Nomura's - India Strategy 2010 - 4th Jan 2010

4 January 2010 Nomura

Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 125 to 128.

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Nomura Anchor Reports examine the key themes and value drivers that underpin our sector views and stock recommendations for the next 6 to 12 months.

Strategy | I N D I A 2010 Outlook Prabhat Awasthi +91 22 4037 4180 [email protected] And the India Research Team

The Indian rebalancing trick We expect the overarching story in India this year to be of re-leveraging and the return of risk-taking, as a combination of easy capital and capacity shortages work to create an ideal platform for the investment cycle to take off. Growth is likely to accelerate as an autonomous pick-up in industrial investment is fortified by a policy push on infrastructure. Meanwhile, the government, bereft of its ability to actively deploy capital in light of its stretched finances, should move away from ultra-loose fiscal policy and share risk-taking with the private sector through increased public-private partnerships. But, every path has its puddle. Early on this path to risk-taking and growth lies the proverbial puddle in the guise of a quick rise in inflation, which when it elicits a response by the central bank, should cause a market correction and an underperformance of rate cyclicals, especially banks. We believe that investors should use this opportunity to buy into the Indian market. Sector-wise, we believe that domestic cyclicals, such as banks, infra & construction and real estate, are the best way to play the India growth story that we expect to unfold in the year ahead. Short term, we would position away from rate cyclicals. Our top BUYs this year are Tata Steel, SBI, M&M, NJCC and Unitech. Our top REDUCE calls are Tata Motors and Ranbaxy.

Inflation and monetary rebalancing — the proverbial puddle

Growth rebalancing — investment to join the mix

Return of risk-taking — from de-leveraging to re-leveraging

Fiscal rebalancing — a marginal move towards consolidation

TOP DOWN

Stocks for action

Stock Rating

Price(24 Dec)

(INR)

Price target(INR)

Tata Steel (TATA IN) BUY 615.6 926SBI (SBIN IN) BUY 2,215 2,590*M&M (MM IN) BUY 1,061.85 1,232NJCC (NJCC IN) BUY 165.85 197Unitech (UT IN) BUY 82 112Tata Motors (TTMT IN) REDUCE 779.95 419Ranbaxy (RBXY IN) REDUCE 520 261

* PT under review

Analysts Prabhat Awasthi +91 22 4037 4180 [email protected] Nipun Prem (Associate) +91 22 4037 5030 [email protected] And the India Research Team (see inside front cover)

N O M U R A F I N A N C I A L A D V I S O R Y A N D S E C U R I T I E S ( I N D I A ) P R I V A T E L I M I T E D

Don’t miss our companion outlook reports on Asia and ASEAN,

also published today.

mailto:[email protected]



CONTACTS

Asia Ex-Japan Coverage Telephone Email

India Aatash Shah Property +91 22 4037 4194 [email protected]

India Alok Kumar Nemani (Associate) Metals & Mining +91 22 4037 4193 [email protected]

India Amar Kedia Electrical Equipment,

Conglomerates

+91 22 4037 4182 [email protected]

India Anil Sharma Oil & Gas +91 22 4037 4338 [email protected]

India Harish Venkateswaran (Associate) Infrastructure & Construction +91 22 4037 4028 [email protected]

India Harmendra Gandhi IT services +91 22 4037 4181 [email protected]

India Jamil Ansari Media, Basic materials +91 22 4037 4192 [email protected]

India Kapil Singh Auto & Auto Parts +91 22 4037 4199 [email protected]

India Mahrukh Adajania Banks +91 22 4037 4157 [email protected]

India Manish Jain Consumer +91 22 4037 4186 [email protected]

India Neeraja Natarajan (Associate) Telecoms +91 22 6723 5231 [email protected]

India Nipun Prem (Associate) India Strategy +91 22 4037 5030 [email protected]

India Pinku Pappan (Associate) IT services +91 22 4037 4360 [email protected]

India Prabhat Awasthi India strategy,

Auto & Auto Parts,

Metals & Mining and Media


India Ravikumar Adukia (Associate) Oil & Gas +91 22 4037 4232 [email protected]

India Saion Mukherjee Pharmaceuticals /

Infrastructure & Construction


India Sanjay Kadam Database analyst +91 22 4037 4187 [email protected]

India Sonal Varma Economics +91 22 4037 4087 [email protected]

India Sreekanth Akula (Associate) Banks +91 22 4037 4361 [email protected]

Singapore Roshan B. Raj Telecoms +65 6433 6961 [email protected]

Singapore Sachin Gupta, CFA Telecoms +65 6433 6968 [email protected]

Singapore Srikanth Vadlamani Financials +65 6433 6957 [email protected]

4 January 2010 Nomura 1

Strategy | I N D I A

Prabhat Awasthi +91 22 4037 4180 [email protected] And the India Research Team

Action

This year’s over-arching story in India will be the return of risk-taking in the system, as a combination of easy capital and shortage in capacity works to create an ideal platform for the investment cycle to take off. We believe this will accelerate, as an autonomous pick-up in industrial investment is fortified by a policy push on infrastructure. We see domestic cyclicals as the best play into this growth story.

Catalysts In the short term, rising inflation and a tightening policy response should lead to a

market correction and underperformance by rate cyclicals. We believe that investors should use this opportunity to buy into the Indian market.

Anchor themes

Return of growth and risk-taking; renewal of the capex cycle; exit of loose monetary policy; consolidation of fiscal deficit; strong capital inflows; an appreciating rupee.

The Indian rebalancing trick Inflation and monetary rebalancing — the proverbial puddle We stand Bullish on a one-year horizon. While valuations do not seem frothy we do feel they remain vulnerable to excessive inflation and ensuing monetary tightening. We would see a correction of some 10% as offering a more attractive entry point into a solid growth story. We revise our Sensex target from 18,800 for September-end to 19,600 for December-end 2010F. Our new target implies ~13% upside.

Growth rebalancing — investment to join the mix The 2H FY09 (fiscal year-ending 31 March, 2009) saw demand reeled in. We expect better growth in FY11F, underpinned by a turn in the investment cycle. Firm signs of a demand recovery are evident. Capacity shortages that had been masked by absent demand are now back to the fore, creating conditions for a capex revival.

Return of risk-taking — from de-leveraging to re-leveraging Re-leveraging in 2010 is a key theme, following as it does de-leveraging by corporates and households; the government had to leverage up as it administered fiscal stimulus. The tilt of corporate capex into infrastructure spells debt. Meanwhile, a strong job market and rising incomes imply households can bear more risk.

Fiscal rebalancing — a marginal move towards consolidation The government stepped up and infused risk-capital into the economy post-crisis when the private sector was in de-leveraging mode. We expect strong growth this year and expect FY11F to move towards consolidation of government finances as a pick-up in revenues is augmented by slowing expenditure, a tapering-off of extraordinary items and a move towards disinvestment.

Strong capital flows and an appreciating rupee The high tide of capex will draw capital inflows as poor disintermediation of savings (underdeveloped long-end corporate bond market and comparatively low level of savings via equity) implies increasing external inflows to finance long-term capex. This will have implications for monetary policy and the rupee.

Reforms — hope springs eternal We are not pinning too much hope on reform in 2010F. But government policy of inviting private sector participation in infrastructure should continue to generate significant opportunities for developers, banks, and bystanders.


Stocks for actionOur top BUYs for 2010F, among stocks in our coverage, are Tata Steel, SBI, M&M, NJCC and Unitech. Our top Sell-style calls are Tata Motors and Ranbaxy.

TOP DOWN

Stock RatingPrice as on

24 Dec (INR)

Price target (INR)

Tata Steel BUY 615.6 926SBI BUY 2,215 2,590*M&M BUY 1,061.85 1,232NJCC BUY 165.85 197Unitech BUY 82 112Tata Motors REDUCE 779.95 419Ranbaxy REDUCE 520 261* Price target under review

Analysts Prabhat Awasthi +91 22 4037 4180 [email protected] Nipun Prem (Associate) +91 22 4037 5030 [email protected] And the India Research Team (see inside front cover)




Strategy | India Prabhat Awasthi


Contents

The proverbial puddle: monetary rebalancing 4 Valuations not excessive, but not immune to monetary rebalancing 5 Rising inflation is a short-term overhang on markets 5 Early rate tightening will curb core inflation and manage inflationary expectations 6

Growth rebalancing: investment to join the mix 7 Industrial capex suffered on account of the crisis 7 Capacity shortages are back 7 Stalled financial closures have restarted 9 Pick-up in capex will translate into greater capital inflows and rupee appreciation 10

Fiscal rebalancing – a marginal move towards consolidation 11 Revenue buoyancy and potential rollback of stimulus should help rein in the deficit 11 Significant one-offs should roll off this year 11 Implications of better fiscal and monetary tightening – flattening of the yield curve 13

Return of risk-taking: from de-leveraging to re-leveraging 14 From government to private risk-taking 14 De-leveraging by corporates following the crisis 14

Back to reforms? 18 What has been the broad thrust of reforms? 18

Key themes for 2010F 21

Sector strategy 23

Appendix 24

India economic outlook 30

India sector views Autos 36 Banks 38 Building materials 40 Consumer 42 Electrical equipment 44 Infrastructure & Construction 46 Insurance 48 IT Services & Software 50 Media 52 Metals & Mining 54 Oil & Gas / Chemical 56 Pharmaceuticals 58 Property 60 Telcos 62 Transport Infrastructure 64

Also see our Asia Strategy 2010 Outlook report, 4 January, 2010

Also see our ASEAN Strategy 2010 Outlook report, 4 January, 2010

Also see our 2010 Global Economic Outlook report, 16 December, 2009

http://www.nomura.com/research/GetPub.aspx?spid=3526

http://www.nomura.com/research/GetPub.aspx?spid=3530

http://www.nomura.com/research/getpub.aspx?spid=352250



India stock picks Mahindra and Mahindra 66

Tata Motors 70

State Bank of India 74

Ambuja Cements 78

ITC Limited 82

Nagarjuna Construction 86

HCL Technologies 90

Zee Entertainment 94

Tata Steel 98

GAIL 102

Dr. Reddy’s Laboratories 106

Ranbaxy 110

Unitech Ltd 114

Appendix 118



Rebalancing

The proverbial puddle: monetary rebalancing The over-arching story in India this year will be the return of risk-taking in the system, as a combination of easy capital and shortages in capacity work to create an ideal platform for the investment cycle to take off. We believe that growth will accelerate, as an autonomous pick-up in industrial investment will be fortified by a policy push on infrastructure. We believe that domestic cyclicals are the best way to play this growth story.

We expect this year to be one of rebalancing: 1) of growth as investment makes a comeback after being on the backburner in FY09; 2) of a move away from an ultra expansionary fiscal policy as the government attempts to fix its finances and as economic buoyancy boosts revenues; 3) of a reversal of loose monetary stance as excessive liquidity is reined in followed by policy tightening, and; 4) finally and most importantly, of risk-taking as growth in investment resumes in earnest after a hiatus following the crisis in mid-2008.

But, every path has its puddle. Early on this path to risk-taking and growth lies the proverbial puddle in the guise of a quick rise in inflation, which when it elicits a response by the central bank, should cause a market correction and an underperformance of rate cyclicals, especially banks. Please see the Exhibits below for how the market and banks have underperformed during episodes of high inflation (when the WPI exceeds 8%, which we think is round the corner).

We would recommend that investors tactically tilt their portfolios towards defensive and non-rate sensitive sectors in the shorter term as the overhang of inflation and RBI policy action abates. A correction of about 10% would offer a better entry point into rate cyclicals, in our view.

We are revising our Sensex target from 18,800 for September-end to 19,600 for December-end 2010. Our new target implies about 13% potential upside from current levels.

We provide a detailed sector allocation strategy later on in this report.

Exhibit 1. Market underperforms during episodes of high inflation

(60)

(40)

(20)

0

20

40

60

80

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

(2)

0

2

4

6

8

10

12

14Sensex 6m-6m (LHS) WPI (RHS)

Circles highlight episodes of WPI > 8% and market underperformance

(y-y %) (y-y %)

Source: Bloomberg, Nomura research

Exhibit 2. Banks underperform the market when inflation rises above 8%

(2)

0

2

4

6

8

10

12

14

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

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Jan-

08

Jan-

09

90

110

130

150

170

190

210

WPI (LHS)Bankex/Sensex (RHS)

Circles highlight episodes of WPI > 8% and Banks underperformance

(y-y %) (Jan '02 = 100)


Long domestic cyclicals to play growth, but short rate-sensitives until inflation overhang abates

The market will have to navigate the proverbial puddle of inflation in the short term

Sensex target of 19,600 for December-end 2010



Valuations not excessive, but not immune to monetary rebalancing We remain Bullish on India on a one-year horizon. With the 12-month forward P/E multiple at 15.8x, we do not think that valuations are too stretched at current levels, especially in the context of strong relative growth differentials in favour of India, and also in comparison to a three-year average multiple of 15.6x. However, we believe that valuations at present remain vulnerable to excessive inflation and ensuing monetary tightening. In our opinion, a correction of about 10% from current levels would offer a more attractive entry point to partake in the solid growth story, which we expect to unfold a bit later in the year.

Exhibit 3. Sensex consensus-based 12m forward P/E

0

5

10

15

20

25

30

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

(x)


Exhibit 4. Sensex earnings yield minus 10-year nominal govt bond yield

(8)

(4)

0

4

8

12

16

Aug

-98

Aug

-99

Aug

-00

Aug

-01

Aug

-02

Aug

-03

Aug

-04

Aug

-05

Aug

-06

Aug

-07

Aug

-08

Aug

-09

(%)

Overvaluation territory

Undervaluation territory


Rising inflation is a short-term overhang on markets The current bout of food price inflation in India can be attributed to a host of factors, largely supply side, led by drought and attendant loss of farm output, inefficient food supply management, high support prices, hoarding and speculation. The misfortune of a drought year — about 50% of cultivated land in India is irrigated — and the ensuing pressure on agricultural prices have been compounded by the large systemic liquidity sloshing around because of expansionary monetary policy.

This extraordinary rise in food prices is mirrored in consumer price inflation, which has remained high compared to other regional economies.

The overall inflation picture in India is being exacerbated by rising global commodity prices — in the backdrop of a sharp rise in food prices (as seen in the slope of the agri spot price curve in the Exhibit overleaf) as mentioned above — which, along with the strong momentum in economic activity and industrial acceleration, is likely to feed into pricing pressures in the wider manufacturing sector. The Exhibits on the following page provide clear evidence of global commodity prices working their way through to domestic manufacturing prices with a lag. Evidence from the BSE100 ex-bank and Oil & Gas group of companies (Exhibit on next page) reveals that raw material price pressure has started to show up in the manufacturing sector with the raw material/sales ratio picking up strongly in 2Q FY10.

Rising food prices have exacerbated India’s inflation problem

Manufacturing prices are rising amid strong domestic activity, capacity shortages and rising global commodity prices

A market correction of 10% or more would offer an attractive entry point



Early rate tightening will curb core inflation and manage inflationary expectations It can be argued that monetary tightening in the form of rate hikes will have little impact on food price inflation, which is largely a supply-side problem. However, we believe that an early rate tightening response by the central bank will be an advance strike against building core inflationary (ex food and energy) pressures that will surface down the line — it takes time for monetary policy to work through the system, 12 to 18 months typically, and it probably takes longer in India — and to help manage inflationary expectations early on in this up-cycle, which is not a bad thing. We remain sanguine about India’s growth prospects and believe that early rate tightening will not jeopardise the recovery of growth. Meanwhile, a normal monsoon this year (we hope!) and a good winter crop will, combined with a withdrawal of liquidity, cap short-term food price pressures.

Exhibit 5. Primary articles inflation and agri spot prices

170190210230250270290310330350370

Jul-0

5

Nov

-05

Mar

-06

Jul-0

6

Nov

-06

Mar

-07

Jul-0

7

Nov

-07

Mar

-08

Jul-0

8

Nov

-08

Mar

-09

Jul-0

9

1,000

1,500

2,000

2,500

3,000

3,500Primary articles WPI Index(6 weeks fwd)Agri spot index (RHS)

(LHS)


Exhibit 6. India CPI vs regional peers

(6)(4)(2)02468

101214

Dec

-06

Mar

-07

Jun-

07

Sep

-07

Dec

-07

Mar

-08

Jun-

08

Sep

-08

Dec

-08

Mar

-09

Jun-

09

Sep

-09

India ChinaSouth Korea ThailandIndonesia Malaysia

(%)


Exhibit 7. Manufacturing WPI index and CRB commodity prices

(60)(50)(40)(30)(20)(10)

01020304050

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

(2)

0

2

4

68

10

12

14CRB index (RHS)

Mfg WPI (LHS)

(Y-Y %) (Y-Y %)

(60)(50)(40)(30)(20)(10)

01020304050

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

(2)

0

2

4

68

10

12

14CRB index (RHS)

Mfg WPI (LHS)

(Y-Y %) (Y-Y %)


Exhibit 8. Raw material prices as % of net sales (BSE100 ex-banks and oil & gas)

25

26

27

28

29

30

3Q F

Y08

4Q F

Y08

1Q F

Y09

2Q F

Y09

3Q F

Y09

4Q F

Y09

1Q F

Y10

2Q F

Y10

(%)

25

26

27

28

29

30

3Q F

Y08

4Q F

Y08

1Q F

Y09

2Q F

Y09

3Q F

Y09

4Q F

Y09

1Q F

Y10

2Q F

Y10

(%)

Source: Capitaline, Nomura research

Rate hikes early in the cycle should stymie building core inflation and manage inflationary expectations



Investment outlook

Growth rebalancing: investment to join the mix Industrial capex suffered on account of the crisis The second half of FY09 was characterised by a sudden slowdown in demand, led by a pullback of liquidity in the economy. As a result, FY09 was the first year in the current cycle since FY03 to witness a slowdown in capex. We believe that most of the slowdown in capex would have taken place in the second half of FY09, as a mix of a sudden drop in demand and a lack of funding caught corporate India on the wrong foot.

Exhibit 9. BSE500 ex-banks corporate capex Exhibit 10. India investment-to-GDP ratio

0

500

1,000

1,500

2,000

2,500

3,000

FY19

93

FY19

95

FY19

97

FY19

99

FY20

01

FY20

03

FY20

05

FY20

07

FY20

09

(INRbn)

28

29

30

31

32

33

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35

Q10

8

Q20

8

Q30

8

Q40

8

Q10

9

Q20

9

Q30

9

Q40

9

Q11

0

Q21

0

(%)

Source: Capitaline, Nomura research Source: CSO, Nomura research

Capacity shortages are back The most important driver of capex is demand visibility. We believe that indications of a significant tightness of capacity are now visible in the Indian economy.

As the chart below shows, capacity utilisation in the manufacturing sector rose to a high of 82.5% in FY08, the highest in nine years. The inability of manufacturing to respond to demand is evident from the slowdown in industrial production, which is symptomatic of a lack of capacity in the system rather than of demand weakness. This is evidenced by: 1) capacity utilisation, which rose sharply even as production slowed down, and; 2) a significant rise in non-oil import growth in FY08. In other words, domestic demand had to be met by imports, given that capacity utilisation was at an all-time high in the manufacturing sector and wider industry.

The sudden drop in demand and pullback in liquidity in 2H FY09 caused corporate capex to fall in FY09

Domestic production was unable to meet demand in FY08, causing capacity utilisation to peak, industrial production to drop and imports to rise



Exhibit 11. Capacity utilisation (%)

75

80

85

90

95

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

78

79

80

81

82

83

84

85

Manufacturing Industry Mining and Quarrying Electricity All industries (RHS)

(%) (%)

Source: Reserve Bank of India (RBI), Nomura research

The sudden disappearance of demand in the wake of the crisis happened despite inherent shortages in the economy, which existed pre-crisis and manifested themselves in the capacity tightness of FY08. Capacity utilisation in the manufacturing sector, along with non-oil imports, fell sharply post crisis. We believe the average capacity utilisation rate of 79.3% in FY09 (vs 82.5% in FY08) subsumed a much lower rate for the second half of FY09. Assuming that capex was relatively buoyant up until the crisis (as demand conditions were strong), we suspect all of the capex slowdown came through in the second half of FY09. Anecdotal evidence suggests that several companies froze capex plans in the wake of the crisis.

It is only in the past few months that firm signs of a demand recovery have become evident. First, we have seen a major acceleration in industrial growth, even on a pre-crisis base, as manufacturing responds to growing demand. Second, despite strong domestic production growth, non-oil imports have started rising sharply, suggesting a spill-over of demand onto imports. Anecdotally, most of our covered companies are running at full capacity. We, therefore, believe that the capacity shortages of FY08, which were masked by the fall in demand in FY09, are back to the fore again, creating conditions for a revival of industrial capex in India.

Exhibit 12. Cap utilisation and industrial production

77

78

79

80

81

82

83

84

85

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

0

2

4

6

8

10

12

14

Cap utilisationIIP growth (RHS)

(%)

FY08: Rising cap util and falling IP

(%)(LHS)

Note: We have assumed 9.5% IIP growth in FY10

Source: Business Beacon, Nomura research

Exhibit 13. Non-oil imports and cap utilisation

0

510

1520

2530

3540

45

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

77

78

79

80

81

82

83

84

85

Non oil import growthcap utilisation (RHS)

Given capacity shortages, imports rose to fill the gap in FY08

(%) (%)(LHS)


Capacity shortages have returned

Capex was strong in 1H FY09 and its slight decline in the full year happened entirely because of the slowdown in capex in 2H FY09, post crisis



Exhibit 14. Non-oil imports

Non-oil imports (Index Base Jul '08 =100)

40

50

60

70

80

90

100

110Ju

l-08

Sep

-08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep

-09

Non-oil imports are up sharply from the bottom


Exhibit 15. Industrial production (y-y %)

-2

0

2

4

6

8

10

12

Jul-0

8

Sep

-08

Nov

-08

Jan-

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Mar

-09

May

-09

Jul-0

9

Sep

-09

IIP growth(%)

Despite sharply rising domestic supply


Stalled financial closures have restarted The other important point is that infrastructure has come to account for an increasingly larger share in India’s overall capex. These infrastructure projects typically rely on significant leverage in terms of funding structures. After the crisis, banks clamped down on incremental lending, which led to significant payment and execution delays for construction companies. In addition, financial closures for several large projects came to a halt, especially in the infrastructure sector, which relies on significant leverage for funding. A lack of funding also made it difficult for the Indian government to hawk infrastructure projects to the private sector on a public private partnership (PPP) basis.

The rapid normalisation of credit markets has meant that stalled financial closures have now accelerated in earnest. The table below shows some of the recent financial closures in the power sector. The two important points to note here are: 1) several of these financial closures were expected last year but were delayed due to the crisis. The majority of the closures happened after March this year, and; 2) there will be a time lag between financial closure and physical implementation. We believe that these closures will have a very positive impact on the economy in terms of physical activity in FY11F.

Exhibit 16. Financial closures in the power sector Project Company Capacity (MW) DateRosa Power Reliance Power 1,200 Jul-09Bina Power Jaiprakash Power Ventures 1,250 Nov-09Tuticorin Power Coastel Energen 1,200 Jul-09Orissa Project Sterlite Power 2,400 Jul-09Butibori Power Project Reliance Power 300 Jul-09GMR Kamalanga Energy GMR Group 1,050 May-09Jhjjar Power Plant CLP India 1,320 Oct-09Salaya Power Plant Essar Power 1,200 Oct-09Tiroda Phase I Adani Power 1,980 Jan-09Mundra Phase IV Adani Power 1,980 Jun-09Sasan Reliance Power 3,960 Apr-09Phata-Byung Lanco 152 Aug-09Amravati Indiabulls Power 1,320 Jun-09Talwandi Sabo Sterlite Power 1,980 Dec-09Jegurupadu IPP GVK 200 Nov-09

Source: Nomura research

Stalled financial closures of many big power projects have completed since March 2009



The experience has been similar in the Indian road sector. In our meetings with the National Highway Authority of India (NHAI), we learned that the numbers of bidders expressing interest in toll projects saw a quantum jump between March 2009 and October 2009.

Pick-up in capex will translate into greater capital inflows and rupee appreciation As can be judged from the relationship between corporate capex and capital flow in the Exhibit below, a major side-effect of the pick-up in capex this year will be a rise in capital flows into the country as poor disintermediation of savings — underdeveloped long-end corporate bond market and a comparatively low level of savings through the equity route — has implied increasing capital inflows into the country to finance long-term capex projects. This has implications for both monetary policy and the rupee. Do note that the second half of FY09 saw significant outflows of the capital account, which led to very minimal net inflows.

Exhibit 17. Net capital inflows and capex

0

5,000

10,000

15,000

20,000

25,000

FY 1

995

FY 1

996

FY 1

997

FY 1

998

FY 1

999

FY 2

000

FY 2

001

FY 2

002

FY 2

003

FY 2

004

FY 2

005

FY 2

006

FY 2

007

FY 2

008

(5,000)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000Capex (LHS)

Net capital inflows (RHS)

(INRmn) (INRmn)

0

5,000

10,000

15,000

20,000

25,000

FY 1

995

FY 1

996

FY 1

997

FY 1

998

FY 1

999

FY 2

000

FY 2

001

FY 2

002

FY 2

003

FY 2

004

FY 2

005

FY 2

006

FY 2

007

FY 2

008

(5,000)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000Capex (LHS)

Net capital inflows (RHS)

(INRmn) (INRmn)

Note: Excludes portfolio flows


Exhibit 18. Investment and capital inflows

(5)

0

5

10

15

20

FY 1

995

FY 1

996

FY 1

997

FY 1

998

FY 1

999

FY 2

000

FY 2

001

FY 2

002

FY 2

003

FY 2

004

FY 2

005

FY 2

006

FY 2

007

FY 2

008

FY 2

009

05101520253035404550

CA/GDP (LHS)Capital flow/GDP (LHS)Investment/GDP (RHS)Gross capital inflow/ investment

(%) (%)

(5)

0

5

10

15

20

FY 1

995

FY 1

996

FY 1

997

FY 1

998

FY 1

999

FY 2

000

FY 2

001

FY 2

002

FY 2

003

FY 2

004

FY 2

005

FY 2

006

FY 2

007

FY 2

008

FY 2

009

05101520253035404550

CA/GDP (LHS)Capital flow/GDP (LHS)Investment/GDP (RHS)Gross capital inflow/ investment

(%) (%)

Note: Excludes portfolio flows


A renewal in capex will translate into higher capital inflows, with implications for monetary policy and the rupee



The coffers

Fiscal rebalancing – a marginal move towards consolidation The fiscal deficit is a counter-cyclical policy tool and the government used it suitably post crisis, stepping up and infusing risk-capital into the economy when the private sector (both corporates and households) was in de-leveraging mode. As we expect growth to be strong this year, we think FY11F will see a move towards consolidation of government finances, as a pick-up in revenues is augmented by slowing expenditure.

Revenue buoyancy and potential rollback of stimulus should help rein in the deficit Our expectation of a rebound in revenue receipts due to a cyclical pick-up in tax collections is underpinned by our positive stance on growth next year, which along with a likely rollback (partial or full) of the excise and services tax cuts that were implemented by the government in FY09, should impart solidity to revenue collections in FY11F.

The 6% reduction in the central excise duty and the 2% cut in service tax rate in FY09 — a 2% CENVAT cut in December 2008 followed by a 4% cut in February 2009 — cost the Indian government INR300bn in lost revenues, about 5% of FY10’s budgeted revenue receipts. Given the strong resurgence in growth since April, which makes for a larger tax base, we estimate that when the likely roll-back in tax rates does happen next year, it could add between 7% and 8% to revenue receipts.

Significant one-offs should roll off this year On the expenditure side, a combination of direct fiscal stimulus, increased welfare and social sector spending, arrears from the Sixth Pay Commission, farm loan waiver, subsidies, and higher oil and fertiliser bond issuances (off-budget) conspired to keep expenditure at cyclical highs in FY09, as was expected of a counter-cyclical and expansionary fiscal policy, which has continued into FY10F.

Exhibit 19. Central revenue receipts vs industrial production

(40)(30)(20)

(10)0

1020304050

Jun-

98M

ar-9

9

Dec

-99

Sep

-00

Jun-

01M

ar-0

2

Dec

-02

Sep

-03

Jun-

04M

ar-0

5D

ec-0

5

Sep

-06

Jun-

07M

ar-0

8D

ec-0

8S

ep-0

9

0

2

4

6

8

10

12

14Central govt. revenue receipts (LHS)

IIP (RHS)

(Y-Y %) (Y-Y %)

(40)(30)(20)

(10)0

1020304050

Jun-

98M

ar-9

9

Dec

-99

Sep

-00

Jun-

01M

ar-0

2

Dec

-02

Sep

-03

Jun-

04M

ar-0

5D

ec-0

5

Sep

-06

Jun-

07M

ar-0

8D

ec-0

8S

ep-0

9

0

2

4

6

8

10

12

14Central govt. revenue receipts (LHS)

IIP (RHS)

(Y-Y %) (Y-Y %)


Exhibit 20. Central non-plan revenue expenditure

0

50

100

150

200

250

300

Apr

May

Jun

Jul

Aug

Sep Oct

Nov

Dec Jan

Feb

Mar

FY06 FY07 FY08FY09 FY10

Note: April expenditure, Base = 100


We expect FY11F to see a move towards consolidation of government finances

Buoyancy in growth should impart a cyclical boost to revenues

While a potential roll-back of excise and service tax cuts could raise revenues



There are a few significant one-off items in the expenditure budget, which we expect will tail off in FY11F:

INR240bn of the Sixth Pay Commission pay hike arrears (60% of total arrears were paid in FY10F and 40% were paid in FY09).

INR200bn was spent directly in FY09 as part of the fiscal stimulus. This might not be rolled back.

INR150bn of the farm loan waiver that was paid in FY10 (of the total INR600bn farm loan waiver programme, INR250bn was paid in FY09, INR120bn is to be paid in FY11F and INR80bn in FY12F.

On the subsidy front, while we see upside risk on the budgeted INR525bn food subsidy for FY10 because of the drought this year, we expect a normal monsoon and a rebound in agricultural output next year to shave off approximately INR150bn of the food subsidy bill in FY11F.

As shown in the chart below, while landed prices of fertilisers have declined to 2006-07 levels, we estimate that budgeted fertiliser subsidy for FY10 of INR500bn could be higher by about INR100bn to INR150bn. So while the downside risk to fertiliser subsidy could get offset by upside risk to food subsidy, we expect both to decline in FY10F by as much as INR250-INR300bn.

Exhibit 21. Fertiliser subsidy and landed prices

05,000

10,00015,00020,00025,00030,00035,00040,00045,00050,000

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000Fert subs (RHS)

Urea (LHS)

DAP (LHS)

(INRmn)(INR/tonne)

05,000

10,00015,00020,00025,00030,00035,00040,00045,00050,000

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000Fert subs (RHS)

Urea (LHS)

DAP (LHS)

(INRmn)(INR/tonne)


Disinvestment: It is difficult to pin down a firm figure on how much the government can raise from disinvestment this year, as valuation issues plague unlisted as well as illiquid listed government-controlled companies. Of the INR968bn budgeted over FY92-FY05, the government only managed to raise about half (INR447bn) of its disinvestment targets; it has not budgeted any targets since FY06.

Based on our analysis, we estimate that the potential pool of disinvestment proceeds available to the government if it disinvests its stakes in listed PSUs down to 51% are:

a) Including PSU banks: US$105bn

b) Excluding PSU banks: US$98bn

As a benchmark, the budget estimate for the fiscal deficit in FY10 is close to US$86bn.

Disinvestment proceeds of INR46bn in FY10 so far. In pipeline are stake sales in REC, NTPC, SJVN and NMDC



In the current fiscal year, the government has raised INR46bn from disinvesting its stakes in National Hydroelectric Power Corporation Ltd (NHPC) (NHPC IN, INR421bn market cap, 13.6% free float) and Oil India Limited (OIL) (OINL IN, INR301bn market cap, 12.4% free float), and the current pipeline of PSUs lined up for disinvestment in FY10 includes Rural Electrification Corporation (REC) (RECL IN, INR202bn market cap, 18.2% free float, 5% stake sale, 15% fresh equity), National Thermal Power Corporation (NTPC) (NATP IN, INR1,896bn market cap, 10.5% free float, 5% stake sale), Satluj Jal Vidyut Nigam Ltd (SJVN) (unlisted, 10% stake sale) and National Mineral Development Corporation (NMDC IN, INR1650bn, 1.6% free float, 8.38% stake sale).

Implications of better fiscal and monetary tightening – flattening of the yield curve We note that fiscal rebalancing should, in the longer term, counter the pressures on long-end rates caused by the RBI tightening. As can be seen in the chart below, India’s yield curve currently is at its steepest ever. Meanwhile, a withdrawal of liquidity should put upward pressure on short-end rates, thus causing the yield curve to flatten. There could be a knee jerk reaction on 10-year yields in the short term amid inflation worries, but this should eventually settle down at lower levels, in our view.

Exhibit 22. Slope of the yield curve (10-yr govt yield minus 1-yr govt yield)

(100)(50)

050

100150200250300350400

Jan-

01M

ay-0

1S

ep-0

1Ja

n-02

May

-02

Oct

-02

Mar

-03

Aug

-03

Dec

-03

May

-04

Sep

-04

Jan-

05M

ay-0

5O

ct-0

5M

ar-0

6A

ug-0

6Ja

n-07

Jun-

07N

ov-0

7

May

-08

Nov

-08

Apr

-09

Sep

-09

0

2

4

6

8

10

1210 yr-1 yr spread (LHS) Govt 1-yr bond (RHS)Govt 10-yr bond (RHS)

(%)(bps)

(100)(50)

050

100150200250300350400

Jan-

01M

ay-0

1S

ep-0

1Ja

n-02

May

-02

Oct

-02

Mar

-03

Aug

-03

Dec

-03

May

-04

Sep

-04

Jan-

05M

ay-0

5O

ct-0

5M

ar-0

6A

ug-0

6Ja

n-07

Jun-

07N

ov-0

7

May

-08

Nov

-08

Apr

-09

Sep

-09

0

2

4

6

8

10

1210 yr-1 yr spread (LHS) Govt 1-yr bond (RHS)Govt 10-yr bond (RHS)

(%)(bps)


We expect the yield curve to flatten



Gearing up

Return of risk-taking: from de-leveraging to re-leveraging From government to private risk-taking The massive spending push by the Indian government has helped the demand side of the economy get back on its feet relatively quickly. Unfortunately, given its fiscal position, the government has gone to the limit of risk-taking. We believe there will be a significant rebalancing in terms of risk-taking in the economy from the government to the private sector this year.

We expect to see re-leveraging and the investment cycle make a comeback as a key theme in FY11 following a period of de-leveraging by corporates and households — the government had to leverage up as it administered the fiscal stimulus — that happened post crisis, and which seems to be continuing as suggested by weak bank credit growth in FY10 so far.

De-leveraging by corporates following the crisis The system-wide rise in risk aversion following the crisis in September 2008 has led to a strong dose of de-leveraging by corporates. Companies put on hold their capex plans, especially in the infrastructure sector, which accounted for half of investment intentions for loans sanctioned by banks and term finance institutions in FY09. This led to a reduction in loan disbursals by banks and resulted in weak credit expansion, as can be seen in the Exhibit below.

Exhibit 23. Bank credit and deposit growth

8

11

14

17

20

23

26

29

32

Dec

-07

Mar

-08

Jun-

08

Sep-

08

Dec

-08

Mar

-09

Jun-

09

Sep-

09

65

67

69

71

73

75

77

79Bank credit (LHS)Aggregate deposits (LHS)Credit deposit ratio (RHS)

(Y-Y %) (%)

8

11

14

17

20

23

26

29

32

Dec

-07

Mar

-08

Jun-

08

Sep-

08

Dec

-08

Mar

-09

Jun-

09

Sep-

09

65

67

69

71

73

75

77

79Bank credit (LHS)Aggregate deposits (LHS)Credit deposit ratio (RHS)

(Y-Y %) (%)


Exhibit 24. Non-food bank credit growth (no. of weeks since beginning of fiscal year)

90

95

100

105

110

115

120

125

130

135

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37

FY06 FY07 FY08

FY09 FY10


Note: Base 100 = Total bank credit outstanding on the first week of the fiscal year

We expect significant rebalancing of risk-taking away from the government to the private sector

De-leveraging by corporates in 2H FY09 showed up in falling capex



Exhibit 25. Industry capex and cost in FY08 and FY09

No of projects

% share

No of projects

% share

Infrastructure 129 40.9 115 50.5Power 64 31.0 68 29.4

Telecom 8 1.9 9 16.4Ports & Airports 6 0.8 4 2.1

Roads, Storage & Water mgmt 4 2.0 5 0.1SEZ, Industrial, Biotech & IT Parks 47 5.1 29 2.6

Sugar 16 1.2 22 1.0Textiles 118 4.3 48 1.4Paper & Paper Products 17 0.8 25 1.1Coke & Petroleum Products 5 7.0 5 1.2Chemicals & Petrochemicals 26 1.0 27 1.2Pharma & Drugs 38 2.1 31 0.5Rubber & Plastic Products 16 1.1 18 0.4Cement 24 5.5 28 4.4Metals & Metal Products 123 16.5 108 19.8Transport Equipment 38 3.3 31 2.3Construction 38 3.7 30 7.9Hotels & Restaurants 52 3.7 60 2.3Transport Services 17 1.3 15 0.8Hospitals 28 1.2 17 0.4Others 194 6.2 170 4.8Total 879 100.0 750 100.0

FY08 FY09

Source: RBI, Nomura research

Exhibit 26. BSE500 ex-banks capex (y-y %)

(20)

(10)

0

10

20

30

40

50

60

70

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

(Y-Y %)

Source: Capitaline, Nomura research

Companies with high leverage sought to recapitalise quickly through QIPs The slower pace of expansion of bank credit has coincided with a pick-up in fund raisings through the Qualified Institutional Placement (QIP) route, predominantly after March 2009 when the markets bottomed. The increase in the leverage ratios of those non-financial companies that raised capital through this route compared to the leverage of the larger BSE500 ex-financials universe provides further corroborating evidence of corporate de-leveraging. As shown in the chart below, the average net debt/equity ratios of the companies who availed themselves of QIPs rose to a high of 151% in FY09 compared with 60.5% for those who did not, thus prompting them to reduce leverage amid falling profits.

Exhibit 27. Higher leverage of companies that recapitalised through QIPs

0

20

40

60

80

100

120

140

160

FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009

BSE500 ex-fin Net Debt/EquityQIPs ex-fin Net Debt/Equity

(%)


Exhibit 28. BSE500 ex-financials net profits (y-y %)

Adj net PAT

(10)

0

10

20

30

40

50

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

(Y-Y %)

Source: SEBI, Nomura research

De-leveraging by households showed up in weak retail credit growth As can be seen in the Exhibit below, de-leveraging by households in response to the crisis has translated into weak demand for personal loans, which make up about 22% of total outstanding bank credit. Among that, demand for home loans — the biggest retail segment comprising 11% of outstanding bank credit — came off amid general job and income losses, a decline in affordability and volatility in property prices.

