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EQUITY RESEARCH 7 December 2011
INDIA CAPITAL GOODS Initiating coverage: In search of survivors India is in the fourth year of an investment downcycle and all end markets are now weak. Earnings catalysts appear limited and order visibility is low; however, the sharp derating of the sector (23x to 13x) and cuts in consensus earnings forecasts (10-40%) make us moderate our bearish view. We initiate coverage of the India Capital Goods sector with a 2-Neutral sector view and look beyond the current downturn to identify companies that are: 1) the best geared to ride out the difficult times and participate in the next upturn (L&T, 1-OW); 2) have strong product positioning (Cummins, Havells 1-OW); or 3) are at the bottom of their valuation cycle (KEC, CRG, 1-OW). We initiate coverage of BHEL at 3-UW. Our top picks are L&T, Cummins and Havells.
Weak demand: Demand will likely remain weak in the near term given that: 1) the power generation market is in a cyclical and structural downturn; 2) the infrastructure end markets have limited order finalisations this year given the long concept-to-order cycle and high interest rates; and 3) industrial capex is decelerating. Margin and working capital pressures will be common at this stage of the cycle.
Our stock picks are based on the following key themes: Exposure to the next upcycle – We expect infrastructure to lead a cyclical recovery
given the strong order pipeline, which we expect to be aided by a government spending push ahead of general elections in 2014. Other drivers include nuclear and defence. An infrastructure recovery would set the stage for recovery in industrial capex. L&T (1-OW) appears best placed.
Robust product portfolio – We like companies with products that have strong market positioning or strong brands, which should help to counter pricing pressure. Cummins (1-OW) commands a 50% market share in power-generation engines, dictating end-market pricing. Havells (1-OW) will likely benefit from brand extension to its consumer appliances business.
Cheap valuations and bottoming EPS – Crompton Greaves (1-OW) and KEC (1-OW) have witnessed consensus EPS cuts ranging from 15% to 40% and valuations have also halved. With expectations being low and the Transmission & Distribution (T&D) market expected to recover, fundamentals appear to be at a trough.
End markets to avoid: We would avoid exposure to the power Boiler & Turbine Generator (BTG) segment, however tempting valuations may appear. The BTG market is facing cyclical issues (planned orders already awarded) and structural issues (oversupply impacting pricing, coal constraints and State Electricity Boards/independent power producer financial health). SEB reforms should take effect, but coal will likely be a challenge and the Central Electricity Authority’s advisory to manufacture equipment for 70:30 blends looks difficult to implement. Companies with weak balance sheets will likely be under stress. We initiate on BHEL, BGR Energy and Thermax with 3-UW ratings.
Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect theobjectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.
This research report has been prepared in whole or in part by research analysts based outside the USwho are not registered/qualified as research analysts with FINRA.
PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE155.
INITIATING COVERAGE India Capital Goods 2-NEUTRAL from N/A For a full list of our ratings, price targets and earnings in this report, please see table on page 2
India Capital Goods Venugopal Garre +91 22 6719 6291 [email protected] BSIPL, Mumbai
Barclays Capital | India Capital Goods
7 December 2011 2
Summary of our Ratings, Price Targets and Earnings Estimates in this Report
Company Rating Price Price Target EPS FY1 (E) EPS FY2 (E)
Old New 02-Dec-11 Old New %Chg Old New %Chg Old New %Chg
India Capital Goods 0-NR 2-Neu
ABB Ltd. (ABB IN / ABB.NS) N/A 3-UW 618.80 N/A 494.00 - N/A 8.50 - N/A 19.80 -
Areva T&D India (ATD IN / AREV.NS) N/A 2-EW 208.65 N/A 193.00 - N/A 7.60 - N/A 9.70 -
BGR Energy Systems Ltd. (BGRL IN / BGRE.NS) N/A 3-UW 270.55 N/A 241.00 - N/A 42.00 - N/A 40.30 -
Bharat Heavy Electricals Ltd. (BHEL IN / BHEL.NS) N/A 3-UW 282.45 N/A 230.00 - N/A 27.00 - N/A 28.30 -
Crompton Greaves Ltd. (CRG IN / CROM.NS) N/A 1-OW 132.15 N/A 147.00 - N/A 6.90 - N/A 9.10 -
Cummins India Ltd. (KKC IN / CUMM.NS) N/A 1-OW 357.85 N/A 428.00 - N/A 18.40 - N/A 20.40 -
Havells India Ltd. (HAVL IN / HVEL.NS) N/A 1-OW 424.55 N/A 502.00 - N/A 27.80 - N/A 34.90 -
KEC International Ltd. (KECI IN / KECL.NS) N/A 1-OW 41.25 N/A 72.00 - N/A 5.70 - N/A 7.10 -
Larsen & Toubro Ltd. (LT IN / LART.NS) N/A 1-OW 1310.75 N/A 1560.00 - N/A 66.20 - N/A 73.00 -
Siemens Ltd. (SIEM IN / SIEM.NS) N/A 3-UW 723.35 N/A 630.00 - N/A 27.90 - N/A 32.10 -
Thermax Ltd. (TMX IN / THMX.NS) N/A 3-UW 469.70 N/A 392.00 - N/A 32.00 - N/A 32.60 -
Voltas Ltd. (VOLT IN / VOLT.NS) N/A 3-UW 92.10 N/A 78.00 - N/A 6.40 - N/A 6.60 -
Source: Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency.
FY1(E): Current fiscal year estimates by Barclays Capital. FY2(E): Next fiscal year estimates by Barclays Capital.
Stock Rating: 1-OW: 1-Overweight 2-EW: 2-Equal Weight 3-UW: 3-Underweight RS: RS-Rating Suspended
Sector View: 1-Pos: 1-Positive 2-Neu: 2-Neutral 3-Neg: 3-Negative
Barclays Capital | India Capital Goods
7 December 2011 3
INVESTMENT SUMMARY
The India Capital Goods sector is undergoing a cyclical deceleration in orders and earnings; however, the sharp derating that has already occurred in valuations and earnings estimates moderates our bearish view. Near-term, we see a lack of catalysts and limited visibility, which we believe is consistent with a cyclical bottoming. However, the downturn is unlikely to be prolonged given the economic significance of the government’s planned investment spend. We expect visibility in some end markets, such as Infrastructure, to recover by FY13 led by the government spending push and recovery in other sectors, such as Industrials, in FY14 but we believe some end markets, such as Power Generation Equipment and Mechanical Electrical & Plumbing (MEP), are facing a combination of cyclical and structural issues and, therefore, will be the last to see a sustained recovery. We initiate coverage of the India Capital Goods sector with a 2-Neutral view. Our top picks are L&T, Cummins and Havells, all rated 1-Overweight.
Race to the bottom
Our bottom-up analysis of more than 20 end markets suggests that India’s corporate and government investment cycle will continue to be in a downturn for the rest of this financial year as not many orders are expected to be finalised. Power Boiler & Turbine orders (20% of overall capex in the economy) will likely be the worst affected as most of the planned orders have already been awarded and our analysis of the order pipeline suggests that the end market is only in the early stage of the next order cycle. Furthermore, we expect ordering to be held back because of weak balance sheets in utilities, structural constraints in coal and land acquisition challenges in the nuclear segment. The Power Transmission & Distribution (T&D) segment may witness a recovery in volumes in the coming months, according to our channel checks, although finalisations in infrastructure and industrial capex remain weak. However, a low beta recovery is likely in FY13, in our view, triggered by a fresh government spending push in the Infrastructure segment or by improvements in market ordering, led by the bunching up of orders.
Converting plans into orders is important
The previous investment cycle was aided by substantial reforms in the power segment in 2003, followed by a focus on the public-private partnership (PPP) route for infrastructure funding for roads and airports. Substantial investments also helped trigger a recovery in industrial capex. Land was not a major challenge as several projects were initially brownfield expansions, unlike the current cycle in which more than 70% of projects are greenfield expansions. For a new upcycle to emerge from the current cyclical bottom, new demand drivers need to be created and the constraints to ordering removed. These include: 1) announcing projects in railways (dedicated freight corridors [DRCs], high speed rail and station modernisation); increasing local sourcing for defence projects; and speeding up nuclear projects and planned metro rail/airport projects. Our detailed assessment of the order pipeline across the various end markets in the infrastructure domain suggests strong potential ahead. However, we note that the pace of conversion of these plans into orders is critical.
Investment cycle is decelerating and all end markets are now in a
downturn
For a new cycle to be created, constraints to ordering need to
be removed
Barclays Capital | India Capital Goods
7 December 2011 4
Figure 1:India Capital Goods – sector derating has tracked changes to consensus earnings estimates
-60%
-40%
-20%
0%
20%
40%
60%
Nov
-97
Aug
-98
Apr
-99
Dec
-99
Sep-
00
May
-01
Jan-
02
Sep-
02
Jun-
03
Feb-
04
Oct
-04
Jul-
05
Mar
-06
Nov
-06
Jul-
07
Apr
-08
Dec
-08
Aug
-09
Apr
-10
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Change in 1 year fwd earnings estimates for the sector YoY 12M fwd PE
Source: Datastream, IBES consensus, Barclays Capital
Hyper-competition and margin risk We believe that the stage is set for margin pressure to become more evident as some of the key end markets are going through a phase of hyper-competition. End markets with high competitive intensity are those exposed to imports from China and Korea and for which the domestic supply build-up has become more recently evident. Our bottom-up analysis of 20 end markets suggests that Power Generation Equipment is the most competitive, followed by T&D, where the delta in competitive intensity is much lower. From a stock perspective, we believe that companies facing a high risk to future margins include BHEL and BGR Energy. We prefer stocks with lower risks to margins.
Initiating coverage We initiate coverage on the India Capital Goods sector with a 2-Neutral sector view. We prefer companies that: 1) are the best geared to ride out the difficult times and participate in the next upturn (L&T, 1-OW); 2) have strong product positioning (Cummins, Havells 1-OW); or 3) are at the bottom of their valuation cycle (KEC, CRG, 1-OW). We also initiate coverage on BHEL, Siemens, ABB, Thermax, Voltas and BGR Energy at 3-UW and Areva T&D at 2-EW.
Figure 2: India Capital Goods – summary of Barclays Capital’s outlook for key segments
Segment Our outlook Our investment view
Power Boilers & Turbines
Segment in a downturn with more than 90% of planned orders for India’s 12th five-year plan having already been ordered; expect 13th plan spend to commence, but several projects are still in the planning/approval phase
Initiate on BHEL, BGR Energy and Thermax with 3-UW
Transmission & Distribution
Expect a recovery in orders in 2H FY12 and strength to continue in the first year of the 12th five-year plan; competitive intensity to remain challenging
Initiate on ABB, Siemens with 3-UW , Areva T&D with 2-EW and CRG and KEC with 1-OW
Industrial Expect market to remain weak with recovery now only in CY13
Siemens, ABB and L&T have exposure to industrial capex
Infrastructure Strong order pipeline in railways, metro, airports (international); recovery to be aided by government push
L&T (1-OW) is the likely key beneficiary of a revival; Cummins also 1-OW
Source: Barclays Capital
Key end markets going through a phase of hyper-competition
Our top picks are L&T, Cummins and Havells
Barclays Capital | India Capital Goods
7 December 2011 5
Top picks Larsen & Toubro: Our PT is based on our SOTP analysis (standalone at 16.5x FY13E, subsidiaries at Rs356). Despite the current weakness in the order cycle for L&T and likely weak 2H earnings, current valuations make us look beyond the near-term risks. L&T’s ability to grow its market share over the years is due to the company’s strong execution, balance sheet and exposure to multiple end markets, which enables it to capture changing ordering trends. We expect L&T to participate in a new upturn (even if it is a low beta one) given exposure to infrastructure that could lead a new cycle, as well as its exposure to emerging demand drivers such as nuclear, railways and defence. We view the stock as attractive on share price weakness.
Havells: Our PT is based on 11x FY13E EV/EBITDA for India, 5x EV/EBITDA for Sylvania. We expect a CAGR of more than 17% for domestic business earnings, driven by new launches in the appliance segment, which should benefit from the company’s strong branding and its entrenched distribution network. Improving the mix of branded consumer business in domestic sales should also help reduce earnings volatility and trigger a re-rating in multiples. With margins at its international business recovering, we expect consolidated earnings to grow at a 23% CAGR over FY11-FY13E. Valuations at 12 x P/E appear attractive given the anticipated strength in earnings.
Cummins: Our PT is based on 20x FY13E plus Rs20 for value of associates. We believe that the sharp reduction in consensus earnings estimates for the stock in recent months captures the impact of near-term weakness in the power generation and industrial markets in India. Cummins is exposed to three strong long-term drivers: 1) continued peak deficits in India that will drive growth for back-up power; 2) increased focus on outsourcing to India from its parent Cummins Inc. due to cost benefits; and 3) strong growth in after-sales service revenues aided by new facilities at the company’s site in Phaltan. End-market exposure is the best relative to peers, in our view, owing to the company’s well diversified end-user base and a stable pricing environment. Earnings growth should trough in FY12E and, with valuations trending below historical averages, we expect the stock to outperform its peers.
Other 1-Overweight stocks KEC International: Our PT is based on 10x FY13E EPS. Earnings growth for KEC should turn around in FY13, led by strength in order inflows and improvement in margins. Margin improvement in FY13 would be driven by improving efficiency in the cables business due to the shift in production to a new facility in Vadodara and scaling up to higher-voltage cables. Improving revenues in new businesses (power T&D EPC, railways, water) should also help to reduce start-up losses. A reduction in debt led by a sale of assets should also help reduce the interest burden. Following a sharp decline in earnings in FY12E, we expect a 27% CAGR out to FY14E. Despite more than 75% potential upside to our price target from current levels, KEC is not our top pick given its lower market cap and liquidity compared with L&T.
Crompton Greaves: Our PT is based on 16x FY13E standalone and 10x FY13E subsidiary earnings. Following the sharp decline in margins in 1H FY12, consensus estimates (40% cuts over past 12 months) are building in no scope for a margin recovery in future years Apart from the consensus earnings cuts (33% to 41% for FY12-14E), the sharp derating of the stock (20x to 11x on consensus forward estimates, over the past 12 months) makes us believe that the expectations for performance are low. We believe CRG’s earnings trajectory may be different from its competitor ABB, given its short execution cycle. A bottoming in fundamentals over the next six months is likely and, given the correction in valuations, now is the time to be 1-Overweight on the stock, we believe.
L&T 1-OW
PT Rs1,560
Havells 1-OW
PT Rs502
Cummins 1-OW
PT Rs428
KEC International 1-OW
PT Rs72
Crompton Greaves 1-OW
PT Rs147
Barclays Capital | India Capital Goods
7 December 2011 6
Figure 3: India Capital Goods – summary of comparative valuations
Market Cap Liquidity PricePotential
up/downside EPS (Rs) EPS growth P/E (x) P/B (x) EV/EBITDA ROE
Ticker (US$ mn) US$mn/shr Rating Price target to PT (%) FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E
L&T LT IN 15,609 69.4 1-OW 1311 1560 19 66.9 73.8 15.0 10.3 19.6 17.8 3.2 2.8 12.7 11.5 16
BHEL BHEL IN 13,469 29.1 3-UW 282 230 -19 27.0 28.3 9.9 4.9 10.5 10.0 2.8 2.3 5.4 5.3 27
Siemens Ltd. SIEM IN 4,793 3.4 3-UW 723 630 -13 27.9 32.1 11 15 26.0 22.5 5.4 4.6 14.8 13.0 21
ABB ABB IN 2,552 1.8 3-UW 619 494 -20 8.5 19.8 184 133 72.9 31.3 5.1 4.4 31.3 16.6 7
Cummins KKC IN 1,933 2.8 1-OW 358 428 20 18.4 20.4 -13.9 10.9 19.5 17.6 4.9 4.3 15.6 13.9 25
Crompton Greaves CRG IN 1,652 12.6 1-OW 132 147 11 6.9 9.1 -52.1 31.3 19.1 14.5 2.3 2.1 9.2 8.0 12
Thermax THMX IN 1,090 1.6 3-UW 470 392 -17 32.0 32.6 -1 2 14.7 14.4 3.7 3.2 7.4 7.1 25
Havells HAVL IN 1,033 3.6 1-OW 425 502 18 27.8 34.9 14.3 25.5 15.3 12.2 5.4 3.8 8.6 7.3 35
Areva T&D ATD IN 972 0.8 2-EW 209 193 -8 7.6 9.7 -3 28 27.6 21.6 4.4 3.8 13.4 10.9 16
Voltas VOLT IN 592 3.4 3-UW 92 78 -15 6.4 6.6 -34 2 14.3 14.0 1.9 1.7 18.5 17.6 13
BGR Energy BGRL IN 380 4.8 3-UW 271 241 -11 42.0 40.3 -6 -4 6.4 6.7 1.7 1.4 4.3 4.3 26
KEC International KECI IN 283 0.3 1-OW 41 72 75 5.7 7.2 -28 25 7.3 5.8 1.0 0.9 5.9 5.0 14
Stock ratings: 1-OW: 1-Overweight, 2-EW: 2-Equal Weight, 3-UW: 3-Underweight. Sector View: 1-Pos: 1-Positive, 2-Neu: 2-Neutral, 3-Neg: 3-Negative. Prices as of the market close on 2 December 2011. Source: Company data, Bloomberg, Barclays Capital estimates
Figure 4: India Capital Goods – summary of historical forward P/Es, price targets and upside and downside cases
Forward P/E range 2003-current (x) Price target Upside case Downside case
Rs Max Min Average Current Rs % diff from
current price Rs % diff from
current price Rs % diff from
current price
L&T 47 8 21 14 1560 19 2488 90% 817 -38% BHEL 36 9 19 10 230 -19 350 24% 208 -26% Siemens Ltd. 38 10 24 21 630 -13 900 24% 334 -54% ABB 48 12 28 29 494 -20 900 45% 247 -60% Cummins 25 8 17 14 428 20 499 39% 204 -43% Crompton Greaves 31 6 17 11 147 11 182 38% 91 -31% Thermax 33 5 17 13 392 -17 625 33% 171 -64% Havells 25.9 3.7 14.2 12 502 18 697 64% 278 -35% Areva T&D 33 10 20 18 193 -8 300 44% 97 -54% Voltas 35.3 4.2 16.0 10 78 -15 132 43% 28 -70% BGR Energy 27.6 5.3 13.1 6 241 -11 337 24% 88 -67% KEC International 19 3 11 5 72 75 86 107% 36 -14%
Note: Prices as of the market close on 2 December 2011. Source: Datastream, IBES Consensus, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 7
3-Underweight stocks BHEL: Our PT is based on a DCF (WACC of 12.9%, EBITDA margins to trend down to 10% by FY20E). Although the stock has de-rated from 22x to 9x forward earnings, multiples for BHEL are on peak cycle earnings, unlike its peers, and we believe they are somewhat propped up by accounting changes. The booking of orders without coal linkages is also a cause for concern, in our opinion. With BHEL losing its monopoly status, its artificially high margins are not sustainable, and we expect its EBITDA margin to trend down to below 10%. The fact that recent bids have been won at prices too low to make a profit is also a concern. Deteriorating working capital metrics, inability to generate cash, and excess cash being deployed into low-return businesses are key reasons for a continued de-rating, in our view. Given the low P/E multiples, we expect to see short-term trading rallies, although we believe these are unlikely to convert into sustained outperformance on a 12-month view.
Voltas: Our PT is based on 11x FY13E earnings. Voltas is undergoing an extremely tough period with almost every segment of its business underperforming. Its core mechanical electrical and plumbing (MEP; HVAC and electrical) business (60% of revenues) faces structural challenges with extended ordering timelines, a change in the geographic scope of the business and heightened competitive intensity. Bidding margins for Voltas are at 5% vs. the more than 9% margin range achieved in the past. The A/C products business (which could have supported earnings) was impacted by a weak summer and higher interest rates. With price discounting by the market likely to intensify, either volumes or margins will be under pressure. While these issues are well understood and built into current-year estimates, we are of the view that it would be difficult to expect a substantial recovery next year with order visibility being low. Despite attractive valuations, it is too early to turn positive, in our view, hence our 3-UW rating.
Thermax: Our PT is based on 12x FY13E earnings. While the core business of Thermax continues to do well, we believe that a weak environment for ordering in the industrial segment should slow order growth rates and earnings momentum in the coming quarters. With the order environment for IPPs weak, it will be difficult for Thermax to win orders beyond what is already expected. Inability to scale up subcritical and supercritical businesses will impact valuations further, in our view.
BGR Energy: Our PT is based on a trough multiple of 6x FY13E earnings. We note free cash flow is expected to be negative for several years and, despite cheap valuations, we are concerned over the company’s ability to make margins in the boiler and turbine segment, as well as fund the substantial capex plans ahead. We believe BGR’s current earnings momentum has peaked and we see risk to current forward valuations, which are based on peak earnings and do not factor in equity dilution and substantial fund raising ahead.
ABB: Our PT is based on a 25x P/E for CY12E earnings. We believe that margins have troughed for ABB due to: 1) a low backlog of rural losses; 2) likely lowering of costs on imports, following the stake increase by the parent; 3) increase in indigenisation with ABB’s Indian factories being approved for supply of high-voltage transformers; and 4) high commodity prices already reflected in current margins. The depreciation of the rupee, while it could help in the near term on gains in FX hedges, could impact the cost structure in the medium term given the high exposure of costs to imports. While margins and earnings growth are expected to recover, current valuations at over 30x P/E are difficult to justify, in our view.
BHEL 3-UW
PT Rs230
Voltas 3-UW
PT Rs78
Thermax 3-UW
PT Rs392
BGR Energy 3-UW
PT Rs241
ABB 3-UW
PT Rs494
Barclays Capital | India Capital Goods
7 December 2011 8
Siemens: Our PT is based on 21x average of Sep 2012E and Sep 2013E earnings. Siemens is exposed to well diversified end markets, which should help it tide over the downturn better, however margins for the company appear to be peaking and near-term order inflows are expected to be weak. Our estimates already factor in long-term drivers such as renewable energy, power EPC and low-priced products, and a delay in execution of these new ventures could impact valuations.
2-Equal Weight stock Areva T&D (2-Equal Weight; PT Rs193): Our PT is based on 20x CY12E earnings. While Areva T&D’s margins appear to have troughed and, after several years of weak T&D markets we are seeing some recovery in ordering, we believe room for upside surprise is limited, given the stiff competition in the T&D end market. A low return on capital ratios (compared with peers such as Siemens) and limited new earnings drivers also call for lower valuations. However, we acknowledge that the premium to peers may persist given the company’s current demerger plans and investor hopes of a future delisting.
Valuation and risks
Valuation methodology: We value BHEL on DCF, given the long cycle nature of its business and our inability to capture margin risk until FY14E. While BGR also has long execution cycles, no free cash generation makes it difficult to value it on DCF, hence we use P/E. The other stocks are valued on P/E multiples on FY13 earnings estimates. Our multiples are based on either a discount or premium to the sector average to reflect the current state of the earnings cycle for these companies.
Risks: The India Capital Goods sector is driven by public policy; hence, the inability of the government to aid a recovery in infrastructure could lead to continued underperformance. Other downside risks to the sector could stem from a weak reporting season in 3Q FY12, continued weakness in India’s Index of Industrial Production (IIP) and a slow pace of execution of reforms.
Upside risks to the sector could stem from strong policy action from the government, improved visibility on new demand drivers and debottlenecking of resource constraints. Given current low expectations, this could lead to a re-rating of the sector. Among segments on which we hold a more negative view, such as power BTG, a resolution of coal issues, stiff import duties and substantial recovery in SEB finances could boost valuations.
Siemens 3-UW
PT Rs630
Areva T&E 2-EW
PT Rs193
Barclays Capital | India Capital Goods
7 December 2011 9
CONTENTS
INVESTMENT SUMMARY..................................................................................................................3
RACE TO THE BOTTOM ..................................................................................................................10
CONVERTING PLANS INTO ORDERS IS CRITICAL......................................................................20
HYPER-COMPETITION AND MARGIN RISK .................................................................................26
VALUATIONS – BACK TO CYCLICAL LOWS.................................................................................36
COMPANIES ......................................................................................................................................41
LARSEN & TOUBRO (1-OW, PT: RS1,560, +19%): LOOKING BEYOND THE DOWNTURN...42
BHEL (3-UW, PT: RS230, -19%): FUNDAMENTALS DETERIORATING....................................51
SIEMENS LTD. (3-UW, PT: RS630, -13%): MARGINS PEAKING; VALUATIONS RICH...........62
ABB LTD. (3-UW, PT: RS494, -20%): FUNDAMENTALS REMAIN UNDER STRESS ...............73
CUMMINS (1-OW, PT: RS428, +20%): STRONG PRODUCT POSITIONING ............................81
CROMPTON GREAVES (1-OW, PT: RS147, +11%): CONTRARIAN PICK; LOW VISIBILITY BUT LOW EXPECTATIONS ..............................................................................................................91
THERMAX (3-UW, PT: RS392, -17%): SLOW PACE OF NEW BUSINESS SCALE UP ........... 100
HAVELLS (1-OW, PT: RS502, +18%): LIGHTING UP................................................................ 109
AREVA T&D (2-EW, PT: RS193, -8%): MARGIN TROUGH AND ORDER RECOVERY ......... 119
VOLTAS (3-UW, PT: RS78, -15%): EMERGING STRUCTURAL RISKS A CONCERN ............ 127
BGR ENERGY (3-UW, PT: RS241, -11%): BUSINESS MODEL CONCERNS............................ 136
KEC INTERNATIONAL (1-OW, PT: RS72, + 75%): TROUGH VALUATIONS ......................... 145
Barclays Capital | India Capital Goods
7 December 2011 10
RACE TO THE BOTTOM
Our bottom-up analysis of more than 20 end markets suggests that the India Capital Goods sector could continue to be in a downturn for the rest of the financial year as not many orders are expected to be finalised. However, we expect a low-beta recovery to emerge at some point in FY13, triggered by government actions in Infrastructure or by broad improvement in ordering, led by a bunching up of orders for projects that may have crossed several hurdles to reach the stage of ordering. For a sustained upcycle, however, we would need affirmative policy action and aggressive implementation to debottleneck resource constraints (coal, land) and to create new demand drivers, which we believe will take more time to resolve.
Expect low beta recoveries amid a downcycle
After a strong upcycle lasting more than five years (FY04-08), the broad investment cycle in India has remained weak since FY09. The country is now in the fourth year of a downcycle, which based on past trends, indicates that India could be much closer to the start of a new upcycle. The outlook of management teams on orders and our analysis of various end markets suggest muted ordering in 2H11.
Figure 5: India infrastructure – investment activity has remained muted since FY09
13%
-10%
15%
-7%
17%19%
-9%
18%
5%
19%
-7%
11%
3%
10%
31%
17%15%18%
-4%
12%8%
-15%-10%
-5%0%5%
10%15%20%25%30%35%
Mar 91 Mar-93 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11
Gross capital formation (constant, 2004-05 price) growth YoY
Infrastructure investment in India remains in a downcycle
Source: Government of India (GOI), Centre for Monitoring Indian Economy (CMIE), Barclays Capital
New project activity in the economy remains weak India has witnessed a strong and sustained investment cycle that lasted more than 4 years only once in the past two decades. The strength of the cycle (for equipment suppliers/contractors) was accentuated by 1) years of underinvestment and capacity constraints; 2) reforms in several segments (power, private participation in infrastructure); 3) shortages of capacity at the supplier end, helping to improve pricing and margins; and 4) easier access to resources (coal, land) somewhat driven by a higher mix of brownfield projects in the mix.
Recent economic data suggest that new project initiations in the quarter ended September 2011 continued to decelerate.
Barclays Capital | India Capital Goods
7 December 2011 11
Industrial production activity has also been decelerating in the past year, which suggests that ordering for the capital goods sector could remain weak in the next few quarters. It may be interesting to note that data for India’s Index of Industrial Production (3-month moving average y/y) correlate well with the capital goods stock price index with the recent decline in stock prices for the sector reflecting that trend.
Figure 8: India Capital Goods – capital goods returns momentum correlates with trends in IIP
-100%
-50%
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Mar-95 Nov-96 Jul-98 Mar-00 Nov-01 Jul-03 Mar-05 Nov-06 Jul-08 Mar-10-30%-20%-10%0%10%20%30%40%50%60%70%
Capgood index YoY IIP capgoods 3mma YoY (RHS)
IIP deceleration suggests weak ordering for sector ahead
Stock prices track IIP and reflect
a similar trend
IIP = India’s Index of Industrial Production Source: MOSPI, Datastream, Barclays Capital
Order outlook for most end markets appears weak Although most end markets do not appear strong in terms of near-term order activity, we note that on a relative basis, Power BTG (boiler and turbine generators) appears to be the weakest (with negative growth rates likely on our estimates). We expect some recovery in T&D ordering (with stable pricing) in 2H11. For infrastructure, apart from roads, overall ordering in the economy remains weak.
Figure 6: India infrastructure – new project initiations continue to decelerate
Figure 7: India infrastructure – sector returns correlate with overall project investment activity in the economy
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Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10
Project investments added during the quarter
-100%
-50%
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50%
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150%
Jul-96 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10-10%
0%
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50%
60%
Sector index return relative to sensexProject investments outstd at the end of the quarter
Source: CMIE, Barclays Capital Source: CMIE, Datastream, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 12
Figure 9: Boiler & Turbines segment has the weakest market growth outlook
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Although growth for most end markets appears weak, on a relative scale, the outlook for
boiler and turbine market growth appears to be the weakest
Note: A low score implies weak outlook. Source: Company data, Barclays Capital
Figure 10: India Capital Goods – cautious comments from management teams suggest a weak 2H11
Company Management comments
BHEL Commented that only two orders were finalised in the market in 1H11; still considering whether to accept the NTPC bids for turbines (prices were low).
Thermax Does not expect any major improvement in orders.
Cethar Vessels Pace of finalisation of orders is very slow. Coal linkages impacting order inflows. Hasn’t received any orders post SKS Ispat power order.
L&T Cautious on order inflows. Revised down its order inflow target to 5% y/y growth.
ABB Pricing environment for T&D orders remains weak. Does not expect any further deterioration in prices though. Positive on demand environment.
KEC Towers: market ordering in India is flat y/y. Opportunity high in Brazil. Railways: Rs10bn-plus ordering per annum. DFC tender expected in November has been postponed.
Havells Continues to see Europe as a flattish market. Margin recovery on track.
Areva T&D T&D order recovery expected. More than 15 substation orders and more than 150 transformers likely to be ordered. Expect an HVDC order next year. Sees lower pressure from Chinese/Korean vendors given their inability to set up local manufacturing.
Hyosung Positive on ordering but believes competition is stiff. Some foreign competitors setting up manufacturing base in India.
Elecon Engg Has an order enquiry of Rs40-50bn although does not see acceleration in order intake.
Voltas Positive on prospects in MEP space (Rs30-35bn order pipeline) but bringing down bidding margins to 5% only. AC demand weak and competition is stiff – expects margins to be under pressure. Worried about price discounting in the market.
Cummins Powergen demand is decelerating (largely in the mid segment). End markets weak. Construction and mining segment stronger relative to Powergen. Pricing for engines though holding up well.
Kirloskar Oil Revised down guidance for September quarter. Concerned about competition in low KVA segment and impact of diesel prices on demand.
Dongfang Positive on prospects in India. Plans to set up manufacturing facility in India.
BGR Energy Several orders in pipeline but pace of finalization of orders slow.
Shriram EPC Ordering in steel and wind weak. Public sector ordering has weakened.
Tecpro Positive on BOP ordering. Has an order pipeline of more than Rs30bn. Also bidding for orders in waste heat recovery segment.
Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 13
Power: More than 95% of ordering has already been completed
Our bottom-up analysis of ordering for the past five years suggests that more than 95% of the planned orders for the Indian government’s 12th five-year development plan for FY2013-17 have already been awarded. Private players such as Lanco and Reliance Power have already ordered for projects expected to be completed in the 13th plan (FY18-FY22).
Figure 11: India Capital Goods – power segment outlook
Segment Market size
(Rs bn) Our Comments
Boilers and turbines 20 Segment in a downturn with more than 90% of planned orders for India’s 12th five-year plan having already been ordered.
Expect 13th plan spend to commence but several projects still in planning/approval phase.
Balance of plant (power) 20 Expect strength in ordering for next 12 months followed by cyclical weakness.
T&D domestic – substation 10 Expect recovery in orders in 2H and strength to continue in the first year of the plan.
More than 15 substations (765 KV) and 150, 765 KV transformers to be ordered in FY12.
Secondary orders from UP BOOT project (Rs10bn) One awarded to ABB.
Several reactor and circuit breaker tenders expected. 3-4 GIS orders from Powergrid Corporation.
T&D international 100 Expect flattish growth. Some recovery in ordering for wind transformers.
Transmission tower 4 Flattish market expected. Ordering from most of the BOOT projects still pending.
Nuclear segment 8 Local protests at nuclear sites (Jaitapur and Kudankulam) to have a significant impact on ordering in this segment. If ordering commences, this could be a US$8bn per annum opportunity (50% of this is outsourced to Indian equipment companies).
Source: Barclays Capital
Total planned orders for the 12th plan are more than 100GW. Our tabulation of orders announced suggests that 95GW of thermal orders have already been awarded. For the 13th plan, more than 16GW has already been awarded. With not many orders left to be awarded, we expect a material slowdown in market ordering, which will likely keep pricing under pressure.
Figure 12: India Capital Goods – sector order inflow growth to decelerate
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2704730000 30000 30000
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Industry ordering MW YoY
Expect market ordering to decelerate
Source: Company data, Barclays Capital estimates
Bulk of 12th plan orders awarded
Barclays Capital | India Capital Goods
7 December 2011 14
Figure 13: India Capital Goods – more than 95GW of orders meant for 12th Five Year Plan already awarded
Plant Capacity
(MW) MW
configuration Technology State Developer
Athena Chhattisgarh TPP 1320 660 Supercritical Chhattisgarh Athena Chhattisgarh Power
Bajaj Hindustan - Lalitpur 1980 660 Supercritical Uttar Pradesh Bajaj Hindusthan
Barh II units 1 and 2/Barh TPP 1 3300 660 Supercritical Bihar NTPC
Dainik Bhaskar 1320 660 Supercritical Madhya Pradesh DB Power
East Coast TPP 1320 660 Supercritical Andhra Pradesh East Coast Energy
JPA Karchana, Prayagraj/Nigri 4620 660 Supercritical Various locations Jaiprakash
Raichur 1600 800 Supercritical Karnataka BHEL state JV
Krishnapatnam 1/2 1600 800 Supercritical Andhra Pradesh APgenco
Mahagenco - Koradi 1320 660 Supercritical Maharashtra Mahagenco
Nagarjuna CC TPP 1 1320 660 Supercritical Andhra Pradesh NCC
Rajpura TPP - Nabha Power 2100 660 Supercritical Punjab L&T
Krishnapatnam/Chitrangi/Tilaya 9940 800 Supercritical Various locations R Power
Thermal Powertech TPP 1 1320 660 Supercritical Andhra Pradesh Thermal Powertech Corp
Tiroda/Kawai 1980 660 Supercritical Maharashtra/Rajasthan Adani Power
Amarkantak 3/4 1320 660 Supercritical Uttar Pradesh Lanco
Bellary TPS 700 660 Supercritical Karnataka KPCL
NTPC bulk tender 7200 800 Supercritical Various locations
GMR – (SJK powergen) Shadol 1320 660 Supercritical Madhya Pradesh GMR
Vidharbha 1320 660 Supercritical Madhya Pradesh Lanco
Mettur/Kalisindh 1980 660 Supercritical Tamil Nadu/Rajasthan TNEB/RRVUNL
Abhijit -/Adhunik 1620 270/540 Subcritical Jharkhand Abhijit I/Adhunik
Kaktiya TPP, Rayalseema 1200 600 Subcritical Andhra Pradesh Apgenco
Bina Power TPP 500 250 Subcritical Madhya Pradesh Bina Power Limited
Chandrapur TPP 1000 500 Subcritical Maharashtra Mahagenco
Dainik Bhaskar Power 1200 600 Subcritical Chhattisgarh Dainik Bhaskar group
Ind Bharat TPP 700 350 Subcritical Orissa Ind-Bharat Energy Utkal Ltd
Indiabulls Amravati 1-2, Nashik 1-2 5400 270 Subcritical Amravati Indiabulls Power
Jhabua Power TPP, Angul, Malwa TPP 1950 300/500 Subcritical Madhya Pradesh Jhabua Power/MPCL
Jindal power 2400 600 Subcritical Chhattisgarh Jindal Power
Jindal TPP 1200 600 Subcritical Orissa Jindal India TPL
Kalisindh TPP 1200 600 Subcritical Rajasthan Rajya Vidyut Utpadan Nigam
KPCL - Bellary/Surana Power 700/420 700/420 Subcritical Karnataka KPCL/Surana power
KVK Neelanchal TPP 1000 500 Subcritical Orissa KVK Nilanchal
Marwah TPP unit 2 1000 500 Subcritical Chhattisgarh Chhattisgarh SEB
Mauda TPP/Ideal Energy 1590 525/540 Subcritical Maharashtra GMR Energy/Ideal Energy
Rihand TPP3, NTPC jhajar, DVC Bokaro 1500 500 Subcritical UP/Haryana/Jharkhand NTPC/DVC
RKM Powergen TPP 1440 360 Subcritical Chhattisgarh RKM Powergen Corp
Singareni Collieries Co Limited (SCCL) 1200 600 Subcritical Andhra Pradesh SCCL
SKS Ispat 1200 600 Subcritical Chhattisgarh SKS Ispat Power Projects
Tuticorn JV 1000 500 Subcritical Tamil nadu Neyveli Lignite
Vindhyachal TPP 1V, Korba 1600 500 Subcritical Madhya Pradesh NTPC/Avantha
Visa Power - Raigarh 1200 600 Subcritical Madhya Pradesh Visa Power
Wardha TPP 1 1800 600 Subcritical Chhattisgarh Wardha Power Limited
Sagardighi 1000 500 Subcritical West Bengal WPCDL
Tori , Salay , Navbharat, Mahan 7920 600 Subcritical Various locations Essar Power
Note: Supercritical: Sets above 660MW size; Subcritical = sets below 600 MW size. Source: CEA, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 15
Order pipeline still in early stages of planning
We analysed more than 110GW of potential projects across utilities such as NTPC Ltd. And Damodar Valley Corp. and the private power plants that are due to be ordered out in the next five years. More than 80-90% of the projects are still in the planning stage or awaiting coal linkages, clearances from the Ministry of Environment and Forests or land acquisitions. This, in our view, suggests that a strong order cycle in FY13/FY14 is unlikely. Although clearances could be speeded up, land acquisitions would still be a stiff challenge to surmount.
Figure 14: India Capital Goods –order pipeline for NTPC Ltd. and Damodar Valley Corp.
Project Capacity
(MW) State Status
Ramagundam Stage-IV 1,000 Andhra Pradesh Under active consideration. Application for coal linkage put.
Pudimadka 4,000 Andhra Pradesh Project conceived in late 2010- Early stage (i.e. no land/coal)
Badarpur Expansion 1,050 Delhi Gas allocation awaited
Kawas and Gandhar 1300 Gujarat Gas projects. Tender floated in Apr 2011
North Karanpura 1,980 Jharkhand Decision on location pending for over a decade. A three member panel set up by GOI to resolve the issue
Vindhyachal-V 500 Madhya Pradesh Bids invited (in Oct 2010) but no award as yet
Barethi 3,960 Madhya Pradesh DPR being prepared. Site specific clearances and in progress
Khargone 1,320 Madhya Pradesh Site selection work commenced. Coal linkage applied. Issue with land emerged in 2010 (largely compensation related)
Gadarwara 1320 Madhya Pradesh TOR issued in Jan 2011. Was earlier a 2640MW project. Approvals awaited
Talcher Kaniha 500 Orissa Tenders awaited
Talcher TPP 1,320 Orissa Tenders awaited
Anta Stage II 1050 Rajasthan Gas allocation awaited , Approvals awaited
Marakkanam 4,000 Tamil Nadu NA
Singrauli III 500 Uttar Pradesh Coal linkages applied and awaited
Feroze Gandhi Unchahar TPP Stage-IV
500 Uttar Pradesh Moef clearance awaited (is an expansion of 1050MW project)
Tanda Expansion 1,320 Uttar Pradesh NA
Bilhaur 1,320 Uttar Pradesh Decision taken in Jan CY11
Auraiya 1400 Uttar Pradesh Approvals awaited
Source: NTPC Ltd., Damodar Valley Corp., Barclays Capital
Although more than 50GW of state projects are in the pipeline, the key issue would be funding, given the state of the balance sheets of state utilities. However, it is possible that some of these plants could be converted into join ventures with equipment manufacturers.
Figure 15: India Capital Goods – BHEL has about 7GW worth of JVs and more are envisaged
Plant Capacity JV partner Status
Yerasmus 1,600 KPCL Order awarded in FY11. Coal linkage awaited
Edlapur 800 KPCL Order awarded in FY11. Coal linkage awaited
Udangudi 1,600 TNEB Order expected in 3Q/4Q FY12
Latur 1,320 Mahagenco Gas based project of 15GW in case coal becomes an issue. Land acquisition is taking place
Khandwa 1,320 MPCL Inducting a strategic partner
Orissa, AP, Tripura N/A N/A Under discussions
Source: BHEL, Barclays Capital
Our analysis of more than 110GW of the order pipeline
suggests that the projects are still in early stages of planning
While more than 50GW of state projects are in the pipeline;
Funding will be an issue. Some could convert to JVs
Barclays Capital | India Capital Goods
7 December 2011 16
Figure 16: India Capital Goods – State Electricity Boards have more than 50GW of projects in pipeline but most are in the early stages of development
Name State Status Capacity
(MW)
Latur ( BHEL JV) Maharashtra MOU for JV signed in Late CY10. Approval process commenced 1,320
Buxar TPP Bihar Approval awaited from CEA 1,320
Lakhisarai TPP Bihar Approval awaited from CEA 1,320
PirpaintiTPP Bihar Approval awaited from CEA 1,320
Kuchhadi TPP Gujarat Project under planning stage 3,200
Sinor TPP Gujarat Project under planning stage 1,600
Dahej TPP Gujarat Project under planning stage 1,600
Kanpa TPP Maharashtra Project under planning stage 1,320
Gondia TPP Maharashtra Project under planning stage 1,320
Mendki TPP Maharashtra Project under planning stage 1,320
GNDTP Bhatinda Ext Stage-II Punjab Coal linkage applied for and awaited 500
GHTP Lehra Mohabbat Ext Stage-III Punjab Coal linkage applied for and awaited 500
Obra TPP Uttar Pradesh Awaiting approvals and linkage 1980
Sonebhadra TPP Uttar Pradesh Awaiting approvals and linkage 1320
Anpra TPP Uttar Pradesh Awaiting approvals and linkage 1320
Adra TPP West Bengal Awaiting clearance from Moef – JV between NTPC and Railways 1,320
Godhna TPP (KPCL) Chattisgarh Coal linkage has been applied. 1,600
Vadarevu TPP Stage-I Andhra Pradesh Coal linkage and approvals awaited 1,600
Bunji Bundeli TPS Chattisgarh Tender issued for DPR. Clearance to be taken later. Coal linkage applied for. 500
Korba South TPP Chattisgarh Tender issued for DPR. Clearance to be taken later 1,000
Vijayawada IGCC - BHEL Andhra Pradesh Coal linkage and others approvals awaited 182
Satupally TPS Andhra Pradesh Water and coal linkage awaited 600
Udangudi- BHEL JV Tamilnadu Awaiting approvals and linkage 1,600
Ennore TPP Tamilnadu Awaiting environment clearance. (EPC tender floated) 1,600
Khandwa – BHEL JV Madhya Pradesh Land acquisition in progress 1,600
Shahpura TPP Madhya Pradesh Clearances awaited 1320
Jharsuguda Orissa Clearances awaited and land for ash disposal not yet obtained 1,320
Bhusawal TPS Maharashtra Land acquired 660
Nashik TPP Maharashtra Converted to supercritical from subcritical earlier 660
Dhopawe TPP Maharashtra Approval received 1,980
Dondaicha TPP Maharashtra Coal available for the first two units . Awaited for others. 3,330
Gidderbaha TPP Punjab Project to be executed by NTPC and MoU signed in late 2010 2640
Banswara TPP Rajasthan NA 1,320
KaliSindh Phase-II Rajasthan DPR to commence 1,320
Ennore TPP Tamil nadu Tender for EPC was floated. Now converted to supercritical hence delay in ordering. 1,600
Katwa TPP West Bengal Project now with NTPC. Some land acquired 1,600
Wanakbori TPP Extension. Gujarat NA 800
Yamuna Nagar Haryana NA 660
Jewargi TPP Karnataka NA 1,320
Bakreswar West Bengal NA 660
Source: CEA, state utilities, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 17
Figure 17: India Capital Goods – Among India’s Independent Power Producers, more than 40-50GW of orders are in the pipeline with several projects in the 12th plan already awarded
Name State Status Total expected capacity (MW) Firm
Adhunik Group Bihar Environment clearance awaited. Land in possession 1,320 Adhunik Group
Ahijit Infra Bihar Environment approval awaited 2,640 Abhijit Group
Adhunik Group Chhatisgarh Environment clearance awaited. Land in possession 1,320 Adhunik Group
GMR Chhattisgarh Chhatisgarh Environmental issue has emerged 1,370 GMR
KSK Narmada Chhatisgarh Current in planning stage 1,800 KSK Energy
Moser Baer –Chhattisgarh Chhatisgarh Pre-developmental work on 1,320 Moser Baer
Adani-Bhadreshwar Gujarat NA 3,300 Adani Power
Dahej Gujarat NA 1,980 Adani Power
Dahej Expansion Gujarat NA 660 Adani Power
Mundra Phase-II Gujarat In Planning stage 1,600 TATA Power
Adhunik Jharkhand Phase II Jharkhand Approvals/linkages obtained 540 Adhunik Group
Indiabulls Jharkhand NA 1,320 Indiabulls Power
Jharkhand CPP (Tata Steel) Jharkhand NA 500 TATA Power
Maithon Phase-II Jharkhand Under planning 1,320 TATA Power
Tiruldih Jharkhand Land acquisition in progress 1,980 TATA Power
Gulbarga Power Plant Karnataka BOOT model - Bids invited 1,320 KPCL - BOOT
Coastal Maharashtra Mahrashtra. NA 2,400 TATA Power
Adani-Chindwara Madhya PradeshNA 1,320 Adani Power
India Bulls-Chindwara Madhya PradeshNA 2,640 Indiabulls Power
Annupur Phase-II Madhya PradeshNA 1,320 Moser Baer
Dhenkanal TPP Orissa Coal linkage awaited 1320 CESC
KS K Orissa Under planning 1,800 KSK Energy
Naraj Marthapur CPP Orissa NA 1,200 TATA Power
Naraj Marthapur IPP Orissa Land acquisition in progress 1,320 TATA Power
Wardha Naini TPP Orissa Planning stage 1,800 KSK Energy
Indiabulls Mansa TPP - Phase-I Punjab NA 540 Indiabulls Power
Bara Phase II Uttar Pradesh Land yet to be acquired 1,320 JVPL
Karchana Phase II Uttar Pradesh Land not available as yet 660 JVPL
CESC-Balagarh West Bengal Coal linkage awaited; targeted for 2016 1320 CESC
Source: CEA, Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 18
Coal a structural issue; risk for the sector
With the intervention of the group of ministers, approval for several coal blocks in no-go areas were received; however, the broader concern for the sector is the likely structural shortage of coal in India.
