,660
-1,500 0 -171 0 0 0 -2,600 0 23,660 7,738 31,398
-1,000 0 738 0 0 0 -3,012 0 31,398 9,202 40,600
Opening cash balance Increase/decrease during the year Closing balance

4,636 4,495 9,131
7 December 2011
72
ABB LTD. (3-UW, PT: RS494, -20%): FUNDAMENTALS REMAIN UNDER STRESS
ABB IN / ABB.NS Stock Rating
3-UNDERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 494.00
Price (02-Dec-2011)
INR 618.80
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 ABBs 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: ABBs 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 companys 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: ABBs 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
Year to Dec 2010A 2011E 2012E 2013E Net profit Rs mn 632 1,798 4,191 4,337 EPS Rs 3.0 8.5 19.8 20.5 EPS growth % -82 184 133 3 P/E (x) 196.1 68.9 29.6 30.2 P/B (x) 5.1 4.8 4.2 3.9 ROE (%) 2.6 7.0 14.2 13.0 Div. yield (%) 0.3 0.1 0.3 0.3
-20%
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COMPANY SNAPSHOT ABB Limited Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2010A 62,871 838 319 1,002 632 2.98 212 2.00 2011E 74,884 3,934 3,098 3,025 1,798 8.49 212 0.80 2012E 88,207 7,432 6,557 6,378 4,191 19.78 212 1.88 2013E 90,554 7,724 6,828 6,601 4,337 20.47 212 1.94 CAGR 12.9% 110% 178% 87.4% 90.0% 90.0% 0.0% -1.0% Average 5.9 4.9 5.0 3.2 9.2 9.2 9.2 INDIAN CAPITAL GOODS
3-UNDERWEIGHT 2-NEUTRAL 618.8 494 ABB IN/ABB.BO
1.3 0.5 1.6 1.0 2.6 2.6 2.6
5.3 4.1 4.0 2.4 7.0 7.0 7.0
8.4 7.4 7.2 4.8 14.2 14.2 14.2
8.5 7.5 7.3 4.8 13.0 13.0 13.0
Why a 3-Underweight? ABB is exposed to high competitive pressures in its T&D business, and this is impacting margins. Furthermore, industrial markets (40% of mix) is decelerating. Margins could recover off the lows in Dec-10 but we believe that current valuations adequately capture the growth.
Balance sheet and cash flow (INRmn) Fixed assets 8,238 Cash and equivalents 5,871 Total assets 57,714 Current liabilities 33,477 Long term liabilities Total liabilities 57,714 Net debt/(funds) (5,871) Shareholders' equity 24,237 Change in working capital 785 Cash flow from operations 2,207 Capital expenditure (1,044) Free cash flow 1,162 Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
9,402 922 60,256 34,419 60,256 (922) 25,837 (5,384) (2,564) (2,000) (4,564)
10,527 573 70,361 40,797 70,361 (573) 29,564 (2,952) 2,351 (2,000) 351
CAGR 10,631 8.9% 3,605 -15.0% 75,564 9.4% 42,142 8.0% NA 75,564 9.4% NA (3,605) 33,422 11.3% (722) NA 4,799 29.6% (1,000) NA 3,799 48.4% Average 30.2 81.2 16.5 51.3 2.9 0.1 1.4 1.6 3.9 4.5 0.3 0.3 0.0 0.0 -11 -10
Upside case 900 Our bull case for ABB is premised on nonfundamental facors. ABB's parent has already increased its stake in ABB Ltd to 75%. A future delisting could lead to the stock heading to its previous open offer price.
Downside case
247 No recovery in margins next year and weak order inflows in 2H could lead to a de-rating of the stock. Expect the stock to head to its historical trough P/E of 12x.
Upside/downside scenarios 196.1 141.0 0.9 1.9 5.1 0.3 0.0 -24 68.9 31.3 -3.7 1.6 4.8 0.1 0.0 -4 29.6 16.6 0.3 1.4 4.2 0.3 0.0 -2
1100 1000 900 800 700 600 500 400 300 200 100 0 15-Dec-10 INR900 (45.3%) INR494 INR494 (-20.1%) INR247 (-20.1%) INR297 (-60.0%) Price (-52.0%) Price
Downside Downside Case Case Target Target
Upside Case
25-Nov-11
High exposure to imports a risk to margins 63,489 -32 85,723 0 98,208 55 107,770 20 88,387 -10 107,950 0 97,226 10 114,622 6
50% 40% 30% 20% 10% 0% Dec05 Dec06 Dec07 Dec08 Dec09 Dec10E Imports as % of material costs
Note: FY end Dec.
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Margin decline
Margins have deteriorated in all segments
ABBs 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
20% 15% 10% 5% 0% -5% -10% -15% Mar-10 Sep-10 Mar-11 Mar-11 Mar-05 Sep-05 Mar-06 Sep-06 Sep-11 Sep-11
75
Margins at power systems division were first to collapse; power products segment has also declined
Mar07
Sep07
Mar08
Sep08
Mar09
Power products margin

Power systems 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
Figure 100: ABB margins in automation segment have also moderated

25% 20% 15% 10% 5% 0% -5% Sep-05 Sep-06 Sep07 Sep08 Mar-05 Mar-06 Sep09 Mar-10 Sep-10 Mar07 Mar08 Mar09
Automation products margin

Power automation margin
Royalty rates up 46% in the worst year at ABB

High import content one of the key reasons for weak margins and high margin volatility
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 companys 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
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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 101: ABB royalties as percentage of sales: increase rose more than 46% y/y in (CY10E)
2.0% 1.5% 1.0% 0.5% 0.0% Dec05 Dec06 Dec07 Dec08 Dec09 Dec10E
Figure 102: ABB imports a percentage of material costs: continues to be high

50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Dec05 Dec06 Dec07 Dec08 Dec09 Dec10E
Royalty as % of sales
Imports as % of mateial costs

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 103: ABB EPS (Rs) vs. EBITDA Margin: recovery expected to be led by margins normalising to high single digits
30 25 20 15 10 10 5 0 Dec93 Dec95 Dec97 Dec99 Dec01 Dec03 Dec05 Dec07 Dec09 Dec11E 1 2 3 4 3 2 2 3 3 4 5 7 3 8 6% 4% 2% 0% 16 23 20 17 8% 26 14% 12% 10%
Adjusted EPS
Ebitda margin RHS
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Valuation
Rich valuations pricing in a recovery
Our 12-month price target of Rs494 is based on an average 25x P/E. Our target multiple is the stocks 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 markets 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 ABBs 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 ABBs parents stake has increased to 75% now. Figure 104: ABB Stock still appears rich on P/E valuation (x)
35 30 25 20 15 10 5 Dec-94 Oct-95 Jun-97 Jan-04 Jul-06 Apr-98 Mar-03 Sep-05 May-02 May-07 Mar-08 Aug-96 Feb-99 Dec-99 Oct-00 Aug-01 Nov-04 Jan-09 Oct-09 Aug-10 Jun-11
77
ABB still trading at the upper end of its valuation band
ABB
Figure 105: ABB history of current consensus EPS forecasts shows stock has seen downgrades in estimates every year since CY07 (Rs)
60 50 40 30 20 10 0 Nov-05
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)
45 40 35 30 25 20 15 10 5 0 Jun-09 CY11
Nov-06 CY05 CY09
Nov-07 CY06 CY10
Nov-08
Nov-09 CY07
Nov-10 CY08
Jun-10 CY12
Jun-11
7 December 2011
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 Sales and services (Net) YoY Cost of materials and erection services % of sales Personnel expenses % of sales Other expenses % of sales EBITDA EBITDA Margin Other income Depreciation and amortisation Interest expenses Profit before tax Profit before tax margin % Tax Tax rate Reported profit after tax Margin Adjusted profit after tax Margin
Source: Company reports, Barclays Capital estimates
2007 59,303 39% 42,920 72% 3,061 5% 6,076 10% 7,246 12% 710 327 68 7,565 13% 2,648 35% 4,917 8% 4,917 8%
2008E 68,370 15% 49,504 72% 4,030 6% 7,183 11% 7,654 11% 1,304 369 347 8,332 12% 2,858 34% 5,474 8% 5,474 8%
2009E 62,372 -9% 45,179 72% 3,892 6% 8,042 13% 5,259 8% 726 488 256 5,274 8% 1,728 33% 3,546 6% 3,546 6%
2010E 62,871 1% 48,021 76% 4,901 8% 9,111 14% 838 1% 855 519 174 1,002 2% 370 37% 632 1% 632 1%
2011E 74,884 19% 55,362 74% 5,694 8% 9,894 13% 3,934 5% 170 836 243 3,025 4% 1,226 41% 1,798 2% 1,798 2%
2012E 88,207 18% 63,155 72% 6,206 7% 11,415 13% 7,432 8% 87 874 266 6,378 7% 2,188 34% 4,191 5% 4,191 5%
2013E 90,554 3% 64,841 72% 6,361 7% 11,628 13% 7,724 9% 90 896 317 6,601 7% 2,264 34% 4,337 5% 4,337 5%
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Figure 108: ABB balance sheet, 2007-13E

Rs mn; years ending December Share capital Reserves and surplus Shareholder funds Total loans Deferred tax liability Total liabilities Net block Capital WIP Deferred tax assets Investments Inventories Inventory days Sundry debtors Debtor days Cash and bank balances Other current assets as % of sales Loans and advances as % of sales Current liabilities Days of sales Provisions % of Current liabilities Net current assets 705 4,887 30 24,236 149 6,429 2,754 5% 2,802 5% 29,315 180 678 2% 11,114 611 6,427 34 29,759 159 3,482 3,813 6% 3,518 5% 31,619 169 1,596 5% 13,783 169 7,294 43 28,577 167 5,241 3,203 5% 3,177 5% 29,869 175 1,450 5% 16,174 2007 424 15,840 16,263 6 128 16,397 3,519 1,059 2008E 424 20,766 21,190 0 38 21,228 5,458 1,375 2009E 424 23,814 24,237 0 0 24,237 6,731 1,163 2010E 424 23,813 24,237 0 0 24,237 7,661 577 46 168 6,979 40 29,260 165 5,871 3,611 5% 3,542 5% 31,630 160 1,846 5% 15,785 2011E 424 25,413 25,837 0 0 25,837 8,825 577 46 168 8,206 40 33,852 165 922 3,846 5% 3,814 5% 32,826 160 1,594 5% 16,221 2012E 424 29,140 29,564 0 0 29,564 9,950 577 46 168 9,908 41 40,116 166 573 4,530 5% 4,493 5% 38,908 161 1,889 5% 18,823 2013E 424 32,998 33,422 0 0 33,422 10,054 577 46 168 10,420 42 41,432 167 3,605 4,650 5% 4,612 5% 40,191 162 1,951 5% 22,577
Total assets
16,397
21,228
24,237
24,237
25,837
29,564
33,422
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Figure 109: ABB cash flow statement, 2007-13E

Rs mn; years ending December Profit before tax Depreciation and amortisation Operating profit be working capital Change in sundry debtors Change in inventories Change in other current assets Change in loans and advances Change in current liabilities and provisions Others Change in working capital Direct taxes paid (net of refund) Net cash from operating activities 2007 7,565 324 7,679 -8,533 -1,340 -1,264 -928 9,820 0 -2,245 -2,759 2,676 2008 8,332 367 9,060 -5,453 -1,539 -1,194 -1,075 2,777 0 -6,484 -2,378 197 2009 5,274 485 5,829 1,172 -868 599 1,065 -1,566 0 403 -2,687 3,545 2010 1,002 517 2,004 -715 316 -407 -160 1,751 0 785 -582 2,207 2011E 3,025 836 4,047 -4,592 -1,228 -234 -273 943 0 -5,384 -1,226 -2,564 2012E 6,378 874 7,490 -6,264 -1,702 -684 -679 6,377 0 -2,952 -2,188 2,351 2013E 6,601 896 7,784 -1,316 -512 -121 -120 1,346 0 -722 -2,264 4,799
Change in fixed assets Change in investments Others Net cash from investing activities
-1,470 69 262 -1,139
-2,639 117 275 -2,247
-1,633 439 194 -986
-1,044 1 114 -929
-2,000 0 57 -1,943
-2,000 0 29 -1,971
-1,000 0 30 -970
Change in shares Change in loans Others Net cash from financing activities
0 -10 -563 -573
0 -5 -891 -896
0 0 -800 -800
0 0 -648 -648
0 0 -442 -442
0 0 -729 -729
0 0 -797 -797
Increase/decrease in cash and equivalent Opening cash Closing cash

964 5,464 6,429
-2,946 6,429 3,482
1,759 3,482 5,241
630 5,241 5,871
-4,949 5,871 922
-350 922 573
3,032 573 3,605
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CUMMINS (1-OW, PT: RS428, +20%): STRONG PRODUCT POSITIONING

KKC IN / CUMM.NS Stock Rating
1-OVERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 428.00
Price (02-Dec-2011)
INR 357.85
+20%
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
Year to 31 Mar 2011A 2012E 2013E 2014E Net profit Rs mn 5,911 5,088 5,642 7,570 EPS Rs 21.3 18.4 20.4 27.3 EPS growth % 33.8 (13.9) 10.9 34.2 P/E (x) 15.7 18.3 16.5 12.3 P/B (x) 5.1 4.5 4.0 3.5 ROE (%) 32.7 24.9 24.4 28.4 Div. yield (%) 3.4 2.9 3.2 4.3
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COMPANY SNAPSHOT CUMMINS Ltd Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2010A 39,454 6,636 4,102 8,024 5,911 21.32 277.20 11.32 2011E 41,665 5,923 4,291 7,144 5,088 18.36 277.20 9.74 2012E 47,313 6,679 4,736 7,925 5,642 20.35 277.20 10.80 2013E 61,002 9,272 5,763 10,624 7,570 27.31 277.20 14.49 CAGR 15.6% 11.8% 12.0% 9.8% 8.6% 8.6% 0.0% 8.6% Average 15.1 10.0 17.9 12.9 27.4 27.4 27.6 CAGR 17.9% 17.5% 14.6% 16.1% NA 14.6% NA 13.8% NA 6.5% NA 11.0% INDIAN CAPITAL GOODS
1-OVERWEIGHT 2-NEUTRAL 357.9 428 KKC IN/CUMM.BO
16.8 10.4 20.3 15.0 32.4 32.4 32.7
14.2 10.3 17.1 12.2 24.7 24.7 24.9
14.1 10.0 16.8 11.9 24.2 24.2 24.4
15.2 9.4 17.4 12.4 28.2 28.2 28.4
Why a 1-Overweight? Dominant positioning in powergen products should help the company to sustain pricing despite weak market ordering. Longterm drivers for its business are intact with peak shortages expected to continue until FY17. We value it at 15% premium to its historical average.
Balance sheet and cash flow (INRmn) Fixed assets 16,805 Cash and equivalents 1,038 Total assets 28,657 Current liabilities 10,412 Long term liabilities 183 Total liabilities 28,657 Net debt/(funds) (855) Shareholders' equity 18,063 Change in working capital (1,053) Cash flow from operations 3,470 Capital expenditure (1,500) Free cash flow 1,970 Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics ICE capaicty Capacity utilisation Domestic sales ex CSS Exports
18,201 525 31,641 11,008 31,641 (342) 20,450 (1,314) 2,554 (2,000) 554
20,947 874 35,781 12,500 35,781 (691) 23,098 (904) 3,492 (2,000) 1,492
27,564 1,684 43,116 16,283 43,116 (1,501) 26,650 (2,024) 4,194 (1,500) 2,694
Upside case 499 A recovery in domestic ordering , improvement in margins (if commodity prices start declining) as well as strength in exports could lead to the stock heading to peak P/E of 25x.
Downside case 204 Continued weakness in revenues and margins especially for exports could lead to the stock trading closer to its recent trough P/E of about 10x.
Upside/downside scenarios 15.7 13.9 2.0 2.3 5.1 3.2 1.0 0.0 18.3 15.6 0.6 2.2 4.5 2.7 0.9 0.0 16.5 13.8 1.5 1.9 4.0 3.0 0.8 0.0 Average 12.3 15.7 9.9 13.3 2.7 1.7 1.5 2.0 3.5 4.3 4.1 3.2 0.7 0.8 0.0 - 0.0
702 600 602 500 502 400 402 300 302 200 202 100 102 0 22-Dec-10 2-Dec-11 INR204 (-42.9%) INR204 (-42.9%) Downside
Case
INR428 (19.6%) INR428 (19.6%)

