INDIA Mfg Sector Report1!03!30 04

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EXECUTIVE SUMMARY

Indian Manufacturing sector signals growth

After a slowdown in the last five years, the Indian manufacturing sector is showing

clear signs of turning around. The manufacturing sector grew at a 4% CAGR during

FY97-FY02. But in FY03 the sector registered a 6% growth.This growth has been

predominantly led by exports which grew 19% in FY03 compared with a 5.4%

CAGR between FY97-02. Going forward, we believe exports will continue to drive

growth in select sectors.

Mindset focused on global markets

Lower growth in domestic markets and liberalisation have stimulated companies to

focus on international markets for growth. In unprecedented moves, companies are

setting up capacities and changing production lines keeping global markets in mind.

They are also investing in international marketing networks and in infrastructure.We

believe this change in mindset of Indian managements is the most significant

factor.

Competitive edge in skill intensive industries

Although overall opportunity and potential for India are immense, we believe that all

industries will not benefit equally. Industry dynamics and the China factor will have

a major role in determining the beneficiaries of this opportunity. We believe Indian

companies engaged in skill intensive industries like Agro-chemicals, Auto components,

Engineering, Pharmaceuticals and Specialty chemicals have sustainable competitive

advantages in international markets. This is also vindicated by the performance of

industries like Pharma and Auto ancillaries which have reported 15% and 24% growth

in export revenues from FY99 to FY02.

Companies with direct sales model to benefit more

We have classified the export sales models followed by companies into five categories

to evaluate long term sustainability of export revenues and profit margins. We believe

companies selling directly to end customers will have higher sustainabilityof revenues

and margins in the long term. This sales strategy calls for significant investments in

international marketing and distribution networks. These factors give the direct sales

model an edge over the contract manufacturing and outsourcing models in the long

term.

Our Picks

Our key sector picks are Agro-chemicals, Auto components, Engineering,

Pharmaceuticals and Specialty chemicals. We have identified two sets of companies

in these sectors. The first set of companies includes those that are at an advanced

stage of export initiative. These companies have in place the necessary ingredients

needed for success in export markets. In this category, our picks include ABB,

Aurobindo, Bharat Forge, Crompton Greaves, Cummins, IPCA, Jubilant,

Shasun, Thermax and United Phosphorus. Companies in this basket are expected

to witness maximum impact of exports on their financials and market capitalisation.

The companies identified in the second set are either at an early stage of export

initiative or are small market cap companies. Our picks in this set are Camlin, Elgi

Equipment, Hindustan Inks, Igarashi Motors, Lupin, Motherson Sumi and Sundaram

Brakelinings.

EXECUTIVE SUMMARY

Executive Summary


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CONTENTS

Executive Summary .................................................................................................................................................... 1

At a Glance .................................................................................................................................................................4

Indian Manufacturing Sector - Waiting In the Wings .................................................................................................6Indian Manufacturing - Shifting Focus to Exports. .................................................................................................... 8

Growing Manufacturing Exports.............................................................................................................................. 10

Advantage India ....................................................................................................................................................... 11

The Time Is Now ..................................................................................................................................................... 15

Evaluation of Export Sales Model ............................................................................................................................ 20

Concerns and Risks ................................................................................................................................................. 23

Annexure 1 .............................................................................................................................................................. 24

Annexure 11............................................................................................................................................................. 26

Annexure 111 ........................................................................................................................................................... 27

Annexure 1V ........................................................................................................................................................... 29

INDUSTRIES AND COMPANIES

Agro-Chemicals Industry ................................................................................................................................... 33

United Phosphorus ............................................................................................................................................... 35

Auto Components Industry................................................................................................................................ 42

Bharat Forge ........................................................................................................................................................ 45

Engineering Industry .......................................................................................................................................... 51

ABB..................................................................................................................................................................... 53

Crompton Greaves ............................................................................................................................................... 58

Cummins .............................................................................................................................................................. 63Thermax............................................................................................................................................................... 68

Pharmaceutical Industry ..................................................................................................................................... 74

Aurobindo Pharma ............................................................................................................................................... 77

IPCA ................................................................................................................................................................... 82

Shasun Chemicals ................................................................................................................................................ 87

Specialty Chemicals............................................................................................................................................. 92

Jubilant Organosys............................................................................................................................................... 95

Emerging Export Stories .................................................................................................................................. 100

Camlin ................................................................................................................................................................ 101Elgi Equipment ................................................................................................................................................... 102

Hindustan Inks ................................................................................................................................................... 103

Igarashi Motors .................................................................................................................................................. 104

Lupin .................................................................................................................................................................. 105

Motherson Sumi ................................................................................................................................................. 106

Sundaram Brakelinings ...................................................................................................................................... 107

MANUFACTURED EXPORTS


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CHARTSCHARTS

Chart 1: Percentage change in manufacturing industry output .................................................................................. 8

Chart 2: Percentage of manufacturing in Indias GDP .............................................................................................. 9

Chart 3: Composition of Indias merchandise exports ............................................................................................. 10

Chart 4: Indias manufactured exports..................................................................................................................... 14

Chart 5: Category-wise CAGR during FY96-FY02 ................................................................................................ 14

Chart 6: Days taken for clearing at ports ................................................................................................................ 15

Chart 7: Contribution of SEZs to total exports in select countries ........................................................................... 16

Chart 8: QS Certified plants in India ........................................................................................................................ 19

Chart 9: Risks v/s Margins of different export sales models ................................................................................... 21

Chart 10: Long term impact of different export sales models ................................................................................. 21

Chart 11: Top twenty internationally traded products by factor intensity - 1980-2000............................................. 25

Chart 12: Growth of world exports by product categories....................................................................................... 28

Chart 13: United Phosphorus Revenue break up in FY03 ....................................................................................... 36Chart 14: Bharat Forge Revenue break up in FY03 ................................................................................................ 46

Chart 15: ABB Revenue break up in CY02 ............................................................................................................ 54

Chart 16: Crompton Revenue break up in FY02 ..................................................................................................... 59

Chart 17: Cummins Revenue break up in FY02 ...................................................................................................... 64

Chart 18: Thermax Revenue break up in FY02 ....................................................................................................... 69

Chart 19: Aurobindo Revenue break up in FY02 ..................................................................................................... 78

Chart 20: IPCA Revenue break up in FY02 ............................................................................................................ 83

Chart 21: Shasun Revenue break up in FY02 .......................................................................................................... 88

Chart 22: Jubilant Organosys Revenue break up in FY03 ....................................................................................... 96

TABLES

Table 1: Compensation for manufacturing workers ................................................................................................. 11

Table 2: Availability of skilled labour ........................................................................................................................ 12

Table 3: Availability of qualified engineers ............................................................................................................... 12

Table 4: Major MNCs having sourcing offices in India ........................................................................................... 17

Table 5: The role of foreign affiliates in the exports of six select economies .......................................................... 17

Table 6: Export sales model Plotting companies according to the business model followed.................................... 22

Table 7: International trade in motor vehicle parts and accessories ........................................................................ 44

Table 8: Major Auto MNCs having sourcing offices in India .................................................................................. 44Table 9: International trade in non-electrical machinery parts and accessories ....................................................... 52

FIGURES

Figure 1: Critical success factors in each category ................................................................................................. 13

Figure 2: Select MNCs outsourcing plans for India................................................................................................ 18


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AT A GLANCE


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All nos for FY04E (INR mn)

Companies Sector Revenues Exports Exp/Rev EBIDTA PAT EPS EV/EBIDTA EV/Sales

(%) (%) (INR) (x) (x)