Figure 18: India Capital Goods – several coal blocks in no-go areas have now been approved
Timeline Progress on change in policy on no go areas for coal mining
2009 MoEF classified all registered forests into different categories depending on density of the forest cover. Over 222 coal blocks were hence designated as no-go areas
Some revision to the criterion was done that brought down the no-go blocks to 209, impacting 50 GW of power projects
Jul-10 MoEF revised forest areas under no-go zones and declared 36,000 hectares to be open for mining
Early 2011 GOM was set up to resolve the issue
Apr-11 Second meeting held; MoeF agreed to free more blocks based on a clustering and boundary modification approach. Now only 125 blocks were left as no go areas
Jul-11 MoeF awards Stage 1 approval to these blocks
Coal blocks associated with Bedabahal UMPP, NTPC Darlipalli project , OPGC's Ib valley project cleared
Jul-11 BK Chaturvedi panel report recommended that forest area classification for clearances to coal blocks is legally not tenable
Source: India Infrastructure, Barclays Capital
Figure 19: India Capital Goods – Supply and demand outlook for domestic coal
0%
20%
40%
60%
80%
100%
FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E
Supply- Demand for domestic coal
We expect a shortfall in coal of more than 30% by FY15
Source: Coal Ministry, Coal India, Barclays Capital estimates
Companies have started booking orders without linkages The slowdown in ordering in the power segment is making companies book orders ahead of the availability of coal linkages. This is concerning, in our view, because project execution cannot commence before firm linkages are obtained as the characteristics of coal are required before embarking on designing boilers. With revenue recognition not commencing as per norms, this distorts the relationship between order bookings and revenues. Execution periods of order books are hence set to lengthen. Our analysis of order books of various equipment manufacturers suggests that companies such as BHEL have booked several orders without linkages. While as a policy, BHEL books awards on receipt of advances, our concern is more about the futility of booking orders without linkages as execution trajectory would be much slower than what the order book may suggest.
Coal approvals speeded up, but structural shortage difficult to
resolve
BHEL has booked several projects without linkages
Barclays Capital | India Capital Goods
7 December 2011 19
Figure 20: India Capital Goods – several orders booked by BHEL in FY11 do not have coal linkages
Plant Utility Supplier Capacity (MW)
Edlapur TPP BHEL - KPCL JV BHEL 800
Bellary TPS KPCL BHEL 700
Yerasmus TPP BHEL - KPCL JV BHEL 1,600
Lalitpur power Bajaj Hindusthan BHEL 1,980
Sagardighi WBPDCL BHEL 1,000
Source: Coal Ministry, BHEL, Barclays Capital
Figure 21: India Capital Goods – cases in which LOA were cancelled. BHEL is implementing these plants
Project Utility Capacity (MW) Location BTG Date of award
Muzaffarpur TPP Stage II NTPC 390 Bihar BHEL 2010
Farakka Stage III NTPC 500 West Bengal BHEL 2008
Bokaro TPS A DVC 500 Jharkhand BHEL 2009
Source: Coal ministry, BHEL, Barclays Capital
T&D: Volume recovery likely
The pace of recovery in the T&D segment depends on the pace of commissioning of power generation projects. With the pace of commissioning expected to be stronger in FY12, we expect a recovery in T&D ordering. Channel checks suggests that in FY12 there is an expectation of more than 150 transformer awards (765KV) and more than 15 substation orders (765KV) and several tenders for circuit breakers and reactors. An HVDC order is also expected next year although the tender is expected to be divided into smaller contracts.
Figure 22: India Capital Goods – Volume of tenders higher than earlier years
Figure 23: India Capital Goods – Sharp increase in substation tenders
64
2 3
10
1
42
7
13
53 2
7
19
7
10 9
02468
101214161820
1Q-2
008
2Q-2
008
3Q-2
008
4Q-2
008
1Q-2
009
2Q-2
009
3Q-2
009
4Q-2
009
1Q-2
010
2Q-2
010
3Q-2
010
4Q-2
010
1Q-2
011
2Q-2
011
3Q-2
011
4Q-2
011
1Q-2
012
2Q-2
012
Transformer or Reactor- No of tenders
64 4 4
34
9
2
7 7 76
9 97
11
5
14
02468
10121416
1Q-2
008
2Q-2
008
3Q-2
008
4Q-2
008
1Q-2
009
2Q-2
009
3Q-2
009
4Q-2
009
1Q-2
010
2Q-2
010
3Q-2
010
4Q-2
010
1Q-2
011
2Q-2
011
3Q-2
011
4Q-2
011
1Q-2
012
2Q-2
012
Substation EPC- No of tenders
Source: Powergrid Corporation, Barclays Capital Source: Powergrid Corporation, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 20
CONVERTING PLANS INTO ORDERS IS CRITICAL
The previous cycle was aided by substantial reforms in the power segment in 2003, followed by a focus on the public-private partnership (PPP) route for infrastructure funding for roads and airports. Substantial investments also helped trigger a recovery in industrial capex. Land was not a major challenge as several projects were initially brownfield expansions unlike the current cycle in which more than 70% of the projects are greenfield. For a new cycle to emerge, apart from removing the constraints to ordering, new demand drivers have to be created. These include announcing several projects in the railways segment (DFCs, high speed rail, station modernisation), increasing sourcing in defence projects from local manufacturers, speeding up nuclear power projects and speeding up the planned metro/mono rail/airport projects. Our analysis of the order pipeline across various end markets in the infrastructure domain suggests that a strong potential lies ahead but that the pace of conversion of these plans into orders is critical.
Infrastructure recovery likely to lead this next cycle: order pipeline encouraging
The Infrastructure segment will likely lead the recovery in this next cycle because capacity constraints are significant. India’s rail and port networks need to be strengthened to transport coal while urban infrastructure needs significant investments (metro rail, monorail). With the pipeline of orders being healthy, we believe that this is a segment for which an increased focus from the government can trigger an order recovery. A bottom-up survey of potential ordering in various segments suggests a healthy pipeline. Metro rail, railways, and defence are key segments for which we expect large investments.
Figure 24: Order pipeline in various end markets in the infrastructure segment
Market size
(US$bn) Comments
Railways 10 Overall slow pace of ordering. Typically US$2-3bn of civil engineering work/signalling work announced per annum.
DFC tendering has commenced, but pace of ordering is slow. One tender has already been released in which three consortiums have been qualified; however, a retendering of this is now likely. This was an Rs60bn tender.
Another tender expected to be released in November but has been delayed. These are large bulk tenders. Overall, Rs350-400bn worth of orders are to come from this segment.
Some JV's with private players expected to be finalized in FY12 (Loco JV, etc.).
Roads 13 Target of 7,300km of road awards vs. 5,000km awarded last year. Likely that only 5,000-5,500km gets bid out. Of the nine mega road projects, four have been ordered out.
Airports/ports 5 No major airport orders are expected this year. However, the pipeline is strong. The largest airport to be finalised next year will be that at Navi Mumbai (late FY13). A large airport in the Middle East is to be finalised next year.
Real estate/broad construction
30 The pace of ordering has been slower than before but no downturn as yet.
Mining equipment 0.4 Flattish trend; no major acceleration expected.
Construction equipment 2 Order growth decelerating due to weak infrastructure and real estate builds.
HVAC 25 Market remains weak in India (larger format retail and commercial real estate are weak areas). Order pipeline in Middle East strong but order finalisations slower than before.
Source: NHAI, Indian Railways, Barclays Capital
A strong potential lies ahead, but the pace of conversion of these
plans into orders is critical
Barclays Capital | India Capital Goods
7 December 2011 21
Metro investments
About Rs1,600bn in metro rail and monorail projects are being planned in various cities in India. These will largely be cash construction projects given they are not viable through a PPP route.
Figure 25: Metro Rail and Monorail – about Rs1,600bn in projects planned in India
City Project
type Cost
(Rs bn) Length
(km) Status
Hyderabad Metro 150 72 PPP awarded; secondary orders for coaches, electrification to be awarded in FY13
Mumbai Metro NA 40 In planning stage. Expected to be implemented over 2016-2021
Kochi Metro 30 26 ICB to be done for awarding project implementation work
Bangalore Mono Rail 36 60 Not ordered as yet. Project viability an issue.
Bangalore Airport Link 66 37 Not ordered as yet
Kozhikode Mono Rail 10 23 Proposed
Trivandrum Mono Rail 30 28 Proposed
Bangalore Metro phase 2 250 18 Process of preparation of DPR
Delhi Metro phase 3 280 105 Tendering has commenced
Jaipur Metro 20 Construction in progress. 35% of civil engineering work completed
Indore Mono Rail n.a. na Feasibility study commenced
Patna Mono Rail n.a na Ground survey to be conducted by RITES
Jodhpur Mono Rail n.a na Scomi to conduct feasibility study
Chennai Mono Rail n.a 111 Bidding commenced; 4 mono rail lines in first phase
Thane Mono Rail n.a 30 Under planning
Thane Metro na 10 Under planning
Ahmedabad Metro 70 40-50kms Work to commence in FY13 in two phases
Ahmedabad Metro link na na Planning stage
Ahmedabad Mono Rail 50 na Planning stage
Chandigarh Metro 150 52 In three corridors
Ludhiana Metro 87 29 In BOT route
Source: Various news reports, DMRC, India infrastructure, Barclays Capital
Railways
The key areas of spending in the rail segment will be on the dedicated freight corridors and modernising railway stations. An aggregate of Rs13,800bn spend is envisaged for the next seven years. Details of some key areas of spending are highlighted in Figure 22.
Figure 26: Railways – Vision 2020 envisages spending of Rs13,800bn to FY20
Rs bn Until FY12 From FY13-20
New lines 100 1,700
Doubling 60 1,240
Metropolitan transport 94.5 510
High-speed corridors 0 2,000
Upgrading of stations 12 stations 38 stations
Passenger coaches 110 714
Wagons 101 765
Diesel locomotives 72 487
Electric locomotives 67 581
Source: Indian Railways Vision 2020, Barclays Capital
Expect several metro projects to be executed in the coming years
Dedicated freight corridors and railway station modernization
are the key areas of spend
Barclays Capital | India Capital Goods
7 December 2011 22
Airport investments
More than Rs270bn worth Airports have been planned in India; however, the bulk of them are small projects. The only relevant project expected next year will be the Navi Mumbai Airport valued at more than Rs96bn that will be awarded through a BOOT model next year.
Figure 27: Indian Airports – Navi Mumbai Airport is the relevant airport planned for FY13
State City Cost
(Rs bn) Status
Maharashtra Navi Mumbai 96 Environmental clearance received in FY11; expected to be ordered in late FY13; EPC order may not be expected in FY13
Maharashtra Nagpur 26 Development work under way Maharashtra Sindhudurg 2 Already awarded to IRB Uttar Pradesh Kushinagar 8 Clearances obtained Uttar Pradesh Jewar Airport Noida 35 Awaiting approval; airport just 72 Kms from Delhi Airport is delaying the project as current rules
do not allow a new airport within 150kms radius of an existing one Punjab Ludhiana 30 NA Karnataka Shimoga 1.0 Land of about 660 acres acquired; work on project has commenced Karnataka Gulbarga 1.0 About 670acres of land acquired; construction work has commenced Karnataka Bijapur 1.0 About half of the land acquired (total 720 acres required) Karnataka Hassan 0.7 More than half of land acquired (total of 960 acres required) West Bengal Durgapur 3.5 Airport work will cost Rs1.6bn of which contracts worth Rs1bn has already been awarded Arunachal Itanagar 10 In planning stage Nagaland Cheitu 10 DPR approved by state government Madhya pradesh
Dabra Approval granted to Gwalior Agriculture Company; will be a cargo airport
Rajasthan Paladi Partnered with Fraport AG for airport development Goa Mopa 25 Through PPP route; bidding has not yet commenced Kerala Kannur 13 1280 acres of land acquired Andhra Pradesh Hyderabad 10 New terminal planned after FY15 Pondicherry Karaikal 2.5 Approval granted
Middle East A US$7bn airport project likely for bid next year
Source: India Infrastructure Journal, Airports Authority of India Economic Times, Times of India, Barclays Capital
Defence
We estimate the Ministry of Defence’s overall capex budget at more than US$80bn for the next five years with imports expected to account for 50% of the total. To increase sourcing from Indian firms a compulsory joint venture route could be deployed. Moreover, L&T, for example, has broad capabilities in building aircraft carriers, submarines, corvettes and frigates.
Figure 28: Ministry of Defence – plans for more than US$80bn in projects
Navy Air force
Items No. Value (US$bn) Items No. Value (US$bn)
Diesel submarines 6 21.0 Aircraft Su-30 MKI 140 9 Nuclear submarines "3-5" 9.0 Multirole combat Aircraft 126 10 Aircraft carriers 2 0.5 LCA (Tejas) 120 2.2 Corvettes 8 2.0 Fifth generation fighter aircraft 10 Destroyers 4 3.3 Medium and Heavy lift Helicopters 117 3.2 Frigates 7 8.0 Basic trainer Aircraft 181 6
Source: Confederation of Indian industry, Deloitte Touche Tohmatsu India, Barclays Capital
Largest Airport to be bid out next year is the one in Navi
Mumbai
Barclays Capital | India Capital Goods
7 December 2011 23
Recovery in industrial capex likely to be late in the cycle
A recovery in ordering in the industrial segment commenced in late FY10 with short-cycle product orders (refurbishment capex, small value items) seeing a recovery and management commentary post 2Q FY11 increasingly pointing at an imminent recovery in project ordering; however, excess supply vs. demand in the cement segment and resource constraints and delays in approvals in the steel segment affected the overall pace of ordering for the sector.
Near term, new orders for cement capex appear weak. For the steel segment, more than US$50bn in projects are in the pipeline; however, our channel checks suggest that tendering in the steel segment near term is weak. Key projects include Posco’s 12mtpa integrated steel facility in Orissa valued at Rs500bn, Arcelor Mittal’s 6mtpa project in Jharkhand and a 6mtpa project in Karnataka with an investment of more than Rs500bn, Bhushan Steel’s project in Bengal, and Tata Steel’s projects in Chhattisgarh and Karnataka.
Figure 29: Industrial Capex – spending like to come late in the cycle
Industrial
Market size
(US$bn) Comments
Cement and steel 2 Cement remains in oversupply; we expect muted ordering activity
For steel, near-term ordering activity is weak, but the project pipeline for the next three years is encouraging. Several pending SAIL projects already awarded. Pace of tendering is now slow. Live projects include ones at SAIL, JSPL, NMDC, Tata Steel.
Oil and gas 7 Ordering in the Middle East continues. Some projects in Southeast Asia. Ordering in India continues (Rs150bn orders from ONGC in 2H likely) but not a strong growth market
Consumer/others
Medical equipment 0.7 We expect mid-teen growth
Lighting 75.0 Continues to remain strong; we expect mid-teens growth
Overseas lighting 0.4 No deterioration in pricing or volumes; we expect growth to be flat
Fans 0.8 Sharp slowdown in demand this year; market growth in single digits
Air conditioners Market growth has sharply moderated due to weak summers and increase in interest rates
Defence 8 Do not expect any increase in ordering to private Indian vendors
Wind 35 Increase in interest rates to impact ordering in domestic market; pricing to decline in India
Source: Company data, Barclays Capital
Progress on reforms There have been some improvements in reform activity in the past six months, in our view, with a new land reforms bill being introduced, some no-go areas being allowed for mining, new infrastructure lending norms for setting up of debt funds, increasing noise on the likely imposition of import duties and increase in power tariffs by various SEBs.
Land: The land reforms bill is likely to be cleared this year. It would give a benchmark for fair compensation (4x the current land value), which would allow the government to acquire land on behalf of private players for public projects. However, a provision for the life-long rehabilitation of the affected landowners is being raised as an issue by potential private investors. We believe that given the fragmented ownership of land in India, acquiring land could still be a challenge and a time-consuming process. What we believe is required is a reform to allow the speedy acquisition of land by the government for public projects much ahead of the actual project starts based on the long-term plans for potential projects.
Industrial capex recovery will emerge after infra recovery pans
out
Barclays Capital | India Capital Goods
7 December 2011 24
Coal: Although some no-go areas have received clearance post the intervention of the Group of Ministers (GoM), the key issue is the long term availability of coal, the pace of approvals and the execution and building of a strong logistics network to help transport coal within the country and to help transport imported coal. The process of ordering for dedicated freight corridors has been slow due to land and financing issues, which could create a material bottleneck in future.
Funding: Recent news reports suggest that the Reserve Bank of India will announce norms on the setting up of infrastructure development debt funds, which could help ease lending constraints for the banking system.
Import duties: The delay in implementation of import duties by the government has already significantly affected market shares for domestic competitors. Several orders for 12th as well as 13th plan have already been given to Chinese vendors through bulk contracts. Although an import duty is closer to being finalised (5% duty, 4% special additional duty and a 10% CVD to counter excise), it be nothing more than an academic impact for the coming years. The T&D segment has witnessed a similar fate with more than 70% of its high voltage orders being won by Korean/Chinese vendors. Some form of domestic manufacturing requirements, however, has now been implemented by Powergrid Corporation in India (these include compulsory JVs with domestic manufacturers with at least one transformer being manufactured in India).
State Electricity Board reforms: Several SEBs have increased tariffs in the past 12 months, ranging from 10-20%. There are also proposals for further increases pending. Since the aggregate losses of SEBs are more than Rs635bn (Tamilnadu, Uttar Pradesh, Andhra Pradesh and Rajasthan are making the largest losses), a committee has been set up under B.K. Chaturvedi, a member of India’s national Planning Commission, with the secretaries of various states and the RBI’s deputy governor to look at the financial health of power distribution companies (discoms) in two phases and suggest likely reforms. The first phase will comprise Andhra Pradesh, Uttar Pradesh, Haryana, Tamilnadu, Rajasthan, Madhya Pradesh and Punjab.
Barclays Capital | India Capital Goods
7 December 2011 25
Figure 30: India’s State Electricity Boards – recent increases in power tariff for consumers
SEB Price increases
Andhra Pradesh Aug 2010: Prices increased for industries and 60 paisa for commercial establishments and railway traction. No change for domestic and agricultural segment.
Mar 2011: Tried increasing tariff but did not get approval from the chief minister of Andhra Pradesh for increasing prices for domestic consumers (slab of 201-300 units) and cottage industries. Average 8-10% hike.
Bihar June 2011: 15-20% hike (applied fuel surcharge again with retrospective impact)
Dec 2011: 10% hike
Orissa April 2011: 20% avg. hike
Delhi Aug 2011: 22% avg. hike
Chattisgarh April 2011: 15% hike (22% increase for domestic consumers and 12% for industrial)
Gujarat April 2010: Avg. 2.36% increase
Sep 2011: 4-5% avg. hike
Rajasthan Sep 2011: 20% avg. hike
Maharashtra Sep 2010: 3% hike (had sought 14%)
Nov 2011: 40 paisa increase; about 8-10%
Madhya Pradesh June 2010: 10.66% increase
May 2011: 40% hike requested
Delhi Aug 2010: 22% hike
Punjab April 2010: 13% hike.; was 10% earlier but ere asked to roll back; approved again in budget
May 2011: 10% hike; about 37 paisa increase
Haryana Oct 2010: About 15%-20% increase (7 paisa increase)
May 2011: 0.5% increase
Another hike being solicited
Karnataka Oct 2011: 7% avg. or 27 paisa
Dec 2010: Avg. hike of 22 paisa; was put on hold for some time
Tamilnadu Aug 2010: Hiked power price for first time in seven years in Aug 2010; increase ranging from 30 paisa to Rs1.1/unit. Increase for consumers using above 300 units and industrial consumers. Avg of 10% hike
Nov 2011: Applied for a 38% tariff hike (about 74-110% in some slabs) in Nov 2011
West Bengal April 2010: 10-15%
April 2011: 11% hike (about 38-46 paisa of avg. hike)
Dec 2011: Another hike likely and to be implemented from April 2012
Uttar Pradesh April 2010: 20% hike
Jharkhand 15-50 paisa plus increase in fixed tariff by 12-40 per month
Source: State utilities, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 26
HYPER-COMPETITION AND MARGIN RISK
While revenue growth and order run rates for the sector have declined sharply, margins have still been holding up well, primarily on account of support from companies with long execution periods. However, we believe the stage is set for margin pressure to become more evident as we enter the second phase of the down-cycle, as some of the key end markets are now going through a period of hyper-competition. End markets with high competitive intensity are those exposed to imports from China and Korea and where domestic supply build up has become more evident in recent times. Our bottom-up analysis of 25 end markets suggests that power generation equipment is the most competitive, followed by power T&D. Our preferred stocks have lower exposure to hypercompetitive segments since lower risk to margins gives more certainty to estimates and multiples. Companies for which we see high margin risks include BHEL, BGR Energy and Siemens. Companies with low risk relative to our estimates are Havells, Cummins and KEC.
Margin pressures
The first phase of the downturn, which commenced in FY09, saw a decline in revenue growth for the sector (Figure 35) due to a sharp deterioration in order activity. Margins held up due to a previous backlog of orders with healthy margins, BHEL’s continued monopoly status (and flat pricing), a sharp decline in commodity prices benefitting Cummins, Crompton Greaves) and general unwillingness of companies to bid for orders at low margins given an already healthy order book.
The second phase of the downturn that commenced earlier this year will bring margin pressures, as pressure on pricing is evident in all end markets. Companies will have to either adjust to the new pricing environment or face significant declines in order book growth. We believe that companies with an inability to fend margin pressures by increasing price of their offerings or by a strategic shift in their order mix would be the most exposed.
In the first phase of the down cycle revenue growth was
impacted but margins held up due to a healthy order book
The second phase has started: we expect margin pressures due
to weak pricing in various end markets; companies with
dominant product positioning will be the least exposed
Figure 31: India Capital Goods – sector revenue growth impacted …
Figure 32: … but margins have been holding up well
6%
17%
-1%
-2%
9%14%
9%
30%33%31%
37%
28%
10%
20%15%
8%10%
-5%0%5%
10%15%20%25%30%35%40%
Mar
98
Mar
99
Mar
00
Mar
01
Mar
02
Mar
03
Mar
04
Mar
05
Mar
06 M
ar07
Mar
08
Mar
09
Mar
10
Mar
11
Mar
12 E
Mar
13
E
Mar
14 E
Revenue growth yoy
0%2%
4%6%8%
10%12%
14%16%
Mar
97M
ar98
Mar
99
Mar
00
Mar
01
Mar
02 M
ar03
Mar
04 M
ar05
Mar
06 M
ar07
Mar
08 M
ar 0
9 M
ar 1
0 M
ar11
Mar
12E
Mar
13E
Mar
14E
EBITDA Margin
Source: Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 27
Figure 33: End-market competitive outlook – a bottom-up analysis of the supply chain
End market Comments based on supply chain survey
Boilers and turbines Over 50GW of boiler and 35-40GW of domestic manufacturing capacity vs. demand of 30GW/annum
Competition from China/Korea is high; Doosan is setting up manufacturing capacity in India and so is Dongfang; this is enough to bring other manufacturers to India
Power BOP Capacity still constrained as labour availability is a key challenge; pricing is stable
T&D domestic Price competition to remain challenging. Chinese (TBEA) to set up capacity in India. ABB/Areva T&D and Siemens to have better cost structure in 765kV as they are eligible for using 100% domestic content. Substation EPC orders more competitive due to change in qualification requirements.
T&D international No major change in competitive intensity – Chinese actively participating in bids
Transmission tower Competitive intensity increased since FY10. From 5-7 bidders earlier, total number of bidders is more than 20 now. Expect some moderation in competitive intensity as Powergrid Corporation has been blacklisting companies with poor execution record. Some recent orders were awarded to KEC despite it not being the lowest bidder.
Power back up Pricing stable in mid-high KVA segment. Pricing went up earlier this year and not expected to decline as companies like Cummins hold a dominant position. Low KVA (sub 200KVA) is facing pressure from Chinese competition.
Mining equipment Competition restricted as Coal India largely orders from BEML. Expect pricing to remain stable. Competition for private sector orders though high (small portion of the market).
Construction equipment Engine pricing largely stable and although demand is decelerating, pace of decline lower than powergen. No major competition from Chinese also helps
Railways Largely EPC work where margins are usually sub 10%. Price trends stable
For Wagons pricing has been stable
For metro coaches price competition is high with several bidders: Alstom , BEML, Bombardier, CAF of Spain, Chinese companies like China CNR, China Southern Railways and Siemens, Mitsubishi and Kawasaki
Electrification: Pricing pressure not as intense
Roads Competition intense. Several small players have become active. Over 114 companies have applied for annual qualification for bidding for road projects. Companies such as L&T no longer bid for road construction work and prefer participating in that segment by bidding for projects (BOT)
Airports/ports Competition for BOT orders expected to be stiff.
Real estate/broad construction
Execution is considered critical; hence, pricing environment not deteriorating. Margins will still be below that of manufacturing/industrial orders (5-7% range).
HVAC Stiff competition for orders expected. Voltas has brought down bidding EBITDA margin targets to 5% vs. last year’s 9% margins in MEP segment.
Other industries General industrial ordering is a high margin business due to limited strong competitors in India. L&T is largely among the only E&C company that caters to E&C jobs for most industries in India.
Cement and steel Not many orders in Cement and Steel but price competition not irrational.
Oil & gas Stiff competition from international firms. With Punj Lloyd typically not getting qualified for ONGC platform projects competition for domestic firms-L&T and Afcons is largely with Singapore/Malaysian and Korean vendors.
Medical equipment Scope for product differentiation is high hence price competition not as intense
Lighting Pricing typically stable in the market. Warranties, life of product key differentiating factor.
Overseas lighting Stable pricing trends in Europe
Fans Competition stiff especially with market slowing down
Air conditioners Stiff competition. High inventory in the channel. Price discounting expected.
Defence Very few competitors in India. Pricing/margins stable
Wind Pricing trends stable this year. Expect pricing to deteriorate due to excess global capacity
Biomass Not much price competition
Water and waste Largely an unorganized market. Competition for BOOT – Desal projects stiff but general contracting work not as competitive
Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 28
Relative attractiveness of end markets
The Boilers & Turbine (BTG) end market is relatively worst placed, on our analysis, since at current pricing levels for orders it is difficult for companies to make profits.
Figure 34: India Capital Goods – BTG, HVAC and T&D are the end markets with the worst competitive outlook
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Boile
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nd
HV
AC
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and
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Win
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l
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Air
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rts
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aste
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pmen
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Cem
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& S
teel
Def
ence
Biom
ass
Competitive outlook
High foreign competitionHigh Domestic competition
Pricing pressure highest in BTG segment, followed by HVAC
Note: Each end market is scored over 1-10 points based on the competitive intensity. Source: Barclays Capital estimates
Figure 35: India Capital Goods – end-market exposure of companies
0
5
10
15
20
25
30
BGR
BHEL
Vol
tas
Ther
max
Are
va &
D
KEC
ABB
L&T
Cro
mpt
onG
reav
es
Hav
ells
Siem
ens
Cum
min
s
Relative exposure to best end markets - High score= better exposure
BGR and BHEL have exposure to the worst placed end markets
Note: Company exposure to various end markets is then compared with the end market score. Source: Barclays Capital estimates
Margin risk for BHEL and BGR is high Three factors dictate margin performance for the companies we analyse: 1) pricing power – ie, the ability to transfer commodity price risk to either customers or vendors; 2) end market exposure – ie, whether the segment is at risk with exposure to low-cost imports and a deteriorating supply-demand environment; and 3) mix shift – whether there is an increase/decrease in exposure to low-margin segments due to a slower pace of ordering in high-margin end markets. In the following table we present our expectations for FY12 EBITDA margin for each company.
Barclays Capital | India Capital Goods
7 December 2011 29
Figure 36: Comparing EBITDA margin estimates for FY12E with past trends; BHEL, BGR Energy face risk of margin downside
Past 10 year EBITDA margin FY12E vs. FY12E vs. Potential risk of downside from
Maximum Average FY12E maximum Average current estimate
BHEL 20 18 19 -1 2 High
L&T 14 11 12 -2 1 Medium
ABB 12 9 6 -6 -2 Low
Siemens 14 10 13 -1 2 High
Crompton Greaves 17 11 9 -8 -2 Low
Thermax 13 11 11 -2 0 Low
Voltas 10 6 5 -4 -1 Low
Cummins 19 15 14 -4 -1 Low
Havells 13 8 10 -3 2 Medium
KEC 13 9 8 -5 -1 Medium
BGR 11 11 12 1 1 High
Areva T&D 18 11 9 -8 -2 Low
Source: Company data, Barclays Capital estimates
Figure 37: India Capital Goods – end-market exposure as a percentage of revenues
(%) End markets BHEL L&T ABB Siemens CGL Thermax Cummins Havells BGR Voltas Areva T&D KEC
Power 85 40 60 45 80 70 0 14 100 0 100 100
Industrial 15 32 40 45 10 20 55 20 0 10 0 0
Infrastructure 0 28 0 10 10 10 45 67 0 90 0 0
Boilers and turbines 60 20 50 80
Balance of plant 20 10 20 20
T&D domestic 5 10 60 30 35 14 100 0
T&D international 15 40 50
Transmission tower 50
Mining equipment 5
Construction equipment 2 5 5
Railways 5 5 5
Roads 7 5
Airports/ports 5 5 10
Real estate 5 20 10
HVAC 40
Other industries 15 17 30 30 10 10 35 20 10
Cement and steel 5 10 15 10 20
Oil and gas 10
Medical equipment 5
Lighting 8
Overseas lighting 50
Fans 10 8
Air conditioners 25
Defence 2
Wind 5
Water and waste 2 10
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 30
Power generation equipment
We estimate more than 50GW of boiler manufacturing capacity in India, apart from the impact of imports of boilers from China and Korea. For turbines, we estimate domestic manufacturing capacity at more than 36GW per annum (excluding imports of turbines from China and Korea). This capacity compares with our estimate of demand in the range of 25-35GW pa over the next few years
We expect excess capacity in power generation equipment to continue to pressure pricing, ensuring that the cost of maintaining market share for incumbents will increase sharply. Import duties may not deter competitive activity from China/Korea given that bulk orders for implementation over the next 10 years have already been awarded. We see an increase in a long-term approach towards India by the incumbents.
Figure 38: Boilers – supply/demand assessment: supply to exceed demand
JV Investment Capacity (GW)
details (Rs mn) Technology FY10 FY11 FY12E FY13E FY14E FY15E Status
BHEL No JV Alstom 10,000 15,000 15,000 20,000 20,000 20,000 Expansion from 15-20GW under way
L&T MHI 51:49 MHI 0 4,000 4,000 4,000 4,000 4,000 Capacity already set up in Gujarat
Thermax 51:49 7,000 B&W 1,500 1,500 4,500 4,500 4,500 4,500 Capacity to be set up in Gujarat
BGR Energy 74:26 15,000 Hitachi 0 0 4,000 4,000 4,000 4,000 Capacity to be set up in TN. Land identified
Cethar Vessels No JV 5,000 Ansaldo Engg 0 8,000 8,000 8,000 12,000 12,000 8GW capacity already exists
Doosan Doosan-Babcock 0 0 0 0 3,000 3,000 To set up capacity in TN
GB Engg- Ansaldo Riley Power 1,000 1,000 1,000 1,000 2,000 2,000 In a court case with NTPC
Industry capacity 12,500 29,500 36,500 41,500 49,500 49,500
Capacity ex-Cethar/GB 11,500 20,500 27,500 32,500 35,500 35,500
Demand 30,000 30,000 25,000 20,000 25,000 30,000
Source: Company data, Barclays Capital estimates
Figure 39: Turbines – supply/demand assessment: supply to exceed demand
JV Investment Capacity (GW)
details (Rs mn) Technology FY10 FY11 FY12E FY13E FY14E FY15E Status
BHEL No JV Siemens 10,000 10,000 15,000 20,000 20,000 20,000
L&T MHI 51:49 MHI 0 4000 4000 4,000 4,000 4,000
Toshiba - JSW 74:26 8,000 Toshiba 0 0 0 3,600 3,600 3,600 Capacity set up in progress (near Chennai)
BharatForge - Alstom 24,000 Alstom 0 0 0 5,000 5,000 5,000 Capacity expected in Gujarat
BGR Energy - Hitachi 30,000 Hitachi 0 0 4000 4,000 4,000 4,000
Industry capacity 10,000 14,000 23,000 36600 36,600 36,600
Demand 30,000 30,000 25,000 20,000 25,000 30,000
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 31
Pricing in a free fall; difficult to make margins at current prices The pricing for generation equipment projects in India prior to FY11 was Rs13-15mn/MW for supercritical turbines, Rs15-Rs20mn/MW for boilers (+ auxiliaries) and Rs50-55mn/MW for supercritical EPC projects. Until mid-FY11, pricing remained firm as competition was limited and market growth was strong.
Starting in FY10, Chinese equipment majors were affected by the introduction of visa restrictions (eg, restricted the number of project managers that could be sourced from China and also allowed only skilled labour to enter India). This increased uncertainty over their ability to implement projects in India. Domestic competitors that had announced capacity expansions were still at an early stage of implementation (BGR Energy-Hitachi JV and Thermax-B&W’s JVs were announced only in the middle of FY10).
Pricing started deteriorating in September 2010, with bulk orders being awarded to the Chinese manufacturers by private sector players in India (Figure 40). Thereafter, domestic competitors (eg, Bharat Forge, Toshiba-JSW) also started bidding for orders and this coincided with a slowdown in order inflows in the sector because of issues with availability of coal.
Price discovery at the recent (September 2011) bulk tender from NTPC (for 9 x 800 MW) indicated a further decline in prices, with turbine pricing seeing a more pronounced decline. The lowest bidder (BGR-Hitachi) quoted a price of Rs10mn/MW. There still remains a gap with pricing offered by the Chinese companies. Our checks with Cethar Vessels (an unlisted Indian boiler manufacturer) suggest that turbines can be obtained from China at Rs6-7mn/MW and boilers at less than Rs10mn/MW. In fact, Cethar Vessels itself quotes a price of Rs11-12mn/MW for supercritical boilers compared with the Rs16.5mn/MW bid put in by Doosan. (The quote given by Cethar Vessels may not, however, be including auxiliaries in the contract.)
Figure 40: Generation Equipment – pricing of orders 4Q FY08-4Q FY11: pricing has declined about 30% in the past year
Date Supplier MW
rating No of
sets NatureOrder value
(Rs mn)Rs
mn/MW Client
4Q FY08 BHEL 1320 2X660 Boiler 25,000 19 NTPC- Barh II 5-Aug-08 BHEL 1600 2X800 Boiler 25,000 16 APPGCL Krishnapatnam 30-Jun-08 L&T 1600 TG+Aux 15,570 10 APPDCL 23-Oct-08 BHEL 660 660 TG 14,740 22 NTPC 12-Aug-09 L&T 1320 2X660 BTG 40,000 30 Jaiprakash 3-Nov-09 L&T 1980 3X660 BTG 68,970 35 Mahagenco 24-Nov-09 BHEL 1920 3X660 BTG 56,000 29 Jaiprakash-Prayagraj Power
30-FY11BHEL 1980 3x660 BTG 54,500 28 Lalitpur Power Gen Co
5-Oct-11 BHEL 1320 2X660 BTG 37,829 29 Dainik Bhaskar Power(DBPL) NTPC bulk tender 4Q FY11 Bharat Forge-Alstom 7260 11X660 TG 33,000 12 Bharat Forge to get 5 sets,
BHEL 4 and Toshiba 2 sets 2Q FY12 Doosan heavy 7200 9X800 Boiler+Aux 66,000 17 Doosan to get 5 sets rest to BHEL 2Q FY12 BGR Energy-Hitachi 7200 9X800 TG 32,320 10 BGR to get 4 sets, BHEL to get 3 sets and 2
sets Chinese bids Abhijeet group Dongfang 6600 10X660 BTG 11,2500 17 Reliance Power Shanghai Electric 23760 36X660 BTG 3,73,500 16 Lanco Harbin Power 10560 16X660 BTG 68,300 6.5
Source: Company data, Barclays Capital
Pricing was firm prior to FY11 due to visa restrictions that
impacted Chinese projects and limited competition from
domestic vendors
Pricing started deteriorating in September 2011
Prices have declined by more than 30% over past year
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7 December 2011 32
Current pricing not profitable Based on our understanding of cost structure of both boiler and turbine manufacturers we calculated expected EBITDA, PBT and returns for manufactures at current prices. Our calculations are conservative and are based on the cost structure of BHEL (for calculating raw material prices and employee cost/other expense).
For turbine manufacturers, our calculations suggest that it would be difficult to make profits at the current average price of Rs9.5mn/MW. While we estimate EBITDA breakeven at the 40% utilisation level, PBT breakeven in the initial years appears difficult at even 65% utilisation. This is because of the high fixed asset intensive nature of turbine manufacturing. We wonder if any of the new turbine manufacturers will be able to return a PBT breakeven in the next five years as we do not expect most to operate at above 60% utilisation.
Figure 41: Cost structure for turbine manufacturers – scenario analysis based on different utilisation rates
Rs mn Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5
Capacity (MW) 4000 4000 4000 4000 4000Price (Rs mn/MW) 9.5 9.5 9.5 9.5 9.5Utilisation (%) 30% 35% 40% 45% 65%Revenue 11400 13300 15200 17100 24700Material cost 7200 8400 9600 10800 15600Employees cost 2400 2400 2400 2400 2400Other exp 2400 2800 3200 3600 5200OBITDA -600 -300 0 300 1500OBITDA margin -5.3% -2.3% 0.0% 1.8% 6.1%Interest 2520 2520 2520 2520 2520Depreciation 1500 1500 1500 1500 1500PBT -4620 -4320 -4020 -3720 -2520PBT margin -41% -32% -26% -22% -10%ROE (%) -36% -34% -31% -29% -20%
Note: We use a capacity cost of Rs35bn for a 4GW integrated turbine manufacturing plant. Source: Barclays Capital estimates
For boiler manufacturers though, a pricing of Rs15mn/MW is sufficient to achieve breakeven at the PBT level at 35% utilisation levels, on our analysis, but if pricing dips another 20% it would be difficult to make profits even if utilisation levels are very high.
Figure 42: Cost structure for boiler manufacturers – scenario analysis based on different pricing and utilisation rates
Rs mn Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5
Capacity (MW) 4000 4000 4000 4000 4000Price (Rs mn/MW) 15 15 14 14 12Utilisation (%) 20% 35% 30% 50% 100%Revenue 12000 21000 16800 28000 48000Material cost 7200 12600 10800 18000 36000Employees cost 2400 2400 2400 2400 2400Other exp 2400 4200 3600 6000 12000Operating EBITDA 0 1800 0 1600 -2400margin 0.0% 8.6% 0.0% 5.7% -5.0%Interest 1008 1008 1008 1008 1008Depreciation 600 600 600 600 600PBT -1608 192 -1608 -8 -4008PBT margin -13% 1% -10% 0% -8%ROE (%) -31% 4% -31% 0% -78%
Source: Barclays Capital estimates
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7 December 2011 33
Need for coal blending increases implementation risk India’s Central Electricity Authority (CEA) in April 2011 advised all power developers and generating companies to plan equipment for coal blends of 70:30 (domestic/imported coal) when ordering equipment. Our discussions with several boiler designers suggest that although it is possible to design equipment for such blends, it is difficult to guarantee/predict performance of equipment post implementation (BHEL commented this was the case during trials with 80:20 blends at a plant in Karnataka). This is because coal blending itself is a complex process given the non-additive nature of several properties of coal, such as ash fusion temperature. This makes it difficult to predict performance.
Key concerns over usage of blended coals include boiler furnace fouling and slagging, which could impact boiler performance. Simply put, lower ash fusion temperatures could lead to deposition of ash on the boiler surface and tubes changing the heat transfer efficiency, and obstruction of flow of gas due to deposits increasing velocity of ash, as well as probably making exit gas temperatures higher. These factors lead to poor boiler efficiency.
Changes at the equipment end to resolve these issues could involve implementation of larger furnaces in order to ensure that heat patterns are more uniform. This could potentially increase the cost of a boiler. Coal mill design may also have to be changed, increasing BOP (balance of plant) costs. With pricing of the product being dictated by competitive activity, such an increase in cost will have to be borne by the equipment manufacturer, in our view. Furthermore, risk of implementation (ie, ability to achieve guaranteed operational parameters) also rests with the boiler manufacturer and this could increase the costs associated with the warranty period. An extreme scenario would be the imposition of liquidation damages due to delay in implementing projects and/or inability to achieve desired performance levels.
T&D: excess capacity impacting pricing A combination of a slower pace of ordering in the past two years, excess domestic manufacturing capacity in India and the entry of foreign players has impacted pricing across voltage levels in India. Prices on an annual basis have declined 15-30% over the past three years. A 765KV transformer available previously at Rs200mn is now being bid at less than Rs80mn per transformer.
Foreign players entered the India market when two key factors made the opportunity (ie, margins) in India attractive:
Tender clauses for high-voltage products that required more than 66% of the tender to be supplied from a factory with a minimum two years’ experience in manufacturing the product.
Subsidiaries of MNCs in India, such as ABB, Siemens and Areva T&D, imported a significant amount of these products from their European factories, which increased the cost of the product.
