Indian Capital Goods

Industrials Electrical equipment January 2011
Indian Capital Goods

Brighter days ahead
India is expected to double its power generation capacity to c300GW by FY17-18. As the Indian government rushes to create the requisite infrastructure for this, we forecast that domestic power transmission orders alone will increase 45-50% during FY12 We drill deep down into order flows and pricing trends in nine different end markets to identify which companies will benefit most, helped by our new proprietary Q-ben analytical tool that compares value with asset quality We initiate coverage of Siemens India (OW), Crompton Greaves (OW), and Areva T&D (Neutral). We are OW on Jyoti Structures and Kalpataru Power, Neutral on KEC International, and UW on ABB India. Our top picks are Siemens and Kalpataru Power
By Rahul Garg, CFA
Disclosures and Disclaimer This report must be read with the disclosures and analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
Industrials Indian Capital Goods January 2011
abc
Contents
Investment summary Demand analysis
End-market analysis Domestic transmission Strong growth ahead Intl transmission A USD400bn opportunity Distribution Little visibility beyond central schemes Construction Infra spend to drive growth Industrial mfg Capacity addition to accelerate Other end markets Rail, Medical, Oil & Consumer
2 23
24 27
Company profiles
Jyoti Structures Plain Jane, but deep value Kalpataru Strong growth at attractive price KEC Robust outlook but priced in ABB An expensive recovery story
145
146 166 189 210 230 248 270
49 Areva T&D Likely recovery seems priced in 55 Crompton Everything premier except the price 65 Siemens Powering through 72 75
Disclosure appendix Disclaimer
293 296
Risk analysis
Competitive landscape changing rapidly Sector remains highly geared to metal prices Excess capacity likely but not a major threat
83
84 90 92
Valuation & performance analysis

Our coverage universe doesnt look overbought
95
96
Benchmarking Analysis
Q-ben Framework Measure of a companys worth
119
120
abc
Investment summary
We are bullish on the demand outlook and expect a turnaround in sector profitability and underlying returns. We forecast order growth of c20% during FY12-13 vs c5% in FY09-10, largely from the pick-up in domestic transmission orders. While we expect competitive and cost pressures to persist, we believe the pricing environment will stabilize. Therefore, we expect margins to improve and forecast an earnings CAGR of c30% for the sector during FY12-13. We continue to find the sector valuation undemanding relative to its history and introduce our proprietary Q-ben analytical tool to better relate valuations to asset quality. We highlight Siemens and KPP as our top picks.
In this report, we initiate coverage of Siemens India, Areva T&D, and Crompton Greaves. In addition, we transfer coverage of Jyoti Structures, Kalpataru, KEC International (from Rajesh Singla) and ABB India (from Suman Guliani) to Rahul Garg.
Brighter days ahead

Capital goods companies saw muted order growth of c5% during FY09-10 (March year-end), driven primarily by a weak economic environment and delays in several large projects. Earnings suffered further due to price erosion and cost pressures and the sector experienced marginal EPS decline of c2% during FY09-10. However, we believe that the demand environment is now at an inflection point, and should benefit in particular from the rush to create the requisite transmission infrastructure for the upcoming generation capacity over the next four to five years. Therefore, we have a positive view on demand outlook and expect a turnaround in sector profitability and underlying returns. The highlights of our report include the following: We discuss nine major end markets for our companies (pages 23-82) and carry out an extensive analysis of the opportunities in the domestic transmission markets (pages 27-48). We drill deep down into Power Grid order flows and analyse the rapidly changing competitive landscape in the transmission value chain (pages 83-89). We introduce our new proprietary analytical tool the Q-ben Framework to better relate companies valuations to their asset quality (pages 119 -143). We have a non-consensus view on three of our seven companies Areva T&D (pages 230-247), KEC International (pages 189-209) and Siemens (pages 270-292). Siemens and Kalpataru Power (pages 166-188) are our top picks in the sector.
abc
We conclude that while companies in our coverage universe serve many end markets, their relatively high gearing to the domestic transmission and distribution (T&D) markets should provide them with strong demand impetus over the next couple of years. This is because we expect domestic transmission orders to pick up sharply (c45-50%) going into FY12 as orders related to the recently announced nine high capacity corridors (HCPTCs), spill-over from the 11th five-year plan and expenditure from the 12th plan feed through. For the overall sector, we forecast demand growth of c28-33% during FY12e. Moreover, while we dont expect earnings growth to be devoid of challenges, such as rising competition, increasing metal prices and a risk of excess capacity, we believe most of our companies remain well placed to deal with them. Consequently, we expect sector profitability (and in turn sector returns) to improve by c70bp during FY12-13e, driven largely by volume growth and self-help initiatives. Overall, we forecast sector earnings CAGR of c30% during FY12-13e. We further note that our coverage universe doesnt look overbought at this stage and, at c20x 12-month forward PE and c11.6x 12-month forward EV/EBITDA (on consensus), is trading at a modest discount of c5% to its historical (FY05-10) average. Within our coverage, while EPC players (Jyoti, KEC and Kalpataru) have de-rated in line with their declining returns, equipment manufacturers (ABB, Areva T&D, Siemens and Crompton) have re-rated in spite of it. In our opinion, this disconnect was primarily driven by the buyout premium built into the valuation of foreign manufacturers. However, as the corporate action is now largely behind us, we expect valuations to normalize and therefore we expect most of the EPC players to re-rate going forward and most of the equipment manufacturers to witness a de-rating. We remain OW on Kalpataru Power and Jyoti Structures, Neutral on KEC, and UW on ABB. We remove the volatility flags on the ratings of Jyoti Structures, KEC, and ABB, as these stocks are no longer considered volatile by HSBCs definition (see definition of volatility status, page 293). We initiate coverage of Siemens and Crompton Greaves with an OW and Areva T&D with a Neutral. We highlight Siemens India and Kalpataru Power as our top picks in the sector. We like Siemens because of its strong order book, improving market position, ambitious capex plan and strong balance sheet to fund growth. We like Kalpataru because of its strong market position, robust earnings outlook and significant discount on valuation. With this report, we also introduce our proprietary analytical tool called the Q-ben Framework (the Quality Benchmarking Framework), to better relate companies relative valuation to their asset qualities. Under this framework, we evaluate companies on five fundamental criteria and measure their quality on 16 objective metrics to arrive at a Q-ben score for each company. When plotted against the forward looking valuation of the company on a scatter chart, we believe that this score is a good way to identify potential cases for re-rating or de-rating in the sector. We note that within our universe Crompton remains most undervalued based on its overall quality relative to its peers, while ABB remains most overvalued. We highlight our key bull and bear points related to the sector as follows:
Bull points
Demand outlook remains strong, particularly for the domestic transmission sector which is the biggest end market (c40% exposure) for our companies.
abc
Our universe should witness strong earnings CAGR of c30% over FY12-13e after a lacklustre recent performance (earnings CAGR of -2% during FY09-10). This is largely driven by an anticipated pick up in deliveries and an improvement in profitability. We expect sector fundamentals to improve (i.e. cash generation, return ratios, financial strength) as demand picks up and investment plans wind down. After a modest underperformance of c5% over the last six months, our companies should outperform the wider capital goods sector as orders pick up and earnings improve. Sector valuation remains undemanding relative to historical average and most of the companies under our coverage should re-rate somewhat as their earnings outlook improves and returns increase.
Bear points
Competition remains intense and although some of the major players have regained their market position in FY11, we believe pricing pressures may persist in the near term. Our sector remains prone to metal price risk (average steel exposure of c9% of sales). Excess capacity built-up remains likely (particularly for transformer manufacturers) in view of capacity ramp-up by major companies and the entry of several new players.
Demand outlook remains strong

Although companies under our coverage serve 8-9 major end markets, they remain highly geared to the T&D markets (c70% exposure), particularly domestic transmission (c40% exposure), and the industrial capex cycle (c12% exposure). In addition, domestic demand remains crucial as the sector derives c70% of its revenues from India. While industrial capex should benefit from a cyclical recovery in the capacity utilization rates and rising business confidence, the investment in the domestic T&D market remains secular. We note that starting with a mere capacity of around 1,350MW at the time of independence, India is now on track to achieve a power generation capacity of c300GW by FY17e. Much of this capacity has either come over the last 7-8 years (c60-65GW) or is expected to arrive over the next 7-8 years (c130-135GW). Given the decadeslong underinvestment in transmission, we believe this sector is now bound to catch up and witness significant investment as the government rushes to create adequate capacity. In this context, we believe that transmission segment provides a two way opportunity for vendors: The ramp up in transmission capacity over the next five years will create significant demand for T&D equipment and engineering, procurement and construction (EPC) work. The increasing private participation in this segment will provide many vendors with an opportunity to partake in asset ownership and raise their business profile. In the near term, we forecast domestic transmission orders to grow by c45-50% in FY12, driven largely by orders related to the nine high capacity corridors (HCPTCs), spill-over from the 11th five-year plan and expenditure from the 12th five-year plan. For most other markets we expect double digit growth in demand in FY12, driving a blended demand growth of c28-33% for the entire sector.
abc
End market growth forecast (5) End market Transmission Domestic Transmission Intl Distribution Construction Industrials Railways Oil & Gas Consumer Durables Healthcare Others Sector growth
Source: HSBC research
Sector exposure 33% 15% 14% 5% 18% 4% 3% 4% 1% 3% 100%
FY11e 20-25% 10-15% 25-30% 15-20% 20-25% 20-25% 8-12% 30-35% 10-15% 10-15% 20-25%
FY12e 45-50% 10-15% 30-35% 25-30% 15-20% 25-30% 10-15% 20-25% 10-15% 10-15% 28-33%
FY13e 5-10% 8-12% 5-10% 15-20% 10-13% 10-15% 10-15% 20-25% 10-15% 10-15% 8-13%
Cost and pricing pressures may persist but wont deteriorate

The sector has seen significant price erosion (c10-20%) over the last couple of years, driven largely by the entry of new players in the EPC segment and, in our view, misguided qualification requirements (QR) in ultra high-voltage (UHV) products such as 765kV transformers. However, we note that the competitive landscape is changing very rapidly and recent developments indicate that the pricing environment will most likely stabilise for our companies. We highlight three key points in support of our view: Vendor concentration for Power Grid (PG) orders has increased again after falling sharply in FY10. In the substation/transformer segment, competition from China for PG orders is absent this year and both Areva and Siemens have regained their position in the market. We expect Chinese competition to ease because the new QRs for 765kV transformers require them to set up local manufacturing facilities. In the tower EPC segment, KEC and Kalpataru have regained their position, winning c25% of the total orders. We expect pricing to stabilise as margins of new entrants look unsustainable. In addition to the weak pricing environment, we expect cost pressures to persist as the sector remains highly geared to metal prices (particularly steel) and our metals and mining team expects steel prices to increase by c10% during 2011. We note that within our coverage universe EPC players remain most at risk, with Jyoti Structures having the highest exposure to steel of c24% (as % sales). We further note that while we dont expect margins in the current contracts to suffer due to price escalation clauses, we believe margins on new contracts may be squeezed. We have also looked at the production capacity of listed players in our space and although excess capacity build up looks likely in the medium term, we dont see it as an immediate threat. We note that the manufacturing capacity (for both transformers/reactors and towers/structures) remains in line with the expected demand; however, if and when the new capacity comes on line (either greenfield or brownfield), the demand supply balance will deteriorate. But having said we believe that utilization rates should remain healthy in the near term, particularly as order inflow picks up.
abc
We forecast sector earnings to grow at c30% during FY12-13

After a marginal earnings decline of c2% over the last couple of years (FY09-10), we forecast earnings momentum to pick up going forward, driven by a pick up in deliveries and improvement in operational performance. As we have highlighted earlier, we remain bullish on the demand outlook and consequently forecast an order growth for the sector of c25% and c15% during FY12 and FY13, respectively. Subsequently, assuming that the execution rates remain at the current level, we forecast sales CAGR of c20% during FY12-13. We also remain optimistic that margin improvement and forecast sector profitability will increase by c70bp during FY12-13, driven largely by volume growth and self-help initiatives. Consequently, we forecast a sector earnings (EPS) CAGR of c30% during FY12-13. We remain c8-10% ahead of consensus on our FY12 estimates for most of our companies. We highlight the summary of our estimates in the table that follows.
Earnings estimate summary
HSBC e s tim ate s FY11e Jyoti Structures Kalpataru Pow er KEC International A BB Ltd A reva T&D Crompton Greaves Siemens Ltd Se ctor Total 25,016 44,933 47,276 82,746 46,803 103,134 115,936 465,843 Sale s (INRm ) FY12e 30,285 56,102 56,829 100,034 55,343 122,198 141,265 562,057 Sale s (INRm ) FY12e 28,380 56,038 54,863 95,717 57,665 113,726 133,790 540,179 Sale s (INRm ) FY12e 7% 0% 4% 5% -4% 7% 6% 4% FY13e 36,328 67,151 64,738 116,019 60,902 142,637 168,734 656,509 2,844 5,134 4,903 7,709 5,479 14,511 15,620 56,200 EBITDA (INRm ) FY11e FY12e 3,376 6,671 5,922 10,128 6,979 17,916 18,659 69,650 FY13e 3,958 7,946 6,617 12,902 7,763 20,947 21,590 81,722 FY11e 13.5 15.1 8.2 23.1 10.6 14.1 29.8 114.4 EPS (INR) FY12e 16.9 21.5 10.5 30.7 14.5 17.4 34.9 146.4 EPS (INR) FY12e 15.5 19.0 10.4 29.9 11.8 16.4 32.3 135.3 EPS (INR) FY12e 9% 13% 2% 3% 23% 6% 8% 8% FY13e 20.6 27.2 12.4 39.6 16.7 20.6 39.9 177.0 Earn ings CAGR (FY11-13e ) 30% 28% 18% 48% 28% 18% 21% 28% Earn ings CAGR (FY11-13e ) 27% 20% 15% n/a n/a 15% 14% 18%
Cons e ns us Jyoti Structures Kalpataru Pow er KEC International A BB Ltd A reva T&D Crompton Greaves Siemens Ltd Se ctor Total HSBC vs . Cons e ns us Jyoti Structures Kalpataru Pow er KEC International A BB Ltd* A reva T&D* Crompton Greaves Siemens Ltd** Se ctor Total
FY11e 24,441 46,992 46,773 81,139 47,658 98,680 111,462 457,145
FY13e 34,555 65,992 57,731 n/a n/a 130,108 159,121 447,507
EBITDA (INRm ) FY11e FY12e 2,704 5,191 4,684 7,733 5,191 13,980 14,415 53,898 3,134 6,212 5,630 9,839 6,217 16,100 17,107 64,239
FY13e 3,767 7,334 6,309 n/a n/a 18,400 18,647 54,456
FY11e 13.1 15.8 8.3 23.9 9.5 14.1 28.1 112.7
FY13e 19.3 22.6 11.2 n/a n/a 18.9 33.9 105.9
FY11e 2% -4% 1% 2% -2% 5% 4% 2%
FY13e 5% 2% 12% n/a n/a 10% 6% 7%
EBITDA (INRm ) FY11e FY12e 5% -1% 5% 0% 6% 4% 8% 4% 8% 7% 5% 3% 12% 11% 9% 8%
FY13e 5% 8% 5% n/a n/a 14% 16% 12%
FY11e 3% -4% -1% -3% 12% 0% 6% 1%
FY13e 7% 20% 10% n/a n/a 9% 18% 14%
* Dec YE ** Sept YE
Source: HSBC estimates
Sector valuation remains undemanding

Our coverage universe doesnt look overbought at this stage and, at c20x 12-month forward PE and c11.6x 12-month forward EV/EBITDA (on consensus), it is trading at a modest discount of c5% to its historical (FY05-10) average. We note that, within our coverage universe, while EPC players have de-rated in line with their declining returns, equipment manufacturers have re-rated in spite of it. This disconnect in our opinion was driven primarily by the takeover premium built into the valuation of foreign manufacturers. However, as the corporate actions are now largely behind us, valuations should normalise and we expect
abc
most of the EPC players to witness a re-rating going forward and most of the equipment manufacturers to see a de-rating. We note that most of our companies also look inexpensive compared with their trade peers or the wider capital goods sector. On our FY12 estimates, our universe is trading at c17x PE and c10.6x EV/EBITDA. We highlight the performance and valuation of our coverage universe relative to their trade peers and the wider capital goods sector in the following tables. We further note that we value companies under our coverage based on the Economic Value Added (EVA) methodology. This is because we believe that being in a capital intensive industry, the quality of a capital goods company (and hence its value) should be judged based on its ability to generate superior returns over and above the cost of capital committed to it. We have also used DCF to sense check the valuations derived from our EVA model.
PE candle chart
60 50 40 30 20 10 0 Jy oti KPTL KEC ABB Arev a CG Siemens EPC Av g Eqp Mfg Av g Trading Range
Sect Av g
Historic Av erage
Current multiple - Consensus
EV/EBITDA candle chart
35 30 25 20 15 10 5 0 Jy oti KPTL KEC ABB Arev a CG Siemens EPC Av g Eqp Mfg Av g Trading Range
Sect Av g
Historic Av erage
abc
EPC PE vs RoE
Equipment Mfg PE vs RoE
30 25 20 15 10 5 0
50% 40% 30% 20% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 EPC Av g 12m fw d RoE
50 40 30 20 10 0
40% 35% 30% 25% 20% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Equipment Mfg Av g 12m fw d RoE
We introduce Q-ben Framework to better judge a companys worth

With this initiation report, we introduce our proprietary analytical tool called the Q-ben Framework to better relate companies relative valuation with their asset qualities. Under this framework, we evaluate companies on five fundamental criteria and measure their quality on 16 objective metrics to arrive at a normalised score, called the Q-ben score, for each company. Barring other factors, we believe that a company with a high Q-ben score should typically trade at a premium to its peers whereas a company with low score should trade at a discount. We have plotted the Q-ben score of all the companies under our coverage (and the sector and sub-sector averages) versus 12-month forward PE and EV/EBITDA in the scatter chart format on the next page. We have divided this chart into four quadrants to identify the potential cases for re-rating and/or de-rating. From our analysis, we conclude that Crompton remains the most attractive on valuation and ABB the least attractive given their overall quality relative to their peers.
Sector score
Median = 5.0 Siemens India Crompton Greav es Arev a T&D India ABB Ltd KEC Intl Kalpataru Pow er Jy oti Structures 0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
abc
FY12e EV/EBITDA
25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
Can be restructuring stories or 'Overvalued'
ABB
Can be premium quality or 'Expensive' Eqp Mf g A vg Siemens Sector Avg Crompton Greaves Can be cyclical or 'Undervalued' 6.0 7.0 8.0 9.0 10.0
12m fwd EV/EBITDA
Areva T&D
EPC Avg Kalpataru Can be 'Undervalued' if operating perf improving Jy oti
KEC
FY12e PE
35.0 30.0 25.0 12m fwd P/E 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
ABB Areva T&D
Eqp Mf g A vg Siemens Sector Avg
Can be premium quality or 'Expensive'
EPC Avg Kalpataru Can be 'Undervalued' if operating perf improving Jyoti
Crompton Greaves KEC Can be cyclical or 'Undervalued' 6.0 7.0 8.0 9.0 10.0
Coverage of seven companies

We initiate coverage of Siemens India, Areva T&D, and Crompton Greaves. In this report we also transfer coverage of Jyoti Structures, Kalpataru, KEC International (from Rajesh Singla) and ABB India (from Suman Guliani) to Rahul Garg. Of these seven companies, three are transmission EPC players (Jyoti Structures, Kalpataru Power, KEC International) and four are equipment manufacturers (ABB, Areva T&D, Crompton Greaves, Siemens). We favour companies which show either or all of the following traits: Strong market position High gearing to domestic growth (particularly in transmission markets) Capacity to generate superior returns Undemanding multiples relative to peers
abc
On the other hand, we remain cautious of the companies which have seen deterioration in their market position and remain expensive relative to their peers. Siemens and Kalpataru Power are our top picks. We briefly discuss our investment case for each of the seven companies below.
Coverage summary
Com pany Jyoti Structures Tick er (RIC HSBC Rating Code) JYTS.BO Overw eight Curre nt price (INIR) 118 HSBC TP (INR) 165 Potential return 41% 12m fw d target P/E 8.4 Ke y inve stm ent drive rs 1) Strong order book w ith high gearing to domestic transmission 2) At c30% d/c to peers, looks attractive on valuation 3) Equity dilution may prove risky 1) Strong market position w ith biggest order book amongst peers 2) Margins likely to improve 3) At c30% d/c to peers, looks attractive on valuation 1) Strong earnings outlook, particularly in light of recent orders 2) Stock has sharply outperformed peers in last 6m 3) Current premium to peers imply outlook is baked in 1) Stock remains rich inspite of our earnings CAGR of c60% during CY11-12e 2) Market position remains w eak w ith significant pricing pressure & cost overruns 3) Currently the w eakest company on fundamentals 1) Strongly geared to domestic transmission grow th 2) Margins likely to pick up as deliveries pick up & pricing stabilizes 3) Valuation looks f ull but company may surprise positively on earnings 1) High quality company w ith a consistent earnings record 2) Earnings to benef it from domestic transmission orders, recovery in industrial capex & improvement in subsidiary mgns 3) Looks attractive on valuation 1) Strong order book w ith improving market position 2) Strong balance sheet & INR16bn capex plan to support grow th 3) Premium quality justifies valuation
Kalpataru Pow er
KECL.BO
Overw eight
149
225
53%
8.8
KEC International
KAPT.BO
Neutral
92
105
16%
8.8
ABB Ltd
AREV.BO
Underw eight
737
630
-14%
20.6
Areva T&D India
SIEM.BO
Neutral
308
340
11%
23.5
Crompton Greaves CROM.BO
Overw eight
289
365
27%
18.4
Siemens India
ABB.BO
Overw eight
732
950
31%
26.3
Note: Potential return includes prospective dividend yield Source: HSBC research and estimates
Jyoti Structures: OW, TP INR165

It is tricky to take an investment call on Jyoti Structures at this stage, as the company seems to be struggling with new orders and its balance sheet doesnt allow much room to test new waters. However, the stock has de-rated significantly over the last six months and Jyoti, at c4.8x FY12e EV/EBITDA and c7.0x FY12e PE, is the most inexpensive stock compared with its peer group as well as its own history. Although some of this de-rating is justified, given the firms deteriorating Power Grid market share and the equity dilution overhang, we believe this does not justify writing-off the companys future earnings potential completely, particularly when it is one of the market leaders and has a strong order book for the next two years. Moreover, the company remains highly geared to strong domestic transmission growth (c70% exposure) and this, coupled with Jyotis strong order book and managements focus on margins, in our opinion
10
abc
should allow the group to report strong earnings over the next couple of years. Consequently, we remain ahead of consensus by c7-9% on FY12-13e earnings. We remain Overweight on the stock with a target price of INR165, which offers c41% potential return. We have removed the volatility flag from the rating, as this stock is no longer considered volatile by HSBCs definition (see definition of volatility status, page 293).
Kalpataru Power: OW, TP INR225

Kalpataru in our opinion is going through an important transition phase, with the company not only expanding the scope of its business but also improving operational efficiency. The group has now built a strong position in several EPC markets, such as T&D, roads and pipelines. The group has also shown improvement in its EBITDA margins over the last six quarters. In spite of this, the stock has significantly underperformed the wider capital goods sector by c15% over the last six months, driven largely, in our opinion, by falling Power Grid orders (until Nov 2010) and the poor order execution at JMC (during H1 FY11). However, we note that Kalpataru remains a clear market leader in the transmission EPC segment and is bound to benefit from strong growth in transmission orders during FY12 and FY13. The company is also seeing strong growth in construction related orders at JMC this year. The group margins are also expected to increase, driven largely by the improving performance of JMC. On top of this, the company has also successfully secured a couple of build-operate-transfer (BOT) projects which should provide further visibility to the top line. In light of all this positive momentum, the sharp underperformance of the stock seems unwarranted at this stage. We see limited risk to Kalpatarus earnings and remain c12-20% ahead of consensus on our FY12-13 EPS estimates. We continue to find Kalpatarus valuation attractive, at c7.4x FY12e PE and c5.4x FY12e EV/EBITDA compared with trade peer average of c11.1x and c8.5x (on consensus), respectively. Therefore, we remain Overweight with a target price of INR225, which offers c53% potential return.
KEC International: Neutral, TP INR105

KEC has made significant strides this year as can be seen from its order book that has grown over 30% since the previous year end (Mar 10). The group has not only secured several large orders in virtually every business segment but has also made a couple of strategic acquisitions, thus bringing in further ammunition for future growth. However, the company has failed to show any improvement in its margins. But even so the stock has reacted well to the order inflows and the news from the recently acquired business of SAE Towers. We highlight that, unlike Kalpataru and Jyoti, who have each underperformed the wider capital goods sector by c15-20% over the last 6 months, KEC has performed inline with the sector. Therefore, although the earnings outlook for KEC remains robust in light of the rising order book, the story seems well known and well owned. After the recent outperformance, KECs valuation now looks full, particularly compared with its closest peers, Jyoti and Kalpataru. On our FY12 estimates, KEC is trading at c8.7x PE versus Jyoti and Kalpatarus multiples of c7.0x and c7.4x, respectively. We believe that KECs growth story is baked into the numbers and hence we remain largely in line with consensus on our FY12 estimates. We remain Neutral with a target price of INR105, which offers c16%
11
abc
potential return. We have removed the volatility flag from the rating, as this stock is no longer considered volatile by HSBCs definition (see definition of volatility status, page 293).
ABB India: UW, TP INR630

ABB has seen significant erosion of margins and hence earnings potential over the last 4-5 years, driven primarily by declining revenues, significant pricing pressure and the cost of exiting non-core businesses, such as Rural Electrification (RE). The margins in the current financial year have taken a further hit from the cost overruns on some large power system orders. The EBIT margins have come down to c1.6% in Q3 CY10 from c12.4% in CY07. While margins are likely to recover going into CY11 and CY12 as exit costs wind down and better margin order backlog starts feeding through into sales, we dont expect the profitability to recover to the pre-recessionary level of c12-13% (EBIT margins during CY07-08) any time soon (i.e. during CY11-13). However, we remain positive on the demand outlook going into CY11-12 (Dec YE) and we expect ABB to witness strong order growth of c20-25% in the next couple of years, assuming it does not lose market share from here on. This strong inflow of orders, coupled with an already strong order book, should drive sales growth of c20-25% during CY11-12e, in our opinion. We remain marginally ahead of consensus (c2-4%) on our FY10-12 sales and EBITDA estimates. But even in light of this recovery potential, ABB remains expensive relative to its peers. On our calendarised FY12 estimate, ABB is trading at c30x PE and c19.5x EV/EBITDA versus equipment manufacturing average of c24x and c14x, respectively. We remain Underweight with a target price of INR630, which offers a potential return of -14%. We have removed the volatility flag from the rating, as this stock is no longer considered volatile by HSBCs definition (see definition of volatility status, page 293).
Areva T&D India: Neutral, TP INR340

Areva T&D has seen significant deterioration in its earnings over the last couple of years, driven largely by declining margins. We note that Areva reported flat EPS growth in CY08 and a c20% decline in EPS in CY09 in spite of c30-35% sales growth during these years. We believe earnings have suffered due to a change in sales mix (increasing content of substation packages versus standalone products such as transformers or reactors), increasing pricing pressure and operational inefficiencies leading to a margin decline of c700bp during FY08 and FY09. However, management has carried out a rationalisation of their manufacturing processes and have tried to reduce their exposure to lower margin offerings such as rural electrification (RE) and low voltage products. The company has also built the necessary capacity and experience to produce 765kV transformers domestically. In addition, the company seems to have consolidated its position with Power Grid during the current financial year (FY11) and hence we remain positive on the companys earnings outlook going forward. Management has highlighted that margins can go back to low-to-mid teen levels by CY12. Although we remain more cautious than management on profitability, we are nonetheless ahead of consensus by c100200bp on our CY10-12e EBITDA margin estimates. This has driven our CY10-11 net income estimates c9% ahead of consensus. We note that there remains significant upside risk to our estimates, if management delivers on margin improvement.
12
abc
However, at this stage the stock remains rich relative to its peers. On our calendarised FY12 estimates, the stock is trading at c27x PE and c14x EV/EBITDA compared with its peer group (ABB, Siemens & Crompton) average of c24x and c14x, respectively. Therefore, in light of these stretched multiples, we initiate coverage with a Neutral and a target price of INR340, which offers c11% potential return.
Crompton Greaves: OW, TP INR365

Crompton is a premium quality company within our coverage universe that has delivered consistent improvement in its operational performance over the last five years. Not only has it increased the range of its product offering but it has also established a solid market position in its key business segments. More importantly, Crompton has managed to grow its business without compromising on returns. In fact, it is the only company within our coverage universe which has shown a consistent improvement in its returns over the last five years and hasnt seen a decline in its earnings during the economic crisis of FY09-10 in spite of having a significant international exposure. Today, Crompton is a leading player in the T&D equipment market and will be a key beneficiary of the expected strong growth in domestic transmission orders going into FY12 and FY13. The company is also a leading player in the consumer segment and should continue to benefit from increasing penetration of basic consumer durables (fans & lighting) in rural areas. Furthermore, we believe that the demand in the groups international markets is currently at an inflection point and should gradually recover going further into CY11 and CY12. This in our opinion should drive improvement in subsidiary margins. Therefore, we remain positive on Cromptons earnings potential over the next two to three years and are c5% ahead of consensus on our FY12 EPS estimate. We continue to find Cromptons valuation attractive relative to its peers as well as its own history. On our FY12 estimates, Crompton remains at a discount to its peers under our coverage (ABB, Areva T&D and Siemens), trading at c16.6x PE and c10x EV/EBITDA compared with its peer group average of c24x and c14x, respectively. Therefore, we initiate coverage with an Overweight rating and a target price of INR365, which offers c27% potential return.
Siemens India: OW, TP INR950

Siemens doesnt look particularly inexpensive at this stage; however, the group is aggressively building its presence in India and hence, we believe, is bound to deliver premium quality growth over the next five years. The company has recently announced an ambitious INR16bn investment plan over the next three years which will not only help Siemens meet domestic demand but also become a global outsourcing hub for lower priced value products. We believe that Siemens is now a key beneficiary of the domestic transmission growth story as not only has it gained market share in substation related orders but also because the energy division is now a key driver of Siemens earnings, contributing c60% to the groups earnings. Moreover, the company has lately shown significant improvement in its EBITDA margins, from c7.5% in FY08 to c13.7% in FY10 (September year-end), driven largely by a sharp improvement in the profitability of the Mobility and the Fossil Power Generation businesses.
13
abc
We are bullish on Siemens in the near term and believe that the group should benefit from its improving market position as well as operational performance. We remain modestly ahead of consensus by c6-8% on our FY11-12 EPS estimates. On our calendarised FY12e numbers, the stock is trading at c22.6x PE and c13.7x EV/EBITDA versus equipment manufacturing average of c24x and c14x, respectively. We further note that over the last five years, both of Siemens closest foreign peers, ABB and Areva, have increased stakes in their Indian subsidiaries; however, Siemens has not. However, we believe that in light of Siemens global expansion plans and strong focus on India, a potential increase in the parents stake in the Indian subsidiary remains likely and hence, we find the current multiples attractive at this stage. Therefore, we initiate coverage with an Overweight and a target price of INR950, which offers c31% potential return.
Summary: Changes to our earnings estimates
INRm A BB Ltd. New Old Change New Old Change New Old Change New Old Change Re ve nue FY11e FY12e 67,047 94,335 -29% 25,016 25,137 0% 44,933 50,654 -11% 47,276 42,809 10% 82,746 112,041 -26% 30,285 29,913 1% 56,012 62,940 -11% 56,829 47,091 21% EBITDA FY11e FY12e 4,197 7409 -43% 2,844 2,771 3% 5,134 5,312 -3% 4,903 4,522 8% 7,709 9,721 -21% 3,376 3,298 2% 6,671 6,434 4% 5,922 4,974 19% EPS (INR) FY11e FY12e 12.0 29.1 -59% 13.5 13.3 1% 14.6 15.2 -4% 8.0 8.1 -1% 23.1 35.4 -35% 16.9 16.7 1% 20.5 19.4 6% 10.3 9.2 12% Tar ge t price (INR) Rating
630 Underw eight 710 UW (V ) 165 185 225 250 105 119 Overw eight OW (V ) Overw eight OW Neutral N (V )
Jyoti Structures
Kalpataru Pow er
KEC International
14
Valuation summary Trade peers (Based on consensus estimates) Company Ticker Current (RIC) share price (INR) Market cap (INRm) ________________________________ FY11e _________________________________ _________________________________ FY12e__________________________________ RoE EBITDA Div yield PE EV/EBITDA EV to PB EPS RoE EBITDA Div yield PE EV/EBITDA EV to PB EPS (%) (%) margins (%) (x) (x) sales (x) (x) growth (%) margins (x) (x) sales (x) (x) growth (%) (%) (%) (%)
EPC: Bajaj Electricals EMCO Gammon Jyoti Structures Kalpataru Power KEC Intl L&T Average simple Average weighted Equipment mfg: ABB Ltd Areva T&D India BHEL Crompton Greaves Indotech Siemens Ltd Voltamp Average simple Average weighted
Note: Priced as of 19 January 2011 Source: Company data, Thomson Reuters Datastream, HSBC
BJEL.NS EMCO.NS GAIN.NS JYTS.NS KAPT.NS KECL.NS LART.NS
208 68 146 118 149 92 1,652
20,476 4,410 19,509 9,583 22,604 23,365 996,273
13.61 na 12.69 8.90 10.16 10.91 26.29 13.76 24.89
8.58 10.58 13.28 5.42 10.04 7.76 20.61 10.89 19.59
0.84 0.63 1.16 0.61 1.16 0.78 2.66 1.12 2.50
3.32 0.78 0.87 1.62 1.51 2.45 4.77 2.19 4.51
20.7% -157.6% -3.6% 18.6% 13.7% 21.5% -10.5% -13.9% -8.9%
26.2% -4.1% 7.1% 19.7% 16.7% 24.6% 19.0% 15.6% 18.9%
9.8% 5.9% 8.7% 11.3% 11.5% 10.0% 12.9% 10.0% 12.7%
1.6% 1.5% 0.6% 0.9% 1.1% 1.4% 0.8% 1.1% 0.8%
10.59 9.05 11.31 7.43 8.25 8.99 21.83 11.06 20.70
6.84 4.79 11.61 4.66 8.14 6.59 16.88 8.50 16.04
0.68 0.54 1.01 0.52 0.91 0.66 2.15 0.93 2.03
2.65 0.73 0.85 1.36 1.28 1.97 3.94 1.83 3.73
28.6% -324.3% 12.2% 19.8% 23.1% 21.4% 20.4% -28.4% 19.1%
27.2% 7.1% 6.5% 19.6% 16.8% 23.9% 19.7% 17.3% 19.6%
10.0% 11.3% 8.7% 11.2% 11.2% 10.1% 12.8% 10.8% 12.5%
1.9% 1.0% 0.5% 1.0% 1.1% 1.3% 0.9% 1.1% 0.9%
ABB.NS AREV.NS BHEL.NS CROM.NS INTT.NS SIEM.NS VOTL.NS
737 154,793 310 72,959 2,182 1,057,756 289 183,700 184 1,942 732 244,565 704 7,060
43.03 38.60 18.90 20.46 16.26 29.37 10.64 25.32 23.52
46.93 18.81 12.15 13.05 9.07 15.94 7.42 17.62 16.17
3.58 1.92 2.37 1.85 0.73 2.13 1.15 1.96 2.36
5.58 6.90 5.36 5.67 1.32 6.80 1.80 4.77 5.66
6.1% 2.3% 31.1% 9.8% -249.5% 15.0% -18.9% -29.2% 22.5%
13.8% 18.9% 30.2% 31.6% 8.4% 22.5% 18.5% 20.6% 27.2%
7.6% 10.2% 19.5% 14.1% 8.0% 13.4% 15.5% 12.6% 16.5%
0.3% 0.6% 1.3% 0.8% 0.9% 0.7% 1.9% 0.9% 1.0%
27.35 28.81 15.73 17.62 6.91 24.54 8.66 18.52 18.74
30.04 15.66 10.07 11.32 4.14 14.27 5.96 13.07 12.81
2.96 1.71 1.97 1.60 0.61 1.78 1.00 1.66 1.97
4.73 5.95 4.31 4.46 1.13 5.55 1.50 3.95 4.59
57.3% 34.0% 20.2% 16.1% 135.4% 19.7% 22.9% 43.6% 23.7%
18.5% na 29.1% 28.4% 17.6% 25.1% 19.2% 23.0% 27.4%
9.8% 10.9% 19.5% 14.1% 14.8% 12.5% 16.7% 14.1% 16.7%
0.4% 0.7% 1.4% 0.9% 2.2% 0.8% 1.9% 1.2% 1.2%
abc
15
16
Valuation summary Sector peers (Based on consensus estimates) Company Ticker Current Market cap _________________________________FY11e _________________________________ RoE EBITDA Div yield (RIC) price (INRm) PE EV/EBITDA EV to PB EPS (%) (%) margins (INR) (x) (x) sales (x) (x) growth (%) (%) ABB.NS AREV.NS BJEL.NS BAJE.NS BHEL.NS BLUS.NS CROM.NS CUMM.NS EMCO.NS GAMM.NS INTT.NS IVRC.NS JAIA.NS JYTS.NS KAPT.NS KECL.NS LART.NS PENG.NS PUJL.NS SIEM.NS SINF.NS THMX.NS VOTL.NS VOLT.BO 737 310 208 1,696 2,182 398 289 744 68 146 184 100 91 118 149 92 1,652 253 99 732 364 724 704 209 154,793 72,959 20,476 134,245 1,057,756 35,540 183,700 146,330 4,410 19,509 1,942 26,382 191,463 9,583 22,604 23,365 996,273 17,499 32,550 244,565 18,029 86,119 7,060 68,615 43.03 38.60 13.61 16.01 18.90 17.30 20.46 23.34 na 12.69 16.26 11.41 17.02 8.90 10.16 10.91 26.29 8.68 20.48 29.37 11.57 23.73 10.64 18.63 18.61 22.90 46.93 18.81 8.58 8.53 12.15 11.25 13.05 17.67 10.58 13.28 9.07 9.90 13.99 5.42 10.04 7.76 20.61 6.90 7.82 15.94 5.86 14.83 7.42 12.48 12.87 16.50 3.58 1.92 0.84 1.68 2.37 1.21 1.85 3.52 0.63 1.16 0.73 0.94 3.69 0.61 1.16 0.78 2.66 1.08 0.65 2.13 0.57 1.74 1.15 1.16 1.57 2.41 5.58 6.90 3.32 2.70 5.36 5.64 5.67 7.64 0.78 0.87 1.32 1.26 2.01 1.62 1.51 2.45 4.77 1.17 1.03 6.80 1.59 6.42 1.80 5.01 3.47 4.97 6.1% 2.3% 20.7% 15.5% 31.1% 4.7% 9.8% 42.1% -157.6% -3.6% -249.5% 16.4% -33.9% 18.6% 13.7% 21.5% -10.5% -3.6% -27.3% 15.0% 26.8% 157.1% -18.9% 20.8% -3.4% 12.8% 13.8% 18.9% 26.2% 17.4% 30.2% 36.1% 31.6% 34.7% -4.1% 7.1% 8.4% 11.0% 12.9% 19.7% 16.7% 24.6% 19.0% 13.7% 5.5% 22.5% 14.6% 29.6% 18.5% 30.2% 19.1% 23.6% 7.6% 10.2% 9.8% 19.6% 19.5% 10.7% 14.1% 19.9% 5.9% 8.7% 8.0% 9.5% 26.4% 11.3% 11.5% 10.0% 12.9% 15.7% 8.3% 13.4% 9.7% 11.8% 15.5% 9.3% 12.5% 15.7% 0.3% 0.6% 1.6% 1.4% 1.3% 2.1% 0.8% 2.0% 1.5% 0.6% 0.9% 1.0% 1.1% 0.9% 1.1% 1.4% 0.8% 0.8% 0.4% 0.7% 0.6% 1.0% 1.9% 1.1% 1.1% 1.0% ________________________________ FY12e _________________________________ RoE EBITDA Div yield PE EV/EBITDA EV to PB EPS (%) (%) margins (x) (x) sales (x) (x) growth (%) (%) 27.35 28.81 10.59 13.78 15.73 14.24 17.62 18.51 9.05 11.31 6.91 9.41 13.29 7.43 8.25 8.99 21.83 7.31 10.53 24.54 8.82 18.22 8.66 15.62 14.03 18.49 30.04 15.66 6.84 7.37 10.07 9.19 11.32 13.91 4.79 11.61 4.14 7.98 10.94 4.66 8.14 6.59 16.88 5.77 5.80 14.27 4.88 11.39 5.96 10.61 9.95 13.26 2.96 1.71 0.68 1.46 1.97 1.02 1.60 2.77 0.54 1.01 0.61 0.76 3.03 0.52 0.91 0.66 2.15 0.90 0.52 1.78 0.47 1.34 1.00 1.00 1.31 1.98 4.73 5.95 2.65 2.34 4.31 4.45 4.46 6.00 0.73 0.85 1.13 1.12 1.78 1.36 1.28 1.97 3.94 1.03 0.94 5.55 1.37 5.08 1.50 3.99 2.85 4.06 57.3% 34.0% 28.6% 16.2% 20.2% 21.5% 16.1% 26.1% -324.3% 12.2% 135.4% 21.3% 28.1% 19.8% 23.1% 21.4% 20.4% 18.8% 94.4% 19.7% 31.2% 30.2% 22.9% 19.3% 17.2% 23.0% 18.5% na 27.2% 17.4% 29.1% 35.5% 28.4% 34.6% 7.1% 6.5% 17.6% 12.2% 14.1% 19.6% 16.8% 23.9% 19.7% 14.3% 9.0% 25.1% 16.6% 30.5% 19.2% 28.3% 20.5% 23.9% 9.8% 10.9% 10.0% 19.8% 19.5% 11.1% 14.1% 19.9% 11.3% 8.7% 14.8% 9.6% 27.7% 11.2% 11.2% 10.1% 12.8% 15.6% 8.9% 12.5% 9.6% 11.8% 16.7% 9.5% 13.2% 15.8% 0.4% 0.7% 1.9% 1.5% 1.4% 2.4% 0.9% 2.3% 1.0% 0.5% 2.2% 1.1% 1.2% 1.0% 1.1% 1.3% 0.9% 0.9% 0.4% 0.8% 0.7% 1.2% 1.9% 1.2% 1.2% 1.2%
ABB Ltd Areva T&D India Bajaj Electricals Bharat Electronics BHEL Blue Star Crompton Greaves Cummins India EMCO Gammon Indotech IVRCL Infra Jaiprakash Assoc Jyoti Structures Kalpataru Power KEC Intl L&T Patel Engineering Punj Lloyd Siemens Ltd Simplex Thermax Voltamp Voltas Average simple Average weighted
Note: Priced as of 19 January 2011 Source: Company, Thomson Reuters Datastream, HSBC [Please indicate for which stocks consensus is used and for which HSBC estimates are given - thx]
abc
Valuation summary Coverage universe Company Current Market cap ____________________________________FY11e ___________________________________ ____________________________________ FY12e ___________________________________ RoE EBITDA Div yield PE EV/EBITDA EV to PB EPS RoE EBITDA Div yield (INRm) PE EV/EBITDA EV to PB EPS share (%) (%) margins (%) (x) (x) sales (x) (x) growth (%) margins (x) (x) sales (x) (x) growth price (%) (%) (%) (%) (INR) 118 149 92 737 310 289 732 9,583 22,604 23,365 154,793 72,959 183,700 244,565 8.75 10.51 11.20 31.93 29.03 20.51 24.61 19.50 24.50 5.39 6.71 7.96 21.00 14.90 12.54 15.09 11.94 15.07 0.61 0.77 0.83 1.96 1.74 1.76 2.03 1.39 1.82 1.63 1.84 2.47 5.09 6.21 5.59 5.94 4.11 5.39 45.5% 17.0% 10.0% 93.2% 34.9% 13.3% 32.4% 35.2% 39.9% 18.7% 20.1% 22.0% 16.0% 21.4% 27.3% 24.2% 21.4% 22.6% 11.4% 11.4% 10.4% 9.3% 11.7% 14.1% 13.5% 11.7% 12.3% 0.9% 1.1% 1.4% 0.3% 0.6% 0.8% 0.8% 0.9% 0.7% 6.97 7.40 8.72 24.06 21.26 16.64 20.97 15.15 19.53 4.82 5.44 6.88 16.05 11.59 9.99 12.56 9.62 12.04 54% 65% 72% 162% 146% 146% 166% 1.16 1.50 1.34 1.48 2.00 4.27 5.01 4.36 4.83 3.33 4.36 25.5% 42.0% 28.3% 32.7% 36.6% 23.2% 17.4% 29.4% 25.4% 19.2% 23.9% 22.9% 17.7% 23.6% 26.2% 23.1% 22.4% 22.7% 11.1% 11.9% 10.4% 10.1% 12.6% 14.7% 13.2% 12.0% 12.7% 1.0% 1.2% 1.5% 0.3% 0.7% 0.9% 0.9% 0.9% 0.8%
Jyoti Structures Kalpataru Power KEC Intl ABB Ltd Areva T&D India Crompton Greaves Siemens Ltd Average simple Average weighted
Note: Priced as of 19 January 2011 Source: Company, HSBC estimates
Valuation summary Coverage universe (calenderised) Company Current Market cap ____________________________________FY11e ___________________________________ ____________________________________ FY12e ___________________________________ RoE EBITDA Div yield PE EV/EBITDA EV to PB EPS RoE EBITDA Div yield price (INRm) PE EV/EBITDA EV to PB EPS (%) (%) margins (%) (x) (x) sales (x) (x) growth (%) margins (INR) (x) (x) sales (x) (x) growth (%) (%) (%) (%) 118 149 92 737 310 289 732 9,583 22,604 23,365 154,793 72,959 183,700 244,565 8.75 10.51 11.20 50.00 36.18 20.51 28.05 23.60 30.34 5.39 6.71 7.96 31.66 17.59 12.54 15.60 13.92 17.84 0.61 0.77 0.83 2.26 1.93 1.76 2.12 1.47 1.93 1.63 1.84 2.47 5.65 7.03 5.59 6.53 4.39 5.80 45.5% 17.0% 10.0% -12.5% 5.4% 13.3% 29.9% 15.5% 13.0% 18.7% 20.1% 22.0% 11.4% 19.7% 27.3% 23.5% 20.4% 21.2% 11.4% 11.4% 10.4% 7.2% 11.0% 14.1% 13.6% 11.3% 11.8% 0.9% 1.1% 1.4% 0.3% 0.7% 0.8% 0.8% 0.9% 0.7% 6.97 7.40 8.72 29.50 26.72 16.64 22.65 16.94 21.85 4.82 5.44 6.88 19.49 13.92 9.99 13.72 10.61 13.42 0.54 0.65 0.72 1.86 1.66 1.46 1.83 1.25 1.63 1.34 1.48 2.00 4.81 5.81 4.36 5.28 3.58 4.72 25.5% 42.0% 28.3% 69.5% 35.4% 23.2% 23.8% 35.4% 35.5% 19.2% 23.9% 22.9% 16.5% 22.0% 26.2% 23.6% 22.0% 22.5% 11.1% 11.9% 10.4% 9.5% 12.0% 14.7% 13.3% 11.9% 12.5% 1.0% 1.2% 1.5% 0.3% 0.7% 0.9% 0.8% 0.9% 0.8%
Note: Priced as of 19 January 2011 Source: Company, HSBC estimates
abc
17
18
Valuation table Global peers (Based on consensus estimates)

Com pany Tick er Curre ncy (RIC Code ) Curre nt s hare price (INR) 208 68 146 118 149 92 1,652 737 310 2,182 289 184 732 704 FY11e Mcap (INRm ) P/E (x) EV/ EBITDA (x) 8.6 10.6 13.3 5.4 10.0 7.8 20.6 55.8 20.1 12.2 13.1 9.1 15.5 7.4 15.0 18.0 EV/ Sale s (x) P/B (x) EPS grow th (%) 20.7% -157.6% -3.6% 18.6% 13.7% 21.5% -10.5% -14.2% -9.5% 31.1% 9.8% -18.0% 21.9% -21.9% -7.0% 9.6% EBITDA RoE (%) m gns (%) Div yie ld (%) 1.6% 1.5% 0.6% 0.9% 1.1% 1.4% 0.8% 0.3% 0.6% 1.3% 0.8% 0.9% 0.7% 1.9% 1.0% 1.0% P/E (x) EV/ EBITDA (x) 6.9 4.8 11.6 4.7 8.1 6.6 16.9 31.8 15.7 10.1 11.3 7.5 13.2 6.0 11.1 14.1 EV/ Sales (x) FY12e P/B (x) EPS grow th (%) 28.6% -324.3% 12.2% 19.8% 23.1% 21.4% 20.4% 76.8% 41.2% 20.2% 16.1% -325.8% 17.9% 24.4% -23.4% 22.7% RoE (%) EBITDA m gns (%) Div yie ld (%) 1.9% 1.0% 0.5% 1.0% 1.1% 1.3% 0.9% 0.4% 0.6% 1.4% 0.9% 2.2% 0.9% 1.9% 1.2% 1.1%
India: Bajaj Electricals EMCO Gammon Jy oti Structures Kalpataru Pow er KEC Intl L&T ABB Ltd Arev a T&D India BHEL Indotech Siemens Ltd BJEL.NS EMCO.NS GAMM.NS JYTS.NS KAPT.NS KECL.NS LART.NS ABB.NS AREV.NS BHEL.NS INTT.NS SIEM.BO INR INR INR INR INR INR INR INR INR INR INR INR INR INR 20,476 4,410 19,509 9,583 22,604 23,365 996,273 154,793 72,959 1,057,756 183,700 1,942 244,565 7,060 13.6 na 12.7 8.9 10.2 10.9 26.3 51.3 42.6 18.9 20.5 na 26.7 11.1 21.1 24.4 0.8 0.6 1.2 0.6 1.2 0.8 2.7 3.8 2.0 2.4 1.8 1.2 2.0 1.2 1.6 2.4 3.3 0.8 0.9 1.6 1.5 2.5 4.8 5.8 7.2 5.4 5.7 1.3 6.1 1.8 3.5 5.2 26.2% -4.1% 7.1% 19.7% 16.7% 24.6% 19.0% 12.3% 18.0% 30.2% 31.6% -4.8% 25.4% 18.5% 17.2% 24.1% 9.7% 5.9% 8.7% 11.3% 11.5% 10.0% 12.9% 6.8% 10.0% 19.5% 14.1% 13.0% 12.6% 15.5% 11.5% 14.9% 10.6 9.1 11.3 7.4 8.3 9.0 21.8 29.0 30.1 15.7 17.6 13.1 22.7 8.9 15.3 19.5 0.7 0.5 1.0 0.5 0.9 0.7 2.2 3.1 1.7 2.0 1.6 0.7 1.6 1.0 1.3 2.0 2.6 0.7 0.8 1.4 1.3 2.0 3.9 4.9 6.0 4.3 4.5 1.1 5.1 1.5 2.9 4.2 27.2% 7.1% 6.5% 19.6% 16.8% 23.9% 19.7% 18.1% 21.9% 29.1% 28.4% 10.7% 24.8% 18.8% 19.5% 24.2% 10.0% 11.3% 8.7% 11.2% 11.2% 10.1% 12.8% 9.7% 10.9% 19.5% 14.1% 9.5% 12.3% 16.7% 12.0% 15.1%
Crompton Greaves CROM.NS
Voltamp VOTL.NS Average - s im ple Average - w e ighte d As ia Pacific: Hyundai Heavy Harbin Pow er Hyosung Corp Mits ubishi Shanghai Elec tric Dongf ang Sams ung C&T Sungjin Geotec h Doosan Heav y Hanw ha BHI Co Ltd Average - s im ple Average - w e ighte d Europe: Cobra COBRA.MI Elecnor ENOR.MC Siemens SIEGn.DE ABB ABBN.VX Arev a CEPFi.PA Alstom ALSO.PA Average - s im ple Average - w e ighte d 009540.KS 1133.HK 004800.KS 7011.T 601727.SS 600875.SS 000830.KS 051310.KS 034020.KS 000880.KS 083650.KQ
KRW HKD KRW JPY CNY CNY KRW KRW KRW KRW KRW
500,000 11 92,300 335 8 31 79,500 13,950 83,800 53,400 21,850
######### 1,866 3,276,351 1,126,205 94,359 62,585 ######### 562,337 8,963,198 4,055,139 288,885
10.8 14.4 7.4 na 36.3 27.5 25.0 8.6 35.8 8.2 12.5 18.6 16.2
10.4 2.8 9.7 10.3 17.5 16.8 36.8 9.1 36.0 29.6 9.3 17.1 19.6
1.8 0.2 0.9 0.8 1.3 1.4 1.2 1.3 3.1 1.9 1.4 1.4 1.8
2.8 1.5 1.0 0.9 3.9 6.0 1.7 4.0 2.5 1.4 3.1 2.6 2.4
29.9% 43.2% 22.3% na 67.5% 23.2% 55.9% na -162.4% -19.0% 1.4% 6.9% 5.8%
29.7% 9.6% 14.5% 1.9% 12.0% 23.0% 7.0% 66.1% 7.1% 19.4% 25.8% 19.7% 21.1%
17.1% 6.0% 9.1% 7.8% 7.3% 8.5% 3.2% 14.8% 8.6% 6.6% 15.1% 9.5% 12.3%
0.8% 0.8% 1.0% 1.2% 0.8% 0.4% 0.7% 0.0% 0.6% 1.2% 0.8% 0.8% 0.8%
11.2 15.8 6.4 na 31.8 21.5 25.8 7.2 16.1 8.5 9.0 15.3 13.9
10.5 2.6 8.9 9.9 13.6 12.8 29.2 9.2 25.7 30.6 7.6 14.6 16.9
1.6 0.2 0.8 0.8 1.1 1.2 1.1 1.3 2.5 1.9 1.0 1.2 1.6
2.3 1.4 0.9 0.9 3.6 5.1 1.6 2.3 2.2 1.2 2.2 2.2 2.0
-3.6% 7.4% 16.3% na 14.1% 27.7% -3.2% 19.0% 123.2% -3.6% 39.2% 23.7% 14.2%
22.5% 9.1% 15.2% 2.2% 12.7% 25.8% 6.3% 38.1% 13.9% 15.4% 28.5% 17.2% 17.5%
15.4% 6.0% 9.4% 7.9% 8.4% 9.4% 3.6% 13.7% 9.8% 6.3% 13.6% 9.4% 11.6%
0.9% 0.9% 1.1% 1.2% 1.0% 0.6% 0.7% 0.0% 0.7% 1.2% 0.0% 0.8% 0.9%
EUR EUR EUR CHF EUR EUR
1 10 92 22 36 40
27 876 83,510 54,641 513 11,688
na 12.5 12.9 19.9 42.5 13.0 20.2 15.5
8.5 8.8 7.8 10.5 12.5 7.8 9.3 8.8
0.6 0.9 1.1 1.6 0.7 0.7 0.9 1.3
0.9 1.9 2.5 3.4 1.4 2.6 2.1 2.8
-83.0% -28.3% 58.7% -5.5% -64.1% -34.2% -26.1% 27.4%
-5.7% 21.5% 18.9% 18.5% 2.0% 19.6% 12.5% 18.8%
6.7% 10.5% 14.5% 15.2% 5.9% 8.4% 10.2% 14.2%
0.0% 2.9% 3.0% 2.3% 1.7% 2.6% 2.1% 2.7%
na 9.7 11.6 15.7 25.6 12.1 14.9 13.2
5.8 7.0 7.1 8.9 5.6 7.3 7.0 7.8
0.5 0.8 1.1 1.5 0.7 0.7 0.9 1.2
1.0 1.7 2.2 3.0 1.4 2.3 1.9 2.5
-96.3% 28.4% 10.7% 21.2% 66.0% 7.8% 6.3% 14.5%
0.7% na 18.8% 20.4% 5.3% 18.5% 12.7% 19.2%
8.8% 11.0% 15.2% 16.5% 12.2% 9.0% 12.1% 15.2%
0.0% 3.8% 3.3% 2.5% 1.6% 2.7% 2.3% 3.0%
abc
Note: Priced as of 19 January 2011 Source: Company, Thomson Reuters Datastream, HSBC [Please indicate for which stocks consensus is used and for which HSBC estimates are given - thx]
Share price performance summary trade peers Company EPC: Bajaj Electricals EMCO Gammon Jyoti Structures Kalpataru Power KEC Intl L&T Average simple Average weighted Eqp Mfg: ABB Ltd Areva T&D India BHEL Crompton Greaves Indotech Siemens Ltd Voltamp Average simple Average weighted 211 68 145 118 149 92 1,652 -3.2% 4.1% -8.8% -4.3% -7.3% -3.8% -6.1% -4.2% -6.0% -9.6% 10.6% -15.1% -4.2% -14.2% 5.9% -16.7% -6.2% -15.8% -34.0% 4.4% -27.4% -12.8% -15.1% -6.6% -17.2% -15.5% -17.3% -12.2% -11.0% -35.0% -27.3% -24.9% -10.2% -12.7% -19.1% -13.4% 16.3% -34.3% -43.9% -35.9% -38.4% -24.5% 0.5% -22.9% -1.8% 1.4% 8.7% -4.2% 0.3% -2.7% 0.8% -1.5% 0.4% -1.4% 2.2% 22.4% -3.3% 7.7% -2.3% 17.7% -4.9% 5.7% -4.0% -19.3% 19.1% -12.8% 1.8% -0.4% 8.1% -2.5% -0.9% -2.6% -2.1% -0.9% -24.9% -17.2% -14.8% 0.0% -2.6% -8.9% -3.3% 21.2% -29.5% -39.0% -31.0% -33.5% -19.6% 5.4% -18.0% 3.1% CMP ___________________________ Absolute performance (%)_____________________________ 1 week 1 mth 3 mths 6 mths 12 mths ___________________________ Relative performance (%) ____________________________ 1 week 1 mth 3 mths 6 mths 12 mths
737 308 2,181 289 185 732 704
-1.3% -3.2% -2.7% -0.9% -7.5% -5.2% -2.5% -3.3% -2.7%
-5.1% -6.0% -5.4% -12.6% -6.0% -5.9% -10.2% -7.3% -6.2%
-18.2% 2.8% -12.7% -5.9% -22.4% -8.7% -21.7% -12.4% -11.3%
-13.5% 6.4% -9.7% 7.2% -32.7% 1.0% -33.7% -10.7% -6.1%
-12.2% 11.6% -9.0% 21.6% -46.8% 13.5% -25.6% -6.7% -2.1%
3.3% 1.4% 2.0% 3.7% -2.9% -0.6% 2.1% 1.3% 1.9%
6.8% 5.9% 6.5% -0.7% 5.8% 6.0% 1.6% 4.5% 5.6%
-3.5% 17.5% 1.9% 8.8% -7.8% 6.0% -7.0% 2.3% 3.3%
-3.3% 16.6% 0.5% 17.4% -22.5% 11.2% -23.5% -0.5% 4.0%
-7.3% 16.5% -4.1% 26.5% -41.9% 18.4% -20.7% -1.8% 2.8%
Source: Thomson Reuters Datastream, HSBC
abc
19
20
Share price performance summary Sector peers Company ABB Ltd Areva T&D India Bajaj Electricals Bharat Electronics BHEL Blue Star Crompton Greaves Cummins India EMCO Gammon Indotech IVRCL Infra Jaiprakash Assoc Jyoti Structures Kalpataru Power KEC Intl L&T Patel Engineering Punj Lloyd Siemens Ltd Simplex Thermax Voltamp Voltas Average simple Average weighted CMP 737 308 211 1,694 2,181 399 289 746 68 145 185 100 91 118 149 92 1,652 253 99 732 368 730 704 209 ___________________________ Absolute performance (%)_____________________________ 1 week 1 mth 3 mths 6 mths 12 mths -1.3% -3.2% -3.2% 0.8% -2.7% -3.2% -0.9% 0.4% 4.1% -8.8% -7.5% -12.6% -6.1% -4.3% -7.3% -3.8% -6.1% -7.1% -3.6% -5.2% -5.7% -7.3% -2.5% -0.1% -4.0% -3.8% -5.1% -6.0% -9.6% -1.9% -5.4% -7.1% -12.6% -2.2% 10.6% -15.1% -6.0% -21.1% -12.6% -4.2% -14.2% 5.9% -16.7% -20.0% -6.9% -5.9% -12.7% -14.3% -10.2% -4.6% -8.2% -9.6% -18.2% 2.8% -34.0% -4.4% -12.7% -12.6% -5.9% 2.8% 4.4% -27.4% -22.4% -35.9% -28.5% -12.8% -15.1% -6.6% -17.2% -33.3% -22.5% -8.7% -23.0% -7.1% -21.7% -10.8% -15.4% -13.6% -13.5% 6.4% -12.2% -5.6% -9.7% -10.2% 7.2% 26.9% -11.0% -35.0% -32.7% -47.6% -29.7% -27.3% -24.9% -10.2% -12.7% -39.0% -28.6% 1.0% -23.5% -5.4% -33.7% 4.0% -15.3% -8.8% -12.2% 11.6% 16.3% -17.7% -9.0% -0.3% 21.6% 67.5% -34.3% -43.9% -46.8% -46.6% -43.3% -35.9% -38.4% -24.5% 0.5% -47.4% -54.2% 13.5% -30.2% 7.9% -25.6% 12.3% -15.0% -2.6% ___________________________ Relative performance (%) ____________________________ 1 week 1 mth 3 mths 6 mths 12 mths 3.3% 1.4% 1.4% 5.4% 2.0% 1.4% 3.7% 5.0% 8.7% -4.2% -2.9% -8.0% -1.4% 0.3% -2.7% 0.8% -1.5% -2.5% 1.0% -0.6% -1.1% -2.7% 2.1% 4.5% 0.6% 0.8% 6.8% 5.9% 2.2% 10.0% 6.5% 4.8% -0.7% 9.6% 22.4% -3.3% 5.8% -9.3% -0.7% 7.7% -2.3% 17.7% -4.9% -8.1% 4.9% 6.0% -0.9% -2.5% 1.6% 7.2% 3.6% 2.3% -3.5% 17.5% -19.3% 10.3% 1.9% 2.0% 8.8% 17.5% 19.1% -12.8% -7.8% -21.2% -13.8% 1.8% -0.4% 8.1% -2.5% -18.7% -7.8% 6.0% -8.4% 7.5% -7.0% 3.8% -0.8% 1.1% -3.3% 16.6% -2.1% 4.6% 0.5% -0.1% 17.4% 37.1% -0.9% -24.9% -22.5% -37.5% -19.5% -17.2% -14.8% 0.0% -2.6% -28.9% -18.4% 11.2% -13.4% 4.7% -23.5% 14.2% -5.1% 1.3% -7.3% 16.5% 21.2% -12.8% -4.1% 4.6% 26.5% 72.3% -29.5% -39.0% -41.9% -41.7% -38.4% -31.0% -33.5% -19.6% 5.4% -42.5% -49.4% 18.4% -25.4% 12.8% -20.7% 17.2% -10.1% 2.3%
abc
Share price performance summary Coverage universe Company Jyoti Structures Kalpataru Power KEC Intl ABB Ltd Areva T&D India Crompton Greaves Siemens Ltd Average simple Average weighted CMP 118 149 92 737 308 289 732 _______________________________Absolute Performance (%)___________________________ ___________________________ Relative Performance (%) ____________________________ 1 week 1 mth 3 mths 6 mths 12 mths 1 week 1 mth 3 mths 6 mths 12 mths -4.3% -7.3% -3.8% -1.3% -3.2% -0.9% -5.2% -3.7% -3.0% -4.2% -14.2% 5.9% -5.1% -6.0% -12.6% -5.9% -6.0% -7.3% -12.8% -15.1% -6.6% -18.2% 2.8% -5.9% -8.7% -9.2% -9.0% -27.3% -24.9% -10.2% -13.5% 6.4% 7.2% 1.0% -8.7% -1.6% -35.9% -38.4% -24.5% -12.2% 11.6% 21.6% 13.5% -9.2% 6.3% 0.3% -2.7% 0.8% 3.3% 1.4% 3.7% -0.6% 0.9% 1.6% 7.7% -2.3% 17.7% 6.8% 5.9% -0.7% 6.0% 5.9% 4.6% 1.8% -0.4% 8.1% -3.5% 17.5% 8.8% 6.0% 5.4% 5.6% -17.2% -14.8% 0.0% -3.3% 16.6% 17.4% 11.2% 1.4% 8.6% -31.0% -33.5% -19.6% -7.3% 16.5% 26.5% 18.4% -4.3% 11.1%
abc
21
abc
This page has been left blank intentionally
22
abc
Demand analysis
Domestic transmission Strong growth ahead International transmission A USD400bn opportunity Distribution Not much visibility beyond central schemes Construction Infra spend to drive growth Industrial Mfg Capacity addition to accelerate Railways A INR14trn opportunity Oil & gas infrastructure Strengthening pipeline Consumer durables Rural penetration strengthens
growth
Healthcare still in its infancy
23
abc
End-market analysis
Our coverage universe remains highly geared to the T&D market
(c70%), with highest exposure of c40% to domestic transmission

Domestic demand remains key for our companies, with an
average exposure of c75%. Africa & Middle East remain the next most important regions
We have analyzed 9 key end markets for our companies and
while we expect double digit growth in most markets, we remain particularly positive on domestic transmission going into FY12
In this section, we discuss in detail most of the key end markets where the companies under our coverage are present.
the international transmission and the power distribution demand. On a sales weighted basis however, the exposure to demand from the industrial manufacturing customers emerges as the second highest for our companies (i.e. ahead of the international transmission and the power distribution markets). This is largely driven by a relatively high exposure of big players like ABB, Siemens and Crompton to the industrial markets.
Domestic transmission a key market for our companies

As we highlight in the table below, our coverage universe is most geared towards the transmission and distribution markets, with highest exposure to the domestic transmission demand followed by
End-market exposure End-market exposure Transmission Transmission Power Construction Industrials domestic international distribution Jyoti Structures Kalpataru Power KEC International EPC average simple EPC average wtd ABB Ltd Areva T&D India Crompton Greaves Siemens Ltd Eqp mfg avg simple Eqp mfg avg wtd Simple average Weighted average
Railways Oil & Gas Consumer Healthcare Others infra durables 0% 1% 2% 1% 1% 4% 0% 0% 10% 4% 4% 2% 4% 0% 9% 0% 3% 4% 5% 0% 0% 6% 3% 3% 3% 3% 0% 0% 0% 0% 0% 0% 0% 18% 0% 5% 6% 3% 4% 0% 0% 0% 0% 0% 0% 0% 0% 5% 1% 2% 1% 1% 0% 1% 6% 2% 3% 0% 0% 0% 10% 3% 3% 2% 3%
Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
68% 36% 26% 43% 39% 45% 60% 22% 20% 37% 31% 40% 33%
8% 19% 51% 26% 29% 4% 15% 20% 4% 11% 10% 17% 15%
25% 1% 15% 14% 12% 5% 17% 26% 9% 14% 14% 14% 14%
0% 33% 0% 11% 13% 6% 0% 0% 3% 2% 2% 6% 5%
0% 0% 0% 0% 0% 31% 8% 14% 33% 22% 23% 12% 18%
24
abc
Geographic exposure End-market exposure Jyoti Structures Kalpataru Power KEC International EPC average simple EPC average wtd ABB Ltd Areva T&D India Crompton Greaves Siemens Ltd Eqp mfg avg simple Eqp mfg avg wtd Simple average Weighted average
India 90% 83% 48% 74% 71% 90% 77% 47% 79% 73% 71% 73% 71%
Europe 0% 0% 0% 0% 0% 1% 3% 17% 10% 8% 9% 4% 7%
North America 0% 2% 10% 4% 5% 1% 1% 13% 1% 4% 5% 4% 5%
RoW 10% 15% 42% 22% 24% 8% 19% 23% 10% 15% 15% 18% 17%
Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Domestic demand remains key for our sector

Our coverage remains highly geared to domestic demand, with c70% exposure to the domestic market. Our universe also has a relatively low exposure of c8-12% to the western economies of North America and Europe, where demand environment remains subdued. The exposure of c18% to the rest of the world (RoW) is largely biased to the regions of Middle East, Africa and Latin America.
International transmission Power distribution Construction Industrials Railways Oil & Gas infrastructure Consumer durables Healthcare While we expect double digit growth in most of these markets going into FY12, we remain particularly positive on demand outlook within the domestic transmission sector. We believe investment in the domestic transmission markets is bound to gather pace as the Indian government prepares for an unprecedented step-up in
We are bullish on demand outlook, particularly domestic T&D markets

In the following chapters, we discuss the following eight key end markets for our companies. Domestic transmission
End market growth (%) End market Transmission Domestic Transmission Intl Distribution Construction Industrials Railways Oil & Gas Consumer Durables Healthcare Others Sector growth
Sector exposure 33% 15% 14% 5% 18% 4% 3% 4% 1% 3% 100%
FY11e 20-25% 10-15% 25-30% 15-20% 20-25% 20-25% 8-12% 30-35% 10-15% 10-15% 20-25%
FY12e 45-50% 10-15% 30-35% 25-30% 15-20% 25-30% 10-15% 20-25% 10-15% 10-15% 28-33%
FY13e 5-10% 8-12% 5-10% 15-20% 10-15% 10-15% 10-15% 20-25% 10-15% 10-15% 8-13%
25
abc
generation capacity and opens the transmission sector to private players. In the medium term, we expect the order activity to pick up sharply, driven largely by the 11th fiveyear plan spillover and the orders related to the nine high capacity corridors (HCPTCs) which have been recently announced. We highlight our growth forecasts for all the end markets in the table on the previous page.
26
abc
Domestic transmission Strong growth ahead

We forecast domestic transmission orders to grow by c45-50% in
FY12, driven largely by HCPTCs, 11th five-year plan spillover and expenditure on the 12 five-year plan
We expect growth to slow down to c10% in FY13; however,
substation vendors should continue to witness growth of c25% in FY13, driven by a lower lead time for their products
Increasing privatization in transmission to provide additional
opportunity for EPC players to partake in asset ownership
At the cusp of strong growth

The last decade (2000-10) has seen a significant progress in power reforms and has laid a strong foundation to enable India to envision ambitious power capacity targets. Starting with capacity of only 1,350MW at the time of independence, India is now on track to achieve power generation capacity of c300GW by FY17e. Much of this capacity has either come over the last 7-8 years (c60-65GW) or is expected to come over the next 7-8 years (c130-135GW). We believe that this heightened sense of urgency to provide the country with more power has led to two things: The power reforms, successive to the Electricity Act of 2003, have changed the industry dynamics at every level. Most notable have been the increasing participation from the private sector and the unbundling of the State Electricity Boards (SEBs) into respective utilities (GenCo, TransCo and Discoms). This
has not only helped the government to expedite power capacity addition in an economically beneficial manner but also diversified (and thus reduced) the risk for other players (such as equipment vendors) in the value chain. The rapid increase in power generation capacity has finally brought the related bottlenecks in the Transmission and Distribution (T&D) network to the forefront. The present investment in generation versus T&D remains at around 1:0.5 compared with the desired ratio of around 1:1. Having tried, tested and successfully deployed various reforms in the generation segment, the Government of India (GoI) is now trying to bring similar changes (i.e. privatization, ultra mega projects, tariff based competitive bidding etc) in the transmission segment, and to some extent in the distribution segment (i.e. franchisee based private participation).
27
28
Report on the performance of state power utilities Milestones Arunachal Pradesh Andhra Pradesh Assam Bihar Chattisgarh Delhi Gujrat Goa Haryana Himachal Pradesh Jammu & Kashmir Jharkhand Karnataka Kerela Meghalaya Manipur Mizoram Maharashtra Madhya Prsdeah Nagaland Orissa Punjab Rajasthan Sikkim Tamilnadu Tripura Uttar Pradesh Uttrakhand West Bengal Total
1 a b c 2 a b 3 a b
SERC Constituted Operationalisation Issuing tariff orders Unbundling / Corporatisation Unbundling / Corporatisation- Implementation Privatisation of distribution Distribution reform 100 % metering -11 kV feeder metering 100 % metering -consumer metering
28 23 23
**
16 2
23 9
Notes: *(i) This includes SERC notified of Manipur, Mizoram & Nagaland (i.e. SERC-25 constituted and 3 notified) (ii) Tariff Order issued include any one Order issued since operationalisation # (iii) Corporatisation is being implemented. **(iv) Steps have been initiated towards corporatisation/unbundling. (v) Consumer and Grid metering almost achieved 95 % and more. Source: APDRP
abc
abc
Per capita electricity consumption
Power generation capacity addition
15,000 12,000 kWh
13,616
200,000 150,000
MW
2,752
9,000 6,000 3,000 0 India
8,475
8,477
100,000 50,000 0
2,346 543 Japan China US
OECD World av erage
VI
VII VIII IX
XI
XII XIII XIV
Five Year Plans

Source: CEA, HSBC research
Source: Power Grid
This, we believe, is a key positive for suppliers, particularly EPC contractors, as not only will they see significant demand for their products as their customers ramp up capacity but some of them may also get an opportunity to partake in asset ownership, thus raising their profile. Even though the pace of power capacity addition has picked up in an unprecedented manner over the last five years, we dont expect the party to end any time soon. We note that Indias per capita electricity consumption stood at around 543kWh in 2009 which was significantly below its closest competitor Chinas consumption of c2,346kWh and the world average of c2,752kWh. It is only natural that as India accelerates its drive towards industrialization, the need for electricity will continue to increase, thus creating continuous demand for additional capacity.
In this section, we discuss the dynamics and drivers within the domestic transmission sector and evaluate the growth opportunities over the next five to six years.
India in the power-play mode!