QIPs picked up in March 2009 after the markets bottomed



Exhibit 29. Sectoral deployment of bank credit % change of amount outstanding

Sector As % of total as

of Aug 0919 Dec 08 until 27

Feb 0927 Feb 09 until 22

May 0922 May 09 until 28

Aug 09 28 May 08 until 28

Aug 09Non-Food Gross Bank Credit (1 to 4) 100.0 0.9 2.6 2.6 13.3 Agriculture & Allied Activities 12.6 2.9 10.7 0.0 25.6 Industry (Small, Medium and Large) 41.8 2.1 0.1 5.4 17.9 Personal Loans 21.5 (2.3) 0.4 1.3 2.3 Housing 10.9 0.3 1.2 3.3 5.4 Advances against Fixed Deposits 1.7 (8.5) 0.0 (2.3) 0.7 Credit Cards Outstanding 0.9 (1.5) (6.7) (15.2) (14.3)Education 1.2 4.0 3.1 11.6 34.5 Consumer Durables 0.3 (10.0) (2.6) (2.1) (16.7)Services 24.1 1.0 5.2 0.3 11.0 Transport Operators 1.5 1.3 1.0 0.6 9.1 Professional & Other Services 1.8 (2.0) 12.1 3.8 20.5 Trade 5.6 (1.4) 2.8 3.7 13.9 Real Estate Loans 3.7 18.7 4.1 2.3 41.5 NBFCs 3.9 5.1 4.6 7.0 30.8


Signs of re-leveraging by corporates are now visible The simultaneous rise in alternative sources for financing for firms suggests to us that while some of this capital is being used to retire old debt (we pointed this out for QIPs earlier on in this section), bolster working capital and supplement general expenses, the major proportion of these fresh funds is being deployed for investments as previously stalled projects come back on line, new long-term projects gets sanctioned, and as firms modernise and expand their facilities.

The charts overleaf provide evidence from four quarters: 1) external commercial borrowings have picked up since June and are at 2007-08 levels. The majority of these funds are being earmarked for capex; 2) funds raised in the primary equity market through public (IPOs and FPOs) and rights issues have picked up since June. We reckon that the majority of QIP issues were used for the purpose of de-leveraging; 3) the amount of funds raised through rights issues has been low this year, but the majority of the proceeds between May and September were used for repaying loans, augmenting working capital and bolstering capital adequacy ratios; and 4) data on the use of proceeds from IPOs that have been completed or are in the pipeline suggests that capex is the main area earmarked for funds.

This availability of capital is setting the stage for the next leg of growth and we expect it to start showing up in the coming four to six months.

Exhibit 30. External commercial borrowings

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

Oct

-09

Jul-0

9

Apr

-09

Jan-

09

Oct

-08

Jul-0

8

Apr

-08

Jan-

08

Oct

-07

Jul-0

7

Apr

-07

OthersRefinancing of old loans / Repayment of ealier ECBOverseas acquisition Financial lease FCCB Buyback Capex

(US$mn)


Exhibit 31. Primary market issuances

0

50,000

100,000

150,000

200,000

250,000

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep

-09

QIPs Rights issues Public issues

(INRmn)


Corporates are raising growth capital



Exhibit 32. Uses of rights issues

Distribution of IPO proceeds in 2009 (Actual and pipeline)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Jul Aug Sep Oct Nov Dec

CapexRepayment of debtWorking capital Acquisitions / Corp investmentsExpensesIssue expensesGeneral corporate purposes Disinvestment


Exhibit 33. Uses of IPO proceeds (actual and pipeline)

Uses of rights issues

0.0

0.2

0.4

0.6

0.8

1.0

1.2

May Jun Aug Sep Oct Nov

Repayment of loans Working Capital Capital adequacy CapexAcquisitions/Inter-corporate investments Others


And households should join them soon One of the factors responsible for the economic acceleration since FY03 relates to increased risk-taking by households through income leveraging. However, this came off significantly since FY08, as tightening by the RBI led to a significant slowdown in personal loans in the second half of FY08 — retail loans have grown slower than nominal GDP and significantly slower than ex-agri nominal GDP. We expect household re-leveraging to resume as the labour market continues to pick up, incomes continue to rise and the job outlook improves. The fact that marginal funding costs for banks are still falling implies that banks will be more aggressive in lending to households.

Exhibit 34. Retail loans slowed down before crisis (INRbn) FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09Consumer durables 69 72 83 91 88 92 88 82Housing 346 366 520 1,287 1,864 2,310 2,578 2,770Advances against fixed deposits 227 227 263 299 349 408 450 487Advances against shares/bonds 18 20 20 41 51 49 42 23Credit cards NA NA NA 58 92 183 264 280Education NA NA NA 51 101 152 205 286Other personal loans 261 279 352 624 993 1,334 1,507 1,698Total retail loans 920 964 1,238 2,451 3,538 4,528 5,134 5,625Growth (%) 4.8 28.4 98.0 44.4 28.0 13.4 9.6 Total loan book of banks 6,169 6,695 7,644 10,409 14,458 18,482 22,473 26,485 % of total loan book 14.9 14.4 16.2 23.5 24.5 24.5 22.8 21.2


The government has to transfer risk-taking to the private sector Finally, even though the government’s ability to directly deploy risk-capital of its own has been impaired because of the difficult state of its finances, we expect the government to share risk-taking with the private sector through more PPP projects. We expect a continued push on roads and power sectors through greater participation of the private sector. For instance, four more Ultra Mega Power Plants (UMPPs) are expected to be awarded this year and there is a pressing urgency to expedite implementation in the road sector (please see a recent report on the road sector by our infrastructure and construction analyst, Saion Mukherjee, The Road Ahead, 14 December 2009).

An improving labour market and falling marginal cost of funds for banks will help households to re-leverage



Political backdrop

Back to reforms? We see the first term (2004-2009) of the incumbent United Progressive Alliance (UPA), led by the Indian National Congress, as insipid in terms of progress made on reforms. While the government did not regress too much on the reform agenda — it can be argued that the UPA was hamstrung because of the left parties in government — most of the path-breaking reforms were mooted during the tenure of the National Democratic Alliance (NDA), led by the Bhartiya Janta Party or the BJP, from 1999 to 2004. Of course, there have been follow-up actions in many cases, such as in the power sector, of the basic reforms process started during the tenure of the NDA. However, the general buoyancy seen in the economy on account of the reforms process can largely be traced back to decisions made during the NDA rule.

What has been the broad thrust of reforms? We take a detailed look at the timeline of reforms in India since 1999 in the Appendix. Broadly, reforms have been of the following types:

Fiscal reforms: The Indian government, through its borrowing, directly influences the level of risk-free interest rates in the economy. Hence, fiscal consolidation becomes necessary to encourage risk-taking. The key reforms here have been the broadening of the tax base and a generally controlled growth in expenditure. The passage of the Fiscal Responsibility and Budget Management (FRBM) Act had kept the government in check until FY08, and great success was achieved on this front. However, leading up to elections in April 2009 and as a response of the crisis, much of what was achieved to FY08 has been lost. We believe this should be one of the most important focus areas of reforms. Speedy tax reforms and expenditure control (especially related to oil and fertiliser subsidies as well as rollback of fiscal giveaways) will be imperative in 2010, in our opinion.

Exhibit 35. Centre and state deficits as % of GDP

as % of GDP Centre State ConsolidatedOil, fertiliser, food

and other bonds Total liability FY01 5.65 4.18 9.51 0.04 9.55 FY02 6.19 4.14 9.94 0.46 10.40 FY03 5.91 4.06 9.57 0.09 9.67 FY04 4.48 4.38 8.51 0.09 8.61 FY05 3.99 3.42 7.45 0.01 7.46 FY06 4.08 2.51 6.68 0.50 7.17 FY07 3.40 1.90 5.58 0.98 6.56 FY08 2.70 1.45 4.17 0.81 4.98 FY09 (RE) 6.00 2.64 8.66 1.76 10.43 FY10 (BE) 6.80 3.34 10.09 0.17 10.27

Note: RE: Revised estimates, BE: Budget estimates

Source: Budget papers, Nomura research

Broader role for the private sector: The government of India, along with state-owned companies, still controls the majority of social (health and education included) infrastructure, resources and many other important sectors in the economy. For example, up until 1995 the entire telecom sector was operated by the government and up until 2000 the entire oil sector was in the government’s domain. The inefficiency of government-run organisations, along with poor financial management, has conspired to seriously constrain the supply side response of the government. A case in point is telecoms, where the entry of the private sector has transformed the teledensity of the country in a relatively short span of time. As emerges from the timeline of reforms (please see Appendix), the NDA government laid down several frameworks across many sectors to attract private capital and the UPA has largely just followed up on

The first term of the UPA government was insipid on the reforms front

Past reforms have emphasised fiscal consolidation, greater private sector participation, reduction of structural rigidities, and creating and streamlining asset markets



most of these. However, a slowdown was seen in roads in the past two years of the UPA regime. No new initiatives in terms of framework revamps have taken place to attract large scale capital in health and education sectors. Urban infrastructure remains very constrained and even though the Urban Renewal Mission is trying to address this, the response has been relatively slow, largely as this remains a state subject. Similarly, the transmission sector has seen very slow progress in private sector participation.

Reducing structural rigidities: In several cases (labour markets, for example), this is a very thorny issue. Subsidies have grown despite a general policy umbrella that has always intended to reduce them. The agriculture sector is plagued by structural rigidities that have played their part in stoking the current bout of food price inflation, and long intended reforms through the introduction of the APMC (Agricultural Produce Marketing Committee) Acts have not happened. Issues related to land acquisition have ensured that large scale capacity has been very slow to come about, slowing down system response to a demand surge. A glaring example of this is India’s net imports of coal, steel and aluminium in the face of large scale reserves of these resources. However, there have been a few successes too — the creation of independent regulators has led to fair and quick decision-making in sectors such as telecom, power and insurance, and these sectors have thrived as a result.

Market reforms: These reforms have essentially been aimed at creating new markets for tradable assets and improving efficiencies of various pre-existing markets. Over the past 10 years, India has developed a thriving derivatives market, strong commodities exchanges and significantly eased direct access to Indian equity markets for foreign investors. However, its bond markets remain quite underdeveloped, especially given India’s requirement for diverse avenues to finance growth capital.

So far, the market has given the benefit of the doubt to the new “left free” government The Sensex rose more than 17% on 18 May, 2009, following the announcement of the results of the central elections, as the markets cheered the prospects of a stable government in the centre, unfettered by the support of the left parties, and a move towards “massification” of the political structure as opposed to the fragmentation of the past 10-15 years.

However, the jury is still out on whether the government will actually deliver incremental reforms Significant sops to farmers (farm loan waiver and major increases in minimum support prices) and government pay hikes were not necessarily at the behest of the left parties. The fact that the government has made a significant departure from the Fiscal Responsibility and Budget Management (FRMB) Rules and has not yet returned to a well laid-out road map for fiscal consolidation (to be provided by the Thirteenth Finance Commission) is worrisome to us. This is especially important given that most policy action in India typically happens in the first three years of a government coming into power, after which populism dictates policy in light of upcoming elections. This lack of willpower to take bold decisions on reforms was also true for the last two years of NDA rule (1999-2004) (especially notable were cancellations of disinvestments and backtracking on free market pricing of oil).

We think there will be reforms, but their pace might be slow There have been policy announcements in key areas, which hold out the potential of translating into significant reforms in the coming year: taxes, both direct (the new direct tax code) and indirect (GST, Goods and Services Tax), disinvestment, pension reforms and consolidation in the banking sector, legal reforms to expedite the judicial process, among others.

Bold reforms are most likely to be made during the first three years of government



While we do believe that we will make progress on the reforms front this year, we choose not to get overexcited about their pace. But then, are reforms necessary for the markets to perform?

Are reforms necessary for the markets to perform? This is a fairly important question, especially because the performance of the Indian stock market in the past has been rather independent of the dosage of reforms administered to the economy. The previous tenure of the UPA government (2004-2009) has been rather light on major reforms, yet the markets have continued to do well. This suggests that either growth has remained independent of the reforms process or that reforms undertaken earlier on were still bearing fruit.

Even as reforms over the past decade have been aimed at enhancing social welfare, creating markets for better resource allocation and easing supply-side constraints, challenges of a high fiscal deficit and capacity bottlenecks will need to be addressed on a priority basis in the short term. In our opinion, fiscal consolidation and infrastructure development remain two key areas that will concern the market the most in the shorter term.

Having said that, we believe that might not be necessary in 2010. Strong GDP growth and general economic buoyancy can by themselves distract the market’s attention away from reforms long enough, just as they did during the 2004-2009 period.

The market performed strongly in 2004-2009, despite lack of major reforms

…and might continue to do so this year, too



Themes

Key themes for 2010F While we see inflation, and the policy response to it, dominating in the short term, we expect the following themes to emerge over a one-year horizon.

Significant improvement in investment cycle: We expect both infrastructure and industrial capex to see significant growth over the rather lacklustre 2009. Infrastructure capex is playing an increasingly important role in overall investment and a pick-up in infrastructure lending should be accompanied by higher bank lending in 2010F.

Strong labour market and consumer incomes: We expect to see multiplier effects of salary hikes to government employees — pay hikes for state government and PSU employees will follow after central pay hikes in 2008 and 2009 — continue to boost incomes and drive consumption this year. Meanwhile, a normal monsoon and continued support from social welfare and employment generation schemes should support rural incomes and consumption.

Re-leveraging in the economy: While credit growth has remained slow in 2009, we expect a significant pick-up to happen in 2010F. First, the recent tilt of corporate capex towards infrastructure will mean a high use of debt to finance overall capital expenditure. Second, a significant amount of equity capital has been raised y-t-d for either de-leveraging or for growth capital. The next phase would be re-leveraging as capex picks up. We also believe that a strong job market and rising incomes will ensure that risk-taking by households also goes up.

Disinvestment: There are two types of disinvestments: 1) A sell-off of the government’s stake in companies, and; 2) Public Private Partnerships (PPP).

The complete disinvestment of government companies in favour of the private sector was jettisoned as soon as the UPA government came to power in 2004. Even now, the government seems to be clear about retaining majority stakes in listed PSUs.

The more palatable form of disinvestment is through: 1) public private partnerships, which involve giving existing government assets to the private sector though a commercial arrangement (for example, airports through joint ventures and roads through BOT projects), and; 2) through a gradual retreat of the government from sectors by inviting private participation on a incremental basis (telecom, power, coal mining, etc).

We are more excited by the second type of disinvestment, as it creates non-linear opportunities for value creation (while the government continues to retain a majority holding in listed companies, higher floating stock alone will not lead to any fundamental change in company behaviour).

Strong capital flows: A major side-effect of the pick-up in capex this year will be a rise in capital flows into the country, as poor disintermediation of savings — an underdeveloped long-end corporate bond market and comparatively low level of savings through the equity route — has meant increasing inflows into the country to finance long-term capex projects.

Improving fiscal situation: As we have mentioned earlier in this report, we expect an improvement in the fiscal situation at the margin. This would likely cause a flattening of the yield curve, as a move towards consolidation of the fiscal deficit will keep long-end borrowing costs under control even as short-end interest rates rise due to a withdrawal of liquidity.

Exit from monetary stimulus: A significant reversal of the hitherto loose monetary stance, with its attendant policy rate hikes and extraction of liquidity, will put rate-cyclicals under pressure early this year. However, given our expectation of a return of growth, pressure on rate-cyclicals will be a good opportunity to buy, we think.



Reforms: As we have said earlier in this report, we are not pinning too much hope on this. However, the government’s policy of continuing to invite private sector participation in infrastructure should continue to generate significant opportunities for several sectors such as construction, developers and banks, among others.

Rupee appreciation: We expect the rupee to appreciate this year as capital inflows increase with rising capex. This will likely be negative for sectors such as IT, as tight labour markets would create upward pressure on input costs and a stronger rupee would hold down any gains that come from traction in volumes.



Strategic view

Sector strategy Our sector allocation is driven by our view of a bifurcated outcome for the market this coming year: short-term weakness but longer-term strength. We expect the market to correct in the first few months of 2010 amid rising inflation and reactionary monetary rebalancing — policy tightening and the withdrawal of liquidity — even as we expect the positive forces of stronger consumption and rising capex continuously at play in the background, solidifying the foundation of growth and risk taking. We recommend a defensive tilt in the portfolio during the correction phase and say a correction of 10% or more signals a good buying opportunity.

Exhibit 36. Relative strategy calls within the Indian market — tactical sector allocation Strategy stance

Sector Headwinds Tailwinds Short-term One-year

Autos Margin pressure from higher raw material prices and possible roll-back of excise duty cuts

Strong consumer incomes and improving labour market, industrial production

NEUTRAL NEUTRAL

Banks Higher inflation, short-term monetary rebalancing

Strong credit growth on back of return of re-leveraging and growth capital

UNDERWEIGHT OVERWEIGHT

Cement New capacity additions and pricing pressure, higher raw material prices (coal)

A pick-up in infra-related activity UNDERWEIGHT UNDERWEIGHT

Consumer Margin pressure from higher raw material prices and ad spends due to greater competition

Strong rural and urban consumption OVERWEIGHT NEUTRAL

Electrical Equipment Margin pressure from increasing competition and higher raw material prices

Exposure to capex in power sector NEUTRAL OVERWEIGHT

Infra & Construction Execution risk; raw material price increases

Re-leveraging; a recovery in order inflows in infra (especially power and roads) and industrial capex

NEUTRAL OVERWEIGHT

Insurance Lukewarm growth, very low persistency, operating cost overruns and regulatory risk

Potentially positive regulation and listings of insurance companies

OVERWEIGHT OVERWEIGHT

IT Services Rupee appreciation, higher labour costs from tighter labour market conditions

Higher discretionary spending in the US upon economic recovery

NEUTRAL UNDERWEIGHT

Media Tough competitive environment A recovery in advertising revenues NEUTRAL NEUTRAL

Metals & Mining Delays in greenfield capacities Rising steel prices and volumes, captive raw materials


Oil & Gas Under-recoveries and sharing mechanism; gas litigation

Ramp-up of oil & gas production from new projects

NEUTRAL NEUTRAL

Pharma Rupee appreciation; regulatory risk Patent expiries; increasing generic penetration; collaboration with big pharma


Real Estate Short-term monetary rebalancing Re-leveraging; improvement in residential volumes and a recovery in office leasing

UNDERWEIGHT OVERWEIGHT

Telcos Tough competitive environment; regulatory risk

Strong subscriber growth UNDERWEIGHT UNDERWEIGHT

Transport infrastructure Regulatory risk A recovery in domestic and international growth and trade

NEUTRAL OVERWEIGHT

Source: Nomura estimates

Short-term weakness, long-term strength



Appendix

Appendix

Exhibit 37. Disinvestment proceeds from 1991-92 through 2009-10 (INR mn)

Year Budgeted

receipts

Receipts through sales of minority shareholding in

CPSEs

Receipts through sale of

majority shareholding of

one CPSE to another CPSE

Receipts through

strategic sale

Receipts from related

transactions

Receipts from sale of residual shareholding in

disinvested CPSEs/cos

Total receipts Transactions

FY92 25,000 30,377 - - - - 30,377 Minority shares sold in Dec 1991 and Feb 1992 by auction method in bundles of “very good”, “good” and “average” companies.

FY93 25,000 19,125 - - - - 19,125 Shares sold separately for each company by auction method.

FY94 35,000 - - - - - - Equity of six companies sold by auction method but proceeds received in 94-95.

FY95 40,000 48,431 - - - - 48,431 Shares sold by auction method. FY96 70,000 1,685 - - - - 1,685 Shares sold by auction method. FY97 50,000 3,797 - - - - 3,797 GDR – VSNL FY98 48,000 9,100 - - - - 9,100 GDR – MTNL FY99 50,000 53,711 - - - - 53,711 GDR-VSNL; Domestic offerings

of CONCOR and GAIL; Cross purchase by 3 Oil sector companies ie, GAIL, ONGC and IOC.

FY00 100,000 14,793 - 1,055 2,754 - 18,601 GDR-GAIL; Domestic offering of VSNL; capital reduction and dividend from BALCO; Strategic sale of MFIL.

FY01 100,000 - 13,172 5,540 - - 18,713 Sale of KRL, CPCL and BRPL to CPSEs; Strategic sale of BALCO and LJMC.

FY02 120,000 - - 30,901 25,676 - 56,577 Strategic sale of CMC, HTL, VSNL, IBP, PPL, hotel properties of ITDC and HCI, slump sale of Hotel Centaur Juhu Beach, Mumbai and leasing of Ashok Bangalore; Special dividend from VSNL, STC and MMTC; sale of shares to VSNL employees.

FY03 120,000 - - 22,527 10,953 - 33,480 Strategic sale of HZL, IPCL, hotel properties of ITDC, slump sale of Centaur Hotel Mumbai Airport, Mumbai; Premium for renunciation of rights issue in favour of SMC; Put Option of MFIL; Sale of shares to employees of HZL and CMC.

FY04 145,000 127,416 - 3,421 - 24,637 155,474 Strategic sale of JCL; Call Option of HZL; Offer for Sale of MUL, IBP, IPCL, CMC, DCI, GAIL and ONGC; Sale of shares of ICI Ltd.

FY05 40,000 27,001 - - 648 - 27,649 Offer for Sale of NTPC and spill over of ONGC; sale of shares to IPCL employees.

FY06 No target fixed - - - 21 15,676 15,697 FY07 No target fixed - - - - - - Sale of MUL shares to Indian

public sector financial institutions & banks and employees

FY08 No target fixed 18,145 - - - 23,669 41,814 Sale of MUL (INR23,669.4mn) shares to public sector financial institutions, public sector banks and Indian mutual funds and sale of PGCIL (INR9,948.2mn) and REC (INR8,196.3mn) shares through Offer for Sale.

FY09 No target fixed - - - - - - FY10 No target fixed 42,599 - - - - 42,599 (INR20,128.5mn - NHPC and

INR22,470.5mn - OIL)

Source: Ministry of Disinvestment, Nomura research



Exhibit 38. Time-line of reforms from FY99-10 FY1999 Comments • De-licensing of coal, lignite, petroleum, bulk drugs and sugar. Major • Coal, lignite and mineral oils removed from sole purview of public sector. Major • Announcement of disinvestment of IOC, GAIL, CONCOR, VNSL. Major • Buybacks by corporates permitted. Minor • Automatic route FDI limits enhanced. Minor • 100% foreign equity permitted in electricity generation, transmission and distribution. Major • 100% foreign equity permitted in construction & maintenance of roads, highways, bridges, ports and

harbours. Major

• No prior approval of RBI for FDI/NRI/OCB after FIPB/Govt approval. Minor • Electricity Act of 1948 amended for private investment in power transmission. Minor • Setting up of central electricity regulatory commission, provisions for state ERCs. Major • Additional tax at the rate of one rupee per litre on petrol imposed. To generate INR790 crore in a year and the

proceeds to be utilised to augment the corpus of the National Highways Authority of India (NHAI). Minor

• A National Integrated Highway Project merging the golden quadrilateral connecting Delhi, Mumbai, Chennai and Calcutta with the East-West (Silchar to Saurashtra) and North-South (Kashmir to Kanya Kumari) corridors launched.

Major

• The Government announces that five cities will be identified for developing world class international airports. Major • IDFC on par with other All India Public Financial Institutions regarding fiscal incentives and the fund raising

benefits extended to these institutions. Minor

• The repeal of the Urban Land (ceiling and regulation) Act, 1976. Major FY2000 Comments • RBI introduces an Interim Liquidity Adjustment Facility (ILAF) in place of the General Refinance Facility with

effect from 21 April,1999. Minor

• Relaxation of listing requirement in respect of securities in the IT sector by reducing the stipulated minimum offering of securities from 25% to 10%.

Minor

• The passing by Parliament of the Securities Laws (Amendment) Bill, 1999, incorporating derivative instruments in the definition of securities in the Securities Contract (Regulation) Act, 1956.

Major

• Introduction of rolling settlement for 10 select scrips with effect from 10 January, 2000. Minor • Insurance Regulatory and Development Authority (IRDA) Bill passed by the Parliament in December, 1999

which, inter alia, gives statutory status to the interim Insurance Regulatory Authority, opens up the insurance sector to private providers, allows foreign equity in domestic insurance companies subject to a maximum of 26% of the total paid-up capital.

Major

• Reduction of long-term capital gains tax from 20% to 10% for resident Indians. Minor • Reduction in the existing seven major ad valorem rates of customs to 5 basic rates and rationalisation of both

import duty and excise duty structures. Minor

• Free Trade Zones (FTZ) to replace export processing zones and to be treated as outside the country’s customs territory.

Minor

• Far-reaching rationalisation of the excise duty structure by reducing the existing eleven rates to only three. Minor • Tax incentives for facilitating industrial restructuring through mergers and amalgamations. Minor • Extension of infrastructure sector tax holiday to power transmission. Major • The scope of the automatic approval scheme of the RBI significantly expanded. Minor • FDI up to 74%, under the automatic route, in bulk drugs and pharmaceuticals. Minor • Restructuring the US 64 scheme of UTI (Unit Trust of India), a favourable tax treatment of incomes earned

through mutual funds. Minor

• A new Department of Disinvestment created for expediting disinvestments in PSEs. Major • Uniform tax holiday of 15 years for all infrastructure sector projects. Major • Mega Power Project policy announced. Major • Accelerated Power Development and Reforms Programme (APDRP) introduced. Major • Restructuring of SEBs to be encouraged; new transmission and distribution systems to get fiscal benefits

given to infrastructure sector. Major

• Domestic long distance calls to be opened up. Major • Department of Telecom Services (DTS) to be corporatised by 2001. Major • DTS/MTNL to enter as third cellular operators. Minor • TRAI (Telecom Regulatory Authority of India) reconstituted through an ordinance. Major • Existing licence holders of basic and value added services allowed to switch over to a revenue sharing

agreement. Major

• A new cess of Re.1 per litre on HSD (High Speed Diesel) imposed to generate funds to be transferred to Central Road Fund. Most of it to be used for development and maintenance of State Roads and National Highways.

Major

• Model Concession Agreement for BOT (Build Operate Transfer) for road project of more than INR100 crore

and less than Rs. 100 crore finalised. Major

• Indian Railway Catering & Tourism Corporation (IRTC) Ltd. incorporated as a government company with the

objective of upgrading and managing rail catering and hospitality. Minor

• Ministry of Petroleum and Natural Gas crafts the New Exploration License Policy (NELP) in 2000, which permits foreign companies to hold 100% equity possession in oil and natural gas projects. To date, only a handful of oil fields controlled by foreign firms.

Major



Exhibit 38. Time-line of reforms from FY99-FY10 (continued) FY2001 Comments

• A new programme called “Sarva Siksha Abhiyan” announced to enable all children to enrol by 2003 and

expand the coverage of District Primary Education Programme. Major

• To fulfil critical needs of the rural people, a new scheme, “Pradhan Mantri Gramodya Yojna” launched with an

outlay of INR5,000 crore. Major

• The system of central excise drastically overhauled with the introduction of a single Central Value Added Tax

(CENVAT) of 16% ad valorem on all manufactured goods with a few exceptions. Major

• States/Union Territories encouraged to implement their agreed programme for converting their sales taxes

into VAT by 1 April, 2002. Major

• The peak rate of import duty scaled down further from 40% to 35%. Minor

• The Budget proposed to bring out an institutional mechanism embodied in the “Fiscal Responsibility Act”. Accordingly, the Fiscal Responsibility and Budget Management Bill (FRBM), 2000 introduced in Lok Sabha in December, 2000. The Bill provides for elimination of revenue deficit and reduction of the fiscal deficit to not more than 2% of gross domestic product within a period of five financial years.

Major

• Transition to a full-fledged Liquidity Adjustment Facility (LAF) involving injection and absorption of liquidity via

variable rate reverse Repo auctions and variable rate Repo auctions respectively. Minor

• Legislative initiative to reduce the proportion of Government holding in the equity of nationalised banks. Major • Permission to raise FII equity limit to 40% through a special resolution by shareholders. Minor • Removal of cap on investment in the power sector. Major • 100% FDI permitted in oil refining. Major • 100% FDI allowed in Special Economic Zones (SEZs) for all manufacturing activities. Major • 100% FDI allowed in Telecom Sector for certain activities with some conditions. Minor

• The States of Orissa, Haryana, Andhra Pradesh, Uttar Pradesh, Karnataka, Delhi and Rajasthan enact their Electricity Reforms Acts. Madhya Pradesh Legislative Assembly passes Electricity Reforms Bill. Gujarat also drafts Reforms Bill.

Follow up

• A fourth cellular operator in all the circles permitted. Follow up • Limited mobility to fixed service providers in the form of Wireless In local loop (WILL). Follow up • 20 BOT road projects awarded. Major FY2002

• The coverage of service tax at the rate of 5% on the value of taxable service expanded to include fifteen new

services. Follow up

• Decision taken that all States and Union Territories will implement VAT from April, 2003. Follow up

• Level playing field to private insurers accorded by allowing similar benefits to them and their clients as are

available to LIC, GIC and their clients. Follow up

• Government of India draws up a scheme called the States' Fiscal Reforms Facility (2000-01 to 2004-05). Incentive Fund of Rs.10,607 crore earmarked over a period of five years to encourage States to implement monitorable fiscal reforms. Three areas emphasised - Fiscal consolidation, PSE Reforms and Power sector reforms.

Follow up

• Income tax at source made deductible at the rate of 10%. Major

• Freedom for banks to lend at interest rates below their respective PLRs (Prime Lending Rates) to exporters

and other creditworthy borrowers (including public enterprises). Minor

• VRS (Voluntary Retirement Scheme) implemented by 26 out of 27 public sector banks in 2000-2001 Follow up • Clearing Corporation of India Limited (CCIL) set up. Minor

• Negotiated Dealing System (NDS) introduced in phases to supplement or replace the current telephone mode

used in trading on the fixed income market. Minor

• Rolling settlement extended to all stocks and all exchanges. Cycle shortened to T+3. Follow up • Peak level of customs duties to decline marginally from 38.5% to 35%. Follow up

• Extension of the concessions available for infrastructure by way of 10-year tax holiday to the developers of

Special Economic Zones (SEZs) on the same lines as developers of industrial parks. Minor

• Further impetus on SEZ. Follow up

• Quantitative restrictions on exports of agricultural items like wheat, wheat products, coarse grains, butter and

non-basmati rice and packaging restrictions on exports of pulses were in February, 2002. Follow up

• Ten-Year tax holiday for the core sector of infrastructure, namely, roads, highways, water-ways, water supply,

sanitation and solid waste management systems, which may be availed of during the initial 20 years. Follow up

• In the case of airports, ports, inland ports, industrial parks and generation and distribution of power, which also become commercially viable only in the long run, a tax holiday of 10 years allowed to be availed of during the initial fifteen years.

Minor

• Tax incentives have been provided for the investors providing long-term finance or investing in the equity capital of the enterprises engaged in infrastructure facility. Any income by way of interest, dividends or long-term capital gains from such investments fully exempt.

Minor

• Electricity Bill 2001 introduced in Parliament. Major • Central Government to accelerate the program of reforms for State Electricity Boards (SEBs) anchored in

Centre-State partnership on the following: 1) A time bound program for installation of 100 percent metering; 2) Energy audit at all levels; 3) Commercialisation of distribution; 4) SEB restructuring.

Major

• Competition introduced in all service segments of telecoms. Major • The total outlay for the road sector enhanced. Follow up • INR2,500 crore assistance out of Pradhan Mantri Gram Sadak Yojana (PMGSY) to provide connectivity of

every village with a population of over 1000 persons through good all weather roads by year 2003 and those with a population of up to 500 persons by 2007.

Major

• Pradhan Mantri Gramin Yojna (PMGY) extended to cover rural electrification. Major • Continued de-reservation for small scale industry. Follow up



Exhibit 38. Time-line of reforms from FY99-FY10 (continued) FY2003 Comments • To reduce the interest burden of States, a debt swap scheme enabling States to swap their high cost Central

Government loans bearing a coupon rate of 13% and above with relatively low cost market borrowings and loans from NSSF, put in place.

Major

• Enactment of “Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002”. Act enabled setting up of ARCs (Asset Restructuring Companies). Enabled debt recovery by taking possession of assets. Paved the way for enhanced power of banks in default situations.

Major

• Further enhancement of SEBI's power. Follow up • Corporate disclosures made widely available through Electronic Data Information Filing and Retrieval. Follow up • Further concession given to SEZs in terms of procurement of duty free equipment, raw materials and

components. Follow up

• Continued de-reservation from small scale industry. Follow up • Reduction in peak import duty from 35% to 30%. Follow up • Significant reduction in ECB usage restrictions. Follow up • 100% FDI permitted in advertising, film, tea, township development including housing, commercial premises,

hotels, resorts and regional urban infrastructure, in manufacturing of SEZs. Follow up

• 26% FDI allowed in print media. Follow up • Disinvestment of Hindustan Zinc, Maruti, IPCL, Modern Foods and eleven government-owned hotels. Major • Infrastructure Equity Fund set up for providing equity investment in infra projects. Major • IDFC to act as coordinating agency for coordinated debt syndication for infrastructure. Minor • 20 state government sign MOUs (Memorandum of Understanding) with centre for time bound reforms. Follow up • State level electricity regulatory commissions start to function. Follow up • SEB (State Electricity Board) de-bundling starts. Follow up • APDRP (Accelerated Power Development and Reform Programme) given further thrust. Follow up • Airport modernisation started. Major • Mass rapid transport thrust introduced. Urban Delhi Metro project slated for completion in 2005.. Minor • Monitoring of government project strengthened to reduce delay. Starts to show results. Minor • Electricity distribution privatised in Delhi in July 2002. Follow up • The Ministry of Agriculture circulates a model Agriculture Produce Marketing Committee (APMC) Act, 2003,

and suggests amendments to the State APMC Acts so as to promote investment in marketing infrastructure, motivating corporate sector to undertake direct marketing and to facilitate a national integrated market.

Major (not completed)

FY2004 — change of the government takes place to UPA late in FY2004 Comments Pre UPA with left • Fiscal Responsibility and Budget Management (FRBM) bill 2003 introduced and made into an Act in August

2003. Specified revenue and fiscal deficit targets. Borrowing from RBI not allowed for bridging deficit. RBI not to subscribe to primary issuances of government paper from FY07. Review of fiscal policy every year. Quarterly review of fiscal situation.

Major

• Shift from contribution pension system to defined pension benefit for central government employees Major • Introduction of risk based supervision in the banking sector. Minor • Issuance of guidelines for "Securitisation, Reconstruction of Financial Assets and Enforcement of Security

Interest Act. Follow up

• FDI in banking increased to 74% from 49%. Foreign banks allowed to operate in India through 1) branches, 2) wholly owned subsidiary, and 3) a subsidiary with aggregate foreign investment up to a maximum of 74% in a private bank.

Follow up

• Commodity futures trading allowed. Recognition granted to various commodity exchanges including MCX, NCDEX etc.

Major

• New regulator for pension sector - PFRDA (Pension Fund Regulatory and Development Authority) created with intent to efficiently manage pension funds and expected to develop a new class of institutional investors.

Major

• ECB policy liberalised further. All sectors except banks and financial institutions allowed in the ECB market. Follow up • Five states enact fiscal responsibility legislations. Follow up Pre UPA with left • Disinvestment in Maruti, Jessop, HZL, ICIL, IBP, IPCL, CMC, DCIL, GAIL, ONGC. Follow up Pre UPA with left • Electricity act notified in June 2003. Follow up Pre UPA with left • 28 States sign the tripartite agreement for onetime settlement of the dues of State Electricity Boards (SEBs) to

Central Public Sector Undertakings (CPSUs), and, after securitisng the dues, 27 states issued bonds amounting to INR28,983.85 crore, August 2003 onwards.

Major

Pre UPA with left • Unified Access Service License regime introduced in October 2003. Follow up Pre UPA with left • Pradhan Mantri Bharat Jodo Project for development of 10,000 kms of roads connecting state capitals with

National Highways launched in January 2004. Follow up

Pre UPA with left • Rail Vikas Nigam set up in January 2003. Major



Exhibit 38. Time-line of reforms from FY99-FY10 (continued)

FY2005 Comments • Disinvestment agenda largely scuttled. Retrograde • FRBM effective from July 2005 with the following targets -1) Reduction of revenue deficit by an amount

equivalent of 0.5% or more of the GDP at the end of each financial year, beginning with 2004-05. 2) Reduction of fiscal deficit by an amount equivalent of 0.3% or more of the GDP at the end of each financial year, beginning with 2004-05. 3) No assumption of additional liabilities (including external debt at current exchange rate) in excess of 9% of GDP for the financial year 2004-05 and progressive reduction of this limit by at least one percentage point of GDP in each subsequent year. 4) No guarantees in excess of 0.5% of GDP in any financial year, beginning with 2004-05. 5) Specifies four fiscal indicators to be projected in the medium term fiscal policy statement. These are, revenue deficit as a percentage of GDP, fiscal deficit as a percentage of GDP, tax revenue as percentage of GDP and total outstanding liabilities as percentage of GDP.

Follow up

• The universally accepted formula of exempt exempt tax (EET) adopted, that is, the contributions will be excluded from income for tax purposes; the accruals will also be exempt from tax; and only the terminal benefits will be taxed at the applicable rate in the year of receipt.

Minor

• Three more states likely to enact fiscal responsibility legislations. Follow up • States entered into debt swap to reduce the cost of debt. Process complete for 20 states. Follow up • Agreement to implement State level VAT from 1 April, 2005. Follow up • Development of mechanism for debt restructuring for medium enterprises on the lines of corporate debt

restructuring. Follow up

• Resident individuals already permitted to remit freely up to US$ 25,000 per calendar year for any current or capital account transaction.

Follow up

• Abolition of long term capital gains tax. Reduction in short term capital gains tax from 30% to 10 per cent. Introduction of STT (Securities Transactions Tax).

Major

• Indian corporates and partnership firms allowed to invest overseas up to 100% of their net worth. Minor • Banks to draw a road map for moving towards Basel II by 31 December, 2004. Minor • Increase in the FDI limits in “Air Transport Services (Domestic Airlines)” up to 49% through automatic route

and up to 100% by non-resident Indians (NRIs) through automatic routes. (No direct or indirect equity participation by foreign airlines allowed).

Follow up

• Foreign investment in the banking sector further liberalised by raising FDI limit in private sector banks to 74% under the automatic route including investment by FIIs. The aggregate foreign investment in a private bank from all sources a maximum of 74% of the paid up capital of the bank and at all times, at least 26% of the paid up capital held by residents except in regard to a wholly owned subsidiary of a private bank. Further, the foreign banks permitted to either have branches or subsidiaries, not both. Foreign banks regulated by a banking supervisory authority in the home country and meeting Reserve Bank’s licence criteria will be allowed to hold 100% paid up capital to enable them to set up wholly-owned subsidiary in India.