Hyosung of Korea was the first to tap this opportunity and gained more than 70% of the 765KV transformer market in India (in FY08). The tender clauses were later (FY10) changed to 50% of product to be sourced from a factory with two years’ experience and, thereafter, compulsory JV clauses were introduced (at end-FY11). Despite the clauses requiring a JV to have an Indian partner, at least one transformer in each tender to be manufactured in India and the JV to be set up within six months of the award, competition continued to be tough
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7 December 2011 34
during FY11 and new entrants such as Korea’s Hyundai and Ukraine’s ZTR (a JV with TRIL of India) managed to win tenders (4Q FY11). This impacted order inflows for Hyosung in India. We have seen recent activity from Chinese equipment manufacturers, in particular TBEA (Tebian Electric Apparatus Ltd), setting up manufacturing capacity in India.
Figure 43: Domestic capacity for transformers (MVA) – capacity more than doubled in the past five years
0
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FY07 FY08 FY09 FY10 FY1150%
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Source: Company data, Barclays Capital
Substation engineering procurement and construction (EPC) Excess capacity across the voltage level has put pressure on prices. Competitive intensity in substation EPC orders increased in FY09 as general contractors like L&T entered the market given weak ordering in industrial and infrastructure segments. Usually 5-10 EPC orders for 765KV are awarded by Powergrid corporation every year with each award being Rs2bn in size. A similar number of 400KV orders are awarded by various Indian states. In FY10, competitive intensity increased further with Powergrid Corporation relaxing the criteria for qualification for substation EPC orders. Powergrid Corporation removed circuit breakers from the substation contract making it easy for general contractors and other firms such as KEC, Jyoti Structures, Techno Electric to bid for these orders. In fact, each of these new contractors (in this segment) managed to garner an order each last year.
The near-term pricing environment remains challenging, according to our supply chain checks.
Barclays Capital | India Capital Goods
7 December 2011 35
Figure 44: High imports from Europe impacted cost structure and margins for subsidiaries of European MNCs in India (FY11)
28% 30%
20%
5%
0%
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10%
15%
20%
25%
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35%
ABB Siemens Areva T&D Crompton Greaves
Imports as % of sales
Source: Company data, Barclays Capital
Figure 45: Most domestic manufacturers have lost share in Powergrid Corporation orders
0%1%2%3%4%5%6%7%8%9%
Cro
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ongr
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s
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ens
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FY09 FY10 FY11 FY12
Note: Data exclude HVDC orders. Source: Powergrid Corporation, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 36
VALUATIONS – BACK TO CYCLICAL LOWS
Sector valuations have de-rated (from 23x in December 2010 to 13x currently) and are now closer to levels at which the previous upcycles commenced (in early CY04 and in early CY09). Furthermore, consensus expectations for sector earnings have been revised down by 10-40% (over the past 12 months). At this point, we believe the sector risk/reward is skewed more to the upside. Hence, our 2-Neutral sector view.
We prefer companies that: 1) are the best geared to ride out the difficult times and participate in the next upturn (L&T, 1-OW); 2) have strong product positioning (Cummins, Havells 1-OW); or 3) are at the bottom of their valuation cycle (KEC, CRG, 1-OW). We also initiate coverage of BHEL, BGR Energy, Thermax, ABB, Siemens and Voltas at 3-UW, and Areva T&D at 2-EW.
Sifting cyclical from structural The current de-rating of the sector is led by a weak order macro backdrop for most end markets; however, we believe that although some end markets are facing a cyclical slowdown (eg, infrastructure, industrial capex) others have structural issues that may take longer to resolve. For example, the BTG segment faces a cyclical slowdown in orders, as the bulk of the 12th plan projects are awarded; however, oversupply in the domestic market will impact margins for incumbents and this may not get resolved until order run rates are significantly higher than projections. We expect this may not happen until FY14-15. Similarly, the MEP (HVAC) segment for Voltas is facing a geographic shift following weakness in Dubai, and this is extending order finalisations and reducing bidding margins to as low as 5%. Hence we do not recommend exposure to the sector, even if valuations may appear attractive.
Figure 46: India Capital Goods – sector valuations close to 2009 previous cycle lows
5
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Aggregate sector fwd PE
13x
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Source: Datastream, IBES Consensus, Barclays Capital
Sector trading at valuations close to levels at which the
previous upcycle had commenced
We favour companies facing a cyclical slowdown in end markets vs. exposure to
structurally weak end markets
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7 December 2011 37
Figure 47: India Capital Goods – Sector derating led by consensus earnings estimate changes
-60%
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Change in 1 year fwd earnings estimates for the sector YoY 12M fwd PE
Sector derating led by change in
consensus earnings estimates
Source: Datastream, IBES Consensus ,Barclays Capital
Figure 48: India Capital Goods – over 15% cut in consensus EPS expectations for the sector since May this year
-20%
-10%
0%10
%
Jun-10 Aug-10 Oct-10 Dec-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11
FY12 EPS YoY decline FY13 EPS YoY decline
Earnings cuts have accelerated since May, led by lower-than-
expected order intake in 1Q FY12 and margin pressures
Source: Datastream, IBES Consensus, Barclays Capital estimates
Figure 49: India Capital Goods – EPS revisions over past 12 months for FY12E and FY13E
-70%
-50%
-30%
-10%
10%
L&T
BHEL
Cro
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onG
reav
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Ther
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Vol
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s
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&D
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FY12 FY13
Crompton Greaves, Voltas and ABB have seen the sharpest
earnings estimates cuts
Source: Datastream, IBES Consensus, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 38
In addition to assessing P/E multiples, we evaluate companies on four key factors: 1) exposure to end markets (order cycle and competition, risk of execution delays or order cancellations; 2) commodity and FX risk; 3) balance sheet (leverage); and 4) risk of earnings downgrades. We summarise our views in the following table.
Figure 50: India Capital Goods – Evaluation of companies on four factors: 1) state of end market, 2) commodity and forex risk, 3) balance sheet risk and 4) risk of EPS downgrades (continued on next page)
Factors BHEL L&T ABB Siemens Crompton Greaves Thermax
State of end-market
With 12th plan orders awarded, there will be a gap before ordering commences for 13th plan
Diversified business. Will be able to manage growth better than peers. Exposed to several end markets; hence, the ability to reduce risk
T&D volume cycle is recovering while industrial is already weak and should recover by FY14
T&D volume cycle is recovering while industrial is already weak and should recover by FY14
T&D volume cycle is recovering.
Expect flattish growth for industrial core ordering but expect weak ordering in IPP sector; however, with low base of orders, impact is not likely very high
Risk of execution delays or order cancellations
BHEL has booked several orders without coal linkages/financial closure. This could impact pace of conversion of order book to revenues
See risk to Hyderabad metro project. JPA Karchana project still has land issues. Gas availability concerns could delay gas projects on book
See limited risk See limited risk See limited risk See limited risk on current order book
Exposed to competition and price pressures
Irrational competition. If current pricing continues there could be a sharp erosion in EBITDA margins
Competition high in only some segments such as power BTG, Oil and Gas. Other EPC work does not see irrational competition and if at all it is order specific and temporary in nature
High competition for T&D orders. Prices have though already declined at a 30% pa over the past three years. Competitive intensity more benign in industrial products and projects
High competition for T&D orders. Prices have though already declined at a 30% pa pace.
Very high competitive activity and irrational pricing exposure is about 15-20% of order book. Rest of the markets are competitive but base of margins are low so risk not very high
Core business can generate 10% EBITDA margins. Risk largely specific to new BTG business and here margins are unremunerative
Commodity price risk
Scale of risk is not very high as 70% of contracts have price variation clauses
Medium risk to margins as 70% of contracts have price variation clauses
Medium risk: 50% has price variation clauses
Medium-high risk as only 35% of contracts may have PV clauses
Only 20% of order book has price variation clauses. Commodity price increase will impact margins but will be the first to benefit from a decline
20-30% of order book has price variation clauses
Forex risks Risk limited to any imports (10% of costs)
Risk is very low. Have US$200mn of FCCBs outstanding and rupee depreciation could increase outflow
Imports 35% of its raw materials (and finished product) and rupee depreciation could impact cost
Imports 25-30% of the product; rupee depreciation to impact cost
Largely hedged as imports are about 10% of costs but exports 10-15% of product. Translation risk likely as 50% of revenues are from outside India
Limited exposure to forex risk
Risk of earrings downgrades
Limited risk for FY12/13 but significant risk to margins from FY14. Accounting changes supporting EPS
With L&T revising down guidance risk has lowered. On a relative scale downside risk should be about 5%
Consensus estimates for CY12 are too high – should see moderation
See margins risk on Siemens. EPS estimates appear achievable but have limited room for upgrades
Risk much lower than two quarters back. Overall risk limited to 10% further cuts. Our EPS estimates assume bear-case scenario
Inability to win order in IPP space can impact EPS estimates for FY14. FY13 numbers are largely a reflection of current order book
Leverage Low Medium Low Low Low Low
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7 December 2011 39
Figure 50 (Continued): India Capital Goods – evaluation of companies on four factors: 1) state of end market, 2) commodity and forex risk, 3) balance sheet risk and 4) risk of EPS downgrades
Factors Cummins Havells BGR Voltas Areva T&D KEC
State of end-market
Demand in Power generation segment is decelerating but exposure to new products in exports to reduce downside risk.
Demand for consumer products remains strong in India. Fans segment is witnessing weak demand this year but appears to more of a cyclical issue.
With 12th plan orders already awarded there will be a phase of slow ordering
With Dubai market being weak, focus of ordering has shifted to Saudi Arabia and Qatar/Oman, etc, butpace of orders much slower although order pipeline appears encouraging
T&D volume cycle is recovering while industrial is already weak and should recover by FY14
Flattish market growth for towers in FY13; however, exposure to Rail, water and substation segment plus acquisition of SAE Towers to help drive growth
Risk of execution delays and order cancellations
Low risk as it is a product business
Low risk as it is a product business
Limited risk on current order book
Limited risk as most projects in current order book under execution
Low risk Low risk. A very small portion of order book is slow moving ((Libya , Tunisia)
Exposed to competition and price pressures
Less risk. Cummins is a dominant player. Prices have gone up this year by 5-6% and are now stable
Competition not irrational - should be able to protect margins
Exposed to stiff competition. Cannot make margins in boiler/turbine (BTG) business
Exposed to high competition in both MEP business and in air-con products. While margins have deteriorated, we do not expect a recoveryin FY13
Exposed to high competition in T&D sector but current margins reflect the impact of weak pricing
High competition in India but exposure to orders outside India lowers the impact on margins
Commodity price risk
High commodity prices have already impacted margins. See low risk from here
Able to pass on increase in commodity prices with a lag
Limited risk now as new orders from NTPC will have price variation clauses
Risk is high as most projects fixed price in nature
Risk reflects in margins. Low risk though as over 60% of book has PV clauses
Over 60% of contracts are fixed price but high commodity prices already reflects in margin estimates
Forex risk Exports comprises about 25% of sales. Should benefit from rupee depreciation
Higher payout on foreign currency loans
Risk largely specific to contracts with Hitachi
Over 50% of revenues stems from Middle East. There could be risk of translation losses due to rupee depreciation
Only 10-15% of products and components are imported so risk is not very high
Rupee depreciation to re-price advances received in international locations and impacts financials. It is a non-cash loss though.
Risk of earnings downgrades
Limited risk post the recent earnings downgrades
Limited risk. A sharp recession in Europe could Impact margins. We continue to build in margin recovery at Sylvania
Substantial risk for FY14. With pricing in recent orders being low there is risk of sharp deterioration in EBITDA margins
Risk lower after recent downgrades but don’t see any scope for recovery in earnings
Less risk of EPS downgrades as margin/order expectations are not very high
Downside risk limited to 5-10% range, and this risk is also due tothe impact of translation losses.
Leverage Low Medium High Low Low Medium
Source: Company data, Barclays Capital estimates
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7 December 2011 40
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COMPANIES
Barclays Capital | India Capital Goods
7 December 2011 42
LARSEN & TOUBRO (1-OW, PT: RS1,560, +19%): LOOKING BEYOND THE DOWNTURN
We initiate coverage of L&T with a 1-Overweight rating and a 12-month price target of Rs1,560 (SOTP based, standalone at 16.5x FY13E, subsidiaries at Rs356). Despite the current weakness in the order cycle for L&T and likely weak 2H earnings, current valuations make us look beyond the near-term risks. L&T’s ability to grow its market share over the years is due to its strong execution, balance sheet and exposure to multiple end markets, which enables it to capture changing trends in orders. We expect L&T to participate in a new upcycle (even if it is a low beta one) given its exposure to infrastructure, as well as emerging demand drivers such as nuclear, railways and defence. We view the stock as attractive on share price weakness.
Well positioned to capture a new upcycle: L&T’s diversified skills, qualifications in several domains and a large balance sheet (compared with other contractors) helps it shift end markets in order to shield itself from a downturn in others. L&T hence tends to gain market share during downturns, and is also able to minimise y/y decline in growth during downturns. L&T is best positioned to capture an upturn in the capex cycle even if it is led by new drivers such as the railways, nuclear or defence industries. With the infrastructure sector being the key driver of a recovery in FY13E and industrial capex in FY14E, we believe that the order inflow trajectory for L&T will outperform relative to peers.
Guidance cut moderates expectations: L&T’s order and margin guidance cut (from 20% to 5% and a 50bs decline to 50-75 bps) post Sep quarter numbers has significantly lowered consensus expectations. A weak order environment is well acknowledged by consensus, in our view, thus we believe that a further moderation in estimates may not be a big surprise. We build in 9% moderation in inflows in FY12E and 11% growth in FY13e.
Looking through the weak near term: L&T’s valuation has witnessed a de-rating (from 23x P/E to 14x) and consensus earnings estimates cuts by 9-18% for FY12-14E. We believe the our bear case scenario suggests an ~35% downside as against a bull case scenario of 90% upside, tilting the risk-reward towards a 1-Overweight rating. L&T, in our view, has always performed best when bought during uncertain times, and while there is always a risk of near-term downside, the stock tends to outperform over the medium term. Our downside case share price of Rs817 suggests an order inflow CAGR of growth of 5% until FY20, margins to moderate to 8%, while our upside case share price of Rs2488 builds in 10% order CAGR and EBITDA margins to remain at 12% levels.
Figure 51: L&T (Standalone financials) – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Mar Rs mn Rs % (x) (x) (%) (%)
2011A 35,033 57.5 12.9 22.8 3.7 16.0 1.2
2012E 40,296 66.2 15.0 19.8 3.2 16.2 1.4
2013E 44,431 73.0 10.3 18.0 2.8 15.8 1.5
2014E 53,315 87.6 20.0 15.0 2.5 16.6 1.8
Source: Company data, Barclays Capital estimates, based on standalone financials
LT IN / LART.NS
Stock Rating 1-OVERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 1560.00
Price (02-Dec-2011) INR 1310.75
Potential Upside/Downside +19%
Barclays Capital | India Capital Goods
7 December 2011 43
COMPANY SNAPSHOT
LARSEN AND TOUBRO INDIAN CAPITAL GOODS
Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 439,049 530,835 565,712 658,443 14.5% Stock Rating 1-OVERWEIGHTEBITDA 55,985 63,337 69,428 82,898 14.0% Sector View 2-NEUTRALEBIT 49,982 56,807 63,197 75,652 14.8% Price (02-Dec-2011) 1310Pre-tax income 57,940 60,979 67,622 81,068 11.8% Price Target 1560Net income 35,033 40,296 44,431 53,315 15.0% Ticker LART.BOEPS (R) 57.5 66.2 73.0 87.6 15.0%Diluted shares (mn) 609 609 609 609 0.0% Investment case
DPS (R) 14 17 18 22 15.0%
Margin and return data (%) AverageEBITDA margin 12.8 11.9 12.3 12.6 12.4EBIT margin 11.4 10.7 11.2 11.5 11.2Pre-tax margin 13.2 11.5 12.0 12.3 12.2Net margin 8.9 7.6 7.9 8.1 8.1ROIC 13.3 12.3 12.0 12.5 12.5ROA 11.9 11.0 10.7 11.3 11.2 Upside case 2488ROE 16.0 16.2 15.8 16.6 16.1
Balance sheet and cash flow (INRmn) CAGRFixed assets 72,370 75,839 79,609 82,363 4.4%Cash and equivalents 17,304 40,799 49,362 60,734 52.0%Total assets 295,571 366,090 414,409 472,389 16.9%Current liabilities 278,233 336,779 358,905 417,737 14.5%Long term liabilities 71,611 111,908 126,904 144,897 26.5% Downside case 817Total liabilities 349,844 448,687 485,809 562,634 17.2%Net debt/(funds) (14,505) 2,297 8,729 15,352 NAShareholders' equity 218,463 248,684 282,008 321,994 13.8%Change in working capital (2,772) (13,553) (5,987) (13,855) NACash flow from operations 38,613 29,100 40,250 41,290 2.3%Capital expenditure (15,468) (10,000) (10,000) (10,000) NAFree cash flow 23,145 19,100 30,250 31,290 10.6%
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 22.8 19.8 18.0 15.0 18.9 EV/EBITDA (x) 15.2 13.7 12.6 10.6 13.1 FCF yield (%) 2.9 2.4 3.8 3.9 3.3 EV/sales (x) 1.9 1.6 1.5 1.3 1.6 Price/BV (x) 3.7 3.2 2.8 2.5 3.0 Dividend yield (%) 1.1 1.3 1.4 1.7 1.4 Total debt/capital (%) 0.4 0.3 0.5 0.5 40.0Net debt/EBITDA (x) 1.0 1.1 1.1 1.0 1.1
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics Expect Order inflow growth to recoverOrder inflow 797,690 728,659 806,407 967,688 Order inflow growth (%) 14 -9 11 20Orderbook 13,027 15,002 17,340 20,353 Orderbook growth (%) 30 15 16 17
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 1-Overweight? Exposure to multiple endmarkets should enable L&T to capture changingordering trends. We expect L&T to participate in anew upturn given its exposure to infrastructure,which should lead the new cycle, and exposure toemerging demand drivers. Consensus EPS cuts andvaluation deratings have moderated expectations.
Our bullish case would be a general recovery in allend markets in India led by government reforms. Inour DCF, we assume margins to remain at 12% andmarket share in power orders at 15%. We valuesubsidiaries at Rs400/L&T share. Terminal growth at0%.
Our bear case would represent market share losses.In our DCF, we assume market share in non-powerorders declines to 11.5% from 15%. We expectpower orders at a market share of only 10% longterm and margins to fall to 8% by FY20. Terminalgrowth at 0%.
-20%-10%
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Order inflow growth
DownsideCase
INR817(-37.6%) Price
Target
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INR2488(89.8%)
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INR817(-37.6%) Price
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INR2488(89.8%)
408
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Barclays Capital | India Capital Goods
7 December 2011 44
Expect order inflow momentum to trough in FY13E
We expect L&T to witness a decline in order inflows in FY12E (vs. guidance of 5% growth) given the slower pace of ordering in most of its end markets in India. We do, however, expect a recovery in infrastructure ordering in India in FY13E and industrial recovery in FY14E. Given the diversified skill sets of L&T, we believe the company should be able to drive a recovery in order inflows. Continued weakness in power BTG orders will however likely keep overall order inflow growth in check in FY13E.
Figure 54: L&T – Expect a recovery in FY14E led by recovery in industrial orders
Rs mn FY12 FY13 FY14 Comments
Power BTG 99,000 118,800 118,800 KPCL JV included in FY12. UMPP win can make a big difference
Power BOP 50,000 40,000 40,000 Expect ordering to weaken by FY14 – largely a cyclical event
Power T&D 60,000 50,000 50,000 Expect wins in substations in India and in middle east
Nuclear 20,000 20,000 40,000 Expect Nuclear orders to commence in FY14
Other utilities 10,000 10,000 20,000 Water/Gas to be the drivers
ONGC +GSPL 20,000 35,000 35,000 More a market share story. Expect flat ordering every year
Other hydrocarbons 20,000 20,000 35,000 More a market share story. Expect flat ordering every year
Metals 50,000 50,000 60,000 FY14 recovery is likely. Can present upside surprises
Cement 5,000 10,000 20,000 Building in moderate growth in FY14
Other industries 30,000 30,000 50,000 Expect ordering in other industries to revive
Short cycle product 80,000 80,000 120,000 Industrial recovery to drive FY14 numbers
Other infra 40,000 80,000 50,000 Ports. Bidding for a large port in East/West coast
Roads 30,000 30,000 30,000 Building in base case orders in this segment
Real estate/buildings 90,000 80,000 100,000 Continue to see strength in this segment
Defence 20,000 30,000 40,000 Expect to benefit from offsets
Ships 10,000 10,000 25,000 Shipyard to start getting traction in FY14
Railways 20,000 40,000 60,000 Expect Rail ordering to recover in FY14
Middle East 60,000 50,000 50,000 Led by infra projects
Order inflow 714,000 783,800 943,800
Source: Company data, Barclays Capital estimates
Figure 52: L&T – revenue by product: mix has always changed in response to market conditions
Figure 53: L&T – Market share over the years has increased
0%10%20%30%40%50%60%70%80%90%
100%
FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E
Infrastructure Power Hydrocarbons Process Others
5% 5%6%
7% 7% 7%9%
10%11%12%
16%14%
0%
2%
4%
6%
8%10%
12%
14%
16%
18%
Mar-00 Mar-02 Mar-04 Mar06 Mar08 Mar10E
L&T E&C market share
Source: Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 45
Limited downside to EPS estimates
L&T’s FY12-14E consensus EPS has seen revisions of 9-18% over the past 12 months and, given management’s revision of guidance following the 2Q FY12 results, we see less risk of further EPS revisions from hereon.
Figure 55: L&T – Barclays Capital’s sensitivity analysis of margins and revenue growth suggests that a further cut in EPS estimates by 15% would represent a bearish scenario
FY12E FY13E
Revenue Growth
15% 18% 21% 25% 7% 10% 15% 20%
EPS forecasts (Rs)
10.8% 57.0 58.3 59.7 61.5 10.5% 62.15 64.00 66.69 69.38
11.9% 63.2 64.7 66.2 68.3 10.9% 64.60 66.52 69.33 72.13
12.8% 67.7 69.3 71.0 73.2 11.8% 70.09 72.19 75.26 78.32
13.5% 71.8 73.5 75.3 77.6 12.3% 72.98 75.17 78.37 81.57
14.0% 74.5 76.3 78.2 80.6 12.8% 76.03 78.32 81.66 85.01
Change from our current base case EPS forecasts
10.8% -14% -12% -10% -7% 10.5% -15% -12% -9% -5%
11.9% -5% -2% 0% 3% 10.9% -11% -9% -5% -1%
12.8% 2% 5% 7% 11% 11.8% -4% -1% 3% 7%
13.5% 8% 11% 14% 17% 12.3% 0% 3% 7% 12%
14.0% 13% 15% 18% 22% 12.8% 4% 7% 12% 16%
EPS growth rates
10.8% 2% 4% 6% 10% 10.5% -6% -3% 1% 5%
11.9% 13% 15% 18% 22% 10.9% -2% 1% 5% 9%
12.8% 21% 23% 26% 30% 11.8% 6% 9% 14% 18%
13.5% 28% 31% 34% 38% 12.3% 10% 14% 18% 23%
Mar
gin
14.0% 33% 36% 39% 44% 12.8% 15% 18% 23% 28%
Source: Barclays Capital estimates
Figure 56: L&T – history of current consensus EPS forecasts shows upward revisions have occurred during positive cycles (Rs)
Figure 57: L&T – history of current consensus EPS forecasts for FY12-14 shows estimates have been revised down 9-18% in past 12 months (Rs)
0
20
40
60
80
100
Nov
-05
Aug
-06
May
-07
Feb-
08
Nov
-08
Aug
-09
May
-10
Feb-
11
FY06 FY07 FY08 FY09FY10 FY11
60
80
100
120
140
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
FY12 FY13 FY14
Source: Datastream, IBES consensus estimates, Barclays Capital Source: Datastream, IBES consensus estimates, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 46
Shares pricing in bearish prospects over the longer term
The current share price reflects a bearish view on L&T’s long-term prospects as per our cash flow analysis. We believe the current share price is reflecting an assumption that order inflows will decline 10% this year, grow only 4% next year and broadly grow at a CAGR of 7% from FY12E until FY20E, leading to revenue and EBITDA CAGRs of 12% and 9%, respectively. We assume a WACC of 13.7% and terminal cash flow growth of 0% as well as subsidiary value of Rs300 per share (i.e., we assign no value to the L&T-MHI JV or the new subsidiaries).
Figure 58: L&T – long-term cash flow analysis
Rs mn; March year-ends Mar-12 Mar13E Mar14E Mar15E Mar-16 Mar-17 Mar-18 Mar-19 Mar-20
GCF 4,671,192 5,138,311 5,652,142 6,499,964 7,474,958 8,596,202 9,885,632 11,368,477 13,073,749
YoY 0% 10% 10% 15% 15% 15% 15% 15% 15%
GCF US$bn 104 114 126 144 166 191 220 253 291
Market share 14% 14% 14% 13% 13% 13% 12% 11% 11%
Power-Industry ordering 25,000 20,000 20,000 30,000 35,000 35,000 35,000 35,000 35,000
L&T market share 10% 10% 10% 10% 10% 10% 10% 10% 10%
L&T MW orders 2,500 2,000 2,000 3,000 3,500 3,500 3,500 3,500 3,500
Order inflow- Power BTG 67,500 60,000 64,000 96,000 119,000 126,000 126,000 126,000 126,000
YoY -35% -11% 7% 50% 24% 6% 0% 0% 0%
Price per MW 27 30 32 32 34 36 36 36 36
Non power inflows 653,967 693,672 763,039 844,995 971,745 1,074,525 1,186,276 1,250,532 1,372,744
YoY -6% 6% 10% 10% 10% 10% 10% 10% 10%
Order inflow 721,467 753,672 827,039 940,995 1,090,745 1,200,525 1,312,276 1,376,532 1,498,744
YoY -10% 4% 10% 14% 16% 10% 9% 5% 9%
Orderbook 1,487,147 1,673,211 1,864,430 2,096,942 2,390,849 2,694,806 2,996,529 3,249,363 3,529,596
YoY 14% 13% 11% 12% 14% 13% 11% 8% 9%
Execution period, months 29 31 32 32 32 32 32 32 32
Sales/orderbook 41% 38% 38% 38% 38% 38% 38% 38% 38%
Gross sales 537,020 567,607 635,820 708,484 796,838 896,568 1,010,552 1,123,699 1,218,511
Net revenues 530,835 560,796 628,190 716,985 806,400 907,327 1,022,679 1,137,183 1,233,133
YoY 21% 6% 12% 14% 12% 13% 13% 11% 8%
EBITDA Margin 12% 12% 11% 11% 11% 11% 10% 10% 10%
EBITDA 63,337 66,174 69,101 78,868 88,704 99,806 102,268 113,718 123,313
Tax + Other income 11,366 12,439 14,537 (13,408) (13,306) (14,971) (15,340) (17,058) (18,497)
Capex (10,000) (10,000) (10,000) (10,000) (10,000) (10,000) (10,000) (10,000) (10,000)
Investments in JVs (15,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000)
Working capital 67,529 73,162 83,530 94,288 106,047 119,320 134,489 149,547 162,165
Days 46 48 49 48 48 48 48 48 48
Change in working capital (13,553) (5,633) (10,368) (10,759) (11,759) (13,273) (15,170) (15,058) (12,618)
FCFF 36,150 47,980 48,270 29,702 38,640 46,562 46,758 56,602 67,198
Present value 36,150 42,188 37,318 20,191 23,095 24,471 21,607 22,998 24,007
Source: Company Data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 47
Valuation
Our 12-month price target of Rs1,560 is based on our sum-of-the-parts (SOTP) analysis in which we value the company on a standalone at 16.5x our EPS estimate for FY13 and its subsidiaries at Rs356 per share. Our target P/E multiple for the standalone business is set at a 25% discount to the stock’s historical average for the past seven years as we do not assume a substantial uptick in all its end markets in FY13.
Figure 59: L&T – sum-of-the-parts valuation
Stake Methodology Multiple Value per share value Rs mn
L&T standalone P/E 16.5FY13 16.5 1,204 733,293
L&T Infotech P/E 12x FY12 12 79 48,029
L&T Finance 83% P/B 1.9x 1.9 85 51,960
L&T IDPL 100% P/B 2.0x 2.0 97 59,152
L&T MHI P/E 12x FY14 discounted 49 30,102
Other subsidiaries P/B 1.5x 1.5 45 27,624
Target price 1,560 950,161
Source: Barclays Capital estimates
L&T’s share is trading a close to its historical trough valuation (Figure 60).
Figure 60: L&T – historical 12-month forward P/E (x): close to historical trough
5
10
15
20
25
30
35
Dec
-94
Oct
-95
Aug
-96
Jun-
97
Apr
-98
Feb-
99
Dec
-99
Oct
-00
Aug
-01
May
-02
Mar
-03
Jan-
04
Nov
-04
Sep-
05
Jul-
06
May
-07
Mar
-08
Jan-
09
Oct
-09
Aug
-10
Jun-
11L&T
Source: Datastream,, IBES consensus estimates, Barclays Capital estimates
Risks
The key risks that could keep our price target from being achieved, in our view, include the following: 1) a sharper-than-expected contraction in margins for the company; 2) order inflow guidance of 5% growth for FY12 is also at risk given the weak ordering activity in various end markets; and 3) although earnings estimates have moderated to reflect near-term weakness, there could be volatility in the stock and some downside around quarterly result announcements in January 2012.
Barclays Capital | India Capital Goods
7 December 2011 48
Financials
Figure 61: L&T – consolidated financials
Rs mn FY11 FY12E FY13E FY14E
Standalone profit after tax 35033 40296 44431 53315
L&T Infotech 3130 3897 4287 4716
L&T Finance 2304 2012 2516 3144
L&T Infrastructure development projects 158 190 218 251
L&T infrastructure finance 2009 1619 1862 2141
Minorities, start-up losses on MHI JV -1003 -3000 -3000 -2500
Consolidated recurring profit after tax 41630 45015 50314 61068
Standalone EPS 58 66 73 88
y/y 13% 15% 10% 20%
Consolidated EPS 68 74 83 100
y/y 14% 8% 12% 21%
Source: Company data, Barclays Capital estimates
Figure 62: L&T – income statement, FY09-14E
Rs mn; years ending March FY09 FY10E FY11E FY12E FY13E FY14E
Net revenue 339,264 370,348 439,049 530,835 565,712 658,443
Change in stocks -1,051 4,230 -5,596 -4,235 - -
Material and mfg costs 263,372 280,306 339,912 409,837 430,128 503,358
% of sales 78% 76% 77% 77% 76% 76%
Staff costs 19,980 23,791 28,845 37,554 37,727 39,265
% of sales 6% 6% 7% 7% 7% 6%
Sales and admin expenses 18,640 13,866 19,903 24,343 28,429 32,922
% of sales 5% 4% 5% 5% 5% 5%
Total expenditure 300,940 322,193 383,064 467,498 496,284 575,545
OBITDA 38,323 48,156 55,985 63,337 69,428 82,898
OBITDA margin 11.3% 13.0% 12.8% 11.9% 12.3% 12.6%
Depreciation 2,630 3,850 5,769 6,530 6,231 7,246
Amortization of intangible assets 212 310 234 - - -
EBIT 35,482 43,997 49,982 56,807 63,197 75,652
EBIT margin 10% 12% 11% 11% 11% 11%
Interest -1,784 -5,053 -6,474 -7,193 -8,014 -9,121
Other Income 5,680 8,144 14,431 11,366 12,439 14,537
Recurring other income 5,658 8,144 10,121 11,366 12,439 14,537
Profit before tax 39,378 47,088 57,940 60,979 67,622 81,068
PBT margin 12% 13% 13% 11% 12% 12%
Tax -12,312 -16,409 -19,459 -20,684 -23,191 -27,753
Profit after tax before Extraordinary items 27,066 30,679 38,481 40,296 44,431 53,315
Profit on sale of business 7,725 12,105 708 - - -
Reported net income 34,790 42,784 39,189 40,296 44,431 53,315
Recurring profit after tax 27,048 30,679 35,033 40,296 44,431 53,315
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 49
Figure 63: L&T – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Equity capital 1,171 1,204 1,218 1,218 1,218 1,218
Reserves and surplus 121,069 178,822 213,562 243,784 277,107 317,093
Loans 65,560 68,008 71,611 111,908 126,904 144,897
Deferred tax liability 4,352 3,893 5,497 5,497 5,497 5,497
Total sources 194,508 255,017 295,571 366,090 414,409 472,389
Net tangible assets 40,128 53,654 64,520 67,989 71,759 74,513
Capital WIP 10,410 8,577 7,850 7,850 7,850 7,850
Intangible assets 1,408 1,427 2,212 2,212 2,212 2,212
Investments 82,637 137,054 146,848 176,848 206,848 236,848
Deferred tax assets 3,867 3,119 2,863 2,863 2,863 2,863
Inventory 58,051 14,154 15,772 18,906 20,149 23,451
Debtors 100,555 111,637 124,276 152,706 164,289 193,023
Cash and bank deposits 7,753 14,319 17,304 40,799 49,362 60,734
Loans and advances plus other cash 67,906 123,507 192,160 232,695 247,983 288,632
Interest accrued on investments 216 0 0 0 0 0
Liabilities 147,759 190,545 255,898 309,775 330,128 384,242
Provisions 30,665 21,884 22,334 27,003 28,778 33,495
Net current assets 56,056 51,188 71,279 108,328 122,878 148,104
Miscellaneous expenses not written off 2 0 0 0 0 0
Assets 194,508 255,017 295,571 366,090 414,409 472,389
Source: Company data, Barclays Capital estimates
Figure 64: L&T – cash flow statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Profit before tax and exceptional items 39,404 58,807 58,329 60,979 67,622 81,068
Dividends paid/received -3,346 -2,586 -3,942 -11,366 -12,439 -14,537
Depreciation 3,060 4,146 5,992 6,530 6,231 7,246
Interest (net) 1,784 5,053 3,114 7,193 8,014 9,121
Others 3,102 -12,981 -2,072 0 0 0
Operating profit be working capital change 44,003 52,438 61,420 63,337 69,428 82,898
Change (inc.)/dec. in working capital -20,487 17,580 -2,772 -13,553 -5,987 -13,855
Tax paid -8,731 -15,193 -20,035 -20,684 -23,191 -27,753
Net cash from operations 14,786 54,825 38,613 29,100 40,250 41,290
Change in financing activities -19,798 -15,598 -15,468 -10,000 -10,000 -10,000
Change in Investments -5,284 -41,597 -6,109 -30,000 -30,000 -30,000
Others 4,169 -3,523 -2,871 11,366 12,439 14,537
Net cash from investing -44,297 -60,717 -24,448 -28,634 -27,561 -25,463
Change in capital 230 21,327 3,473 0 0 0
Change in loans 23,606 6,680 -1,615 40,297 14,995 17,994
Dividends paid -5,054 -6,170 -7,562 -10,074 -11,108 -13,329
Others(interest paid) -2,374 -9,381 -5,544 -7,193 -8,014 -9,121
Cash flow from financing activities 16,408 12,456 -11,248 23,030 -4,126 -4,456
Opening cash balance 9,645 6,569 14,319 17,304 40,799 49,362
Inc./dec during the year -1,887 6,563 2,985 23,496 8,563 11,372
Closing balance 7,753 14,319 17,304 40,799 49,362 60,734
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 50
Figure 65: L&T – historical consolidated income statement, FY05-11
Rs mn; years ended March FY05 FY06 FY07 FY08 FY09 FY10 FY11
Gross revenues 145,993 167,474 207,005 295,611 406,079 438,542 519,785
Less: excise duty 2,200 2,472 3,645 3,626 4,209 3,407 4,264
Sales and services 143,793 165,002 203,360 291,985 401,870 435,136 515,520
Add: operational other inc 1,176 611 1,768 1,519 2,929 4,562 5,371
Revenue 144,969 165,613 205,129 293,504 404,799 439,698 520,891
Expenditures
Mfg cons other expenses 112,168 124,912 151,215 219,679 302,128 323,400 375,409
Staff costs 8,719 10,469 14,882 20,494 26,660 30,658 38,020
Sales and admin expenses 12,290 14,384 12,885 17,341 26,423 21,246 29,888
EBITDA 11,793 15,848 26,146 35,990 49,586 64,394 77,575
EBITDA margin 8% 10% 13% 12% 12% 15% 15%Depreciation 1,941 2,240 2,997 4,063 7,283 9,793 13,189
Amortization 181 195 452 1,035
Interest (net) -1,025 -1,303 -504 -896 -4,620 6,919 8,309
Recurring other income 1,350 2,063 3,174 2,947 5,754 8,630 9,191
Profit on sale of investments 4,057 2,510 4,683 1,243 149
Profit before tax 14,052 16,683 30,050 34,186 43,587 56,312 65,269
Exceptional items post tax 7,725 18,664 2,053
Taxation 2,775 4,313 7,327 11,471 14,257 20,388 23,554
Reported profit after tax 11,277 12,369 22,723 22,715 37,055 54,589 43,768
Adjusted profit after tax 7,250 10,467 18,655 22,259 30,034 36,009 41,630
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 51
BHEL (3-UW, PT: RS230, -19%): FUNDAMENTALS DETERIORATING
We initiate coverage on BHEL with a 3-Underweight rating and a 12-month price target of Rs230. While the stock has de-rated (from 22x to 10x) unlike its peers, multiples for BHEL are on peak cycle earnings and somewhat propped by accounting changes. Booking of orders without coal linkages is also a cause for concern. With BHEL losing its monopoly status, the artificially high margins it sports are not sustainable and should trend down to below 10%. The fact that recent bids at prices where it is not possible to make profits is concerning. Deteriorating working capital metrics, inability to generate cash, more than 15% of order book with slow moving orders and excess cash being deployed into low return businesses are key reasons for the de-rating.
Exposed to a competitive end market: BHEL’s order inflow is exposed to the boiler and turbine segment, an end market that is the worst placed, in this cycle as per our analysis of over 20 end markets. The slow pace of diversification in the industrial segment, implies that the earlier street view of industrial business supporting decelerating power order inflows does not hold good. Furthermore, BHEL now has to compete for every order, whereas in the past it received orders on a negotiated basis or had price preference clauses during bids. Order growth rates are set to slow, in our view.
Order booking without coal linkages and financial closures: Our analysis of BHEL’s order book suggests that BHEL has booked several orders in FY11(~15% of orderbook) that have not received coal linkage (Figures 20 and 21). Without coal linkage, it is not possible to design a boiler, hence project execution does not commence. This is a concern as it extends order execution cycles.
Current margins unsustainable: BHEL has successfully managed to ward off margin pressures through accounting changes. Over 20% of FY11E profits and 8% of 2Q FY12E PAT was due to accounting changes. The piecemeal approach towards implementation of such changes has distorted earnings predictability, and is partially responsible for the de-rating of the stock. As such, we believe that BHEL will be unable to maintain EBITDA margins at the current 20% range. Margins post FY14E should trend down to around 15% and longer-term margins should be below 10%.
More de-rating likely: BHEL is trading at 10x peak year earnings; at these valuations the stock is pricing in cyclical concerns, but structural factors (i.e. coal shortage, and competition driving down margins) will continue to pressure the stock, in our view.
Figure 66: BHEL – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Mar Rs mn Rs % (x) (x) (%) (%)
2011A 60113 24.6 39.4 11.5 3.4 29.8 2.2
2012E 66089 27.0 9.9 10.5 2.8 26.7 2.5
2013E 69358 28.3 4.9 10.0 2.3 23.4 2.6
2014E 64169 26.2 -7.5 10.8 2.0 18.8 2.4
Source: Company data, Barclays Capita estimates
BHEL IN / BHEL.NS
Stock Rating 3-UNDERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 230.00
Price (02-Dec-2011) INR 282.45
Potential Upside/Downside -19%
Barclays Capital | India Capital Goods
7 December 2011 52
COMPANY SNAPSHOT
BHEL INDIA CAPITAL GOODS
Income statement (INRmn) 2011A 2012E 2013E 2014E CAGRRevenue 422,466 476,781 500,629 493,826 5.3% Stock Rating 3-UNDERWEIGHTEBITDA 85,857 92,755 95,554 87,551 0.7% Sector View 2-NEUTRALEBIT 80,416 86,006 88,367 80,512 0.0% Price (02-Dec-2011) 283Pre-tax income 90,057 95,749 101,132 95,263 1.9% Price Target 230Net income 60,113 66,089 69,358 64,169 2.2% Ticker BHEL IN/BHEL.BOEPS (R) 24.6 27.0 28.3 26.2 2.2%Diluted shares (mn) 2,448 2,448 2,448 2,448 0.0% Investment case
DPS (R) 6 7 7 7 2.7%
Margin and return data (%) AverageEBITDA margin 20.3 19.5 19.1 17.7 19.1EBIT margin 19.0 18.0 17.7 16.3 17.8Pre-tax margin 21.3 20.1 20.2 19.3 20.2Net margin 14.2 13.9 13.9 13.0 13.7ROIC 26.6 31.5 27.5 22.6 27.0ROA 29.6 26.4 23.2 18.7 24.5 Upside case 350ROE 29.8 26.7 23.4 18.8 24.7
Balance sheet and cash flow (INRmn) CAGRFixed assets 51,631 64,882 72,696 75,657 13.6%Cash and equivalents 96,302 120,742 153,675 204,473 28.5%Total assets 592,606 679,769 755,782 799,941 10.5%Current liabilities 389,434 429,735 457,197 456,437 5.4%Long term liabilities 1,634 1,634 1,634 1,634 0.0% Downside case 208Total liabilities 391,067 431,368 458,831 458,071 5.4%Net debt/(funds) (94,668) (119,108) (152,041) (202,839) NAShareholders' equity 201,538 247,801 296,352 341,270 19.2%Change in working capital (30,929) (4,171) (2,804) 13,841 NACash flow from operations 26,586 59,524 60,976 70,298 38.3%Capital expenditure (17,300) (20,000) (15,000) (10,000) NAFree cash flow 9,286 39,524 45,976 60,298 86.6%
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 11.5 10.5 10.0 10.8 10.7 EV/EBITDA (x) 6.2 5.6 5.0 4.8 5.4 FCF yield (%) 1.3 5.7 6.7 8.7 5.6 EV/sales (x) 1.4 1.2 1.1 1.0 1.2 Price/BV (x) 3.4 2.8 2.3 2.0 2.6 Dividend yield (%) 2.2 2.5 2.6 2.4 2.4 Total debt/capital (%) 0.8 0.7 0.6 0.5 0.6 Net debt/EBITDA (x) -1.1 -1.3 -1.6 -2.3 -1.6
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics Order inflows expected to remain weakOrder inflow, Rs bn 6,051 5,336 4,545 5,473 Order inflow growth (%) 1.4 -11.8 -14.8 20.4Orderbook, Rs bn 16,211 16,705 16,131 16,555 Orderbook growth (%) 12.3 3.0 -3.4 2.6
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 3-Underweight? Power BTG sector is goingthrough a weak phase of ordering. Oversupply isimpacting pricing and margins. BHEL’s currentmargin trajectory is unsustainable. Whilefundamentals are weak, P/E at 10x is pricing in someof the weakness.
A recovery in BTG market led by resolution of coalcrisis, improved financial health of utilities andreduction in competition in India could help drivemultiples. Upside case assumptions: market sharelong term at 45%, margins at 16% by FY20, terminalgrowth of 5%.
Our bearish case estimates assume a market sharelong term of 35%. Margins to fall to 10% by FY20.Terminal growth at 3%.
-20%
-10%
0%
10%
20%
30%
Mar-10 Mar11 Mar12E Mar13E Mar14E
Order inflow growth rates
DownsideCase
INR208(-26.5%)
PriceTarget
INR230(-18.7%)
UpsideCase
INR350(23.6%)
104
204
304
404
504
16-Dec-10 2-Dec-11
INR208(-26.5%)Downside
Case
INR230(-18.7%)
PriceTarget
INR350(23.6%)
UpsideCase
0
100
200
300
400
500
16-Dec-10 2-Dec-11
Barclays Capital | India Capital Goods
7 December 2011 53
Current margins unsustainable; accounting changes impacting quality of earnings
We see significant margins risk ahead for BHEL due to 1) the increase in competitive activity which is impacting pricing of new projects, 2) likely increase in mix of EPC projects and 3) increase in the mix of supercritical projects under execution. Margin risk emerges from FY14E, as we expect execution of high margin orders in the backlog to support margins in the near term.