Price Price Target Target
INR499 INR499 (39.4%) (39.4%)

Upside Upside Case Case
Capacity utilisation decline reflected in estimates 53,300 72.8 23,677 10,230 83,300 48.5 24,310 11,253 83,300 50.0 27,168 13,128 83,300 70.0 37,291 15,641
120% 100% 80% 60% 40% 20% 0% Mar-05 Mar-06 Mar-07 Capacity utilisation
Mar-08
Mar-09
Mar-10
Note: FY end Mar.
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82
Near-term cyclical pressures evident

Sales guidance has been cut from 20% y/y at start of the year to single-digit growth
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
Powergen demand decelerating at a faster pace than industrial
Management expects EBITDA margins to decline by another 1% over the next two quarters
We expect capacity utilisation to decline given weak demand and an increase in capacity for medium KVA engines
120% 100% 80% 60% 40% 20% 0% 83%
102% 94%
109%
73% 53% 55% 49% 50%
70%
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

Peers such as Kirloskar Oil engines have also given a cautious view on sales growth
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
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Commonwealth Games came out for sale in the market in 3Q FY11, after the event was over, and this increased supply in the market.
KOEL decreased guidance from 15-20% sales growth to 10%
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 KOELs sales growth trends are a leading indicator for Cummins
Management appeared more concerned over low KVA compared with medium-high KVA engines
KOELs sales trends are a good leading indicator of trends at Cummins

25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% Sep-07 Sep-08 Sep-09 Sep-10 Dec-07 Dec-08 Dec-09 Dec-10 Mar-08 Mar-09 Mar-10 Mar-11 Sep-11 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 100% 80% 60% 40% 20% 0% -20% -40%
Kirloskar oil engines quarterly sales YoY

Cummins quarterly sales growth YoY
Weak earnings in the near term and risk of consensus EPS cuts
EPS estimates now reflect weak demand; we expect 6% growth in sales in FY12E followed by 14% growth in FY13E
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).
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Figure 113: Cummins sales: we expect only 6% sales growth in FY12E

Rs mn Domestic y/y Overseas y/y Cummins sales and services y/y Total
FY11 23,677 24% 10,230 137% 5,547 15% 39,454
FY12E 24,310 3% 11,253 8% 6,102 10% 41,665
FY13E 27,168 12% 13,128 17% 7,017 15% 47,313
Mar14E 37,291 37% 15,641 19% 8,070 15% 61,002
Earnings may have troughed in September quarter

Quarterly earnings momentum at historical lows; we expect momentum to improve next year led by easy y/y comps
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. Figure 115: Cummins Earnings growth close to trough on quarterly basis; expect improvement from 2H FY13E
25% 20% 15% 6 10% 5% 120% 90% 60% 30% 0% -30% -60% Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12
Figure 114: Cummins Annual sales growth was below 10% in only 5 of the past 20 years
50 40 30 20 10 0 -10 -20 Mar-92 Mar-94 Mar-96 (7) (13) Mar-98 Mar-00 21 10 14 4 33 21 22 12 12 28 28 26 27 40 23 39
(14) Mar-02 Mar-04 Mar-06 Mar-08
(13) Mar-10 Mar-12
0%
Annual revenue growth YoY

EBITDA Margin
EPS YoY growth (RHS)
Long-term drivers intact

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
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.
7 December 2011
85
Figure 116: Cummins management expects peak deficit to continue at 15%

Peak shortages are expected to fall but remain at 15% levels until FY17
350 GW 300 250 200 150 100 50 0 Demand Peak defecit :17% Base surplus : 4%
2009 Demand 132 GW 53 79 Supply 109 GW 27 82 Available supply
2012 300 GW 190 GW 82 106 Demand Peak defecit :22% Base surplus : 8 % 148 GW 31
2017 256 GW 129 54
171 117
202
Available supply
Demand
Available supply Peak defecit :15% Base surplus : 18%
With Cummins introducing new product lines for exports, longterm potential remains high
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

Strong and dominant market positioning helps protect pricing
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
Cyclical weakness captured in valuations
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 companys 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 companys 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.
7 December 2011
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Valuations are below historical averages; further derating likely only in a deep recession
Figure 117: Cummins historical 12-month forward P/E (x): valuations have witnessed a sharp correction
24 20 16 12 8 4 Sep-05 Feb-04 Dec-04 Sep-96 Jun-02 Jul-06 May-07 Aug-01 Sep-10 Jul-97 Feb-99 Jan-95 Dec-99 Oct-00 Nov-95 May-98 Apr-03 Mar-08 Jan-09 Nov-09 Jul-11 Sep-11
87
Cummins
Linear (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
45 40 35 30
25 20 15 10 5 0 May-06 May-07 May-08 May-09 May-10 May-11 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10
25 20 15 Dec-10 Jun-10 Sep-10 Mar-10 Mar-11 FY14 Dec-09 Jun-09 Sep-09 Jun-11
FY06 FY10
FY07 FY11
FY08
FY09 FY12 FY13
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.
7 December 2011
Figure 120: Cummins income statement, FY09-14E

Rs mn; years ending March Net sales YoY Expenditure Total material costs % of sales Employee costs % of sales Other costs OBITDA OBITDA margin Other income plus other operating income Depreciation Interest Pre-tax exceptional items Profit before tax Profit before tax Margin Tax Tax rate Post-tax exceptional items Profit after tax reported Profit after tax adjusted
FY09 32,741 40% 27,968 22,338 68% 2,130 7% 3,501 4,772 15% 1,507 456 26 192 5,990 18% 1,654 28% 0 4,337 4,202
FY10 28,449 -13% 23,174 18,552 65% 1,953 7% 2,670 5,275 19% 1,216 381 21 0 6,089 21% 1,670 27% 0 4,419 4,419
FY11 39,454 39% 32,818 25,803 65% 2,546 6% 4,469 6,636 17% 1,774 367 19 0 8,024 20% 2,114 26% 0 5,911 5,911
FY12E 41,665 6% 35,741 27,881 67% 3,157 8% 4,704 5,923 14% 1,657 413 23 0 7,144 17% 2,056 29% 0 5,088 5,088
FY13E 47,313 14% 40,634 31,809 67% 3,484 7% 5,342 6,679 14% 1,876 606 24 0 7,925 17% 2,283 29% 0 5,642 5,642
FY14E 61,002 29% 51,730 40,847 67% 4,339 7% 6,544 9,272 15% 2,157 781 24 0 10,624 17% 3,054 29% 0 7,570 7,570
7 December 2011
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Figure 121: Cummins balance sheet, FY09-14E

Rs mn; years ending March Share capital Reserves and surplus Shareholders equity Secured loans Unsecured loans Loan funds Finance lease liability Total sources of funds Gross block Less: depreciation Net block Investments Deferred tax net Inventories Inventory days Debtors Debtor days Cash and bank Other current assets as % of sales Loans and advances as % of sales Current liabilities Current liabilities days Provisions Number of days net sales Net current assets No of days net sales Total application of funds
FY09 396 13,551 13,947 212 0 212 17 14,176 7,414 4,324 3,090 3,993 231 4,680 52 6,821 76 323 83 0 2,663 0 5,977 67 1,732 19 6,862 77 14,176
FY10 396 15,214 15,610 86 0 86 15,696 8,041 4,704 3,337 7,329 169 4,098 53 5,229 67 559 93 0 2,695 0 5,178 66 2,634 34 4,862 62 15,696
FY11 396 17,667 18,063 183 183 18,246 9,144 4,733 4,411 7,255 187 5,190 52 7,182 67 1,038 99 0 3,297 0 7,109 66 3,303 33 6,393 62 18,246
FY12E 396 20,054 20,450 183 20,633 11,144 5,146 5,997 7,255 187 5,936 52 7,658 67 525 136 0 3,947 0 7,583 66 3,424 30 7,194 62 20,633
FY13E 396 22,702 23,098 183 23,281 13,144 5,752 7,391 7,255 187 6,741 52 8,696 67 874 154 0 4,482 0 8,611 66 3,889 30 8,448 62 23,281
FY14E 396 26,254 26,650 183 26,833 14,644 6,534 8,110 7,255 187 8,691 52 11,212 67 1,684 199 0 5,779 0 11,102 66 5,181 31 11,281 62 26,833
7 December 2011
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Figure 122: Cummins cash flow statement, FY09-14E

Rs mn; years ending March Profit before tax Depreciation Cash flow from operations excluding working capital Changes in working capital Cash flow from operations Tax paid Cash flow from operating activities FY09 5,990 456 6,085 (2,023) 4,062 (1,850) 2,212 FY10 6,109 361 5,872 1,436 7,309 (1,550) 5,759 FY11 8,024 367 6,636 (1,053) 5,584 (2,114) 3,470 FY12E 7,144 413 5,923 (1,314) 4,609 (2,056) 2,554 FY13E 7,925 606 6,679 (904) 5,775 (2,283) 3,492 FY14E 10,624 781 9,272 (2,024) 7,248 (3,054) 4,194
Purchase of fixed assets Sale of fixed assets Purchase of investments Sale of investments Cash flow from investing activities Change in debt Interest paid Dividend paid Cash flow from financing activities Change in cash and cash equivalents Opening cash and cash equivalents Closing cash and cash equivalents
(908) 312 (17,092) 17,504 104 (107) (26) (2,099) (2,231) 84 239 323
(665) 46 (17,146) 13,806 (3,368) (126) (21) (1,192) (2,155) 236 323 559
(1,500) 274 97 (19) (3,137) (3,059) 685 559 1,038
(2,000) (343) (23) (2,701) (2,724) (513) 1,038 525
(2,000) (124) (24) (2,995) (3,019) 349 525 874
(1,500) 657 (24) (4,018) (4,042) 810 874 1,684
7 December 2011
90
CROMPTON GREAVES (1-OW, PT: RS147, +11%): CONTRARIAN PICK; LOW VISIBILITY BUT LOW EXPECTATIONS
CRG IN / CROM.NS Stock Rating
1-OVERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 147.00
Price (02-Dec-2011)
INR 132.15
We initiate coverage of Crompton Greaves (CRG) with a 1-Overweight rating and a 12month 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 CRGs 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 CRGs 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 companys new CEO indicated managements 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
Year to Mar 2011A 2012E 2013E 2014E Net profit Rs mn 9,268 4,441 5,833 7,031 EPS Rs 14.4 6.9 9.1 11.0 EPS growth % 13.5 -52.1 31.3 20.5 P/E (x) 9.1 19.1 14.5 12.1 P/B (x) 2.6 2.3 2.1 1.8 ROE (%) 28.1 12.3 14.3 15.1 Div. yield (%) 1.8 1.3 1.3 1.5
+11%
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91
COMPANY SNAPSHOT Crompton Greaves Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2010A 100,051 13,438 11,502 12,291 9,268 14.45 641.52 2.20 2011E 94,185 8,074 6,003 6,425 4,441 6.92 641.52 1.55 2012E 94,272 9,219 7,590 8,217 5,833 9.09 641.52 1.62 2013E 102,619 10,900 9,189 9,858 7,031 10.96 641.52 1.88 CAGR 0.8% -6.7% -7.2% -7.1% -8.8% -8.8% 0.0% -5.2% Average 10.6 8.7 9.4 6.8 15.8 15.4 17.4 CAGR 3.5% 78.7% 7.6% 3.0% 1.5% 7.6% NA 12.7% NA 12.3% NA NA INDIA CAPITAL GOODS
1-OVERWEIGHT 2-NEUTRAL 132.15 147 CRG IN
13.4 11.5 12.3 9.3 25.1 24.6 28.1
8.6 6.4 6.8 4.7 11.3 10.8 12.3
9.8 8.1 8.7 6.2 13.0 12.7 14.3
10.6 9.0 9.6 6.9 13.9 13.5 15.1
Why a 1-Overweight? After our cuts of more than 3540% for EPS for FY12-14 and stock multiples coming down from over 22x to 12x, we believe that weak fundamentals are priced in. We model conservative EPS and value Crompton on a P/E of 14x.
Balance sheet and cash flow (INRmn) Fixed assets 19,417 Cash and equivalents 2,984 Total assets 71,500 Current liabilities 33,892 Long term liabilities 4,703 Total liabilities 71,500 Net debt/(funds) 1,719 Shareholders' equity 32,747 Change in working capital (5,133) Cash flow from operations 5,605 Capital expenditure (7,592) Free cash flow (1,987) Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
Upside case 182 A recovery in margins especially at the subsidiaires could take its P/E back to 25x, which is closer to the sector average P/E.
19,845 9,655 75,644 34,370 4,922 75,637 (4,733) 36,206 4,156 10,267 (2,500) 7,767
20,715 12,873 80,465 34,369 4,922 80,458 (7,951) 41,028 16 6,878 (2,500) 4,378
21,504 17,025 89,026 37,066 4,923 89,019 (12,102) 46,891 (172) 7,935 (2,500) 5,435
Downside case
91 Continued weakness could lead to the stock trending back to sector trough P/E of 10x. Continued weakness could lead to stock trending back to sector trough P/E of 10x.
Upside/downside scenarios 9.1 6.4 -2.3 0.9 2.6 1.7 12.5 0.1 19.1 9.9 9.2 0.8 2.3 1.2 11.9 -0.1 14.5 8.3 5.2 0.8 2.1 1.2 10.7 -0.2 Average 12.1 13.7 6.7 7.8 6.4 4.6 0.7 0.8 1.8 2.2 1.4 1.4 9.5 11.1 -0.3 -0.1
350 300 250 200 150 100 50 0 15-Dec-10
INR91 (-31.1%)
Downside Case
INR147 (11.2%)
Price Target
INR182 INR181 (37.7%) (36.9%)

Upside Case
2-Dec-11
EPS expected to recover in FY13 109,620 7 71,690 12 92,445 -16 68,571 -4 98,128 6 69,718 2 116,192 18 80,151 15
60% 40% 20% 0% -20% -40% -60% Mar10 Mar11 EPS growth
Mar12E Mar13E Mar14E
Note: FY end Mar.
7 December 2011
92
Margin recovery the key driver

Margin decline could have been led by commodity price increases and project-specific losses at its subsidiaries
CRGs 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 125: Crompton Greaves operating margin: subsidiaries made a loss in the June quarter
16% 12% 8% 4% 0% -4% Sep-08 Sep-09 Sep-10 Mar-08 Mar-09 Mar-10
Figure 124: Crompton Greaves operating margin: standalone margins have moderated
18% 16% 14% 12% 10% 8% 6% 4% 0% Sep03 Mar05 Jun04 Sep06 Mar08 Dec05 Mar-11 Jun07 Dec08 Sep09 Jun-10 2%
Operating margins
Operating margins
Source: . Company data, Barclays Capital
Figure 126: Crompton Greaves Consolidated EBITDA margin: recent margins of 7-8% are significantly lower than in the past
18% 16% 16% 14% 14% 14% 14% 14% 13% 13% 13% 14% 11% 11% 11% 12% 10% 11% 10% 10% 8% 6% 4% 2% 0% Sep-07 Jun-08 Sep-08 Jun-09 Sep-09 Jun-10 Sep-10 Dec-07 Dec-08 Dec-09 Mar-08 Mar-09 Mar-10 Dec-10 Mar-11
Mar-11 7% Jun-11
8%
OBITDA Margins
Source:: Company data, Barclays Capital
7 December 2011
Sep-11
93
Sep-11
Sep07
Building conservative estimates