ABB Engineering 14,080 1,917 13.6 10.7 1,098 25.9 6.9 0.7

Aurobindo Pharma 14,170 7,486 52.8 17.7 1,425 58.9 4.6 0.8

Bharat Forge Auto Components 7,953 3,780 47.5 31.7 1,217 32.3 5.4 2.0

Crompton Engineering 17,915 3,366 18.8 10.5 647 12.4 3.6 0.4

Cummins Engineering 11,738 2,210 18.8 13.9 1,231 6.3 6.7 0.9

IPCA Pharma 5,902 3,349 56.7 22.0 838 67.0 2.8 0.6

Jubilant Specialty Chemicals 8,333 2,552 30.6 17.8 637 45.5 3.9 0.7

Shasun Pharma 2,952 2,161 73.2 19.7 241 29.4 3.1 0.6

Thermax Engineering 7,848 2,370 30.2 11.6 515 20.9 2.0 0.2

UPL Agro Chemicals 10,926 5,958 54.5 24.3 1,165 45.7 2.7 0.7

* CY03

At a glance


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AT A GLANCE

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RoE CAGR 02-05E(%) Sales Model Price(INR) Market Cap P/E(x) Reco

(%) Revenues Exports PAT

19.4 17.6 51.3 30.7 Sales to Parent 340 14,391 13.1 VALUE BUY

22.0 15.7 19.7 33.9 Direct Sales/Contract Mfr 273 6,361 4.6 VALUE BUY

47.6 32.8 76.1 108.5 Sales to OEMs 299 11,263 9.3 VALUE BUY

13.8 10.0 29.7 33.8 Direct Sales 62 3,255 5.0 VALUE BUY

16.7 9.8 1.4 14.4 Sales to Parent 70 13,840 11.2 VALUE BUY


30.2 18.6 35.6 49.2 Direct Sales/Contract Mfr 178 2,492 3.9 VALUE BUY

25.5 18.0 25.0 37.9 Contract Manufacturer 135 1,110 4.6 VALUE BUY




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INDIAN MANUFACTURING SECTOR WAITING IN THE WINGS

Export growth of Indian manufacturing sector picks up

The Indian manufacturing sector is showing clear signs of turning around, re-emerging

from a five-year phase of a slowdown. The sector registered a 6% growth in FY03 alone

as against 4% annually from FY97-FY02. We believe exports will play a significant rolein driving the growth of the manufacturing sector.

In FY03 alone, Indias merchandised exports surged 18% to USD 51.7 bn. The

composition of Indian exports too has changed. For instance, in the past, primary products

i.e natural resources that were raw materials for manufacturing products, dominated

exports. The contribution of manufactured products to exports has increased from 46%

in FY82 to 76% in FY02.

Skill-intensive sectors will grow fast

We believe that select skill-intensive manufacturing sectors like Pharmaceuticals,

Engineering, Agro-Chemicals, Auto ancillary and Specialty chemicals will play a key role

in driving this export-led growth. During the last three years, Pharmaceutical andEngineering industries reported a 15% and 14% CAGR in export revenues respectively,

where as overall export revenues have grown at a 9% CAGR.

India enjoys a distinct advantage of having abundant skilled manpower. The Indian IT

sector has already displayed the benefits of leveraging this advantage. India has the second

largest pool of scientific talent in the world. The country adds around 0.14 mn engineers

every year apart from 1 mn polytechnic diploma holders. According to The World

Competitiveness Yearbook published by the International Institute for Management

Development (IMD), India ranks first in the availability of qualified engineers and second

in the availability of skilled manpower.

Since the Pharmaceutical, Auto ancillary, Engineering and Specialty chemicals sectors

predominantly employ skilled and technically competent manpower, we believe that this

advantage will be one of the triggers in an environment conducive to export-led growth.

Changing business environment

Liberalisation has had a positive impact on the Indian manufacturing sector. Companies

that operated for decades together in regulated markets could now operate in a free

environment with the government acting as an enabler. The earlier mindset of seeking

protection from imports was replaced by a new confidence to take on global competition.

The slowdown at home acted as a catalyst in bringing about an attitudinal change

of focussing on global markets. In a reversal of roles, companies across sectors that

were hither to more inward looking in a protected regime have emerged major exporters

after the slowdown in late nineties.

The change in mindset of Indian managements is reflected in the fact that over the last

five years, Indian companies rationalised work force, modernised and upgraded shopfloors,

consciously imparted a focus on quality and invested in international markets for business

development. All this, complemented by improved infrastructure and simplified

procedures, has made exports a more attractive option for Indian companies. We believe

Indian companies will leverage the overriding advantages offered by India to establish

themselves as global players.

Manufacturing industries

have grown at 6% in FY03

as against a 4% CAGR fromFY97-FY02

However, merchandised

exports rose 18% to

USD 51.7 bn in FY03

Skill-intensive industries

like Pharma and

Engineering reported 15%

and 14% CAGR in export

revenues respectively in the

last three years


Perceived change seen in

managements attitude

towards exports

INDIAN MANUFACTURING SECTOR


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The new business environment has brought about vibrant changes. For instance Telco

has indigenously designed the Indica car at one-fourth the cost of developed countries

and recently signed an agreement with Rover of the U.K to export over 100,000 cars for

the next five years. From its manufacturing base in India, Ford India manufactured

50,000 cars in CY02, of which 28,915 cars were exported, clearly indicating India as a

chosen outsourcing destination.

A number of large and mid-sized players emerging

The phenomenal success of the Indian pharmaceutical and engineering companies in the

global arena is now well recognised. For instance, the success of Ranbaxy and

Dr Reddys in the global markets is quite well known and documented and their current

market capitalisation also reflects this.

We believe that there are numerous other large-cap and mid-cap Pharma, Engineering

and Auto ancillary companies that are pursuing the export-led path to growth. We have

selected companies which will see maximum impact of exports on their revenues and

market capitalisation going forward.

Bharat Forge, a company in our universe for instance, has captured 25% of world market

share of front axle beams for heavy commercial vehicles. United Phosphorus has emerged

the fourth largest global player in the agro-chemical generic category. Jubilant Organosys,

yet another company in our universe, is a world leader in the manufacture of a range of

Specialty chemicals. Our attempt has been to pick up companies across sectors that

display the capability to translate potential into performance in the global marketplaces.

Evaluating export business models

We have identified and analysed different export business models of companies and their

impact on long-term sustainability of revenues and profit margins. For instance, Cummins

and Thermax, two companies in our universe, are expected to report 30% and 25%

CAGR in export revenues respectively over FY03-FY05. Thermax has invested in

marketing infrastructure and is out to win direct sales opportunities. Cummins, however,

benefits from outsourcing by its parent. While both these translate into export-led growth,

we believe that the Thermax model is more dynamic, offering possibilities of exponential

growth and in turn is rated higher than the Cummins model.

While evaluating export business models of companies, we have also taken into

consideration whether the company is at an advanced stage of the export business model

or whether it has just made an export foray. There are risks and rewards associated with

each of these. We have considered further the export business models followed by these

companies. The two sets of companies we have selected also factor in above criteria.

Ford India exports 30,000

cars from its Indian

manufacturing facility

Numerous emerging mid-

sized players will see

maximum impact of exports

on revenues and market cap

Direct sales to customers as

a model has long term

advantages over contract

manufacturing and

oursourcing

INDIAN MANUFACTURING SECTOR WAITING IN THE WINGS


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Source: CMIE

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INDIAN MANUFACTURING - SHIFTING FOCUS TO EXPORTS

Impact of liberalisation

The Indian business scenario underwent a seachange following liberalisation in 1991. In

the period prior to this, the Indian economy was primarily supply driven with shortagefor everything from steel to scooters. From FY93 to FY97, the impact of liberalisation

resulted in a buoyant 10% CAGR in manufacturing output (see Chart 1), 8% CAGR in

Index of Industrial Production and 6.7% CAGR in GDP. This period was characterised

by strong domestic demand. De-licensing of industries, additional investments and FDI

inflows led the rapid growth of industrial production in the early nineties up to FY97.

Chart 1: Percentage change in manufacturing industry output

4.14

8.49

11.95

14.9

9.66

1.512.72

4.24

6.66

2.83

0

2

4

6

8

10

12

14

16

1992-93

(%)

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

A CAGR of 10% in

manufacturing output, 8%in IIP and 6.7% in GDP

seen during FY93-97

immediately after

liberalisation

But, a slowdown in growth from FY98 and increased

capacities impacted

companies....