As we highlight in the chart above, India is rapidly moving from a conservative 15-20GW five year power plan on average to an ambitious 80-100GW five-year plan. The 11th five-year plan (FY07-12) marked the first material step change in the generation capacity target and the subsequent plans are expected to follow suit. We note that Indias power deficit (based on peak demand) has averaged around 14% during the last decade with a peak deficit of over 16% in FY08 and the current deficit of just under 13%. The
Peak demand scenario
Installed capacity requirement
500 400
GW
437 323
GW
600 500 400 300 200 100 0 132 86 GW 88 GW 220 306 119 GW
150 GW 575 425
300 200 100 0 End of X Plan 2012 100 152
218
During 12th During 11th plan plan
During 13th plan
2017
2022
2027
2007
2012
2017
2022
2027
Source: Power Grid
Source: Power Grid
29
abc
Demand supply deficit to narrow, but could be higher if we consider latent demand
300 250 200 150 100 50 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY17e Installed capacity (GW) Peak shortfall %
24% 20% 16% 12% 8% 4% 0% Peak demand (GW) Deficit considering latent demand % Peak met (GW)
deficit problem persists in India even through the countrys per capita electricity consumption of c623kWh is among the lowest in the world. A study released by IEA in 2009 shows that Indias electricity consumption stood at around one-fifth of that of China and the world average in 2007. Our India Utilities analyst, Arun Kumar, forecasts that even with an increase in generation capacity to around 300GW by FY17e, the power deficit will only reduce to c8.5%. Including the latent demand, the deficit will stand at c14%. Our analyst has assumed only a modest increase in electricity consumption to c1,050kWh by FY17e, which continues to remain significantly below Chinas current consumption of c2,760kWh. It is only natural that with rising industrialization, urbanization and factory automation, the need for electricity and the per capita consumption will move closer to the world average, thus creating continuous demand for additional capacity. In this context, we believe that the power deficit in India may persist for a long time, driving increasing investment into the power value chain.
consolidating the laws relating to generation, transmission, distribution, trading and the use of electricity. Not only did this act bring in several game changing proposals, such as Opening up the power generation segment for direct private participation Unbundling SEBs into respective utilities GenCo, TransCo and DisCom to improve their operational efficiency and financial viability Making theft of electricity a criminal offence but it also acted as a catalyst for future reforms, such as: Introduction of tariff based competitive bidding for generation projects Introduction of provision for open access to utilities The launch of Rajiv Gandhi Gramin Vidyutikaran Yojna (RGGVY) in 2005 which aimed at electrifying all villages under the banner of Power for all by 2012 Restructuring of the Accelerated Power Development & Reforms Programme (APDRP) and the introduction of R-APDRP.
Same game, different rules

The Electricity Act introduced in 2003 replaced the old Electricity Act of 1948 and was aimed at
30
abc
Most of these reforms/developments have significantly changed the playing field for players in the power value chain. For example, while the increase in private participation has brought in cost and operational efficiencies in the system (reducing the risk of project delays and deferrals), the unbundling of SEBs to some extent has limited the financial/counterparty risk for the vendors. The net effect of all these reforms has been a significant increase in India Incs ability to channel substantial investments into the power sector and undertake ambitious capacity addition plans. Since the power generation landscape has changed rapidly, we believe its rub-off effect on the T&D segment will not only drive significant investment into the sector but change the rules of the game here too.
as the GoI rushes to clear the backlog and create adequate transmission capacity for the upcoming generation capacity. The increasing private participation in this segment will provide many vendors with an opportunity to partake in asset ownership and raise their business profile.
A brief history of transmission

Landmark events in the development of power sector 1948 1950-60 1964 1965-73 1977 1980-88 1989 1990 1997 1999 2000 2002 2003 2003 2003 2003 2006 2007 2007 Electricity (Supply) Act 1948 Growth of state grids & introduction of 220kV voltage level Constitution of Regional Electricity Boards Interconnecting state grids to form Regional grid systems Introduction of 400kV voltage level Growth of Regional Grid Systems as associated transmission system with Central Sector Generation HVDC back-to-back system Introduction of HVDC bi-pole line Synchronous interconnection of ER and NER Transmission planning re-oriented towards all-India system 765kV transmission line (initially charged at 400kV) Planning for National Power Grid by 2010 Electricity Act 2003 Open access in transmission Synchronous interconnection of WR with ER-NER system Bulk inter-regional HVDC transmission system Synchronous interconnection of NR with ER-NER-WR system 765kV operation of Sipat substation 765kV operation of 765kV transmission lines
Transmission a two way opportunity

We believe that most of the major bottlenecks associated with setting up new generation capacity have been addressed over the last 5-8 years. There is now a strong need to address the bottlenecks associated with the downstream operations like transmission and distribution of power. While distribution is largely managed at the state level, with only a handful of central schemes (such as RGGVY and R-APDRP), a significant portion of the transmission segment (in the form of National Grid) remains under the purview of the central sector and is managed by the Power Grid (PGCIL). The transmission segment is similar to the generation segment in this regard and therefore should enjoy similar levels of political will and consensus for the on-going and/or future reforms. In this context, we believe that the transmission segment provides a two way opportunity: Given the decades-long underinvestment in the sector, the transmission segment is now bound to catch up and witness significant investments
Source: National Electricity Plan
Historically most of the transmission capex has been evacuation based i.e. utilities used to lay transmission lines as per the power evacuation requirements of the up-coming generation plants rather than based on a central plan. This naturally led to an inefficient development of the grid which was incapable of transmitting electricity over long distances. This led to the incorporation of Power Grid in 1989, which aimed at creating a national grid with the capability to transfer electricity across states and regions. Since then, Power Grid has become the third largest transmission utility in the world and the biggest transmission utility in India, carrying over 50% of the total power generated in India.
31
abc
National Grid a dream come true

Power Grid has been very systematic in its approach to building the National Grid and as a result India now has one of the largest synchronized grids in the world. Indias transmission grid today can be divided into five main regions: Northern Region (NR) Southern Region (SR) Western Region (WR) Eastern Region (ER)
The development of National Grid has played a key role in streamlining the transmission planning in India. Not only has it enabled India to move from an Evacuation based planning to a Grid based planning, but also provided the flexibility to undertake transmission planning in parallel to the generation plans (i.e. before the identification of PowerGen beneficiaries). The development of the National Grid in terms of the inter-regional (IR) transmission capacity has been slow as much of the time went on proper planning and rationalization of the network. However, the pace of IR capacity addition has picked up lately and the Power Grid is now targeting an IR transmission capacity of 32,650MW by FY12e and 75,000MW by FY17e compared with a capacity of around 14,100MW in FY07.
National grid inter regional transfer capacity
North-Eastern Region (NER) Four of these regions have been synchronized so far and the Southern Region (SR) is expected to be hooked up to the grid by the end of 2012. After the synchronization of all the five regions, Indias National Grid will be the worlds largest synchronized grid.
Transmission regions in India
80,000 70,000 60,000 MW 50,000 40,000 30,000 20,000 10,000 0 5050 14100 32650
75000
Northern region North Eastern region Eastern region Western region
2002
2007
2012E
2017E
Southern region
Source: CEA
32
abc
Inter-regional transmission capacity in India System Eastern region -Southern region Gazuwaka HVDC back to back Balimela Upper Sileru 220 kV S/C Talcher Kolar HVDC bipole Talcher Kolar HVDC bipole upgrade Subtotal Eastern region Northern region Muzaffarpur Gorakhpur 400 kV D/C (quad moose) with TCSC Dehri Sahupuri 220 kV S/C Patna Balia 400 kV D/C quad Biharshariff Balia 400 kV D/C quad Barh Balia 400 kV D/C quad Sasaram Fatehpur 765 kV S/C line 1 Gaya Balia 765 kV S/C Sasaram: (i) HVDC back-to-back (ii) Bypassing of HVDC back-to-back to establish Sasaram Allahabad / Varanasi 400 kV D/C line Subtotal Eastern region Western region Rourkela Raipur 400 kV D/C TCSC on Rourkela Raipur 400 kV D/C Budhipara Korba 220 kV D/C + S/C Ranchi Sipat 400 kV D/C Ranchi Rourkela Raipur 400 kV D/C with fixed series capacitor, TCSC in parallel line Ranchi Sipat Pooling Point 765 kV S/C Subtotal Eastern region North-eastern region Birpara Salakati 220 kV D/C Malda Bongaigaon 400 kV D/C Bongaigaon Siliguri 400 kV D/C quad Subtotal Northern region Western region Vindhychal HVDC back to back Auria Mlanpur 220 kV D/C Kota Ujjain 220 kV D/C Agra Gwalior 765 kV S/C line1 400 kV op. Agra Gwalior 765 kV S/C line2 400 kV op. Kankroli Zerda 400 kV D/C Subtotal Western region Southern region Chandrapur HVDC back to back Barsur-L. Sileru 200 kV HVDC monopole Kolhapur Belgaum 220 kV D/C Ponda Nagajhari 220 kV D/C Narendra / Kolhapur HVDC back-to-back with Narendra Kolhapur 400 kV D/C line Subtotal All India (200 kV & above) 132 kV / 110 kV interregional links Total (110/132 kV & above)
At the end of the Additions during As of Sep 2009 Balance prog for Proposed by the end the 11th plan of the 11th plan 10th five-yr plan 11th five-yr plan 1000 130 2000 3,130 2000 130 800 500 3,430 1000 400 390 1,790 260 1000 1,260 500 260 260 1100 2,120 1000 200 260 260 0 1,720 13,450 600 14,050 500 500 800 1600 500 2900 1200 1,200 1100 1000 2,100 6,700 6,700 1000 130 2000 500 3,630 2000 130 1600 1600 1000 6,330 1000 400 390 1200 2,990 260 1000 1,260 500 260 260 1100 1100 1000 4,220 1000 200 260 260 1,720 20,150 600 20,750 1600 2100 2100 5,800 1400 2100 3,500 1600 1,600 1000 1,000 11,900 11,900 1000 130 2000 500 3,630 2000 130 1600 1600 1600 2100 2100 1000 12,130 1000 400 390 1200 1400 2100 6,490 260 1000 1600 2,860 500 260 260 1100 1100 1000 4,220 1000 200 260 260 1000 2,720 32,050 600 32,650
33
abc
Regional grid map
Source: CEA
34
abc
Technology has turned the corner

As we have highlighted earlier, the transmission planning in India had historically been evacuation based which meant that most of the transmission requirements were inter-state or intra-state, thus requiring relatively shorter transmission lines. As a result, most of the transmission lines used 400kV and 220kV AC transmission. We note that the load centres are usually far away from the supply centres and with the introduction of Ultra Mega Power Projects (UMPPs), there is a strong need to create efficient and high capacity transmission lines, which can transfer electricity over very long distances (i.e. up to 2,000kms).
Hence, India is now rapidly moving towards superior technologies, such as Ultra High Voltage AC (UHVAC) 765kV and 1200kV and High Voltage DC (HVDC) 500kV, are required. We note that India has successfully installed a transmission line using 800kV UHVDC line and is currently testing a 1200kV UHVAC line at Bina, Madhya Pradesh.
India Load centres are far away from the supply centres, increasing the need for transmission
Jammu
Transmission capacity targets Transmission capacity addition 9th plan 10th plan 11th plan 12th plan (1998-02) (2003-07) (2008-12e) (2013-17e) 733 0 2,734 0 26,344 17,636 47,447 5,428 0 5,206 0 49,278 35,371 95,283 27,500 5,000 0 0 50,000 40,000 122,500
Ludhiana Delhi
NR
Jaipur RAPP Lucknow Partabpur Patna Gandhinagar Korba Bhopal Raipur
Talcker/lb valley Chichen Neck
Guwahati
NER
ER
Kolkata
Pipavav
Indore
Bhubaneswar
WR
Tarapur Mumbai Hydrabad
Transmission lines (ckms) 765 KV 562 HVDC +/- 800 KV 0 HVDC +/- 500 KV 0 HVDC 200kV 162 Monopole 400 KV 13,236 220 KV 17,392 Total 31,352 Substation capacity (MVA) HVDC BTB 500 HVDC Bipole + 1,700 Monopole 765 KV 0 400 KV 19,515 220 KV 32,186 Total 53,901
Vizag Simhadri Coal Krishnapatnam Ennore South Madras Cuddalore Hydro Lignite Coastal Nuclear Load-Centre
SR
Kaiga Bangalore Kozhikode Mangalore
1,000 2,000 2,000 32,562 40,134 77,696
0 6,000 51,000 52,058 73,503 182,561
0 15,000 120,000 80,000 95,000 310,000
Chennai
Kayamkulam Thiruvananthapuram
Kudaokolam
Source: Power Grid
35
abc
Transmission lines built historically
18000 16000 14000 12000 10000 8000 6000 4000 2000 0 FY86 FY88 FY90 FY92 FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 220 KV 400 KV 765 KV +/-500 KV
Transformation capacity built historically
30000 220 KV 25000 20000 15000 10000 5000 0 FY86 FY88 FY90 FY92 FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 400 KV 765 KV +/-500 KV
36
abc
On the road to privatisation

The GoI has been slow to embrace private players in the transmission segment, largely, we believe, due to the apprehension of Power Grid (as the development of National Grid requires systematic planning and too many inexperienced players could jeopardize the efficiency). But after the introduction of the Electricity Act, Power Grid established a Joint Venture (JV) with Tata Power (51% stake) for implementation of transmission system for the Tata Hydro Electric project. Subsequent to the successful implementation of projects under this JV, Power Grid entered into a few more JVs, but with a lesser stake of 24%.
Power Grid JVs % stake Powerlinks Transmission Ltd. (POWERLINKS) Jaypee Powergrid Ltd. (JPL) Torrent Powergrid Ltd. (TPL) Parbati Koldam Transmission Company Ltd. Teestavalley Power Transmission Ltd. North East Transmission Company Ltd. (NETC) National High Power Test Laboratory Pvt. Ltd. Energy Efficiency Services Ltd. Powergrid IL&FS Transmission Pvt. Ltd.
Source: Power Grid annual report
List of original 14 IPTC projects Evacuation System for 1980MW North Karanpura project Talcher Augmentation scheme Evacuation System for 1000MW Maithon RB project Import of NER/ER surplus by NR SR-WR Synchronous Inter-connector Kawas-Navsari 400kV D/C Navsari-Mumbai 400kV D/C Evacuation System for 1320MW Barh-II project Evacuation System for 1000MW Nabinagar project Evacuation System for 3200MW Daripally project Evacuation System for 500MW Koderma project Evacuation System for 1000MW Mejia Ext project Evacuation System for 4000MW Lara project Evacuation System for 1000MW Simhadri Ext project
Source: Project Monitor
The first of these projects Western Region System Strengthening Scheme (WRSSS II) with a cost of INR18bn (transmission line of 1,500km) was awarded to Reliance Power Transmission in late 2007. We expect several such large central transmission projects to come under the private sector during the 12-five-year plan, thus eliminating the monopoly of Power Grid. On similar lines to the central sector, the state sector has also adopted the PPP route and several state transmission projects have been awarded on a BOT basis. Given the weak financial health of most of the state TransCos, we expect the state sector to increasingly invite private players for transmission projects. The increasing size of the generation projects has also led to the development of dedicated transmission lines for end-to-end power transfer. The recent example is the construction of Indias longest private 500kV HVDC line to transfer power from Mundra (Gujarat) to Mohindergarh (Haryana). The 1,000km line is owned by Adani Power Ltd.
49% 26% 26% n/a 26% n/a 50% 50% 50%
After the success of these JVs, the GoI decided to give 100% ownership of transmission projects to the private players (similar to the generation projects) and identified around 14 large transmission lines which were to be developed with private participation through the Independent Private Transmission Company (IPTC) route. The GoI appointed REC and PFC as the nodal agency to award the first four (two each) of such projects costing a total of around INR120bn during the 11th five-year plan.
37
abc
Summary of private participation Type Type 1 Project structure Dedicated power transmission corridors: transmission projects which are set up by IPP to evacuate power JVs with Central Transmission Utility (CTU) or STU for setting up transmission evacuation systems 100% private sector participation Project details Adani Powers INR15bn dedicated 1000km bipolar 500kV HVDC line from its Mundra project in Gujarat to Mohindergarh in Haryana
Transmission capacity growth Transmission 9th plan 10th plan 11th plan 12th plan capacity growth (%) (1998-02) (2003-07) (2008-12e) (2013-17e) Transmission lines 765 KV HVDC +/- 800 KV HVDC +/- 500 KV HVDC 200kV Monopole 400 KV 220 KV Total Substation capacity HVDC BTB HVDC Bipole + Monopole 765 KV 400 KV 220 KV Total
137% n/a 0% n/a 37% 22% 26%
75% n/a 87% 0% 53% 18% 31%
319% n/a 89% 0% 65% 31% 48%
386% n/a 0% 0% 40% 27% 42%
Type 2
Adani Power is developing a 765kV line in a JV with Mahatransco to secure evacuation of power from its upcoming plant in the state
Type 3
Type 4
STU linked BOT projects
1. East West Interconnection System: Awarded to Sterlite Technologies by PFC 2. Transmission system for North Karanpura (2000 MW): Awarded to Reliance Power Transmission by REC 3. Augmentation of Talcher II Transmission system: Awarded to RPTL by REC Haryana Vidyut Prasaran Nigam awarded a INR3.8bn Jhajjar power transmission project to Jhajjar KT Transco, SPV of Kalpataru Power Transmission and Techno Electric and Engineering. The project includes setting up of two 400kV substations and an associated 100km D/C 400 kV transmission line
33% 113% n/a 48% 38% 42%
50% 63% n/a 54% 34% 43%
0% 115% 2550% 56% 47% 70%
0% 134% 226% 55% 41% 70%
We also highlight the intended use of the transmission capex planned at both the state and the central level. Of the various participants in this plan, we believe that Power Grid is on track to invest its intended INR550bn by FY12e.
Transmission capex end use
11th plan (FY08-12) so far so good

After steady growth in the transmission capacity over the last few five-year plans, the 11th plan brought in a material step change in addition targets. The plan aimed to increase the size of the transmission network in India by c50% (versus c25% growth seen in previous plans) and transformation capacity by c70% (versus c35% growth seen in previous plans), with greater emphasis on 765kV AC lines and 500kV HVDC lines. India planned to invest a total of around INR1,400bn on transmission during the 11th plan, with the state sector contributing around INR650bn and the rest coming from the central and the private sector. We highlight the original 11th plan transmission outlay on the following page.
Central sector (11th plan)
Fund estimates (INRbn) 592 80 70 8 750 Fund estimates (INRbn) 144 288 60
11th plan transmission schemes for central sector generation capacity requiring inter-state transmission Transmission schemes for IPP generation capacity seeking open access from CTU Spill over from 10th plan and advance action for 12th plan Other related important schemes in the central sector Total central sector State sector (11th plan)
11th plan transmission schemes for state sector & IPP generation capacity requiring inter-state transmission STU transmission schemes at 220kV, 132kV and 66kV Transmission schemes for 220kV, 132kV and 66kV system in the states of Assam, Nagaland, Bihar, Jharkhand, Goa and UP Spill over from 10th plan and advance action for 12th plan Other related important schemes in the state sector Total state sector
78 80 650
38
abc
Transmission capex 11th five-year plan Utilities State Sector: Northern Region (N.R.) Chandigarh DTL HPSEB HVPN PDD,J&K PSEB RVPN UPPCL Uttarakhand Total N.R. Western Region (W.R.) CSEB GETCO GOA MPPTCL MSETCL D&D DNH Total W.R. Southern Region (S.R.) APTRANSCO KPTCL KSEB TNEB Puducherry Total S.R. Eastern Region (S.R.) BSEB OPTCL JSEB WBSEB Sikkim Total E.R. North-Eastern Region (NER) Arunachal ASEB Manipur MeSEB Mizoram Nagaland Tripura Total NER Total State Sector Central Sector: PGCIL JV with PGCIL DVC Private bidders Total Central Sector Total All India
_____________ Proposed transmission works (INRm)______________ FY08 FY09 FY10 FY11 FY12
Total
120 3,750 3,000 430 2,050 1,850 4,480 5,620 1,000 22,300
40 5,950 2,390 1,270 2,000 2,410 6,400 4,250 1,500 26,210
40 5,410 3,950 2,360 1,040 3,100 8,430 4,250 2,000 30,580
60 3,780 2,100 1,280 4,000 3,780 7,100 5,500 2,500 30,100
70 1,170 850 200 4,350 4,210 6,300 6,500 2,500 26,150
330 20,060 12,290 5,540 13,440 15,350 32,710 26,120 9,500 135,340
5,530 390 350 3,460 5,810 20 30 15,590
11,850 2,650 420 6,970 11,170 30 230 33,320
13,920 3,050 450 7,150 28,000 310 270 53,150
7,740 360 450 4,520 25,070 150 300 38,590
1,770 1,000 500 1,260 18,360 20 10 22,920
40,810 7,450 2,170 23,360 88,410 530 840 163,570
7,440 11,890 2,500 17,020 320 39,170
8,970 12,980 3,000 16,660 510 42,120
9,460 4,470 3,500 2,680 490 20,600
7,660 2,180 4,000 4,780 550 19,170
9,090 3,750 4,500 12,170 560 30,070
42,620 35,270 17,500 53,310 2,430 151,130
5,000 6,600 1,550 1,420 6,380 20,950
5,500 4,050 3,190 2,040 25,880 40,660
6,000 2,460 2,200 14,260 29,190 54,110
6,500 1,280 1,930 2,870 13,000 25,580
7,000 930 1,450 3,090 6,500 18,970
30,540 15,320 10,320 23,680 80,950 160,810
1,070 1,120 300 1,290 860 930 260 5,830 103,840
1,290 2,940 350 1,470 520 1,140 550 8,260 150,570
1,740 4,430 400 1,060 190 140 600 8,560 167,000
2,430 4,780 450 720 190 0 650 9,220 122,660
1,930 3,410 570 570 200 0 670 7,350 105,460
8,460 16,680 2,070 5,110 1,960 2,210 2,730 39,220 650,070
64,650 350 1,020 25,000 91,020 194,860
110,140 1,670 4,280 30,000 146,090 296,660
130,840 1,200 3,670 40,000 175,710 342,710
130,090 680 3,790 45,000 179,560 302,220
109,790 420 4,180 50,000 164,390 269,850
545,510 4,320 16,940 190,000 756,770 1,406,840
39
abc
Transmission line achievable vs target Transmission lines addition (CKM) Central Sector: 765 KV +/- 500 KV 400 KV 220 KV Total State Sector: 765 KV +/- 500 KV D/C 400 KV 220 KV Total Total additions: 765 KV +/- 500 KV D/C 400 KV 220 KV Total Completion vs target
FY08
FY09
FY10
FY11e
FY12e
____________ 11th plan ___________ Achievable Target Slippage 2,646 2,880 33,236 1,667 40,429
370 120 5,688 381 6,559
564 1,180 5,120 241 7,105
318 1,580 8,811 955 11,664
501 0 9,354 56 9,911
893 0 4,263 34 5,190
0 0 1,259 3,779 5,038
0 0 1,707 3,930 5,637
0 0 5,508 11,462 16,970
0 0 5,396 7,492 12,888
1,345 0 8,685 2,247 12,277
1,345 0 22,555 28,910 52,810
370 120 6,947 4,160 11,597 12%
564 1,180 6,827 4,171 12,742 13%
318 1,580 14,319 12,417 28,634 30%
501 0 14,750 7,548 22,799 24%
2,238 0 12,948 2,281 17,467 18%
3,991 2,880 55,791 30,577 93,239
5,428 5,206 49,278 35,371 95,283
26% 45% 0% 14% 21%
Substation: achievable vs target Substation capacity (MVA) Central Sector: 765 KV 500 KV HVDC/BTB 400 KV 220 KV Total State Sector: 765 KV 500 KV HVDC/BTB 400 KV 220 KV Total Total additions: 765 KV 500 KV HVDC/BTB 400 KV 220 KV Total Completion vs target
FY08
FY09
FY10
FY11e
FY12e
____________ 11th plan ___________ Achievable Target Slippage 10,500 3,000 28,905 2,380 44,785
4,500 500 8,375 200 13,575
0 0 6,930 200 7,130
0 2,500 6,615 1,060 10,175
0 0 2,205 920 3,125
6,000 0 4,780 0 10,780
0 0 1,890 9,458 11,348
0 0 1,065 11,034 12,099
0 0 6,300 10,301 16,601
0 0 13,860 13,751 27,611
10,500 0 9,355 3,480 23,335
10,500 0 32,470 48,024 90,994
4,500 500 10,265 9,658 24,923 14%
0 0 7,995 11,234 19,229 11%
0 2,500 12,915 11,361 26,776 15%
0 0 16,065 14,671 30,736 17%
16,500 0 14,135 3,480 34,115 19%
21,000 3,000 61,375 50,404 135,779
51,000 6,000 52,058 73,503 182,561
59% 50% 0% 31% 35%
40
abc
PGCIL Capex pattern 11th plan INRm FY08 FY09 FY10 FY11e FY12e Total
Source: Power Grid, HSBC Research
Transmission capacity development % spent 12% 15% 20% 22% 31% 100% 8th plan 9th plan 10th plan 11th plan 12th plan (93-97) (98-02) (03-07) (08-12e) (13-17e) Transmission lines (ckms) 765 KV 409 971 1,704 7,132 34,632 HVDC +/- 800 KV 0 0 0 0 5,000 HVDC +/- 500 KV 3,138 3,138 5,872 11,078 11,078 HVDC 200kV 0 162 162 162 162 Monopole 400 KV 36,142 49,378 75,722 125,000 175,000 220 KV 79,601 96,993 114,629 150,000 190,000 Total 119,290 150,642 198,089 293,372 415,872 Substation capacity (MVA) HVDC BTB 1,500 2,000 3,000 3,000 3,000 HVDC Bipole 1,500 3,200 5,200 11,200 26,200 + Monopole 765 KV 0 0 2,000 53,000 173,000 400 KV 40,865 60,380 92,942 145,000 225,000 220 KV 84,177 116,363 156,497 230,000 325,000 Total 128,042 181,943 259,639 442,200 752,200
66,560 81,670 106,170 119,000 167,000 540,400
However, our analysis of the transmission work completed to date (both transmission lines and substation capacity) and the pipeline for FY1112e suggests that there has been a slippage of c25% compared with the initial target. We believe most of this slippage has come from the private and the state sector. We expect most of the slippage in the transmission projects to fall in FY13 and expect the orders for the same to flow in FY11-12.
12th plan (FY13-17e) the dream just got bigger

The 12th plan will mark another step change in the transmission capacity targets compared with the current plan. Moreover, as we have highlighted in the table, the focus of the 12th plan is clearly on the development of high capacity, highly efficient, long distance transmission lines. Although currently not included in the 12th plan base paper, we believe that the period may also see the successful deployment of UHVAC 1200kV transmission lines in India (one of the most superior transmission technologies in the world).
Given the focus on superior technology, the 12th plan transmission budget of around INR2,400bn is almost double the size of 11th plan budget of around INR1,400bn. Of the 12th plan budget, around INR1,000bn is expected to come from the state sector whereas the rest should come from the central and the private sector. Power Grid (PGCIL) has recently stated its intent to invest around INR1,200bn in transmission projects during the 12th plan, which leaves investment of only around INR200bn from the private sector. We believe that this is an exceptionally low investment level for the private sector (given that it was the target in the 11th plan), so either the private sector will share a large chunk of the PGCILs intended investment or there remains an upside to the total expected investment of INR 2,400bn. Either way, the transmission segment will continue to enjoy significant investment in the foreseeable future, benefiting several players in the value chain.
41
abc
HCPTC HCPTCs HCPTC I HCPTC II HCPTC III HCPTC IV HCPTC V HCPTC VI HCPTC VII HCPTC VIII HCPTC IX Total IPP regions Orissa Jharkhand Sikkim Chhattisgarh and MP Chhattisgarh Andhra Pradesh Tamil Nadu Andhra Pradesh Southern Region Planned investment Installed capacity (INRm) (MW) 875,200 570,900 130,400 124,300 2,882,400 206,500 235,700 298,600 482,100 5,806,100 10,090 4,540 2,358 4,370 15,485 4,600 2,600 3,960 11,526 59,529 ____________ Target beneficiaries _____________ NR WR ER SR Total 3,315 2,340 225 200 6,080 2,264 1,170 650 0 4,084 ____________________ n/a_____________________ 1,318 2,843 0 0 4,160 6,204 8,681 0 300 15,185 1,258 912 0 857 3,027 425 516 0 1,104 2,045 320 1,000 0 2,440 3,760 2,153 2,628 0 4,401 9,182 17,257 20,090 875 9,302 47,523
Source: Power Grid, HSBC research
The road ahead for orders

In this section, we forecast the potential orders from the transmission players (i.e. asset owners) to the transmission vendors over the next five to six years. For the purpose of this analysis, we have analysed the following sources for transmission orders.
Major drivers
1. High capacity power transmission corridors (HCPTCs)
Orders related to High Capacity Power Transmission Corridors (HCPTCs) Orders from the 12th plan outlay excluding the investment in HCPTC
Minor drivers
Pursuant to the introduction of Long Term Open Access (LTOA) in the interstate transmission system, Power Grid granted open access to over 90 applicants. Most of the generation projects related to these LTOA applications are concentrated in small pockets in areas like pithead in Orissa, Chhattisgarh, Jharkhand or coastal sites with port facilities in Andhra Pradesh, Tamil Nadu or hydel sites in Sikkim etc. These projects are likely to add generation capacity of around 49GW of which LTOA has been sought for around 42GW. To meet the evacuation requirement of these LTOAs, PGCIL has planned the construction of nine high capacity power transmission corridors, requiring a total investment of around INR580bn. Power Grid has highlighted that they intend to execute HCPTCs on their own without any private participation. Given the commissioning timelines associated with the respective generation projects, we expect the bulk of orders from these projects to flow in FY12 and FY13. We highlight the aggregate commissioning schedule of the related IPP projects in the table that follows. Assuming that these generation projects will see a delay of around one year on average and the transmission equipment orders will start flowing around 15 months ahead of the commissioning
Orders related to 11th plan slippage to FY13e Orders remaining for transmission capacity coming in FY12e Orders remaining from the Power Grid during the 11th plan Orders related to the 13th plan transmission outlay
Commissioning schedule Date of commissioning FY10 FY11 FY12 FY13 FY14 FY15 Total
Source: Power Grid, HSBC research
Generation capacity (MW) 3,365 4,680 25,567 16,037 7,680 2,200 59,529
As % total 6% 8% 43% 27% 13% 4% 100%
42
abc
date, we forecast that of the total HCPTC orders, c70% will flow in FY12-13 and the remaining 30% in FY14.
2. 12th plan investment ex-HCPTC
3. 11th plan slippage
As we have highlighted above, the total investment in the 12th plan (based on the 12th plan base paper) is expected to be around INR2,400bn. We note that this expenditure also includes the proposed investment in the HCPTCs. The reason why we have tried to forecast the order flow separately for HCPTC and the remaining 12th plan investment is because we believe that the timing of the HCPTC investment is going to be different from the usual trend seen in transmission capex in any five-year plan (i.e. investment typically skewed towards the end). We have also assumed that c10% of the 12th plan investment exHCPTC will slip to the 13th plan, implying that other than the investment in HCPTCs, we will see an investment of around INR1,640bn in transmission during the 12th plan. We highlight our assumptions below. We have taken the investment pattern of PGCIL during the 11th plan as the proxy for investment pattern in the 12th plan and assuming an average 18 months lead in ordering transmission equipment, we have arrived at the following order flow pertaining to the investment of aforementioned investment of INR1,640bn.
Derived order pattern for 12th plan capex ex-HCPTC INRm FY11e FY12e FY13e FY14e FY15e FY16e FY17e Total
As we have highlighted earlier, our analysis of the transmission works to date and the pipeline for FY11-12e suggests that there has been a slippage of c25-30% compared with the original transmission capacity addition target in the11th plan. We estimate this slippage to be around INR240bn compared with the total targeted investment of around INR1,400bn in the 11th plan. We expect most of this slippage in the transmission projects to materialise in FY13 and expect the orders for the same to flow in FY1112. Due to the lack of information, we have assumed that c75% of the orders related to this slippage will come in FY12 and the remaining 25% will come in FY11.
4. Orders remaining for transmission capacity planned for FY12
Our analysis of the on-going transmission work and the capacity planned for FY12 suggests that around 18-20% of the 11th plan capacity addition target will materialise in FY12. Assuming a lead time of around 15-18 months in ordering transmission equipment, we believe that around 75% of this investment will be ordered in FY11, resulting in orders of around INR195bn. We highlight details of the FY12 capacity addition plan in in the tables on the following pages.
Capex: 12th plan INRm
% spent 6% 14% 17% 21% 26% 15% 0% 100%
100,875 224,649 284,680 341,255 433,446 253,096 0 1,638,000
Total Capex HCPTC Capex ex-HCPTC Slippage assumption Net capex ex-HCPTC
2,400,000 580,000 1,820,000 10% 1,638,000
43
abc
5. Remaining orders from Power Grid in the 11th plan
6. Orders related to the 13th plan
Of its original investment plan of around INR550bn in the 11th plan, Power Grid spent around INR255bn during the first three years of the plan (FY08-10). Of the remaining capex, the company plans to invest around INR119bn in FY11e and around INR167bn in FY12e. In line with our earlier lead time assumptions, we believe that c50% of the FY12e investment will be ordered in FY11e with nothing from the 11th plan capex being ordered during FY12e.
Due to the lack of information we have assumed that the 13th plan (FY18-22e) investment in transmission will be around 50% higher compared with the 12th plan expenditure (assuming an inflation rate of c7%). This implies a total investment of around INR3,600bn during the 13th plan. Assuming a similar order pattern as the 12th plan, we expect c20% of this investment to be ordered during FY16-17e.
Derived order pattern for 13th plan INRm FY16e FY17e FY18e FY19e FY20e FY21e FY22e Total
% spent 6% 14% 17% 21% 26% 15% 0% 100%
221,702 493,734 625,670 750,011 952,628 556,255 0 3,600,000
44
abc
Transmission lines (km) addition in FY12 No. of circuits Central sector: 765KV System for Central Part of Northern Grid PART-I Western Region Strengthening Scheme X Western Region Strengthening Scheme XI Total 765 KV lines URI II HEP Trans. System Transmission System Associated with Chamera-III HEP Northern Region System Strengthening Scheme IX Northern Region System Strengthening Scheme XV Northern Region System Strengthening Scheme XVII Northern Region System Strengthening Scheme XVIII Northern Region System Strengthening Scheme XIX System Strengthening in Northern Region Grid for Karcham-WangtooHEP Trans. System Associated with RAMPUR HEP. Northern Region System Strengthening Scheme XIII 765KV System for Central Part of Northern Grid PART-I Trans. System Associated with KORBA III Western Region Stregthening Scheme X Western Region Stregthening Scheme XI Trans. System Assciated with Tuticorin TPS ( JV) System Strengthening -IX of SR System Strengthening -XI of SR Trans. System Associated with FARAKKA III North East / Northern Western Interconnector -I Project Total 400 KV lines Trans. System associated with Chamera III HEP Total 220 KV lines Total Central sector addition State Sector: Uttar Pradesh (UPPCL) Total 765 KV lines Rajasthan (RVPN) Uttar Pradesh (UPPCL) Uttarakhand (UPTCL) Chhattisgarh (CSEB) Maharashtra (MSEB) Madhya Pradesh Andhra Pradesh (APTRANSCO) North Chennai TPS Mettur TPS Orissa (OPTCL) Jharkhand (JSEB) West Bengal (WBSETC) Total 400 KV lines Himachal Pradesh (HPSEB) Chhattisgarh (CSEB) Gujarat Madhya Pradesh (MPPTCL) Maharashtra (MSETCL) Andhra Pradesh (APTRANSCO) Jharkhand (JSEB) West Bengal (WBSETC) Total 220 KV lines Total State sector addition Total addition in FY12
Total length (km) 855 14 24 893 114 308 788 315 320 340 144 300 230 38 10 430 14 24 316 200 104 214 54 4,263 34 34 5,190
Completion target Feb-12 Feb-12 Feb-12
S/C S/C S/C
S/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C
May-11 Jul-11 Jul-11 Nov-11 Aug-11 Nov-11 Feb-12 Sep-11 Nov-11 Nov-11 Feb-12 Jun-11 Feb-12 Feb-12 Feb-12 Feb-12 Jul-11 Jun-11 Jun-11
S/C
Jul-11
D/C and S/C
1,345 1,345 1,530 230 352 1,330 1,196 830 1,187 N/A N/A 100 450 1,480 8,685 415 178 260 125 672 127 70 400 2,247 12,277 17,467
Dec-11
D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C D/C
Dec-11 Dec-11 Jun-11 Jul-11 Mar-12 Mar-12 Mar-12 Mar-12 Mar-12 Mar-12 Jun-12 Mar-12
D/C D/C D/C D/C D/C D/C D/C D/C
Mar-12 Jul-11 Nov-11 Mar-12 Mar-12 Nov-11 Jul-11 Mar-12
45
abc
Transformer capacity (MVA) addition in FY12 Substation capacity additions (MVA) Central sector: Western Region System Strengthening Scheme X Western Region System Strengthening Scheme XI Total 765/400 KV substations Northern Region System Strengthening Scheme XV Northern Region System Strengthening Scheme XVIII Northern Region System Strengthening Scheme XIX Transmission System Associated with RAMPUR HEP Northern Region System Strengthening Scheme XIII Transmission System Associated with KORBA III System Strenthening XI of SR Total 400/220 KV substations Total Central sector addition State Sector: Uttar Pradesh (UPPCL) Maharashtra Total 765/400 KV substations Rajasthan (RVPN) Uttar Pradesh (UPPCL) Maharashtra (MSEB) Madhya Pradesh Andhra Pradesh (APTRANSCO) Tamil Nadu Orissa (OPTCL) Total 400/220 KV substations Himachal Pradesh (HPSEB) Chhattisgarh (CSEB) Madhya Pradesh (MPPTCL) Maharashtra (MSETCL) Andhra Pradesh (APTRANSCO) Tamil Nadu Jharkhand (JSEB) Orissa West Bengal (WBSETC) Total 220/132/33 KV substations Total State Sector addition Total addition in FY12
Voltage ratio
Total capacity (MW/MVA) 3,000 3,000 6,000 1,890 1,260 N/A N/A 1,000 N/A 630 4,780 10,780
Completion target
765/400 765/400
Feb-12 Feb-12
400/220 400/220 400/220 400/220 400/220 400/220 400/220
Nov-11 Nov-11 Feb-12 Nov-11 Nov-11 Jun-11 Jul-11
765/400 765/400
7,000 3,500 10,500 1,000 315 3,000 1,260 630 1,260 1,890 9,355 310 160 320 250 600 300 300 600 640 3,480 23,335 34,115
Dec-11 Mar-12
400/220 400/220 400/220 400/220 400/220 400/220 400/220
Dec-11 Mar-12 Mar-12 Mar-12 Jun-11 Mar-12 Mar-12
220/132 220/132 220/132 220/33 220/132 220/132 220/132 220/132 220/132
Mar-12 Dec-11 Mar-12 Mar-12 Nov-11 Mar-12 Jul-11 Jun-11 Mar-12
46
abc
Aggregating the orders from the above six sources and adjusting for the interest during construction (IDC), we arrive at the order flow pattern as highlighted below. We forecast significant growth of c45-50% in orders during FY12 and then a decline in growth to a more modest level of c10% in FY13.
Total orders Year FY09e FY10e FY11e FY12e FY13e FY14e FY15e FY16e FY17e Total
Our channel checks suggest that while the transmission line cost breakdown is broadly similar across different voltage levels, the substation cost breakdown can vary significantly as we move from a 400/220kV substation to a 765/400kV substation. We highlight the average cost breakdown in the tables below.
INRm 241,875 307,218 393,638 577,904 632,680 515,255 433,446 520,298 630,234 3,703,455
Exp ex IDC 200,756 254,991 326,719 479,660 525,124 427,662 359,760 431,848 523,094 3,073,868
% Growth 27% 28% 47% 9% -19% -16% 20% 21%
Transmission line cost breakdown Clearances Design & testing Tower & accessories Conductor and ground wiring Insulators Civil work / erection Total cost
0.5% 0.5% 35.0% 35.0% 10.0% 19.0% 100.0%
Substation cost breakdown Common ground works
400/220 KV 20.0% 20.0% 10.0% 30.0% 20.0% 100.0%
Where do these orders flow into?

The orders related to investments in transmission flow into two main areas:
1 2
Power transformers Shunt reactors 400 KV bay & equipment 200 KV bay & equipment Total cost
Transmission line capex (including conductors) Substation and related equipment
Substation cost breakdown Common ground works Power Transformers Shunt reactors 765 KV bay & equipment 400 KV bay & equipment 200 KV bay & equipment Steel structures Civil works Total cost
765/400/220 KV 6.0% 55.0% 14.0% 12.0% 6.0% 2.0% 2.0% 3.0% 100.0%
If we assume that the technological scope/profile of the nine HCPTCs is similar to the wider grid development proposed during the 12th and the 13th plan, then transmission lines & towers should account for c60% of the investment in transmission while substations & related equipment should account for the remaining 40%.
Planned spends for HCPTC corridors INRm HCPTC-1 HCPTC-2 HCPTC-3 HCPTC-4 HCPTC-5 HCPTC-6 HCPTC-7 HCPTC-8 HCPTC-9 Total % of total cost
Total cost, with IDC 87,520 57,090 13,040 12,430 288,240 20,650 23,570 29,860 48,210 580,610
Total cost, ex. IDC 74,805 48,795 11,207 10,620 246,361 17,650 20,145 25,520 41,205 496,308
Total cost for substations 12,510 7,920 3,810 1,950 87,440 2,470 2,700 3,860 6,890 129,550 26.1%
Total cost for Reactors/ transformers 16,800 8,700 200 2,500 22,500 3,100 300 3,600 8,400 66,100 13.3%
Total cost for transmission lines 45,495 32,175 7,197 6,170 136,421 12,080 17,145 18,060 25,915 300,658 60.6%
47
abc
Transmission equipment cost breakup

Transmission line c Substation capex 60% 40% Tower & accessories Conductor and ground wiring Insulators Civil work / Erection / Design / Testing / Clearanc 35% 35% 10% 20% Power Transformers Shunt reactors Common ground works Bays & equipments 765/400 KV 400/220/132 KV 67% 33% Power Transformers Shunt reactors Common ground works Bays & equipments 20% 10% 20% 50% 55% 14% 11% 20%
Voltage level - FY Capacity 765 KV 45% 400 KV 25% 220 KV 30% Total 100% Share of orders Tower EPCs Substation equipm
No. of Units 15% 25% 60% 100%
Expenditure 67% 15% 18% 100%
Power Transformers Shunt reactors Common ground works Bays & equipments
44% 13% 14% 30%
43% 40%
Our analysis of the substation capacity planned during the 12th plan suggest that c45% of the transformation capacity addition will be 765kV AC and HVDC based while the remaining 55% addition will be 400/220/132kV AC based. Using the cost breakdown as highlighted and the proposed capacity for different transmission voltage level, we break down the transmission capex/orders into key components as we show below. Overall, we forecast that c43% of the total transmission orders will flow to transmission line EPC contractors & tower companies, c17% will flow to conductor manufacturers and the remaining 40% to substation vendors. Assuming c18 months lead time for the transmission (tower) EPC orders and c12 months lead time for substation equipment (transformers, reactors, etc) orders, we arrive at the order flow pattern as highlighted below.
Transmission capacity split (%) 9th plan 10th plan 11th plan 12th plan (98-02) (03-07) (08-12e) (13-17e) Transmission lines 765 KV HVDC +/- 800 KV HVDC +/- 500 KV HVDC 200kV Monopole 400 KV 220 KV Total Substation capacity HVDC BTB HVDC Bipole + Monopole 765 KV 400 KV 220 KV Total
2% 0% 0% 1% 42% 55% 100%
2% 0% 6% 0% 56% 37% 100%
6% 0% 5% 0% 52% 37% 100%
22% 4% 0% 0% 41% 33% 100%
1% 3% 0% 36% 60% 100%
1% 3% 3% 42% 52% 100%
0% 3% 28% 29% 40% 100%
0% 5% 39% 26% 31% 100%
Potential orders Potential orders FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 Total Tower EPC contractors 110,156 141,143 207,213 226,854 184,750 155,416 186,558 225,977 1,327,911 Growth Substation (%) vendors 28% 47% 9% -19% -16% 20% 21% 91,150 116,342 161,276 200,957 190,557 157,484 158,321 190,988 1,175,926 Growth (%) 28% 39% 25% -5% -17% 1% 21%
48
abc
Intl transmission A USD400bn opportunity

International transmission markets present a USD400bn
opportunity over the next five years

Africa and the Middle East remain the key markets for our
companies, but they are aggressively expanding in Americas

Increasing exposure to international markets in our opinion bodes
well for sectors profitability
Big opportunity but limited presence

The world is going to see significant investment in the transmission sector over the next 20 years, driven by upgrade requirements in the West and capacity ramp-up in the East. According to industry estimates, close to USD1.7trn will be invested in the transmission capacity over the next 20 years. The presence in the international markets not only provides an opportunity for Indian companies to tap international avenues for growth but also helps them improve their operating margins, as
international orders typically offer a higher spread to compensate for the raw material price risk. The contracts awarded in these geographies may range from turnkey orders for setting up a new transmission lines (60KV/220KV/400KV) to refurbishment of parts existing transmission lines. We note that although the global opportunity is big, most of the companies under our coverage have limited geographic exposure in the international power transmission market. In terms of presence, our companies are particularly strong in emerging markets, such as the Middle East and
Global investment trends in power sector 2015-30 Geography North America Europe Pacific E. Europe/Eurasia Asia Middle East Africa Latin America Total
Source: Company data; HSBC research
_______________ Year 2007-15 (USDbn)_______________ _______________Year 2016-30 (USDbn) ______________ Capacity (GW) Generation Transmission Distribution Capacity (GW) Generation Transmission Distribution 215 221 78 137 781 78 59 121 1691 379 457 146 180 794 59 59 123 2197 121 93 65 55 433 32 28 41 867 260 281 115 183 894 67 58 84 1941 480 465 163 159 1,170 160 91 149 2837 1136 1048 283 274 1,379 135 159 230 4644 238 94 71 51 596 71 47 72 1239 512 286 124 173 1,231 146 97 148 2716
49
abc
Global investment in T&D over next 5 years
450 400 350 300 250 200 150 100 50 0 America Europe Africa Middle East Asia ANZ China Total 89 107 13 15 9 90 399 76
Africa, and are gaining increasing traction in certain western regions, such as North & South America. Industry sources indicate that over the next five years, there is an opportunity worth USD400bn in the international markets for the power transmission players. Of this total, around USD118bn is available in the Asian, Middle Eastern and African regions. Given the relative importance of the transmission market in Middle East and Africa to our companies, we discuss in detail the dynamics of these markets and opportunities available there.
Order pipeline in Middle East and Africa Country Client No of projects 2 1 1 1 2 1 5 4 1 2 1 3 2 Approx length (km) 22 88 279 185 477 169 870 292 108 556 83 1,181 488 Approx cost (USDm) NA NA 64 63 100 18 NA 241 22 268 NA NA 290
Africa
Electricity for the few
The African continent, which accounts for c13% of the world population, consumes only c6% of the worlds energy and c3% of the worlds electricity generated. (Source: SADC Infrastructure report September 2009) The per capita energy consumption for Africa is only c0.6MWh as compared with the world average of c2.6MWh. Furthermore, the access to electricity in the region is very low, averaging c30% and varying from c7% in certain regions (Malawi, DRC) to over 70% in others (South Africa, Mauritius) as compared with the global average of c75%.
Power generation sub-optimal

Most of the power produced in Africa is from thermal power stations (c82%) which are primarily located in South Africa, North Africa and Nigeria. The contribution of hydroelectricity is c15% while the remainder comes from the only nuclear power facility located in the Cape Town in South Africa. Apart from this, West Africa is focused on generating electricity from natural gas and there are also several renewable plants (solar, wind) operational in different countries.
Abu Dhabi Cambodia Congo Egypt Kenya Mozambique Nigeria Oman Philippines Saudi Arabia South Africa Tanzania Ukraine
Transco EDC DRC EETC KEITRACO EdM PHCN OETC NGCP SEC ESKOM MCA NPC
50
abc
Most of the utilities are government owned with little participation from the private players. Also, even though there are abundant resources for power generation in Africa, the utilisation of these resources is sub-optimal due to the lack of proper transportation infrastructure.
the aim of ensuring the well being and improving the standard of living and quality of life for the people of southern Africa. SADC has a membership of 15 member states Angola, Botswana, Democratic Republic of Congo (DRC), Lesotho, Madagascar, Malawi, Mauritius, Mozambique, Namibia, Seychelles, South Africa, Swaziland, United Republic of Tanzania, Zambia and Zimbabwe. Southern African Power Pool (SAPP): SAPP was established in 1995 with the primary aim to provide reliable and economical electricity supply to the consumers of each of the SAPP members, consistent with the reasonable utilisation of natural resources and the effect on the environment. It has 12 members, of which eight are operating members and one is an observer member (HCB Cahora Bassa of Mozambique). The 12 members of the SAPP are: South Africa, Botswana, Swaziland, Mozambique, Lesotho, Namibia Zimbabwe, Zambia, Angola, DRCongo, Malawi and Tanzania. Members are national utilities, but this is being revised to include other participants in future. Regional Electricity Regulators Association of South Africa (RERA): The organization was established in July 2002 with the aim of ensuring a consistent and harmonized regulatory framework in the energy sector within the SADC region.
Electricity demand on the rise

We expect continued investment in the power sector in Africa, driven by the increasing demand for electricity and the need for optimizing resource utilization. Some of the main drivers for electricity demand and/or investments in the power related assets, in our opinion, are: Relatively high economic growth of c5% in most of the Southern African Development Community (SADC) countries leading to higher demand for energy. Increasing demand for metals, leading to the establishment of new mining companies in the SADC region. This in turn will lead to increasing demand for power. Inadequate investment in generation and transmission infrastructure over the last 20 years. Electrification programs during the last decade have led higher consumption of and thus higher domestic demand for electricity.
The power toolkit

Organisations leading the development in Africa
Southern African Development Community (SADC): SADC was established in 1992, with
Ongoing projects in Africa Project Zambia Tanzania Kenya Interconnection project Mozambique Malawi Interconnection project Zimbabwe Zambia Botswana Namibia (ZIZABONA) Interconnection project Mozambique backbone transmission project Westcor Project
Source: SADC
Details Interconnection of Tanzania to SAPP and to facilitate power sharing with East Africa Financing through World Bank being considered for both Malawi and Mozambique Project progressing well. Inter-governmental MoU has been drafted and is being finalized. Project implementation to begin after closure of joint development agreement between utilities Awaiting No objection decision from the World Bank. Selection of project consultants yet to be done Project was derailed in 2007-08 due to policy inconsistencies. Efforts are being made to accelerate implementation
51
abc
Planned interregional transmission projects Africa
Rwanda
2010 2011: ZIZABONA 220/330 kV 2012: Mozambique Malawi 2014: Zambia Tanzania 400 kV 2015: DRC Angola 400 kV
Democratic Republic of Congo
Burundi
Tanzania
Angola
Malawi Zambia Mozambique
2015: MOZAMBIQUE BACKBONE - RSA 2015 - 2025: 765 kV Strengthening 2015: RSA Strengthening 2015: Botswana Strengthening
Namibia
Botswana
Zimbabwe
Swaziland South Africa Lesotho
Source: SADC
Inter-regional transmission projects key to growth

There are several inter-regional or inter-country projects which are in pipeline for the next five years (see chart). We believe that these projects are critical for the development of transmission infrastructure in Africa as these will enable the non-connected members of SAPP to get connected. This would in turn facilitate trading among member countries and relieve the congestion in transmission. According to the SADC infrastructure report, published in September 2009, it is estimated that an investment to the tune of cUSD5.6bn would be required to implement the crucial transmission line projects outlined in the map above. On an overall basis, industry sources suggest that the transmission and distribution investment in Africa over the next five years is likely to be cUSD13bn for the entire continent. Over the subsequent 15 years (FY15-30), the transmission investment is estimated to be cUSD47bn.
We highlight details relating to some of the ongoing projects in the table below.
Stock presence in Africa

Within our coverage universe all the seven companies have exposure to the African transmission market, but five of them Jyoti Structures, KEC International, Kalpataru Power, Areva T&D and Crompton Greaves have a relatively high (mid single-to-low double digit) exposure.
Middle East
Powering through
The Middle East power sector has seen significant growth over the last few years. This has been primarily driven by various government subsidies, industrialization and growth in the residential sector. Among the various countries in the Middle East, the countries which represent the fastest growing power sector within the region include Iran, Oman, UAE (United Arab Emirates), Saudi Arabia and Jordan. The primary reason for high growth in these countries is because their governments have
52
abc
liberalised their power policies and are in the process of formulating strategy for the privatization of the sector.
Privatization in the offing
Most of the countries in the Middle East are at the cusp of privatizing at least some part of the power sector. We believe that privatization will have a three fold benefit:
1
The Middle East accounts for c3-4% of the global power generation. Out of the total generation capacity, c57% of the power generation is gas based, c36% is oil based, while the remaining 8% is based on other resources including, but not limited to, coal. According to the United Arab Emirates (UAE) Power Report in 1Q FY10, the Middle Eastern and African regional power generation is expected to increase to c1,523tWh (terawatt-hours), representing an increase of c29.3%, over the period of 2008-13. We note that the demand for power in the region has been growing at c6% y-o-y over the past decade. (Source: Middle East Electricity website).
It will lead to a rapid strengthening of the power infrastructure It will result in the efficient management of transmission and distribution network It should eventually establish a balance between power supply and demand dynamics in the region.
A large regional grid in the making

GCC interconnection project
Generation capacity to grow steadily over the next 3 years

According to BP statistical review of World Energy in June 2008, Saudi Arabia and Iran are the largest power generation markets in the Middle East, together accounting for more than 55% of the power generated in the region in 2007.
The Gulf Cooperation Council (GCC) is carrying out the GCC interconnect project to interconnect six countries in the Middle East, namely, Saudi Arabia, Qatar, Bahrain, Oman, Kuwait and UAE. This has been done with the objective of supplying electricity during emergencies, reducing generation reserves for the countries, improve efficiency and providing a basis for electric power exchange.
Middle East power generation & dependence on fuel Generation TWh

Saudi Arabia Egypt UAE Kuwait Algeria Syria Iraq Libya Morocco Qatar Oman Tunisia Bahrain Jordan Lebanon Sudan Yemen Mauritania Total
Source: Middle East Economic Survey
Gas (%)
48 73 95 13 100 50 10 20 100 85 90 90 75 80 Neg -
Oil (%)
52 13 5 87 Neg 30 80 80 15 10 10 25 20 50 100 -
Other (%)
Neg 14 Neg Neg Neg 20 10 Neg Coal Neg 50 Neg -
Gas
90.24 79.57 59.85 6.24 35 18.5 3.1 4.8 16 14.45 11.7 9 8.25 8 0
Oil
97.76 14.17 3.15 41.76 11.1 24.8 19.2
Other
15.26
188 109 63 48 35 37 31 24 19 16 17 13 10 11 10 5 6 1 643
7.4 3.1 19
2.55 1.3 1 2.75 2 2.5 6
2.5 1
53
abc
Phase I of the grid connecting Saudi Arabia, Qatar, Bahrain and Kuwait) is complete and began operations in 2009, supplying c1.5GW to the region. The cost of the Phase I was cUSD1.2bn and Saudi Arabia funded c40% of this cost. Phase II will connect the UAE to Oman and is expected to be completed in 2011. Phase III will link the first two sections of the grid. The map on the previous page shows the phases of implementation along with the route.
Future electricity demand (GW) 2006

Arab World Arab/ World %
Source: Middle East Economic Survey
2015
233 5,652 4.1%
2030
500 5,875 8.5%
138 4,400 3.1%
Stock presence in Middle East

Within our coverage universe all seven companies have exposure to the African transmission market, but five of them Jyoti Structures, KEC International, Kalpataru Power, Areva T&D and Crompton Greaves have a relatively high (midto-high single digit) exposure.
An investment of cUSD15bn in T&D likely over the next 5 years

According to an Arab Petroleum Investment Corporation (APICORP) report, an investment of around USD70bn is required in the power generation sector over the next five years. This implies an average spend of around USD14bn per year over the coming five years. It is further estimated that c40% of this additional capacity will be IPP owned with the rest being set-up by the government entities. We expect this to translate into a T&D expenditure of cUSD50bn, of which we expect around USD15bn to go into transmission and the remaining to go into distribution.
GCC Interconnect project
Kuwait Ras Mahaab Safariya Ras Al Zawr Ghazlan Ghunan
Arabian Gulf
Baharain Doha Salwa Abu Dhabi Tarif Al Ajn Shanjah Dubai Sohar Wadi Jizzi Muscat Oman
Saudi Arabia
400kV Interconnector Phase I 220kV Interconnector Phase I 400kV Interconnector Phase II 400kV Interconnector Phase III 220kV Interconnector Phase III Frequency conversion station Substation (400/220 kV)
Source: MEE; HSBC research
Ruwals
United Arab Emirates
Oman
54
abc
Distribution Little visibility beyond central schemes

Although planned expenditure in distribution is significant, there
remains little visibility on its use due to decentralization

Our companies are largely exposed to central schemes related to
rural electrification (RGGVY) and system improvement (APDRP)

We forecast order growth of c30-35%, driven largely by the
RGGVY and APDRP spill over
A black hole in the power universe

Distribution plays a significant role in the power value chain as it connects the end customers to the grid. Hence, to optimize power capacity utilization, it is paramount to have a robust and efficient distribution network. Typically, electricity distribution (i.e. to households and commercial establishments) takes place at 11kV or below while transmission between 11kV to 66kV is termed as sub-transmission & distribution. Like the national transmission grid, the distribution network has been built in a suboptimal manner, which has led to significant aggregate technical and commercial (AT&C) losses, theft and pilferage of electricity and inefficient tariff plans.
Distribution efficiency Key parameters

AT&C losses above 20% Consumer metering below 80% Metering of Agricultural consumers 5% Reliability of supply
Source: CEA
43 utilities 8 states 50% Far below world standard
Interestingly, the planned expenditure in the distribution segment (cINR3.1trn in 11th plan and cINR4trn in 12th plan) is quite significant compared with the transmission expenditure (cINR1.4trn in 11th plan and cINR2.4tn in 12th plan). However, due to the state-wise development of the distribution network and the involvement of various stakeholders, there remains little visibility on the efficiency of these planned investments.
55
abc
Region wise AT&C losses
20 15 10 5 0 6 2 1 NER 7 1 0 ER <20%
Source: CEA presentation
Accelerated Power Development & Reforms Programme (APDRP)

11 6 2 4 NR 2--30% 2 2 WR >30% 6 SR 3 3
Background
The accelerated power development program (APDP) was introduced in 2000-01 by the Ministry of Power (MoP) to improve power supply reliability at distribution level and achieve commercial viability for the state electricity departments. This APDP was re-casted as APDRP in 2002 in order to restore and sustain the financial viability in the power sector.
Objectives
But on a positive note, we believe that it has increasingly become evident that for India to take advantage of its generation capacity expansion, the distribution system will need a major overhaul and this will require a concerted effort at an administrative level. The government has already taken several steps to not only enhance the distribution system (through the RGGVY scheme) but also improve its efficacy (through APDRP and the subsequent R-APDRP programme). We highlight the 11th plan (FY08-12) investment in the distribution segment below.
Planned investment (11th plan) Distribution Heads
Sub transmission & distribution RGGVY APDRP/Other schemes (pumpsets etc) Decentralized Distribution Generation Others Total
Source: CEA
The key objectives of the program were: Reduction of AT&C losses Reduction outages & interruptions Bringing about commercial viability in the sector Increasing consumer satisfaction It was planned to achieve these objectives via interventions at six levels namely administrative, state level, SEB, commercial, town, feeder and consumers. The APDRP has two components the investment component and the incentive component.
Investment component
INRbn
1,970 280 510 200 110 3,070
As we have mentioned above, the Government of India (GoI) has launched two programs Accelerated power development and reforms program (APDRP) for investment in urban areas and the Rajiv Gandhi Grameen Vidyutikaran Yojana (RGGVY) for creating electricity infrastructure in rural areas.
Under the investment component the funds were provided as an additional central assistance to state utilities through state governments. Initial assistance was to the tune of c50% of the project cost c25% in the form of grants and c25% in loans.
Incentive component
The assistance under the incentive component was primarily to motivate the state utilities to reduce their losses. The utilities were given an incentive of c50% of their actual cash loss reduction in the form of grants with 2001 being set as the base year.
56
abc
The government has approved a budget of cINR400bn for the APDRAP programme in the 10th plan, of which INR200bn is allocated under the investment component and the remaining INR200bn under the incentive component.
APRDP under 10th plan Details
Project cost GOI component Loan Grant Total funds released by GOI Loan Grant Total Funds drawn from FIs Total funds utilised
Source: Ministry of Power
Reduction in AT&C (aggregate technical & commercial) losses from 38.86% in 2002 to 34.44% in 2006.
Need for restructuring

Unrealistic targets
INRbn
170 22 64 87 22 48 71 48 110
The plan to reduce the total AT&C losses from 60% in 2001 to 15% in 2007 could not be achieved as it required a reduction of 9% per annum. There was a lack of proper studies before the scheme when it was believed that the actual losses were much less than 60%.
Delay in transfer of funds
Status post 10th plan

Under the investment component the government had sanctioned 583 projects with an outlay of INR192bn. However, only c50% of the planned addition could be completed, amounting to INR97bn. Under the incentive scheme, 19 states had submitted their claims but only eight were granted incentives amounting to INR15.3bn. Hence, a large portion of the funds granted were left unutilised.
The funds granted to assist the state utilities from the central government were received via the state governments through an indirect route causing a delay ranging from three months to more than a year.
Delay in supply of equipment due to increased demand
The industry was not geared up for the sudden increase in the demand for equipment. This demand supply gap led to a further delay in the implementation of the projects and hence only c50% of the planned addition was realised.
IT roadmap for utilities was not planned
Achievements during 10th plan

AT&C losses have been reported below 20% in 212 APDRP towns in the country of which 169 have brought AT&C losses below 15%. Reduction in financial losses of the state electricity boards from INR311bn in 2001 to INR195bn in 2006. Reduction in revenue gap from 73 paisa per unit in 2001 to 36 paisa per unit in 2006. Improvement in billing efficiency from 65% in 2001 to 69.8% in 2006.
The IT implementation in the various utilities was not planned which delayed the beginning of IT related work in utilities.
Other bottlenecks
There were several other bottlenecks, such as an increase in the price of the equipment, resistance from the employees of the utilities, poor response to the turnkey offers by contractors in the initial phase.
Recommendations
An evaluation of APDRP was done by IIM-A, TERI (the energy research institute), ASCI (Administrative staff college of India), TCS & SBI CAPS and following recommendation were made:
57
abc
Adoption of IT Direct release of funds to utilities Modify criteria with realistic and graded loss reduction targets Increase in grant Better project management Third party quality checks Cash incentives to utility employees Capacity building (training) of utility staff Standardization of specifications
Part B:
Planned investment of cINR400bn. Focus area: System improvement projects, which includes renovation, modernization and strengthening of 11kV level substations, transformers/transformer centres, reconductoring of line at 11kV level and below Load bifurcation, HVDS, installation of capacitor banks and mobile service centres 25-90% loans to Non-special (NS)/Special Category (SC) states Conversion of loan into grant up to 50-90% to NS/SC states. Completion time: to be fixed by the steering committee up to a maximum of five years. Target: 3% reduction per year for utilities having AT&C losses > 30% and 1.5% reduction per year for utilities having losses <= 30%. We highlight on the following page the progress made under the R-APDRP program up to September 2009.
Restructured APDRP (R-APDRP) under 11th plan

The government under the 11th plan gave approval to a new APDRP program in late 2008 and rechristened it R-APDRP, The planned investment under the R-APDRP is around INR510bn and the target is to bring down the AT&C losses to c20% in the project areas. The projects under the R-APDRP are being taken over in two parts:
Part A:
Planned investment of cINR100bn Applicable to towns having population of more than 30,000 (or more than 10,000 in special category states) Preparation of base line data for project area including consumer indexing, GIS mapping, metering automatic data logging for all distribution transformers and feeders and SCADA/DMS systems for big cities. Completion time is three years.
58
abc
Status of loan sanctioned/ disbursement for Part-A (INRm) State

Andhra Pradesh Arunachal Pradesh Assam Bihar Chandigarh Chhattisgarh Goa Gujarat Haryana Himachal Pradesh Jammu and Kashmir Jharkhand Karnataka Kerala Madhya Pradesh Maharashtra Manipur Meghalaya Mizoram Nagaland Puducherry Punjab Rajasthan Sikkim Tamil Nadu Tripura Uttar Pradesh Uttaranchal West Bengal Total
Source: R-APDRP
No. of towns sanctioned

113 10 67 71 1 20 4 84 36 14 30 30 100 43 83 130 13 9 9 9 4 47 87 2 110 16 168 31 62 1403
Loan amount sanctioned

3,880 377 1,738 1,946 333 1,225 1,107 2,253 1,656 811 1,345 1,606 3,912 2,144 2,289 3,243 316 340 351 346 275 2,728 3,160 263 4,171 352 6,655 1,258 1,600 51,678
Loans disbursement
1,164 520 584 367 315 676 497 243 404 300 1,173 643 684 972 819 948 79 1,251 103 1,903 377 480 14,501
No. of DISCOMS
4 1 1 1 1 1 1 4 2 1 1 1 5 1 3 1 1 1 1 1 1 1 3 1 1 1 4 1 1 47
Rajiv Gandhi Grameen Vidyutikaran Yojana (RGGVY)

Rajiv Gandhi Grameen Vidyutikaran Yojana (RGGVY) was launched in April-05 by merging all ongoing schemes.
Objective of the program
RGGVY was launched with the aim of: Electrifying all villages and habitations Providing access to electricity to all rural households
Status of loan sanctioned/ disbursement for Part-B (INRm) State

Andhra Pradesh Gujarat Himachal Pradesh Karnataka Kerala Madhya Pradesh Maharashtra Punjab Rajasthan Sikkim Tamil Nadu Uttar Pradesh West Bengal Total
Source: R-APDRP
No. of towns sanctioned

42 63 4 88 32 81 66 15 63 2 61 104 23 644
Loan amount sanctioned

10,566 8,732 1,655 9,490 3,611 19,682 13,140 5,118 12,849 685 6,661 13,576 2,829 108,593
Loans disbursement
1,585 1,310 497 737 234 2,953 685 1,899 999 10,897
No. of DISCOMS
4 4 1 5 1 3 1 1 3 1 1 4 1 47
59
abc
States with more than 10% villages to be electrified
Status of states with more than 25% households to be electrified
100% 80% 60% 40% 20% 0% UP Meghalaya Arunachal Jharkhand Bengal Orissa Assam West Bihar
100% 80% 60% 40% 20% 0% J&K Karnataka Gujarat Tamil Chandigarh Andaman Kerala <aharashtr Madhya Andhra Nagaland Manipur Uttranchal Arunachal Mizoram Rajasthan Tripura Meghalaya West Uttar Orissa Assam Jharkhand Bihar
Source: REC; HSBC research
Source: REC; HSBC research
Providing electricity connection to Below Poverty Line (BPL) families free of charge. To achieve this it was planned to create the following infrastructure: Rural Electricity Distribution Backbone (REDB) with 33/11 KV (or 66/11 KV) substation of adequate capacity in blocks where these do not exist. Village Electrification Infrastructure (VEI) with the provision of distribution transformer of appropriate capacity in villages/habitations. Decentralized Distributed Generation (DDG) Systems based on conventional & non conventional energy sources where grid supply is not feasible or cost-effective.
Funding & nodal agency
Under the programme a 90% grant is provided by the GoI and a 10% loan by REC to the state governments. The nodal agency for this program is REC (Rural Electrification Corporation)
RGGVY in the XI plan

THE RGGVY scheme was sanctioned in the 11th plan for attaining the goal of providing access to electricity to all households, electrification of about 115,000 un-electrified villages and electricity connections to c23.4m BPL households by 2009.
Status of village electrification (in number)
Status of household electrification (in million)
700,000 600,000 500,000 400,000 300,000 200,000 100,000 -
593,732 474,162
119,570
160 140 120 100 80 60 40 20 0
138.3
78.1 60.2
Total v illages
Electrified v illages
Unelectrified v illages
Total households
Electrified households
Unelectrified households
Source: Census 2001, REC presentation
Source: Census 2001, REC presentation
60
Status of RGGVY under 10th 5-yr plan (INRm) State/UT Name (Total No. of Districts
ANDHRA PRADESH (23) ARUNACHAL PRADESH (16) ASSAM (23) BIHAR (38) CHHATTISGARH (16) GUJARAT (25) HARYANA (20) HIMACHAL PRADESH (12) JAMMU & KASHMIR (14) JHARKHAND (22) KARNATAKA (27) KERALA (14) MADHYA PRADESH (48) MAHARASHTRA (36) MANIPUR (9) MEGHALAYA (7) MIZORAM (8) NAGALAND (11) ORISSA (30) RAJASTHAN (32) SIKKIM (4) TRIPURA (4) UTTAR PRADESH (70) UTTARAKHAND (13) WEST BENGAL (18)
No. of DPRs
17 2 3 26 3 3 4 1 3 13 17 1 8 4 2 2 2 2 4 25 2 1 64 13 13
Project cost sanctioned

6,482 433 1,580 14,958 1,490 609 485 250 976 12,877 3,754 198 3,956 789 641 460 418 163 4,341 4,532 261 198 27,195 6,439 3,857
Awarded cost/ Revised cost

6,482 680 1,991 23,079 1,656 671 526 663 1,016 18,449 5,698 200 5,230 862 863 564 1,136 383 4,469 5,306 712 248 34,809 7,601 4,851
Total amount Electrification of Intensive electrification of No. of connections to released ______ Un-/De-Electrified villages ______ _________ Electrified villages__________ __________ BPL households __________ Coverage in No. Achievement in No. (%) Coverage in No. Achievement in No. (%) Coverage in No. Achievement in No. (%)
5,193.8 (80.1%) 484.1 (71.2%) 1,716.0 (86.2%) 21,430.6 (92.9%) 1,323.2 (79.9%) 549.0 (81.8%) 436.6 (83.0%) 596.6 (89.9%) 830.4 (81.7%) 15,646.2 (84.8%) 4,704.8 (82.6%) 165.5 (83.0%) 4,185.1 (80.0%) 664.6 (77.1%) 722.8 (83.7%) 507.3 (90.0%) 1,017.0 (89.5%) 95.4 (24.9%) 3,773.0 (84.4%) 4,029.2 (75.9%) 636.8 (89.5%) 215.4 (86.8%) 32,218.8 (92.6%) 6,609.0 (86.9%) 4,296.9 (88.6%) 0 237 903 17,125 117 0 0 0 103 8,727 49 0 115 0 186 174 90 12 2,602 1,705 16 48 30,802 1,469 4,283 0 (0.0%) 112 (47.3%) 903 (100.0%) 16,039 (93.7%) 56 (47.9%) 0 (0.0%) 0 (0.0%) 8 (0.0%) 72 (69.9%) 7,581 (86.9%) 46 (93.9%) 0 (0.0%) 89 (77.4%) 0 (0.0%) 150 (80.6%) 127 (73.0%) 14 (15.6%) 0 (0.0%) 2,159 (83.0%) 1,645 (96.5%) 10 (62.5%) 28 (58.3%) 27,757 (90.1%) 1,499 (102.0%) 3,907 (91.2%) 21,623 321 1,746 0 3,504 2,409 1,075 1,118 1,444 4,379 21,152 38 9,653 4,052 270 797 209 279 4,637 15,608 158 72 3,287 14,105 0 18,286 (84.6%) 53 (16.5%) 1,744 (99.9%) 0 (0.0%) 2,689 (76.7%) 2,110 (87.6%) 661 (61.5%) 1,059 (94.7%) 703 (48.7%) 3,163 (72.2%) 18,883 (89.3%) 37 (97.4%) 7,354 (76.2%) 4,052 (100.0%) 188 (69.6%) 620 (77.8%) 60 (28.7%) 0 (0.0%) 3,514 (75.8%) 14,712 (94.3%) 94 (59.5%) 49 (68.1%) 2,763 (84.1%) 8,557 (60.7%) 0(0.0%) 2,114,317 4,377 148,971 843,499 122,326 188,471 49,198 647 59,731 942,319 631,828 17,834 311,295 262,538 14,447 23,676 8,618 14,290 335,080 699,951 3,724 13,119 1,120,648 281,615 97,847 2,137,150 (101.1%) 2,176 (49.7%) 122,456 (82.2%) 735,944 (87.2%) 119,238 (97.5%) 165,115 (87.6%) 33,738 (68.6%) 683 (105.6%) 16,185 (27.1%) 520,972 (55.3%) 635,509 (100.6%) 17,238 (96.7%) 213,145 (68.5%) 209,313 (79.7%) 7,056 (48.8%) 16,447 (69.5%) 2,283 (26.5%) 2,933 (20.5%) 317,738 (94.8%) 475,633 (68.0%) 2,155 (57.9%) 8,224 (62.7%) 872,993 (77.9%) 222,078 (78.9%) 91,671 (93.7%)
TOTAL of 10th PLAN PROJECT

Source: RGGVY
235
97,338
128,146
112,048.1 (87.4%)
68,763
62,202 (90.5%)
111,936
91,351 (81.6%)
8,310,366
6,948,073(83.6%)
abc
61
62
RGGVY status under 11th 5-yr plan (INRm) State/UT Name (Total No. of Districts
ANDHRA PRADESH (23) ARUNACHAL PRADESH (16) ASSAM (23) BIHAR (38) CHHATTISGARH (16) GUJARAT (25) HARYANA (20) HIMACHAL PRADESH (12) JAMMU & KASHMIR (14) JHARKHAND (22) KARNATAKA (27) KERALA (14) MADHYA PRADESH (48) MAHARASHTRA (36) MANIPUR (9) MEGHALAYA (7) MIZORAM (8) NAGALAND (11) ORISSA (30) PUNJAB (17) RAJASTHAN (32) SIKKIM (4) TAMIL NADU (30) TRIPURA (4) WEST BENGAL (18)
No. of DPRs
9 14 20 17 11 22 14 11 11 9 8 6 24 30 7 5 6 9 27 17 15 2 26 3 15
Project cost sanctioned

191.94 494.39 1,501.97 1,480.09 956.28 299.59 148.92 180.24 538.31 1,374.94 219.93 114.57 1,137.77 634.58 293.72 244.42 62.5 94.92 3,141.01 154.37 801.26 31.01 447.41 111.89 1,959.61
Awarded cost/ Revised cost

181.94 857.56 1,779.18 1,806.32 983.5 344.03 180.04 275.53 726.15 1438.5 315.56 0 1,254.12 725.91 293.72 328.75 154.38 195.4 3,152.54 183.91 773.09 77.74 647.41 133.2 1,957.25
Total amount Electrification of Intensive Electrification of No. of connections to released ______ Un-/De-Electrified villages ______ _________ Electrified villages__________ __________ BPL households __________ Coverage in No. Achievement in No. (%) Coverage in No. Achievement in No. (%) Coverage in No. Achievement in No. (%)
135.53 (74.5%) 500.85 (58.4%) 1,404.56 (78.9%) 1,137.67 (63.0%) 426.03 (43.3%) 130.11 (37.8%) 91.10 (50.6%) 160.16 (58.1%) 544.04 (74.9%) 1,140.52 (79.3%) 165.33 (52.4%) 0 (0.0%) 531.83 (42.4%) 440.14 (60.6%) 143.69 (48.9%) 113.31 (34.5%) 135.91 (88.0%) 113.67 (58.2%) 2,180.32 (69.2%) 56.90 (30.9%) 388.96 (50.3%) 68.70 (88.4%) 275.92 (42.6%) 55.05 (41.3%) 1,311.61 (67.0%) 0 1,892 7,622 6,086 1,015 0 0 93 180 11,010 83 0 691 6 696 1,769 47 93 15,293 0 2,749 9 0 112 290 0 (0.0%) 319 (16.9%) 3,243 (42.5%) 2,817 (46.3%) 44 (4.3%) 0 (0.0%) 0 (0.0%) 5 (5.4%) 34 (18.9%) 7,617 (69.2%) 13 (15.7%) 0 (0.0%) 135 (19.5%) 0 (0.0%) 13 (1.9%) 19 (1.1%) 11 (23.4%) 46 (49.5%) 8,095 (52.9%) 0 (0.0%) 1,793 (65.2%) 4 (44.4%) 0 (0.0%) 28 (25.0%) 259 (89.3%) 5,858 1,435 11,584 6,651 12,829 15,525 4,910 9,548 4,606 3,243 7,039 592 24,441 36,240 1,108 2,739 361 873 24,585 11,840 19,233 260 12,416 570 24,775 3,500 (59.7%) 336 (23.4%) 4,520 (39.0%) 1,702 (25.6%) 4,739 (36.9%) 3,753 (24.2%) 1,478 (30.1%) 0 (0.0%) 848 (18.4%) 1,345 (41.5%) 3,839 (54.5%) 0 (0.0%) 1,528 (6.3%) 16,453 (45.4%) 0 (0.0%) 347 (12.7%) 70 (19.4%) 237 (27.1%) 8,064 (32.8%) 0 (0.0%) 8,856 (46.0%) 159 (61.2%) 4,862 (39.2%) 115 (20.2%) 6,710 (27.1%) 477,823 36,433 842,685 1,918,956 654,839 766,679 174,875 11,801 76,999 749,478 260,111 38,517 1,064,947 1,613,853 92,922 92,771 18,799 55,610 2,850,783 148,860 1,050,167 7,734 545,511 181,611 2,601,887 398,469 (83.4%) 4,250 (11.7%) 344,697 (40.9%) 734,217 (38.3%) 233,759 (35.7%) 432,298 (56.4%) 142,692 (81.6%) 36 (0.3%) 10,269 (13.3%) 445,696 (59.5%) 127,461 (49.0%) 0 (0.0%) 44,010 (4.1%) 696,228 (43.1%) 119 (0.1%) 10,504 (11.3%) 3,491 (18.6%) 9,707 (17.5%) 1,176,628 (41.3%) 44,456 (29.9%) 364,381 (34.7%) 2,725 (35.2%) 498,643 (91.4%) 39,896 (22.0%) 818,684 (31.5%)
TOTAL of 11th PLAN PROJECT

Source: RGGVY
338
16,615.64
18,765.7
11,651.91 (62.1%)
49,736
24,495 (49.3%)
243,261
73,461 (30.2%)
16,334,651
6,583,316 (40.3%)
abc
abc
RGGVY was launched in two phases. The first phase targeted complete electrification of villages and hamlets with a population of less than 300 by 2009. The total investment in phase I was cINR240bn. The second phase aimed to completely electrify the remaining un-electrified hamlets by 2012. The cost for phase II was estimated at INR160bn. The tentative cost of RGGVY Phase II has now been revised upwards to cINR300bn. In the charts below, we highlight the status of electrification in India at the beginning of the last decade. We note that, of the FY11 targets, c36% of the villages and c57% of the households have been electrified as of 30 September 2010. The initial plan was to electrify 17,500 villages and 4,700,000 households in 2010-11. We highlight the progress of the RGGVY programme during the 10th and the 11th plan in the tables on the previous pages.
investment had been distributed. While it is quite normal for 5-yr plan investments to be back-end loaded, a mere 6% spend in the first two years clearly highlights that work is behind schedule.
Funds requirement & expenditure 11th plan Funds requirement
R -APDRP RGGVY NEF Shortfall Total requirement
INRm
510 280 1,000 1,300 3,090 88 90 178
Funds expenditure 2007-08 2008-09 Total expenditure

Source: CEA
However, the CEA in its presentation highlighted that it is confident of achieving most of its targeted objectives during the 11th plan. We highlight the summary of anticipated achievement versus the original target in the 11th plan below.
11th plan targets vs anticipated achievements Category
Consumer Indexing (towns) SCADA (cities) IT and Energy accounting AT & C Losses Metering Prepaid Metering HVDS Development of PPPs RE Customer CareCentres (No) Energization of Pumpsets RE Franchisee
Source: CEA
Target
2000 27 all Towns 15% 100% Pilot project All Towns Major towns 100% 1000 35 lakhs 2,50,000
Anticipated achievement
1000 27 1000 15% 100% Achieved 1000 20 towns 100% 1000 20 lakhs 2,50,000
Other programs
There are several other government programs/initiatives which include: Minimum needs program (MNP) Kutir Jyoti program Pradhan Mantri Gramidaya Yojana Accelerated rural electrification program (AREP)
Overall, we believe that significant funds have been earmarked for distribution for both 11th and the 12th plan. However, the visibility on the use of a large proportion of these funds (i.e. excluding central programs likes R-APDRP and RGGVY) remains opaque. Therefore, although we realise the potential size of the opportunity in this sector, we are not much hopeful of it coming through anytime soon.
Progress in the distribution works remains dull

Due to the decentralized nature of distribution, it is difficult to get the most up-to-date information on the progress that has been made. However, a recent presentation from the CEA suggests that by the end of the first two fiscal years (FY07-09) of the 11th plan, only c6% of the planned INR3.1trn
63
abc
Stocks with exposure to distribution

All of our companies under coverage, except for Kalpataru Power (which has minimal exposure), have sizeable exposure to the distribution market. Jyoti Structures and Crompton Greaves have the highest exposure (c25-26%) while the sectors (i.e. the coverage universe) average exposure to the distribution market is c15%.
64
abc
Construction Infra spend to drive growth

We expect robust growth in construction expenditure, driven by
increasing urbanization and strong economic growth

Our sector is mainly geared to infrastructure spend, driven by
Kalpatarus majority stake in JMC Projects

We forecast order growth of c25-30% in FY12e, driven by
recovery in commercial markets and robust infra spend
Urbanization to drive the demand

Urbanization is key to economic development in any country and the situation is no different in India. Interestingly, while agricultural production in India constitutes just c15-20% to GDP, the rural population involved in it accounts for c70% of Indias population. Clearly, to sustain strong economic growth going forward, India will likely see the expansion of the urban areas and increasing shift of rural population to industrial hubs.
We note that Indian urbanization, currently at c30%, is significantly below the c40% of China, its closest Asian competitor. However, the rate of urbanization is increasingly rapidly, as can be seen in the chart below which highlights the incremental urban population in India as a percentage of total population of some of the developed countries. We think increasing urbanization should create significant demand for urban housing.
Economic growth set to expand current low urbanization

100% U rbanization % 80% 60% 40% 20% China India Japan Franc e UK U SA
Urbanization should create demand for urban housing

India's incremental urban population (07-20) as % of current population of few large economies 216% 213% 159% 103% 43%
Germ any
0% 10,000 20,000 30,000 40,000 50,000
Nominal GDP per c apita

Source: World Urbanization prospects report by United Nations
UK
France
Germany
Japan
US
Source: United Nations population division
65
abc
More households likely to move towards high income groups

60% 50% 40% 30% 20% 10% 0% (<90) 2005 2015 2025
Deprived significantly low in urban households by 2015

Depriv ed (<90) Striv ers (500-1000) 100% 80% 60% 40% Aspirers (90-200) Rich (>1000) Seekers (200-500)
Depriv ed Aspirers
Seekers
Striv ers (5001000)
Rich (>1000)
20% 0% Rural 2005 Rural 2015 Urban 2005 Urban 2015
(90-200) (200-500)
Source National Centre for Applied Economic Research, McKinsey Global Institute
Source: National Centre for Applied Economic Research, McKinsey Global Institute
Demographics favouring higher urbanization
3 key segments in the construction sector
Some of the key demographics which offer a bullish outlook towards strong urbanization are: More households moving towards high income groups The ratio of deprived households as a percentage of urban households is expected to fall sharply by 2015 (Source: National Centre for Applied Economic Research). High working population (age group 25-39 years) should lead to higher consumption. Falling household size (number of people) is also boosting the housing demand.
The construction sector can be broadly divided into three main segments residential, commercial (including retail) and infrastructure (including civil works, industrial buildings, etc). We discuss each of these segments in greater detail below.
High working population should lead to increased consumption
Falling household demand should boost household demand

U rban hous e hold s iz e 5.8 All India hous ehold size
0-14 100% 80% 60% 40% 20% 0% 19% 37% 19% 35% 38% 39%
15-24
25-59
+59
40% 19% 33%
42% 19% 31%
44% 19% 29%
45% 18% 27%
47% 17%
5.4 5.0 4.6
25%
4.2 1951
Source: Census of India
1995 2000 2005 2010 2015 2020 2025

Source: UN population division
1961
1971
1981
1991
2001
66
abc
Top 10 Indian cities execution challenge (m sq ft)
Top 2 Indian developers planned execution during FY11-13 on existing launched projects
800 600 431 400 200 0 CY07-09
759
44 42 42 40 38 36
39
CY10-12 Ex ecution (m sq ft)
DLF FY11-13
Source: Company data, HSBC research
Unitech
Source: Prop Equity
Residential execution may prove challenging

The residential construction segment mainly comprises of two parts:
Newly built houses Refurbishment of existing houses
Residential market recovery well underway
the residential sector is highly correlated to overall economic growth.