We expect flattish sales in FY13 but more than31% growth in PAT
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 Power systems Growth Industrial systems Growth Consumer products Growth (y/y)
FY07 17,750 46% 8,874 29% 9,940 22%
FY08 19,633 11% 11,246 27% 11,002 11%
FY09 22,585 15% 10,943 -3% 13,384 22%
FY10 25,103 11% 11,780 8% 16,120 20%
FY11 25,542 2% 14,066 19% 20,212 25%
FY12E 21,353 -16% 12,642 -10% 21,729 8%
FY13E 20,053 -6% 10,981 -13% 24,988 15%
FY14E 22,684 13% 13,485 23% 28,736 15%
Figure 128: Crompton Greaves forecasts by segment: expect margin recovery in FY13E
Rs mn; years ending March Standalone Order inflow y/y Order book y/y Net sales y/y EBITDA margin Net Income y/y Subsidiaries Order inflow y/y Order book y/y Net sales y/y EBITDA Margin Net Income y/y Consolidated Order inflow y/y Order book y/y Net sales y/y EBITDA Margin Net Income y/y
FY10 64,271 7% 34,000 23% 52,840 15% 16.2% 5,613 41% 37,940 0% 30,000 -21% 38,569 -7% 10.9% 2,550 43% 102,211 4% 64,000 -3% 91,409 5% 14.0% 8,162 42%
FY11E 65,100 1% 34,860 3% 59,515 13% 15.7% 6,724 20% 44,520 17% 36,830 23% 40,536 5% 10.1% 2,545 0% 109,620 7% 71,690 12% 100,051 9% 13.4% 9,268 14%
FY12E 56,829 -13% 34,686 0% 55,631 -7% 11.8% 4,610 -31% 35,616 -20% 33,886 -8% 38,560 -5% 4.0% -156 -106% 92,445 -16% 68,571 -4% 94,185 -6% 8.6% 4,441 -52%
FY13E 62,512 10% 38,466 11% 56,022 1% 11.9% 4,807 4% 35,616 0% 31,252 -8% 38,250 -1% 6.6% 1,054 -777% 98,128 6% 69,718 2% 94,272 0% 9.8% 5,833 31%
FY14E 77,015 23% 47,436 23% 64,905 16% 11.9% 5,468 14% 39,178 10% 32,715 5% 37,714 -1% 8.4% 1,593 51% 116,192 18% 80,151 15% 102,619 9% 10.6% 7,031 21%
7 December 2011
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Shares are pricing in a weak near term

CRGs estimates have seen a 40% revision for FY12-14, the highest decline among peers
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 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)
25 23 21 19 17 15 13 11 9 7 5 Jun-11 Dec-10 Sep-10 Mar-10 Mar-11 Dec-09 Sep-09 Sep-11 Mar-10 Jun-11
95
Figure 129: Crompton Greaves history of current consensus EPS forecasts shows estimates typically were revised up for FY06-11 (Rs)
16 14 12 10 8 6 4 2 0 May-06 May-07 May-08 May-09 May-10 May-11 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10
FY06 FY10
FY07 FY11
FY08
FY09 FY12 FY13 FY14
Valuation
Initiate at 1-Overweight
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. Figure 132: Crompton Greaves EV/order book close to historical lows (x)
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Dec-03 Mar-95 Mar-00 Mar-05 Dec-98 Dec-08 Jun-06 Sep-97 Sep-02 Sep-07 Jun-96 Jun-01
Figure 131: Crompton Greaves Stock trading at close to historical P/E lows (x)
30 25 20 15 10 5 0 Sep-98 Sep-03 Dec-94 Dec-99 Dec-04 Sep-08 Mar-96 Mar-01 Mar-06 Dec-09 Jun-97 Jun-02 Jun-07 Mar-11
Jun-09
Crompton
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
7 December 2011
Jun-10
EV/orderbook
Figure 133: Crompton Greaves Trading at a steep P/E discount to ABB (x)
0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Jul-97 Aug-02 Feb-05 Dec-94 Oct-98 Jan-00 May-06 Nov-03 Aug-07 Apr-96 Apr-01 Mar-10 Jun-11 Nov-08
Figure 134: and Siemens (P/E x)
1.2 1.0 0.8 0.6 0.4 0.2 0.0 Jul-97 Aug-02 Dec-94 Feb-05 Oct-98 Jan-00 May-06 Nov-03 Aug-07 Apr-96 Apr-01 Mar-10 Nov-08 Jun-11
96
CRG over ABB

CRG over Siemens'

Figure 135: Crompton Greaves cash flow generation has typically been strong
16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Mar03 Mar04 Mar05 Mar06 Mar07 Mar08 Mar09 Mar10 Mar11
Operating profit before WC changes

Source:: Company data, Barclays Capital
Cash flow from operating activities, Rs mn
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.
7 December 2011
Figure 136: Crompton Greaves income statement, FY09-14E

Rs mn; years ending March Net sales YoY Materials, manufacturing and operating expenses % of sales Staff cost % of sales Sales and administrative expenses % of sales Expenditure % of sales OBITDA OBITDA margin Other income Depreciation Interest Exceptional items Profit before tax Total taxation Tax rate Profit after tax before minority interests Minority interests Share of profits of associates Reported profit after tax Adjusted profit after tax Adjusted profit after tax margin YoY
FY09 87,373 28% 56,938 65% 10,627 12% 9,852 11% 77,418 89% 9,955 11.4% 740 1,216 655 0 8,824 3,047 35% 5,777 17 -9 5,751 5,751 7% 0%
FY10 91,409 5% 55,923 61% 11,131 12% 11,585 13% 78,640 86% 12,769 14.0% 1,100 1,551 265 0 12,053 3,650 30% 8,403 -26 32 8,409 8,162 9% 42%
FY11 100,051 9% 64,980 65% 11,811 12% 451,175 451% 527,967 528% 13,438 13.4% 1,142 1,936 209 0 12,291 3,100 25% 9,192 -4 80 9,268 9,268 9% 14%
FY12E 94,185 -6% 63,037 67% 11,706 12% 11,368 12% 86,111 91% 8,074 8.6% 758 2,072 336 0 6,425 1,971 31% 4,454 -14 1 4,441 4,441 5% -52%
FY13E 94,272 0% 61,839 66% 11,849 13% 11,365 12% 85,053 90% 9,219 9.8% 879 1,630 251 0 8,217 2,357 29% 5,860 -29 2 5,833 5,833 6% 31%
FY14E 102,619 9% 67586 66% 11,885 12% 12,248 12% 91,718 89% 10,900 10.6% 920 1,711 251 0 9,858 2,794 28% 7,064 -35 3 7,031 7,031 7% 21%
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97
Figure 137: Crompton Greaves balance sheet, FY09-14E

Rs mn; years ending March Share capital Reserves and surplus Total shareholder equity Minority interest Secured loans Unsecured loans Total loans Total sources of funds FY09 733 17,577 18,310 139 6,923 260 7,182 25,631 FY10 1,283 23,760 25,043 43 4,766 244 5,010 30,095 FY11 1,283 31,464 32,747 157 4,554 149 4,703 37,607 FY12E 1,283 34,923 36,206 139 4,802 149 4,922 41,267 FY13E 1,283 39,745 41,028 139 4,802 149 4,922 46,089 FY14E 1,284 45,607 46,891 139 4,802 149 4,923 51,953
Application of funds Gross block Less: depreciation Net block Capital WIP Total fixed assets Investments Deferred tax assets net Inventory Inventory days Debtors Debtor days Cash and bank Loans and advances Days of sales Total current assets Current liabilities Current liability days Provisions Provision days Total current liabilities and provisions 30,289 17,040 13,248 537 13,785 1,672 482 10,949 46 20,556 86 5,656 4,537 19 41,699 26,022 109 5,986 25 32,008 29,858 17,234 12,623 1,137 13,760 5,536 -49 10,412 42 21,463 86 6,688 2,455 19 41,018 26,567 106 3,603 14 30,170 37,805 19,490 18,314 1,102 19,417 6,747 -160 11,893 45 25,427 86 2,984 5,192 19 45,496 29,595 115 4,298 14 33,892 40,305 21,562 18,743 1,102 19,845 7,497 -160 10,848 45 22,205 86 9,622 5,780 19 48,455 27,934 115 6,436 14 34,370 42,805 23,192 19,613 1,102 20,715 8,247 -160 10,811 45 22,213 86 12,839 5,792 19 51,655 27,925 115 6,444 14 34,369 45,305 24,903 20,402 1,102 21,504 8,997 -160 11,250 46 24,054 87 16,992 6,382 19 58,677 30,024 116 7,041 14 37,066
Net current assets Net current assets excluding cash Days of sales Miscellaneous expenditures Total application of funds
9,692 4,035 17 0 25,631
10,849 4,161 17 0 30,095
11,604 8,620 31 0 37,607
14,085 4,463 17 0 41,267
17,286 4,448 17 0 46,089
21,612 4,620 16 0 51,953
7 December 2011
98
Figure 138: Crompton Greaves cash flow statement, FY09-14E

Rs mn; years ending March Profit before tax Depreciation Others Operating profit before working capital changes Debtors Inventory Trade and other payables Others Operating cash flow Taxation Cash flow from operating activities Change in fixed assets Change in investments Others Cash flow from investing activities Change in equity Change in loans Dividend paid and tax thereon Others Cash flow from financing activities Net change in cash and cash equivalents Opening balance of cash and equivalents Closing balance of cash and equivalents
FY09 8,672 1,216 1,689 11,577 -3,147 -251 3,228 228 11,635 -2,165 9,470 -1,977 -714 -652 -3,343
FY10 11,891 1,551 -509 12,932 -664 726 407 74 13,475 -2,920 10,555 -2,070 21,330 -25,010 -5,751
FY11 12,291 1,936 -223 14,004 -6,276 -1,692 2,989 -155 8,871 -3,266 5,605 -7,592 -1,200 1,411 -7,382
FY12E 6,425 2,072 -422 8,074 3,222 1,045 478 -588 12,231 -1971 10,259 -2,500 -750 758 -2,492
FY13E 8,217 1,630 -628 9,219 -8 36 -1 -12 9,235 -2,357 6,877 -2,500 -750 879 -2,371
FY14E 9,858 1,711 -669 10,900 -1,841 -438 2,697 -590 10,728 -2,794 7,934 -2,500 -750 920 -2,330
-1,374 -814 -702 -2,890 3,238 2,445 5,682
-2,169 -1,159 -451 -3,778 1,032 5,656 6,688
-379 -1,195 -354 -1,927 -3,704 6,688 2,985
219 -996 -354 -1,131 6,637 2,985 9,622
0 -1,038 -251 -1,290 3,217 9,622 12,839
1 -1,203 -249 -1,451 4,153 12,839 16,992
7 December 2011
99
THERMAX (3-UW, PT: RS392, -17%): SLOW PACE OF NEW BUSINESS SCALE UP
TMX IN / THMX.NS Stock Rating
3-UNDERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 392.00
Price (02-Dec-2011)
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 Thermaxs 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 companys potential inability to scale up subcritical and supercritical businesses would likely impact the stocks 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 managements performance and the companys strong execution skills, we would revisit the stock at levels below the core value (ie, Rs308). Figure 139: Thermax statistical abstract
Year to Mar 2011A 2012E 2013E 2014E Net profit Rs mn 3,831 3,812 3,889 4,671 EPS Rs 32 32 33 39 EPS growth % 70.8 -0.5 2.0 20.1 P/E (x) 14.6 14.7 14.4 12.0 P/B (x) 4.3 3.7 3.2 2.8 ROE (%) 29.6 25.1 22.2 23.0 Div. yield (%) 2.4 2.9 2.9 3.5
INR 469.70
-17%
7 December 2011
100
COMPANY SNAPSHOT THERMAX Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2010A 48,832 5,668 5,236 5,737 3,831 32.15 119.15 10.46 2011E 51,072 5,544 5,001 5,616 3,812 31.99 119.15 12.80 2012E 52,376 5,688 5,046 5,775 3,889 32.64 119.15 13.06 2013E 62,767 6,815 6,049 6,939 4,671 39.20 119.15 15.68 CAGR 8.7% 6.3% 4.9% 6.5% 6.8% 6.8% 0.0% 14.4% Average 11.0 9.9 11.2 7.5 24.1 23.9 25.0 CAGR 0.3% 21.1% 11.4% 8.7% 0.0% 11.4% NA 16.3% NA 63.0% NA 94.6% INDIA CAPITAL GOODS
3-UNDERWEIGHT 2-NEUTRAL 469.7 392 THMX.BO/TMX IN
11.6 10.7 11.7 7.8 28.3 28.2 29.6
10.9 9.8 11.0 7.5 24.2 24.0 25.1
10.9 9.6 11.0 7.4 21.5 21.3 22.2
10.9 9.6 11.1 7.4 22.4 22.2 23.0
Why a 3-Underweight? Weak investment cycle to impact industrial ordering. Expect earnings momentum to weaken. With order environment for IPPs weak, Thermax may find it difficult to scale up sub/supercritical businesses which would impact valuations further, in our view.
Balance sheet and cash flow (INRmn) Fixed assets 5,163 Cash and equivalents 6,566 Total assets 35,928 Current liabilities 22,323 Long term liabilities 682 Total liabilities 35,928 Net debt/(funds) (6,085) Shareholders' equity 12,923 Change in working capital (1,161) Cash flow from operations 1,142 Capital expenditure (572) Free cash flow 570 Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
5,121 7,664 39,239 23,346 682 39,239 (7,183) 15,210 (232) 3,508 (500) 3,008
5,229 8,939 42,168 23,943 682 42,168 (8,458) 17,544 49 3,856 (750) 3,106
5,213 11,651 49,721 28,693 682 49,721 (11,170) 20,347 394 4,949 (750) 4,199
Upside case 625 We see an upside to our estimates for FY14 and beyond on order wins of over Rs20bn in the IPP segment. A large supercritical win could rerate multiples. Assuming supercritical wins and subcritical wins of Rs20bn, stock could trend up to P/E of 18x and forward EPS of Rs33. Downside case 171 Core business in a normal cycle supports a valuation of Rs308. We believe that weak industrial cycle typically leads to order cancellations and in that scenario there is a likelihood of stock going down to trough P/E.
Upside/downside scenarios 14.6 8.1 1.0 1.0 4.3 2.2 3.5 -1.1 14.7 7.9 5.4 1.0 3.7 2.7 3.0 -1.3 14.4 7.4 5.5 0.9 3.2 2.8 2.6 -1.5 Average 12.0 13.9 5.8 7.3 7.5 4.9 0.7 0.9 2.8 3.5 3.3 2.8 2.3 2.9 -1.6 -1.4
850 800 700 680 600 500 510 400 340 300 200 170 100 0 15-Dec-10 INR625 (33.0%)
INR171 (-63.5%)
Downside Downside Case Case
INR392 INR392 (-16.5%) (-16.5%)