A marked slowdown in the domestic market

However, from FY98 onwards, a slowdown in demand for industrial products andincreased capacities led to lower revenues and pressure on realisations and margins (See

Annexure II). As shown in Chart 2, the share of manufacturing in Indian GDP declined

from 17.7% in FY98 to 16.8% in FY02. As per Centre for Monitoring Indian Economy

(CMIE) data, Indian manufacturing industry sales grew at a 17.6% CAGR from FY90-

FY95 and a 13.8% CAGR from FY96-FY01. This growth too was driven primarily by

the petroleum industry. Net profits of the Indian manufacturing industry grew at a 34.5%

CAGR from FY90-FY95. But, this declined to 14.3% annually during FY96-FY01.

Similarly, net profit margin, which improved from 1.8% in 1992 to 4.2% in 1996, slipped

to 0.8% in FY00. Some sectors like Auto and Industrial machinery reported a decline in

sales in FY98-FY99 and flat revenues in FY00.

Slowdown engenders shift in focusSlack demand and oversupply at home motivated companies to focus on international

markets. This called for structural changes requiring companies to focus on costs,

enhance quality and initiate global marketing efforts. This entailed redesigning plants,

rationalising workforce, automating processes, streamlining vendors network and

eliminating wastages.

Compelling them to look at

international markets for

growth

INDIAN MANUFACTURING - SHIFTIChart 1: Percentage change in


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Manufactured product exports accelerateIndian exports have grown faster than the GDP in the last three decades, registering an

11% CAGR during FY72-FY02 to USD 43.7 bn. From FY93-FY02, Indian exports

recorded a 9.3% growth annually compared with world export growth of 5.5%.

However, Indias share in world trade is still a negligible 0.7%. Traditionally, primary

products and handicrafts dominated Indian exports. But a gradual yet definite shift

towards export of manufactured products is discernible since the eighties as India

progressed towards industrialisation.

Chart 2: Percentage of manufacturing in Indias GDP

15.7

16.1

16.8

17.9 18.317.7

17.1

16.8

17.2

16.8

14.0

14.5

15.0

15.5

16.0

16.517.0

17.5

18.0

18.5

1992-93

(%)

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

Source: CSO

INDIAN MANUFACTURING - SHIFTING FOCUS TO EXPORTS

Indian exports grew faster

than the GDP, at an 11%

CAGR during FY72-FY02

Chart 2: Percentage of manufac


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In FY02 manufactured products accounted for 76% of total merchandised exports. Twenty

years ago this share was 46%. In the last ten years, manufactured exports have grown at

a 10% CAGR as against a 6% CAGR in primary products. From FY99-FY02, the trend

is strikingly in favour of manufactured products with a 9% CAGR compared with a 1%CAGR in primary products. In spite of the increasing share of manufactured products as

a percentage of the export pie, the top ten products are primarily from labour-intensive

categories. Going forward, we see this composition changing significantly.

GROWING MANUFACTURED EXPORTS

Chart 3: Composition of Indias merchandise exports

Source: DGCIS

0

1970-71

(USDbn)

Primary Products

1973-74

1976-77

1979-80

1982-83

1985-86

1991-92

1994-95

1997-98

2000-02

1988-89

510

15

20

25

30

35

40

45

Manufactured Products Others

During FY99-FY02

manufactured products

grew at a 9% CAGR

compared with a 1% CAGRin primary products

Engineering sector reported

a 25% export growth in

FY03


Gaining prominence of skill intensive manufactured exports

We firmly believe that India enjoys a strong advantage in skill-intensive products. In the

last decade (FY92-FY02), Drugs and Pharmaceuticals (13% CAGR) Engineering goods

(12% CAGR) and Chemicals (11%CAGR) led the growth of manufactured exports. The

last three years (FY99-FY02) data of Director General of Commerce and Intelligence

(DGCIS) of the government of India clearly shows acceleration of exports from these

sectors. Engineering goods reported a 15% CAGR in exports and Pharmaceutical and

Chemicals exports registered a 14% CAGR during this period. As per the preliminary

numbers released for FY03 by the DGCIS, the engineering sector reported a 24.7%

growth and basic chemicals reported an 18.2% growth in exports.

GROWING MANUFACTURED EXPORTSChart 3: Composition of India


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These dormant and

unexploited factors are now

acting as catalysts for future

growth

Availability of a large

labour force at low cost,

skilled manpower and rich

natural resources have

historically been positives

for India

Employee cost as a

percentage of revenues is

6% in India

ADVANTAGE INDIA

ADVANTAGE INDIA

Leveraging traditional advantages

India offers a host of advantages that could directly and indirectly drive export growth of

manufacturing companies. These include availability of inexpensive labour, availability of

skilled manpower, low labour costs, a rich natural resources base and availability of

metal-based raw materials at lower prices.

India has historically had these advantages. However, in the absence of favourable

business policies, these advantages remained dormant and unexploited. Following

liberalisation, in the new changed business scenario, these advantages emerged as factors

that could catalyse Indias export growth.

In this section, we review the advantages offered by India. We attempt to position India

vis--vis other emerging markets including China and identify niches in which India

emerges strong (See Annexure IV - India vis--vis China). These niches, we believe will

trigger export-led growth of manufacturing companies going forward.

a) Availability of labour and low labour costs

This advantage, an attractive feature of developing countries, is typically characterised

by huge populations with a majority of them still engaged in agriculture work.

In India, 62% of the workforce continues to be employed in the agricultural sector. For

such agricultural labourers, shifting to factory jobs would be an improvement in standard

of living, a steady income job replacing a low income seasonal employment, which too is

subject to the vagaries of nature. Given high unemployment and underemployment rates

and low standards of living, wages in India are much lower than in developed countries.

Low labour cost also works in favour of Indian manufacturers. The average hourly

wages for a graduate/skilled worker in India are USD 7 as against USD 3050 in most

developed countries and USD 15-40 in developing countries. Table 1 below gives a per-

hour comparison of wages across countries. India is closer to China and is well poised to

exploit this advantage. Though India ranks low on labour productivity, wages, as a

percentage of sales, are around 5-9% vis--vis 25-35% in Europe and U.S. for similar

industries. Low labours costs will continue to remain a major advantage for the Indian

manufacturing industry.

Table 1: Compensation for manufacturing workers (in 1999)

Country USD per hour

Germany 22.7

USA 19.2

Brazil 6.7

Mexico 2.1

India 0.6

China 0.5

Source: IMD

Average hourly wages for

Indian graduate/skilled

worker are USD 7 vis-a-vis

USD 30-50 in developed

countries and USD 15-40 in

developing countries

ADVANTAGE INDIATable 1: Compensation for manu


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India ranks first in

availability of engineersand second in availability

of skilled labour

Lower cost of skilled labour

reduces employee expense

as a percentage of revenues,

making Indian companies

cost competitive globally


b) Availability of skilled manpower

India has the second largest pool of scientific talent in the world. The country adds

around 0.14 mn engineers every year, apart from 1 mn polytechnic diploma holders.

According to The World Competitiveness Yearbook published by the International

Institute for Management Development (IMD), in availability of skilled manpower rating,Indian ranks second with 7.4 points, the first being Germany as shown in Table 2 below.

However on availability of qualified engineers (see Table 3), India ranks first with 8.5

points followed by Brazil. India has 0.8 mn engineering graduates who are in the working

age category. Importantly, the working age group will continue to be favourable to India

vis--vis other countries.