Follow up

• FDI ceiling in telecom sector in certain services (such as basic, public mobile radio trunked services (PMRTS), global mobile personal communication service (GMPCS) and other value added services), increased from 49% to 74%, in February 2005. The total composite foreign holding 160 Economic Survey 2004-2005 including but not limited to investment by FIIs, NRI/OCB, FCCB, ADRs, GDRs, convertible preference shares, proportionate foreign investment in Indian promoters/investment companies including their holding companies etc, not to exceed 74%.

Follow up

• Generally, profit-making companies not to be privatised. Retrograde • NHDP (National Highway Development Project) Phase IV, a new initiative proposed with a view to providing

balanced and equitable distribution of improved/widening highway network throughout the country by upgrading 21,000 kilometre of single - lane roads to 2-lane roads with paved shoulders, and for strengthening of 17,000 kilometre of the existing 2-lane highways and construction of paved shoulders.

Follow up

FY2006 Comments • The corporate income tax rate for domestic companies and firms reduced from 35% to 30%. However, a

surcharge of 10% applies. Follow up

• Service tax rate increased from 8% to 10%. Minor • Rural Electricity Infrastructure and Household Electrification introduced in April, 2005. Rural thrust • National Rural Employment Guarantee bill passed in August 2005. Rural thrust • Viability gap funding schemes introduced on generalised basis. Major • Peak rate of customs duty for non-agricultural products reduced from 20% to 15%. Follow up • The emphasis on infrastructure development continued with the decision to set up a special purpose vehicle

(SPV) for large infrastructure projects. Follow up

• The Special Economic Zone (SEZ) Bill passed by Parliament in June 2005. Follow up • Five sites including three coastal sites, one each in Karnataka, Gujarat and Maharashtra identified for

development of Ultra-Mega Power plants (UMPP) with capacity of 4,000 MW each. Major

• An All-India power grid, also called the “National Grid”, envisaged to be developed in a phased manner – first by integrating a cluster of regions, and subsequently all the regions by the year 2012.

Major

• NHDP (National Highway Development Project) Phase V, VI and VII proposed. All future phases to be taken up on a PPP (Public Private Partnership) basis.

Follow up



Exhibit 38. Time-line of reforms from FY99-FY10 (continued)

FY2007 Comments • The peak rate of duty on non-agricultural products reduced from 15% to 12.5 per cent. Ambit of service tax to

include several new categories. Follow up

• Union Budget for 2006-07 announced interest rate relief at two percentage points on the principal amount up to INR1 lakh on crop loans availed of by the farmers for Kharif and Rabi seasons 2005-06.

Rural Thrust

• PAN has been made mandatory with effect from January 1, 2007, for operating a Beneficiary Owner account and for trading in the cash segment.

Minor

• The application process of FII investment simplified and new categories of investment (insurance and reinsurance companies, foreign central banks, investment managers, international organizations) were included under FII.

Minor

• UMPP numbers expanded to 9 in total. Follow up • For encouraging competition in development of transmission projects, Ministry of Power notified Tariff-Based

Competitive Bidding Guidelines for Transmission Service under Section 63 of the Electricity Act, 2003. Follow up

• The Ministry of Power issuance on approach and guidelines on development of merchant power plants (MPPs). Unlike traditional utilities, MPPs compete for customers and absorb the full market risk.

Major

• On 23 August, 2006, Government notified Rural Electrification Policy under section 4 & 5 of the Electricity Act, 2003.

Rural Thrust

FY2008 Comments • The peak rate of customs duty on non-agricultural products reduced from 12.5% in 2006-07 to 10% in 2007-

08, with a few exceptions. Follow up

• Further increase in services eligible for service tax. Follow up • De-tariffing of the general insurance industry. Follow up • Appointment by PFRDA (Pension Fund Regulatory and Development Authority) of three sponsors for pension

funds for managing the corpus under the New Pension System for the Government employees after due consideration. These were the State Bank of India, UTI Asset Management Company Private Limited and Life Insurance Corporation of India.

Follow up

• 3 UMPPs (Ultra Mega Power Plants) awarded. Follow up FY2009 and interim budget for FY2010 Comments • Additional plan expenditure up to INR20,000 crore for social sector schemes during financial year 2008-09. Populist • An amount of INR85,942 crore authorised by way of bonds in 2008-09 for FCI, oil and fertilizer units. Populist • Across the board cut of 4pp in ad valorem CENVAT rate except for petroleum products. Response to

crisis • Farm loan waiver (0.3% of GDP). Populist • Significant customs duty exemptions announced to address the slowdown. Response to

crisis • Implementation of the Sixth Pay Commission award (0.65% of GDP). Populist • Higher levels of food and fertiliser subsidy (1.03% of GDP). Populist • 49% FDI in credit information companies allowed. Follow up • FDI up to 26% and FII up to 23% in commodity exchanges, subject to no single investor holding more than

5% allowed. Follow up

• FDI up to 100% under the automatic route allowed both in setting up and in established industrial parks. Follow up • FDI cap in the civil aviation sector, which includes 74% FDI in non-scheduled airlines, chartered airlines and

cargo airlines, relaxed. 100% FDI in maintenance and repair organizations, flying training institutes, technical training institutions, and helicopter services/seaplane services allowed.

Follow up

• FDI up to 100% (with prior government approval) in mining and mineral separation of titanium-bearing minerals and ores, its value addition, and integrated activities allowed.

Follow up

• One more UMPP awarded. Follow up • Under NELP-VII, the award of 44 blocks has been approved. Follow up

Note: 10 lakh = 1 million; 1 crore = 10 million

Source: Budget documents, Nomura research



The macro balancing act

India: high-growth high-inflation paradox Sonal Varma

A rebound in private demand, rising inflation and a surge in capital inflows have set the stage for policy reversal in 2010. However, managing the fiscal deficit will remain a challenge.

We expect GDP growth to rebound from 7.0% in FY10F to 8.0% in FY11F. This rebound underlines a shift in growth drivers from industry to services and from government to private demand.

Higher demand and rising input cost pressures have set the foundation for greater cost pass-through or margin pressures for firms in the coming quarters. We expect WPI inflation at 8.0% y-y by end-FY10F and an average of 6.8% in FY11F.

The centre’s fiscal deficit should fall as a percentage of GDP owing to revenue buoyancy and higher disinvestments. However, gross borrowings are likely to stay high, which could push long-term yields above 8%.

We expect Indian rupee/US dollar to touch 42.3 by end-2010F, due to capital inflows. Rising domestic inflation, improving export demand and appreciation of other Asian currencies should lessen the policy resistance against rupee appreciation.

We expect the RBI to use multiple tools in 2010F: repo/reverse repo rate hikes starting in January, CRR hikes to tackle liquidity, tighter prudential norms and countercyclical capital account norms.

Downside risks to our view: sharply higher commodity prices, negative global developments, geo-political risks. Upside risk: virtuous dynamics.

Back to an 8% economy, but underlying shift in growth drivers India has weathered not just the global crisis, but also weak monsoons, and is likely to post a robust GDP growth rate of 8% in FY11F (year ending March 2011) from an estimated 7% in FY10F. The rebound underlines a structural shift in the growth drivers: first, the recovery will shift to services-led growth from the manufacturing-led recovery so far; and second, the demand baton is likely to be passed from the government to the private sector (see Exhibit “Contribution to GDP growth”). In our view, this rebalancing will be supported by an improvement in a number of fundamental drivers of the economy.

Improving consumption prospects: Rising income and stable employment should boost consumer demand. Various survey data suggest that employment prospects have improved in 4Q09 and we expect them to improve further (see Exhibit “Employment and private consumption”). This, together with lower interest costs, and rising confidence, should support a strong recovery in urban consumption demand. Assuming a normal monsoon, the structural uptick in rural demand should remain underpinned by income support from higher food prices and rural employment and social spending schemes by the government.

Roads-led infrastructure push: India has major infrastructure bottlenecks. We expect investments to rebound in FY11F, led by infrastructure, with the largest policy thrust on roads. Nomura’s construction sector analysts estimate the government has already awarded orders for US$4.5bn worth of road projects in FY10-to-date and another US$35bn is planned by end-FY11F. The multiplier impact from investment in roads, including greater construction activity, employment in rural and semi-urban areas and demand for raw materials, should provide the necessary fillip to manufacturing capex as well. Rural infrastructure and power are other areas of policy focus. Currently, more than 30% of incremental bank credit is for infrastructure, reflecting the hectic pace of activity in this sector (see Exhibit “Incremental credit to infrastructure”).

A rebound in private sector demand should offset lower fiscal stimulus in 2010F

Consumer demand and infrastructure investment to drive this pick-up



Exhibit 39. Contribution to GDP growth

(2)

2

6

10

14

Mar-07 Mar-08 Mar-09 Mar-10 Mar-11

Government Private demandOthers GDP

(%)

Forecasts

Source: CEIC and Nomura Global Economics estimates

Exhibit 40. Employment and private consumption

(5)

5

15

25

Dec-02 Feb-04 Apr-05 Jun-06 Aug-07 Oct-08 Dec-092

4

6

8

10Employment survey (LHS)

Real private consumption (3qma)

(%) (% y-y)

Source: RBI, CEIC and Nomura Global Economics

A credit-led recovery: Unlike in 2009, we expect private credit growth to clock growth of more than 20% y-y by end-FY11F. The lack of private credit growth last year was a result of companies tapping non-banking sources of debt and equity financing. This can be gauged by the divergent credit off-take for micro and small enterprises (MSE) and larger firms: while credit growth to medium and large corporates slowed to 14.9% y-y as of August 2009, credit to MSEs was still growing at a strong 27.4%. This reflects the easier access of larger corporates to alternative (and less expensive) sources of capital market financing. As domestic liquidity tightens and the capex cycle strengthens, we expect firms to take greater recourse to bank financing. Retail credit should pick up, backed by lower interest rates and robust consumer demand growth, while rising industrial activity and higher commodity prices suggest an improvement in working capital loans in the coming quarters.

Reform stimulus to continue: We expect incremental reforms to continue over 2010, lending support to growth: implementation of the goods and services tax by end-FY11F; disinvestment of public sector enterprises to partly finance the government’s capital investment in social sectors; implementation of financial sector reforms such as allowing repo in the corporate bond market and insurance and pension reforms to deepen financial markets; implementation of the direct tax code and unique identity number and encouraging infrastructure investments, to name a few. Ongoing internal battles within opposition parties and a long haul before the next elections imply that there will be less coherent political opposition to incremental reforms put forth by the current administration.

From supply- to demand-led inflation; more margin pressures We expect higher-than-consensus inflation by end-FY10F and in FY11F. Wholesale price index (WPI) inflation rose to 4.8% y-y in November and we expect it to inch towards 8.0% by March 2010 and average at 6.8% in FY11F (see Exhibit “WPI inflation projections”). We expect the fundamental driver of inflation to shift from supply-side to demand-side inflation. India is experiencing accelerating inflation, which is at odds with the slack in the global economy, but reflects the supply-constrained nature of India’s economy combined with the rapid recovery in domestic demand.

Food inflation is a concern. We believe food prices could remain high in early-2010 due to hoarding until there is clarity on the next monsoons. Non-food inflationary pressures are also building due to higher oil and other commodity prices much of which has yet to be passed on to consumers or reflected in the index, but which is adding to input cost pressures for firms. A sustainable demand recovery and rising input cost pressures are setting the foundation for greater cost pass-through in the coming quarters, in our view. Already, our estimates of core inflation have started

We expect credit growth to pick up in FY11F as investment plans come to fruition

Political opposition to incremental reforms is much more mild today

Inflationary pressures are building up…

…this should fuel demand-side inflation or increase margin pressure for firms



rising and we expect a further acceleration in 2010 (see Exhibit “Various measures of core WPI inflation”). If cost pressures are not passed through, firms will see higher margin pressure vis-à-vis the margin expansion that benefitted them in early-FY10F.

Separately, the launch of the new monthly WPI index with a wider basket and base year of 2004-05 will be an important event to watch for in 2010. Past base revisions have led to a structurally lower inflation rate due to substitution effect. This is because commodities that gain in weight will be the ones whose relative prices fall due to increased production and trade. Consumers prefer goods with lower relative prices, increasing the weight of such goods in the revised inflation index. However, since the new index will substantially alter the composition of the basket and include items that have much better quality, and therefore higher prices, the historical evidence may not set the correct precedent. Risks, therefore, lie on either side.

Exhibit 41. Incremental credit to infrastructure

0

10

20

30

40

Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09

Share of infrastructure in incremental credit

(%)

Source: CEIC and Nomura Global Economics

Exhibit 42. WPI inflation projections

(1)

2

5

8

11

14

Mar-07 Dec-07 Sep-08 Jun-09 Mar-10 Dec-10

Primary FuelManufacturing WPI

(% y-y)

Forecasts


Fiscal deficit to fall; but borrowings remain a risk Fiscal consolidation is likely in FY11F, with the centre’s fiscal deficit likely to fall to around 6.2% of GDP in FY11F from 6.8% in FY10F. However, much of this consolidation is likely to be a result of higher revenues rather than expenditure control. While one-off expenses such as pay arrears are unlikely to be a burden in FY11F, most other government expenses such as interest expenses, pensions and wages are sticky and will remain high. In addition, we expect plan expenditure to be increased in FY11F, in line with the government’s greater social-sector focussed efforts. Therefore, we expect overall expenditure to be increased moderately in FY11F, from an already high INR10.2tn in FY10F.

On the revenue side, disinvestment is likely to play a key role in lowering the fiscal deficit. Selective roll-back on excise and services tax rates are likely, while export sops may continue a while longer. With higher nominal GDP growth likely to increase overall revenue buoyancy, our worry is that the government will bank on this to lower the fiscal deficit rather than pruning wasteful expenses.

On an absolute basis, we expect gross borrowings to remain high, at slightly above the INR4.5tn expected in FY10F (see Exhibit “Centre’s market borrowings and yields”), which should continue to put upward pressure on long-term yields and push the benchmark 10-year bond yield to 8% and above. Unlike last year, when the Reserve Bank of India (RBI) accommodated the higher deficit by open-market operations purchase and unwinding the market stabilisation scheme (MSS), these facilities will not be available in FY11F. Yields may also be pressured by rising inflation and a reversal in the accommodative policy stance. Therefore, while fiscal consolidation will occur, management of the government’s higher borrowing will remain as much of a challenge in 2010 as it was in 2009.

Fiscal consolidation is likely to be left to revenue buoyancy rather than expenditure control

With continued large borrowings in FY11 and no RBI support, long-term yields could rise sharply



Rupee appreciation to continue Fundamental factors continue to point towards rupee appreciation: India’s higher growth and interest rate differentials, which should attract capital inflows; a more hawkish central bank in the region and an undervalued currency. India’s vulnerability is mainly through higher oil prices, but on our house view that oil prices will average at US$72bbl in FY11F, we expect the current account deficit to be easily offset by a surge in net capital inflows to US$50bn in FY11F. While equity capital flows have already rebounded, we expect debt capital flows to follow suit, attracted by rising interest rate differentials (see Exhibit “Components of balance of payments”). We expect the rupee/US dollar to touch 42.3 by end-2010F.

Exhibit 43. Various measures of core WPI inflation

(3)

0

3

6

9

12

15

May-05 Feb-06 Nov-06 Aug-07 May-08 Feb-09 Nov-09

Trimmed mean (20%)Core WPI (ex-food, fuel)Mean +/- 1.5 S.D

(% y-y)


Exhibit 44. Centre’s market borrowings and yields

0

1

2

3

4

5

FY01 FY03 FY05 FY07 FY09 FY11E4

5

6

7

8

9

10Gross market borrowing, lhsNet market borrowing, lhs10-year bond yield, rhs

INR tr (%)

Source: Budget documents, CEIC and Nomura Global Economics estimates

The larger debate concerns policy comfort on rupee appreciation. So far, with sluggish external demand and rising job losses, policy bias has been to let the currency remain undervalued. We expect this to shift gradually in favour of letting the rupee appreciate.

First, export growth has rebounded sharply to positive territory in November. Second, export-oriented sectors such as textiles, information technology and gems & jewellery have reported increased net hiring in 2H09, according to a Labour Bureau survey. Third, we expect the RBI to accept some monetary tightening through rupee appreciation due to inflation concerns. Aggressive intervention, if left unsterilised, will only fuel domestic liquidity and inflation, or if sterilised, raise interest rates as the RBI sterilises this liquidity. The impossible ‘trinity dilemma’ lurks around the corner. Fourth, Nomura’s forex strategists expect cyclical superiority and recommencement of renminbi appreciation to facilitate a greater acceptance of forex appreciation across Asia. This should reduce the RBI’s fear of Indian exporters losing their relative competitiveness. And finally, if demand is truly weak globally, then keeping the price low (weaker exchange rate), will make no difference to export demand, but only aggravate inflation.

Multiple tools to tackle multiple policy objectives We expect the RBI to use multiple tools to tackle its often-conflicting short-term objectives of controlling inflation without hurting growth, preventing rupee appreciation without fuelling liquidity and asset price inflation, withdrawing liquidity without disrupting the government’s borrowing programme.

First, with both growth and inflation heading towards 8%, we expect the RBI to start normalising its policy rates in January by delivering 25bps hikes to its repo and reverse repo rates followed by further 100bps hikes each through the remainder of 2010F (see Exhibit “Policy rate projections”). Excess systemic liquidity suggests that reverse-repo will remain the effective rate at least until mid-2010, when RBI rate actions and higher

Rupee should appreciate due to higher capital inflows and easing policy resistance

Policy normalisation should start in January with 125bps of policy rate hikes in 2010



credit growth absorb all the liquidity. Initially, therefore, we expect the reverse repo to be the key “signalling” tool for the RBI to indicate a turn in the rate cycle. Since there will be a lag between RBI rate hikes and tighter systemic liquidity, bank lending rates are likely to respond to tighter monetary policy with a lag, delaying the policy transmission mechanism when the rate cycle is moving up.

Second, to tackle capital inflows, the RBI is likely to partially intervene to prevent rapid rupee appreciation and build up its forex reserve buffer. This excess liquidity is likely to be mopped up using cash reserve ratio hikes, dollar sell-buy swaps and issuance of market stabilisation securities. We are pencilling in 125bps of CRR hikes in 2010F.

Third, to prevent too-rapid asset price inflation, the RBI is likely to tighten the provisioning norms on standard assets, increase risk weightages (in the bank capital adequacy requirement) on loans for commercial real estate, unrated corporate claims and non-banking finance corporations and keep a strict vigil on banks’ capital market exposures. A bigger concern for the RBI will arise if the asset price inflation is fuelled by credit, but we do not expect this to be the case owing to strict regulatory controls.

Fourth, the RBI is likely to follow counter-cyclical capital account liberalisation. If capital inflows rise rapidly, as we expect, tighter end-use restrictions could be re-imposed on external commercial borrowings, where lower interest rates abroad may result in large borrowing by corporates. Interest rates on NRE deposits may also be lowered to slow the pace of debt capital inflows. Policymakers have to balance the need to attract sufficient foreign inflows to ensure the success of the government’s disinvestment agenda and meet India’s investment needs, without complicating RBI’s monetary policy management. Therefore, punitive capital controls are unlikely.

Fifth, to ensure that the government’s borrowing programme progresses smoothly, the RBI is likely to continue to issue floating rate bonds and possibly hike the hold-to-maturity limit for banks. Open market purchase of government bonds may not be the ideal solution, since it will only counter liquidity absorption operations by the RBI.

Risks to our view We see four key downside risks for India. First, sharply higher commodity prices could widen India’s trade and fiscal deficits, putting upward pressure on inflation. Second, India remains vulnerable to negative global developments, such as a double-dip in developed economies. Third, a new capex cycle depends on continuation of positive business confidence and availability and cost of capital. Any setback in these factors could delay a pick-up in the capex cycle. Fourth, India remains vulnerable to geo-political risks, such as a border conflict with China or Pakistan. The main upside risk is the virtuous dynamic of rising consumption, higher investment, higher capital flows, asset price inflation and rising wealth effect that can all lead to positive feedback loops, strengthen domestic demand and lead to sharply higher growth in 2010F.

Exhibit 45. Components of balance of payments

(30)

(10)

10

30

50

70

90

110

FY01 FY03 FY05 FY07 FY09 FY11

Current accountDebt capitalEquity capital

(US$bn)

Forecast


Exhibit 46. Policy rate projections

3

4

5

6

7

8

9

Mar-03 Oct-04 May-06 Dec-07 Jul-09 Mar-11

CRR Repo rate Reverse repo(%)

Forecast


We expect 125bps of CRR hikes in 2010 to withdraw excess liquidity

RBI is likely to follow counter-cyclical prudential and capital liberalisation norms

Downside risks: commodity prices, global double-dip, geo-political factors



Exhibit 47. Details of forecast y-y- growth (%) unless otherwise stated 3Q09 4Q09F 1Q10F 2Q10F 3Q10F 4Q10F 1Q11F FY09F FY10F FY11FReal GDP (sa, q-q, %, annualised) 11.4 2.4 9.7 8.5 10.9 4.7 6.9 Real GDP 7.9 6.5 7.5 7.9 8.1 8.3 7.7 6.7 7.0 8.0Private consumption 5.6 5.0 6.0 6.5 7.0 7.0 7.6 2.9 4.6 7.0Government consumption 26.9 5.0 5.0 5.0 3.5 6.0 5.0 20.2 9.9 5.0Fixed investment 7.3 6.0 8.0 7.8 8.2 9.2 9.5 8.2 6.4 8.7Exports (goods and services) (15.0) 3.0 6.0 14.5 14.9 9.5 9.0 12.8 (4.0) 11.7Imports (goods and services) (29.8) (2.0) 9.0 14.0 8.4 11.5 10.5 17.9 (11.2) 11.1 M3 money supply 19.8 18.6 18.1 18.0 18.5 18.4 17.3 18.8 18.0 17.3Non-food credit 14.7 11.1 14.8 15.2 17.3 19.7 21.1 17.4 15.5 21.5Wholesale price index (0.1) 4.0 7.5 7.4 6.3 6.7 7.0 8.4 3.0 6.8Consumer price index 11.8 11.5 11.3 10.4 5.8 5.3 5.5 10.9 6.6 6.0 Merchandise trade balance (% GDP) (7.7) (9.6) (7.0) (6.7) (6.6) (9.7) (5.5) (10.4) (7.8) (6.9)Current account balance (% GDP) (2.6) (0.8) (1.1)Centre’s fiscal balance (% GDP) (6.0) (6.8) (6.2) Repo rate (%) 4.75 4.75 5.00 5.25 5.50 6.00 6.25 5.00 5.00 6.25Reverse repo rate (%) 3.25 3.25 3.50 3.75 4.00 4.50 4.75 3.50 3.50 4.75Cash reserve ratio (%) 5.00 5.25 5.50 5.75 6.00 6.25 6.50 5.00 5.50 6.5010-year bond yield (%) 7.34 7.00 7.25 7.30 7.50 7.75 8.00 7.04 7.25 8.00Exchange rate (INR/US$) 48.0 45.8 46.2 45.0 43.7 42.3 40.5 51.0 46.2 40.5

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. CPI is for industrial workers. Table last revised on 24 December, 2009.


Strategy | India Kapil Singh


Autos

Action With the economic revival, we believe that growth in FY11F is likely to remain

strong. We believe that cars and commercial vehicles will deliver strong volume growth of 15% and 20%, respectively, and tractors will see growth of 10% in FY11F. While there are concerns regarding increases in duties and material costs, we believe that these will ease due to strong demand.

Catalysts We believe that strong volume growth and stable margins are potential key

catalysts for the sector.

Anchor themes

We believe that strong growth in automobiles will be fuelled by a revival in economic growth, which leads to job creation, benefits coming from the Sixth Central Pay commission, and increased affordability due to increases in incomes. We also believe that weak monsoons will not have a significant impact on demand.

Strong growth set to continue Economic revival to fuel growth Historically, there has been a strong relationship between periods of high industrial growth and high automotive demand growth. This is because companies tend to invest and new jobs are created during these periods. With IIP estimated to pick up from 2.7% in FY09 to 9.5% in FY10F and 8% in FY11F, we expect demand across different categories of automobiles to remain strong. For FY11F, we estimate demand growth for cars at 15%, commercial vehicles at 20% and two-wheelers at 10%.

Benefits from Sixth Central Pay Commission to continue Automobile demand benefited from the Sixth Central Pay Commission in FY10, and we see more benefits to come. Although 3mn central government employees received pay hikes, a number of employees from the remaining 15mn state and quasi-state government employees have yet to see a pay rise take effect. Note that these employees will also be getting back-pay from 2006.

Only nine cars per thousand people India had about nine cars per 1,000 people at the end of FY09. This is nearly one-fourth the equivalent figure for China. We estimate that demand for cars in India will witness a CAGR of 14% over the next five years, if it replicates the China path, with a slower GDP growth rate of 7.5%. Based on forecasts by the National Council for Applied Economic Research (NCAER), we estimate the addressable segment for cars will post a CAGR of 15% over the next five years.

Weak rainfall not an important factor; even tractor demand is likely to remain strong Historically, we find little correlation between weak monsoons and automobile demand. The only category where there is some correlation is tractors. However, we highlight that the minimum support price of agri commodities increased less than 5% in the previous weak monsoon cycle (FY03), compared with a 20% CAGR in the past two years. In addition, schemes such as the National Rural Employment Guarantee Act (NREGA) have created a shortage of farm labour, which should lead to increased mechanisation at farms.

Analysts Kapil Singh +91 22 4037 4199 [email protected] Prabhat Awasthi +91 22 4037 4180 [email protected]

Stocks for action We maintain Mahindra and Mahindra as our top BUY, given the outlook of structural improvement in tractor demand and new launches in commercial vehicles. We maintain REDUCE on Tata Motors, given the cashflow concerns from JLR.

NEUTRAL

Stock RatingPrice(INR)

Price target(INR)

Mahindra & Mahindra (MM IN)

BUY 1,061.85 1,232

Tata Motors (TTMT IN) REDUCE 779.95 419

Prices as of 24 December 2009



Strategy | India Kapil Singh


Exhibit 48. Relationship of IIP growth to automobile growth

(40)

(20)

0

20

40

60

80

100

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

F

FY11

F

2468101214161820

Cars (LHS) Two wheelers (LHS)

Commercial vehicles (LHS) IIP (RHS)

(%) (%)

Source: Business Beacon, Society of Indian Automobile Manufacturers (SIAM), Nomura estimates

Exhibit 49. Relationship of GDP/capita and car penetration

0

10,000

20,000

30,000

40,000

50,000

Indi

a

Phi

llippi

nes

Indo

nesi

a

Sri

Lank

a

Chi

na

Thai

land

Bra

zil

Mex

ico

Mal

asiy

a

Sou

thK

orea

Japa

n

UK

US

A

Ger

man

y

0

100

200

300

400

500

600GDP PPP in 2006 (LHS)

Cars/1000 (RHS)


Exhibit 50. Relationship of weak monsoons and auto demand in India

(50)(40)(30)(20)(10)

0102030405060

FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09(25)

(20)

(15)

(10)

(5)

0

5

2W (LHS) Cars (LHS)MHCVs (LHS) Exide (LHS)Rainfall deviation (RHS)

(%) (%)



Strategy | Banks Mahrukh Adajania

Banks

Action We see negative drivers for India banks in the short term, although the sector looks

poised for strong long-term structural growth. Rising inflation, higher policy rates, low credit growth and uncertainty over incremental provisioning policy pose short-term risks. We expect banks to revise down loan growth guidance for FY10F. After slow growth in FY10F, a pick-up in credit growth could be a driver in FY11F on pent-up housing and infrastructure demand. Asset quality likely to remain benign.

Catalysts

We see a pick-up in fortnightly credit growth, listing guidelines for life insurance and clarity from the RBI on new provisioning norms as key catalysts.

Anchor themes SBI remains our top pick. We believe banks will underperform in the short term.

Specific finance companies, especially the power financiers, will likely outperform.

Loan growth is key Credit growth Credit growth in the system looks unusually weak in FY10F at 4.6% YTD, versus 9-10% YTD over the past seven years. We believe volatility in property prices and delays in financial closure of infrastructure projects are the culprits. We expect banks to revise down their credit growth numbers for the next three months. On our estimates, credit growth for FY10F could be as low as 13% y-y, versus our current forecast of 15% y-y, if we do not see a pick-up in the next several weeks. We expect FY11F to see strong credit growth of 18-19% y-y, driven by pent-up demand for housing loans and financial closure of infrastructure projects.

Reversal of the rate cycle We expect the RBI to hike CRR in its January 2010 credit policy. Given strong cashflows in the corporate sector and pent-up housing demand, we do not see a rising rate cycle hurting credit demand. Bank bond portfolios are better hedged than they used to be, with durations of 1.5-2.5 years for mark-to-market portfolios. This has reduced the sensitivity to rate hikes of bank bond portfolios. For every 50bps rise, we estimate a 5-7% drop in FY11F earnings for banks, compared with earlier sensitivity of 13-18% in FY04-07. Historical price performance suggests banks generally outperform in a rising rate cycle when accompanied by strong credit growth. The coincidence of high inflation, driven mainly by food inflation, weak credit growth, stiff competition in mortgages, rising rates and uncertain provisioning norms, will likely put pressure on bank stock price performance over the next few months. However, strong credit growth and higher lending rates in 2H FY11F should revive core earnings in FY11F, in our opinion.

Proposed provisioning norms: a possible dampener The RBI, in its October policy, proposed a minimum provisioning cover of 70% for banks effective September 2010. Banks are currently mandated to provide according to the age of the bad loan — 10-15% provisioning in the first year. The new guidelines imply a sharp rise in credit costs and pressure on near-term ROE. While this is negative, bank stocks have not reacted negatively as most investors seem to believe that implementation of the guidelines in their current form is

Stocks for action SBI is our preferred sector pick. Improving NIMs and a pick-up in loan growth are key catalysts.


Pricetarget(INR)

Axis (AXSB IN) BUY 990 1,185ICICI (ICICBC IN) BUY 875 910PNB (PNB IN) NEUTRAL 911 960SBI (SBIN IN) BUY 2,215 2,590*

* PT under review; Prices as of 24 December, 2009

Analysts Mahrukh Adajania +91 22 4037 4157 [email protected] Sreekanth Akula (Associate) +91 22 4053 3685 [email protected]

NEUTRAL



Strategy | India Mahrukh Adajania


unlikely. Banks are already in discussion with the RBI and we expect the RBI to phase out the provisioning guidelines.

Capital requirements Most large Indian banks appear to have adequate capital to support growth for the next year and a half. Among the large banks, we expect SBI to raise fresh capital in the next 12-18 months.

Unlocking value through life insurance Over the next 12-18 months, we look for ICICI Bank, Reliance Capital and HDFC to list their life insurance companies, which should be positive for these stocks.

Major bank reforms unlikely; no M&A among state banks We do not see any major sector reform for banks. The government seems less than keen to bring down its stake in state banks from the current 51% or to relax the FII limit for state banks. Recently, there have been fresh reports of possible M&A activity among state banks (eg, “India finmin: state banks have to decide on mergers”, Reuters, 7 December 2009). However, this looks unlikely given protests from bank unions, as well as overlapping branch networks. The government, however, may align the minimum government stake in SBI to that of the other state banks – ie, bringing down the minimum government stake in SBI from 55% to 51%.

Exhibit 51. India: incremental loan/deposit ratio (%) Nov (% y-y) Apr-Nov Apr-Sep Apr-Jun Jan-MarFY03 69.4 62.5 56.0 53.3 109.5FY04 55.7 23.6 4.7 (48.9) 74.2FY05 112.3 195.9 100.2 23.4 100.6FY06 98.1 103.7 87.0 38.7 106.3FY07 90.7 72.5 68.8 27.8 77.8FY08 66.0 46.0 37.8 (37.1) 99.0FY09 93.7 86.8 77.6 76.3 52.5FY10 39.9 36.2 35.6 5.4 NA Source: RBI

Exhibit 52. India banks: valuation comparison Axis BOI HDFC HDFC Bank ICICI PNB SBI Union BankTicker AXSB IN BOI IN HDFC IN HDFCB IN ICICIBC IN PNB IN SBIN IN UNBK INPrice (INR) 937 363 2,609 1,693 823 891 2,153 263Rating BUY REDUCE REDUCE NEUTRAL BUY NEUTRAL BUY NEUTRALP/E core business (x) FY08 31.3 9.5 24.7 37.7 17.2 13.7 20.0 9.6FY09 18.5 6.4 26.4 32.1 19.0 9.1 14.9 7.7FY10F 15.0 9.6 23.3 26.5 16.6 8.4 13.4 7.1FY11F 12.0 7.2 20.2 20.3 13.8 7.1 11.4 5.9P/BV core business (x) FY08 3.9 2.2 12.3 5.2 1.7 2.6 1.9 2.3FY09 3.4 1.8 9.7 4.8 1.7 2.1 1.7 1.8FY10F 2.3 1.6 5.6 3.6 1.6 1.8 1.5 1.5FY11F 2.0 1.3 4.9 3.2 1.5 1.5 1.4 1.3P/adjusted BV core business (x) FY08 3.8 2.5 12.3 5.2 1.7 3.2 2.2 3.2FY09 3.3 1.9 9.7 4.8 1.7 2.5 1.9 2.4FY10F 2.2 1.7 5.6 3.6 1.6 2.0 1.7 1.9FY11F 2.0 1.4 4.8 3.2 1.5 1.6 1.5 1.5 Note: pricing as of 24 December 2009

Source: Company data, Nomura estimates

Strategy | India Jamil Ansari


Building materials

Action We expect 2010 to be the most painful year in the current downcycle for India’s

cement sector. In our opinion, the demand-supply mismatch will be most severe in 2010, as incremental demand could fall far short of incremental new capacity added. We expect operating rates to hit their lowest level of the past 10 years.

Catalysts The commissioning of significant amounts of new capacity in mid-2010F and a rise

in input costs for elements such as coal could be key catalysts.

Anchor themes

The outlook for profitability in 2010 appears bleak but valuations for most of the companies in the sector do not reflect this, in our view. Stocks are at mid-cycle EV/tonne valuations even though a severe downcycle in 2010-11F seems likely.

A tough year ahead Demand-supply mismatch expected in 2010F We expect the cement sector in India to witness a substantial demand-supply mismatch in 2010 as the new capacity additions are commissioned. We believe the situation will be particularly bad after April when a large amount of the capacity will come online.

Significant new capacity due to be added in 2010

Exhibit 53. Cement capacity additions

7

12

2

31

20

42

29

17

4 5

0

5

10

15

20

25

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35

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45

FY05 FY06 FY07 FY08 FY09 FY10F FY11F FY12F FY13F FY14F

7

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17

4 5

0

5

10

15

20

25

30

35

40

45

FY05 FY06 FY07 FY08 FY09 FY10F FY11F FY12F FY13F FY14F Source: Crisil, Nomura estimates

Demand is steady but not strong enough to absorb new capacity Cement demand continues to be steady across most parts of the country, except for some regions in southern India, according to the Cement Manufacturers’ Association. We expect overall cement demand to grow by 9% in FY10F. In FY11F, we expect cement demand to continue to be robust due to heightened activity in the infrastructure development area. However, we think this level of growth is not sufficient to absorb all the new capacity and operating rates will decline to their lowest levels in at least a decade in 2010F.

Analyst Jamil Ansari +91 22 4037 4192 [email protected]

Stocks for action We have a REDUCE rating on both stocks in the sector. We are particularly negative on Ambuja Cement and ACC due to high valuation. Ambuja Cement is our topREDUCE.

BEARISH


Price target(INR)

Ambuja Cement (ACEM IN)

REDUCE 99.45 67

ACC (ACC IN) REDUCE 859.7 609





Prices — the big fall is yet to come Cement prices have declined in recent months, though the fall has been patchy and prices in most regions have fallen markedly. Even though the price correction has been as severe as -35% in states like Andhra Pradesh, the average all-India price is down by less than 10% from the recent peak. We believe with the bulk of capacity lined up to be commissioned in mid-2010, cement prices will continue to be under pressure and fall significantly.

Exhibit 54. Cement prices: all-India average

0

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96

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09

(INR/bag)

Source: CMA, Nomura Research

Profitability outlook bleak; valuations not reflecting this With the outlook for cement prices remaining bleak and signs of input cost pressures returning (coal costs specifically), we expect profitability in the cement sector to decline substantially in 2010F. We expect profitability per tonne (EBITDA/tonne) for most players to decline by 20-30% y-y in 2010F. Players that concentrate on southern India may be hit hardest. Valuations across the sector still look high, with most companies at mid-cycle EV/tonne valuation.

Maintain Bearish stance on the sector We expect 2010 to be a challenging year for the cement sector, with the sector likely to reel under the dual pressure of lower cement prices and higher costs. Valuations are still high and we foresee a correction. Given this scenario, we maintain a Bearish outlook. Our top REDUCE call is Ambuja Cement.

Price correction has been limited to only a few regions in the South

Dual pressure likely in 2010: lower cement prices and higher costs

We expect a 20-30% decline in EBITDA / tonne in 2010

Strategy | India Manish Jain


Consumer

Action We believe that investors in India should look to shift from mid-cap consumer

companies that have had a fairly decent run in the past few months to large-cap names. Our top pick in the consumer sector is ITC, where we see very strong tailwinds in the core cigarettes business and attractive valuations.

Catalysts A steady demand outlook for the urban markets and acceleration in the rural

markets are likely to be key catalysts in the near to medium term.

Anchor themes

We believe that the growth outlook remains robust on sustained demand pull from the rural markets. Consumer companies have increased focus on smaller-sized packs, as they look to play on consumer aspirations in these markets.

Demand outlook remains steady Growth outlook remains strong… Despite all the economic turbulence witnessed in the past few months, growth has remained strong in the Indian consumer sector across all major segments, such as beverages, alcohol, tobacco and personal products. The overall sector has registered steady growth of 16-17% pa over the past three years in value terms, driven by accelerating rural demand.

While growth has remained strong, there has been apprehension in the market over potential down-trading by consumers, given high food inflation. However, we have yet to witness any early signs of consumers cutting back on consumption, either in terms of quantity or quality.

Over the next couple of years, we expect the demand outlook to remain steady, with the current growth trajectory maintained on the back of steady demand from both the rural and urban markets.

…driven by robust demand in rural markets Growth for consumer products in India over the past couple of years has been driven by a marked acceleration in rural demand. Rural incomes have seen a boost from: 1) a steady 10-25% increase in minimum support prices (MSPs); 2) four consecutive years of positive output growth; and 3) union government programmes, such as the National Rural Employment Guarantee Act. We see no let-up in rural demand in the coming months.

But margins may come under pressure We think one of the key highlights for FY10F is margin expansion to all-time highs at most consumer companies in India. But we believe that margins will incrementally come under pressure, given: 1) a steady increase in input prices; and 2) an increase in advertising spend in response to rising competition.