Price Target
2-Dec-11
Expect Rs20bn worth of IPP wins until FY14 53,180 -5 56,050 4 53,180 0 58,158 4 63,339 19 69,121 19 74,537 18 80,891 17
15000 10000 5000 0 Mar-10 Mar-12E Mar-14E 0 0 10000 7500 12500 20% 15% 10% 5% 0%
Power sector IPP inflow (Rs mn) Power IPP inflow as % of total inflow Source: Company data, Barclays Capital estimates Note: FY end Mar.
7 December 2011
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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.
We forecast Rs20bn in order wins for FY13-14 for Thermax
Figure 140: Thermax IPP order wins, FY10-14E (Rs mn)

15000 10000 7500 10000 20% 12500 16% 12% 8% 4% 0 Mar-10 Mar-11 Mar-12E Mar13E Mar14E 0%
5000
Power sector IPP inflow

Power IPP inflows as % of overall inflows
We expect earnings momentum to weaken
Figure 141: Thermax Earnings growth rates, June 2005-September 2012E

160% 140% 120% 100% 80% 60% 40% 20% 0% -20% -40% Dec05 Dec06 Dec07 Dec08 Jun05 Jun06 Jun08 Jun09 Jun07 Earnings growth to head to negative territory
Dec-09
Dec10
Jun10
Jun11
Earnings growth YoY

7 December 2011
Dec11E
Jun12E
102
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).
Focus on balance sheet protection is good, in our view, but it will impact growth as there are no good projects in the market
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
140 120 100 80 60 40 20 0 -20 -40 -60 116 90 61 33 100 89 91 92 53 22 12 -4 -25 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 -21 -37 Mar-07 Mar-08 Mar-09 Mar-10 -48
The working capital cycle is negative, and Thermax intends to maintain such a trend, in our view
1 -16 Mar-11
103
Net working capital days

Cash flow generation has been strong in the past
Figure 143: Thermax Cash flow generation (Rs bn), March 2003-March 2011
8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 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
7 December 2011
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.
Core business supports a valuation of Rs308, on our estimate, and a stock price above that appears to build in success in new businesses
Figure 144: Thermax estimates of value of core business plus value accretion led by various additional contract wins (Rs/share)
800 700 600 500 400 300 200 100 0 Core Subcritical wins of Rs10bn Subcritical wins of Subcritcial+supercritical Rs20bn win 308 442 587 Order inflow: Rs65bn, Inflow: Rs80bn, Add value of supercritical Order inflow: Rs54bn, P/E of 18x, EPS of JV, EPS of Rs33 Rs33 P/E of 16x, EPS of Rs28 Order inflow: Rs44bn, P/E of 12x, EPS of Rs26 625
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.
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104
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
Figure 145: Thermax historical 12-month forward P/E, 1994-2011E

35 30 25 20 15 10 5 May-07 Mar-08 Nov-04 Oct-09 May-02 Mar-03 Aug-96 Aug-01 Aug-10 Dec-94 Oct-95 Apr-98 Dec-99 Oct-00 Sep-05 Jul-06 Jan-09 Feb-99 Jun-97 Jan-04 Jun-11
Thermax
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)
60 55 50 45 40 35 30 25 20 Jun-11 FY14E Dec-10 Sep-10 Mar-10 Mar-11 Dec-09 Sep-09 Sep-11
105
50 40 30 20 10 0 May-06 May-07 May-08 May-09 May-10 May-11 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10
FY06 FY10
FY07 FY11
FY08
FY09 FY12E FY13E
Source: Datastream, IBES consensus, Barclays Capita
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.
7 December 2011
Jun-09
Jun-10
Figure 148: Thermax income statement, FY09-14E

Rs mn; years ending March Net sales Material costs % of sales Personnel costs % of sales Other expenses % of sales Operating profits OBITDA margin EBITDA EBITDA margin Depreciation Interest Other income Profit before tax and extraordinary items Extraordinary items Profit before tax Profit before tax margin Taxation Tax rate Profit after tax Profit after tax margin Reported profit after tax Adjusted profit after tax Adjusted profit after tax margin
FY09 32,644 20,976 64% 2,546 8% 4,953 15% 4,168 13% 4,556 14% 321 33 388 4,202 -14 4,216 13% 1,319 31% 2,896 9% 2,896 2,910 9%
FY10 31,855 20,585 65% 2,927 9% 4,477 14% 3,866 12% 4,363 14% 404 15 498 3,944 -1,149 2,795 9% 1,356 49% 1,439 5% 1,439 2,243 7%
FY11 48,832 34,159 70% 3,686 8% 5,320 11% 5,668 12% 6,190 13% 432 22 523 5,737 0 5,737 12% 1,906 33% 3,831 8% 3,831 3,831 8%
FY12E 51,072 36,207 71% 3,675 7% 5,646 11% 5,544 11% 6,198 12% 542 39 654 5,616 0 5,616 11% 1,804 32% 3,812 7% 3,812 3,812 7%
FY13E 52,376 37,201 71% 3,706 7% 5,781 11% 5,688 11% 6,459 12% 642 46 771 5,771 4 5,775 11% 1,882 33% 3,889 7% 3,889 3,889 7%
FY14E 62,767 44,590 71% 4,433 7% 6,928 11% 6,815 11% 7,752 12% 766 55 937 6,931 8 6,939 11% 2,260 33% 4,671 7% 4,671 4,671 7%
7 December 2011
106
Figure 149: Thermax balance sheet, FY09-14E

Rs mn; years ending March Ordinary share capital Preference share capital Reserves and surplus Total shareholder equity Loan funds Net deferred tax liability Total funds employed Gross fixed assets Depreciation Net fixed assets Capital WIP Investments Inventory Inventory days Contracts in progress Number of days of sales Receivables Receivable days Cash and bank Other current assets % of sales Loans and advances % of sales Current liabilities Current liability days Contracts in progress Days of sales Provisions Days of sales Net current assets Misc. expenditure not written off Total assets
FY09 238 0 9,381 9,619 0 181 9,799 6,029 1,630 4,399 177 1,765 2,664 30 2,269 25 5,408 60 3,408 387 1% 2,022 6% 11,190 125 559 6 949 11 3,459 0 9,799
FY10 238 0 10,270 10,508 0 172 10,680 6,884 1,946 4,939 112 3,782 2,464 28 2,762 32 7,471 86 6,056 525 2% 3,014 9% 18,794 215 674 8 975 11 1,848 0 10,680
FY11 238 0 12,685 12,923 481 201 13,605 7,171 2,305 4,866 297 4,044 2,823 21 3,571 27 10,013 75 6,566 654 1% 3,094 6% 19,688 147 1,014 8 1,621 12 4,398 0 13,605
FY12E 238 0 14,972 15,210 481 201 15,892 7,671 2,848 4,824 297 5,044 3,498 25 3,498 25 10,494 75 7,664 684 1% 3,236 6% 20,591 147 1,060 8 1,695 12 5,728 0 15,892
FY13E 238 0 17,306 17,544 481 201 18,226 8,421 3,490 4,931 297 6,044 3,587 25 3,587 25 10,762 75 8,939 702 1% 3,319 6% 21,117 147 1,087 8 1,739 12 6,954 0 18,226
FY14E 238 0 20,108 20,347 481 201 21,028 9,171 4,256 4,916 297 6,544 4,299 25 4,299 25 12,897 75 11,651 841 1% 3,977 6% 25,306 147 1,303 8 2,083 12 9,272 0 21,028
7 December 2011
107
Figure 150: Thermax cash flow statement, FY09-14E

Rs mn; years ending March Net profit before tax Depreciation and amortization Others Operating profit before working capital changes Change in receivables Change in inventory Change in trade payables Change in contracts in progress Total changes in working capital Operating cash flow Direct taxes Cash flow from operating activities Change in fixed assets Change in investments Others Cash flow from investing activities Change in share capital Change in loans Change in preference shares Dividend paid Others Cash flow from financing activities Net change in cash flows Opening cash Closing cash
FY09 4,179 321 -147 4,353 771 -669 -260 -1,318 -1,476 2,890 -1,393 1,480 -1,595 4,189 201 2,795 0 0 0 -1,114 -33 -1,147 3,129 279 3,408
FY10 3,919 404 -201 4,122 1,385 201 2,033 -378 3,240 7,363 -1,346 5,834 -880 -2,010 417 -2,474 0 0 0 -696 -15 -712 2,648 3,408 6,056
FY11 5,730 432 -503 5,659 -3,179 -360 2,846 -469 -1,161 4,498 -1,799 1,142 -572 -260 435 -397 0 481 0 -695 -22 -236 510 6,056 6,566
FY12E 5,616 542 -615 5,544 -482 -774 903 121 -232 5,312 -1,804 3,508 -500 -1,000 654 -846 0 0 0 -1,525 -39 -1,564 1,098 6,566 7,664
FY13E 5,771 642 -725 5,688 -268 -279 526 70 49 5,737 -1,882 3,856 -750 -1,000 771 -979 0 0 0 -1,556 -46 -1,602 1,275 7,664 8,939
FY14E 6,931 766 -881 6,815 -2,135 -2,221 4,189 561 394 7,209 -2,260 4,949 -750 -500 937 -313 0 0 0 -1,868 -55 -1,924 2,712 8,939 11,651
7 December 2011
108
HAVELLS (1-OW, PT: RS502, +18%): LIGHTING UP

HAVL IN / HVEL.NS Stock Rating
1-OVERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 502.00
Price (02-Dec-2011)
INR 424.55
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 wellentrenched 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
Year to Mar 2011A 2012E 2013E 2014E Net profit Rs mn 3035 3467 4351 5147 EPS Rs 24.3 27.8 34.9 41.2 EPS growth % 335.9 14.3 25.5 18.3 P/E (x) 17.5 15.3 12.2 10.3 P/B (x) 8.1 5.4 3.8 2.8 ROE (%) 46.4 35.5 31.4 27.6 Div. yield (%) 0.7 0.5 0.6 0.7
+18%
7 December 2011
109
COMPANY SNAPSHOT HAVELLS Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2011A 56,126 5,571 4,766 4,066 3,035 24.32 124.78 2.91 2012E 64,133 6,401 5,512 4,660 3,467 27.79 124.78 1.86 2013E 71,684 7,538 6,551 6,017 4,351 34.87 124.78 2.26 2014E 80,526 8,586 7,490 7,127 5,147 41.25 124.78 2.64 CAGR 12.8% 15.5% 16.3% 20.6% 19.3% 19.3% 0.0% -3.1% Average 10.3 8.9 7.9 5.8 20.5 18.2 35.2 CAGR -1.9% 98.9% 12.8% 10.7% -9.2% 12.8% NA 41.9% NA 34.9% NA 70.4% INDIA CAPITAL GOODS
1-OVERWEIGHT 2-NEUTRAL 424.55 502 HAVL IN/HVLE.BO
9.9 8.5 7.2 5.4 20.3 16.6 46.4
10.0 8.6 7.3 5.4 21.0 18.5 35.5
10.5 9.1 8.4 6.1 21.1 19.1 31.4
10.7 9.3 8.9 6.4 19.8 18.7 27.6
Why a 1-Overweight? We forecast a CAGR of more than 23% in PAT for FY11-14 due to strength in the domestic business aided by new consumer launch and improving margins at Sylvania. The increasing mix of the consumer business should help damp volatility and boost valuations.
Balance sheet and cash flow (INRmn) Fixed assets 10,204 Cash and equivalents 1,779 Total assets 35,635 Current liabilities 17,361 Long term liabilities 11,173 Total liabilities 35,635 Net debt/(funds) 9,395 Shareholders' equity 6,537 Change in working capital (2,013) Cash flow from operations 3,426 Capital expenditure (1,887) Free cash flow 1,540 Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Revenues for new business Sylvania revenues Eumn Sylvania ebitda margins Europe revenue growth
Upside case 697 Continued strength in domestic market and Sylvania margins could lead to the stock heading to sector average P/E of 20x.
10,115 5,287 38,383 18,746 9,300 38,383 4,013 9,773 1,721 7,952 (800) 7,152
9,928 8,774 43,732 20,953 8,372 43,732 (402) 13,843 (143) 7,395 (800) 6,595
9,631 13,992 51,134 23,538 8,372 51,134 (5,620) 18,660 (168) 8,418 (799) 7,619
Downside case 278 In a rare scenario, if Sylvania starts making losses, it is likely that the stock could head to a sector trough P/E of 10x on current year earnings.
Upside/downside scenarios 17.5 11.2 2.9 1.1 8.1 0.7 61.1 1.7 15.3 8.9 13.5 0.9 5.4 0.4 47.4 0.6 12.2 7.0 12.4 0.7 3.8 0.5 36.8 0.1 Average 10.3 13.8 5.5 8.1 14.4 10.8 0.6 0.8 2.8 5.0 0.6 0.6 30.3 43.9 0.7 0.4
900 700 600 500 300 300 100 0 16-Dec-10 2-Dec-11 INR697 INR697 (64.1%) INR502 (64.1%) INR502 (18.2%) (18.2%)
Price Price Target Target Upside Case
INR278 INR278 (-34.5%) (-34.5%)

Downside Downside Case Case
EBITDA margin expected to remain steady 300.0 27,836 5.8 -4.8 900.0 30,352 7.9 0.7 2,000.0 32,141 8.4 0.0 3,500.0 34,418 8.6 0.0
11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% FY11 EBITDA margin
FY12E
FY13E
FY14E
Note: FY end Mar.
7 December 2011
110
Consumer business new growth driver

Expect domestic profits to grow at a CAGR of 17% until FY14, led by strong growth in the consumer segment
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 Cables and wires Lighting and fixtures Electrical consumer durables
12% 10% 17% 26%
11% 13% 18% 30%
Management expects 12-15% growth Expect 8-10% volume growth; value growth could be higher as prices have increased y/y Expect 20% growth for the market 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 Havells positioning

Estimated market size (Rs mn) Domestic switchgear Industrials switchgear Switches modular Motors Cables Wires Lights-CFL Fixtures Fans Geysers and other products 15,680 32,100 13,200 27,563 110,000 66,000 17,250 30,000 35,000 33,600 CAGR FY11-14E 12% 7% 12% 8% 9% 10% 15% 20% 10% 20% Market growth Market share Market growth Market share Market growth Market share Market growth Market share Market growth Market share Market growth Market share Market growth Market share Market growth Market share Market growth Market share Market growth Market share
FY12E 12% 28% 7% 5% 10% 14% 5% 3% 10% 8% 10% 9% 15% 11% 20% 12% 0% 14% 20% 3%
FY13E 12% 28% 7% 5% 12% 14% 10% 3% 8% 8% 10% 9% 15% 11% 20% 12% 15% 15% 25% 5%
FY14E 12% 28% 7% 5% 15% 14% 10% 4% 8% 8% 10% 9% 15% 11% 20% 12% 15% 15% 25% 8%
7 December 2011
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Figure 154: Havells Switchgears and cables to comprise more than 60% of revenues, FY12E
Electrical consumer durables 18% Others 0.2%
Figure 155: Havells Expect higher profits from the consumer segment, FY12E
Electrical consumer durables 18% Switchgears 46%
Switchgears 24%
Lighting and fixtures 16%
Lighting and fixtures 18%
Cables and wires 42%

Cables and wires 18%

Consumer appliances business launched in FY12

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
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