Table 2: Availability of skilled labour (in 2000) Survey results 1=low, 10=high

Country Score

Germany 7.5

India 7.4

USA 7.2

Brazil 6.4

Mexico 6.3

China 4.8

Source: IMD

Table 3 : Availability of qualified engineers (in 2000) Survey results 1=low, 10=high

Country Score

India 8.5

Brazil 7.5

USA 7.4

Mexico 6.6

Germany 6.6China 4.2

Source: IMD

The advantage of availability of skilled labour at lower costs has a multiple impact on a

firms cost structure which comprise capital, product design and production costs. Also

a significant aspect is that expenditure on design, including product design and related

activities would be lower. Manufacturing today involves a significant amount of designing

work that uses the latest software programs. These programs require skilled design

engineers. Companies like Bharat Forge, Telco, BHEL and L&T have in-house design

centres with capabilities on par with global companies. The result is that employee

expenses as a percentage of revenues would be lower compared with other countries.This gives Indian corporates a strong edge when pitching in global markets.

Table 2: Availability of skill

Table 3 : Availability of qual


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c) Availability of metal-based raw materials at lower prices

India is endowed with rich natural resources, a major plus for a number of metal-based

industries. Leveraging this advantage, Tisco and Hindalco have emerged the lowest cost

producers of steel and aluminium respectively in the new business scenario.

UNCTAD classificationTo identify Indias competitive advantages in various categories of manufactured products,

we have used the UNCTAD classification of products as a basis. (See Annexure I and

Annexure III).

UNCTAD has classified products according to industrial upgrading based on factor intensity

relating to resources, skill and technology. Thus all products have been classified under

five categories.

1) Non-fuel primary products (Vegetables and Fruits, Minerals and Tobacco)

2) Labour and resource-intensive products (Textiles, Leather, Toys and Clothing)

3) Low skill technology-intensive products (Iron and Steel, Metal products)

4) Medium skill and technology-intensive products (Motor vehicles, Electrical and non

Electrical Machinery and Plastic products)

5) High-skill and technology-intensive products (Computers, Communication equipment,

Chemicals Pharmaceutical and Scientific instruments)

Factors that determine success in these categories

We have analysed critical factors required for being successful in each of these categories

in the Figure 1. We have considered categories 2,3, 4 and 5 from the above since they are

relevant to our study.

Figure 1: Critical success factors in each category

Labour intensive

Availability of labour (uneducated,

labour with no technical training)

Productivity of Labour

Favourable Labour laws

Medium- tech intensive

Availability of skilled labour

(Engineers, Chemists etc.)

Customised production

Production in batch quantities

Low tech-intensive

Availability of medium skill labour

(Diploma holders)

Economies of scale

Long product life cycles

High-tech intensive

Availability of highly skilled work force

(Scientists)

Environment for innovation (patent laws,

risk capital, rewards for innovation)

High R&D investment

Large domestic market (ability to identify

trends)

Source: Edelweiss

ADVANTAGE INDIA

Using Indias rich iron ore

and aluminium resources

Tisco and Hindalco have

emerged globally

competitive

Our analysis uses the

UNCTAD classification of

products as a base

Figure 1: Critical success fac


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India has a competitive

advantage in medium and

high skill- intensive

products

India emerges strong in the skill intensive category

Considering the above factors and India-specific advantages, we believe that India has an

edge in medium and high skill-intensive products. Our discussions with Indian managements

and industry experts also corroborate our view that India has a competitive advantage in

manufactured products which require:- Engineering and design capabilities

- Low volume not involving mass production

- Skilled manpower

We have identified the following sectors which fit into the above categories, considering

their competitive global advantages. We believe these industries will report faster export

growth rates in the coming years and our effort has been directed towards identifying

companies in these sectors with maximum growth potential. The industries identified are:

1. Agro-chemicals

2. Auto components

3. Engineering4. Pharmaceuticals

5. Specialty chemicals

Recent performance validates this

We have mapped Indian manufactured exports as per UNCTAD product classification

using the DGCIS data on commodity-wise exports from India. DGCIS categorises total

exports into 100 products. Of these 70 products are under the manufactured exports

category. We have mapped data for these products from FY96-FY02.

As can be seen from Chart 4 below, in India labour and resource-intensive industries

accounted for 60% of total manufactured exports of USD 34.5 bn in FY02. The growth

rates clearly indicate the shape of things to come. High skill and technology-intensiveproducts have grown at a 13% CAGR during the last six years primarily led by

pharmaceuticals and medical equipment industries. Compared with this, labour-intensive

products have grown at a 5% CAGR during the same period.

Pharmaceuticals and medical instruments are part of high skill-intensive products while

electrical and non-electrical machinery like diesel engines and auto components form part

of medium skill-intensive products.

High skill-intensive product

exports grew at a 13%

CAGR during FY96-FY02

Chart 4: Indias manufactured exports

Source: DGCIS & Edelweiss

0

5,000

10,000

15,000

20,00025,000

30,000

35,000

40,000

1996-97 1997-98 1998-99 1999-00 2000-01 2001-02

USDM

n

Labor-intensive and resource intensive Low skill-technology-capital

intensiveMedium skill-technology, capital

intensive High skill-technology

Chart 5: Category-wise CAGR during FY96-02

Source: DGCIS & Edelweiss

0

(%)

2

4

6

8

10

12

14

Labor-

intensive

and resource

intesive

Low skill-

technology-

capital

intensive

Medium

skill-technology,

capital

intensive

High skill-

technology


Chart 4: Indias manufacturedChart 5: Category-wise CAGR du


17/110

17Edelweiss

THE TIME IS NOW

In the earlier sections, we have listed the various India-specific advantages and factors that

engendered a conducive business climate. We had also stated that the single most important

factor that we believe will drive export-led growth of Indian manufacturing companies is

the change in the mindset of the Indian management. We wish to argue that a newbusiness environment has emerged in which the government is more a facilitator than an

impediment to business. There have been other business enablers as well. We believe this

has had a tremendous positive impact on Indian companies. We have categorised these

business enablers into Industry/economy level enablers and company level enablers. Going

forward, these enablers will catalyse export-led growth for manufacturing companies.

I) Economy/Industry level enablers

a) Improving regulatory issues and policies: Today, the governments role in export

promotion is more of a facilitator than a regulator. The governments efforts to boost

exports are directed at i) Simplifying procedures to eliminate administrative and legal

hassles ii) Announcing policies and incentives aimed at increasing exports.

i) Simplification of procedures:Over the last five years, the government has simplifiedprocedures for exports tremendously. Our interactions with industry indicate that today,

enterprises spend around two days clearing their consignments with customs officials

compared with around fourteen days in CY96 and seven days in CY99 as shown in Chart

6 below. In some cases goods are cleared in less than 24 hours from the time they arrive

at the ports. All 32 offices of the Director General of Foreign Trade (DGFT ), the nodal

agency for foreign trade, have been computerised and exporters can transact with DGFT

online. In the new EXIM policy for FY03-FY04, the government has announced 50%

lower transaction fees for applications filed online. Customs officials are available at

ports at any time of the day as against past practice of working to a clock.

ii) Encouraging policies: The Government has been improvising its export policies in

the post-liberalisation era. Some measures include setting up of new Special Economic

Zones (SEZs), launching special export promotion programmes, conducting market

studies and identifying special products for export promotion. Up to 100% foreign equity

is permitted without requirement of an approval in construction and maintenance of ports

and harbours and in projects providing support services to water transport, such as

operation and maintenance of ports and loading and discharging of vehicles. These initiatives

are helping in reducing infrastructure bottlenecks.

New business enablers are

acting as triggers of growth

Goods are cleared at ports

within 24 hours against 14

days earlier

Companies can transact

online with the DGFT

THE TIME IS NOW

Chart 6: Days taken for clearing exports at ports

Source: Edelweiss

0

2

4

6

8

10

12

14

16

1996 1999 2002

No.ofdays

Days for clearance

Governments role as an

enabler is increasing

SEZs along the lines of

China are emerging

The Time is NowChart 6: Days taken for clear


18/110

18 Edelweiss

b) Improved infrastructure: During the last five years, India has made significant

progress in improving infrastructure. This is noticeable in port capacities and in telecom

and road infrastructure. Average ship turnaround time at major ports has reduced from

7.5 days in CY97 to 3.4 days in CY02. In the telecom sector, a near-monopoly scenario

characterised by years of waiting to secure a telephone connection, old technology and

very low penetration levels are things of the past. The changes have been dramatic. In thelast seven years, the country has moved from this (penetration levels of two per hundred)

to a scenario of multiple operators competing vigorously, (80% drop in domestic long

distance tariffs in the last three years), state-of-the-art technologies in telecom, fibre

optic network connecting all major towns and penetration levels reaching 4.3 per hundred.