Figure 67: BHEL – EBITDA margins at ~20% are unsustainable
23%22%21%
11%10%
14%
18%17%
13%15%
9%
14%15%16%17%
19%20%
19%
16%18%
20%19%19%18%
0
0
0
0
0
0
Mar91E Mar-94 Mar-97 Mar-00 Mar-03 Mar-06 Mar-09 Mar12E
Operating Ebitda margin
Current EBITDA margins for BHEL are unsustainable, in our
view. We believe that downside post FY14E could be higher than
expected
Source: Company data, Barclays Capital estimates
Figure 68: BHEL – accounting changes support margins – PBT increased by ~ 20% in Mar-11 and over 8% in Sep-11
Quarter Sales
(Rs mn) PBT
(Rs mn) %
of PBT Changes
Dec-11 4440 880 4% Changed accounting policy with respect to provision for warranties. As against creation of provision for warranties at 2.5% of contract value on trial operation, the company has revised it and provides warranty cost at 2.5% of revenue progressively as and when it recognized the revenue and maintains same throughout the warranty period. This is against the earlier policy of deferring warranty provisions and corresponding revenues till the completion of trial operation
Mar1111
23288 8950 21% Cumulative impact of the three accounting changes in the Mar quarter
23288 6075 Change in accounting policy of provisioning during trial operation
468 Cranes used at site have been classified as general plant and machinery as against erection equipment and accordingly depreciation rate has been changed from 20% to 8% with retrospective effect.
2408 As against creation of leaves on accrual basis, it has been changed to actuarial valuation basis treating the same as other long-term benefits based on behavioural patterns.
Sep-11 1660 8% Company has accounted for leave encashment expenditure with 30 days per month as base for computation of encashment leave as per specific instructions by DP/E on this subject. This is compared with earlier formula of computation of leave based on 26 days a month
Source: Company data, Barclays Capital estimates
Execution of supercritical projects: Supercritical projects will have lower margins in the initial stages due to higher import content. We expect over 36% of FY13E and 57% of FY14E revenues to stem from supercritical projects, which should have an impact on blended margins. The impact though will not be pronounced as these supercritical projects were obtained at a higher price compared with recent trends.
Barclays Capital | India Capital Goods
7 December 2011 54
Earnings momentum to decelerate
A combination of slower ordering for equipment (as over 95% of 12th plan orders have already been awarded, coal availability issues delaying project ordering) and competitive activity (market share moderation) will impact order inflow growth for BHEL, in our view. While we expect BHEL’s state JVs to support order inflow, this would however impact the company’s returns ratio.
Weak order inflow momentum will start impacting sales growth from FY13E, in our view, and in turn earnings growth. Even in the near term, we expect the high base of 2HFY11 to impact earnings growth in the coming quarters. While we are still building in a modest single-digit growth in earnings for both December and March quarters, it is likely that BHEL may report negative growth rates. If BHEL manages to implement some more accounting changes it is likely that the deterioration in earnings growth could be lower than our expectations.
Figure 69: BHEL – earnings momentum to deteriorate sharply in 2H FY12
64
78
62
85
38
58
3322
91
16
(3)
33
(10)
2
21 22
39 3642 42
33 31
47
22 24
4 4
-20
0
20
40
60
80
100
Sep-
05
Jun-
06
Mar
-07
Dec
-07
Sep-
08
Jun-
09
Mar
-10
Dec
-10
Sep-
11
Quarterly EPS YoY
Watch out for sharp decline in EPS momentum in 2H FY12
Source: Company data, Barclays Capital estimates
With EPS likely to decline sharply should one expect more
accounting changes?
Figure 70: BHEL – order inflows to deteriorate sharply
Figure 71: BHEL – sales growth to single digits by FY14
-40%
-20%
0%
20%
40%
60%
80%
100%
Mar-95 Mar-99 Mar-03 Mar-07 Mar-11
Order inflow YoY
10th plan9th plan8th plan 12th plan11th plan
-10%-5%0%5%
10%15%20%25%30%35%40%
Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar12E
Sales YoY
10th plan9th plan8th plan 12th plan11th plan
Source: : Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 55
Working capital under stress
BHEL’s cash flow generation has been affected by deterioration in the working capital situation with receivables days expanding sharply. Furthermore, a slowdown in order inflow growth has also impacted growth in advances received. Management, in a recent quarterly conference call, has highlighted that they are monitoring receivables/collections and that there have been some delays in payments. We believe that this could be largely due to the weak financial situation of the SEBs.
Figure 74: BHEL – net current asset (less cash) days more than doubled in the past year
Sep-10 Sep-11
Capital 4,895 4,895
Reserves and surplus 172,378 218,919
Loan funds 4,170 14,801
Fixed assets 41,159 53,793
Investments 4,284 4,617
Deferred tax assets 15,175 23,656
Inventories 107,081 131,586
Inventory days 117 116
Sundry Debtors 221,039 305,693
Debtor days 242 270
Cash and bank balances 86,770 79,491
Other current assets 2,587 3,087
Loans and advances 38,882 34,102
Current liabilities 295,584 328,381
Current liability days 323 290
Provisions 39,950 69,029
As days of sales 44 61
Net current assets 120,826 156,548
Net current assets less cash 34,056 77,057
Days of sales 37 68
Source: Company data, Barclays Capital
Cash generation affected by deteriorating receivable days
Figure 72: BHEL – Working capital days starting to deteriorate
Figure 73: BHEL – Working capital changes (Rs mn)
-50
0
50
100
150
200
Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10
Net current asset days
-40,000
-30,000
-20,000
-10,000
0
10,000
20,000
30,000
Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10
Change in working capital
Source: Company data, Barclays Capital Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 56
Not much value at current price
Although BHEL’s P/E has corrected from 22x to 10x in the past year, our long-term cash flow projections suggest that the current share price builds in the market orders of 140GW in both the 11th and 12th plans, BHEL has a long-term market share of 40%, margins will remain steady near-term and decline to 14% by FY20E, WACC of 12.9%, and terminal cash flow growth of 3%.
Figure 75: BHEL – cash flow analysis: share price builds in a long-term market share of 40% and margins trending down to 14% by FY20E
Mar (Rs m) Mar-11 Mar-12 Mar13E Mar14E Mar15E Mar-16 Mar-17 Mar-18 Mar-19 Mar-20
Industry ordering 30,000 25,000 20,000 20,000 30,000 35,000 35,000 35,000 35,000 35,000
BHEL orders in GW 16,500 15,000 11,000 9,000 13,500 14,000 14,000 14,000 14,000 14,000
BHEL market share 55% 60% 55% 45% 45% 40% 40% 40% 40% 40%
Order inflow- Power 463,930 427,750 330,000 270,000 432,000 448,000 448,000 448,000 448,000 448,000
YoY 11% -8% -23% -18% 60% 4% 0% 0% 0% 0%
Price per MW 28 29 30 30 32 32 32 32 32 32
Order inflow- Industry + Others
141,140 192,488 148,500 121,500 216,000 246,400 246,400 246,400 246,400 246,400
YoY -17% 36% -23% -18% 78% 14% 0% 0% 0% 0%
as % of power inflow 30% 45% 45% 45% 50% 55% 55% 55% 55% 55%
Order inflow 605,070 620,238 478,500 391,500 648,000 694,400 694,400 694,400 694,400 694,400
YoY 2% 3% -23% -18% 66% 7% 0% 0% 0% 0%
Gross Revenues 418,419 486,323 515,466 504,377 470,514 523,760 574,952 610,786 635,870 653,429
Orderbook 1,621,076 1,718,222 1,681,255 1,568,379 1,745,865 1,916,506 2,035,954 2,119,568 2,178,097 2,219,068
Execution period, mth 41 40 40 40 40 40 40 40 40 40
Gross sales 418,419 486,323 515,466 504,377 470,514 523,760 574,952 610,786 635,870 653,429
Excise Duty (18,011) (21,050) (22,312) (21,832) (20,366) (22,671) (24,887) (26,438) (27,523) (28,283)
Excise as % of sales -4% -4% -4% -4% -4% -4% -4% -4% -4% -4%
Net revenues 400,408 465,272 493,155 482,545 450,148 501,089 550,065 584,349 608,347 625,146
YoY 27% 16% 6% -2% -7% 11% 10% 6% 4% 3%
EBITDA Margin 20% 20% 18% 17% 17% 17% 15% 16% 15% 14%
EBITDA 81,436 92,538 86,652 82,033 76,525 85,185 82,510 93,496 91,252 87,520
Tax + Other income (19,738) (23,135) (21,663) (20,508) (18,366) (20,444) (19,802) (22,439) (21,900) (21,005)
Others as % of EBITDA -24% -25% -25% -25% -24% -24% -24% -24% -24% -24%
Capex (17,300) (15,000) (10,000) (7,000) (7,000) (7,000) (7,000) (7,000) (7,000) (7,000)
Investments in JVs (5,000) (10,000) (10,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000)
Working capital 29,212 34,417 36,480 33,051 30,832 34,321 37,676 40,024 41,668 42,818
Days 27 27 27 25 25 25 25 25 25 25
Change in working capital
(22,182) (5,205) (2,063) 3,429 2,219 (3,489) (3,355) (2,348) (1,644) (1,151)
FCFF 18,622 44,199 42,926 47,953 38,378 39,252 37,353 46,709 45,708 43,365
Discount factor 1.0 0.9 0.8 0.7 0.6 0.5 0.5 0.4 0.4
Present value of cash flows 44,199 38,022 37,621 26,669 24,159 20,364 22,555 19,549 16,428
Source: Company Data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 57
Valuation
Our 12-month price target of Rs230 for BHEL is based on our discounted cash flow valuation analysis because we believe estimates for the next two years do not capture the impact of current pricing trends on margins.
Our assumptions appear to be a bit aggressive but capture long-term margin concerns:
Assume 140GW ordering in 12th and 13th plan. Execution period of 40 months. Healthy industry order book of over Rs200bn post FY16.
EBITDA margin to trend down to 14% from FY16 and 10% by FY20. Terminal growth of 3%. We value JVs at 1.2x P/B.
Figure 76: BHEL – discounted cash flow valuation analysis
Mar (Rs m) Mar-11 Mar-12 Mar13E Mar14E Mar15E Mar-16 Mar-17 Mar-18 Mar-19 Mar-20
Industry ordering 30,000 25,000 20,000 20,000 30,000 35,000 35,000 35,000 35,000 35,000
BHEL orders in GW 16,500 15,000 11,000 9,000 12,000 14,000 14,000 14,000 14,000 14,000
BHEL market share 55% 60% 55% 45% 40% 40% 40% 40% 40% 40%
Order inflow- Power 463,930 371,250 300,000 337,500 384,000 448,000 448,000 448,000 448,000 448,000
YoY 11% -20% -19% 13% 14% 17% 0% 0% 0% 0%
Price per MW 28 29 30 30 32 32 32 32 32 32
Order inflow - Industry + Others 141,140 162,311 184,508 209,819 192,000 224,000 224,000 224,000 246,400 246,400
YoY -17% 15% 14% 14% -8% 17% 0% 0% 10% 0%
as % of power inflow 30% 45% 45% 45% 50% 50% 50% 50% 55% 55%
Order inflow 605,070 533,561 484,508 547,319 576,000 672,000 672,000 672,000 694,400 694,400
YoY 2% -12% -9% 13% 5% 17% 0% 0% 3% 0%
Gross Revenues 418,419 474,450 505,527 502,075 502,212 524,348 568,644 599,651 621,355 643,269
Orderbook 1,621,076 1,670,464 1,639,084 1,674,039 1,747,827 1,895,479 1,998,835 2,071,185 2,144,229 2,195,361
Execution period, months 41 40 40 40 40 40 40 40 40 40
Gross sales 418,419 474,450 505,527 502,075 502,212 524,348 568,644 599,651 621,355 643,269
Excise Duty -17,709 -7,158 -11,089 -11,013 -21,738 -22,696 -24,614 -25,956 -26,895 -27,844
Excise as % of sales -4% -4% -4% -4% -4% -4% -4% -4% -4% -4%
Net revenues 400,711 467,292 494,438 491,061 480,474 501,652 544,030 573,695 594,460 615,425
YoY 27% 17% 6% -1% -2% 4% 8% 5% 4% 4%
EBITDA Margin 20% 19% 19% 18% 16% 14% 14% 14% 12% 10%
EBITDA 81,436 90,909 94,390 87,058 76,876 70,231 76,164 80,317 71,335 61,543
Tax + Other income -19,738 -19,516 -18,905 -16,432 -15,375 -14,046 -15,233 -16,063 -14,267 -12,309
Others as % of EBITDA -24% -21% -20% -19% -20% -20% -20% -20% -20% -20%
Capex -17,300 -20,000 -15,000 -10,000 -7,000 -7,000 -7,000 -7,000 -7,000 -7,000
Investments in JVs -3,594 -5,000 -5,000 -10,000 -15,000 -20,000 -20,000 -20,000 -15,000 -15,000
Working capital 29,212 33,383 37,114 36,325 35,542 37,109 40,243 42,438 43,974 45,525
Days 27 26 27 27 27 27 27 27 27 27
Change in working capital -22,182 -4,171 -3,731 789 783 -1,567 -3,135 -2,194 -1,536 -1,551
FCFF 18,622 42,222 51,754 51,415 40,284 27,618 30,797 35,059 33,532 25,683
Present value of cash flows 42,222 45,841 40,337 27,993 16,999 16,789 16,929 14,342 9,730
Source: Company Data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 58
Figure 77: BHEL – historical 12-month forward P/E (x): close to historical trough
5
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Dec
-94
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-95
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-96
Jun-
97
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-10
Jun-
11
BHEL
Valuations for BHEL are on peak EPS; hence, despite its decline, the stock may not outperform
Source: Datastream, Barclays Capital
Risks The key risks that could keep our price target from being achieved, in our view, include a recovery in order inflows in the power segment led by the government’s positive policy action in solving the coal issue and issue with financials of state electricity boards. Stiff import duties would also help limit competition for local players. Shift in ordering to EPC will help reduce competition as only BHEL, L&T and BGR will then qualify for orders. Continued sustenance of margins and improved pricing trends in the market would support the share price, in our view.
Figure 78: BHEL – history of consensus EPS forecasts shows consensus earnings predictability has been high in the past (Rs)
Figure 79: BHEL – history of current consensus EPS forecasts for FY12-14 shows estimates have remained steady given a healthy order book
0
5
10
15
20
25
30
Nov
-05
May
-06
Nov
-06
May
-07
Nov
-07
May
-08
Nov
-08
May
-09
Nov
-09
May
-10
Nov
-10
May
-11
FY06 FY07 FY08 FY09
FY10 FY11
2526272829303132333435
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
FY12 FY13 FY14
Source: Datastream, IBES consensus estimates, Barclays Capital Source: Datastream, IBES consensus estimates ,Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 59
Figure 80: BHEL – income statement, FY09-14E
Rs mn; years ending 31 March FY09 FY10 FY11 FY12E FY13E FY14E
Net revenue 267,268 333,545 422,466 476,781 500,629 493,826
Raw material expenses adjusted for inventory 164,685 198,856 230,817 289,894 304,678 305,515
% of sales 62% 60% 55% 61% 61% 62%
Staff cost 29,837 65,395 53,967 54,340 57,582 58,480
% of sales 11% 20% 13% 11% 12% 12%
Provisions for expenses 12,810 (9,342) 27,151 4,768 5,006 4,938
% of sales 5% -3% 6% 1% 1% 1%
Other expenses 17,746 19,438 24,674 35,024 37,810 37,342
% of sales 7% 6% 6% 7% 8% 8%
OBITDA 42,190 59,198 85,857 92,755 95,554 87,551
Operating margin 16% 18% 20% 19% 19% 18%
Depreciation and amortization 3,343 4,580 5,441 6,749 7,187 7,039
Interest expenses 307 335 547 401 423 423
Interest and other miscellaneous income 9,829 11,552 10,206 10,144 13,188 15,175
Other extraordinary items - (73) 18 - - -
Profit before tax 49,100 65,907 90,057 95,749 101,132 95,263
Profit before tax margin 18% 20% 21% 20% 20% 19%
Tax 17,106 22,800 29,945 29,660 31,774 31,094
Profit after tax 31,994 43,107 60,113 66,089 69,358 64,169
Profit after tax margin 12% 13% 14% 14% 14% 13%
Adjusted profit after tax 31,994 43,165 53,709 66,089 69,358 64,169
Adjusted profit after tax margin 12% 13% 13% 14% 14% 13%
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 60
Figure 81: BHEL – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Share capital 4,895 4,895 4,895 4,895 4,895 4,895
Reserves and surplus 124,493 154,278 196,643 242,906 291,456 336,375
Shareholder funds 129,388 159,174 201,538 247,801 296,352 341,270
Total debt 1,494 1,278 1,634 1,634 1,634 1,634
Capital employed 130,882 160,451 203,172 249,435 297,985 342,904
Net fixed assets 14,704 24,154 34,009 47,261 55,074 58,035
Capital WIP 11,570 15,296 17,622 17,622 17,622 17,622
Investments 523 798 4,392 9,392 14,392 19,392
Deferred tax and others 18,403 15,272 21,636 21,636 21,636 21,636
Cash and bank balance 103,147 97,901 96,302 120,742 153,675 204,473
Receivables 159,755 206,888 273,546 308,275 323,695 311,178
Receivable days 218 226 236 236 236 230
Inventories 78,370 92,355 109,630 124,094 137,159 135,295
Inventory days 107 101 95 95 100 100
Loans and advances 24,237 28,137 32,373 27,653 29,037 28,642
Others 3,502 4,069 3,096 3,096 3,494 3,669
Current liabilities 233,573 280,237 313,466 353,767 371,462 366,414
Current liabilities days 319 307 271 271 271 271
Provisions 49,756 44,180 75,968 75,968 85,735 90,023
Net current assets 85,682 104,931 125,514 154,125 189,862 226,819
Total assets 130,882 160,451 203,172 250,035 298,585 343,504
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 61
Figure 82: BHEL – cash flow statement, FY09-14
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Profit before tax 49,100 65,907 90,057 95,749 101,132 95,263
Depreciation 3,343 4,580 5,441 6,749 7,187 7,039
Others (8,448) (8,175) 665 (9,143) (12,765) (14,751)
Operating cash before working capital 43,995 62,313 96,163 93,355 95,554 87,551
Change in receivables (49,110) (52,089) (74,073) (34,728) (15,420) 12,517
Change in inventories (21,006) (13,984) (17,380) (14,463) (13,065) 1,864
Change in other assets - - - 4,720 (1,781) 220
Change in current liabilities and provisions 82,102 38,645 60,524 40,301 27,462 (760)
Change in working capital 11,986 (27,428) (30,929) (4,171) (2,804) 13,841
Tax paid (23,069) (19,035) (38,648) (29,660) (31,774) (31,094)
Cash flow from operations 32,912 15,851 26,586 59,524 60,976 70,298
Change in fixed assets (13,236) (17,137) (17,237) (20,000) (15,000) (10,000)
Change in investments (441) (275) (3,594) (5,000) (5,000) (5,000)
Others 8,549 7,746 7,403 - - -
Cash flow from investing activities (5,128) 9,666 (13,428) (25,000) (20,000) (15,000)
Inc./(dec.) in debt 526 (215) 351 - - -
Issue of share capital - - - - - -
Others (9,023) (11,214) (15,108) (10,084) (8,042) (4,499)
Cash flow from financing activities (8,498) (11,429) (14,757) (10,084) (8,042) (4,499)
Opening cash balance 83,860 103,147 97,901 96,302 120,742 153,675
Increase/(decrease) during the year 19,286 (5,246) (1,599) 24,440 32,933 50,798
Closing balance 103,147 97,901 96,302 120,742 153,675 204,473
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 62
SIEMENS LTD. (3-UW, PT: RS630, -13%): MARGINS PEAKING; VALUATIONS RICH
We initiate coverage of Siemens Ltd. with a 3-Underweight rating and a 12-month price target of Rs630 (based on 21x average FY12-13E earnings). Siemens is exposed to well diversified end markets, which should help it endure the downturn; however, margins for the company appear to be peaking and near-term order inflows are expected to be weak. Our estimates factor in long-term drivers such as renewable energy, power EPC and low-priced products.
End market exposure attractive: Siemens’ end market exposure is attractive. Gearing to powergen, renewable, T&D, medical products, building automation products and industrial, as well as exports, makes its exposure the most versatile among the peer group. This is the primary reason for Siemens rarely suffering negative growth in order inflows in the past. We estimate a modest 15% CAGR in inflows until September 2014; however, the near term is expected to be weak due to slowing industrial capex and few order finalisations in infrastructure. Order trajectory could be volatile – and lumpy – but the exposure of the company to segments such as metro and railways provided, sufficient opportunities for growth over the longer term.
Strong long-term drivers: Expansion initiatives by Siemens were announced in February 2010 when management highlighted plans to invest Rs16bn over three years to set up a wind manufacturing facility and expand its presence in low-priced products. The company’s target from these initiatives is to achieve revenues of Rs65bn per annum by 2020. The six hubs planned are for setting up centres of competence for: 1) low-end signalling systems; 2) ring main units; 3) steam turbine generators above 45MW; and 4) iron and steel making equipment; 5) wind turbine manufacturing; and 6) EPC execution for power plants.
Valuations rich: Siemens will continue to enjoy a premium to sector multiples on account of expectations of strong growth over the longer term given its new initiatives and strong balance sheet. Current valuations are, however, rich. Given the likely peaking of margins and weak order inflow, we expect the derating of multiples to continue through 2012. We value Siemens at a 15% discount to its average historical P/E multiples over 2004-11.
Figure 83: Siemens Ltd – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Sept Rs mn Rs % (x) (x) (%) (%)
2011A 8,454 25.0 2 28.8 6.4 22.2 0.9
2012E 9,390 27.9 11 26.0 5.4 20.7 1.0
2013E 10,831 32.1 15 22.5 4.6 20.2 1.1
2014E 12,548 37.2 16 19.4 3.9 19.9 1.3
Source: Company data, Barclays Capita estimates
SIEM IN / SIEM.NS
Stock Rating 3-UNDERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 630.00
Price (02-Dec-2011) INR 723.35
Potential Upside/Downside -13%
Barclays Capital | India Capital Goods
7 December 2011 63
COMPANY SNAPSHOT
Siemens INDIA CAPITAL GOODS
Income statement (INRmn) 2011A 2012E 2013E 2014E CAGRRevenue 119,419 123,008 139,864 160,238 10.3% Stock Rating 3-UNDERWEIGHTEBITDA 13,496 14,907 16,940 19,404 12.9% Sector View 2-NEUTRALEBIT 11,974 13,344 15,162 17,367 13.2% Price (02-Dec-2011) 723.35Pre-tax income 12,750 14,297 16,491 19,105 14.4% Price Target 630Net income 8,454 9,390 10,831 12,548 14.1% Ticker SIEM IN/SIEM.BOEPS (R) 25.07 27.85 32.13 37.22 14.1%Diluted shares (mn) 337.16 337.16 337.16 337.16 0.0% Investment case
DPS (R) 6.06 6.68 7.71 8.93 13.8%
Margin and return data (%) AverageEBITDA margin 11.3 12.1 12.1 12.1 11.9EBIT margin 10.0 10.8 10.8 10.8 10.6Pre-tax margin 10.7 11.6 11.8 11.9 11.5Net margin 7.1 7.6 7.7 7.8 7.6ROIC 22.2 20.7 20.2 19.9 20.8ROA 22.2 20.7 20.2 19.9 20.8 Upside case 900ROE 22.2 20.7 20.2 19.9 20.8
Balance sheet and cash flow (INRmn) CAGRFixed assets 14,183 14,120 13,843 12,806 -3.3%Cash and equivalents 12,750 23,660 31,398 40,600 47.1%Total assets 101,577 110,620 127,803 148,158 13.4%Current liabilities 63,415 65,321 74,272 85,091 10.3%Long term liabilities - - - - NA Downside case 334Total liabilities 101,577 110,619 127,802 148,158 13.4%Net debt/(funds) (12,750) (23,660) (31,398) (40,600) NAShareholders' equity 38,162 45,298 53,530 63,067 18.2%Change in working capital (8,097) 3,710 (771) (1,371) NACash flow from operations 1,124 13,784 10,508 11,475 117%Capital expenditure (5,900) (1,500) (1,500) (1,000) NAFree cash flow (4,776) 12,284 9,008 10,475 NA
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 28.8 26.0 22.5 19.4 24.2 EV/EBITDA (x) 17.1 14.8 12.5 10.5 13.7 FCF yield (%) -2.0 5.0 3.7 4.3 2.8EV/sales (x) 1.9 1.8 1.5 1.3 1.6 Price/BV (x) 6.4 5.4 4.6 3.9 5.0 Dividend yield (%) 0.2 0.3 0.3 0.4 0.3Total debt/capital (%) 0.0 0.0 0.0 0.0 0.0Net debt/EBITDA (x) -0.3 -0.5 -0.6 -0.6 -0.5
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics High risk to marginsOrder inflow 122,886 141,319 162,517 186,894 Order inflow growth (%) -1 15 15 15Orderbook 139,213 157,524 180,176 206,832 Orderbook growth (%) 7 13 14 15
Source: Company data, Barclays Capital estimates Note: FY end Sep.
Why a 3-Underweight? The stock’s valuation at 25xFY12E appears rich especially given only 2% PATgrowth in Sep-11 and a 14% EPS CAGR. Risks to thedownside for our estimates are high as we arebuilding in margin growth, which could be difficultgiven pricing pressure in various end markets
A bullish case for Siemens would be theannouncement of a delisting, which could lead to thestock heading to at least its previous open offer price
An earnings shock led by margin compression couldlead to the stock heading to its historical low P/E of10x
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Barclays Capital | India Capital Goods
7 December 2011 64
End market exposure attractive
Siemens has seen a sharp increase in order inflows in the past two years, largely led by large order wins in Qatar (transmission projects) and Powergen EPC orders (gas-based EPC projects). While we build a modest 15% growth in inflows over Sep12-14E into our model, we see risk to our estimates in the near term given low order finalisations. Long-term growth is attractive given new initiatives, including announcements of: a JV in railways; orders in the new rolling stock business and a tie-up with BEML Ltd to jointly manufacture and market stainless steel coaches; exposure to powergen markets through EPCs of gas-based projects; exposure to several new products (including manufacturing of wind turbines of 250MW capacity by 2013) and outsourcing from its parent for such products.
Figure 84: Siemens – order inflows (Rs mn): inflow have grown at a CAGR of 20% since September 2005
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Source: Company data, Barclays Capital
Figure 85: Siemens – annual order inflows: rate of growth has rarely declined in the past decade
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Note: Order inflow decline in Sep-08 largely due to divestment of automotive business. Source: Company data, Barclays Capital
New expansion initiatives to drive growth
Barclays Capital | India Capital Goods
7 December 2011 65
Progress on these initiatives has been good. Siemens has expanded manufacturing capacity for its steam turbine and compressor manufacturing facility in Vadodara. The facility can manufacture turbines up to 150MW now. Siemens has also introduced a new direct drive-based wind turbine for low wind speed locations such as India; production is expected to commence in 2013. Annual capacity of this facility is expected to be 250MW initially and expanded to 500MW pa by 2015. Siemens is also investing in R&D at its facility in Vadodara.
Figure 86: Siemens – sales by end markets, September 2011: diversified exposure
Industrial Solutions and
Services9%
Transport6%
Generation 4%
Automation and Drives19%
Transmission 27% Oil gas
11%
Real Estate0%
Building Technologies
7%Healthcare and other services
8%
Distribution 9%
Well diversified company
Source: Company data, Barclays Capital
Strong balance sheet and cash generation ability
Siemens has typically been efficient in its working capital management, although working capital metrics deteriorated in FY11 (ending September 2011) due to the lower pace of growth in advances (no order inflow growth). Siemens continues to have no debt on its balance sheet.
Figure 87: Siemens – cash generation (Rs mn): growth has been below our expectations
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Cash generation was weak last year
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 66
Increase in exports could counter rupee depreciation impact
While Siemens is a net importer and has seen forex gains and losses every year, we believe that the long-term risk may be limited given increasing indigenisation that can help reduce the level of imports and improve the ability to increase exports. Management highlighted that the company is also an exporter of products/projects and, hence, further depreciation of the rupee could make sourcing from India attractive. It would also make the case for the Indian entity becoming a sourcing hub for more products.
Figure 88: Siemens – rupee depreciation could have a medium-term impact as Siemens is a net importer
Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10
Export of goods 955 2,287 2,368 4033 2,570 1,996
Project business 2,056 6,692 23,557 26,377 17,304 13,459
Commission 387 399 490 452 520 446
Service charges and others 789 1,174 301 94 144 116
Exports 4,187 10,553 26,716 30,957 20,538 16,017
As % of sales 9% 14% 32% 37% 22% 13%
Expenditure in foreign currency 745 4,195 8,435 11,896 5312 7,398
as % of sales 2% 5% 10% 14% 6% 6%
RM imports 8,792 13,758 3,340 4,432 26,398 33,960
Capital goods 92 682 14,492 19,950 529 819
Imports 8,884 14,440 17,832 24,382 26,926 34,779
As % of sales 20% 19% 22% 29% 29% 29%
Net imports 12% 11% -1% 6% 13% 22%
Forex loss 286 -141 -1,085 -2,017 83 676
as % of sales 1.1% -0.3% -1.4% -2.4% 0.1% 0.7%
Adjusted EBITDA margin 11.5% 8.7% 8.2% 7.0% 12.4% 14.7%
Reported EBITDA margin 10.1% 8.9% 9.5% 9.3% 12.1% 13.8%
Source: Company Data, Barclays Capital
Siemens can increase exports to counter Rs depreciation; it is a
net importer
Barclays Capital | India Capital Goods
7 December 2011 67
Figure 89: Siemens – net imports: company is a net importer of products
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Rupee depreciation could have a medium-term impact as Siemens
is a net importer
Source: Company data, Barclays Capital
Valuation Our 12-month price target of Rs630 for Siemens is based on a P/E of 21x applied to an average of our EPS estimates for FY12 and FY13. We use average earnings as we are valuing peers on earnings for financial years ending in March 2013. Our multiple of 21x is set at a 15% discount to its historical 12-month forward P/E multiple for the past seven years given risk to margins, which appear to be peaking.
With the financial performance for Siemens in FY11 being modest on our estimates and the recent quarter margins impacted by forex losses, valuations have been tempered and now are close to historical averages. We believe that current valuations are rich and the stock should trade at a discount to its historical average given modest growth in the near term and peaking margins.
Figure 90: Siemens – historical 12-month forward P/E (x): stock trading below average
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Siemens Linear (Siemens)
SISL /SIPS stake sale
Stock trading below historical average multiples but valuations
appear rich
Source: Datastream, Barclays Capital
Current valuations are rich
Barclays Capital | India Capital Goods
7 December 2011 68
ABB trading at a premium to Siemens While we have 3-Underweight ratings on both Siemens and ABB, we note that Siemens is trading at a steep discount to ABB despite better diversification, better cash generation and return ratios (Figure 91).
Figure 91: Siemens – ABB is trading at a historical premium to Siemens
0.60.70.80.91.01.11.21.31.41.51.6
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ABB 12M fwd PE as a ratio of Siemens 12M Fwd PE
ABB is trading at a 50% premium to Siemens, highest over the past
decade
Source: Company data, Barclays Capital
Figure 92: Siemens – historical performance has been significantly superior to that of ABB
FY05 FY06 FY07 FY08 FY09 FY10 FY11E CAGR
Order inflows (Rs mn)
ABB 37,645 56,236 76,682 86,008 93,977 63,489 98,208 17%
Siemens 41,233 82,026 95,720 87,722 87,960 124,304 122,886 20%
Profit after tax (Rs mn)
ABB 2,187 3,403 4,917 5,474 3,546 632 1,798 -3%
Siemens 2,548 3,602 5,968 5,954 10,449 8,272 8,454 22%
Net working capital (days)
ABB 20 22 29 55 64 58 na
Siemens -38 -62 4 -5 6 5 29
ROE (%)
ABB 20% 24% 27% 21% 13% 0% 7% 14%
Siemens 33% 33% 34% 25% 23% 24% 22% 21%
Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 69
Risks
The key risks that could keep our price target from being achieved, in our view, include large order wins in the Rail segment or in Power EPC market as well as forex gains or increases in core margins.
Figure 93: Siemens – history of current consensus EPS forecasts shows estimates after the strong period of 2005-2006 were moderated due to losses in some projects (Rs)
Figure 94: Siemens – history of current consensus EPS forecasts for FY12-14 shows estimates upgrades in recent years (Rs)
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Source: Datastream Barclays Capital Source: Datastream, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 70
Figure 95: Siemens – income statement, FY08-14E
Rs mn; years ending September FY08 FY09 FY10 FY11E FY12E FY13E FY14E
Net sales 82,504 83,367 92,707 119,419 123,008 139,864 160,238
Other operating income plus commissions 1,074 1217 1294 1,645 1,623 1,846 2,115
Raw material expenses adj for inventory 67,972 63,977 68,474 90,267 91,972 104,581 119,817
% of sales 82% 77% 74% 76% 75% 75% 75%
Staff cost 4,476 5,499 6,325 9,174 9,496 10,796 12,369
% of sales 5% 6.6% 6.8% 7.7% 7.7% 7.7% 7.7%
Other expenses 3,339 4,878 6,269 8,127 8,257 9,394 10,764
% of sales 4% 6% 7% 7% 7% 7% 7%
OBITDA 7,791 10,231 12,932 13,496 14,907 16,940 19,404
OBITDA margin 9% 12% 14% 11% 12% 12% 12%
Depreciation and amortization 637 778 1,015 1,522 1,563 1,778 2,037
Interest income net 472 465 670 755 879 1,329 1,738
Other income 67 2,341 0 21 74 0 0
Other extraordinary items 1,246 2,059 0 0 0 0 0
Profit before tax 8,938 14,319 12,587 12,750 14,297 16,491 19,105
Profit before tax margin 11% 17% 14% 11% 12% 12% 12%
Tax 2,984 3,870 4,315 4,295 4,907 5,660 6,557
Reported profit after tax 5,954 10,449 8,272 8,454 9,390 10,831 12,548
Adjusted profit after tax 5,124 6,731 8,272 8,454 9,390 10,831 12,548
Adjusted profit after tax margin 6.2% 8.1% 8.9% 7.1% 7.6% 7.7% 7.8%
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 71
Figure 96: Siemens – balance sheet, FY08-14E
Rs mn; years ending September FY08 FY09 FY10 FY11E FY12E FY13E FY14E
Share capital 674 674 674 681 681 681 681
Reserves and surplus 20,017 28,492 34,103 37,481 44,618 52,850 62,386
Shareholder funds 20,691 29,166 34,778 38,162 45,298 53,530 63,067
Total debt 11 6 2 0 0 0 0
Capital employed 20,701 29,172 34,780 38,162 45,298 53,530 63,067
Net fixed assets 5,572 6,295 7,340 11,718 11,655 11,378 10,341
Capital WIP 870 1,057 2,465 2,465 2,465 2,465 2,465
Investments 5,236 4,770 3,885 1 1 1 1
Deferred tax and others 910 1,119 1,313 1,889 1,889 1,889 1,889
Cash and bank balance 9,131 14,449 18,534 12,750 23,660 31,398 40,600
Receivables 34,328 34,583 33,023 41,733 42,988 48,878 55,998
Receivable days 152 151 130 128 128 128 128
Inventories 7,621 9,722 15,335 16,961 13,480 15,328 17,999
Inventory days 34 43 60 52 40 40 41
Loans & advances 6,173 10,458 12,449 14,060 14,483 16,467 18,866
as % of sales 7% 13% 13% 12% 12% 12% 12%
Current liabilities 41,868 40,585 43,892 45,376 46,740 53,145 60,887
Current liabilities days 185 178 173 139 139 139 139
Provisions 7,272 12,695 15,672 18,039 18,581 21,127 24,204
Provisions as % of current liabilities 32 56 62 55 55 55 55
Net current assets -1,018 1,482 1,243 9,340 5,630 6,401 7,773
Total assets 20,701 29,172 34,780 38,162 45,299 53,531 63,067
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 72
Figure 97: Siemens – cash flow statement, FY08-14E
Rs mn; years ending September FY08 FY09 FY10 FY11E FY12E FY13E FY14E
Profit before tax 8,918 14,319 12,587 12,750 14,297 16,491 19,105
Depreciation 637 778 1,015 1,522 1,563 1,778 2,037
Others -1,255 -6,006 -349 -755 -879 -1,329 -1,738
Operating cash before working capital 8,300 9,091 13,253 13,516 14,981 16,940 19,404
Change in receivables -10,569 -1,261 588 -10,321 -1,677 -7,875 -9,519
Change in inventories -396 -2,101 -5,187 -1,626 3,481 -1,847 -2,672
Change in current liabilities and provisions 12,208 3,371 6,169 3,850 1,906 8,951 10,819
Change in working capital 1,243 9 1,570 -8,097 3,710 -771 -1,371
Restructuring costs 0 0 0 0 0 0 0
Taxes paid -3,970 -5,631 -4,812 -4,295 -4,907 -5,660 -6,557
Cash flow from operations 5,574 3,468 10,012 1,124 13,784 10,508 11,475
Discontinued operations -105 0 0 0 0 0 0
Change in fixed assets -1,657 -1,451 -2,577 -5,900 -1,500 -1,500 -1,000
Change in investments -467 1,320 -703 -3,884 0 0 0
Others
Cash flow from investing activities -108 2,140 -4,413 -9,029 -621 -171 738
Discontinued operations -42 0 0 0 0 0 0
Inc./(dec.) in debt -5 -5 -3 -2 0 0 0
Issue of share capital 0 0 0 0 0 0 0
Others
Cash flow from financing activities -971 -290 -2,007 -2,044 -2,254 -2,600 -3,012
0 0 0 0 0 0 0
Opening cash balance 4,636 9,131 14,449 18,534 12,750 23,660 31,398
Increase/decrease during the year 4,495 5,318 3,592 -9,949 10,909 7,738 9,202
Closing balance 9,131 14,449 18,534 12,750 23,660 31,398 40,600
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 73
ABB LTD. (3-UW, PT: RS494, -20%): FUNDAMENTALS REMAIN UNDER STRESS
We initiate coverage of ABB Ltd. with a 3-UW rating and a 12-month price target of Rs494 (based on a 25x P/E for CY12E earnings). We believe that margins have troughed for ABB due to: 1) a low backlog of rural losses; 2) likely lowering of costs on imports, following the stake increase by the parent; 3) increase in indigenisation, with ABB’s Indian factories being approved for supply of high-voltage transformers; and 4) high commodity prices already reflected in current margins. The depreciation of the rupee, while it could help in the near term on gains in forex hedges, could impact the cost structure in the medium term given the high exposure of costs to imports. While margins and earnings growth are expected to recover, current valuations at over 30x P/E (on recovered earnings) appear rich and difficult to justify, in our view.
Margins at trough levels: ABB’s cost structure and execution skills have come under scrutiny, especially following the sharp deterioration in margins and project-specific losses. Exit from rural electrification projects and market share losses due to high costs have substantially affected financial performance. Margins are expected to recover next year, however. More than 35% of the company’s costs are exposed to imports therefore the current depreciation of the rupee will have a long-term cost impact; we note that in the near term there could be forex gains on hedges. The sharp increase in royalty cost (46% y/y in CY10 is also worth noting, especially given weak financials last year.
Order recovery in power, industrials to weaken: We believe that improving ordering in the T&D segment and the recent HVDC project win (worth Rs10bn) will help support order growth in the coming quarters. However, industrial business (projects and products) should weaken given limited recovery in project ordering. With refurbishment capex that supported short cycle orders already behind, it is likely that product ordering should also weaken. We expect a recovery in this segment at end-CY12, coinciding with a likely recovery in ordering from the infrastructure segment.
Rich valuations: ABB’s current valuations at 30x forward earnings are rich, in our view, especially given that they are based on consensus estimates that we believe are building in a substantial recovery in earnings. A continued weakness in margins would imply that actual valuations are much higher. We value ABB at 25x P/E (25x is the average multiple since 2003), giving us a price target of Rs494.
Figure 98: ABB – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Dec Rs mn Rs % (x) (x) (%) (%)
2010A 632 3.0 -82 196.1 5.1 2.6 0.3
2011E 1,798 8.5 184 68.9 4.8 7.0 0.1
2012E 4,191 19.8 133 29.6 4.2 14.2 0.3
2013E 4,337 20.5 3 30.2 3.9 13.0 0.3
Source: Company data, Barclays Capital estimates
ABB IN / ABB.NS
Stock Rating 3-UNDERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 494.00
Price (02-Dec-2011) INR 618.80
Potential Upside/Downside -20%
Barclays Capital | India Capital Goods
7 December 2011 74
COMPANY SNAPSHOT
ABB Limited INDIAN CAPITAL GOODS
Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 62,871 74,884 88,207 90,554 12.9% Stock Rating 3-UNDERWEIGHTEBITDA 838 3,934 7,432 7,724 110% Sector View 2-NEUTRALEBIT 319 3,098 6,557 6,828 178% Price (02-Dec-2011) 618.8Pre-tax income 1,002 3,025 6,378 6,601 87.4% Price Target 494Net income 632 1,798 4,191 4,337 90.0% Ticker ABB IN/ABB.BOEPS (R) 2.98 8.49 19.78 20.47 90.0%Diluted shares (mn) 212 212 212 212 0.0% Investment case
DPS (R) 2.00 0.80 1.88 1.94 -1.0%
Margin and return data (%) AverageEBITDA margin 1.3 5.3 8.4 8.5 5.9EBIT margin 0.5 4.1 7.4 7.5 4.9Pre-tax margin 1.6 4.0 7.2 7.3 5.0Net margin 1.0 2.4 4.8 4.8 3.2ROIC 2.6 7.0 14.2 13.0 9.2ROA 2.6 7.0 14.2 13.0 9.2 Upside case 900ROE 2.6 7.0 14.2 13.0 9.2
Balance sheet and cash flow (INRmn) CAGRFixed assets 8,238 9,402 10,527 10,631 8.9%Cash and equivalents 5,871 922 573 3,605 -15.0%Total assets 57,714 60,256 70,361 75,564 9.4%Current liabilities 33,477 34,419 40,797 42,142 8.0%Long term liabilities - - - - NA Downside case 247Total liabilities 57,714 60,256 70,361 75,564 9.4%Net debt/(funds) (5,871) (922) (573) (3,605) NAShareholders' equity 24,237 25,837 29,564 33,422 11.3%Change in working capital 785 (5,384) (2,952) (722) NACash flow from operations 2,207 (2,564) 2,351 4,799 29.6%Capital expenditure (1,044) (2,000) (2,000) (1,000) NAFree cash flow 1,162 (4,564) 351 3,799 48.4%
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 196.1 68.9 29.6 30.2 81.2 EV/EBITDA (x) 141.0 31.3 16.6 16.5 51.3 FCF yield (%) 0.9 -3.7 0.3 2.9 0.1EV/sales (x) 1.9 1.6 1.4 1.4 1.6 Price/BV (x) 5.1 4.8 4.2 3.9 4.5 Dividend yield (%) 0.3 0.1 0.3 0.3 0.3Total debt/capital (%) 0.0 0.0 0.0 0.0 0.0Net debt/EBITDA (x) -24 -4 -2 -11 -10
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics High exposure to imports a risk to marginsOrder inflow 63,489 98,208 88,387 97,226 Order inflow growth (%) -32 55 -10 10Orderbook 85,723 107,770 107,950 114,622 Orderbook growth (%) 0 20 0 6
Source: Company data, Barclays Capital estimates Note: FY end Dec.
Why a 3-Underweight? ABB is exposed to highcompetitive pressures in its T&D business, and this isimpacting margins. Furthermore, industrial markets(40% of mix) is decelerating. Margins could recoveroff the lows in Dec-10 but we believe that currentvaluations adequately capture the growth.
Our bull case for ABB is premised on non-fundamental facors. ABB's parent has alreadyincreased its stake in ABB Ltd to 75%. A futuredelisting could lead to the stock heading to itsprevious open offer price.
No recovery in margins next year and weak orderinflows in 2H could lead to a de-rating of the stock.Expect the stock to head to its historical trough P/Eof 12x.