ITC is our top consumer pick We select ITC as our top pick in the consumer space. We are also bullish on Asian Paints (APNT IN, INR1,756.7, BUY) and Tata Tea (TT IN, INR949.95, BUY).

Analyst Manish Jain +91 22 4037 4186 [email protected]

Stocks for action Our top sector pick is ITC, where we see strong tailwinds for its core business. Our top sector REDUCE is Colgate-Palmolive, which we believe will face growing competition in the near term.

BULLISH


Price target(INR)

ITC Ltd (ITC IN) BUY 256 309Colgate-Palmolive (CLGT IN) REDUCE 663 600Prices as of 24 December 2009


Strategy | India Manish Jain


Exhibit 55. India consumer sector: sales growth remains strong

3.7

(1.0)

3.0

8.0

10.7

16.5 17.0 17.5

7.0

(2.5)(5)

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FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09

(%)

z


Exhibit 56. India: steady agri output growth

(2.6)

6.3

2.7

(0.3)

6.3

(7.2)

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(0.1)

5.93.8 4.6

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Exhibit 57. India: minimum support prices

400500600700800900

1,0001,1001,2001,300

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-03

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-04

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-06

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Paddy Wheat Jute Jowar(INR/quintal)

Source: Ministry of Agriculture, Nomura research

Exhibit 58. India: domestic polymer prices

20

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-01

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(INR/kg)


Exhibit 59. India: domestic LAB prices

40,00050,00060,00070,00080,00090,000

100,000110,000120,000130,000

May

-02

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(INR/te)


Strategy | India Amar Kedia


Electrical equipment

Action While a pick-up in industrial activity is imminent, near-term pain for T&D equipment

manufacturers (ABB) will be a key overhang, while competition pressure and margin risks will likely play out in the generation equipment space (BHEL). Niche segments such as BOP, captive and back-up power offer better opportunities (Cummins India and Thermax), in our view.

Catalysts Steady earnings disappointment vs Street expectations and delay in corporate

capex revival may drive down the stock prices of BHEL, ABB and TMX.

Anchor themes

We believe India’s power equipment sector promises a huge opportunity unfolding over the coming years. However, rising competition will hurt margins and the market shares of existing leaders. In contrast, we see new opportunities in hitherto under-penetrated segments such as BOP and captive/back-up power equipment.

Waiting for capex revival Opportunity in the power equipment sector We believe the Indian electrical equipment sector is poised to benefit from a strong pipeline of potential order inflows in the power sector, under the Eleventh and Twelfth plans. Of the planned addition in the Eleventh Plan, very little has actually materialised, which leaves a wide gap to be covered over the remaining three years. Also, in order to be able to meet the full target of the Twelfth Plan (initial estimates: 100,000MW), ordering activity has to commence now. Typically, generation equipment orders precede T&D orders and, thus, even as BHEL is now amid the best order-intake cycle in its lifetime, T&D equipment manufacturers are still reeling under recession woes.

Growth and margin concerns for BTG manufacturers … BHEL is already benefiting from a historically high book-to-bill ratio, which provides strong visibility on near-term growth; however, we are concerned about market share loss and margin risk due to growing competition in the sector. Several new players, including L&T, are now eyeing the market, and there is the threat of Chinese and Korean imports; both will likely exert pressure on margins.

… while T&D equipment orders suffer lack of near-term visibility Even as the long-term opportunity appears robust, near-term order inflow for the sector has been a concern. Key players such as ABB India that have more exposure to industrial capex are the ones affected the most. With little visibility on a pick-up in the commodity cycle currently, we believe industrial capex will still take a couple of quarters to pick up. Meanwhile, stocks in the space have run up on the back of expectations of a strong recovery and are unlikely to offer value in the near term, in our view.

Niche segments offer better value We like companies in niche segments such as Balance of Plants (BOP), captive power and back-up power, which offer better value compared with their larger counterparts. We prefer Cummins India in this space – a strong candidate for a recovery play in India and the export markets. We also like Thermax, a dominant player in the captive power space with a diversified presence in BOP and environment-related products; it is also diversifying into the utility boiler space.

Analyst Amar Kedia +91 22 4037 4182 [email protected]

Rating summary

Stock Price(INR)

Pricetarget(INR) Rating

BHEL (BHEL IN) 2,368.00 1,850 REDUCEABB Ltd (ABB IN) 771.00 535 REDUCECummins India (KKC IN)

405.50 450 BUY

Thermax Ltd (TMX IN)

592.55 515 NEUTRAL


Valuation summary

Stock FY10F P/E

(x)FY11F P/E

(x()BHEL (BHEL IN) 28.9 23.5ABB Ltd (ABB IN) 26.3 21.0Cummins India (KKC IN) 20.0 15.9Thermax Ltd (TMX IN) 28.9 20.5


Stocks for action ABB and TMX have run up significantly over the past six months in anticipation of capex revival; we expect slowing growth and margin risks for BHEL.

BEARISH


Price target(INR)

BHEL REDUCE 2,368 1,850ABB Ltd REDUCE 771 535





Exhibit 60. Industrial activity on the rise

0

4

8

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16

Mar-96 Jul-98 Nov-00 Mar-03 Jul-05 Nov-07 Mar-10(2)

(1)

0

1

2IIP (3mma), lhsOECD CLI for India (6-month lead), rhs

(% m-m)(% y-y)IIP (3mma) (LHS)OECD CLI for India (6-month lead) (RHS)

Source: IPA, Nomura research

Exhibit 61. BHEL: order flows are peaking

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E

0.00.51.01.52.02.53.03.54.04.55.0

order infloworder book coverageOrder inflow (LHS)Order book coverage (RHS)

Source: BHEL, Nomura estimates

Exhibit 62. Thermax: benefitting from power orders

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(%)

Source: Thermax, Nomura research

Exhibit 63. ABB: segmental revenue still declining …

(40)

(20)

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-07

Power systemsPower productsProcess automationAutomation products

(%)

Source: ABB India, Nomura research

Exhibit 64. … thus pressurising margins

2 4 6 8 10 12 14 16 18 20

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Power systems Power productsProcess automation Automation products

(%)

Source: ABB India, Nomura research

Strategy | India Saion Mukherjee


Infrastructure and construction

Action We expect construction companies to benefit from a pick-up in order inflows in the

infrastructure segment. An increasing backlog and pick-up in execution should result in acceleration in growth. We have a BUY on Nagarjuna, HCC, IVRCL and L&T. We prefer construction companies over road developers, particularly at current valuations, and hence we rate IRB REDUCE.

Catalysts Announcement of large orders, quarterly results exhibiting pick-up in execution.

Anchor themes

We expect a pick-up in order inflow, particularly in power and roads. Corporate capex-related inflows are also expected to record y-y growth in FY11. We expect execution rates to improve. Unlocking value for subsidiaries through stake sales or listings may also emerge as a theme.

Key trends for 2010 Pick-up in order inflows Order inflows have slowed down over the past three-four quarters because of the financial crisis and general elections in the country. However, there is a pick-up in order activity as projects achieve financial closure and the government takes initiatives to expedite infrastructure investments. Among the infrastructure segments, roads and power will be the key growth drivers for construction companies. In the power segment we expect increased inflows from across chain-power equipment, BOP and transmission. Roads award activity is expected to witness a steep jump in award activity under the National Highway Development Program as more than 10,000km are planned for award in FY10F and FY11F. With the rise in commodity prices on an increase in demand, we expect a pick-up in corporate capex as well.

Exhibit 65. Expected pick-up in award activity in road sector

310 89

5

3,47

6

671

342 1,

305

4,74

0

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47

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391 13

18 2351

636 16

14 2148

754

0

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FY10

E

FY11

E

Length (Km)Contracts awarded (Km) Contracts completed (Km)

Source: NHAI, Report on “Private Participation in Infrastructure” by Committee on Infrastructure, June 2009

Analysts Saion Mukherjee +91 22 4037 4184 [email protected] Harish Venkateswaran (Associate) +91 22 4037 4028 [email protected]

Stocks for action Among the stocks in our coverage universe we rate Nagarjuna Construction our top pick.

NEUTRAL


Price target(INR)

L&T (LT IN) BUY 1,682 1,867IVRCL (IVRC IN) BUY 357 451Nagarjuna (NJCC IN) BUY 165.85 197HCC (HCC IN) BUY 151 157*Punj Lloyd (PUNJ IN) NEUTRAL 202 228IRB Infra (IRB IN) REDUCE 242 193

* PT under review; Prices as of 24 December 2009





Execution rate set to rise Execution slowed following the financial crisis. Companies were cautious on managing receivables and working capital. With improvement in liquidity and likely improvement in the government’s fiscal position, we expect the execution rate to rise again in 2010.

Unlocking of value for infrastructure subsidiaries We expect the construction companies under our coverage to continue to focus on infrastructure development. Most of the companies are likely to participate in BOT road projects. Some, like NJCC, have also added large power projects in their portfolio. This implies there can be additional funding requirements over and above funds raised so far. We expect companies to explore opportunities to list infrastructure development subsidiaries and sell stakes in projects to mobilise funds. Such actions could potentially lead to an unlocking of value for infrastructure projects. We do not expect any significant rise in investment in real estate subsidiaries. The volume increase in real estate has been limited only to certain cities such as Mumbai and Delhi and, with a potential rise in interest rates in 2010, demand is unlikely to revive substantially. Demand for commercial real estate is still weak and there are no signs of revival yet.

Attractive valuation particularly for mid-tier construction companies Adjusted for subsidiary valuations, we find mid-tier construction companies are trading at 9-11x FY11F. These are attractive valuations, in our opinion, given the expected rise in order inflows and backlog ratio. We expect the backlog ratio to remain at 3x; hence, companies can deliver 20%-plus growth over the next two years. NJCC is our top pick in the sector. L&T is relatively expensive at 22x FY11F P/E, which is in line with the historical range. We expect significant positive surprises on order inflows and execution in FY11 and, therefore, believe current valuations can hold. We maintain a BUY rating on L&T.

Strategy | India Srikanth Vadlamani


Insurance

Action We continue to advocate a very conservative stance in valuing insurance

companies in India, as we believe that they continue to face headwinds from lukewarm growth, very low persistency, operating cost overruns and regulatory risk.

Catalysts Enhanced disclosure from companies should bring operating metrics into focus.

Anchor themes

We believe that the insurance industry is in the midst of a mid-term slowdown. We expect downward revision of profitability estimates, since companies may be unable to realise cost efficiencies. We also expect companies to take on more lapsation risk to make products more attractive to customers.

Unexciting outlook Growth: lukewarm despite revival in equity markets New premium sales growth has not picked up significantly, in spite of the equity markets seeing a strong up-tick over the past six months. This slack in sales growth is all the more noteworthy considering the positive base effect in play, with FY09 not seeing any growth. We believe that the lukewarm sales growth has been on account of three factors. First, penetration levels are no longer low. Second, we note that the downturn in the equity markets in FY09 was the first since the introduction of unit-linked products in India. Following this experience, we believe that customers will not be as enthusiastic as before in making multi-year commitments based on near-term stock market performance. The strong growth in single premium sales this year supports this view. Third, geographical expansion, which was a key growth driver during the boom years, is no longer present. Based on these three factors continuing into 2010F, we expect new premium sales growth for the private sector in FY11F of 13-15%.

Persistency: remains at alarming levels We highlight low persistency in the industry as our biggest concern in India’s insurance sector. Persistency levels had nose-dived in FY09, in line with the sharp slowdown in new premium sales. However, even before FY09, when the industry was clocking fast growth rates in new premium sales, persistency levels were well below acceptable levels. Importantly, data points up to 1H FY10 indicate that while persistency has improved from FY09 levels, it is only around pre-FY09 levels. We attribute the low persistency to mis-selling. We believe that there is significant regulatory risk on account of this low persistency, as the regulator may force companies to bear the lapsation risk.

Operating efficiency: management focus, but verdict still out Another key concern is about the ability of companies to achieve the operating cost efficiencies that they had built into their product pricing. With a rather dramatic change in the growth outlook since FY09, a significant mismatch has developed between the infrastructure that companies have built up and the sales that they are now able to generate. We note that companies had started focusing on cost efficiencies since the start of FY10. Indeed, the cost control being exhibited has been a positive surprise. However, some of the companies that had

Analyst Srikanth Vadlamani +65 6433 6957 [email protected]

Stocks for action We maintain REDUCE on RCFT, as we believe that its life insurance business faces the twin risks of higher operating costs and high lapsation.

BEARISH


Price target(INR)

Reliance Capital (RCFT IN)

REDUCE 851 834



Strategy | India Srikanth Vadlamani


expanded their distribution networks just before the onset of the downturn still face a significant challenge in terms of operating efficiency. We highlight Reliance Life and Max New York Life as two companies with exposure to this risk. A key valuation parameter for these companies in FY11F will be their ability to gain market share while maintaining costs, in our opinion.

Regulations: impact of this year’s changes to be seen in FY11F We flag several regulatory changes/proposals relating to the insurance industry, with most of them having negative implications for the sector. We expect the margin impact on account of the cap on ULIP to become apparent in FY11F. Enhanced and more periodic disclosures, which would start from 4Q FY10F, will be keenly awaited by investors. With these disclosures, we expect an increased investor focus on hitherto neglected operating metrics. Equally important, we expect clarity in FY11F on key regulatory issues affecting the industry. We note that the draft direct tax code has negative implications for the sector. Also, while the Swarup panel recommendation of scrapping the present commission structure may not go through, there will be increasing clamour to normalise insurance’s preferred status vis-à-vis other savings products. The only positive regulatory change that we expect in FY11F is a hike in the foreign ownership limit in insurance to 49%.

Valuations: market becoming increasingly circumspect; we concur We believe that the market is becoming increasingly circumspect of insurance company valuations. Of the three closest proxies to life insurance in the listed space, RCFT and BJFIN have significantly underperformed both the broader market and the banking index since June this year, returning -15% compared to a SENSEX return of 14% and a BANKEX return of 18%. Even MAX has performed just about in line with the market, returning 14%. RCFT’s underperformance is especially noteworthy, as management has said that it will be going in for a value-unlocking exercise soon, either through private placement or stock listing. We believe that investors are increasingly focusing on the rather dismal operating metrics, and not just on new premium sales growth. We concur with the market scepticism. We factor this into our valuations by assuming margins that are materially below what is being declared by the companies.

Reliance Capital. Using SOTP, we value RCFT at INR834/share. We value the life insurance business at 15x FY11F NBAP, asset management business at 4.5% FY11F AUM and RMoney at 14x FY11F earnings. The key upside risk to our valuation is if margins in the insurance business come in higher than we are forecasting.

Exhibit 66. Persistency ratios

0102030405060708090

100

FY06 FY07 FY08 FY09 1Q10 2Q10

ICICI Prudential Bajaj Allianz SBI life HDFC Standard

Reliance Life Kotak Max

(%)

Source: IRDA, company data, Nomura estimates

Several regulatory changes/proposals for the insurance industry, most having negative implications

We assume margins that are materially below what is being declared by the companies

Using SOTP, we value RCFT at INR834/share

Strategy | India Harmendra Gandhi


IT Services & Software

Action IT stocks have outperformed the Sensex by a wide margin on a YTD basis. We

maintain a Neutral stance on the sector as FY11F revenue growth is unlikely to top 20% and margin upside appears difficult to achieve going forward. Among tier-1 stocks we prefer TCS as we expect its near-term growth to be better than peers and among tier-2 stocks we prefer HCL Tech due to strong deal win momentum.

Catalysts A return of discretionary spending could boost earnings. The risk of a sharp

appreciation in the rupee remains a downside risk.

Anchor themes

Client IT budgets are not expected to increase dramatically and the combination of a higher offshore mix and lower pricing could restrain companies from achieving historic revenue growth rates.

On the recovery path Revenue growth steadily improving Volume growth for all companies has trended into positive territory as clients have become more open to spending, especially to improve business efficiency. There have been gains from vendor consolidation and one-off work related to M&A and compliance. BFSI and retail verticals have recovered well, while manufacturing and telecom still show signs of weakness. Meanwhile, companies have resumed hiring and net employee adds are now trending upward after declining over three quarters.

Margins have improved on a y-y basis; further upside difficult Compared to a year ago, most companies have improved margins by using a variety of options — significantly reducing hiring, increasing the offshore revenue mix and fixed price project mix. The weak rupee also aided margin improvement. Going forward, further improvement seems difficult as the appreciating rupee, wage inflation, and increase in hiring and onsite sales presence by companies will exert pressure on margins.

Stocks have run-up IT stocks have outperformed the Sensex by a wide margin on a YTD basis, especially tier-2 names. Currently, tier-1 stocks are trading at 21-23x and tier-2 12-16x one-year forward earnings. Our price targets imply one-year forward P/E valuations of 18-20x for tier-1 companies and 12-14x for tier-2 companies.

P/E de-rating risk due to rupee appreciation still looms P/E valuations of IT companies are highly sensitive to US dollar/Indian rupee rates and the premium to the Sensex could narrow if the rupee appreciates against the US dollar, as seen in the past.

Analysts Harmendra Gandhi +91 22 4037 4181 [email protected] Pinku Pappan +91 22 4037 4360 [email protected]

Stocks for action We maintain our BUY rating on HCL Tech, Patni and Tech Mahindra and NEUTRAL rating on Infosys, TCS and Wipro.

NEUTRAL


Price target(INR)

TCS (TCS IN) NEUTRAL 749 785HCL Tech (HCLT IN) BUY 375 397*Patni (PATNI IN) BUY 473 540Tech Mahindra (TECHM IN)

BUY 1,003 1,250

Infosys (INFO IN) NEUTRAL 2,592 2,600Wipro (WPRO IN) NEUTRAL 694 740* PT under review; Prices as of 24 December 2009



Strategy | India Harmendra Gandhi


Exhibit 67. Q-Q US$ revenue growth in +ve territory

(8.0)

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(4.0)

(2.0)

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2.0

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3Q FY09 4Q FY09 1Q FY10 2Q FY10

Infosys TCS Wipro(%)

Source: Company data, Nomura research

Exhibit 68. Net employee adds also trending upward

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Exhibit 69. EBITDA margins have improved y-y

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2Q FY09 3Q FY09 4Q FY09 1Q FY10 2Q FY10

Infosys TCS Wipro(%)


Exhibit 70. Valuation sensitivity to rupee appreciation

(40)

(20)

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Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-0836

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46Infosys premium (%) to Sensex P/E (LHS)US$/INR rate (RHS)


Exhibit 71. One-year forward P/E trend for Infosys, HCL Tech and the Sensex in the past three years

23.0

16.215.7

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Media

Action We expect advertising spending in the industry to bounce back in 2010F. At the

same time, consolidation within the industry may cap cost elements like staff and carriage costs. This combination should result in a better operating environment for the broadcasters, leading to improved sector profitability. We remain Bullish.

Catalysts We think strong recovery in advertising revenue growth and reasonable growth in

subscription income fuelled by direct to home (DTH) revenue growth are key catalysts for the sector in 2010F.

Anchor themes

Competitive intensity in the sector is showing signs of a revival, with the weaker players getting bought out by stronger names. Any significant change in the competitive landscape would prompt us to revisit our stance.

2010F — a year of recovery Advertising revenue growth expected to bounce back After a decline in advertising revenues in 2009, we expect growth in advertising revenues to return to positive territory in 2010F. In fact, due to a weak base, we expect the headline growth number to be strong for the industry. Most of the user industries (like consumer goods and automobiles) are witnessing better profitability compared with 2009, which could ensure that money is ploughed back by these businesses through investment in advertising. We expect the industry to record advertising revenue growth of more than 20% in 2010F.

Exhibit 72. Zee Entertainment: ad-revenue growth

(10)

(5)

0

5

10

15

20

25

30

35

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10F FY11F

(%)


DTH to ensure steady subscription revenue growth Robust growth in DTH subscriber additions should help broadcasters register reasonable growth in their subscription incomes. The 17mn subscriber-strong DTH industry is expected to add another 7-8mn subscribers in 2010F, which would translate into significant additional subscription income for the broadcasters in the form of DTH revenues. We expect DTH revenues at most of the large broadcasters to grow by more than 50% in 2010F; this should ensure decent growth in subscription income for these companies.

Analysts Jamil Ansari +91 22 4037 4192 [email protected] Prabhat Awasthi +91 22 4037 4180 [email protected]

Stocks for action Zee Entertainment is our top pick as we expect it to benefit from a recovery in ad-spending and recent restructuring.

BULLISH

Stock RatingPrice (INR)

Price target(INR)

Zee Entertainment (Z IN)

BUY 265.5 292

Sun TV (SUNTV IN)

BUY 336.25 355*

* PT under review; Prices as of 24 December 2009





Consolidation in the industry underway There are signs of consolidation in the Hindi general entertainment channel (GEC) space. In early December 2009, Turner International bought a 92% stake in NDTV Imagine (the number five player in the Hindi GEC arena), which was languishing with low viewership. There are expectations that the other channels that were launched in late 2007, and which have failed to garner significant viewership, are planning to cease operations as investors are no longer interested in sustaining respective losses. Though the closure of these channels may not be particularly positive for the leaders in terms of viewership gains, it eases pressure on certain cost items like employee expenses and carriage fees.

Competitive intensity might increase Sony Entertainment Television, which had been a distant number four player in the Hindi GEC market (gap of more than 100GRPs [gross rating points] from the number three player) has improved viewership in recent months, thereby closing the gap with the top three. Sony has stated that it plans to revamp programming in January 2010 with the inclusion of a number of shows from the “Yashraj Films” production house (a credible name in the Hindi movie space). We think these shows may help Sony to break into the top three, thereby increasing the competitive intensity in the Hindi GEC market. Also, with the change in ownership, NDTV Imagine might make another push towards making it to a top three slot. These moves indicate that competitive intensity in the Hindi genre space, which had eased in 2H09, might resurface in 2010F. We believe this is a worrying development for Hindi GEC broadcasters such as Zee Entertainment as profitability in broadcasting tends to be highly sensitive to competitive intensity due to high fixed costs.

Positive on the sector The media sector, which underperformed broader Indian markets significantly in the 18 months ending July 2009, fared relatively well in 2H09. Positive developments in the operating environment have led to these stocks to outperform other sectors in the past six months. We maintain our positive stance. We note that the profitability of most of the companies is highly sensitive to competitive intensity in the genre, which is increasing. Hence, we are slightly less positive on the sector now compared with six months ago, although our stance remains Bullish. Zee Entertainment is our top pick.

Weaker players getting bought out by stronger names

Moderately positive on the sector

Competition in the Hindi GEC space is increasing again



Metals

Action In an environment of higher raw material costs and increased steel prices, we

believe steel producers, vertically integrated into raw materials, are likely to benefit the most. Therefore, we see Indian steel companies as being the largest beneficiaries, as we expect limited cost increases owing to captive iron ore production.

Catalysts We expect inventory restocking in developed economies to begin in 1Q10, which

should result in higher steel prices. This, in our opinion, should act as the main catalyst for the sector.

Anchor themes

We believe Indian steel companies are well placed to enjoy the recovery in global steel prices, owing to captive iron ore and strong domestic demand. We expect 50% one-year returns for Tata Steel and 5.5% for SAIL.

Striking red hot Indian steel companies are in a sweet spot Our global steel team expects a strong recovery in steel prices. Consequently, we expect Indian steel prices to also improve significantly. Since the global price increase would be led by rising raw material prices, Indian steel makers would benefit significantly given their captive raw material advantage.

China remains the key steel demand driver… Our China economist believes that the investment boom in China will continue in 2010 and beyond, driven by the large number of projects announced by provincial governments. While the stimulus package has played its part, we believe the bigger thrust will come from fixed asset investments by projects that were stalled earlier due to concerns about an overheating economy.

…resulting in rising raw material prices With China producing more than 600mn tonnes of steel annually, the market for key raw materials such as iron ore and coking coal has remained firm. Incremental capacities in China are dependent on imported iron ore, resulting in spot iron ore prices increasing from close to US$60/tonne in early 2009 to US$100/tonne in November 2009. We expect iron ore contract prices to rise by nearly 30% in FY11, driven by heavy Chinese demand.

With increasing steel production, we believe even coking coal prices should rebound after a more than 50% contraction in FY10. We expect coking coal contract prices to increase to US$180/tonne in FY11 from US$129 in FY10.

Threat of cheap Chinese exports overdone We believe concerns about overcapacity in China are overdone and that strong steel demand growth should be able to absorb the increased production in the country. At the same time, we expect the marginal cost of production for Chinese mills to be high (at around US$550/tonne) as shown above. Therefore, we see little risks to global steel prices on account of cheap exports from China.

Analysts Prabhat Awasthi +91 22 4037 4180 [email protected] Alok Kumar Nemani (Associate) +91 22 4037 4193 [email protected]

Stocks for action We recommend BUY on Tata Steel and SAIL. However, Tata Steel is our top pick as 1) it is a much better volume play; 2) its raw material costs are expected to decline owing to captive coal; and 3) Corus is expected to turn around.

BULLISH


Price target(INR)

TATA Steel BUY 615.6 926SAIL BUY 237 250Prices as of 24 December 2009.





We expect steel prices to remain strong in FY11 With the combined impact of higher raw material costs (resulting in high cost of production) and strong demand from China, we believe steel prices should remain at US$650-700/tonne for HR coils in FY11-12. We have built in domestic prices corresponding to US$650/tonne and US$700/tonne for FOB prices.

Exhibit 73. Global steel production has picked up over the past six months

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May-08

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USA EU CIS China World

Source: World Steel Organization

Exhibit 74. Domestic steel demand vs fixed asset investments

(5)

0

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20

FY05 FY06 FY07 FY08 FY09F FY10F FY11F FY12F

FAI growth Steel demand growth(%)

Source: Ministry of Steel, Nomura estimates

Exhibit 75. India has turned into a net importer of steel since 2004

0

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FY04 FY05 FY06 FY07 FY08 FY09(4,000)

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3,000Capacity (LHS) Crude steel production (LHS)Consumption (LHS) Net imports (RHS)

(Tonnes) (Tonnes)

Source: Ministry of Steel, Nomura research

We believe steel prices should remain at US$650-700/tonne for HR coils in FY11-12

Strategy | India Anil Sharma


Oil & Gas / Chemicals

Action 2010F will be a year of consolidation and will see the ramp-up of many projects that

commenced operations in 2009. KG-D6 production will reach its initial peak; the Mangala field in Cairn’s Rajasthan block will also reach its peak; Reliance’s new refinery will see the first full year of operations. The year will also see a few new starts-ups, chiefly BPCL’s Bina Refinery and GAIL’s HVJ upgradation projects.

Catalysts Recommendations of the Expert Group headed by Dr Kirit S Parikh (likely by end-

January) would be a key event, with implications for PSU oil companies. Progress on gas litigation and the LyondellBasell deal would be key issues for RIL.

Anchor themes

There are growing expectations that the Expert Group will provide a dynamic solution to long-pending critical issues such as pricing & subsidies on petro fuels. An early end to gas litigation would draw attention back to large growth at RIL.

Raising the bar 2010F – year of consolidation and growth in domestic production With several new projects commissioned in 2009, we believe 2010F will witness large production increases. We expect gas production to increase by 47% to 132mmscmd in FY10F and 31% in FY11F to 173mmscmd. Oil production will also rise by 5% in FY10F and 17% in FY11F. Similarly, we expect new refining capacities of around 53mmtpa to come on line by FY12F, which should further widen the existing gap between refining capacity and product demand.

High expectations from the Kirit Parikh report There are growing expectations from the Expert Group, and the industry expects the Group will provide a much more dynamic report. More than the report itself, we believe the key will be the government’s willingness to implement suggested changes, introduce much-needed pricing reforms and remove ad-hoc/non-transparency issues in the subsidy-sharing mechanism.

Gas litigation and possible LyondellBasell acquisition With the Supreme Court hearings continuing for a couple of months, we continue to believe that the RIL-RNRL gas litigation has reached the end-stage, and the that the Supreme Court ruling could be announced in early 2010F. Some clarity should also emerge on Reliance’s plans to acquire LyondellBasell.

GAIL is our top pick, BPCL our top REDUCE GAIL remains our top pick in the Indian oil and gas space. The company’s gas transmission volumes have increased sharply — by ~40mmscmd over the past nine months, compared with only ~23mmscmd over the previous nine years. The stock has also outperformed the SENSEX by 14%/29%/29% over the past three/six/twelve months. Apart from growth in gas volumes, its petrochemicals business remains resilient. Incremental news flow is likely to be positive; GAIL is likely to be given marketing margins for administered pricing mechanism (APM) gas, and its subsidy burden could also ease. We estimate GAIL’s earnings will grow by a sharp 32% in FY11F, and expect the share of utility type earnings from its transmission business to increase to 68% in FY10F/FY11F (vs 51% in FY09). With an increased share of utility earnings, GAIL is likely to be re-rated as a utility play, in our view.

Analysts Anil Sharma +91 22 4037 4338 [email protected] Ravi Kumar Adukia (Associate) +91 22 4037 4232 [email protected]

Stocks for action GAIL is our top pick in the Indian oil and gas sector. A key beneficiary of increased gas volume, GAIL is a re-rating story, in our view.

NEUTRAL


Price target(INR)

GAIL BUY 420 500Prices as of 24 December 2009.



Strategy | India Anil Sharma


Exhibit 76. India: at current retail prices, large under-recoveries are expected to continue FY07 FY08 FY09 FY10F FY11F FY12FBrent price (US$/bbl) 64.4 82.3 84.8 69.4 72.0 75.0

Exchange rate (INR/US$) 45.3 40.2 46.0 47.2 45.0 45.0

Gross U/R per unit

Petrol (INR/ltr) 1.6 5.2 0.1 3.1 2.2 3.3

Diesel (INR/ltr) 3.9 6.2 6.2 1.2 1.2 2.0

PDS Kerosene (INR/ltr) 16 17 23 16 17 18

Domestic LPG (INR/cyl) 169 220 247 196 209 231

Gross under-recoveries (INRbn)

Petrol 20 73 52 46 38 60

Diesel 188 353 523 59 77 141

PDS Kerosene 179 191 282 175 196 206

Domestic LPG 107 156 176 130 144 163

Total 494 773 1033 411 455 571

Source: Petroleum Planning & Analysis Cell, Nomura estimates

Exhibit 77. India: per unit under-recoveries and underlying Brent prices at current retail prices

Product Unit

Retail prices (INR)

Under-recoveries

(INR)

UnderlyingBrent

(US$/bbl)MS per litre 44.5 2.6 67.0 Diesel per litre 32.9 2.3 68.0 PDS Kerosene per litre 9.1 16.8 18.0 Domestic LPG per cylinder 321.3 304.0 35.0 Overall 58.5

Note: Based on prices and exchange rates as of the first fortnight of December 2009


Exhibit 78. India oil production: Cairn’s Rajasthan block and RIL’s KG-D6 contribute to large increase

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Exhibit 79. India gas production: RIL’s KG-D6 to double gas production by FY11

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Exhibit 80. India’s refining capacity and consumption — product exports likely to increase

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Refining capacity Product demand(MMT)


Exhibit 81. India: key new projects in 2010

Project Owner Capex

(INRbn) TimelineGas transmission pipelines DVPL GREP upgradation GAIL - Dahej- Vijaipur P has e II (48") 44 Dec-10 - Vijaipur - Dadri P pipeline (48") 58 Dec 2009* Dadri - Bawana - Nangal GAIL 23 Oct-10 Bina Refinery BPCL 104 Apr-10 Naphtha Cracker (800kta) IOCL 144 May-10

* October 2010 (With Compressor)




Pharmaceuticals

Action Our pharma coverage universe has re-rated y-t-d from 14.4x to 18.9x. Despite this

re-rating, we remain Bullish on the sector, given comfortable relative valuations and improved fundamentals. We recommend a stock-specific approach given the dominance of company-specific issues. Our top BUY in the sector is Dr. Reddy’s.

Catalysts Visibility on product-specific upside in the US, with an increase in patent expiries

and value-accretive tie-ups with global pharma, particularly in innovation R&D.

Anchor themes

Improved fundamentals are based on: 1) intent to improve profitability; 2) interest in Indian companies on the global stage; 3) renewed focus on the domestic market; 4)expanding opportunities in the US; 5) increased traction in CRAMS and end of inventory de-stocking; and 6) potential upside from innovation R&D.

Key trends for 2010F Intent to improve profitability There is a clear intent shown by many Indian pharma companies to improve profitability, as opposed to the aggressive revenue growth strategy employed previously. This is reflected in consolidation of businesses and cut-backs in investments toward acquiring assets and innovation R&D.

Growing interest in Indian pharma companies on global stage Partnerships have been struck with global players across the pharmaceutical chain. We believe such strategic tie-ups can lead to substantial synergy benefits.

Renewed focus on the domestic market Some of the larger Indian pharma companies had lost their focus on the domestic market as they expanded elsewhere. However, this trend has been reversed over the past year. We note that the Indian pharma market offers relatively steady secular growth rates and, more importantly, is a highly profitable market.

Exhibit 82. Clear intent to improve profitability


Company Steps taken to improve profitability Dr. Reddy's Exited 31 emerging markets as part of its consolidation strategy. Signed deal with

GSK to tap emerging market opportunities, which should be less risky and more profitable. Significant cut-backs witnessed in innovation R&D spend.

Glenmark Sharp cut-backs in acquisition-led growth (primarily in emerging markets) as management focuses on improving cashflows and lowering leverage. Out-licensing deals help limit innovation R&D spend.

Lupin Continues to expand geographically. However, it has not followed its larger peers in making large acquisitions. Acquisitions have been opportunistic (eg, to gain a foothold in a new market) and the targets have been relatively small.

Piramal Healthcare The last big-ticket acquisitions were made in 2005-06 (custom manufacturing facilities in UK and Canada). No further plans for inorganic growth in custom manufacturing. Divested innovation R&D venture into Piramal Life Sciences.

Ranbaxy Focus on improving profitability in Western Europe, even at the cost of top-line growth.

Sun Pharma Divested innovation R&D venture into a separate company, SPARC. Management has been historically conservative and shied away from aggressive inorganic growth strategy.

Analyst Saion Mukherjee +91 22 4037 4184 [email protected]

Stocks for action Among the stocks in our coverage universe, Dr. Reddy’s is our top pick.

BULLISH


Price target(INR)

Dr. Reddy’s (DRRD IN)

BUY 1,186 1,329

Ranbaxy (RBXY IN) REDUCE 520 261Prices as of 24 December 2009




Expanding opportunities in the US We believe the US market outlook has improved, with unfolding differentiated pipelines, product-specific opportunities, and a significant increase in patent expiries.

Exhibit 83. Quantum jump in patent expiries expected over 2010-12F

Patent expiries by value

1012141618202224262830

2008 2009 2010 2011 2012

(US$ bn)

Source: Glenmark

Custom manufacturing — fundamentals in place The current slowdown in custom manufacturing is temporary, in our view, as we believe that the underlying fundamentals remain strong. In fact, we are of the view that the worst is behind us as we do not expect further inventory de-stocking by big pharma companies.

Potential upside from innovation R&D We believe there is little value attributed to innovation R&D pipelines currently in stock prices. As companies continue to invest in innovation R&D, we believe there is potential for value creation, either through strategic tie-ups or out-licensing deals, in the next two years.

Strategy | India Aatash Shah


Property

Action We believe that investors should keep their faith in developers with a focus on

growing volumes rather than increasing prices. Developers with a good mix of residential and commercial developments and with repaired balance sheets should outperform, in our view. Our top pick is Unitech, trading at a 27% discount to NAV.

Catalysts We think improvement in residential volumes from here, accompanied by

increasing office leasing and visible execution, could act as a catalyst.

Anchor themes

Residential volume revival has been a mirage so far, with a limited and localised recovery. We believe that CY10/FY11F will be crucial in deciding whether the Indian property sector can move closer to its volume potential through rational pricing. A recovery in commercial space leasing is likely in CY10F.

Not yet out of the woods Residential revival yet to occur despite perceptions Contrary to popular perception, the volume recovery in the residential sector has been limited and localised in nature. Only the areas of Mumbai and National Capital Region (NCR) have shown a semblance of recovery, while other cities such as Bangalore and Chennai are struggling to pick themselves out of the slowdown. Hyderabad and Kolkata are moving from bad to worse in terms of residential transaction volumes. This makes CY10/FY11F one of the most crucial years in deciding whether the Indian property sector can move from a high-priced/low-volume model to a more desirable affordably-priced/high-volume model. We believe that the latter model is more desirable, given the potential for substantial volume increases in India with a small cut in pricing, as witnessed from March to May 2009.

If volumes do not recover from here, we expect that NAVs of developers with rapid build-up in volumes are likely to witness downgrades.

Exhibit 84. Mumbai: good upturn in residential property transactions

Mumbai

0123456789

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(mn sqft)

44505662687480869298

(mn sqft)

Total absorption (LHS) Unsold stock (RHS)

Source: Propequity, Nomura research

Analyst Aatash Shah +91 22 4037 4194 [email protected]

Stocks for action Our picks are Unitech and Indiabulls Real Estate, which are trading below NAV. Our top REDUCE is DLF, which is trading 12% above NAV.

BULLISH


Price target(INR)

Unitech (UT IN) BUY 82 112Indiabulls Real Estate (IBREL IN) BUY 216.5 339DLF Ltd (DLFU IN) REDUCE 371 330Prices as of 24 December 2009


Strategy | India Aatash Shah


Exhibit 85. Bangalore: poor recovery in residential property transactions

Bangalore

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Total absorption (LHS) Unsold stock (RHS)

Source: Propequity, Nomura research

While demand is weak, inventory levels are down substantially, offering support for prices at current levels. Given an increasing possibility of policy rate hikes in India on rising inflation, we think that developers will have to keep prices subdued to achieve volumes. Hence, we look for price consolidation at least over the next six months.

Office space recovery on the way Demand for office space has been very weak in the past year, while supply has been relentless. This has resulted in vacancies increasing to 12% in Mumbai and NCR, and to 22-25% in Chennai, Hyderabad and Pune. This has seen a rental correction of about 25-35% in most cities. Only in the past quarter has there been a ray of light in terms of leasing picking up pace, with rentals starting to consolidate. As per our channel checks, Unitech and DLF have been successful in leasing more than 1mn sqft of space each, while Brigade Developers is in talks with Oracle for the sale of its 1.1mn sqft office development in Bangalore. Ishaan Plc leased out 0.6mn sqft of space in Hyderabad in 3Q CY09. We expect CY10/FY11F to be a story of improving leasing demand in the office space as the IT/ITeS industry recovers and hires, though the significant oversupply will likely keep rentals at current levels.