The road infrastructure has also seen improvement with the commissioning of expressways

(Mumbai-Pune, Bangalore-Hosur). Implementation of the Golden Quadrilateral project

and national highway projects are well underway.

c) Emergence of SEZs and EOUs: The effectiveness of SEZs in generating export

production is already well established by the performance of such Zones worldwide (see

Chart 7). Exports in the year 2000 from these Zones were USD 850 bn, representing

15% of the total world exports. These Zones are also increasingly being perceived as amajor source of attracting FDI.

At present there are 2700 SEZ/EOU units in India. In FY02 they contributed INR 270 bn

in exports revenues, a growth of 15% YoY. The units also provide employment to 700,000

people. The EOUs/SEZ units cover major industrial sectors like textiles, garments and

yarn, food and agro products, electronics and software, chemicals, engineering, minerals,

and granites. The Export Promotion Council (EPC), with the support of EOUs/SEZs, has

an ambitious road map to achieve and contribute 25% of the national exports through

manufacturing exports by FY08. In the next two years this segment is looking at achieving

USD10 bn worth of exports.

Significant improvements

seen in Road and Telecom

infrastructure

Interest rates have reduced

considerably in recent

times, helping Indian

companies

Chart 7: Contribution of SEZs to total exports in select countries

Source: KPMG

0

10

20

30

40

50

60

70

80

90

1992 1993 1994 1995 1996 1997 1998

Philippines China Dominican Republic Indian

EPC targets a 25%

contribution to national

exports through SEZs and

EOUs


d) Lower interest rates: The steady decline of interest rates has led to lower cost of

capital and companies becoming more competitive in global markets. Over the last four

years, India has seen a decline in real and nominal interest rates. Corporates can now

borrow at 8-9% compared with 14-15% four years ago. This is mitigating the disadvantages

the Indian corporates faced while competing internationally.

(%)

Chart 7: Contribution of SEZs


19/110

19Edelweiss

THE TIME IS NOW

Favourable policies and

improving infrastrutureluring MNCs to set base in

India for catering to global

requirements

e) Increased outsourcing by MNCs: Multinational corporations (MNCs) have played a

major role in globalisation and exports of developing countries. The barriers to international

transactions are falling, spurred by liberalisation, technological innovations and speedier

transportation. This is intensifying competition urging MNCs to internationalise production

systems. Thus, different activities can be performed in locations that offer the best

conditions in terms of costs, resources, logistics and market access. The MNCs mentionedin Table 4 below have established sourcing offices in India with an aim to increase sourcing

and develop the vendor market.

Table 4: Major MNCs having sourcing offices in India

Volvo Ford

General Motors Delphi

GE Cummins

Hyundai Toyota

Daimler Chrysler

Source: Edelweiss

Multinationals have played a major role in contributing to the export growth of various

countries in which they have established a presence (see Table 5). In China, the share offoreign affiliates in exports rose from 17% in CY91 to 50% in CY01.

The affiliates of five multinational auto manufacturers contributed USD 27 bn to total

exports of Mexico. In India, until late nineties, the role of MNCs was very limited.

Favourable policies and improving infrastructure have attracted many MNCs to set up

and expand operations in India to cater to global requirements. In CY00, MNCs accounted

for 5% of Indias total exports.

Table 5 : The role of foreign affiliates in the exports of six select economies

Economy Total exports Share of foreign Top three MNC Exports

(Year) CY00 affiliates in total exporters in CY00

(USD bn) exports (%) CY00 (USD bn)

China 279.6 50.0 IBM 1.5

(CY01) Samsung Electronics 1.5

Nokia 1.1

Costa Rica 6.7 50.0 Intel 1.7

(CY00) Dole Food 0.2

Del Monte 0.1

Hungary 25.5 80.0 Volkswagen 3.2

(CY99) IBM 2.2

Philips Electronics 2

Ireland 52.5 90.0 Intel (CY98) 4.8

(CY98) Dell Computer (CY98) 4.3Microsoft (CY98) 2.4

Mexico 180.4 31.0 IBM 9.6

(CY00) Daimler Chrysler 6.9

General Motors 6.7

Republic of Korea 150.4 15.0 Amkor Technology 4.7

(CY99) Nokia 2.4

Chip Pak 2.4

Source: UNCTAD

Table 4: Major MNCs having souTable 5 : The role of foreignTable 5 : The role of foreign


20/110

20 Edelweiss

GE is among the foremost to declare intentions to use India as a manufacturing base for

medical equipment and motors. In CY02 General Electric (GE) exported INR 10 bn

worth medical equipment and is expected to scale this up to INR 25 bn by CY05. In the

Fig.2 below, we present examples of MNCs who have displayed strong intentions of

outsourcing from India.

Over the last five years numerous MNCs have opened dedicated offices called international

purchase office (IPO) or global procurement divisions (GPD) in India to identify and

expand their sourcing operations.

GE takes the lead in

outsourcing to India....

Thrust on exports entails

focus on quality and

structural changes

Companies spending more

on increasing visibility and

developing and nurturing

international markets

Figure 2: Select MNCs outsourcing plans for India

Unilever sources around INR 8 bn worth FMCG productsfrom HLL, which is expected to touch INR 50 bn over the

next three-four years.

Ford India exports to Brazil, Mexico and South Africa. In CY02,it exported 28,915 passenger cars, while it sells only half of

that in India. Whirlpool plans to increase contribution of exports in totalrevenues from present 12% to 25% in the next three years.

Clariant India is amongst the three global sourcing bases ofthe parent company.

Toyota is sourcing propeller shaft and rear and front axles.Soon it will be sourcing transmissions for seven SUV plants

located worldwide

Techumseh of U.S. has invested USD 100 mn in India sinceCY97 and is expanding capacities to increase its export business

from current 30% to 50-70% in the coming years.

Sourcing from Indian suppliers by Daimler Chrysler hasincreased from Euro 6 mn in CY98 to Euro 63 mn in CY02.


II) Company level enablers

a) Focus on exports: Competing in the global marketplace is a totally different ballgame.

Indian managements that hitherto thrived in a protected regime had to take on the challenges

of international competition. Focus on export markets called for companies making

structural changes. Companies needed to improve their cost structure, enhance quality

and establish a dynamic marketing infrastructure. It also called for redesigning plants,

rationalising workforce, automating processes and streamlining vendors network. To

supplement the above efforts, companies also upgraded systems and sought accreditionslike QS9000 and QS 14000. Chart 8 captures this scenario, showing how the number of

accredited plants increased from virtually zero in CY91 to 8000 in CY99 in the post-

liberalisation phase.

During the same period, companies made vigorous efforts to explore and improve their

visibility in international markets. This is evident from the foreign travel expenses of BSE

500 companies for the manufacturing sector. This expense reported an 11% CAGR during

FY99-FY02.

Source: Industry

While numerous others are

following suit

Figure 2: Select MNCs outsour


21/110

21Edelweiss

Chart 8: QS certified plants in India

Source: ISO and Edelweiss estimates

0

500

1,000

1,500

2,000

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001E

2002E

Incrementalplants

0

2,000

4,000

6,000

8,000

TotalNo.ofplants

Incremental Total in India

Indian companies are

establishing international

marketing facilities

THE TIME IS NOW

b) Strategic initiatives: Until a few decades ago, India was perceived as the land of

snakes and elephants. Though this perception has undergone a dramatic change since

the advent of liberalisation, we believe that foreign players still harbour reservations about

dealing with India. We have said elsewhere in the Report that the Indian software industryhas established a comfort level of dealing with a number of Fortune 500 companies. This

is a major plus. But the process of establishing global presence is time-consuming.