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Barclays Capital | India Capital Goods
7 December 2011 75
Margin decline
ABB’s quarterly EBITDA margins have fallen from a peak of 14% in December 2007 to 3.6% now. A collapse in power systems margins due to execution issues in rural electrification projects was the key driver; however, margins in most segments have deteriorated over the past year suggesting that these are not project-specific losses. Lower margins could be either attributed to price competition in the market or due to the impact of commodity price rises. There is evidence that margins have, however, started recovering on a y/y basis and we model margins to head towards the high single digits in CY12.
Figure 99: ABB – power systems and products margins
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11
Power products margin Power systems margin
Margins at power systems division were first to collapse; power products segment has
also declined
Source: Barclays Capital
Figure 100: ABB – margins in automation segment have also moderated
-5%
0%
5%
10%
15%
20%
25%
Mar
-05
Sep-
05
Mar
-06
Sep-
06
Mar
07
Sep0
7
Mar
08
Sep0
8
Mar
09
Sep0
9
Mar
-10
Sep-
10
Mar
-11
Sep-
11
Automation products margin Power automation margin
While margins for automation business have been holding up
well relative to power, there has been a sharp deceleration in profits even in this segment
Source: Barclays Capital
Royalty rates up 46% in the worst year at ABB
ABB imports more than 35-40% of its material costs and these high-cost imports – which also increase the impact of forex volatility, and some of which are from parent factories outside India – are part of the reason for the company’s’ structural decline in margins. While ABB was earlier able to charge a premium on these imported products as new technology items got introduced to India, commoditisation of the industry and thin margins in the India
Margins have deteriorated in all segments
High import content one of the key reasons for weak margins
and high margin volatility
Barclays Capital | India Capital Goods
7 December 2011 76
business mean margins are now impacted. Interestingly, in one of the toughest years for ABB, there was an increase in royalty expenditure by about 46% y/y (representing 2% of sales as of CY10).
With margins in the India business being weak and the poor cost structure impacting order wins, ABB was forced to announce an open offer for purchasing a 20% stake in its Indian subsidiary at steep valuations.
Figure 103: ABB – EPS (Rs) vs. EBITDA Margin: recovery expected to be led by margins normalising to high single digits
1 2 34
32 2 3 3
4 57
10
16
2326
17
3
8
20
0
5
10
15
20
25
30
Dec93 Dec95 Dec97 Dec99 Dec01 Dec03 Dec05 Dec07 Dec09 Dec11E0%
2%
4%
6%
8%
10%
12%
14%
Adjusted EPS Ebitda margin RHS
We expect EPS to recover in CY12 led by normalising of
margins; margin recovery could be led by completion of rural
projects, lower transfer price on products imported
Source: Company data, Barclays Capital
Figure 101: ABB – royalties as percentage of sales: increase rose more than 46% y/y in (CY10E)
Figure 102: ABB – imports a percentage of material costs: continues to be high
0.0%
0.5%
1.0%
1.5%
2.0%
Dec05 Dec06 Dec07 Dec08 Dec09 Dec10E
Royalty as % of sales
0%5%
10%15%20%25%30%35%40%45%50%
Dec05 Dec06 Dec07 Dec08 Dec09 Dec10E
Imports as % of mateial costs
Source: Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 77
Valuation
Our 12-month price target of Rs494 is based on an average 25x P/E. Our target multiple is the stock’s historical average 12-month forward P/E since 2003. Despite the recent moderation in valuations, ABB still trades at 30x forward earnings. The reason for the stock trading at such a high multiple we believe is the market’s expectation of a possible delisting of the stock and a lower cost of capital from the parent being used in cash flow valuations. However, we use a higher target P/E multiple for ABB compared with that used for peers as the cost of capital being used for any cash flow calculations will be that of its parent. This is because the recent open offer done by ABB’s parent for purchasing 20% of shares in ABB India at steep valuations were justified largely on account of lower cost of capital of its parent. Valuations will remain high relative to peers also due to expectations of a delisting in future as ABB’s parent’s stake has increased to 75% now.
Figure 104: ABB – Stock still appears rich on P/E valuation (x)
5
10
15
20
25
30
35
Dec
-94
Oct
-95
Aug
-96
Jun-
97
Apr
-98
Feb-
99
Dec
-99
Oct
-00
Aug
-01
May
-02
Mar
-03
Jan-
04
Nov
-04
Sep-
05
Jul-
06
May
-07
Mar
-08
Jan-
09
Oct
-09
Aug
-10
Jun-
11
ABB
ABB still trading at the upper end of its valuation band
Source: Datastream, Barclays Capital
Rich valuations pricing in a recovery
Figure 105: ABB – history of current consensus EPS forecasts shows stock has seen downgrades in estimates every year since CY07 (Rs)
Figure 106: ABB – history of current consensus EPS forecasts for FY12-14 shows estimates have been cut but still appear high in the context of current margins (Rs)
0
10
20
30
40
50
60
Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10
CY05 CY06 CY07 CY08
CY09 CY10
0
5
1015
20
25
3035
40
45
Jun-09 Jun-10 Jun-11
CY11 CY12
Source: Datastream, IBES consensus estimates, Barclays Capital Source: Datastream, IBES consensus, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 78
Risks
The key risks that could keep our price target from being achieved, in our view, include: 1) a faster-than-expected uptick in margins; 2) a sharp recovery in the T&D market and market share gains for ABB; and 3) announcement of a delisting by parent at substantially higher valuations.
Figure 107: ABB – income statement, 2007-2013E
Rs mn; years ending December 2007 2008E 2009E 2010E 2011E 2012E 2013E
Sales and services (Net) 59,303 68,370 62,372 62,871 74,884 88,207 90,554
YoY 39% 15% -9% 1% 19% 18% 3%
Cost of materials and erection services 42,920 49,504 45,179 48,021 55,362 63,155 64,841
% of sales 72% 72% 72% 76% 74% 72% 72%
Personnel expenses 3,061 4,030 3,892 4,901 5,694 6,206 6,361
% of sales 5% 6% 6% 8% 8% 7% 7%
Other expenses 6,076 7,183 8,042 9,111 9,894 11,415 11,628
% of sales 10% 11% 13% 14% 13% 13% 13%
EBITDA 7,246 7,654 5,259 838 3,934 7,432 7,724
EBITDA Margin 12% 11% 8% 1% 5% 8% 9%
Other income 710 1,304 726 855 170 87 90
Depreciation and amortisation 327 369 488 519 836 874 896
Interest expenses 68 347 256 174 243 266 317
Profit before tax 7,565 8,332 5,274 1,002 3,025 6,378 6,601
Profit before tax margin % 13% 12% 8% 2% 4% 7% 7%
Tax 2,648 2,858 1,728 370 1,226 2,188 2,264
Tax rate 35% 34% 33% 37% 41% 34% 34%
Reported profit after tax 4,917 5,474 3,546 632 1,798 4,191 4,337
Margin 8% 8% 6% 1% 2% 5% 5%
Adjusted profit after tax 4,917 5,474 3,546 632 1,798 4,191 4,337
Margin 8% 8% 6% 1% 2% 5% 5%
Source: Company reports, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 79
Figure 108: ABB – balance sheet, 2007-13E
Rs mn; years ending December 2007 2008E 2009E 2010E 2011E 2012E 2013E
Share capital 424 424 424 424 424 424 424
Reserves and surplus 15,840 20,766 23,814 23,813 25,413 29,140 32,998
Shareholder funds 16,263 21,190 24,237 24,237 25,837 29,564 33,422
Total loans 6 0 0 0 0 0 0
Deferred tax liability 128 38 0 0 0 0 0
Total liabilities 16,397 21,228 24,237 24,237 25,837 29,564 33,422
Net block 3,519 5,458 6,731 7,661 8,825 9,950 10,054
Capital WIP 1,059 1,375 1,163 577 577 577 577
Deferred tax assets 46 46 46 46
Investments 705 611 169 168 168 168 168
Inventories 4,887 6,427 7,294 6,979 8,206 9,908 10,420
Inventory days 30 34 43 40 40 41 42
Sundry debtors 24,236 29,759 28,577 29,260 33,852 40,116 41,432
Debtor days 149 159 167 165 165 166 167
Cash and bank balances 6,429 3,482 5,241 5,871 922 573 3,605
Other current assets 2,754 3,813 3,203 3,611 3,846 4,530 4,650
as % of sales 5% 6% 5% 5% 5% 5% 5%
Loans and advances 2,802 3,518 3,177 3,542 3,814 4,493 4,612
as % of sales 5% 5% 5% 5% 5% 5% 5%
Current liabilities 29,315 31,619 29,869 31,630 32,826 38,908 40,191
Days of sales 180 169 175 160 160 161 162
Provisions 678 1,596 1,450 1,846 1,594 1,889 1,951
% of Current liabilities 2% 5% 5% 5% 5% 5% 5%
Net current assets 11,114 13,783 16,174 15,785 16,221 18,823 22,577
Total assets 16,397 21,228 24,237 24,237 25,837 29,564 33,422
Source: Company reports, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 80
Figure 109: ABB – cash flow statement, 2007-13E
Rs mn; years ending December 2007 2008 2009 2010 2011E 2012E 2013E
Profit before tax 7,565 8,332 5,274 1,002 3,025 6,378 6,601
Depreciation and amortisation 324 367 485 517 836 874 896
Operating profit be working capital 7,679 9,060 5,829 2,004 4,047 7,490 7,784
Change in sundry debtors -8,533 -5,453 1,172 -715 -4,592 -6,264 -1,316
Change in inventories -1,340 -1,539 -868 316 -1,228 -1,702 -512
Change in other current assets -1,264 -1,194 599 -407 -234 -684 -121
Change in loans and advances -928 -1,075 1,065 -160 -273 -679 -120
Change in current liabilities and provisions 9,820 2,777 -1,566 1,751 943 6,377 1,346
Others 0 0 0 0 0 0 0
Change in working capital -2,245 -6,484 403 785 -5,384 -2,952 -722
Direct taxes paid (net of refund) -2,759 -2,378 -2,687 -582 -1,226 -2,188 -2,264
Net cash from operating activities 2,676 197 3,545 2,207 -2,564 2,351 4,799
Change in fixed assets -1,470 -2,639 -1,633 -1,044 -2,000 -2,000 -1,000
Change in investments 69 117 439 1 0 0 0
Others 262 275 194 114 57 29 30
Net cash from investing activities -1,139 -2,247 -986 -929 -1,943 -1,971 -970
Change in shares 0 0 0 0 0 0 0
Change in loans -10 -5 0 0 0 0 0
Others -563 -891 -800 -648 -442 -729 -797
Net cash from financing activities -573 -896 -800 -648 -442 -729 -797
Increase/decrease in cash and equivalent 964 -2,946 1,759 630 -4,949 -350 3,032
Opening cash 5,464 6,429 3,482 5,241 5,871 922 573
Closing cash 6,429 3,482 5,241 5,871 922 573 3,605
Source: Company reports, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 81
CUMMINS (1-OW, PT: RS428, +20%): STRONG PRODUCT POSITIONING
We initiate coverage of Cummins India with a 1-Overweight rating and a 12-month price target of Rs428 (20x FY13E plus Rs20 for value of associates). We believe the sharp reduction in consensus earnings estimates for the stock captures the impact of near-term weakness in the powergen and industrial markets in India. Cummins is exposed to three strong long-term drivers: 1) continued peak deficits in India that will driver growth for back-up power; 2) an increased focus on outsourcing to India from Cummins Inc. due to cost benefits; and 3) strong growth in after-sales service, aided by new facilities at the site in Phaltan. We view end-market exposure as the best relative to peers, due to a well-diversified end-user base and a stable pricing environment. Earnings growth should trough in FY12 and, with valuations trending below historical averages, the stock should outperform, in our view.
Near-term cyclical pressures: long-term drivers intact: With demand for powergen and industrial segments slowing and also impacted by stiff base comparison, management has revised down guidance for y/y sales growth in FY12 from 20% to single digits. Peers such as Kirloskar Oil Engines have also given a cautious commentary on demand and revised down sales guidance to flat y/y. With weak end-market demand, there has been an inventory correction at the OEM end, which has impacted sales sharply. While we expect demand to be weak in the near term, exports and growth from Cummins sales and services business will likely damp the impact. We expect modest 6% y/y growth in sales in FY12E followed by a recovery (14% y/y) next year. Note that past trends suggest that sales growth of less than 5% is usually a rare event for Cummins.
Long-term drivers intact: Long-term drivers for Cummins are promising and are the key reason for our positive view. A continued shortage of peak power as well as regulations, (change in emission norms in 2014) will continue to drive demand for power back-up generators. Furthermore, with Cummins Inc. intent on expanding outsourcing from India, owing to cost benefits, it is likely that base level exports will continue to grow.
Dominant positioning to support pricing: Cummins sports over 50% market share in the mid-high KVA segment and dictates price trends in the market. Cummins increased prices by 3-4% this year, in order to manage commodity pressure, and management is intent on keeping prices at current levels, ensuring that downside risk to margins is reduced.
Derating captures near-term concerns: Cummins stock has de-rated from 20x to 12x forward earnings (based on consensus estimates) and estimates have been revised down by 17-23% for FY12-14. With valuations below historical growth rates and modest earnings forecasts, we believe the stock offers a good investment opportunity on a long-term view.
Figure 110: Cummins – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
31 Mar Rs mn Rs % (x) (x) (%) (%)
2011A 5,911 21.3 33.8 15.7 5.1 32.7 3.4
2012E 5,088 18.4 (13.9) 18.3 4.5 24.9 2.9
2013E 5,642 20.4 10.9 16.5 4.0 24.4 3.2
2014E 7,570 27.3 34.2 12.3 3.5 28.4 4.3
Source: Company data, Barclays Capital estimates
KKC IN / CUMM.NS
Stock Rating 1-OVERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 428.00
Price (02-Dec-2011) INR 357.85
Potential Upside/Downside +20%
Barclays Capital | India Capital Goods
7 December 2011 82
COMPANY SNAPSHOT
CUMMINS Ltd INDIAN CAPITAL GOODS
Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 39,454 41,665 47,313 61,002 15.6% Stock Rating 1-OVERWEIGHTEBITDA 6,636 5,923 6,679 9,272 11.8% Sector View 2-NEUTRALEBIT 4,102 4,291 4,736 5,763 12.0% Price (02-Dec-2011) 357.9Pre-tax income 8,024 7,144 7,925 10,624 9.8% Price Target 428Net income 5,911 5,088 5,642 7,570 8.6% Ticker KKC IN/CUMM.BOEPS (R) 21.32 18.36 20.35 27.31 8.6%Diluted shares (mn) 277.20 277.20 277.20 277.20 0.0% Investment case
DPS (R) 11.32 9.74 10.80 14.49 8.6%
Margin and return data (%) AverageEBITDA margin 16.8 14.2 14.1 15.2 15.1EBIT margin 10.4 10.3 10.0 9.4 10.0Pre-tax margin 20.3 17.1 16.8 17.4 17.9Net margin 15.0 12.2 11.9 12.4 12.9ROIC 32.4 24.7 24.2 28.2 27.4ROA 32.4 24.7 24.2 28.2 27.4 Upside case 499ROE 32.7 24.9 24.4 28.4 27.6
Balance sheet and cash flow (INRmn) CAGRFixed assets 16,805 18,201 20,947 27,564 17.9%Cash and equivalents 1,038 525 874 1,684 17.5%Total assets 28,657 31,641 35,781 43,116 14.6%Current liabilities 10,412 11,008 12,500 16,283 16.1%Long term liabilities 183 - - - NA Downside case 204Total liabilities 28,657 31,641 35,781 43,116 14.6%Net debt/(funds) (855) (342) (691) (1,501) NAShareholders' equity 18,063 20,450 23,098 26,650 13.8%Change in working capital (1,053) (1,314) (904) (2,024) NACash flow from operations 3,470 2,554 3,492 4,194 6.5%Capital expenditure (1,500) (2,000) (2,000) (1,500) NAFree cash flow 1,970 554 1,492 2,694 11.0%
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 15.7 18.3 16.5 12.3 15.7 EV/EBITDA (x) 13.9 15.6 13.8 9.9 13.3 FCF yield (%) 2.0 0.6 1.5 2.7 1.7EV/sales (x) 2.3 2.2 1.9 1.5 2.0 Price/BV (x) 5.1 4.5 4.0 3.5 4.3 Dividend yield (%) 3.2 2.7 3.0 4.1 3.2Total debt/capital (%) 1.0 0.9 0.8 0.7 0.8Net debt/EBITDA (x) - 0.0 - 0.0 - 0.0 - 0.0 - 0.0
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics Capacity utilisation decline reflected in estimatesICE capaicty 53,300 83,300 83,300 83,300 Capacity utilisation 72.8 48.5 50.0 70.0Domestic sales ex CSS 23,677 24,310 27,168 37,291 Exports 10,230 11,253 13,128 15,641
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 1-Overweight? Dominant positioning inpowergen products should help the company tosustain pricing despite weak market ordering. Long-term drivers for its business are intact with peakshortages expected to continue until FY17. We valueit at 15% premium to its historical average.
A recovery in domestic ordering , improvement inmargins (if commodity prices start declining) as wellas strength in exports could lead to the stockheading to peak P/E of 25x.
Continued weakness in revenues and marginsespecially for exports could lead to the stock tradingcloser to its recent trough P/E of about 10x.
0%20%40%60%80%
100%120%
Mar
-05
Mar
-06
Mar
-07
Mar
-08
Mar
-09
Mar
-10
Mar
-11
Mar
-12
EM
ar-1
3E
Mar
14E
Capacity utilisation
DownsideCase
INR204(-42.9%) Price
Target
INR428(19.6%)
UpsideCase
INR499(39.4%)
102
202
302
402
502
602
702
22-Dec-10 2-Dec-11
DownsideCase
INR204(-42.9%) Price
Target
INR428(19.6%)
UpsideCase
INR499(39.4%)
0
100
200
300
400
500
600
22-Dec-10 2-Dec-11
Barclays Capital | India Capital Goods
7 December 2011 83
Near-term cyclical pressures evident
It is now apparent that FY12 will be a weak year for growth, with management guiding for single-digit growth in sales in the domestic market (overall sales guidance was for 20% y/y growth, which was reduced to 15% after 1Q). For exports, management says it is not witnessing any unusual slowdown but base comparisons remain a challenge, in our view. In the domestic market, management is of the view that a slowdown in various end markets in the past six months has impacted demand and this has led to an inventory overhang at OEMs (Powerica, among others), which in turn has impacted demand for products.
Demand for powergen was decelerating at a faster pace than the industrials segment, according to our checks with management. In the industrials sector, demand from the water well segment fell sharply largely due to cyclical factors. On pricing trends, management is of the view that after two price hikes this year, prices should remain firm at current levels. Management also noted that it does not expect weak demand to lead to a price cut in the market.
Weak demand will impact capacity utilisation for Cummins and, given the ramp up of medium KVA engines at Phaltan, capacity is increasing. A combination of lower capacity utilisation and a high price of raw materials (pig iron) will continue to impact margins, leading management to expect a further 1% decline over the next two quarters. Our estimates reflect this scenario.
Figure 111: Cummins – capacity utilisation: we expect a fall, in turn, affecting margins
We expect capacity utilisation to decline given weak demand and
an increase in capacity for medium KVA engines 83%
102%94%
109%
53% 55%
73%
49% 50%
70%
0%
20%
40%
60%
80%
100%
120%
Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar14E
Capacity utilisation
Source: Company data, Barclays Capital estimates
Cautious view from Kirloskar Oil management We find Kirloskar Oil Engines (KOEL) view on the market useful, as it helps to get a good read on demand trends for powergen engines and engines for construction equipment. KOEL is a competitor of Cummins and we believe its sales are a leading indicator for sales trends at Cummins , in our view. This could be because of its higher gearing to the low KVA segment, which may be the first to see the impact of a slowdown in the market.
KOEL management has been negative on trends in the powergen market since the December quarter. In December, management was of the view that old engines from the
Sales guidance has been cut from 20% y/y at start of the year
to single-digit growth
Powergen demand decelerating at a faster pace than industrial
Management expects EBITDA margins to decline by another
1% over the next two quarters
Peers such as Kirloskar Oil engines have also given a
cautious view on sales growth
Barclays Capital | India Capital Goods
7 December 2011 84
Commonwealth Games came out for sale in the market in 3Q FY11, after the event was over, and this increased supply in the market.
After 4Q/FY11 management guided for 15-20% sales growth in FY12 (as the market slowdown was still not evident in the mid- to high-end segment) on the hope that successes in the mid-high KVA segment would help drive sales. After 1Q FY12, however, a weaker-than-expected market led to a downward revision to guidance (to 10% y/y growth). After 2Q FY12, the guidance was further revised down to 0% growth. Management commented that powergen demand was weak due to good overall availability of power.
KOEL management appeared more positive on the high KVA segment (recent entrant) as competition from Chinese players was high in the low KVA segment and demand from some key segments such as telecom remained weak. Management was of the view that the implementation of CPCB pollution norms for diesel generation sets from October 2013 should help reduce competitive intensity as not all players will have engines that will fulfil the emission standards.
While KOEL has a dominant market share in the construction equipment segment, this was affected by the shift of JCB to its own engines. We note that the impact on Cummins would have been much lower given the lower mix of sales to JCB. Overall, though, management was of the view that high interest rates are impacting demand in this segment.
Figure 112: Cummins – KOEL’s sales growth trends are a leading indicator for Cummins
-25%-20%-15%-10%
-5%0%5%
10%15%20%25%
Jun-
07
Sep-
07
Dec
-07
Mar
-08
Jun-
08
Sep-
08
Dec
-08
Mar
-09
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
-40%
-20%
0%
20%
40%
60%
80%
100%
Kirloskar oil engines quarterly sales YoY Cummins quarterly sales growth YoY
KOEL’s sales trends are a good leading indicator of trends at
Cummins
Source: Company data, Barclays Capital
Weak earnings in the near term and risk of consensus EPS cuts Management is guiding for single-digit growth in domestic sales and, for exports, while management does note expect any unusual slowdown, base comparison remains a challenge, in our view.
We are building in 6% y/y sales growth for FY12E and 14% growth for FY13 (largely led by exports as we expect the new 200KVA facility to start contributing next year).
KOEL decreased guidance from 15-20% sales growth to 10%
Management appeared more concerned over low KVA
compared with medium-high KVA engines
EPS estimates now reflect weak demand; we expect 6% growth
in sales in FY12E followed by 14% growth in FY13E
Barclays Capital | India Capital Goods
7 December 2011 85
Figure 113: Cummins – sales: we expect only 6% sales growth in FY12E
Rs mn FY11 FY12E FY13E Mar14E
Domestic 23,677 24,310 27,168 37,291
y/y 24% 3% 12% 37%
Overseas 10,230 11,253 13,128 15,641
y/y 137% 8% 17% 19%
Cummins sales and services 5,547 6,102 7,017 8,070
y/y 15% 10% 15% 15%
Total 39,454 41,665 47,313 61,002
Source: Company data, Barclays Capital estimates
Earnings may have troughed in September quarter
Quarterly earnings growth for Cummins may have already troughed, in our view, but it will likely remain at low levels until 1HCY12. An easy base comparison, coupled with a contribution from the low KVA facility at Phaltan should help drive a y/y recovery in sales, in our view.
Long-term drivers intact
Key drivers of demand for Cummins include: 1) continued peak deficits in India ensuring that demand for power remains strong; 2) growth in exports; 3) likely strength in demand for mining and construction equipment (cycles are more pronounced though); 4) changing emission norms that drive replacement/upgrade demand; and 5) increase in supply of alternate fuel sources such as natural gas.
Cummins’ business model remains strong given the structural shortfall of power in India – and what matters to Cummins, we believe, is a shortage of peak power as its generators are used primarily for standby application. While the addition of over 200GW of power capacity until FY17 should reduce the overall power deficit, the peak deficit is envisaged to still remain above 15%, according to Cummins’ management.
Quarterly earnings momentum at historical lows; we expect
momentum to improve next year led by easy y/y comps
Figure 114: Cummins – Annual sales growth was below 10% in only 5 of the past 20 years
Figure 115: Cummins – Earnings growth close to trough on quarterly basis; expect improvement from 2H FY13E
21
1014
33
2122
(7)(13)
28
4
(14)
1212
282326 27
40
(13)
39
6
-20
-10
0
10
20
30
40
50
Mar
-92
Mar
-94
Mar
-96
Mar
-98
Mar
-00
Mar
-02
Mar
-04
Mar
-06
Mar
-08
Mar
-10
Mar
-12
Annual revenue growth YoY
0%
5%
10%
15%
20%
25%Ju
n-02
Jun-
03
Jun-
04
Jun-
05
Jun-
06
Jun-
07
Jun-
08
Jun-
09
Jun-
10
Jun-
11
Jun-
12
-60%
-30%
0%
30%
60%
90%
120%
EBITDA Margin EPS YoY growth (RHS)
Source: Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates
Continued peak deficits for India, growth in exports, cyclical
improvement in demand for construction/mining engines
should help drive a recovery in the medium term
Barclays Capital | India Capital Goods
7 December 2011 86
Figure 116: Cummins – management expects peak deficit to continue at 15%
79 82 106 117171 20253 27
82 31
129 54
0
50
100
150
200
250
300
350
Demand Availablesupply
Demand Availablesupply
Demand Availablesupply
Demand Supply
2009 20172012
Peak defecit :17%Base surplus : 4%
Peak defecit :15%Base surplus : 18%
Peak defecit :22%Base surplus : 8 %
132 GW109 GW
190 GW 148 GW
300 GW 256 GW
GWPeak shortages are expected to
fall but remain at 15% levels until FY17
Source: Company data, Barclays Capital
Exports will continue to be a driver for Cummins in the long term as outsourcing to India is being expanded from the largely high-HP power-gen segment to the less than 200KVA segment
Strong market positioning Cummins has a high share (50-60%)of the mid-high KVA powergen market in India ,(as per management estimates) due to its strong product quality, after sales services and well entrenched presence in India. Cummins’ competitors in India sell at a discount to Cummins but it has nevertheless been able to hold onto its market share because of strong quality and service . Cummins is now also expanding its presence in the lower KVA segment in India and the export market. KOEL dominates the low KVA segment in India. Strong and dominant market positioning helps Cummins protect pricing during downturns, which helps support margins.
Valuation
Our 12-month price target of Rs428 for Cummins is based on a P/E of 20x applied to our EPS forecast for FY13E plus Rs20 for the value of associates. Our target P/E for the core business is at a multiple set at a 10% premium to the average of the past eight years’ P/E valuation. Since we have already cut earnings estimates to capture the cyclical weakness, we are using average P/E multiples. We give a premium of 10% because of the company’s well developed sales and service business and the likely higher mix of exports that could offset the impact of a weak domestic market in the coming year. In addition, we also value the 50% stakes in Valvoline Cummins and Cummins Research & Technology India at Rs20 per share based on 18x FY13E. We are not factoring in upside risk to the current stock price if the parent of Cummins in the US decides to do an open offer.
The company’s weak earnings momentum has led to a derating of Cummins share price in the past 12 months. The stock is trading below its historical average valuations. We believe that the cyclical pressures are largely reflected in the valuations.
With Cummins introducing new product lines for exports, long-
term potential remains high
Strong and dominant market positioning helps protect pricing
Cyclical weakness captured in valuations
Barclays Capital | India Capital Goods
7 December 2011 87
Figure 117: Cummins – historical 12-month forward P/E (x): valuations have witnessed a sharp correction
4
8
12
16
20
24
Jan-
95
Nov
-95
Sep-
96
Jul-
97
May
-98
Feb-
99
Dec
-99
Oct
-00
Aug
-01
Jun-
02
Apr
-03
Feb-
04
Dec
-04
Sep-
05
Jul-
06
May
-07
Mar
-08
Jan-
09
Nov
-09
Sep-
10
Jul-
11
Cummins Linear (Cummins)
Valuations are below historical averages; further derating likely
only in a deep recession
Source: Datastream, Barclays Capital
Risks The key risks that could keep our price target from being achieved, in our view, include the following: 1) a recession in export markets impacting sourcing from India; 2) further deceleration in domestic markets; and 3) price discounting in the market that could impact margins. In addition, any further shift among its customers in construction and mining equipment to their own engines would be a concern. And some competitors such as KOEL are scaling up their business in India and their ability to win customers could impact the dominant position of Cummins.
Figure 118: Cummins – history of consensus EPS forecasts shows estimates have often been underestimated
Figure 119: Cummins – history of current consensus EPS forecasts for FY12-14 shows recent sharp estimates cuts (20-23% for FY12-14) should capture the cyclical downturn
0
5
10
15
20
25
Nov
-05
May
-06
Nov
-06
May
-07
Nov
-07
May
-08
Nov
-08
May
-09
Nov
-09
May
-10
Nov
-10
May
-11
FY06 FY07 FY08 FY09
FY10 FY11
15
20
25
30
35
40
45
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
FY12 FY13 FY14
Source: Datastream, IBES consensus, Barclays Capital Source: Datastream, IBES consensus, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 88
Figure 120: Cummins – income statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Net sales 32,741 28,449 39,454 41,665 47,313 61,002
YoY 40% -13% 39% 6% 14% 29%
Expenditure 27,968 23,174 32,818 35,741 40,634 51,730
Total material costs 22,338 18,552 25,803 27,881 31,809 40,847
% of sales 68% 65% 65% 67% 67% 67%
Employee costs 2,130 1,953 2,546 3,157 3,484 4,339
% of sales 7% 7% 6% 8% 7% 7%
Other costs 3,501 2,670 4,469 4,704 5,342 6,544
OBITDA 4,772 5,275 6,636 5,923 6,679 9,272
OBITDA margin 15% 19% 17% 14% 14% 15%
Other income plus other operating income 1,507 1,216 1,774 1,657 1,876 2,157
Depreciation 456 381 367 413 606 781
Interest 26 21 19 23 24 24
Pre-tax exceptional items 192 0 0 0 0 0
Profit before tax 5,990 6,089 8,024 7,144 7,925 10,624
Profit before tax Margin 18% 21% 20% 17% 17% 17%
Tax 1,654 1,670 2,114 2,056 2,283 3,054
Tax rate 28% 27% 26% 29% 29% 29%
Post-tax exceptional items 0 0 0 0 0 0
Profit after tax – reported 4,337 4,419 5,911 5,088 5,642 7,570
Profit after tax – adjusted 4,202 4,419 5,911 5,088 5,642 7,570
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 89
Figure 121: Cummins – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Share capital 396 396 396 396 396 396
Reserves and surplus 13,551 15,214 17,667 20,054 22,702 26,254
Shareholders equity 13,947 15,610 18,063 20,450 23,098 26,650
Secured loans 212 86 183 - - -
Unsecured loans 0 0 - - - -
Loan funds 212 86 183 183 183 183
Finance lease liability 17 - - - - -
Total sources of funds 14,176 15,696 18,246 20,633 23,281 26,833
Gross block 7,414 8,041 9,144 11,144 13,144 14,644
Less: depreciation 4,324 4,704 4,733 5,146 5,752 6,534
Net block 3,090 3,337 4,411 5,997 7,391 8,110
Investments 3,993 7,329 7,255 7,255 7,255 7,255
Deferred tax net 231 169 187 187 187 187
Inventories 4,680 4,098 5,190 5,936 6,741 8,691
Inventory days 52 53 52 52 52 52
Debtors 6,821 5,229 7,182 7,658 8,696 11,212
Debtor days 76 67 67 67 67 67
Cash and bank 323 559 1,038 525 874 1,684
Other current assets 83 93 99 136 154 199
as % of sales 0 0 0 0 0 0
Loans and advances 2,663 2,695 3,297 3,947 4,482 5,779
as % of sales 0 0 0 0 0 0
Current liabilities 5,977 5,178 7,109 7,583 8,611 11,102
Current liabilities days 67 66 66 66 66 66
Provisions 1,732 2,634 3,303 3,424 3,889 5,181
Number of days net sales 19 34 33 30 30 31
Net current assets 6,862 4,862 6,393 7,194 8,448 11,281
No of days net sales 77 62 62 62 62 62
Total application of funds 14,176 15,696 18,246 20,633 23,281 26,833
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 90
Figure 122: Cummins – cash flow statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Profit before tax 5,990 6,109 8,024 7,144 7,925 10,624
Depreciation 456 361 367 413 606 781
Cash flow from operations excluding working capital 6,085 5,872 6,636 5,923 6,679 9,272
Changes in working capital (2,023) 1,436 (1,053) (1,314) (904) (2,024)
Cash flow from operations 4,062 7,309 5,584 4,609 5,775 7,248
Tax paid (1,850) (1,550) (2,114) (2,056) (2,283) (3,054)
Cash flow from operating activities 2,212 5,759 3,470 2,554 3,492 4,194
Purchase of fixed assets (908) (665) (1,500) (2,000) (2,000) (1,500)
Sale of fixed assets 312 46 - - - -
Purchase of investments (17,092) (17,146) - - - -
Sale of investments 17,504 13,806 - - - -
Cash flow from investing activities 104 (3,368) 274 (343) (124) 657
Change in debt (107) (126) 97 - - -
Interest paid (26) (21) (19) (23) (24) (24)
Dividend paid (2,099) (1,192) (3,137) (2,701) (2,995) (4,018)
Cash flow from financing activities (2,231) (2,155) (3,059) (2,724) (3,019) (4,042)
Change in cash and cash equivalents 84 236 685 (513) 349 810
Opening cash and cash equivalents 239 323 559 1,038 525 874
Closing cash and cash equivalents 323 559 1,038 525 874 1,684
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 91
CROMPTON GREAVES (1-OW, PT: RS147, +11%): CONTRARIAN PICK; LOW VISIBILITY BUT LOW EXPECTATIONS
We initiate coverage of Crompton Greaves (CRG) with a 1-Overweight rating and a 12-month price target of Rs147, based on 16x FY13E standalone and 12x FY13E subsidiary earnings. Following the sharp decline in margins in 1H/FY12, consensus estimates (40% cuts over the past 12 months) are building in no scope for a margin recovery in future years. We take a non-consensus view of this stock and believe there is scope for margin recovery given the product nature of the business, which ensures low correlation between yearly margins. Apart from the earnings cuts, the sharp derating of the stock (20x to 11x over the past 12 months) makes us believe that the expectations for performance are low. A bottoming in fundamentals over the next six months and weak quarterly earnings support our view that now is the time to be 1-Overweight on the stock.
Margin trough likely in FY12: We believe the reasons for CRG’s margin increase last year and the current decline across most segments remain unclear in the market. We believe the current margin decline arises from a combination of the impact of commodity price increases and pressures at some projects being executed by subsidiaries. With CRG’s exposure to an extremely tough pricing environment in the domestic T&D segment (limited to 15% of order book on our estimates), we believe that any unusual weakness in margins should be limited to that portion of business only. In recent discussions, the company’s new CEO indicated management’s intent is to purge costs over the longer term, with new initiatives such as sourcing from China.
Downgrade cycle nearing an end: Another weak quarter should lead to the last round of earnings downgrades, in our view, but the key point to ponder is whether a further 10-15% decline in EPS estimates will impact the stock price. We note that there have been cuts of more than 40% – and not just for FY12 estimates, but also for FY13 and FY14, even though there is little relationship between margins year to year for CRG as it is a product business, and the stock has de-rated from a P/E of 20x forward earnings to 11x currently. We think the impact of continued weakness in near-term earnings will be temporary.
Trading at a steep discount to ABB and Siemens: . The current 50-60% discount to ABB and Siemens valuations are not justified, in our view given a better earnings track record for CRG.
Figure 123: Crompton Greaves – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Mar Rs mn Rs % (x) (x) (%) (%)
2011A 9,268 14.4 13.5 9.1 2.6 28.1 1.8
2012E 4,441 6.9 -52.1 19.1 2.3 12.3 1.3
2013E 5,833 9.1 31.3 14.5 2.1 14.3 1.3
2014E 7,031 11.0 20.5 12.1 1.8 15.1 1.5
Source: Barclays Capital estimates
CRG IN / CROM.NS
Stock Rating 1-OVERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 147.00
Price (02-Dec-2011) INR 132.15
Potential Upside/Downside +11%
Barclays Capital | India Capital Goods
7 December 2011 92
COMPANY SNAPSHOT
Crompton Greaves INDIA CAPITAL GOODS
Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 100,051 94,185 94,272 102,619 0.8% Stock Rating 1-OVERWEIGHTEBITDA 13,438 8,074 9,219 10,900 -6.7% Sector View 2-NEUTRALEBIT 11,502 6,003 7,590 9,189 -7.2% Price (02-Dec-2011) 132.15Pre-tax income 12,291 6,425 8,217 9,858 -7.1% Price Target 147Net income 9,268 4,441 5,833 7,031 -8.8% Ticker CRG INEPS (R) 14.45 6.92 9.09 10.96 -8.8%Diluted shares (mn) 641.52 641.52 641.52 641.52 0.0% Investment case
DPS (R) 2.20 1.55 1.62 1.88 -5.2%
Margin and return data (%) AverageEBITDA margin 13.4 8.6 9.8 10.6 10.6EBIT margin 11.5 6.4 8.1 9.0 8.7Pre-tax margin 12.3 6.8 8.7 9.6 9.4Net margin 9.3 4.7 6.2 6.9 6.8ROIC 25.1 11.3 13.0 13.9 15.8ROA 24.6 10.8 12.7 13.5 15.4 Upside case 182ROE 28.1 12.3 14.3 15.1 17.4
Balance sheet and cash flow (INRmn) CAGRFixed assets 19,417 19,845 20,715 21,504 3.5%Cash and equivalents 2,984 9,655 12,873 17,025 78.7%Total assets 71,500 75,644 80,465 89,026 7.6%Current liabilities 33,892 34,370 34,369 37,066 3.0%Long term liabilities 4,703 4,922 4,922 4,923 1.5% Downside case 91Total liabilities 71,500 75,637 80,458 89,019 7.6%Net debt/(funds) 1,719 (4,733) (7,951) (12,102) NAShareholders' equity 32,747 36,206 41,028 46,891 12.7%Change in working capital (5,133) 4,156 16 (172) NACash flow from operations 5,605 10,267 6,878 7,935 12.3%Capital expenditure (7,592) (2,500) (2,500) (2,500) NAFree cash flow (1,987) 7,767 4,378 5,435 NA
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 9.1 19.1 14.5 12.1 13.7 EV/EBITDA (x) 6.4 9.9 8.3 6.7 7.8 FCF yield (%) -2.3 9.2 5.2 6.4 4.6EV/sales (x) 0.9 0.8 0.8 0.7 0.8 Price/BV (x) 2.6 2.3 2.1 1.8 2.2 Dividend yield (%) 1.7 1.2 1.2 1.4 1.4Total debt/capital (%) 12.5 11.9 10.7 9.5 11.1Net debt/EBITDA (x) 0.1 -0.1 -0.2 -0.3 -0.1
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics EPS expected to recover in FY13Order inflow 109,620 92,445 98,128 116,192 Order inflow growth (%) 7 -16 6 18Orderbook 71,690 68,571 69,718 80,151 Orderbook growth (%) 12 -4 2 15
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 1-Overweight? After our cuts of more than 35-40% for EPS for FY12-14 and stock multiplescoming down from over 22x to 12x, we believe thatweak fundamentals are priced in. We modelconservative EPS and value Crompton on a P/E of14x.
A recovery in margins especially at the subsidiairescould take its P/E back to 25x, which is closer to thesector average P/E.
Continued weakness could lead to the stock trending back to sector trough P/E of 10x. Continuedweakness could lead to stock trending back to sectortrough P/E of 10x.
-60%-40%-20%
0%20%40%60%
Mar10 Mar11 Mar12E Mar13E Mar14E
EPS growth
DownsideCase
INR91(-31.1%)
PriceTarget
INR147(11.2%)
UpsideCase
INR181(36.9%)
050
100150200250300350
15-Dec-10 2-Dec-11
DownsideCase
INR91(-31.1%)
PriceTarget
INR147(11.2%)
UpsideCase
INR182(37.7%)
050
100150200250300350
15-Dec-10 2-Dec-11
Barclays Capital | India Capital Goods
7 December 2011 93
Margin recovery the key driver
CRG’s margins have fallen to significantly lower levels that in the past, due to losses at subsidiaries and a moderation in margins in India. While CRG may have benefitted from lower commodity prices in 2009, which may have helped increase margins in all segments until late FY11, we believe that this does not explain the sharp deterioration in margins at the subsidiaries. We believe there is a possibility of project-specific losses that may have been booked. The losses could be in the 765KV orders being manufactured in Ganz (we would get more clarity only from the FY12 annual report) as the revenue booking for these projects was expected to commence in 4Q FY10 or 1Q FY12. If the losses were specific to certain projects then margins could retrace back by 200-300bps, in the coming quarters, on our estimates. Commodity price increases and product price declines in the market will continue to pressure margins, in our view.
Figure 126: Crompton Greaves – Consolidated EBITDA margin: recent margins of 7-8% are significantly lower than in the past
10% 11%
14%
10%11% 11%
13%
11%
14% 14%16%
13%14% 14%
13%
7%8%
0%2%4%6%8%
10%12%14%16%18%
Sep-
07
Dec
-07
Mar
-08
Jun-
08
Sep-
08
Dec
-08
Mar
-09
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
OBITDA Margins
Source:: Company data, Barclays Capital
Margin decline could have been led by commodity price
increases and project-specific losses at its subsidiaries
Figure 124: Crompton Greaves – operating margin: standalone margins have moderated
Figure 125: Crompton Greaves – operating margin: subsidiaries made a loss in the June quarter
0%
2%
4%
6%
8%10%
12%
14%
16%
18%
Sep0
3
Jun0
4
Mar
05
Dec
05
Sep0
6
Jun0
7
Mar
08
Dec
08
Sep0
9
Jun-
10
Mar
-11
Operating margins
-4%
0%
4%
8%
12%
16%
Sep
07
Mar
-08
Sep-
08
Mar
-09
Sep-
09
Mar
-10
Sep-
10
Mar
-11
Sep-
11
Operating margins
Source: Company data, Barclays Capital Source: . Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 94
Building conservative estimates
We have taken a conservative stance on both order inflows and margins while building our estimates. We expect flattish sales in FY13 but a 31% growth in PAT in FY13E given the low base. Absolute PAT in FY13E would still be lower than achieved in FY10.
Figure 127: Crompton Greaves – revenue by product segment: building in modest estimates
Rs mn, years ending March FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E
Power systems 17,750 19,633 22,585 25,103 25,542 21,353 20,053 22,684
Growth 46% 11% 15% 11% 2% -16% -6% 13%
Industrial systems 8,874 11,246 10,943 11,780 14,066 12,642 10,981 13,485
Growth 29% 27% -3% 8% 19% -10% -13% 23%
Consumer products 9,940 11,002 13,384 16,120 20,212 21,729 24,988 28,736
Growth (y/y) 22% 11% 22% 20% 25% 8% 15% 15%
Source: Company data, Barclays Capital
Figure 128: Crompton Greaves – forecasts by segment: expect margin recovery in FY13E
Rs mn; years ending March FY10 FY11E FY12E FY13E FY14E
Standalone
Order inflow 64,271 65,100 56,829 62,512 77,015
y/y 7% 1% -13% 10% 23%
Order book 34,000 34,860 34,686 38,466 47,436
y/y 23% 3% 0% 11% 23%
Net sales 52,840 59,515 55,631 56,022 64,905
y/y 15% 13% -7% 1% 16%
EBITDA margin 16.2% 15.7% 11.8% 11.9% 11.9%
Net Income 5,613 6,724 4,610 4,807 5,468
y/y 41% 20% -31% 4% 14%
Subsidiaries
Order inflow 37,940 44,520 35,616 35,616 39,178
y/y 0% 17% -20% 0% 10%
Order book 30,000 36,830 33,886 31,252 32,715
y/y -21% 23% -8% -8% 5%
Net sales 38,569 40,536 38,560 38,250 37,714
y/y -7% 5% -5% -1% -1%
EBITDA Margin 10.9% 10.1% 4.0% 6.6% 8.4%
Net Income 2,550 2,545 -156 1,054 1,593
y/y 43% 0% -106% -777% 51%
Consolidated
Order inflow 102,211 109,620 92,445 98,128 116,192
y/y 4% 7% -16% 6% 18%
Order book 64,000 71,690 68,571 69,718 80,151
y/y -3% 12% -4% 2% 15%
Net sales 91,409 100,051 94,185 94,272 102,619
y/y 5% 9% -6% 0% 9%
EBITDA Margin 14.0% 13.4% 8.6% 9.8% 10.6%
Net Income 8,162 9,268 4,441 5,833 7,031
y/y 42% 14% -52% 31% 21%
Source: Company data, Barclays Capital estimates
We expect flattish sales in FY13 but more than31% growth in
PAT
Barclays Capital | India Capital Goods
7 December 2011 95
Shares are pricing in a weak near term
After a 40% cut in forward estimates and a derating of the stock from over 20x to 11x, we believe that near-term margin pressures are reflected in valuations. A recovery in earnings in Q3/Q4 could be the key driver of a stock rebound, in our view
Valuation
Our 12-month price target of Rs147 for CRG is based on 16x standalone FY13E earnings of Rs7.50 and 12x subsidiary earnings of Rs1.69. Our multiples are set at historical average multiples for the past seven years for CRG despite the recent sharp increase in consensus earnings estimates.