Stock picks Amid a faltering residential revival and a nascent commercial space recovery, we believe that investors should keep their faith in developers with a focus on growing volumes over increasing prices. Also, we think that developers with a good mix of residential and commercial developments should outperform as both segments are likely to improve from here. Again, developers that have managed to strengthen their balance sheets by raising capital through equity or selling land and reducing debt in FY10 should be much more comfortable going into CY10/FY11F. In this sense, our top pick is Unitech, which is clearly focused on increasing residential volumes (11.5mn sq ft sold between March and October 2009) and has a reasonable mix of residential and commercial developments, with a much stronger balance sheet to boot (raised almost US$1bn in equity). The company also trades at an attractive 27% discount to NAV, on our estimate.

On the flip side, our top REDUCE is DLF, where valuation appears to be stretched, at a 12% premium to NAV. Given its status as the largest pan-India property developer, we think the company has failed to lead the residential revival, relying solely on sales from its Capital Greens project in Delhi to shore up revenues. The restructuring of DLF Assets through a merger with DLF may help to monetise its commercial assets through a REIT listing in CY10F, but this is unlikely to affect valuations, on our reading.

Strategy | India Sachin Gupta, CFA


Telecoms

Action We see little respite from price-wars in 1H; in fact, 3G and MNP will create more

volatility. Neither do we see any new-comers packing up or consolidating anytime soon. Large established players may look to consolidate, but regulations are unclear and so are various permutations. 2H should see greater stability on competition as the market moves from initial promotions to sustainable plans.

Catalysts Price-stability, 3G and MNP decisions and consolidation.

Anchor themes

The subscriber growth cycle is by no means over; however, the returns on an incremental subscriber are uncertain.

A tale of two halves 1H — from voice to SMS to data Virtually everyone, from operators to regulators, expects the market to remain uncertain and volatile for the next three to six months. Price wars continue, on calling, roaming rates or SMS, which provides little certainty on APRU trends. Resolution on 3G and MNP will at least remove some uncertainty but the subsequent three to six months could see greater competition and churn. Further charges on spectrum beyond 6.2Mhz also seem likely, and a change in M&A regulations is not imminent. The major disconnect still appears to be between what TRAI and the operators are thinking. Operators are seeking an amendment to M&A regulations, but we did not get the impression in recent industry meetings that major changes are forthcoming. Some amendments could be announced in the next couple of months, but the regulator wants to see further investments made in the country (50% rollout obligation within three years). Therefore, spectrum trading/sharing may not be permitted at this stage, in our view.

2H — a shift from launch plans to sustainable plans Most key carrier launches have occurred, at least in select circles with pan-India expansion over 2010. Etisalat DB and S Tel are the two pending near-term launches. With subscriber traction, companies could potentially begin to look beyond price differentiation. Headline tariffs may not rise, but companies could strive to boost overall realisation. With 3G and MNP also implemented in 1H, 2H could see more stability. However, an asymmetric 3G outcome whereby one or two incumbents lose out significantly could again trigger market irrationality.

Bharti — a solid franchise despite current hiccups We like Bharti’s solid execution capability, its superior returns profile among various Indian telcos and its strong balance sheet. The company should emerge as one of the early and strong beneficiaries post this turbulent phase. Core Bharti is cash flow positive, and on a consolidated basis, we still see potential for the group to be free cash by FY11. Bharti remains focussed on expanding its overseas’ footprint. However, in the absence of M&A, we see potential near-term capital management, although the probability of this remains low. At 13-14x FY11F EPS, we believe the stock is fairly priced.

Analysts Sachin Gupta, CFA +65 6433 6968 [email protected] B. Roshan Raj +65 6433 6961 [email protected] Neeraja Natarajan (Associate) +91 22 6723 5231 [email protected]

Sector valuations

Stock Market cap

(INRbn) P/E (x)EV/EBITDA

(x)Bharti 1,224 15.3 8.6RCOM 361 13.5 7.1

Based on closing price on 8th December

Source: Bloomberg, Nomura

Stocks for action Our NEUTRAL rating for Bharti is on account of valuations that are not inexpensive, in our view. We have a REDUCE rating for RCOM.

NEUTRAL


Price target(INR)

Bharti Neutral 321 330RCOM Reduce 175 154Prices as of 24 December 2009




Strategy | India Sachin Gupta, CFA


Exhibit 86. Bharti, RCOM — revenue outlook

0

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500,000

2006 2007 2008 2009 2010 2011 2012

(INRmn)

010

20304050

6070

Bharti RCOMBharti y-y chg % RCOM y-y chg % (%)

Source: TRAI, Nomura research

Exhibit 87. Bharti, RCOM — margin outlook

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2006 2007 2008 2009 2010 2011 2012

Bharti RCOM(%)

Source: TRAI, Nomura research

Exhibit 88. India — subscriber and wireless revenue trends

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02468101214

Subscribers (LHS) q-q change (RHS)(mn) (%)

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(4)(2)024681012

Wireless gross revenues (LHS)q-q change (RHS)

(INRbn) (%)

Source: Telecom Regulatory Authority of India (TRAI), Company data, Nomura research

Exhibit 89. India — subscriber share, pricing and usage trends

Bharti23.7%

Idea11.0%

HFCL0.1%

Reliance18.5%

MTNL0.9% Aircel

5.5%

BPL0.5%

BSNL11.5%

Shyam0.4%

Tata Teleservices

10.0%Vodafone

17.8%

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Bharti RCOMIdea Vodafone

(INR)

300350400450500550600

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Bharti RCOMIdea Vodafone

(mins)

Source: Telecom Regulatory Authority of India (TRAI), Company data, Nomura research



Transport Infrastructure

Action Ports and logistics companies will likely benefit from an imminent recovery in

India’s trade. We highlight Mundra Port & SEZ and Container Corp of India to play the theme. While airports will also benefit from rising air traffic, we believe regulatory challenges to aero-revenue pricing could pose downside risks and the market already seems to be pricing in the best-case for non-aero revenue potential.

Catalysts Continued strength in port traffic is the key to MSEZ and CCRI, while non-aero

revenue and real-estate monetisation will drive GVKP and GMRI, in our view.

Anchor themes

Pick-up in industrial activity will likely lead to a turnaround in EXIM traffic benefiting port entities and container logistics companies. Similarly, an improving macro-economy will benefit air traffic and related revenue streams at the airports. The key is to pick stocks that still offer value after a substantial run-up in 2009.

Play the recovery on rising traffic Recovery in the economy to pave way for EXIM traffic growth There are visible signs of a recovery in the manufacturing and construction sectors. As such, our economics team has raised its FY10F average IIP growth forecast to 9.5% from 7%. Historically, EXIM traffic growth numbers have mirrored IIP growth trends, which is a clear measure of activity levels in an economy. US PMI and Euro zone PMI also rose above 50.0 in August 2009 and October 2009, respectively. Given that both these PMI act as leading indicators for container throughput growth in Asia, the continuing upward trend is seen as a positive indicator for EXIM volumes in 2010.

Ports and logistics companies to benefit from rising traffic An upward trend has already been observed in railway freight data and port data, including that for containers. We believe companies operating in the port space and those directly involved in container cargo movement will benefit from the expected surge in 2010. We recommend Mundra Port & SEZ (MSEZ IN, BUY) and Container Corp of India (CCRI IN, NEUTRAL) as our top picks in the space.

Recovery to benefit traffic at airports as well Traffic at privatised metro airports was growing at 15-30% pa until CY08 before the recession. Following two years of negative growth, some key airports are now witnessing revival and are expected to benefit further as international traffic also rises, leading to higher passenger spend at duty free retail shops.

Regulatory issues, real-estate and passenger spends are the key A pick up in air traffic is just one of several things that need to fall in place for the airport sector in India; the others being regulatory approval for a shift to RoCE model for aero-revenues, monetisation of real-estate and commercialisation of several potentially lucrative non-aero revenue contracts such as advertisement, retail shops, etc. We believe the market is factoring in the best-case scenario for airport valuations, but we remain sceptical of value-creation potential from these projects in the medium term for conglomerates such as GMR Infrastructure (GMRI IN, REDUCE) and GVK Power & Infrastructure (GVKP IN, REDUCE).

Analyst Amar Kedia +91 22 4037 4182 [email protected]

Recommendation summary

Stock Price (INR)

Target price (INR) Rating

Container Corp of India (CCRI IN)

1270.00 1,300 NEUTRAL

Mundra Port & SEZ (MSEZ IN)

560.50 615 BUY

GMR Infrastructure (GMRI IN)

67.15 47 REDUCE

GVK Power & Infrastructure (GVKP IN)

47.60 24.3 REDUCE

Price as of 24 Dec

Source: Nomura

Stocks for action Mundra Port & SEZ offers a strong and diversified play on rising traffic as well as capacity shortages at major Indian ports. GMR Infra is our top REDUCE on account of steep valuation as we believe the best-case scenario is already factored in.

BULLISH


Price target(INR)

Mundra Port & SEZ (MSEZ IN)

BUY 560.50 615

GMR Infrastructure (GMRI IN)

REDUCE 67.15 47





Exhibit 90. Visible uptrend in industrial activity…

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Mar-96 Jul-98 Nov-00 Mar-03 Jul-05 Nov-07 Mar-10(2)

(1)

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2IIP (3mma) (LHS)

OECD CLI for India (6-month lead)

(% m-m)(% y-y)

Source: OECD, CEIC and Nomura Global Economics

Exhibit 91. …leads to expectation of revival in air traffic

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FY04 FY05 FY06 FY07 FY08 FY09F FY10F(20)

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HYD (LHS) DEL (LHS)BOM (LHS) HYD (RHS)DEL (RHS) BOM (RHS)

(% y-y)(mn pax)

Source: Airports Authority of India, Nomura estimates

Exhibit 92. Both US and Euro zone PMI on the rise

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Source: Bloomberg

Exhibit 93. Port traffic has historically mirrored IIP

(15) (10) (5) 0 5 10 15 20 25 30

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Total commodity traffic at major ports ex oilIIP (RHS)

(%) (%)


Exhibit 94. Container traffic at ports already rising…

(25)

(20)

(15)

(10)

(5)

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10 ('000 TEUs)

0100200

300400500600

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All Major Ports% Growth YoYAll major ports (LHS)Growth (RHS)

(% y-y)

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Source: IPA, Nomura research

Exhibit 95. …led by rising imports; exports to follow (indexed to 1)

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Monthly Exports

Monthly Non-oil Imports

CRB Index



Mahindra and Mahindra MM IN

AUTOS | INDIA

Kapil Singh +91 22 4037 4199 [email protected] Prabhat Awasthi +91 22 4037 4180 [email protected]

Strong growth across segments Structural improvement in tractor demand We look for a structural improvement in tractor demand in India, mainly owing to farm labour shortages created under the NREGA. About 44mn people were employed under this scheme for three months last year. Hence, an average of 11mn people were employed at any one point, representing about 8% of rural households. In addition, the Indian government focused on providing floor prices for agri commodities in 2009. We believe that the sharp price hikes will help to offset the impact of lower crop production attributable to weak monsoons. Tractor demand is now growing at a 23% seasonally adjusted annualised run-rate (SAAR), ahead of our estimate of 15.6%.

Launch of new UV — Xylo has been very successful MM’s recent launch of its new utility vehicle (UV), Xylo, has been very successful, lifting its UV market share from 48% to 58%. The current UV SAAR is at 37.6%, versus our estimate of just 20%. The company also plans to launch an all-new SUV in 1Q11F.

MM plans to enter the commercial vehicle segment from January 2010. It will launch a light commercial vehicle and a full range of medium and heavy commercial vehicles. Having a solid nationwide distribution network should be a key advantage, in our view.

The company also plans to launch its entry-level pick-up trucks in the US, targeting 2,000-3,000 units per month. We have not assigned any value to this venture at this stage.

Standalone business trading at only 10x MM’s standalone business is trading at only 10x FY11F EPS (ex dividend) of INR66.9, versus an average of 14x for the other India auto stocks under our coverage. We continue to value MM at 12x FY11F EPS, which is the mid-point of its historical trading range of 10-14x during up-cycles. Our tech analyst Harmendra Gandhi values Tech Mahindra (TECHM IN) at INR250/share. We value the rest of the

Key financials & valuations31 Dec (INR mn) FY08 FY09F FY10F FY11FRevenue 115,914 131,860 157,196 187,930Reported net profit 11,038 7,869 18,523 21,040Normalised net profit 9,386 8,265 17,829 21,040Normalised EPS (INR) 40.45 28.84 67.87 77.10Norm. EPS growth (%) 34.39 30.29 65.33 77.10Norm. P/E (x) 35.8 40.7 18.9 16.0EV/EBITDA (x) 21.6 26.6 12.4 10.3Price/book (x) 6.0 5.6 4.2 3.5Dividend yield (%) (1.2) (1.0) (1.8) (2.1)ROE (%) 27.9 16.4 29.6 26.3 Net debt/equity (%) 39.7 47.1 26.6 21.1 Earnings revisionsPrevious norm. net profit 8,265 17,829 21,040Change from previous (%) - - - Previous norm. EPS (INR) 28.84 67.87 77.10Source: Compa ny, Nomura e stimate s

Share price relative to MSCI India

1m 3m 6m (0.5) 23.4 47.0 (1.1) 26.9 52.9 (2.3) 17.9 23.4

Hard

Source: Compa ny, Nomura e stimate s

52-week range (INR)3-mth avg daily turnover (US$mn)

LIC

Stock borrowability

17.52

Major shareholders (%)M&M Group 33.27

Absolute (INR)Absolute (US$)Relative to Index

Estimated free float (%)Market cap (US$mn) 6,387

671,080/255.8

28.28

170

370

570

770

970

1,170

Dec

08

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80100120140160180200220

PriceRel MSCI India

(Rs)

Closing price on 24 Dec INR1,061.85

Price target INR1,232(set on 30 Oct 09)

Upside/downside 16.0%Difference from consensus 10.5%FY11F net profit (INRmn) 21,044

Difference from consensus 12.1%Source: Nomura

Nomura vs consensus We are more upbeat than the street, as we expect structural improvement in tractor volumes due to labour shortages, and only limited impact on tractor demand from weak monsoons.

Maintained

BUY


Action MM’s auto business is trading at only 10x FY11F EPS (vs 14x for our coverage

universe), we think on concerns over tractor demand due to below-normal rainfall in India in 2009. We expect a structural improvement in tractor demand due to the National Rural Employment Guarantee Act (NREGA), continued success of Xylo and potential upside from new commercial vehicle launches.

Catalysts Delivery of tractor growth and success of new commercial vehicle launches by the

company are potential key triggers for the stock.

Anchor themes

MM has been a big beneficiary of the Indian government’s focus on rural areas. Under the NREGA, not only has farm labour become expensive, but worker shortages have also surfaced. We see this as a key catalyst for increased mechanisation at farms.



Mahindra and Mahindra Kapil Singh


subsidiaries at market capitalisation. We roll forward the target price at 11.6% cost of equity to November 2010. At our target price, the implied EV/EBITDA ratio for the standalone business is about 8x. Note that we have not assigned any value to the Mahindra International and Mahindra-Renault joint ventures.

Key risks include: 1) slow growth in rural incomes due to bad monsoons; 2) a complete rollback of excise duties could affect volume growth and margins; and 3) a sharp increase in raw material costs could erode margins.

Exhibit 96. India: UV market share

58.3

12.8

48.543.441.344.346.648.5

22.420.0 20.0 22.1 20.8 19.8

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30

40

50

60

70

FY04 FY05 FY06 FY07 FY08 FY09 FY10-ytd

GM Toyota MM TTMT(%)

Source: Society of Indian Automobile Manufacturers (SIAM), Nomura research

Exhibit 97. MM: tractor SAAR

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(Nos)


Exhibit 98. MM: UV + LCV SAAR

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(Nos)




Robust revenue growth of around 20% in FY11F

Financial statements

Income statement (INR mn)Year-end 31 Dec FY08 FY09F FY10F FY11FRevenue 115,914 131,860 157,196 187,930Cost of goods sold (79,648) (95,657) (104,139) (125,350)Gross profit 36,266 36,202 53,057 62,580SG&A (15,882) (17,022) (20,243) (24,012)Employee share expense (8,525) (10,246) (11,783) (13,668)Operating profit 11,860 8,934 21,031 24,900

- - - - EBITDA 14,248 11,849 24,984 29,908Depreciation (2,389) (2,915) (3,954) (5,008)Amortisation - - - - EBIT 11,860 8,934 21,031 24,900Net interest expense (242) (453) (194) (335)Associates & JCEs - - - - Other income 803 1,780 2,903 3,320Earnings before tax 12,420 10,262 23,740 27,886Income tax (3,034) (1,997) (5,906) (6,842)Net profit after tax 9,386 8,265 17,835 21,044Minority interests - - - - Other items - - - - Preferred dividends - - - - Normalised NPAT 9,386 8,265 17,835 21,044Extraordinary items 1,652 (396) 694 - Reported NPAT 11,038 7,869 18,529 21,044Dividends 3,211 3,121 5,559 6,313Transfer to reserves 14,249 10,990 24,087 27,357

Valuation and ratio analysisFD normalised P/E (x) 31.0 35.2 16.3 13.8 FD normalised P/E at price targe 35.8 40.7 18.9 16.0 Reported P/E (x) 26.3 36.9 15.7 13.8 Dividend yield (%) (1.2) (1.0) (1.8) (2.1) Price/cashflow (x) 18.7 15.5 11.0 9.9 Price/book (x) 6.0 5.6 4.2 3.5 EV/EBITDA (x) 21.6 26.6 12.4 10.3 EV/EBIT (x) 26.0 35.3 14.7 12.4 Gross margin (%) 31.3 27.5 33.8 33.3 EBITDA margin (%) 12.3 9.0 15.9 15.9 EBIT margin (%) 10.2 6.8 13.4 13.2 Net margin (%) 9.5 6.0 11.8 11.2 Effective tax rate (%) 24.4 19.5 24.9 24.5 Dividend payout (%) (29.1) (39.7) (30.0) (30.0) Capex to sales (%) 6.0 10.1 8.9 7.4 Capex to depreciation (x) 2.9 4.6 3.5 2.8

ROE (%) 27.9 16.4 29.6 26.3 ROA (pretax %) 15.0 8.2 15.4 15.6

Growth (%)Revenue 15.1 13.8 19.2 19.6 EBITDA 10.7 (16.8) 110.9 19.7 EBIT 10.1 (24.7) 135.4 18.4 Normalised EPS (1.3) (11.9) 115.8 18.0 Normalised FDEPS (1.3) (11.9) 115.8 18.0

Per shareReported EPS (INR) 40.4 28.8 67.9 77.1 Norm EPS (INR) 34.4 30.3 65.4 77.1 Fully diluted norm EPS (INR) 34.4 30.3 65.4 77.1 Book value per share (INR) 179.0 188.5 251.6 302.6 DPS (W) (13.2) (11.2) (19.3) (21.9) Source: Nomura estimates



Solid free cashflow growth

Cashflow (INR mn)Year-end 31 Dec FY08 FY09F FY10F FY11FEBITDA 14,248 11,849 24,984 29,908Change in working capital 2,133 8,524 3,924 3,454Other operating cashflow (822) (1,675) (2,575) (3,856)Cashflow from operations 15,560 18,698 26,333 29,505Capital expenditure (6,923) (13,380) (14,000) (14,000)Free cashflow 8,637 5,318 12,333 15,505Reduction in investments (19,776) (15,714) (8,333) (8,333)Net acquisitions - - - - Reduction in other LT assets - - - - Addition in other LT liabilities - - - - Adjustments - - - - Cashflow after investing acts (11,139) (10,396) 4,000 7,172Cash dividends (3,211) (3,121) (5,559) (6,313)Equity issue 285 361 7,000 - Debt issue 9,511 20,461 (9,082) 1,569Convertible debt issue - - - - Others - - - - Cashflow from financial acts 6,585 17,701 (7,640) (4,744)Net cashflow (4,554) 7,306 (3,640) 2,427Beginning cash 13,261 8,612 15,744 12,177Ending cash 8,706 15,918 12,104 14,604Ending net debt 17,258 24,783 19,269 18,411Source: Nomura estimates

Balance sheet (INR mn)As at 31 Dec FY08 FY09F FY10F FY11FCash & equivalents 8,612 15,744 12,177 14,604Marketable securities - - - - Accounts receivable 10,049 10,437 12,493 14,984Inventories 10,841 10,607 14,098 16,851Other current assets 7,052 13,842 11,957 13,535Total current assets 36,554 50,629 50,726 59,973LT investments 42,151 57,864 66,197 74,531Fixed assets 23,609 32,143 42,190 51,182Goodwill - - - - Other intangible assets (432) 489 489 489Other LT assets - - - - Total assets 101,881 141,126 159,602 186,175Short-term debt - - - - Accounts payable 22,871 34,431 32,511 38,992Other current liabilities 9,639 13,547 23,054 26,846Total current liabilities 32,510 47,978 55,565 65,839Long-term debt 25,871 40,528 31,446 33,014Convertible debt - - - - Other LT liabilities - - - - Total liabilities 58,381 88,505 87,011 98,853Minority interest - - - - Preferred stock - - - - Common stock 2,431 2,792 2,886 2,886Retained earnings 41,070 49,829 69,705 84,435Proposed dividends - - - - Other equity and reserves - - - - Total shareholders' equity 43,501 52,621 72,590 87,321Total equity & liabilities 101,881 141,126 159,601 186,174

Liquidity (x)Current ratio 1.12 1.06 0.91 0.91 Interest cover 48.93 19.74 108.68 74.40

LeverageNet debt/EBITDA (x) 1.2 2.1 0.8 0.6 Net debt/equity (%) 39.7 47.1 26.5 21.1

Activity (days)Days receivable 26.9 28.4 26.6 26.7 Days inventory 45.1 40.9 43.3 45.1 Days payable 97.0 109.3 117.3 104.1 Cash cycle (25.0) (40.1) (47.4) (32.4) Source: Nomura estimates


Tata Motors TTMT IN

AUTOS | INDIA

Kapil Singh +91 22 4037 4199 [email protected] Prabhat Awasthi +91 22 4037 4180 [email protected]

Cashflow concerns remain at JLR Much higher R&D capitalisation than peers We believe that the street has ignored Tata Motors’ (TTMT) high R&D capitalisation compared with peers. In FY09, TTMT capitalised 96% of its R&D expenses in India, compared with peers’ ~55%. Moreover, it expensed only 10% of R&D at JLR, compared with 60% for global peers. Hence, we believe the EBITDA numbers require adjustment for comparison with peers in order to give a clear picture of cashflows.

Weak recovery expected in Europe; falling quality rankings JLR’s biggest market is Europe, which contributes 50% of volume. Nomura’s auto analyst in Europe, Dorothee Cresswell, expects a weak recovery in volumes in 2010F. In addition, JLR’s quality rankings were among the lowest in 2009, according to JD Power’s Initial Quality Study. We think this augurs badly for a premium car maker. JLR’s volumes remain ~30% below 2007 levels, the only year it was profitable in the past five years.

High R&D requirements to cut emissions; cashflow concerns We estimate JLR requires ~£600mn for R&D expenses. Even assuming strong margin expansion of 6pp and 20% higher volumes than current levels, the company will not break even on a cash basis, in our view. We believe the business will continue to destroy value for TTMT shareholders through continued cash burn.

Domestic MHCV business to remain slow after FY11F While FY10F and FY11F should see strong growth in medium and heavy commercial vehicles amid a recovery in the domestic market, we think volume growth is likely to slow to 10% after FY11F. Even this forecast may face downside risk due to competition from new entrant Mahindra and Mahindra, as well as dedicated freight corridor railways.

Key financials & valuations31 Dec (INR mn) FY08 FY09F FY10F FY11FRevenue 283,622 254,712 326,164 399,722Reported net profit 20,289 10,013 25,082 29,016Normalised net profit 15,216 4,094 25,082 29,016Normalised EPS (INR) 47.43 19.48 46.11 53.35Norm. EPS growth (%) 35.57 7.96 46.11 53.35Norm. P/E (x) 11.8 52.6 9.1 7.9EV/EBITDA (x) 17.4 36.0 14.3 10.9Price/book (x) 3.8 3.3 2.7 2.4Dividend yield (%) 2.2 0.9 2.0 2.4ROE (%) 27.6 10.0 18.0 17.5 Net debt/equity (%) 49.5 98.3 110.4 91.0 Earnings revisionsPrevious norm. net profit 4,094 25,082 29,016Change from previous (%) na na naPrevious norm. EPS (INR) 19.48 46.11 53.35Source: Company, Nomura estimates


1m 3m 6m 20.0 29.1 118.3 19.3 32.7 127.0 18.0 23.7 97.5

Hard

Source: Company, Nomura estimates

8,01840

780/130.870.8

Absolute (INR)Absolute (US$)Relat ive to Index

Estimated free float (%)Market cap (US$mn)

11.50

Major shareholders (%)Tata Sons 27.13


LIC

Stock borrowability

65165265365465565665765865

Dec0

8

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9

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9M

ar09

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110

160

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310PriceRel MSCI India

(Rs)

Closing price on 24 Dec INR779.95

Price target INR419(set on 30 Nov 09)

Upside/downside -39.2%Difference from consensus -30.3%FY11F net profit (INRmn) 25,082


Nomura vs consensus Consensus is not adjusting valuations for Tata Motors’ high R&D capitalisation policy and is assuming free cashflow generation at JLR.

Maintained

REDUCE


Action

TTMT’s free cashflow generation remains at risk due to severe financial strain from Jaguar and Land Rover (JLR). Even though accounting under Indian standards means that JLR should report profits, the cashflow situation is bleak, in our view. We estimate JLR will have a cash loss of ~INR70/share in FY10F. REDUCE.

Catalysts

We believe that management not delivering on its guidance to make JLR free cashflow positive by FY11F could be a key negative catalyst for the stock.

Anchor themes

Cashflow generation at JLR remains clouded. Volume recovery in Europe is likely to be weak and quality rankings slipped in 2009. The company needs to spend about £600mn per year for R&D. Unless the volume recovery is strong, JLR looks set to remain free cashflow negative.



Tata Motors Kapil Singh


We value Tata Motors at INR419/share We value Tata Motors on an EV/EBITDA basis. For the purpose of valuation, we have used normalised EV/EBITDA (for comparison with other OEMs), assuming 2% of sales as normalised R&D expense.

We have used an EV/EBITDA multiple of 8.5x, which is close to the upper end of the stock’s trading band (as we estimate a strong recovery).

Key risks to our call:

A strong recovery in volumes in Europe, leading to JLR volumes touching 2007 levels.

Very strong growth in industrial production for the next few years, leading to high demand for medium and heavy commercial vehicles.

Exhibit 99. TTMT’s Indian business R&D capitalised R&D capitalised as % of net sales FY05 FY06 FY07 FY08 FY09 TTMT 1.0 1.7 2.3 3.7 5.6AL 1.2 0.9 1.1 1.2 2.5MSIL 0.3 0.2 0.1 0.1 0.1MM 0.2 0.1 0.3 0.3 2.2

Source: Companies, Nomura research

Exhibit 100. JD Power Initial Quality Study (IQS) rankings 2008 2009 JD Power Survey Defects/100 Rank (/ 37) Defects/100 Rank (/ 38)Lexus 99 3 84 1 Porsche 87 1 90 2 Mercedes Benz 104 4 101 6 Jaguar 112 9 134 29 Land Rover 161 35 150 36 Industry average 118 NA 108 NA

Source: JD Power, Nomura Research

Exhibit 101. JLR volumes in Europe

0

5,000

10,000

15,000

20,000

25,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2007 2008 2009(Numbers)

Source: Auto data, Nomura research



Substantial slowdown in EPS growth in FY11F


Income statement (INR mn)Year-end 31 Dec FY08 FY09F FY10F FY11FRevenue 283,622 254,712 326,164 399,722Cost of goods sold (208,755) (194,506) (226,859) (280,664)Gross profit 74,867 60,207 99,305 119,058SG&A (39,351) (38,321) (50,025) (57,524)Employee share expense (15,446) (15,514) (17,743) (19,773)Operating profit 20,071 6,372 31,537 41,761

- - - - EBITDA 26,594 15,117 41,841 53,766Depreciation (6,523) (8,745) (10,304) (12,004)Amortisation - - - - EBIT 20,071 6,372 31,537 41,761Net interest expense (2,824) (6,737) (9,907) (9,214)Associates & JCEs - - - - Other income 3,444 4,585 8,255 1,391Earnings before tax 20,691 4,219 29,885 33,938Income tax (5,476) (125) (4,804) (4,923)Net profit after tax 15,216 4,094 25,082 29,016Minority interests - - - - Other items - - - - Preferred dividends - - - - Normalised NPAT 15,216 4,094 25,082 29,016Extraordinary items 5,073 5,918 - - Reported NPAT 20,289 10,013 25,082 29,016Dividends (6,597) (3,457) (8,660) (10,018)Transfer to reserves 13,692 6,556 16,422 18,997

Valuation and ratio analysisFD normalised P/E (x) 21.9 97.9 16.9 14.6 FD normalised P/E at price target (x) 11.8 52.6 9.1 7.9 Reported P/E (x) 16.4 40.0 16.9 14.6 Dividend yield (%) 2.2 0.9 2.0 2.4 Price/cashflow (x) 4.4 29.0 10.1 8.7 Price/book (x) 3.8 3.3 2.7 2.4 EV/EBITDA (x) 17.4 36.0 14.3 10.9 EV/EBIT (x) 23.1 85.4 18.9 14.0 Gross margin (%) 26.4 23.6 30.4 29.8 EBITDA margin (%) 9.4 5.9 12.8 13.5 EBIT margin (%) 7.1 2.5 9.7 10.4 Net margin (%) 7.2 3.9 7.7 7.3 E ffective tax rate (%) 26.5 3.0 16.1 14.5 Dividend payout (%) 32.5 34.5 34.5 34.5 Capex to sales (%) 16.2 19.5 8.0 6.4 Capex to depreciation (x) 7.1 5.7 2.5 2.1 ROE (%) 27.6 10.0 18.0 17.5 ROA (pretax %) 9.7 2.1 7.6 8.7

Growth (%)Revenue 3.0 (10.2) 28.1 22.6 EBITDA (8.2) (43.2) 176.8 28.5 EBIT (13.1) (68.3) 395.0 32.4 Normalised EPS (13.4) (77.6) 479.0 15.7 Normalised FDEPS (13.4) (77.6) 479.0 15.7

Per shareReported EPS (INR) 47.4 19.5 46.1 53.3 Norm EPS (INR) 35.6 8.0 46.1 53.3 Fully diluted norm EPS (INR) 35.6 8.0 46.1 53.3 Book value per share (INR) 203.3 237.9 287.0 322.0 DPS (W) 17.1 6.7 15.9 18.4 Source: Nomura estimates



Net cashflow of standalone business remains very low, even in FY11F

Cashflow (INR mn)Year-end 31 Dec FY08 FY09F FY10F FY11FEBITDA 26,594 15,117 41,841 53,766Change in working capital 48,163 (4,944) 6,423 7,521Other operating cashflow 219 3,641 (6,455) (12,746)Cashflow from operations 74,976 13,814 41,810 48,541Capital expendi ture (46,067) (49,634) (25,943) (25,537)Free cashflow 28,909 (35,821) 15,866 23,004Reduction in investments (24,333) (80,579) (76,804) - Net acquisitions - - - - Reduction in other LT assets - - - - Addition in other LT liabilities 40 1,682 - - Adjustments 40 40 40 - Cashflow after investing acts 4,657 (114,677) (60,897) 23,004Cash dividends (6,597) (3,457) (8,660) (10,018)Equity issue (3,995) 39,580 17,402 - Debt issue 21,681 67,680 55,080 (10,501)Convertible debt issue - - - - Others - - - - Cashflow from financial acts 11,089 103,804 63,822 (20,519)Net cashflow 15,746 (10,873) 2,925 2,485Beginning cash 8,268 23,973 11,418 14,303Ending cash 24,013 13,100 14,343 16,788Ending net debt 38,832 120,237 172,433 159,447Source: Nomura estimates

Balance sheet (INR mn)As at 31 Dec FY08 FY09F FY10F FY11FCash & equivalents 23,973 11,418 14,303 16,788Marketable securities - - - - Accounts receivable 11,149 15,499 15,620 18,334Inventories 24,218 22,298 25,636 29,433Other current assets 44,498 47,701 59,737 66,056Total current assets 103,838 96,917 115,296 130,612LT investments 49,103 129,681 206,485 206,485Fixed assets 104,523 145,993 161,632 175,165Goodwill - - - - Other intangible assets - - - - Other LT assets - - - - Total assets 257,463 372,591 483,413 512,262Short-term debt - - - - Accounts payable 83,917 87,313 105,398 122,574Other current liabilities 32,407 29,701 33,533 36,709Total current liabilities 116,324 117,013 138,931 159,283Long-term debt 62,805 131,656 186,736 176,235Convertible debt - - - - Other LT liabilities (61) 1,621 1,621 1,621Total liabilities 179,068 250,290 327,288 337,139Minority interest - - - - Preferred stock - - - - Common stock 3,855 5,141 5,439 5,439Reta ined earnings 74,540 117,161 150,686 169,684Proposed dividends - - - - Other equity and reserves - - - - Total shareholders' equity 78,395 122,302 156,125 175,123Total equity & liabilities 257,463 372,591 483,413 512,262

Liquidity (x)Current ratio 0.89 0.83 0.83 0.82 Interest cover 7.11 0.95 3.18 4.53

LeverageNet debt/EBITDA (x) 1.5 8.0 4.1 3.0 Net debt/equity (%) 49.5 98.3 110.4 91.0

Activity (days)Days receivable 11.9 19.1 17.4 15.5 Days inventory 43.2 43.6 38.6 35.8 Days payable 123.6 160.7 155.0 148.2 Cash cycle (68.6) (97.9) (99.1) (96.9) Source: Nomura estimates


State Bank of India SBIN IN

BANKS | INDIA

Mahrukh Adajania +91 22 4037 4157 [email protected] Akula (Associate) +91 22 4037 4361 [email protected]

Still our top pick Aggressive loan pricing strategies should benefit SBI SBI is offering competitive rates on housing and auto loans to improve its loan/deposit ratio, which has been the key drag on NIM in the past two quarters. SBI can price its loans lower than other banks because its incremental cost of funds is lower than other banks’, given its high CASA and rapid deposit rate cuts. Rate cuts will likely continue to improve loan/deposit ratios at SBI, which bodes well for margins.

Recent deposit rate cuts to help margins in long run SBI has been aggressive in cutting deposit rates, which should boost its NIM in the long run. However, this is unlikely to help near-term margins given that the bank’s 1,000-day deposit scheme (effective October 2008 to September 2009) increased the overall maturity profile of deposits.

Continued NIM improvement We expect incremental NIM to improve, with the bank’s improving loan/deposit ratio, rapid deposit rate cuts and re-pricing of old high-cost deposits. Around 16% of SBI’s total deposits will mature in 2H FY10F, which should help to reduce the total cost of funds. As such, we expect the NIM decline in FY10F to settle at 40bps y-y, versus the YTD decline of 70bps, indicating that margins will improve by 30bps in 2H FY10F from current levels.

Acquisition of home loan M/S, proactive management of treasury portfolio SBI has ramped up its market share in home loans over the past four quarters. It is now the largest home loan financier, with a 35% market share of all housing loans. Similarly, its treasury operations have strengthened in recent years. Despite the rise in bond yields in 2Q, the bank avoided mark-to-market losses owing to active reshuffling of securities between its mark-to-market and held-to-maturity portfolios.

Key financials & valuations31 Mar (INRmn) FY08 FY09F FY10F FY11FPPOP 131,076 179,152 196,437 240,312Reported net profit 67,291 91,212 100,403 118,156Normalised net profit 67,291 91,212 100,403 118,156Normalised EPS (Rs) 106.5 143.7 158.1 186.1Norm. EPS growth (%) 53.0 34.8 10.1 17.7 Norm. P/E (x) 20.2 15.0 13.6 11.6Price/adj. book (x) 2.8 2.4 2.1 1.8Price/book (x) 2.8 2.4 2.1 1.8Dividend yield (%) 1.0 1.3 0.8 0.8ROE (%) 16.7 17.0 16.3 16.9 ROA (%) 1.0 1.1 0.9 0.9 Earnings revisionsPrevious norm. net profit 91,212 100,403 118,156Change from previous (%) - - - Previous norm. EPS (INR) 143.70 158.10 186.10Source: Company, Nomura estimates


1m 3m 6m (3.8) 2.4 29.3 (4.3) 5.3 34.4 (5.5) (3.8) 4.9

Easy


Stock borrowabilityMajor shareholders (%)Govt of India 59.3

155.5




30,19530.4

2,471/895

730

1,230

1,730

2,230

2,730

Dec

08

Jan0

9

Feb

09

Mar

09

Apr0

9

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

707580859095100105

P rice

Rel M SCI India(Rs)

Closing price on 24 Dec INR2,215

Price target INR2,590(set on 8 Oct 09)

Upside/downside 10.9%Difference from consensus 16.9%

FY10F net profit (INRmn) 100,403Difference from consensus 1.3%Source: Nomura Note: Price target under review

Nomura vs consensus Our earnings are broadly in line with consensus. We believe the composition is different, however, with consensus assuming higher NIMs and lower non-interest income.

Maintained

BUY

Action We believe that SBI is well poised to improve NIM and acquire loan market share,

given its strong balance sheet and focus on improving its loan/deposit ratio through competitive pricing strategies. We reiterate our BUY call. Price target under review, with an upward bias.

Catalysts Continuous NIM expansion in the forthcoming quarterlies, listing guidelines for life

insurance, and clarity from RBI on new provisioning norms are potential catalysts.

Anchor themes

Strong growth in loans, NIM and fees will be key stock drivers, in our view. SBI is trading at 1.8x FY11F P/adjusted BV on the core banking business, which we believe is undemanding in the context of its growth potential and risk profile. We have already adjusted for the provisioning shortfall in our price target.




State Bank of India Mahrukh Adajania


Valuation We value SBI at 1.8x FY11F P/BV for the core banking business, based on sustainable ROE of 17%. Our fair value for the core business works out to INR2,356. We have valued subsidiaries at INR231 per share. The subsidiary valuation is driven by life insurance, which we have valued at 18x NBAP FY11F.

Investment risks: A faster-than-expected rise in rates or slower-than-expected loan growth are key risks to price target and earnings forecast.