Execution remains a key challenge
Our Real Estate & Property analyst, Ashutosh Narkar, is of the view that execution is going to remain a challenge because:
The industry must deliver 76% higher volumes over next three years Commodity prices could become a critical factor as a major share of execution is affordable housing Funding constraints could impact execution of second tier developers
We note that the residential market has recovered quite substantially from the lows of 2008; however, the recovery has slowed over the last few months. This in our opinion is partly driven by increasing interest rates and partly by reducing affordability (due to rapid increase in house prices). Overall, we note that the growth rate of
Residential segment recovery has slowed but not stopped
Absorption 70,000 60,000 50,000 (units) 40,000
y oy grow th (RHS) 150%
100%
50% 30,000 20,000 10,000 Q1 CY08 Q2 CY08 Q3 CY08 Q4 CY08 Q1 CY09 Q2 CY09 Q3 CY09 Q4 CY09 Q1 CY09 Q2 CY10 -50% 0%
Source: Prop Equity
67
abc
Hiring by top 4 IT companies
Commercial space absorption rate across India
Top 4 IT Co. hiring ('000) 35 28 21 14 7 (7) Q3 FY09
Grow th y oy (RHS) 70% 35% 0% -35% -70% -105% -140% Q3 FY10 Average Absorption Rate (%)
70 60 50 40 30 20 10 0 2Q04 4Q04 2Q05 4Q05 2Q06 4Q08 2Q09 4Q09

20% 16% 12% 20 8% 4% 0%
Q1 FY07
Q1 FY08
Q1 FY09
Q1 FY10
Q3 FY07
Q3 FY08
4Q06
2Q07
4Q07
Source: Company data
Source: Prop Equity
Commercial showing early signs of recovery

According to the HSBC Real Estate team, the Indian commercial market is expected to recover strongly as the macro-economic outlook improves. The optimism is largely based on the following factors:
HSBC forecasts economic growth of 9.2% in FY11 and 8.1% in FY12
Early signs of recovery in sight
The demand in the Indian commercial property segment fell c40% in 2009, driven largely by the deteriorating economic situation; however the supply remained stable. This led to a significant increase in the vacancy rates. However, the demand is now showing signs of revival, as:
IT companies are hiring more employees than planned at the beginning of the year. The commercial property space absorption rate, which had dipped sharply at the beginning of FY09, has recovered.
Improved outlook for the IT and IT enabled services (ITES) industry (22% volume CAGR during FY10-12).
We note that the Indian commercial property segment is largely driven by Indian IT/ITeS, telecom and BFSI sectors.
Our real estate analyst expects the commercial segment to bounce back significantly driven
Demand fell 40% in 2009, while supply remained flat increasing vacancy rates to 18%
50 40 29 (m n s q f 30 20 10 0 2005 2006 Supp ly
Source: JLL Meghraj
43 33 29 23 22 32 33
42
2 007 Dem an d
2008 Vac anc y rate (R HS)
2 009
68
2Q08
abc
Indian property developer commercial space development plan and potential delivery estimate in 2010
Property price growth (y-o-y) and vacancy rates
80 60 Mn sq ft 40 20 0
71 42
60
68 44
67 45 49 45% 30% 15%
Rental rates grow th (LHS)
Vacancy rate (RHS) 20% 15% 10%
0% 2009 2010e 2011e 2012e Dev elopment plans at end Q4 CY08 Dev elopment plans at end Q4 CY09 Potential deliv ery -15% -30% 2011e 2012e 2005 2006 2007 2008 2009 2010e 5% 0%
Note: Potential delivery volumes is as per HSBC estimate Source: JLL Meghraj, HSBC estimates
Note: Rental rate growth and vacancy rate forecasts as per HSBC estimates Source: JLL Meghraj, HSBC estimates
largely by the revival in the IT hiring. He expects commercial property demand to grow c65% in FY11e and c25% in FY12e, after falling c40% in FY10.
Commercial property demand calculation FY09 FY10e FY11e FY12e FY13e
IT/ITES employee addition (000) Space demand (m sq ft) Total space demand (m sq ft) IT market demand 226 21.1 32.8 128 12.0 23.0 294 24.0 37.0 331 27.0 41.6 372 30.4 46.8
segment slumped and developers struggled to get access to funding. As a result, vacancy rates rose but then stabilised at c18%.
Further delays in supply expected
Four reasons why the demand/supply equation will improve:

Large developers will tap existing customer relationships with demand to be dominated by large customers like the big Indian IT players and multinational companies, who insist on timely delivery and will not compromise on quality. While large developers have managed to raise equity capital and restructure debt over the past 12 months, many small and mid-sized developers have only managed to restructure their debt. Small/mid-sized developers lack marketing reach. The majority of the planned supply for CY12 has yet to break ground, in our view. This will allow flexibility in shifting/delaying supply, in turn reducing pressure on vacancy rates.
64.3% 52.1% 65.0% 65.0% 65.0%
CY08
Commercial space demand (m sq ft) y-o-y growth 33.1
CY09 CY10e CY11e CY12e

19.6 32.6 40.4 45.5
3.4% -40.8% 66.5% 23.9% 12.5%
Source: Nasscom, JLL Meghraj, HSBC estimates
Demand supply reaching a balance
Property prices across most markets in India corrected by c25-40% during 2009 from their cyclical peaks on the back of weak demand and developers facing liquidity problems. Further, supply was likely delayed or cut owing to a sharp fall in the prices and demand in 2009. Developers either reduced or put on hold about 40% of the planned new supply for 2009, delivering only 42m sq ft against a planned 71m sq ft (Fig 5). The majority of the planned supply was shifted to CY10 as demand from the IT/ITES
69
abc
Infra investment trend
250 USD b 200 154 (USD b) 150 111 100 50 FY03 FY05 FY07 FY08 FY09 FY10 FY11e FY12e FY13e FY14e FY15e FY16e 27 32 37 45 52 52 68 77 89 131 y oy grow th 169 195
223
35% 30% 25% 20% 15% 10% 5% 0%
Source: Planning Commission
Rental rates should increase c5-10% over 2009-12
in 2008-09 and has clocked GDP growth of 7.4% in FY10, up from 6.7% reported in FY09. According to HSBC economists, Indian GDP is expected to grow by 8.8% in FY11 and c8.3% in FY12, driven by an increase in industrial output and an improvement in the macro sentiment.
Target infrastructure spend
Flattening vacancy rates should improve pricing in the commercial segment. We expect rental rates to rise by a total of 5-10% over FY09-12. Our estimates for existing leased properties factor in 3% annual growth, while for new projects we have estimated a flat rental rate growth.
Infrastructure still going strong

Infrastructure sector driven by economic growth
The infrastructure growth is largely driven by Indian GDP growth. The Indian economy has recovered from the recent downturn it witnessed
It is possible to achieve double digit growth in GDP only if infrastructure investment is increased by the government. The total infrastructure spend as a percentage of GDP was only 5.3% in 2007. The government envisages infrastructure spend to reach c9% of the GDP in 11th five-year plan (by 2012).
India GDP growth trend
12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% FY01

Source: RBI, HSBC estimates
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY17e FY11e
FY04
FY06
FY12e
70
abc
Infrastructure spending pattern in FY08-10
Infrastructure spending pattern in FY11-12
Equity ECB 6% Insurance cos 4% NBFC Incl) IIFCL) 10% Comm banks 21%
Equity ECB 4% Budgetary support 45% Insurance cos 3% NBFC Comm Budgetary support 55% Incl) FDI) 14%
Incl) FDI) 14%
Incl) IIFCL) banks 8% 16%
The government has planned a total investment of USD441bn in the 11th five-year plan which is expected to be scaled up by 100% during the 12th five-year plan (FY13-17)
Huge growth opportunity in short term
Funding infrastructure spend
Of the total planned investment of cUSD441bn, the government has planned investment of USD271bn to be spent during FY11 and FY12. Assuming a success ratio of 80%, as reported during the period of FY08-10, it appears that near term growth for infrastructure could be extremely strong.
Infrastructure investment pattern in the 11th five-year plan (USDbn)
Planned Actual Shortfall
Source: Planning Commission, Ministry of Finance
The infrastructure spend in FY08-10 was largely funded by budgetary support (c45%) while 21% was contributed by commercial banks and 14% through equity funds. It was estimated that for the remaining two years (2010 and 2011) of the fiveyear plan the expected budgetary support would be c55% of the funding requirement.
Stocks with exposure to Construction

Within our coverage, Kalpataru Power is the single largest beneficiary of construction expenditure, through its subsidiary JMC Projects. The groups exposure is largely biased towards infrastructure projects. Other than Kalpataru, ABB and Siemens also have low-to-mid single digit exposure to the construction markets, largely through their building technologies and low voltage products division. Crompton Greaves also has some indirect exposure to the construction markets through its consumer products division which manufactures electrical items, such as fans.
FY08-10
208.7 166.1 -20.4%
FY11-12
271.0
71
abc
Industrial mfg Capacity addition to accelerate

We expect capacity addition in the industrial manufacturing sector
to pick up as utilization levels have picked up sharply

HSBC forecasts an average capex growth of c15-20% for all the
sectors (ex-financials) under its coverage

HSBC Economics team forecasts FAI to grow by c14-15% during
FY12-13e
Back to capacity constraints

As highlighted in the chart below, for a large part of this decade Indias manufacturing sector has operated at or above optimal capacity. The rule of thumb suggests that for optimal use of the capital resources, capacity addition is warranted once the utilization levels cross c82-85%. We note that before the recession in 2008-09, the capacity constraints had started affecting the industrial production (IP) growth. Even though the
demand had stayed strong during most of 2007, the IP growth was constantly declining. At the same time we note that imports were on the rise. This was typical of situation where due to capacity constraints domestic demand was being met by imports rather than the in-house industrial production. The situation, in our opinion, warranted capacity expansion across most of the industries. However, just when the industry was gearing up their capex plans, the global meltdown hit Indian corporates. As a result of this, industrial production growth
IIP growth trend
IIP index
400 350 300 250 200 150 1-Sep-05 1-Mar-07 1-Sep-07 1-Sep-08 1-Sep-09 1-Sep-10 1-Mar-04 1-Mar-05 1-Mar-06 1-Mar-08 1-Mar-09 1-Mar-10 1-Sep-04 1-Sep-06
20% 15% 10% 5% 0% 1-Sep-06 1-Sep-08 1-Mar-04 1-Mar-05 1-Mar-07 1-Mar-09 1-Sep-04 1-Mar-06 1-Mar-08 1-Mar-10 1-Sep-05 1-Sep-07 1-Sep-09
Source: CEIC
Source: CEIC
72
abc
went down, capacity utilization slumped and most of the capex plans were put on hold. However, post recession, the IP growth has picked up again and the capacity utilization level is back to the high 90s. According to a recent survey by NCAER, c97% of companies believe that they are operating at or above their normal capacity utilisation levels. This is similar to the situation before the recession and thus, in our opinion, warrants capacity expansion.
NCAER survey: Are you operating at or above optimal capacity?
of c18% during FY07-10. The growth was much higher during FY07-09 (c43% CAGR) as earnings during FY10 were severely impacted by the downturn. For its overall coverage, HSBC is currently forecasting earnings CAGR of c20-25% during FY11-12e. This earnings growth is backed by an estimated increase in capex of c15-20% during FY11-12e. We expect the industrial segment for E&C companies to reflect a similar growth trajectory during this period. We highlight the HSBC capex estimates for different sectors in the chart below.
100 90 80 70 60
Oct 04 Oct 07 Jan 04 Jan 07 Jan 10 Oct 10 Jul 05 Apr 06 Jul 08 Apr 09
Significant increase in gross capital formation

The gross fixed capital formation as a percentage of GDP for the Indian economy has been steadily increasing since 2004. The gross capital formation (GCF) to GDP ratio has increased from c27% at the end of March 2004 to c36% by September 2010. Our HSBC Economics team expects the GCF to continue to increase as a percentage of GDP, implying that well continue to see increasing investment into addition capacity to fuel future growth. Even if we assume that GCF remains
Source: NCAER
HSBC forecasts annual capex to grow at c15-20% during FY11-12e

The cumulative earnings of the companies under HSBCs coverage (ex-financials) rose at a CAGR
HSBC industrial capex forecasts
2,500 2,000
(INR bn)
1,500 1,000 500 0 FY07 Auto Construction FY08 Consumer FY09 Industrials IT FY10 Metals Oil & Gas FY11e Pow er FY12e Property
Source: Company, HSBC estimates
73
abc
constant as a percentage of GDP, the capital investments will have to increase at least at a rate similar to nominal GDP growth of c18% in FY11e and c14.5% in FY12e.
GCF as % of GDP
39% 37% 35% 33% 31% 29% 27% 25%

Jun-04
74
Source: CEIC
Furthermore, we note that Fixed Asset Investment (FAI) is usually a good proxy for a countrys capex. We note that our economics team currently forecasts FAI to grow at a rate of c15.5% in FY11e and c14.5% in FY12e.
Dec-04
Jun-05
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
abc
Other end markets Rail, Medical, Oil & Consumer

Our sector exposure to these four end markets is relatively small
at c9-10%
We expect strong demand from railways and the consumer
durables markets
Within our universe, Siemens has most exposure to railways,
while Crompton has most exposure to Consumer durables
Railways a INR14trn opportunity

The demand for railway transport is directly linked to economic growth. According to the white paper published on Indian railways, empirical evidence suggests that developing countries like India tend to report transportation elasticity of greater than 1. However, the elasticity of rail transport to GDP growth in India has been assessed at c0.79 since independence (1947). This was largely due to the mismatch between the higher demand in both passenger and freight traffic (driven by higher economic growth) versus the weak existing infrastructure. It is important to note that rail infrastructure creation, being capital intensive and time consuming, has a long gestation period.
December 2009, Indian railways plan to grow the revenue from current level of c1.2% of Indian GDP to c3% over next 10 years. To realise this, Indian railways must achieve c10% annual growth over the next 10 years, which should be possible through network expansion and capacity creation.
Network expansion
The rail network has increased by only c10,000km over the last 62 years to the current c64,099km. The railway ministry has proposed adding c25,000km of new lines by 2020, supported by government funding and a significant increase in public private partnerships (PPPs).
Capacity creation
Vision 2020 for Indian railways

According to the Indian railway vision 2010 document presented to the parliament in
To achieve the above mentioned revenue target the Indian railways ministry has also proposed increasing capacity through double-tracking and quadruple-tracking lines, the segregation of passenger traffic and freight lines on high density network routes and electrification on busy trunk routes. It proposes:
75
abc
More than 30,000km should be multiple tracked of which c6,000km should be quadruple lines with a segregation of freight and passenger services into separate double line corridors. 33,000km should be electrified. Guage conversion should be completed for the entire railway network.
link all the ports in western and eastern India to New Delhi and Punjab. The corridor will be built though a mix of EPC and PPP (public private partnership). It is then planned to build further new corridors covering up to c11,500km.
Dedicated freight corridors (Eastern)
Punjab
AMBALA Uttaranchal SAHARANPUR MEERUT

Delhi
EXISTING LINE DFC LINE (PARALLEL) EXISTING STNS.
Proposed investment plan

The ministry has assessed that a total investment of cINR14trn would be required to carry out capacity augmentation, upgrades and modernization of Indian railways.
Funding
Rajasthan
HAPUR KHURJA HATHRAS ALIGARH
TUNDLA Uttar Pradesh BHAUPUR ETAWAH KANPUR PREMPUR Bihar ALLAHABAD NEW GANJKHWAJA NEW KARWANDIYA MUGHALSARAI SONNAGAR
Jharkhand West Bengal
Madhya Pradesh
Chhattisgarh Orissa
Of this amount the ministry has proposed that c64% be funded through a surplus from the high growth in passenger and freight traffic supported by borrowing and PPP initiatives. For the remaining 36%, the ministry has proposed that the government set up an Accelerated Rail Development Fund (ARDF).
Investment planned for railway infra (INRbn)
Source: Ministry of Railways
Dedicated freight corridors (Western)
Haryana
EXISTING LINE DFC LINE (PARALLEL) EXISTING STNS.
REWARI NIM KA THANA RINGAS

Rajasthan
REWARI
3,000 2,500 2,000 1,500 1,000 500 342 1,197 410 495 604 767
2,618
PHULERA AJMER SENDRA MARWAR MARWAR SIROHI ABU RD PALANPUR PALANPUR

MAHESANA SANAD
PHULERA
MAHESANA AHMEDABAD VADODRA BHARUCH

GOTHANGAM Madhya Pradesh
Gujarat MAKARPURA
SANJALI SURAT VALSAD SANJAN DAHANU VASAI PANVEL JNPT
10th Plan
Source: Planning Commission Source: Ministry of Railways
Projects under implementation

Freight corridor project
11th Plan
VASAI
Maharashtra
2007-08
2008-09
2009-10
2010-11
2011-12
Railway station modernization
The freight corridor project is Indias largest railway and infrastructure project. The corridor will cover the western and eastern routes with a length of c2,700km at a cost of USD5.5bn. It will
The ministry has also tentatively identified 16 railway stations for modernization: New Delhi, Chhatrapati Shivaji Mumbai, Howrah, Chennai Central, Amritsar, Ahmedabad, Bangalore,
76
abc
Bhopal, Bhubaneshwar, Chandigarh, Lucknow, Mathura, Pune, Patna, Secuderabad, and Thiruvananthapuram.
Port connectivity
Oil & Gas infra strengthening pipeline

The strong growth of the Indian economy and the consequent increase in energy demand has resulted in the need to develop an efficient distribution network for oil and natural gas transportation. The current low per capita usage of pipes in India, the discovery of large oil and gas reserves in various parts of the country, the central governments decision to permit oil retailing by the private sector, the formulation of a national pipeline grid by GAIL and infrastructure development projects by other major players in the energy industry are expected to increase the E&C activity in the Indian energy sector. Demand for and the supply of natural gas in India is also expected to increase in the next few years. Increased demand for natural gas in India is also expected to result in the need for an extensive gas transportation pipeline infrastructure. India permits 100% foreign direct investment (FDI) in exploration, refining, petroleum and gas pipelines and marketing, which is favourable for the business. India is the third largest oil consumer in the Asia-Pacific region after China and Japan. Demand for petroleum, in absolute terms, is expected to be c195 million tons for 2011 and 2012. Importantly, pipelines transport only c30% of the petroleum products consumed by the Indian industry in spite of being cheaper than rail, coastal tankers and road transportation, which account for 40%, 12% and 18%, respectively.
The government has also planned port connectivity of c6000km, gauge conversion of c12,000km, the upgrade of feeder routes, and modernization of freight terminals.
Exposure of stocks under coverage to railways expenditure

Within our coverage universe, Siemens has the single highest exposure of c10% to railway related expenditure through its mobility division. The business offers solutions for rail automation, railway electrification, light and heavy rail, locomotives, trains, turnkey projects and integrated services. Among the EPC players, KEC and Kalpataru Power have around low single digit exposure to railway spending. However, we note that both these companies are increasingly focusing their efforts on this market and we should see an increasing contribution to their top line. The scope of work includes earth work, track laying, electrification and signalling, bridgework, platform construction and power systems.
Opportunity in oil and gas

The total expenditure in the pipeline network over the next three years is estimated at cINR156bn (cUSD3.37bn).
77
abc
It is planned to increase the total pipeline network from current 18,000km to c40,000km over the next five years.
Opportunity in domestic oil & gas infra Investment opportunity Pipelines GAIL Southern, Jagdishpur-Haldia, Hyderabad-Vijaypur Oil marketing companies City gas distribution Gas gathering stations ONGC OIL/CAIRN
Plants & tank farms Total opportunity
Consumer durables rural penetration boosts growth

Classification of the consumer durables industry
The Indian consumer durables segment can be segregated into consumer electronics (TVs, VCD players and audio systems etc) and consumer appliances like refrigerators, washing machines, fans, air conditioners, microwave ovens, vacuum cleaners and dishwashers. The consumer durables can be further classified as white goods and brown goods which are primarily kitchen appliances.
USDm
1.02 0.52 0.1
INRm
47 24 5
0.86 0.65 0.22 3.37
40 30 10 156
We also highlight below some of the key upcoming pipeline projects in India.
Indian opportunities in pipelines Upcoming pipeline projects
GAIL IOCL GSPL HPCL RGTIL Total
Key characteristics
Some of the key characteristics of the Indian consumer durable market are:
Highly competitive Low margin business Highly susceptible to raw material price volatility Low penetration
Multi national companies dominate the market
Length (km)
6,483 781 450 300 3,030 11,044
Cost (INRbn)
261 11 9 6 182 470
Exposure of stocks under coverage to oil & gas infrastructure

Among the EPC players under our coverage, Kalpataru has significant exposure of c9% to oil & gas infrastructure expenditure. Kalpataru is largely involved in pipeline EPC work. Among the equipment manufacturing companies, ABB and Siemens have high single digit to low double digit exposure to the oil & gas markets. While ABB provides process automation products to the industry, Siemens, through its oil and gas division, offers products and solutions that are used for the extraction, conversion and transport of oil and gas.
The Indian consumer durable market is dominated by multinational companies. These companies have an edge over the domestic players because of superior technology and better access to funds. The domestic companies on the other hand benefit from local market insight and higher market share of the existing brands.
Indian middle class key target market

The rapid rise in the countrys middle and highincome classes is likely to lead to an even sharper rise in demand for both consumer durables and consumables. The National Council of Applied Economic Research (NCAER) defines the middle class as a
78
abc
household with an annual income of INR200,000 (USD4,938) to INR1m (USD24,691). Between 1995 and 2005, total middle class households grew more than 3x from 4.5m to 18.7m. By the end of 2010, this number is expected to have increased to 32.7m which will translate to around 160m middle class consumers. This does not include the upper income group that will continue to be a prime consumer for consumer durables market. Furthermore, India benefits from its demographics as the country boasts the youngest population among the major countries. Nearly two-thirds of the countrys population is below the age of 35 years and nearly 50% is below 25. There are around 56m people in middle class, who earn cUSD4,400-21,800 a year, while there are around 6m rich households in India.
electrification. This has discouraged most companies to market their products in rural areas. We believe that as rural infrastructure improves, supported by national development plans, the demand for consumer durables in the rural sector will rise and this will be a key driver for the industry.
Growth opportunity
The consumer durables market is expected to grow at c30-35% in 2010-11 (Source: NCAER). It is growing rapidly because of the rise in living standards, easy access to consumer finance and a wide range of choices with many foreign players entering the market. In terms of purchasing power parity (PPP), India is the fourth largest economy in the world and is expected to overtake Japan in the near future to become the third largest. The Indian consumer goods market is expected to have reached USD400bn by the end of 2010. The rural sector accounts for 70% of the Indian population. Rural areas have a penetration level of only c2% for brown goods and c0.5% for white
Government spending on infra to drive consumer durables market

The primary reason for low penetration in the Indian rural market has been inefficient infrastructure development, particularly
Classification of consumer durable industry
Consumer durable industry
White Goods
Brown Goods (Kitchen Appliances)
Consumer Electronics
Refrigerators Washing Machines Air-conditioners Speakers and audio components
Mixers Grinders Microwave ovens Iron Electric fans Cooking range
Mobile phones Television MP3 players DVD players VCD players
Source: Market survey
79
abc
goods. The annual growth rate of urban and rural markets is c7-10% and c25%, respectively. The rural market is growing faster than the urban market, which has now largely become a product replacement market.
Healthcare still in its infancy

The Indian healthcare sector is still at a nascent stage with tremendous opportunity for growth and development. The total expenditure on the Indian healthcare sector is only c4.8% of GDP, of which c1.2% is public health spending with the balance from the private sector.
Stock exposure to consumer durables market

Within our coverage, only Crompton has exposure to the consumer durables market through its consumer products division. The business supplies fans, lighting equipment, pumps, integrated security systems, home automation and a range of electrical household appliances.
Growth drivers
The key growth drivers for the Indian healthcare market include:
Favourable demographics the rise in the middle class population (as discussed in the consumer durables section), demographics inclined towards a large proportion of senior citizens. Increasing expenditure on healthcare increased disposable incomes and rise in population is expected to result in better healthcare awareness and higher expenditure on healthcare. Preference for private treatment with the increase in disposable income most people prefer private medical services. Shift in disease pattern from communicable to lifestyle related diseases
Healthcare expenditure of different countries as % of GDP
United States Australia South Africa Brazil Mex ico China India Russia Sri Lanka 0 1 1.2 1.2 1.8 1.7 2 3 4 Public health ex penditure (% of GDP) 2 2.9 3.1 3.2 3.2 3.3 3.6 3.6 2.5 4.2 5.2 6.4
6.8
8.4
5 6 7 Priv ate health ex penditure (% of GDP)
Source: Indian retail sector report
80
abc
Projected growth rate of Indian healthcare market
Estimated density of doctors, nurses and beds per 1000 population by year 2025
14,000 12,000 10,000 8,000 6,000 4,000 2,000 2007 2012 2017 2022
6 5 2 0.9 0.6 1.3 Current Nurses density

Source: IBEF presentation
15% CAGR
4 3 2 1 0
1 2.2
Projected demand Doctors density Bed density
Source: Indian retail sector report 2009
and a demand for tertiary and quaternary care.

Additional infrastructure requirements The Indian healthcare infrastructure is not sufficient to meet the growing population and increase in number of patients. Among the BRIC countries India has the lowest ratio of doctors and nurses as well as lowest bed topopulation ratio.
Projected infrastructure USD78bn opportunity

According to the IBEF presentation:
The number of hospital beds per 1,000 people is less than the current international average. An additional 1.75m beds are needed for India to achieve the target of two beds per 1,000 people by 2025. An additional 700,000 doctors will be required by 2025 to reach a ratio of one medical doctor per 1,000 individuals. To maintain the current doctor-to-nurse ratio of 2.2, an additional 1,600,000 nurses will have to be trained by 2025.
Projected growth for Indian healthcare sector

According to the India Retail report 2009, the Indian healthcare industry was estimated at cINR1,500bn at the end of 2007. With additional infrastructure requirements (cUSD37.5bn) it is expected to grow to INR3,000bn (cUSD75bn) over the next few years.
Achieving these targets will require a total investment of USD77.9bn.
81
abc
82
abc
Risk analysis
Competitive landscape changing rapidly Sector remains highly geared to metal prices Excess capacity likely, but not a major threat
at this stage
83
abc
Competitive landscape changing rapidly

Vendor concentration for the Power Grid (PG) orders has
increased again after falling sharply in FY10

For substations/transformers, Chinese competition is absent this
year (for PG orders) and both Areva and Siemens have regained their position. We expect Chinese competition to ease up as new QRs require them to set up local manufacturing facilities
In the tower EPC segment, KEC and Kalpataru have regained
their position, winning c25% of the total orders. We expect pricing to stabilise as margins of new entrants look unsustainable
Competition is fierce
The Transmission & Distribution (T&D) segment has seen a significant increase in competition across all the product categories. The competition has not only come from Low Cost Country (LCC) manufacturers, such as China and Korea, but also from an increasing number of local vendors. We note that the competitive landscape not only varies across different product segments i.e. transformers, substations, tower EPCs etc but also across different technology segments i.e. 765kV+ versus 400/220kV-. Another key feature of the competitive landscape is that market share for most companies is currently very volatile. As a result, price stability is very weak as new entrants try to build market position through aggressive pricing.
We note that it is difficult to get reliable data on market dynamics for the entire T&D value chain in India as there is no third party aggregator of such data (most of the companies assess their position in the market using their in-house analysis). Therefore, we analyse Power Grid (PGCIL) order awards to identify the competitive trends in the market. The reasons why Power Grid order awards are a good benchmark for competition analysis are:
Power Grid, being the only Central Transmission Utility (CTU) in India, is the single largest transmission customer in the country and accounts for c50% of Indias transmission capex. Hence, the analysis of its order awards is able to capture half of the market.
84
abc
PGCIL monthly orders
60.0 50.0 40.0 30.0 20.0 10.0 0.0 Dec-10 Nov-10 Oct-10 Sep-10 Aug-10 Jul-10 Jun-10 May-10 Apr-10 Mar-10 Feb-10 Jan-10 Dec-09 Nov-09 Oct-09 Sep-09 Aug-09 Jul-09 Jun-09 May-09 Apr-09 Mar-09 Feb-09 Jan-09 Dec-08 Nov-08 Oct-08 Sep-08 Aug-08 Jul-08 Jun-08 May-08 Apr-08
Source: PGCIL, HSBC
Being the biggest and the only central transmission customer, Power Grid is usually the primary target for competition entering the T&D market for the first time. Hence, Power Grid order awards are usually a good representation of competitive trends.
financial year (FY11 y-t-d) in the table opposite. We note that while transformer/reactor orders have reduced sharply, the proportion of tower & substation related orders has increased significantly (from c46% in FY09 to c67% in FY11 y-t-d).
Power Grid order mix FY09
Tower Insulator Civil Conductor Rural Elec Substation Transformers/Reactors Others Total
Source: PGCIL, HSBC
Power Grid orders backend loaded

Power Grid orders have historically been backend loaded in any given year. This trend was amply visible in both of the previous financial years, FY09 and FY10, with Power Grid ordering almost half of the total orders in the last quarter in both financial years. We expect this trend to continue this year and expect significant order inflow during Q4 FY11. In that context, our analysis of Power Grid orders year-to-date (Apr 10 to Nov 10) is only indicative in nature rather than conclusive as vendor market shares (for Power Grid orders) might change significantly during Q4 FY11. We highlight Power Grids monthly order awards in the chart above.
FY10
32% 7% 1% 13% 3% 20% 24% 0% 100%
y-t-d
41% 4% 0% 20% 0% 26% 8% 1% 100%
27% 3% 1% 27% 14% 19% 8% 1% 100%
On the other hand, the proportion of transformer orders has fallen to c8% in FY11 y-t-d compared with c24% in FY10. Moreover, within transformers and substations, the proportion of 400/220kV products has increased relative to the 765kV products. In fact, so far in the current financial year, there has been only one 765kV transformer order, which was awarded to Hyosung Corp.
Less of transformers and more of towers and substations

We highlight the Power Grid order mix for previous financial years and for the current
85
abc
PGCIL order mix Transformer order mix

765kV 400/220kV Total
FY09
42% 58% 100%
FY10
20% 80% 100%
y-t-d
32% 68% 100%
Whos who of the T&D league table

The transformer and reactor product segment has historically seen a high concentration of players for all voltage levels (i.e. 765/400/220kV), with Crompton Greaves being the largest domestic supplier and Koreas Hyosung Corp the largest foreign supplier in FY09. However, the competition intensified in FY10 as a couple of Chinese players (TBEA and Baoding) entered the 765kV transformer segment. We believe that the main catalyst for Chinese competition in this segment was the Qualification Requirement (QR) set by Power Grid for its 765kV transformer orders, which required that only up to c33% of the transformer orders could be supplied from a domestic production facility, while the remainder had to come from a foreign production facility. This clearly put European vendors at a disadvantageous position to Chinese vendors, as a result of which Chinese won several transformer orders in FY10. Interestingly, Chinese competition was only limited to the 765kV transformer segment. Power Grid has recently relaxed its QRs and has added certain additional points to make sure that only credible vendors enter this market. The two key changes in the QRs are:
Domestic versus International production requirement has been relaxed to 50:50 from 33:67 earlier. It is now required that all foreign suppliers will have to set up their local production facility within three years of winning the order. These requirements, in our opinion, will stabilize the transformer market in the near term and will create some barriers for entry as new entrants will need to establish production facilities in India.
Substation order mix

765kV 400/220kV Total
Source: PGCIL, HSBC
FY09
52% 48% 100%
FY10
45% 55% 100%
YTD
24% 76% 100%
Intensifying competition for orders

Our analysis of the Power Grid orders suggests that the vendor concentration in the T&D value chain has historically been moderate to high (depending on the product segment). However, the vendor concentration declined significantly (or the market became highly competitive) in all product segments during FY10 with the entry of several foreign and local players into the market. We note that the vendor concentration has increased somewhat during the current financial year (FY11). This implies that several of the new entrants during FY10 didnt get repeat orders in the current financial year. While it is difficult to draw any definitive conclusion from this trend (as the market is witnessing a lot of flux because of the entry of new players), we believe an increase in vendor concentration at least bodes well for the pricing environment in the T&D equipment market. We highlight the vendor concentration in different product segments as measured by the HHI index.
HHI Index Segments
765kV Transformers/Reactors 765kV Substations 400/220kV Transformers/Reactors 400/220kV Tower EPC
Source: PGCIL, HSBC
FY09
0.47 0.26 0.36 0.11 0.13
FY10
0.26 0.35 0.32 0.16 0.11
YTD
1.00 0.49 0.33 0.23 0.12
86
abc
We note that there has been only one 765kV transformer order this year, which was won by Hyosung Corp.
Market share transformer 765kV Transformers/Reactors
Hyosung Corp TBEA (China) Baoding (China) ABB Areva T&D Crompton Greaves JV of CGL & ZTR Total
Source: PGCIL, HSBC
Substation market share 765kV Substations

ABB Areva T&D GET Power Siemens AG Siemens L&T and Areva JV Hyosung Corp Total
Source: PGCIL, HSBC
FY09
23% 0% 0% 5% 13% 37% 22% 100%
FY10
11% 15% 0% 23% 51% 0% 0% 100%
y-t-d FY11
57% 41% 2% 0% 0% 0% 0% 100%
FY09
51% 0% 0% 0% 3% 46% 0% 100%
FY10
20% 28% 13% 5% 0% 35% 0% 100%
y-t-dFY11
100% 0% 0% 0% 0% 0% 0% 100%
In the 400/220kV transformer/reactor segment, Siemens has sharply increased its market share to c51% from c22% in FY09 and is the number 1 player. The other two prominent players in this segment this year are Vijai Electricals and Areva T&D, who have each increased their market share to c16-18% from 0% in FY09. On the other hand, both BHEL and Crompton have significantly lost market share in this segment and have won only c11% and c5% of the total orders, respectively, compared with c40% each in FY09.
Market share transformer 400/220kV Transformers/Reactors
Siemens Vijai Electricals Areva T&D BHEL Crompton Greaves ABB EMCO Total
Source: PGCIL, HSBC
In the 400/220kV substation segment, Siemens has also gained considerable market share (c37% versus c18% in FY09). The next biggest players in this segment are GET Power and KEC, who have each increased their market share by c15-20% since FY09. We note that none of the previous big players in this segment Crompton, Hyosung, Areva T&D, ICSA have won any major orders this year. On the other hand, there are five new entrants in this segment this year KEC, Tata Projects, Jyoti Engineers, Jyoti Structures and Bharat Bijlee.
Substation market share 400/220kV Substations
Siemens/Siemens AG GET Power KEC International Tata Projects Jyoti Engineers Jyoti Structures Areva T&D Bharat Bijlee ICSA Crompton Greaves Hyosung Corp ABB Indo Power BHEL ECI Engg EMC EMCO Indotech L&T Shyama Power Voltech Projects Total
Source: PGCIL, HSBC
FY09
18% 10% 0% 2% 0% 8% 4% 0% 0% 8% 0% 19% 0% 2% 8% 4% 7% 0% 5% 4% 1% 100%
FY10
9% 6% 0% 0% 0% 0% 25% 0% 14% 18% 15% 2% 0% 0% 0% 0% 9% 2% 0% 0% 0% 100%
y-t-d
37% 25% 15% 8% 7% 5% 2% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 100%
FY09
22% 0% 0% 36% 43% 0% 0% 100%
FY10
0% 3% 16% 39% 37% 0% 5% 100%
y-t-d FY11
51% 18% 16% 11% 5% 0% 0% 100%
In the 765kV substation segment, ABB and Areva have re-established their leadership this year, with a market share of c57% and c41%, respectively. No other player has won any major order in this segment this year.
Within the tower EPC segment, SPIC (Southern Petroleum Industries Corporation), through its JVs,
87
abc
has won c35% of the total orders this year compared with just one small order in FY09.Within our tower EPC coverage, both KEC and Kalpataru have regained their position with Power Grid and have each won c12% of the total orders. Jyoti Structures on the other hand has not won any tower EPC order from Power Grid this year.
EPC tower market share Tower EPC
SPIC & Aster JV SPIC & BST JV Kalpataru Power KEC International Gammon India Tata Projects Tata Power Shyama Power Navyug Aravali Siemens AG C & C CONSTRUCTIONS GEO Foundation & GPT Infraprojects JV Meher Jyoti Structures EMC & ICOMM JV L&T IVRCL Infra A2Z Bajaj Electricals A2Z & Karamtara JV SPIC & Sujana JV ITPL EMCO Aster Tele Best & Crompton ECI & ICOMM JV ICOMM Tele Inabensa Others Total
Source: PGCIL, HSBC
Crompton transformer/reactor price growth
80% 60% 40% 20% 0% -20%
FY09
1% 0% 15% 19% 17% 6% 0% 1% 0% 0% 0% 0% 0% 0% 15% 6% 7% 0% 0% 2% 0% 0% 0% 8% 1% 1% 1% 0% 0% 0% 100%
FY10
7% 0% 5% 2% 3% 22% 0% 0% 0% 0% 0% 0% 0% 0% 14% 6% 9% 9% 0% 1% 0% 2% 0% 0% 0% 0% 0% 8% 4% 9% 100%
y-t-d
20% 14% 12% 12% 10% 9% 5% 5% 5% 2% 2% 2% 1% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 100%
FY05
FY06
FY07
FY08
FY09
FY10
Source: Company, HSBC
Areva transformer/reactor price growth
200% 150% 100% 50% 0% -50% FY05 FY06 FY07 FY08 FY09
From pricing power to pricing pressure

The pricing environment in the T&D equipment market has worsened over the last few years, particularly in the transformer and the tower EPC segment. Analysis of Areva and Crompton product prices suggests that transformer/reactor prices went down by c8-10% in FY10.
Margin analysis of the tower EPC players suggests that there is also increasing pricing pressure in that segment. The margins for KEC, Kalpataru and Jyoti, on average, have declined by c200bp. The management of all these companies have highlighted aggressive pricing by their competitors, especially new entrants, as the main reason behind the decline in their market share. We note that SPIC stands out as an aggressive competitor in the tower EPC segment, given that it has established a strong market position in just two years. However, when we take a quick look at its financials, the company has not only made operating losses in two out of last six quarters, but its near zero average EBITDA margin over the last six quarters is significantly below the average
88
abc
margin of c11.5% for the Big 3 KEC, Kalpataru & Jyoti during the same period.
SPIC EBITDA margin
8% 6% 4% 2% 0% -2% -4% -6% -8% Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11
None of the tower EPC companies under our coverage have shown such a declining trend in their margins. Furthermore, their average EBITDA margin of c11.5% remains comfortably above the average EBITDA margin of competition. This implies that, unlike competition, these companies were not bidding at aggressive prices and hence lost market share with Power Grid during FY10. We believe that the margins which the competition has produced in recent quarters are not healthy and/or sustainable. Hence, even though the sector may have lost its pricing power, we expect the pricing environment to stabilize going forward.
Moreover, most of the other players who have increased their market share in FY10 have seen a decline in their EBITDA margins recently.
Average EBITDA margin of tower EPC players (ex-Big 3)
14% 12% 10% 8% 6% 4% 2% 0% Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11
89
abc
Sector remains highly geared to metal prices

Our metals team forecasts steel prices to rise by c10-12% in 2011 Within our coverage, EPC players remain most at risk with Jyoti
having the highest exposure to steel (c24%)

While margins in the current contracts remain secure due to price
escalation clauses, margins on new contracts may be squeezed
Plus the raw material inflation burden

Increasing competition is never good for vendors, but it is particularly bad news during inflationary periods as suppliers often have to squeeze margins to remain competitive on bidding. For example, due to increasing competition in the T&D equipment market, the price for Areva T&D Indias products went down by c6% on average in CY09 even though the raw material prices went up by c34% on average.
Areva average price vs raw material price growth
We highlight the exposure of companies under our coverage to various raw materials (i.e. metals) in the table below. We note that the EPC players are more susceptible to raw material price increases, as they manufacture relatively low value added pylons with high steel content. The substation equipment manufacturers on the other hand have a lower exposure to metal prices as they manufacture products which have high technology content. Within substation vendors, however, Crompton remains highly geared to metal prices. Our Metals & Mining team, forecasts steel price to go up by c11% in 2011 and iron ore prices to go down by c14%. Among the non-ferrous metals, our mining analyst forecasts copper prices to decline by c15% in 2011 and zinc prices to decline by c3%.
40% 30% 20% 10% 0% -10% FY07 Product price grow th

FY08
FY09
RM price grow th
90
abc
Raw material price exposure Company Areva T&D Metal Exposure

4.2% 1.95% 1.33% 11.78% 9.59% 0.10% 0.67% 23.91% 2.43% 11.18% 1.52% 13.94% 1.82% 0.72% 1.62% 0.79% 0.05%
Zinc price trend
2.0 1.5 1.0 0.5 0.0
Copper Steel Aluminium Crompton Greaves Ferrous Metals Non-ferrous Metals ABB India Ferrous Metals Non-ferrous Metals Jyoti Structures Steel Zinc Kalpataru Steel Zinc KEC Steel Zinc Copper Siemens Steel sheets and castings Copper strips and wire Aluminium ingots, profiles and castings
Mar-91
Mar-11 Mar-10 Mar-11 Mar-12
Mar-87
Mar-07
Mar-95
Mar-99
Mar-03
Zinc (USD/lb)
Zinc forecast
Steel price trend
1,500 1,000
Given that steel prices are expected to increase, the company that remains most vulnerable to cost pressures is Jyoti Structures, whose exposure to steel is c24% of sales. This added steel cost inflation burden might further dampen Jyotis ability to bid competitively without compromising significantly on margins.
Iron price trend
500 -
Mar-02
Mar-06
Mar-00
Mar-04
Steel prices(USD/tonne) Steel price forecast

200 150 100 50 0

Copper price trend
5.0 4.0 3.0 2.0 1.0 0.0
Mar-99
Mar-11
Mar-87
Mar-91
Mar-95
Mar-03
Mar-07
Mar-15
Mar-87
Mar-91
Mar-08
Mar-07
Mar-95
Mar-99
Mar-03
Iron Ore - Lump (AUS) USD/t Iron forecast

Copper price (USD/lb) Copper price forecast

Mar-15
Mar-15
91
abc
Excess capacity likely but not a major threat

Manufacturing capacity is in line with the expected demand;
however, with increasing players and expansion plans, the demand supply balance may deteriorate
We dont see excess capacity as a near term threat as utilization
levels are likely to remain high over the next two to three years
More capacity on line

Transformer manufacturing capacity
A significant amount of manufacturing capacity for transformers/reactors has come on line over the last couple of years, driven by the expansion plans of old players and entry of several new players. Based on the last reported figures, the transformer manufacturing capacity of some of the major listed players stands at over 150,000MVA. We highlight the major players and their production capacities in the table below.
Transformer manufacturing capacity
data is not available but have decent size capacities. Furthermore, there are players such as BHEL who are ramping up their production capacities.
Tower manufacturing capacity

Tower manufacturing capacity has also increased significantly over the years. The domestic manufacturing capacity of some of the major listed players stands at c643,000MT. In addition to this, there are several small players who have production capacity ranging from 10,000MT to 30,000MT. We highlight the production capacities of major players below.
Tower manufacturing capacity
V e ndor s A BB Ltd A reva T&D India BHEL Crompton Greaves Siemens Ltd V oltamp TRIL Total
Re por te d capacity (M V A) 18,375 30,075 20,500 31,608 15,000 13,000 23,200 151,758
V e ndor s Bajaj Electricals EMCO Gammon Jyoti Structures Kalpataru Pow er KEC Intl L&T Total
Repor te d capacity (M T) 24,000 45,000 110,000 110,000 108,000 151,000 95,000 643,000
In addition to these players, we note that there are several small and/or unlisted players, such as Indotech and Vijai Electricals, whose operational
92
abc
Excess capacity likely but situation doesnt look abysmal

We note that transmission expenditure of INR2,400bn in the 12th (FY13-17) plan is going to be nearly double the size of the 11th plan (FY08-12). India Inc currently plans to add a transformation capacity of c310,000MVA during the 12th plan compared with the targeted capacity addition of c182,561MVA in the 11th plan. The 12th plan target equates to an annual transformation capacity addition of c62,000MVA. In addition to this there remains a sizeable cINR4,000bn budget for distribution in the 12th plan, of which around two thirds will be spent on sub-transmission and distribution. Given the similar size of expenditure in transmission and sub-T&D, we assume a similar annual transformation capacity addition, taking the total demand to c125,000MVA per annum. In addition to this there will be distribution and power transformer demand by the industrial players.
Assuming c80% as the optimal capacity utilization level, the visible supply of c121,000MVA looks in line with the visible demand of c125,000MVA. Similarly, according to the industry sources, tower demand is expected to annualize at c620,000MT over the next 5-7 years. Given that most of the tower manufacturing company operate at near 100% utilization levels, the current supply of c643,000MT remains largely in line with the expected demand.
Structures demand
Structur e Tow er (PGCIL) Tow er (SEBs/IPTCs) Sw t Y rd Structures Total

Re quire m e nt (M T pa) 345,000 175,000 100,000 620,000
We believe that over the coming years, as new players enter into the market and as the incremental capacities of the existing companies come on-stream, the demand supply imbalance may become critical. However, we dont see this as an immediate threat in the near term (i.e. over the next two to three years).
93
abc
94
abc
Valuation & performance analysis

95
abc

Our coverage universe remains modestly inexpensive compared
with its historical trading average or trade peers

EPC players have de-rated in line with declining returns, but
equipment manufacturers have re-rated in spite of it

EPC players have underperformed the sector by c10% over the
last 6m while equipment manufacturers have outperformed by c10%. Overall, our coverage universe has performed inline
Making sense of multiples

Different investors focus on different multiples and in most cases all the multiples do not paint a coherent picture. We evaluate companies on four key multiples and believe that all these multiples should be looked in conjunction to each either to arrive at valuation related conclusions. The four multiples that we have chosen for our analysis are as follows:
12-month forward PE. This is the most common multiple used by investors to analyse companies because not only it is simple to calculate but also easy to understand. This multiple is most relevant to equity shareholders; however, the PE multiple has its own shortcomings. When looked at in isolation to other multiples, it can paint a very wrong picture if the companies have very different capital structure. 12-month forward EV/EBITDA. This is an important capital structure neutral multiple.
The multiple puts a value on the returns generated by the business (operating profit) and hence differentiates companies based on the quality of their business rather than just the quality of earnings to the shareholders. In our opinion, this multiple should be looked at in conjunction to PE to understand if a stock is mispriced.
12-month forward EV to sales. This is another EV based (i.e. capital structure neutral) multiple. Investors usually prefer to look at this multiple when it is difficult to forecast margins or when earnings show significant volatility. The basic assumption here is that during most part of the cycle, the visibility on sales is usually much better than the visibility on margins, especially during difficult times. Empirical evidence suggests that companies usually trade at c10-12x their through cycle EBIT margins on 12-month forward EV to sales.
96
abc
EV to backlog. This is a multiple which is specifically used for businesses which have long lead times and hence, order books running over 12-18 months. This multiple is particularly useful for our coverage universe as companies with increasing order backlogs typically tend to outperform their peers on future earnings. Hence, the market often chooses to place the value on order backlog rather than the earnings. In our view, again this multiple should be looked at in conjunction to PE and EV/EBITDA.
Sector EV/EBITDA vs history
20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Sector Av g

Historic av erage
Sector looks inexpensive

As we highlight in the chart below our coverage universe doesnt look expensive compared with its historical trading multiples. In fact, on consensus numbers, our sector is trading bang in line with historical average (FY05-10), at c20x 12-month forward PE.
Sector PE vs history
We note that our sector has de-leveraged over the last five years with average gearing reducing from c1.0x in FY06 to c0.3x in FY10. This has artificially inflated the PE multiple, as underlevered companies usually appear expensive on PE. Therefore, even though our sector appears to be trading in line with historical average on PE, when adjusted for de-leveraging, it is actually trading at a discount to the historical average. The sector also looks a little inexpensive versus history when compared on the 12-month forward EV-to-sales multiple. On this multiple, the sector is trading at c1.3x versus the historical average of c1.4x. We find this discount (c7%) unwarranted because EBITDA margin expectations have not changed much versus history. Based on consensus numbers, the 12-month forward EBITDA margin for the sector is expected to be c11.4% versus historical average of c11.6%.
40 30 20 10 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Sector Av g

Historic av erage
However, the sector looks a little inexpensive versus the historical average (c5% discount) when compared on the 12-month forward EV/EBITDA multiple, trading at c11.2x versus historical average of c11.7x.
97
abc
Sector EV to sales vs history
Sector EV to backlog vs history
3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jan05 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11
3.0 2.5 2.0 1.5 1.0 0.5 0.0 Sep-06 Sep-07 Sector Av g
Sep-08
Sep-09
Sep-10
Sector Av g
Historic av erage
Historic av erage
Sector EV to sales vs EBITDA margin
13.0% 12.5% 12.0% 11.5% 11.0% 10.5% 10.0%
EPC players trading at significant discount to history

EPC players (Jyoti, KEC and Kalpataru) have derated quite significantly over the last couple of years. On 12-month forward consensus based PE, the EPC players are trading at a significant discount of c30% versus their historical average (FY05-10). We note that this is in spite of them de-leveraging significantly over the last five years (gearing of 0.9x in FY10 versus 1.6x in FY06).
EPC PE vs history
Sector Av g
12m fw d EBITDA mgn
Interestingly, when we compare the sector versus its historical average on EV to backlog, the current discount widens sharply to c30%, implying either the market is moving on from being order focused to being execution focused or that it has assigned a higher risk to the order book. Either way, the relative value of order book seems to have diminished somewhat.
30 25 20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 EPC Av g

Historic av erage
On 12-month forward EV/EBITDA, the EPC players are trading at a discount of c25% versus historical average.
98
abc
EPC EV/EBITDA vs history
EPC EV to sales vs EBITDA margin
20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 EPC Av g

2.0 1.5 1.0 0.5 0.0 Jan05 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11
15.0% 14.0% 13.0% 12.0% 11.0% 10.0% 9.0%
Historic av erage
EPC Av g
12m fw d EBITDA mgn
EPC players also look significantly inexpensive on 12m EV to sales, trading at c0.5x versus a historical average of c0.8x. We note that EBITDA margin expectations have come down (c10.9%) versus historical average (c11.7%), justifying a large part of this de-rating.
EPC EV to sales vs history
Interestingly, the EPC sub-segment has NOT derated much on EV to backlog basis. The EPC players are trading at an EV-to-backlog multiple of c0.4x versus a historical average of c0.5x, implying that the value of EPC players is still driven by their order book.
EPC EV to backlog vs history
2.0 1.5 1.0 0.5 0.0 Jan05 Jan06 Jan07 EPC Av g

1.0 0.8 0.6 0.4 0.2 Jan08 Jan09 Jan10 Jan11 0.0 Sep-06 Sep-07 EPC Av g
Sep-08
Sep-09
Sep-10
Historic av erage
Historic av erage
Equipment manufacturers actually at a premium to their historical average

Equipment manufacturers (ABB, Siemens, Areva T&D and Crompton) have re-rated upwards over the last couple of years and are now trading at premium to their historical trading average. On consensus 12-month forward PE the equipment manufacturers are trading at c28x versus historical average of c24x (a premium of c15%).
99
abc
Equipment mfg PE vs history
Equipment mfg EV to sales vs history
50 40 30 20 10 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Equipment Mfg Av g

Historic av erage
Equipment Mfg Av g
Historic av erage
On 12-month forward EV/EBITDA, the equipment manufacturers are trading at a small premium of c10% versus history.
Equipment mfg EV/EBITDA vs history
Equipment mgf EV to sales vs EBITDA margin
14.0% 13.0% 12.0% 11.0% 10.0%
30 25 20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Equipment Mfg Av g

Equipment Mfg Av g
12m fw d EBITDA mgn
Historic av erage
The equipment manufacturers are trading in line with history on 12m EV to sales, at c1.9x versus historical average of c1.8x. The slight premium doesnt look unwarranted given that EBITDA margin expectations have also slightly gone up (c40bp).
Interestingly, equipment manufacturers have derated quite significantly on EV to backlog and are trading at c1.6x versus their historical average of c2.2x. We believe that this de-rating can be partly explained by the significant price erosion which equipment manufacturers, particularly, transformer makers, have witnessed over the last two years. This, in our opinion, has reduced the quality of order book somewhat and hence the value subscribed to it.
100
abc
Equipment mfg EV to backlog vs history
6.0 5.0 4.0 3.0 2.0 1.0 0.0 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10
Jyoti Structures is the second most inexpensive stock within our universe after Kalpataru. It is trading at a discount of c25% versus its historical average on both 12-month forward PE and EV/EBITDA. Areva T&D India, on the other hand, has re-rated upwards the most within our universe. It is trading at a premium of c25% on PE and c20% on EV/EBITDA versus its FY06-10 average. In the candle charts that follow, for each of the companies and the sector, we highlight the historical trading range, the historical average multiple and the current multiple, based on consensus 12-month forward PE, EV/EBITDA, EV to sales and EV to backlog.
Equipment Mfg Av g
Historic av erage
Jyoti and Kalpataru have de-rated the most; Areva has re-rated the most
Kalpataru Power has de-rated most in our coverage universe and is trading at a discount of c30% on PE and c35% on EV/EBITDA. Given that the PE multiple for Kalpataru has inflated a bit due to de-leveraging, the EBITDA multiple in our opinion highlights the correct underlying discount versus history.
12 month trailing EV to backlog
7 6 5 4 3 2 1 0 Jy oti KPTL KEC ABB Arev a Siemens EPC Av g Eqp Mfg Av g Sect Av g
Trading Range
Historic Av erage
101
abc
12 month forward PE (Consensus)
60 50 40 30 20 10 0 Jy oti KPTL KEC ABB Arev a CG Siemens EPC Av g Eqp Mfg Av g Trading Range
Sect Av g
Historic Av erage
12 month forward EV/EBITDA (Consensus)
35 30 25 20 15 10 5 0 Jy oti KPTL KEC ABB Arev a CG Siemens EPC Av g Eqp Mfg Av g Trading Range
Sect Av g
Historic Av erage
12 month forward EV to sales (Consensus)
6.0 5.0 4.0 3.0 2.0 1.0 0.0 Jy oti KPTL KEC ABB Arev a CG Siemens EPC Av g Eqp Mfg Av g Trading Range
Sect Av g
Historic Av erage
102
abc
Returns have deteriorated, justifying de-rating

Although our sector is trading at a discount to its historical (FY06-10) trading average, we believe that the discount can be largely justified by the deterioration in the sector returns i.e. return on Equity (RoE) and return on capital employed (RoCE). In some cases, returns have deteriorated much more than the de-rating. We note that the average sector RoE has come down to c22% versus its historical average of c29% while the average RoCE has come down to c29% versus its historical average of c40%.
Sector PE vs RoE
EPC returns have deteriorated in line with de-rating

The average RoE for EPC players has come down to c20% versus its historical average of c27%. As we highlight in the chart below, the EPC 12-month forward PE seems to have moved in line with the EPC RoE.
EPC PE vs RoE
30 25 20 15 10 5 0
50% 40% 30% 20% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
40 30 20 10 0
40% 35% 30%

EPC Av g
12m fw d RoE
25% 20% 15% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Sector Av g
12m fw d RoE
Similarly, EPC players average RoCE has come down to c20% versus their historical average of c30%. As we show below in the chart, the trend in the EPC EV/EBITDA multiple also looks in line with the trend in the EPC RoCE.
EPC EV/EBITDA vs RoCE
Sector EV/EBITDA vs RoCE
20 70% 60% 50% 40% 15 10 5 0
80% 60% 40% 20% 0% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 EPC Av g 12m fw d RoCE
20 15 10 5 0
30% 20% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Sector Av g 12m fw d RoCE
103
abc
Equipment manufacturers have rerated in spite of deteriorating returns

As we highlighted earlier, equipment manufacturers have re-rated upwards over the last couple of years and are now trading at premium versus their historical average. The average 12-month forward PE for equipment manufacturers has gone up to c28x (versus a historical average of c24x) even though their average RoE has come down to c24% versus the historical average of c31%.
Equipment mfg PE vs ROE
ABB, Areva T&D show biggest disconnect between returns, re-rating

We note that within our coverage universe ABB and Areva show the biggest disconnect between their re-rating and operational performance in terms of return ratios. While Areva is trading at a premium of c25% and c20% on consensus 12-month forward PE and EV/EBITDA (versus the historical average), both its RoE and its RoCE have declined by c8% and c4%, respectively, versus historical average.
Areva PE vs ROE
50 40 30 20 10 0
40% 35% 30% 25% 20% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Equipment Mfg Av g 12m fw d RoE
60 50 40 30 20 10 0
50% 40% 30% 20% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Arev a T&D India 12m fw d RoE
Similarly, on 12-month forward EV/EBITDA the equipment manufacturers are trading at a premium of c7% even though their average RoCE has come down to c36% versus a historical average of c47%.
Equipment mfg EV/EBITDA vs RoCE
Areva EV/EBITDA vs RoCE
20 15
40% 30% 20% 10% 0% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Arev a T&D India 12m fw d RoCE
30 25 20 15 10 5 0
70% 60% 50% 40% 30% 20% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
10 5 0
Equipment Mfg Av g
12m fw d RoCE
104
abc
On the other hand, ABB is trading at a premium of c10% on both PE and EV/EBITDA; however, both its RoE and RoCE have declined significantly by c10% and c30% respectively versus its historical average. We note that both ABB and Areva T&D India have witnessed an increase in the equity stake by their parent companies, often at a significant premium to the then current prices, thus driving their multiples higher than the fundamentals warrant
ABB PE vs RoE
Equipment manufacturers enjoy acquisition premium while EPC players suffer from dilution discount
It is quite evident from our analysis so far that the two sub-segments under our coverage EPC and equipment manufacturing show quite a bit of disconnect in valuation trends. Apart from the quality of business, we believe that this disconnect is partly driven by the acquisition premium built into the valuation of equipment manufacturers (mostly foreign) and the dilution discount built into the valuation of EPC players. Our hypothesis is based on our observation of the corporate activity in the sector over the last five years. While on one hand EPC players have frequently adopted the route of equity dilution to increase their equity base and fund future growth, the equipment manufacturers, particularly the subsidiaries of foreign firms, have seen several bids by their parent companies to increase their stake in the subsidiary. The most recent example is the open offer by the consortium of Alstom and Schneider to acquire up to 20% of equity in the Areva T&D India business. We highlight major corporate actions over the last five years in the table on the following page.
50 40 30 20 10 0
40% 35% 30% 25% 20% 15% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 ABB Ltd 12m fw d RoE
ABB EV/EBITDA vs RoCE
40 30 20 10 0
110% 90% 70% 50% 30% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 ABB Ltd 12m fw d RoCE
105
abc
Corporate events last 5 years

Company Announced Da te Action No. of Shares (million) 2.07 Price (INR) 10 Am ount raised (INRm) na Marke t Price No. of Share s before the issue (million) 581 49.35 Rem arks
KEC
Kalpataru
Issue of shares pursuant ot scheme of 27-Apr-10 amalgamation of RPG Cables Ltd with KEC International Ltd Issue of shares pursuant to scheme of arrangement b/w National Information Technologies Ltd. (NITEL) and RPG 29-Feb-08 Transmission Ltd (RPGT) and Octav Investments Ltd.(formerly MP Power Line Ltd) 29-Apr-10 QIP 1-Sep-06 QIP
11.66
10
na
728 37.69 26.50 21.72 As per Bloomberg, offer price is at 17.83% announced premium and 6.90% final n/a premium As per Bloomberg, offer price is at 15.04% announced premium and -7.91% final n/a premium As per Bloomberg, offer price is at 5.11% announced premium and -73.77% final n/a premium
4.19 4.78
1074.2 727
4,503 3,473
1,087 764
ABB India
17-May-10
ABB Ltd made open offer for acquiring 22.89% of the voting share capital of ABB India. Shareholding of parent before the offer was 52.11%
48.51
900
43,660
Open Price - Rs. 700 Close Price - Rs. 831 Previous Close - Rs. 686
Areva T&D Holdings SA made open offer for acquiring 20% of the issued share capital. Shareholding of parent 28-May-10 before the offer was 72.18%. But is was able to acquire only 1.22% (i.e., 2.91 milllion shares) at the offer price Areva T&D
47.82
295
14,124
Open Price - Rs. 280 Close Price - Rs. 287 Previous Close - Rs. 267
7-Apr-05
Areva T&D Holdings SA made open offer for acquiring 20% of the issued share capital. Shareholding of parent before the offer was 66.35%.
7.98
75
599
Open Price - Rs. 91 Close Price - Rs.91 Previous Close - Rs. 76
The persistence of this trend over the last five years, in our opinion, has built an acquisition premium in the valuation of foreign equipment manufacturers, and a dilution discount in the valuation of EPC players. We have taken a period of 10 years (due to a long reporting history) to analyse the acquisition premium built into equipment manufacturers and a period of five years (due to a relatively short reporting history) to analyse the dilution discount built into the valuation of EPC players. We have then compared the re-rating with the wider capital goods index,
Equipment mfg re-rating
50 40 30 20 10 0 Jan-01 Jan-03 Jan-05 Avg P/E = 11.2
Avg P/E = 25.2
Jan-07
Jan-09
Jan-11
Equipment Mfg Av g Historic Av g (06-10)

Historic Av g (01-05)
106
abc
EPC de-rating
30 25 20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 EPC Av g Historic Av g (05-07) Historic Av g (08-10)
Avg P/E = 16.0 Avg P/E = 10.1
Our comparison of the sector re-rating and the capital goods index re-rating suggests that there is c30% acquisition premium built into the valuation of equipment manufacturers while there is c50% dilution discount built into the valuation of the EPC players. If we take the example of the recent ABB deal, where the parent company paid a c31% premium to the prevailing price, the acquisition premium built into the valuation of foreign equipment manufacturers seems justified. However, a 50% dilution discount for EPC players looks a bit overdone to us. And while there may be other risk factors built into this relative discount, we dont believe that the profile of EPC players have changed significantly over the last three years to justify a big portion of this discount. Hence, the dilution hangover, in our opinion, should be the biggest driver of this discount. To put this dilution into context, we note that the RoE of both Kalpataru and KEC (two companies which have undergone equity dilution in the EPC space) has declined by c9% after the dilution (c33% RoE during FY05-07 to c24% RoE during FY08-10). Even if we assume that this entire decline was driven by dilution, it doesnt warrant a 50% de-rating. We believe that further corporate events in the sector remain likely. The parent companies of most of the foreign equipment manufacturers have sizeable net cash positions, implying minimal opportunity cost for acquisitions. Hence, it is likely that they may continue to increase stake in their Indian subsidiaries. On the other hand, EPC players are not only expanding their EPC businesses but are also trying to become transmission asset owners by bidding for private transmission projects. Hence, it is likely that we may see some further equity dilution.
MSCI Cap Goods index 10 year re-rating chart
40 30 Avg P/E = 10.6 20 10 0 Dec-00 Dec-02 Dec-04 Dec-06
Avg P/E = 20.6
Dec-08
Dec-10
MSCI Cap Goods Historic Av g (06-10)

MSCI Cap Goods Index 5 year re-rating chart
40 Avg P/E = 20.7 30 20 10 Avg P/E = 18.4 0 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10

107
abc
Jyoti and Siemens most likely candidates for corporate action

Jyoti Structures management indicated last year (2010) that they were planning a potential QIP (Qualified Institutional Placement) after which the stock has consistently suffered from the dilution hangover. Although not much progress has been made on this front and management has denied any immediate need for cash and/or equity expansion, the stock has nonetheless suffered. We note that, like other EPC players, Jyoti remains keen to expand and venture into private transmission projects and hence a potential dilution cannot be ruled out, particularly because Jyoti still has a small equity base to bid for transmission projects. Although this equity dilution may prove risky for the firm, as Jyoti not only has a weak RoE of c15% but also a weak interest cover (on EBIT) of c2.8x, (implying limited ability to service additional debt or in other words, limited ability to gear up for transmission BOT projects), we believe it is too early to factor in a worst case scenario into the stock. Therefore, we view some of the recent derating of the stock as unwarranted. Among the foreign equipment manufacturers under our coverage, ABB and Areva have already seen an increase in the stake of their parent companies in the recent past. Both ABB and Areva now have parent company holdings of close to 75% (i.e. the highest possible holding for a listed company in India). However, Siemens Ltd still has a free float of c48% and its parent company, Siemens AG, has indicated that they plan to bring their focus back on acquisitions during 2011 now that their restructuring is largely over. Therefore, we believe it is possible that Siemens AG may look to increase their holding in the Indian subsidiary to tap more of the Indian growth story.
What does the peer group analysis suggest?

To understand the relative valuation of companies under our coverage and evaluate their share price performance, we have considered them in terms of three different peer groups:
Trade peers. In this peer set, we have compared our companies against their trade peers i.e. companies which manufacture the same products and compete directly with them. We note that there are 7-8 listed companies in each, EPC sub-segment and substation (equipment mfg) sub-segment. The valuation for this set is based on consensus forecasts and compares companies with same industry specific risks. Sector peers. In this peer set, we have compared our companies against their sector peers i.e. companies which are a part of wider capital goods sector but do not necessarily compete head-on with our companies. The valuation for this set is also based on consensus forecasts and compares companies with same sector specific risks. Coverage universe. In this peer set, we have included companies which are under our coverage. The valuation for this peer set is based on our forecasts and compares companies with similar estimation risks.
Jyoti and Crompton the least expensive among trade peers

Jyoti Structures is now the cheapest stock in its trade peer group. On FY12e consensus numbers, the stock is trading at c7.4x PE and c4.7x EV/EBITDA versus its trade peers average valuation of c11.1x and c8.5x, respectively. On the other hand, although Crompton is not the cheapest stock among its trade peer group, it is definitely inexpensive compared with the sector average. On FY12e consensus numbers, the stock
108
abc
is trading at c17.6x PE and c11.3x EV/EBITDA versus its trade peers average valuation of c18.5x and c13.1x, respectively.
ABB and Areva the most expensive stocks among sector peers
ABB is currently the most expensive stock within the wider capital goods sector. On FY12e consensus numbers, the stock is trading at c28x PE and c30x EV/EBITDA versus its trade peers average valuation of c18.5x and c13.1x, respectively. After ABB, Areva is the next most expensive in the sector. On FY12e consensus numbers, Areva is trading at c29x PE and c16x EV/EBITDA versus its trade peers average valuation of c18.5x and c13.1x, respectively.
Within our sector, EPC players have been bigger underperformers compared with the equipment manufacturers. While EPC players have underperformed the wider index by c10%, equipment manufacturers have outperformed by c10%. Within our coverage universe, Kalpataru and Jyoti have under-performed the most, by c15% and c17% respectively, while Crompton has outperformed the most (c17%). Given a relatively weak performance over the last two quarters, our coverage universe doesnt appear over-bought at this stage. Therefore, we believe we may see some strong performance from the sector in the coming quarters, particularly as the order flow increases in the seasonally strong fourth quarter (FY11). We highlight the performance tables for trade peers, sector peers and our coverage universe in the following pages.
Jyoti and KPP the cheapest within our coverage, ABB the most expensive
On our FY12e forecasts, Jyoti and KPP remain the least expensive stocks within our universe while ABB remains the most expensive. On FY12e PE Jyoti and Kalpataru Power are trading at a multiple of c7.0x and c7.4x while ABB is trading at a multiple of c29.5x, versus sector average of c17x. On FY12e EV/EBITDA, Jyoti and Kalpataru are trading at a multiple of c4.8x and c5.4x while ABB is trading at a multiple of c19.5x, versus sector average of c10.6x. We highlight the valuation tables for trade peers, sector peers and our coverage universe in the following pages.
A guide to our price targets

Capital Goods is a diversified sector and includes several kinds of players, ranging from contractors to manufacturers. Hence, it is difficult to value all the companies using a single consistent valuation methodology. However, being a capital intensive industry, the quality of a company and hence its value can be judged based on its ability to generate returns on the capital committed to it. This (in)ability is often enough to differentiate between winners and losers. Therefore, in most cases, we have used Economic Value Added (EVA) methodology to value companies. We have also used DCF to cross check the valuation derived from the EVA model. In certain cases, where there are strategic holdings or SPVs, we have used a sum-of-the-parts (SOTP) approach to value the group, whereby we have valued each individual project or holding using the
Share price performance remains dull

Our coverage universe has under-performed the wider capital goods index by c5% over the last six months. We note that the large cap stocks have performed better than the small cap stocks over the last two quarters and the hence the sector has outperformed the wider index marginally by c1.5%.
109
abc
most suitable valuation methodology (usually either a PB based multiple or an EVA/DCF approach). We discuss below the valuation methodologies employed and their key aspects.
Key considerations in our valuation

Customer advances treatment?
Most of the equipment manufacturers with long lead times for their products often rely on customer advances to fund their working capital requirements and the cost of manufacturing the products. This is particularly true in cases where the lead time for the product can stretch up to as long as two to three years. The return on capital employed (RoCE) for companies which have significant customer advances, and hence a significant cash position, on their balance sheet usually appears superior to their peers in the industry. However, we note that for a company which is a going concern, the customer advances sitting within the cash in the balance sheet cannot be used to repay the debt (as they are earmarked/required against a particular product) and hence, should not be netted off against the debt when calculating the capital employed (CE) for a company. Consequently, we have adjusted customer advances in our calculation of CE and, in turn, EV by treating them as an operating asset. In principle, what this means is that we view customer advances as the financing provided by the customers and hence we take it out of the cash or simply add it to the capital employed. To make the return comparable, we assume a fictional risk free rate of return (c.5%) on these advances and add it to our clean EBIT to calculate the operating return (OR) on the adjusted capital employed (CE). This is what we call the HSBC RoCE and use in our EVA valuation methodology. This is a more conservative approach of evaluating a companys performance than when you treat customer advances as cash; however, this is less conservative than treating customer advances as debt.
Valuation methodologies
Economic Value Added EVA
For capital equipment manufacturers we believe that the firms earnings power and, in turn, its value is driven by the managements capability to generate a superior return on the total capital committed to them (as can be gauged from the RoCE). To value such companies, we adopt a technique similar to Miller-Modigliani/EVA analysis, which values the company as the sum of the cash flow of its assets now in place, plus the value of its growth opportunities.
EVA
EV = OR + WAC C ((Tre nd Sale s * Sales Grow th * RoS) - (Tren d C E * CE gro wth * WACC)) * CAP pos t-ta x WACC * (1 + p ost-tax WACC)
The first part of the equation represents a companys sustainable target earnings, being the product of a target RoCE and our company forecasts of capital employed. The second part represents the net present value of future returns accruing during a ten-year forecasting period the competitive advantage period (CAP). This we calculate by inputting a target sales growth, a target return on sales and the amount by which the company has to increase its capital employed in order to achieve this sales growth.
Discounted cash flow DCF

We note that most of the companies are currently in a high growth phase, adding significant capacity. In such situations, we believe that the value of the company can also be judged by the groups ability to generate cash flows in the future. Therefore, we have used DCF as our secondary valuation methodology (i.e. in addition to EVA) to check the valuations derived from EVA.
110
abc
High cash position good, bad or ugly?