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
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 Europe sales Margin Americas sales Margin Asia sales Margin 1Q FY11 66 2.8% 33 8% 5 3.3% 2Q FY11 65 3.0% 38 8% 6 4.0% 3Q FY11 74 4.5% 36 9% 5 5.0% 4Q FY11 73 4.9% 36 9% 5 5.4% 1Q FY12 64 6.1% 36 10% 7 5.8% 2Q FY12 69 6.5% 40 10% 7 6.2%
7 December 2011
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Figure 157: Havells Sylvanias EBITDA margins expected to recover to over 8% in FY13E
Figure 158: Havells Consolidated EBITDA margins to be supported by improvements at Sylvania
9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
7.9% 5.8%
8.4%
8.6%
12% 9.9% 10% 8% 6.9% 5.3% 5.9% 10.0%
10.5%
10.7%
5.3%
2.8% 2.1%
6% 4% 2%
FY08
FY09
FY10
FY11
FY12
FY13
FY14
0% FY08 FY09 FY10 FY11 FY12E FY13E FY14E
EBITDA margin
EBITDA margin
Figure 159: Havells Country exposure in Europe (FY11)
Figure 160: Havells Strong presence in LatAm (FY11)
France 21% Others 33%
Others 25%
Colombia 24%
East Europe 5% Spain 9%

UK 18%
USA 13% Mexixo 10% Argentina 7%
Brazil 21%
Germany and Austria 14%
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.
7 December 2011
113
Figure 161: Havells consumer accounts for 33% of domestic sales
Figure 162: and 29% of segment profitability
45% 40% 35% 30% 25% 20% 15% 10% 5% 0% FY08 FY09 FY10 33% 29% 24%
37%
39%
40% 35% 30% 25% 20% 15% 10% 5% 0% FY08 FY09 FY10 FY11 25% 25% 29% 32%
34%
FY11
FY12E
FY12E
Revenue from consumer segments

profit from consumer statement

Figure 163: Havells Valuation methodology

We see significant upside for Havells despite factoring in conservative multiples
Standalone EBITDA Sylvania EBITDA EV Net debt Equity value Share count (Mn shares) Price target (Rs)
Rs mn 4,837 2,701 66,713 4,106 62,607 125 502
FY12E 18% 47%
FY13E 20% 13%
FY14E 17% 9%
Multiple 11x 5x
Figure 164: Havells historical 12-month forward P/E (x): trading at the lower end
The sharp correction in valuations in early 2009 was led by Sylvanias weak financial position
20 15 10 5 0 Jan-08 May-08 Oct-08 Feb-09 30 25
Jul-09
Dec-09 Apr-10 Sep-10 12 M fwd PE
Jan-11
Jun-11 Nov-11
Source: Datastream, IBES consensus estimates, Barclays Capital estimates
7 December 2011
114
Figure 165: Havells history of consensus EPS forecasts shows estimates were impacted in 2009 due to losses at Sylvania
30 25 20 15 10 5 0 -5 -10 May-06 May-07 May-08 May-09 May-10 May-11 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10
Figure 166: Havells history of current consensus EPS forecasts for FY12-14 shows that the strong recovery at Sylvania has led to estimates upgrades
45 40 35 30 25 20 15 Dec-10 Mar-10 Mar-11 Dec-09 Sep-09 Sep-10 Sep-11
115
FY06 FY10
FY07 FY11
FY08
FY09 FY12 FY13 FY14

Source: Datastream, IBES consensus estimates , Barclays Capital
Source: Datastream, IBES consensus estimates ,Barclays Capital
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.
7 December 2011
Jun-09
Jun-10
Jun-11
Figure 167: Havells income statement, FY09-14E

Rs mn; years ending March Net sales Total material costs % of sales Employee costs % of sales Other costs EBITDA OBITDA margin Other income plus other operating income Depreciation Interest Pre-tax exceptional items Profit before tax Profit before tax margin Tax Tax rate Post-tax exceptional items Profit after tax - reported Profit after tax - adjusted Profit after tax margin
FY09 54,775 30,070 55% 8,452 15% 10,701 2,886 5% 86 905 1,253 -1,986 -1,172 -2% 429 -37%
FY10 54,315 29,180 54% 7,602 14% 11,062 3,222 6% 222 837 979 0 1,628 3% 932 57%
FY11 56,126 32,556 58% 6,319 11% 8,484 5,571 10% 237 804 902 -36 4,066 7% 1,031 25%
FY12E 64,133 32,207 50% 6,953 11% 18,572 6,401 10% 202 889 884 -170 4,660 7% 1,192 26%
FY13E 71,684 35,999 50% 7,772 11% 20,376 7,538 11% 87 987 620 0 6,017 8% 1,666 28%
FY14E 80,526 40,439 50% 8,730 11% 22,770 8586 11% 87 1,096 450 0 7,127 9% 1,980 28%
-1,601 -1,601 -3%
696 696 1%
3,035 3,035 5%
3,467 3,467 5%
4,351 4,351 6%
5,147 5,147 6%
7 December 2011
116
Figure 168: Havells balance sheet, FY09-14E

Rs mn; years ending March Share capital Reserves and surplus Shareholders equity Secured loans Unsecured loans Loan funds Total sources of funds Gross block Less: depreciation Net block Investments Deferred tax net Inventories Inventory days Debtors Debtor days Cash and bank Other current assets as % of sales Loans and advances as % of sales Current liabilities Current liabilities days Provisions as % of sales Net current assets Total application of funds
FY09 301 5,822 6,147 10,624 1,654 12,278 18,426 28,961 20,427 8,534 0 0 7,947 53 7,573 50 2,473 79 0 2,335 0 13,934 93 567 1% 5,907 18,426
FY10 312 3,692 4,004 9,963 700 10,664 14,934 26,963 18,089 8,874 0 -266 8,246 55 6,982 47 1,481 102 0 1,578 0 15,555 105 321 1% 2,512 14,934
FY11 624 5,914 6,537 9,933 1,240 11,173 18,275 28,454 18,499 9,955 0 -559 10,860 55 7,724 47 1,779 100 0 1,615 0 16,722 105 639 1% 4,717 18,275
FY12E 624 9,150 9,773 0 0 9,300 19,638 29,254 19,388 9,866 0 -559 9,736 55 8,244 47 5,287 120 0 1,863 0 18,367 105 379 1% 6,504 19,638
FY13E 624 13,219 13,843 0 0 8,372 22,779 30,054 20,375 9,679 0 -559 10,883 55 9,215 47 8,774 134 0 2,082 0 20,529 105 424 1% 10,134 22,779
FY14E 624 18,036 18,660 0 0 8,372 27,596 30,853 21,471 9,382 0 -559 12,225 55 10,352 47 13,992 150 0 2,339 0 23,062 105 476 1% 15,520 27,596
7 December 2011
117
Figure 169: Havells cash flow statement, FY09-14E

Rs mn; years ending March Profit before tax Depreciation Trade and other receivables Inventories Trade payables Other liabilities Direct taxes paid Others Net cash from operating activities FY09 -1,172 905 414 2,472 -1,232 514 -400 698 2,199 FY10 1,628 837 1,232 -139 226 1,224 -699 -1,396 2,913 FY11 4,066 804 -564 -2,751 1,923 -621 -851 569 2,575 FY12E 4,660 889 -788 1,124 1,645 -260 -1,192 683 6,760 FY13E 6,017 987 -1,204 -1,146 2,163 45 -1,666 534 5,729 FY14E 7,127 1,096 -1,410 -1,342 2,532 52 -1,980 363 6,439
Purchase of fixed assets Sale of investment Addition of goodwill Sale of fixed assets Others Net cash used in investing activities
-1,403 33 -233 53 -75 -1,626
-1,536 0 367 92 16 -1,061
-1,887 63 -142 239 8 -1,719
-800 0 335 0 202 -263
-800 0 302 0 87 -411
-799 0 272 0 87 -441
Issue of preferential equity shares Receipt of share premium Proceeds from borrowings Repayment of borrowings Interest paid Dividends paid Others Net cash from financing activities
11 1,386 217 -1,873 -1,084 -145 971 -515
0 0 -631 -176 -871 -226 -954 -2,858
0 0 45 -131 -819 -207 540 -572
0 0 0 0 -884 -231 -1,873 -2,989
0 0 0 0 -620 -282 -928 -1,830
0 0 0 0 -450 -330 0 -779
Net increase in cash Cash at the beginning of the year Cash at the close of the year
57 2,358 2,415
-1,006 2,425 1,481
285 1,471 1,779
3,508 1,779 5,287
3,487 5,287 8,774
5,219 8,774 13,992
7 December 2011
118
AREVA T&D (2-EW, PT: RS193, -8%): MARGIN TROUGH AND ORDER RECOVERY
ATD IN / AREV.NS Stock Rating
2-EQUAL WEIGHT
Sector View
2-NEUTRAL
Price Target
INR 193.00
Price (02-Dec-2011)
INR 208.65
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&Ds 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&Ds 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
Year to Dec 2010A 2011E 2012E 2013E Net profit Rs mn 1,868 1,810 2,312 2,598 EPS Rs 7.8 7.6 9.7 10.9 EPS growth % -2.8 -3.1 27.7 12.4 P/E (x) 26.7 27.6 21.6 17.9 P/B (x) 5.0 4.4 3.8 3.3 ROE (%) 18.6 15.9 17.5 18.2 Div. yield (%) 0.9 0.8 1.0 1.1
-8%
7 December 2011
119
COMPANY SNAPSHOT AREVA T&D Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2010A 40,200 4,238 3,302 2,816 1,868 7.81 239.00 1.80 2011E 44,991 4,220 3,257 2,711 1,810 7.57 239.00 1.51 2012E 50,131 5,183 4,107 3,469 2,312 9.67 239.00 1.93 2013E 57,991 6,061 4,821 4,183 2,788 11.67 239.00 2.33 CAGR 13.0% 12.7% 13.4% 14.1% 14.3% 14.3% 0.0% 9.0% Average 10.2 8.0 6.8 4.5 12.4 10.3 17.6 INDIAN CAPITAL GOODS SECTOR
2-EQUAL WEIGHT 2-NEUTRAL 208.65 193 ATD IN/AREV.NS
10.5 8.2 7.0 4.6 12.1 9.8 18.6
9.4 7.2 6.0 4.0 10.9 8.9 15.9
10.3 8.2 6.9 4.6 12.6 10.7 17.5
10.5 8.3 7.2 4.8 13.8 12.0 18.2
Why a 2-Equal weight? While margins have troughed and orders are recovering, room for upside surprises appear limited given stiff competition in the sector. With valuations being rich (vs expectations), we believe that the stock is pricing in a recovery.
Balance sheet and cash flow (INRmn) Fixed assets 8,939 Cash and equivalents 1,199 Total assets 44,681 Current liabilities 25,662 Long term liabilities 8,957 Total liabilities 44,681 Net debt/(funds) 7,758 Shareholders' equity 10,024 Change in working capital (3,519) Cash flow from operations 1,075 Capital expenditure (1,131) Free cash flow (56) Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
8,976 109 44,314 23,909 8,957 44,314 8,848 11,410 (2,440) 879 (1,000) (121)
8,401 667 48,321 26,645 8,457 48,321 7,790 13,181 (1,289) 2,737 (500) 2,237
CAGR 8,161 -3.0% 478 -26.4% 54,134 6.6% 30,823 6.3% 7,957 -3.9% 54,135 6.6% 7,479 -1.2% 15,317 15.2% (2,065) NA 2,602 34.2% (1,000) NA 1,602 NA Average 17.1 23.2 9.5 12.0 3.4 1.9 1.0 1.2 3.3 4.1 1.2 0.9 34.1 41.0 0.5 0.7
Upside case 300 If a delisting is announced the stock could head to its previous open offer price. Fundamental upside can be driven by higher-than-expected order wins in powergrid orders at good pricing.
Downside case 97 In a worst case scenario, stock could head to its historic trough P/E of 10x. This would happen only if pricing pressure continues in powergrid orders and order book starts shrinking.
Upside/downside scenarios 26.7 13.6 -0.1 1.4 5.0 0.9 47.1 0.8 27.6 13.9 -0.3 1.3 4.4 0.8 43.9 0.8 21.6 11.1 4.7 1.2 3.8 1.0 39.0 0.6
400 348 300 248 200 148 100 48 0 15-Dec-10 INR97 INR97 (-53.5%) (-53.5%) Downside
Downside Case Case
INR193 INR193 (-7.50%) (-7.50%)

Price Price Target Target
INR300 INR300 (43.7%) (43.7%)

25-Nov-11
Ebita margins expected to stabilise now 41,848 -69 49,365 345 48,858 1,675 53,232 783 57,200 1,707 60,300 1,328 70,356 2,300 72,665 2,051
20% 15% 10% 5% 0% Dec-08 Dec-09 Dec-10 Dec11E Dec12E Dec13E EBITDA margins
Note: FY end Dec.
7 December 2011
120
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
120% 100% 80% 60% 40% 20% 0% CY05 CY06 CY07 CY08 CY09 CY10 Switchgear-capacity utilisation
Figure 172: Areva T&D capacity utilisation in switchgears still low

120% 107% 87% 89% 90% 77%
94% 81%
98%
96%
100% 80%
49%
49%
60% 40% 20% 0% CY06 CY07 CY08 CY09 CY10
Capacity utilisation- transformers

Figure 173: Areva T&D high cost imports as percentage of costs reducing
25% 20% 20% 15% 10% 5% 14% 19% 14%
Figure 174: Areva EBITDA margins recovering
20% 16% 12% 8% 4% 0% Dec-06 13%
18% 15% 11% 11% 9% 11% 11%
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
0% CY07 CY08 CY09 CY10
import as % of sales
EBITDA Margin
7 December 2011
Dec-13
121
Order momentum improving

Order recovery for the market and stable pricing should help drive order inflow growth for the company
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&Ds 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 RRVPNL Powergrid Corporation Sterlite Technology BHEL Reliance Infrastructure OPTCL Aditya Aluminium Lanco Infratech NEEPCO India projects
Product 765 kV substation package 765 kV transformer at Bareilly 765 kV substation package GIS package for SJVNL Rampur 220 kV substation for Rajasthan Solar 63 MVA power transformer package ETC package Substation package at Anuppur 132 kV switchyard
Order value Rs mn 4,000 850 2,200 580 400 340 300 300 250 180
Figure 176: Areva T&D order inflows expected to improve after three years of weak ordering (Y/Y growth)
70 60 50 40 30 20 10 0 -10 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 3 21 17 (1) 3 17 8 17 23 21 13 58
53 46 40
49
Order inflow YoY

Orderbook YoY
Valuation
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
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 stocks 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.
7 December 2011
122
Figure 177: Areva T&D historical 12-month forward P/E

Areva T&Ds valuation multiples have derated from a peak of 35x to 19x now
35 30 25
Given risk to earnings, we do not expect a re-rating of the stock near term
20 15 10 5 0 Jul-09 Sep-09 Jan-10 Aug-10 Mar-09 Dec-10 Jun-10 Nov-09 Sep-08 May-09 Feb-11 Oct-10 Apr-10 Jan-09 Jul-08 Jun-11 Aug-11
Sep-11
Nov-08
May-08
Areva T&D
Linear (Areva T&D)
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
25 20 15 10 5 0 Mar-09 Mar-10 Mar-11 Jun-08 Jun-09 Dec-08 Dec-09 Jun-10 Dec-10 Sep-08 Sep-09 Sep-10
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
20 18 16 14 12 10 8 6 Mar-10 Mar-11 Dec-09 Dec-10 Jun-10 Sep-09 Sep-10 Jun-09 Jun-11
CY08
CY09
CY10
CY11
CY12
Figure 180: Areva T&D stock price vs. EBITDA margin