Exhibit 102. SBI: historical net interest margin

Period NIM (%)9M FY07 3.32 FY07 3.09 1Q FY08 3.27 1H FY08 3.01 9M FY08 3.01 FY08 3.07 1Q FY09 3.03 1H FY09 3.16 9M FY09 3.15 FY09 2.93 1Q FY10 2.30 2Q FY10 2.50

Source: Company data

Exhibit 103. Home loan disbursements

(INRmn) 1Q FY10 FY09 FY08ICICI Bank + ICICI Home Finance 11,000 102,000 185,000 HDFC 86,800 396,500 328,750 SBI 48,000 138,400 116,700 Axis Bank 9,200 NA NA HDFC Bank 12,000 NA NA LIC Housing Finance 24,300 87,620 70,715 Note: Disbursements for HDFC and LIC include developer loans


Continued NIM improvement




Profit and Loss (INRmn)Year-end 31st March FY07 FY08 FY09 FY10F FY11FInterest income 372,421 489,503 637,884 750,320 884,345 Interest expense (230,580) (319,291) (429,153) (515,046) (591,494) Net interest income 141,842 170,212 208,731 235,274 292,851 Net fees and commissions 48,045 59,143 76,172 89,883 103,366 Trading related profits 5,678 16,498 25,673 20,000 10,000 Other operating revenue 13,918 11,308 25,063 30,612 33,118 Non-interest income 67,641 86,949 126,908 140,495 146,484 Operating income 209,483 257,162 335,639 375,769 439,335 Depreciation na na na na naOperating expenses (118,235) (126,086) (156,487) (179,332) (199,023) Employee share expense na na na na naOp. profit before provisions 91,248 131,076 179,152 196,437 240,312 Provisions for bad debt (14,295) (20,009) (24,750) (52,080) (56,149) Other provision charges (9,255) (4,490) (2,045) 6,729 (5,770) Operating profit 67,697 106,576 152,357 151,086 178,393 Amortisation na na na na naOther non-operating income na na na na naAssociates & JCEs na na na na naPre-tax profit 67,697 106,576 152,357 151,086 178,393 Income tax (31,036) (39,285) (61,145) (50,683) (60,237) Net profit after tax 36,661 67,291 91,212 100,403 118,156 Minority interests na na na na naOther items na na na na naPreferred dividends na na na na naNormalised NPAT 36,661 67,291 91,212 100,403 118,156 Extraordinary items na na na na naReported NPAT 36,661 67,291 91,212 100,403 118,156 Dividends (8,620) (15,235) (20,892) (20,892) (20,892) Transfer to reserves 28,041 52,056 70,320 79,511 97,264

Valuation and ratio analysisFD normalised P/E (x) 30.9 20.2 15.0 13.6 11.6 FD normalised P/E at price target (x) 37.2 24.3 18.0 16.4 13.9 Reported P/E (x) 30.9 20.2 15.0 13.6 11.6 Dividend yield (%) 0.7 1.0 1.3 0.8 0.8 Price/book (x) 3.6 2.8 2.4 2.1 1.8 Price/adjusted book (x) 3.6 2.8 2.4 2.1 1.8 Net interest margin (%) 2.83 2.82 2.63 2.29 2.41 Yield on interest earning assets (%) 7.43 8.11 8.03 7.32 7.29 Cost of interest bearing liabilities (%) 5.08 5.80 5.97 5.66 5.55 Net interest spread (%) 2.35 2.32 2.05 1.66 1.74 Non-interest/operating income (%) 32.3 33.8 37.8 37.4 33.3 Cost to income (%) 56.4 49.0 46.6 47.7 45.3 Effective tax rate (%) 45.8 36.9 40.1 33.5 33.8 Dividend payout (%) 23.5 22.6 22.9 20.8 17.7 ROE (%) 12.4 16.7 17.0 16.3 16.9 ROA (%) 0.69 1.04 1.08 0.93 0.93 Operating ROE (%) 23.0 26.5 28.5 24.5 25.5 Operating ROA (%) 1.28 1.65 1.81 1.41 1.40

Growth (%)Net interest income (9.0) 20.0 22.6 12.7 24.5 Non-interest income (9.0) 28.5 46.0 10.7 4.3 Non-interest expenses 0.8 6.6 24.1 14.6 11.0 Pre-provision earnings (19.2) 43.6 36.7 9.6 22.3 Net profit (16.8) 83.5 35.5 10.1 17.7 Normalised EPS (16.8) 53.0 34.8 10.1 17.7 Normalised FDEPS (16.8) 53.0 34.8 10.1 17.7 Source: Nomura estimates

Net interest income likely to grow by 13% y-y in FY10F and 24% y-y in FY11F



Balance Sheet (INRmn)As at 31st March FY07 FY08 FY09 FY10F FY11FCash and equivalents 25,301 32,203 42,955 54,320 62,468 Inter-bank lending 52,433 57,150 265,987 362,132 416,451 Deposits with central bank 265,463 483,143 512,507 555,430 633,650 Total securities na na na na naOther interest earning assets 1,667,975 1,997,442 2,982,129 3,895,688 4,397,136 Gross loans 3,420,770 4,221,812 5,485,398 6,577,295 7,559,623 Less provisions (47,405) (54,130) (60,366) (67,256) (73,079) Net loans 3,373,365 4,167,682 5,425,032 6,510,038 7,486,544 Long-term investments na na na na naFixed assets 28,189 33,735 38,378 44,135 50,756 Goodwill na na na na naOther intangible assets na na na na naOther non IEAs 252,923 444,170 377,333 433,933 499,023 Total assets 5,665,649 7,215,525 9,644,321 11,855,675 13,546,028 Customer deposits 4,355,211 5,374,039 7,420,731 9,053,292 10,411,286 Bank deposits, CDs, debentures 58,198 128,025 36,783 66,000 66,000 Other interest bearing liabilities 500,531 602,142 803,798 833,788 867,167 Total interest bearing liabilities 4,913,939 6,104,207 8,261,312 9,953,081 11,344,453 Non interest bearing liabilities 438,728 620,730 803,532 1,250,538 1,454,808 Total liabilities 5,352,667 6,724,937 9,064,844 11,203,618 12,799,261 Minority interest na na na na naCommon stock 5,263 6,316 6,349 6,349 6,349 Preferred stock na na na na naRetained earnings 307,723 484,012 573,128 645,708 740,418 Proposed dividends na na na na naOther equity na na na na naShareholders' equity 312,983 490,588 579,477 652,057 746,767 Total liabilities and equity 5,665,649 7,215,525 9,644,321 11,855,675 13,546,028 Non-performing assets (INRmn) 99,982 128,373 155,886 215,561 248,112

Balance sheet ratios (%)Loans to deposits 78.5 78.6 73.9 72.7 72.6 Equity to assets 5.5 6.8 6.0 5.5 5.5

Asset quality & capitalNPAs/gross loans (%) 2.9 3.0 2.8 3.3 3.3 Bad debt charge/gross loans (%) 0.42 0.47 0.45 0.79 0.74 Loss reserves/assets (%) 0.84 0.75 0.63 0.57 0.54 Loss reserves/NPAs (%) 47.4 42.2 38.7 31.2 29.5 Tier 1 capital ratio (%) 7.9 9.3 9.3 8.9 8.7 Total capital ratio (%) 13.2 14.0 14.8 14.1 13.5

Growth (%)Loan growth 28.9 23.5 30.2 20.0 15.0 Interest earning assets 14.8 25.1 37.0 23.3 14.2 Interest bearing liabilities 18.2 24.2 35.3 20.5 14.0 Asset growth 14.7 27.4 33.7 22.9 14.3 Deposit growth 14.6 23.4 38.1 22.0 15.0

Per shareReported EPS (INR) 69.7 106.5 143.7 158.1 186.1Norm EPS (INR) 69.7 106.5 143.7 158.1 186.1Fully diluted norm EPS (INR) 69.7 106.5 143.7 158.1 186.1DPS (INR) 16.0 21.5 29.0 18.0 18.0PPOP PS (INR) 173.4 207.5 282.2 309.4 378.5BVPS (INR) 594.7 776.4 912.7 1,027.1 1,176.2ABVPS (INR) 594.7 776.4 912.7 1,027.1 1,176.2NTAPS (INR) 594.7 776.4 912.7 1,027.1 1,176.2Source: Nomura estimates

Balance sheet growth to pick up in FY11F


Ambuja Cements ACEM IN

BUILDING MATERIALS | INDIA

Jamil Ansari +91 22 4037 4192 [email protected]

Challenging times Business outlook appears bleak The outlook for India’s cement sector appears bleak. Cement prices have started correcting significantly (especially in the country’s southern regions). Demand for cement has held firm until recently, with signs of weakness emerging in recent months. We note that the sector will add significant new capacity in the near future, putting further pressure on pricing.

Quarterly performance to deteriorate Although the recent quarterly results of most Indian cement companies have been good, we believe the operating environment for the sector will worsen in the quarters ahead, as capacity additions put further pressure on realisations. Moreover, we expect cost pressures, including those from coal costs, to resurface shortly, weighing on profitability at Ambuja.

Valuations still high Prevailing valuations do not appear to reflect the likely significant deterioration in profitability at Ambuja. Indeed, valuations have not corrected much at all, which dictates our negative view of the stock.

Looks expensive relative to sector peers Currently trading at an EV/tonne of US$140, Ambuja appears to be one of the most expensive cement stocks in India.

REDUCE call, PT of INR67 reaffirmed

We value Ambuja on the basis of the long-term expected return on the replacement cost of assets. The long-term growth rate and pre-tax WACC are assumed at 0% and 12%, respectively. Our PT of INR67 implies potential downside of 33%. Risks to our call: 1) stronger-than-expected demand growth could result in a strong pricing environment; 2) the stock could find support if parent Holcim goes for majority control.

Key financials & valuations31 Dec (INRmn) FY08 FY09F FY10F FY11FRevenue 62,347 68,400 70,400 naReported net profit 14,023 11,183 9,264 naNormalised net profit 10,939 11,183 9,264 naNormalised EPS (INR) 7.2 7.3 6.1 naNorm. EPS growth (%) 11.2 2.2 (17.2) naNorm. P/E (x) 13.8 13.5 16.3 naEV/EBITDA (x) 7.5 7.2 8.2 naPrice/book (x) 2.7 2.4 2.2 naDividend yield (%) 2.2 2.2 2.2 naROE (%) 21.2 18.5 13.9 naNet debt/equity (%) (9.9) (4.4) (0.0) naEarnings revisionsPrevious norm. net profit 11,183 9,264 naChange from previous (%) - - -Previous norm. EPS (INR) 7.3 6.1 naSource: Company, Nomura estimates


1m 3m 6m 10.3 1.3 10.6 9.7 4.2 15.0 8.4 (4.9) (14.5)

Hard


3,22353.6

110.3/63.68.98



Major shareholders (%)Holcim 46.45

52-week range (INR)3-mth avg daily turnover (US$mn)Stock borrowability

5868788898

108118

Dec0

8

Jan0

9

Feb0

9M

ar09

Apr0

9

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

60708090100110120

PriceRel MSCI India


Price target INR67(set on 10 Jul 09)


Difference from consensus -11.0%Source: Nomura

Nomura vs consensus We are much more pessimistic in our estimates for 2010F, as we expect the cement price correction to be much more severe than the market anticipates.

Maintained

REDUCE


Action We expect the profitability of Ambuja Cements to come under significant pressure

in 2010F as cement realisations continue to fall on the back of new capacity additions. We expect the company’s quarterly performance, which to date has been very strong, to reflect this change in operating environment from calendar 4Q10F onward. Thereafter, we expect severe pressure on earnings. REDUCE reaffirmed.

Catalysts Weakness in cement realisations due to new capacity additions and an increase in

cost elements such as coal strike us as the stock’s key catalysts in 2010F.

Anchor themes

Although the 2010F outlook for the company appears bleak, prevailing valuations have the stock at a mid-cycle EV/tonne multiple. Ambuja Cements, at US$140/tonne, appears to be one of the most expensive cement stocks in India.


Ambuja Cements Jamil Ansari



We expect net profit to decline by 17% in FY10F due to lower cement realisation and higher costs

Income statement (INRmn)Year-end 31 Dec FY08 FY09F FY10FRevenue 62,347 68,400 70,400Cost of goods sold 32,121 35,072 37,752Gross profit 30,226 33,328 32,648SG&A 12,446 14,317 15,774Employee share expense - - - Operating profit 17,779 19,012 16,874

EBITDA 17,779 19,012 16,874Depreciation 2,598 3,067 3,708Amortisation - - - EBIT 15,182 15,945 13,166Net interest expense 321 657 770Associates & JCEs - - - Other income 1,754 1,555 1,555Earnings before tax 16,615 16,843 13,952Income tax 5,676 5,659 4,688Net profit after tax 10,939 11,183 9,264Minority interests - - - Other items - - - Preferred dividends - - - Normalised NPAT 10,939 11,183 9,264Extraordinary items 3,083 - - Reported NPAT 14,023 11,183 9,264DividendsTransfer to reserves

Valuation and ratio analysisFD normalised P/E (x) 13.8 13.5 16.3FD normalised P/E at price target (x)Reported P/E (x) 13.8 13.5 16.3Dividend yield (%) 2.2 2.2 2.2Price/cashflow (x) 11.2 10.6 11.7Price/book (x) 2.7 2.4 2.2EV/EBITDA (x) 7.5 7.2 8.2EV/EBIT (x) 8.6 8.5 10.3Gross margin (%) 48.5 48.7 46.4EBITDA margin (%) 31.3 30.1 26.2EBIT margin (%) 27.2 25.6 20.9Net margin (%) 17.5 16.4 13.2Effective tax rate (%) 28.8 33.6 33.6Dividend payout (%) 35.8 35.0 42.3Capex to sales (%)Capex to depreciation (x)ROE (%) 21.2 18.5 13.9ROA (pretax %) 23.6 20.6 15.6

Growth (%)Revenue 10.7 9.7 2.9EBITDA (12.7) 5.3 (10.4)EBIT (15.4) 3.3 (15.9)Normalised EPS 11.2 2.2 (17.2)Normalised FDEPS

Per shareReported EPS (INR) 9.2 7.3 6.1Norm EPS (INR) 7.2 7.3 6.1Fully diluted norm EPS (INR) 7.2 7.3 6.1Book value per share (INR) 37.2 42.0 45.5DPS (INR) 2 2 2Source: Nomura estimates



Cashflow (INRmn)Year-end 31 Dec FY08 FY09F FY10FPre-tax profit 19,698 16,843 13,952Depreciation 2,598 3,067 3,708Tax paid (5,676) (5,659) (4,688)Chg in working capital (2,464) (1,926) 185Other operating activities 0 0 0Cash flow from operations (a) 14,157 12,324 13,157Capital expenditure (17,263) (11,246) (12,000)Chg in investments 9,566 0 0Chg in associates 0 0 0Other investing activities 0 0 0Cash flow from investing (b) (7,698) (11,246) (12,000)Free cash flow (a+b) 6,459 1,078 1,157Equity raised/(repaid) (0) 0 0Chg in minorities 0 0 0Debt raised/(repaid) (418) 6,918 (2,500)Dividend (incl. tax) (3,919) (3,919) (3,919)Other financing activities 0 0 0Cash flow from financing (c) (4,527) 2,483 (7,030)Net chg in cash (a+b+c) 1,932 3,561 (5,873)Beginning cash 6,508 8,518 12,595Ending cash 8,518 12,595 7,336Ending net debt (5,632) (2,791) (31)Source: Nomura estimates

Balance sheet (INRmn)As at 31 Dec FY08 FY09F FY10FCash & equivalents 8,518 12,595 7,336Marketable securities 0 0 0Accounts receivable 2,246 2,489 2,697Inventories 9,398 9,878 10,705Other current assets 234 234 234Total current assets 20,396 25,196 20,972LT investments 3,324 3,324 3,324Fixed assets 51,400 60,048 68,981Goodwill 0 0 0Other intangible assets 0 0 0Other LT assets 2,999 3,117 3,420Total assets 78,118 91,685 96,697Short-term debtAccounts payable 10,032 9,878 10,705Other current liabilities 4,706 3,776 4,472Total current liabilities 14,738 13,654 15,178Long-term debt 2,887 9,804 7,304Convertible debt 0 0 0Other LT liabilities (43) 450 1,093Total liabilities 17,582 23,908 23,575Minority interest 0 0 0Preferred stock 0 0 0Common stock 3,045 3,045 3,045Retained earnings 53,680 60,945 66,289Proposed dividends 0 0 0Other equity and reserves 3,811 3,788 3,788Total shareholders' equity 60,536 67,777 73,122Total equity & liabilities 78,118 91,685 96,697

Liquidity (x)Current ratio 2 3 2Interest cover 53 27 19

LeverageNet debt/equity (%) (10) (4) (0)

Activity (days)Days receivable 13 13 14Days inventory 55 53 56Days payable 82 73 73Source: Nomura estimates

Gearing is much more comfortable compared with earlier downcycles



This page has been intentionally left blank


ITC Limited ITC IN

CONSUMER | INDIA

Manish Jain +91 22 4037 4186 [email protected]

Strong tailwinds Cigarettes: strong growth ahead We believe that the core cigarette business (around 90% of consolidated EBIT in FY09) is on a strong growth path, given: 1) easing competition in India; 2) minimal regulatory risk, given that India fully complies with tobacco control convention norms; 3) minimal taxation risk, given that a goods and services tax is likely to be implemented soon; and 4) the company enjoys strong pricing power.

Our estimates show the business easily sustaining 10-12% pa revenue growth and 18-20% pa EBIT growth over the medium term.

Hotels: strong revival ahead Among the other key businesses, we think the outlook looks fairly strong for the hotels business. In the aftermath of the recent macro economic turbulence, average room rates and occupancy have begun to climb steadily in the past few months. We believe that this business is poised for a strong revival in FY11F, which the market has yet to factor in.

Shrinking losses from non-cigarette FMCG The company has guided for a 25% y-y reduction in losses in the non-cigarette FMCG business in FY10F and breakeven by FY12F. This, in our view, augurs well for ITC.

Valuation relatively inexpensive; BUY reaffirmed At 20.1x FY11F EPS of INR12.7, we believe that the risk-reward is favourable given a strong earnings outlook and relatively inexpensive valuation. We value ITC using sum-of-the-parts methodology. We value the core cigarette business at INR227/share, based on 19x FY11F earnings of INR11.9. The other core businesses are valued at around INR71/share. We value the net cash at book value. As for risks to our call, we note that any structural change in regulations could hamper the growth trajectory of the core cigarette business.

Key financials & valuations31 Mar (INRmn) FY08 FY09 FY10F FY11FRevenue 147,877 164,655 178,186 207,881Reported net profit 31,578 33,246 39,884 47,962Normalised net profit 30,255 32,411 39,884 47,962Normalised EPS (INR) 8.38 8.81 10.57 12.71Norm. EPS growth (%) 10.5 7.0 23.1 20.3 Norm. P/E (x) 31.9 29.8 24.2 20.1EV/EBITDA (x) 19.1 17.3 14.3 11.8Price/book (x) 7.8 6.8 6.0 5.4Dividend yield (%) 1.4 1.4 1.9 2.7ROE (%) 26.1 24.4 26.4 28.3 Net debt/equity (%) na na na naEarnings revisionsPrevious norm. net profit 32,411 39,884 47,962Change from previous (%) - - -Previous norm. EPS (INR) 8.8 10.6 12.7Source: Company, Nomura estimates


1m 3m 6m (3.0) 10.0 28.7 (3.6) 13.1 33.9 (4.8) 4.1 4.4

Easy



Unit Trust of India

Stock borrowability

11.84

Major shareholders (%)Life Insurance corp. of India 13.59



67.0268.9/158.4

24.78

140160180200220240260280

Dec

08

Jan0

9

Feb0

9

Mar

09

Apr0

9

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

60708090100110120130

PriceRel MSCI India

(Rs)

Closing price on 24 Dec INR256

Price target INR309(set on 28 Oct 09)



Nomura vs consensus We believe the market is still underestimating potential growth in the cigarette business and has yet to factor in the revival in other businesses, such as hotels.

Maintained

BUY


Action We believe that ITC should enjoy strong tailwinds in the core cigarette business in

the near to medium term. After two difficult years, demand is steadily returning and strong pricing power means ITC is likely to see margins expand from current levels. We reaffirm our BUY rating and price target of INR309.

Catalysts Strong growth in the cigarette business along with a revival in the hotels business

should be key catalysts.

Anchor themes

We believe that the cigarette business in India is poised for strong growth in the near to medium term. Demand at the bottom end has been fairly strong from the rural markets, on the back of a steady increase in rural incomes and government support.


ITC Limited Manish Jain

4January 2010 Nomura 83

Strong revenue growth aided by robust growth across all businesses


Income statement (INRmn)Year-end 31 Mar FY08 FY09 FY10F FY11F FY12FRevenue 147,877 164,655 178,186 207,881 236,259Cost of goods sold 59,430 63,946 62,892 71,324 79,229Gross profit 88,447 100,709 115,294 136,557 157,030SG&A 41,280 48,043 52,569 60,999 68,824Operating profit 47,168 52,666 62,725 75,558 88,206

EBITDA 47,168 52,666 62,725 75,558 88,206Depreciation 4,729 5,809 6,516 7,311 7,974EBIT 42,439 46,858 56,209 68,247 80,233Net interest expense 192 290 196 177 177Other income 3,182 2,446 3,515 3,515 3,215Earnings before tax 45,429 49,013 59,529 71,585 83,271Income tax 14,970 16,254 19,644 23,623 27,479Net profit after tax 30,459 32,759 39,884 47,962 55,791Minority interests (204) (348) - - - Normalised NPAT 30,255 32,411 39,884 47,962 55,791Extraordinary items 1,323 835 - - - Reported NPAT 31,578 33,246 39,884 47,962 55,791

Valuation and ratio analysisFD normalised P/E (x) 31.9 29.8 24.2 20.1 17.3 FD normalised P/E at price target (x) 38.5 36.0 29.2 24.3 20.9 Reported P/E (x) 30.6 29.1 24.2 20.1 17.3 Dividend yield (%) 1.4 1.4 1.9 2.7 3.8 Price/book (x) 7.8 6.8 6.0 5.4 5.0 EV/EBITDA (x) 19.1 17.3 14.3 11.8 10.1 Gross margin (%) 59.8 61.2 64.7 65.7 66.5 EBITDA margin (%) 31.9 32.0 35.2 36.3 37.3 Net margin (%) 20.6 19.9 22.4 23.1 23.6 Effective tax rate (%) 33.0 33.2 33.0 33.0 33.0 Dividend payout (%) 51.0 51.0 52.0 63.0 75.0 ROE (%) 26.1 24.4 26.4 28.3 30.1

Growth (%)Revenue 16.0 11.3 8.2 16.7 13.7 EBITDA 13.6 9.5 20.2 19.4 15.6 Normalised EPS 10.5 7.0 23.1 20.3 16.3 Normalised FDEPS 10.5 7.0 23.1 20.3 16.3

Per shareReported EPS (INR) 8 9 11 13 15Norm EPS (INR) 8 9 11 13 15Fully diluted norm EPS (INR) 8 9 11 13 15Book value per share (INR) 33 37 42 47 51DPS (W) 4 4 5 7 10Source: Nomura estimates



Strong cashflow to sustain ambitious expansion plans

Cashflow (INRmn)Year-end 31 Mar FY08 FY09 FY10F FY11F FY12FEBITDA 47,168 52,666 62,725 75,558 88,206Change in working capital (1,077) (2,888) (1,852) (3,906) (3,909)Other operating cashflow (10,657) (13,264) (16,325) (20,285) (24,441)Cashflow from operations 35,434 36,514 44,548 51,367 59,856Capital expenditure (23,051) (18,200) (15,000) (7,569) (5,000)Free cashflow 12,383 18,315 29,548 43,798 54,856Reduction in investments (1,020) 1,008 - - - Net acquisitionsReduction in other LT assetsAddition in other LT liabilitiesAdjustmentsCashflow after investing acts 11,363 19,323 29,548 43,798 54,856Cash dividends (15,568) (16,452) (20,640) (30,336) (41,704)Equity issue 6 6 - - - Debt issue 240 (383) - - 189Others (148) (180) - - (304)Cashflow from financial acts (15,469) (17,009) (20,640) (30,336) (41,820)Net cashflow (4,107) 2,314 8,908 13,462 13,036Beginning cash 10,865 7,768 13,183 22,091 35,554Ending cash 7,768 13,183 22,091 35,554 48,705Ending net debt 2,249 1,867 1,867 1,867 1,867Source: Nomura estimates

Balance sheet (INRmn)As at 31 Mar FY08 FY09 FY10F FY11F FY12FCash & equivalents 7,768 13,183 22,091 35,554 48,705Marketable securities 26,079 25,071 25,071 25,071 25,071Accounts receivable 1,577 2,326 2,517 2,937 3,236Inventories 42,683 47,943 51,883 60,371 71,201Other current assets 21,312 21,669 23,449 27,357 31,070Total current assets 99,419 110,192 125,012 151,289 179,283Fixed assets 78,193 91,258 99,741 99,999 97,026Total assets 177,611 201,450 224,753 251,288 276,309Short-term debt 2,249 1,867 1,867 1,867 1,867Accounts payable 29,708 32,147 34,789 40,587 48,546Other current liabilities 16,213 17,252 18,669 21,781 24,754Total current liabilities 48,170 51,266 55,325 64,234 75,167Long-term debt - - - - - Total liabilities 48,170 51,266 55,325 64,234 75,167Minority interest 1,132 1,300 1,300 1,300 1,300Common stock 3,769 3,774 3,774 3,774 3,774Retained earnings 119,105 136,504 155,748 173,374 187,462Other equity and reserves 5,436 8,606 8,606 8,606 8,606Total shareholders' equity 129,442 150,184 169,428 187,054 201,142Total equity & liabilities 177,611 201,450 224,753 251,288 276,309Source: Nomura estimates





Nagarjuna Construction NJCC IN

ENGINEERING & CONSTRUCTION | INDIA

Saion Mukherjee +91 22 4037 4184 [email protected]

Diversified presence Well diversified orderbook NJCC has a well diversified orderbook, with a presence across many segments. Unlike other mid-tier construction companies, aside from just being exposed to infrastructure, NJCC has a presence in the industrial and international segments. As indicated in the Exhibit below, diversification has increased over the years with NJCC’s entry into new segments such as metals, oil & gas and the international market. Transportation / roads has witnessed a continuous decline, but that may change as award activity picks up in the road segment.

Exhibit 104. Orderbook - diversified across segments

% 0

% 20

% 40

% 60

% 80

100

FY03 FY04 FY05 FY06 FY07 FY08 FY09

International

Metals

Oil & gas

Power

Real estate

Irrigation & hydropower

Electrical

Water & environment

Transportation

Industrial structures &housing

(%)


Key financials & valuations31 Mar (INRmn) FY08 FY09F FY10F FY11FRevenue 34,729 41,514 47,989 54,453Reported net profit 1,619 1,539 2,578 2,546Normalised net profit 1,619 1,539 2,172 2,546Normalised EPS (INR) 6.40 6.00 8.47 9.92Norm. EPS growth (%) 8.0 (6.2) 41.2 17.2 Norm. P/E (x) 25.92 27.65 19.58 16.71EV/EBITDA (x) 14.9 14.4 11.2 9.9Price/book (x) 2.7 2.5 1.9 1.7Dividend yield (%) 0.8 0.7 0.7 0.7ROE (%) 10.4 9.1 9.5 10.2 Net debt/equity (%) 42.0 65.8 42.5 45.2 Earnings revisionsPrevious norm. net profit 1,539 2,172 2,546Change from previous (%) na na naPrevious norm. EPS (INR) 6.00 8.47 9.92Source: Company, Nomura estimates


1m 3m 6m (1.9) 14.1 32.9 (2.4) 17.3 38.3 (3.7) 8.2 8.8

Hard

6.05 6.00


20.50


Blackstone GPV Capital Partners Mauritius V Ltd

Stock borrowability



HDFC Trustee Company Ltd A/cHSBC Global Investment Funds A/c

91279.5

177.7/37.107.41

8.33

Major shareholders (%)AVS Raju and related enitities

23

73

123

173

223

Dec

08

Jan0

9

Feb0

9

Mar

09

Apr0

9

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

50

70

90

110

130


(Rs)


Price target INR197(set on 2 Oc t 09)



Nomura vs consensus Nomura’s FY10F EPS is 10% above consensus and FY11F EPS is 2% above consensus.

Maintained

BUY


Action Nagarjuna Construction (NJCC) has recorded strong order inflows and we expect it

to benefit from a pick-up in award activity, particularly in the infrastructure segment. A diversified orderbook allows NJCC to participate in a pick-up in corporate capex as well. Lower expectations and an improving outlook are key reasons to BUY.

Catalysts A positive surprise in order-booking for domestic and international markets, steady

execution and unlocking value at subsidiaries.

Anchor themes

Nagarjuna Construction has a diversified presence across many segments in infrastructure and corporate capex and is a play on a pick-up in investments. We expect companies such as NJCC to retain bargaining power, given the dearth of large contracting companies.


Nagarjuna Construction Saion Mukherjee


On track in order inflows NJCC has reported strong new orders, worth INR53bn, so far for FY10, which is 82% of its guidance of INR65bn for FY10F. We expect strong inflows from roads and the international segment in the near term. The company is set to beat guidance for the year, in our view.

Margin pressures have eased EBITDA margins are likely to return to FY07-08 levels. FY09 was an aberration on account of provisioning for losses for road projects and (to an extent) higher commodity prices. For 1H FY10, the company has reported a 41.2bps improvement in the EBITDA margin year-on-year. We expect a substantial improvement in 2H, on account of a low base. Management now expects an FY10F EBITDA margin of 10.25-10.5%, higher than its earlier guidance of 9.5-10.0%.

Unlocking value at subsidiary is a possibility Unlocking value at its infrastructure subsidiary is a possibility. NJCC has one of the largest portfolios of BOT assets, with an equity investment of INR4.6bn. Currently, the company has nine BOT projects (excluding Gautami Power) that are in various stages of development. Value unlocking can happen through a stake sale of assets or potential listing of the subsidiary. We believe NJCC will require additional equity funding and hence will explore stake sale and listing opportunities.

Attractive valuations, in our view On a standalone basis (excluding international orders), NJCC had a backlog ratio of 2.8x as of September 2009. We expect this backlog ratio to hold or even improve on the back of strong order inflows. Adjusted for the subsidiary valuation, the stock is trading at 11.6x FY11F P/E and 12.0x one-year forward EPS, which we reckon is attractive and is at the lower end of the fair value range of 10-15x. We value NJCC using a sum-of-the-parts methodology. The core construction business is valued at 13.5x one-year forward earnings, to arrive at the value of INR146. We value NJCC's construction business in-line with other mid-tier construction companies and at a 40% discount to L&T (LT IN, INR1,682, BUY). We have valued the BOT segment at 2x equity invested and NJCC Urban at its current book value. We have separately valued the current orderbook in its international operations. Our 12-month price target is INR197. The key risks to our call are a deterioration in the macro environment, execution delays and a fall in subsidiary valuations.

The chief risk is macro risk, given the sector



Potential for upside in revenues in FY11F on the back of strong order inflow in FY10 to date

Management guides for FY10F margin in the range 10.25-10.5%

Financial statements Income statement (INRmn)Year-end 31 Mar FY08 FY09 FY10F FY11F FY12FRevenue 34,729 41,514 47,989 54,453 64,161Operating profit 3,171 3,245 4,203 4,764 5,650

EBITDA 3,598 3,737 4,799 5,445 6,416Depreciation (482) (533) (626) (711) (797)Amortisation - - - - - EBIT 3,116 3,204 4,173 4,734 5,620Net interest expense (719) (964) (982) (989) (1,172)Associates & JCEs - - - - - Other income 56 42 30 30 30Earnings before tax 2,452 2,282 3,222 3,776 4,478Income tax (811) (743) (1,049) (1,230) (1,458)Net profit after tax 1,641 1,539 2,172 2,546 3,020Minority interests - - - - - Other items (22) - - - - Preferred dividends - - - - - Normalised NPAT 1,619 1,539 2,172 2,546 3,020Extraordinary items - - 406 - - Reported NPAT 1,619 1,539 2,578 2,546 3,020Dividends (348) (295) (295) (295) (295)Transfer to reserves 1,271 1,244 2,284 2,251 2,725

Valuation and ratio analysisFD normalised P/E (x) 25.9 27.7 19.6 16.7 14.1 FD normalised P/E at price target (x) 30.8 32.8 23.3 19.8 16.7 Reported P/E (x) 26.3 27.7 16.5 16.7 14.1 Dividend yield (%) 0.8 0.7 0.7 0.7 0.7 Price/cashflow (x) 21.9 22.4 16.4 14.1 12.0 Price/book (x) 2.7 2.5 1.9 1.7 1.5 EV/EBITDA (x) 14.9 14.4 11.2 9.9 8.4 EV/EBIT (x) 17.2 16.7 12.9 11.3 9.5 Gross margin (%)EBITDA margin (%) 10.4 9.0 10.0 10.0 10.0 EBIT margin (%) 9.0 7.7 8.7 8.7 8.8 Net margin (%) 4.7 3.7 4.5 4.7 4.7 Effective tax rate (%) 33.1 32.6 32.6 32.6 32.6 Dividend payout (%) 21.5 19.1 13.6 11.6 9.8 Capex to sales (%) 4.6 3.9 2.3 1.8 1.6 Capex to depreciation (x) 3.3 3.0 1.7 1.4 1.3 ROE (%) 10.4 9.1 9.5 10.2 10.9 ROA (pretax %) 8.5 7.4 8.0 8.5 9.0

Growth (%)Revenue 21.0 19.5 15.6 13.5 17.8 EBITDA 33.4 3.9 28.4 13.5 17.8 EBIT 29.9 2.8 30.3 13.4 18.7 Normalised EPS 8.0 (6.2) 41.2 17.2 18.6 Normalised FDEPS 8.0 (6.2) 41.2 17.2 18.6

Per shareReported EPS (INR) 6.31 6.00 10.05 9.92 11.77Norm EPS (INR) 6.40 6.00 8.47 9.92 11.77Fully diluted norm EPS (INR) 6.40 6.00 8.47 9.92 11.77Book value per share (INR) 61.3 65.7 88.9 97.7 108.3DPS (INR) 1.3 1.1 1.1 1.1 1.1Source: Nomura estimates



Cash outflow for investments could be higher than expected in FY11F if stake sale/listing does not happen

Cashflow (INRmn)Year-end 31 Mar FY08 FY09 FY10F FY11F FY12FEBITDA 3,653 3,778 4,829 5,475 6,446Change in working capital (4,292) (4,485) (2,211) (2,207) (3,315)Other operating cashflow (2,778) (4,559) (2,714) (2,597) (3,920)Cashflow from operations (3,416) (5,266) (96) 671 (789)Capital expenditure (1,588) (1,613) (1,082) (1,000) (1,000)Free cashflow (5,004) (6,879) (1,178) (329) (1,789)Reduction in investments (2,104) (1,290) (1,210) (1,000) (1,000)Net acquisitions - - - - - Reduction in other LT assets - 1,538 - - - Addition in other LT liabilities - - - - - Adjustments (0) 0 - - - Cashflow after investing acts (7,108) (6,631) (2,388) (1,329) (2,789)Cash dividends (228) (348) (295) (295) (295)Equity issue 4,050 0 3,673 - - Debt issue 2,569 3,501 - - 2,000Convertible debt issue - - - - - Others - - - - - Cashflow from financial acts 6,390 3,153 3,379 (295) 1,705Net cashflow (718) (3,478) 991 (1,623) (1,084)Beginning cash 2,434 2,330 1,345 2,754 1,113Ending cash 2,330 1,345 2,754 1,113 819Ending net debt 6,608 11,094 9,685 11,325 13,620Source: Nomura estimates

Balance sheet (INRmn)As at 31 Mar FY08 FY09 FY10F FY11F FY12FCash & equivalents 2,330 1,345 2,754 1,113 819Marketable securities 1,898 2,223 1,683 1,683 2,683Accounts receivable 8,677 10,260 11,861 13,458 15,858Inventories 5,493 7,495 8,664 9,832 11,584Other current assets 11,888 12,291 14,913 16,717 18,334Total current assets 30,286 33,615 39,875 42,803 49,277LT investments 3,750 5,180 6,930 7,930 7,930Fixed assets 5,339 4,873 5,330 5,619 5,822Goodwill - - - - - Other intangible assets - - - - - Other LT assets 1,898 2,223 1,683 1,683 2,683Total assets 41,274 45,891 53,817 58,034 65,712Short-term debt 1,750 3,575 3,575 3,575 5,575Accounts payable 6,025 6,357 7,349 8,338 9,825Other current liabilities 10,419 10,051 11,029 12,005 13,471Total current liabilities 18,194 19,983 21,952 23,918 28,871Long-term debt 7,188 8,864 8,864 8,864 8,864Convertible debt - - - - - Other LT liabilities 167 188 188 188 188Total liabilities 25,549 29,035 31,004 32,970 37,922Minority interest - - - - - Preferred stock - - - - - Common stock 460 458 513 513 513Retained earnings 15,208 16,398 22,300 24,551 27,276Proposed dividends - - - - - Other equity and reserves 54 - - - - Total shareholders' equity 15,723 16,855 22,813 25,064 27,789Total equity & liabilities 41,274 45,891 53,817 58,034 65,712

Liquidity (x)Current ratio 1.66 1.68 1.82 1.79 1.71 Interest cover 4.3 3.3 4.3 4.8 4.8

LeverageNet debt/EBITDA (x) 1.84 2.97 2.02 2.08 2.12 Net debt/equity (%) 42.0 65.8 42.5 45.2 49.0

Activity (days)Days receivable 91.2 90.2 90.2 90.2 90.2 Days inventory 57.7 65.9 65.9 65.9 65.9 Days payable 63.3 55.9 55.9 55.9 55.9 Cash cycle 79.3 104.9 116.2 117.2 115.2 Source: Nomura estimates


HCL Technologies HCLT IN

SOFTWARE & IT SERVICES | INDIA

Harmendra Gandhi +91 22 4037 4181 [email protected] Pinku Pappan (Associate) +91 22 4037 4360 [email protected]

Good top-line growth Ahead of peers in revenue growth HCL Tech’s revenues have grown faster than peers such as Infosys and Wipro in recent quarters, and it has done so by winning a series of large deals despite the challenging environment for IT spending. The company's focus on infrastructure services and total outsourcing has resulted in an order book of more than US$2bn.

Improved margins HCL Tech’s EBITDA margin has widened in the past two quarters and, at 22.7% currently is back to the level of a year ago. We think this is impressive considering HCL Tech has acquired and integrated large companies such as Axon during this period.

EPS growth to improve significantly in FY11F The forex overhang that has affected EPS growth will likely be over by the next four quarters, on our reading. Moreover, debt was recently restructured, with the average cost of debt coming down to around 6%. We see the improved picture on forex and debt supporting robust EPS growth at HCL Tech in FY11F; our forecasts call for an EPS CAGR of around 22% in FY09-11F.

BUY reaffirmed HCL Tech is trading at discounts of 35% and 40% to Infosys on one-year forward and two-year forward P/E multiples, respectively. On FY11F EV/EBITDA, the stock is at a 50% discount to Infosys, on our estimate. We believe this discount will narrow. Our DCF-based price target of INR397 is calculated using an 11% discount rate and 5% terminal growth rate assumption and implies 14x one-year forward P/E, which marks a 30% discount to the one-year forward multiple implied by our price target for Infosys. Sharp appreciation of the rupee against the US dollar stands as a risk to our BUY call.