While strong cash position is usually seen as a positive, a stale net cash position with no real visibility on future investments, in our opinion, doesnt bode well for the company, as then investors are effectively buying cash rather than future earnings when investing into the stock. In such cases, we believe it is prudent to discount cash to reflect its true return, which is usually the risk free rate. We are currently not discounting the net cash position of any of the companies; however, we note that some of the companies like Siemens, for example, derive a significant portion of their total fair value from their cash position. However, in case the company fails to deploy its cash in profitable ventures, we believe the market may start discounting the cash and the stock price may come under pressure.
111
112
Valuation summary trade peers Company Current Share price (INR) Market _____________________________________ FY11e ________________________________________________________________________ FY12e __________________________________ cap PE (x) EV/ EV/ PB (x) EPS RoE (%) EBITDA Div PE (x) EV/ EV/ PB (x) EPS RoE (%) EBITDA Div (INRm) EBITDA sales (x) growth (%) mgns (%) yield (%) EBITDA sales (x) growth (%) mgns (%) yield (%) (x) (x)
EPC: Bajaj Electricals EMCO Gammon Jyoti Structures Kalpataru Power KEC Intl L&T 208 68 146 118 149 92 1,652 20,476 4,410 19,509 9,583 22,604 23,365 996,273 13.61 na 12.69 8.90 10.16 10.91 26.29 8.58 10.58 13.28 5.42 10.04 7.76 20.61 0.84 0.63 1.16 0.61 1.16 0.78 2.66 3.32 0.78 0.87 1.62 1.51 2.45 4.77 20.7% -157.6% -3.6% 18.6% 13.7% 21.5% -10.5% 26.2% -4.1% 7.1% 19.7% 16.7% 24.6% 19.0% 9.8% 5.9% 8.7% 11.3% 11.5% 10.0% 12.9% 1.6% 1.5% 0.6% 0.9% 1.1% 1.4% 0.8% 10.59 9.05 11.31 7.43 8.25 8.99 21.83 6.84 4.79 11.61 4.66 8.14 6.59 16.88 0.68 0.54 1.01 0.52 0.91 0.66 2.15 2.65 0.73 0.85 1.36 1.28 1.97 3.94 28.6% -324.3% 12.2% 19.8% 23.1% 21.4% 20.4% 27.2% 7.1% 6.5% 19.6% 16.8% 23.9% 19.7% 10.0% 11.3% 8.7% 11.2% 11.2% 10.1% 12.8% 1.9% 1.0% 0.5% 1.0% 1.1% 1.3% 0.9%
Average simple Average weighted

Eqp Mfg: ABB Ltd Areva T&D India BHEL Crompton Greaves Indotech Siemens Ltd Voltamp 737 154,793 310 72,959 2,182 1,057,756 289 184 732 704 183,700 1,942 244,565 7,060
13.76 24.89
10.89 19.59
1.12 2.50
2.19 4.51
-13.9% -8.9%
15.6% 18.9%
10.0% 12.7%
1.1% 0.8%
11.06 20.70
8.50 16.04
0.93 2.03
1.83 3.73
-28.4% 19.1%
17.3% 19.6%
10.8% 12.5%
1.1% 0.9%
43.03 38.60 18.90 20.46 16.26 29.37 10.64
46.93 18.81 12.15 13.05 9.07 15.94 7.42
3.58 1.92 2.37 1.85 0.73 2.13 1.15
5.58 6.90 5.36 5.67 1.32 6.80 1.80
6.1% 2.3% 31.1% 9.8% -249.5% 15.0% -18.9%
13.8% 18.9% 30.2% 31.6% 8.4% 22.5% 18.5%
7.6% 10.2% 19.5% 14.1% 8.0% 13.4% 15.5%
0.3% 0.6% 1.3% 0.8% 0.9% 0.7% 1.9%
27.35 28.81 15.73 17.62 6.91 24.54 8.66
30.04 15.66 10.07 11.32 4.14 14.27 5.96
2.96 1.71 1.97 1.60 0.61 1.78 1.00
4.73 5.95 4.31 4.46 1.13 5.55 1.50
57.3% 34.0% 20.2% 16.1% 135.4% 19.7% 22.9%
18.5% na 29.1% 28.4% 17.6% 25.1% 19.2%
9.8% 10.9% 19.5% 14.1% 14.8% 12.5% 16.7%
0.4% 0.7% 1.4% 0.9% 2.2% 0.8% 1.9%

Source: Company, Thomson Reuters Datastream, HSBC
25.32 23.52
17.62 16.17
1.96 2.36
4.77 5.66
-29.2% 22.5%
20.6% 27.2%
12.6% 16.5%
0.9% 1.0%
18.52 18.74
13.07 12.81
1.66 1.97
3.95 4.59
43.6% 23.7%
23.0% 27.4%
14.1% 16.7%
1.2% 1.2%
abc
Valuation summary sector peers Company Current share price (INR) Market ____________________________________ FY11e __________________________________ ____________________________________ FY12e ___________________________________ cap PE (x) EV/ EV/ PB (x) EPS RoE (%) EBITDA Div PE (x) EV/ EV/ PB (x) EPS RoE (%) EBITDA Div (INRm) EBITDA (x) Sales (x) growth (%) mgns (%) yield (%) EBITDA (x) Sales (x) growth (%) mgns (%) yield (%)
43.03 38.60 13.61 16.01 18.90 17.30 20.46 23.34 na 12.69 16.26 11.41 17.02 8.90 10.16 10.91 26.29 8.68 20.48 29.37 11.57 23.73 10.64 18.63 46.93 18.81 8.58 8.53 12.15 11.25 13.05 17.67 10.58 13.28 9.07 9.90 13.99 5.42 10.04 7.76 20.61 6.90 7.82 15.94 5.86 14.83 7.42 12.48 3.58 1.92 0.84 1.68 2.37 1.21 1.85 3.52 0.63 1.16 0.73 0.94 3.69 0.61 1.16 0.78 2.66 1.08 0.65 2.13 0.57 1.74 1.15 1.16 5.58 6.90 3.32 2.70 5.36 5.64 5.67 7.64 0.78 0.87 1.32 1.26 2.01 1.62 1.51 2.45 4.77 1.17 1.03 6.80 1.59 6.42 1.80 5.01 6.1% 2.3% 20.7% 15.5% 31.1% 4.7% 9.8% 42.1% -157.6% -3.6% -249.5% 16.4% -33.9% 18.6% 13.7% 21.5% -10.5% -3.6% -27.3% 15.0% 26.8% 157.1% -18.9% 20.8% 13.8% 18.9% 26.2% 17.4% 30.2% 36.1% 31.6% 34.7% -4.1% 7.1% 8.4% 11.0% 12.9% 19.7% 16.7% 24.6% 19.0% 13.7% 5.5% 22.5% 14.6% 29.6% 18.5% 30.2% 7.6% 10.2% 9.8% 19.6% 19.5% 10.7% 14.1% 19.9% 5.9% 8.7% 8.0% 9.5% 26.4% 11.3% 11.5% 10.0% 12.9% 15.7% 8.3% 13.4% 9.7% 11.8% 15.5% 9.3% 0.3% 0.6% 1.6% 1.4% 1.3% 2.1% 0.8% 2.0% 1.5% 0.6% 0.9% 1.0% 1.1% 0.9% 1.1% 1.4% 0.8% 0.8% 0.4% 0.7% 0.6% 1.0% 1.9% 1.1% 27.35 28.81 10.59 13.78 15.73 14.24 17.62 18.51 9.05 11.31 6.91 9.41 13.29 7.43 8.25 8.99 21.83 7.31 10.53 24.54 8.82 18.22 8.66 15.62 30.04 15.66 6.84 7.37 10.07 9.19 11.32 13.91 4.79 11.61 4.14 7.98 10.94 4.66 8.14 6.59 16.88 5.77 5.80 14.27 4.88 11.39 5.96 10.61 2.96 1.71 0.68 1.46 1.97 1.02 1.60 2.77 0.54 1.01 0.61 0.76 3.03 0.52 0.91 0.66 2.15 0.90 0.52 1.78 0.47 1.34 1.00 1.00 4.73 5.95 2.65 2.34 4.31 4.45 4.46 6.00 0.73 0.85 1.13 1.12 1.78 1.36 1.28 1.97 3.94 1.03 0.94 5.55 1.37 5.08 1.50 3.99 57.3% 34.0% 28.6% 16.2% 20.2% 21.5% 16.1% 26.1% -324.3% 12.2% 135.4% 21.3% 28.1% 19.8% 23.1% 21.4% 20.4% 18.8% 94.4% 19.7% 31.2% 30.2% 22.9% 19.3% 18.5% na 27.2% 17.4% 29.1% 35.5% 28.4% 34.6% 7.1% 6.5% 17.6% 12.2% 14.1% 19.6% 16.8% 23.9% 19.7% 14.3% 9.0% 25.1% 16.6% 30.5% 19.2% 28.3% 9.8% 10.9% 10.0% 19.8% 19.5% 11.1% 14.1% 19.9% 11.3% 8.7% 14.8% 9.6% 27.7% 11.2% 11.2% 10.1% 12.8% 15.6% 8.9% 12.5% 9.6% 11.8% 16.7% 9.5% 0.4% 0.7% 1.9% 1.5% 1.4% 2.4% 0.9% 2.3% 1.0% 0.5% 2.2% 1.1% 1.2% 1.0% 1.1% 1.3% 0.9% 0.9% 0.4% 0.8% 0.7% 1.2% 1.9% 1.2%
ABB Ltd Areva T&D India Bajaj Electricals Bharat Electronics BHEL Blue Star Crompton Greaves Cummins India EMCO Gammon Indotech IVRCL Infra Jaiprakash Assoc Jyoti Structures Kalpataru Power KEC Intl L&T Patel Engineering Punj Lloyd Siemens Ltd Simplex Thermax Voltamp Voltas
737 154,793 310 72,959 208 20,476 1,696 134,245 2,182 1,057,756 398 35,540 289 183,700 744 146,330 68 4,410 146 19,509 184 1,942 100 26,382 91 191,463 118 9,583 149 22,604 92 23,365 1,652 996,273 253 99 732 364 724 704 209 17,499 32,550 244,565 18,029 86,119 7,060 68,615

18.61 22.90
12.87 16.50
1.57 2.41
3.47 4.97
-3.4% 12.8%
19.1% 23.6%
12.5% 15.7%
1.1% 1.0%
14.03 18.49
9.95 13.26
1.31 1.98
2.85 4.06
17.2% 23.0%
20.5% 23.9%
13.2% 15.8%
1.2% 1.2%
abc
113
114
Valuation summary coverage universe Company Current share price

118 149 92 737 310 289 732
Market _____________________________________ FY11e ________________________________________________________________________ FY12e __________________________________ Cap PE (x) EV/ EV/ PB (x) EPS RoE (%) EBITDA Div PE (x) EV/ EV/ PB (x) EPS RoE (%) EBITDA Div EBITDA Sales (x) growth (%) mgns (%) yield (%) EBITDA Sales (x) growth (%) mgns (%) yield (%) (x) (x)
9,583 22,604 23,365 154,793 72,959 183,700 244,565 8.75 10.51 11.20 31.93 29.03 20.51 24.61 5.39 6.71 7.96 21.00 14.90 12.54 15.09 0.61 0.77 0.83 1.96 1.74 1.76 2.03 1.63 1.84 2.47 5.09 6.21 5.59 5.94 45.5% 17.0% 10.0% 93.2% 34.9% 13.3% 32.4% 18.7% 20.1% 22.0% 16.0% 21.4% 27.3% 24.2% 11.4% 11.4% 10.4% 9.3% 11.7% 14.1% 13.5% 0.9% 1.1% 1.4% 0.3% 0.6% 0.8% 0.8% 6.97 7.40 8.72 24.06 21.26 16.64 20.97 4.82 5.44 6.88 16.05 11.59 9.99 12.56 54% 65% 72% 162% 146% 146% 166% 1.34 1.48 2.00 4.27 5.01 4.36 4.83 25.5% 42.0% 28.3% 32.7% 36.6% 23.2% 17.4% 19.2% 23.9% 22.9% 17.7% 23.6% 26.2% 23.1% 11.1% 11.9% 10.4% 10.1% 12.6% 14.7% 13.2% 1.0% 1.2% 1.5% 0.3% 0.7% 0.9% 0.9%
Jyoti Structures Kalpataru Power KEC Intl ABB Ltd Areva T&D India Crompton Greaves Siemens Ltd

19.50 24.50
11.94 15.07
1.39 1.82
4.11 5.39
35.2% 39.9%
21.4% 22.6%
11.7% 12.3%
0.9% 0.7%
15.15 19.53
9.62 12.04
1.16 1.50
3.33 4.36
29.4% 25.4%
22.4% 22.7%
12.0% 12.7%
0.9% 0.8%
Valuation summary coverage universe (Calenderised) Company Current share price

118 149 92 737 310 289 732
Market cap
____________________________________ FY11e __________________________________ ____________________________________ FY12e __________________________________ PE (x) EV/ EV/ PB (x) EPS RoE (%) EBITDA Div PE (x) EV/ EV/ PB (x) EPS RoE (%) EBITDA Div EBITDA Sales (x) growth (%) mgns (%) yield (%) EBITDA Sales (x) growth (%) mgns (%) yield (%) (x) (x)
8.75 10.51 11.20 50.00 36.18 20.51 28.05 5.39 6.71 7.96 31.66 17.59 12.54 15.60 0.61 0.77 0.83 2.26 1.93 1.76 2.12 1.63 1.84 2.47 5.65 7.03 5.59 6.53 45.5% 17.0% 10.0% -12.5% 5.4% 13.3% 29.9% 18.7% 20.1% 22.0% 11.4% 19.7% 27.3% 23.5% 11.4% 11.4% 10.4% 7.2% 11.0% 14.1% 13.6% 0.9% 1.1% 1.4% 0.3% 0.7% 0.8% 0.8% 6.97 7.40 8.72 29.50 26.72 16.64 22.65 4.82 5.44 6.88 19.49 13.92 9.99 13.72 0.54 0.65 0.72 1.86 1.66 1.46 1.83 1.34 1.48 2.00 4.81 5.81 4.36 5.28 25.5% 42.0% 28.3% 69.5% 35.4% 23.2% 23.8% 19.2% 23.9% 22.9% 16.5% 22.0% 26.2% 23.6% 11.1% 11.9% 10.4% 9.5% 12.0% 14.7% 13.3% 1.0% 1.2% 1.5% 0.3% 0.7% 0.9% 0.8%
Jyoti Structures Kalpataru Power KEC Intl ABB Ltd Areva T&D India Crompton Greaves Siemens Ltd
9,583 22,604 23,365 154,793 72,959 183,700 244,565

23.60 30.34
13.92 17.84
1.47 1.93
4.39 5.80
15.5% 13.0%
20.4% 21.2%
11.3% 11.8%
0.9% 0.7%
16.94 21.85
10.61 13.42
1.25 1.63
3.58 4.72
35.4% 35.5%
22.0% 22.5%
11.9% 12.5%
0.9% 0.8%
abc
Valuation table Global peers

Com pany Currency Current share price (INR) FY11e Mcap (INRm) P/E (x) EV/ EBITDA (x) EV/ Sales (x) P/B (x) EPS gr ow th (%) RoE (%) EBITDA m gns(%) Div yield (%) P/E (x) EV/ EBITDA (x) EV/ Sales (x) P/B (x) FY12e EPS grow th (%) RoE (%)
India: Bajaj Electricals EMCO Gammon Jyoti Structures Kalpataru Pow er KEC Intl L&T ABB Ltd Areva T&D India BHEL Crompton Greaves Indotech Siemens Ltd Voltamp Average - sim ple Average - w eighted Asia Pacific: Hyundai Heavy Harbin Pow er Hyosung Corp Mitsubishi Shanghai Electric Dongfang Samsung C&T Sungjin Geotech Doosan Heavy Hanw ha BHI Co Ltd Average - sim ple Average - w eighted Europe: Cobra Elecnor Siemens ABB Areva Alstom Average - sim ple Average - w eighted KRW HKD KRW JPY CNY CNY KRW KRW KRW KRW KRW 500,000 11 92,300 335 8 31 79,500 13,950 83,800 53,400 21,850 38,410,441 1,866 3,276,351 1,126,205 94,359 62,585 12,705,932 562,337 8,963,198 4,055,139 288,885 10.8 14.4 7.4 na 36.3 27.5 25.0 8.6 35.8 8.2 12.5 18.6 16.2 10.4 2.8 9.7 10.3 17.5 16.8 36.8 9.1 36.0 29.6 9.3 17.1 19.6 1.8 0.2 0.9 0.8 1.3 1.4 1.2 1.3 3.1 1.9 1.4 1.4 1.8 2.8 1.5 1.0 0.9 3.9 6.0 1.7 4.0 2.5 1.4 3.1 2.6 2.4 29.9% 43.2% 22.3% na 67.5% 23.2% 55.9% na -162.4% -19.0% 1.4% 6.9% 5.8% 29.7% 9.6% 14.5% 1.9% 12.0% 23.0% 7.0% 66.1% 7.1% 19.4% 25.8% 19.7% 21.1% 17.1% 6.0% 9.1% 7.8% 7.3% 8.5% 3.2% 14.8% 8.6% 6.6% 15.1% 9.5% 12.3% 0.8% 0.8% 1.0% 1.2% 0.8% 0.4% 0.7% 0.0% 0.6% 1.2% 0.8% 0.8% 0.8% 11.2 15.8 6.4 na 31.8 21.5 25.8 7.2 16.1 8.5 9.0 15.3 13.9 10.5 2.6 8.9 9.9 13.6 12.8 29.2 9.2 25.7 30.6 7.6 14.6 16.9 1.6 0.2 0.8 0.8 1.1 1.2 1.1 1.3 2.5 1.9 1.0 1.2 1.6 2.3 1.4 0.9 0.9 3.6 5.1 1.6 2.3 2.2 1.2 2.2 2.2 2.0 -3.6% 7.4% 16.3% na 14.1% 27.7% -3.2% 19.0% 123.2% -3.6% 39.2% 23.7% 14.2% 22.5% 9.1% 15.2% 2.2% 12.7% 25.8% 6.3% 38.1% 13.9% 15.4% 28.5% 17.2% 17.5% INR INR INR INR INR INR INR INR INR INR INR INR INR INR 208 68 146 118 149 92 1,652 737 310 2,182 289 184 732 704 20,476 4,410 19,509 9,583 22,604 23,365 996,273 154,793 72,959 1,057,756 183,700 1,942 244,565 7,060 13.6 na 12.7 8.9 10.2 10.9 26.3 51.3 42.6 18.9 20.5 na 26.7 11.1 21.1 24.4 8.6 10.6 13.3 5.4 10.0 7.8 20.6 55.8 20.1 12.2 13.1 9.1 15.5 7.4 15.0 18.0 0.8 0.6 1.2 0.6 1.2 0.8 2.7 3.8 2.0 2.4 1.8 1.2 2.0 1.2 1.6 2.4 3.3 0.8 0.9 1.6 1.5 2.5 4.8 5.8 7.2 5.4 5.7 1.3 6.1 1.8 3.5 5.2 20.7% -157.6% -3.6% 18.6% 13.7% 21.5% -10.5% -14.2% -9.5% 31.1% 9.8% -18.0% 21.9% -21.9% -7.0% 9.6% 26.2% -4.1% 7.1% 19.7% 16.7% 24.6% 19.0% 12.3% 18.0% 30.2% 31.6% -4.8% 25.4% 18.5% 17.2% 24.1% 9.7% 5.9% 8.7% 11.3% 11.5% 10.0% 12.9% 6.8% 10.0% 19.5% 14.1% 13.0% 12.6% 15.5% 11.5% 14.9% 1.6% 1.5% 0.6% 0.9% 1.1% 1.4% 0.8% 0.3% 0.6% 1.3% 0.8% 0.9% 0.7% 1.9% 1.0% 1.0% 10.6 9.1 11.3 7.4 8.3 9.0 21.8 29.0 30.1 15.7 17.6 13.1 22.7 8.9 15.3 19.5 6.9 4.8 11.6 4.7 8.1 6.6 16.9 31.8 15.7 10.1 11.3 7.5 13.2 6.0 11.1 14.1 0.7 0.5 1.0 0.5 0.9 0.7 2.2 3.1 1.7 2.0 1.6 0.7 1.6 1.0 1.3 2.0 2.6 0.7 0.8 1.4 1.3 2.0 3.9 4.9 6.0 4.3 4.5 1.1 5.1 1.5 2.9 4.2 28.6% -324.3% 12.2% 19.8% 23.1% 21.4% 20.4% 76.8% 41.2% 20.2% 16.1% -325.8% 17.9% 24.4% -23.4% 22.7% 27.2% 7.1% 6.5% 19.6% 16.8% 23.9% 19.7% 18.1% 21.9% 29.1% 28.4% 10.7% 24.8% 18.8% 19.5% 24.2%
EUR EUR EUR CHF EUR EUR
1 10 92 22 36 40
27 876 83,510 54,641 513 11,688
na 12.5 12.9 19.9 42.5 13.0 20.2 15.5
8.5 8.8 7.8 10.5 12.5 7.8 9.3 8.8
0.6 0.9 1.1 1.6 0.7 0.7 0.9 1.3
0.9 1.9 2.5 3.4 1.4 2.6 2.1 2.8
-83.0% -28.3% 58.7% -5.5% -64.1% -34.2% -26.1% 27.4%
-5.7% 21.5% 18.9% 18.5% 2.0% 19.6% 12.5% 18.8%
6.7% 10.5% 14.5% 15.2% 5.9% 8.4% 10.2% 14.2%
0.0% 2.9% 3.0% 2.3% 1.7% 2.6% 2.1% 2.7%
na 9.7 11.6 15.7 25.6 12.1 14.9 13.2
5.8 7.0 7.1 8.9 5.6 7.3 7.0 7.8
0.5 0.8 1.1 1.5 0.7 0.7 0.9 1.2
1.0 1.7 2.2 3.0 1.4 2.3 1.9 2.5
-96.3% 28.4% 10.7% 21.2% 66.0% 7.8% 6.3% 14.5%
0.7% na 18.8% 20.4% 5.3% 18.5% 12.7% 19.2%
abc
115
116
Share price performance summary trade peers Company EPC: Bajaj Electricals
EMCO Gammon Jyoti Structures Kalpataru Power KEC Intl L&T Average simple Average weighted
CMP ___________________________ Absolute Performance (%) ____________________________ 1 week 1 mth 3 mths 6 mths 12 mths
211 68 145 118 149 92 1,652 -3.2% 4.1% -8.8% -4.3% -7.3% -3.8% -6.1% -4.2% -6.0% -9.6% 10.6% -15.1% -4.2% -14.2% 5.9% -16.7% -6.2% -15.8% -34.0% 4.4% -27.4% -12.8% -15.1% -6.6% -17.2% -15.5% -17.3% -12.2% -11.0% -35.0% -27.3% -24.9% -10.2% -12.7% -19.1% -13.4% 16.3% -34.3% -43.9% -35.9% -38.4% -24.5% 0.5% -22.9% -1.8%
____________________________Relative Performance (%) ____________________________ 1 week 1 mth 3 mths 6 mths 12 mths

1.4% 8.7% -4.2% 0.3% -2.7% 0.8% -1.5% 0.4% -1.4% 2.2% 22.4% -3.3% 7.7% -2.3% 17.7% -4.9% 5.7% -4.0% -19.3% 19.1% -12.8% 1.8% -0.4% 8.1% -2.5% -0.9% -2.6% -2.1% -0.9% -24.9% -17.2% -14.8% 0.0% -2.6% -8.9% -3.3% 21.2% -29.5% -39.0% -31.0% -33.5% -19.6% 5.4% -18.0% 3.1%
Eqp Mfg: ABB Ltd Areva T&D India BHEL Crompton Greaves Indotech Siemens Ltd Voltamp Average simple Average weighted
737 308 2,181 289 185 732 704
-1.3% -3.2% -2.7% -0.9% -7.5% -5.2% -2.5% -3.3% -2.7%
-5.1% -6.0% -5.4% -12.6% -6.0% -5.9% -10.2% -7.3% -6.2%
-18.2% 2.8% -12.7% -5.9% -22.4% -8.7% -21.7% -12.4% -11.3%
-13.5% 6.4% -9.7% 7.2% -32.7% 1.0% -33.7% -10.7% -6.1%
-12.2% 11.6% -9.0% 21.6% -46.8% 13.5% -25.6% -6.7% -2.1%
3.3% 1.4% 2.0% 3.7% -2.9% -0.6% 2.1% 1.3% 1.9%
6.8% 5.9% 6.5% -0.7% 5.8% 6.0% 1.6% 4.5% 5.6%
-3.5% 17.5% 1.9% 8.8% -7.8% 6.0% -7.0% 2.3% 3.3%
-3.3% 16.6% 0.5% 17.4% -22.5% 11.2% -23.5% -0.5% 4.0%
-7.3% 16.5% -4.1% 26.5% -41.9% 18.4% -20.7% -1.8% 2.8%
abc
Share price performance summary Sector peers Company

ABB Ltd Areva T&D India Bajaj Electricals Bharat Electronics BHEL Blue Star Crompton Greaves Cummins India EMCO Gammon Indotech IVRCL Infra Jaiprakash Assoc Jyoti Structures Kalpataru Power KEC Intl L&T Patel Engineering Punj Lloyd Siemens Ltd Simplex Thermax Voltamp Voltas Average simple Average weighted
CMP ____________________________Absolute performance (%)_____________________________ ____________________________ Relative performance (%) ____________________________ 1 week 1 mth 3 mths 6 mths 12 mths 1 week 1 mth 3 mths 6 mths 12 mths
737 308 211 1,694 2,181 399 289 746 68 145 185 100 91 118 149 92 1,652 253 99 732 368 730 704 209 -1.3% -3.2% -3.2% 0.8% -2.7% -3.2% -0.9% 0.4% 4.1% -8.8% -7.5% -12.6% -6.1% -4.3% -7.3% -3.8% -6.1% -7.1% -3.6% -5.2% -5.7% -7.3% -2.5% -0.1% -4.0% -3.8% -5.1% -6.0% -9.6% -1.9% -5.4% -7.1% -12.6% -2.2% 10.6% -15.1% -6.0% -21.1% -12.6% -4.2% -14.2% 5.9% -16.7% -20.0% -6.9% -5.9% -12.7% -14.3% -10.2% -4.6% -8.2% -9.6% -18.2% 2.8% -34.0% -4.4% -12.7% -12.6% -5.9% 2.8% 4.4% -27.4% -22.4% -35.9% -28.5% -12.8% -15.1% -6.6% -17.2% -33.3% -22.5% -8.7% -23.0% -7.1% -21.7% -10.8% -15.4% -13.6% -13.5% 6.4% -12.2% -5.6% -9.7% -10.2% 7.2% 26.9% -11.0% -35.0% -32.7% -47.6% -29.7% -27.3% -24.9% -10.2% -12.7% -39.0% -28.6% 1.0% -23.5% -5.4% -33.7% 4.0% -15.3% -8.8% -12.2% 11.6% 16.3% -17.7% -9.0% -0.3% 21.6% 67.5% -34.3% -43.9% -46.8% -46.6% -43.3% -35.9% -38.4% -24.5% 0.5% -47.4% -54.2% 13.5% -30.2% 7.9% -25.6% 12.3% -15.0% -2.6% 3.3% 1.4% 1.4% 5.4% 2.0% 1.4% 3.7% 5.0% 8.7% -4.2% -2.9% -8.0% -1.4% 0.3% -2.7% 0.8% -1.5% -2.5% 1.0% -0.6% -1.1% -2.7% 2.1% 4.5% 0.6% 0.8% 6.8% 5.9% 2.2% 10.0% 6.5% 4.8% -0.7% 9.6% 22.4% -3.3% 5.8% -9.3% -0.7% 7.7% -2.3% 17.7% -4.9% -8.1% 4.9% 6.0% -0.9% -2.5% 1.6% 7.2% 3.6% 2.3% -3.5% 17.5% -19.3% 10.3% 1.9% 2.0% 8.8% 17.5% 19.1% -12.8% -7.8% -21.2% -13.8% 1.8% -0.4% 8.1% -2.5% -18.7% -7.8% 6.0% -8.4% 7.5% -7.0% 3.8% -0.8% 1.1% -3.3% 16.6% -2.1% 4.6% 0.5% -0.1% 17.4% 37.1% -0.9% -24.9% -22.5% -37.5% -19.5% -17.2% -14.8% 0.0% -2.6% -28.9% -18.4% 11.2% -13.4% 4.7% -23.5% 14.2% -5.1% 1.3% -7.3% 16.5% 21.2% -12.8% -4.1% 4.6% 26.5% 72.3% -29.5% -39.0% -41.9% -41.7% -38.4% -31.0% -33.5% -19.6% 5.4% -42.5% -49.4% 18.4% -25.4% 12.8% -20.7% 17.2% -10.1% 2.3%
abc
117
118
Share price performance summary Coverage universe Company

CMP
118 149 92 737 308 289 732
_______________________________ Absolute performance (%) _____________________ ____________________________ Relative performance (%) ____________________________ 1 week 1 mth 3 mths 6 mths 12 mths 1 week 1 mth 3 mths 6 mths
-4.3% -7.3% -3.8% -1.3% -3.2% -0.9% -5.2% -3.7% -3.0% -4.2% -14.2% 5.9% -5.1% -6.0% -12.6% -5.9% -6.0% -7.3% -12.8% -15.1% -6.6% -18.2% 2.8% -5.9% -8.7% -9.2% -9.0% -27.3% -24.9% -10.2% -13.5% 6.4% 7.2% 1.0% -8.7% -1.6% -35.9% -38.4% -24.5% -12.2% 11.6% 21.6% 13.5% -9.2% 6.3% 0.3% -2.7% 0.8% 3.3% 1.4% 3.7% -0.6% 0.9% 1.6% 7.7% -2.3% 17.7% 6.8% 5.9% -0.7% 6.0% 5.9% 4.6% 1.8% -0.4% 8.1% -3.5% 17.5% 8.8% 6.0% 5.4% 5.6% -17.2% -14.8% 0.0% -3.3% 16.6% 17.4% 11.2% 1.4% 8.6%
12 mths
-31.0% -33.5% -19.6% -7.3% 16.5% 26.5% 18.4% -4.3% 11.1%
abc
abc
Benchmarking Analysis
119
abc

We introduce our proprietary analytical tool, the Q-ben Framework,
to better relate companys valuation with asset quality

We evaluate companies on 5 fundamental criteria and measure
their quality on 16 objective metrics to arrive at a normalized score, called the Q-ben score, for each company
A company with high Q-ben score should trade at a premium in
our opinion; within our universe, Crompton has the highest potential to re-rate while ABB has the highest potential to de-rate
Introduction to the Q-ben Framework

With this initiation report, we introduce our proprietary analytical tool, called the Q-ben Framework, which we believe is a very effective tool in identifying anomalies in the trading behaviour of a stock vis--vis the quality of its underlying business. This framework is also helpful in identifying stocks/companies which deserve a premium or discount with respect to their peers and hence can explain whether the current valuation of any stock is justified or not versus its peers. The theoretical framework for the construction of our benchmarking model uses the so-called key ingredients of a good company/stock as a starting point:
Strong market position and the ability to command pricing power Emphasis on top-line growth Competitive cost base and the ability to generate cash Efficient use of cash flow to fund acquisitions and/or increase shareholders returns Ability to fund future growth and focus on high value added areas Critical mass in few core areas of competence The ability to diversify risk Sufficient market in the security for investors to trade freely
While these characteristics make for good theory, it is often difficult to objectively evaluate
120
abc
Q-ben Framework criteria
Cr ite ria Internal Perf ormance
Explanation Measures of prof itability and opportunity
M e trics Free cash f low A dded value Capital Expentiture Return on capital employed
Market Performance
The dynamics of the end markets and company's position in them
Organic sales grow th Market position Customer diversity Geographic diversity Cyclical resilience
Balancing risk
A nalysis of the market diversity and cyclicality of the business
Financial Strength
A nalysis of the company's financial strength and their ability to f und f uture grow th
Financial leverage Net debt/EBITDA Interest cover FCF yield
Equity Structure
A nalysis of the stock's trading characteristics Free f loat (%) Dividend yield Trading volume (3m avg)
companies on each of the aforementioned points. This is particularly true in the context of the Indian mid-cap companies under our coverage, which do not have a long history of reporting and have often changed their reporting structure. Therefore, we have identified five criteria and 16 metrics within them which have little overlap and are measurable across the broad range of the capital goods sector. These criteria/metrics not only take fundamental parameters into consideration to assess the quality of the underlying business but also take into account the trading characteristics of the stock, to better judge the overall appeal of the asset to an investor. We highlight these criteria in the table above and also list the metrics that we have used to evaluate the performance of the companies within each of these criteria. We believe that these criteria form the benchmark for evaluating the qualities of a capital goods company and should be looked at in detail
before looking at the valuation or the timing of the investment.
The formulation of the Q-ben score

As we have mentioned above, we have identified 16 metrics to objectively evaluate the quality of the company and the associated stock. We have taken a five-year time period to calculate the performance of the companies on average during this time period. We note that because of 1) India being a structural growth market and 2) lack of comparable reported data for previous cycles, we have taken the current business cycle (FY09-13e) as the relevant period. To further validate the appropriateness of our choice of the five-year period, we highlight below that the average EPS of our coverage universe does indeed indicate a cyclical trend.
121
abc
Business cycle
25.0 20.0 15.0 10.0 5.0 0.0 FY06 FY07 FY08 FY09 FY10 FY11eFY12e FY13e Sector Av g EPS
simple average of scores against every metric to arrive at the final Q-ben score. However, investors may choose to give higher weighting to the internal and market performance characteristics as these are the main drivers of the companys performance. Similarly, investors may also choose to give a slightly higher weighting to the trading characteristics of the stock as this often signifies whether an investment proposition is commercially viable or not. On the other hand, investors may choose to give a lower weighting to balance of risk criterion and the financial strength, as 1) India is currently witnessing a lot of structural growth and hence, domestic companies do not have the necessity to look outside for growth, and 2) most of the companies under our coverage at this stage are either net cash or under-levered.
A further benefit of using a mix of reported (delivered) and the forecasted (potential) financial performance is that it provides us with the ability to adequately award or penalize the company for not only its past record but also its future potential. We further note that we have calendarised all the data to March year-end to make it comparable. Also, of the data used, only the market position analysis is based on our experience and the qualitative data rather than the quantitative data that we have used for all other metrics so that the majority of our analysis is objective and uses uniform definitions. Even with market position analysis, we have tried to use a methodical approach and score each of the companys divisions on a uniform scale and then weighted the total. For each of the metrics, we have calculated a sector median and then benchmarked all the companies around that sector median on a uniform score of 1 to 10, with the sector median having a score of 5. We have then taken a simple average of all the 16 scores (on the scale of 1 to 10) which the company has received against the 16 metrics to arrive at the final quality benchmark score for the respective company. We call this score the Q-ben score. We note that for the sake of simplicity and in the absence of any empirical support, we have taken a
How does the scorecard look?

As we noted earlier in the report, our coverage universe can be divided into two sub-segments the EPC players (mostly the transmission line contractors) and the equipment manufacturers (mostly substation equipment and other capital goods). On an overall basis, the equipment manufactures, for understandable reasons, come out much better with an average Q-ben score of 5.9 compared with the EPC players, who got an average score of 4.7. Two areas where equipment manufacturers relatively stand out are internal performance and financial strength. While the out-performance on the internal performance criterion is largely driven by the superior cash generation and higher RoCE, the higher score on financial strength is mainly due to the fact that most of the equipment manufacturers under our coverage are by and large debt free.
122
abc
Q-ben Scorecard
Crite ria Internal Perf ormance Market Perf ormance Balancing risk Financial Strength Equity Struc ture Ave rage Score Jyoti Structure s 4.4 7.1 2.6 3.7 6.2 4.6 Kalpataru Pow e r 3.2 6.6 4.5 3.6 5.1 4.3 KEC Intl 4.6 5.7 6.5 3.5 6.8 5.2 ABB Ltd 4.7 3.3 4.1 7.4 1.7 4.5 Are va T&D India 5.0 6.6 3.9 6.1 3.0 4.9 Crom pton Gre ave s 7.8 5.1 8.5 8.3 8.0 7.7 Sie m e ns India 6.7 3.0 5.2 8.9 6.5 6.5 EPC Avg 4.0 6.5 4.5 3.6 6.1 4.7 Subs tation Avg 6.0 4.5 5.4 7.7 4.8 5.9 Se ctor Avg 5.2 5.4 5.0 5.9 5.3 5.4
Crite ria Internal Perf ormance
Me trics Free cash f low Added value Capital Expentiture Return on capital employed
Jyoti Structure s 4.3 5.0 3.3 5.0 7.2 7.0 0.0 2.8 5.0 3.2 4.9 3.8 2.7 10.0 4.9 3.8 4.6
Kalpataru Pow e r 3.2 0.0 4.7 4.8 6.3 7.0 5.0 4.1 4.5 4.3 4.4 5.0 0.6 5.0 7.1 3.3 4.3
KEC Intl 5.0 5.4 3.9 4.1 5.0 6.4 1.1 8.3 10.0 0.0 3.8 4.5 5.8 7.4 9.8 3.3 5.2
ABB Ltd 6.0 4.5 3.4 4.7 0.2 6.3 5.2 2.8 4.3 6.1 8.6 10.0 5.0 0.2 0.0 5.0 4.5
Are va T&D India 4.6 2.1 8.0 5.4 6.3 7.0 1.5 5.2 5.0 5.0 5.0 10.0 4.3 0.5 3.0 5.5 4.9
Crom pton Gre ave s 10.0 8.1 3.0 10.0 3.3 7.0 5.4 10.0 10.0 6.5 6.8 10.0 10.0 6.8 7.2 10.0 7.7
Sie m e ns India 8.3 8.2 2.5 7.7 0.0 6.0 7.1 5.0 3.5 9.0 10.0 10.0 6.5 4.4 5.0 10.0 6.5
EPC Avg 4.2 3.5 3.9 4.6 6.2 6.8 2.0 5.1 6.5 2.5 4.4 4.4 3.1 7.5 7.3 3.4 4.7
Subs tation Avg 7.2 5.7 4.2 6.9 2.4 6.6 4.8 5.8 5.7 6.7 7.6 10.0 6.5 2.9 3.8 7.6 5.9
Se ctor Avg 5.9 4.8 4.1 6.0 4.0 6.7 3.6 5.5 6.1 4.9 6.2 7.6 5.0 4.9 5.3 5.8 5.4
Market Perf ormance
Organic sales grow th Market position
Balancing risk
Customer diversity Geographic diversity Cyclic al resilience
Financial Strength
Financial leverage Net debt/EBITDA Interest cover FCF yield
Equity Struc ture
Free f loat (%) Dividend yield Trading volume (3m avg)
Ave rage Score
HSBC research
The EPC players on the other hand fair better on the market performance criterion, owing largely to the higher organic growth that they should witness during FY09-13e as compared with the equipment manufacturers. We believe one of the main reasons for their superior organic growth is lesser customer diversity (a score of 2.0 versus
Sector score
equipment manufacturers 4.8), particularly compared with the likes of ABB and Siemens, and hence a higher concentrated growth. We highlight the sector Q-ben score card and overall score of each company in the table above and the chart below.
Median = 5.0 Siemens India Crompton Greav es Arev a T&D India ABB Ltd KEC Intl Kalpataru Pow er Jy oti Structures 0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
123
abc
What should you pay for these scores?

It is difficult to justify the prevailing valuation of the companies in its entirety by the Q-ben score alone, as valuation often incorporates expectations/risks beyond financial measures. However, the Q-ben Framework and the resulting Q-ben score highlights the distinction between the companies and is often helpful in identifying where opportunities and/or anomalies lie when plotted against the prevailing valuation multiples. We have plotted the Q-ben score of all the companies under our coverage (and the sector and
Scatter plot- FY12e PE vs Q-ben score
35.0 30.0 25.0 12m fwd P/E 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 Can be 'Undervalued' if operating perf improving Can be restructuring stories or 'Overvalued' ABB Areva T&D
sub-sector averages) versus 12-month forward PE and EV/EBITDA in the scatter chart format, as we highlight below. We have further divided the scatter chart into four quadrants to identify the potential cases for re-rating and/or de-rating. Other than observing the current position of the stocks on this chart, we would also like to draw investors attention to those stocks which are near the vertical median line but have the potential to crossover to the right (we call these crossover stories/plays). These are the stocks which we believe may see significant re-rating if they show improvement in their performance.
EPC Avg Kalpataru Jyoti
Crompton Greaves KEC Can be cyclical or 'Undervalued'
5.0 Q-be n Score
6.0
7.0
8.0
9.0
10.0
Scatter plot: FY12e EV/EBITDA vs Q-ben score

25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
ABB
12m fwd EV/EBITDA
Areva T&D
KEC
124
abc
On an overall basis, we make the following observations about the stocks under our coverage:
ABB (Q-ben score: 4.5) clearly appears over-valued at this stage. The company has seen significant price erosion over the last couple of years and even if its operational performance improves over the coming years, its current high valuation leaves little room, if any, for re-rating. Areva T&D (Q-ben score: 4.9) can be seen as a classic crossover or restructuring story. The stock looks relatively inexpensive compared with ABB and Siemens on EV/EBITDA and the company is just about to complete its expansion and rationalization plans. We believe that the company may surprise positively on its operational performance going forward, thus driving the re-rating of the stock. Siemens (Q-ben score: 6.5) is the second best quality company within our coverage universe based on our Q-ben Framework. It also remains relatively inexpensive compared with its peers ABB and Areva. The company has also shown strong improvement in its market position and hence we expect Siemens to show improvement in its operational performance. Therefore, we continue to find Siemens valuation attractive relative to others based on its premium quality. Crompton Greaves (Q-ben score: 7.7) lies at the far right end of the chart, highlighting its premium quality. Interestingly, the stock doesnt look very expensive either particularly compared with the other equipment manufacturers. The company has also shown significant improvement in its operational performance and market position over the last several years. The company also scores the highest on 8 of the 16 metrics.
Hence, we believe that with a robust earnings outlook, we should see further upward rerating of the stock going forward.
Kalpataru (Q-ben score: 4.3) scored the lowest of all the companies in our universe on the Q-ben score. However, it does score highly on the market performance criterion (6.6 versus the highest score of 7.1 and sector average of 5.4), implying robust earnings outlook. We note that Kalpataru has been in an expansion mode over the last few years, because of which it doesnt fare well versus others on the internal performance criterion (i.e. metrics such as FCF generation, added value and RoCE); however, we expect the groups past investment to bear fruit going forward and hence we expect an improvement in Kalpatarus operational performance. In that context, we find Kalpatarus current valuation attractive. Jyoti Structures (Q-ben score: 4.6) is one of the cheapest stock in our sector and may also fit the bill of another crossover story. We do not see many catalysts at this stage which may lead to a positive surprise on its operational performance; but the company is nevertheless exploring new avenues for growth, such as BOT projects and international EPC markets. But even if the company doesnt improve its Q-ben score, we believe that current valuation discount looks unjustified and the stock should re-rate based on the quality and the potential of the business. KEC (Q-ben score: 5.2) scores the best among the EPC players, but is also one of the most expensive stocks within this subsegment. The company has the highest geographic diversity with c52% of revenues coming from outside India. While in a normal situation this should be seen as a strong point, we believe it may prove as a slight
125
abc
disadvantage in the current scenario, where we forecast India to witness a sharp increase in T&D related orders during FY12-13e but dont expect any surge in international order growth. This may benefit companies who are more geared to the Indian markets. Therefore, even through the company looks better on the Q-ben score, we find its valuation rich relative to its peers Jyoti and KEC. We discuss each of the five criteria, the related 16 metrics and the performance of our sector on each of these metrics in detail below.
Free Cash Flow (FCF) to Sales Added value (Gross Profit/No. of employees) Capital expenditure Return on capital employed (RoCE)
We discuss each of these metrics in details below.
FCF to Sales key measure of opportunity

We view Free Cash Flow (FCF) to Sales as a key measure of opportunity. Not only does it highlight the companys ability to pay dividends but also signifies its potential to fund future growth, both organic (through greenfield and brownfield projects) and acquisitions. Cash generation tends to follow a cyclical trend in our opinion, with the high points generally being in the early stages of recovery when both working capital and capex are managed tightly, followed by reduction in cash margins as volume growth comes through. However, this trend was not visible within our coverage universe given that most of the companies saw negative cash flow during the weak years of FY09 and FY10. This is largely due the fact that most of our companies continued
1. Internal performance A measure of companys intrinsic characteristics

Our first criterion in the Q-ben Framework is internal performance which aims to differentiate companies based on their intrinsic strengths and capabilities. The aim is to identify and award a higher score to those companies which show superior operational performance and are strong in cash generation and operating returns. We use the following four metrics to evaluate the companies on the Internal Performance criterion.
Free cash flow score
Median = 5.0 Siemens India Crompton Greav es Arev a T&D India ABB Ltd KEC Intl Kalpataru Pow er Jy oti Structures (1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
126
abc
FCF to sales Calendarised
8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0%
highest average cash margin of c6.9% but also the most consistent track record of generating cash. We highlight in the chart below how companies fare on this metric relative to each other.
Added value key measure of productivity

Structures International Kalpataru ABB Ltd Greaves Areva T&D Crompton Siemens India
with their capex plans even during weak years, thus leading to negative cash flows. The average capex for EPC players was c4.7x depreciation during FY09-10, while for equipment manufacturers, the average capex was c3.7x. We expect the pace of capacity addition to slow down from here on and average capex to decline to c1.5x depreciation for the sector by FY13e, which should benefit cash generation. This may potentially lead to some re-rating of the sector, particularly EPC players who are one of the weakest in terms of cash generation. In terms of companies, we would like to highlight Crompton Greaves which not only has the
We calculate added value as gross profit generated per employee. We view added value as a key metric to evaluate a companys productivity, which is driven in part by companys own efficiency and in part by the nature of the business. For example, given the low proprietary technology content in the contracting work (EPC players), it is natural to expect contractors to score lower on value added compared with equipment manufacturers, particularly those who are technology leaders. We believe that companies that add more value to their products relative to their trade peers have better long term prospects for sustainable growth and should be rewarded. Within our coverage universe, EPC players have received an added value score of 3.5 versus equipment manufacturers score of 5.7.
Kalpataru has come out as the weakest player with an average (FY09-13e) value add of
Added value score
Siemens India Crompton Greav es Arev a T&D India ABB Ltd KEC Intl Kalpataru Pow er Jy oti Structures (1.0)
Power Jyoti
India
KEC
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
127
abc
Added value (INRm)
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

Structures
128
Capital expenditure key measure of future potential

We view capex trend as a key proxy for future growth potential. The assumption here is that the company is adept enough to evaluate the demand environment and will not, for most part of the cycle, create excess capacity.
International Kalpataru
ABB Ltd
Greaves Areva T&D
Crompton
Siemens India
Source: HSBC Research
cINR1.6m while both Crompton and Siemens come out as the strongest with an average value add of cINR4.2m (i.e. 2.5x to that of Kalpataru). As we have noted earlier, Kalpataru has undergone significant capacity expansion over the last few years (the number of employees has doubled since FY07), putting a temporary dent in its productivity. However, given that both of Kalpatarus closest peers, KEC and Jyoti, generate a value add of cINR3.2-3.4m, we believe that there remains significant scope for improvement in Kalpatarus productivity. We highlight in the chart below how companies fare on this metric relative to each other.
Capex score
Power Jyoti
India
The capex trend also highlights managements confidence in future growth and if often able to highlight managements growth strategy (i.e. organic versus acquisitive). We value organic growth more than acquisitive growth as very few companies in our coverage have a strong track record of making value accretive acquisitions and integrating them efficiently. Moreover, we believe that in the current market environment, it is less expensive to fund organic growth than acquisitive growth. Therefore, we award a higher score to companies which show significant capacity built-up during FY09-13e. Interestingly, there is not much distinction between EPC players and the equipment manufacturers when it comes to capacity addition. EPC players fare slightly weaker than the equipment manufacturers with an average score of 3.9 (versus 4.2). This in part is owing to the fact that all three of our EPC companies (KEC, Jyoti and Kalpataru) had a very
KEC
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
abc
Capex as % sales
Capex to depreciation
6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0%

Structures International Kalpataru ABB Ltd Greaves Areva T&D Crompton Siemens India Power Jyoti India KEC
4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

small base to begin with and have invested significantly over the last many years to grow their business (sales on average have gone up 3x in the last 4-5 years). Therefore, there is not much need for capex during FY09-13e. Within our covered companies, Areva T&D stands out on this metric with a score of 8.0. Siemens on the other hand comes out as the weakest player with 2.5. This we believe is largely due to the fact that Siemens already has a large capacity base and it outsources most of the high value contracts to its parent company. We highlight in the chart below how companies fare on this metric relative to each other.
RoCE key measure of profitability

Return on capital employed (RoCE) is a true blend of a companys profitability and its asset efficiency. Hence, in our view, RoCE is the most effective tool (particularly for capital intensive businesses) to evaluate the earnings power of a company. From an analytical perspective RoCE also forms the basis of our preferred valuation methodology, which is Economic Value Added (EVA). We believe that the firms earnings power and in turn its value is driven by the managements capability to generate superior returns on the total capital committed to them (as can be gauged from the RoCE).
ROCE score
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
129
abc
RoCE Calendarised
RoCE ex-cust adv Calendarised
30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0%

50.0% 40.0% 30.0% 20.0% 10.0% 0.0%

Furthermore, we believe that a company should be rewarded or penalized based on its capability to generate Excess returns over and above its cost of capital. Hence, RoCE forms a strong basis for the appraisal of a company in terms of both relative and absolute valuation. We note that the EPC players, because of the low value added nature of their business, come out as the weakest on this metric with an average score of 4.6. While the equipment manufacturers, because of high technology content in their products, are strong with an average score of 6.9. This also reflects the difference between the valuation multiples of EPC players (average 12month forward EV/EBITDA of c6.3x) versus equipment manufacturers (average 12-month forward EV/EBITDA of c16.5x). We highlight Crompton Greaves in our universe (average RoCE of c28% during FY09-13e), which has generated the highest RoCE within our universe over the last couple of years and we expect the company to continue to do so going forward. The second best company on this metric is Siemens with an average RoCE of c22%. ABB comes out as the weakest company in spite of being a technology leader and its average RoCE of c14% is even below that of some of the EPC players, such as Jyoti (c14.7%) and Kalpataru (c14.2%).
We highlight in the chart on the previous page how companies fare on this metric relative to each other.
2. Market performance A measure of companys positioning in the market

Our second criterion in the Q-ben Framework is market performance which aims to differentiate companies based on their relative positioning (i.e. whether favourable or disadvantageous) within the markets. The aim is to identify and award a higher score to companies which have the potential to witness strong organic growth and enjoy strong pricing power in the market. We use the following two metrics to evaluate the companies on the Market Performance criterion.
Organic sales growth Market position
We discuss each of these metrics in details below.
Organic growth key indicator of market dynamics

Although there are many sources of data to evaluate the growth dynamics in relevant markets, few fit the precise characteristics of each company. This is largely owing to the fact that companies often have different addressable segments within the same broader market and the
130
abc
Organic growth score
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
relative exposure of each company to a particular market is invariably different. Therefore, assuming that companies have maintained their market share in their respective markets, we believe that the organic growth trend proves to be a good proxy for evaluating which company has a better or worse blend of exposure versus others. This metric is also able to capture the merit or demerit of a particular companys style of balancing risk i.e. whether the company is benefiting from its customer or geographic diversity or whether it is having to let go of some growth to attain diversity (or balance risks). As a rule of thumb, we believe that lower risks should usually lead to lower returns (and lower growth rates in this case) but, on the positive side, should also reduce the volatility in growth rates over the cycle. Therefore, the score achieved by the companies on this metric should be evaluated based on where we stand in the cycle. A higher score on this metric, in our opinion, should be rewarded more when we are heading into a strong demand environment. Our thesis around the risk versus growth trade-off proves accurate when we look at the scores
received by the companies within our universe. Jyoti Structures, which is the least diversified company (both in terms of customers and geography), has scored highest on this metric (7.2) while Siemens and ABB, which are the most diversified companies (end market wise), have the lowest score of 0 and 0.2, respectively. Crompton Greaves, which has high end market concentration but high geographic diversity, is in the middle with a score of 3.3. The EPC sub-segment has received a higher score of 6.2 compared with the equipment manufacturers (a score of 2.4). This is largely because of their high end market concentration (i.e. mostly T&D) versus equipment manufacturers.
Sales growth Calendarised (March year-end)
25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Structures International Kalpataru ABB Ltd Greaves Areva T&D Crompton Siemens India Power Jyoti India KEC
131
abc
We highlight in the chart below how companies fare on this metric relative to each other.
Market position indicator of pricing power, ability to capture opportunities

One way in which businesses can mitigate the impact of negative pricing is to build a strong market position. In our view, a company better positioned to understand and serve its customers can sometimes influence market pricing. A strong market position also helps to create a high barrier to entry for competition, thus providing the company with an ability to capture opportunities in its addressable markets. All of this ties in well with our belief that companies should, over a period of time, focus on their core competencies and build a critical mass in few core areas. This not only helps them achieve higher growth over a period of time but also mitigate pricing pressures by gaining market share during weak demand environment. Therefore, we award a higher score to companies with strong market position versus those with weaker position and believe that companies with higher scores on this metric should be rewarded with higher valuations.
Due to the lack of availability of exact market share data for all the companies for all their businesses, this is the only metric where we have used subjective judgement to award scores. We highlight our scoring criterion in the table below.
Market position
M ark e t position Clear global leader (m.share > 30%) Global leader (m.share < 30%) Top 5 global player Regional leader in regional market Regional leader in global market Mid size player Local leader Niche company
HSBC research
Score 10 9 8 7 5-6 4 3 2
We note that all of the companies under our coverage have strong market position in their core businesses i.e. either they are a market leader or one of the top 3-4 players. Again, the companies which have critical mass in one or two core areas (and hence a higher probability of having a strong market position) fare well on this metric. But overall, all of the companies score between 6 and
Market position score

0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
132
abc
Market position
Com pany ABB Ltd Divis ions Pow er Systems Pow er Products Proces s A utomation Discrete A utomation & Motion Low Voltage Products Areva T&D India Crompton Greaves Ove rall Score Transmission & Distribution Ove rall Score Pow er Systems Consumer Products Industrial Systems Siemens India Ove rall Score Pow er Gen Pow er T&D Oil & Gas A utomation & Drives Industrial Solutions & Svcs Building Technologies Mobility Healthcare IT Serv ices Ove rall Score % Split 25% 29% 19% 21% 6% 100% 100% 100% 68% 17% 15% 100% 4% 33% 6% 21% 11% 3% 10% 5% 6% 100% Score 6.0 7.0 5.0 7.0 6.0 6.3 7.0 7.0 7.0 7.0 7.0 7.0 4.0 7.0 4.0 7.0 6.0 4.0 4.0 7.0 4.0 6.0 KEC Intl Kalpataru Pow er Com pany Jyoti Structures Divis ions Transmission & Distribution Ove rall Score Transmission & Distribution Construction Infrastructure Biomas s Ove rall Score International transmission South Asia transmission Distribution & Substation Cables Railw ay & Telecom Ove rall Score % Split 100% 100% 56% 33% 9% 1% 100% 44% 34% 18% 2% 2% 100% Score 7.0 7.0 7.0 7.0 7.0 5.0 7.0 7.0 7.0 4.0 7.0 5.0 6.4
HSBC research
7, highlighting that they are one of the regional leaders in the market. We highlight in the charts how companies fare on this metric relative to each other.
3. Balancing risk A measure of diversity and the inherent cyclicality of the business
Our third criterion in the Q-ben Framework is balancing risk, which aims to differentiate
companies based on the diversity of their customer base and inherent cyclicality of the business. The aim is to identify and award a higher score to companies which have the ability to limit the downside risk to their earnings during a weak environment and hence show lesser cyclicality. We use the following three metrics to evaluate companies on the balancing-risk criterion.
Customer diversity (early versus late cycle exposure)
Customer diversity score

0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
133
abc
Geographic diversity (dependence on domestic versus international growth) Cyclical resilience (ability to limit losses during a downturn) We discuss each of these metrics in detail below.
markets as either early, mid or late cyclical. We highlight our classification below. As we have stated earlier, the strategy for good diversification without compromising market position is to build a strong position in several markets which fall in different stages of the cycle and for this metric, we have awarded a higher score to the companies which have managed to do the same. We have calculated a mathematical score to arrive at the extent of diversity and then we have used this score to rank the companies on a uniform scale of 1 to 10.
Customer breakdown
Early cycle M id cycle Late cycle Consumer Durables Industrial Manufacturing Construction Pow er Transmission Pow er Distribution Railw ays Process Industries Healthcare Others
Customer diversity key measure of earnings risk

Although we view a focused divisional structure as mark of a good strategy, an ideal company is typically not exposed to one powerful customer or one group of customers with the same demand dynamics. In that context, we believe that customer diversity can be seen as a key measure of the earnings risk and/or the quality of earnings. The key in achieving customer diversity is to build critical mass in several core markets which are geared to different stages of the cycle (early, mid, late) rather than building weak positions in many markets which are concentrated to any one particular stage of the cycle. We note that our coverage universe is exposed to around eight major end markets and a few minor end markets. Based on our experience of the business cycles, we classify each of these end
Othe rs
We note that the EPC players, because of their concentration to the T&D market, have received a low average score of 2.0 whereas the equipment manufacturers have received a high score of 4.8. In terms of companies, Siemens has received the
Customer diversity
Siemens India Crompton Greav es Arev a T&D India ABB Ltd KEC International Kalpataru Pow er Transmission Jy oti Structures 0% 10% 20% 30% Mid Cy cle 40% 50% 60% Others 70% 80% 90% 100%
Early Cy cle
Late Cy cle
134
abc
highest score of 7.1, followed by Crompton (5.4) and ABB (5.2).

Jyoti Structures has received a score of 0 because its entire business comes from the T&D market.
America and Rest of World (RoW). We calculate the geographic diversity score in a similar manner to that of the customer diversity score. We award a higher score to companies with more geographic diversity and vice versa.
Geographic exposure bar chart
12.0 10.0 8.0 6.0 4.0 2.0 0.0 Structures International Kalpataru ABB Ltd Greaves Areva T&D Crompton Siemens India Power Jyoti India KEC
Geographic diversity key measure of regional risk

Similar to customer diversity, geographic diversity is also usually a key ingredient of a good company. However, in the context of the Indian companies, this measure is less relevant than customer diversity. This is so because companies usually diversify geographically to tap higher growth in the emerging markets; however, for an Indian company which is already seeing a lot of structural growth in the domestic market, the benefits of searching for international growth diminish considerably. In that context, the only benefit which a company may get by looking outside is less dependence on one market and hence greater immunity to the country risk. We have divided the companies exposure into four main geographies India, Europe, North
Cyclical resilience key measure of cyclical risk

It is difficult to assess the cyclicality of the Indian companies as the markets and the companies themselves have changed significantly from the previous cycles. Therefore, to avoid structural distortions in our analysis, we have taken the current cycle for analysis and have tried to identify the peak and trough earnings during the
Geographic diversity
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
135
abc
Cyclical resilience
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
pre-to-post downturn between FY07 and FY10. It has become quite evident from our analysis that companies which had higher geographical diversity i.e. KEC and Crompton were able to weather the downturn much better than the other players. In fact, both of these companies showed continuous growth in earnings even through the weakest years of FY09-10. In that context, unlike others, KEC and Crompton has shown an unbroken earnings record since FY07. The weakest companies in our universe have come out to be ABB and Siemens, where trough earnings were c56% and c67% of the peak earnings, respectively. We believe that the main reason behind significant deterioration in their earnings is because these companies operate in markets (such as transformers) which saw significant price erosion in addition to volume decline, thus putting a disproportionate dent in the margins. In case of ABB, EBITDA margins declined to c5.8% from the peak of 13.9% while in case of Siemens, the EBITDA margin declined to c7.5% from a peak of 10.7%. Just like geographic diversity, we find this metric less relevant for Indian companies as the domestic market is witnessing strong structural growth and
in the absence of a massive global shock, we dont expect to see any downturn in the Indian market in the medium term. We highlight in the chart below how companies fare on this metric relative to each other.
4. Financial strength A measure of companys ability to fund growth

Our fourth criterion in the Q-ben Framework is financial strength, which aims to identify companies which have the fire power to fund future growth. A high net cash position on the balance sheet doesnt bode well for the company if the cash is sitting idle; however, if the company has expansion plans and has room to gear up, then it usually implies that the company will see superior growth in the future. Financial strength is also a measure of a companys ability to service its debt obligations and immunity to any breach in debt covenants in the wake of any crisis. Finally, we believe that financial strength also plays a key role in determining the cost of capital to the company and hence its capability to generate excess returns. Under-levered
136
abc
companies are usually able to get a favourable credit rating and hence competitive interest rates for their debt requirements compared with the companies which are already highly geared. Equity investors also tend to look at companies with higher free cash flow yield more favourably than. those with lower yields, resulting in lower cost of equity. Therefore, the aim of this criterion is to identify and award a higher score to those companies which have the ability to fund new ventures of growth at a competitive cost of capital and continue to service their debt obligations in the wake of any business related crisis. We use the following four metrics to evaluate companies on the financial strength criterion.
Financial leverage (Assets/Equity or 1+Gearing) Net debt/EBITDA (a typical covenant for most debt obligations) Interest cover (the ability to service debt) FCF yield
On the face of it, our coverage universe looks relatively under-levered with an average leverage of c0.96x. However, we note that most of the capital goods companies with long lead times for their products and/or services often rely on customer advances and bankers acceptances to fund their working capital requirement and the cost of the projects. This is particularly true in cases where the lead time for the product/projects can stretch up to 18-24 months.
Financial leverage (incl acceptances) calendarised
3.00 2.50 2.00 1.50 1.00 0.50 0.00 Structures International Kalpataru ABB Ltd Greaves Areva T&D Crompton Siemens India Power Jyoti India KEC
We discuss each of these metrics in detail below.
Financial leverage key measure of firing (funding) power

We view financial leverage as a key measure of a companys ability to gear up and hence its fire power in the case of expansion. We believe financial gearing can prove an important parameter to assess companies in India because: 1) companies are still ramping up their capacity to meet the growing demand; 2) the cost of debt is high in India and therefore a highly geared company may find it difficult to raise funds at a reasonable cost; 3) the project related risks are high in India and a crisis in 1-2 big projects can put a company in a difficult situation if it doesnt have room on its balance sheet.
Taking a conservative approach, particularly when trying to evaluate companies ability to manage a crisis, the customer funding can be viewed as another debt like obligation, particularly when it is interest bearing. While customer advances in most cases are interest free, bankers acceptances usually have an interest component built into them. Therefore, although a conservative investor may choose to treat customer advances as debt, we have chosen to treat them as an operating asset. However, for the purpose of this analysis, we treat bankers acceptances as debt and have included it in our calculation of the underlying financial leverage. After this adjustment, the distinction between the two sub-segments in our coverage universe the EPC players and the equipment manufacturers
137
abc
Financial leverage score
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
clearly comes to the forefront. While EPC players now look relatively highly geared (average leverage of 1.79), the equipment manufacturers are clearly under-levered (average leverage of 0.78). Surprisingly, this distinction is quite consistent across all the companies i.e. all equipment manufacturers, barring Areva, have leverage of less than 1 (implying net cash position) while all EPC players have gearing ranging from 40% to 140%. Owing to the project oriented nature of the business, we believe that the relatively high gearing of EPC players increases their business risk because a couple of bad projects can put them in a critical situation. Moreover, given that all these three EPC players are trying to venture into BOT projects, their gearing and the associated business risk is bound to increase in the near term. We particularly highlight KEC here which has a gearing of c1.4x and an average (FY09-13e) cash margin of just around 0.5%, implying limited ability to reduce the debt burden. The equipment manufacturers on the other hand have strong firing power, with most of them having huge net cash positions. Areva T&D is the only company in this space which is geared at the
moment; however, we expect its imminent asset sale to bring down the gearing to 0. We highlight in the chart above how companies fare on this metric relative to each other.
Net debt to EBITDA one of the key covenants

Most of the debt obligations have embedded covenants to ensure prudent behaviour on the borrowers part and a breach of any of these covenants may often lead to a costly debt restructuring if not a bankruptcy. While covenants could be many and specific to the individual debt contracts, it is generally believed that a net debt to EBITDA ratio of less than 3.0x is usually required
Net debt/EBITDA calendarised
1.50 1.00 0.50 0.00 (0.50) (1.00) (1.50) (2.00) (2.50) Structures International Kalpataru ABB Ltd Greaves Areva T&D Crompton Siemens India Power Jyoti India KEC
138
abc
Net debt to EBITDA score
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
in most debt contracts. And while a ratio of more than 3.0x doesnt necessarily imply a breach of covenant, it does raise a red flag. We note that all the companies under our coverage remain well within this requirement, with KEC having the highest net debt to EBITDA ratio of 0.98. But even that remains comfortably below the benchmark of 3.0. We note that even though EPC players are in a strong position on this metric they have received a lower score because the strong cash position of equipment manufacturers have skewed the score strongly in their favour. The EPC players get an average score of 4.4 versus a score of 7.6 for equipment manufacturers. Siemens, having the highest net cash position, has received the perfect score of 10.0. We highlight in the chart below how companies fare on this metric relative to each other.
Interest cover key measure of debt servicing capability

We define interest cover as clean EBIT divided by net interest. It is usually also one of the covenants in most of the debt contracts, but more than a covenant its a strong indicator of a companys ability to service debt, particularly during economically weak times. It is usually believed that companies should have an interest cover of more than 3.0x to avoid a crisis.
Interest cover (on EBIT) calendarised
100.00 80.00 60.00 40.00 20.00 0.00 (20.00) (40.00) Structures International Kalpataru ABB Ltd Greaves Areva T&D Crompton Siemens India Power Jyoti India KEC
139
abc
Interest cover score
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
While the equipment manufacturers under our coverage do not have much debt on their balance sheet to service, the EPC players are certainly feeling the heat. The average interest cover of the EPC players is c3.8x, which although above the benchmark of 3.0x, doesnt leave much room for additional interest burden. The weakest player on this metric is Jyoti Structures, which has an interest cover of c3.2x, leaving little room for further gearing. KEC, on the other hand, in spite of its highest gearing within the sector, has the best interest cover at c4.3x among the EPC players. Interestingly, this is not because KEC is able to raise debt at a lower cost but because it generates superior return on equity (RoE) versus both Kalpataru and Jyoti, thus being able to service a much higher gearing. We highlight in the chart above how companies fare on this metric relative to each other.
doesnt necessarily form a part of the fundamental analysis; however, we believe it would be nave to ignore the importance of trading characteristics of an asset when assessing its attractiveness. Our experience suggests that there is usually an illiquidity discount on thinly traded securities, while there is usually a premium on stocks which deliver consistent and high dividend yields. The trading volumes are often a determining factor of a fund managers ability or inability to invest in a particular security, which in turn, determines the size of the market in that security. All these factors, directly or indirectly, play a key role in determining the cost of equity for a company and whether a security should trade at a premium or discount to its wider peer group. Therefore, the aim of this criterion is to identify and award a higher score to those companies whose securities have a sizeable market and attractive yields. Such companies in our opinion appeal more to a wider base of investors and typically command a premium in the market. We use the following three metrics to evaluate companies on the equity structure criterion.
Free float (the % of total equity which trades freely in the market)
5. Equity structure A measure of companys trading characteristics

Our fifth and the last criterion in the Q-ben Framework is equity structure, which aims to differentiate companies based on their trading characteristics. We understand that this criterion
140
abc
Dividend yield Daily trading volume (3MMA)
Free float (%)
We discuss each of these metrics in detail below.
Free float key measure of investor presence in the security

The extent of free float can have several implications for a company and different investors may have different reservations with respect to the desired level of the free float. But as a general rule of thumb investors generally prefer a higher free float the more the merrier. Some of the key reasons behind this are:
A larger free float usually implies a lower holding by the major shareholder and higher investor participation, thus providing investors with enough voting rights to approve or disapprove of key strategic decisions A lower free float is usually seen as a red flag for poor corporate governance, particularly in India where financial transparency is still not adequate A lower free float usually implies a lower trading volume and hence a smaller market in the security
80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0%
In India it is quite common to have a free float of less than 50% as most of the companies are family run businesses. Another reason for a lower free float is that most of the multinational companies are subsidiaries of bigger parent companies who usually have a majority stake in the subsidiary (hence, a subsidiary). But we nonetheless continue to prefer companies with higher free float versus those with lower free float. Within our coverage universe EPC players have a much higher free float of c60% versus equipment manufacturers (mostly subsidiaries of foreign companies) who have a free float of c38%.
Structures
ABB Ltd
Greaves Areva T&D
Crompton
Siemens India
Power Jyoti
India
KEC
Free float score
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
141
abc
Jyoti Structures has the highest free float of c72%, followed by KEC and Crompton with a free float of c59% and c56%, respectively. ABB on the other hand has the lowest free float of 25% followed by Areva T&D which has a free float of c26%.
Dividend yield calendarised
1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0%
Structures
ABB Ltd
Greaves Areva T&D
Crompton
Siemens India
Power Jyoti
India
KEC
Dividend yield key determinant of value

The days of the basic Gordon growth model might be behind us but the significance of dividends has not reduced. Empirical evidence suggests that investors pay a premium for companies which show consistent and high dividend yields relative to their peer group. We believe dividend yields are often more important for minority shareholders in situations where companies have relatively high levels of majority ownership, because minority shareholders have no control or say on the use of free cash flows generated by the company.
In that context, dividend yield should be an important aspect of an investment case on Indian companies. However, it is not necessarily the case and we believe that a large part of the reason lies in the Indian growth story. As most of the companies are witnessing a strong growth in demand they usually use most of the available cash to fund future growth. Hence, investors also focus on growth returns (i.e. capital appreciation) rather than income returns (i.e. dividend yields). Within our coverage universe, KEC has the best average dividend yield of c1.4% while ABB has the worst dividend yield of c0.3%. The average dividend yield for EPC players is c1.1% versus c0.7% for equipment manufacturers.
Dividend yield score
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
142
abc
Trading volume key measure of liquidity

Our last metric is the daily trading volume (3MMA) which we believe is often a good indicator of the size of the market in the security and hence its liquidity. Investors always prefer liquid securities over illiquid ones and there is usually an illiquidity discount on stocks with lower trading volumes. The market is usually small in securities with lower trading volumes because most of the funds have a minimum threshold for trading volumes below which they never invest regardless of how attractive the opportunity is. However, we also note that illiquid stocks are usually less covered by the brokers in the market and hence the chances of price discovery are usually higher in such names versus their bigger, better-known peers. But that also implies that trading anomalies can persist for a longer period of time than usual, forcing even patient investors out of the stock.
Within our coverage universe, Crompton and Siemens have the highest daily trading volumes (3MMA) of cUSD9.6m, followed by Areva and ABB which trade cUSD3.5-4m a day. Within the EPC players, Jyoti has the highest trading volume (owing to its higher free float) of cUSD1.7m per day while KEC and Kalpataru trade cUSD1.1m a day.
Trading volumes (USDm) 3MA
12.0 10.0 8.0 6.0 4.0 2.0 0.0
Structures
ABB Ltd
Greaves Areva T&D
Crompton
Siemens India
Power Jyoti
India
KEC
Trading volume score
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
143
abc
144
abc
Company profiles
Jyoti Structures Plain Jane, but deep value Kalpataru Power Strong growth at attractive price KEC Robust outlook but priced in ABB An expensive recovery story Areva T&D Likely recovery seems priced in Crompton Greaves Everything is premier but the price Siemens Powering through
145
abc
Jyoti Structures Plain Jane, but deep value

Although Jyoti has struggled with new orders in FY11 (Mar YE),
we believe its robust order book and strong gearing to domestic transmission growth bodes well for its future earnings
A potential equity dilution may prove risky but management
rightfully focusing on margins and funding international capex through internal accruals
The stock has underperformed and remains at c30% discount to
its trade peers; we are 9% ahead of consensus on FY12e. Overweight, TP INR165
A risky but attractive proposition

It is tricky to take an investment call on Jyoti Structures at this stage as the company seems to be struggling with new orders and its balance sheet doesnt allow much room to test new waters. However, the stock has de-rated significantly over the last six months and at c4.8x FY12e (March year-end) EV/EBITDA and c7.0x FY12e PE is the most in-expensive stock at this stage compared with its peer group as well as its own history. Although some of this de-rating is justified, given the firms deteriorating market share with Power Grid and the equity dilution overhang, we believe that writing-off the companys future earnings potential is not justified, particularly when the company is one of the market leaders and has a strong order book for the next two years.
We highlight the key bull and bear points related to Jyoti below:
Bull points
Strong order book with two years visibility Highly geared to domestic transmission growth story Management seems keen to preserve margins Currently the cheapest stock in the sector
Bear points
Losing market share with Power Grid Doesnt have much room in the balance sheet to aggressively pursue new ventures, such as BOT projects or International capex. An equity dilution for the same may prove risky for returns Highly geared to steel prices and hence vulnerable to cost pressures in addition to pricing pressures
146
abc
High interest cost burden leaving little room for further gearing
Quarterly order intake (INRm)
10,000 8,000 6,000 4,000 2,000 -
We acknowledge that the company is going through a rough patch and there are several limitations (and hence risks) associated with its balance sheet. However, the current discount on Jyoti (versus trade peers) of c30% and c40% on FY12e PE and EV/EBITDA more than accounts for these risks, in our opinion. Moreover, the company should benefit from strong domestic transmission capex that we expect during FY12-13. This, coupled with Jyotis strong order book and managements focus on margins, should allow the group to report strong earnings over the next couple of years. Consequently, we remain ahead of consensus by c7-9% on FY12-13e earnings.
Power Grid should again become a level playing field in the medium term
As far as the Power Grid orders are concerned, we note that the situation has deteriorated for each of the Big 3 players (i.e. KEC, Kalpataru and Jyoti) as c35% of the tower EPC orders in this financial year have gone to SPIC JVs. And although Jyoti has not won any tower EPC contracts from Power Grid this year, it has been awarded a sizeable INR430m substation contract, representing c5% of Power Grids total substation orders in the 400/220kV segment. We note that the key reason behind Jyotis loss of market share with Power Grid is that the pricing environment has deteriorated quite significantly for tower EPC orders; however, we believe that the new entrants are trying to win orders at unsustainable margins. This is evident in the absolute margins made by the new entrants and the underlying trend over the last six quarters, as we highlight in the following chart. Therefore, we believe that the pricing environment for Power Grid related orders is bound to improve in the medium term if not immediately.
Strong earnings visibility in spite of weak orders this year

A lacklustre performance on new order wins has been a key concern for Jyoti this year. The order intake for the first six months of FY11 is down c4% over the same period last year. The market seems to be particularly worried about the fact that the company has not secured any Tower EPC orders from Power Grid so far this year. While these concerns are valid, we believe that due to the inherent lumpy nature of the EPC business, it is a bit too early to jump to any definitive conclusions about the companys market position or its ability to win new orders. The company did in fact report strong growth in orders in Q2 FY11, both on the y-o-y (c68%) and the q-o-q (c32%) basis.
Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10
147
abc
EBITDA margin competitors vs Jyoti
15% 10% 5% 0% Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Competitors

compared with KEC and Kalpataru, whose order book extends to 1.7 and 1.8 years, respectively.
Order book visibility (x)
3.0 2.5 2.0 1.5 1.0 0.5 -
Jun-07 Sep-07 Dec-07
Dec-08 Mar-09
Mar-08 Jun-08 Sep-08
Jyoti primarily a domestic growth story

As highlighted in our End-market analysis section, we expect significant growth in domestic transmission orders during FY12 and FY13, driven by 11th plan spillover and HCPTC related orders. We expect Jyoti to be a key beneficiary of this growth as, of the Big Three players, it is the most geared to the domestic transmission market.
Exposure to domestic transmission market (%)
Potential for upside from Gulf Jyoti