CRG’s estimates have seen a 40% revision for FY12-14, the highest decline among peers
Figure 129: Crompton Greaves – history of current consensus EPS forecasts shows estimates typically were revised up for FY06-11 (Rs)
Figure 130: Crompton Greaves – history of current consensus EPS forecasts for FY12-14 shows weak 1Q/2Q FY12E led to 40% cuts in estimates (Rs)
02468
10121416
Nov
-05
May
-06
Nov
-06
May
-07
Nov
-07
May
-08
Nov
-08
May
-09
Nov
-09
May
-10
Nov
-10
May
-11
FY06 FY07 FY08 FY09
FY10 FY11
579
1113151719212325
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
FY12 FY13 FY14
Source: Datastream, IBES consensus estimates, Barclays Capital Source: Datastream, IBES consensus estimates, Barclays Capital
Initiate at 1-Overweight
Figure 131: Crompton Greaves – Stock trading at close to historical P/E lows (x)
Figure 132: Crompton Greaves – EV/order book close to historical lows (x)
0
5
10
15
20
25
30
Dec
-94
Mar
-96
Jun-
97
Sep-
98
Dec
-99
Mar
-01
Jun-
02
Sep-
03
Dec
-04
Mar
-06
Jun-
07
Sep-
08
Dec
-09
Mar
-11
Crompton
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Mar
-95
Jun-
96
Sep-
97
Dec
-98
Mar
-00
Jun-
01
Sep-
02
Dec
-03
Mar
-05
Jun-
06
Sep-
07
Dec
-08
Mar
-10
Jun-
11
EV/orderbook
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 96
Figure 135: Crompton Greaves – cash flow generation has typically been strong
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
Mar03 Mar04 Mar05 Mar06 Mar07 Mar08 Mar09 Mar10 Mar11
Operating profit before WC changes Cash flow from operating activities, Rs mn
Source:: Company data, Barclays Capital
Risks
The key risks that could keep our price target from being achieved, in our view, include a higher-than-expected decline in order inflows due to stiff competitive pressures in the domestic market and continued price declines and risks could emerge from weak demand for T&D products from Europe since CRG derives more than 50% of revenues from international geographies.
Figure 133: Crompton Greaves – Trading at a steep P/E discount to ABB (x) …
Figure 134: … and Siemens (P/E x)
0.00.10.20.30.40.50.60.70.80.9
Dec
-94
Apr
-96
Jul-
97
Oct
-98
Jan-
00
Apr
-01
Aug
-02
Nov
-03
Feb-
05
May
-06
Aug
-07
Nov
-08
Mar
-10
Jun-
11CRG over ABB
0.0
0.2
0.4
0.6
0.8
1.0
1.2
Dec
-94
Apr
-96
Jul-
97
Oct
-98
Jan-
00
Apr
-01
Aug
-02
Nov
-03
Feb-
05
May
-06
Aug
-07
Nov
-08
Mar
-10
Jun-
11
CRG over Siemens'
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 97
Figure 136: Crompton Greaves – income statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Net sales 87,373 91,409 100,051 94,185 94,272 102,619
YoY 28% 5% 9% -6% 0% 9%
Materials, manufacturing and operating expenses 56,938 55,923 64,980 63,037 61,839 67586
% of sales 65% 61% 65% 67% 66% 66%
Staff cost 10,627 11,131 11,811 11,706 11,849 11,885
% of sales 12% 12% 12% 12% 13% 12%
Sales and administrative expenses 9,852 11,585 451,175 11,368 11,365 12,248
% of sales 11% 13% 451% 12% 12% 12%
Expenditure 77,418 78,640 527,967 86,111 85,053 91,718
% of sales 89% 86% 528% 91% 90% 89%
OBITDA 9,955 12,769 13,438 8,074 9,219 10,900
OBITDA margin 11.4% 14.0% 13.4% 8.6% 9.8% 10.6%
Other income 740 1,100 1,142 758 879 920
Depreciation 1,216 1,551 1,936 2,072 1,630 1,711
Interest 655 265 209 336 251 251
Exceptional items 0 0 0 0 0 0
Profit before tax 8,824 12,053 12,291 6,425 8,217 9,858
Total taxation 3,047 3,650 3,100 1,971 2,357 2,794
Tax rate 35% 30% 25% 31% 29% 28%
Profit after tax before minority interests 5,777 8,403 9,192 4,454 5,860 7,064
Minority interests 17 -26 -4 -14 -29 -35
Share of profits of associates -9 32 80 1 2 3
Reported profit after tax 5,751 8,409 9,268 4,441 5,833 7,031
Adjusted profit after tax 5,751 8,162 9,268 4,441 5,833 7,031
Adjusted profit after tax margin 7% 9% 9% 5% 6% 7%
YoY 0% 42% 14% -52% 31% 21%
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 98
Figure 137: Crompton Greaves – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Share capital 733 1,283 1,283 1,283 1,283 1,284
Reserves and surplus 17,577 23,760 31,464 34,923 39,745 45,607
Total shareholder equity 18,310 25,043 32,747 36,206 41,028 46,891
Minority interest 139 43 157 139 139 139
Secured loans 6,923 4,766 4,554 4,802 4,802 4,802
Unsecured loans 260 244 149 149 149 149
Total loans 7,182 5,010 4,703 4,922 4,922 4,923
Total sources of funds 25,631 30,095 37,607 41,267 46,089 51,953
Application of funds
Gross block 30,289 29,858 37,805 40,305 42,805 45,305
Less: depreciation 17,040 17,234 19,490 21,562 23,192 24,903
Net block 13,248 12,623 18,314 18,743 19,613 20,402
Capital WIP 537 1,137 1,102 1,102 1,102 1,102
Total fixed assets 13,785 13,760 19,417 19,845 20,715 21,504
Investments 1,672 5,536 6,747 7,497 8,247 8,997
Deferred tax assets net 482 -49 -160 -160 -160 -160
Inventory 10,949 10,412 11,893 10,848 10,811 11,250
Inventory days 46 42 45 45 45 46
Debtors 20,556 21,463 25,427 22,205 22,213 24,054
Debtor days 86 86 86 86 86 87
Cash and bank 5,656 6,688 2,984 9,622 12,839 16,992
Loans and advances 4,537 2,455 5,192 5,780 5,792 6,382
Days of sales 19 19 19 19 19 19
Total current assets 41,699 41,018 45,496 48,455 51,655 58,677
Current liabilities 26,022 26,567 29,595 27,934 27,925 30,024
Current liability days 109 106 115 115 115 116
Provisions 5,986 3,603 4,298 6,436 6,444 7,041
Provision days 25 14 14 14 14 14
Total current liabilities and provisions 32,008 30,170 33,892 34,370 34,369 37,066
Net current assets 9,692 10,849 11,604 14,085 17,286 21,612
Net current assets excluding cash 4,035 4,161 8,620 4,463 4,448 4,620
Days of sales 17 17 31 17 17 16
Miscellaneous expenditures 0 0 0 0 0 0
Total application of funds 25,631 30,095 37,607 41,267 46,089 51,953
Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 99
Figure 138: Crompton Greaves – cash flow statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Profit before tax 8,672 11,891 12,291 6,425 8,217 9,858
Depreciation 1,216 1,551 1,936 2,072 1,630 1,711
Others 1,689 -509 -223 -422 -628 -669
Operating profit before working capital changes 11,577 12,932 14,004 8,074 9,219 10,900
Debtors -3,147 -664 -6,276 3,222 -8 -1,841
Inventory -251 726 -1,692 1,045 36 -438
Trade and other payables 3,228 407 2,989 478 -1 2,697
Others 228 74 -155 -588 -12 -590
Operating cash flow 11,635 13,475 8,871 12,231 9,235 10,728
Taxation -2,165 -2,920 -3,266 -1971 -2,357 -2,794
Cash flow from operating activities 9,470 10,555 5,605 10,259 6,877 7,934
Change in fixed assets -1,977 -2,070 -7,592 -2,500 -2,500 -2,500
Change in investments -714 21,330 -1,200 -750 -750 -750
Others -652 -25,010 1,411 758 879 920
Cash flow from investing activities -3,343 -5,751 -7,382 -2,492 -2,371 -2,330
Change in equity
Change in loans -1,374 -2,169 -379 219 0 1
Dividend paid and tax thereon -814 -1,159 -1,195 -996 -1,038 -1,203
Others -702 -451 -354 -354 -251 -249
Cash flow from financing activities -2,890 -3,778 -1,927 -1,131 -1,290 -1,451
Net change in cash and cash equivalents 3,238 1,032 -3,704 6,637 3,217 4,153
Opening balance of cash and equivalents 2,445 5,656 6,688 2,985 9,622 12,839
Closing balance of cash and equivalents 5,682 6,688 2,985 9,622 12,839 16,992
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 100
THERMAX (3-UW, PT: RS392, -17%): SLOW PACE OF NEW BUSINESS SCALE UP
We initiate coverage on Thermax with a 3-Underweight rating and a 12-month price target of Rs392 (P/E of 12 for FY13E). Although its core business continues to do well, we believe that a weak environment for ordering in the industrial segment should slow of Thermax’s order growth rates and earnings momentum in the coming quarters. With the order environment for IPPs weak, we believe it would be difficult for Thermax to win orders beyond what is already in the pipeline. The company’s potential inability to scale up subcritical and supercritical businesses would likely impact the stock’s valuations further.
Earnings momentum to decelerate: We expect earnings growth rates for Thermax to head into negative territory in the coming quarters given declining order book growth (down 7% in September quarter). We expect single-digit growth in earnings (3% y/y) and revenue next year due to weak order growth this year. Thermax has not won another subcritical utility order since the contract for Rs10bn for the Meenakshi power projects in FY10, which we believe is the result of depleting market ordering and stiff competition. The lack of new subcritical orders is the key reason for weak order growth in FY12.
Option value: Given the large market sizes of the new businesses that Thermax is venturing into, it would be prudent to expect some large wins in the coming year and some of these wins could have a substantial impact on order inflow growth for the company. We estimate a single supercritical 660MW EPC order win would double the order book for the company. The consensus forecasts, however, do not yet reflect that value, which we believe is because competition has decreased margins on new orders and hence the potential impact of a win is much lower than we thought earlier.
Core business priced in: Our analysis of four scenarios for ordering – 1) orders from core business only, 2) core business of Rs10bn-plus from subcritical wins, 3) core Rs20bn-plus wins, and 4) core Rs20bn-plus subcritical wins and Rs15bn-plus supercritical wins – suggests a price target range of Rs304-625. Therefore, the current stock price appears to be building in normal growth in the core business (ie, no recession) and some modest subcritical wins. We believe that given a weak industrial environment, which could impact the core business and likely create an inability to win modest subcritical orders, there is downside to the current stock price. Hence, we initiate coverage with a 3-Underweight rating. Given our positive view on management’s performance and the company’s strong execution skills, we would revisit the stock at levels below the core value (ie, Rs308).
Figure 139: Thermax – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Mar Rs mn Rs % (x) (x) (%) (%)
2011A 3,831 32 70.8 14.6 4.3 29.6 2.4
2012E 3,812 32 -0.5 14.7 3.7 25.1 2.9
2013E 3,889 33 2.0 14.4 3.2 22.2 2.9
2014E 4,671 39 20.1 12.0 2.8 23.0 3.5
Source: Company data, Barclays Capital estimates
TMX IN / THMX.NS
Stock Rating 3-UNDERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 392.00
Price (02-Dec-2011) INR 469.70
Potential Upside/Downside -17%
Barclays Capital | India Capital Goods
7 December 2011 101
COMPANY SNAPSHOT
THERMAX INDIA CAPITAL GOODS
Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 48,832 51,072 52,376 62,767 8.7% Stock Rating 3-UNDERWEIGHTEBITDA 5,668 5,544 5,688 6,815 6.3% Sector View 2-NEUTRALEBIT 5,236 5,001 5,046 6,049 4.9% Price (02-Dec-2011) 469.7Pre-tax income 5,737 5,616 5,775 6,939 6.5% Price Target 392Net income 3,831 3,812 3,889 4,671 6.8% Ticker THMX.BO/TMX INEPS (R) 32.15 31.99 32.64 39.20 6.8%Diluted shares (mn) 119.15 119.15 119.15 119.15 0.0% Investment case
DPS (R) 10.46 12.80 13.06 15.68 14.4%
Margin and return data (%) AverageEBITDA margin 11.6 10.9 10.9 10.9 11.0EBIT margin 10.7 9.8 9.6 9.6 9.9Pre-tax margin 11.7 11.0 11.0 11.1 11.2Net margin 7.8 7.5 7.4 7.4 7.5ROIC 28.3 24.2 21.5 22.4 24.1ROA 28.2 24.0 21.3 22.2 23.9 Upside case 625ROE 29.6 25.1 22.2 23.0 25.0
Balance sheet and cash flow (INRmn) CAGRFixed assets 5,163 5,121 5,229 5,213 0.3%Cash and equivalents 6,566 7,664 8,939 11,651 21.1%Total assets 35,928 39,239 42,168 49,721 11.4%Current liabilities 22,323 23,346 23,943 28,693 8.7%Long term liabilities 682 682 682 682 0.0% Downside case 171Total liabilities 35,928 39,239 42,168 49,721 11.4%Net debt/(funds) (6,085) (7,183) (8,458) (11,170) NAShareholders' equity 12,923 15,210 17,544 20,347 16.3%Change in working capital (1,161) (232) 49 394 NACash flow from operations 1,142 3,508 3,856 4,949 63.0%Capital expenditure (572) (500) (750) (750) NAFree cash flow 570 3,008 3,106 4,199 94.6%
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 14.6 14.7 14.4 12.0 13.9 EV/EBITDA (x) 8.1 7.9 7.4 5.8 7.3 FCF yield (%) 1.0 5.4 5.5 7.5 4.9EV/sales (x) 1.0 1.0 0.9 0.7 0.9 Price/BV (x) 4.3 3.7 3.2 2.8 3.5 Dividend yield (%) 2.2 2.7 2.8 3.3 2.8Total debt/capital (%) 3.5 3.0 2.6 2.3 2.9Net debt/EBITDA (x) -1.1 -1.3 -1.5 -1.6 -1.4
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics Expect Rs20bn worth of IPP wins until FY14Order inflow 53,180 53,180 63,339 74,537 Order inflow growth (%) -5 0 19 18Orderbook 56,050 58,158 69,121 80,891 Orderbook growth (%) 4 4 19 17
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 3-Underweight? Weak investment cycle toimpact industrial ordering. Expect earningsmomentum to weaken. With order environment forIPP’s weak, Thermax may find it difficult to scale upsub/supercritical businesses which would impactvaluations further, in our view.
We see an upside to our estimates for FY14 andbeyond on order wins of over Rs20bn in the IPPsegment. A large supercritical win could reratemultiples. Assuming supercritical wins andsubcritical wins of Rs20bn, stock could trend up toP/E of 18x and forward EPS of Rs33.
Core business in a normal cycle supports a valuationof Rs308. We believe that weak industrial cycletypically leads to order cancellations and in thatscenario there is a likelihood of stock going down totrough P/E.
10000
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INR171(-63.5%)Downside
Case
INR392(-16.5%)
PriceTarget
INR625(33.0%)
UpsideCase
0
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15-Dec-10 2-Dec-11
INR171(-63.5%)
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INR392(-16.5%)
PriceTarget
INR625(33.0%)
UpsideCase
0100200300400500600700800
15-Dec-10 2-Dec-11
Barclays Capital | India Capital Goods
7 December 2011 102
Near-term momentum weak but there is an option value
Thermax has been attempting to scale up its business from an industrial captive power boiler/boiler manufacturer and industrial solutions providers (water, air pollution control) to a manufacturer of subcritical utility boiler/EPC and supercritical boilers. Thermax has partnered with Babcock and Wilcox for both ventures. For supercritical boilers, however, it is in the form of a joint venture with Thermax holding a majority stake.
While Thermax is now exposed to businesses with significantly bigger market sizes than earlier (revenue of Rs1,000bn pa vs. Rs200bn), it has won only one order in the LPP (large power plant) subcritical segment while in the supercritical business, bidding has just commenced. The potential upside surprise, however, would likely come from an ability to convert even a few orders or a market share of only 5% in the initial years, which we believe would be sufficient to double the current order book. Given that Thermax has all the capabilities and manufacturing facilities (in India) to set up this business, it is likely that some orders will come through. In our revenue forecast for FY13, we include an estimate of Rs12.5bn for such orders.
Figure 140: Thermax – IPP order wins, FY10-14E (Rs mn)
1250010000
7500
0
5000
10000
15000
Mar-10 Mar-11 Mar-12E Mar13E Mar14E0%
4%
8%
12%
16%
20%
Power sector IPP inflow Power IPP inflows as % of overall inflows
We forecast Rs20bn in order wins for FY13-14 for Thermax
Source: Company data, Barclays Capital estimates
Figure 141: Thermax – Earnings growth rates, June 2005-September 2012E
-40%-20%
0%20%40%60%80%
100%120%140%160%
Jun0
5
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11E
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Earnings growth YoY
Earnings growth to head to negative territory
We expect earnings momentum to weaken
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 103
Balance sheet over growth
Thermax sports a negative working capital (advances) and has no leverage. Management has typically been unwilling to take projects with unfavourable terms (that could impact balance sheet) or have exposure to companies with weak balance sheets (state utilities).
With the order environment for the power segment challenging and competition high, we believe that the terms of new contracts will not be as favourable for vendors as before, and from that perspective, Thermax will likely have to either accept balance sheet risk or decide not to take such orders. We believe that given the large size of power contracts. it would be prudent for Thermax to protect its balance sheet (only Rs12bn). Therefore, we expect order inflow to be lower than guidance. That said, unlike BGR Energy, Thermax appears to have sufficient cash reserves to set up new capacity without any equity dilution.
Figure 142: Thermax – net working capital days, March 1994-March 2011: now negative
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90100
89 91 92
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020406080
100120140
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Net working capital days
The working capital cycle is negative, and Thermax intends to maintain such a trend, in our
view
Source: Company data, Barclays Capital
Figure 143: Thermax – Cash flow generation (Rs bn), March 2003-March 2011
0
1,000
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8,000
Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
Operating profit before WC changes Pre tax cash flow post WC changes
Cash flow generation has been strong in the past
Source: Company data, Barclays Capital
Focus on balance sheet protection is good, in our view,
but it will impact growth as there are no good projects in the
market
Barclays Capital | India Capital Goods
7 December 2011 104
Understanding the value of the core business
If we were to take a view that Thermax will not be able to win orders in the new businesses, then how much support can the core business lend to valuations? Essentially, we are stripping core from the new and trying to understand what the stock price currently implies. In order to calculate this we have made assumption on order inflows based on various scenarios and calculated fwd EPS. We also use different P/E ranges for each scenario as we believe that while a win in supercritical order does not impact EPS in the near term it would lead to a rerating of P/E as investors will start valuing the supercritical JV.
Figure 144: Thermax – estimates of value of core business plus value accretion led by various additional contract wins (Rs/share)
625
587442308
0
100
200
300
400
500
600
700
800
Core Subcritical wins ofRs10bn
Subcritical wins ofRs20bn
Subcritcial+supercriticalwin
Order inflow: Rs44bn, P/E of 12x, EPS of Rs26
Order inflow: Rs54bn, P/E of 16x, EPS of Rs28
Order inflow: Rs65bn, P/E of 18x, EPS of Rs33
Inflow: Rs80bn, Add value of supercritical JV, EPS of Rs33
Core business supports a valuation of Rs308, on our
estimate, and a stock price above that appears to build in
success in new businesses
Source: Barclays Capital estimates
Valuation
Our 12-month price target of Rs392 for Thermax is based on 12x our earnings estimate for FY13. Our target P/E multiple is set at a 30% discount to its historical average for the past seven years as the average multiples have been propped, in our view, by the expectation of success in the subcritical and supercritical IPP foray. We are modelling only core industrial business and modest wins in subcritical space and hence the discount.
Our valuations build in modest wins in the subcritical IPP space of Rs12.5bn in FY13 and hence are pegged between the first (core) and second scenarios as shown in Figure 144.
Barclays Capital | India Capital Goods
7 December 2011 105
Figure 145: Thermax – historical 12-month forward P/E, 1994-2011E
5
10
15
20
25
30
35
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-94
Oct
-95
Aug
-96
Jun-
97
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Thermax
Stock has de-rated due to low visibility on order wins in
subcritical space
Valuations have compressed but 12-month forward P/E is base on
peak cycle earnings
Source: Datastream, Barclays Capital
Risks The key risks that could keep our price target from being achieved, in our view, include the following: 1) Given the large scale of the new businesses that Thermax has ventured into, any large order wins in either subcritical or supercritical businesses at a good pricing could re-rate the stock. 2) Continued strength in core industrial business could also lead to earnings surprises, 3) A faster-than-expected scaling up of new business ventures in the solar and geothermal segments could also help multiples.
Figure 146: Thermax – history of consensus EPS forecasts shows that estimates typically get cut in downturns (Rs)
Figure 147: Thermax – history of consensus EPS forecasts for FY12-14E shows some moderation in FY13 earnings estimates (Rs)
0
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FY12E FY13E FY14E
Source: Datastream, IBES consensus, Barclays Capita Source: Datastream, IBES consensus, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 106
Figure 148: Thermax – income statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Net sales 32,644 31,855 48,832 51,072 52,376 62,767
Material costs 20,976 20,585 34,159 36,207 37,201 44,590
% of sales 64% 65% 70% 71% 71% 71%
Personnel costs 2,546 2,927 3,686 3,675 3,706 4,433
% of sales 8% 9% 8% 7% 7% 7%
Other expenses 4,953 4,477 5,320 5,646 5,781 6,928
% of sales 15% 14% 11% 11% 11% 11%
Operating profits 4,168 3,866 5,668 5,544 5,688 6,815
OBITDA margin 13% 12% 12% 11% 11% 11%
EBITDA 4,556 4,363 6,190 6,198 6,459 7,752
EBITDA margin 14% 14% 13% 12% 12% 12%
Depreciation 321 404 432 542 642 766
Interest 33 15 22 39 46 55
Other income 388 498 523 654 771 937
Profit before tax and extraordinary items 4,202 3,944 5,737 5,616 5,771 6,931
Extraordinary items -14 -1,149 0 0 4 8
Profit before tax 4,216 2,795 5,737 5,616 5,775 6,939
Profit before tax margin 13% 9% 12% 11% 11% 11%
Taxation 1,319 1,356 1,906 1,804 1,882 2,260
Tax rate 31% 49% 33% 32% 33% 33%
Profit after tax 2,896 1,439 3,831 3,812 3,889 4,671
Profit after tax margin 9% 5% 8% 7% 7% 7%
Reported profit after tax 2,896 1,439 3,831 3,812 3,889 4,671
Adjusted profit after tax 2,910 2,243 3,831 3,812 3,889 4,671
Adjusted profit after tax margin 9% 7% 8% 7% 7% 7%
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 107
Figure 149: Thermax – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Ordinary share capital 238 238 238 238 238 238
Preference share capital 0 0 0 0 0 0
Reserves and surplus 9,381 10,270 12,685 14,972 17,306 20,108
Total shareholder equity 9,619 10,508 12,923 15,210 17,544 20,347
Loan funds 0 0 481 481 481 481
Net deferred tax liability 181 172 201 201 201 201
Total funds employed 9,799 10,680 13,605 15,892 18,226 21,028
Gross fixed assets 6,029 6,884 7,171 7,671 8,421 9,171
Depreciation 1,630 1,946 2,305 2,848 3,490 4,256
Net fixed assets 4,399 4,939 4,866 4,824 4,931 4,916
Capital WIP 177 112 297 297 297 297
Investments 1,765 3,782 4,044 5,044 6,044 6,544
Inventory 2,664 2,464 2,823 3,498 3,587 4,299
Inventory days 30 28 21 25 25 25
Contracts in progress 2,269 2,762 3,571 3,498 3,587 4,299
Number of days of sales 25 32 27 25 25 25
Receivables 5,408 7,471 10,013 10,494 10,762 12,897
Receivable days 60 86 75 75 75 75
Cash and bank 3,408 6,056 6,566 7,664 8,939 11,651
Other current assets 387 525 654 684 702 841
% of sales 1% 2% 1% 1% 1% 1%
Loans and advances 2,022 3,014 3,094 3,236 3,319 3,977
% of sales 6% 9% 6% 6% 6% 6%
Current liabilities 11,190 18,794 19,688 20,591 21,117 25,306
Current liability days 125 215 147 147 147 147
Contracts in progress 559 674 1,014 1,060 1,087 1,303
Days of sales 6 8 8 8 8 8
Provisions 949 975 1,621 1,695 1,739 2,083
Days of sales 11 11 12 12 12 12
Net current assets 3,459 1,848 4,398 5,728 6,954 9,272
Misc. expenditure not written off 0 0 0 0 0 0
Total assets 9,799 10,680 13,605 15,892 18,226 21,028
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 108
Figure 150: Thermax – cash flow statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Net profit before tax 4,179 3,919 5,730 5,616 5,771 6,931
Depreciation and amortization 321 404 432 542 642 766
Others -147 -201 -503 -615 -725 -881
Operating profit before working capital changes 4,353 4,122 5,659 5,544 5,688 6,815
Change in receivables 771 1,385 -3,179 -482 -268 -2,135
Change in inventory -669 201 -360 -774 -279 -2,221
Change in trade payables -260 2,033 2,846 903 526 4,189
Change in contracts in progress -1,318 -378 -469 121 70 561
Total changes in working capital -1,476 3,240 -1,161 -232 49 394
Operating cash flow 2,890 7,363 4,498 5,312 5,737 7,209
Direct taxes -1,393 -1,346 -1,799 -1,804 -1,882 -2,260
Cash flow from operating activities 1,480 5,834 1,142 3,508 3,856 4,949
Change in fixed assets -1,595 -880 -572 -500 -750 -750
Change in investments 4,189 -2,010 -260 -1,000 -1,000 -500
Others 201 417 435 654 771 937
Cash flow from investing activities 2,795 -2,474 -397 -846 -979 -313
Change in share capital 0 0 0 0 0 0
Change in loans 0 0 481 0 0 0
Change in preference shares 0 0 0 0 0 0
Dividend paid -1,114 -696 -695 -1,525 -1,556 -1,868
Others -33 -15 -22 -39 -46 -55
Cash flow from financing activities -1,147 -712 -236 -1,564 -1,602 -1,924
Net change in cash flows 3,129 2,648 510 1,098 1,275 2,712
Opening cash 279 3,408 6,056 6,566 7,664 8,939
Closing cash 3,408 6,056 6,566 7,664 8,939 11,651
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 109
HAVELLS (1-OW, PT: RS502, +18%): LIGHTING UP
We initiate coverage of Havells with a 1-Overweight rating and a 12-month price target of Rs502 (11x FY13E EV/EBITDA for India, 5x EV/EBITDA for Sylvania). We expect a CAGR of over 17% for domestic business earnings, driven by the new launches in the appliance sector, which should benefit from Havells’ strong branding and its well-entrenched distribution network. The improving mix of branded consumer business for domestic sales should also help damp earnings volatility and rerate multiples. With margins at Sylvania recovering, we expect consolidated earnings to grow at a 23% CAGR over FY11-13E. Valuations at 12x appear attractive, given the strength in earnings.
Consumer business new growth driver: We expect a domestic PAT growth CAGR at over 23% out to FY14E, with growth stemming from success of its new consumer initiatives. Havells is considered a strong brand in India with an efficient and loyal distribution network. The growth in PAT is due to its 17% CAGR for sales, which is modest compared with past trends and factors in the fact that over 60% of the business stems from new build. Given the slower growth in project starts, we expect slower growth in segments such as cables and wires and switchgears. Overall, we believe that Havells will continue to grow market share in most segments and this will help it grow at a faster pace than peers.
Business in Europe stable; should support earnings growth: While overall growth in Europe remains flattish, pricing is firm as per management comments. While we expect Havells to be able to hold up margins, this is primarily led by our view of an increase in the mix shift to faster-growth and higher-margin geographies. What Sylvania has given Havells is a global brand and a scale that helps it reduce costs through outsourcing. We also expect Havells to utilise its design capabilities and increase mix of the fixtures business in Europe.
Case for a rerating: Havells is trading at a forward P/E of 12x, despite the strong 23% CAGR in earnings expected. A key reason for the lower P/E appears to be due to the high revenue mix of commodity/industrial businesses and gearing to international business through Sylvania. The structure of growth for Havells, however, suggests that the mix of the consumer business and the contribution from high-growth geographies will increase. The change in mix will help the stock rerate, in our view.
Figure 151: Havells – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Mar Rs mn Rs % (x) (x) (%) (%)
2011A 3035 24.3 335.9 17.5 8.1 46.4 0.7
2012E 3467 27.8 14.3 15.3 5.4 35.5 0.5
2013E 4351 34.9 25.5 12.2 3.8 31.4 0.6
2014E 5147 41.2 18.3 10.3 2.8 27.6 0.7
Source: Company data, Barclays Capital estimates
HAVL IN / HVEL.NS
Stock Rating 1-OVERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 502.00
Price (02-Dec-2011) INR 424.55
Potential Upside/Downside +18%
Barclays Capital | India Capital Goods
7 December 2011 110
COMPANY SNAPSHOT
HAVELLS INDIA CAPITAL GOODS
Income statement (INRmn) 2011A 2012E 2013E 2014E CAGRRevenue 56,126 64,133 71,684 80,526 12.8% Stock Rating 1-OVERWEIGHTEBITDA 5,571 6,401 7,538 8,586 15.5% Sector View 2-NEUTRALEBIT 4,766 5,512 6,551 7,490 16.3% Price (02-Dec-2011) 424.55Pre-tax income 4,066 4,660 6,017 7,127 20.6% Price Target 502Net income 3,035 3,467 4,351 5,147 19.3% Ticker HAVL IN/HVLE.BOEPS (R) 24.32 27.79 34.87 41.25 19.3%Diluted shares (mn) 124.78 124.78 124.78 124.78 0.0% Investment case
DPS (R) 2.91 1.86 2.26 2.64 -3.1%
Margin and return data (%) AverageEBITDA margin 9.9 10.0 10.5 10.7 10.3EBIT margin 8.5 8.6 9.1 9.3 8.9Pre-tax margin 7.2 7.3 8.4 8.9 7.9Net margin 5.4 5.4 6.1 6.4 5.8ROIC 20.3 21.0 21.1 19.8 20.5ROA 16.6 18.5 19.1 18.7 18.2 Upside case 697ROE 46.4 35.5 31.4 27.6 35.2
Balance sheet and cash flow (INRmn) CAGRFixed assets 10,204 10,115 9,928 9,631 -1.9%Cash and equivalents 1,779 5,287 8,774 13,992 98.9%Total assets 35,635 38,383 43,732 51,134 12.8%Current liabilities 17,361 18,746 20,953 23,538 10.7%Long term liabilities 11,173 9,300 8,372 8,372 -9.2% Downside case 278Total liabilities 35,635 38,383 43,732 51,134 12.8%Net debt/(funds) 9,395 4,013 (402) (5,620) NAShareholders' equity 6,537 9,773 13,843 18,660 41.9%Change in working capital (2,013) 1,721 (143) (168) NACash flow from operations 3,426 7,952 7,395 8,418 34.9%Capital expenditure (1,887) (800) (800) (799) NAFree cash flow 1,540 7,152 6,595 7,619 70.4%
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 17.5 15.3 12.2 10.3 13.8 EV/EBITDA (x) 11.2 8.9 7.0 5.5 8.1 FCF yield (%) 2.9 13.5 12.4 14.4 10.8EV/sales (x) 1.1 0.9 0.7 0.6 0.8 Price/BV (x) 8.1 5.4 3.8 2.8 5.0 Dividend yield (%) 0.7 0.4 0.5 0.6 0.6Total debt/capital (%) 61.1 47.4 36.8 30.3 43.9Net debt/EBITDA (x) 1.7 0.6 - 0.1 - 0.7 0.4
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics EBITDA margin expected to remain steadyRevenues for new business 300.0 900.0 2,000.0 3,500.0 Sylvania revenues Eumn 27,836 30,352 32,141 34,418 Sylvania ebitda margins 5.8 7.9 8.4 8.6 Europe revenue growth -4.8 0.7 0.0 0.0
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 1-Overweight? We forecast a CAGR of morethan 23% in PAT for FY11-14 due to strength in thedomestic business aided by new consumer launchand improving margins at Sylvania. The increasingmix of the consumer business should help dampvolatility and boost valuations.
Continued strength in domestic market and Sylvaniamargins could lead to the stock heading to sectoraverage P/E of 20x.
In a rare scenario, if Sylvania starts making losses, itis likely that the stock could head to a sector troughP/E of 10x on current year earnings.
5.0%6.0%7.0%8.0%9.0%
10.0%11.0%
FY11 FY12E FY13E FY14E
EBITDA margin
DownsideCase
INR278(-34.5%)
PriceTarget
INR502(18.2%)
UpsideCase
INR697(64.1%)
100
300
500
700
900
16-Dec-10 2-Dec-11
DownsideCase
INR278(-34.5%)
PriceTarget
INR502(18.2%)
UpsideCase
INR697(64.1%)
0
300
600
900
16-Dec-10 2-Dec-11
Barclays Capital | India Capital Goods
7 December 2011 111
Consumer business new growth driver
We expect domestic revenues and profits to grow at a CAGR of 17% until FY14, led largely by strong growth in the consumer segment (40% of revenues). Our forecast growth rate for Havells is much slower than what Havells has achieved in the past, and this is because over 60% of its business is driven by new build (new build in real estate-housing, retail malls, commercial construction, etc), in our view, and given the slower pace of new builds in the past two years, we believe that Havells’ growth will be impacted with a lag. Continued market-share gains led by strong branding and increasing distribution reach will, however, enable the company to outperform peers, in our view.
Figure 152: Havells – growth expectations for various sub-segments
FY08-11 CAGR FY11-14E CAGR
Switchgears 12% 11% Management expects 12-15% growth
Cables and wires 10% 13% Expect 8-10% volume growth; value growth could be higher as prices have increased y/y
Lighting and fixtures 17% 18% Expect 20% growth for the market
Electrical consumer durables 26% 30% Fans- expect 10-12% value growth in FY12 and 15% in FY13; new business: Geysers and appliance target of Rs1bn revenue each
Source: Company data, Barclays Capital
Figure 153: Havells – market growth and Havell’s positioning
Estimated market
size (Rs mn) CAGR
FY11-14E FY12E FY13E FY14E
Domestic switchgear 15,680 12% Market growth 12% 12% 12%
Market share 28% 28% 28%
Industrials switchgear 32,100 7% Market growth 7% 7% 7%
Market share 5% 5% 5%
Switches modular 13,200 12% Market growth 10% 12% 15%
Market share 14% 14% 14%
Motors 27,563 8% Market growth 5% 10% 10%
Market share 3% 3% 4%
Cables 110,000 9% Market growth 10% 8% 8%
Market share 8% 8% 8%
Wires 66,000 10% Market growth 10% 10% 10%
Market share 9% 9% 9%
Lights-CFL 17,250 15% Market growth 15% 15% 15%
Market share 11% 11% 11%
Fixtures 30,000 20% Market growth 20% 20% 20%
Market share 12% 12% 12%
Fans 35,000 10% Market growth 0% 15% 15%
Market share 14% 15% 15%
Geysers and other products 33,600 20% Market growth 20% 25% 25%
Market share 3% 5% 8%
Source: Company data, Barclays Capital estimates
Expect domestic profits to grow at a CAGR of 17% until FY14, led
by strong growth in the consumer segment
Barclays Capital | India Capital Goods
7 December 2011 112
Consumer appliances business launched in FY12 Havells entered the geysers business in FY11 and thereafter entered the consumer appliance business in mid-FY12. The consumer appliances business is targeted to generate revenues of Rs500mn in FY12 and Rs1bn in FY13. The consumer appliance launch helps Havells target a market of over Rs20bn pa where Bajaj and Philips are the key competitors. Havells has launched products such as steam iron, toasters, ovens, juicer mixer grinders etc (See Figure89).
Business in Europe stable; to support earnings growth
Margin recovery at Sylvania continues to be strong and although market volumes remain flattish in Europe, pricing remains firm. Attempts to increase the mix of fixtures in sales could also help support margins. LatAm and Asia continue to be growth markets and given entry into new geographies, we continue to see strong growth (35-40% of revenue stems from these geographies).
Figure 156: Havells –sales and gross margin by region: strong recovery in margins in Europe was a key surprise
euro mn; March 1Q FY11 2Q FY11 3Q FY11 4Q FY11 1Q FY12 2Q FY12
Europe sales 66 65 74 73 64 69
Margin 2.8% 3.0% 4.5% 4.9% 6.1% 6.5%
Americas sales 33 38 36 36 36 40
Margin 8% 8% 9% 9% 10% 10%
Asia sales 5 6 5 5 7 7
Margin 3.3% 4.0% 5.0% 5.4% 5.8% 6.2%
Source: Company data, Barclays Capital estimates
Figure 154: Havells – Switchgears and cables to comprise more than 60% of revenues, FY12E
Figure 155: Havells – Expect higher profits from the consumer segment, FY12E
Switchgears24%
Cables and wires42%
Lighting and fixtures
16%
Others0.2%
Electrical consumer durables
18%
Switchgears46%
Cables and wires18%
Lighting and fixtures
18%
Electrical consumer durables
18%
Source: Company data, Barclays Capital Source: Company data, Barclays Capital
Havells launched its new consumer appliances business in
mid-FY12; we expect success in this business to drive growth and
also help increase the mix of consumer business in sales
Margins at Sylvania are expected to remain in a recovery mode;
An increasing mix of Americas and Asia led by expansion of its
geographic presence should also help margins
Barclays Capital | India Capital Goods
7 December 2011 113
Valuation Our 12-month price target of Rs502 for Havells is based on forward EV/EBITDA multiples of 5x for Sylvania, taking conservative valuations due to exposure to Europe, and 11x for the domestic business. Our target price implies a P/E of 15.8x for FY13E. Our target multiples are set at the historical average for the past seven years.
Havells is still viewed as an industrial stock given that more than 60% of its domestic revenue stems from segments such as switchgears and cables/wires, which are considered a commodity business and prone to sharp cyclical swings in revenues as well as margins. Its consumer business, however, is growing at a faster pace than the industrials business, and this should ensure that the business mix will change in favour of consumer business in the coming years. Given the branded nature of the business, it is expected to render stability to revenues and margins. Multiples should hence rerate for the stock over the longer term. At a consolidated level, consumer business already comprises more than 70% of revenue; however, low profitability at Sylvania and the exposure to international business (slower growth) keeps multiples under check.
Figure 157: Havells – Sylvania’s EBITDA margins expected to recover to over 8% in FY13E
Figure 158: Havells – Consolidated EBITDA margins to be supported by improvements at Sylvania
5.3%
2.8%2.1%
5.8%
7.9% 8.4% 8.6%
0%1%2%3%4%5%6%7%8%9%
FY08 FY09 FY10 FY11 FY12 FY13 FY14
EBITDA margin
6.9%
5.3%5.9%
9.9% 10.0% 10.5% 10.7%
0%
2%
4%
6%
8%
10%
12%
FY08 FY09 FY10 FY11 FY12E FY13E FY14E
EBITDA margin
Source: Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates
Figure 159: Havells – Country exposure in Europe (FY11)
Figure 160: Havells – Strong presence in LatAm (FY11)
France21%
UK18%
Germany and Austria
14%
Spain 9%
East Europe5%
Others33%
Colombia24%
Brazil21%
Argentina7%
Mexixo10%
USA13%
Others25%
Source: Company data, Barclays Capital Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 114
Figure 163: Havells – Valuation methodology
Rs mn FY12E FY13E FY14E Multiple
Standalone EBITDA 4,837 18% 20% 17% 11x
Sylvania EBITDA 2,701 47% 13% 9% 5x
EV 66,713
Net debt 4,106
Equity value 62,607
Share count (Mn shares) 125
Price target (Rs) 502
Source: Company data, Barclays Capital estimates
Figure 164: Havells – historical 12-month forward P/E (x): trading at the lower end
0
5
10
15
20
25
30
Jan-08 May-08 Oct-08 Feb-09 Jul-09 Dec-09 Apr-10 Sep-10 Jan-11 Jun-11 Nov-11
12 M fwd PE
The sharp correction in valuations in early 2009 was led
by Sylvania’s weak financial position
Source: Datastream, IBES consensus estimates, Barclays Capital estimates
Figure 161: Havells – consumer accounts for 33% of domestic sales …
Figure 162: …and 29% of segment profitability
24%29%
33%37% 39%
0%5%
10%15%20%
25%30%35%
40%45%
FY08 FY09 FY10 FY11 FY12E
Revenue from consumer segments
25% 25%29%
32%34%
0%
5%
10%
15%
20%
25%
30%
35%
40%
FY08 FY09 FY10 FY11 FY12E
profit from consumer statement
Source: Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates
We see significant upside for Havells despite factoring in
conservative multiples
Barclays Capital | India Capital Goods
7 December 2011 115
Risks
The key risks that could keep our price target from being achieved, in our view, include a weak margin performance at Sylvania, any failure to scale up new consumer launches; and sharp increase in commodity pricing could also impact numbers.