We believe that the entrepreneurship displayed and strategies deployed by Indian

corporates will play a major role in acceleration of exports. Some of these strategies are

outlined below.

i) Acquiring front-end companies: Indian companies face a major challenge of

selling themselves, especially in high skill-intensive products. The lead times

for initiating discussions and ramping up are high. To counter this many firms

like Ranbaxy, Dr Reddys and Bharat Forge have acquired local marketing and

distribution companies in their key markets of U.S. and Europe. Some companies

like Sun Pharma have acquired firms with manufacturing facilities, where finalpackaging is being done.

ii) Investing in a marketing and distribution network: This involves sustained

investment in sales and marketing and distribution network in the initial years though

benefits will accrue over a period of time. Companies like Crompton Greaves have

invested heavily for establishing their presence globally.

iii) Leveraging existing clientele: A well-reputed client base can be leveraged

for increasing customers. For instance, Bharat Forge, with clients like Daimler

Chrysler, Volvo and Cummins, will find it much easier to attract new clients in

international markets. Indian software companies offer a very good example of

leveraging existing clientele to attract new clients. A fine example would be that of

Satyam leveraging its relationship with GE and Dun & Bradstreet to become a

leading software services player.

This entails acquiring

front-end companies.....

investing heavily in a sales

and distribution network

Chart 8: QS certified plants i


22/110

EVALUATION OF EXPORT SALES MODELS

In this Report, our attempt has been to identify companies with potential for export-led

growth. We believe companies in Pharmaceuticals, Engineering, Auto Ancillaries and

Specialty Chemicals are likely to show robust overall growth in export revenues going

forward. But we believe profit margins over the long term would also depend on theexport sales model of the company.

We define an export sales model as a strategy used by a company to reach its clients.

We have identified different export sales models followed by companies to achieve

export growth and have analysed their impact on long-term sustainability of revenues and

profit margins.

i) Direct Sales Model: This comprises:

1) Sales to retail and wholesale customers

2) Original Equipment Manufacturers (OEMs)

This model entails establishment of a global distribution network to reach end

customers.

ii) Outsourcing Model: Outsourcing is defined as the contracting of one or more of a

companys businesses/products to an external firm. This is sub-divided into three

categories:

1) Supplying to the parent

2) Outsourcing for a third party

3) Contract manufacturing

We attempt to show how the export sales model of the company will drive margins and

long-term sustainability of revenues. For instance, we believe that companies following

the Direct Sales Model will see high sustainability of revenues and profit margins in thelong run. The risk here is in investing in companies which are at the early stage of adopting

the direct sales model. During the initial phase of two to three years, overheads will be

high, impacting profits.

On the other hand, Outsourcing by the parent will show fast growth in the short term,

with least effort (no S G & A expenses). However, in the long term, the margins could be

under pressure considering the parents interest in maintaining its profit margins.

We believe contract manufacturing is a good model for a company as an entry strategy

and as a means of achieving faster growth in the initial period. It also offers high revenue

sustainability. It is a good foot-in-the-door strategy offering sustained revenues since a

contract usually stretches over five years. The underlying danger is that, as in case ofsales to parent mode the buyers here too would be well aware of the cost structure and

would constantly work towards cutting prices.

Chart: 9 shows how each business model is positioned in terms of risks and margins

across different categories and sub categories. Chart 10 shows the long term impact of

these sales models on sustainability of revenues and profits of companies.


22 Edelweiss

Sales strategy followed by

companies will be

crucial in determining

revenue sustainability

High initial marketing

expenses in case of a direct

sales model

Evaluation of Export Sales Mod


23/110

Explanation for terms used in the charts above

Parent : Exports to parent

Cont : Contract manufacturing

DS : Direct Sales

T P : Third party manufacturing

OEM : Original Equipment Manufacturers

Chart 9: Risk vs Margins of different export sales models

Source: Edelweiss

Margins

Risk

Cont

TP

Parent

OEM

DS

Low

Low High

High

Chart 10: Long term impact of different export sales models

Source: Edelweiss

Sustainability of Earnings

Parent

Low

Low High

High

Cont

TP

OEM

DS

SustainabilityofRevenues

EVALUATION OF EXPORT SALES MODELS

23Edelweiss

Risks higher, but margins

higher too in case of a

direct sales model

Sales to parent model offers

high revenue sustainabilitybut low margins

Returns low in contract

manufacturing but a good

foot-in-the-door policy

Chart 9: Risk vs Margins of diChart 10: Long term impact of


24/110


24 Edelweiss

Companies covered

Our objective is to identify companies that are likely to benefit from export growth and

see maximum market cap expansion. Our focus has been on the following industries:

a) Agro-chemicals

b) Auto components

c) Engineering

d) Pharma

e) Specialty chemicals

We have identified companies from the above industries considering factors such as

export potential, the export phase in which company is at present, the degree to which

current market price reflects potential from export business and share of export revenues

to total revenues and size. Based on these we have categorised companies likely to benefit

from exports into three categories.

1. Large market cap companies, where current market cap factors in the companys

international presence. This category includes companies who will report faster

export growth but this will not have a significant impact on their revenues.

2. Companies that will see a major impact on market capitalisation due to increased

exports. In most cases, these companies have just entered a high growth phase.

This is our primary focus area of this report.

3. Companies that are at an early stage of initiative in exports and small cap companies

having good potential going forward. We have presented these companies in a

separate section under the category Emerging Exports Stories.

Thus, we have not considered in this Report large corporations like L&T, BHEL or HLL

who are aiming at aggressive export growth since we believe that overall contribution of

exports to their revenues will be insignificant. We have also not covered companies likeRanbaxy and Dr Reddys whose export forays are largely factored in to current market

price.

Table 6: Export sales model followed by companies

Direct Sales Outsourcing

Direct OEM Parent Contract Third Party

Manufacturing Outsourcing

Agro. Chem UPL

Auto Comp. Sund. Brake Bharat Forge Igarashi Motherson Bharat Forge

Engineering CG Cummins

Elgi ABB ABB

Thermax

Pharma IPCA, Shasun

Lupin,

Aurobindo

Spl. Chem Jubilant Camlin, Hind. Inks

Table 6: Export sales model fo


25/110

CONCERNS AND RISKS

CONCERNS AND RISKS

Delays in closing existing businesses

The business Indian firms will be getting in the coming years will be increasingly from

replacing existing manufacturers than from additional or new demand. The present

requirements of these firms are being met by a) in-house manufacturing facilities andb) outsourcing from other firms in the same region.

While a slowdown in demand and need to cut costs are pushing companies to look for

low cost suppliers, it entails closing down in-house manufacturing facilities or reducing

offtake from existing suppliers. Both the decisions are sensitive and involve issues of

laying off employee and relationships with suppliers.

As a result, though there is a compelling need for sourcing their requirements from

countries like India, implementing the measures to outsource or relocate manufacturing

bases could take time.

Anti-dumping duties and non tariff barriers

In the nineties most developed countries saw growth and economic expansion. But in the

last two years, growth rates have slowed considerably resulting in recessionary trends.

In this scenario a foreign entity taking away business from local supplier is a sensitive

issue. Apart from anti-dumping cases, there will be many non-tariff barriers that Indian

companies will encounter. For instance, to sell their products in the U.S., auto

manufacturers will have to get registered with local authorities in the respective cities,

which is a time-consuming process.

Rigid labour laws and low labour productivity

Archaic labour laws and low productivity levels are concerns. We believe countries like

China have advantage over India in labour intensive products. Foreign companies who

believe in paring payrolls to remain cost competitive view the rigid Indian labour laws asa major impediment.

Power, infrastructure and regulatory problems

Apart from high tariffs, Indian industry is dogged by power shortages and poor quality of

power. India continues to have 14% peak power deficit. Though road and port

infrastructure improved considerably in the recent past, we believe we have a long way

to go to match standards of developing countries, especially our East Asian neighbours.