Jyoti Structures has a 30% stake in a JV in Dubai with Gulf Investment Corporation (GIC) called Gulf Jyoti International LLC. The company is entitled to receive c15% of the net profits as the management fee; however, the group has never consolidated earnings from this venture as it was a minority holding. We note that the order book at Gulf Jyoti has now increased to cINR11.5bn (compared with Jyotis order book of cINR42.5bn) and the JV is expected to turn profitable this year. Although management remains against the consolidation of this JV, we believe it will be value accretive going forward.
80% 60% 40% 20% 0% KEC Jy oti Kalpataru
Management keen to preserve margins

Jyoti has limited risk to margins baked into its existing order book as the company derives c90% of its revenues from domestic contracts which usually have price escalation clauses built into them. However, there is constant pressure on margins when bidding for new projects, particularly as the competition has intensified lately.
Therefore, we expect Jyoti to witness strong order growth going into FY12 and FY13.
Strong visibility through order book

In the interim, we believe the company should find support from its robust order book which provides sales (and hence earnings) visibility for c2 years. Among the Big 3, we note that the overall sales visibility is slightly better at Jyoti
148
Mar-10 Jun-10 Sep-10
Jy oti
Jun-09 Sep-09 Dec-09
abc
Margins stable in last six quarters

However, based on our conversation with the management, we believe the company remains keen to preserve margins and is not willing to compromise significantly on prices to get the volumes. This is also evident in Jyotis quarterly results where margins have increased y-o-y in both Q1 and Q2 FY11.
Quarterly EBITDA margin (%)
Steel exposure FY10
30% 25% 20% 15% 10% 5% 0% KEC 14%
24%
11%
Jy oti
Kalpataru
14.0% 13.0% 12.0% 11.0% 10.0% 9.0% 8.0% 7.0%
Small balance sheet limits ability to test new waters

Jyoti has seen a more than four fold increase in its equity base over the last four years (FY07-10); however, it still has the smallest balance sheet compared with the other Big Two players (KEC and Kalpataru). At the end of FY10, Jyotis total shareholder equity (or net assets) was cINR5bn compared with cINR7.8bn and cINR11.5bn for KEC and Kalpataru, respectively.
Jyoti Shareholders equity (INRm)
Q2FY10
Q3FY10
Q4FY10
KEC
Jy oti
Kalpataru Parent
Foray into international markets should support margins

Jyoti has recently announced that they have received board approval to invest cUSD12m or cINR550m to set up a lattice tower manufacturing company in the US. The management has indicated that this would be largely funded through internal cash flows. We believe that this will not only help Jyoti to tap international growth opportunities but will also support its margins in the long term.
Q2FY11
Q1FY10
Q1FY11
6,000 5,000 4,000 3,000 2,000 1,000 FY06 FY07 FY08 FY09 FY10
Steel prices remain a key risk

Jyoti is highly geared to steel prices. Its current exposure to steel is c24% of its sales, implying that the company has significant raw material price risk relative to others. Our Metals and Mining team forecasts steel prices to go up by c10% in 2011, which we believe will put further pressure on Jyoti when bidding for new orders.
Weak ROE is a key deterrent

More than the actual size of the equity base, the key disadvantage for Jyoti is its weaker ROE of c15.5% (FY10) compared with KEC (FY10: c23.4%) and Kalpataru (FY10: 16.7%).
149
abc
Jyoti ROE
Jyoti cash flow from operations (INRm)
25.0% 20.0% 15.0% 10.0% 5.0% 0.0%
23.1%
20.8%
22.3%
22.8% 15.5%
1,500 1,000 500 (500) (1,000)
FY06
FY07
FY08
FY09
FY10
FY06
FY07
FY08
FY09
FY10
This means that even with a lower gearing of c0.7x (adjusted for loans & advances) compared with, for example, KEC (gearing of 1.5x) and similar margins and interest cost, Jyoti has a much lower interest cover (c2.8x) than KEC (c4.4x). This limits Jyotis ability to service additional debt and hence its ability to further gear up.
Jyoti interest cover
Equity dilution may prove risky

Given the limitations on cash generation and the ability to gear up, we believe that it is only natural that the company will have to undertake equity dilution for any major capex plans. There could be two potential uses for fresh equity, both of which in our opinion come with significant risks in the near term:
The company may choose to use this fresh equity to enter into BOT projects which usually entail a gearing of c3x. This will put further interest burden on the P&L and the already stretched interest cover may fall to a critical level, leaving no room for crisis management. The company may choose to use fresh equity to expand the international footprint, either through greenfield expansion or acquisition. In either case, the already weak ROE will take a further hit in the near term.
4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 -
3.7 2.7
3.6 3.0 2.8
FY06
FY07
FY08
FY09
FY10
On top of this, Jyotis cash generation has also been relatively weak, with the group reporting negative cash from operations for four out of last five years.
We note that Jyoti revealed its intentions concerning equity dilution in the beginning of this financial year; however, the company has since kept this issue on the backburner. We believe it is the right thing to do at this stage, given that the groups returns have recently taken a hit and its coverage ratios have been stretched.
150
abc
Working capital needs strict management

We also note that companys working capital management has deteriorated lately, with trade working capital (i.e. excl other receivables and other payables) rising to c23% of sales in FY10 compared with c17% in FY06. This is largely driven by an increase in receivable days and a decline in payable days. The inventories have also increased over the last few years. We believe that in the current state it is imperative that the company manages its working capital tightly and focuses on cash generation.
Working capital as % of sales Jyoti
Asset turns Jyoti
25 20 15 10 5 0 FY06 FY07 FY08 FY09 FY10
Fix ed Asset turns

Asset (CE) turn
60% 40% 20% 0% -20% -40% FY06 Trade WC FY07 Inv entories FY08 FY09 FY10 Pay ables
Overall, we believe that the company needs to improve its balance sheet in a risk controlled manner otherwise it may run into financial difficulties.
We remain c9% ahead of consensus on FY12e earnings

Jyoti is highly geared to domestic T&D markets, deriving c90% of its sales from this market. This in our opinion should prove a blessing in disguise for Jyoti as we expect India to witness a disproportionate growth in the T&D orders during FY12 and FY13 relative to other geographies and/or other end markets. Therefore, we remain bullish on the new order outlook going into FY12, assuming that Jyoti will maintain its market share in the broader Indian T&D market (i.e. beyond just the Power Grid orders). Consequently, we forecast order intake to grow at c36% in FY12 and c12% in FY13. We expect the order book visibility to remain at c2 years and forecast order backlog to grow to cINR63bn and cINR76bn by FY12 and FY13, respectively.
Reciev ables
Company is right in funding capex through internal accruals

Moreover, we believe that the company is right in its decision to fund international growth through internal cash accruals. This will help the firm tap international growth opportunities and improve margins without incurring additional cost of capital and increasing financial risks. The company should also focus on its asset turns which have deteriorated significantly over the last few years. We believe that with a revival in sales growth going into FY12, Jyotis asset turns should automatically improve unless the company goes on a capex spree.
151
abc
Order intake and order book (INRm) Jyoti
80,000 60,000 40,000 20,000 FY08 FY09 FY10e FY11e FY12e FY13e Order intake
We are marginally ahead of consensus on our FY11 estimates; however, we are c9% ahead of consensus on FY12e EPS and c7% ahead on FY13e EPS. Our higher than consensus estimates are largely driven by our more bullish view on sales growth as we remain broadly in line with consensus on our EBITDA margin estimates. We highlight our forecasts and consensus estimates in the table on the following page.
Order book
We dont expect any change in the order execution rate compared with historical average of c33-34% and hence we forecast sales growth of c22% in FY12 and c20% in FY13. In terms of margins, we assume that Jyoti will only be able to pass the inflation burden (rather than a mark-up) through pricing and hence we expect EBITDA margins to decline c50bp from c11.4% in FY11 to c10.9% in FY13. Overall, we forecast FY12 and FY13 sales of INR30,285m and INR36,328m, clean EBITDA of INR3,376m and IINR3,958m and clean EPS of INR16.9 and INR20.6, respectively.
Sales & clean EBITDA margin
The stock looks very attractive on valuation

Jyoti Structures is trading at a significant discount to its historical trading multiple. On consensus numbers, the stock is trading at c9.0x 12-month forward PE and c4.7x 12-month forward EV/EBITDA versus historical averages of c12.2x and c6.3x, respectively.
Consensus 12-month forward PE vs history
25 20 15 10 5 0 15% 12% 9% 20000 6% 10000 0 3% 0%

40000 30000
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jy oti Structures Historic av erage
Sales
EBIDTA Margins
152
FY13e
FY06
FY07
FY08
FY09
FY10e
FY11e
FY12e
abc
Consensus 12-month forward EV/EBITDA vs history
Consensus 12-month forward PE vs RoE
12 10 8 6 4 2 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jy oti Structures Historic av erage
25 20 15 10 5 0
40% 35% 30% 25% 20% 15% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jy oti Structures 12m fw d RoE
FY11-12 earnings forecasts

Jyoti Structure s - M ar YE (INR m ) Order Backlog Ne t Sale s Clean EBITDA Re porte d EBITDA Clean EBIT Re porte d EBIT Other Income Net Financials Profit be fore tax Income tax Extraordinary items Minorities Clean Net Income Re porte d Ne t Incom e Clean EPS Re porte d EPS DPS FY10 41,500 21,298 2,189 2,326 2,011 2,147 0 (771) 1,376 (533) 0 0 759 843 9.3 10.3 1.0 Ne w Fore cas ts FY11e FY12e 49,100 25,016 2,844 2,844 2,649 2,649 0 (868) 1,781 (677) 0 0 1,104 1,104 13.5 13.5 1.1 62,870 30,285 3,376 3,376 3,169 3,169 0 (933) 2,236 (850) 0 0 1,386 1,386 16.9 16.9 1.2 FY13e 75,618 36,328 3,958 3,958 3,745 3,745 0 (1,017) 2,728 (1,037) 0 0 1,691 1,691 20.6 20.6 1.3 Bloom be rg Cons e ns us FY11e FY12e FY13e 24,441 28,380 34,555
HSBC vs. Consensus FY11e 2.4% FY12e 6.7% FY13e 5.1%
2,704 2,562
3,134 2,963
3,767 3,288
5.2% 3.4%
7.7% 6.9%
5.1% 13.9%
1,657
1,992
2,469
7.5%
12.3%
10.5%
1,069
1,261
1,578
3.4%
9.9%
7.2%
13.1 1.1
15.5 1.1
19.3 1.4
3.0% 4.4%
9.0% 5.3%
7.1% -4.1%
M argins & Tre nd Sales visibility (yrs) Sale s grow th Clean EBITDA mgn Re porte d EBITDA m gn Clean EBIT mgn Re porte d EBIT m gn PBT mgn Clean NI mgn Re porte d NI m gn
FY10 1.9 16% 10.3% 10.9% 9.4% 10.1% 6.5% 3.6% 4.0%
Ne w Fore cas ts FY11e FY12e 2.0 17% 11.4% 11.4% 10.6% 10.6% 7.1% 4.4% 4.4% 2.1 21% 11.1% 11.1% 10.5% 10.5% 7.4% 4.6% 4.6%
FY13e 2.1 20% 10.9% 10.9% 10.3% 10.3% 7.5% 4.7% 4.7%
Bloom be rg Cons e ns us FY11e FY12e FY13e 15% 16% 22%
HSBC vs. Consensus FY11e FY12e FY13e 2.7% 4.9% -1.8%
11.1% 10.5% 6.8% 4.4%
11.0% 10.4% 7.0% 4.4%
10.9% 9.5% 7.1% 4.6%
30 11 34 4
10 2 36 13
(1) 79 36 9
Source: Thomson Reuters Datastream, HSBC estimates
153
abc
We note that some of this discount can be explained by the deterioration in the returns expectations, such as RoE and RoCE. However, as we highlight in the charts below, the de-rating has continued even though the return expectations have stabilized.
Consensus 12-month forward EV/EBITDA vs RoCE
We note that Jyoti is also the cheapest stock in its trade peer group. On FY12e consensus numbers, the stock is trading at c7.4x PE and c4.7x EV/EBITDA versus the EPC peer group average of c11.1x and c8.5x, respectively. Within our coverage universe, Jyoti is also the most inexpensive stock. On our FY12 estimates, Jyoti is trading at c7.0x PE and c4.8x EV/EBITDA compared with our universe average of c17x and c10.6x, respectively. Jyoti also remains at a discount to both Kalpataru and KEC, who on our FY12 estimates are trading at c7.4x and c8.7x PE, respectively. We also note that Jyoti has underperformed the capital goods sector by c17% over the last six months, driven largely by the muted order intake and the dilution overhang. Therefore, we believe that most of the bad news is already baked into the share price and the stock should start outperforming going into FY12.
Absolute vs relative performance Jyoti
12 10 8 6 4 2 0
50% 40% 30% 20% 10% 0% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jy oti Structures 12m fw d RoCE
The discrepancy in the valuation becomes evident when we look at the 12-month forward EV-tosales multiple. On consensus estimates the stock is trading at c0.5x EV to sales versus a 12-month forward EBITDA margin estimate of c11.2%. As we highlighted in our valuation chapter, empirical evidence suggests that, on EV to sales, stocks typically trade at c10-12x EBIT margins. This means either that consensus expects margins to go down to the mid-single digits or that the stock is genuinely undervalued.
Cons 12-month forward EV to sales vs EBITDA margin
10.0% 0.0% -10.0% -20.0% -30.0% -40.0% 1 w eek 1 mth 3 mths 6 mths 12 mths Relativ e performance
1.5 1.0 0.5 0.0 Jan05 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11
14.0% 13.0% 12.0% 11.0% 10.0% 9.0% 8.0%
Absolute performance
Jy oti Structures
12m fw d EBITDA mgn
154
abc
Jyoti Structures: benchmarking score on 16 metrics
Median = 5.0 Free cash flow Added v alue Capital Ex pentiture Return on capital Organic sales grow th Market position Customer div ersity Geographic div ersity Cy clical resilience Financial lev erage Net debt/EBITDA Interest cov er FCF y ield Free float (%) Div idend y ield Trading v olume (3m (1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
Jyoti scores well on our Q-ben Framework

Within our coverage universe of seven companies, Jyoti has a Q-ben score of 4.6. Compared to its trade peers, Jyoti has come out better than Kalpataru (4.3) and worse than KEC (5.2). We highlight the performance of the company on each of the criteria and each of the metrics in the bar charts. We note that Jyoti has scored lowest on its ability to balance risk, driven largely by its concentrated
end market and geographic exposure. The company has scored highest on the market performance criterion, driven largely by its good market position and strong growth potential (5-yr average from FY09-13e). As we highlight in the scatter charts, Jyoti lies close to the vertical median line but farthest from the horizontal line, implying that the stock remains significantly undervalued relative to its quality. It also implies that the stock has significant potential to re-rate and an improvement in its operational performance can act as a catalyst for re-rating.
Jyoti Structures: benchmarking score on 5 criteria
Median = 5.0 Internal Performance Market Performance
Balancing risk
Financial Strength Equity Structure
(1.0)
Source: Company, HSBC Estimates
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
155
abc

ABB Areva T&D
We believe that the metrics/areas where Jyoti can register improvement going forward are:
Cash generation Return on capital employed Geographic diversity Interest cover

25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
ABB
12m fwd EV/EBITDA
Areva T&D
KEC
156
abc
Valuation summary Key assumptions

Target sales growth Target OR margin Target asset turn Tax rate WACC CAP 9.0% 10.0% 2.0 36% 14.5% 10.0
We also highlight the sensitivity of our target price to our assumptions in the tables below.
Target price sensitivity
12m PT 164 6% 7% 8% 9% 10% 11% 12% 12m PT 164 12% 13% 14% 15% 16% 17% 18% WACC 12m PT 164 12% 13% 14% 15% 16% 17% 18% WACC Sales Growth 7% 59 61 64 67 70 72 75 Operating Re turn (OR) 8% 9% 10% 86 113 141 90 119 148 95 125 156 99 131 164 103 137 171 108 143 179 112 149 186 Operating Re turn (OR) 8% 9% 10% 162 202 242 138 175 212 117 151 186 99 131 164 84 114 144 70 99 127 58 85 112 Sales 8% 230 202 177 156 138 122 107 Grow th 9% 242 212 186 164 144 127 112 M argins 11% 168 177 187 196 205 214 224 M argins 11% 282 249 220 196 175 156 139 12% 196 206 217 228 239 250 261 13% 223 235 248 260 273 285 298
Value of current op
Trend sales Trend CE CE growth RoIC Trend OR Value of current op 30,285 14,270 4.5% 20.0% 2,854 12,594
Value of future inv

Incremental return Incremental cost EVA Value of future inv 273 93 81 4,896
7% 122 101 82 67 53 41 31
12% 322 286 255 228 205 185 166
13% 362 323 289 260 235 213 194
12-month forward implied market cap EV EV 12-month forward Net debt Customer advances Bankers acceptances Minorities Investments/associates Implied market cap Target price 12-month forward TP Published TP
17,490 20,027 1,361 2,321 3,094 0 (167) 13,417
6% 206 181 160 141 125 110 98
7% 218 191 168 148 131 116 103
10% 254 222 195 171 151 133 117
11% 266 232 204 179 157 139 122
12% 278 242 212 186 164 144 127
164
165
Under HSBCs research model, a non-volatile Indian stock with a potential return of 6-16% merits a Neutral rating. Our target price of INR165 implies a potential return of 41%; we therefore rate the shares Overweight. Our earlier target price (under the previous covering analyst) was also based on MACC valuation methodology.
Overweight and a TP of INR165

We are OW on Jyoti Structures, with a target price of INR165, implying a c41% potential return. We value Jyoti based on our preferred Economic Value Added (EVA) valuation methodology. Our valuation model assumes a WACC of c14.5%, sales growth of c9.0%, through cycle margin of c10% and a competitive advantage period (CAP) of 10 years. Our price target implies a 12-month forward target multiple of c8.4x PE and c5.3x EV/EBITDA compared with current 12-month forward multiple (on our estimates) of c7.4x PE and c5.0x EV/EBITDA.
Key risks
We highlight the key risks to our investment case on Jyoti:
Metal price inflation Rising competition in the transmission EPC segment Deterioration in returns after the potential equity dilution
157
abc
Company profile
Jyoti Structures is Indias leading power transmission line EPC player. The companys business lines of operation include areas of transmission lines, sub stations and distribution networks. It also undertakes turnkey projects on a global scale, offering a complete range of services n design, engineering, tower testing, manufacturing, construction and project management.
electrify c1.5m villages, of which the company has completed the electrification of c0.9m villages. The distribution projects include village electrification, household electrification, feeder renovation, constructing distribution transformation substation and laying cables and conductors. This segment contributes c25% to the total revenue.
Jyoti Structures Africa

Jyoti Structures formed a joint venture in South Africa to explore EPC opportunities in power transmission in the African region. Jyoti has a stake of c70%. The company has successfully completed projects awarded by Eskom and Nam Power.
Order pipeline: Although the company does not have any orders at the moment, they expect new orders in future from other African regions. The management has indicated in its 2Q FY11 results conference call that it has bid for INR7-8bn orders in the African region.
Jyoti Structures India

Jyoti Structures India is a leader in Turnkey/EPC projects in the field of power transmission with a focus on transmission lines, substations and distribution projects.
Transmission
Jyoti Structures offers complete solutions for power transmission line projects. This includes geological and topographical surveys of the tower erection area, tower design, and tower testing, manufacturing and onsite construction. The annual tower manufacturing capacity of Jyoti is c110,000 tonnes in India while the Dubai facility has the capacity of c50,000 tonnes. The company has completed construction of c24,568 circuit kms transmission line and also designed and tested towers up to a capacity of 800 kV HVAC or 500 kV HVDC for various utilities. Transmission is the primary business segment and contributes c65% to the revenue of the company.
Substations
Gulf Jyoti International LLC

Jyoti Structures has also formed another joint venture in Dubai Gulf Jyoti International LLC with a stake of c30% and the remaining 70% is held by Gulf Investment Corporation (GIC). The company is entitled to get c15% of the profits of the joint venture as management fees.
Order pipeline: The order book of Gulf Jyoti had remained muted while the entity was loss making. However the JV won new orders in FY11 and the current order book is cINR11.5bn.
Jyoti Structures is also involved in design (electrical, civil and structural), sourcing and supply, construction and project management of EHV substations and switchyards. This segment contributes c10% to the revenue.
Distribution
Gulf Jyoti was a loss making entity until FY10, however the management expects it to break even in FY11.
JYS also executes rural electrification projects. Over the last three years, Jyoti has received orders to
158
abc
Company structure Jyoti Structures
Jyoti Structures
JSL Strctures (Holding 98.57%in 2009)
JSLCorporate Services Lim ited (100% )
Jyoti Energy Lim ited (100% )
Jyoti Structures A frica (70% )
Order book of INR42bn

Jyoti Structures has an outstanding order book of INR42.5bn, of which c81% are from the domestic transmission market and 19% from international geographies (at the close of Sept 2010) The order book contains c76% transmission orders, c9% orders for substations and 14% for rural electrification.
Gulf Jyoti the JV in Middle East has an outstanding order book of INR11.5bn.
Exploring new geographies

Jyoti Structures had recently announced that the board has approved an investment of USD12m (INR550m) for setting up a lattice tower manufacturing company in the US. The management has indicated that this would be funded through internal cash flows. As a result the revenue from international market currently only c10% of the total revenue is likely to go up in coming years. Further, the company expects that the revenue would double over the next two years.
Focus on domestic market

Unlike peer companies (KEC and Kalpataru), Jyoti Structures operations are primarily focused on the domestic market with c80% of revenue booked from orders executed in India. The key clients in the domestic market include Power Grid Corporation and State Electricity Boards. The key point is that the domestic orders are variable price contracts with price escalation clauses where any hike in raw material prices (primarily steel and zinc) is passed on to the end consumers.
159
abc
Company profile in charts

Sales, Order book, EBITDA margin Business segments
80000 60000 40000 20000 0
15% 12% 9% 6% 3% 0%
FY10e
FY11e
FY12e
FY13e
FY06
FY07
FY08
FY09
T&D 100%
Sales
Order Book
EBIDTA Margins
Geographic exposure
End-market exposure
India 90%
Transmissi
Transmissi on - Intl 8%
- on
Domestic 67%
Pow er Distribution
RoW 10%
Source: Company, HSBC Source: Company, HSBC
25%
EPS vs DPS
FCF to sales vs capex to sales
25 20 15 10 5 0
1.5 1.0 0.5 -
FY10e
FY12e
FY06
FY08
FY07
FY09
FY11e
FY13e
6% 4% 2% 0% -2% -4% -6% -8% -10%
EPS
DPS
FCF/Sales
Capex /Sales
160
FY13e
FY07
FY08
FY06
FY09
FY10e
FY11e
FY12e
abc
Financials & valuation: Jyoti Structures Ltd

Financial statements Year to 03/2010a 03/2011e 03/2012e 03/2013e Valuation data Year to
EV to sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%)
*Based on HSBC EPS (diluted)
Overweight
03/2010a
0.8 7.6 1.6 15.4 2.4 3.6 0.7
03/2011e
0.6 5.4 1.3 8.8 1.6 0.3 0.9
03/2012e
0.5 4.8 1.1 7.0 1.3 1.2 1.0
03/2013e
0.5 4.4 1.0 5.7 1.1 2.6 1.1
Profit & loss summary (INRm)

Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit 21,298 2,189 -178 2,011 -771 1,376 1,239 -533 843 759 25,016 2,844 -195 2,649 -868 1,781 1,781 -677 1,104 1,104 30,285 3,376 -207 3,169 -933 2,236 2,236 -850 1,386 1,386 36,328 3,958 -213 3,745 -1,017 2,728 2,728 -1,037 1,691 1,691
Issuer information
Share price (INR) 118.00 Target price (INR) JYTS.BO 213 69 India Rahul Garg 165.00 Potentl return (%) 41
Cash flow summary (INRm)

Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 957 -559 -534 -86 -151 423 381 -350 -350 -96 65 31 402 -290 -290 -106 -6 112 539 -290 -290 -115 -134 249
Reuters (Equity) Market cap (USDm) Free float (%) Country Analyst
Bloomberg (Equity) JYS IN Market cap (INRm) 9,687 Enterprise value (INRm) 10,888 Sector Electrical Equipment Contact +91 22 22681245
Balance sheet summary (INRm)

Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders funds Invested capital 21 1,756 13,487 2,387 15,432 6,371 3,690 1,303 4,911 10,389 27 1,906 15,329 2,322 17,429 7,360 3,690 1,368 5,920 12,052 22 1,994 18,079 2,328 20,262 8,912 3,690 1,361 7,201 14,270 20 2,073 21,358 2,462 23,617 10,691 3,690 1,227 8,777 16,793
Price relative
205 185 165 145 125 105 85 65 45 25 2009
Jyoti Structures Ltd
205 185 165 145 125 105 85 65 45 25 2010 2011 2012

Rel to BOMBAY SE SENSITIVE INDEX
Ratio, growth and per share analysis Year to Y-o-y % change

Revenue EBITDA Operating profit PBT HSBC EPS 15.8 -4.3 -8.1 2.3 -20.6 17.5 29.9 31.7 29.5 45.5 21.1 18.7 19.6 25.5 25.5 20.0 17.2 18.2 22.0 22.0
Source: HSBC
03/2010a
03/2011e
03/2012e
03/2013e
Note: Priced at close of 19 January 2011
Ratios (%)
Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt 2.0 12.4 15.5 9.4 10.3 9.4 2.8 26.5 0.6 73.5 2.1 14.1 18.7 6.7 11.4 10.6 3.3 23.1 0.5 27.8 2.1 14.3 19.2 7.4 11.1 10.5 3.6 18.9 0.4 29.5 2.2 14.3 19.3 7.7 10.9 10.3 3.9 14.0 0.3 43.9
Per share data (INR)

EPS rep (diluted) HSBC EPS (diluted) DPS Book value 10.28 9.26 1.00 59.89 13.47 13.47 1.10 72.19 16.90 16.90 1.20 87.81 20.63 20.63 1.30 107.03
161
abc
Jyoti Structures Income statement (INRm)

Net sales Cost of goods sold (COGS) Gross income Employee expense Selling, general & admin exp (SG&A) Other operating income EBITDA Exceptionals Clean EBITDA Depreciation & amortization EBIT Clean EBIT Other income O/w exceptional O/w dividend/inv income Interest income Interest expense Other financial exp/inc Profit before tax (PBT) Clean PBT Income tax Income from JVs (post-tax) Profit after tax (PAT) Extraordinary items Minorities Reported net income HSBC net income No. of shares outstanding Reported EPS HSBC EPS (recurring)
FY06
6,993 (5,367) 1,626 (193) (699) 21 755 (16) 771 (56) 699 715 0 0 0 0 (259) 0 440 456 (182) 0 259 0 (0) 259 268 69.1 3.7 3.9
FY07
9,724 (7,327) 2,397 (277) (857) 8 1,271 (11) 1,283 (59) 1,212 1,223 0 0 0 0 (329) 0 883 894 (328) 0 555 0 0 555 562 80.7 6.9 7.0
FY08
13,738 (10,631) 3,107 (358) (991) 15 1,772 (16) 1,789 (72) 1,700 1,717 0 0 0 1 (467) 0 1,234 1,250 (489) 0 745 0 0 745 755 81.2 9.2 9.3
FY09
18,394 (14,241) 4,152 (461) (1,616) 52 2,127 (161) 2,288 (99) 2,027 2,188 0 0 0 5 (688) 0 1,345 1,505 (493) 0 851 0 0 851 953 81.7 10.4 11.7
FY10
21,298 (16,286) 5,012 (719) (2,006) 39 2,326 137 2,189 (178) 2,147 2,011 0 0 0 24 (796) 0 1,376 1,239 (533) 0 843 0 0 843 759 82.0 10.3 9.3
FY11e
25,016 (19,364) 5,651 (763) (2,044) 0 2,844 0 2,844 (195) 2,649 2,649 0 0 0 12 (879) 0 1,781 1,781 (677) 0 1,104 0 0 1,104 1,104 82.0 13.5 13.5
FY12e
30,285 (23,469) 6,816 (810) (2,630) 0 3,376 0 3,376 (207) 3,169 3,169 0 0 0 12 (945) 0 2,236 2,236 (850) 0 1,386 0 0 1,386 1,386 82.0 16.9 16.9
FY13e
36,328 (28,364) 7,964 (851) (3,155) 0 3,958 0 3,958 (213) 3,745 3,745 0 0 0 12 (1,028) 0 2,728 2,728 (1,037) 0 1,691 0 0 1,691 1,691 82.0 20.6 20.6
Jyoti Structures Margin & Trend analysis

Sales growth Organic growth Clean EBITDA growth Clean EBIT growth Reported EPS growth HSBC EPS growth Gross margins Clean EBITDA margins Clean EBIT margins OR margins PBT margins PAT margins Change in no. of employees Wage inflation Rate on interest income Rate on interest expense P&L tax rate Dividend tax rate Excise duty Dividend payout ratio
FY06
na na na na na na 23.2% 11.0% 10.2% 10.8% 6.3% 3.7% na na na na 41.2% 14.0% 5.5% 11.9%
FY07
39.0% 38.7% 66.4% 73.3% 83.8% 79.7% 24.6% 13.2% 12.6% 12.8% 9.1% 5.7% 0.0% 0.0% 0.0% 20.5% 37.1% 17.0% 5.3% 8.7%
FY08
41.3% 36.7% 39.5% 40.3% 33.5% 33.5% 22.6% 13.0% 12.5% 12.7% 9.0% 5.4% 0.0% 0.0% 0.1% 24.2% 39.6% 17.0% 2.1% 8.7%
FY09
33.9% 32.6% 27.9% 19.2% 13.5% 25.5% 22.6% 12.4% 11.9% 12.2% 7.3% 4.6% 0.0% 0.0% 0.3% 19.1% 36.7% 17.0% 1.2% 8.6%
FY10
15.8% 17.1% -4.3% 5.9% -1.4%
FY11e
17.5% 17.2% 29.9% 23.4% 31.0% 45.5% 22.6% 11.4% 10.6% 11.0% 7.1% 4.4% 3.0% 3.0% 0.5% 14.5% 38.0% 17.0% 2.1% 8.2%
FY12e
21.1% 21.1% 18.7% 19.6% 25.5% 25.5% 22.5% 11.1% 10.5% 10.8% 7.4% 4.6% 3.0% 3.0% 0.5% 14.5% 38.0% 17.0% 2.1% 7.1%
FY13e
20.0% 20.0% 17.2% 18.2% 22.0% 22.0% 21.9% 10.9% 10.3% 10.7% 7.5% 4.7% 2.0% 3.0% 0.5% 14.5% 38.0% 17.0% 2.1% 6.3%
23.5% 10.3% 9.4% 9.8% 6.5% 4.0% na! na! 1.0% 14.7% 38.7% 16.6% 2.3% 9.7%
162
abc
Jyoti Structures Balance sheet (INRm)

Share capital Reserves & surplus Shareholders equity Minorities Total equity Secured loans Unsecured loans Total debt Loan & Advances Cash & Equivalents Net (debt)/cash Tangible assets Intangible assets Capital work in progress (CWIP) Deferred tax assets Investments Other assets Total fixed assets Inventories Sundry debtors Sundry creditors Customer advances Acceptances Other receivables Other payables Total working capital Provisions Deferred tax liability Other long-term liabilities
FY06
153 1,006 1,159 0 1,159 (1,203) (406) (1,609) 474 39 (1,096) 554 0 17 0 102 5 678 1,219 2,490 (1,714) (741) 0 633 (116) 1,772 (142) (54) 0
FY07
161 2,544 2,705 0 2,705 (1,515) (93) (1,608) 1,043 93 (471) 594 0 11 0 121 24 750 818 3,639 (1,976) (521) 0 905 (188) 2,678 (197) (55) 0
FY08
162 3,217 3,380 0 3,380 (1,827) (422) (2,249) 1,095 140 (1,014) 684 0 15 0 96 18 813 793 4,998 (2,290) (430) 0 1,184 (175) 4,081 (432) (68) 0
FY09
164 4,024 4,188 0 4,189 (3,073) (52) (3,125) 2,274 391 (460) 1,339 11 44 0 167 20 1,581 1,534 7,124 (2,184) (1,002) (1,833) 0 (190) 3,448 (290) (91) 0
FY10
164 4,747 4,911 0 4,911 (3,644) (46) (3,690) 1,845 542 (1,303) 1,729 21 17 0 167 10 1,944 2,472 8,629 (2,206) (1,688) (2,195) 0 (283) 4,729 (282) (178) 0
FY11e
164 5,756 5,920 0 5,920 (3,644) (46) (3,690) 1,845 477 (1,368) 1,879 27 17 0 167 10 2,099 2,888 10,120 (2,555) (1,917) (2,555) 0 (332) 5,648 (282) (178) 0
FY12e
164 7,037 7,201 0 7,201 (3,644) (46) (3,690) 1,845 484 (1,361) 1,966 22 17 0 167 10 2,182 3,497 12,254 (3,094) (2,321) (3,094) 0 (402) 6,839 (282) (178) 0
FY13e
164 8,613 8,777 0 8,777 (3,644) (46) (3,690) 1,845 618 (1,227) 2,046 20 17 0 167 10 2,259 4,195 14,700 (3,712) (2,784) (3,712) 0 (483) 8,204 (282) (178) 0
Net assets
1,159
2,705
3,380
4,189
4,911
5,920
7,201
8,777
Jyoti Structures Key balance sheet ratios

Gearing Gearing incl acceptances Leverage Leverage incl acceptances Interest cover (on EBIT) Net debt to EBITDA Fixed asset turns Asset (CE) turn Asset (CE) turn excl cust adv Total working capital days Inventories Sundry debtors Sundry creditors Other receivables Other payables Working capital as % sales
FY06
94.6% 94.6% 1.95 1.95 2.70 1.42 12.23 2.26 2.98 na na na na na na na
FY07
17.4% 17.4% 1.17 1.17 3.68 0.37 16.06 2.54 2.94 124 47 159 (114) 40 (8) 32.0%
FY08
30.0% 30.0% 1.30 1.30 3.64 0.57 19.64 2.63 2.86 126 32 156 (93) 37 (5) 34.8%
FY09
11.0% 54.7% 1.11 1.55 2.97 0.20 13.19 2.39 2.75 138 45 162 (64) 0 (4) 21.5%
FY10
26.5% 71.2% 1.27 1.71 2.78 0.60 12.05 2.05 2.45 160 59 159 (53) 0 (5) 23.8%
FY11e
23.1% 66.3% 1.23 1.66 3.05 0.48 13.01 2.08 2.47 161 59 160 (52) 0 (5) 24.4%
FY12e
18.9% 61.9% 1.19 1.62 3.40 0.40 15.10 2.12 2.53 163 60 162 (53) 0 (5) 24.7%
FY13e
14.0% 56.3% 1.14 1.56 3.68 0.31 17.44 2.16 2.59 163 59 161 (52) 0 (5) 24.6%
163
abc
Jyoti Structures Cash Flow Statement (INRm) EBITDA Adjusted for: Unrealized fx (gains)/losses Loss on sale of fixed assets Other non-cash exceptionals Change in working capital Tax paid Net financials Others Cash flow from operations
Capital expenditure Disposals Change in other assets Free cash flow (FCF) Dividends FCF post-dividend Acquisition subs/assoc/investments Change in debt Share buyback/issue Others Net cash flow
FY06 755
0 0 1 (674) (181) (259) 4 (355) (175) 33 (2) (499) (31) (529) (78) 435 15 23 (135)
FY07 1,271
0 2 6 (1,399) (335) (329) 71 (713) (115) 13 (0) (815) (48) (864) (71) 12 1,019 (43) 54
FY08 1,772
0 0 7 (1,182) (487) (467) (0) (357) (163) 1 (20) (540) (65) (605) 2 666 8 (25) 47
FY09 2,127
0 0 5 (1,006) (653) (683) 35 (174) (768) 2 (20) (961) (76) (1,036) 402 890 9 (14) 251
FY10 2,326
(53) (7) 0 (81) (490) (771) 34 957 (579) 20 25 423 (86) 337 (756) 570 5 (6) 151
FY11e 2,844
0 0 0 (919) (677) (868) 0 381 (370) 20 0 31 (96) (65) 0 0 0 0 (65)
FY12e 3,376
0 0 0 (1,191) (850) (933) 0 402 (310) 20 0 112 (106) 6 0 0 0 0 6
FY13e 3,958
0 0 0 (1,365) (1,037) (1,017) 0 539 (310) 20 0 249 (115) 134 0 0 0 0 134
Jyoti Structures Key cash ratios

Cash tax rate Change in WC as % sales Capex to depreciation Capex as % sales Operating cash conversion FCF yield FCF yield post-dividend
FY06
41.2% -9.6% 3.1 2.5% -50.7% -12.5% -13.3%
FY08
37.9% -14.4% 1.9 1.2% -58.9% -8.5% -9.0%
FY08
27.5% -8.6% 2.3 1.2% -21.0% -3.0% -3.4%
FY09
30.7% -5.5% 7.7 4.2% -8.6% -12.3% -13.3%
FY10
21.1% -0.4% 3.2 2.7% 44.6% 3.6% 2.9%
FY11e
23.8% -3.7% 1.9 1.5% 14.4% 0.3% -0.6%
FY12e
25.2% -3.9% 1.5 1.0% 12.7% 1.0% 0.1%
FY13e
26.2% -3.8% 1.5 0.9% 14.4% 2.2% 1.2%
164
abc
Jyoti Structures Valuation

Avg price Market cap Net debt Customer advances Bankers acceptances Minorities Investments/associates Enterprise value (EV) EV to sales EV/CE EV/EBITDA EV/EBIT EV/OR P/E PB Dividend yield FCF yield FCF yield post-dividend RoCE RoCE excl cust adv RoE
FY06
58 3,991 1,096 741 0 0 (102) 5,726 82% 185% 7.4 8.0 7.6 14.9 3.4 0.8% -12.5% -13.3% 14.3% 17.9% 23.1%
FY07
118 9,546 471 521 0 0 (121) 10,416 107% 272% 8.1 8.5 8.3 17.0 3.5 0.5% -8.5% -9.0% 20.5% 23.3% 20.8%
FY08
221 17,942 1,014 430 0 0 (96) 19,290 140% 369% 10.8 11.2 11.1 23.8 5.3 0.4% -3.0% -3.4% 20.1% 21.6% 22.3%
FY09
96 7,804 460 1,002 1,833 0 (167) 10,933 59% 142% 4.8 5.0 4.9 8.2 1.9 0.9% -12.3% -13.3% 18.4% 20.7% 22.8%
FY10
142 11,663 1,303 1,688 2,195 0 (167) 16,682 78% 161% 7.6 8.3 8.0 15.4 2.4 0.7% 3.6% 2.9% 12.4% 14.2% 15.5%
FY11e
118 9,664 1,368 1,917 2,555 0 (167) 15,337 61% 127% 5.4 5.8 5.6 8.8 1.6 0.9% 0.3% -0.7% 14.1% 16.2% 18.7%
FY12e
118 9,664 1,361 2,321 3,094 0 (167) 16,274 54% 114% 4.8 5.1 5.0 7.0 1.3 1.0% 1.2% 0.1% 14.3% 16.4% 19.2%
FY13e
118 9,664 1,227 2,784 3,712 0 (167) 17,221 47% 103% 4.4 4.6 4.4 5.7 1.1 1.1% 2.6% 1.4% 14.3% 16.6% 19.3%
Jyoti Structures Profitability RoCE

Clean EBIT Add back: Return on cust adv Less: Associate/div income Assumptions: Return on cust adv Tax rate Operating return (OR) Post-tax OR Equity Net deferred tax liability Provisions Debt Customer advances Banks acceptances Less: Cash & eqv Loans & advances Investment/associates Capital employed Pre-tax RoCE RoCE RoCE ex-cust adv
FY06
715 37 0 5.0% 41.2% 752 442 1,159 54 142 1,609 741 0 39 474 102 3,090 24.3% 14.3% 17.9%
FY07
1,223 26 0 5.0% 37.1% 1,249 785 2,705 55 197 1,608 521 0 93 1,043 121 3,828 32.6% 20.5% 23.3%
FY08
1,717 21 0 5.0% 39.6% 1,738 1,050 3,380 68 432 2,249 430 0 140 1,095 96 5,227 33.3% 20.1% 21.6%
FY09
2,188 50 0 5.0% 36.7% 2,238 1,417 4,189 91 290 3,125 1,002 1,833 391 2,274 167 7,698 29.1% 18.4% 20.7%
FY10
2,011 84 0 5.0% 38.7% 2,095 1,284 4,911 178 282 3,690 1,688 2,195 542 1,845 167 10,389 20.2% 12.4% 14.2%
FY11e
2,649 96 0 5.0% 38.0% 2,745 1,702 5,920 178 282 3,690 1,917 2,555 477 1,845 167 12,052 22.8% 14.1% 16.2%
FY12e
3,169 116 0 5.0% 38.0% 3,285 2,036 7,201 178 282 3,690 2,321 3,094 484 1,845 167 14,270 23.0% 14.3% 16.4%
FY13e
3,745 139 0 5.0% 38.0% 3,884 2,408 8,777 178 282 3,690 2,784 3,712 618 1,845 167 16,793 23.1% 14.3% 16.6%
165
abc
Kalpataru Strong growth at attractive price

Kalpataru has not only maintained its leadership in T&D markets
but also built a strong position in other infra EPC works

We expect strong earnings momentum (c28% FY11-13e CAGR)
driven by order book (c2.3x FY10 group sales) and improving margins at JMC
Stock remains attractive (c30% d/c vs peers on 12-month forward
PE) after underperformance (c15%) over last 6 months; we are 12% ahead of consensus on FY12e; OW, TP INR225
A success story in the making

Kalpataru, in our opinion, is going through an important transition phase with the company not only expanding the scope of its business but also improving its operational efficiency. The group has now built a strong position in several EPC markets, such as T&D, roads and pipelines. The group has also shown improvement in its EBITDA margins over the last six quarters. In spite of this, the stock has significantly underperformed the wider capital goods sector by c30% over the last six months, driven largely, in our opinion, by the loss of Power Grid orders and the poor order execution at JMC. However, we note that Kalpataru remains a clear market leader in the transmission EPC segment and is bound to benefit from strong growth in transmission orders during FY12 and FY13 (March year-end). The company is also seeing
strong growth in construction related orders at JMC this year. The group margins are also expected to increase, driven largely by the improving performance of JMC. On top of this, the company has also successfully secured a couple of BOT projects which should provide further visibility to the top-line. In light of all this positive momentum, the sharp underperformance of the stock seems unwarranted at this stage. We highlight the key bull and bear points related to Kalpataru below:
Bull points
The biggest domestic transmission EPC player, with a strong presence in international markets and order book visibility of c1.8 years Improving market share with Power Grid The rising order backlog at JMC now offers visibility of up to 3.5 years
166
abc
Improving profitability at JMC should continue to benefit group margins The groups success in new areas, such as pipeline EPC and BOT projects, provides new frontiers for future growth Strong balance sheet provides enough fire power to fund growth The stock looks attractive after recent underperformance
Bear points
JMC order book drives visibility

While the order book at JMC has grown rapidly over the last few quarters, driven by several large orders, the order book of the parent company has struggled to make any significant leap forward.
JMC order book drives visibility (INRm)
100,000 80,000 60,000 40,000 20,000 -
Dec-09
Sep-09
Jun-10
Highly geared to steel prices and hence margins remain at risk, particularly in international contracts
KPP Parent
JMC
KPP consol
Given that we expect strong order flow for the parent company in the transmission markets and JMC has already built a strong order book, we remain positive about the groups earnings outlook going into FY12 and FY13. Consequently, we remain c12% and c20% ahead of consensus on our FY12e and FY13 EPS estimates. We see limited risk to Kalpatarus earnings at this stage and believe that there remains further upside to our estimates, particularly as the earnings stream from BOT projects picks up and JMC delivers operational improvement. Therefore, we find Kalpatarus current valuation, at c7.4x FY12e PE and c5.4x FY12e EV/EBITDA, attractive compared with trade peer average of c11.1x and c8.5x, respectively.
However, we note that the parent company not only holds the biggest transmission order book in the domestic market but also one with strong visibility of c1.9 years. Moreover, the group should now find sizeable support from the JMC order book which is now c80% of the size of the parent order book. More importantly, JMCs order book now provides significant visibility of c3.5 years ahead, thus driving groups earnings visibility to c2.5 years.
Power Grid orders lumpy but large

One of the major concerns with the Big 3 (Kalpataru, KEC and Jyoti) has been their deteriorating share of Power Grid orders due to the plethora of new players entering this market. However, as we have mentioned in our investment thesis on Jyoti, we believe that the intensity of the competition for Power Grid orders should eventually come down as the new players seem to be bidding at unsustainable margins. We note that the average margins of the competitors have gone down much more drastically that those of Kalpataru.
Strong sales visibility of c2.5 years

A large proportion of Kalpatarus order book is driven by two main segments transmission orders at the parent company and infrastructure orders at JMC.
Sep-10
Jun-09
Mar-10
Weakest company in our sector on fundamentals
167
abc
KPP EBITDA margin vs Competition
15.0% 10.0% 5.0%
in FY12 and FY13 (please see our End-market analysis section).

Domestic transmission exposure
80% 60% 0.0%
Dec-09
Jun-09
Sep-10
Sep-09
Mar-10
Jun-10
40% 20%
KPP
Competition 0% Jy oti Structures Kalpataru Pow er KEC International
And although Kalpataru didnt win any orders from Power Grid for most of the last year, the company did announce three big orders worth INR6bn in total on 10 Dec 2010, two of which were from Power Grid. We believe that Power Grid orders are worth cINR2.2bn, making Kalpataru one of the three biggest contractors with Power Grid again in this financial year.
PGCIL tower orders share y-t-d FY11
Strong presence in international markets as well

As we have discussed in detail in our End market chapter, we expect the power markets in the emerging economies of Africa and Middle East to witness significant investment in transmission projects over the next 5-10 years. We note that Kalpataru has a strong presence in these markets with a market share of c10-12%. The company has an international transmission order backlog of cINR16bn, of which c90% is attributable to these two regions. Therefore, we believe that the company remains in a strong position to benefit from transmission opportunities in both Africa and Middle East.
40% 30% 20% 10% 0% SPIC JVs Kalpataru Pow er KEC Intl
PGCIL Tow er orders share

Source: Power Grid
Key beneficiary of domestic transmission growth

In spite of its diversification in other business areas and geographies, Kalpataru remains the biggest transmission EPC player in India with c18-20% market share. Therefore, we believe that Kalpataru should be a key beneficiary of the strong transmission order growth that we expect
168
abc
Kalpataru Power end market exposure
Pow er Distribution 1% Constructio n 33% Railw ay s 1%
fall in FY09. The stabilization in margins is largely driven by an increasing proportion of international orders feeding through into sales. We note that international T&D sales increased from c28% of the parent sales in FY09 to c45% in FY10, thereby increasing T&D EBIT margins by c140bp in FY10.
Geographical segment sales split Segments
T&D Infra Biomass Real Estate Total
Transmissi - on Domestic 36%

Oil & Gas Others 1% 9%
_____ FY09 ______ _____ FY10______ India Intl India Intl

61% 9% 3% 0% 72% 28% 0% 0% 0% 28% 40% 14% 2% 0% 55% 45% 0% 0% 0% 45%
We also note that the group is increasingly focusing on their presence in US as the region is expected to see significant refurbishment activity along with fresh investment in cross-border ultra high voltage transmission lines. This, in our opinion, should provide further growth opportunities for the company.
KPP international order split
Segment EBIT margin Segment EBIT margins

T&D Infra Biomass Real estate Total
FY07
15.8% 7.9% 32.1% -15.2% 15.9%
FY08
12.1% 17.2% 27.6% 40.4% 13.7%
FY09
9.4% 8.9% 32.5% 66.7% 11.1%
FY10
10.8% 7.0% 24.1% 85.7% 11.5%
&US Canada 10% Africa 50% Middle East 40%
Leveraged growth at JMC to drive margins further

We note that JMC has undergone significant investment over the last 4-5 years (c5-7x depreciation); however, the investment phase is now largely behind us and the capex in FY10 has come down to c0.9x depreciation.
EBITDA margins likely to improve

Geographical sales mix supporting transmission margins
While the margin potential in the domestic transmission EPC market has deteriorated over the last couple of years due to pricing pressure in wake of competition, the parent company has seen its margins stabilize in FY10 after a reasonable
169
abc
JMC capex to depreciation
JMC EBITDA margin
8 6 4 2 0 FY06 FY07 FY08 FY09 FY10
12% 10% 8% 6% 4% 2% 0% 5.5% 8.1% 7.7%
9.6% 9.5% 8.7% 8.8% 9.1%
FY06
FY10
FY07
FY08
FY09
FY11e
FY12e
Moreover, the company has seen strong growth in orders and the order backlog has increased more than five fold compared with FY06 order book of cINR8bn.
Growth in JMC order book (INRbn)
Steel prices remain a key risk

Like other EPC players in our coverage, Kalpataru remains highly geared to steel prices. On the positive side, its steel exposure of c11% at the group level is currently the lowest among the Big 3. As we have highlighted in our Competition Analysis chapter, our metals and mining team expects steel prices to go up by c10% in 2011, which in our opinion could prove to be a double whammy for Kalpataru.
As the domestic transmission market is already suffering from pricing pressure, an added steel cost burden may compel the firm to compromise margins when bidding for new orders. For the international market orders where Kalpataru has fixed price contracts, rising steel prices may erode margins in the existing order book.
50 40 30 20 10 Sept-06 Sept-10
In light of both these events, i.e. completion of investment phase and significant increase in order book, we believe JMC should now witness strong operational performance as its order book feeds through into sales. There has been some improvement in margins (c110bp) during FY09 and FY10 due to a reduction in capex and focus on capacity utilization, but we expect to see further improvement in margins as strong growth in sales drives up the companys capacity utilization. We agree with the management that this business is capable of producing an EBITDA margin of c9-10%.
170
FY13e
abc
Steel exposure (as % of sales)
Financial leverage FY10
30% 25% 20% 15% 10% 5% 0% KEC 14%
24%
3.00 2.50 2.00 11% 1.50 1.00 0.50 0.00
Jy oti
Kalpataru
Jy oti Structures Kalpataru Pow er KEC International Transmission
Strong balance sheet, weak returns improvement likely

Kalpataru has the biggest balance sheet among the Big 3 EPC players (i.e. KPP, KEC and Jyoti) which in our opinion provides the group with enough ability to venture into new areas, such as BOT projects.
Shareholders equity (INRm)
Returns likely to recover in the medium term

Kalpataru has seen significant deterioration in its returns (RoE and RoCE) over the last four years. The biggest hit came in FY09 when the groups ROE fell from c21% to c13.4% and the RoCE declined from c15.3% to c10.8%. The deterioration was largely driven by two key factors:
Significant decline in clean EBIT margins from c10.9% in FY08 to c8.6% in FY09 Significant decline in asset turns from c1.85x in FY08 to c1.57x in FY09
12,000 10,000 8,000 6,000 4,000 2,000 KPP Jy oti KEC
While margins suffered from a deteriorating market environment, asset turns suffered from increasing capex. However, capex fell in FY10 and margins improved, thus improving returns marginally.
Moreover, in spite of heavy capex over the last 45 years, Kalpataru is the most under-levered company (c1.6x incl bankers acceptances) among our EPC coverage, implying less financial risk vs competitors.
171
abc
ROE and RoCE KPP
Trade working capital as % of sales
30% 25% 20% 15% 10% 5% 0% FY07 FY08 RoE

30% 25% 20% 15% 10% 5% FY09 RoCE

FY10
0% FY07 FY08 FY09 FY10 FY11e FY12e FY13e
We believe capex should normalize from here on as the investment phase at JMC is now largely behind us, so we should see significant improvement in asset turns going forward. Moreover, as we have highlighted earlier, we expect margins to continue to improve over the next couple of years. Therefore, we believe that the groups returns, both ROE and RoCE, should recover from the current level. We forecast the groups ROE to reach c24% and RoCE c18% by FY13e.
Cash generation likely to improve

The group has reported negative free cash flow in three out of last four years. This has been largely driven by significant investment in capacity (capex c4-5x depreciation) during FY06-10. However, we expect capex levels to come down significantly during FY11-13e and this, coupled with improving margins and tight working capital management, should improve cash flows going forward.
FCF pre dividend (INRm)
Working capital showing signs of improvement

After deteriorating significantly in FY09, trade working capital showed some improvement in FY10. The improvement was largely driven by better inventory management. However, we note that the working capital (as % sales) remains high compared with historical levels and has further scope for improvement. We forecast working capital to show marginal improvement during FY11-13e, driven largely by the reduction in inventory levels.
4,000 2,000 (2,000) (4,000) (6,000) FY07 FY08 FY09 FY10 FY11e FY12e FY13e
Interest burden should reduce as margins pick up

Kalpataru has a low interest cover (on EBIT) of c2.6x, implying limited ability to service additional debt. We note that this low interest burden is not driven by excessive leverage or high interest cost, rather its a result of significant deterioration in the groups ROE. However, as we
172
abc
expect see improvement in EBIT margins going forward, the interest cover should automatically improve. We forecast interest cover to reach historical levels of over 6.0x by FY13e.
Interest cover
The order intake at JMC has already shown a growth of c85% y-o-y. We expect the order momentum to continue going into FY12-13 and we forecast orders to grow at c25% in FY12 and c20% in FY13.
JMC order book and order intake (INRm)
7.0 6.0 5.0 4.0 3.0 2.0 1.0 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
80,000 60,000 40,000 20,000 FY09 FY10 Order book FY11e FY12e FY13e
Order intake
Source: Company, HSBC estimates Source: Company, HSBC estimates
We remain c12% ahead of consensus on FY12e earnings

Kalpataru has many businesses but derives a large proportion of its earnings from three key EPC markets domestic transmission, international transmission and construction. We remain bullish on the domestic transmission growth and also expect continuation of orders from the international markets over the next couple of years. Therefore, we forecast order intake growth of c35% at the parent company in FY12 and c11% in FY13.
Order book and order intake Kalpataru parent (INRm)
We expect the execution rate to improve somewhat at the parent company and fall a bit at JMC (as the order book has swelled rapidly). However, compared with the previous two quarters, we expect execution at JMC to pick up in Q3 and Q4 as last years orders feed through to sales. Overall, at the group level, we forecast net sales to grow at c25% in FY12e and c20% in FY13. In terms of margins, we forecast an improvement in group EBITDA margin of c100bp during FY11-13e. Our estimates are largely driven by strong volume growth and improving operational performance at JMC. Overall, we forecast FY12e and FY13e group sales of INR56bn and INR67bn, clean EBITDA of INR6,671m and IINR7,946m and clean EPS of INR21.5 and INR27.2, respectively. We are marginally below consensus on our FY11e EBITDA estimate; however, we remain comfortably above consensus on our FY12 and FY13 estimates. A major disconnect between our FY11e numbers and consensus is on depreciation, where consensus is forecasting a very low number
80,000 60,000 40,000 20,000 FY09 FY10 Order book

FY11e
FY12e
FY13e
Order intake
173
abc
FY11-12e Earnings forecast

Kalpataru Pow e r - M ar YE (INR m ) Order Backlog Ne t Sale s Clean EBITDA Re porte d EBITDA Clean EBIT Re porte d EBIT Other Income Net Financials Profit be fore tax Income tax Extraordinary items Minorities Clean Net Income Re porte d Ne t Incom e Clean EPS Re porte d EPS DPS FY10 76,705 39,963 4,331 4,404 3,586 3,659 222 (1,234) 2,647 (691) 0 (179) 1,715 1,777 12.9 13.4 1.7 Ne w Fore cas ts FY11e FY12e 90,995 44,933 5,134 5,134 4,309 4,309 151 (1,053) 3,407 (908) 0 (176) 2,323 2,323 15.1 15.1 1.7 112,421 56,102 6,671 6,671 5,804 5,804 178 (1,091) 4,891 (1,272) 0 (322) 3,297 3,297 21.5 21.5 1.9 FY13e 132,554 67,151 7,946 7,946 7,079 7,079 205 (1,094) 6,190 (1,567) 0 (447) 4,176 4,176 27.2 27.2 2.0 Bloom be rg Cons e ns us FY11e FY12e FY13e 46,992 56,038 65,992
HSBC vs. Consensus FY11e -4.4% FY12e 0.1% FY13e 1.8%
5,191 (559) 4,632
6,212 5,537
7,334 6,228
-1.1% -7.0%
7.4% 4.8%
8.3% 13.7%
(1,009) 3,623
(1,066) 4,471
(935) 5,293
-6.0%
9.4%
17.0%
2,488
2,952
3,468
-6.6%
11.7%
20.4%
15.8 1.7
19.0 1.9
22.6 2.0
-4.2% 0.0%
12.9% 2.2%
20.4% -2.0%
FY10 1.9 16% 10.8% 11.0% 9.0% 9.2% 6.6% 4.3% 4.4%
FY13e 2.0 20% 11.8% 11.8% 10.5% 10.5% 9.2% 6.2% 6.2%
HSBC vs. Consensus FY11e FY12e FY13e -5.2% 5.6% 1.9%
11.0% 9.9% 7.7% 5.3%
11.1% 9.9% 8.0% 5.3%
11.1% 9.4% 8.0% 5.3%
38 (27) (13) (13)
81 46 74 61
72 110 120 96
of INR559m whereas we estimate depreciation at INR825m (vs INR745m in FY10). The depreciation expense has been higher in the first half of this year compared with the previous year and therefore, we see no reason why the full year depreciation will be significantly lower than the previous year.
We are c12% and c20% ahead of consensus on our FY12e and FY13 EPS estimates, driven largely by our more bullish view on margins. We highlight our forecasts in the table above.
174
abc
The stock has retreated to attractive levels

Kalpataru has sharply underperformed the wider capital goods sector by c15% over the last six months, driven in our opinion by the absence of Power Grid orders and weak order execution at JMC. However, we find these concerns temporary in nature, as the swelling order book at JMC will eventually feed through into sales and the parent company has already announced a couple of major orders from Power Grid. Therefore, we dont see any reason why Kalpataru should continue to underperform the market, particularly when its earnings outlook is improving.
Kalpataru: Absolute and relative performance to BSE cap goods index
EV/EBITDA compared with historical average of c13.0x and c7.3x, respectively.

Kalpataru power PE vs history
30 25 20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Kalpataru Pow er

Historic av erage
Kalpataru EV/EBITDA vs history
20 0.0% -10.0% -20.0% -30.0% -40.0% -50.0% 1 w eek Absolute performance

15 10 5 0 1 mth 3 mths 6 mths 12 mths Kalpataru Pow er Relativ e performance

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Historic av erage
After the recent underperformance, the stock now looks very attractive on valuation, trading at the lowest multiples within our coverage universe after Jyoti. On our FY12 estimates, the stock is trading at c7.4x PE and c5.4x EV/EBITDA compared with our universe average of c17x and c10.6x, respectively. While Kalpataru is trading at a marginal premium to Jyoti, it is trading at a significant discount to KEC of c15% and c20% on FY12e PE and EV/EBITDA. Kalpataru also looks inexpensive compared with its historical trading range. On consensus numbers, Kalpataru is trading at 9.3x 12-month forward PE and c4.7x 12-month forward
We note that some of this de-rating can be explained by the deteriorating returns during FY09 and FY10; however, given that we expect return ratios to improve going forward, the stock should re-rate, in our opinion.
175
abc
Kalpataru PE vs ROE
EV to sales vs EBITDA margin
30 25 20 15 10 5 0
40% 30% 20% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Kalpataru Pow er 12m fw d RoE
2.5 2.0 1.5 1.0 0.5 0.0 Jan05 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11
17.0% 15.0% 13.0% 11.0% 9.0%
Kalpataru Pow er
12m fw d EBITDA mgn
EV/EBITDA vs RoCE
20 15 10 5 0
60% 50% 40% 30% 20% 10% 0% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Kalpataru Pow er 12m fw d RoCE
We further note that the stock has found little strength from the groups rising order backlog as the stock remains inexpensive on EV to backlog, trading at c0.4x versus the historical average of c0.6x.
EV to backlog vs history
1.5 1.0 0.5 0.0 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10
Furthermore, the discrepancy in the valuation becomes evident when we look at the 12-month forward EV-to-sales multiple. On consensus estimates the stock is trading at c0.5x EV to sales versus our 12-month forward EBITDA margin estimate of c11.1%. As we highlighted in our valuation chapter, empirical evidence suggests that on EV to sales, stocks typically trade at c1012x EBIT margins. This means that either consensus expects margins to go down to midsingle digits a misguided expectation in our view or the stock is genuinely undervalued.
Kalpataru Pow er
Historic av erage
176
abc
Kalpataru benchmarking overall score
Median = 5.0 Free cash flow Added v alue Capital Ex pentiture Return on capital Organic sales grow th Market position Customer div ersity Geographic div ersity Cy clical resilience Financial lev erage Net debt/EBITDA Interest cov er FCF y ield Free float (%) Div idend y ield Trading v olume (3m (1.0) 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0
Kalpataru scores poorly on fundamentals

Within our coverage universe, Kalpataru has received the lowest Q-ben score of 4.3 in our quality benchmarking analysis. Among all the criteria, the company has scored lowest on internal performance and highest on market performance. This implies that even though the company remains a market leader and has seen good growth, it has failed to translate that into returns and/or cash generation. Consequently, we
believe that the company needs to focus on its operational performance to make optimal use of its market position. We highlight the performance of the company on each of the criteria and each of the metrics in the bar charts.
High employee cost a key weakness

Of the 16 metrics, Kalpataru has scored lowest on added value, which is defined as the gross profit generated by employee. We note that while
Kalpataru benchmarking
Median = 5.0 Internal Performance Market Performance
Balancing risk
(1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
177
abc

40.0 35.0 30.0 25.0 FY12e P/E Sector A vg 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
A BB A reva T&D Eqp Mf g A vg Siemens
EPC A vg Kalpataru Can be 'Undervalued' if operating perf improving Jyoti KEC
Crompton Greaves Can be cyclical or 'Undervalued' 6.0 7.0 8.0 9.0 10.0
Kalpatarus gross margins are in line with other players its employee cost is significantly higher compared with both KEC and Jyoti. In FY10, Kalpatarus employee cost stood at c6.6% of sales compared with KECs cost of c4.3% and Jyotis cost of c3.3%. We believe that the high employee cost could be a result of significant capacity expansion over the last few years as we have highlighted several times in this chapter. But we think now that the investment phase is behind us, the employee cost should come down as sales pick up.
Strong market position a key strength

On the other hand, Kalpataru has scored highest on market position as it is not only a market leader in domestic transmission EPC markets but also has strong presence in international markets. JMC on the other hand has also become one of the top five construction EPC players. As we highlight in the scatter charts, Kalpataru is the furthest from the vertical median line, implying that even if the company shows improvement in fundamentals it will not be an immediate crossover story. However, given the

25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
ABB
12m fwd EV/EBITDA
Areva T&D
KEC
178
abc
valuation discount, an improvement in fundamentals should act as a catalyst for re-rating. We believe that the metrics/areas where Kalpataru can register improvement going forward are:
Cash generation Return on capital employed Added value
Valuation summary Kalpataru standalone Key assumptions

Overweight, TP INR225
We are OW on Kalpataru Power with a target price of INR225, implying c53% potential return. We value Kalpataru Power using a sum of the parts (SOTP) approach, valuing the parent group, JMC Projects and the transmission BOT project separately. We have not valued the construction BOT project as financial closure has not been announced yet. We value the parent company and JMC Projects based on our preferred Economic Value Added (EVA) valuation methodology. For the parent companys valuation, we assume a WACC of c14.7%, sales growth of c9.0% and through cycle margin of c12%. For JMC Projects, we assume a WACC of c15.0%, sales growth of c9.0% and through cycle margin of c8.0%. For both these businesses, we have used a competitive advantage period (CAP) of 10 years. For the annuity based transmission BOT project, we have used an NPV based approach, assuming an inflation rate of c3%, interest cost of c11% and cost of equity of c13%. Our price target implies a 12-month forward target multiple of c8.5x PE for the parent company, c9.2x PE for JMC Projects and c1.2x PB for the transmission BOT project. For the group, our target price implies a 12-month forward target multiple of c8.8x PE. We also highlight the sensitivity of our target price to our assumptions in the tables that follow.
Value of current op Trend sales Trend CE CE growth RoIC Trend OR Value of current op Value of future inv Incremental return Incremental cost EVA Value of future inv 12-month forward Implied market cap EV EV 12-month forward Net debt Customer advances Bankers acceptances Minorities Investments/associates Implied market cap
35,098 20,924 5.3% 20.4% 4,269 21,501
379 163 118 6,989
28,489 32,675 1,592 3,924 1,783 0 (323) 25,699
Under HSBCs research model, a non-volatile Indian stock with a potential return of 6-16% merits a Neutral rating. Our target price of INR226 implies a potential return of 53%; we therefore rate the shares Overweight. Our earlier target price (under the previous covering analyst) was based on MACC valuation methodology.
179
abc
Valuation summary JMC projects Key assumptions

Price target sensitivity

12m PT 226 6% 7% 8% 9% 10% 11% 12% 12m PT 226 5% 6% 7% 8% 9% 10% 11% Sales Growth 12m PT 226 12% 13% 14% 15% 16% 17% 18% WACC Sales Growth 9% 148 150 152 155 157 159 162 Oper ating Return (OR) M argins - Standalone 10% 11% 12% 13% 14% 168 188 209 229 249 172 193 214 236 257 175 198 220 243 265 179 202 250 274 226 182 207 232 257 282 186 212 238 264 290 189 216 243 271 298 M ar gins 9% 197 207 216 226 234 243 252 Grow th 9% 294 268 245 226 209 194 181 - JM C Proje cts 10% 11% 199 200 208 210 218 220 228 231 237 240 246 250 256 260 15% 270 279 288 297 307 316 325
Value of current op Trend sales Trend CE CE growth RoIC Trend OR Value of current op Value of future inv
Incremental return Incremental cost EVA Value of future inv
21,004 6,654 3.0% 24.0% 1,597 7,890
Operating Re turn (OR) 6% 7% 8% 193 195 196 201 203 205 209 211 213 217 220 223 224 227 231 232 235 239 239 244 248 Sales 8% 284 260 238 220 204 190 178
12% 202 212 222 234 243 254 264
151 30 82 4,762
12-month forward implied market cap EV EV 12-month forward Net debt Customer advances Bankers acceptances Minorities Investments/associates Implied market cap
12,652 14,547 (14) 2,100 210 0 (69) 12,319
6% 266 244 225 209 194 182 171
7% 275 252 232 214 199 186 174
10% 303 276 252 232 214 198 185
11% 312 283 259 237 219 203 188
12% 322 291 266 243 224 207 191
Key risks
The key risks related to our investment case on Kalpataru are as follows:
Raw material price inflation
SOTP valuation Kalpataru Power SOTP

Kalpataru Parent JMC Projects Haryana BOT project Total
Equity value Per share

25,699 8,500 492 34,691 167 55 3 226
Implied multiple
PE = 8.5 PE = 9.2 PB = 1.2 PE = 8.8
Increasing competition in the transmission EPC segment
180
abc
Company profile
Kalpataru is a leading turnkey player in power (transmission/distribution/construction), infrastructure (oil & gas/railways/building & factories/roads & bridges) and asset creation (transmission systems/roads/logistics & warehouses), having a presence in more than 30 countries globally. The company is currently supplying customers in Africa, the Middle East, Far East, Australia, US and Canada.
Biomass
Kalpataru ventured into green power generation in 2003. This segment produces power using renewable/ non-conventional sources such as agricultural waste/biomass. Kalpataru has two biomass plants an 8MW facility in Ganganagar, Rajasthan, and a 7.8MW facility in Tonk, Rajasthan. The company has entered two long-term power purchase agreements (PPAs) with RRVPN (Rajasthan Vidyut Prasaran Nigam). The total investment in setting up these power plants is cINR700m. This segment contributes c2% to the total revenues of the parent company.
Power transmission and distribution

Transmission and distribution is Kalpataru powers core business and contributes c85% to the parent companys revenues. The company is involved in design and engineering, manufacturing, tower testing and providing turnkey solutions to transmission line companies. The current installed capacity of transmission tower manufacturing is 108,000 metric tonnes and it has a tower testing facility for up to 1200kV in Gujarat India. The company caters to clients in the domestic as well as international markets. It has presence across 30 countries. Besides execution of transmission line projects, Kalpataru also carries out the EPC for distribution related projects in rural India.
Subsidiaries
Logistics Shree Shubham Logistics India Limited
Shree Shubham logistics is a subsidiary of Kalpataru Power which was set up to provide endto-end logistics solutions to all agri-commodity related markets. The total stake of Kalpataru in the subsidiary is c80%. The services provided by Shree Shubham logistics include storage & preservation, commodity funding, collateral management, testing & certification, fumigation & pest management, commodity procurement, trading & exports and branded commodities. The company operates 12 agricultural logistics parks in Rajasthan and Gujarat with a total storage capacity of c590,000 tonnes. Besides this, it has also entered a partnership with RSWC to operate 38 warehouses (dry and cold) on revenue sharing basis with a total capacity of c405,000 tonnes.
Infrastructure/pipeline
The company entered this segment in FY04 with the focus on construction of oil and gas pipelines. The company has expertise in constructing cross country oil and gas pipeline networks. It has successfully executed c1,800km of pipeline networks of 8-48 inches diameter in the last five years. This segment contributed c14% to the parent companys revenues in FY10. The company is executing a crude oil pipeline project for Hindustan Petroleum Mittal Energy private limited (c550km) which is worth cINR3.85bn.
JMC Projects
JMC Projects is a leading construction company undertaking works for commercial & residential buildings, industrial, infrastructure & power plant
181
abc
projects at various locations in India. Kalpataru has a c53% stake in JMC. The company has moved from EPC to BOOT based project. It has recently won a NHAI project to construct four-lane highways between Rohtak and Bawal on a BOOT (Build Own Operate Transfer) basis in a consortium with SREI Infrastructure Ltd. It has also received two jobs for Bangalore metro and one contract from AIIMS (All India Institute of Medical Sciences) in Bhopal and Rishikesh.
Open offer to JMC projects shareholders
Foray into BOT projects

Kalpataru has recently been awarded the first transmission line BOT project as part of a consortium with Techno Electric and Engineering Limited from Haryana Vidyut Prasaran Nigam Limited. Financial closure was completed in November 2010. The project is expected to be completed within 14 months of that date and will be operated by the SPV for a concession period of 25 years.
Kalpataru Power had announced early in October that it would be making an open offer to the equity shareholders of the JMC Projects to acquire 5,280,687 fully paid up equity shares of INR10, representing 20.22% of the post preferential issue paid up capital and 20% of the emerging voting capital of the JMC Projects at a offer price of INR207 per share payable in cash
Strongest order book among peers INR93bn

The closing order book of Kalpataru (standalone) at the end of 2Q FY11 was cINR50bn (c1.9x FY10 sales). Of this c60% are from international markets, c32% from domestic markets, 6% are for pipeline projects and the remaining 2% for distribution projects. JMC projects had a closing order book of cINR43bn (c3.3x of FY10 sales), where in c50% orders are for factories and buildings, c34% for infra related projects and the remainder for power projects. The consolidated order book stands at INR93bn, c2.4x FY10 consolidated sales, which provides strong revenue visibility going forward.
Kalpataru standalone order book (INR50bn)
JMC order book (INR43bn)
Distribution 2% Infra 6% Transmissi on international 32% Transmisis on domestic 60%

4
Source: Company, HSBC Source: Company, HSBC
Pow er 16%
Factories 50% Infra 34%
182
abc
Kalpataru Power
Sales vs order book vs EBITDA margin Segment contribution FY10 sales
80000 60000 40000 20000 0 FY07 FY08 FY09 FY10 FY11eFY12eFY13e Sales Order Book
18% 15% 12% 9% 6% 3% 0%
JMC Projects 33% Real Estate 0% T&D 84%
Biomass Energy 1%
Infra 14%
EBIDTA Margins
Geographic exposure
End-market exposure
India 83%
Europe 0% North America 2%
Pow er Distribution 1% Constructio n 33% Railw ay s 1%
RoW 15%
Transmissi
- on
Oil & Gas Others 1% 9%
Domestic 36%
DPS vs EPS
30 25 20 15 10 5 0 FY07 FY08 FY09 FY10 FY11e FY12e FY13e EPS

2.5 2.0 1.5 1.0 0.5 -
10% 5% 0% -5% -10% -15% -20% FY07 FY08 FY09 FY10 FY11e FY12e FY13e
DPS
FCF/Sales
Capex /Sales
183
abc
Financials & valuation: Kalpataru Power Transmission

Financial statements Year to 03/2010a 03/2011e 03/2012e 03/2013e Valuation data Year to
Overweight
03/2010a
0.9 7.9 1.4 13.0 1.9 2.3 1.0
03/2011e
0.7 6.4 1.4 9.8 1.7 2.5 1.2
03/2012e
0.6 5.2 1.3 6.9 1.4 4.3 1.3
03/2013e
0.5 4.5 1.1 5.5 1.1 11.1 1.3

Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit 39,963 4,331 -745 3,586 -1,426 2,647 2,563 -691 1,777 1,715 44,933 5,134 -825 4,309 -1,053 3,407 3,407 -908 2,323 2,323 56,102 6,671 -867 5,804 -1,091 4,891 4,891 -1,272 3,297 3,297 67,151 7,946 -867 7,079 -1,094 6,190 6,190 -1,567 4,176 4,176
Issuer information
Share price (INR) 148.60 Target price (INR) KAPT.BO 501 39 India Rahul Garg 225.00 Potentl return (%) 53

Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 3,543 -3,021 -3,021 -237 -18 522 1,850 -1,270 -1,270 -267 31 580 2,154 -1,170 -1,170 -312 -672 984 3,213 -670 -670 -341 -2202 2543
Bloomberg (Equity) KPP IN Market cap (INRm) 22,804 Enterprise value (INRm) 24,604 Sector Electrical Equipment Contact +91 22 22681245

Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders funds Invested capital 83 8,748 28,862 3,822 37,759 15,431 9,014 5,192 10,271 24,087 0 6,012 34,010 5,551 40,413 17,544 7,742 2,191 11,549 23,428 0 6,315 41,113 6,165 47,820 21,702 7,742 1,577 13,818 27,579 0 6,118 49,630 8,308 56,140 25,799 7,742 -566 16,658 31,151
Price relative
270 220 170 120 70 20 2009 2010 2011
Rel to BOMBAY SE SENSITIVE INDEX Kalpataru Power Transmiss
270 220 170 120 70 20 2012
Ratio, growth and per share analysis Year to Y-o-y % change

Revenue EBITDA Operating profit PBT HSBC EPS 23.1 28.5 28.3 55.7 46.9 12.4 18.5 20.2 28.7 17.0 24.9 29.9 34.7 43.6 42.0 19.7 19.1 22.0 26.6 26.7
Source: HSBC
03/2010a
03/2011e
03/2012e
03/2013e
Ratios (%)
Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt 1.7 11.6 16.7 8.7 10.8 9.0 3.0 45.1 1.2 68.2 1.9 14.2 20.1 6.4 11.4 9.6 4.9 16.5 0.4 84.4 2.0 16.4 23.9 8.2 11.9 10.3 6.1 9.5 0.2 136.6 2.2 17.8 25.1 8.9 11.8 10.5 7.3 -2.7 -0.1

EPS rep (diluted) HSBC EPS (diluted) DPS Book value 13.41 12.94 1.74 86.98 15.13 15.13 1.74 86.52 21.49 21.49 1.90 107.70 27.21 27.21 2.00 135.21
184
abc
Kalpataru Income statement (INRm)