Key financials & valuations30 Jun (INRmn) FY08 FY09F FY10F FY11FRevenue 74,772 106,311 122,354 138,037Reported net profit 11,136 12,784 12,973 18,955Normalised net profit 11,136 12,784 12,973 18,955Normalised EPS (INR) 16.7 19.1 19.4 28.3Norm. EPS growth (%) (20.3) 14.4 1.5 46.1 Norm. P/E (x) 22.5 19.6 19.4 13.3EV/EBITDA (x) 15.0 11.8 10.1 8.9Price/book (x) 4.8 4.4 3.7 3.0Dividend yield (%) 2.5 2.8 1.2 1.2ROE (%) 21.8 23.5 20.8 25.0 Net debt/equity (%) net cash 45.0 32.2 15.7 Earnings revisionsPrevious norm. net profit 12,784 12,973 18,955Change from previous (%) na na naPrevious norm. EPS (INR) 19.1 19.4 28.3Source: Company, Nomura estimates


1m 3m 6m 10.4 8.1 96.2 9.7 11.1 104.0 8.5 2.0 74.5

Easy


5,12730.0

374.9/89.710.12



Major shareholders (%)Shiv Nadar 60.00


61111161211261311361411

Dec

08

Jan0

9

Feb0

9

Mar

09

Apr

09

May

09

Jun0

9

Jul0

9

Aug

09

Sep

09

Oct

09

Nov

09

7090110130150170190

PriceRel MSCI India

(Rs)





Note: price target under review

Nomura vs consensus Our forecasts are above consensus, since we expect HCL Tech’s top line growth to be better than its peers’.

Maintained

BUY

Action HCL Tech has grown revenues faster than peers such as Infosys and TCS in the

past few quarters, and we believe the company will continue to outperform peers in q-q volume growth in the near term, owing to its focus on infrastructure services and total outsourcing. We reaffirm our BUY call and price target of INR397.

Catalysts IT budgets for calendar 2010F should be firmed up by end-December, and we

believe HCL Tech will be able to sustain its momentum in deal wins.

Anchor themes

HCL Tech has won a series of large deals despite a challenging environment for IT spending. Strong top-line growth and reduced forex losses should significantly improve EPS in FY11F. We look for the stock’s 50% discount to Infosys in terms of EV/EBITDA (FY11F) to narrow.




HCL Technologies Harmendra Gandhi


Significant improvement in Net profit for FY11F


Income statement (INRmn)Year-end 30 Jun FY07 FY08F FY09F FY10F FY11FRevenue 60,332 74,772 106,311 122,354 138,037Cost of goods sold (39,616) (48,285) (69,071) (82,083) (91,502)Gross profit 20,716 26,487 37,240 40,271 46,535SG&A (9,887) (12,903) (18,260) (18,701) (22,343)Employee share expense - - - - - Operating profit 10,829 13,584 18,980 21,569 24,192

EBITDA 13,361 16,549 23,467 27,083 29,938Depreciation (2,532) (2,965) (4,487) (5,514) (5,747)Amortisation - - - - - EBIT 10,829 13,584 18,980 21,569 24,192Net interest expense 985 1,672 1,626 (738) (154)Associates & JCEs - - - - - Other income 3,441 (2,842) (5,298) (4,926) (900)Earnings before tax 15,255 12,414 15,308 15,905 23,138Income tax (1,521) (1,258) (2,544) (2,919) (4,165) Net profit after tax 13,734 11,156 12,764 12,987 18,973Minority interests (58) (20) 29 - - Other items (11) - (10) (14) (18)Preferred dividends - - - - - Normalised NPAT 13,666 11,136 12,784 12,973 18,955Extraordinary itemsReported NPAT 13,666 11,136 12,784 12,973 18,955Dividends (5,853) (6,375) (7,156) (3,138) (3,138)Transfer to reserves 7,813 4,761 5,628 9,835 15,817

Valuation and ratio analysisFD normalised P/E (x) 17.9 22.5 19.6 19.4 13.3 FD normalised P/E at price target (x) - - - - - Reported P/E (x) 17.9 22.5 19.6 19.4 13.3 Dividend yield (%) 2.4 2.5 2.8 1.2 1.2 Price/cashflow (x) 22.8 17.7 25.2 9.7 8.7 Price/book (x) 4.9 4.8 4.4 3.7 3.0 EV/EBITDA (x) 18.6 15.0 11.8 10.1 8.9 EV/EBIT (x) 23.0 18.3 14.6 12.7 11.0 Gross margin (%) 34.3 35.4 35.0 32.9 33.7 EBITDA margin (%) 22.1 22.1 22.1 22.1 21.7 EBIT margin (%) 17.9 18.2 17.9 17.6 17.5 Net margin (%) 22.7 14.9 12.0 10.6 13.7 Effective tax rate (%) 10.0 10.1 16.6 18.4 18.0 Dividend payout (%) 42.8 57.3 56.0 24.2 16.6 Capex to sales (%) 7.2 8.3 6.0 5.7 5.8 Capex to depreciation (x) 1.7 2.1 1.4 1.3 1.4

ROE (%) na 21.8 23.5 20.8 25.0 ROA (pretax %) na 20.0 19.1 17.0 17.4

Growth (%)Revenue 37.5 23.9 42.2 15.1 12.8 EBITDA 41.0 23.9 41.8 15.4 10.5 EBIT 46.0 25.4 39.7 13.6 12.2 Normalised EPS 73.9 (20.3) 14.4 1.5 46.1 Normalised FDEPS 73.9 (20.3) 14.4 1.5 46.1

Per shareReported EPS (INR) 21 17 19 19 28Norm EPS (INR) 21 17 19 19 28Fully diluted norm EPS (INR) 21 17 19 19 28Book value per share (INR) 77 78 85 102 125DPS (W) 9 10 11 5 5Source: Nomura estimates



Debt-to-equity position to improve in FY11F

Cashflow (INRmn)Year-end 30 Jun FY07 FY08F FY09F FY10F FY11FEBITDA 13,361 16,549 23,467 27,083 29,938Change in working capital (3,296) 2,227 401 (1,099) (1,058)Other operating cashflow 685 (4,598) (13,902) - - Cashflow from operations 10,750 14,178 9,966 25,984 28,881Capital expenditure (4,320) (6,200) (6,400) (7,000) (8,000)Free cashflow 6,430 7,978 3,566 18,984 20,881Reduction in investments (2,068) (1,520) 5,718 197 - Net acquisitions - - (30,932) - - Reduction in other LT assets - (2,714) (3,542) (7,661) (7,055)Addition in other LT liabilities - 4,667 1,675 1,420 1,543Adjustments - - - - - Cashflow after investing acts 4,362 8,411 (23,515) 12,940 15,369Cash dividends (5,853) (6,375) (7,156) (3,138) (3,138)Equity issue 2,080 409 202 - - Debt issue - 27,060 - - Convertible debt issue - - - - - Others 710 (2,192) 3,771 (7,071) (3,481)Cashflow from financial acts (3,063) (8,158) 23,878 (10,209) (6,619)Net cashflow 1,299 253 363 2,731 8,750Beginning cash 2,288 3,587 3,840 4,203 6,934Ending cash 3,587 3,840 4,203 6,934 15,685Ending net debt (3,587) (3,840) 25,568 21,895 13,144Source: Nomura estimates

Balance sheet (INRmn)As at 30 Jun FY07 FY08F FY09F FY10F FY11FCash & equivalents 3,587 3,840 4,203 6,934 15,685Marketable securities 19,264 20,779 14,792 14,596 14,596Accounts receivable 12,278 18,940 27,083 28,889 33,813Inventories - - - - - Other current assets 7,117 8,713 10,699 9,935 11,628Total current assets 42,246 52,272 56,777 60,354 75,722LT investments 96 101 370 369 369Fixed assets 10,495 13,317 15,862 17,445 19,698Goodwill - - - - - Other intangible assets 8,061 9,585 45,325 44,111 42,373Other LT assets 2,349 5,063 8,605 16,266 23,321Total assets 63,247 80,338 126,939 138,545 161,483Short-term debt - - - - - Accounts payable 7,696 14,616 21,566 21,528 25,197Other current liabilities 3,964 7,529 11,110 11,090 12,980Total current liabilities 11,660 22,145 32,675 32,618 38,178Long-term debt - - 29,771 28,829 28,829Convertible debt - - - - - Other LT liabilities 1,292 5,959 7,634 9,054 10,598Total liabilities 12,952 28,104 70,080 70,501 77,604Minority interest 145 57 16 16 16Preferred stock - - - - - Common stock 1,327 1,333 1,341 1,341 1,341Retained earnings 48,823 50,844 55,503 66,687 82,522Proposed dividends - - - - -

Other equity and reserves - - - - - Total shareholders' equity 50,150 52,177 56,843 68,027 83,862Total equity & liabilities 63,247 80,338 126,939 138,545 161,483

Liquidity (x)Current ratio 3.62 2.36 1.74 1.85 1.98 Interest cover na na na 29.2 157.3

LeverageNet debt/EBITDA (x) net cash net cash 1.09 0.81 0.44 Net debt/equity (%) net cash net cash 45.0 32.2 15.7

Activity (days)Days receivable 78.0 76.4 79.0 83.5 82.9 Days inventory - - - - - Days payable 85.0 84.6 95.6 95.8 93.2 Cash cycle (7.0) (8.2) (16.6) (12.3) (10.3) Source: Nomura estimates





Zee Entertainment Z IN

INTERNET & MEDIA | INDIA

Jamil Ansari +91 22 4037 4192 [email protected] Prabhat Awasthi +91 22 4037 4180 [email protected]

Recovery play Operating environment improving We believe that with the operating environment showing clear signs of improvement, earnings visibility for ZEEL has improved considerably. Our view is that this will be reflected in positive earnings momentum for the company from 3Q FY10F. As we see it, the market is underestimating the cost savings that ZEEL will realise, such that earnings could surprise consensus expectations to the upside.

Multiples highly correlated with ad revenue growth We note that ZEEL’s P/E multiple tends to be highly correlated with the company’s advertising revenue growth. Since we see clear signs of a recovery in advertising revenue growth in the medium term, we look for ZEEL shares to be re-rated in the near term.

Key triggers in 2010F — restructuring benefits and ad revenue growth pick up The proposed restructuring is a significant long-term positive for ZEEL, on our reading, since it will give the company exposure to fast-growing regional markets. We see improvement in advertising revenue growth from 3Q FY10F and possible synergy benefits arising from the recently announced restructuring as potential positive triggers for the stock.

Valuations At the current price, ZEEL is trading at 19.1x FY11F EPS of INR13.9. We value ZEEL at 21x FY11F estimated EPS, which is based on a 30% premium to broader market multiples. Our price target of INR292 implies 10% upside from current levels. Key risks to our positive call on Zee include: 1) a slowdown in economic activity in India, leading to slower-than-expected growth in advertising spending and 2) higher-than-anticipated competition in the Hindi GEC space.

Key financials & valuations31 Mar (INRmn) FY09F FY10F FY11F FY12FRevenue 21,773 23,722 33,139 38,695Reported net profit 5,124 4,832 6,719 7,976Normalised net profit 3,673 4,832 6,719 7,976Normalised EPS (INR) 8.5 10.8 13.9 16.5Norm. EPS growth (%) (4.9) 27.9 28.2 18.7 Norm. P/E (x) 31.4 24.5 19.1 16.1 EV/EBITDA (x) 16.9 14.3 10.2 8.6 Price/book (x) 3.3 3.2 3.2 2.9 Dividend yield (%) 0.5 0.4 0.5 0.5 ROE (%) 11.4 13.3 17.2 18.7 Net debt/equity (%) 11.0 (5.9) (11.7) (14.8)Earnings revisionsPrevious norm. net profit 4,832 6,719 7,976Change from previous (%) na na naPrevious norm. EPS (INR) 10.8 13.9 16.5Source: Company, Nomura estimates


1m 3m 6m 0.9 16.9 56.8 0.4 20.2 63.1

(0.9) 11.1 33.6

Hard


52-week range (INR)3-mth avg daily turnover (US$mn)Stock borrowabilityMajor shareholders (%)Subhash Chandra 41.50



58.5272.0/90.5

8.18

72

122

172

222

272

322

Dec

08

Jan0

9

Feb0

9

Mar

09

Apr0

9

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

60

70

80

90

100


(Rs)





Nomura vs consensus We believe the street is under-estimating the recovery in advertising rates and the effectiveness of ZEEL’s cost management.

Maintained

BUY


Action We expect the improvement in the operating environment for Zee Entertainment

(ZEEL), which started a quarter ago, to continue through 2010F, on robust growth in advertising and stringent cost management. Moreover, we believe the benefits of the company’s recent restructuring will start playing out in 2010F, resulting in incremental growth and profitability. BUY maintained.

Catalysts Recovery in advertising revenue growth and synergies from the merger of regional

channels from the Zee News stable should be key drivers of ZEEL’s stock price in 2010F.

Anchor themes

ZEEL’s P/E multiple tends to be highly correlated with growth in advertising revenue. With advertising revenue set for a rebound in 2010F, we expect Zee’s multiple to be re-rated from current levels.



Zee Entertainment Jamil Ansari



Impact of R-GEC restructuring will be fully visible in FY11

Income statement (INR mn)Year-end 31 Mar FY08 FY09F FY10F FY11F FY12FRevenue 18,354 21,773 23,722 33,139 38,695Cost of goods sold 7818 9810 10176 12463 14331Gross profit 10,536 11,963 13,546 20,676 24,364SG&A 5113 6483 7570 13262 15553Employee share expense - - - - - Operating profit 5,423 5,480 5,976 7,414 8,811

EBITDA 5,423 5,480 5,976 7,414 8,811Depreciation 232 310 348 383 421Amortisation - - - - - EBIT 5,191 5,170 5,628 7,032 8,390Net interest expense 516 1,339 391 360 360Associates & JCEs 5 1 0 0 0Other income 1,138 1,572 1,562 1,719 1,890Earnings before tax 5,818 5,405 6,799 8,390 9,920Income tax 1,627 1,633 2,057 2,517 2,976Net profit after tax 4,191 3,771 4,742 5,873 6,944Minority interests (333) (99) (120) (140) (180)Other items - - - - - Preferred dividends - - - - - Normalised NPAT 3,858 3,673 4,623 5,733 6,764Extraordinary items -26 1,451 0 0 0Reported NPAT 3,833 5,124 4,623 5,733 6,764DividendsTransfer to reserves

Valuation and ratio analysisFD normalised P/E (x) 29.8 31.4 24.5 19.1 16.1FD normalised P/E at price target (x) 32.8 34.5 27.0 21.1 17.7Reported P/E (x) 29.8 31.4 24.5 19.1 16.1Dividend yield (%) 0.4 0.5 0.4 0.5 0.5Price/cashflow (x) 28.1 28.9 22.6 17.5 14.9Price/book (x) 3.9 3.3 3.2 3.2 2.9EV/EBITDA (x) 17.9 16.9 14.3 10.2 8.6EV/EBIT (x) 18.6 17.7 15.1 10.9 9.0Gross margin (%) 57.4 54.9 54.8 54.9 55.3EBITDA margin (%) 29.5 25.2 26.6 26.9 27.5EBIT margin (%) 34.5 31.0 31.9 31.7 32.1Net margin (%) 22.8 17.3 21.1 21.3 21.7Effective tax rate (%) 28.0 30.2 30.3 30.0 30.0Dividend payout (%) 22.5 47.3 46.9 45.4 44.9Capex to sales (%) 2.8 12.4 4.4 1.8 1.6Capex to depreciation (x) 2.3 8.7 2.9 1.3 1.2

ROE (%) 15.3 12.0 13.5 15.5 16.8ROA (pretax %) 19.8 18.2 17.6 20.8 23.0

Growth (%)Revenue 21.1 18.6 9.0 39.7 16.8EBITDA 66.0 7.5 12.1 36.5 17.6EBIT 68.0 6.5 11.1 35.6 18.2Normalised EPS 62.4 (4.9) 27.9 28.2 18.7Normalised FDEPS 62.4 (4.9) 27.9 28.2 18.7

Per shareReported EPS (INR) 8.9 8.5 10.8 13.9 16.5Norm EPS (INR) 8.9 8.5 10.8 13.9 16.5Fully diluted norm EPS (INR) 8.9 8.5 10.8 13.9 16.5Book value per share (INR) 68.6 80.5 84.0 84.2 92.2DPS (W) 2.0 4.0 5.0 6.0 7.0Source: Nomura estimates



Cashflow (INR mn)Year-end 31 Mar FY08 FY09F FY10F FY11F FY12FPre-tax profit 5,792 6,856 7,098 9,799 11,651Depreciation 232 310 414 633 681Tax paid (1,627) (1,633) (2,057) (2,517) (2,976)Chg in working capital (1,551) (5,719) 3,599 (600) (1,726)Other operating activities 0 0 0 0 0Cash flow from operations (a) 2,847 (186) 9,054 7,315 7,630Capital expenditure (923) (2,757) (481) (500) (750)Chg in investments (190) 1,244 0 0 0Chg in associates 5 1 0 0 0Other investing activities 0 0 0 0 0Cash flow from investing (b) (1,107) (1,511) (481) (500) (750)Free cash flow (a+b) 1,740 (1,697) 8,574 6,815 6,880Equity raised/(repaid) 0 0 (0) 0 0Chg in minorities 299 (169) 120 140 180Debt raised/(repaid) 640 1,891 (2,257) (1,000) (1,000)Dividend (incl. tax) (498) (538) (503) (594) (673)Other financing activities (168) 0 0 0 0Cash flow from financing (c) 272 1,185 (2,640) (1,454) (1,493)Net chg in cash (a+b+c) 2,012 (513) 5,934 5,361 5,388Beginning cash 955 1,652 1,926 5,708 7,260Ending cash 1,652 1,926 5,708 7,260 8,112Ending net debt 2,214 3,831 (2,208) (4,760) (6,612)Source: Nomura estimates

Balance sheet (INR mn)As at 31 Mar FY08 FY09F FY10F FY11F FY12FCash & equivalents 1,652 1,926 5,708 7,260 8,112Marketable securities - - - - - Accounts receivable 5907.2 6436.5 7158.3 8385.6 10060.4Inventories 31.9 43.9 59.7 61.7 75.6Other current assets 13917.2 18619.6 14951.8 14880.8 16418.8Total current assets 21,508 27,026 27,878 30,588 34,666LT investments 2,515 1,271 1,271 1,271 1,271Fixed assets 15,605 18,093 18,225 18,342 18,671Goodwill - - - - - Other intangible assets - - - - - Other LT assets 243.1 112.8 112.8 112.8 112.8Total assets 39,872 46,503 47,487 50,314 54,721Short-term debt - - - - - Accounts payable 4152 4318 4772 4933 6051Other current liabilities 2127 1486 1700 2098 2480Total current liabilities 6,279 5,803 6,472 7,030 8,531Long-term debt 3866 5757 3500 2500 1500Convertible debt - - - - - Other LT liabilities - - - - - Total liabilities 10,144 11,560 9,972 9,530 10,031Minority interest 1117 948 1067 1207 1387Preferred stock - - - - - Common stock 433.6 434.0 434.0 434.0 434.0Retained earnings 28177 33561 36014 39143 42869Proposed dividends - - - - - Other equity and reserves - - - - - Total shareholders' equity 28,611 33,995 36,448 39,577 43,303Total equity & liabilities 39,872 46,503 47,487 50,314 54,721

Liquidity (x)Current ratio 3.4 4.7 4.3 4.4 4.1Interest cover 12.3 5.0 19.2 28.2 33.4

LeverageNet debt/EBITDA (x) 0.3 0.5 (0.3) (0.5) (0.6)Net debt/equity (%) 7.4 11.0 (5.9) (11.7) (14.8)

Activity (days)Days receivable 117 119 120 136 133Days inventory 1 1 1 1 1Days payable 83 80 80 80 80Cash cycleSource: Nomura estimates

ZEEL expected to generate significant free cash in the next few years





Tata Steel TATA IN

STEEL | INDIA

Prabhat Awasthi +91 22 4037 4180 [email protected] Alok Kumar Nemani (Associate) +91 22 4037 4193 [email protected]

Showing its mettle A turnaround story We expect Tata Steel India to see significant earnings expansion on account of new capacity, lower raw material costs and an improving price cycle. With its European operations improving rapidly, we believe the negative attribution to Corus will turn positive with a turnaround in earnings. This, in our view, makes Tata Steel one of the most attractive plays in India’s steel sector.

Sharp improvement in FY11F consolidated earnings We expect Tata Steel to post consolidated losses for FY10F due to hefty losses at Corus attributable to low capacity utilisation, high restructuring costs and increased raw material prices. However, we look for a return to profit in FY11F, with the domestic operations remaining strong and a turnaround at Corus. We forecast consolidated net profit of INR79.7bn for FY11F and INR107.4bn for FY12F, up from a loss of INR23.5bn in FY10F.

Corus likely to become a profit centre After reporting losses for the past year, we believe Corus will return to profitability from 4Q10F (adjusted for one-offs), owing to: 1) falling coal costs; 2) the mothballing of the Teesside steel plant; 3) cost cutting measures; and 4) improving capacity utilisation. These factors should see total EBITDA rise from -US$375mn in 2Q10F to US$250mn in 3Q10F and US$350mn in 4Q10F. Moreover, with the full impact of the company’s restructuring and a stronger steel cycle, we expect EBITDA to improve further in FY11F to US$1.7bn.

Key financials & valuations31 Dec (INRmn) FY09 FY10F FY11F FY12FRevenue 1,512,646 1,067,038 1,236,746 1,390,256Reported net profit 50,509 (23,487) 79,721 107,396Normalised net profit 91,510 (6,461) 79,721 107,396Normalised EPS (INR) 125.2 (7.3) 89.9 121.0Norm. EPS growth (%) 21.9 (105.8) n/a 34.7 Norm. P/E (x) 4.9 6.9 5.1EV/EBITDA (x) 5.3 11.6 4.9 3.7Price/book (x) 1.6 1.7 1.4 1.1Dividend yield (%) 3.3 2.6 2.5 2.5ROE (%) 34.8 (2.1) 22.0 24.4 Net debt/equity (%) 190.8 142.8 111.1 72.8 Earnings revisionsPrevious norm. net profit (23,487) 79,721 107,396Change from previous (%) na na naPrevious norm. EPS (INR) (7.3) 89.9 121.0 Source: Compa ny, Nomura e stimate s


1m 3m 6m 10.2 20.1 51.3 9.6 23.4 57.3 8.3 14.4 27.8

Easy

Source: Compa ny, Nomura e stimate s

11,70672.8

616/151.8124.1



Major shareholders (%)Promoters 27.20


100200300400500600700

Dec

08

Jan0

9

Feb0

9

Mar

09

Apr

09

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

70

90

110

130

150


(Rs)

Closing price on 24 Dec 615.6

Price target INR926(set on 16 Dec 09)

Upside/downside 50.4%Difference from consensus 66.8%FY10F net profit (INRmn) -23,487


Nomura vs consensus We are more bullish than the street on Tata Steel, owing to our optimistic view on steel prices, driven by strong demand growth in China and a recovery in developed economies.

Maintained

BUY


Action We reiterate our BUY call on Tata Steel as we believe: 1) it is a much better volume

play relative to peers; 2) its raw material costs are set to decline on account of captive coal; 3) it has the best product mix in the country, enabling the highest realisations and hence the highest profitability in the domestic steel industry; and 4) with improved efficiency at Corus, we look for substantial earnings growth.

Catalysts Two potential triggers for the stock are: 1) increasing steel prices in 1Q10F; and 2)

a return to profit at Corus in 3Q10F.

Anchor themes

With a turnaround expected at Corus, 3mtpa expansion in India and higher captive coal capacity, we rate Tata Steel a BUY even at current steel prices. At CMP, Corus acquires negative equity value, which we believe is unjustified given that the worst appears to be over for Corus and we expect results to improve.

CONVICTION CALL CONVICTION CALL CONVICTION CALL CONVICTION CALL



Tata Steel Prabhat Awasthi


Increased captive coal to boost domestic profitability Tata Steel is also augmenting its coal mine capacity, along with the 3mn tonne expansion at its Jamshedpur plant. After the 1.8mn tonne expansion completed earlier this year, the company’s dependence on imported coking coal has risen from 30% to 50%.

However, with the ongoing capacity expansion of its coal mines, the company expects to meet 60% of its overall coal requirement through domestic coal. This, we believe, should bring the company considerable cost savings.

Appealing valuation We believe current valuations do not fully take into account the improved performance of Corus, nor the 3mn tonne capacity expansion at Jamshedpur. Given the high visibility on the turnaround at Corus, as well as the completion of the 3mn tonne expansion, we believe current valuations provide an attractive opportunity.

We value Tata Steel on a sum-of-the-parts basis at INR926/share. We value Tata Steel India at 9x FY12F EPS of INR92.3. We have discounted this back a year to arrive at our valuation of INR735/share. Meanwhile, we value Corus at 5x FY11F EV/EBITDA which derives a value of US$8.3bn or INR173/share. We value the South East Asia business at US$364mn, contributing INR19/share to our price target. We value the company at 5x FY11F EV/EBITDA, which implies a value of US$393mn.

Risks to price target. Key risks include: 1) persistent steel price weakness; 2) delayed economic recovery; and 3) higher-than-expected raw material prices.

Exhibit 105. Tata Steel: consolidated earnings forecast (INRmn) FY08 FY09 FY10F FY11F FY12FTata Steel India 46,870 52,017 41,128 52,359 81,847Corus 24,630 547 (63,482) 27,161 25,185SE Asia business 7,994 (2,056) (1,133) 200 364Total consolidated profit 79,494 50,509 (23,487) 79,721 107,396EPS (INR) 108.8 69.1 (26.5) 89.9 121.0


Exhibit 106. Tata Steel: sum-of-the-parts valuation Value Value/share (INR)TATA steel standalone (INRmn) 651,876 735EV of Corus (US$mn) 8,293Corus equity value (US$mn) 2,882 173South East Asia business (US$mn) 364 19Price target (INR) 926FY11F P/E (x) 10.3


Exhibit 107. Tata Steel: change in value of domestic business vs steel price Steel price (US$/tonne)

(INR/share) 750 700 650 600 55012 1,148 980 811 643 47411 1,053 898 744 589 43510 957 816 676 535 395

9 861 735 608 482 356P/E multiple

8 765 653 541 428 316


Current valuations provide an attractive opportunity, in our view




Income statement (INR mn)Year-end 31 Dec FY08 FY09 FY10F FY11F FY12FRevenue 1,316,463 1,512,646 1,067,038 1,236,746 1,390,256Cost of goods sold 1,182,621 1,372,647 1,036,890 1,104,068 1,223,972Gross profit 133,842 140,000 30,149 132,678 166,284SG&AEmployee share expenseOperating profit 133,842 140,000 30,149 132,678 166,284

EBITDA 174,618 184,352 75,749 177,363 213,037Depreciation 40,776 44,352 45,600 44,685 46,753AmortisationEBIT 62,658 77,228 (20,826) 83,949 121,922Net interest expense 37,267 32,927 27,488 26,364 24,181Associates & JCEsOther income 3,350 3,083 4,000 4,000 4,000Earnings before tax 99,925 110,155 6,661 110,314 146,103Income tax 24,903 18,645 13,122 30,593 38,707Net profit after tax 75,021 91,510 (6,461) 79,721 107,396Minority interestsOther itemsPreferred dividendsNormalised NPAT 75,021 91,510 (6,461) 79,721 107,396Extraordinary items 4,473 (41,001) (17,026) - - Reported NPAT 79,494 50,509 (23,487) 79,721 107,396Dividends 13,714 13,830 13,572 13,495 13,495Transfer to reserves 65,781 36,679 (37,059) 66,226 93,901

Valuation and ratio analysisFD normalised P/E (x) 6.0 4.9 n/a 6.9 5.1 FD normalised P/E at price target (x) 9.0 7.4 n/a 10.3 7.6 Reported P/E (x) 5.7 8.9 n/a 6.9 5.1 Dividend yield (%) 3.1 3.3 2.6 2.5 2.5 Price/cashflow (x) 3.9 3.3 14.0 4.4 3.5 Price/book (x) 1.8 1.6 1.7 1.4 1.1 EV/EBITDA (x) 5.4 5.3 11.6 4.9 3.7 EV/EBIT (x) 7.0 6.9 27.0 6.5 4.7 Gross margin (%) 10.2 9.3 2.8 10.7 12.0 EBITDA margin (%) 13.3 12.2 7.1 14.3 15.3 EBIT margin (%) 10.8 6.7 1.6 11.1 12.2 Net margin (%) 6.0 3.3 (2.2) 6.4 7.7 Effective tax rate (%) 23.9 27.0 n/a 27.7 26.5 Dividend payout (%) 17.5 - n/a - - Capex to sales (%) 23.2 3.5 5.3 5.6 3.8 Capex to depreciation (x) 7.5 1.2 1.2 1.5 1.1

ROE (%) 38.8 34.8 (2.1) 22.0 24.4 ROA (pretax %) 19.0 12.0 2.9 11.8 13.9

Growth (%)Revenue 14.9 (29.5) 15.9 12.4 EBITDA 5.6 (58.9) 134.1 20.1 EBIT 23.3 (127.0) n/a 45.2 Normalised EPS 21.9 (105.8) n/a 34.7 Normalised FDEPS (36.5) (146.5) n/a 34.7

Per shareReported EPS (INR) 109 69 (26) 90 121Norm EPS (INR) 103 125 (7) 90 121Fully diluted norm EPS (INR) 90 57 (26) 90 121Book value per share (INR) 336 383 373 445 549DPS (W) 16 16 13 13 13Source: Nomura estimates

Turnaround at Corus should drive FY11F EBITDA growth, while 3mn tonne expansion should drive FY12F EBITDA growth



Cashflow (INR mn)Year-end 31 Dec FY08 FY09F FY10F FY11F FY12FEBITDA 174,618 184,352 75,749 177,363 213,037Change in working capital (134,277) 84,447 29,173 (9,035) (4,235)Other operating cashflow (79,722) (94,411) (57,636) (56,957) (62,888)Cashflow from operations (39,382) 174,387 47,287 111,370 145,914Capital expenditure (305,746) (52,960) (56,163) (69,223) (52,408)Free cashflow (345,128) 121,427 (8,876) 42,147 93,506Reduction in investments 5,809 (134,226) (5,326) 2,368 647Net acquisitionsReduction in other LT assets (180,500) - - - - Addition in other LT liabilitiesAdjustments 760 5,185 11,453 2,734 3,007Cashflow after investing acts (519,058) (7,614) (2,749) 47,249 97,160Cash dividends (13,936) (14,925) (14,028) (13,495) (13,495)Equity issue 96,660 (2,790) 24,203 (0) (0)Debt issue 402,124 73,165 (33,868) (44,816) (30,000)Convertible debt issueOthersCashflow from financial acts 484,848 55,450 (23,693) (58,311) (43,495)Net cashflow (34,210) 47,837 (26,442) (11,061) 53,666Beginning cash 78,594 44,384 92,221 65,779 54,718Ending cash 44,384 92,221 65,779 54,718 108,384Ending net debt 508,918 534,246 472,094 438,339 354,673Source: Nomura estimates

Balance sheet (INR mn)As at 31 Dec FY08 FY09F FY10F FY11F FY12FCash & equivalents 44,384 92,221 65,779 54,718 108,384Marketable securitiesAccounts receivable 174,945 121,160 81,797 96,851 107,145Inventories 200,520 191,915 141,809 163,733 186,025Other current assets 65,669 45,780 36,430 36,430 36,431Total current assets 485,518 451,076 325,816 351,732 437,986LT investments 55,253 189,478 194,804 192,436 191,789Fixed assets 375,896 384,504 395,066 419,604 425,259Goodwill 180,500 180,500 180,500 180,500 180,500Other intangible assetsOther LT assets 38,073 37,572 39,245 38,255 37,750Total assets 1,135,239 1,243,129 1,135,431 1,182,527 1,273,284Short-term debtAccounts payable 238,553 240,514 171,854 199,109 226,456Other current liabilities 62,635 62,842 61,857 62,544 63,549Total current liabilities 301,188 303,356 233,711 261,653 290,005Long-term debt 498,577 571,742 537,874 493,058 463,058Convertible debtOther LT liabilities 33,531 32,193 32,193 32,193 32,193Total liabilities 532,108 603,935 570,067 525,251 495,251Minority interestPreferred stockCommon stock 7,308 7,308 8,874 8,874 8,874Retained earnings 65,781 36,679 (37,059) 66,226 93,901Proposed dividends 13,714 13,830 13,572 13,495 13,495Other equity and reserves 215,141 278,022 346,266 307,029 371,758Total shareholders' equity 301,943 335,838 331,654 395,624 488,028Total equity & liabilities 1,135,239 1,243,129 1,135,431 1,182,527 1,273,284

Liquidity (x)Current ratio 2.04 1.88 1.90 1.77 1.93 Interest cover 3.7 4.3 1.2 5.2 7.0



Company will generate operating cash of INR110-150bn in FY11-12F, which even after capex should be enough to pre-pay debt significantly


GAIL GAIL IN

OIL & GAS | INDIA

Anil Sharma +91 22 4037 4338 [email protected] Ravi Kumar Adukia (Associate) +91 22 4037 4232 [email protected]

Propelled by gas Strong gas transmission growth GAIL is a key beneficiary of increased domestic gas production volumes. Its gas transmission volumes have already increased by about 40mmscmd over the past nine months to around 120mmscmd, compared with an increase of 23mmscmd in the past nine years from FY00 to FY09. Compared with an average of 83 mmscmd in FY09 and 102 mmscmd in 1HFY10, we expect average gas volume to increase to 122 mmscmd in 2HFY10F. While we remain concerned about likely bottlenecks in GAIL’s transmission network in 1H FY11F, we believe that our average transmission volume assumption of 136mmscmd for FY11F is conservative, with potential upside.

Re-rating continues We see GAIL’s earnings growing by 32% in FY11, and expect share of utility-type earnings from transmission business to increase to 68% in FY10/FY11 (51% in FY09). With an increased share of utility earnings GAIL is likely to re-rate as a utility play, in our view.

Continued resilience in petrochemicals Since bottoming out in October 2009, prices and margins of key polymers have rebounded strongly on improving demand and further delays in new supply.

Valuation methodology and risks Compared with 11-13x 2010F EV/EBITDA multiples for regional utilities, and 10x FY11F EV/EBITDA for Indian power utilities, GAIL trades at 9x FY11F EV/EBITDA. We value GAIL’s gas transmission business at 10x and the petchem business at 7x FY11F EV/EBITDA. Key risks include a likely bottleneck in the HVJ network in the near term, a sharp tariff cut by regulators (we do not assume any significant cuts), a sharper-than-expected decline in polymer prices and a higher subsidy burden.

Key financials & valuations31 Mar (INRbn) FY08 FY09 FY10F FY11FRevenue 180 238 255 365Reported net profit 26 28 31 41Normalised net profit 26 28 31 41Normalised EPS (INR) 21 22 25 32 Norm. EPS growth (%) 27 8 11 32 Norm. P/E (x) 20 19 17 13 EV/EBITDA (x) 13 13 11 9 Price/book (x) 4 4 3 3 Dividend yield (%) 2 2 2 3 ROE (%) 20 19 19 22 Net debt/equity (%) (25) (15) 4 8 Earnings revisionsPrevious norm. net profit 26 28 31 41Change from previous (%) - - - - Previous norm. EPS (INR) 21 22 25 32 Source: Company, Nomura estimates


1m 3m 6m 4.1 17.8 49.3 3.6 21.1 55.3 2.3 12.1 25.8

Easy


11,39635.0

429.8/184.815.77



5.43

Major shareholders (%)Government of India 57.34


Life Insurance Corporation of India

Stock borrowability

160210260310360410460

Dec

08

Jan0

9

Feb0

9

Mar

09

Apr0

9

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

80

90

100

110

120



Price target INR500(set on 16 Dec 09)

Upside/downside 19.0%Difference from consensus 39.0%FY11F net profit (INRbn) 41


Nomura vs consensus We expect GAIL to re-rate as a utility play as share of transmission earnings goes over 70%. GAIL’s transmission business deserves a higher valuation multiple, in our view.

Maintained

BUY


Action GAIL’s gas transmission volumes have increased sharply by ~40mmscmd over the

past nine months compared with only ~23mmscmd over the previous nine years. Apart from growth in gas volumes, its petchem business is resilient. Newsflow should be positive — GAIL is likely to be given marketing margins for APM gas, and subsidy burden could ease. GAIL remains our top pick in the Indian oil & gas space.

Catalysts Gas volume ramp-up, new tariff determination by PNGRB and recommendations of

the expert group headed by Dr Kirit Parikh (likely by end-January 2010).

Anchor themes

GAIL’s re-rating as a utility appears to be playing out well. With its earnings mix shifting towards regulated ROCE-based transmission earnings (allowed a pre-tax ROCE of 18%), we believe that the re-rating could continue.



GAIL Anil Sharma


Exhibit 108. GAIL: gas transmission volume

0

20

40

60

80

100

120

140

160FY

00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

1QFY

10

2QFY

10

2HFY

10E

FY11

E

FY12

E

Next 3 year CAGR of 21%mmscmd

Last 9 years CAGR of 3.7%


Exhibit 109. GAIL: subsidy sharing INR bn FY06 FY07 FY08 FY09 1QFY10 2QFY10

Gross Under-recoveries 400.0 493.9 773.0 1032.9 54.4 104.2

Upstream share 140.0 205.2 257.1 329.4 5.6 34.4% share 35% 42% 33% 32% 10% 33%

GAIL's share 10.6 14.9 12.9 17.8 0.7 4.6% of Gross U/R 2.7% 3.0% 1.7% 1.7% 1.4% 4.4%% of Upstrem share 7.6% 7.3% 5.0% 5.4% 13.3% 13.3%

Subsidy burden on GAIL has increased from ~5%of total upstream share in FY08/09 to ~13% in 1HFY10.