Figure 165: Havells – history of consensus EPS forecasts shows estimates were impacted in 2009 due to losses at Sylvania
Figure 166: Havells – history of current consensus EPS forecasts for FY12-14 shows that the strong recovery at Sylvania has led to estimates upgrades
-10
-5
0
5
10
15
20
25
30
Nov
-05
May
-06
Nov
-06
May
-07
Nov
-07
May
-08
Nov
-08
May
-09
Nov
-09
May
-10
Nov
-10
May
-11
FY06 FY07 FY08 FY09FY10 FY11
15
20
25
30
35
40
45
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
FY12 FY13 FY14
Source: Datastream, IBES consensus estimates ,Barclays Capital Source: Datastream, IBES consensus estimates , Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 116
Figure 167: Havells – income statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Net sales 54,775 54,315 56,126 64,133 71,684 80,526
Total material costs 30,070 29,180 32,556 32,207 35,999 40,439
% of sales 55% 54% 58% 50% 50% 50%
Employee costs 8,452 7,602 6,319 6,953 7,772 8,730
% of sales 15% 14% 11% 11% 11% 11%
Other costs 10,701 11,062 8,484 18,572 20,376 22,770
EBITDA 2,886 3,222 5,571 6,401 7,538 8586
OBITDA margin 5% 6% 10% 10% 11% 11%
Other income plus other operating income 86 222 237 202 87 87
Depreciation 905 837 804 889 987 1,096
Interest 1,253 979 902 884 620 450
Pre-tax exceptional items -1,986 0 -36 -170 0 0
Profit before tax -1,172 1,628 4,066 4,660 6,017 7,127
Profit before tax margin -2% 3% 7% 7% 8% 9%
Tax 429 932 1,031 1,192 1,666 1,980
Tax rate -37% 57% 25% 26% 28% 28%
Post-tax exceptional items
Profit after tax - reported -1,601 696 3,035 3,467 4,351 5,147
Profit after tax - adjusted -1,601 696 3,035 3,467 4,351 5,147
Profit after tax margin -3% 1% 5% 5% 6% 6%
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 117
Figure 168: Havells – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Share capital 301 312 624 624 624 624
Reserves and surplus 5,822 3,692 5,914 9,150 13,219 18,036
Shareholders equity 6,147 4,004 6,537 9,773 13,843 18,660
Secured loans 10,624 9,963 9,933 0 0 0
Unsecured loans 1,654 700 1,240 0 0 0
Loan funds 12,278 10,664 11,173 9,300 8,372 8,372
Total sources of funds 18,426 14,934 18,275 19,638 22,779 27,596
Gross block 28,961 26,963 28,454 29,254 30,054 30,853
Less: depreciation 20,427 18,089 18,499 19,388 20,375 21,471
Net block 8,534 8,874 9,955 9,866 9,679 9,382
Investments 0 0 0 0 0 0
Deferred tax net 0 -266 -559 -559 -559 -559
Inventories 7,947 8,246 10,860 9,736 10,883 12,225
Inventory days 53 55 55 55 55 55
Debtors 7,573 6,982 7,724 8,244 9,215 10,352
Debtor days 50 47 47 47 47 47
Cash and bank 2,473 1,481 1,779 5,287 8,774 13,992
Other current assets 79 102 100 120 134 150
as % of sales 0 0 0 0 0 0
Loans and advances 2,335 1,578 1,615 1,863 2,082 2,339
as % of sales 0 0 0 0 0 0
Current liabilities 13,934 15,555 16,722 18,367 20,529 23,062
Current liabilities days 93 105 105 105 105 105
Provisions 567 321 639 379 424 476
as % of sales 1% 1% 1% 1% 1% 1%
Net current assets 5,907 2,512 4,717 6,504 10,134 15,520
Total application of funds 18,426 14,934 18,275 19,638 22,779 27,596
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 118
Figure 169: Havells – cash flow statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Profit before tax -1,172 1,628 4,066 4,660 6,017 7,127
Depreciation 905 837 804 889 987 1,096
Trade and other receivables 414 1,232 -564 -788 -1,204 -1,410
Inventories 2,472 -139 -2,751 1,124 -1,146 -1,342
Trade payables -1,232 226 1,923 1,645 2,163 2,532
Other liabilities 514 1,224 -621 -260 45 52
Direct taxes paid -400 -699 -851 -1,192 -1,666 -1,980
Others 698 -1,396 569 683 534 363
Net cash from operating activities 2,199 2,913 2,575 6,760 5,729 6,439
Purchase of fixed assets -1,403 -1,536 -1,887 -800 -800 -799
Sale of investment 33 0 63 0 0 0
Addition of goodwill -233 367 -142 335 302 272
Sale of fixed assets 53 92 239 0 0 0
Others -75 16 8 202 87 87
Net cash used in investing activities -1,626 -1,061 -1,719 -263 -411 -441
Issue of preferential equity shares 11 0 0 0 0 0
Receipt of share premium 1,386 0 0 0 0 0
Proceeds from borrowings 217 -631 45 0 0 0
Repayment of borrowings -1,873 -176 -131 0 0 0
Interest paid -1,084 -871 -819 -884 -620 -450
Dividends paid -145 -226 -207 -231 -282 -330
Others 971 -954 540 -1,873 -928 0
Net cash from financing activities -515 -2,858 -572 -2,989 -1,830 -779
Net increase in cash 57 -1,006 285 3,508 3,487 5,219
Cash at the beginning of the year 2,358 2,425 1,471 1,779 5,287 8,774
Cash at the close of the year 2,415 1,481 1,779 5,287 8,774 13,992
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 119
AREVA T&D (2-EW, PT: RS193, -8%): MARGIN TROUGH AND ORDER RECOVERY
We initiate coverage on Areva T&D with a 2-Equal Weight rating and a 12-month price target of Rs193 (20x CY12E). Although Areva T&D’s margins appear to have troughed, and, after several years of weakness in the power transmission and distribution equipment (T&D) market, we are seeing some recovery in ordering, we believe that room for upside surprises are limited given the stiff competition in the T&D end market. Low returns on capital ratios (compared with peers such as Siemens) and limited new earnings drivers also do not help justify such rich valuations, in our view. However, we acknowledge that the premium may continue given the current demerger of the company and the hope of a future delisting.
Operating metrics recovering: The operating margin for Areva T&D has shrunk more than 800bps since its peak five years back. The greater mix of EPC projects, competitive end market and decrease in capacity utilisation were the key drivers. A likely improvement in order growth and an improved cost structure (lower imports due to the ability to use 100% domestic content from Indian factories) should help arrest the decline in margins and ensure that the current margins are sustainable, in our view.
Order momentum improving: The T&D market has witnessed several years of single-digit growth rates in ordering, and sharp price declines have also impacted value growth. With the T&D market expected to witness some recovery in volumes in the current year (as evident from improvement in tendering activity), we expect order growth rates for Areva T&D to improve. Continued pressure on pricing could, however, be a damper.
Key catalysts: Recovery in earnings growth and continued strength in inflows would serve as the key catalyst for the stock, in our view.
Valuations and rating: The three local arms of multinational T&D companies trade at steep valuations to peers, largely due to the perception on their ability to drive their long-term growth through their strong technology backing. Furthermore, the parents of all three companies – Siemens Ltd, Areva T&D India and ABB Ltd – have announced open offers in the past at steep valuations (due to strategic benefit of acquisition and lower cost of capital). Furthermore, a reduction in free floats has also helped support valuations. We believe that Areva T&D’s return ratios and growth expectations do not justify such steep valuations, but given the ongoing demerger and hopes of delisting at a future date, the artificially high multiples could be sustained. Therefore, we value Areva T&D at a P/E of 20x (avg P/E), and given limited downside to current price, we initiate with a 2-Equal Weight rating.
Figure 170: Areva T&D – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Dec Rs mn Rs % (x) (x) (%) (%)
2010A 1,868 7.8 -2.8 26.7 5.0 18.6 0.9
2011E 1,810 7.6 -3.1 27.6 4.4 15.9 0.8
2012E 2,312 9.7 27.7 21.6 3.8 17.5 1.0
2013E 2,598 10.9 12.4 17.9 3.3 18.2 1.1
Source: Company data, Barclays Capital estimates
ATD IN / AREV.NS
Stock Rating 2-EQUAL WEIGHT
Sector View 2-NEUTRAL
Price Target INR 193.00
Price (02-Dec-2011) INR 208.65
Potential Upside/Downside -8%
Barclays Capital | India Capital Goods
7 December 2011 120
COMPANY SNAPSHOT
AREVA T&D INDIAN CAPITAL GOODS SECTOR
Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 40,200 44,991 50,131 57,991 13.0% Stock Rating 2-EQUAL WEIGHTEBITDA 4,238 4,220 5,183 6,061 12.7% Sector View 2-NEUTRALEBIT 3,302 3,257 4,107 4,821 13.4% Price (02-Dec-2011) 208.65Pre-tax income 2,816 2,711 3,469 4,183 14.1% Price Target 193Net income 1,868 1,810 2,312 2,788 14.3% Ticker ATD IN/AREV.NSEPS (R) 7.81 7.57 9.67 11.67 14.3%Diluted shares (mn) 239.00 239.00 239.00 239.00 0.0% Investment case
DPS (R) 1.80 1.51 1.93 2.33 9.0%
Margin and return data (%) AverageEBITDA margin 10.5 9.4 10.3 10.5 10.2EBIT margin 8.2 7.2 8.2 8.3 8.0Pre-tax margin 7.0 6.0 6.9 7.2 6.8Net margin 4.6 4.0 4.6 4.8 4.5ROIC 12.1 10.9 12.6 13.8 12.4ROA 9.8 8.9 10.7 12.0 10.3 Upside case 300ROE 18.6 15.9 17.5 18.2 17.6
Balance sheet and cash flow (INRmn) CAGRFixed assets 8,939 8,976 8,401 8,161 -3.0%Cash and equivalents 1,199 109 667 478 -26.4%Total assets 44,681 44,314 48,321 54,134 6.6%Current liabilities 25,662 23,909 26,645 30,823 6.3%Long term liabilities 8,957 8,957 8,457 7,957 -3.9% Downside case 97Total liabilities 44,681 44,314 48,321 54,135 6.6%Net debt/(funds) 7,758 8,848 7,790 7,479 -1.2%Shareholders' equity 10,024 11,410 13,181 15,317 15.2%Change in working capital (3,519) (2,440) (1,289) (2,065) NACash flow from operations 1,075 879 2,737 2,602 34.2%Capital expenditure (1,131) (1,000) (500) (1,000) NAFree cash flow (56) (121) 2,237 1,602 NA
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 26.7 27.6 21.6 17.1 23.2 EV/EBITDA (x) 13.6 13.9 11.1 9.5 12.0 FCF yield (%) -0.1 -0.3 4.7 3.4 1.9EV/sales (x) 1.4 1.3 1.2 1.0 1.2 Price/BV (x) 5.0 4.4 3.8 3.3 4.1 Dividend yield (%) 0.9 0.8 1.0 1.2 0.9Total debt/capital (%) 47.1 43.9 39.0 34.1 41.0Net debt/EBITDA (x) 0.8 0.8 0.6 0.5 0.7
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics Ebita margins expected to stabilise nowOrder inflow 41,848 48,858 57,200 70,356 Order inflow growth (%) -69 1,675 1,707 2,300Orderbook 49,365 53,232 60,300 72,665 Orderbook growth (%) 345 783 1,328 2,051
Source: Company data, Barclays Capital estimates Note: FY end Dec.
Why a 2-Equal weight? While margins havetroughed and orders are recovering, room for upsidesurprises appear limited given stiff competition in the sector. With valuations being rich (vs expectations),we believe that the stock is pricing in a recovery.
If a delisting is announced the stock could head to itsprevious open offer price. Fundamental upside canbe driven by higher-than-expected order wins inpowergrid orders at good pricing.
In a worst case scenario, stock could head to itshistoric trough P/E of 10x. This would happen only ifpricing pressure continues in powergrid orders andorder book starts shrinking.
0%
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Dec-08 Dec-09 Dec-10 Dec11E Dec12E Dec13E
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INR97(-53.5%) Price
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INR300(43.7%)
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INR97(-53.5%)
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INR300(43.7%)
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Barclays Capital | India Capital Goods
7 December 2011 121
Operating metrics set to recover
Areva T&D suffered a sharp deterioration in margins from Dec-08 due to weak order inflows, a significant decline in pricing in the market, lower capacity utilisation (as capacity increased sharply to cater to higher voltage products) and high import content. Areva was also not able to utilise its new factories as they were unable to win significant orders in the 765kV transformer and reactor space given tender clauses that required procurement of at least 66% of the tender from factories with two years of experience in supplying the product. We believe that margins may have bottomed out and that they should stabilise at the current levels due to 1) stable pricing in the market as entry-level pricing has impacted margins for incumbents, 2) new tender clauses that require compulsory JVs and domestic content, 3) factories approved for 100% domestic content, which should help reduce high cost imports, and 4) likely improvement in order momentum.
Figure 171: Areva T&D – transformer/reactor capacity utilisation has improved
Figure 172: Areva T&D – capacity utilisation in switchgears still low
94%
81%
98%
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96%
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20%
40%
60%
80%
100%
120%
CY05 CY06 CY07 CY08 CY09 CY10
Capacity utilisation- transformers
87%
107%
89% 90%77%
0%
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40%
60%
80%
100%
120%
CY06 CY07 CY08 CY09 CY10
Switchgear-capacity utilisation
Source: Company data, Barclays Capital Source: Company data, Barclays Capital
Figure 173: Areva T&D – high cost imports as percentage of costs reducing
Figure 174: Areva – EBITDA margins recovering
14%
20% 19%
14%
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25%
CY07 CY08 CY09 CY10
import as % of sales
13%
18%
15%
11% 11%9%
11% 11%
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8%
12%
16%
20%
Dec
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Dec
-07
Dec
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Dec
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Dec
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-11
Dec
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Dec
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EBITDA Margin
Source: Company data, Barclays Capital Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 122
Order momentum improving
We expect an improvement in ordering (volumes) in the T&D segment led by a combination of recovery in Powergrid Corporation orders and ordering from various BOOT projects awarded this year. Areva T&D’s order inflows in 3Q FY11 were strong and led largely by wins in the 765kV segment (Figure 176).
Figure 175: Areva T&D – strong order wins in F3Q11
Client Product Order value
Rs mn
RRVPNL 765 kV substation package 4,000
Powergrid Corporation 765 kV transformer at Bareilly 850
Sterlite Technology 765 kV substation package 2,200
BHEL GIS package for SJVNL Rampur 580
Reliance Infrastructure 220 kV substation for Rajasthan Solar 400
OPTCL 63 MVA power transformer package 340
Aditya Aluminium ETC package 300
Lanco Infratech Substation package at Anuppur 300
NEEPCO 132 kV switchyard 250
India projects 180
Source: Company data, Barclays Capital
Figure 176: Areva T&D – order inflows expected to improve after three years of weak ordering (Y/Y growth)
58
21
40
3 (1)
17 1723
5346 49
17
38
1321
-10
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70
Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
Order inflow YoY Orderbook YoY
Source: Company data, Barclays Capital
Valuation Our 12-month price target of Rs193 for Areva T&D is based on a target P/E of 20x applied to our EPS forecast for 2012. The stock’s valuations are like its other MNC T&D peers, Siemens and ABB, which have typically been rich with an average forward P/E multiple of more than 20x. Our target multiple of 20x is set at the historical average multiple for the past seven years. The demerger process for Areva T&D (Areva T&D has been sold globally to Alstom and Schneider) has also been approved, and there could be a renewed interest in the stock during the period of the demerger, in our opinion.
Order recovery for the market and stable pricing should help
drive order inflow growth for the company
MNC stocks typically trade at a steep premium to peers in India.
We value Areva T&D at a forward P/E of 20x at the historical average values
Barclays Capital | India Capital Goods
7 December 2011 123
Figure 177: Areva T&D – historical 12-month forward P/E
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Areva T&D Linear (Areva T&D)
Areva T&D’s valuation multiples have derated from a peak of 35x
to 19x now
Given risk to earnings, we do not expect a re-rating of the stock
near term
Source: Barclays Capital
Figure 180: Areva T&D – stock price vs. EBITDA margin
0
100
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600
Jan-
05
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06
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Price EBITDA margins
Areva T&D’s stock price has tracked trends in its EBITDA margin. With our forecast of
EBITDA margins to remain at current levels, room for EPS
upgrades and a stock rerating appears limited.
Source: Datastream, Barclays Capital estimates
Figure 178: Areva T&D – history of consensus EPS forecasts shows that estimates were sharply revised down largely due to a sharp compression in margins
Figure 179: Areva T&D – history of consensus EPS forecasts shows for 2012-14 that consensus numbers post the recent cuts are expecting margins and order volumes to improve
0
5
10
15
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25
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08
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Source: Datastream, IBES consensus estimates , Barclays Capital Source: Datastream, IBES consensus estimates , Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 124
Risks
The key risks that could keep our price target from being achieved, in our view, include the following: 1) Continued pressure on pricing from competitors and setting up of domestic manufacturing by Chinese or Korean firms could lead to a further deterioration in margins. 2) The change in substation tendering clauses have increased competitive intensity in that segment and inability to win orders (market share losses) could impact our view of recovery in order inflows for the company. And 3) execution delays in power projects and subsequent delays in ordering for T&D projects could impact market ordering.
Figure 181: Areva T&D – income statement, 2008-13E
Rs mn; years ending December 2008 2009 2010 2011E 2012E 2013E
Net sales 26,412 35,659 40,200 44,991 50,131 57,991
Materials, manufacturing and operating expenses 17,141 24,926 27,531 30,950 34,466 39,828
% of sales 65% 70% 68% 69% 69% 69%
Staff cost 2,091 2,924 3,460 3,681 4,303 4,970
% of sales 8% 8% 9% 8% 9% 9%
Sales and administrative expenses 2,928 3,794 4,971 6,140 6,179 7,132
% of sales 11% 11% 12% 14% 12% 12%
Expenditure 22,557 31,711 35,962 40,771 44,949 51,930
% of sales 85% 89% 89% 91% 90% 90%
OBITDA 3,855 3,947 4,238 4,220 5,183 6,061
OBITDA margin 15% 11% 11% 9% 10% 10%
Depreciation 340 611 936 963 1,075 1,240
Other income 142 173 169 82 - -
Interest 302 579 655 628 638 638
Profit before tax 3,355 2,931 2,816 2,711 3,469 4,183
Total taxation 1,196 1,010 949 901 1,157 1,395
Tax rate 36% 34% 34% 33% 33% 33%
Reported profit after tax 2,263 1,921 1,868 1,810 2,312 2,788
Adjusted profit after tax 2,160 1,921 1,868 1,810 2,312 2,788
Adjusted profit after tax margin 8% 5% 5% 4% 5% 5%
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 125
Figure 182: Areva T&D – balance sheet, 2008-13E
Rs mn; years ending December 2008 2009 2010 2011E 2012E 2013E
Share capital 478 478 478 478 478 478
Reserves and surplus 6,772 8,188 9,546 10,932 12,703 14,839
Total shareholder equity 7,250 8,666 10,024 11,410 13,181 15,317
Unsecured loans 4,692 7,676 8,957 8,957 8,457 7,957
Total loans 4,692 7,676 8,957 8,957 8,457 7,957
Total sources of funds 11,942 16,342 19,019 20,405 21,676 23,312
Application of funds
Adjusted gross block 4,062 10,839 11,949 12,949 13,449 14,449
Less: depreciation 2,104 2,455 3,233 4,197 5,272 6,512
Net block 1,971 8,384 8,715 8,752 8,177 7,937
Capital WIP 4,500 519 224 224 224 224
Investments 0 0 2 1 1 -
Deferred tax assets net 387 100 - - - -
Inventory 3,862 3,790 4,808 6,579 7,330 8,421
Inventory days 53 53 53 53 53 53
Debtors 11,889 15,994 21,400 20,253 22,567 26,056
Debtor days 164 164 164 164 164 164
Cash and bank 451 1,325 1,199 109 667 478
Loans and advances 2,816 3,174 3,192 4,797 5,345 6,379
Total current assets 21,601 28,759 35,740 35,337 39,919 45,973
Current liabilities 15,405 20,321 24,635 21,441 23,898 27,645
Current liability days
Provisions 1,111 1,099 1,027 2,468 2,747 3,178
Provision days
Total current liabilities and provisions 16,516 21,420 25,662 23,909 26,645 30,823
Net current assets 5,085 7,339 10,078 11,428 13,274 15,150
Net current assets excluding cash 4,634 6,014 8,878 11,319 12,607 14,673
Total application of funds 11,942 16,342 19,019 20,405 21,676 23,312
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 126
Figure 183: Areva T&D – cash flow statement, 2008-13E
Rs mn; years ending December Dec-08 Dec-09 Dec-10 Dec11E Dec12E Dec13E
PBT 3,470 2,931 2,816 2,711 3,469 4,183
Depreciation 340 611 936 963 1,075 1,240
Others 839 1,230 1,437 545 638 639
Operating profit before working capital changes 4,650 4,772 5,190 4,220 5,183 6,062
Debtors (5,815) (6,376) (6,705) 1,084 (3,273) (5,153)
Inventory (1,133) 72 (1,018) (1,771) (752) (1,090)
Trade and other payables 5,362 5,093 4,204 (1,753) 2,736 4,178
Others
Operating cash flow 3,064 3,561 1,670 1,780 3,894 3,997
Taxation (1,521) (1,282) (595) (901) (1,157) (1,395)
Cash flow from operating activities 1,543 2,280 1,075 879 2,737 2,602
Change in fixed assets (4,217) (3,201) (1,131) (1,000) (500) (1,000)
Change in investments 118 16 - - - -
Others 3 1 2 82 - -
Cash flow from investing activities (4,096) (3,185) (1,129) (918) (500) (1,000)
Change in equity - - - - - -
Change in loans 3,543 2,873 1,079 - (500) (500)
Dividend paid and tax thereon (500) (499) (500) (424) (541) (652)
Others (272) (595) (650) (628) (638) (638)
Cash flow from financing activities 2,771 1,779 (71) (1,051) (1,679) (1,791)
Net change in cash and cash equivalents 217 874 (125) (1,090) 558 (189)
Opening balance of cash and equivalents 223 451 1,325 1,199 109 667
Closing balance of cash and equivalents 441 1,325 1,199 109 667 478
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 127
VOLTAS (3-UW, PT: RS78, -15%): EMERGING STRUCTURAL RISKS A CONCERN
We initiate coverage on Voltas with a 3-Underweight rating and a 12-month price target of Rs78 (11x FY13E). Voltas is undergoing an extremely tough patch, in our view, with almost every segment of its business underperforming. The core Mechanical and Electrical Projects (MEP) business (60% of revenue) faces structural challenges with extended ordering timelines, changes in geographic scope and heightened competition. Bidding margins for Voltas are at 5% vs. more than 9% in the past. The A/C products business, which could have supported earnings (30% of segment profits), was affected by cooler summers and higher interest rates. With price discounting by the market likely to intensity, either volumes or margins could be under pressure. Although these issues appear well understood and reflected in current-year consensus estimates, we still do not expect a substantial recovery next year with order visibility being low. Despite the attractive valuations, it may be too early to bottom fish, in our view.
Structural and cyclical concerns: The fundamental issues that Voltas is facing are not just a reflection of a weak cycle, in our view. The core MEP segment thrives on demand from the Middle East, where after the problems in Dubai market, contractors were forced to search for new geographies. Voltas has hence been targeting Qatar and Saudi Arabia, but the pace of order wins in those countries has been disappointing. With competition intensifying, management plans to bid for projects using a margin of 5% vs. 9% for this segment in FY10-11. The product business that was experiencing strong growth rates is also witnessing a decline in growth rates, largely attributed to cooler summers and higher interest rates.
Low visibility on earnings: Apart from the weak order inflow momentum, we note that Voltas has been impacted by losses at Rohini Electricals as well as losses and execution issues at the two projects in Qatar. This has materially affected margins in the MEP business (0.7% for the September quarter vs. 8% for the previous year). With bidding margins now as low as 5%, the business is becoming more sensitive to project-specific execution issues. For the products business, we expect competition in the AC business to further shrink the already low margins in this segment.
Heading to cyclical lows: We expect earnings growth to remain muted in FY13 and decelerate at a CAGR of 14% for FY11- FY14. While the order book gives visibility into the next 1.5 years of revenue, we believe that despite taking a conservative view on order inflows, our numbers build in Rs22bn of MEP orders in 2HFY12, which given the current environment, may prove difficult, implying that more downgrades could follow.
Figure 184: Voltas – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Mar Rs mn Rs % (x) (x) (%) (%)
2011A 3,234 9.8 -12.1 9.4 2.2 23.8 1.4
2012E 2,130 6.4 -34.1 14.3 1.9 13.4 1.1
2013E 2,180 6.6 2.4 14.0 1.7 12.4 0.8
2014E 2,068 6.2 -5.2 14.7 1.6 10.7 0.7
Source: Company data, Barclays Capital estimates
VOLT IN / VOLT.NS
Stock Rating 3-UNDERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 78.00
Price (02-Dec-2011) INR 92.10
Potential Upside/Downside -15%
Barclays Capital | India Capital Goods
7 December 2011 128
COMPANY SNAPSHOT
VOLTAS INDIA CAPITAL GOODS
Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 51,768 50,287 51,127 57,257 3.4% Stock Rating 3-UNDERWEIGHTEBITDA 4,408 2,666 2,798 2,660 -15.5% Sector View 2-NEUTRALEBIT 4,198 2,370 2,582 2,420 -16.8% Price (02-Dec-2011) 92.1Pre-tax income 4,843 4,123 3,160 2,998 -14.8% Price Target 78.0Net income 3,234 2,130 2,180 2,068 -13.8% Ticker VOLT IN/VOLT.BOEPS (R) 9.78 6.44 6.59 6.25 -13.9%Diluted shares (mn) 330.74 330.74 330.74 331.00 0.0% Investment case
DPS (R) 2.32 1.74 1.31 1.24 -18.8%
Margin and return data (%) AverageEBITDA margin 8.5 5.3 5.5 4.6 6.0EBIT margin 8.1 4.7 5.1 4.2 5.5Pre-tax margin 9.4 8.2 6.2 5.2 7.2Net margin 6.2 4.2 4.3 3.6 4.6ROIC 22.0 13.3 12.3 10.8 14.6ROA 21.2 12.1 11.3 9.9 13.6 Upside case 132ROE 23.8 13.4 12.4 10.7 15.1
Balance sheet and cash flow (INRmn) CAGRFixed assets 2,458 2,661 2,945 3,206 9.3%Cash and equivalents 4,980 6,746 7,621 7,971 17.0%Total assets 41,466 43,067 45,219 49,921 6.4%Current liabilities 26,232 25,481 25,907 29,013 3.4%Long term liabilities 1,381 1,432 1,412 1,351 -0.7% Downside case 28Total liabilities 41,466 43,067 45,219 49,921 6.4%Net debt/(funds) (3,599) (5,313) (6,209) (6,621) NAShareholders' equity 13,617 15,915 17,649 19,293 12.3%Change in working capital (3,317) 117 (67) (485) NACash flow from operations 392 3,583 2,600 2,095 74.8%Capital expenditure (446) (500) (500) (500) NAFree cash flow (54) 3,083 2,100 1,595 NA
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 9.4 14.3 14.0 14.7 13.1 EV/EBITDA (x) 6.1 9.4 8.7 9.0 8.3 FCF yield (%) -0.2 10.1 6.9 5.2 5.5EV/sales (x) 0.5 0.5 0.5 0.4 0.5 Price/BV (x) 2.2 1.9 1.7 1.6 1.9 Dividend yield (%) 2.5 1.9 1.4 1.3 1.8Total debt/capital (%) 9.1 8.1 7.3 6.5 7.7Net debt/EBITDA (x) -0.8 -2.0 -2.2 -2.5 -1.9
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics Order inflows continue to remain weak Order inflow 32,091 32,091 33,696 38,750 Order inflow growth (%) -15 0 5 15Orderbook 48,880 50,230 53,586 59,516 Orderbook growth (%) 4 3 7 11
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 3-Underweight? Voltas is facing issues in allits areas of operation. 1) MEP business has seen alarge geographic shift and increase in competitiveintensity; bidding margins are now only 5%. 2) ACmarket also going through cyclical issues.
A recovery in MEP business through large order winsin Middle East could help multiples recover to 20x -close to sector trading averages.
Continued weakness in margins and inability to evenmatch last year's inflows could lead to the stockmoving back to its trough P/E of ~5x.
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INR28(-69.5%)
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Barclays Capital | India Capital Goods
7 December 2011 129
Cyclical and structural issues
We expect all three segments – Mechanical and Electrical Projects, Engineering and Cooling Products – to witness a sharp deterioration in revenue and margins due to the weak ordering environment and significant increases in competition.
Figure 185: Voltas – management views on demand and competition not encouraging
Volume Competition Our view
Mechanical and Electrical Projects
Order volumes slow in established geographies
Profitability impacted by rising input costs, restrictive visa conditions and setbacks in cash flows amplified by higher capital engagement.
With bidding margins now at 5%, we believe that this leaves limited scope for errors in execution. We remain concerned on the medium-term outlook for this segment.
Rohini Order book at Rs2.6bn, up 13% y/y in 2Q FY12. Loss of Rs353mn in FY11. Management has set up a dedicated team to focus on business development, and this should help increase inflows.
Margins impacted by the slow progress of some orders (including a high-value rural electrification job). Receivables expanding and a concern.
Voltas continues to face integration challenges with Rohini Electricals. We do not expect significant improvements in the medium term. Receivable write offs could also impact goodwill in this business and remains a risk
Engineering Economic slowdown, inflation and high interest rates have significantly impacted investment sentiment and forward visibility is limited. In textile segment, pace of order inflows slowed down due to significant profitability concerns in the user industry. While TUF may continue beyond 2012, environmental problems at Tirupur and the change in business confidence and investment sentiment could impact inflows in the coming quarters
There has been a consolidation amongst global equipment manufacturers with Bucyrus and Letourneau (erstwhile principals) being taken over by Caterpillar and Joy respectively. Voltas faces tough competition from entrenched Indian distributors of the acquirers
We expect industrial segments to remain weak until FY14 and, hence, expect no recovery in revenues or margins next year
Air Conditions Market volumes impacted due to unfavourable weather conditions.
Competitive intensity increasing with market fragmenting. Several players (MNCs) stepping up ad spends and reducing prices in the market.
We are positive on long=term prospects of this market but do not expect significant volume recovery in FY12. In addition, margins will be under tremendous pressure due to price discounting by peers.
Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 130
Earnings momentum likely to remain weak
With Voltas bidding at 5% margins in the MEP segment and competitive activity in the cooling product segment likely to temper margins for Voltas, we believe that earnings growth for Voltas will remain weak for the next two years.
Figure 188: Voltas –EPS growth rate likely to remain weak
19%32%
41%
89%66%
21% 27%
56%
-12%
-34%
2%
-5%
-60%
-40%
-20%
0%
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60%
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100%
Mar
-03
Mar
-04
Mar
-05
Mar
-06
Mar
-07
Mar
-08
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-09
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-11
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12E
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13E
Mar
14 E
EPS growth YoY
Source: Company data, Barclays Capital estimates
Figure 186: Voltas – revenue mix, FY11: skewed towards MEP segment; slower ordering and low margins on new wins will likely impact earnings growth
Figure 187: Voltas – Profit mix, FY11: margins in key segments of MEP and cooling products to sharply deteriorate
MEP59%
Engineering 11%
Cooling products
30%
Others 0%
EMP48%
Engineering 20%
Cooling products
32%
Others 0%
Source: Company data, Barclays Capital Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 131
Figure 189: Voltas – segment revenues and profitability
Rs mn FY03 FY04 FY05 FY06 FY07 FY08 FY09 Mar10 Mar11 Mar12E Mar13E Mar14E
Segmental revenues
Electro-mechanical projects 7,017 7,778 8,556 11,897 14,383 17,449 27,668 31,134 30,411 30,741 30,340 32,820
y/y 11% 10% 39% 21% 21% 59% 13% -2.3% 1.1% -1.3% 8.2%
Engineering 649 837 1,591 2528 4,162 5,535 5,422 4,680 5,638 5,084 4,597 5,012
y/y 29% 90% 59% 65% 33% -2% -14% 20% -10% -10% 9%
Unitary cooling products 4561 4,596 4,617 5,006 5957 8,259 9,223 11,871 15,608 14,108 15,771 18,962
y/y 1% 0% 8% 19% 39% 12% 29% 31% -10% 12% 20%
Segmental profits
Electro-mechanical projects 341 216 460 673 685 1,170 2,134 3,091 2,393 830 1,196 1,081
Margin 4.9% 2.8% 5.4% 5.7% 4.8% 6.7% 7.7% 9.9% 7.9% 2.7% 3.9% 3.3%
Engineering 216 275 401 697 984 1,136 626 768 1,030 742 626 622
Margin 33% 33% 25% 28% 24% 21% 12% 16.4% 18.3% 14.6% 13.6% 12.4%
Unitary cooling 24 86 -53 -337 26 553 550 1,203 1,600 971 808 1,138
Margin 1% 2% -1% -7% 0% 7% 6.0% 10.1% 10.3% 6.9% 5.1% 6.0%
Source: Company data, Barclays Capital estimates
Significant risk to consensus estimates Although consensus earnings estimates have been revised down by 20-35% for FY12-13, we believe that the current numbers do not adequately capture the impact of likely weak margins in the key segments.
Figure 190: Voltas – history of consensus EPS forecasts shows that estimates typically get cut in downturns (Rs)
Figure 191: Voltas –history of consensus EPS forecasts for FY12-14 shows some moderation in FY13 earnings estimates (Rs)
0
2
4
6
8
10
12
14
Nov
-05
May
-06
Nov
-06
May
-07
Nov
-07
May
-08
Nov
-08
May
-09
Nov
-09
May
-10
Nov
-10
May
-11
FY06 FY07 FY08 FY09FY10 FY11
02468
1012141618
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
FY12 FY13 FY14
Source: IBES consensus, Barclays Capital Source: IBES consensus, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 132
Valuation
Our 12-month price target of Rs78 for Voltas is based on a P/E of 11 applied to our estimate for FY13. We set our P/E multiple of 11x at a 30% discount to the stocks historical average for the past seven years as 1) the MEP business has seen a large geographic shift and an increase in competitive intensity with bidding margins are now only 5% and 2) the AC market is also going through cyclical issues, seeing high competitive intensity.
Figure 192: Voltas – historical 12-month forward P/Es
05
101520
2530
3540
Sep-
04
Jan-
05
Jun-
05
Oct
-05
Feb-
06
Jun-
06
Oct
-06
Feb-
07
Jun-
07
Nov
-07
Mar
-08
Jul-
08
Nov
-08
Mar
-09
Jul-
09
Nov
-09
Apr
-10
Aug
-10
Dec
-10
Apr
-11
Aug
-11
Voltas 12M fwd PE
Source: Datastream, Barclays Capital
Risks
The key risks that could keep our price target from being achieved, in our view, include large order wins in the MEP segment in the Middle East and a recovery in the AC market next year.
Barclays Capital | India Capital Goods
7 December 2011 133
Figure 193: Voltas – income statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Net sales 43,252 47,575 51,768 50,287 51,127 57,257
Change in stock in trade -1,557 -596 -,645
Cost of materials 33,243 32,876 36,808 36,886 37,310 42,253
% of sales 73% 68% 68% 73% 73% 74%
Staff expenses 4,656 4,922 5,019 5,953 6,275 7,014
% of sales 11% 10% 10% 12% 12% 12%
Other expenses 4,087 5,777 7,178 4,781 4,744 5,331
% of sales 9% 12% 14% 10% 9% 9%
OBITDA 2,824 4,596 4,408 2,666 2,798 2,660
OBITDA margin 7% 10% 9% 5% 5% 5%
Interest 110 98 165 296 284 284
Other income 945 785 810 988 862 862
Depreciation 210 214 210 297 216 239
Profit before tax 3,456 5,068 4,843 4,123 3,160 2,998
Profit before tax margin 8% 11% 9% 8% 6% 5%
Extraordinary income/expenses 261 250 402 1,065 0 0
Profit before tax 3,717 5,318 5,244 4,123 3,160 2,998
Tax 1,172 1,472 1,729 1,248 979 929
Tax rate 32% 28% 33% 30% 31% 31%
Profit after tax 2,545 3,846 3,515 2,875 2,180 2,068
Profit after tax margin 6% 8% 7% 6% 4% 4%
Adjusted profit after tax 2,362 3,678 3,234 2,130 2,180 2,068
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 134
Figure 194: Voltas – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Share capital 331 331 331 331 331 331
Reserves and surplus 7,567 10,521 13,286 15,584 17,318 18,963
Total shareholder funds 7,897 10,852 13,617 15,915 17,649 19,293
Minority interest 159 139 218 220 234 246
Secured loans 1,688 306 1,280 1,331 1,311 1,249
Unsecured loans 127 45 101 101 101 101
Total debt 1,814 352 1,381 1,432 1,412 1,351
Deferred tax liability - 1 18 18 18 18
Total sources of funds 9,871 11,343 15,234 17,585 19,312 20,908
Gross fixed assets 3,986 3,890 4,410 4,910 5,410 5,910
Depreciation 1,839 1,821 1,987 2,284 2,500 2,739
Net fixed assets 2,148 2,069 2,422 2,626 2,910 3,171
Change WIP 132 193 36 36 36 36
Goodwill on consolidation 675 764 916 916 916 916
Investments 1,562 2,339 2,613 3,113 3,613 4,113
Inventories 11,194 6,579 8,224 7,989 8,122 9,096
Inventory days 94 50 58 58 58 58
Sundry debtors 9,521 9,555 11,705 11,370 11,560 12,946
Debtor days 80 77 83 83 83 83
Cash and bank balances 4,571 4,689 4,980 6,746 7,621 7,971
Other current assets - 4,866 7,961 7,733 7,862 8,805
Loans and advances 2,203 -7 2,440 2,370 2,409 2,698
Total current assets 27,489 28,249 35,309 36,207 37,575 41,516
Current liabilities 19,714 19,830 23,075 22,415 22,789 25,522
Current liabilities days 166 429 163 163 163 163
Provisions 2,645 2,645 3,157 3,067 3,118 3,492
Provision days 22 20 22 22 22 22
Current liabilities and provisions 22,360 22,475 26,232 25,481 25,907 29,013
Net current assets 5,129 5,774 9,077 10,726 11,667 12,503
Deferred tax assets 224 204 170 170 170 170
Total usage of funds 9,871 11,343 15,234 17,585 19,312 20,908
Source: Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 135
Figure 195: Voltas – cash flow statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Profit before tax 3,717 5,318 5,244 4,123 3,160 2,998
Depreciation 210 214 210 297 216 239
Operating profit before working capital 3,780 5,023 5,023 4,713 3,647 3,509
Change in inventories -4,618 -247 -4,737 235 -134 -974
Change in trade and other receivables -2,994 -411 -1,488 335 -190 -1,386
Change in loans and advances -507 263 -204 298 -169 -1,232
Change in advances from customers 1,813 579 438 -660 375 2,733
Change in trade payables 4,546 -442 2,673 -90 51 374
Change in working capital -1,760 -89 -3,317 117 - 67 -485
Others -1,487 - - -
Tax 1,048 1,611 1,879 1,248 979 929
Cash from operating activities 973 3,065 392 3,583 2,600 2,095
Purchase of fixed assets -439 -317 -446 -500 -500 -500
Sale of fixed assets 72 350 442 - - -
Purchase of investments -9,082 -1,664 -21,997 -500 -500 -500
Sale of investments 10,158 889 21,726 - - -
Cash from investing activities 649 -764 -288 -1,296 -1,284 -1,284
Repayment of loans -152 -1,463 1,029 51 - 20 - 61
Dividend paid -520 -615 -768 -575 -433 -411
Others 619 -99 -166 3 13 13
Net cash used in financing activities - 53 -2,177 96 -521 -441 -460
Net increase in cash and equivalents 1,569 124 200 1,766 875 350
Opening cash balance 3,002 4,571 4,695 4,980 6,746 7,621
Closing cash balance 4,571 4,695 4,980 6,746 7,621 7,971
Cash added on acquisition of subsidiaries 100
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 136
BGR ENERGY (3-UW, PT: RS241, -11%): BUSINESS MODEL CONCERNS
We initiate coverage on BGR Energy with a 3- Underweight rating and a 12-month price target of Rs241 (P/E of 6x for FY13E earnings). Despite its cheap forward valuations on our estimates, our concern on BGR Energy is its ability to make margins in the Boiler & Turbine end market and its ability to fund its substantial capex plans. BGR’s current earnings momentum appears to have peaked and its current forward valuations could have more downside as they are based on peak earnings, in our view, and do not factor in equity dilution and substantial fund raising.
Business model concerns: BGR Energy’s business model has changed over the years. From being a strong player in EPC for the balance of plants for power equipment, BGR has scaled up its business to subcritical EPC largely for state electricity utilities. Equipment was sourced from its Chinese collaborator, Dongfang Electric, and in the process, BGR Energy locked in a healthy 10% EBITDA margin. The business model, however, is set to change as the introduction of domestic manufacturing clauses in government contracts prompted it to set up a joint venture with Hitachi. Although a shift from EPC to a manufacturing focus is good, in our view, the timing may not be the best given the oversupply in the equipment space, weak order cycle until at least FY14 and current pricing at which margins are difficult to make.
Earnings concerns: We believe that BGR Energy’s earnings may have peaked. We expect a healthy FY13 followed by a collapse in earnings in FY14. Earnings for BGR Energy will likely be affected by rising interest rates, a gap in order inflows that will impact sales growth in the coming quarters and a new order wins that come with low margins. Cash flow generation has typically been weak and lumpy, and receivables days have extended further in the September quarter due to retention money getting delayed in some contracts (Vijayawada BOP contract by more than eight months).
Funding and dilution: We expect BGR Energy to spend about Rs35bn in the next three years to set up a boiler and turbine manufacturing facility. Or analysis of cash flows suggests a funding gap of about Rs24bn. With leverage already being high (Rs17bn, D/E of 1.5x), we believe that the funding will have to be through equity fund raising, which indicates a potential dilution ahead.
Underperformance to continue: BGR Energy’s stock has derated to 7x FY13 earnings and may appear cheap on historical comparisons, but these valuations are based on peak cycle earnings and do not reflect potential dilution. Any valuations methodology for BGR Energy will have to capture the likely weak margins post FY14 (or even losses) and dilution. We value BGR Energy at 6x (trough valuations) on FY13 (peak cycle earnings) and obtain a price target of Rs241.
Figure 196: BGR Energy – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Mar Rs mn Rs % (x) (x) (%) (%)
2011A 3,230 45 60 6.0 2.1 33.9 3.8
2012E 3,034 42 -6 6.4 1.7 25.8 3.5
2013E 2,906 40 -4 6.7 1.4 20.9 3.3
2014E 1,215 17 -58 16.1 1.3 8.2 1.4
Source: Company data, Barclays Capital estimates
BGRL IN / BGRE.NS
Stock Rating 3-UNDERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 241.00
Price (02-Dec-2011) INR 270.55
Potential Upside/Downside -11%
Barclays Capital | India Capital Goods
7 December 2011 137
COMPANY SNAPSHOT
BGR ENERGY INDIA CAPITAL GOODS
Income statement (INRmn) 2010A 2011E 2012E 2013E CAGRRevenue 47,498 45,979 49,860 53,718 4.2% Stock Rating 3-UNDERWEIGHTEBITDA 5,363 5,536 5,593 4,445 -6.1% Sector View 2-NEUTRALEBIT 5,190 5,334 5,373 4,209 -6.7% Price (02-Dec-2011) 270.55Pre-tax income 4,808 4,431 4,196 1,685 -29.5% Price Target 241Net income 3,230 3,034 2,906 1,215 -27.8% Ticker BGRL IN/BGRE.BOEPS (R) 44.77 42.05 40.27 16.83 -27.8%Diluted shares (mn) 72.16 72.16 72.16 72.16 0.0% Investment case
DPS (R) 10.01 9.25 8.86 3.70 -28.2%
Margin and return data (%) AverageEBITDA margin 11.3 12.0 11.2 8.3 10.7EBIT margin 10.9 11.6 10.8 7.8 10.3Pre-tax margin 10.1 9.6 8.4 3.1 7.8Net margin 6.8 6.6 5.8 2.3 5.4ROIC 13.7 11.1 9.4 4.8 9.8ROA 12.2 9.2 7.3 1.9 7.7 Upside case 337ROE 33.9 25.8 20.9 8.2 22.2
Balance sheet and cash flow (INRmn) CAGRFixed assets 2,840 3,637 8,417 38,181 138%Cash and equivalents 10,449 12,743 13,353 5,316 -20.2%Total assets 54,006 59,672 68,715 94,074 20.3%Current liabilities 27,516 26,636 28,884 31,120 4.2%Long term liabilities 9,520 11,776 13,936 14,840 15.9% Downside case 88Total liabilities 54,006 59,672 68,715 94,074 20.3%Net debt/(funds) 2,925 4,921 8,945 39,203 138%Shareholders' equity 9,520 11,776 13,936 14,840 15.9%Change in working capital (7,138) (3,455) (1,405) (1,397) NACash flow from operations (1,297) 685 2,898 2,578 NACapital expenditure (700) (1,000) (5,000) (30,000) NAFree cash flow (1,997) (315) (2,102) (27,422) NA
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 6.0 6.4 6.7 16.1 8.8 EV/EBITDA (x) 4.2 4.4 5.1 13.2 6.7 FCF yield (%) -10.2 -1.6 -10.8 -140.5 - 0.4 EV/sales (x) 0.5 0.5 0.6 1.1 0.7 Price/BV (x) 2.1 1.7 1.4 1.3 1.6 Dividend yield (%) 3.7 3.4 3.3 1.4 2.9Total debt/capital (%) 50.5 53.5 56.0 70.7 57.7Net debt/EBITDA (x) 0.5 0.9 1.6 8.8 3.0
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics Leverage expected to increaseOrder inflow 29,410 118,125 63,000 84,000 Order inflow growth (%) -20 302 -47 33Orderbook 79,710 151,856 164,996 195,277 Orderbook growth (%) -22 91 9 18
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 3-Underweight? Recent bids suggest that it isdifficult to make margins in the BTG sector. WithBGR set to spend over US$1bn on capex to set up itsBGR facilities we are concerned on its ability togenerate returns on this business.