FY07
15,982 (11,982) 3,999 (777) (505) 0 2,718 0 2,718 (182) 2,536 2,536 92 1 74 31 (439) 0 2,220 2,219 (590) 0 1,630 0 (17) 1,613 1,612 132.5 12.2 12.2
FY08
26,749 (19,525) 7,224 (1,522) (2,408) 0 3,294 0 3,294 (386) 2,908 2,908 158 4 253 93 (674) 0 2,485 2,481 (689) 0 1,797 0 (148) 1,649 1,646 132.5 12.4 12.4
FY09
32,460 (24,828) 7,632 (1,988) (2,352) 0 3,292 (79) 3,370 (576) 2,716 2,794 190 2 49 162 (1,149) (220) 1,700 1,777 (417) 0 1,283 0 (173) 1,109 1,167 132.5 8.4 8.8
FY10
39,963 (29,950) 10,013 (2,632) (2,977) 0 4,404 73 4,331 (745) 3,659 3,586 222 11 0 26 (1,452) 192 2,647 2,563 (691) 0 1,956 0 (179) 1,777 1,715 132.5 13.4 12.9
FY11e
44,933 (33,000) 11,933 (3,319) (3,633) 153 5,134 0 5,134 (825) 4,309 4,309 151 0 0 261 (1,304) 0 3,416 3,416 (911) 0 2,505 0 (261) 2,245 2,245 153.5 14.6 14.6
FY12e
56,102 (41,817) 14,285 (3,711) (4,114) 210 6,671 0 6,671 (867) 5,804 5,804 178 0 0 268 (1,340) 0 4,911 4,911 (1,277) 0 3,634 0 (478) 3,156 3,156 153.5 20.6 20.6
FY13e
67,151 (50,419) 16,733 (4,166) (4,889) 268 7,946 0 7,946 (867) 7,079 7,079 205 0 0 313 (1,386) 0 6,211 6,211 (1,572) 0 4,639 0 (663) 3,976 3,976 153.5 25.9 25.9
Kalpataru Margin & trend analysis

FY07
FY08
67.4% 23.4% 21.2% 14.7% 2.2% 2.1% 27.0% 12.3% 10.9% 11.4% 9.3% 6.7% 0.0% 0.0% 3.2% 14.6% 27.7% 22.0% 1.1% 12.1%
FY09
21.4% 12.3% 2.3% -6.6% -32.7% -29.1% 23.5% 10.4% 8.6% 9.1% 5.2% 4.0% 0.0% 0.0% 4.6% 15.0% 24.5% 19.3% 1.0% 17.9%
FY10
23.1% 24.8% 28.5% 34.7% 60.2% 46.9% 25.1% 10.8% 9.0% 9.5% 6.6% 4.9% na na 0.7% 13.9% 26.1% 16.2% 1.2% 13.0%
FY11e
12.4% 19.6% 18.5% 17.8% 9.1% 13.0% 26.6% 11.4% 9.6% 10.1% 7.6% 5.6% 8.3% 16.4% 5.4% 13.1% 26.7% 17.0% 1.1% 11.9%
FY12e
24.9% 10.5% 29.9% 34.7% 40.6% 40.6% 25.5% 11.9% 10.3% 10.9% 8.8% 6.5% 5.3% 6.2% 4.3% 14.0% 26.0% 17.0% 1.0% 9.2%
FY13e
19.7% 8.8% 19.1% 22.0% 26.0% 26.0% 24.9% 11.8% 10.5% 11.1% 9.2% 6.9% 5.4% 6.6% 4.1% 14.0% 25.3% 17.0% 1.0% 7.7%
185
abc
Kalpataru Balance sheet (INRm)

FY07
265 6,178 6,443 625 7,067 (3,954) (32) (3,986) 1,458 1,367 (1,161) 3,098 83 51 na 1,392 1 4,625 1,890 6,999 (2,498) (2,454) (329) 1,747 (815) 4,541 (780) (158) 0
FY08
265 7,566 7,831 822 8,653 (4,150) (317) (4,467) 1,959 1,085 (1,423) 4,297 83 80 na 356 29 4,844 2,677 9,332 (3,617) (3,053) (459) 2,857 (1,272) 6,465 (1,023) (210) 0
FY09
265 8,433 8,698 947 9,645 (7,530) (1,922) (9,451) 3,395 583 (5,474) 5,331 83 1,132 na 34 17 6,598 3,270 14,160 (5,177) (3,280) (901) 3,553 (1,695) 9,931 (1,203) (206) 0
FY10
265 10,006 10,271 1,254 11,525 (7,926) (1,088) (9,014) 3,266 557 (5,192) 6,843 83 1,895 na 66 9 8,898 3,485 18,263 (6,900) (4,157) (1,491) 3,292 (2,884) 9,609 (1,593) (196) 0
FY11e
265 11,291 11,556 2,072 13,629 (6,665) (1,077) (7,742) 5,113 788 (1,841) 5,891 0 113 na 391 8 6,404 3,822 20,872 (7,869) (4,843) (1,659) 3,765 (3,174) 10,914 (1,637) (212) 0
FY12e
265 13,574 13,839 3,053 16,892 (6,665) (1,077) (7,742) 5,113 1,416 (1,212) 6,194 0 113 na 391 8 6,707 4,674 25,816 (9,781) (6,024) (1,993) 4,459 (3,904) 13,246 (1,637) (212) 0
FY13e
265 16,430 16,695 4,435 21,130 (6,665) (1,077) (7,742) 5,113 3,575 946 5,997 0 113 na 391 8 6,510 5,509 30,688 (11,669) (7,191) (2,318) 5,126 (4,621) 15,523 (1,637) (212) 0
Net assets
7,067
8,653
9,645
11,525
13,629
16,892
21,130
Kalpataru Key balance sheet ratios

FY07
16.4% 21.1% 1.16 1.21 6.21 0.43 4.95 1.51 1.97 na na na na na na na
FY08
16.4% 21.7% 1.16 1.22 5.01 0.43 6.00 1.85 2.34 165 62 159 (84) 49 (22) 30.3%
FY09
56.8% 66.1% 1.57 1.66 2.75 1.62 4.96 1.57 1.87 166 54 175 (85) 44 (21) 33.5%
FY10
45.1% 58.0% 1.45 1.58 2.56 1.20 4.53 1.66 2.01 143 46 184 (92) 33 (29) 26.5%
FY11e
13.5% 25.7% 1.14 1.26 4.13 0.36 7.48 1.92 2.42 138 44 179 (91) 32 (27) 25.7%
FY12e
7.2% 19.0% 1.07 1.19 5.42 0.18 8.89 2.03 2.60 141 46 187 (95) 32 (28) 26.2%
FY13e
-4.5% 6.5% 0.96 1.06 6.60 (0.12) 10.99 2.16 2.80 136 44 182 (92) 30 (27) 25.2%
186
abc
Kalpataru Cash flow statement (INRm) EBITDA Adjusted for: Unrealized fx (gains)/losses Loss on sale of fixed assets Other non-cash exceptionals Change in working capital Tax paid Net Interest paid Others Cash flow from operations
FY07 2,718
(0) 2 1 (2,308) (556) (252) (73) (468) (869) 2 0 (1,335) (124) (1,459) (3,009) 978 3,442 0 (48)
FY08 3,294
(2) 7 0 (2,139) (628) (390) (31) 111 (1,652) 30 0 (1,511) (235) (1,746) 1,277 480 50 0 61
FY09 3,292
44 (1) 1 (4,541) (589) (760) (262) (2,817) (2,691) 29 0 (5,480) (238) (5,718) 886 4,119 0 752 39
FY10 4,404
(1) (1) 0 1,014 (889) (1,044) 59 3,543 (3,039) 18 0 522 (237) 285 17 (1,112) 0 828 18
FY11e 5,134
0 0 0 (1,473) (911) (1,043) 151 1,857 (1,300) 30 0 587 (267) 320 0 0 0 0 320
FY12e 6,671
0 0 0 (2,332) (1,277) (1,071) 178 2,169 (1,200) 30 0 999 (312) 687 0 0 0 0 687
FY13e 7,946
0 0 0 (2,277) (1,572) (1,073) 205 3,229 (700) 30 0 2,559 (341) 2,217 0 0 0 0 2,217
Kalpataru Key cash ratios

FY07
20.4% -14.4% 4.8 5.4% -18.5% -5.7% -6.2%
FY08
19.1% -8.0% 4.3 6.2% 3.8% -3.9% -4.5%
FY09
17.9% -14.0% 4.7 8.3% -103.7% -33.1% -34.5%
FY10
20.2% 2.5% 4.1 7.6% 96.8% 2.3% 1.3%
FY11e
17.7% -3.3% 1.6 2.9% 43.1% 2.3% 1.2%
FY12e
19.1% -4.2% 1.4 2.1% 37.4% 3.9% 2.7%
FY13e
19.8% -3.4% 0.8 1.0% 45.6% 9.9% 8.6%
abc
Kalpataru Valuation
FY07
178 23,519 1,161 2,454 329 625 (1,392) 26,695 167% 253% 9.8 10.5 10.0 14.6 3.3 0.8% -5.7% -6.2% 18.5% 23.0% 25.0%
FY08
294 38,939 1,423 3,053 459 822 (356) 44,341 166% 307% 13.5 15.2 14.5 23.7 4.5 0.5% -3.9% -4.5% 15.3% 18.4% 21.0%
FY09
125 16,573 5,474 3,280 901 947 (34) 27,140 84% 131% 8.1 9.7 9.2 14.2 1.7 1.2% -33.1% -34.5% 10.8% 12.1% 13.4%
FY10
169 22,344 5,192 4,157 1,491 1,254 (66) 34,372 86% 143% 7.9 9.6 9.1 13.0 1.9 1.0% 2.3% 1.3% 11.6% 13.3% 16.7%
FY11e
149 22,820 2,191 4,843 1,659 1,729 (391) 32,850 73% 140% 6.4 7.6 7.2 9.8 1.7 1.2% 2.5% 1.4% 14.2% 17.0% 20.1%
FY12e
149 22,820 1,577 6,024 1,993 2,709 (391) 34,732 62% 126% 5.2 6.0 5.7 6.9 1.4 1.3% 4.3% 2.9% 16.4% 19.9% 23.9%
FY13e
149 22,820 (566) 7,191 2,318 4,092 (391) 35,463 53% 114% 4.5 5.0 4.8 5.5 1.1 1.3% 11.1% 9.6% 17.8% 22.1% 25.1%
Kalpataru Profitability RoCE

FY07
2,536 123 0 5.0% 26.6% 2,659 1,952 7,067 158 780 3,986 2,454 329 1,367 1,458 1,392 10,557 25.2% 18.5% 23.0%
FY08
2,908 153 0 5.0% 27.7% 3,060 2,212 8,653 210 1,023 4,467 3,053 459 1,085 1,959 356 14,465 21.2% 15.3% 18.4%
FY09
2,794 164 0 5.0% 24.5% 2,958 2,233 9,645 206 1,203 9,451 3,280 901 583 3,395 34 20,675 14.3% 10.8% 12.1%
FY10
3,586 208 0 5.0% 26.1% 3,793 2,803 11,525 196 1,593 9,014 4,157 1,491 557 3,266 66 24,087 15.7% 11.6% 13.3%
FY11e
4,309 242 0 5.0% 26.7% 4,551 3,337 13,629 212 1,637 7,742 4,843 1,659 788 5,113 391 23,428 19.4% 14.2% 17.0%
FY12e
5,804 301 0 5.0% 26.0% 6,105 4,518 16,892 212 1,637 7,742 6,024 1,993 1,416 5,113 391 27,579 22.1% 16.4% 19.9%
FY13e
7,079 360 0 5.0% 25.3% 7,438 5,555 21,130 212 1,637 7,742 7,191 2,318 3,575 5,113 391 31,151 23.9% 17.8% 22.1%
abc
KEC Robust outlook but priced in

KEC has won several large orders this year and made a couple of
strategic acquisitions, driving its order book visibility to c1.8 years

However, its robust earnings outlook seems priced in, as the stock
has outperformed its peers (Jyoti and KPP) by c15-20% in last 6m and trades at a premium of c20% on FY12e (Mar YE) EV/EBITDA
Even though we remain c5% ahead of consensus on FY12e, the
valuation looks full; Neutral, TP INR105
A well owned story

KEC has made significant strides this year which is now visible in its order book that has grown more than 30% since the previous year-end (March 2010). The group has not only secured several large orders in virtually every business segment but has also made a couple of strategic acquisitions, thus bringing in further ammunition for future growth. However, the company has failed to show any improvement in its margins. But even then, the stock has reacted well to all the order inflow news and about the SAE Tower acquisition, which is expected to be earnings accretive in this financial year. We highlight that, unlike Kalpataru and Jyoti, who have each underperformed the wider capital goods sector by c15-20% over the last six months, KEC has performed in line with the sector. Therefore, although the earnings outlook for KEC remains robust in light of rising order book, the story seems well known and well owned.
We highlight the key bull and bear points related to KEC below:
Bull points
Strong inflow of new orders drives order book visibility to c1.7 years Diversification into other EPC segments provides several avenues of growth Recent acquisitions, particularly SAE Towers, a boost to earnings in the near term Growing balance sheet with better returns and lower working capital requirement than the peer group One of the best EPC players on fundamentals
Bear points
After the recent out-performance, valuation looks rich Balance sheet remains highly leveraged, limiting ability to gear up further
189
abc
Highly geared to steel prices; this, coupled with substantial exposure to international fixed price contracts, poses significant margin risk Significant exposure to international markets also poses currency risk
Jyoti. At c1.8 years, the order book visibility of KEC remains below both Kalpataru and Jyoti.
Order book visibility
2.5 2.0 1.5 1.0 0.5 KEC Jy oti Kalpataru
We note that after the recent out-performance the stock looks rich on valuation compared with its closest peers, Jyoti and Kalpataru. On our FY12 estimates, KEC is trading at c8.7x PE versus Jyoti and Kalpatarus multiples of c7.0x and c7.4x, respectively. We believe that KECs growth story is well baked into the numbers and we remain largely in line with consensus on our FY12 estimates.
Strong inflow drives order book visibility to c1.8 years

KECs order book has grown significantly this year, driven by several large orders and the acquisition of SAE Towers in the US. At the end of Q2 FY11, KECs order book stood at cINR70bn and in a recent order-related press release, management highlighted that the order book has grown to cINR73bn in Q3 FY11.
Order book and order intake (INRm)
New business areas seeing strong development

At the end of FY10, KECs relatively new EPC businesses cables, railways and telecom contributed only c4% to the order book. However, because of strong order inflow in the first half, the contribution from these businesses has grown to c7% of the order book (at the end of Q2 FY11). Based on the order intake during the first half and the orders announced in Q3, we expect the cables, railway and telecom business to register growth of c200-400% in FY11.
80,000 60,000 40,000 20,000 -
Q1 FY10
Q2 FY10
Q3 FY10
Q4 FY10
Q1 FY11
Order book
Order intake
Visibility not any better than peers

Even though the order book has grown over 30% y-t-d (in FY11), the sales visibility at KEC is not any better than its closest peers Kalpataru and
190
Q2 FY11
abc
Order book: Railways and telecom (INRm)
4,000 3,000 2,000 1,000 -
80% 60% 40% 20% 0% KEC Cables Railw ay s & telecom

Q1 FY10
Q2 FY10
Q1 FY11
Q2 FY11
Q3 FY10
Q4 FY10
Kalpataru
Jy oti
SAE acquisition added c10% to the order book

SAE Tower was merged with KEC just before the end of Q2 FY11. The acquired company brought with it an order book of cINR5,800m which increased KECs order book of cINR56bn (at the end of Q1 FY11) by c10%. More importantly, we believe the acquisition should prove helpful in tapping growth opportunities in the Americas, which is the biggest transmission market in the world. The company has already announced orders worth over INR10bn from Americas post the acquisition of SAE Towers.
We expect significant growth in the Indian transmission orders during FY12-13 but due to its lower exposure to domestic transmission, KEC will register a smaller part of this growth compared with its peers. KEC can offset this by increasing its market share either in domestic or international markets.
International exposure brings in price and currency risk

Highest currency risk
KEC has the highest exposure to international markets among the EPC players under our coverage. While this provides KEC with an opportunity to tap international growth, it does bring currency risk. Even if the company is able to hedge the transaction effect, the translation effect of currency appreciation will remain a key overhang on top-line growth.
Least geared to Indian transmission growth story among peers

KEC has always had a stronger presence in international markets compared with its peer group; however, with its increasing exposure to other domestic EPC markets and the acquisition of SAE Towers, KECs exposure to domestic transmission markets has fallen to c25%.
191
abc
Domestic vs international exposure
100% 80% 60% 40% 20% 0% KEC Domestic ex posure

Growing balance sheet with better returns than peers

KECs balance sheet has grown over four fold since FY06 and the company has still managed to limit deterioration in its return on equity (ROE) compared with its peers. While Jyoti has seen its ROE fall from c23% in FY06 to c15.5% in FY10 Kalpatarus fell from c25% in FY07 to c16.5% in FY10 and KECs from c32% in FY06 to c24% in FY10. Moreover, KECs ROE still remains best in its EPC peer group.
ROE trend
Kalpataru
Jy oti
International ex posure
Significant gearing to metal prices

With c14% of sales exposure, KEC is the second most vulnerable company to steel prices in our coverage. In addition to steel, KEC also has a relatively large exposure to aluminium of c8-10% of sales. Our metals and mining team forecasts steel prices to go up by c10% in 2011 which we believe is a key negative for KEC. This is because over 50% of KECs order book contains international orders which are typically fixed price contracts and hence any increase in input prices can erode margins in the existing order book.
Steel price exposure
40% 30% 20% 10% 0% FY07 KEC

FY08 Kalpataru
FY09 Jy oti
FY10
Higher leverage driving the RoE, as RoCE remains inline with peers
24%
30% 25% 20% 15% 10% 5% 0% KEC 14%
11%
We note that KECs return on capital employed (RoCE) at c11.5% in FY10 is in line with its closest peers, Jyoti and Kalpataru. Therefore, it is not the superior returns on the committed capital but the capital structure itself which drives KECs higher ROE. We note that KEC is the most geared company within our universe with a leverage of c2.5x.
Jy oti
Kalpataru
192
abc
Financial leverage (including acceptances)
3.00 2.50 2.00 1.50 1.00 0.50 0.00 Jy oti Kalpataru KEC
Customer advances need better management

KEC has the lowest working capital (WC) requirement in its peer group. Its trade working capital in FY10 stood at c12.5% of sales, compared with Jyoti and Kalpatarus WC at c23% of sales. The main driver behind KECs lower WC requirement is its much better payable days management.
Inventory, trade receivables, trade payables and trade working capital as % of sales
The group should gear up further only for margin accretive investments
Interestingly, KECs high leverage has driven ROE up which in turn has limited the increase in interest burden even with rising leverage. However, we believe that company now needs to focus on margins and only borrow more money for investments which are earnings accretive and do not affect margins. Any dilution in margins in our opinion can hamper the groups ability to service its debt and may warrant a reduction in leverage, which could put the company in a vicious circle of declining returns.
Interest cover vs EBIT margin vs interest rate
60% 40% 20% 0% -20% -40% -60% Inv entory Trade reciev ables KEC
Source: Company, HSBC research
Trade Pay ables Jy oti
Trade WC
Kalpataru
6.0 5.0 4.0 3.0 2.0 1.0 FY06 FY07 FY08 FY09 FY10
20.0% 15.0% 10.0% 5.0% 0.0%
However, KEC has shown significant volatility in its customer advances over the last few years. The customer advances in FY10 declined to as low as 2.5% sales compared with the healthier level of c10-12% seen in FY06. The customer advances at Jyoti and Kalpataru remain at a much better level of c8% and c10%, respectively. Therefore, we believe the company should focus on customer advances to further improve its working capital requirements.
KEC customer advances as % of sales
12% 10% 8%
Interest cover
EBIT margins
Interest rate
6% 4% 2% 0% FY06 FY07 FY08 FY09 FY10
193
abc
We remain modestly above consensus on FY12

KEC derives a significant proportion of its revenues from the transmission & distribution markets. However, it is much more geared to international transmission markets (c51% of order book) than domestic transmission markets (c26% of order book). We believe this puts KEC at a slight disadvantage to its competitors who are more geared to domestic transmission markets. This is because, we expect significantly higher growth in the domestic transmission orders compared with the international transmission orders. Therefore, at the group level, we expect KEC to witness a lower growth in orders of c25% during FY12e compared with c35% growth for its competitors, Jyoti and Kalpataru. A key upside risk to our forecasts is an increase in KECs market share in overseas markets, particularly in the Americas where the company has entered with a small base.
Order intake and order book (INRm)
we expect order intake to grow by c40% in FY11e. Consequently, we forecast sales growth of c21% in FY11e and c20% in FY12e. We expect the sales growth to taper off in FY13e to c14%.
Sales growth
40% 35% 30% 25% 20% 15% 10% 5% 0% FY07 FY08 FY09 FY10 FY11e FY12e FY13e
140,000 120,000 100,000 80,000 60,000 40,000 20,000 FY09 FY10 FY11e FY12e FY13e
In terms of margins, we dont see any particular driver for improvement. In fact, we believe it is likely that order mix and hence sales mix may shift towards domestic orders, in which case margins may see some downward pressure (as margins on international contracts are better than margins on domestic contracts). On the other hand, if the international growth outpaces domestic growth (which we believe is less likely), then margins may see some improvement. We forecast EBITDA margins to stay in a band of 10-10.5% during FY11-13e.
Order intake
Order book
However, we do expect the group to report strong order flow in FY11, driven by several large order wins so far and the step-up effect from the SAE Tower acquisition. We expect above normal order growth (c200-400%) from the newly focused EPC businesses of cable, railways & telecom. Overall,
Overall, we forecast FY12e and FY13e group sales of INR57bn and INR65bn, clean EBITDA of INR5,922m and IINR6,617m and clean EPS of INR8.2 and INR10.5, respectively. We are broadly in line with consensus on our FY11 estimates; however, we remain modestly ahead the following year. For FY12e, we are c3.5% ahead of consensus on sales and c5% ahead of consensus on EBITDA margins, implying that our higher numbers are primarily driven by our more bullish view on sales growth.
194
abc
However, we note that we are c1% below consensus on FY12e EPS, in spite of our higher net income estimate (c4.5%). This is largely due to the fact that consensus doesnt seem to be factoring in the latest number of shares reported during the previous three quarters. Based on FY11 estimates, consensus is assuming c246.6m shares for EPS calculation, whereas we assume c257.1m shares, as reported during Q1 and Q2. We highlight our forecasts and consensus estimates in the table on the following page.
The stock looks rich on valuation

KEC has sharply outperformed the wider capital goods sector by c30% over the last month, driven primarily by the recent order announcements and the stock split. The stock has also outperformed its closest peers Jyoti and Kalpataru by c10% and c20% during the same period. Therefore, we believe that the earnings outlook is now largely factored into the share price.
FY11-13e Earnings forecasts

KEC Inte rnational - M ar YE (INR m ) Order Backlog Ne t Sale s Clean EBITDA Re porte d EBITDA Clean EBIT Re porte d EBIT Other Income Net Financials Profit be fore tax Income tax Extraordinary items Minorities Clean Net Income Re porte d Ne t Incom e Clean EPS Re porte d EPS DPS FY10 57,070 39,072 3,979 4,069 3,709 3,798 0 (865) 2,934 (1,037) 0 0 1,839 1,897 7.5 7.7 1.2 Ne w Fore cas ts FY11e FY12e 77,779 47,276 4,903 4,903 4,537 4,537 (85) (1,295) 3,157 (1,105) 0 0 2,107 2,052 8.2 8.0 1.3 98,218 56,829 5,922 5,922 5,518 5,518 (100) (1,389) 4,028 (1,390) 0 0 2,704 2,639 10.5 10.3 1.4 FY13e 116,821 64,738 6,617 6,617 6,197 6,197 (100) (1,377) 4,720 (1,605) 0 0 3,181 3,115 12.4 12.1 1.5 Bloom be rg Cons e ns us FY11e FY12e FY13e 46,773 54,863 57,731
4,684 4,411
5,630 5,353
6,309 5,810
4.7% 2.9%
5.2% 3.1%
4.9% 6.7%
(1,315) 3,096
(1,524) 3,829
(1,462) 4,348
2.0%
5.2%
8.6%
2,047
2,525
2,852
0.2%
4.5%
9.2%
8.3 1.2
10.4 1.2
11.2 1.3
-3.8% 11.1%
-0.9% 13.1%
7.8% 19.6%
FY10 1.5 16% 10.2% 10.4% 9.5% 9.7% 7.5% 4.7% 4.9%
FY13e 1.8 14% 10.2% 10.2% 9.6% 9.6% 7.3% 4.9% 4.8%
HSBC vs. Consensus FY11e FY12e FY13e 1.3% 2.9% 8.7%
10.0% 9.4% 6.6% 4.4%
10.3% 9.8% 7.0% 4.6%
10.9% 10.1% 7.5% 4.9%
36 17 6 (4)
16 (5) 11 4
(71) (49) (24) (13)
195
abc
Share price performance
PE vs history
20% 10% 0% -10% -20% -30% 1 w eek 1 mth 3 mths 6 mths 12 mths Relativ e performance
20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 KEC International

Source: HSBC; Thomson Reuters Datastream
Historic av erage
*relative to BSE Capital Goods Index; prices as at close of 19 January 2011 Source: Thomson Reuters Datastream, HSBC
EV/EBITDA vs history Share price performance
10 10% 0% -10% -20% -30% -40% -50% 1 w eek 1 mth 3 mths 6 mths 12 mths KEC
Source: Thomson Reuters Datastream, HSBC Source: Thomson Reuters Datastream, HSBC
8 6 4 2 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 KEC International Historic av erage
Jy oti
Kalpataru
Because of this recent strength, the stock now looks rich on valuation compared with its peer group. On our FY12 estimates, the stock is trading at c9.2x PE and c7.1x EV/EBITDA versus Jyoti and Kalpatarus average multiples of c8.1x and c5.4x, respectively. The stock also doesnt appear materially inexpensive compared with its historical trading average. On consensus numbers, KEC is trading at c10.5x 12-month forward PE and c5.8x 12month forward EV/EBITDA compared with historical average of c11.6x and c5.9x, respectively.
We note that the small discount on KECs valuation relative to history can be explained by the decline in its return ratios compared with historical average, as we highlight below.
PE and EV/EBITDA ____FY11e ____ ____ FY12e ____ ____ FY13e____ PE EV/EBITDA PE EV/EBITDA PE EV/EBITDA KEC 11.2 Kalpataru 10.5 Jyoti 8.7
8.0 8.7 6.7 7.4 5.4 7.0
6.9 7.4 5.4 5.8 4.8 5.7
6.2 4.7 4.3
196
abc
PE vs ROE
20 15 10 5 0
50% 40% 30% 20% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 KEC International 12m fw d RoE
The group stacks up well on fundamentals

Within our coverage universe, KEC has a Q-ben score of 5.2, which is the highest within our EPC coverage and the third highest (after Crompton and Siemens) within our entire coverage. The company has scored highest on its ability to balance risk (largely driven by its customer and geographical diversity and hence lower cyclicality) and lowest on its financial strength (largely driven by its excessive leverage). We highlight the performance of the company on each of the criteria and each of the metrics in the bar charts.
EV/EBITDA vs RoCE
10 8 6 4 2 0
120% 100% 80% 60% 40% 20% 0% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 KEC International 12m fw d RoCE
Lower cyclicality a key strength

KEC is one of only two companies within our coverage universe (Crompton is the other one) which didnt see its earnings decline in FY09-10 in the wake of the cyclical downturn. This, in our opinion, is largely driven by KECs strong diversification across different customer segments (end markets) as well as across different geographies. However, the downside of this diversification is the trade off between lower volatility and higher concentrated growth. We believe that India is witnessing a lot of secular growth and should not see many cyclical downturns over the next 5-10 years. In that context, we believe that lower cyclicality, although a strength, remains less relevant than other performance criterion such as market performance.
EV to backlog vs history
0.8 0.6 0.4 0.2 0.0 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10
KEC International
Historic av erage
High leverage a key weakness

As we have highlighted during our discussion on the groups balance sheet, KEC is the most leveraged company within our coverage universe. While this has so far not increased the interest burden to critical levels as the group has managed to generate superior ROE, we believe any further gearing should only be done for margin accretive
We further note that the rise in KECs order backlog seems to have been reflected in its share price as the stock is now trading in line with its historical EV to backlog where its peers are still trading below their historic averages.
197
abc
Benchmarking chart
Median = 5.0
Free cash flow Added v alue Capital Ex pentiture Return on capital Organic sales grow th Market position Customer div ersity Geographic div ersity Cy clical resilience Financial lev erage Net debt/EBITDA Interest cov er FCF y ield Free float (%) Div idend y ield Trading v olume (3m (1.0) 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0
investments. Any dilution in margins from here on, in our opinion, could erode the interest cover and may require de-leveraging, putting further downward pressure on ROE. As we highlight in the scatter charts below, KEC is the only EPC player which remains to the right of the vertical median line highlighting its superior fundamental quality. However, KEC is also the most expensive stock compared with its EPC peers and hence, we believe that the quality of KECs business is adequately factored into its share price.
We believe that the metrics/areas where KEC can see further improvement and/or needs to focus on are:
Return on capital employed Financial leverage
Benchmarking charts
Median = 5.0
Internal Performance Market Performance
Balancing risk
(1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
198
abc

ABB Areva T&D

25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
ABB
12m fwd EV/EBITDA
Areva T&D
KEC
Neutral, TP INR105
We are Neutral on KEC with a target price of INR105, implying c16% potential return. We value the group based on our preferred Economic Value Added (EVA) valuation methodology. Our valuation model assumes a WACC of c14.4%, sales growth of c9.0%, through cycle margin of c10% and a competitive advantage period (CAP) of 10 years.
Our price target implies a 12-month forward target multiple of c8.8x PE and c6.8x EV/EBITDA for the group compared with current 12-month forward multiples of c9.9x and c7.4x, respectively.
199
abc
Valuation summary KEC International Key assumptions

We highlight the sensitivity of our target price in the following table.

12m PT 103 6% 7% 8% 9% 10% 11% 12% 12m PT 103 11% 12% 13% 14% 15% 16% 17% WACC 12m PT 103 11% 12% 13% 14% 15% 16% 17% WACC Sales Growth 7% 33 34 36 37 39 41 42 Operating Re turn (OR) 8% 9% 10% 52 71 90 54 74 94 57 78 99 59 81 103 62 85 108 65 89 113 67 92 117 Operating Re turn (OR) 8% 9% 10% 103 130 157 86 111 136 72 95 119 59 81 103 49 69 90 39 59 79 31 50 68 Sales 8% 150 130 113 99 86 75 65 Grow th 9% 157 136 119 103 90 79 68 M argins 11% 109 114 120 126 131 137 142 M argins 11% 185 162 142 125 111 98 87 12% 128 134 141 148 154 161 167 13% 147 154 162 170 177 185 193
Value of current op Trend sales Trend CE CE growth RoIC Trend OR Value of current op Value of future inv Incremental return Incremental cost EVA Value of future inv 12-month forward Implied market cap EV EV 12-month forward Net debt Customer advances Bankers acceptances
Minorities Investments/associates Implied market cap
56,829 29,996 4.3% 21.0% 6,299 28,955
511 185 153 9,317
7% 75 61 48 37 28 20 13
12% 212 187 166 147 132 118 105
13% 240 212 189 170 152 137 124
38,272 43,767 5,914 1,442 9,808 0 0 26,603
6% 135 118 103 90 78 68 60
7% 143 124 108 94 82 72 62
10% 165 143 124 108 94 82 71
11% 172 149 129 113 98 85 74
12% 179 155 135 117 102 89 77
Target price 12-month forward TP Published TP

INR103
INR105
Under HSBCs research model, a non-volatile Indian stock with a potential return of 6-16% merits a Neutral rating. Our target price of INR105 implies a potential return of 16%; we therefore rate the shares Neutral. Our earlier target price (under the previous covering analyst) was based on MACC valuation methodology.
Key risks
We highlight the key risks to our investment case on KEC below:
Upside risk: Increasing penetration in the international markets Downside risk: Raw material price inflation Downside risk: Increasing competition in the transmission EPC segment
200
abc
Company profile
KEC International Ltd. (KEC) was established as Kamani Engineering Corp. Ltd. in 1945 and was taken over by R. P. Goenka (RPG) Enterprises in 1982 and renamed KEC International Ltd in 1984. KEC Internationals business is primarily focused on power transmission EPC projects. The company is experienced in the construction of power transmission lines and power related turnkey projects and has a presence both in India and overseas. The company has also diversified into power distribution, telecom & railways EPC, and completed forward integration with the merger of the RPG Cables segment. Overall, KEC is one of the few players in the EPC space with well diversified business segments.
Some of the key clients in the South East Asian market are Power Grid, West Bengal state electricity transmission company, Chhatisgarh state electricity board, Rajasthan Rajya Vidyut Prasaran Nigam Limited, AP Transmission Company, Madhya Pradesh Power Transmission Company Limited(MPPTCL) and Maharashtra State Electricity Transmission Company Limited.
Power transmission International

KEC derives c55% of its revenue from the international transmission line projects. The division has more than 60 years of experience in the turnkey construction of transmission lines. It has the experience to execute up to 800kV projects. The company has executed projects across 40 countries and has a strong base in the Middle East and Africa. Some of the key clients include EEPCO, Ethiopia, Ministry of Energy, Kenya, Sonelgaz, Algeria, Nampower, Namibia, General Electricity Company of Libya, Zesco, Zambia, Abu Dhabi Water & Electricity Authority, SEC Saudi Arabia, Barki Tajik, Tajikistan, Ministry of Energy & Water, Afghanistan, Daewoo, Korea and Hyundai.
Power transmission South East Asia

KEC International is a leader in the domestic EPC (engineering, procurement & construction) space for transmission line companies. It has the experience to execute up to 1200kV projects. The company has clients across South East Asia and is executing c58 projects in the Indian subcontinent. The company has its own tower manufacturing facilities located in Jaipur, Nagpur and Jabalpur with a total tower manufacturing capacity of c151,000 tonnes. Besides this, it has dedicated value added partners supplying c60,000 tonnes. These partners work as the outsourcing arm of the company. KEC has contractual agreements with these partners and a minimum amount of business is guaranteed to them by KEC. Also, KEC provides the technical know how on design and construction of towers. The contracts are reviewed by KEC annually depending on the competitiveness of the partner.
Power distribution
Apart from power transmission, the company also executes substation, distribution and rural electrification projects in India and overseas. The company has electrified 7,500 villages and generated c2,250,000 below poverty line (BPL) connections in India. This business unit has a strategic alliance with Power Engineers Inc., USA, and undertakes complete design & engineering of substations up to 500 kV in India and overseas. Some of the key clients for power distribution include Oman Electric Transmission Co. Oman, Ministry of Energy & Water, Afghanistan,
201
abc
Powergrid, National Hydro Power Corporation, Maharashtra State Electricity Distribution Co. Ltd. (MSEDCL) and Kenya Power & Lighting Co (Kenya).
in March 2010 with a view to consolidate KECs presence in the post-generation power value chain. The company manufactures a range of control & power cables that are critical to the distribution network of power utilities and for industrial expansion. It also provides end-to-end total cable solutions and manufactures optic fibre and jelly filled copper telecom cables.
Synergies post merger
Railways
KEC International has been in the railway market since 1961. The company has electrified c5000km of railway tracks, which is c20% of the total track laid by Indian railways. This division now provides complete turnkey solutions for railways EPC and services include:
Civil infrastructure, including earthwork, bridges, tunnels, station building and facilities. New track laying and rehabilitation of existing tracks. Railway electrification and power systems. Signalling and telecommunication network.
Acquisition of Jai Railways strategically positive
RPG Cables is likely to benefit as KEC will help source raw material and lower interest rates. RPG Cables has carried forward losses of INR1.6bn, which KEC Intl is likely to take tax advantage of.
Cable manufacturing capacity Cable type
High tension power cables Jelly filled telecom cables Optic fibre cable LT power cable Low tension power cables Railway cables Instrumentation cables
Installed capacity
1000 km 1.2m CKM 0.6mm CKM 5000 km 10000 km 1000 km 2400 km
KEC International recently announced (Sept 2010) that it has signed an agreement to acquire Jay Railway Signalling Private Limited for an enterprise value of cINR140m. Jay Railway signalling is involved in signal automation systems and technology and executes contracts for Indian Railways. KEC executes orders for civil infrastructure & tracks and railway electrification for the railway infrastructure segment, with the exception of signalling works. This acquisition would enable KEC to provide an entire range of services in railway infrastructure projects, which would be strategically positive.
Telecom
KEC is also among leading EPC players to provide telecom towers on turnkey basis to operators, tower management companies and utilities. The company has experience in laying OFC and OPGW cables on a turnkey basis and live line conditions. It has also executed projects carrying out installation & commissioning of GSM/CDMA equipment. The company supplies towers to all telecom operators and tower management companies and also exports to African countries. Some of the key clients include BSNL, Airtel, Vodafone, Aircel, Tata Communications and Reliance Communications.
Cables
RPG Cables was a separate company within the RPG group. RPG Cables was merged with KEC
202
abc
SAE tower acquisition strategically compelling

KEC has recently (Sept 10) acquired SAE Towers, a leading tower manufacturing company in North America and Latin America. The company manufactures lattice towers, steel poles and related hardware and has annual production capacity of 100,000 tonnes (35,000 tonnes in Mexico and 65,000 tonnes in Brazil). The transaction provides KEC with to North and Latin America and should also lead to KEC becoming the largest lattice tower manufacturing company globally. It will also help both companies, leaders in their respective markets, to draw synergies from each other in terms of technology and processes.
Exploring new business opportunities

The company is also exploring opportunities in water management related projects. KEC plans to focus on irrigation projects, hydro electric projects, and embankment work and flood control as the entry level strategy. The company plans to eventually move into the design and construction of water treatment plans, laying pipelines and other maintenance related activities.
203
abc
KEC International
Sales order book and EBITDA margins Revenue composition FY10
140,000 120,000 100,000 80,000 60,000 40,000 20,000 0
15% 12% 9% 6% 3% 0%
Railw ay Telecom & 4% Internationa Distribution

&
transmissio n 48%
FY09
FY12e
FY07
FY08
FY10
FY11e
FY13e
Substation South Asia 19% transmissio n 29%

Sales
Order Book
EBIDTA Margins
End-market exposure
Geographical exposure
Transmissi on - Intl 51% Pow er Distribution 15%
North America 10%
Europe 0% RoW 42%
India
Transmissi - on Domestic 26%

Railw ay s 2% Others 6%
48%
EPS vs DPS
15 10 5 0
2.0 1.5 1.0 0.5 -
6% 4% 2% 0% -2% -4% -6% FY06 FY07 FY08 FCF/Sales

FY11e
FY13e
FY08
FY09
FY12e
FY07
FY10
FY09 FY10 FY11e FY12e Capex /Sales
EPS
DPS
204
abc
Financials & valuation: KEC International

Financial statements Year to 03/2010a 03/2011e 03/2012e 03/2013e Valuation data Year to 03/2010a 03/2011e 03/2012e
Neutral
03/2013e
Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit
39,072 3,979 -270 3,709 -865 2,934 2,844 -1,037 1,897 1,839
47,276 4,903 -366 4,537 -1,295 3,157 3,241 -1,105 2,052 2,107
56,829 5,922 -404 5,518 -1,389 4,028 4,128 -1,390 2,639 2,704
64,738 6,617 -420 6,197 -1,377 4,720 4,820 -1,605 3,115 3,181
0.9 9.1 1.7 12.8 3.0 -4.7 1.3
0.8 8.0 1.5 11.2 2.5 -3.5 1.4
0.7 6.9 1.4 8.7 2.0 2.4 1.5
0.6 6.2 1.2 7.4 1.6 6.3 1.6
Issuer information
Share price (INR) -517 -588 -588 -285 840 -1,106 692 -1,510 -1,510 -361 -21 -818 1,360 -796 -796 -391 -173 564 2,142 -645 -645 -421 -1,076 1497 Reuters (Equity) Market cap (USDm) Free float (%) Country Analyst
91.60 Target price (INR) KECL.BO 508 91 India Rahul Garg
105.00 Potentl return (%)
16
Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity
Bloomberg (Equity) KECI IN Market cap (INRm) 23,148 Enterprise value (INRm) 29,234 Sector Electronic Equipment Contact +91 22 22681245
Price relative
Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders funds Invested capital
1,868 5,332 26,775 2,959 33,975 17,214 7,867 4,908 7,871 21,410
1,777 6,567 32,234 2,981 40,578 20,926 9,067 6,087 9,562 26,030
1,690 7,045 38,318 3,154 47,054 25,155 9,067 5,914 11,809 29,996
1,608 7,353 44,288 4,230 53,249 28,655 9,067 4,837 14,504 33,180
130 110 90 70 50 30 10 2009

KEC International
130 110 90 70 50 30 10 2010 2011 2012

Ratio, growth and per share analysis Year to Y-o-y % change 03/2010a 03/2011e 03/2012e 03/2013e
Source: HSBC
Revenue EBITDA Operating profit PBT HSBC EPS

Ratios (%)
14.0 0.6 -0.5 64.2 3.1
21.0 23.2 22.3 7.6 10.0
20.2 20.8 21.6 27.6 28.3
13.9 11.7 12.3 17.2 17.7
Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt
1.8 11.3 23.4 7.7 10.2 9.5 4.6 62.4 1.2
1.8 11.5 22.0 5.5 10.4 9.6 3.8 63.7 1.2 11.4
1.9 12.2 22.9 6.0 10.4 9.7 4.3 50.1 1.0 23.0
2.0 12.5 21.9 6.2 10.2 9.6 4.8 33.4 0.7 44.3
EPS rep (diluted) HSBC EPS (diluted) DPS Book value
7.69 7.45 1.20 31.90
7.98 8.20 1.30 37.19
10.26 10.52 1.40 45.93
12.12 12.37 1.50 56.41
205
abc
KEC International Income statement (INRm) FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
17,272 (13,047) 4,225 (838) (1,765) 4 1,627 (153) 1,780 (269) 1,357 1,510 0 0 0 45 (637) 0 765 918 (272) 0 493 0 0 493 592 188.4 2.6 3.1
20,406 (14,564) 5,843 (955) (2,370) 7 2,525 43 2,483 (334) 2,191 2,148 0 0 0 11 (603) 0 1,599 1,556 (552) 0 1,046 0 0 1,046 1,018 188.4 5.6 5.4
28,145 (20,319) 7,826 (1,233) (3,050) 3 3,546 104 3,441 (251) 3,295 3,191 0 0 0 4 (681) 0 2,619 2,514 (897) 0 1,722 0 0 1,722 1,653 246.7 7.0 6.7
34,288 (25,508) 8,780 (1,420) (4,350) 6 3,016 (940) 3,957 (230) 2,786 3,727 0 0 0 17 (1,017) 0 1,786 2,727 (618) 0 1,168 0 0 1,168 1,783 246.7 4.7 7.2
39,072 (29,709) 9,363 (1,689) (3,616) 10 4,069 90 3,979 (270) 3,798 3,709 0 0 0 80 (945) 0 2,934 2,844 (1,037) 0 1,897 0 0 1,897 1,839 246.7 7.7 7.5
47,276 (36,080) 11,196 (1,988) (4,320) 14 4,903 0 4,903 (366) 4,537 4,537 (85) (85) 0 59 (1,355) 0 3,157 3,241 (1,105) 0 2,052 0 0 2,052 2,107 257.1 8.0 8.2
56,829 (43,479) 13,349 (2,252) (5,192) 17 5,922 0 5,922 (404) 5,518 5,518 (100) (100) 0 61 (1,451) 0 4,028 4,128 (1,390) 0 2,639 0 0 2,639 2,704 257.1 10.3 10.5
64,738 (49,790) 14,948 (2,436) (5,915) 20 6,617 0 6,617 (420) 6,197 6,197 (100) (100) 0 74 (1,451) 0 4,720 4,820 (1,605) 0 3,115 0 0 3,115 3,181 257.1 12.1 12.4
KEC International Margin & Trend analysis FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
18.1% 17.4% 39.5% 61.4% 112.3% 72.2% 28.6% 12.2% 10.5% 11.1% 7.8% 5.1% 25.8% -9.4% 0.5% 16.8% 34.5% 17.0% 1.7% 16.2%
37.9% 37.5% 38.6% 50.4% 25.7% 24.0% 27.8% 12.2% 11.3% 11.6% 9.3% 6.1% 20.5% 7.2% 0.2% 13.9% 34.3% 17.0% 1.4% 14.3%
21.8% 22.0% 15.0% -15.4% -32.2% 7.9% 25.6% 11.5% 10.9% 11.3% 5.2% 3.4% 4.0% 10.8% 0.5% 16.8% 34.6% 17.0% 1.5% 21.1%
14.0% 13.5% 0.6% 36.3% 62.4% 3.1% 24.0% 10.2% 9.5% 9.6% 7.5% 4.9% 23.1% -3.4% 2.5% 13.4% 35.3% 17.0% 1.1% 15.6%
21.0% 21.4% 23.2% 19.4% 3.8% 10.0% 23.7% 10.4% 9.6% 9.7% 6.7% 4.3% 10.0% 7.0% 2.0% 16.0% 35.0% 17.0% 1.5% 16.3%
20.2% 20.2% 20.8% 21.6% 28.6% 28.3% 23.5% 10.4% 9.7% 9.8% 7.1% 4.6% 10.0% 3.0% 2.0% 16.0% 34.5% 17.0% 1.5% 13.6%
13.9% 13.9% 11.7% 12.3% 18.1% 17.7% 23.1% 10.2% 9.6% 9.7% 7.3% 4.8% 5.0% 3.0% 2.0% 16.0% 34.0% 17.0% 1.5% 12.4%
206
abc
KEC International Balance sheet (INRm) FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
Net assets
507 1,365 1,872 0 1,872 (3,325) (1) (3,326) 1,619 636 (1,071) 1,892 2,339 51 8 205 8 4,502 1,249 6,803 (4,147) (1,996) (3,102) 0 (21) (1,214) (136) (209) 0
1,872
507 2,213 2,720 0 2,720 (3,863) (1) (3,864) 1,717 214 (1,933) 1,871 2,205 18 44 206 5 4,350 1,506 9,041 (3,783) (2,248) (3,498) 0 (10) 1,008 (370) (335) 0
2,720
597 4,354 4,952 0 4,952 (5,906) (11) (5,918) 2,701 680 (2,536) 2,245 2,069 169 246 5 20 4,754 2,053 14,300 (7,567) (1,434) (3,605) 0 (28) 3,720 (540) (447) 0
4,952
493 5,087 5,581 0 5,581 (5,839) (379) (6,218) 2,121 1,411 (2,686) 3,099 1,937 504 0 0 76 5,615 2,258 18,662 (9,651) (2,850) (5,905) 907 (25) 3,396 (445) (298) 0
5,581
493 7,377 7,871 0 7,871 (7,755) (112) (7,867) 2,262 698 (4,908) 4,882 1,868 379 0 0 71 7,200 2,498 19,624 (9,568) (900) (6,708) 1,694 (37) 6,601 (562) (461) 0
7,871
493 9,068 9,562 0 9,562 (8,955) (112) (9,067) 2,262 719 (6,087) 6,117 1,777 379 0 0 71 8,344 3,096 23,998 (11,519) (1,200) (8,159) 2,160 (48) 8,327 (562) (461) 0
9,562
493 11,316 11,809 0 11,809 (8,955) (112) (9,067) 2,262 892 (5,914) 6,595 1,690 379 0 0 71 8,736 3,721 28,847 (13,847) (1,442) (9,808) 2,596 (58) 10,010 (562) (461) 0
11,809
493 14,010 14,504 0 14,504 (8,955) (112) (9,067) 2,262 1,968 (4,837) 6,903 1,608 379 0 0 71 8,961 4,239 32,862 (15,774) (1,643) (11,173) 2,958 (66) 11,403 (562) (461) 0
14,504
KEC International Key balance sheet ratios FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
57.2% 222.9% 1.57 3.23 2.29 0.60 4.03 2.11 2.80 na na na na na na na
71.1% 199.7% 1.71 3.00 3.70 0.78 4.98 1.88 2.37 115 40 175 (100) 0 (0) 5.3%
51.2% 124.0% 1.51 2.24 4.87 0.74 6.28 2.12 2.38 99 43 215 (158) 0 (0) 15.3%
48.1% 153.9% 1.48 2.54 2.79 0.68 6.19 1.93 2.30 111 36 218 (154) 11 (0) 10.9%
62.4% 147.6% 1.62 2.48 4.39 1.23 5.48 1.82 1.91 118 33 195 (126) 17 (0) 18.0%
63.7% 149.0% 1.64 2.49 3.50 1.24 5.71 1.82 1.90 127 34 203 (128) 18 (0) 19.3%
50.1% 133.1% 1.50 2.33 3.97 1.00 6.56 1.89 1.99 127 34 202 (127) 18 (0) 19.2%
33.4% 110.4% 1.33 2.10 4.50 0.73 7.28 1.95 2.05 124 33 197 (123) 18 (0) 18.8%
207
abc
KEC International Cash flow statement (INRm) EBITDA Adjusted for: Unrealized fx (gains)/losses Loss on sale of fixed assets Other non-cash exceptionals Change in working capital Tax paid Net financials Others Cash flow from operations FY06 1,627 FY07 2,525 FY08 3,546 FY09 3,016 FY10 4,069 FY11e 4,903 FY12e 5,922 FY13e 6,617
11 0 0 (404) (77) (580) 0 577 (385) 10 0 202 0 202 0 (1,226) 1 0 (1,024)
(136) 0 0 (2,213) (395) (601) (0) (819) (118) 6 0 (931) (51) (982) (1) 567 0 0 (416)
53 19 0 (2,669) (905) (663) (0) (619) (338) 16 0 (941) (197) (1,138) 0 1,470 (50) 0 282
377 3 0 1,010 (640) (1,032) (0) 2,735 (1,432) 37 0 1,340 (287) 1,053 0 (205) (149) 0 699
(431) 7 0 (2,519) (778) (864) (0) (517) (618) 30 0 (1,106) (285) (1,391) 0 551 0 0 (840)
0 0 0 (1,726) (1,105) (1,295) (85) 692 (1,540) 30 0 (818) (361) (1,179) 0 1,200 0 0 21
0 0 0 (1,683) (1,390) (1,389) (100) 1,360 (826) 30 0 564 (391) 173 0 0 0 0 173
0 0 0 (1,393) (1,605) (1,377) (100) 2,142 (675) 30 0 1,497 (421) 1,076 0 0 0 0 1,076
KEC International Key cash ratios FY06 FY08 FY08 FY09 FY10 FY11e FY12e FY13e
10.0% -2.3% 1.4 2.2% 42.5% 1.2% 1.2%
24.7% -10.8% 0.4 0.6% -37.4% -6.8% -7.2%
25.5% -9.5% 1.3 1.2% -18.8% -2.9% -3.5%
21.2% 2.9% 6.2 4.2% 98.2% 8.6% 6.7%
19.1% -6.4% 2.3 1.6% -13.6% -4.7% -5.9%
22.5% -3.7% 4.2 3.3% 15.3% -3.3% -4.7%
23.5% -3.0% 2.0 1.5% 24.7% 2.3% 0.7%
24.3% -2.2% 1.6 1.0% 34.6% 6.0% 4.3%
208
abc
KEC International Valuation FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
91 17,200 1,071 1,996 3,102 0 (205) 23,164 134% 283% 13.0 15.3 14.4 29.1 9.2 0.3% 1.2% 1.2% 12.7% 15.8% 31.6%
72 13,636 1,933 2,248 3,498 0 (206) 21,109 103% 195% 8.5 9.8 9.3 13.4 5.0 1.2% -6.8% -7.2% 13.6% 16.3% 37.4%
131 32,217 2,536 1,434 3,605 0 (5) 39,787 141% 300% 11.6 12.5 12.2 19.5 6.5 0.8% -2.9% -3.5% 16.2% 17.7% 33.4%
63 15,609 2,686 2,850 5,905 0 0 27,050 79% 152% 6.8 7.3 7.0 8.8 2.8 1.6% 8.6% 6.7% 14.2% 16.3% 31.9%
96 23,620 4,908 900 6,708 0 0 36,137 92% 169% 9.1 9.7 9.6 12.8 3.0 1.3% -4.7% -5.9% 11.3% 11.7% 23.4%
92 23,588 6,087 1,200 8,159 0 0 39,034 83% 150% 8.0 8.6 8.5 11.2 2.5 1.4% -3.5% -5.0% 11.5% 11.9% 22.0%
92 23,588 5,914 1,442 9,808 0 0 40,752 72% 136% 6.9 7.4 7.3 8.7 2.0 1.5% 2.4% 0.7% 12.2% 12.7% 22.9%
92 23,588 4,837 1,643 11,173 0 0 41,241 64% 124% 6.2 6.7 6.6 7.4 1.6 1.6% 6.3% 4.6% 12.5% 13.0% 21.9%
KEC International Profitability RoCE FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
Clean EBIT Add back: Return on cust adv Less: Associate/div income Assumptions: Return on cust adv Tax rate Operating return (OR) Post-tax OR Equity Deferred tax liability Provisions Debt Customer advances Banks acceptances Less: Cash & eqv Loans & advances Investment/associates Capital employed Pre-tax RoCE RoCE RoCE ex-cust adv
1,510 100 0 5.0% 35.5% 1,610 1,038 1,872 201 136 3,326 1,996 3,102 636 1,619 205 8,174 19.7% 12.7% 15.8%
2,148 112 0 5.0% 34.5% 2,261 1,480 2,720 290 370 3,864 2,248 3,498 214 1,717 206 10,853 20.8% 13.6% 16.3%
3,191 72 0 5.0% 34.3% 3,262 2,145 4,952 200 540 5,918 1,434 3,605 680 2,701 5 13,262 24.6% 16.2% 17.7%
3,727 143 0 5.0% 34.6% 3,869 2,530 5,581 298 445 6,218 2,850 5,905 1,411 2,121 0 17,766 21.8% 14.2% 16.3%
3,709 45 0 5.0% 35.3% 3,754 2,427 7,871 461 562 7,867 900 6,708 698 2,262 0 21,410 17.5% 11.3% 11.7%
4,537 60 0 5.0% 35.0% 4,597 2,988 9,562 461 562 9,067 1,200 8,159 719 2,262 0 26,030 17.7% 11.5% 11.9%
5,518 72 0 5.0% 34.5% 5,590 3,661 11,809 461 562 9,067 1,442 9,808 892 2,262 0 29,996 18.6% 12.2% 12.7%
6,197 82 0 5.0% 34.0% 6,279 4,144 14,504 461 562 9,067 1,643 11,173 1,968 2,262 0 33,180 18.9% 12.5% 13.0%
209
abc
ABB An expensive recovery story

ABB has seen significant erosion in its earnings power, driven by
deteriorating market position, pricing pressure and cost overruns. It also has the weakest returns among its peers
We forecast earnings CAGR of c60% (CY11-12e), driven by
recovery in domestic orders and improvement in operating costs, but even then the stock remains rich (c25% premium to peers)
We remain broadly in line with consensus on CY11; Underweight,
TP INR630
Recovery potential doesnt justify the current price

ABB has seen significant erosion in its margins (and hence earnings potential) over the last 4-5 years, driven primarily by declining revenues, pricing pressure and the cost of exiting non-core businesses, such as Rural Electrification (RE). The margins in the current financial year have taken a further hit from cost overruns on some large power system orders. The EBIT margins have come down to c1.6% in Q3 CY10 compared with c12.4% in CY07. While margins are likely to recover going into CY11 and CY12, as exit costs wind down and better margin order backlog starts feeding through into sales, we dont expect profitability to recover to the prerecessionary level of c12-13% (EBIT margins during CY07-08) any time soon (i.e. during CY11-13).
However, we remain positive on the demand outlook going into CY11-12 and we expect ABB to witness strong order growth of c20-25% in the next couple of years assuming that it will not lose market share from here on. This strong inflow of orders, coupled with an already strong order book, should drive a sales growth of c20-25% during CY11-12, in our opinion. But even in light of this recovery potential, ABB remains significantly expensive relative to its peers, whether we compare it on CY11e multiples (i.e. 12-month forward multiples) or CY13e multiples (i.e. 36m fwd multiples). Therefore, although we are cognizant of ABBs recovery potential, we continue to find the stock unjustifiably expensive. We highlight our bull and bear points related to ABB as follows:
210
abc
Bull points
Order book and order intake
Relatively strong order book visibility of c1.5 years Increasing focus on power products and the plan to make ABB India an outsourcing hub should drive growth in the future Balance sheet remains under-levered providing ability to grow acquisitively
Bear points
100,000 80,000 60,000 40,000 20,000 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Order book Order intake
Order intake remains sluggish due to the absence of any large order wins Overall presence with Power Grid continues to diminish Margins have eroded significantly and the visibility on recovery remains opaque Currently one of the weakest company in our universe on fundamentals, including return ratios and working capital management The stock remains rich relative to its peers
Order intake momentum likely to continue

The company highlighted in its Q3 FY10 press release that orders have now started to pick up. The improvement is largely driven by several large order wins in the power systems and the process automation segments. As highlighted in our End-market analysis section, we remain bullish on domestic transmission orders going into FY12 and FY13 and for companies which supply substation equipment, we expect order growth to be sustained well into FY13, before retreating in FY14. Therefore, we expect the power related orders to continue to improve at ABB as the company heads into CY11 and CY12. We also expect orders in the industrial segment (process automation & automation products) to pick up from the current level and witness a growth of c15% in CY11, driven by the revival in the industrial capex.
We believe that at this stage the bear case on ABB outweighs the bull points, which make the current share price look even more unjustified. We remain marginally ahead of consensus (c2-4%) on our FY10-12 sales and EBITDA estimates, but even then the stock looks expensive compared with its peers under our coverage. On our calendarised FY12 estimate, ABB is trading at c29.5x PE and c19.5x EV/EBITDA versus equipment manufacturing average of c24x and c14x, respectively.
Demand outlook likely to improve going into CY11

ABB has seen significant deterioration in its order inflow, driven largely by the absence of large orders in the power segment and muted capex recovery in the industrial segment.
Power Grid orders improving in the 765kV segment but overall situation remains grim
ABB has shown some improvement in its position with Power Grid on 765kV substation orders. The company has increased its share in this segment to c57% y-t-d FY11 from c11% in FY10.
211
abc
765kV substation market share (PGCIL orders)
765kV substation orders as % of total substation orders

60% 50% 40% 30% 20% 10%
60% 50% 40% 30% 20% 10% 0% FY09

Source: PGCIL, HSBC
FY10
YTD
0% FY09
Source: PGCIL, HSBC
FY10
YTD
While this improvement is definitely encouraging, we believe investors should not read too much into it, at least at this stage. This is because these orders are often large and lumpy and therefore market share in these orders can change substantially over the quarters. Moreover, these orders are a relatively small proportion of Power Grids total spend on transformers and substations, as we highlight below.
Substation orders as % of total orders by Power Grid
30% 25% 20% 15% 10% 5% 0% FY09 FY10 YTD
What is more important in our opinion is the fact that ABB has lost its share of transformer and substation orders in the 400/220kV segment (which is the biggest proportion of Power Grid substation capex) to its competitors Siemens and Areva T&D.
400/220kV substation orders as % of total substation orders
80% 70% 60% 50% 40% 30% 20% 10% 0% FY09 FY10 YTD
Source: PGCIL, HSBC
ABB 400/220kV substation market share
20%
Source: PGCIL, HSBC
15% 10% 5% 0% FY09 FY10 YTD
Source: PGCIL, HSBC
212
abc
Increasing focus on products to support growth in the future

At the end of 2007, ABB announced an additional USD100m investment plan to expand their manufacturing footprint in India. As part this plan, the company aimed to open a new greenfield facility at Neelamangla, Bangalore, to manufacture lowvoltage (LV) products and power electronics. The company also aimed at establishing a new manufacturing unit in Vadodara to manufacture small power transformers and distribution automation products. Apart from these greenfield investments, the group also aimed to double its production capacity for high-voltage (HV) breakers, instrument transformers and high-tension (HT) machines. The company also highlighted its intention to make ABB India a global sourcing hub for the group.
Capex as % of sales and depreciation
Margins likely to recover but visibility remain opaque

ABB has witnessed significant margin erosion over the last couple of years and its underlying clean EBIT margins have come down from a peak of c13.3% in FY07 to c9.5% in FY09.
Net sales and EBIT margin
80,000 60,000 40,000 20,000 FY06 FY07 FY08 FY09 FY10e
15.0% 10.0% 5.0% 0.0%
Net sales
Clean EBIT margin
8.0 6.0 4.0
5.0% 4.0% 3.0% 2.0%
The situation has worsened drastically this year and the company has struggled to remain profitable, reporting an EBIT margin of c1.6% in Q3 FY10. We believe margins have taken a particularly sharp hit this year because of:
Cost overruns on certain large power systems orders Significant price erosion (high single digit to
2.0 FY06 FY07 FY08 FY09 FY10e
1.0% 0.0%
Depreciation
Capex as % of sales
low double digit), particularly in the power segment

Revenue declines in the first nine months, particularly in the Power segment
We note that all of this capacity has now come on stream. In addition, the company has also set up a new wind power generator factory in Vadodara, Gujarat. Therefore, we believe that going forward, the company will benefit from its expanded product portfolio and increasing in-house demand for power products (as part of sourcing initiatives).
213
abc
Sales and EBIT margin
20,000 15,000 10,000 5,000 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Sales
10.0% 8.0% 6.0% 4.0% 2.0% 0.0%
We believe margins will likely recover going forward, as we expect:

Order intake and sales growth to pick up in
CY11 and CY12

Better margin orders to start feeding through to sales The exit cost from non-core businesses to diminish Pricing to stabilize
EBIT Margin
Furthermore, while the losses in the power systems business have trimmed down over the last three quarters, profitability has taken a hit at the power products and the process automation businesses and these segments have reported fresh losses, driven in our opinion by significant sales decline of c15-16% in Q3 FY10.
Segment sales growth
However, visibility remains opaque at this stage, with reasonable downside risk to our assumptions. Therefore, we believe the company needs to report a few quarters of sustainable improvement in margins to give credibility to the likely recovery.
Balance sheet remains strong but returns remain weak

Strong firepower with minimal financial risk
We note that ABBs balance sheet has grown c2.5x over the last five years and at c35% of equity, the company has the second highest net cash position in our coverage universe. We believe this is a key positive as it provides ABB with enough fire power to pursue acquisitions for future growth. Moreover, given that the company doesnt have any debt on its balance sheet, the financial risk (i.e. the inability to service debt) remains minimal even in the event of declining profitability (as is the case right now).
Equity and net cash
30,000 25,000 20,000 15,000 10,000 5,000 FY06 FY07 Equity
40.0% 20.0% 0.0% -20.0% -40.0% Q110

Power Systems Process Aut omation Low V olt age Product s
Q210
Power Products
Q310
Discrete Aut omat ion and M ot ion
Segment EBIT margin
20% 15% 10% 5% 0% -5% -10% -15% Q110

Power Systems Process Automat ion Low Voltage Products
Q210
Power Products
Q310
Discrete Aut omation and M otion
FY08 Net cash
FY09
FY10e
214
abc
Leverage and leverage including acceptances
RoCE -FY10
1.20 1.00 0.80 0.60 0.40 0.20 FY06 FY07 FY08 FY09 FY10e
35% 30% 25% 20% 15% 10% 5% 0%
ABB Ltd
T&D India
Crompton
Siemens
Greaves
Areva
India
Lev erage
Lev erage incl. acceptances
Returns have deteriorated significantly

ABB has seen significant deterioration in its return on capital employed (RoCE) over the last five years, driven largely by the declining profitability and reducing asset turns. Given that the companys leverage hasnt changed much during this time, the groups ROE has also taken a hit and we expect it to reach a low of c9.6% in the current financial year (FY10, December year-end). We note that ABB remains by far the weakest player among its peers on both these return measures.
ROE , Leverage including acceptances
ROE FY10
35% 30% 25% 20% 15% 10% 5% 0%

ABB Ltd
1.2 1.0 0.8 0.6 0.4 0.2 FY06 FY07 FY08 FY09 FY10e RoE
40% 30% 20% 10% 0%
Overall, we believe that volume recovery is the key to improvement in returns at ABB, as it will not only drive margins but will also lead to improving asset turns, which have been impacted by heavy capex and weaker volumes.
Working capital needs tight management

The trade working capital requirement has increased significantly at ABB from c1.4% of sales in FY06 to c13.4% of sales in FY09. Rising inventory levels, particularly work-in-progress and the increase receivables, are the key drivers of this deterioration.
T&D India
Crompton
Siemens
Greaves
Areva
India
Lev erage incl. acceptances

215
abc
Trade working capital (WC), inventories, receivables as % of sales
50% 40% 30% 20% 10% 0% FY06 Trade WC

FY07 Inv entories
FY08
FY09
As highlighted in our End-market analysis section, we expect domestic transmission markets to see significant order growth in FY12 and FY13. Therefore, assuming that ABB doesnt lose its market share further in these markets and the pricing environment stabilizes, we forecast order intake to grow at c25-30% in the power products and power systems segment in CY11-12. On the other hand, we expect industrial capex to recover from its lows and grow at double digits over the next couple of years. Hence, we forecast an order intake growth of c10-15% in the process automation and automation products segment in CY11-12. Overall, we forecast orders to grow at c20-25% during CY11-12. We further note that the order execution rate seems to have declined this year compared with previous years. Assuming that the execution levels remain broadly at current levels over the next few years, we forecast sales to grow at c8% during CY10 and c20-25% during CY11-12. In terms of profitability, as we have highlighted earlier in this chapter, we expect margins to recover going into CY11 and CY12, driven by increase in volumes and stabilization of prices. We forecast clean EBIT margin of c8.7% and c9.5% during CY11e and CY12e, respectively. We remain modestly ahead of consensus (c2-4%) on our CY10-11 Sales and EBITDA estimates. However, on our EPS estimates for the same period, we are c3-7% below consensus. This is largely because:
We are ahead of consensus on our D&A cost
Reciev ables
We believe that the work-in-progress situation should improve in the medium term as focus on products increase and large projects get executed; however, we remain cautious on the extended receivable days and believe that the company needs to either reduce them or compensate for them through increased payable days.
In line with consensus on CY10-11 sales and EBITDA

The order intake at ABB is largely driven by transmission capex and industrial capex. Within the transmission capex, the company has an equal bias to transmission products (transformers, reactors, etc) and transmission systems (substations etc). Within the industrial markets the company more or less has a similar presence in late cycle process industry and mid cycle industrial manufacturing. We highlight ABBs end market exposure on our estimates below.
End-market exposure
Power Distribution 5% Construction 6%
Transmission Intl 4% Transmission Domestic 47% Industrials 33% Oil & Gas 5% Others 0%
estimates and are forecasting the depreciation cost in Q4 to remain in line with previous quarters.
We are ahead of consensus in our estimate of total number of shares for CY10. We note
that our estimate is in line with the number of shares reported in the first three quarters.
216
abc
Overall, we forecast CY10e, CY11e and CY12e group sales of INR67bn, INR83bn and INR100bn, Clean EBITDA of INR4,197m, INR7,709m and INR10,128m and clean EPS of INR12.0, INR23.1 and INR30.7, respectively. We highlight our forecasts and the consensus estimates in the table below.

ABB Ltd - De c YE (INR m ) Order Backlog Ne t Sale s Clean EBITDA Re porte d EBITDA Clean EBIT Re porte d EBIT Other Income Net Financials Profit be fore tax Income tax Extraordinary items Minorities Clean Net Income Re porte d Ne t Incom e Clean EPS Re porte d EPS DPS FY09 84,787 62,372 6,382 5,832 5,897 5,347 0 (73) 5,274 (1,728) 0 0 3,916 3,546 18.5 16.7 2.0 Ne w Fore cas ts FY10e FY11e 108,665 67,047 4,197 4,197 3,702 3,702 0 (30) 3,671 (1,138) 0 0 2,533 2,533 12.0 12.0 2.0 137,607 82,746 7,709 7,709 7,168 7,168 0 246 7,414 (2,521) 0 0 4,894 4,894 23.1 23.1 2.2 FY12e 170,947 100,034 10,128 10,128 9,544 9,544 0 299 9,843 (3,346) 0 0 6,496 6,496 30.7 30.7 2.5 Bloom be rg Cons e ns us FY10e FY11e FY12e 66,149 81,139 95,717
4,104 3,925
7,733 7,365
9,839 9,340
2.3% -5.7%
-0.3% -2.7%
2.9% 2.2%
(64) 3,861
357 7,722
350 9,690
-4.9%
-4.0%
1.6%
2,663
5,065
6,420
-4.9%
-3.4%
1.2%
12.9 2.1
23.9 2.5
29.9 2.9
-7.3% -4.8%
-3.4% -12.0%
2.5% -13.8%
FY09 1.4 16% 10.2% 9.4% 9.5% 8.6% 8.5% 6.3% 5.7%
FY12e 1.7 21% 10.1% 10.1% 9.5% 9.5% 9.8% 6.5% 6.5%
6.2% 5.9% 5.8% 4.0%
9.5% 9.1% 9.5% 6.2%
10.3% 9.8% 10.1% 6.7%
5 (41) (36) (25)
(21) (41) (56) (33)
(16) (22) (28) (21)
Source: HSBC research, Thomson Reuters Datastream
217
abc
Benchmarking chart: ABB
Median = 5.0
Free cash flow Added v alue Capital Ex pentiture Return on capital Organic sales grow th Market position Customer div ersity Geographic div ersity Cy clical resilience Financial lev erage Net debt/EBITDA Interest cov er FCF y ield Free float (%) Div idend y ield Trading v olume (3m (1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
ABB scores poorly on fundamentals

Within our coverage universe, ABB has a relatively lower Q-ben score of 4.5 in our quality benchmarking analysis. The company has scored a below average (i.e. below 5.0/10) score on four out of five quality criteria, highlighting that the group needs to focus on its operational performance.
The company scored lowest on the equity structure criterion (1.7/10), driven largely by its low dividend yield and relatively small free float. Among operational criterions, the company scored lowest on market performance criterion (3.3/10), driven by its poor performance on growth and deteriorating market share. The company scored highest on the financial strength criterion (7.4/10) driven largely by its under-levered balance sheet.
Benchmarking chart
Median = 5.0
Balancing risk
(1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
218
abc

ABB Areva T&D
We further note that within these broad five criteria, we use 16 metrics to analyse the quality of the company and the underlying security. ABB received a below average score in eight out of these 16 metrics, making it one of the weakest companies in our coverage. We highlight the performance of the company on each of the criteria and each of the metrics in the bar charts on the previous page.
Poor quality does little justice to the valuation premium

As we highlight in the scatter charts, ABB lies on the far left of the vertical median line (the quality line) and far upwards of the horizontal median line (the valuation line). This implies that the stock is clearly overvalued in light of its quality relative to its other competitors. This also reinforces our view on the stock that although ABB is a restructuring story, its valuation premium remains excessive. Therefore, we continue to find ABBs valuation unjustified.

25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
Source: HSBC
ABB
12m fwd EV/EBITDA
Areva T&D
KEC
219
abc
The stock remains significantly expensive

In spite of significant deterioration in its earnings power, ABB continues to trade at a slight premium to its historical multiples. Based on consensus numbers, ABB is trading at a premium of c10% on both 12-month forward PE and EV/EBITDA compared with historical average.
PE vs history
PE vs ROE
50 40 30 20 10 0
40% 35% 30% 25% 20% 15% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 ABB Ltd 12m fw d RoE
50 40 30 20 10 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 ABB Ltd

EV/EBITDA vs RoCE
40 30 20 10 Historic av erage 0
110% 90% 70% 50% 30% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 ABB Ltd 12m fw d RoCE
EV/EBITDA vs history
40 30 20 10 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 ABB Ltd

Historic av erage
The discrepancy between the valuation and operational performance outlook becomes evident when we compare the return expectations (i.e. 12month forward ROE and RoCE) with the trading multiples (i.e. 12-month forward PE and EV/EBITDA).
The valuation looks even more unjustified when we look at the stock on an EV-to-sales multiple. We note that empirical evidence suggests that companies usually trades at c10-12x their EBIT margins on EV to sales. While ABB has historically shown decent correlation between this multiple and EBITDA margins a disconnect has emerged during 2010. Therefore, it seems that the stock has failed to factor in the deteriorating profitability.
220
abc
Absolute and relative performance
5.0 4.0 3.0 2.0 1.0 0.0 Jan05 Jan06 ABB Ltd Jan07 Jan08 Jan09 Jan10 Jan11
14.0% 13.0% 12.0% 11.0% 10.0% 9.0%
10% 5% 0% -5% -10% -15% -20% 1 w eek 1 mth 3 mths 6 mths 12 mths Relativ e performance
12m fw d EBITDA mgn
We further note that ABB is also the most expensive stock among its trade peers. On FY12e (calendarised to March year-end) consensus numbers, the stock is trading at c27x PE versus its trade peer group average of c18.5. Within our coverage universe also, ABB remains the most expensive stock. On our calendarised FY12 estimates, ABB is trading at c29.5x PE and c19.5x EV/EBITDA compared with its peer group (Siemens, Crompton & Areva T&D) average of c24x and c14x, respectively. Moreover, we highlight that ABB has outperformed the capital goods sector by c7% over the last one month, which in our opinion has done little to support valuation. Therefore, we continue to find ABBs valuation unjustified.
Underweight, TP INR630
We are UW on ABB with a target price of INR630, implying a potential return of -14%. We value ABB based on our preferred Economic Value Added (EVA) valuation methodology. Our valuation model assumes a WACC of c11.7%, sales growth of c9%, through cycle margin of c9.5% and a competitive advantage period (CAP) of 30 years. Our target price implies a 12-month forward target multiple of c21x PE and c14x EV/EBITDA compared with current 12-month forward multiple (on our estimates) of c32x PE and c21x EV/EBITDA.
221
abc
Valuation summary: ABB Key assumptions

We also highlight the sensitivity of our target price.