Areva T&Ds 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.
600 500 400 300 200 100 0 Sep-05 Feb-07 Feb-08 Mar-09 Jul-09 Mar-10 Jul-10 May-05 Aug-11 Jan-05 Jan-06 Oct-06 Oct-07 Oct-08 Jun-06 Jun-07 Jun-08 Nov-09 Nov-10 Apr-11 10% 5% 0% 25% 20% 15%
Price
Source: Datastream, Barclays Capital estimates
EBITDA margins
7 December 2011
Oct-11
123
Apr-11
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 Net sales Materials, manufacturing and operating expenses % of sales Staff cost % of sales Sales and administrative expenses % of sales Expenditure % of sales OBITDA OBITDA margin 2008 26,412 17,141 65% 2,091 8% 2,928 11% 22,557 85% 3,855 15% 2009 35,659 24,926 70% 2,924 8% 3,794 11% 31,711 89% 3,947 11% 2010 40,200 27,531 68% 3,460 9% 4,971 12% 35,962 89% 4,238 11% 2011E 44,991 30,950 69% 3,681 8% 6,140 14% 40,771 91% 4,220 9% 2012E 50,131 34,466 69% 4,303 9% 6,179 12% 44,949 90% 5,183 10% 2013E 57,991 39,828 69% 4,970 9% 7,132 12% 51,930 90% 6,061 10%
Depreciation Other income Interest Profit before tax Total taxation Tax rate Reported profit after tax Adjusted profit after tax Adjusted profit after tax margin
340 142 302 3,355 1,196 36% 2,263 2,160 8%
611 173 579 2,931 1,010 34% 1,921 1,921 5%
936 169 655 2,816 949 34% 1,868 1,868 5%
963 82 628 2,711 901 33% 1,810 1,810 4%
1,075 638 3,469 1,157 33% 2,312 2,312 5%
1,240 638 4,183 1,395 33% 2,788 2,788 5%
7 December 2011
124
Figure 182: Areva T&D balance sheet, 2008-13E

Rs mn; years ending December Share capital Reserves and surplus Total shareholder equity Unsecured loans Total loans Total sources of funds 2008 478 6,772 7,250 4,692 4,692 11,942 2009 478 8,188 8,666 7,676 7,676 16,342 2010 478 9,546 10,024 8,957 8,957 19,019 2011E 478 10,932 11,410 8,957 8,957 20,405 2012E 478 12,703 13,181 8,457 8,457 21,676 2013E 478 14,839 15,317 7,957 7,957 23,312
Application of funds Adjusted gross block Less: depreciation Net block Capital WIP Investments Deferred tax assets net Inventory Inventory days Debtors Debtor days Cash and bank Loans and advances Total current assets Current liabilities Current liability days Provisions Provision days Total current liabilities and provisions 16,516 21,420 25,662 23,909 26,645 30,823 1,111 1,099 1,027 2,468 2,747 3,178 4,062 2,104 1,971 4,500 0 387 3,862 53 11,889 164 451 2,816 21,601 15,405 10,839 2,455 8,384 519 0 100 3,790 53 15,994 164 1,325 3,174 28,759 20,321 11,949 3,233 8,715 224 2 4,808 53 21,400 164 1,199 3,192 35,740 24,635 12,949 4,197 8,752 224 1 6,579 53 20,253 164 109 4,797 35,337 21,441 13,449 5,272 8,177 224 1 7,330 53 22,567 164 667 5,345 39,919 23,898 14,449 6,512 7,937 224 8,421 53 26,056 164 478 6,379 45,973 27,645
Net current assets Net current assets excluding cash Total application of funds
5,085 4,634 11,942
7,339 6,014 16,342
10,078 8,878 19,019
11,428 11,319 20,405
13,274 12,607 21,676
15,150 14,673 23,312
7 December 2011
125
Figure 183: Areva T&D cash flow statement, 2008-13E

Rs mn; years ending December PBT Depreciation Others Operating profit before working capital changes Debtors Inventory Trade and other payables Others Operating cash flow Taxation Cash flow from operating activities Change in fixed assets Change in investments Others Cash flow from investing activities Change in equity Change in loans Dividend paid and tax thereon Others Cash flow from financing activities Net change in cash and cash equivalents Opening balance of cash and equivalents Closing balance of cash and equivalents
Dec-08 3,470 340 839 4,650 (5,815) (1,133) 5,362 3,064 (1,521) 1,543 (4,217) 118 3 (4,096) 3,543 (500) (272) 2,771 217 223 441
Dec-09 2,931 611 1,230 4,772 (6,376) 72 5,093 3,561 (1,282) 2,280 (3,201) 16 1 (3,185) 2,873 (499) (595) 1,779 874 451 1,325
Dec-10 2,816 936 1,437 5,190 (6,705) (1,018) 4,204 1,670 (595) 1,075 (1,131) 2 (1,129) 1,079 (500) (650) (71) (125) 1,325 1,199
Dec11E 2,711 963 545 4,220 1,084 (1,771) (1,753) 1,780 (901) 879 (1,000) 82 (918) (424) (628) (1,051) (1,090) 1,199 109
Dec12E 3,469 1,075 638 5,183 (3,273) (752) 2,736 3,894 (1,157) 2,737 (500) (500) (500) (541) (638) (1,679) 558 109 667
Dec13E 4,183 1,240 639 6,062 (5,153) (1,090) 4,178 3,997 (1,395) 2,602 (1,000) (1,000) (500) (652) (638) (1,791) (189) 667 478
7 December 2011
126
VOLTAS (3-UW, PT: RS78, -15%): EMERGING STRUCTURAL RISKS A CONCERN

VOLT IN / VOLT.NS Stock Rating
3-UNDERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 78.00
Price (02-Dec-2011)
INR 92.10
-15%
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
Year to Mar 2011A 2012E 2013E 2014E Net profit Rs mn 3,234 2,130 2,180 2,068 EPS Rs 9.8 6.4 6.6 6.2 EPS growth % -12.1 -34.1 2.4 -5.2 P/E (x) 9.4 14.3 14.0 14.7 P/B (x) 2.2 1.9 1.7 1.6 ROE (%) 23.8 13.4 12.4 10.7 Div. yield (%) 1.4 1.1 0.8 0.7
7 December 2011
127
COMPANY SNAPSHOT VOLTAS Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2010A 51,768 4,408 4,198 4,843 3,234 9.78 330.74 2.32 2011E 50,287 2,666 2,370 4,123 2,130 6.44 330.74 1.74 2012E 51,127 2,798 2,582 3,160 2,180 6.59 330.74 1.31 2013E 57,257 2,660 2,420 2,998 2,068 6.25 331.00 1.24 CAGR 3.4% -15.5% -16.8% -14.8% -13.8% -13.9% 0.0% -18.8% Average 6.0 5.5 7.2 4.6 14.6 13.6 15.1 CAGR 9.3% 17.0% 6.4% 3.4% -0.7% 6.4% NA 12.3% NA 74.8% NA NA INDIA CAPITAL GOODS
3-UNDERWEIGHT 2-NEUTRAL 92.1 78.0 VOLT IN/VOLT.BO
8.5 8.1 9.4 6.2 22.0 21.2 23.8
5.3 4.7 8.2 4.2 13.3 12.1 13.4
5.5 5.1 6.2 4.3 12.3 11.3 12.4
4.6 4.2 5.2 3.6 10.8 9.9 10.7
Why a 3-Underweight? Voltas is facing issues in all its areas of operation. 1) MEP business has seen a large geographic shift and increase in competitive intensity; bidding margins are now only 5%. 2) AC market also going through cyclical issues.
Balance sheet and cash flow (INRmn) Fixed assets 2,458 Cash and equivalents 4,980 Total assets 41,466 Current liabilities 26,232 Long term liabilities 1,381 Total liabilities 41,466 Net debt/(funds) (3,599) Shareholders' equity 13,617 Change in working capital (3,317) Cash flow from operations 392 Capital expenditure (446) Free cash flow (54) Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
Upside case 132 A recovery in MEP business through large order wins in Middle East could help multiples recover to 20x close to sector trading averages.
2,661 6,746 43,067 25,481 1,432 43,067 (5,313) 15,915 117 3,583 (500) 3,083
2,945 7,621 45,219 25,907 1,412 45,219 (6,209) 17,649 (67) 2,600 (500) 2,100
3,206 7,971 49,921 29,013 1,351 49,921 (6,621) 19,293 (485) 2,095 (500) 1,595
Downside case 28 Continued weakness in margins and inability to even match last year's inflows could lead to the stock moving back to its trough P/E of ~5x.
Upside/downside scenarios 9.4 6.1 -0.2 0.5 2.2 2.5 9.1 -0.8 14.3 9.4 10.1 0.5 1.9 1.9 8.1 -2.0 14.0 8.7 6.9 0.5 1.7 1.4 7.3 -2.2 Average 14.7 13.1 9.0 8.3 5.2 5.5 0.4 0.5 1.6 1.9 1.3 1.8 6.5 7.7 -2.5 -1.9
200 150 100 50 0 22-Dec-10 INR28 (-69.5%)
Downside Case
INR132 (43.3%) INR78 (-15.3%)

Price Target Upside Case
2-Dec-11
Order inflows continue to remain weak 32,091 -15 48,880 4 32,091 0 50,230 3 33,696 5 53,586 7 38,750 15 59,516 11
40% 20% 0% -20% -40% Mar 09 Mar11 Mar13E Order inflow growth
Note: FY end Mar.
7 December 2011
128
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 Mechanical and Electrical Projects Order volumes slow in established geographies Competition Profitability impacted by rising input costs, restrictive visa conditions and setbacks in cash flows amplified by higher capital engagement. Margins impacted by the slow progress of some orders (including a high-value rural electrification job). Receivables expanding and a concern. Our view 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. 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 We expect industrial segments to remain weak until FY14 and, hence, expect no recovery in revenues or margins next year
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. 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
Engineering
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
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
129
Figure 186: Voltas revenue mix, FY11: skewed towards MEP segment; slower ordering and low margins on new wins will likely impact earnings growth
Others 0% Cooling products 30%
Figure 187: Voltas Profit mix, FY11: margins in key segments of MEP and cooling products to sharply deteriorate
Others 0% Cooling products 32% EMP 48%
MEP 59% Engineering 11%
Engineering 20%
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
100% 80% 60% 40% 20% 0% -20% -40% -60% Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 -12% -34% Mar 13E Mar14 E
130
89% 66% 32% 19% 41% 21% 27% 2% -5% 56%
EPS growth YoY

7 December 2011
Mar12E
Figure 189: Voltas segment revenues and profitability

Rs mn Segmental revenues Electro-mechanical projects y/y Engineering y/y Unitary cooling products y/y Segmental profits Electro-mechanical projects Margin Engineering Margin Unitary cooling Margin 341 4.9% 216 33% 24 1% 216 2.8% 275 33% 86 2% 460 5.4% 401 25% -53 -1% 673 5.7% 697 28% -337 -7% 685 4.8% 984 24% 26 0% 1,170 6.7% 1,136 21% 553 7% 2,134 7.7% 626 12% 550 6.0% 3,091 9.9% 768 16.4% 1,203 10.1% 2,393 7.9% 1,030 18.3% 1,600 10.3% 830 2.7% 742 14.6% 971 6.9% 1,196 3.9% 626 13.6% 808 5.1% 1,081 3.3% 622 12.4% 1,138 6.0% 4561 649 7,017 7,778 11% 837 29% 4,596 1% 8,556 11,897 14,383 17,449 27,668 31,134 30,411 30,741 30,340 32,820 10% 1,591 90% 4,617 0% 39% 2528 59% 5,006 8% 21% 4,162 65% 5957 19% 21% 5,535 33% 8,259 39% 59% 5,422 -2% 12% 13% 4,680 -14% 29% -2.3% 5,638 20% 31% 1.1% 5,084 -10% -10% -1.3% 4,597 -10% 12% 8.2% 5,012 9% 20% FY03 FY04 FY05 FY06 FY07 FY08 FY09 Mar10 Mar11 Mar12E Mar13E Mar14E
9,223 11,871 15,608 14,108 15,771 18,962
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)
18 16 14 12 10 8 6 4 2 0 Jun-11 Dec-10 Sep-10 Mar-10 Mar-11 Dec-09 Sep-09 Sep-11
131
14 12 10 8 6 4 2 0 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 FY10
FY07 FY11
FY08
FY09 FY12
Source: IBES consensus, Barclays Capital
Jun-09
Jun-10
FY13
FY14
Source: IBES consensus, Barclays Capital
7 December 2011
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
40 35 30 25 20 15 10 5 0 Jun-05 Jun-06 Sep-04 Feb-06 Feb-07 Jun-07 Jan-05 Aug-10 Mar-08 Mar-09 Aug-11
132
Dec-10
Oct-05
Oct-06
Jul-08
Jul-09
Apr-10
Nov-07
Nov-08
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
Nov-09
Apr-11
Figure 193: Voltas income statement, FY09-14E

Rs mn; years ending March Net sales Change in stock in trade Cost of materials % of sales Staff expenses % of sales Other expenses % of sales OBITDA OBITDA margin Interest Other income Depreciation Profit before tax Profit before tax margin Extraordinary income/expenses Profit before tax Tax Tax rate Profit after tax Profit after tax margin Adjusted profit after tax
FY09 43,252 -1,557 33,243 73% 4,656 11% 4,087 9% 2,824 7% 110 945 210 3,456 8% 261 3,717 1,172 32% 2,545 6% 2,362
FY10 47,575 -596 32,876 68% 4,922 10% 5,777 12% 4,596 10% 98 785 214 5,068 11% 250 5,318 1,472 28% 3,846 8% 3,678
FY11 51,768 -,645 36,808 68% 5,019 10% 7,178 14% 4,408 9% 165 810 210 4,843 9% 402 5,244 1,729 33% 3,515 7% 3,234
FY12E 50,287
FY13E 51,127
FY14E 57,257
36,886 73% 5,953 12% 4,781 10% 2,666 5% 296 988 297 4,123 8% 1,065 4,123 1,248 30% 2,875 6% 2,130
37,310 73% 6,275 12% 4,744 9% 2,798 5% 284 862 216 3,160 6% 0 3,160 979 31% 2,180 4% 2,180
42,253 74% 7,014 12% 5,331 9% 2,660 5% 284 862 239 2,998 5% 0 2,998 929 31% 2,068 4% 2,068
7 December 2011
133
Figure 194: Voltas balance sheet, FY09-14E

Rs mn; years ending March Share capital Reserves and surplus Total shareholder funds Minority interest Secured loans Unsecured loans Total debt Deferred tax liability Total sources of funds Gross fixed assets Depreciation Net fixed assets Change WIP Goodwill on consolidation Investments Inventories Inventory days Sundry debtors Debtor days Cash and bank balances Other current assets Loans and advances Total current assets Current liabilities Current liabilities days Provisions Provision days Current liabilities and provisions Net current assets Deferred tax assets Total usage of funds
Source: Source: Company data, Barclays Capital estimates
FY09 331 7,567 7,897 159 1,688 127 1,814 9,871 3,986 1,839 2,148 132 675 1,562 11,194 94 9,521 80 4,571 2,203 27,489 19,714 166 2,645 22 22,360 5,129 224 9,871
FY10 331 10,521 10,852 139 306 45 352 1 11,343 3,890 1,821 2,069 193 764 2,339 6,579 50 9,555 77 4,689 4,866 -7 28,249 19,830 429 2,645 20 22,475 5,774 204 11,343
FY11 331 13,286 13,617 218 1,280 101 1,381 18 15,234 4,410 1,987 2,422 36 916 2,613 8,224 58 11,705 83 4,980 7,961 2,440 35,309 23,075 163 3,157 22 26,232 9,077 170 15,234
FY12E 331 15,584 15,915 220 1,331 101 1,432 18 17,585 4,910 2,284 2,626 36 916 3,113 7,989 58 11,370 83 6,746 7,733 2,370 36,207 22,415 163 3,067 22 25,481 10,726 170 17,585
FY13E 331 17,318 17,649 234 1,311 101 1,412 18 19,312 5,410 2,500 2,910 36 916 3,613 8,122 58 11,560 83 7,621 7,862 2,409 37,575 22,789 163 3,118 22 25,907 11,667 170 19,312
FY14E 331 18,963 19,293 246 1,249 101 1,351 18 20,908 5,910 2,739 3,171 36 916 4,113 9,096 58 12,946 83 7,971 8,805 2,698 41,516 25,522 163 3,492 22 29,013 12,503 170 20,908
7 December 2011
134
Figure 195: Voltas cash flow statement, FY09-14E