Bull case for BGR Energy is a recovery in powermarket led by reforms in coal . In that case visibilityof orders improve and fwd valuations trend up to20x (avg of BHEL's P/E) on FY14 earnings. FY14captures the impact of weak margins
Bear case is that future wins for BGR Energy happenat prices which are perceived to be low. Street couldthen value it at trough P/E on FY14 earnings.
0.0
1.0
2.0
3.0
4.0
FY08 FY09 FY10 FY11 FY12E FY13E FY14E
Debt to equity ratio
DownsideCase
INR88(-67.4%)
PriceTarget
INR241(-10.9%)
UpsideCase
INR337(24.5%)
44
244
444
644
844
22-Dec-10 2-Dec-11
DownsideCase
INR88(-67.4%) Price
Target
INR241(-10.9%)
UpsideCase
INR337(24.5%)
0
100
200
300
400
500
600
22-Dec-10 2-Dec-11
Barclays Capital | India Capital Goods
7 December 2011 138
Funding concerns: weak cash generation and high capex plans
BGR Energy’s cash flow generation has usually been weak given the EPC nature of business and the fact that advances were not taken on some contracts (as these were interest bearing, e.g.- TNEB contract).Since FY08, aggregate cash generation has been less than 10% of overall profit generated. Working capital metrics deteriorated further in the Sep quarter with debtor days at over 440 days and delayed receivables (retention money) at some projects. Retention funds at Vijayawada BOP project are expected to be delayed by 9-12 months as per management comments.
Figure 197: BGR Energy – Sharp deterioration in working capital metrics; debt levels rising (Rs mn) Sep-10 FY11 Sep-11
Loan funds 14,224 13,363 23,074Debtor days 232 173 464Liability days 165 131 268Provision days 21 19 39Net current assets ex cash 13,312 13,391 23,744Working capital days 107 74 280
Source: Company data, Barclays Capital
Funding capex could be a challenge
The BGR Energy-Hitachi join venture is set to invest more than Rs45bn in the boiler and turbine joint venture of which BGR’s contribution is to be Rs34bn. Our analysis of cash flows for the next three years when this capex is likely to be incurred suggests that there would be a funding gap of Rs23bn. This funding gap will have to be bridged by raising debt or equity. We note that raising these funds through debt would be difficult as that would raise the company’s overall debt/equity ratio to more than 3.0x by FY14 and its interest burden pa could range to Rs3-4bn (depending on interest rate) as compared with our estimate of an EBITDA of Rs4-5bn pa. Since raising the entire gap through debt will not be possible, we believe that either BGR Energy will have to scale down its capex plans or extend the period of implementation of the project or raise equity. Given the negative outlook on power equipment sector, equity fund raising would be difficult, in our view.
BGR Energy’s cash flow generation has usually been
weak. Receivable days in Sep quarter has expanded to over
440 days
Figure 198: BGR Energy – net cash from operating activities: cash flow generation has usually been weak (Rs mn)
Figure 199: BGR Energy – net current assets ex-cash days: its business is working capital intensive (days)
-463
-1696
773
3299
-1297-2,000
-1,000
0
1,000
2,000
3,000
4,000
Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
Net cash from operating activities
134
120 119
73
101
0
20
40
60
80
100
120
140
160
Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
Net current assets ex cash days
Source: Company data, Barclays Capital Source: Company data, Barclays Capital
We expect a funding gap of more than Rs24bn, which has to
be bridged though equity fund raising
Barclays Capital | India Capital Goods
7 December 2011 139
Figure 200: BGR Energy –funding for capex plan appears difficult Calculations Rs bn
Current debt/equity ratio 1.40Current debt 13,373Current cash balance 10,449Cash generation (FY12-14) 6,256Cash tied up in working capital 6,415Total cash for capex 10,290Capex planned 33,750Cash required 23,460Debt at end of FY14E 36,833New debt/equity ratio 2.5Annual interest outflow Rs3-4bnEBIDTA 4,250
Source: Company data, Barclays Capital estimates
Figure 201: BGR Energy – debt/equity at consolidated level: set to increase to 3.0x
05,000
10,000
15,00020,00025,00030,00035,000
40,00045,00050,000
FY08 FY09 FY10 FY11 FY12 E FY13 E FY14 E0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Total Debt D/E
Source: Company data, Barclays Capital estimates
Earnings peaking; margins to deteriorate
BGR’s business model has changed. It was earlier an EPC contractor thriving on two end markets, 1) BOP EPC and 2) subcritical EPC largely for state electricity boards. The model was unique given that BOP was a strong volume and stable margin business and with several utilities shifting to ordering BOP packages to a single contractor instead of tendering out several packages separately. This was largely done to ensure that there are no delays in the implementation of the BOP packages. In the BTG space, BGR had a unique business model as it had partnered with Dongfang Electric for supplies of boilers and turbines while EPC, and BOP were implemented by BGR Energy. This benefitted the Chinese vendors as they were able to participate in orders for which ordering was for the entire EPC of the project. Visa issues and difficulty in managing several local contractors was the key issue that Chinese vendors were facing while bidding for EPC contracts. Given the pricing of Chinese equipment and limited competition in state utility orders, BGR was able to achieve EBITDA margins of more than 10% for these contracts.
BGR Energy’s business model has changed now to manufacturing of boiler and turbines in a new JV with Hitachi (announced last year). This change was largely dictated by introduction
Business model is changing now to a manufacturer of BTG
equipment; however, oversupply in the BTG markets could impact viability of new business venture
Barclays Capital | India Capital Goods
7 December 2011 140
of domestic manufacturing clauses in NTPC orders and an advisory sent to all state utilities to also implement domestic manufacturing clauses in future tenders. With large IPPs directly obtain boilers and turbines from China, this was a segment that BGR could not have targeted. While BGR Energy’s shift to manufacturing is a positive, our concern largely stems from the company’s ability to sustain current margins in the new business model. We believe that until indigenisation levels are increased (could take over 3-4 years), the business could be unprofitable. Furthermore, at the price levels in recent orders, it is difficult to generate returns at even very high indigenisation levels. Turbine manufacturing is capex intensive, and at the current pricing utilisation levels need to be higher than 60% to break even pre-taxes. We wonder if BGR Energy would be able to run at 60% or higher utilisation levels in its turbine business given the current excess capacity in the market.
Figure 202: BGR Energy – operating EBITDA margins could get severely affected
10.2% 10.8% 11.2% 11.3%12.0%
11.2%
8.3%
0%
2%
4%
6%
8%
10%
12%
14%
FY08 FY09 FY10 FY11 FY12 E FY13 E FY14 E
EBITDA margin
Our margin estimates could be aggressive. BGR Energy could be
generating losses in FY14
Source: Company data, Barclays Capital estimates
BGR Energy’s sales growth may have peaked in FY12. We expect the execution period to extend as BGR Energy has not won orders for several quarters. While the NTPC orders are expected to be booked in January, revenue recognition may not commence until 3Q FY12.
Figure 203: BGR Energy – execution period expected to lengthen and this will impact sales growth
20
36
26
21
37 37
0
5
10
15
20
25
30
35
40
FY09 FY10 FY11 FY12 E FY13 E FY14 E
Execution months
We expect execution period for BGR Energy to lengthen given the
gap in ordering and shift to longer lead time supercritical
projects
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 141
Expect more consensus earnings downgrades
We calculate that consensus numbers are not building in a drop in earnings growth rates in FY13 as they continue to factor in 10% margins on supercritical contracts, which we believe is difficult to achieve given the likelihood of weak utilisation rates and low pricing in the current order.
Valuation
Our 12-month price target of Rs241 for BGR Energy is based a target P/E of 6x applied to our EPS forecast for FY13E given our view that FY13 broadly represents the peak of its earnings cycle. Our P/E target represents the stock’s recent trough valuation since the financial crisis.
Figure 206: BGR Energy – historical 12-month forward P/E
0
5
10
15
20
25
30
Mar
-08
Sep-
08
Mar
-09
Sep-
09
Mar
-10
Sep-
10
Mar
-11
Sep-
11
BGR Energy 12M fwd PE
Source: Datastream, IBES consensus estimates ,Barclays Capital estimates
We expect consensus earnings downgrades to continue
Figure 204: BGR Energy – history of consensus EPS forecasts shows that continued upward revisions led to a re-rating in FY11 (Rs)
Figure 205: BGR Energy – history of consensus EPS forecasts shows that the earnings downgrade cycle has just commenced; we expect more cuts (Rs)
05
101520253035404550
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
FY08 FY09 FY10 FY11
30
35
40
45
50
55
60
Jun-09 Dec-09 Jun-10 Dec-10 Jun-11
FY12 FY13 FY14
Source: Company data, Barclays Capital estimates Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 142
Risks
The key risks that could keep our price target from being achieved, in our view, include a recovery in the power BTG market and an improved pricing on new orders. The ability to generate higher-than-expected cash flows through core operations would also help to reduce level of debt required for capex.
Figure 207: BGR Energy – income statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Net sales 19,303 30,734 47,498 45,979 49,860 53,718
Total expenditure 17214 27,292 42,136 40,443 44,266 49,274
Increase/decrease in WIP -11 25 -51 -2 0 0
Material and manufacturing cost 15,119 23,616 37,772 37,372 41,180 45,698
% of sales 78% 77% 80% 81% 83% 85%
Staff cost 731 1,248 1,431 1,613 1,564 1,822
% of sales 4% 4% 3% 4% 3% 3%
Administration, selling and general expenses 1,375 2,403 2,984 1,460 1,523 1,754
% of sales 7% 8% 6% 3% 3% 3%
OBITDA 2,089 3,442 5,363 5,536 5,593 4,445
OBITDA margin 11% 11% 11% 12% 11% 8%
Interest 579 538 605 945 1,221 2,541
Depreciation 75 103 173 202 220 236
Other income 317 250 223 42 44 18
Profit before tax 1,752 3,051 4,808 4,431 4,196 1,685
Profit before tax margin 9% 10% 10% 10% 8% 3%
Provision for taxation 586 1,037 1,577 1,397 1,290 470
Tax rate 33% 34% 33% 32% 31% 28%
Profit after tax 1,165 2,015 3,230 3,034 2,906 1,215
Profit after tax margin 6% 7% 7% 7% 6% 2%
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 143
Figure 208: BGR Energy – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12E FY13E FY14E
Share capital 720 720 722 722 722 722
Employee stock options application money 0.00 0.00 0.04 0.04 0.04 0.04
Reserves and surplus 4,919 6,343 8,798 11,054 13,215 14,118
Shareholder funds 5,639 7,063 9,520 11,776 13,936 14,840
Minority Interest 28 29 519 519 519 519
Secured loans 6,360 4,052 8,604 12,895 17,529 39,750
Unsecured loans 730 4,023 4,769 4,769 4,769 4,769
Total debt 7,090 8,075 13,373 17,664 22,298 44,519
Deferred tax liabilities 747 1,551 3,078 3,078 3,078 3,078
Total liabilities 13,504 16,717 26,490 33,036 39,831 62,954
Goodwill on consolidation of subsidiaries 6 6 6 6 6 6
Gross block 1,245 1,819 2,508 3,508 8,508 38,508
Less: depreciation and impairment 268 365 530 733 953 1,189
Net Block 977 1,454 1,978 2,775 7,555 37,319
CWIP (including capital advances) 54 104 862 862 862 862
Investments 5 5 5 5 5 5
Inventories 140 162 411 398 431 464
Sundry debtors 12,789 19,803 31,580 33,382 36,200 39,001
Debtor days 242 235 243 265 265 265
Cash and bank balances 6,152 9,019 10,449 12,743 13,353 5,316
Other current assets 178 181 315 305 331 357
OCA days 3 2 2 2 2 2
Loans and Advances 6,432 7,273 8,400 9,196 9,972 10,744
Current assets, loans and advances 25,690 36,438 51,155 56,024 60,286 55,882
Liabilities 12,326 18,955 23,971 23,204 25,163 27,110
Liability days 233 225 184 184 184 184
Provisions 903 2,334 3,545 3,432 3,722 4,010
Provision days 17 28 27 27 27 27
Current liabilities and provisions 13,229 21,289 27,516 26,636 28,884 31,120
Net current assets 12,462 15,149 23,639 29,388 31,402 24,762
Total assets 13,504 16,717 26,490 33,036 39,831 62,954
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 144
Figure 209: BGR Energy – cash flow statement, FY08-14E
Rs mn; years ending March FY08 FY09 FY10 FY11 FY12E FY13E FY14E
Net profit before tax and extraordinary items 1296 1,752 3,051 4,808 4,431 4,196 1,685
Depreciation and amortization 55 75 103 173 202 220 236
Operating profit before working capital changes 1,594 234 4,369 6,456 5,536 5,593 4,445
(Increase)/decrease in sundry debtors -3,672 -5,428 -7,079 -11,827 -1,803 -2,817 -2,802
(Increase)/decrease in inventories 146 10 -22 -249 13 -34 -33
(Increase)/decrease in other current assets -46 -92 -3 -134 10 -26 -26
(Increase)/decrease in loans and advances -1,807 -3,771 -841 -517 -795 -776 -772
Increase/(decrease) in trade payables 2,153 7,754 6,589 5,589 -880 2,248 2,235
Change in working capital -3,226 -1,528 -1,356 -7,138 -3,455 -1,405 -1,397
Cash generated from operations -1,632 -1,294 3,013 -681 2,082 4,189 3,048
Direct tax paid -64 -37 286 -616 -1,397 -1,290 -470
Net cash flow from operating activities -1,696 773 3,299 -1,297 685 2,898 2,578
Purchase of fixed assets -238 -544 -589 -700 -1,000 -5,000 -30,000
Sale of fixed assets 62 21 10 2 0 0 0
Purchase of investments -1,517 1,509 0 0 0 0 0
Net cash flow from investing activities -1,631 967 -629 -1,456 -958 -4,956 -29,982
Secured loans (repaid)/availed 23 60 230 51 4,291 4,634 22,220
Unsecured loans (repaid)/availed -24 695 3,293 746 0 0 0
Payment of dividend -32 -144 -216 -505 -668 -639 -267
Tax on dividend paid 2,564 1,307 -37 -86 -111 -106 -44
Net cash flow from financing activities 5,469 1,342 197 4,183 2,567 2,667 19,367
Net Increase in cash and cash equivalents 2,141 3,081 2,867 1,430 2,294 610 -8,037
Cash and cash equivalents (opening balance) 929 3,070 6,152 9,019 10,449 12,743 13,353
Cash and cash equivalents (closing balance) 3,070 6,152 9,019 10,449 12,743 13,353 5,316
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 145
KEC INTERNATIONAL (1-OW, PT: RS72, + 75%): TROUGH VALUATIONS
We initiate coverage on KEC International with a 1-Overweight rating and a 12-month price target of Rs72 (based on 10x FY13E EPS). Earnings growth for KEC should turnaround in FY13, led by strength in order inflows and improvement in margins. Margin improvement in FY13, would be driven by improving efficiencies in the cables business due to the shift in production to a new facility in Vadodara and scale up to higher voltage cables. Improving revenues in new businesses will also help to reduce start up losses. A reduction in debt led by sale of assets should also help reducing interest burden. Post a sharp decline in earnings in FY12, we expect a 27% CAGR out to FY14.
Diversification key driver: KEC has outpaced peers in the transmission tower segment owing to success in winning orders in international markets and led by new initiatives such as substation EPC, Railways and Water. While the mix of rail and water business is currently small, the market size of these businesses are large, hence growth for KEC off a low base should be strong. We are though building in a modest mid teens growth rates in order inflows from FY13 and it is likely that new businesses provide an upside surprise.
Margins to trough in FY12 KEC international’s margins have been impacted due to forex losses as well as repricing of foreign advances due to rupee depreciation (these are non-cash expenses) and start-up losses in the rail business. We build in a trough in margins in FY12E and expect modest improvements thereafter as we expect: 1) margins in the cables business to improve due to the scaling up to higher-voltage lines and a shift in the manufacturing base from Thane to Vadodara; 2) improved margins in the railway and water segments, which are currently affected by the lower order book and entry-level pricing; and 3) strong growth at SAE, which should help given the higher margins. The impact of the increase in interest rates should get reflected in the base this year and should not impact y/y growth, and further cash flow from the sale of land at Vashi should help reduce debt.
Valuations at historical trough: KEC is trading at a P/E of 6x on our EPS estimate for FY13 and P/B of 0.9x, which are close to the historical troughs for the stock. We are unable to comprehend the reasons for such low valuations for KEC given that the company continues to be profitable. We expect the company to generate an ROE upwards of 15% even in a bear case. Moreover, the company does not typically raise dilutive funding. The current high gearing may be cited as a concern but is in fact a reflection of acquisition of SAE Towers last year.
Figure 210: KEC – statistical abstract
Year to Net profit EPS EPS growth P/E P/B ROE Div. yield
Mar Rs mn Rs % (x) (x) (%) (%)
2011A 2,057 8.0 4.4 5.2 1.1 21.7 3.1
2012E 1,472 5.7 -28.4 7.2 1.0 13.8 2.2
2013E 1,839 7.2 25.0 5.8 0.9 15.1 2.8
2014E 2,382 9.3 29.5 4.5 0.8 16.9 3.6
Source: Company data, Barclays Capital estimates
KECI IN / KECL.NS
Stock Rating 1-OVERWEIGHT
Sector View 2-NEUTRAL
Price Target INR 72.00
Price (02-Dec-2011) INR 41.25
Potential Upside/Downside +75%
Barclays Capital | India Capital Goods
7 December 2011 146
COMPANY SNAPSHOT
KEC international INDIAN CAPITAL GOODS
Income statement (INRmn) 2011A 2012E 2013E 2014E CAGRRevenue 43,232 53,844 59,714 66,245 15.3% Stock Rating 1-OVERWEIGHTEBITDA 3,115 4,365 5,089 5,992 24.4% Sector View 2-NEUTRALEBIT 2,707 3,799 4,458 5,291 25.0% Price (02-Dec-2011) 41.25Pre-tax income 3,167 2,338 2,830 3,664 5.0% Price Target 72Net income 2,057 1,472 1,839 2,382 5.0% Ticker KECI INEPS (R) 8.00 5.72 7.15 9.26 5.0%Diluted shares (mn) 257.10 257.10 257.10 257.10 0.0% Investment case
DPS (R) 1.30 0.93 1.16 1.51 5.0%
Margin and return data (%) AverageEBITDA margin 7.2 8.1 8.5 9.0 8.2EBIT margin 6.3 7.1 7.5 8.0 7.2Pre-tax margin 7.3 4.3 4.7 5.5 5.5Net margin 4.8 2.7 3.1 3.6 3.5ROIC 11.3 8.6 9.8 11.0 10.2ROA 8.5 5.3 6.2 7.6 6.9 Upside case 86ROE 21.7 13.8 15.1 16.9 16.9
Balance sheet and cash flow (INRmn) CAGRFixed assets 8,409 8,932 9,501 10,001 5.9%Cash and equivalents 1,614 1,723 929 449 -34.7%Total assets 47,094 56,137 61,216 66,483 12.2%Current liabilities 22,809 28,462 31,565 35,018 15.4%Long term liabilities 14,322 16,519 17,006 16,891 5.7% Downside case 36Total liabilities 47,094 56,136 61,215 66,482 12.2%Net debt/(funds) 12,708 14,796 16,077 16,442 9.0%Shareholders' equity 9,466 10,658 12,147 14,076 14.1%Change in working capital (2,297) (2,756) (2,202) (1,795) NACash flow from operations 1,694 853 1,904 2,920 19.9%Capital expenditure (780) (1,200) (1,200) (1,200) NAFree cash flow 914 (347) 704 1,720 23.5%
Upside/downside scenarios
Valuation and leverage metrics AverageP/E (x) 5.2 7.2 5.8 4.5 5.6 EV/EBITDA (x) 7.5 5.8 5.2 4.5 5.8 FCF yield (%) 8.6 -3.3 6.6 16.2 7.0EV/sales (x) 0.5 0.5 0.4 0.4 0.5 Price/BV (x) 1.1 1.0 0.9 0.8 0.9 Dividend yield (%) 3.2 2.3 2.8 3.7 3.0Total debt/capital (%) 59.0 59.7 57.4 53.7 57.4Net debt/EBITDA (x) 4.1 3.4 3.2 2.7 3.3
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics EBITDA margins expected to recover in FY13Order inflow 63,626 62,405 70,206 78,396 Order inflow growth (%) 48 -2 13 12Orderbook 78,000 89,555 99,138 101,531 Orderbook growth (%) 42 15 11 2
Source: Company data, Barclays Capital estimates Note: FY end Mar.
Why a 1-Overweight? Earnings growth shouldrecover in FY13, led by strength in order inflows andmargins recovery. Margin improvements will likelybe aided by a shift in cable production to a newfacility that will bring in efficiencies and reduction instart up losses in new businesses.
Success in substation EPC wins in India, large wins inRail business could help re-rate valuations. Weexpect the stock to head closer to its near term peakP/E of 12x on improved order visibility and earningsperformance.
Continued weakness in earnings acccentuated byaccounting losses on account of translation offoreign currency advances (rupee dep) and a weak2H order inflow performance could lead to the stockheading to a P/E of 5x (close to trough P/E).
0%
5%
10%
15%
FY08 FY09 FY10 FY11 FY12E FY13E FY14E
EBITDA margins
DownsideCase
INR36(-12.7%) Price
Target
INR72(74.5%)
UpsideCase
INR86(108.%)
18
38
58
78
98
118
15-Dec-10 25-Nov-11
DownsideCase
INR36(-12.7%)
PriceTarget
INR72(74.5%)
UpsideCase
INR86(108.%)
0
20
40
60
80
100
120
15-Dec-10 25-Nov-11
Barclays Capital | India Capital Goods
7 December 2011 147
Diversification key driver
KEC’s order inflows have been strong in the past two years despite flattish ordering in the domestic transmission tower segment due to strong wins in international orders, scaling up the value chain by order wins in high voltage substation (Kazakhstan), acquisition of SAE Towers and diversification into substation orders.
Figure 211: KEC – overview of businesses
Market size Order book
(Rs) Capability
Cables Current revenue of Rs120bn pa expected to increase to Rs200bn pa
1774 High-tension power cables: Installed capacity (Power Cables): 1,200km/annum
Power cables and telecom cables: Installed capacity of 10,000km/annum
Jelly-filled cables and optic fibre cables: 965,000km/annum
Low tension power cables: Installed capacity (power cables): 14,580km/annum.
Greenfield capacity being set up in Vadodara
Railways Orders in excess of Rs10bn pa. DFC orders of Rs400bn likely in next few years
3718 Civil infrastructure including bridges, tunnels, platform, workshop modernization, building of stations and facilities
Earthwork, new track laying and rehabilitation of existing tracks
Railway electrification and power systems
Signalling and telecommunication network
Water 11th plan allocation of US$50bn for irrigation, flood control and command area development
US$23bnfor urban water supply and sanitation projects
780 Irrigation and Hydroelectric construction
Embankment and Flood Control
Sewage and industrial effluent treatment
Potable water treatment and distribution
Source: Company data, Barclays Capital
Figure 212: KEC – strong order inflows due to success in international geographies, acquisition of SAE and diversification (Rs mn)
Figure 213: KEC – revenue breakdown, FY12
-9%
56%
11%
-4%
48%
54%
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
FY06 FY07 FY08 FY09 FY10 FY11-20%
-10%
0%
10%
20%
30%
40%
50%
60%
Order inflows Y/Y growth
Intll. distribution
Domestic transmission
27%
Intll. Transmission
51%
Cable 2%
Telecom3%Domestic
distribution 10%
Railways 1%
Source: Company data, Barclays Capital Source: Company data, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 148
Margins to trough in FY12
We believe that margins for KEC International may have troughed in FY12. We expect improvements in FY13 led by improvements in margins for the cables segment given the shift to higher voltage lines as well as commencement of new factory in Vadodara, which should reduce costs and increase efficiency, improved margins in railway and water segments (facing low margins now due to lower order book and entry level pricing). SAE Towers should continue to support blended margins subject to the quantum of orders wins next year.
We also expect the impact of high interest rates to get reflected in interest costs this year and hence should not impact y/y profits next year. Note that more than 50% of the debt is in foreign currency and, hence, is not impacted by the increase in interest rates. Debt levels are also expected to come down next year with the likely sale of land in Vashi.
Figure 214: KEC – EBITDA margins; FY12 likely to be impacted due to commodity-related pressure in cables business and non-cash translation of forex losses
6.8%
12.1%
9.6% 9.4%
12.3% 12.6%
8.7%
10.4%
7.21%8.11% 8.5% 9.0%
0%
2%
4%
6%
8%
10%
12%
14%
FY03 FY05 FY07 FY09 FY11 FY13E
EBITDA Margin
Source: Company data, Barclays Capital estimates
Figure 215: KEC – revenue growth rates; expect some moderation in FY13 as we build in weaker order inflows in FY12 – our numbers could serve as the base case
45%
12%
51%
40%
18%
38%
22%
14%11%
25%
11% 11%
0%
10%
20%
30%
40%
50%
60%
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 E FY13E FY14E
Y/Y growth
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 149
Valuation
Our 12-month price target of Rs72 for KEC is based on a target P/E of 10x applied to our EPS forecast for FY13. We set the multiple at a 10% discount to the historical average for the past seven years despite our view of less risk to earnings and our view that current estimates reflect a trough due to our expectation of lower margins and cash flows in this cycle. KEC is trading at 6x our FY13E estimates and 0.9x P/B, which are close to the historical troughs for the stock. We are unable to comprehend the reasons for such low valuations for KEC given that the company continues to be profitable and even under our worst-case scenario, we estimate it will generate an ROE of 15%, is able to generate cash to manage working capital and also does not typically raise dilutive funding. The company’s current high gearing may be cited as a concern, but this is in fact a reflection of acquisition of SAE Towers last year.
Figure 216: KEC – historical 12-month forward P/Es: close to historical lows
0
5
10
15
20
25
Jun-
06
Sep-
06
Dec
-06
Mar
-07
Jul-
07
Oct
-07
Jan-
08
Apr
-08
Aug
-08
Nov
-08
Feb-
09
May
-09
Aug
-09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Apr
-11
Jul-
11
Oct
-11
KEC
Source: Datastream, IBES consensus estimates
Pricing in a downturn
Figure 217: KEC – history of consensus EPS forecasts shows that estimates typically get cut in downturns (Rs)
Figure 218: KEC – history of consensus EPS forecasts shows that post the recent cuts, current estimates appear achievable
02468
10121416
Nov
-05
May
-06
Nov
-06
May
-07
Nov
-07
May
-08
Nov
-08
May
-09
Nov
-09
May
-10
Nov
-10
May
-11
FY06 FY07 FY08 FY09
FY10 FY11
56789
101112131415
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
FY12 FY13 FY14
Source: Datastream IBES consensus, Barclays Capital Source: Datastream IBES consensus, Barclays Capital
Barclays Capital | India Capital Goods
7 December 2011 150
Risks
The key risks that could keep our price target from being achieved, in our view, include execution delays or lower margins on the order book; weak order inflows due to high price competition in India; and inability to counter that with strong growth outside India. The company is currently highly leveraged, which is a concern in case it is unable to eventually reduce debt burden.
Figure 219: KEC – income statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12 E FY13E FY14E
Net sales 34,274 39,064 43,232 53,844 59,714 66,245
Y/Y growth 22% 14% 11% 25% 11% 11%
Cost of materials 19,758 20,127 22,552 28,486 31,727 34,855
% of sales 58% 52% 52% 53% 53% 53%
Erection and subcontracting expenses 5,750 9,581 9,806 11,235 12,490 13,856
% of sales 17% 25% 23% 21% 21% 21%
Personnel expenses 1,420 1,689 2,833 3,780 4,130 4,580
% of sales 4% 4% 7% 7% 7% 7%
Other expenses 4,350 3,616 4,926 5,978 6,277 6,963
% of sales 13% 9% 11% 11% 11% 11%
Total expenses 31,278 35,013 40,117 49,479 54,624 60,254
OBITDA 2,996 4,051 3,115 4,365 5,089 5,992
OBITDA margin 9% 10% 7% 8% 9% 9%
Depreciation and amortisation (net) 230 270 408 566 631 700
Other income 20 18 1,536 10 8 8
Interest 1,000 865 1,075 1,461 1,636 1,636
Profit after interest but before exceptional items 1,786 2,934 3,167 2,348 2,830 3,663
Exceptional items - - (85) (10) - 1
Profit before tax 1,786 2,934 3,167 2,338 2,830 3,664
Profit before tax margin 5% 8% 7% 4% 5% 6%
Tax 618 1,037 1,111 866 990 1,282
Tax rate 35% 35% 35% 37% 35% 35%
Profit after tax before extraordinary items 1,168 1,897 2,057 1,472 1,839 2,382
Profit after tax margin 3% 5% 5% 3% 3% 4%
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 151
Figure 220: KEC – balance sheet, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12 E FY13E FY14E
Share capital 493 493 514 514 514 514
Equity share suspense - 21 - - - -
Reserves and surplus 5,087 7,357 8,952 10,143 11,633 13,562
Shareholder funds 5,581 7,871 9,466 10,658 12,147 14,076
Secured loans 5,839 7,755 14,296 - - -
Unsecured loans 379 112 11 - - -
Total debt 6,218 7,867 14,322 16,519 17,006 16,891
Deferred tax liability 298 461 497 497 497 497
Total 12,097 16,199 24,285 27,674 29,650 31,464
Fixed assets
Gross block 6,320 8,357 10,382 11,582 12,782 13,982
Less: Depreciation and amortisation 1,248 1,570 2,366 2,932 3,563 4,264
Net block 5,072 6,787 8,016 8,650 9,219 9,718
Capital work in progress 504 379 278 278 278 278
Advances for capital expenditure 10 4 4 4 4 4
Investments 30 30 - - - -
Deferred tax assets - - - - - -
Goodwill 2,813 2,813 2,813 2,813
Inventories 2,258 2,498 3,359 4,183 4,639 5,147
Inventory days 24 23 28 28 28 28
Sundry debtors 18,662 19,624 26,177 32,603 36,810 40,836
Inventory days 199 183 221 221 225 225
Cash and bank balances 1,411 698 1,614 1,723 929 449
Loans and advances 3,028 3,956 4,724 5,883 6,524 7,238
as % of sales 0 0 0 0 0 0
Current assets 25,359 26,775 35,873 44,392 48,902 53,670
Liabilities 18,431 17,214 22,248 27,710 30,730 34,092
Current liability days 196 161 188 188 188 188
Provisions 445 562 561 753 835 926
as % of sales 0 0 0 0 0 0
Current liabilities 18,876 17,776 22,809 28,462 31,565 35,018
Net current assets 6,482 8,999 13,063 15,930 17,337 18,652
Total assets 12,097 16,199 24,285 27,674 29,651 31,465
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 152
Figure 221: KEC – cash flow statement, FY09-14E
Rs mn; years ending March FY09 FY10 FY11 FY12 E FY13E FY14E
Profit before tax 1,786 2,934 3,167 2,338 2,830 3,664
Depreciation and amortisation (net) 230 270 408 566 631 700
Operating profit before working capital changes 3,397 3,644 4,670 4,476 5,096 5,995
Trade and other receivables (3,876) (367) (6,005) (7,585) (4,849) (4,740)
Inventories (204) 415 735 (824) (456) (507)
Trade and other payables 5,091 (2,567) 2,973 5,653 3,103 3,453
Miscellaneous expenditures - - - - - -
Cash from operations 4,407 1,125 2,373 1,719 2,894 4,200
Taxes (640) (778) (679) (866) (990) (1,282)
Others - - - - - 2
Net cash from operating activities 3,767 347 1,694 853 1,904 2,920
Change in financing activities (1,395) (588) (780) (1,200) (1,200) (1,200)
Change in investments - - - - - -
Interest received 14 80 60 - - -
Others - - (4,391) - - -
Cash used in investing (1,381) (509) (5,111) (1,200) (1,200) (1,200)
Change in equity/preferred equity (149) - - - - 1
Change in debt (205) 551 5,453 2,198 487 (115)
Interest paid (1,046) (944) (1,140) (1,461) (1,636) (1,636)
Dividends paid (287) (285) (354) (280) (350) (453)
Others - - - - - -
Change in financing (1,687) (678) 3,959 457 (1,499) (2,203)
Net change in cash equivalents 699 (840) 541 110 (795) (482)
Opening cash 690 1,410 698 1,614 1,723 929
Adjustments 21 130 - - 1 2
Closing cash 1,410 699 1,614 1,723 929 449
Source: Company data, Barclays Capital estimates
Barclays Capital | India Capital Goods
7 December 2011 153
Valuation Methodology and Risks
India Capital Goods
ABB Ltd. (ABB IN / ABB.NS)
Valuation Methodology: Our 12-month price target of Rs494 is based on an average 25x P/E. Our target multiple is the stock's historical average 12-month forward P/E since 2003. We use a higher P/E compared with that used for peers as the cost of capital being used for any cash flow calculations will be that of its parent. This is because the recent open offer done by ABB's parent for purchasing 20% of shares in ABB India at steep valuations were justified largely on account of lower cost of capital of its parent.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include: 1) a faster-than-expected uptick in margins; 2) a sharp recovery in the T&D market and market share gains for ABB; and 3) announcement of a delisting by parent at substantially higher valuations.
Areva T&D India (ATD IN / AREV.NS)
Valuation Methodology: Our 12-month price target of Rs193 for Areva T&D is based on a target P/E of 20x applied to our EPS forecast for 2012. The stock's valuations are like its other MNC T&D peers, Siemens and ABB, which have typically been rich with an average forward P/E multiple of more than 20x. Our target multiple of 20x is set at the historical average multiple for the past seven years.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include the following: 1) Continued pressure on pricing from competitors and setting up of domestic manufacturing by Chinese or Korean firms could lead to a further deterioration in margins. 2) The change in substation tendering clauses have increased competitive intensity in that segment and inability to win orders (market share losses) could impact our view of recovery in order inflows for the company. And 3) execution delays in power projects and subsequent delays in ordering for T&D projects could impact market ordering.
BGR Energy Systems Ltd. (BGRL IN / BGRE.NS)
Valuation Methodology: Our 12-month price target of Rs241 for BGR Energy is based a target P/E of 6x applied to our EPS forecast for FY13E given our view that FY13 broadly represents the peak of its earnings cycle. Our P/E target represents the stock's recent trough valuation since the financial crisis.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include a recovery in the power BTG market and an improved pricing on new orders. The ability to generate higher-than-expected cash flows through core operations would also help to reduce level of debt required for capex..
Bharat Heavy Electricals Ltd. (BHEL IN / BHEL.NS)
Valuation Methodology: Our 12-month price target of Rs230 for BHEL is based on our discounted cash flow valuation analysis because we believe estimates for the next two years do not capture the impact of current pricing trends on margins.Our assumptions appear to be a bit aggressive but capture long-term margin concerns. We assume 1) 140GW ordering in 12th and 13th plan, 2) execution period of 40 months and healthy industry order book of over Rs200bn post FY16. 3) EBITDA margin to trend down to 14% from FY16 and 10% by FY20. Terminal growth of 3%. We value JVs at 1.2x P/B.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include a recovery in order inflows in the power sector led by the government's positive policy action in solving the coal issue and issue with financials of state electricity boards. Stiff import duties would also help limit competition for local players. Shift in ordering to EPC will help reduce competition as only BHEL, L&T and BGR will then qualify for orders. Continued sustenance of margins and improved pricing trends in the market would support the share price, in our view.
Crompton Greaves Ltd. (CRG IN / CROM.NS)
Valuation Methodology: Our 12-month price target of Rs147 for CRG is based on 16x standalone FY13E earnings of Rs7.50 and 12x subsidiary earnings of Rs1.69. Our multiples are set at historical average multiples for the past seven years for CRG despite the recent sharp increase in consensus earnings estimates.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include a higher-than-expected decline in order inflows due to stiff competitive pressures in the domestic market and continued price declines and risks could emerge from weak demand for T&D products from Europe since CRG derives more than 50% of revenues from international geographies.
Cummins India Ltd. (KKC IN / CUMM.NS)
Valuation Methodology: Our 12-month price target of Rs428 for Cummins is based on a P/E of 20x applied to our EPS forecast for FY13E plus Rs20 for the value of associates. Our target P/E for the core business is at a multiple set at a 10% premium to the average of the past eight years' P/E valuation. Since we have already cut earnings estimates to capture the cyclical weakness, we are using average P/E multiples. We give a premium of 10% because of the company's well developed sales and service business and the likely higher mix of exports that could offset the impact of a weak domestic market in the coming year
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include the following: 1) a recession in export markets impacting sourcing from India; 2) further deceleration in domestic markets; and 3) price discounting in the market that could impact margins. In addition, any further shift among its customers in construction and mining equipment to their own engines would be a concern. And some competitors such as KOEL are scaling up their business in India and their ability to win customers could impact the dominant position of Cummins.
Havells India Ltd. (HAVL IN / HVEL.NS)
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Valuation Methodology and Risks
Valuation Methodology: Our 12-month price target of Rs502 for Havells is based on forward EV/EBITDA multiples of 5x for Sylvania, taking conservative valuations due to exposure to Europe, and 11x for the domestic business. Our target price implies a P/E of 15.8x for FY13E. Our target multiples are set at the historical average for the past seven years.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include a weak margin performance at Sylvania, any failure to scale up new consumer launches; and sharp increase in commodity pricing could also impact numbers.
KEC International Ltd. (KECI IN / KECL.NS)
Valuation Methodology: Our 12-month price target of Rs72 for KEC is based on a target P/E of 10x applied to our EPS forecast for FY13. We set the multiple at a 10% discount to the historical average for the past seven years despite of our view of less risk to earnings and our view that current estimates reflect a trough due to our expectation of lower margins and cash flows in this cycle.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include execution delays or lower margins on the order book; weak order inflows due to high price competition in India; and inability to counter that with strong growth outside India. The company is currently highly leveraged, which is a concern in case it is unable to eventually reduce debt burden.
Larsen & Toubro Ltd. (LT IN / LART.NS)
Valuation Methodology: Our 12-month price target of Rs1,560 is based on our sum-of-the-parts (SOTP) analysis in which we value the company on a standalone at 16.5x our EPS estimate for FY13 and its subsidiaries at Rs356 per share. Our target P/E multiple for the standalone business is set at a 25% discount to the stock's historical average for the past seven years as we do not assume a substantial uptick in all its end markets in FY13.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include the following: 1) a sharper-than-expected contraction in margins for the company; 2) order inflow guidance of 5% growth for FY12 is also at risk given the weak ordering activity in various end markets; and 3) although earnings estimates have moderated to reflect near-term weakness, there could be volatility in the stock and some downside around quarterly result announcements in January 2012.
Siemens Ltd. (SIEM IN / SIEM.NS)
Valuation Methodology: Our 12-month price target of Rs630 for Siemens is based on a P/E of 21x applied to an average of our EPS estimates for FY12 and FY13. We use average earnings as we are valuing peers on earnings for financial years ending in March 2013. Our multiple of 21x is set at a 15% discount to its historical 12-month forward P/E multiple for the past seven years given risk to margins, which appear to be peaking.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include large order wins in the Rail segment or in Power EPC market as well as forex gains or increases in core margins.
Thermax Ltd. (TMX IN / THMX.NS)
Valuation Methodology: Our 12-month price target of Rs392 for Thermax is based on 12x our earnings estimate for FY13. Our target P/E multiple is set at a 30% discount to its historical average for the past seven years as the average multiples have been propped, in our view, by the expectation of success in the subcritical and supercritical IPP foray. We are modelling only core industrial business and modest wins in subcritical space and hence the discount.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include the following: 1) Given the large scale of the new businesses that Thermax has ventured into, any large order wins in either subcritical or supercritical businesses at a good pricing could re-rate the stock. 2) Continued strength in core industrial business could also lead to earnings surprises, 3) A faster-than-expected scaling up of new business ventures in the solar and geothermal sectors could also help multiples.
Voltas Ltd. (VOLT IN / VOLT.NS)
Valuation Methodology: Our 12-month price target of Rs78 for Voltas is based on a P/E of 11 applied to our estimate for FY13. We set our P/E multiple of 11x at a 30% discount to the stocks historical average for the past seven years as 1) the MEP business has seen a large geographic shift and an increase in competitive intensity with bidding margins are now only 5% and 2) the AC market is also going through cyclical issues, seeing high competitive intensity.
Risks which May Impede the Achievement of the Price Target: The key risks that could keep our price target from being achieved, in our view, include large order wins in the MEP segment in the Middle East and a recovery in the AC market next year.
Source: Barclays Capital
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ANALYST(S) CERTIFICATION(S)
I, Venugopal Garre, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of thesubject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.
IMPORTANT DISCLOSURES CONTINUED
For current important disclosures, including, where relevant, price target charts, regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer tohttp://publicresearch.barcap.com or call 1-212-526-1072.
The analysts responsible for preparing this research report have received compensation based upon various factors including the firm's totalrevenues, a portion of which is generated by investment banking activities.
Research analysts employed outside the US by affiliates of Barclays Capital Inc. are not registered/qualified as research analysts with FINRA.These analysts may not be associated persons of the member firm and therefore may not be subject to NASD Rule 2711 and incorporated NYSERule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst’saccount.
Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in othertypes of research products, whether as a result of differing time horizons, methodologies, or otherwise.
Primary Stocks (Ticker, Date, Price)
ABB Ltd. (ABB.NS, 02-Dec-2011, INR 618.80), 3-Underweight/2-Neutral
Areva T&D India (AREV.NS, 02-Dec-2011, INR 208.65), 2-Equal Weight/2-Neutral
BGR Energy Systems Ltd. (BGRE.NS, 02-Dec-2011, INR 270.55), 3-Underweight/2-Neutral
Bharat Heavy Electricals Ltd. (BHEL.NS, 02-Dec-2011, INR 282.45), 3-Underweight/2-Neutral
Crompton Greaves Ltd. (CROM.NS, 02-Dec-2011, INR 132.15), 1-Overweight/2-Neutral
Cummins India Ltd. (CUMM.NS, 02-Dec-2011, INR 357.85), 1-Overweight/2-Neutral
Havells India Ltd. (HVEL.NS, 02-Dec-2011, INR 424.55), 1-Overweight/2-Neutral
KEC International Ltd. (KECL.NS, 02-Dec-2011, INR 41.25), 1-Overweight/2-Neutral
Larsen & Toubro Ltd. (LART.NS, 02-Dec-2011, INR 1310.75), 1-Overweight/2-Neutral
Siemens Ltd. (SIEM.NS, 02-Dec-2011, INR 723.35), 3-Underweight/2-Neutral
Thermax Ltd. (THMX.NS, 02-Dec-2011, INR 469.70), 3-Underweight/2-Neutral
Voltas Ltd. (VOLT.NS, 02-Dec-2011, INR 92.10), 3-Underweight/2-Neutral
Guide to the Barclays Capital Fundamental Equity Research Rating System:
Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the "sector coverage universe").
In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investorsshould carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.
Stock Rating
1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.
2-Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.
3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.
RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable orto comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting in an advisorycapacity in a merger or strategic transaction involving the company.
Sector View
1-Positive - sector coverage universe fundamentals/valuations are improving.
2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.
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7 December 2011 156
IMPORTANT DISCLOSURES CONTINUED
3-Negative - sector coverage universe fundamentals/valuations are deteriorating.
Below is the list of companies that constitute the "sector coverage universe":
India Capital Goods
ABB Ltd. (ABB.NS) Areva T&D India (AREV.NS) BGR Energy Systems Ltd. (BGRE.NS)
Bharat Heavy Electricals Ltd. (BHEL.NS) Crompton Greaves Ltd. (CROM.NS) Cummins India Ltd. (CUMM.NS)
Havells India Ltd. (HVEL.NS) KEC International Ltd. (KECL.NS) Larsen & Toubro Ltd. (LART.NS)
Siemens Ltd. (SIEM.NS) Thermax Ltd. (THMX.NS) Voltas Ltd. (VOLT.NS)
Distribution of Ratings:
Barclays Capital Inc. Equity Research has 2045 companies under coverage.
44% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 56% of companies with this rating are investment banking clients of the Firm.
41% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 50% ofcompanies with this rating are investment banking clients of the Firm.
12% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 38% ofcompanies with this rating are investment banking clients of the Firm.
Guide to the Barclays Capital Price Target:
Each analyst has a single price target on the stocks that they cover. The price target represents that analyst's expectation of where the stock willtrade in the next 12 months. Upside/downside scenarios, where provided, represent potential upside/potential downside to each analyst's price target over the same 12-month period.
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