12m PT 628 6% 7% 8% 9% 10% 11% 12% 12m PT 628 9% 10% 11% 12% 13% 14% 15% WACC 12m PT 628 9% 10% 11% 12% 13% 14% 15% WACC Sales Growth 7% 291 313 336 358 380 403 425 Operating Re turn (OR) 8% 9% 10% 360 429 499 389 466 542 419 502 585 448 538 628 477 574 671 507 610 714 536 647 757 M argins 11% 568 618 668 718 768 818 868 12% 637 694 751 808 865 922 979 13% 707 771 834 898 962 1,026 1,089
Value of current op Trend sales Trend CE CE growth RoIC Trend OR Value of current op Value of future inv Incremental return Incremental cost EVA Value of future inv 12-month forward Implied market cap EV EV 12-month forward Net debt Customer advances Bankers acceptances
82,746 37,763 3.8% 22.8% 8,610 50,580
707 166 322 73,563
7% 556 477 413 358 315 277 244
Operating Re turn (OR) M argins 8% 9% 10% 11% 12% 677 797 918 1,038 1,159 586 694 802 911 1,019 512 610 709 807 906 448 538 718 808 628 399 482 566 649 733 355 432 510 588 665 317 389 462 534 607 Sales 8% 852 746 659 585 528 476 432 Grow th 9% 918 802 709 628 566 510 462
13% 1,279 1,128 1,004 898 816 743 679
124,143 138,724 (10,567) 8,619 7,757 0 (169) 133,083
6% 720 632 560 498 451 409 372
7% 786 689 610 542 489 442 402
10% 984 859 758 671 604 544 492
11% 1,050 916 808 714 642 578 522
12% 1,115 973 857 757 680 611 552

628
630
Under HSBCs research model, a non-volatile Indian stock with a potential return of 6-16% merits a Neutral rating. Our target price of INR630 implies a potential return of -14%; we therefore rate the shares Underweight. Our earlier target price (under the previous covering analyst) was based on MACC valuation methodology.
Key risks
We highlight key risks related to our investment case on ABB below:
Better-than-expected improvement in margins Significant increase in market share
222
abc
Company profile
ABB has historically had four key business segments power systems, power products, process automation and automation products. The company has recently carved out a fifth segment from the automation segments, called low voltage products. We briefly discuss each of these segments below.
services needed to ensure products performance and extend their lifespan.
Process automation
The main focus of this business is to provide customers with products and solutions for instrumentation, automation and optimization of industrial processes. The industries served include oil and gas, power, chemicals and pharmaceuticals, pulp and paper, metals and minerals, marine and turbocharging. Key customer benefits include improved asset productivity and energy savings.
Power systems
The segment offers turnkey systems and services for power transmission and distribution grids and power plants. The company offers solutions for substations, grid systems and power generation. Of the above three, the focus is on substations and substation automation systems. The company has exited the rural electrification business due to low margins. The revenue from this segment has not grown significantly in FY10 due to a slowdown in orders, increased credit risk, decision to exit rural electrification and requests from customers to defer supplies.
Power system services & key deliverables Services offered Substation offering Grid systems offering Key deliverables
Air and gas insulated substation Substation automation and protection Substation automation services HVDC FACTS series compensation FACTS shunt compensation Consulting & service Plant electrical systems Plant automation systems System integration Life cycle management
Automation products
This division provides products, solutions and related services that increase industrial productivity and energy efficiency. Its motors, generators, drives, programmable logic controllers (PLCs), power electronics and robotics provide power, motion and control for a wide range of automation applications. The leading position in wind generators and a growing offering in solar complement the industrial focus, leveraging joint technology, channels and operation platforms.
Low voltage products

The low voltage products division manufactures low-voltage circuit breakers, switches, control products, wiring accessories, enclosures and improving industrial productivity cable systems to protect people, installations and electronic equipment from electrical overload. The division further makes KNX systems that integrate and automate a buildings electrical installations, ventilation systems and security and data communication networks.
Power generation offering
Power products
Power products are the key components to transmit and distribute electricity. The division incorporates the ABB manufacturing network for transformers, switchgear, circuit breakers, cables and associated equipment. It also offers all the
223
abc
ABB
Sales, order book and EBITDA margin Segment exposure
200000 150000 100000
15% 12% 9% 6%
Automation Products 27%
Others 1%
Power Systems 25%
50000 0
3% 0%
FY10e
FY11e
FY12e
FY07
FY08
FY09
Process Automation 18%

Power Products 29%
Sales
Order Book
EBIDTA Margins
Geographic exposure
End-market exposure
Power Distribution 5% Construction 6%
India 90% Europe 1% North America 1% RoW 8%

Transmission Intl 4% Transmission Domestic 47% Industrials 33% Oil & Gas 5% Others 0%
EPS vs DPS
40 30 20 10 0 FY06 FY07 FY08 FY09 FY10e FY11e FY12e EPS

3.0 2.5 2.0 1.5 1.0 0.5 -
6% 4% 2% 0% -2% -4% -6% FY06 FY07 FY08 FY09 FY10e FY11e FY12e Capex /Sales
DPS
FCF/Sales
224
abc
Financials & valuation: ABB India

Financial statements Year to 12/2009a 12/2010e 12/2011e 12/2012e Valuation data Year to 12/2009a 12/2010e
Underweight
12/2011e 12/2012e
62,372 6,382 -485 5,897 -73 5,274 5,824 -1,728 3,546 3,916
67,047 4,197 -495 3,702 -30 3,671 3,671 -1,138 2,533 2,533
82,746 7,709 -541 7,168 246 7,414 7,414 -2,521 4,894 4,894
100,034 10,128 -584 9,544 299 9,843 9,843 -3,346 6,496 6,496
2.2 21.4 4.6 34.0 5.5 1.4 0.3
2.4 38.2 5.1 61.7 5.9 0.8 0.3
1.9 21.0 4.3 31.9 5.1 1.2 0.3
1.6 16.1 3.7 24.0 4.3 2.1 0.3
Issuer information
Share price (INR) 3,484 -1,619 -1,619 -544 -1,759 1,864 2,455 -1,230 -1,230 -496 -730 1,225 3,145 -1,230 -1,230 -496 -1,419 1,915 4,559 -1,230 -1,230 -545 -2,783 3,329
737.00 Target price (INR) ABB.BO 3,430 16 India Rahul Garg
-14
Bloomberg (Equity) ABB IN Market cap (INRm) 156,176 Enterprise value (INRm) 146,860 Sector Electrical Equipment Contact +91 22 22681245
Price relative
107 7,787 47,493 8,418 55,557 29,869 0 -8,418 24,237 29,466
123 8,507 51,401 9,148 60,201 32,476 0 -9,148 26,275 31,677
134 9,185 62,714 10,567 72,203 40,080 0 -10,567 30,672 37,763
143 9,822 76,393 13,351 86,528 48,454 0 -13,351 36,623 44,352
977 877 777 677 577 477 377 277 2009

ABB India
977 877 777 677 577 477 377 277 2010 2011 2012
Source: HSBC

Ratios (%)
-8.8 -23.7 -26.2 -36.7 -23.5
7.5 -34.2 -37.2 -30.4 -35.3
23.4 83.7 93.6 102.0 93.2
20.9 31.4 33.1 32.7 32.7
2.1 14.2 16.2 6.8 10.2 9.5 87.5 -34.7 -1.3
2.1 8.8 9.6 4.4 6.3 5.5 137.9 -34.8 -2.2
2.2 13.3 16.0 7.4 9.3 8.7 -34.5 -1.4
2.3 15.0 17.7 8.2 10.1 9.5 -36.5 -1.3
16.74 18.48 2.00 114.38
11.95 11.95 2.00 123.99
23.09 23.09 2.20 144.74
30.66 30.66 2.50 172.82
225
abc
ABB Income statement (INRm) FY06 FY07 FY08 FY09 FY10e FY11e FY12e
42,740 (31,445) 11,295 (2,414) (4,113) 513 5,280 (50) 5,330 (265) 5,015 5,065 8 7 0 217 (7) 0 5,232 5,275 (1,829) 0 3,403 0 0 3,403 3,431 211.9 16.1 16.2
59,303 (42,920) 16,383 (3,061) (6,076) 433 7,679 (551) 8,230 (324) 7,355 7,906 0 0 0 277 (68) 0 7,565 8,116 (2,648) 0 4,917 0 0 4,917 5,275 211.9 23.2 24.9
68,370 (49,504) 18,866 (4,030) (7,095) 1,093 8,835 475 8,360 (367) 8,468 7,994 70 70 0 141 (347) 0 8,332 7,788 (2,858) 0 5,474 0 0 5,474 5,117 211.9 25.8 24.1
62,372 (45,179) 17,193 (3,892) (8,011) 542 5,832 (550) 6,382 (485) 5,347 5,897 0 0 0 183 (256) 0 5,274 5,824 (1,728) 0 3,546 0 0 3,546 3,916 211.9 16.7 18.5
67,047 (48,820) 18,228 (4,924) (9,778) 670 4,197 0 4,197 (495) 3,702 3,702 0 0 0 220 (250) 0 3,671 3,671 (1,138) 0 2,533 0 0 2,533 2,533 211.9 12.0 12.0
82,746 (62,072) 20,674 (5,173) (8,619) 827 7,709 0 7,709 (541) 7,168 7,168 0 0 0 246 0 0 7,414 7,414 (2,521) 0 4,894 0 0 4,894 4,894 211.9 23.1 23.1
100,034 (75,052) 24,982 (5,435) (10,420) 1,000 10,128 0 10,128 (584) 9,544 9,544 0 0 0 299 0 0 9,843 9,843 (3,346) 0 6,496 0 0 6,496 6,496 211.9 30.7 30.7
ABB Margin & trend analysis FY06 FY07 FY08 FY09 FY10e FY11e FY12e
38.8% 38.6% 54.4% 46.7% 44.5% 53.7% 27.6% 13.9% 13.3% 13.8% 12.8% 8.3% 6.7% 18.8% 3.4% na 35.0% 17.0% 7.1% 9.5%
15.3% 15.0% 1.6% 15.1% 11.3% -3.0% 27.6% 12.2% 11.7% 12.1% 12.2% 8.0% 17.4% 12.2% 1.7% na 34.3% 17.0% 6.9% 8.5%
-8.8% -11.5% -23.7% -36.9% -35.2% -23.5% 27.6% 10.2% 9.5% 10.0% 8.5% 5.7% -4.2% 0.8% 2.4% na 32.8% 17.0% 4.0% 12.0%
7.5% 7.5% -34.2% -30.8% -28.6% -35.3% 27.2% 6.3% 5.5% 6.0% 5.5% 3.8% 10.0% 15.0% 2.5% na 31.0% 17.0% 4.0% 16.7%
23.4% 23.4% 83.7% 93.6% 93.2% 93.2% 25.0% 9.3% 8.7% 9.2% 9.0% 5.9% 2.0% 3.0% 2.5% na 34.0% 17.0% 4.0% 9.5%
20.9% 20.9% 31.4% 33.1% 32.7% 32.7% 25.0% 10.1% 9.5% 10.1% 9.8% 6.5% 2.0% 3.0% 2.5% na 34.0% 17.0% 4.0% 8.2%
226
abc
ABB Balance Sheet (INR m) FY06 FY07 FY08 FY09 FY10e FY11e FY12e
Net assets
424 11,535 11,958 0 11,958 0 (15) (15) 1,778 5,464 7,227 2,932 140 246 0 774 0 4,091 3,547 15,703 (10,706) (2,888) (5,027) 1,474 (743) 1,361 (556) (165) 0
11,958
424 15,840 16,263 0 16,263 0 (6) (6) 2,802 6,429 9,225 3,382 137 1,059 0 705 0 5,283 4,887 24,236 (15,693) (5,016) (7,009) 2,754 (1,596) 2,561 (678) (128) 0
16,263
424 20,766 21,190 0 21,190 0 (0) (0) 3,518 3,482 7,000 5,350 109 1,375 0 611 0 7,445 6,427 29,759 (16,501) (5,778) (7,268) 3,813 (2,073) 8,379 (1,596) (38) 0
21,190
424 23,814 24,237 0 24,237 0 0 0 3,177 5,241 8,418 6,624 107 1,163 1 169 0 8,064 7,294 28,577 (14,784) (6,534) (5,832) 3,203 (2,719) 9,205 (1,450) 0 0
24,237
424 25,851 26,275 0 26,275 0 0 0 3,177 5,971 9,148 7,344 123 1,163 1 169 0 8,800 8,032 30,730 (16,063) (6,984) (6,286) 3,492 (3,143) 9,778 (1,450) 0 0
26,275
424 30,249 30,672 0 30,672 0 0 0 3,177 7,390 10,567 8,021 134 1,163 1 169 0 9,489 9,912 37,925 (19,825) (8,619) (7,757) 4,310 (3,879) 12,067 (1,450) 0 0
30,672
424 36,199 36,623 0 36,623 0 0 0 3,177 10,174 13,351 8,659 143 1,163 1 169 0 10,135 11,983 45,849 (23,967) (10,420) (9,378) 5,210 (4,689) 14,588 (1,450) 0 0
36,623
ABB Key balance sheet ratios FY06 FY07 FY08 FY09 FY10e FY11e FY12e
Source: Company, HSBC Estimates
-60.4% -18.4% 0.40 0.82 (23.95) (1.36) 12.88 3.39 4.40 na na na na na na na
-56.7% -13.6% 0.43 0.86 (35.21) (1.12) 12.95 3.09 4.19 76 48 173 (154) 20 (11) 5.0%
-33.0% 1.3% 0.67 1.01 41.22 (0.84) 10.01 2.42 3.04 101 51 170 (130) 22 (12) 13.1%
-34.7% -10.7% 0.65 0.89 73.30 (1.32) 7.90 2.12 2.72 105 56 160 (114) 18 (15) 14.1%
-34.8% -10.9% 0.65 0.89 121.67 (2.18) 7.77 2.12 2.72 113 62 173 (125) 20 (18) 15.1%
-34.5% -9.2% 0.66 0.91 (29.09) (1.37) 8.88 2.19 2.84 122 65 185 (131) 21 (19) 16.1%
-36.5% -10.8% 0.64 0.89 (31.92) (1.32) 10.04 2.26 2.95 121 64 183 (128) 21 (19) 16.0%
227
abc
ABB Cash flow statement (INRm) EBITDA Adjusted for: Unrealized fx (gains)/losses Loss on sale of fixed assets Other non-cash exceptionals Change in working capital Tax paid Net financials Others Cash flow from operations FY06 5,280 FY07 7,679 FY08 8,835 FY09 5,832 FY10e 4,197 FY11e 7,709 FY12e 10,128
0 0 4 (984) (1,846) 201 0 2,654 (933) 33 0 1,754 (385) 1,369 98 (12) 0 0 1,455
0 0 (0) (2,245) (2,759) 193 0 2,869 (1,489) 20 0 1,400 (495) 905 69 (10) 0 0 964
0 0 225 (6,484) (2,378) (71) 0 126 (2,721) 82 0 (2,513) (544) (3,058) 117 (5) 0 0 (2,946)
0 73 (77) 403 (2,687) (61) 0 3,484 (1,633) 13 0 1,864 (544) 1,320 439 (0) 0 0 1,759
0 0 0 (573) (1,138) (30) 0 2,455 (1,250) 20 0 1,225 (496) 730 0 0 0 0 730
0 0 0 (2,289) (2,521) 246 0 3,145 (1,250) 20 0 1,915 (496) 1,419 0 0 0 0 1,419
0 0 0 (2,521) (3,346) 299 0 4,559 (1,250) 20 0 3,329 (545) 2,783 0 0 0 0 2,783
ABB Key cash ratios FY06 FY08 FY08 FY09 FY10e FY11e FY12e
35.0% -2.3% 3.5 2.2% 52.9% 1.5% 1.1%
35.9% -3.8% 4.6 2.5% 39.0% 0.6% 0.4%
26.9% -9.5% 7.4 4.0% 1.5% -1.3% -1.6%
46.1% 0.6% 3.4 2.6% 65.2% 1.4% 1.0%
27.1% -0.9% 2.5 1.9% 66.3% 0.7% 0.4%
32.7% -2.8% 2.3 1.5% 43.9% 1.1% 0.8%
33.0% -2.5% 2.1 1.2% 47.8% 1.9% 1.6%
228
abc
ABB Valuation FY06 FY07 FY08 FY09 FY10e FY11e FY12e
568 120,430 (7,227) 2,888 5,027 0 (774) 120,344 282% 956% 22.6 23.8 23.1 35.1 10.1 0.4% 1.5% 1.1% 26.9% 33.9% 28.7%
1,059 224,434 (9,225) 5,016 7,009 0 (705) 226,531 382% 1182% 27.5 28.7 27.8 42.5 13.8 0.2% 0.6% 0.4% 27.7% 36.3% 32.4%
917 194,231 (7,000) 5,778 7,268 0 (611) 199,666 292% 707% 23.9 25.0 24.1 38.0 9.2 0.2% -1.3% -1.6% 19.3% 23.4% 24.1%
628 133,085 (8,418) 6,534 5,832 0 (169) 136,864 219% 464% 21.4 23.2 22.0 34.0 5.5 0.3% 1.4% 1.0% 14.2% 17.3% 16.2%
737 156,272 (9,148) 6,984 6,286 0 (169) 160,225 239% 506% 38.2 43.3 39.6 61.7 5.9 0.3% 0.8% 0.5% 8.8% 10.3% 9.6%
737 156,272 (10,567) 8,619 7,757 0 (169) 161,913 196% 429% 21.0 22.6 21.3 31.9 5.1 0.3% 1.2% 0.9% 13.3% 16.2% 16.0%
737 156,272 (13,351) 10,420 9,378 0 (169) 162,551 162% 367% 16.1 17.0 16.2 24.1 4.3 0.3% 2.1% 1.8% 15.0% 18.6% 17.7%
ABB Profitability RoCE FY06 FY07 FY08 FY09 FY10e FY11e FY12e
5,065 144 0 5.0% 35.0% 5,209 3,388 11,958 165 556 15 2,888 5,027 5,464 1,778 774 12,593 41.4% 26.9% 33.9%
7,906 251 0 5.0% 35.0% 8,157 5,302 16,263 128 678 6 5,016 7,009 6,429 2,802 705 19,166 42.6% 27.7% 36.3%
7,994 289 0 5.0% 34.3% 8,282 5,441 21,190 38 1,596 0 5,778 7,268 3,482 3,518 611 28,259 29.3% 19.3% 23.4%
5,897 327 0 5.0% 32.8% 6,224 4,185 24,237 (1) 1,450 0 6,534 5,832 5,241 3,177 169 29,466 21.1% 14.2% 17.3%
3,702 349 0 5.0% 31.0% 4,051 2,795 26,275 (1) 1,450 0 6,984 6,286 5,971 3,177 169 31,677 12.8% 8.8% 10.3%
7,168 431 0 5.0% 34.0% 7,599 5,015 30,672 (1) 1,450 0 8,619 7,757 7,390 3,177 169 37,763 20.1% 13.3% 16.2%
9,544 521 0 5.0% 34.0% 10,065 6,643 36,623 (1) 1,450 0 10,420 9,378 10,174 3,177 169 44,352 22.7% 15.0% 18.6%
229
abc
Areva T&D Likely recovery seems priced in

Earnings poised for recovery, driven by domestic transmission
growth & improving position with Power Grid. Margins should also recover as deliveries pick up and pricing stabilizes
We are c9% ahead of CY11 consensus and believe there is
significant upside risk to our estimates (particularly on margins); therefore, we find Arevas valuation (c27x FY12e PE vs peer group average of c24x) somewhat justified
We initiate with a Neutral and a TP of INR340
Turnaround likely but visibility remains opaque

Areva T&D has seen significant deterioration in its earnings over the last couple of years, driven largely by declining margins. We note that Areva reported flat EPS growth in CY08 and c20% decline in EPS in CY09 in spite of c30-35% sales growth during these years. We believe earnings have suffered due to a change in sales mix (increasing content of substation packages versus standalone products such as transformers or reactors), increasing pricing pressure and operational inefficiencies leading to a margin decline of c700bp during FY08 and FY09. However, management has rationalized their manufacturing processes and tried to reduce exposure to lower margin offerings such as rural electrification (RE) and low voltage products. The company has also built the necessary capacity and experience to produce 765kV transformers
domestically. In addition, the company seems to have consolidated its position with Power Grid during the current financial year (FY11, December year-end) and hence we remain positive on the earnings outlook going forward. Management has highlighted that margins can go back to low-to-mid teen levels by CY12; however, we remain cautious in our estimates at this stage and need more visibility before we factor in that kind of recovery potential. We highlight the key bull and bear points related to Areva T&D below:
Bull points
Highly geared to the domestic transmission
markets
Market position recovering with Power Grid EBITDA margins have picked up sharply
from the lows of Q1 CY10
230
abc
A potential separation of the T & D business during CY11 will strengthen the balance sheet
and profitability
Impending assets sale likely to reduce debt
burden
Bear points
Order book visibility remains weakest among
year and the total orders awarded by Power Grid in 2010 were down by c10%. In that context, it doesnt seem the company has underperformed the market in terms of growth. However, we expect order awards by the Power Grid and the SEBs to pick up going further into 2011, driven largely by the 11th plan spillover and the high capacity corridors (HCPTCs) orders.
Order intake and order backlog
its closest peers, ABB and Siemens

Order intake has remained sluggish in the first
60,000 50,000 40,000 30,000 20,000 10,000 -
nine months of CY10

The company doesnt stand out on fundamentals Valuation looks expensive at this stage
Q109
Q110
Q209
Q309
Q409
Q210
Although we remain more cautious than management on profitability, we are nonetheless ahead of consensus by c100-200bp on our CY1012e EBITDA margin estimates. This has driven our CY10-11 net income estimates c9% ahead of consensus. However, we note that if the management delivers on margin improvement, then there remains significant upside to even our estimates. However, the valuation looks full at this stage with stock trading at c29x CY11e PE. On our calendarised FY12 estimates, the stock is trading at c27x PE and c14x EV/EBITDA compared with its peer group (ABB, Siemens & Crompton) average of c24x and c14x, respectively. Therefore we initiate coverage of Areva T&D with a Neutral rating and a target price of INR340, implying c11% potential return.
Order intake
Order backlog
Moreover, the current order book visibility at Areva of c1.1 years is low relative to its peers, such as ABB and Siemens, which both have order books extending up to 1.5 years.
Position with Power Grid improves

The silver lining for Areva is that it has somewhat improved its position with Power Grid (PG) during FY11 compared with FY10. It has emerged as the No. 2 vendor in the 765kV substation segment (c41% share of PG orders) and No. 3 vendor in the 400/220kV transformer segment (c16% share of PG orders).
Orders remain sluggish

Market position improving but order visibility remains weak
Arevas order intake has remained flat in the first 9m of CY10 compared with the same period last year. We note that ordering has been slow this
Q310
231
abc
Areva market share 765kV substation orders PGCIL
Substation and transformer orders as % of total PGCIL orders
50% 30% 40% 30% 20% 10% 0% FY09 FY10 YTD FY11 Substation
Source: PGCIL, HSBC Source: PGCIL, HSBC
25% 20% 15% 10% 5% 0% FY09 FY10 Transformers YTD FY11
Areva market share 400/220kV transformer
20% 15%
400/220kV substation orders as % total PGCIL substation orders
80% 60% 10% 40% 5% 20% 0% FY09 FY10 YTD FY11 0% FY09
Source: PGCIL, HSBC Source: PGCIL, HSBC
FY10
YTD FY11
However, the bad news is that Areva has not been able to win many orders in the 400/220kV substation segment, which has seen the most orders in FY11.
Areva market share in 400.220kV substation segment
30% 25% 20% 15% 10% 5% 0% FY09 FY10 YTD FY11
Source: PGCIL, HSBC
Furthermore, in the 765kV transformer segment, only one order has been awarded (to Hyosung) by the Power Grid and therefore Areva has not received any orders for this product.
232
abc
Areva remains highly geared to domestic transmission growth

Areva remains highly geared to domestic transmission markets relative to its peers, with an exposure of c60%. Given that we are particularly bullish on domestic transmission growth, we believe that Areva is better placed than its peers to capture this growth.
Sales & clean EBITDA margin
40000 30000 20000 10000 0 FY06 Sales

21% 18% 15% 12% 9% 6% 3% 0% FY07 FY08 FY09
EBIDTA Margins
70% 60% 50% 40% 30% 20% 10% 0% ABB Arev a Crompton Siemens
However, management has highlighted that the pricing environment is stabilizing and margins should improve from here on as deliveries pick up and rationalization benefits feed through. Encouragingly, the company has reported a sharp improvement in its profitability over the last two quarters compared with the lows of Q1 CY10.
Sales & EBITDA margin
We further note that management has recently announced that the transmission and the distribution businesses will be separated during CY11. Areva T&D has c25% exposure to the distribution business and therefore once that business is sold off, the companys exposure to domestic transmission markets should increase significantly to c80%, making it the biggest beneficiary of the domestic growth among its peers.
40,000 30,000 20,000 10,000 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Sales
15% 10% 5% 0%
EBITDA margin
Margins likely to improve going forward

As we have noted earlier, Areva T&D has seen a big 700bp decline in its EBITDA margins from the peak of CY07. Management highlighted that the margin decline has been largely driven by falling prices, which have come down by c2025% since then. We believe margins have also somewhat deteriorated due to change in sales mix i.e. due to increasing content systems versus products in the top line.
Moreover, as we have highlighted earlier, the distribution business will be separated from Areva T&D during CY11. We believe that the distribution business will be taken by Schneider Electric (in accordance with the global acquisition) and Areva T&D will receive cash based on an independent valuation of the distribution business. This, in our opinion, will result in a step change in the companys profitability as we believe that the margin
233
abc
differential between the distribution and the transmission business is c500-600bp. In addition to this, the impending asset sales, in our opinion, should significantly reduce the groups debt burden, thereby improving net income margins. Overall, we forecast EBITDA margins to improve by c100bp in CY11e and c90bp in CY12e.
Sales & EBITDA margin
60000 50000 40000 30000 20000 10000 0 FY06 FY07 FY08 FY09 FY10eFY11eFY12e Sales
21% 18% 15% 12% 9% 6% 3% 0%
c8% ahead of consensus on our CY10-11 estimates

As highlighted in our End-market analysis section, we expect domestic transmission orders to pick up going into FY12 and FY13. This, as we have explained, is largely driven by orders related to 11th plan spillover and the nine high capacity corridors (HCPTCs). Given that Areva is highly geared to the domestic transmission markets, we expect this growth to feed through into Arevas orders. Therefore, we forecast order intake at Areva to grow by c20-25% during CY11-12.
Order intake and order book
EBIDTA Margins
We remain c7-8% ahead of consensus on our CY10-11 net income estimates and c15% ahead of consensus on our CY12 net income estimates. Our higher than consensus numbers are largely driven by our more bullish view on margins where we are c100-200bp ahead of consensus on our CY1012 EBITDA margin estimates. We note that consensus EPS estimates seem erratic to us, as consensus has assumed a continuous increase in the number of shares from c213m in CY10 to c251m in CY12. We dont agree with consensus estimates on this and we have taken the last reported number of shares (c239.1m) for our CY10-12e EPS calculations. Overall, we forecast CY10, CY11 and CY12 Sales of cINR41bn, cINR47bn and cINR55bn, clean EBITDA of cINR4.4bn, cINR5.5bn and cINR7.0bn and clean EPS of INR7.9, INR10.6 and INR14.5. We highlight our forecasts and the consensus estimates in the table on the following page.
80,000 60,000 40,000 20,000 FY07 FY08 FY09 FY10e FY11e FY12e
Order intake
Order backlog
Assuming the execution rate improves (driven by the incremental capacity), we forecast sales to grow c14% in CY11 and c18% in CY12. In terms of profitability, as we highlighted earlier, we expect EBITDA margins to improve by c190bp over the next two years, driven by volumes and rationalization benefits.
234
abc

Are va T&D India - De c YE (INR m ) Order Backlog Ne t Sale s Clean EBITDA Re porte d EBITDA Clean EBIT Re porte d EBIT Other Income Net Financials Profit be fore tax Income tax Extraordinary items Minorities Clean Net Income Re porte d Ne t Incom e Clean EPS Re porte d EPS DPS FY09 47,717 35,659 4,183 4,188 3,572 3,577 (68) (579) 2,930 (1,010) 0 0 1,961 1,920 8.2 8.0 1.8 Ne w Fore cas ts FY10e FY11e 50,103 40,973 4,391 4,391 3,445 3,445 (240) (551) 2,654 (929) 0 0 1,881 1,725 7.9 7.2 1.8 57,232 46,803 5,479 5,479 4,519 4,519 (100) (554) 3,865 (1,391) 0 0 2,538 2,474 10.6 10.3 2.0 FY12e 67,675 55,343 6,979 6,979 5,964 5,964 (100) (549) 5,315 (1,913) 0 0 3,465 3,401 14.5 14.2 2.2 Bloom be rg Cons e ns us FY10e FY11e FY12e 43,122 47,658 57,665
HSBC vs. Consensus FY10e -5.0% FY11e -1.8% FY12e -4.0%
4,057 3,198
5,191 4,330
6,217 5,158
8.2% 7.7%
5.6% 4.4%
12.3% 15.6%
(629) 2,569
(636) 3,694
n/a 4,465
3.3%
4.6%
19.0%
1,599 213.2 7.5 1.7
2,310 243.2 9.5 1.9
2,963 251.1 11.8 1.9
7.9%
7.1%
14.8%
-3.8% 5.9%
8.9% 5.3%
20.6% 15.8%
FY09 1.3 16% 11.7% 11.7% 10.0% 10.0% 8.2% 5.5% 5.4%
FY12e 1.2 18% 12.6% 12.6% 10.8% 10.8% 9.6% 6.3% 6.1%
HSBC vs. Consensus FY10e FY11e FY12e -6.0% 3.7% -2.8%
9.4% 7.4% 6.0% 3.7%
10.9% 9.1% 7.8% 4.8%
10.8% n/a 7.7% 5.1%
131 99 52 50
81 57 51 44
183 n/a 186 101
Source: HSBC research, Thomson Reuters Datastream
235
abc
Benchmarking chart: Areva
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
The company remains average on fundamentals

Areva T&D has a Q-ben score of 4.9/10 in our quality benchmarking analysis, putting it in the middle of our coverage universes quality ladder. The company has high scores (more than 6.0/10) on the market performance and the financial strength criteria but low scores (less than 4.0/10) on balancing risk and equity structure criteria. While the high scores are largely driven by the companys strong market position and robust
sales growth record, the low scores are largely driven by the companys concentration in the T&D markets. Overall, there are no red flags as far as the companys quality is concerned, and it stacks up decently on most of the key metrics, such as RoCE, sales growth, market position and financial strength. We believe Arevas poor score on customer diversity is in fact good for the company at this stage as it makes the company a bigger beneficiary of the domestic transmission growth.
Benchmarking chart: Areva
Median = 5.0
Balancing risk
(1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
236
abc

ABB Areva T&D
We highlight the performance of the company on each of the criteria and each of the metrics in the bar charts.
company is trading at a much higher multiple than what could be justified by the overall quality of its business relative to the peer group.
Average quality doesnt justify valuation premium

As we highlight in the scatter charts, Areva remains to the left of the median vertical line (the quality line) but significantly above the horizontal median line (the valuation line). This implies that even though the company can be seen as a restructuring story at this stage, the recovery is already priced into the stock. This is because the
Valuation appears rich

Areva T&D looks rich on valuation at this stage compared with its history or its peer group on consensus numbers.

25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
ABB
12m fwd EV/EBITDA
Areva T&D
KEC
237
abc
PE vs history
60 50 40 30 20 10 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Arev a T&D India
of Areva T&D with a Neutral and a target price of INR360, which offers a potential return of c10%. We value Areva based on our preferred Economic Value Added (EVA) valuation methodology. Our valuation model assumes a WACC of c11.3%, sales growth of c9%, through cycle margin of c11% and a competitive advantage period (CAP) of 30 years. Our target price implies a 12-month forward target multiple of c23.5x PE and c12.8x EV/EBITDA compared with current 12-month forward multiple (on our estimates) of c29x PE and c15x EV/EBITDA.
Valuation summary: Areva (INRm) Key assumptions
Historic av erage
However, we believe that there remains significant upside to consensus numbers as the market is very pessimistic on margins. However, we believe that as the distribution business goes off and as order inflows pick up, margins may surprise significantly on the upside.
20.0% 18.0% 16.0% 14.0% 12.0% 10.0%
Target sales growth Target OR margin Target asset turn Tax rate WACC CAP
Value of current op Trend sales Trend CE CE growth RoIC Trend OR Value of current op Value of future inv Incremental return
9.0% 11.0% 2.3 35% 11.3% 30.0 46,803 20,858 3.9% 25.3% 5,277 30,411 463 92 209 49,983 80,394 89,462 1,566 6,338 98 0 (0) 81,460 INR341 INR340
Arev a T&D India

12m fw d EBITDA mgn
Incremental cost EVA Value of future inv

12-month forward Implied market cap EV EV 12-month forward Net debt Customer advances Bankers acceptances
On our calendarised FY12 estimates, Areva is trading at c27x PE and c14x EV/EBITDA compared with its peer group average of c24x and c14x, respectively.
We initiate with a Neutral and a TP of INR340

Although Arevas valuation remains rich relative to its peers, we believe that a significant possibility of earnings surprise should continue to support the stock. Therefore, we initiate coverage

238
abc

12m PT 341 6% 7% 8% 9% 10% 11% 12% Sales Growth 12m PT 341 8% 9% 10% 11% 12% 13% 14% WACC 12m PT 341 8% 9% 10% 11% 12% 13% 14% WACC 8% 164 179 195 211 226 242 258 Operating Re turn (OR) 9% 10% 11% 197 230 263 216 252 289 235 275 315 254 297 341 273 320 367 292 342 392 311 365 418 Operating Re turn (OR) 9% 10% 11% 390 448 507 335 387 439 290 337 385 254 297 341 223 262 302 197 234 270 174 209 243 Sales 8% 467 405 355 315 280 250 225 Grow th 9% 507 439 385 341 302 270 243 M argins 12% 296 326 355 384 413 442 472 M argins 12% 565 491 432 384 342 307 277 13% 329 362 395 427 460 493 525 14% 363 399 435 471 507 543 579
Key risks
We highlight some of the key risks related to our investment case on Areva T&D below:
Downside risk: International competition in
the T&D equipment market

Downside risk: Worse than expected improvement in operational performance Downside risk: Under-valuation of the distribution business during the break up of
8% 331 282 243 211 183 160 140
13% 623 544 479 427 382 344 312
14% 682 596 527 471 422 381 346
the T and D segment this year

Upside risk: Better than expected improvement in margins
6% 389 338 296 263 234 210 189
7% 428 372 326 289 257 230 207
10% 546 473 414 367 325 291 261
11% 585 507 443 392 348 311 279
12% 624 540 473 418 371 331 297
Under HSBCs research model, a non-volatile Indian stock with a potential return of 6-16% merits a Neutral rating. Our target price of INR340 implies a potential return of 11%; we therefore rate the shares Neutral.
239
abc
Company profile
Areva T&D is a leading player in the power transmission and distribution sector and provides equipment and services to improve transmission network stability and enable efficient transmission of electricity. The company has a presence in all stages of power supply chain with a wide range of products such as transformers, circuit breakers, gas insulated switchgears, general circuit breakers, instrument transformers, protection relays and power system automation equipment.
technology products and solutions for the extra high voltage (EHV) and ultra high voltage segments also.
Business segments
Areva T&D operates in four business segments in India products, systems, automation and services.
Products
Its portfolio includes wide range of products such as transformers, circuit breakers, gas insulated switchgears, generator circuit breakers, instrument transformers, protection relays & power system automation equipment. The company has a presence in products of up to 765 KV. Areva T&D mainly focuses on Medium Voltage (MV 33 KV and below) to Extra High Voltage (EHV 132 KV and above) products. Some of the key clients include Power Grid (PGCIL), NTPC, BHEL and RRVPNL.
Background
Areva
Areva, a French public sector undertaking (PSU), has manufacturing facilities in 41 countries and a sales network in more than 100 countries. Areva is a global leader in nuclear power and the third largest in power transmission and distribution space. Arevas primary focus was initially on nuclear energy, however the transfer of the Alstom T&D segment (following financial trouble due to the failure of certain investments, leading to the French Government organizing a bailout) resulted in Areva entering the power transmission and distribution segment.
Systems
The systems business provides turnkey solutions to the Utility, Industry and Infrastructure sector. The company is a market leader in power transmission and distribution segment and is involved in executing high-end T&D solutions such as 765 KV & HVDC transmission projects. It also executes orders for building substations and switchyards and gas insulated substations. The key clients in the systems segment include NTPC, PGCIL, Hindalco, the Adani group, the Jaiprakash group and Lanco Infratech.
Areva T&D India

Areva T&D was earlier known as Alstom India. Alstom India was formed in 1998 and in 2005 Areva T&D India was formed as a result of Areva acquiring Alstoms global Transmission and Distribution (T&D) business. Later in 2008, the company transferred its low margin non T&D business to Alstom Energy for a consideration of INR414m and focused on the T&D operations. The company was initially involved in rural electrification projects but has eventually moved to providing superior
240
abc
Areva T&D India
Areva T&D
Products
Systems
Automation
Services
Automation systems
Areva is a global leader in energy management and has expertise in network management services (NMS) and delivering technologies like energy management systems, SCADA and telecom backbone networks. The automation systems segment of the company is involved in providing hardware and software solutions for managing energy flows from load dispatch centres.
Power transmission & distribution

The power transmission solutions are customised and ensure efficient grid connections and in-house electrical distribution of power plants. On the distribution side the company provides equipment and services, thereby guaranteeing secure distribution network.
Railways
The company offers high quality products and solutions for railways, metros and trams.
Services
This segment comprises services for network planning and single point services through the product life cycle for various products to the customers. These services include supervision, warranty support, technical training, long term maintenance contracts, repair and overhauling, retrofit and spares.
Oil & gas

The company offers a range of intelligent integrated solutions and project management for reliable electrical distribution and control.
Industries & buildings

These solutions cater to the medium voltage demand for industrial, commercial and public infrastructure.
Areva T&D solutions

Areva T&D provides energy solutions across sectors such as power generation, transmission distribution, railways, industries and metals & mining.
Metals & mining

The company provides systems to ensure that the complex distribution requirements of the metals and mining sector are met.
Power generation
In the power generation sector, the company provides a wide range of equipment, turnkey systems and services to manage the power transmission network & high voltage substations.
241
abc
Areva T&D
Order book, Sales and EBITDA margin Segment exposure
80000 60000 40000 20000 0
21% 18% 15% 12% 9% 6% 3% 0%
T&D, 100%
FY06
FY07
FY10e
FY11e
Sales
Order Book
EBIDTA Margins
Geographic exposure
FY12e
FY08
FY09
End-market exposure
Europe India 77% North America 1% RoW 19% 3%

Transmission Domestic 60%
Transmission Intl 15% Power Distribution 17% Industrials 8%
EPS vs DPS
20 15 10 5 0 FY06 FY07 FY08 FY09 FY10e FY11e FY12e EPS

2.5 2.0 1.5 1.0 0.5 -
20% 15% 10% 5% 0% -5% -10% -15% FY06 FY07 FY08 FY09 FY10e FY11e FY12e Capex /Sales
DPS
FCF/Sales
242
abc
Financials & valuation: Areva T&D

Financial statements Year to 12/2009a 12/2010e 12/2011e 12/2012e Valuation data Year to 12/2009a 12/2010e 12/2011e
Neutral
12/2012e
35,659 4,183 -611 3,572 -579 2,930 2,993 -1,010 1,920 1,961
40,973 4,391 -946 3,445 -551 2,654 2,894 -929 1,725 1,881
46,803 5,479 -960 4,519 -554 3,865 3,965 -1,391 2,474 2,538
55,343 6,979 -1,015 5,964 -549 5,315 5,415 -1,913 3,401 3,465
2.0 17.1 4.0 32.4 7.3 -2.4 0.7
2.0 18.7 4.2 39.3 7.5 1.1 0.6
1.7 14.9 3.9 29.2 6.2 2.4 0.6
1.5 11.6 3.5 21.4 5.0 3.3 0.7
Issuer information
Share price (INR) 1,684 -3,202 -3,202 -499 -870 -1,518 2,000 -1,180 -1,180 -504 -317 820 2,778 -980 -980 -504 -1,294 1,798 3,456 -980 -980 -560 -1,916 2,476
309.50 Target price (INR) AREV.BO 1,625 23 India Rahul Garg
11
Bloomberg (Equity) ATD IN Market cap (INRm) 74,003 Enterprise value (INRm) 76,863 Sector Electrical Equipment Contact +91 22 22681245
Price relative
0 8,903 28,759 4,499 37,762 20,321 7,676 3,177 8,666 17,721
0 9,137 32,558 4,816 41,795 23,133 7,676 2,860 9,888 19,380
0 9,157 37,800 6,110 47,057 26,424 7,676 1,566 11,858 20,858
0 9,122 45,498 8,026 54,720 31,246 7,676 -350 14,699 22,958
410 360 310 260 210 160 110 2009

Areva T&D
410 360 310 260 210 160 110 2010 2011 2012
Source: HSBC

Ratios (%)
35.0 -4.7 -11.8 -15.6 -19.8
14.9 5.0 -3.5 -9.4 -4.1
14.2 24.8 31.2 45.6 34.9
18.2 27.4 32.0 37.5 36.6
2.0 14.1 22.6 6.9 11.7 10.0 7.2 36.7 0.8 53.0
2.1 12.5 19.0 4.3 10.7 8.4 8.0 28.9 0.7 69.9
2.2 14.8 21.4 5.6 11.7 9.7 9.9 13.2 0.3 177.3
2.4 17.7 23.6 6.7 12.6 10.8 12.7 -2.4 -0.1
8.03 8.20 1.80 36.24
7.22 7.87 1.80 41.35
10.35 10.61 2.00 49.59
14.23 14.49 2.20 61.48
243
abc
Areva T&D India Income statement (INRm) FY06 FY07 FY08 FY09 FY10e FY11e FY12e
16,058 (10,851) 5,207 (1,163) (1,946) 93 2,191 1 2,189 (187) 2,004 2,002 97 97 0 58 (44) (27) 2,089 1,990 (719) 0 1,370 0 0 1,370 1,305 199.4 6.9 6.5
20,063 (12,671) 7,391 (1,532) (2,285) 159 3,734 0 3,733 (231) 3,503 3,502 0 0 0 19 (85) (5) 3,432 3,431 (1,269) 0 2,163 0 0 2,163 2,163 210.2 10.3 10.3
26,412 (17,258) 9,154 (2,091) (2,812) 139 4,390 1 4,389 (340) 4,049 4,049 (281) (281) 0 4 (302) 0 3,470 3,751 (1,207) 0 2,263 0 0 2,263 2,446 239.1 9.5 10.2
35,659 (24,926) 10,733 (2,924) (3,794) 173 4,188 5 4,183 (611) 3,577 3,572 (68) (68) 0 1 (579) 0 2,930 2,993 (1,010) 0 1,920 0 0 1,920 1,961 239.1 8.0 8.2
40,973 (29,113) 11,860 (3,406) (4,268) 205 4,391 0 4,391 (946) 3,445 3,445 (240) (240) 0 140 (691) 0 2,654 2,894 (929) 0 1,725 0 0 1,725 1,881 239.1 7.2 7.9
46,803 (33,034) 13,769 (3,649) (4,875) 234 5,479 0 5,479 (960) 4,519 4,519 (100) (100) 0 137 (691) 0 3,865 3,965 (1,391) 0 2,474 0 0 2,474 2,538 239.1 10.3 10.6
55,343 (38,815) 16,528 (4,060) (5,765) 277 6,979 0 6,979 (1,015) 5,964 5,964 (100) (100) 0 141 (691) 0 5,315 5,415 (1,913) 0 3,401 0 0 3,401 3,465 239.1 14.2 14.5
Areva T&D India Margin & trend analysis FY06 FY07 FY08 FY09 FY10e FY11e FY12e
24.9% 25.7% 70.5% 74.8% 49.8% 57.2% 36.8% 18.6% 17.5% 17.9% 17.1% 10.8% 9.4% 20.5% 1.2% 16.3% 37.0% 17.0% 9.5% 17.5%
31.6% 27.5% 17.6% 15.6% -8.0% -0.6% 34.7% 16.6% 15.3% 16.3% 13.1% 8.6% 24.3% 9.8% 0.2% 10.6% 34.8% 17.0% 6.6% 19.0%
35.0% 31.8% -4.7% -11.7% -15.2% -19.8% 30.1% 11.7% 10.0% 10.7% 8.2% 5.4% 19.5% 17.0% 0.0% 9.4% 34.5% 17.0% 4.2% 22.4%
14.9% 14.6% 5.0% -3.7% -10.1% -4.1% 28.9% 10.7% 8.4% 9.1% 6.5% 4.2% 12.0% 4.0% 3.0% 9.0% 35.0% 17.0% 4.0% 24.9%
14.2% 14.2% 24.8% 31.2% 43.4% 34.9% 29.4% 11.7% 9.7% 10.3% 8.3% 5.3% 3.0% 4.0% 2.5% 9.0% 36.0% 17.0% 4.0% 19.3%
18.2% 18.2% 27.4% 32.0% 37.5% 36.6% 29.9% 12.6% 10.8% 11.5% 9.6% 6.1% 7.0% 4.0% 2.0% 9.0% 36.0% 17.0% 4.0% 15.5%
244
abc
Areva T&D India Balance sheet (INRm) FY06 FY07 FY08 FY09 FY10e FY11e FY12e
Net assets
478 3,357 3,835 0 3,835 0 (33) (33) 1,046 525 1,537 960 75 100 251 97 0 1,481 2,386 6,237 (5,197) (1,700) (205) 0 (8) 1,513 (697) 0 0
3,835
478 5,015 5,493 0 5,493 0 (1,012) (1,012) 1,347 230 565 1,666 41 586 283 0 0 2,576 2,729 10,286 (7,462) (1,887) (206) 0 (7) 3,454 (1,101) 0 0
5,493
478 6,772 7,250 0 7,250 0 (4,692) (4,692) 2,816 451 (1,425) 1,963 8 4,500 387 0 0 6,858 3,862 11,889 (4,089) (5,245) (141) 2,583 (5,930) 2,929 (1,111) 0 0
7,250
478 8,188 8,666 0 8,666 0 (7,676) (7,676) 3,174 1,325 (3,177) 8,384 0 519 100 0 0 9,003 3,790 15,994 (7,460) (4,793) (86) 4,475 (7,982) 3,939 (1,099) 0 0
8,666
478 9,409 9,888 0 9,888 0 (7,676) (7,676) 3,174 1,642 (2,860) 8,618 0 519 100 0 0 9,237 4,268 18,353 (8,536) (5,548) (85) 5,122 (8,963) 4,609 (1,099) 0 0
9,888
478 11,379 11,858 0 11,858 0 (7,676) (7,676) 3,174 2,936 (1,566) 8,638 0 519 100 0 0 9,257 4,875 20,964 (9,751) (6,338) (98) 5,850 (10,238) 5,265 (1,099) 0 0
11,858
478 14,221 14,699 0 14,699 0 (7,676) (7,676) 3,174 4,852 350 8,603 0 519 100 0 0 9,222 5,765 24,789 (11,530) (7,494) (115) 6,918 (12,106) 6,226 (1,099) 0 0
14,699
Areva T&D India Key balance sheet ratios FY06 FY07 FY08 FY09 FY10e FY11e FY12e
-40.1% -34.8% 0.60 0.65 (140.78) (0.70) 14.16 3.53 5.63 na na na na na na na
-10.3% -6.5% 0.90 0.93 52.82 (0.15) 8.75 2.56 3.37 61 85 208 (232) 0 (0) 19.1%
19.7% 21.6% 1.20 1.22 13.59 0.32 4.08 1.79 2.77 129 94 187 (100) 41 (93) 12.6%
36.7% 37.7% 1.37 1.38 6.18 0.76 4.01 2.01 2.76 83 66 188 (129) 53 (94) 12.7%
28.9% 29.8% 1.29 1.30 6.25 0.65 4.48 2.11 2.96 81 58 175 (115) 49 (85) 12.0%
13.2% 14.0% 1.13 1.14 8.15 0.29 5.11 2.24 3.22 81 57 174 (115) 49 (85) 12.0%
-2.4% -1.6% 0.98 0.98 10.85 (0.05) 6.07 2.41 3.58 82 59 177 (117) 49 (87) 12.2%
245
abc
Areva T&D India Cash Flow Statement (INRm) EBITDA Adjusted for: Unrealized fx (gains)/losses Loss on sale of fixed assets Other non-cash exceptionals Change in working capital Tax paid Net financials Others Cash flow from operations FY06 2,191 FY07 3,734 FY08 4,390 FY09 4,188 FY10e 4,391 FY11e 5,479 FY12e 6,979
1 (1) 33 (1,441) (687) 25 126 245 (376) 7 0 (124) (112) (236) 414 (157) 0 0 21
3 (0) 115 (2,384) (1,114) (77) 55 332 (1,375) 1 0 (1,042) (332) (1,374) 97 979 0 0 (298)
148 0 179 (1,586) (1,509) (269) (80) 1,274 (4,224) 6 0 (2,943) (500) (3,443) 118 3,543 0 0 217
343 0 185 (1,195) (1,282) (595) 39 1,684 (3,224) 22 0 (1,518) (499) (2,017) 16 2,872 0 0 870
0 0 0 (671) (929) (551) (240) 2,000 (1,200) 20 0 820 (504) 317 0 0 0 0 317
0 0 0 (656) (1,391) (554) (100) 2,778 (1,000) 20 0 1,798 (504) 1,294 0 0 0 0 1,294
0 0 0 (961) (1,913) (549) (100) 3,456 (1,000) 20 0 2,476 (560) 1,916 0 0 0 0 1,916
Areva T&D India Key cash ratios FY06 FY08 FY08 FY09 FY10e FY11e FY12e
31.4% -9.0% 2.0 2.3% 12.2% -0.5% -0.9%
29.8% -11.9% 5.9 6.9% 9.5% -1.6% -2.1%
34.4% -6.0% 12.4 16.0% 31.5% -4.2% -5.0%
30.6% -3.3% 5.3 9.0% 47.1% -2.4% -3.2%
21.2% -1.6% 1.3 2.9% 58.1% 1.0% 0.4%
25.4% -1.4% 1.0 2.1% 61.5% 2.3% 1.7%
27.4% -1.7% 1.0 1.8% 57.9% 3.2% 2.4%
246
abc
Areva T&D India Valuation FY06 FY07 FY08 FY09 FY10e FY11e FY12e
132 26,229 (1,537) 1,700 205 0 (97) 26,500 165% 582% 12.1 13.2 12.7 20.1 6.8 0.9% -0.5% -0.9% 30.1% 46.1% 34.0%
319 67,007 (565) 1,887 206 0 (0) 68,535 342% 874% 18.4 19.6 19.1 31.0 12.2 0.6% -1.6% -2.1% 28.9% 37.1% 39.4%
290 69,446 1,425 5,245 141 0 (0) 76,257 289% 516% 17.4 18.8 17.7 28.4 9.6 0.6% -4.2% -5.0% 19.0% 27.7% 33.7%
266 63,591 3,177 4,793 86 0 (0) 71,647 201% 404% 17.1 20.1 18.8 32.4 7.3 0.7% -2.4% -3.2% 14.1% 18.1% 22.6%
308 73,656 2,860 5,548 85 0 (0) 82,150 200% 424% 18.7 23.8 22.1 39.2 7.4 0.6% 1.1% 0.4% 12.5% 16.2% 19.0%
308 73,656 1,566 6,338 98 0 (0) 81,658 174% 391% 14.9 18.1 16.9 29.0 6.2 0.6% 2.4% 1.8% 14.8% 19.9% 21.4%
308 73,656 (350) 7,494 115 0 (0) 80,916 146% 352% 11.6 13.6 12.8 21.3 5.0 0.7% 3.4% 2.6% 17.7% 24.7% 23.6%
Areva T&D India Profitability RoCE FY06 FY07 FY08 FY09 FY10e FY11e FY12e
2,002 85 0 5.0% 34.4% 2,087 1,369 3,835 (251) 697 33 1,700 205 525 1,046 97 4,552 45.9% 30.1% 46.1%
3,502 94 0 5.0% 37.0% 3,597 2,267 5,493 (283) 1,101 1,012 1,887 206 230 1,347 0 7,839 45.9% 28.9% 37.1%
4,049 262 0 5.0% 34.8% 4,311 2,811 7,250 (387) 1,111 4,692 5,245 141 451 2,816 0 14,785 29.2% 19.0% 27.7%
3,572 240 0 5.0% 34.5% 3,812 2,498 8,666 (100) 1,099 7,676 4,793 86 1,325 3,174 0 17,721 21.5% 14.1% 18.1%
3,445 277 0 5.0% 35.0% 3,723 2,420 9,888 (100) 1,099 7,676 5,548 85 1,642 3,174 0 19,380 19.2% 12.5% 16.2%
4,519 317 0 5.0% 36.0% 4,836 3,095 11,858 (100) 1,099 7,676 6,338 98 2,936 3,174 0 20,858 23.2% 14.8% 19.9%
5,964 375 0 5.0% 36.0% 6,339 4,057 14,699 (100) 1,099 7,676 7,494 115 4,852 3,174 0 22,958 27.6% 17.7% 24.7%
247
abc
Crompton Everything premier except the price

Crompton remains a high quality company with a consistent track
record over the last five years in spite of rising competition in domestic markets and weakening demand in western markets
We believe earnings should benefit from strong growth in
domestic transmission orders, imminent recovery in industrial capex and improvement in subsidiary margins
We are c6% ahead of consensus on FY12e (Mar YE) and find the
valuation attractive (c16.6x FY12e PE), particularly in light of its premium quality relative to its peers; initiate OW with a TP of INR365
High on quality low on price

Crompton Greaves, a premium quality company within our coverage universe, has delivered consistent improvement in its operating performance over the last five years. Not only has it increased the range of its product offering but also established a solid market position in its key business segments. More importantly, Crompton has managed to grow its business without compromising on returns. In fact, it is the only company within our coverage universe which has shown a consistent improvement in its returns over the last five years and hasnt seen a decline in its earnings during economic crisis of FY09-10 in spite of having significant international exposure. Today, Crompton is a leading player in the T&D equipment market and will be a key beneficiary of the expected strong growth in domestic
transmission orders going into FY12 and FY13. The company is also a leading player in the consumer segment and should continue to benefit from increasing penetration of basic consumer durables (fans & lighting) in rural areas. Furthermore, we believe that the demand in the groups international markets is at an inflection point and should gradually recover going further into CY11 and CY12. Therefore, we believe that Crompton is in a sweet spot with a strong earnings outlook. We highlight the bull and bear points related to Crompton below:
Bull points
Geared to growth in the domestic transmission orders The impending recovery in the domestic industrial capex should benefit the group
248
abc
Margins likely to benefit from an improvement in profitability of subsidiaries Domestic transmission margins remain stable even in light of increasing competition Strong balance sheet to support acquisitive
Demand outlook robust

Domestic transmission orders likely to see strong growth in FY12 and FY13
The group order intake has remained robust during the first half of FY11, recording a growth c25% y-o-y. Orders for the standalone business grew by c17% during the same period.
Order intake (INRm)
growth
Crompton scores best among its peers on
fundamentals, highlighting its superior quality

Valuation remains attractive
Bear points
30,000 25,000 20,000 15,000 10,000 5,000 Q110 Q210 Q310 Q410 Q111 Q211
Power Grid orders remain muted this year Visibility on recovery in the Western markets (NA & Europe) remains opaque Higher exposure to metal prices relative to its peers (ABB, Areva and Siemens) Relatively high currency risk within its peer
Consolidated
Standlaone
group Overall, we remain positive on Cromptons earnings potential over the next two to three years and are c5% ahead of consensus on our FY12 EPS estimate. We are largely in line with consensus on our FY11 estimates. We continue to find Cromptons valuation attractive relative to its peers as well as its own history. On FY12e consensus numbers, Crompton is trading at c17.6x PE and c11.3x EV/EBITDA versus its trade peers average of c18.5x and c13.1x, respectively. On our FY12 estimates also, Crompton remains at a discount to its peers under our coverage (ABB, Areva T&D and Siemens), trading at c16.6x PE and c10x EV/EBITDA compared with its peer group average of c24x and c14x, respectively. Therefore, we initiate coverage of Crompton with an Overweight rating and a target price of INR365, which offers c27% potential return. While Q1 was strong in terms of growth, order intake in Q2 has been flat y-o-y in the standalone business. We believe this is largely a timing issue, as the order intake is often lumpy in the power systems business and can show considerable volatility across quarters. But more importantly, as highlighted in our Endmarket analysis section, we expect significant growth in transmission orders during FY12 and FY13, driven largely by the 11th plan spillover and the high capacity corridors (HCPTC) related orders. Moreover, due to companys presence in substation equipment, which typically have shorter lead times (c8-10 months) and are ordered closer to line completion, we expect the order growth to extend well into FY13 before tapering off in FY14 (for details on our T&D end-market forecasts, please refer to the End-market analysis section earlier in this report).
249
abc
Consequently, we forecast order intake in the power systems India segment to grow at c40% in FY12 and c20% in FY13.
Order book and order intake for power systems in India
Crompton share of Power Grid orders 765kV transformer segment
50% 40% 30% 20%
80,000 60,000
10% 40,000 0% 20,000 FY09 FY10 YTD
FY12e
FY08
FY07
FY09
FY10
FY11e
FY13e
Source: PGCIL, HSBC
Order intake
Orde book
Crompton share of Power Grid orders 400/220KV transformers
50%
Power Grid orders have been muted this year, but we remain optimistic
Crompton has not won many orders from Power Grid during the current financial year. While there was only one order awarded by Power Grid in the 765kV transformer segment (which went to Hyosung), there were several orders in the 400/220kV segment (both transformers and substations). However, Crompton won only one order from the Power Grid in 400/220kV segment, reducing its share in the segment to c5% from c35-45% in FY09-10.
40% 30% 20% 10% 0% FY09 FY10 YTD
Source: PGCIL, HSBC
Crompton share Power Grid orders 400/220kV substations
20% 15% 10% 5% 0% FY09 FY10 YTD
Source: PGCIL, HSBC
However, we note that Power Grid has been slow in awarding orders in the current financial year and we expect the order activity to pick up going further into CY11. As the volumes increase, we expect the market share to normalize again.
250
abc
International orders improving, but visibility remains opaque

The orders in the international subsidiaries of Crompton have shown strong growth of c42% during the first half of FY11. While the y-o-y growth is benefiting from the base effect, we nevertheless feel encouraged to see demand recovery coming through in the international business. However, management recently highlighted during their Q2 results call that they expect demand in the western markets to remain lumpy in the near future.
Subsidiary order intake and order book
Order book and order intake : Industry Systems
20,000 15,000 10,000 5,000 -
FY12e
Q111
FY08
FY07
FY09
FY10
FY11e
Order intake
Order book
40,000 30,000 20,000 10,000 Q110 Q210 Q310 Q410 Q111 Q211
Demand outlook in the consumer segment remains robust

Crompton has witnessed strong growth in consumer sales, driven by rising consumer spending and increasing penetration of the basic consumer durable products (lights, fans etc) into the rural markets. We remain positive on the demand outlook in the consumer business and expect revenues in this business to grow by c30% in FY11 and c25% in FY12 (for details on our consumer market forecasts, please refer to the End-market analysis section earlier in this report).
Sales consumer products
Order intake
Orde book
Industrial capex recovery to pick up

As highlighted in our End-market analysis section, we expect the industrial capex to increase by double digits during FY12, driven by rising capacity utilization and improving business confidence. Based on the bottom up analysis of the HSBC capex forecasts for all the Indian companies under our coverage (ex-Financials) and FAI (Fixed Asset Investment) forecasts by the HSBC Economics team, we expect the domestic industrial capex to grow c15-20% in FY12. Assuming high single digit growth in the international industrial markets, we forecast the order intake in the industry systems business to grow by c14-15% in FY12-13.
6,000 5,000 4,000 3,000 2,000 1,000 Q110 Q210 Q310 Q410 Q211
FY13e
251
abc
Sales consumer products segment
35,000 30,000 25,000 20,000 15,000 10,000 5,000 -
c51%. We note that the company had earlier entered into another JV with the same company to manufacture medium power transformers in Saudi Arabia.
Acquisitions likely to be a key lever for growth

Crompton has a long term target of reaching cUSD8bn in sales by 2015. The company intends to achieve this through a mix of organic and acquisitive growth and has made several acquisitions over the last five years. The company has announced two major acquisitions this year, one in the power segment (power technology systems) and the other in the industrial segment (Nelco Ltd). We expect these acquisitions, just like the JVs, to continue to support the product offering of CG and provide critical mass in important geographical locations. We believe management will continue to invest in acquisitions, with the focus on filling gaps in the product offering (such as automation services) and/or penetrating emerging markets, such as Latin America. We note that Crompton had a net cash position of cINR4bn (including loans & advances) and we forecast the company to generate free cash flow of cINR10-11bn over the next two years. Therefore, we believe that Crompton can spend up to INR15bn in acquisitions without incurring any debt. Given such firepower, we expect acquisitions to remain a key lever for future growth.
Recent JVs step up product range as well as sales potential

Crompton has entered into several JVs over the last few years, the most recent being with ZIV in Spain. These JVs have proved beneficial as it has not only enhanced the groups technological presence but also its geographical reach. In addition, these JVs have provided additional support to group sales over the years. We note that the firm has entered into two JVs/tieups this year which should provide a revenue opportunity of cINR7-7.5bn over the next two to three years.
JV with ZIV, Spain: CG has entered into this
JV for the manufacture of substation automation systems in the EHV and UHV range (66-800kV), including protective relays, differential relays, bay control units, bus-bar systems, etc. This JV will take CG one step closer to becoming a solution provider from being products company. CG has invested INR70m into this JV to buy a stake of c70%.
Tie-up with EIC, Saudi Arabia: CG has
FY13e
FY09
FY10
FY06
FY07
FY08
FY11e
FY12e
Margins likely to improve further in the medium term

Crompton has shown a strong improvement in its profitability over the last five years, delivering an improvement of c600bp in its group EBITDA margins. This has been largely driven by increasing technology content in the sales mix and self-help initiatives to rationalise manufacturing processes.
signed a MoU with EIC, Saudi Arabia, to form a JV to further enhance its position in the EPC segment in the Middle East. CG will invest USD1.53m in this JV to buy a stake of
252
abc
EBITDA and EBIT margins
Margins safe from competition, so far

We further note that margins have thus far remained unscathed by the rising competition in the power systems business. We believe this can be largely explained by the increasing content of higher margin products in the sales mix (for example, increasing supply of 765kV and 1200kV transformers).
15.0% 10.0% 5.0% 0.0% FY06 FY07 FY08 FY09 FY10
Power systems standalone EBIT margin
EBITDA margin
EBIT margin
25% 20% 15%
Management has highlighted that there remains limited scope for further improvement in margins at the standalone business. However, we note that there still remains a significant difference of c550bp between the EBITDA margin of the standalone business and the international subsidiaries.
EBITDA margin
10% 5% 0% Q110 Q210 Q310 Q410 Q111 Q211
20.0% 15.0% 10.0% 5.0% 0.0% FY06 FY07 Standalone

High metal exposure remains a key risk to margins

Crompton has c22% exposure (as % sales) to various ferrous and non-ferrous metals, which in our opinion remains a key risk to margins. Management has noted that they hedge the metal price risk by entering into forward contracts at the time of order intake; however, we believe that in the wake of rising competition (particularly in the power systems business), the company may not be able to pass on price increases if the metal prices rise sharply.
FY08
FY09
FY10
Subsidiaries
We believe that as sales pick up over the coming years in the international business its profitability should improve further. Management has highlighted that in a normal business environment the margin differential between the international subsidiaries and the standalone business should not be more than c300bp. This implies that international EBITDA margins (at c10.9% in FY10 and c10.7% in Q2 FY11) still remain c200250bp below its potential. Hence, there remains scope for further improvement.
Strong balance sheet, with superior returns

Cromptons balance sheet has grown over three fold over the last five years, driven primarily by a strong growth in fixed assets.
253
abc
Total equity vs total fixed assets
Capital employed vs RoCE
30,000 25,000 20,000 15,000 10,000 5,000 FY06 FY07 Equity

30,000 25,000 20,000 15,000 10,000 5,000 FY08 Fix ed Assets

40.0% 30.0% 20.0% 10.0% 0.0% FY06 FY07 FY08 FY09 FY10 RoCE
FY09
FY10
Capital Employ ed
We note that within fixed assets, intangible assets have grown much more (c25x) than the tangible assets (c2x) over the same period. A large portion of intangible assets is goodwill, which implies that company has made significant investment in acquisitions along with greenfield expansion.
Tangible vs Intangible assets
We note that both, OR (operating return) margins and asset turns have contributed to this improvement in returns.
Asset turnover vs OR margin
4.0 3.0 2.0 1.0 FY06 FY07 FY08 FY09 FY10
15% 10% 5% 0%
10,000 8,000 6,000 4,000 2,000 FY06 FY07 FY08 FY09 FY10
Asset turnov er
OR margins
Tangible assets
Intangible assets
We further note that Cromptons RoCE is the best within our coverage universe and also among its closest peers.
RoCE FY10
Interestingly, in spite of this strong focus on acquisitive growth, the company has managed to improve its return on capital employed (RoCE), underlining its ability to make value accretive acquisitions.
35% 30% 25% 20% 15% 10% 5% 0% Siemens ABB Arev a Crompton
254
abc
Crompton also remains under-levered at this stage, with a net cash position (including loans & advances) of INR4,134m (FY10) and a leverage of c0.9x. This, coupled with strong cash generating capability, provides Crompton with enough firepower to fund future acquisitions, in our opinion.
Financial leverage including acceptances
ROE FY10
35% 30% 25% 20% 15% 10% 5% 0%

ABB Ltd T&D India Crompton Siemens Greaves Areva India
1.4 1.2 1.0 0.8 0.6 0.4 0.2 FY06 FY07 FY08 FY09 FY10
ROE FY10
35% 30% 25% 20% 15% 10%
5% 0%
ABB Ltd T&D India Crompton Siemens Greaves
Free cash flow
Areva
India
10,000 8,000 6,000 4,000 2,000 (2,000) (4,000) FY06 FY07 FY08 FY09 FY10
Working capital management has improved

Crompton Greaves is the only company within our coverage universe which has shown strong improvement in its trade working capital requirement (i.e. excluding other receivables & payables) over the last four years. The improvement has been largely driven by better inventory management, for both raw materials and work-in-progress.
We note that in spite of its declining leverage, Cromptons return on equity (ROE) has shown improvement over the last five years and remains the best within our coverage universe.
255
abc
Trade WC, inventory, payables, receivables as % of sales
Sales
30% 20% 10% 0% -10% -20% -30% FY07 Trade WC FY08 Inv entories FY09 Pay ables FY10 Reciev ables
150,000 100,000 50,000 FY06 FY07 FY09 FY11e FY12e 18% 15% 12% 9% 6% 3% 0% FY07 FY09 FY11e FY13e FY13e FY08 FY10
To tal Co nsumer pro ducts

P o wer Systems Industrial Systems
c6% ahead of consensus on our FY12 EPS estimates

As we have highlighted earlier in this section, we remain bullish on domestic demand outlook in all three business segments going into FY12. We also expect gradual recovery in the western markets and expect an order growth of c10% at international subsidiaries in FY12. Overall, we forecast the order backlog to grow by c12% in FY11 and c20% in FY12-13.
Order backlog
In terms of profitability, we expect a modest y-o-y improvement in margins during FY11 (c10bp) and FY12 (c60bp), driven primarily by volume growth and improvement in subsidiary margins.
Sales and EBITDA margin
150000 100000 50000 0
250,000 200,000 150,000 100,000 50,000 -
Sales
EBIDTA Margins
Pow er Sy stems India Industrial Sy stems

Pow er Sy stems Ov erseas Total
We remain largely in line with consensus on our FY11 estimates; however, we are modestly ahead (c6%) on our FY12 EPS estimate. For FY12, we are c3% ahead of consensus on sales growth forecast and c50bp ahead of consensus on our margin estimates. Overall, we forecast FY12e and FY13e group sales of INR122bn and INR143bn, clean EBITDA of INR18bn and INR21bn and clean EPS of INR17.4 and INR20.6, respectively. We highlight our forecasts and the consensus estimates in the table on the following page.
FY06
FY07
FY09
FY11e
FY12e
We further assume that the order execution rate remains at the current levels and hence we forecast group sales to grow by c13% in FY11e and c18% in FY12e.
256
FY13e
FY08
FY10
abc

Crom pton Gre ave s - M ar YE (INR m ) Order Backlog Ne t Sale s Clean EBITDA Re porte d EBITDA Clean EBIT Re porte d EBIT Other Income Net Financials Profit be fore tax Income tax Extraordinary items Minorities Clean Net Income Re porte d Ne t Incom e Clean EPS Re porte d EPS DPS FY10 63,650 91,409 12,771 12,770 11,220 11,219 937 (265) 11,891 (3,618) 352 (26) 7,982 8,599 12.4 13.4 2.2 Ne w Fore cas ts FY11e FY12e 71,104 103,134 14,511 14,511 12,610 12,610 635 (238) 13,007 (3,932) 0 (30) 9,045 9,045 14.1 14.1 2.4 85,599 122,198 17,916 17,916 15,569 15,569 752 (177) 16,144 (4,970) 0 (30) 11,144 11,144 17.4 17.4 2.7 FY13e 102,155 142,637 20,947 20,947 18,352 18,352 878 (70) 19,159 (5,904) 0 (30) 13,225 13,225 20.6 20.6 3.0 Bloom be rg Cons e ns us FY11e FY12e FY13e 98,680 113,726 130,108
13,980 12,618
16,100 14,674
18,400 16,909
3.8% -0.1%
11.3% 6.1%
13.8% 8.5%
13,083
15,337
17,885
-0.6%
5.3%
7.1%
9,003
10,474
12,031
0.5%
6.4%
9.9%
14.1 2.0
16.4 2.3
18.9 2.9
0.3% 22.4%
6.2% 19.5%
8.8% 2.7%
FY10 0.7 16% 14.0% 14.0% 12.3% 12.3% 13.0% 8.7% 9.4%
FY13e 0.7 17% 14.7% 14.7% 12.9% 12.9% 13.4% 9.3% 9.3%
14.2% 12.8% 13.3% 9.1%
14.2% 12.9% 13.5% 9.2%
14.1% 13.0% 13.7% 9.2%
(10) (56) (65) (35)
50 (16) (27) (9)
54 (13) (31) 2
The best company on fundamentals

Within our coverage universe, Crompton has emerged as the best company in our quality benchmarking analysis, receiving a Q-ben score of 7.7/10. The company has above average scores (above 5.0) on all five criteria, highlighting its well rounded superior quality. The company has scored highest (8.5/10) on its ability to balance risk and lowest (5.1/10) on market performance. The company has a high score on balancing risk because it is a well diversified company and has also shown consistent growth in EPS even during the economically weak years of FY09-10, thus achieving a high score on its cyclical resilience.
The company received a low score on market performance because it only marginally outperforms its peer group on sales growth potential during FY09-13e. We highlight the performance of the company on each of the criteria and each of the metrics in the bar charts.
Top score on several quality metrics

Crompton has received a perfect score of 10/10 on seven out of 16 of our quality metrics. Furthermore, of the remaining nine metrics, Crompton has an above average score (more than 5.0) on seven. We discuss below some of the most relevant metrics/areas where Crompton has topped the chart:
257
abc
Benchmarking: Crompton Greaves
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
Free cash flow generation: Crompton remains the best company within our universe
on its ability to generate cash. We forecast an average cash margin (FCF to sales) for Crompton of c6.9% during FY09-13e compared with the sector average of c1.7%. Over the last three years, the group has reported an average cash margin of c6.7% compared with sector average of c-0.9%.
Return on capital employed (RoCE): Crompton not only generates the highest
RoCE within our universe but has also shown consistent improvement in its returns (as we highlighted earlier in this section). We forecast an average RoCE for Crompton of c28% during FY09-13e compared with the sector average of c17.2%.
Market position: Crompton has a high score of 7.0/10 on this metric, highlighting that its a
regional leader in its key business areas. This is the highest score that any company within our universe has received on this metric as none of
Benchmarking Crompton Greaves
Median = 5.0
Internal Performance Market Performance Balancing risk Financial Strength Equity Structure
(1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
258
abc

ABB Areva T&D
these companies is a global leader in its area of business. Crompton remains one of the market leaders in all its business segments, with a relatively strong position in power and consumer segments and a slightly weaker position in the Industry segment.
Cyclical resilience: Crompton is one of the only two companies within our universe
therefore the group has shown great ability to manage earnings risk.
Financial strength: As we highlighted
which didnt witness a decline in its EPS in the wake of the economic downturn during FY09-10. The group managed to achieve growth in EPS in spite of having over 30% exposure to Europe & North America and
25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 EPC Avg Kalpataru Can be 'Undervalued' if operating perf improving Jy oti Can be restructuring stories or 'Overvalued' ABB
earlier, Crompton remains under-levered with a strong cash generation record. Therefore, the company has scored strongly on all four metrics within this criterion, namely, financial leverage, net debt to EBITDA, interest cover, and FCF yield. We forecast an average leverage for Crompton of c0.8x during FY09-13 compared with the sector average of c1.2x.
Can be premium quality or 'Expensive' Eqp Mf g A vg Siemens Sector Avg KEC Can be cyclical or 'Undervalued' 6.0 7.0 8.0 9.0 10.0 Crompton Greaves
12m fwd EV/EBITDA
Areva T&D
Q-be n Score
259
abc
Trading volumes: Cromptons stock has the highest trading volume (along with Siemens)
EV/EBITDA vs history
25 20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Crompton Greav es

within our coverage universe and therefore the company has scored a perfect 10 on this metric. We note that empirical evidence suggests that the market usually awards a premium to the stocks with higher liquidity compared with the ones with lower liquidity.
PE vs history
Historic av erage
40 30 20 10 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Crompton Greav es

Historic av erage
However, this modest premium versus history can largely be explained by the consistent improvement in returns. In fact, we believe that the stock has not re-rated enough on 12-month forward EV/EBITDA compared with the improvement in the RoCE expectations.
PE vs RoE
40
40% 35% 30% 25% 20% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Crompton Greav es 12m fw d RoE
Valuation does little justice to the groups superior quality

As we highlight in the scatter charts, Crompton lies to the far right of the vertical median line (the quality lines). However, it is slightly below the horizontal median line (the valuation line), highlighting that the stock clearly remains undervalued based on its overall quality relative to its peer group. In fact, we believe that the company which has scored so highly on fundamentals should actually trade at a premium to its peer group. Therefore, we continue to find Cromptons valuation attractive at these levels.
30 20 10 0
EV/EBITDA vs RoCE
25 20 15 10 5 0
50% 40% 30% 20% 10% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Crompton Greav es 12m fw d RoCE
Valuation looks attractive on several fronts

Crompton has re-rated upwards from the lows of 2008-09 and on consensus numbers, the stock is trading at a modest premium to its average historical 12-month forward multiples (PE and EV/EBITDA).
260
abc
The re-rating in the stock also looks insufficient when we look at its 12-month forward EV-tosales multiple which seems to have re-rated less than improvement in margin expectations. Given that we expect margins to improve further, we believe that the stock should further re-rate on this multiple.
methodology. Our valuation model assumes a WACC of c12.4%, sales growth of c7%, through cycle margin of c12% and a competitive advantage period (CAP) of 30 years. Our target price implies a 12-month forward target multiple of c18.4x PE and c11.3x EV/EBITDA for the group compared with current 12-month forward multiples of c17.6x and c10.6x, respectively.
Valuation summary: Crompton Greaves Key assumptions
2.5 2.0 1.5 1.0 0.5 0.0 Jan05 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11
15.0% 13.0% 11.0% 9.0% 7.0% 5.0%
Value of current op Trend sales Trend CE CE growth RoIC Trend OR Value of current op Value of future inv Incremental return Incremental cost EVA Value of future inv 12-month forward implied market cap EV EV 12-month forward Net debt Customer advances Bankers acceptances Minorities Investments/associates Implied market cap Target price 12-month forward TP Published TP
7.0% 12.0% 2.9 31% 12.4% 30.0
Crompton Greav es
12m fw d EBITDA mgn
Crompton also looks inexpensive compared with its trade peers. On FY12e consensus numbers, the stock is trading at c17.6x PE and c11.3x EV/EBITDA compared with its peer group average of c18.5x and c13.1x, respectively. We reiterate that the stock should actually trade at a premium to its peers given the superior quality of its business. Finally, on our estimates the stock also looks attractive relative to its peers under our coverage (ABB, Areva and Siemens). On our FY12e, the stock is trading at c16.6x PE and c10x EV/EBITDA versus its peer group average of c24x and c14x, respectively.
122,198 39,587 2.5% 34.2% 13,539 75,602
1,026 120 588 127,085
202,688 227,733 (12,335) 10,027 1,253 43 (5,536) 234,280
365 365
We initiate with an Overweight and a TP of INR365

We initiate coverage of Crompton Greaves with an Overweight rating and a target price of INR365, implying c25% potential return. We value the group based on our preferred Economic Value Added (EVA) valuation
261
abc
TP Sensitivity analysis
12m PT 365 4% 5% 6% 7% 8% 9% 10% Sales Growth 12m PT 365 9% 10% 11% 12% 13% 14% 15% WACC 12m PT 365 9% 10% 11% 12% 13% 14% 15% WACC 9% 198 221 243 265 287 310 332 Operating Re turn (OR) 10% 11% 12% 222 246 270 248 275 302 273 303 333 298 332 365 324 360 397 349 389 429 375 418 461 Operating Re turn (OR) 10% 11% 12% 400 443 487 359 398 438 325 361 398 298 331 365 273 304 335 253 282 310 235 262 289 Sales 6% 443 399 363 333 306 284 265 Grow th 7% 487 438 398 365 335 310 289 M argins 13% 294 329 364 399 434 469 504 M argins 13% 530 477 434 398 366 339 316 14% 317 356 394 432 470 508 546 15% 341 383 424 465 507 548 589
Key risks
We highlight the key risks related to our investment case on Crompton below:
Raw material price inflation International competition in the T&D equipment market Delay in economic recovery in the western regions, such as NA and Europe Appreciation of INR against the USD and
9% 356 320 289 265 243 224 208
14% 574 517 470 431 397 368 343
15% 617 556 506 465 428 397 370
EUR.
4% 355 321 293 270 249 231 216
5% 399 360 328 302 278 258 240
8% 530 477 433 397 364 337 313
9% 574 516 468 429 393 363 337
10% 618 555 503 460 422 390 362
Under HSBCs research model, a non-volatile Indian stock with a potential return of 6-16% merits a Neutral rating. Our target price of INR365 implies a potential return of 27%; we therefore rate the shares Overweight.
262
abc
Company profile
Crompton Greaves, an Avantha group company, is one of the largest Indian engineering conglomerates which manufactures diverse range of power equipment and provides turnkey solutions for power transmission and distribution. The group is also involved in manufacturing consumer products. The company has manufacturing facilities in India as well as abroad (bases in Belgium, Canada, Hungary, Indonesia, Ireland, France, UK and US). The company operates across three business units power systems, industrial systems and consumer products.
international markets. This segment contributes c70% to the consolidated revenue of the company.
Industrial systems
The industrial system business unit is involved in the manufacturing of power conversion equipment, high and low voltage rotating equipment, railway transportation and signalling equipment. The CG industrial systems product portfolio includes high tension (HT) motors, railway transportation equipment, low tension (LT) motors, direct current (DC) motors, AC drives, railway signalling equipment, fractional horse power (FHP) motors, AC generators and stampings. The company is a market leader in AC motors and the second largest player in AC generators and DC motors in India. It is also the largest manufacturer of low tension motors in India, offering a range of AC and DC motors, ranging from 0.18kW to 450kW. This business segment largely caters to the domestic market. The key customers for this business group include the textile, cement, sponge iron and large steel plants sectors.
Power systems
The power systems business unit is the largest business unit of Crompton Greaves and is involved in global transmission and distribution businesses. The company manufactures equipment required for power transmission and distribution as well as provides transmission and distribution (T&D) solutions. The product portfolio comprises power transformers, distribution transformers, switchgears, circuit breakers (extra high voltage and medium voltage), vacuum interrupters, network protection and control gear. Crompton is among the top 10 transformer manufacturers in the world. The company also provides transmission and distribution (T&D) solutions such as customised substation projects, EPC and other integrated endto-end contracts that encompass solutions, design, products, procurement, construction, erection and servicing. This business sectors caters to key industries which include power utilities, manufacturing, and railways and mines both in the domestic and
Consumer products
The consumer products segment is involved in manufacturing and marketing of a large variety of industrial and household solutions in lighting, fans, pumps and home appliances. The key products include fans, lighting equipment (light sources and luminaries), wiring accessories, pumps, integrated security systems, home automation and a range of electrical household appliances. The company is a market leader in fans with a strong brand image; and is the second largest player in lighting. It is also the fastest growing brand in home appliances; and is the leader in the domestic pumps segment.
263
abc
Crompton Greaves
Sales Order book and EBITDA margin Segment split
150000
18% 15%
Industrial Systems 14% Consumer Products 18%
Others 1%
100000 50000
12% 9% 6% 3%
Power Systems 67%
0 FY07 FY09 FY10 FY11e FY12e FY13e FY08
0%
Sales
Order Book
EBIDTA Margins
Geographic exposure
End-market exposure
Europe 17% North America India 47% RoW 23% 13%
Transmission Intl 20%
Power Distribution 26% Industrials 14%
Consumer Transmission Domestic 22% Durables 18%
EPS vs DPS
25 20 15 10 5 0 FY11e FY07 FY09 FY06 FY08 FY10 FY12e FY13e
4.0 3.0 2.0 1.0 -
15% 10% 5% 0% -5% -10% FY12e FY13e FY06 FY07 FY08 FY09 FY10 FY11e
EPS
DPS
FCF/Sales
Capex /Sales
264
abc
Financials & valuation: Crompton Greaves Ltd