Rs mn; years ending March Profit before tax Depreciation Operating profit before working capital Change in inventories Change in trade and other receivables Change in loans and advances Change in advances from customers Change in trade payables Change in working capital Others Tax Cash from operating activities Purchase of fixed assets Sale of fixed assets Purchase of investments Sale of investments Cash from investing activities Repayment of loans Dividend paid Others Net cash used in financing activities 1,048 973 -439 72 -9,082 10,158 649 -152 -520 619 - 53 1,611 3,065 -317 350 -1,664 889 -764 -1,463 -615 -99 -2,177 FY09 3,717 210 3,780 -4,618 -2,994 -507 1,813 4,546 -1,760 FY10 5,318 214 5,023 -247 -411 263 579 -442 -89 FY11 5,244 210 5,023 -4,737 -1,488 -204 438 2,673 -3,317 -1,487 1,879 392 -446 442 -21,997 21,726 -288 1,029 -768 -166 96 FY12E 4,123 297 4,713 235 335 298 -660 -90 117 1,248 3,583 -500 -500 -1,296 51 -575 3 -521 FY13E 3,160 216 3,647 -134 -190 -169 375 51 - 67 979 2,600 -500 -500 -1,284 - 20 -433 13 -441 FY14E 2,998 239 3,509 -974 -1,386 -1,232 2,733 374 -485 929 2,095 -500 -500 -1,284 - 61 -411 13 -460
Net increase in cash and equivalents Opening cash balance Closing cash balance Cash added on acquisition of subsidiaries
1,569 3,002 4,571
124 4,571 4,695
200 4,695 4,980 100
1,766 4,980 6,746
875 6,746 7,621
350 7,621 7,971
7 December 2011
135
BGR ENERGY (3-UW, PT: RS241, -11%): BUSINESS MODEL CONCERNS

BGRL IN / BGRE.NS Stock Rating
3-UNDERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 241.00
Price (02-Dec-2011)
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. BGRs 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 Energys 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 Energys 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 Energys 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
Year to Mar 2011A 2012E 2013E 2014E Net profit Rs mn 3,230 3,034 2,906 1,215 EPS Rs 45 42 40 17 EPS growth % 60 -6 -4 -58 P/E (x) 6.0 6.4 6.7 16.1 P/B (x) 2.1 1.7 1.4 1.3 ROE (%) 33.9 25.8 20.9 8.2 Div. yield (%) 3.8 3.5 3.3 1.4
INR 270.55
-11%
7 December 2011
136
COMPANY SNAPSHOT BGR ENERGY Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2010A 47,498 5,363 5,190 4,808 3,230 44.77 72.16 10.01 2011E 45,979 5,536 5,334 4,431 3,034 42.05 72.16 9.25 2012E 49,860 5,593 5,373 4,196 2,906 40.27 72.16 8.86 2013E 53,718 4,445 4,209 1,685 1,215 16.83 72.16 3.70 CAGR 4.2% -6.1% -6.7% -29.5% -27.8% -27.8% 0.0% -28.2% Average 10.7 10.3 7.8 5.4 9.8 7.7 22.2 INDIA CAPITAL GOODS
3-UNDERWEIGHT 2-NEUTRAL 270.55 241 BGRL IN/BGRE.BO
11.3 10.9 10.1 6.8 13.7 12.2 33.9
12.0 11.6 9.6 6.6 11.1 9.2 25.8
11.2 10.8 8.4 5.8 9.4 7.3 20.9
8.3 7.8 3.1 2.3 4.8 1.9 8.2
Why a 3-Underweight? Recent bids suggest that it is difficult to make margins in the BTG sector. With BGR set to spend over US$1bn on capex to set up its BGR facilities we are concerned on its ability to generate returns on this business.
Balance sheet and cash flow (INRmn) Fixed assets 2,840 Cash and equivalents 10,449 Total assets 54,006 Current liabilities 27,516 Long term liabilities 9,520 Total liabilities 54,006 Net debt/(funds) 2,925 Shareholders' equity 9,520 Change in working capital (7,138) Cash flow from operations (1,297) Capital expenditure (700) Free cash flow (1,997) Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
3,637 12,743 59,672 26,636 11,776 59,672 4,921 11,776 (3,455) 685 (1,000) (315)
8,417 13,353 68,715 28,884 13,936 68,715 8,945 13,936 (1,405) 2,898 (5,000) (2,102)
CAGR 38,181 138% 5,316 -20.2% 94,074 20.3% 31,120 4.2% 14,840 15.9% 94,074 20.3% 39,203 138% 14,840 15.9% (1,397) NA 2,578 NA (30,000) NA (27,422) NA Average 16.1 8.8 13.2 6.7 -140.5 - 0.4 1.1 0.7 1.3 1.6 1.4 2.9 70.7 57.7 8.8 3.0
Upside case 337 Bull case for BGR Energy is a recovery in power market led by reforms in coal . In that case visibility of orders improve and fwd valuations trend up to 20x (avg of BHEL's P/E) on FY14 earnings. FY14 captures the impact of weak margins
Downside case 88 Bear case is that future wins for BGR Energy happen at prices which are perceived to be low. Street could then value it at trough P/E on FY14 earnings.
Upside/downside scenarios 6.0 4.2 -10.2 0.5 2.1 3.7 50.5 0.5 6.4 4.4 -1.6 0.5 1.7 3.4 53.5 0.9 6.7 5.1 -10.8 0.6 1.4 3.3 56.0 1.6
600 844 500 644 400 300 444 200 244 100 0 44 22-Dec-10 INR88 INR88 (-67.4%) Downside (-67.4%) Downside
Case Case
INR337 INR241 (24.5%) INR337 (-10.9%) INR241 (24.5%) (-10.9%) Upside

Price Price Target Target Upside Case Case
2-Dec-11
Leverage expected to increase 29,410 -20 79,710 -22 118,125 302 151,856 91 63,000 -47 164,996 9 84,000 33 195,277 18
4.0 3.0 2.0 1.0 0.0 FY08 FY09 FY10 FY11 FY12E FY13E FY14E Debt to equity ratio
Note: FY end Mar.
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Funding concerns: weak cash generation and high capex plans

BGR Energys cash flow generation has usually been weak. Receivable days in Sep quarter has expanded to over 440 days
BGR Energys 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 912 months as per management comments. Figure 197: BGR Energy Sharp deterioration in working capital metrics; debt levels rising
(Rs mn) Loan funds Debtor days Liability days Provision days Net current assets ex cash Working capital days
Sep-10 14,224 232 165 21 13,312 107
FY11 13,363 173 131 19 13,391 74
Sep-11 23,074 464 268 39 23,744 280
Figure 198: BGR Energy net cash from operating activities: cash flow generation has usually been weak (Rs mn)
4,000 3,000 2,000 1,000 0 -1,000 -2,000 Mar-07 -463 -1696 Mar-08 -1297 Mar-09 Mar-10 Mar-11 773 3299
Figure 199: BGR Energy net current assets ex-cash days: its business is working capital intensive (days)
160 140 120 100 80 60 40 20 0 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 73 134 120 119 101
Net cash from operating activities

Net current assets ex cash days

Funding capex could be a challenge

We expect a funding gap of more than Rs24bn, which has to be bridged though equity fund raising
The BGR Energy-Hitachi join venture is set to invest more than Rs45bn in the boiler and turbine joint venture of which BGRs 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 companys 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.
138
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Figure 200: BGR Energy funding for capex plan appears difficult
Calculations Current debt/equity ratio Current debt Current cash balance Cash generation (FY12-14) Cash tied up in working capital Total cash for capex Capex planned Cash required Debt at end of FY14E New debt/equity ratio Annual interest outflow EBIDTA
Rs bn 1.40 13,373 10,449 6,256 6,415 10,290 33,750 23,460 36,833 2.5 Rs3-4bn 4,250
Figure 201: BGR Energy debt/equity at consolidated level: set to increase to 3.0x
50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 FY08 FY09 FY10 FY11 Total Debt
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 FY12 E D/E FY13 E FY14 E
Earnings peaking; margins to deteriorate

Business model is changing now to a manufacturer of BTG equipment; however, oversupply in the BTG markets could impact viability of new business venture
BGRs 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 Energys 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
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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 Energys shift to manufacturing is a positive, our concern largely stems from the companys 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
Our margin estimates could be aggressive. BGR Energy could be generating losses in FY14
14% 12% 10% 8% 6% 4% 2% 0% FY08 FY09 FY10 FY11 EBITDA margin
10.2%
10.8%
11.2%
11.3%
12.0%
11.2% 8.3%
FY12 E
FY13 E
FY14 E
BGR Energys 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
40 35 30 25 20 15 10 5 0 FY09 FY10 FY11 FY12 E FY13 E FY14 E 20 26 21 36 37 37
We expect execution period for BGR Energy to lengthen given the gap in ordering and shift to longer lead time supercritical projects
Execution months
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Expect more consensus earnings downgrades

We expect consensus earnings downgrades to continue
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. Figure 205: BGR Energy history of consensus EPS forecasts shows that the earnings downgrade cycle has just commenced; we expect more cuts (Rs)
60 55 50 45 40 35 30 Jun-09
Figure 204: BGR Energy history of consensus EPS forecasts shows that continued upward revisions led to a re-rating in FY11 (Rs)
50 45 40 35 30 25 20 15 10 5 0 Jan-08 Jul-08 FY08
Jan-09 Jul-09 FY09
Jan-10 Jul-10 FY10
Jan-11
Dec-09
Jun-10 FY12
Dec-10 FY13
Jun-11 FY14
FY11
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 stocks recent trough valuation since the financial crisis. Figure 206: BGR Energy historical 12-month forward P/E
30 25 20 15 10 5 0 Sep-08 Sep-09 Sep-10 Mar-08 Mar-09 Mar-10 Mar-11 Sep-11
141
BGR Energy 12M fwd PE

Source: Datastream, IBES consensus estimates ,Barclays Capital estimates
7 December 2011
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
Rs mn; years ending March Net sales Total expenditure Increase/decrease in WIP Material and manufacturing cost % of sales Staff cost % of sales Administration, selling and general expenses % of sales OBITDA OBITDA margin Interest Depreciation Other income Profit before tax Profit before tax margin Provision for taxation Tax rate Profit after tax Profit after tax margin
FY09 19,303 17214 -11 15,119 78% 731 4% 1,375 7% 2,089 11% 579 75 317 1,752 9% 586 33% 1,165 6%
FY10 30,734 27,292 25 23,616 77% 1,248 4% 2,403 8% 3,442 11% 538 103 250 3,051 10% 1,037 34% 2,015 7%
FY11 47,498 42,136 -51 37,772 80% 1,431 3% 2,984 6% 5,363 11% 605 173 223 4,808 10% 1,577 33% 3,230 7%
FY12E 45,979 40,443 -2 37,372 81% 1,613 4% 1,460 3% 5,536 12% 945 202 42 4,431 10% 1,397 32% 3,034 7%
FY13E 49,860 44,266 0 41,180 83% 1,564 3% 1,523 3% 5,593 11% 1,221 220 44 4,196 8% 1,290 31% 2,906 6%
FY14E 53,718 49,274 0 45,698 85% 1,822 3% 1,754 3% 4,445 8% 2,541 236 18 1,685 3% 470 28% 1,215 2%
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Figure 208: BGR Energy balance sheet, FY09-14E

Rs mn; years ending March Share capital Employee stock options application money Reserves and surplus Shareholder funds Minority Interest Secured loans Unsecured loans Total debt Deferred tax liabilities Total liabilities Goodwill on consolidation of subsidiaries Gross block Less: depreciation and impairment Net Block CWIP (including capital advances) Investments Inventories Sundry debtors Debtor days Cash and bank balances Other current assets OCA days Loans and Advances Current assets, loans and advances Liabilities Liability days Provisions Provision days Current liabilities and provisions Net current assets Total assets
FY09 720 0.00 4,919 5,639 28 6,360 730 7,090 747 13,504 6 1,245 268 977 54 5 140 12,789 242 6,152 178 3 6,432 25,690 12,326 233 903 17 13,229 12,462 13,504
FY10 720 0.00 6,343 7,063 29 4,052 4,023 8,075 1,551 16,717 6 1,819 365 1,454 104 5 162 19,803 235 9,019 181 2 7,273 36,438 18,955 225 2,334 28 21,289 15,149 16,717
FY11 722 0.04 8,798 9,520 519 8,604 4,769 13,373 3,078 26,490 6 2,508 530 1,978 862 5 411 31,580 243 10,449 315 2 8,400 51,155 23,971 184 3,545 27 27,516 23,639 26,490
FY12E 722 0.04 11,054 11,776 519 12,895 4,769 17,664 3,078 33,036 6 3,508 733 2,775 862 5 398 33,382 265 12,743 305 2 9,196 56,024 23,204 184 3,432 27 26,636 29,388 33,036
FY13E 722 0.04 13,215 13,936 519 17,529 4,769 22,298 3,078 39,831 6 8,508 953 7,555 862 5 431 36,200 265 13,353 331 2 9,972 60,286 25,163 184 3,722 27 28,884 31,402 39,831
FY14E 722 0.04 14,118 14,840 519 39,750 4,769 44,519 3,078 62,954 6 38,508 1,189 37,319 862 5 464 39,001 265 5,316 357 2 10,744 55,882 27,110 184 4,010 27 31,120 24,762 62,954
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Figure 209: BGR Energy cash flow statement, FY08-14E

Rs mn; years ending March Net profit before tax and extraordinary items Depreciation and amortization Operating profit before working capital changes (Increase)/decrease in sundry debtors (Increase)/decrease in inventories (Increase)/decrease in other current assets (Increase)/decrease in loans and advances Increase/(decrease) in trade payables Change in working capital Cash generated from operations Direct tax paid Net cash flow from operating activities Purchase of fixed assets Sale of fixed assets Purchase of investments Net cash flow from investing activities Secured loans (repaid)/availed Unsecured loans (repaid)/availed Payment of dividend Tax on dividend paid Net cash flow from financing activities Net Increase in cash and cash equivalents Cash and cash equivalents (opening balance) Cash and cash equivalents (closing balance)
FY08 1296 55 1,594 -3,672 146 -46 -1,807 2,153 -3,226 -1,632 -64 -1,696 -238 62 -1,517 -1,631 23 -24 -32 2,564 5,469 2,141 929 3,070
FY09 1,752 75 234 -5,428 10 -92 -3,771 7,754 -1,528 -1,294 -37 773 -544 21 1,509 967 60 695 -144 1,307 1,342 3,081 3,070 6,152
FY10 3,051 103 4,369 -7,079 -22 -3 -841 6,589 -1,356 3,013 286 3,299 -589 10 0 -629 230 3,293 -216 -37 197 2,867 6,152 9,019
FY11 4,808 173 6,456 -11,827 -249 -134 -517 5,589 -7,138 -681 -616 -1,297 -700 2 0 -1,456 51 746 -505 -86 4,183 1,430 9,019 10,449
FY12E 4,431 202 5,536 -1,803 13 10 -795 -880 -3,455 2,082 -1,397 685 -1,000 0 0 -958 4,291 0 -668 -111 2,567 2,294 10,449 12,743
FY13E 4,196 220 5,593 -2,817 -34 -26 -776 2,248 -1,405 4,189 -1,290 2,898 -5,000 0 0 -4,956 4,634 0 -639 -106 2,667 610 12,743 13,353
FY14E 1,685 236 4,445 -2,802 -33 -26 -772 2,235 -1,397 3,048 -470 2,578 -30,000 0 0 -29,982 22,220 0 -267 -44 19,367 -8,037 13,353 5,316
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KEC INTERNATIONAL (1-OW, PT: RS72, + 75%): TROUGH VALUATIONS