China

China has clear advantage in products, which are either labour intensive or scale intensive.

Judged from todays point of view, China does look as though it could out-compete other

economies in the manufacturing of almost anything labour-intensive. This is substantiatedby the fact that 70% of Chinas exports today are of garments, toys, shoes and furniture.

In Annexure IV, we have attempted to present a head-on of India vis-a-vis China. As

reiterated in this Report in earlier sections, our analysis clearly points out that India has a

distinct advantage in skill-intensive areas.

25Edelweiss

Initiating outsourcing

measures or relocating

manufacturing bases aretime-consuming processes

Indian companies could

encounter anti-dumping

duties and non-tariff

barriers

Rigid Indian labour laws a

dampener

Infrastructure needs

vigorous changes for

companies to be in the

reckoning

China has clear advantages

in labour-intensive

categories

Concerns and Risks


26/110

ANNEXURE I

What is manufacturing?

Manufacturing is defined as a process that combines machinery, tools and manual labour

to bring material closer to a final state. It consists of a set of processes, materials, and

systems (including people) that transforms a limited range of materials into products of

increased value.

Manufactured products can be classified in numerous ways. For the purpose of our

study in this Report, we have used UNCTADs Standard International Trade Classifica-

tion (SITC). The SITC groups all products in three categories.

a) Primary products consisting of agricultural products, mining products, fuels

and non-ferrous metals.

b) Manufactured products - This segment has seven sub segments:

1) Iron and Steel

2) Chemicals

3) Other Semi-Manufactures

4) Machinery and Transport equipment

5) Textiles

6) Clothing

7) Other Consumer Goods

c) Other products - consists of commodities and transactions not classified

elsewhere.

UNCTADS CLASSIFICATION OF PRODUCTS

UNCTAD has classified products according to industrial upgrading based on factor in-

tensity relating to resources, skill and technology. Thus all products have been classified

under five categories.

1) Non-fuel primary products

2) Low skill and technology-intensive products

3) Medium skill and technology-intensive products

4) High-skill and technology intensive products

Relevance of UNCTAD classification to our study

Since our study is focused on manufactured products, we have considered the last four

categories of UNCTADs classification in this Report. In Chart 11 we attempt to showthe top products in each category, their market share in international trade and their

growth rates in the last twenty years.


26 Edelweiss

ANNEXURE I


27/110

ANNEXURE I

27Edelweiss

Chart 11 Top twenty internationally traded products by factor intensity - 19802000

Animal oils and fats

Crude rubberHides and skins

Textile fibres

Crude fertilizers and mineralsCereals

Oil-seeds

Tropical beverages & spicesSugar

Live animals

Metalliferous oresPulp and waste paper

Feeding stuff for animalsDairy products

Cork and wood

Fixed vegetable oils and fatsMeat

Non-ferrous metals

Vegetables and fruitsProcessed animal and veg oil, etc

Crude animal & vegetable mat.

TobaccoFish

Beverages

Misc. edible products

Computers & office equip.

Comm. equip. & semicond.

Chemical and Pharm. productsAircraftScientific instruments

El. machinery excl. semicond.Rubber and plastic products

Road motor vehiclesNon electrical machinery

Clothing

Wood and paper productsToy and sporting goods

LeatherNon metallic mineral products

Textiles

FootwearSanitary and Plumbing equipment

Simple transport equipment

Fabricated mental productsIron & Steel

Ships and Boats

15 10 5 0 5 10 15 20

Non-fuel primary commodities High technology-intensive manufactures Medium technology-intensive manufactures

Labour- and resource-intensive manufactures Low technology-intensive manufactures

Share in world non -fuel ex po rts, 20 00 Ave rag e an nu al exp ort valu e g ro wt h, 19 80 2 00 0

(%) (%)

Source: UNCTAD

Chart 11 Top twenty intern


28/110

ANNEXURE II

The Indian manufacturing sector - A perspective

The share of manufacturing in Indian GDP in FY02 was 16.8%. This share has reduced

from 17.7% in FY98 primarily due to faster growth of the services sector. Significantsigns of a turnaround however seem to be emerging, with the manufacturing sector

posting 6% growth in FY03.

According to the Annual Survey of Industries, conducted by the government of India, at

the end of FY00, Indian manufacturing sector comprised of 131,558 factories, invested

INR 5,666 bn and reported INR 8,979 bn in revenues. According to the Economic

Census, which is the most comprehensive study on enterprises, including the unorgan-

ised sector, there were 65 mn people employed in enterprises at end of FY98.

The manufacturing sector plays a significant role in productive use of labour and transi-

tion of agricultural workforce to manufacturing workforce. The sector employs only

14% of the total workforce in India. Agricultural sector accounts for 62% and services

sector for 24%.

According to CMIE, which maintains financials of over 5,000 corporates, Indian manu-

facturing industry sales grew at a 17.6% CAGR in the first half of the nineties and 13.8%

CAGR in the second half. This growth too was primarily driven by petroleum industry.

Aggregate revenues of these companies were INR 8,882 bn in FY01.


28 Edelweiss

ANNEXURE II


29/110

ANNEXURE III

Trends in global trade

In the last twenty years, the value of world merchandise exports has grown at an 8%

CAGR compared with less than 6% CAGR in global output. In FY02, international trade

in merchandised goods was at USD 6.1 trillion. Of these manufactured goods accounted

for 75% at USD 4.6 trillion.In the changing international trade scenario, some products

have registered much higher growth than others for a number of reasons. It is easy to

achieve export growth and gain market shares through focus on these products.

Growing share of developing countries

The share of developed countries to total world exports was 64.1% in CY01, a decline

from 71.5% in CY90. The steady growth in world trade has been attributed to a)

Increasing integration of national economies b) Deepening of international division of

labour c) International production networks.

Since the early eighties, most developing countries have rapidly liberalised trade and

are working towards increasing Foreign Direct Investment (FDI). This implies openness

to international market forces, thus altering the pace and pattern of international trade

of developing countries. These countries currently account for one third of

world merchandise trade. Manufactured products account for 70% of developing

countries exports.

The increased mobility of capital has led to international production networks where

production chains can be split up and located in different countries For example, U.S.

based pharmaceutical majors source incipient and other basic chemicals from China,

which are then transported to India. The end product i.e. the bulk drug is then sourced

from India. The final formulation is manufactured in the U.S. This spread of production

sharing networks is also facilitated by reduced transport and communications costs and

falling trade and regulatory barriers.

Products that have participated maximum in international production sharing arrange-

ments during last two decades are categorised in three distinct groups:

a) Components and parts for electrical and electronic goods

b) Labour intensive products like clothing

c) Goods with high R&D content

.

Shifting manufacturing bases to low cost countries

In the U.S, the number of jobs in manufacturing at present is same as it was CY91.

During the same period, the U.S. economy grew at a 4% CAGR. The average U.S.manufacturing worker is paid USD14.35 per hour. Comparative wages for workers in

India and China are USD 0.6.

In developed countries, standards of living are much higher compared with developing

countries. This along with limited populations and low unemployment rates is putting

pressure on availability of unskilled or factory labour. In the U.S., employment growth

ANNEXURE III

29Edelweiss

Annexure III


30/110

has been primarily led by the services sector. In the first nine months of 2002 alone,

the manufacturing industry in U.S. lost 332,000 jobs while the services sector added

506,000 jobs.

Non-availability of workforce, high wages and higher overheads are forcing companies

to shift manufacturing bases to developing countries like China and India.

Source: UNCTAD

50

150

250

350

450

550

650

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

All products Non-fuel primary commodities

Labor- and resource-intensivemanufactures

Low technology-intensivemanufactures

Medium technology-intensivemanufactures

High technology-intensivemanufactures


Fast growing trade in skill-intensive products

As can be seen from Chart 12 above, the difference in growth rates of world exports in

these five product categories during FY80-FY98 is dramatic. The high skill and technology-

intensive products category reported the strongest growth with a five-fold increase in

exports during this period. Significantly, developing countries reported stronger

growth in high skill and technology-intensive products with a 14 times increase in exports

during this period. This category now accounts for the highest share in world non-fuel

exports category.