Overweight
03/2012e 03/2013e
91,409 12,771 -1,551 11,220 -265 11,891 11,509 -3,650 8,573 7,982
103,134 14,511 -1,900 12,610 -238 13,007 13,007 -3,967 9,015 9,045
122,198 17,916 -2,347 15,569 -177 16,144 16,144 -5,005 11,114 11,144
142,637 20,947 -2,594 18,352 -70 19,159 19,159 -5,939 13,195 13,225
1.3 9.4 4.3 15.1 4.8 6.8 1.2
1.8 12.5 5.5 20.5 5.6 2.3 0.8
1.5 10.0 4.5 16.6 4.4 3.6 0.9
1.2 8.2 4.0 14.0 3.4 6.1 1.0
Issuer information
Share price (INR) 10,275 -2,070 -2,070 -1,159 -1,032 8,205 10,012 -5,700 -5,700 -947 -3,364 4,312 12,338 -5,700 -5,700 -1,801 -4,836 6,638 14,583 -3,200 -3,200 -2,027 -9,356 11,383
288.90 Target price (INR) CROM.BO 4,070 54 India Rahul Garg
27
Bloomberg (Equity) CRG IN Market cap (INRm) 185,327 Enterprise value (INRm) 172,336 Sector Electrical Equipment Contact +91 22 22681245
Price relative
3,404 10,357 41,018 9,144 61,210 26,567 5,010 -4,134 25,043 27,564
3,394 14,166 48,684 12,508 72,676 29,935 5,010 -7,499 33,140 33,321
3,385 17,527 60,208 17,344 87,552 35,469 5,010 -12,335 42,483 39,587
3,378 18,140 76,733 26,700 104,683 41,401 5,010 -21,691 53,681 43,316
375 325 275 225 175 125 75 25 2009

Crompton Greaves Ltd
375 325 275 225 175 125 75 25 2010 2011 2012

Source: HSBC

Ratios (%)
4.6 13.7 12.0 37.1 24.7
12.8 13.6 12.4 9.4 13.3
18.5 23.5 23.5 24.1 23.2
16.7 16.9 17.9 18.7 18.7
Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x)
3.3 29.1 31.9 15.1 14.0 12.3 48.2 -16.5 -0.3
3.1 27.2 27.3 13.5 14.1 12.2 60.9 -22.6 -0.5
3.1 28.0 26.2 13.9 14.7 12.7 101.3 -29.0 -0.7
3.3 30.2 24.6 13.8 14.7 12.9 297.4 -40.4 -1.0
13.40 12.44 2.20 39.10
14.10 14.10 2.40 51.72
17.37 17.37 2.70 66.29
20.61 20.61 3.00 83.74
265
abc
Crompton Greaves Income statement (INRm) FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
41,265 (27,749) 13,516 (5,536) (4,728) 0 3,252 0 3,252 (762) 2,490 2,490 653 0 0 0 (360) 0 2,783 2,783 (453) 0 2,330 0 (32) 2,299 2,299 458.2 5.0 5.0
56,396 (38,483) 17,912 (7,171) (5,914) 0 4,827 0 4,827 (954) 3,873 3,873 1,053 0 0 0 (566) 0 4,360 4,360 (1,495) 0 2,865 0 (47) 2,818 2,818 641.5 4.4 4.4
68,323 (45,660) 22,663 (7,968) (7,256) 0 7,439 0 7,439 (1,263) 6,176 6,176 677 0 0 0 (701) 0 6,152 6,152 (2,054) 17 4,115 0 (48) 4,067 4,067 641.5 6.3 6.3
87,373 (56,938) 30,435 (10,646) (9,833) 0 9,956 (1,278) 11,234 (1,216) 8,740 10,018 587 39 14 153 (808) 0 8,672 9,911 (3,047) (9) 5,616 0 (17) 5,599 6,403 641.6 8.7 10.0
91,409 (57,966) 33,443 (11,131) (9,542) 0 12,770 (2) 12,771 (1,551) 11,219 11,220 937 383 2 163 (428) 0 11,891 11,509 (3,650) 32 8,272 352 (26) 8,599 7,982 641.5 13.4 12.4
103,134 (65,890) 37,244 (12,155) (10,578) 0 14,511 0 14,511 (1,900) 12,610 12,610 635 0 2 162 (401) 0 13,007 13,007 (3,967) 35 9,075 0 (30) 9,045 9,045 641.5 14.1 14.1
122,198 (78,349) 43,849 (13,400) (12,533) 0 17,916 0 17,916 (2,347) 15,569 15,569 752 0 2 224 (401) 0 16,144 16,144 (5,005) 35 11,174 0 (30) 11,144 11,144 641.5 17.4 17.4
142,637 (92,010) 50,627 (15,051) (14,629) 0 20,947 0 20,947 (2,594) 18,352 18,352 878 0 2 330 (401) 0 19,159 19,159 (5,939) 35 13,255 0 (30) 13,225 13,225 641.5 20.6 20.6
Crompton Greaves Margin & trend analysis FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
36.7% 36.5% 48.4% 55.5% -12.4% -12.4% 31.8% 8.6% 6.9% 7.0% 7.7% 5.1% 2.2% 26.8% 0.0% 8.5% 34.3% 14.3% 5.0% 31.9%
21.2% 21.0% 54.1% 59.5% 44.3% 44.3% 33.2% 10.9% 9.0% 9.5% 9.0% 6.0% 4.2% 6.6% 0.0% 8.0% 33.4% 17.0% 4.9% 25.2%
27.9% 25.8% 51.0% 41.5% 37.6% 57.4% 34.8% 12.9% 10.0% 11.9% 9.9% 6.4% 3.1% 29.6% 2.2% 10.4% 35.1% 17.1% 3.3% 22.9%
4.6% 3.8% 13.7% 28.4% 53.6% 24.7% 36.6% 14.0% 12.3% 12.7% 13.0% 9.0% 1.0% 3.6% 1.9% 7.0% 30.7% 17.5% 2.5% 16.4%
12.8% 12.8% 13.6% 12.4% 5.2% 13.3% 36.1% 14.1% 12.2% 12.6% 12.6% 8.8% 5.0% 4.0% 1.5% 8.0% 30.5% 17.0% 2.5% 17.0%
18.5% 18.5% 23.5% 23.5% 23.2% 23.2% 35.9% 14.7% 12.7% 13.2% 13.2% 9.1% 6.0% 4.0% 1.5% 8.0% 31.0% 17.0% 2.5% 15.5%
16.7% 16.7% 16.9% 17.9% 18.7% 18.7% 35.5% 14.7% 12.9% 13.3% 13.4% 9.3% 8.0% 4.0% 1.5% 8.0% 31.0% 17.0% 2.5% 14.6%
266
abc
Crompton Greaves Balance Sheet (INRm) FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
Net assets
524 7,330 7,854 117 7,970 (3,895) (327) (4,222) 2,206 2,073 57 5,059 137 207 877 651 0 6,931 5,959 10,950 (9,016) (3,182) 0 0 (2,265) 2,445 (1,012) (451) 0
7,970
733 8,955 9,688 284 9,972 (8,726) (319) (9,045) 3,644 2,415 (2,986) 7,317 2,535 1,021 930 645 1 12,449 9,156 14,214 (11,662) (1,701) 0 0 (6,874) 3,133 (2,112) (512) 0
9,972
733 12,285 13,018 123 13,140 (8,120) (300) (8,420) 3,704 2,445 (2,271) 8,799 3,170 476 1,307 934 0 14,685 10,664 17,204 (12,229) (6,736) 0 0 (2,750) 6,153 (4,708) (719) 0
13,140
733 17,577 18,311 139 18,449 (6,923) (260) (7,182) 2,290 5,656 764 9,363 3,886 537 1,330 1,672 0 16,787 10,949 20,556 (14,319) (7,290) (1,565) 0 (2,847) 5,484 (3,739) (848) 0
18,449
1,283 23,760 25,043 43 25,086 (4,766) (244) (5,010) 2,455 6,688 4,134 9,220 3,404 1,137 896 5,536 0 20,192 10,412 21,463 (14,865) (7,263) (1,233) 0 (3,206) 5,308 (3,603) (945) 0
25,086
1,283 31,857 33,140 43 33,183 (4,766) (244) (5,010) 2,455 10,053 7,499 13,029 3,394 1,137 896 5,536 0 23,992 11,847 24,329 (16,924) (8,462) (1,058) 0 (3,491) 6,241 (3,603) (945) 0
33,183
1,283 41,200 42,483 43 42,526 (4,766) (244) (5,010) 2,455 14,889 12,335 16,391 3,385 1,137 896 5,536 0 27,344 14,037 28,826 (20,053) (10,027) (1,253) 0 (4,136) 7,395 (3,603) (945) 0
42,526
1,283 52,398 53,681 43 53,724 (4,766) (244) (5,010) 2,455 24,245 21,691 17,003 3,378 1,137 896 5,536 0 27,950 16,385 33,648 (23,407) (11,704) (1,463) 0 (4,828) 8,631 (3,603) (945) 0
53,724
r
Crompton Greaves Key balance sheet ratios FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
-0.7% -0.7% 0.99 0.99 6.93 (0.02) 7.64 3.74 5.26 na na na na na na na
29.9% 29.9% 1.30 1.30 6.84 0.62 5.19 3.59 4.03 27 101 106 (129) 0 (51) 6.4%
17.3% 17.3% 1.17 1.17 8.81 0.31 5.49 2.70 3.67 71 93 101 (106) 0 (16) 9.9%
-4.1% 4.3% 0.96 1.04 13.34 (0.07) 6.34 3.11 4.19 59 78 96 (102) 0 (13) 7.0%
-16.5% -11.6% 0.84 0.88 42.35 (0.32) 6.64 3.32 4.50 46 66 88 (94) 0 (13) 5.9%
-22.6% -19.4% 0.77 0.81 52.90 (0.52) 5.87 3.10 4.15 48 70 91 (100) 0 (13) 6.4%
-29.0% -26.1% 0.71 0.74 88.02 (0.69) 5.84 3.09 4.13 50 71 93 (101) 0 (13) 6.6%
-40.4% -37.7% 0.60 0.62 260.59 (1.04) 6.63 3.29 4.51 49 70 93 (100) 0 (13) 6.5%
267
abc
Crompton Greaves Cash Flow Statement (INRm) EBITDA Adjusted for: Unrealized fx (gains)/losses Loss on sale of fixed assets Other non-cash exceptionals Change in working capital Tax paid Net financials Others Cash flow from operations FY06 3,252 FY07 4,827 FY08 7,439 FY09 9,956 FY10 12,770 FY11e 14,511 FY12e 17,916 FY13e 20,947
(81) (88) 0 (1,369) (313) (336) 558 1,623 (787) 149 0 985 (267) 718 (389) 1,075 0 0 1,404
(57) (62) 8 (751) (1,136) (563) 960 3,226 (6,484) 119 0 (3,139) (503) (3,642) (880) 4,863 0 0 341
(4) (9) 180 (844) (1,868) (684) 625 4,836 (2,583) 58 0 2,311 (696) 1,614 (676) (908) 0 0 30
897 (39) 190 58 (2,165) (702) 561 8,756 (2,012) 36 0 6,779 (814) 5,965 (1,380) (1,374) 0 0 3,212
(1,010) (67) 304 543 (2,920) (288) 943 10,275 (2,904) 833 0 8,205 (1,159) 7,046 (3,845) (2,169) 0 0 1,032
0 0 0 (933) (3,967) (238) 640 10,012 (6,000) 300 0 4,312 (947) 3,364 0 0 0 0 3,364
0 0 0 (1,154) (5,005) (177) 757 12,338 (6,000) 300 0 6,638 (1,801) 4,836 0 0 0 0 4,836
0 0 0 (1,237) (5,939) (70) 883 14,583 (3,500) 300 0 11,383 (2,027) 9,356 0 0 0 0 9,356
Crompton Greaves Key cash ratios FY06 FY08 FY08 FY09 FY10 FY11e FY12e FY13e
9.6% -3.3% 1.0 1.9% 65.2% 4.0% 2.9%
23.5% -1.3% 6.8 11.5% 83.3% -5.0% -5.9%
25.1% -1.2% 2.0 3.8% 78.3% 2.1% 1.4%
21.8% 0.1% 1.7 2.3% 100.2% 9.5% 8.4%
22.9% 0.6% 1.9 3.2% 91.6% 6.8% 5.8%
27.3% -0.9% 3.2 5.8% 79.4% 2.2% 1.7%
27.9% -0.9% 2.6 4.9% 79.2% 3.3% 2.4%
28.4% -0.9% 1.3 2.5% 79.5% 5.7% 4.7%
268
abc
Crompton Greaves Valuation FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
54 24,533 (57) 3,182 0 117 (651) 27,124 66% 246% 8.3 10.9 10.2 10.7 3.1 2.6% 4.0% 2.9% 20.1% 26.6% 29.3%
97 62,163 2,986 1,701 0 284 (645) 66,490 118% 423% 13.8 17.2 16.8 22.1 6.2 1.4% -5.0% -5.9% 16.6% 18.2% 29.1%
175 111,980 2,271 6,736 0 123 (934) 120,175 176% 474% 16.2 19.5 18.5 27.5 8.5 0.9% 2.1% 1.4% 17.1% 22.1% 31.2%
111 71,370 (764) 7,290 1,565 139 (1,672) 77,928 89% 277% 6.9 7.8 7.5 11.1 3.9 1.8% 9.5% 8.4% 23.9% 31.2% 35.0%
188 120,608 (4,134) 7,263 1,233 43 (5,536) 119,477 131% 433% 9.4 10.6 10.3 15.1 4.8 1.2% 6.8% 5.8% 29.1% 38.3% 31.9%
289 185,467 (7,499) 8,462 1,058 43 (5,536) 181,996 176% 546% 12.5 14.4 14.0 20.5 5.6 0.8% 2.3% 1.8% 27.2% 35.3% 27.3%
289 185,467 (12,335) 10,027 1,253 43 (5,536) 178,920 146% 452% 10.0 11.5 11.1 16.6 4.4 0.9% 3.6% 2.6% 28.0% 36.3% 26.2%
289 185,467 (21,691) 11,704 1,463 43 (5,536) 171,450 120% 396% 8.2 9.3 9.1 14.0 3.5 1.0% 6.1% 5.0% 30.2% 40.1% 24.6%
Crompton Greaves Profitability RoCE FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
2,490 159 0 5.0% 16.3% 2,649 2,218 7,970 (426) 1,012 4,222 3,182 0 2,073 2,206 651 11,030 24.0% 20.1% 26.6%
3,873 85 0 5.0% 34.3% 3,958 2,601 9,972 (418) 2,112 9,045 1,701 0 2,415 3,644 645 15,708 25.2% 16.6% 18.2%
6,176 337 0 5.0% 33.4% 6,513 4,338 13,140 (588) 4,708 8,420 6,736 0 2,445 3,704 934 25,333 25.7% 17.1% 22.1%
10,018 365 0 5.0% 35.1% 10,383 6,735 18,449 (482) 3,739 7,182 7,290 1,565 5,656 2,290 1,672 28,125 36.9% 23.9% 31.2%
11,220 363 0 5.0% 30.7% 11,584 8,028 25,086 49 3,603 5,010 7,263 1,233 6,688 2,455 5,536 27,564 42.0% 29.1% 38.3%
12,610 423 0 5.0% 30.5% 13,034 9,058 33,183 49 3,603 5,010 8,462 1,058 10,053 2,455 5,536 33,321 39.1% 27.2% 35.3%
15,569 501 0 5.0% 31.0% 16,070 11,088 42,526 49 3,603 5,010 10,027 1,253 14,889 2,455 5,536 39,587 40.6% 28.0% 36.3%
18,352 585 0 5.0% 31.0% 18,937 13,067 53,724 49 3,603 5,010 11,704 1,463 24,245 2,455 5,536 43,316 43.7% 30.2% 40.1%
abc
Siemens Powering through

The earnings outlook remains strong as the company has seen
significant improvement in its margins and market position in the transmission segment
Siemens should also benefit from its INR16bn capex plan which
will help capture domestic demand and also help the company become a global outsourcing hub for value products
We are c8% ahead of consensus on FY12 (Sept YE) and find the
stock attractive relative to peers, particularly as it has re-rated inline with the wider sector; initiate OW with a TP of INR950
A premium growth story

Siemens doesnt look particularly inexpensive at this stage; however, the group is aggressively building its presence in India and hence we believe is bound to deliver premium quality growth over the next five years. The company has recently announced an ambitious INR16bn investment plan over the next three years which will not only help Siemens India meet domestic demand but also become a global outsourcing hub for lower priced value products. We believe Siemens is now a key beneficiary of the domestic transmission growth story as not only has it gained market share in substation related orders but also because the energy division is now a key driver, contributing c60% to the groups earnings. Moreover, the company has shown significant improvement in its EBITDA
margins lately, from c7.5% in FY08 to c13.7% in FY10 (September year-end), driven by a sharp improvement in the profitability of the mobility and the fossil power businesses. We highlight our key bull and bear points related to Siemens below:
Bull points
After strong order growth (c40%) in FY10,
the order book visibility at c1.5 years is among the best in the peer group
Gained significant market share with Power
Grid in the 400/220kV segment so far during FY11

EBITDA margins have shown significant improvement over the past three years Strong balance sheet with significant fire
power
270
abc
Strong focus on growth with a sizeable INR16bn (c17% FY10 sales and c9.5x FY10
Strong order book, rising market position

After three years of stagnant backlog, Siemens has finally seen a strong 32% increase in its order book, driven by strong growth in order intake of c41% during FY10. Consequently, the sales visibility has also increased to c1.5 years (among the best in the peer group) from c1.2 years over the last three years.
Order intake and order book (INRm)
D&A) investment plan over the next 3 years

Currently the second best company within our
coverage universe on fundamentals

Bear points
Working capital needs better management The company has lost market share to ABB and Areva T&D in the 765kV substation
orders from Power Grid so far during FY11

150,000
EBIT margins may face some downward pressure going forward, driven by higher capex
100,000
in the medium term and increasing proportion of low value products in the longer term Overall, we remain bullish on Siemens in the near term and believe the group should benefit from its improving market position as well as operational performance. Our FY11-12 EPS estimates remain 6-8% ahead of consensus. On our calendarised FY12e numbers, the stock is trading at c22.6x PE and c13.7x EV/EBITDA versus the equipment manufacturing averages of c24x and c14x, respectively. We further note that over the last five years both of Siemens closest foreign peers, ABB and Areva, have increased stakes in their Indian subsidiaries but Siemens has not. However, we believe that in light of Siemens global expansion plans and strong focus on India, a potential increase in the parents stake in the Indian subsidiary remains likely and hence we find the current multiples attractive at this stage. We initiate coverage of Siemens with an Overweight and a target price of INR950, which implies c31% potential return.
50,000
0 FY05 FY06 FY07 FY08 FY09 FY10
Order intake
Order book
Energy segment sales and EBIT as % of total and EBIT margins
80% 60% 40% 20% 0% FY08 Sales

20% 15% 10% 5% 0% FY09 EBIT FY10 Energy Margins
Key beneficiary of domestic transmission growth

Although Siemens is highly diversified, it derives a large portion (c45-50%) of its sales and even a larger proportion of its EBIT (c60-70%) from the energy division.
271
abc
We further note that within the energy division, the group derives over 80% of its divisional sales and EBIT from the transmission & distribution (T&D) markets, thus making the business highly geared to the domestic transmission growth story. Moreover, due to the companys presence in substation equipment, which typically have shorter lead times and are ordered closer to line completion, we expect the order growth to extend well into FY13 before tapering off in FY14 (for details on our T&D end-market forecasts, please refer to the End-market analysis section earlier in this report).
T&D, oil & gas, power generation sales and EBIT
Not only are these orders large (Power Grid is mandated to spend over 50% of the nations transmission budget) but they are also regular, with decent visibility and minimal financial risk (Power Grid has always achieved its investment targets and has a well managed balance sheet). Therefore, a strong position with Power Grid is a key positive in our opinion. Our analysis of the Power Grid order awards during the current financial year suggests that Siemens has gained strongly in the 400/220kV segment. In this segment, the company has received c51% of the total transformer/reactor orders and c37% of the total substation orders. These gains are important because a bulk of Power Grid order fall into this segment and hence provide significant volumes. So far in the current financial year, c68% of the total transformer orders and c76% of the total substation orders have come in the 400/220kV segment.
400/220kV transformer & substation orders as % of total transformer & substation orders
100% 50% 0% -50% -100% Sales EBIT Sales EBIT Sales EBIT
FY08 T&D
FY09 Oil &Gas
FY10 Fossil pow er
100% 80% 60% 40% 20% 0% FY09 Transformer

Source: Power Grid, HSBC
Strengthening position with Power Grid

Power Grid order awards are often seen as a proxy for market position of various vendors, particularly as the competition for these orders is often intense.
FY10 Substation
YTD
Siemens market share: transformers & substations (400kV)
60% 50% 40% 30% 20% 10% 0% FY09 Transformer

Source: Power Grid, HSBC
FY10 Substation
YTD
On the negative side, however, Siemens has lost its entire share in Power Grid orders within the 765kV segment to ABB and Areva T&D this year. We believe it will be unwise to read too much into this at this stage, as 765kV substation orders are often large and lumpy and can result in significant volatility in the market share during the course of a year.
272
abc
For example, only three 765kV substation packages have been awarded by Power Grid during the current financial year, of which ABB has won two and Areva one. Therefore, if Siemens can win even one 765kV substation package during the remaining part of the year, its position relative to ABB and Areva will not look as bad.
Siemens & Siemens AG 765kV substation market share
Capex (INRm)
6,000 5,000 4,000 3,000 2,000 1,000 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
60% 50% 40% 30% 20% 10% 0% FY09 Siemens

Source: Power Grid, HSBC Source: Company, HSBC estimates
A product range that suits every customer

FY10 Siemens AG YTD
INR16bn capex plan likely to boost future growth

The company announced in Feb 2010, that they intend to invest around INR16bn (c17% FY10 sales and c9.5x FY10 D&A) in India over the next three years. The intention is to build a strong presence in the renewable energy market (i.e. the wind turbines) and expand its offering in value priced products, which constitute a bulk of total volumes in India. The company intends to create six hubs as part of this investment plan to build strong presence in rail signalling, wind turbines, mid-sized steam turbines and power plants EPC work. Investment in these areas, in our opinion, will provide a further boost to orders in the industry and energy divisions and is a potential area for positive surprises.
Siemens, in our opinion, is not only a technology leader in its areas of operations but also a leading player in low value-add volume based products. For example, in the T&D markets, Siemens was not only the first company to establish the 500kV HVDC terminal with the highest transformation capacity (1500MVA) but is also a market leader in relatively low value-add 400/220kV substation equipment. We believe that the groups ability to bring superior technology from its parent company and its strong focus on the value segment in India (as is evident in its expansion plan) make a strong combination for significant but profitable growth going forward.
Margins may deteriorate in medium to long term

Siemens has shown strong improvement in its margins over the last few years, driven primarily by the sharp increase in profitability of the mobility and the power generation business. As we highlight in the following chart, margins in both the industry and energy segments have shown improvement in FY10 (on standalone numbers as segment information for consolidated numbers is not available).
273
abc
Segment EBIT margin (standalone) Segment EBIT margin Industry FY08 FY09 FY10
Total metal exposure (as% of sales)
25% 20% 15% 10% 5% 0% Siemens ABB Arev a Crompton
Industry Automation Drive Technologies Building Technologies Industry Solutions Mobility Total Industry
Energy
9.3% 8.2% 6.0% 13.1% -2.7% 7.9%
8.6% 6.3% 3.8% 9.3% -0.7% 5.4%
9.3% 7.9% 4.0% 9.2% 8.4% 8.1%
Fossil Power generation Oil & Gas Power Transmission Power Distribution Total Energy
-143.0% 11.2% 12.0% 12.3% 7.3%
10.4% 14.4% 16.2% 7.4% 13.6%
30.9% 13.3% 17.8% 5.6% 15.0%
However, in the medium to long term we believe margins at Siemens may deteriorate somewhat, driven, in the medium term, by increasing capex (and hence rising depreciation) and in the longer term by increasing proportion of value priced products. In the near term, however, the margins should broadly remain around current levels, as improvement in margins at building technology may be offset by normalization of margins at power generation and real estate.
EBIT margins (%)
Strong balance sheet with superior returns

Strong growth but not at the expense of returns
The companys balance sheet has grown nearly three fold over the last five years, driven largely by strong cash generation, continuous investment in fixed assets and creation of working capital assets. Therefore, the company remains in a strong position to fund future growth.
Key balance sheet drivers (INRm)
14% 12% 10% 8% 6% 4% 2% 0% FY06 FY10 FY11e FY12e FY13e FY09 FY07 FY08
40,000 30,000 20,000 10,000 (10,000) (20,000) FY06 Total Equity Net Cash FY07 FY08 Total WC Total Fix ed assets FY09 FY10
Metal prices not a major risk

Siemens has a relatively low steel exposure of c11.5% of sales compared with its competitors. Therefore, even though our metals and mining team expects the steel prices to increase in 2011, we dont see it as a significant risk to Siemens.
We note that although growth in the equity base has been accompanied by a decline in returns, the extent of deterioration has been much smaller at Siemens compared with two of its closest competitors, ABB and Areva T&D.
274
abc
RoCE
FY10 ROE
40% 30% 20% 10% 0% FY07 FY08 Siemens

35% 30% 25% 20% 15% 10% 5% FY09 ABB Arev a FY10 0%
ABB Ltd
We highlight that at c22%, the groups return on capital employed (RoCE) is the second best (after Crompton) within our coverage universe.
FY10 RoCE
Working capital needs strict management

Over the last five years, Siemens has been transformed from a negative working capital company to a positive working capital company. This has been largely been driven by a sharp increase in trade receivables and inventories over the last three years.
Total working capital (WC), inventory and trade receivables as % of sales
T&D India
Crompton
Siemens
Greaves
Areva
India
35% 30% 25% 20% 15% 10% 5% 0%

ABB Ltd
50% 40% 30% 20% 10% 0% -10% FY07 Total WC

And even though Siemens is the most underlevered stock in our universe, the groups return on equity (RoE) is also among the best in the peer group.
T&D India
Crompton
Siemens
Greaves
Areva
India
FY08 Inv entory
FY09
Trade reciev ables
Although this increase in working capital assets was partly offset by increasing customer advances, there has been no improvement in payable days. Consequently, the working capital requirement has increased.
275
abc
Customer advances and payables as % of sales
0% -5% -10% -15% -20% -25% -30% FY07 FY08 Pay ables FY09
We expect cash generation to remain strong at Siemens and we believe the group should be able to fund its INR16bn investment plan through internal cash generation.
FCF and capex
Customer adv ances

10,000 8,000 6,000 4,000 2,000 (2,000) (4,000) FY13e FY10 FY06 FY09 FY10 FY11e FY09 FY12e FY07 FY08 FCF
We believe that working capital at Siemens needs better management and although the FY10 balance sheet is yet to be reported, we hope to see some improvement in the working capital, at least in the inventories.
Capex
Cash generation remains among the best in the peer group

In spite of spending quite heavily on capex, free cash flow generation at Siemens is one of the best within our coverage universe. Over the last five years, Siemens has generated free cash of c4.5% of sales even though the capex has been in the range of 2.5-4.0% of sales.
FCF to sales (last reported)
We further note that this strong cash generation, coupled with an already strong net cash position (c80% equity), provides the group with significant firepower to grow acquisitively in the coming years.
Equity, net cash
40,000 30,000 20,000 10,000 FY06 FY07 Equity FY08 Net cash
10%
5%
0%
-5% Siemens ABB Arev a Crompton
c6-8% ahead of consensus on our FY11-12 estimates

Siemens India has many businesses; however, the key drivers of its earnings are the industry and energy divisions. Within these divisions, industrial capex and the power transmission capex are the key drivers of demand.
Note: Siemens Sept 2009, ABB Dec-09, Areva Dec-09, Compton March-2010 Source: Company, HSBC
276
abc
End-market exposure FY10
Oil & Gas 7% Power Distribution 9% Power Transmission 28%
Healthcare 7% Industrial capex 32% Construction exp (Non) infra 6% Power Gen 1% Railways capex 10%
capacity constraints and strong growth in GDP. We forecast industrial orders to grow c15-20% in FY11-12 before tapering off to c10% in FY13.
Industry order intake growth
25% 20% 15% 10% 5%
0%
As we highlighted in our End-market analysis section, we are bullish on the transmission segment, particularly in the domestic markets. We believe India will witness strong growth in transmission orders over the next two to three years, driven by 11th plan spillover and the orders related to high capacity corridors (HCPTCs). Moreover, given that Siemens makes substation equipment which typically has shorter lead times and is ordered closer to transmission line completion, we expect the order growth to extend well into FY13 before tapering off in FY14. Consequently, we forecast the orders in the Energy division to grow by c20-25% during FY11-13 (September year-end).
Energy order intake growth
FY11e
FY12e
FY13e
Overall, we forecast the groups order intake to grow at c17% in FY11e and c20% in FY12e.
Order intake growth
50% 40% 30% 20% 10% 0% -10% -20% FY07 FY08 FY09 FY10 FY11e FY12e FY13e
25% 20% 15% 10% 5% 0% FY11e FY12e FY13e
The industrial markets should also continue to see double digit capex growth driven by persistent
We note that due to a sharp increase of over 40% y-o-y in order intake in FY10, the order execution rate has come down to c41% from c45-46% historically. We assume the execution rate to remain at c40-41% level over the next three years and hence we forecast a sales growth of c20-22% during FY11-13. However, we note that there remains a possibility that the execution rate might improve faster than we expect, particularly as capacity utilization picks up from the lows of FY09, in which case there remains further upside to our FY11-13 estimates.
277
abc
In terms of profitability, we expect a modest decline of c80bp in EBITDA margins over the next three years, driven largely by the normalization of power gen and real estate margins and pricing pressure in the T&D business. A higher than expected price erosion in the T&D segment remains a key downward risk to our margin estimates. Overall, we forecast FY11e and FY12e group sales of INR116bn and INR141bn, clean EBITDA of INR15.6bn and INR18.7bn and clean EPS of INR29.8 and INR34.9, respectively. We are modestly ahead of consensus by c6-8% on our FY11-12e EPS estimates. Our higher numbers
are driven by our more bullish view on future growth and profitability. Consequently, for FY1112e, we are ahead of consensus by c4-6% on sales and by c40-50bp on EBITDA margins. We highlight our forecasts and the consensus estimates in the table below.
Siemens scores strongly on fundamentals

Within our coverage universe, Siemens has the second highest Q-ben score of 6.5 in our quality benchmarking analysis, emerging as a premium quality company. The company has received high scores (i.e. above 6) on three of the five criteria,

Sie m e ns - Se pt YE (INR m) Order Backlog Ne t Sale s Clean EBITDA Re por te d EBITDA Clean EBIT Re por te d EBIT Other Income Net Financials Profit be fore tax Income tax Extraordinary items Income f rom JV s Minorities Clean Net Income Re por te d Ne t Incom e Clean EPS Re por te d EPS DPS FY10 135,839 96,201 13,196 13,196 11,509 11,509 0 557 12,066 (4,501) 0 0 12 7,578 7,578 22.5 22.5 5.0 Ne w Fore cas ts FY11e FY12e 168,481 115,936 15,620 15,620 13,704 13,704 0 725 14,429 (4,473) 0 85 (10) 10,031 10,031 29.8 29.8 5.5 205,659 141,265 18,659 18,659 16,358 16,358 0 848 17,206 (5,506) 0 85 (10) 11,775 11,775 34.9 34.9 6.3 FY13e 245,791 168,734 21,590 21,590 18,969 18,969 0 1,004 19,973 (6,591) 0 85 (10) 13,457 13,457 39.9 39.9 7.6 Bloom be rg Cons e ns us FY11e FY12e FY13e 111,462 133,790 159,121
14,415 12,927
17,107 15,243
18,647 16,012
8.4% 6.0%
9.1% 7.3%
15.8% 18.5%
761 13,688
1,013 16,256
996 17,008
5.4%
5.8%
17.4%
9,463
11,085
11,409
6.0%
6.2%
18.0%
28.1 5.5
32.3 6.4
33.9 5.4
6.1% 0.0%
8.1% -1.2%
17.9% 40.6%
M argins & Tre nd FY10 Sales visibility (yrs) Sale s grow th Clean EBITDA mgn Re por te d EBITDA m gn Clean EBIT mgn Re por te d EBIT m gn PBT mgn Clean NI mgn Re por te d NI m gn 1.4 16% 13.7% 13.7% 12.0% 12.0% 12.5% 7.9% 7.9%
FY13e 1.5 19% 12.8% 12.8% 11.2% 11.2% 11.8% 8.0% 8.0%
12.9% 11.6% 12.3% 8.5%
12.8% 11.4% 12.2% 8.3%
11.7% 10.1% 10.7% 7.2%
54 22 17 16
42 19 3 5
108 118 115 81
278
abc
Siemens benchmarking
Median = 5.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
highlighting its well rounded performance. The company has scored best on financial strength (a score of 8.9/10) and worst on market performance (a score of 3.0/10). While the companys score on financial strength is obviously driven by its highly underlevered balance sheet and decent FCF yield, its low score on market performance is mainly driven by its flattish growth over the last three years. The company also scored low on its cyclical resilience. We highlight the performance of the company on each of the criteria and each of the metrics in the bar charts.
During our five year analysis period (FY0913e, March year-end), we estimate average FCF of c4.7% sales versus our sector average of c1.7%.
Return on capital employed: Again, as we have highlighted earlier, Siemens is the
second best company in our universe on its ability to generate returns. The company has scored 7.4/10 on this metric, again, second only to Crompton Greaves. During our analysis period, we forecast Siemens to generate an average RoCE of c22% versus sector average of c17.2%.
Market position: In an absolute sense,
High scores on several metrics

Out of the 16 metrics which we used to benchmark a companys quality against its peers, Siemens scored high (i.e. more than 6.0/10) on 10 of the metrics, highlighting the companys well rounded superior quality. Some of the most relevant metrics/areas where Siemens has a high score are:
Free cash flow generation: As we have highlighted earlier, Siemens is one of the best
Siemens has scored high on this metric, with a score of 6.0/10; however, on a relative basis, this is the lowest score within our universe. This is largely driven by the groups diversification into business areas where it doesnt have a market leading position. The group nevertheless remains one of the top three players in most of its key business segments.
Customer diversity: Siemens has naturally
in the sector in terms of cash generation. The company scored 8.3/10 on this metric, second to only Crompton Greaves in our universe.
received the highest score (7.1/10) within our universe on this metric. The company is not
279
abc
Customer diversity analysis
Siemens India Crompton Greav es Arev a T&D India ABB Ltd KEC International Kalpataru Pow er Transmission Jy oti Structures 0% 10% 20% 30% Mid Cy cle 40% 50% 60% Others 70% 80% 90% 100%
Early Cy cle
Late Cy cle
only present in various end markets, but also has a well-diversified exposure to different phases of a business cycle (i.e. early, mid, and late cycle).
Financial strength: As we have highlighted
this criterion relative to other criteria but also relative to other companies in our coverage universe.
Trading volumes: Siemenss stock has the highest trading volume within our coverage
earlier, Siemens has a highly under-levered balance sheet and strong cash generating capabilities. Therefore the company has scored strongly on all four metrics within this criterion, namely, financial leverage, net debt to EBITDA, interest cover and FCF yield. Siemens has not only scored the highest on
universe and therefore the company has scored a perfect 10 on this metric. We note that empirical evidence suggests that the market usually awards a premium to the stocks with higher liquidity compared with the ones with lower liquidity.
Siemens benchmarking
Median = 5.0
Internal Performance Market Performance Balancing risk Financial Strength Equity Structure
(1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
280
abc

ABB Areva T&D
Premium quality warrants a valuation premium

As we highlight in the scatter charts, Siemens lies in the Premium Quality quadrant, with a better quality score than other equipment manufacturers (shown as Eqp Mfg Avg) but at a modest valuation discount to them. Therefore, we dont find the current valuation expensive or unwarranted. Furthermore, we believe that the stock can re-rate upwards if it shows improvement in its weaker areas (like sales growth).
Inexpensive relative to peers

Siemens has re-rated upwards from the lows of 2008 and on consensus numbers the stock is trading at a modest premium to its average historical 12-month forward multiples (PE and EV/EBITDA).

25.0 20.0 15.0 10.0 5.0 0.0 0.0 1.0 2.0 3.0 4.0 5.0 Q-be n Score
ABB
12m fwd EV/EBITDA
Areva T&D
KEC
281
abc
PE vs history
EV/EBITDA vs RoCE
40 30 20 10 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Siemens Ltd

30 25 20 15 10 5 0
100% 80% 60% 40% 20% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Siemens Ltd 12m fw d RoCE
Historic av erage
EV/EBITDA vs historical average
30 25 20 15 10 5 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Moreover, the stock looks inexpensive on a 12month forward EV-to-sales multiple, as it seems to have re-rated in line with its improving profitability.
4.0 3.0 2.0 Siemens Ltd Historic av erage 1.0 0.0
16.0% 14.0% 12.0% 10.0% 8.0% Jan05 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11
However, we believe that this premium can be largely explained by improving growth prospects and increasing returns.
PE vs EPS growth
Siemens Ltd
12m fw d EBITDA mgn
40 30 20 10 0
150% 100% 50% 0% -50% -100% Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Siemens Ltd EPS grow th
The stock also seems to be trading in line with its historical average on EV to backlog as we show in the charts on the previous page. Therefore, we conclude that even though the stock has re-rated upwards over the last couple of years, most of this re-rating is justified.
282
abc
EV/backlog vs history
4.0 3.0 2.0 1.0 0.0 Sep-06 Sep-07 Siemens Ltd

Sep-08
Sep-09 Historic av erage
Sep-10
We further note that over the last five years, both of Siemens closest foreign peers, ABB and Areva, have increased stakes in their Indian subsidiaries; however, Siemens has not. However, we believe that in light of Siemens global expansion plans and strong focus on India, a potential increase in parents stake in the Indian subsidiary remains likely and in that context, Siemens current multiples actually look attractive (as the stock has re-rated only in line with the wider sector, there seems to be no or minimal acquisition premium built into the valuation). Finally, on our estimates also, the stock looks inexpensive relative to its peers under our coverage. On our calendarised FY12e numbers, Siemens is trading at c22.6x PE and c13.7x EV/EBITDA versus its peer group average (ABB, Areva and Crompton) of c24x and c14x, respectively.
Moreover, as we highlight in the charts below, over the last five years Siemens has actually re-rated largely in line with the wider capital goods sector. Both MSCI Cap Goods index and Siemens has rerated by c90-95% on 12-month forward PE (based on consensus) over the last 5 years on average.
Siemens re-rating
40 30 20 10 0 Jan-01 Jan-03 Jan-05 Siemens Ltd Historic Av g (06-10)

Avg P/E = 14.0
We initiate with an Overweight and a TP of INR950

We initiate coverage of Siemens with an Overweight and a target price of INR950, implying c30% potential return. We value the group based on our preferred Economic Value Added (EVA) valuation methodology. Our valuation model assumes a WACC of c11.3%, sales growth of c9.0%, through cycle margin of c12.0% and a competitive advantage period (CAP) of 30 years. Our target price implies a 12-month forward target multiple of c26x PE and c16x EV/EBITDA for the group compared with current 12-month forward multiples of c24x and c14.5x, respectively.
Avg P/E = 25.8
Jan-07 Jan-09 Jan-11 Historic Av g (01-05)
MSCI cap goods re-rating
40 30 A vg P/E = 10.6 20 10 0 Dec-00 Dec-02 Dec-04 Dec-06
A vg P/E = 20.6
Dec-08
Dec-10

283
abc
Valuation summary: Siemens Key assumptions
We also highlight the sensitivity of our target price to our assumptions.

9.0% 12.0% 3.0 31% 11.3% 30.0
12m PT 952 6% 7% 8% 9% 10% 11% 12% 12m PT 952 8% 9% 10% 11% 12% 13% 14% WACC 12m PT 952 8% 9% 10% 11% 12% 13% 14% WACC Sales Growth 9% 553 600 646 693 740 787 833 Operating Re turn (OR) M argins 10% 11% 12% 13% 14% 619 686 752 819 885 673 746 819 892 965 726 806 886 965 1,045 780 866 1,039 1,125 952 833 926 1,019 1,112 1,205 886 986 1,086 1,185 1,285 940 1,046 1,152 1,259 1,365 Operating Re turn (OR) M argins 10% 11% 12% 13% 14% 1,082 1,199 1,315 1,432 1,549 960 1,064 1,168 1,273 1,377 861 955 1,050 1,144 1,239 780 866 1,039 1,125 952 712 791 871 950 1,030 654 728 801 875 949 604 673 742 810 879 Sales Grow th 8% 9% 10% 1,220 1,315 1,411 1,084 1,168 1,252 975 1,050 1,124 886 1,019 952 810 871 931 747 801 856 692 742 792 15% 952 1,038 1,125 1,211 1,298 1,385 1,471
Value of current op Trend sales Trend CE CE growth RoIC Trend OR Value of current op Value of future inv Incremental return Incremental cost EVA Value of future inv 12-month forward Implied market cap EV EV 12-month forward Net debt Customer advances Bankers acceptances Minorities Investments/associates Implied market cap Target price 12-month forward TP Published TP
122,268 43,977 3.0% 36.0% 15,832 96,672
1,320 149 762 181,776 278,448 309,912 (31,312) 20,082 0 56 (0) 321,086
9% 965 855 766 693 632 580 535
15% 1,665 1,481 1,333 1,211 1,109 1,023 948
6% 1,029 917 827 752 690 637 592
7% 1,124 1,001 901 819 750 692 642
11% 1,506 1,336 1,199 1,086 991 911 842
12% 1,602 1,420 1,273 1,152 1,051 965 892
952 950
Under HSBCs research model, a non-volatile Indian stock with a potential return of 6-16% merits a Neutral rating. Our target price of INR950 implies a potential return of 31%; we therefore rate the shares Neutral.
Key risks
We highlight key risks related to our investment case on Siemens below:
Increasing competition in the T&D equipment market Higher than expected margin dilution due to increasing focus on value products Muted recovery in the industrial capex.
284
abc
Company profile
Siemens India is one of the most diversified engineering companies in the sector with operations across industries such as power, oil and gas, healthcare and consumer durables. Siemens India is a 55% subsidiary of Siemens AG, Germany, which has a presence in more than 190 countries. The company offers diverse products and services solutions in power generation, transmission and distribution, automation & drives, industrial solution, and healthcare. It has a nationwide sales and service network, 17 manufacturing plants and strong network of channel partners. The company operates across three main divisions:
Energy Industry
AC transmission system (FACTS) with series and shunt compensation, high voltage direct current equipment such as high-voltage field such as High Voltage Direct Current (HVDC) transmission systems, substations, switchgear and transformers.
Industry
The industry segment provides end-to-end products and solutions for industrial and building automation as well as infrastructure installations. The scope of the work includes project management, engineering and software, installation, commissioning, after-sales service, plant maintenance and training. The industry segment includes industry automation (IA), drive technologies (DT), industry solutions (IS), building technology (BT), mobility (Mob) and OSRAM (lighting).
Industry automation
Healthcare
Energy
Siemens is the one of few companies that provides customers with efficient products and solutions along the entire value chain in energy conversion i.e. from the production of oil & gas to power generation to transmission and distribution of the electrical energy. On the generation side the company has experience in setting up simple cycle power plants, combined cycle power plants, steam power plants up to integrated gasification combined cycle plants, ensuring high efficiency and climate friendly power generation. It also provides solutions for the automation of power grids and products such as medium voltage switchgear and components. The Siemens power transmission and distribution segment offers products and solutions in the high voltage segment. The portfolio comprises flexible
The industry automation sub-division provides a complete range of automation products & systems customised according to the requirements of the clients. The product offerings range from standard products to system solutions for energy and automation technologies used in manufacturing and process industries. This includes standard drives and motors, special purpose motors, process and motion control systems. The company also provides software solutions for manufacturing companies, including product design and development, to production, sales and service.
Drive technologies
This sub-division provides a complete range of electrical and mechanical technologies and components. This includes factory and process automation, low voltage switchgears and motor, manufacturing execution systems, products and
285
abc
systems for industry, products for building and infrastructure and windmill generators, services, maintenance and support training. This segment caters to industries ranging from aerospace, automobiles, and oil and gas to plastics, packaging, logistics and material handling.
Industry solutions (IS)
Healthcare
The Siemens Healthcare Division is one of the largest suppliers of healthcare technology in the world. It offers solutions for the entire supply chain under one roof from prevention and early detection through diagnosis and on to treatment and after care. In addition, Siemens Healthcare is the market leader for innovative hearing devices. The product range includes diagnostic, therapeutic and life-saving products in computer tomography (CT), magnetic resonance imaging (MRI), ultrasonography, nuclear medicine, digital angiography, patient monitoring systems, digital radiography systems, radiology networking systems, lithotripsy and linear accelerators.
Laboratory diagnostics
The industry solutions division executes turnkey projects in the industrial and infrastructure sectors. The scope of the work includes concept, engineering, procurement, supplies, installation, commissioning and after sales services. The company offers packaged solutions specific to a particular industry which combine plant technology concepts with IT applications and comprehensive services to carry out complete operations. The segment caters to various industries such as metals and mining, water technologies, cement, paper and pulp and airports.
Building technology (BT)
The building technology sub-division caters to the demand of personal safety and security of public and private infrastructure by providing electronic security and building automation systems. These include products for buildings such as miniature circuit breakers, distribution boards, residual current circuit breakers, etc.
Mobility (Mob)
The diagnostics division generates clinical diagnostic test results using tissue and fluid analysis a process known as in-vitro diagnostics, as well as immune diagnostics and molecular analysis. The divisions solutions range from point-of-care applications to the automation of large laboratories.
Real Estate
The real estate segment is involved in providing comprehensive real estate management. It also manages the surplus real estate within the company.
Siemens mobility division is a key player in rail based transport solutions. Some of the services provided include solutions for rail automation, railway electrification, light and heavy rail, locomotives, trains, turnkey projects and integrated services. The company has also started providing infrastructure logistics and traffic solutions business, thus transforming its into a complete mobility solutions provider.
286
abc
Siemens
Sales, order book EBITDA margin Segment breakdown
300000 250000 200000 150000 100000 50000 0 FY07 FY08 FY11e FY12e FY13e FY09 FY10
15% 12% 9% 6% 3% Energy 0% 45%
Healthcare 7%
Real Estate 1%
Industry 47%
Sales
Order Book
EBIDTA Margins
End-market exposure
Geographic exposure
Industrials Construction 3% 33%
Railways 10% Oil & Gas 6% Healthcare
India 79%
Europe 10% North America 1%
Power Distribution 9% Transmission Intl 4%

5%
Transmission Domestic 20%
Others 10%
RoW 10%
EPS vs DPS
50 40 30 20 10 0 FY06 FY08 EPS

8 6 4 2 0 FY10 DPS FY12e
15% 10% 5% 0% -5% FY13e FY06 FY10 FY07 FY08 FY09 FY11e FY12e
FCF/Sales
Capex /Sales
287
abc
Financials & valuation: Siemens India

Overweight
09/2012e 09/2013e
96,201 13,196 -1,687 11,509 557 12,066 12,066 -4,501 7,590 7,578
115,936 15,620 -1,916 13,704 725 14,429 14,429 -4,473 10,021 10,031
141,265 18,659 -2,300 16,358 848 17,206 17,206 -5,506 11,765 11,775
168,734 21,590 -2,621 18,969 1,004 19,973 19,973 -6,591 13,447 13,457
2.2 16.2 6.2 29.6 6.7 2.3 0.8
2.0 15.1 5.6 24.6 5.9 2.5 0.8
1.7 12.6 4.7 21.0 4.8 3.2 0.9
1.4 10.8 3.9 18.3 4.0 3.8 1.0
Issuer information
Share price (INR) 8,321 -3,100 -3,100 -1,972 -3,249 5,221 10,798 -4,700 -4,700 -1,972 -4,125 6,098 12,590 -4,700 -4,700 -2,170 -5,720 7,890 14,474 -5,200 -5,200 -2,495 -6,779 9,274
732.40 Target price (INR) SIEM.BO 5,423 31 India Rahul Garg
31
Bloomberg (Equity) SIEM IN Market cap (INRm) 246,936 Enterprise value (INRm) 215,680 Sector Electrical Equipment Contact +91 22 22681245
Price relative
2,746 9,552 75,885 27,193 89,379 43,107 6 -27,187 33,418 34,537
3,334 11,748 90,030 31,319 106,309 51,978 6 -31,312 41,477 41,898
3,769 13,713 108,706 37,039 127,384 63,448 6 -37,033 51,083 50,215
4,090 15,471 129,469 43,818 150,227 75,829 6 -43,811 62,045 59,182
906 806 706 606 506 406 306 206 106 2009
Siemens India
906 806 706 606 506 406 306 206 106 2010 2011 2012
Source: HSBC

Ratios (%)
3.6 27.7 33.8 10.9 26.8
20.5 18.4 19.1 19.6 32.4
21.8 19.5 19.4 19.2 17.4
19.4 15.7 16.0 16.1 14.3
2.8 22.4 22.7 8.8 13.7 12.0 -81.2 -2.1
2.8 24.2 24.2 10.3 13.5 11.8 -75.4 -2.0
2.8 23.8 23.1 10.1 13.2 11.6 -72.4 -2.0
2.9 23.1 21.7 9.7 12.8 11.2 -70.5 -2.0
22.48 22.48 5.00 99.28
29.75 29.75 5.50 123.19
34.93 34.93 6.33 151.68
39.91 39.91 7.59 184.19
288
abc
Siemens India Income statement (INRm) FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
60,323 (38,441) 21,882 (7,500) (8,229) 398 6,551 100 6,451 (1,260) 5,292 5,191 155 92 63 432 (43) 0 5,835 5,643 (1,955) 40 3,921 0 (4) 3,917 3,789 169.4 23.1 22.4
93,786 (66,214) 27,572 (9,139) (8,984) 389 9,837 1,704 8,133 (1,403) 8,433 6,730 894 798 96 588 (45) 0 9,869 7,367 (3,007) 78 6,940 0 (11) 6,929 5,189 169.4 40.9 30.6
96,798 (69,643) 27,155 (9,203) (9,326) 498 9,123 1,854 7,269 (1,617) 7,506 5,652 1,334 1,235 99 648 (66) 0 9,422 6,334 (3,483) 75 6,014 0 (19) 5,995 4,048 337.2 17.8 12.0
92,865 (65,679) 27,185 (9,444) (7,853) 627 10,515 179 10,336 (1,733) 8,783 8,604 1,616 1,501 115 558 (74) 0 10,883 9,203 (3,960) 82 7,005 0 41 7,046 5,977 337.2 20.9 17.7
96,201 (70,325) 25,876 (7,052) (6,857) 1,229 13,196 0 13,196 (1,687) 11,509 11,509 0 0 0 564 (6) 0 12,066 12,066 (4,501) 0 7,566 0 12 7,578 7,578 337.2 22.5 22.5
115,936 (84,574) 31,362 (7,772) (9,451) 1,482 15,620 0 15,620 (1,916) 13,704 13,704 0 0 0 731 (6) 0 14,429 14,429 (4,473) 85 10,041 0 (10) 10,031 10,031 337.2 29.8 29.8
141,265 (104,310) 36,955 (8,566) (11,536) 1,805 18,659 0 18,659 (2,300) 16,358 16,358 0 0 0 854 (6) 0 17,206 17,206 (5,506) 85 11,785 0 (10) 11,775 11,775 337.2 34.9 34.9
168,734 (126,249) 42,484 (9,264) (13,787) 2,156 21,590 0 21,590 (2,621) 18,969 18,969 0 0 0 1,011 (6) 0 19,973 19,973 (6,591) 85 13,467 0 (10) 13,457 13,457 337.2 39.9 39.9
Siemens India Margin & trend analysis FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
55.5% 54.0% 26.1% 59.4% 76.9% 36.9% 29.4% 8.7% 7.2% 7.6% 10.5% 7.4% 8.9% 11.9% 3.9% 25.4% 30.5% 25.5% 3.4% 11.7%
3.2% 3.0% -10.6% -11.0% -56.5% -60.8% 28.1% 7.5% 5.8% 6.9% 9.7% 6.2% 0.0% 0.7% 3.8% 30.5% 37.0% 56.3% 3.2% 16.9%
-4.1% -4.9% 42.2% 17.0% 17.5% 47.6% 29.3% 11.1% 9.3% 10.1% 11.7% 7.5% 2.8% -0.2% 2.6% 124.5% 36.4% 17.0% 2.4% 23.9%
3.6% 3.6% 27.7% 31.0% 7.5% 26.8% 26.9% 13.7% 12.0% 12.8% 12.5% 7.9% 5.0% -28.9% 2.2% 100.0% 37.3% 17.0% 2.4% 22.2%
20.5% 20.6% 18.4% 19.1% 32.4% 32.4% 27.1% 13.5% 11.8% 12.7% 12.4% 8.7% 7.0% 3.0% 2.5% 100.0% 31.0% 17.0% 2.4% 18.5%
21.8% 22.1% 19.5% 19.4% 17.4% 17.4% 26.2% 13.2% 11.6% 12.4% 12.2% 8.3% 7.0% 3.0% 2.5% 100.0% 32.0% 17.0% 2.5% 18.1%
19.4% 19.5% 15.7% 16.0% 14.3% 14.3% 25.2% 12.8% 11.2% 12.1% 11.8% 8.0% 5.0% 3.0% 2.5% 100.0% 33.0% 17.0% 2.5% 19.0%
289
abc
Siemens India Balance sheet (INRm) FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
Net assets
337 12,056 12,393 40 12,433 (20) (20) (40) 4,629 11,618 16,206 3,798 1,136 1,743 629 2,138 0 9,444 5,429 15,098 (21,841) (7,563) 0 4 (8) (8,882) (4,335) 0 0
12,433
337 17,964 18,301 80 18,381 (302) (15) (317) 5,415 8,570 13,668 5,583 1,963 1,103 775 1,943 0 11,367 7,898 25,628 (26,045) (8,622) 0 0 (10) (1,151) (5,503) 0 0
18,381
674 22,100 22,774 147 22,921 (102) (11) (112) 6,450 13,222 19,559 6,499 1,449 1,068 1,462 2,450 0 12,928 8,257 37,564 (26,666) (21,177) 0 0 (11) (2,033) (7,534) 0 0
22,921
674 27,139 27,813 56 27,869 (1) (6) (6) 9,199 14,746 23,938 6,965 2,303 1,616 1,196 0 0 12,081 10,555 36,134 (25,731) (16,304) 0 0 (14) 4,640 (12,791) 0 0
27,869
674 32,744 33,418 56 33,475 (1) (6) (6) 9,199 17,994 27,187 7,935 2,746 1,616 1,196 0 0 13,494 10,973 37,719 (26,452) (16,655) 0 0 0 5,584 (12,791) 0 0
33,475
674 40,803 41,477 56 41,534 (1) (6) (6) 9,199 22,120 31,312 10,132 3,334 1,616 1,196 0 0 16,278 13,231 45,481 (31,896) (20,082) 0 0 0 6,734 (12,791) 0 0
41,534
674 50,409 51,083 56 51,139 (1) (6) (6) 9,199 27,840 37,033 12,097 3,769 1,616 1,196 0 0 18,678 16,150 55,517 (38,934) (24,514) 0 0 0 8,219 (12,791) 0 0
51,139
674 61,371 62,045 56 62,101 (1) (6) (6) 9,199 34,619 43,811 13,855 4,090 1,616 1,196 0 0 20,758 19,302 66,350 (46,531) (29,297) 0 0 0 9,823 (12,791) 0 0
61,601
Siemens India Key balance sheet ratios FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
-130.3% -130.3% (0.30) (0.30) (13.60) (2.51) 9.03 11.26 (27.36) na na na na na na na
-74.4% -74.4% 0.26 0.26 (15.55) (1.68) 10.84 5.82 12.51 (5) 55 121 (182) 0 (0) -1.5%
-85.3% -85.3% 0.15 0.15 (12.89) (2.69) 10.74 3.44 13.86 45 44 144 (143) 0 (0) -2.1%
-85.9% -85.9% 0.14 0.14 (18.13) (2.32) 8.53 2.92 5.98 57 57 139 (139) 0 (0) 4.9%
-81.2% -81.2% 0.19 0.19 (20.66) (2.06) 7.82 2.79 5.38 63 59 146 (142) 0 0 5.9%
-75.4% -75.4% 0.25 0.25 (18.90) (2.00) 7.69 2.77 5.31 69 62 157 (150) 0 0 6.3%
-72.4% -72.4% 0.28 0.28 (19.29) (1.98) 8.08 2.81 5.50 70 62 158 (150) 0 0 6.4%
-70.5% -70.5% 0.29 0.29 (18.89) (2.03) 8.63 2.85 5.65 70 61 156 (147) 0 0 6.3%
290
abc
Siemens India Cash flow statement (INRm) EBITDA Adjusted for: Unrealized fx (gains)/losses Loss on sale of fixed assets Other non-cash exceptionals Change in working capital Tax paid Net financials Others Cash flow from operations FY06 6,551 FY07 9,837 FY08 9,123 FY09 10,515 FY10 13,196 FY11e 15,620 FY12e 18,659 FY13e 21,590
(432) (35) 150 6,599 (2,650) 430 183 10,797 (2,792) 83 0 8,088 (542) 7,546 (1,819) (923) 0 45 4,849
(2,091) (936) 139 (5,142) (3,305) 639 722 (137) (2,375) 195 0 (2,317) (811) (3,128) 253 (95) 0 34 (2,937)
(455) (260) 408 1,138 (4,715) 607 157 6,003 (2,369) 418 0 4,052 (946) 3,106 1,035 (205) 0 0 3,936
(1,027) (241) 112 589 (5,928) 539 318 4,877 (2,826) 306 0 2,357 (1,578) 779 2,116 (106) 0 0 2,789
0 0 0 (944) (4,501) 557 12 8,321 (3,400) 300 0 5,221 (1,972) 3,249 0 0 0 0 3,249
0 0 0 (1,149) (4,473) 725 75 10,798 (5,000) 300 0 6,098 (1,972) 4,125 0 0 0 0 4,125
0 0 0 (1,486) (5,506) 848 75 12,590 (5,000) 300 0 7,890 (2,170) 5,720 0 0 0 0 5,720
0 0 0 (1,604) (6,591) 1,004 75 14,474 (5,500) 300 0 9,274 (2,495) 6,779 0 0 0 0 6,779
Siemens India Key cash ratios FY06 FY08 FY08 FY09 FY10 FY11e FY12e FY13e
40.4% 10.9% 2.2 4.6% 204.0% 10.9% 10.1%
33.6% -5.5% 1.7 2.5% -1.6% -2.3% -3.1%
51.7% 1.2% 1.5 2.4% 80.0% 1.7% 1.3%
56.4% 0.6% 1.6 3.0% 55.5% 2.0% 0.7%
34.1% -1.0% 2.0 3.5% 72.3% 2.3% 1.4%
28.6% -1.0% 2.6 4.3% 78.8% 2.2% 1.5%
29.5% -1.1% 2.2 3.5% 77.0% 2.9% 2.1%
30.5% -1.0% 2.1 3.3% 76.3% 3.4% 2.5%
291
abc
Siemens India Valuation FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
440 74,531 (16,206) 7,563 0 40 (2,138) 63,790 106% 1190% 9.9 12.3 11.5 19.7 6.0 0.9% 10.9% 10.1% 69.1% -156.6% 30.6%
599 101,570 (13,668) 8,622 0 80 (1,943) 94,662 101% 587% 11.6 14.1 13.2 19.6 5.5 0.8% -2.3% -3.1% 30.9% 62.4% 28.4%
693 233,570 (19,559) 21,177 0 147 (2,450) 232,885 241% 827% 32.0 41.2 34.7 57.7 10.2 0.4% 1.7% 1.3% 15.0% 51.0% 17.8%
347 116,841 (23,938) 16,304 0 56 (0) 109,263 118% 343% 10.6 12.7 11.6 19.5 4.2 1.4% 2.0% 0.7% 18.8% 35.3% 21.5%
665 224,309 (27,187) 16,655 0 56 (0) 213,833 222% 619% 16.2 18.6 17.3 29.6 6.7 0.8% 2.3% 1.4% 22.4% 40.4% 22.7%
732 246,902 (31,312) 20,082 0 56 (0) 235,729 203% 563% 15.1 17.2 16.0 24.6 5.9 0.8% 2.5% 1.7% 24.2% 43.3% 24.2%
732 246,902 (37,033) 24,514 0 56 (0) 234,440 166% 467% 12.6 14.3 13.3 21.0 4.8 0.9% 3.2% 2.3% 23.8% 43.3% 23.1%
732 246,902 (43,811) 29,297 0 56 (0) 232,445 138% 393% 10.8 12.3 11.4 18.3 4.0 1.0% 3.8% 2.7% 23.1% 42.5% 21.7%
Siemens India Profitability RoCE FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
5,191 378 0 5.0% 33.5% 5,570 3,703 12,433 (629) 4,335 40 7,563 0 11,618 4,629 2,138 5,359 103.9% 69.1% -156.6%
6,730 431 0 5.0% 30.5% 7,161 4,979 18,381 (775) 5,503 317 8,622 0 8,570 5,415 1,943 16,120 44.4% 30.9% 62.4%
5,652 1,059 0 5.0% 37.0% 6,711 4,231 22,921 (1,462) 7,534 112 21,177 0 13,222 6,450 2,450 28,161 23.8% 15.0% 51.0%
8,604 815 0 5.0% 36.4% 9,419 5,992 27,869 (1,196) 12,791 6 16,304 0 14,746 9,199 0 31,829 29.6% 18.8% 35.3%
11,509 833 0 5.0% 37.3% 12,342 7,738 33,475 (1,196) 12,791 6 16,655 0 17,994 9,199 0 34,537 35.7% 22.4% 40.4%
13,704 1,004 0 5.0% 31.0% 14,709 10,149 41,534 (1,196) 12,791 6 20,082 0 22,120 9,199 0 41,898 35.1% 24.2% 43.3%
16,358 1,226 0 5.0% 32.0% 17,584 11,957 51,139 (1,196) 12,791 6 24,514 0 27,840 9,199 0 50,215 35.0% 23.8% 43.3%
18,969 1,465 0 5.0% 33.0% 20,434 13,691 62,101 (1,196) 12,791 6 29,297 0 34,619 9,199 0 59,182 34.5% 23.1% 42.5%
292
abc
Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Rahul Garg
Important disclosures
Stock ratings and basis for financial analysis
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investors existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: (1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month horizon; and (2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0- to 3-month horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below. This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website. HSBC believes an investors decision to buy or sell a stock should depend on individual circumstances such as the investors existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.
Rating definitions for long-term investment opportunities

Stock ratings
HSBC assigns ratings to its stocks in this sector on the following basis: For each stock we set a required rate of return calculated from the risk-free rate for that stocks domestic, or as appropriate, regional market and the relevant equity risk premium established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the implied return must exceed the required return by at least 5ppt over the next 12 months (or 10ppt for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5ppt over the next 12 months (or 10ppt for a stock classified as Volatile*). Stocks between these bands are classified as Neutral. Our ratings are re-calibrated against these bands at the time of any material change (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change. *A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past months average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5ppt past the 40% benchmark in either direction for a stocks status to change.
293
abc
Rating distribution for long-term investment opportunities

As of 21 January 2011, the distribution of all ratings published is as follows: Overweight (Buy) 48% (23% of these provided with Investment Banking Services) Neutral (Hold) Underweight (Sell) 37% 15% (20% of these provided with Investment Banking Services) (22% of these provided with Investment Banking Services)
Information regarding company share price performance and history of HSBC ratings and price targets in respect of its longterm investment opportunities for the companies the subject of this report,is available from www.hsbcnet.com/research.
HSBC & Analyst disclosures

Disclosure checklist Company Ticker Recent price Price Date Disclosure
ABB INDIA AREVA T&D CROMPTON GREAVES LTD KALPATARU POWER TRANSMISSION SIEMENS INDIA
Source: HSBC
ABB.BO AREV.BO CROM.BO KAPT.BO SIEM.BO
743.40 306.85 278.40 152.30 734.85
21-Jan-2011 21-Jan-2011 21-Jan-2011 21-Jan-2011 21-Jan-2011
4, 5, 6, 7, 11 2, 5, 7 4 4 4
1 2
HSBC* has managed or co-managed a public offering of securities for this company within the past 12 months. HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 31 December 2010 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 30 November 2010, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 30 November 2010, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking-securities related services. 7 As of 30 November 2010, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.
HSBC Legal Entities* are listed in the Disclaimer below.
294
abc
Additional disclosures
1 2 3 This report is dated as at 25 January 2011. All market data included in this report are dated as at close 19 January 2011, unless otherwise indicated in the report. HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBCs analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBCs Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. As of 31 December 2010, HSBC and/or its affiliates (including the funds, portfolios and investment clubs in securities managed by such entities) either, directly or indirectly, own or are involved in the acquisition, sale or intermediation of, 1% or more of the total capital of the subject companies securities in the market for the following Company(ies) : ABB INDIA , SIEMENS INDIA , CROMPTON GREAVES LTD , KALPATARU POWER TRANSMISSION
295
abc
Disclaimer
* Legal entities as at 31 January 2010 Issuer of report UAE HSBC Bank Middle East Limited, Dubai; HK The Hongkong and Shanghai Banking Corporation HSBC Securities and Capital Markets Limited, Hong Kong; TW HSBC Securities (Taiwan) Corporation Limited; CA HSBC Securities (Canada) (India) Private Limited Inc, Toronto; HSBC Bank, Paris branch; HSBC France; DE HSBC Trinkaus & Burkhardt AG, Dusseldorf; Registered Office 000 HSBC Bank (RR), Moscow; IN HSBC Securities and Capital Markets (India) Private Limited, Mumbai; 52/60 Mahatma Gandhi Road JP HSBC Securities (Japan) Limited, Tokyo; EG HSBC Securities Egypt SAE, Cairo; CN HSBC Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Banking Fort, Mumbai 400 001, India Corporation Limited, Singapore Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Telephone: +91 22 2267 4921 Securities Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Branch; HSBC Fax: +91 22 2263 1983 Securities (South Africa) (Pty) Ltd, Johannesburg; GR HSBC Pantelakis Securities SA, Athens; HSBC Bank Website: www.research.hsbc.com plc, London, Madrid, Milan, Stockholm, Tel Aviv; US HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler AS, Istanbul; HSBC Mxico, SA; Institucin de Banca Mltiple; Grupo Financiero HSBC; HSBC Bank Brasil SA - Banco Mltiplo; HSBC Bank Australia Limited; HSBC Bank Argentina SA; HSBC Saudi Arabia Limited; The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch This document has been issued by HSBC Securities and Capital Markets (India) Private Limited (HSBC) for the information of its customers only. HSBC Securities and Capital Markets (India) Private Limited is regulated by the Securities and Exchange Board of India. If it is received by a customer of an affiliate of HSBC, its provision to the recipient is subject to the terms of business in place between the recipient and such affiliate. This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. HSBC has based this document on information obtained from sources it believes to be reliable but which it has not independently verified; HSBC makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of the Research Division of HSBC only and are subject to change without notice. HSBC and its affiliates and/or their officers, directors and employees may have positions in any securities mentioned in this document (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). HSBC and its affiliates may act as market maker or have assumed an underwriting commitment in the securities of companies discussed in this document (or in related investments), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting services for or relating to those companies and may also be represented in the supervisory board or any other committee of those companies. The information and opinions contained within the research reports are based upon publicly available information and rates of taxation applicable at the time of publication which are subject to change from time to time. Past performance is not necessarily a guide to future performance. The value of any investment or income may go down as well as up and you may not get back the full amount invested. Where an investment is denominated in a currency other than the local currency of the recipient of the research report, changes in the exchange rates may have an adverse effect on the value, price or income of that investment. In case of investments for which there is no recognised market it may be difficult for investors to sell their investments or to obtain reliable information about its value or the extent of the risk to which it is exposed. HSBC Securities (USA) Inc. accepts responsibility for the content of this research report prepared by its non-US foreign affiliate. All U.S. persons receiving and/or accessing this report and wishing to effect transactions in any security discussed herein should do so with HSBC Securities (USA) Inc. in the United States and not with its non-US foreign affiliate, the issuer of this report. In the UK this report may only be distributed to persons of a kind described in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. The protections afforded by the UK regulatory regime are available only to those dealing with a representative of HSBC Bank plc in the UK. In Singapore, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch for the general information of institutional investors or other persons specified in Sections 274 and 304 of the Securities and Futures Act (Chapter 289) (SFA) and accredited investors and other persons in accordance with the conditions specified in Sections 275 and 305 of the SFA. This publication is not a prospectus as defined in the SFA. It may not be further distributed in whole or in part for any purpose. The Hongkong and Shanghai Banking Corporation Limited Singapore Branch is regulated by the Monetary Authority of Singapore. Recipients in Singapore should contact a Hongkong and Shanghai Banking Corporation Limited, Singapore Branch representative in respect of any matters arising from, or in connection with this report. In Australia, this publication has been distributed by The Hongkong and Shanghai Banking Corporation Limited (ABN 65 117 925 970, AFSL 301737) for the general information of its wholesale customers (as defined in the Corporations Act 2001). Where distributed to retail customers, this research is distributed by HSBC Bank Australia Limited (AFSL No. 232595). These respective entities make no representations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particular person or appropriate in accordance with local law. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. This publication is distributed in New Zealand by The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch. In Japan, this publication has been distributed by HSBC Securities (Japan) Limited. In Hong Kong, this document has been distributed by The Hongkong and Shanghai Banking Corporation Limited in the conduct of its Hong Kong regulated business for the information of its institutional and professional customers; it is not intended for and should not be distributed to retail customers in Hong Kong. The Hongkong and Shanghai Banking Corporation Limited makes no representations that the products or services mentioned in this document are available to persons in Hong Kong or are necessarily suitable for any particular person or appropriate in accordance with local law. All inquiries by such recipients must be directed to The Hongkong and Shanghai Banking Corporation Limited. In Korea, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch (HBAP SLS) for the general information of professional investors specified in Article 9 of the Financial Investment Services and Capital Markets Act (FSCMA). This publication is not a prospectus as defined in the FSCMA. It may not be further distributed in whole or in part for any purpose. HBAP SLS is regulated by the Financial Services Commission and the Financial Supervisory Service of Korea. Copyright 2011, HSBC Securities and Capital Markets (India) Private Limited, ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of HSBC Securities and Capital Markets (India) Private Limited. MICA (P) 142/06/2010 and MICA (P) 193/04/2010
296
Rahul Garg* CFA Analyst, Industrials Research HSBC Securities and Capital Markets (India) Private Ltd +91 22 2268 1245 rahul1garg@hsbc.co.in Rahul joined HSBC in August 2010, bringing with him over five years of international experience in equity research with leading investment banks, most of it in the European Capital Goods sector advising institutional investors. Prior to that, he worked at a US investment bank. Rahul holds a B.Tech in Chemical Engineering from Indian Institute of Technology (IIT) Bombay and is a member of the CFA Institute (US) and the Indian Association of Investment Professionals (IAIP).
Kunal Arora* Associate Bangalore
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

Indian Capital Goods - HSBC Jan 2011

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Indian Capital Goods - HSBC Jan 2011

Uploaded by

Copyright:

Available Formats

Industrials Electrical equipment January 2011

By Rahul Garg, CFA

Industrials Indian Capital Goods January 2011

Disclosure appendix Disclaimer

Valuation & performance analysis

Industrials Indian Capital Goods January 2011

Brighter days ahead

Industrials Indian Capital Goods January 2011

Industrials Indian Capital Goods January 2011

Demand outlook remains strong

Industrials Indian Capital Goods January 2011

Sector exposure 33% 15% 14% 5% 18% 4% 3% 4% 1% 3% 100%

Cost and pricing pressures may persist but wont deteriorate

Industrials Indian Capital Goods January 2011

We forecast sector earnings to grow at c30% during FY12-13

FY11e 24,441 46,992 46,773 81,139 47,658 98,680 111,462 457,145

FY13e 34,555 65,992 57,731 n/a n/a 130,108 159,121 447,507

FY13e 3,767 7,334 6,309 n/a n/a 18,400 18,647 54,456

FY11e 13.1 15.8 8.3 23.9 9.5 14.1 28.1 112.7

FY13e 19.3 22.6 11.2 n/a n/a 18.9 33.9 105.9

FY11e 2% -4% 1% 2% -2% 5% 4% 2%

FY13e 5% 2% 12% n/a n/a 10% 6% 7%

EBITDA (INRm ) FY11e FY12e 5% -1% 5% 0% 6% 4% 8% 4% 8% 7% 5% 3% 12% 11% 9% 8%

FY13e 5% 8% 5% n/a n/a 14% 16% 12%

FY11e 3% -4% -1% -3% 12% 0% 6% 1%

FY13e 7% 20% 10% n/a n/a 9% 18% 14%

Source: HSBC estimates

Sector valuation remains undemanding

Industrials Indian Capital Goods January 2011

Current multiple - Consensus

EV/EBITDA candle chart

Current multiple - Consensus

Industrials Indian Capital Goods January 2011

Equipment Mfg PE vs RoE

Source: HSBC research

Source: HSBC research

We introduce Q-ben Framework to better judge a companys worth

Industrials Indian Capital Goods January 2011

Can be restructuring stories or 'Overvalued'

12m fwd EV/EBITDA

EPC Avg Kalpataru Can be 'Undervalued' if operating perf improving Jy oti

Can be restructuring stories or 'Overvalued'

ABB Areva T&D

Eqp Mf g A vg Siemens Sector Avg

Can be premium quality or 'Expensive'

EPC Avg Kalpataru Can be 'Undervalued' if operating perf improving Jyoti

Coverage of seven companies

Industrials Indian Capital Goods January 2011

Areva T&D India

Crompton Greaves CROM.BO

Jyoti Structures: OW, TP INR165

Industrials Indian Capital Goods January 2011

Kalpataru Power: OW, TP INR225

KEC International: Neutral, TP INR105

Industrials Indian Capital Goods January 2011

ABB India: UW, TP INR630

Areva T&D India: Neutral, TP INR340

Industrials Indian Capital Goods January 2011

Crompton Greaves: OW, TP INR365

Siemens India: OW, TP INR950

Industrials Indian Capital Goods January 2011

Source: HSBC estimates