KECI IN / KECL.NS Stock Rating
1-OVERWEIGHT
Sector View
2-NEUTRAL
Price Target
INR 72.00
Price (02-Dec-2011)
INR 41.25
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 internationals margins have been impacted due to forex losses as well as repricing of foreign advances due to rupee depreciation (these are noncash 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
Year to Mar 2011A 2012E 2013E 2014E Net profit Rs mn 2,057 1,472 1,839 2,382 EPS Rs 8.0 5.7 7.2 9.3 EPS growth % 4.4 -28.4 25.0 29.5 P/E (x) 5.2 7.2 5.8 4.5 P/B (x) 1.1 1.0 0.9 0.8 ROE (%) 21.7 13.8 15.1 16.9 Div. yield (%) 3.1 2.2 2.8 3.6
+75%
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COMPANY SNAPSHOT KEC international Income statement (INRmn) Revenue EBITDA EBIT Pre-tax income Net income EPS (R) Diluted shares (mn) DPS (R) Margin and return data (%) EBITDA margin EBIT margin Pre-tax margin Net margin ROIC ROA ROE 2011A 43,232 3,115 2,707 3,167 2,057 8.00 257.10 1.30 2012E 53,844 4,365 3,799 2,338 1,472 5.72 257.10 0.93 2013E 59,714 5,089 4,458 2,830 1,839 7.15 257.10 1.16 2014E 66,245 5,992 5,291 3,664 2,382 9.26 257.10 1.51 CAGR 15.3% 24.4% 25.0% 5.0% 5.0% 5.0% 0.0% 5.0% Average 8.2 7.2 5.5 3.5 10.2 6.9 16.9 INDIAN CAPITAL GOODS
1-OVERWEIGHT 2-NEUTRAL 41.25 72 KECI IN
7.2 6.3 7.3 4.8 11.3 8.5 21.7
8.1 7.1 4.3 2.7 8.6 5.3 13.8
8.5 7.5 4.7 3.1 9.8 6.2 15.1
9.0 8.0 5.5 3.6 11.0 7.6 16.9
Why a 1-Overweight? Earnings growth should recover in FY13, led by strength in order inflows and margins recovery. Margin improvements will likely be aided by a shift in cable production to a new facility that will bring in efficiencies and reduction in start up losses in new businesses.
Balance sheet and cash flow (INRmn) Fixed assets 8,409 Cash and equivalents 1,614 Total assets 47,094 Current liabilities 22,809 Long term liabilities 14,322 Total liabilities 47,094 Net debt/(funds) 12,708 Shareholders' equity 9,466 Change in working capital (2,297) Cash flow from operations 1,694 Capital expenditure (780) Free cash flow 914 Valuation and leverage metrics P/E (x) EV/EBITDA (x) FCF yield (%) EV/sales (x) Price/BV (x) Dividend yield (%) Total debt/capital (%) Net debt/EBITDA (x) Selected operating metrics Order inflow Order inflow growth (%) Orderbook Orderbook growth (%)
8,932 1,723 56,137 28,462 16,519 56,136 14,796 10,658 (2,756) 853 (1,200) (347)
9,501 929 61,216 31,565 17,006 61,215 16,077 12,147 (2,202) 1,904 (1,200) 704
CAGR 10,001 5.9% 449 -34.7% 66,483 12.2% 35,018 15.4% 16,891 5.7% 66,482 12.2% 16,442 9.0% 14,076 14.1% (1,795) NA 2,920 19.9% (1,200) NA 1,720 23.5% Average 4.5 5.6 4.5 5.8 16.2 7.0 0.4 0.5 0.8 0.9 3.7 3.0 53.7 57.4 2.7 3.3
Upside case 86 Success in substation EPC wins in India, large wins in Rail business could help re-rate valuations. We expect the stock to head closer to its near term peak P/E of 12x on improved order visibility and earnings performance.
Downside case 36 Continued weakness in earnings acccentuated by accounting losses on account of translation of foreign currency advances (rupee dep) and a weak 2H order inflow performance could lead to the stock heading to a P/E of 5x (close to trough P/E).
Upside/downside scenarios 5.2 7.5 8.6 0.5 1.1 3.2 59.0 4.1 7.2 5.8 -3.3 0.5 1.0 2.3 59.7 3.4 5.8 5.2 6.6 0.4 0.9 2.8 57.4 3.2
120 118 100 98 80 78 60 58 40 38 20 18 0 15-Dec-10 25-Nov-11 INR86 INR72 (108.%) INR86 INR72 (74.5%) (108.%) (74.5%)
Price Price Target Target Upside Upside Case Case
INR36 (-12.7%) INR36 (-12.7%) Downside

Case
EBITDA margins expected to recover in FY13 63,626 48 78,000 42 62,405 -2 89,555 15 70,206 13 99,138 11 78,396 12 101,531 2
15% 10% 5% 0% FY08 FY09 FY10 FY11 FY12E FY13E FY14E EBITDA margins
Note: FY end Mar.
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Diversification key driver

KECs 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 Cables Current revenue of Rs120bn pa expected to increase to Rs200bn pa Order book (Rs) Capability 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
70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 FY06
54%
56%
60% 50% 48% 40% 30% 20% 11% 10% -4% 0% -10% -20%
Domestic distribution 10%
Cable 2%
Telecom 3%
Railways 1%
-9% FY07 FY08 FY09
FY10
FY11
Domestic transmission 27%
Intll. Transmission
51% Intll. distribution
Order inflows
Y/Y growth
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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
14% 12% 10% 8% 6% 4% 2% 0% FY03 FY05 FY07 FY09 EBITDA Margin
12.1% 9.6% 6.8% 9.4%
12.3% 12.6% 10.4% 8.7% 7.21% 8.11% 8.5% 9.0%
FY11
FY13E
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
60% 51% 50% 40% 30% 20% 10% 0% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 E FY13E FY14E 18% 12% 45% 40% 38% 25% 14% 11% 11% 11%
22%
Y/Y growth
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Valuation
Pricing in a downturn
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 companys 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
25 20 15 10 5 0 Sep-06 Jul-07 Aug-08 Dec-06 Feb-09 Oct-07 Jan-08 Jun-06 Mar-07 Nov-08 Sep-10 May-09 Aug-09 Dec-09 Dec-10 Apr-08 Jul-11 Sep-11
149
Mar-10
KEC
Source: Datastream, IBES consensus estimates
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
15 14 13 12 11 10 9 8 7 6 5 Dec-10 Jun-10 Sep-10 Mar-10 Mar-11 Dec-09 Jun-09 Sep-09 Jun-11
16 14 12 10 8 6 4 2 0 May-06 May-07 May-08 May-09 May-10 May-11 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10
FY06 FY10
FY07 FY11
FY08
FY09 FY12 FY13 FY14
Source: Datastream IBES consensus, Barclays Capital
Source: Datastream IBES consensus, Barclays Capital
7 December 2011
Oct-11
Jun-10
Apr-11
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 Net sales Y/Y growth Cost of materials % of sales Erection and subcontracting expenses % of sales Personnel expenses % of sales Other expenses % of sales Total expenses OBITDA OBITDA margin Depreciation and amortisation (net) Other income Interest Profit after interest but before exceptional items Exceptional items Profit before tax Profit before tax margin Tax Tax rate Profit after tax before extraordinary items Profit after tax margin
FY09 34,274 22% 19,758 58% 5,750 17% 1,420 4% 4,350 13% 31,278 2,996 9% 230 20 1,000 1,786 1,786 5% 618 35% 1,168 3%
FY10 39,064 14% 20,127 52% 9,581 25% 1,689 4% 3,616 9% 35,013 4,051 10% 270 18 865 2,934 2,934 8% 1,037 35% 1,897 5%
FY11 43,232 11% 22,552 52% 9,806 23% 2,833 7% 4,926 11% 40,117 3,115 7% 408 1,536 1,075 3,167 (85) 3,167 7% 1,111 35% 2,057 5%
FY12 E 53,844 25% 28,486 53% 11,235 21% 3,780 7% 5,978 11% 49,479 4,365 8% 566 10 1,461 2,348 (10) 2,338 4% 866 37% 1,472 3%
FY13E 59,714 11% 31,727 53% 12,490 21% 4,130 7% 6,277 11% 54,624 5,089 9% 631 8 1,636 2,830 2,830 5% 990 35% 1,839 3%
FY14E 66,245 11% 34,855 53% 13,856 21% 4,580 7% 6,963 11% 60,254 5,992 9% 700 8 1,636 3,663 1 3,664 6% 1,282 35% 2,382 4%
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Figure 220: KEC balance sheet, FY09-14E

Rs mn; years ending March Share capital Equity share suspense Reserves and surplus Shareholder funds Secured loans Unsecured loans Total debt Deferred tax liability Total Fixed assets Gross block Less: Depreciation and amortisation Net block Capital work in progress Advances for capital expenditure Investments Deferred tax assets Goodwill Inventories Inventory days Sundry debtors Inventory days Cash and bank balances Loans and advances as % of sales Current assets 2,258 24 18,662 199 1,411 3,028 0 25,359 2,498 23 19,624 183 698 3,956 0 26,775 6,320 1,248 5,072 504 10 30 8,357 1,570 6,787 379 4 30 10,382 2,366 8,016 278 4 2,813 3,359 28 26,177 221 1,614 4,724 0 35,873 11,582 2,932 8,650 278 4 2,813 4,183 28 32,603 221 1,723 5,883 0 44,392 12,782 3,563 9,219 278 4 2,813 4,639 28 36,810 225 929 6,524 0 48,902 13,982 4,264 9,718 278 4 2,813 5,147 28 40,836 225 449 7,238 0 53,670 FY09 493 5,087 5,581 5,839 379 6,218 298 12,097 FY10 493 21 7,357 7,871 7,755 112 7,867 461 16,199 FY11 514 8,952 9,466 14,296 11 14,322 497 24,285 FY12 E 514 10,143 10,658 16,519 497 27,674 FY13E 514 11,633 12,147 17,006 497 29,650 FY14E 514 13,562 14,076 16,891 497 31,464
Liabilities Current liability days Provisions as % of sales Current liabilities Net current assets Total assets
18,431 196 445 0 18,876 6,482 12,097
17,214 161 562 0 17,776 8,999 16,199
22,248 188 561 0 22,809 13,063 24,285
27,710 188 753 0 28,462 15,930 27,674
30,730 188 835 0 31,565 17,337 29,651
34,092 188 926 0 35,018 18,652 31,465
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Figure 221: KEC cash flow statement, FY09-14E

Rs mn; years ending March Profit before tax Depreciation and amortisation (net) Operating profit before working capital changes Trade and other receivables Inventories Trade and other payables Miscellaneous expenditures Cash from operations Taxes Others Net cash from operating activities Change in financing activities Change in investments Interest received Others Cash used in investing Change in equity/preferred equity Change in debt Interest paid Dividends paid Others Change in financing FY09 1,786 230 3,397 (3,876) (204) 5,091 4,407 (640) 3,767 (1,395) 14 (1,381) (149) (205) (1,046) (287) (1,687) FY10 2,934 270 3,644 (367) 415 (2,567) 1,125 (778) 347 (588) 80 (509) 551 (944) (285) (678) FY11 3,167 408 4,670 (6,005) 735 2,973 2,373 (679) 1,694 (780) 60 (4,391) (5,111) 5,453 (1,140) (354) 3,959 FY12 E 2,338 566 4,476 (7,585) (824) 5,653 1,719 (866) 853 (1,200) (1,200) 2,198 (1,461) (280) 457 FY13E 2,830 631 5,096 (4,849) (456) 3,103 2,894 (990) 1,904 (1,200) (1,200) 487 (1,636) (350) (1,499) FY14E 3,664 700 5,995 (4,740) (507) 3,453 4,200 (1,282) 2 2,920 (1,200) (1,200) 1 (115) (1,636) (453) (2,203)
Net change in cash equivalents Opening cash Adjustments Closing cash

699 690 21 1,410
(840) 1,410 130 699
541 698 1,614
110 1,614 1,723
(795) 1,723 1 929
(482) 929 2 449
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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 153
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.
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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 the subject 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 to http://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 total revenues, 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 NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analysts account. 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 other types 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 3Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should 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 12month 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 or to comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting in an advisory capacity 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.
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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) Bharat Heavy Electricals Ltd. (BHEL.NS) Havells India Ltd. (HVEL.NS) Siemens Ltd. (SIEM.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% of companies 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% of companies 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 will trade 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) So Paulo Banco Barclays S.A. (BBSA, So 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) Areva T&D India (AREV.NS) Crompton Greaves Ltd. (CROM.NS) KEC International Ltd. (KECL.NS) Thermax Ltd. (THMX.NS) BGR Energy Systems Ltd. (BGRE.NS) Cummins India Ltd. (CUMM.NS) Larsen & Toubro Ltd. (LART.NS) Voltas Ltd. (VOLT.NS)
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Barcap India - Capital - Goods 7 Dec 2011

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Barcap India - Capital - Goods 7 Dec 2011

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EQUITY RESEARCH

INDIA CAPITAL GOODS Initiating coverage: In search of survivors

Barclays Capital | India Capital Goods

%Chg Old New %Chg Old New %Chg

N/A 1560.00 N/A 630.00 N/A 392.00 N/A 78.00

Barclays Capital | India Capital Goods

Race to the bottom

Converting plans into orders is important

Barclays Capital | India Capital Goods

Change in 1 year fwd earnings estimates for the sector YoY

Hyper-competition and margin risk

Transmission & Distribution Industrial Infrastructure

Source: Barclays Capital

Barclays Capital | India Capital Goods

Havells 1-OW PT Rs502

Cummins 1-OW PT Rs428

Other 1-Overweight stocks

Crompton Greaves 1-OW PT Rs147

Barclays Capital | India Capital Goods

Figure 3: India Capital Goods summary of comparative valuations

Barclays Capital | India Capital Goods

Voltas 3-UW PT Rs78

Thermax 3-UW PT Rs392

BGR Energy 3-UW PT Rs241

ABB 3-UW PT Rs494

Barclays Capital | India Capital Goods

Siemens 3-UW PT Rs630

2-Equal Weight stock

Valuation and risks

Barclays Capital | India Capital Goods

Barclays Capital | India Capital Goods

RACE TO THE BOTTOM

Expect low beta recoveries amid a downcycle

New project activity in the economy remains weak

Barclays Capital | India Capital Goods

Figure 6: India infrastructure new project initiations continue to decelerate

IIP capgoods 3mma YoY (RHS)

Order outlook for most end markets appears weak

Barclays Capital | India Capital Goods

End market cycle outlook

Source: Company data, Barclays Capital

Barclays Capital | India Capital Goods

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

Figure 11: India Capital Goods power segment outlook

Source: Barclays Capital

Barclays Capital | India Capital Goods

Barclays Capital | India Capital Goods

Order pipeline still in early stages of planning

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

Barclays Capital | India Capital Goods

GHTP Lehra Mohabbat Ext Stage-III Punjab

Source: CEA, state utilities, Barclays Capital

Barclays Capital | India Capital Goods

Barclays Capital | India Capital Goods

Coal a structural issue; risk for the sector

Source: India Infrastructure, Barclays Capital

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

Supply- Demand for domestic coal

Companies have started booking orders without linkages