30 Edelweiss

Chart 12: Growth of world exports by product category

(Index numbers, 1980 = 100)

Chart 12: Growth of world expo


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ANNEXURE IV

China vis--vis India

We have argued in this Report that Indian companies in select industrial sectors will

leverage the India advantage and report exponential growth. We have also enumerated

how export growth will come from direct sales, outsourcing and contract manufacturing.

Given a number of similarities, it is inevitable that parallels are drawn between India and

China. In this Annexure, we list factors that give China its pre-eminent status. We go on

to compare India with China and show that Indias core competence is in skill intensive

sectors.

China gains pre-eminence in exports

China is amongst the top five players for eight out of the 20 dynamic products in world

trade. China has emerged as an outsourcing destination and manufacturing base for the

world in several products and has captured a large share of world trade. Manufactured

exports from China have registered a 16% CAGR in the last ten years to USD 280 bn in

FY01. Today China accounts for 29% of world trade in bicycles, 28% in toys, 25% infootwear, 20% in readymade garments and 14% in electric power machinery. In con-

trast Indias total manufactured exports were USD 34 bn, of which USD 7.4 bn are from

gems and jewellery business. The only other product categories where India has a

noticeable share are readymade garments (3.8% market share), bicycles (2.15% market

share) and pharmaceuticals (2% market share).

A new trend is emerging

We believe that China will continue to enjoy leadership in labour-intensive and mass

production categories. In these categories, Indian companies will not be able to compete

with China. Instead, as seen in case of our basket of companies, Indian companies will

increasingly use China as an outsourcing or contract manufacturing base, perform the

value addition in India and export to a third country. As current trends indicate, at onelevel, the Indian manufacturing sector is identifying opportunities to win a slice of the

burgeoning Chinese market. At another, it is leveraging China as a source for components

and finished goods to cut costs for its own products and stay competitive at home

and internationally.

Some of the companies like Aurobindo have already begun the process. In a new emerging

trend, companies like Bharat Forge and Tisco have started exporting to China. Bajaj

Electricals stopped manufacturing table, pedestal and wall fans and started importing

these from China. Thus, we believe, in the new scenario, with a changed mindset, cross-

border trade between India and China is showing a positive trend.

Factors that give China its overriding advantage

China has a clear advantage in products, which are either labour-intensive or

scale- intensive. About 70% of Chinas exports today are of garments, toys, shoes,

furniture and other such labour intensive products. We believe, it would be difficult for

India to match Chinese labour productivity in the medium term.

ANNEXURE IV

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ANNEXURE IV


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The Chinese success has mainly been due to the following factors:

a) FDI China received USD 336 bn FDI inflows in the last ten years. Exports of

multinationals now account for 49% of total Chinese exports of USD 280 bn.

This was only 4% in CY91. Comparitively, India has attracted a cumulative FDI

of USD 38 bn during the same period.

b) SEZs: Over the last twenty years, China has created over 500 special economic

zones in the country. All these zones provide several benefits like quick approv-

als, ready office and plant infrastructure, flexible labour policies, attractive fi-

nancial incentives and ready to access domestic market. These SEZs have been

instrumental in the growth of Chinese manufacturing industry. In FY01, these

SEZs accounted for 75% of total FDI inflows into the country. The Indian

government is working on setting up SEZs along these lines.

c) Manufacturing employment: The employment by agriculture in China reduced

from 68% in CY81 to 54% in CY99. This has played a major role in improving

purchasing power of people, apart from increasing availability of labour for manu-

facturing industry. In India however, agricultural employment has fallen from69% to 62% only during this period. China has achieved a 12% annual labour

productivity growth during the last ten years, whereas during the same period

productivity growth in Indian manufacturing was 2.2%.

d) Lower duties and taxes: Average import duty in China is 17% compared with

24% in India. In indirect taxes, China has a flat 17% value added tax, whereas in

India these taxes account for 25-30% of retail prices. This leads to higher raw

material prices and products being expensive overall.


32 Edelweiss


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INDUSTRIES

AND

COMPANIES

INDUSTRIES

AND

COMPANIES

industries


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AGRO

CHEMICALS

AGRO CHEMICAL INDUSTRY


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An INR 45 bn industry

Agro chemicals is an INR 45 bn industry in India. Insecticides account for 75% of the

market, Fungicides 14% and Herbicides 9%. In terms of chemical compounds, Synthetic

Pyretheroids account for 50%, Organophosphates 16%, Organochlorines 19% and

Carbonates 35%. Exports from India are around INR 10 bn.

The Indian market is the thirteenth largest in the world with a 2.5% share. In the domestic

market, the industrys fortunes depend on the monsoons with most consumption happening

during the Kharif (September-March) period.

The composition of the industry indicates that it is still largely unorganised.There are 80

organised players as against 500 unorganised players in the segment.

Major Indian players are United Phosphorus (INR 10 bn), Rallis (INR 10 bn) and Excel

industries (INR 4 bn). Multinational companies having a major presence in India are

Bayer (INR 6 bn), Syngenta (INR 4 bn) and Monsanto (INR 3 bn).

A USD 30 bn global market

The global agro chemicals market is USD 32 bn in size. It has grown at a 2-3% CAGR in

the last five years. Of this, the generic opportunity is approximately USD 24 bn. Globally,

share of Herbicides is the highest (48%), followed by Insecticides (29%), Fungicides

(17%) and others.

Key markets for agro-chemicals are North America (30% share), Western Europe (22%),

Asia Pacific (25%) and Latin America (16%). In the last three to four years sales growth

of these markets have been depressed due to the entry of generic products and slow pace

of new introductions. The global market is highly consolidated with the top ten companies

commanding a 70% marketshare. In North America and Europe, the markets are highly

regulated. Players here have to comply with stringent environmental safety tests. It takes

approximately 12-18 months for generic companies to get approvals for their products

due to rigorous regulatory requirements.

Leading global players are Bayer Crop Science (USD 6 bn), Syngenta (USD 5 bn), BASF

(USD 3 bn) and Monsanto (USD 3 bn).

Key growth drivers

Key growth drivers for the industry are a) Increased domestic consumption b) Global

opportunity.

AGRO CHEMICAL INDUSTRYGlobal generics a massive opportunity

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I. Increased domestic consumption. In India, pesticides are used for 36% of the area

under cultivation. Further, this is confined to a few crops and a few states. The farming

industry in India is getting corporatised gradually. Growth of the food processing industry

and entry of corporates into commercial agriculture are expected to provide the necessary

fillip to the sector.

II. Attractive export opportunity

Of the USD 30 bn, global industry, generics accounts for 80%. For competitive Indian

companies, this is a vast opportunity. Companies like United Phosphorus and Rallis have

just begun to enter the export markets. Indian companies enjoy cost advantages due to

high level of integration in operations and low labour costs. An added attraction is the

absence of intense competition in the generic category where costs of registrations are

prohibitive and act as an entry barrier. Indias share in the global pie is less than 1%. We

expect companies that have already ventured into exports to show over 30% CAGR in

the next three to four years.

Key success factors

Key success factors for agro chemical companies intending to tap export opportunitiesare:

- Integrated manufacturing facilities

- Active product pipeline for export markets

- Plants and facilities that meet global environmental norms

- Availability of skilled R&D people with experience in global companies

Outlook

Indian agro-chemical manufacturers have invested in building integrated facilities, lowering

cost structures and enhancing R&D in the last five to six years. These companies have

also built an active product pipeline for registrations in the global markets. Companieshave now begun to make significant investments towards branding of products and

building a strong distribution network across markets.

We believe that the USD 24 bn generic market place provides a good opportunity to

Indian companies who have marketing infrastructure and globally compliant manufacturing

facilities in place. Exports currently do not form a sign

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INDIA Mfg Sector Report1!03!30 04