Exhibit 110. GAIL: EBIT breakdown FY09A FY12E

EBIT Break-down (%)Transmisson & Trading 51% 68% 68% 70%Petrochemicals 29% 24% 15% 14%LPG & Liquid HC 20% 8% 17% 16%

FY10E FY11E


Exhibit 111. GAIL: SOTP valuation INRbn US$ bn INR / Share Comments

Gas Transmission 437 9.7 345 10x FY11 EBITDAPetrochemicals 71 1.6 56 7x FY11 EBITDALPG & Liquid HC 63 1.4 49 6x FY11 EBITDAE&P Upside 18 0.4 15 Investments 56 1.2 44 Enterprise Value 645 14.3 509

Less: Net Debt 15 0.3 12 FY11EEquity Value 630 14.0 496 Target Price 500 Implied FY11 P/E multiple of 15.5x


Increasing utility-type earnings

Lower sharing could offer respite

Now in a rapid growth phase

GAIL Anil Sharma


Financial statements Income statement (INRbn)Year end 31 March 2008 2009 2010F 2011F 2012FRevenue 180.1 237.8 255.2 365.0 420.8Operating cost 140.6 197.2 207.6 306.0 356.3EBITDA 39.5 40.5 47.6 58.9 64.5Depreciation 5.7 5.6 6.5 7.8 9.4Amortisation 0.0 0.0 0.0 0.0 0.0EBIT 33.8 34.9 41.1 51.1 55.0Net interest expense 0.8 0.9 1.1 1.9 2.3Others income 5.6 8.0 5.0 5.5 6.0Earnings before tax 38.5 42.0 45.0 54.7 58.8Income tax 12.5 14.0 13.8 13.7 14.7Net profit after tax 26.0 28.0 31.1 41.0 44.1Minorities 0.0 0.0 0.0 0.0 0.0Normalised NPAT 26.0 28.0 31.1 41.0 44.1Exceptionals 0.0 0.0 0.0 0.0 0.0Reported NPAT 26.0 28.0 31.1 41.0 44.1Dividends 9.9 10.4 12.7 16.8 18.1Transfer to reserves 16.1 17.6 18.4 24.2 26.1

Valuation and ratio analysisFD normalised P/E (x) 20.5 19.0 17.1 13.0 12.1FD normalised P/E at fair value (x) 22.6 20.4 15.5 14.4Reported P/E (x) 20.5 19.0 17.1 13.0 12.1Dividend yield (%) 2% 2% 2% 3% 3%Price/cashflow (x) 15.6 20.6 15.9 8.6 9.1Price/book (x) 4.2 3.7 3.2 2.8 2.5EV/EBITDA (x) 12.7 12.6 11.3 9.3 8.6EV/EBIT (x) 14.8 14.6 13.1 10.7 10.1EBITDA margin (%) 22% 17% 19% 16% 15%EBIT margin (%) 19% 15% 16% 14% 13%Net margin (%) 14% 12% 12% 11% 10%Effective tax rate (%) 33% 33% 31% 25% 25%Dividend payout (%) 33% 32% 35% 35% 35%Capex to sales (%) 7% 12% 20% 15% 12%Capex to depreciation (x) 2.2 5.0 7.7 6.8 5.3ROE (%) 20% 19% 19% 22% 21%ROCE (%) 24% 23% 20% 21% 20%ROA (pretax %) 16% 14% 15% 15% 15%

Growth (%)Revenue 12% 32% 7% 43% 15%EBITDA 32% 3% 17% 24% 9%EBIT 39% 3% 18% 24% 8%PAT 27% 8% 11% 32% 8%Normalised EPS 27% 8% 11% 32% 8%Normalised FDEPS 27% 8% 11% 32% 8%

Per shareReported EPS 20.5 22.1 24.5 32.3 34.8Norm EPS 20.5 22.1 24.5 32.3 34.8Fully diluted norm EPS 20.5 22.1 24.5 32.3 34.8Book value per share 101 114.7 129.2 148.3 168.9DPS 6.7 7.0 8.6 11.3 12.2 Source: Nomura estimates

Strong earnings growth in FY11F, mainly on growth in gas transmission volumes

GAIL Anil Sharma


Cashflow (INRbn)Year end 31 March 2008 2009 2010F 2011F 2012FEBITDA 39.5 40.5 47.6 58.9 64.5Change in WC (0.4) (5.6) (4.0) 12.8 4.8Other operating cashflow (5.0) (9.2) (10.0) (10.1) (10.9)Cashflow from operations 34.1 25.8 33.5 61.7 58.4Capex (12.7) (28.0) (50.1) (53.5) (50.1)Free cashflow 21.4 (2.2) (16.5) 8.2 8.3Other Investing cash flow 4.2 5.5 0.0 0.0 0.0Cashflow after investing acts 25.6 3.3 (16.5) 8.2 8.3Cash dividends (5.9) (11.9) (12.7) (16.8) (18.1)Equity issue 0.0 0.0 0.0 0.0 0.0Debt issue (0.7) (0.7) 10.0 15.0 1.0Others (0.8) (0.9) 0.0 0.0 0.0Cashflow from financial acts (7.5) (13.4) (2.7) (1.8) (17.1)Net cash flow 18.1 (10.2) (19.3) 6.4 (8.7)Beginning cash 26.6 44.7 34.6 15.3 21.7Ending cash 44.7 34.6 15.3 21.7 12.9Ending net debt (32.1) (22.6) 6.7 15.3 25.1

Balance sheet (INRbn)Year end 31 March 2008 2009 2010F 2011F 2012FCash & equivalents 44.7 34.6 15.3 21.7 12.9Accounts receivable 10.7 15.0 13.8 18.2 20.7Inventories 5.7 6.0 6.6 7.2 7.8Other current assets 42.9 66.8 67.0 67.2 67.5Total current assets 104.1 122.4 102.6 114.2 108.9LT investments 14.9 17.4 17.4 20.9 21.0Fixed assets 97.5 114.8 158.2 200.4 241.0Other LT assets 0.0 0.0 0.0 0.0 0.0Total assets 216.5 254.5 278.3 335.5 370.9Accounts payable 18.0 19.7 26.8 41.1 47.0Other current liabilities 42.6 61.8 50.2 54.0 56.3Total current liabilities 60.6 81.5 77.0 95.1 103.3Long-term debt 12.7 12.0 22.0 37.0 38.0Other LT liabilities 13.2 13.3 13.2 13.2 13.2Total liabilities 86.5 106.8 112.2 145.2 154.5Minority interest 0.0 0.0 0.0 0.0 0.0Common stock 8.5 12.7 12.7 12.7 12.7Retained earnings 119.5 132.9 151.3 175.5 201.5Other equity & reserves 2.1 2.1 2.1 2.1 2.1Total shareholder's equity 130.0 147.7 166.1 190.3 216.4Total equity & liabilties 216.5 254.5 278.3 335.5 370.9

Liquidity (x)Current ratio 1.7 1.5 1.3 1.2 1.1Interest cover 42.5 40.2 37.7 26.9 24.5

LeverageNet debt/EBITDA (x) (0.8) (0.6) 0.1 0.3 0.4Net debt/equity (%) -25% -15% 4% 8% 12%

Activity (days)Days receivable 21.8 23.1 19.7 18.2 17.9Days inventory 11.5 9.2 9.4 7.2 6.8Days payable 36.4 30.3 38.4 41.1 40.8Cash cycle (3.1) 2.0 (9.3) (15.8) (16.1)Source: Nomura estimates

Strong balance sheet and flexibility in capital structure


Dr. Reddy’s Laboratories DRRD IN

HEALTH CARE & PHARMACEUTICALS | INDIA


Execution risks recede US — potential surprises from product-specific opportunities Growth in US generic sales should be driven by: 1) increase in patent expiries, and; 2) product-specific opportunities — either Para IV-related exclusivities or difficult-to-develop products presenting limited competition. Patent expiries are set to jump in the US over 2010-2012F. Key disclosed product-specific opportunities in the near term include: 1) Prilosec OTC; 2) Arixtra; 3) Allegra D 24; 4) Lotrel; and 5) Exelon. Furthermore, beyond the disclosed products there can be additional surprises from products with limited competition. Some of the products that could present upside over the next three years include Accolate, Avandia, Geodon and Prograf.

Growth in API business is underappreciated The API business segment has been a traditional stronghold for DRRD, which is the largest generic API player globally after Teva and has established relationships with many large generic companies. In fact, DRRD is the largest third-party API supplier to Teva, the largest generic company. Growth rates in the API segment are set to accelerate, based on increased patent expiries and DRRD’s strong pipeline (over 150 filings to date). As per management, DRRD’s pipeline covers 60-80% of the patent expiries over the next few years in the US. Furthermore, we note that DRRD’s API business is characterised by early DMF filings. Our analysis indicates that DRRD figures among the first five filers in over half of its DMF filings.

India — a renewed focus Compared with peers, DRRD’s focus on the India business had been less intense, since resources were primarily dedicated to regulated markets. This resulted in fewer new product introductions by the company and DRRD eventually lost the spot among the top-10 domestic players. Management’s focus is back on India now. Its strategy is to participate in the penetration-driven growth in the Indian

Key financials & valuations31 Mar (INRmn) FY08 FY09F FY10F FY11FRevenue 50,006 69,441 71,203 82,578Reported net profit 3,846 (5,168) 8,410 11,972Normalised net profit 6,947 8,855 8,410 11,972Normalised EPS (INR) 41.2 52.5 49.9 71.0Norm. EPS growth (%) (40) 27 (5) 42 Norm. P/E (x) 28.8 22.6 23.8 16.7EV/EBITDA (x) 23.5 14.2 13.8 10.1Price/book (x) 4.2 4.8 4.1 3.3Dividend yield (%) 0.4 0.6 0.6 0.6 ROE (%) 8.0 (12.0) 17.0 20.0 Net debt/equity (%) 25 34 11 (4)Earnings revisionsPrevious norm. net profit na na naChange from previous (%) na na naPrevious norm. EPS (INR) na na naSource: Company, Nomura estimates


1m 3m 6m 6.7 32.7 59.2 6.1 36.4 65.6 4.9 27.4 36.1

Easy




Stock borrowability

12.80

Major shareholders (%)Anji Reddy and related entities 25.80



74.21,222/374.0

14.58

280

480

680

880

1,080

1,280

Dec0

8

Jan0

9

Feb0

9

Mar

09

Apr0

9

May

09

Jun0

9Ju

l09

Aug0

9

Sep0

9

Oct

09

Nov0

9

708090100110120130140150

PriceRel MSCI India

(Rs)

Closing price on 24 Dec INR1,186

Price target INR1,329(set on 27 Nov 09)



Nomura vs consensus Our estimates and PT are ahead of consensus. We believe the street is sceptical given past execution slips. We expect a positive surprise for the US, India and API businesses.

Maintained

BUY


Action We believe investor scepticism is high, resulting from execution slippage and poor

profitability in the past. However, given increased focus on profitability and a clear road map for execution, we believe there is lower probability of slippage. In our view, near-term weakness on account of Betapharm would not be a cause for concern but an opportunity to get in on lower valuations; maintain BUY.

Catalysts News flow on product-specific opportunities, clarity on upside from the Glaxo deal

and improvement in profitability.

Anchor themes

This is a play on two themes: 1) patent expiries and product-specific opportunities in the US — DRRD will participate in many of these, not only as a finished dose player but also as a bulk supplier; and 2) collaboration with big pharma — the deal with Glaxo is likely to scale up substantially over the next two years.


Dr. Reddy’s Laboratories Saion Mukherjee


pharma market by improving its sales reach and therapeutic coverage. The Indian pharmaceutical market presents the potential of secular, profitable growth. We have already witnessed acceleration in new product introductions in the recent past. Management expects growth in the high-teen levels in India in the near future, compared with 5% growth in FY09.

Emerging markets — GSK deal a potential game changer In an effort towards consolidating its operations and improving its profitability, DRRD exited 31 emerging markets (that accounted for less than 5% of its revenues) towards the end of FY09. The subscale operation in these countries resulted in inefficient usage of manufacturing and marketing infrastructure and, more importantly, large unabsorbed overheads relating to front-end presence. In June 2009, DRRD tied up with GSK to develop and market branded formulations across various emerging markets, outside India. We believe this deal will enable DRRD to tap the emerging market opportunity more efficiently. The tie-up will enable DRRD to gain economies of scale in manufacturing and R&D, without incurring any overheads related to front-end presence in these markets. Furthermore, DRRD will leverage on GSK’s extensive marketing presence (with some 10,000 field force personnel) and premium pricing power. According to management, this is a revenue-sharing deal and profit margins will be similar to what DRRD would have been able to achieve post scale-up. The revenue contribution is estimated to be significant (possibly in excess of US$100mn by FY12F). Some of the key markets that will be addressed as part of the deal include Brazil, Mexico and Turkey.

Remain positive despite the run-up in stock price in 2009 DRRD has been one of the best performing stocks y-t-d. The stock is up 138% y-t-d, significantly outperforming the healthcare index (BSETHC, up 58%) and the broader market (SENSEX, up 70%). We believe the outperformance has been owing to increased visibility of certain product-specific opportunities in the US and improving profitability. Despite the strong run-up in the stock we remain positive and believe there can be further upside driven by: 1) more product-specific opportunities in the US; 2) stronger-than-expected growth in the North American generics and API business on patent expiries, and; 3) scale-up of the GSK deal and revival of growth in India. We believe there is scepticism given slippages on execution and low profitability in the past. We identify the possibility of slippage as the key risk in the shares.

However, given increased focus on profitability and a clear road map for execution, there is a lower probability of slippage, in our view. We maintain a BUY with a price target of INR1,329 based on SOTP valuation. Base business (ex-Betapharm, one-offs) at INR1,217 (18x one-year forward adjusted earnings) + Betapharm at INR32/share (1x FY11F sales estimate) + one-off product-specific opportunities at INR80/share. The stock is trading at the lower end of peers’ average multiple. Adjusted for one-off earnings, DRRD is trading at 14.4x FY12F EPS, compared with 13-17x for peers.

We see concrete drivers that can provide outperformance, even on top of a rather strong run

A strategic retreat and a strategic tie-up make for a far more profitable structure



Our estimates build in upside from Prilosec OTC, Arixtra. We have not built in upside from Lotrel and other potential launches with low competition

Financial statements Income statement (INRmn)Year-end 31 Mar FY08 FY09F FY10F FY11F FY12FRevenue 50,006 69,441 71,203 82,578 95,695Cost of goods sold 24,598 32,941 34,373 39,690 46,891Gross profit 25,408 36,500 36,830 42,888 48,804SG&A 15,247 19,517 20,680 22,186 24,833Other expenses 3,131 4,291 4,130 4,656 5,244Operating profit 7,030 12,692 12,021 16,046 18,727

EBITDA 8,804 15,003 14,890 19,512 22,646Depreciation 1,774 2,311 2,870 3,466 3,919Amortisation 1,588 1,503 1,500 1,500 1,500EBIT 5,442 11,189 10,521 14,546 17,227Net interest expense 218 552 324 (208) (745)Associates & JCEs (2) (24) (26) (26) (26)Other income 739 (634) 160 - - Earnings before tax 5,965 10,027 10,382 14,780 17,998Income tax (972) 1,172 1,973 2,808 3,420Net profit after tax 6,937 8,855 8,410 11,972 14,578Minority interests (10) - - - - Other itemsPreferred dividendsNormalised NPAT 6,947 8,855 8,410 11,972 14,578Extraordinary items (3,101) (14,023) - - - Reported NPAT 3,846 (5,168) 8,410 11,972 14,578Dividends 738 1,232 1,232 1,232 1,232Transfer to reserves 3,108 (6,400) 7,178 10,740 13,346

Valuation and ratio analysisFD normalised P/E (x) 28.8 22.6 23.8 16.7 13.7 FD normalised P/E at price target (x) 32.3 25.3 26.7 18.7 15.4 Reported P/E (x) 52.0 (38.7) 23.8 16.7 13.7 Dividend yield (%) 0.4% 0.6% 0.6% 0.6% 0.6%Price/cashflow (x) 19.4 15.8 15.7 11.8 10.0 Price/book (x) 4.2 4.8 4.1 3.3 2.7 EV/EBITDA (x) 23.5 14.2 13.8 10.1 8.3 EV/EBIT (x) 38.1 19.1 19.5 13.6 10.8 Gross margin (%) 51% 53% 52% 52% 51%EBITDA margin (%) 18% 22% 21% 24% 24%EBIT margin (%) 11% 16% 15% 18% 18%Net margin (%) 14% 13% 12% 14% 15%Effective tax rate (%) -16% 12% 19% 19% 19%Dividend payout (%) 19% -24% 15% 10% 8%Capex to sales (%) 13% 12% 8% 5% 4%Capex to depreciation (x) 3.8 3.6 2.1 1.3 1.0 ROE (%) 8% -12% 17% 20% 20%ROA (pretax %) 7% 12% 12% 16% 17%

Growth (%)Revenue -23% 39% 3% 16% 16%EBITDA -45% 70% -1% 31% 16%EBIT -58% 106% -6% 38% 18%Normalised EPS -40% 27% -5% 42% 22%Normalised FDEPS -40% 27% -5% 42% 22%

Per shareReported EPS (INR) 22.8 (30.6) 49.9 71.0 86.4Norm EPS (INR) 41.2 52.5 49.9 71.0 86.4Fully diluted norm EPS (INR) 41.2 52.5 49.9 71.0 86.4Book value per share (INR) 281 249 292 355 435DPS (INR) 4.4 7.3 7.3 7.3 7.3Source: Nomura estimates



We expect cashflows to remain strong resulting in DRRD becoming net debt-free by FY11

Cashflow (INRmn)Year-end 31 Mar FY08 FY09F FY10F FY11F FY12FEBITDA 8,804 15,003 14,890 19,512 22,646Change in working capital (2,675) (8,267) 2,978 (3,451) (4,262)Other operating cashflow 399 (2,231) (1,787) (2,782) (3,394)Cashflow from operations 6,528 4,505 16,082 13,279 14,990Capital expenditure (6,716) (8,224) (6,000) (4,500) (4,000)Free cashflow (188) (3,719) 10,082 8,779 10,990Reduction in investments (2,651) 4,752 475 800 1,050Net acquisitionsReduction in other LT assetsAddition in other LT liabilitiesAdjustmentsCashflow after investing acts (2,651) 4,752 475 800 1,050Cash dividends (737) (738) (1,232) (1,232) (1,232)Equity issue 15 5 - - - Debt issue (6,015) (662) (3,501) (4,135) (5,740)Convertible debt issueOthers (1,128) (1,132) (799) (592) (305)Cashflow from financial acts (7,865) (2,527) (5,532) (5,959) (7,277)Net cashflow (10,704) (1,494) 5,025 3,619 4,763Beginning cash 18,588 7,421 5,596 10,621 14,240Ending cash 7,421 5,596 10,621 14,240 19,003Ending net debt 11,931 14,105 5,579 (2,175) (12,678)Source: Nomura estimates

Balance sheet (INRmn)As at 31 Mar FY08 FY09F FY10F FY11F FY12FCash & equivalents 7,421 5,596 10,621 14,240 19,003Marketable securities 4,753 530 530 530 530Accounts receivable 6,823 14,592 9,804 11,412 13,622Inventories 11,133 13,226 15,180 17,782 20,911Other current assets 3,858 5,066 5,066 5,066 5,066Total current assets 33,988 39,010 41,200 49,030 59,132LT investments 237 262 262 262 262Fixed assets 16,765 20,882 24,012 25,046 25,128Goodwill 16,997 7,300 7,300 7,300 7,300Other intangible assets 16,756 14,879 13,379 11,879 10,379Other LT assets 891 1,459 1,459 1,459 1,459Total assets 85,634 83,792 87,613 94,976 103,660Short-term debt 6,654 9,569 10,203 11,808 6,077Accounts payable 5,767 6,619 6,768 7,527 8,604Other current liabilities 7,180 10,365 10,360 10,360 10,360Total current liabilities 19,601 26,553 27,331 29,695 25,041Long-term debt 12,698 10,132 5,997 257 248Convertible debtOther LT liabilities 5,985 5,062 5,062 5,062 5,062Total liabilities 38,284 41,747 38,390 35,014 30,351Minority interestPreferred stockCommon stock 841 842 842 842 842Retained earnings 24,211 18,305 25,483 36,222 49,568Proposed dividendsOther equity and reserves 22,298 22,898 22,898 22,898 22,898Total shareholders' equity 47,350 42,045 49,223 59,962 73,308Total equity & liabilities 85,634 83,792 87,613 94,976 103,660

Liquidity (x)Current ratio 1.73 1.47 1.51 1.65 2.36 Interest cover 25.0 20.3 32.5 NA NA

LeverageNet debt/EBITDA (x) 1.36 0.94 0.37 (0.11) (0.56) Net debt/equity (%) 25% 34% 11% -4% -17%



Ranbaxy RBXY IN

HEALTH CARE & PHARMACEUTICALS | INDIA


Rich valuations Base business performance uninspiring The recent fall in sales and profitability is not entirely on account of regulatory issues and the product ban in the US. Even growth rates in the non-US markets have been uninspiring, on our reading. Emerging markets and Europe have witnessed stagnant to declining sales.

Resolution of Dewas facility to have marginal impact We believe resolution of the Dewas facility would result in incremental sales of just US$25mn, based on: 1) sales contribution of US$60mn from Dewas (pre-ban); 2) a sharp drop in RBXY’s share of prescriptions for even non-banned products; and 3) hurdles in regaining market share. We believe such incremental sales are unlikely to meaningfully revive the company’s EBITDA margin/RoE.

Slippage in FTF present significant risk At the current price, we believe the market is assuming Ranbaxy will realise one-off product specific exclusivity upside in the US. Sentiment has improved post the Valtrex launch. We believe that the Valtrex launch through a site transfer doesn’t imply resolution of pending USFDA issues. The risks of FTFs filed, particularly from Poanta Sahib, remain. The two most important FTFs — Lipitor and Nexium — are filed from the site.

Valuations rich Our price target of INR261/share is based on a sum-of-the-parts valuation: 1) base business valuation at INR141/share, using DCF valuation; and 2) one-off product specific upside at INR120/share. At the market price of INR520, we believe the market is already building in: 1) no slippage in realisation of FTF P4 opportunities; and 2) a quick revival in base business profitability (RoE). Adjusting for FTF P4 opportunities, we estimate the market is ascribing a value of INR400/share to RBXY’s base business — 2.7x FY10F base business

Key financials & valuations31 Dec (INRmn) FY08 FY09F FY10F FY11FRevenue 69,822 70,852 71,471 84,571Reported net profit 7,745 (9,513) 1,110 7,888Normalised net profit 7,745 (1,811) 2,231 7,888Normalised EPS (INR) 18.1 (4.2) 5.2 18.5Norm. EPS growth (%) (33) (123) (223) 254 Norm. P/E (x) 28.7 (122.6) 99.5 28.2EV/EBITDA (x) 26.2 90.5 54.9 16.5Price/book (x) 7.8 5.1 5.0 4.2Dividend yield (%) 1.7 0.0 0.0 0.0 ROE (%) 27 (22) 2 15 Net debt/equity (%) 69 (5) (13) (21)Earnings revisionsPrevious norm. net profit (1,811) 2,231 7,888Change from previous (%) na na naPrevious norm. EPS (INR) (4.2) 5.2 18.5Source: Company, Nomura estimates


1m 3m 6m 23.5 32.1 90.2 22.8 35.8 97.9 21.6 26.8 68.3

Hard


20.3452-week range (INR)3-mth avg daily turnover (US$mn)


Stock borrowability

7.03

Major shareholders (%)Daiichi Sankyo Company Ltd 63.90

4,68636.1

530/134.7



95

195

295

395

495

595

Dec

08

Jan0

9

Feb0

9M

ar09

Apr

09

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

50

70

90

110

130

150P rice

Rel MS CI India(Rs)


Price target INR261(set on 17 Sep 09)



Nomura vs consensus We believe we are conservative on base business valuation vis-à-vis consensus.

Maintained

REDUCE


Action A run-up in the stock price leaves little room for slippage in realising upside from

product-specific opportunities in the US and synergy benefits from Daiichi Sankyo, in our view. The current USFDA investigation could lead to lower-than-expected upside from exclusivity and the base business still appears to be struggling. The risk/reward is therefore unfavourable, and we maintain our REDUCE call.

Catalysts We see as potential catalysts: 1) fall in earnings in 2H CY10, when exclusivity-

related sales subside; and 2) delay in resolution of the standoff with the USFDA.

Anchor themes

The Application Integrity Policy invoked against Ranbaxy’s Poanta Sahib facility puts at risk the key FTF filings.


Ranbaxy Saion Mukherjee


book value. These valuations imply a revival in base business profitability (RoE) levels to 21-22% by FY14F, in our view, higher than even historical base business RoEs over FY05-07.

Realisation of product-specific opportunities (such as an extended period of low competition in Lipitor) and greater-than-estimated synergy benefits from the Daiichi Sankyo acquisition present a risk to our call.

Exhibit 112. Ranbaxy: declining emerging-market sales

0

20

40

60

80

100

120

140

160

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

(US$mn)

Note: Emerging market (excludes India, includes Romania)





Income statement (INRmn)Year-end 31 Dec FY08 FY09F FY10F FY11F FY12FRevenue 69,822 70,852 71,471 84,571 89,941Cost of goods sold 30,570 35,188 31,100 34,569 37,428Gross profit 39,252 35,664 40,370 50,002 52,513SG&A 16,907 19,311 20,969 20,997 22,655Other expenses 13,199 13,983 15,563 16,564 17,636Operating profit 9,147 2,370 3,839 12,442 12,222

EBITDA 9,147 2,370 3,839 12,442 12,222Depreciation 1,752 2,232 2,108 2,213 2,292Amortisation 431 593 643 643 643EBIT 6,964 (455) 1,088 9,586 9,287Net interest expense 1,412 2,055 1,087 1,087 1,714Associates & JCEsOther income 4,434 (4,788) 2,612 1,466 2,627Earnings before tax 9,985 (7,298) 2,614 9,965 10,200Income tax 2,119 (5,650) 299 1,993 2,040Net profit after tax 7,867 (1,649) 2,315 7,972 8,160Minority interests 122 84 84 84 84Other items 78Preferred dividendsNormalised NPAT 7,745 (1,811) 2,231 7,888 8,076Extraordinary items - (7,702) (1,121) - - Reported NPAT 7,745 (9,513) 1,110 7,888 8,076Dividends 3,711 - - - - Transfer to reserves 4,034 (9,513) 1,110 7,888 8,076

Valuation and ratio analysisFD normalised P/E (x) 28.7 (122.6) 99.5 28.2 27.5 FD normalised P/E at price target (x) 14.4 (61.5) 50.0 14.1 13.8 Reported P/E (x) 28.7 (23.3) 200.1 28.2 27.5 Dividend yield (%) 1.7% 0.0% 0.0% 0.0% 0.0%Price/cashflow (x) 22.4 219.1 44.6 20.7 20.2 Price/book (x) 7.8 5.1 5.0 4.2 3.6 EV/EBITDA (x) 26.2 90.5 54.9 16.5 18.3 EV/EBIT (x) 34.4 (471.2) 193.8 21.4 24.1 Gross margin (%) 56% 50% 56% 59% 58%EBITDA margin (%) 13% 3% 5% 15% 14%EBIT margin (%) 10% -1% 2% 11% 10%Net margin (%) 11% -3% 3% 9% 9%Effective tax rate (%) 21% 77% 11% 20% 20%Dividend payout (%) 48% 0% 0% 0% 0%Capex to sales (%) 12% 8% 3% 2% 2%Capex to depreciation (x) 4.8 2.6 1.2 0.7 0.7

ROE (%) 27% -22% 2% 15% 13%ROA (pretax %) 11% -6% 2% 7% 7%

Growth (%)Revenue 14% 1% 1% 18% 6%EBITDA 4% -74% 62% 224% -2%EBIT -8% -107% -339% 781% -3%Normalised EPS -33% -123% -223% 254% 2%Normalised FDEPS -33% -123% -223% 254% 2%

Per shareReported EPS (INR) 18.1 (22.3) 2.6 18.5 18.9Norm EPS (INR) 18.1 (4.2) 5.2 18.5 18.9Fully diluted norm EPS (INR) 18.1 (4.2) 5.2 18.5 18.9Book value per share (INR) 67 102 105 124 143DPS (INR) 8.7 - - - - Source: Nomura estimates

We have included Valtrex, Flomax, Aricept and Nexium upside in our estimates. We haven't yet included Lipitor and Caduet in estimates, but they are included in valuations



Cashflow (INRmn)Year-end 31 Dec FY08 FY09F FY10F FY11F FY12FEBITDA 13,581 (2,418) 6,451 13,908 14,849Change in working capital 573 (2,387) 1,447 (4,374) (2,746)Other operating cashflow (3,921) 3,257 (2,347) (3,176) (4,230)Cashflow from operations 10,232 (1,549) 5,552 6,358 7,873Capital expenditure (8,406) (5,751) (2,500) (1,500) (1,500)Free cashflow 1,826 (7,299) 3,052 4,858 6,373Reduction in investments (2) (1,217) 1,540 1,800 2,190Net acquisitionsReduction in other LT assetsAddition in other LT liabilitiesAdjustmentsCashflow after investing acts (2) (1,217) 1,540 1,800 2,190Cash dividends (3,642) (2,620) - - - Equity issue 92 35,944 - - - Debt issue 4,333 (4,497) (0) (0) 0Convertible debt issueOthers (1,176) (1,942) (1,087) (1,087) (1,714)Cashflow from financial acts (392) 26,885 (1,087) (1,087) (1,714)Net cashflow 1,433 18,369 3,505 5,571 6,849Beginning cash 2,951 4,379 23,956 27,461 33,032Ending cash 4,379 23,956 27,461 33,032 39,881Ending net debt 19,692 (2,222) (5,726) (11,297) 6,952Source: Nomura estimates

Balance sheet (INRmn)As at 31 Dec FY08 FY09F FY10F FY11F FY12FCash & equivalents 4,379 23,956 27,461 33,032 39,881Marketable securities 2,403 5,432 5,432 5,432 5,432Accounts receivable 14,931 13,310 12,855 15,330 16,319Inventories 16,409 19,643 18,293 20,950 23,410Other current assets 1,616 2,283 2,120 2,428 2,713Total current assets 39,737 64,624 66,161 77,172 87,754LT investmentsFixed assets 45,619 49,607 49,357 48,001 46,566GoodwillOther intangible assetsOther LT assets 7,426 7,729 13,314 15,696 16,379Total assets 92,782 121,961 128,831 140,868 150,699Short-term debtAccounts payable 8,556 8,183 9,250 9,844 9,510Other current liabilities 12,771 39,256 44,374 47,227 45,622Total current liabilities 21,327 47,438 53,623 57,071 55,131Long-term debt 24,071 21,735 21,735 21,735 46,834Convertible debt 17,345 21,380 20,872 21,488 - Other LT liabilities 1,434 (12,229) (12,229) (12,229) (12,229)Total liabilities 64,178 78,323 84,000 88,065 89,736Minority interest 571 675 759 843 928Preferred stockCommon stock 1,865 2,102 2,102 2,102 2,102Retained earningsProposed dividendsOther equity and reserves 26,169 40,861 41,970 49,858 57,933Total shareholders' equity 28,604 43,637 44,831 52,803 60,963Total equity & liabilities 92,782 121,961 128,831 140,868 150,699

Liquidity (x)Current ratio 1.86 1.36 1.23 1.35 1.59 Interest cover 4.9 (0.2) 1.0 8.8 5.4

LeverageNet debt/EBITDA (x) 2.15 (0.94) (1.49) (0.91) 0.57 Net debt/equity (%) 69% -5% -13% -21% 11%


Expect cashflow to remain strong on back of product-specific upside


Unitech Ltd UT IN

PROPERTY | INDIA

Aatash Shah +91 22 4037 4194 [email protected]

Still the best option Continued focus on volumes is the right way Unitech has led developers across India in terms of volumes in 1H FY10. The company has sold more than 10mn sf in the period, which is its highest run-rate ever and possibly the highest volumes by a single developer in the country. Unitech had targeted to launch 30mn sf and sell 20mn sf in FY10F, and with launches of 21mn sf to date appears to be well on track to achieve its goal. The company plans to launch another 25-30mn sf in FY11F.

In spite of larger populations, Indian cities register far lower volumes than their counterparts across the developing world. We believe that a focus on generating high volumes through affordable pricing is the model which will succeed in India, and that Unitech through its ‘Unihomes’ brand will be the prime exponent of the same.

Exposure to high-value Mumbai property increasing Over the past two years, Unitech has built up a development portfolio of 40mn sf in Mumbai through its 50:50 joint venture with local player Omkar. These projects, both residential and commercial, are mainly based on the slum rehabilitation and redevelopment model. Given the high capital values prevalent in Mumbai, this could prove to be a substantial kicker to valuations if executed well.

Balance sheet strengthening in FY10F The company, after nearing bankruptcy with a net debt/equity ratio of 1.6x, has raised almost US$1bn (INR44bn) in equity through two QIP issues and warrants subscribed to by promoters. This has enabled repayment of INR24 bn of loans and investment of the rest in working capital. The result has been a reduction in net leverage to 0.6x as of September 2009. Further cashflow from customers and future sales should enable Unitech to meet its repayment and construction obligations. The key here will be execution and continued selling. Any faltering here could lead to another cash shortfall.

Key financials & valuations31 Mar (INRmn) FY09 FY10F FY11F FY12FRevenue 29,265 22,509 48,201 81,519Reported net profit 11,964 7,355 15,108 29,296Normalised net profit 11,964 7,355 15,108 29,296Normalised EPS (INR) 7.37 3.01 5.78 11.21Norm. EPS growth (%) (28.0) (59.2) 92.0 93.9 Norm. P/E (x) 11.1 27.3 14.2 7.3EV/EBITDA (x) 3.1 13.6 8.8 5.3Price/book (x) 2.5 1.9 1.6 1.3Dividend yield (%) 0.3 0.0 0.0 0.0ROE (%) 22.9 6.9 11.6 18.4 Net debt/equity (%) 160.8 42.0 21.8 3.8 Earnings revisio nsPrevious norm. net profit 7355 15108 29296Change from previous (%) - - -Previous norm. EPS (INR) 0.01 5.78 11.21

Source: Company, Nomura est imat es


1m 3m 6m 2.8 (25.0) 5.2 2.2 (22.9) 9.4 0.9 (31.9) (20.1)

Hard

Source: Company, Nomura est imat es


Estimated free float (%)M arket cap (US$mn) 4,199

52.0115.1/24.80

116.052-week range (INR)3-mth avg daily turnover (US$mn)Stock borrowabilityM ajor shareholders (%)Ramesh Chandra and family 48.00

1535557595

115135

Dec

08

Jan0

9

Feb0

9

Mar

09

Apr0

9

May

09

Jun0

9

Jul0

9

Aug0

9

Sep0

9

Oct

09

Nov

09

6080100120140160180200

PriceRel MSCI India

(Rs)


Price target INR112(set on 2 Nov 09)

Upside/dow nside 32.4%Difference from consensus 10.0%FY10F net prof it (INRmn) 7,355


Nomura vs consensus Consensus believes the residential recovery is priced in, whereas we believe the residential revival to date has been muted and a country-wide revival will benefit Unitech.

Maintained

BUY


Action Unitech continues to focus on volumes, with forecast sales of 20mn sf in FY10F

and plans to launch 25-30mn sf in FY11F. We believe that a focus on generating high volumes through affordable pricing is the model which will succeed in India, and Unitech through its ‘Unihomes’ brand will be the prime exponent of the same.

Catalysts We think improvement in residential volumes from here, accompanied by

increasing office leasing and visible execution, could act as a catalyst.

Anchor themes

Residential volume revival has been a mirage so far, with a limited and localised recovery. We believe that CY10/FY11F will be crucial in deciding whether the Indian property sector can move closer to its volume potential through rational pricing. A recovery in commercial space leasing is likely in CY10F.


Unitech Ltd Aatash Shah


Valuations still attractive Our NAV for Unitech is INR103/share, while we value its 32.75% stake in Unitech Wireless at INR9/share. The stock (ex-Unitech Wireless) is trading at a 27% discount to NAV, which we find attractive in an environment of improving commercial leasing and residential volumes.

Exhibit 113. Unitech: valuation summary (as of Sep 2010) Value (INR mn) Value (INR/share) NAV 258,865 99 Existing commercial assets on book + retail assets 10,000 4 33% stake in Unitech Wireless 24,893 9 Price target 293,758 112 Implied discount to NAV 0%


Exhibit 114. Unitech: NAV breakdown by geography

Kolkata8%

NCR-Noida6%

NCR-Delhi6%

Mumbai14%

Others3%

Bangalore2%Mohali

6%

NCR-Gurgaon

26%

Chennai11%

NCR-Greater Noida

3%Hyderabad

11%

Kochi4%


Exhibit 115. Unitech: NAV breakdown by segment

Residential49%

Commercial38%

Retail13%


Risks to price target. With increasing inflation in India, chances of monetary tightening are increasing. Policy rate hikes could lead to higher mortgage rates and reduced demand. We think that banks may not raise mortgage rates immediately following a policy rate hike, while demand would depend more on economic and income growth than interest rates. Other risks include inability to refinance debt or generate cash to service debt, and inability to launch and sell projects at lower prices.

Attractive valuation considering improving residential volumes and upcoming improvement in commercial leasing



Targeted sale volumes of 20mn sqft in FY10F should support FY11-12F revenue


Income statement (INRmn)Year-end 31 Mar FY08 FY09F FY10F FY11F FY12FRevenue 41,826 29,265 22,509 48,201 81,519Cost of goods sold (12,887) (6,650) (10,263) (25,872) (40,792)Gross profit 28,939 22,615 12,246 22,329 40,727SG&A (6,649) (6,727) (800) (1,200) (1,199)Operating profit 22,291 15,888 11,446 21,129 39,528

EBITDA 22,291 15,888 11,446 21,129 39,528Depreciation (205) (209) (295) (385) (492)EBIT 22,085 15,679 11,151 20,744 39,036Net interest expense (2,804) (5,546) (3,373) (4,413) (6,222)Other income 1,397 4,259 1,846 3,439 5,364Earnings before tax 20,678 14,392 9,624 19,770 38,178Income tax (3,986) (2,424) (2,270) (4,662) (8,883)Net profit after tax 16,692 11,968 7,355 15,108 29,296Minority interests (79) (4)Normalised NPAT 16,613 11,964 7,355 15,108 29,296Reported NPAT 16,613 11,964 7,355 15,108 29,296DividendsTransfer to reserves

Valuation and ratio analysisFD normalised P/E (x) 8.0 11.1 27.3 14.2 7.3 FD normalised P/E at price target (x) 10.9 15.2 37.2 19.4 10.0 Reported P/E (x) 8.0 11.1 27.3 14.2 7.3 Dividend yield (%) 0.3 0.3 - - - Price/cashflow (x) (12.9) (92.8) (26.3) 14.4 7.3 Price/book (x) 3.6 2.5 1.9 1.6 1.3 EV/EBITDA (x) 2.8 3.1 13.6 8.8 5.3 EV/EBIT (x) 2.8 3.1 14.0 9.0 5.3 Gross margin (%) 69.2 77.3 54.4 46.3 50.0 EBITDA margin (%) 53.3 54.3 50.9 43.8 48.5 EBIT margin (%) 52.8 53.6 49.5 43.0 47.9 Net margin (%) 39.7 40.9 32.7 31.3 35.9 Effective tax rate (%) 19.3 16.8 23.6 23.6 23.3 ROE (%) 44.7 22.9 6.9 11.6 18.4 ROA (pretax %) 9.8 6.0 4.1 7.2 12.8

Growth (%)Revenue (30.0) (23.1) 114.1 69.1 EBITDA (28.7) (28.0) 84.6 87.1 EBIT (29.0) (28.9) 86.0 88.2 Normalised EPS (28.0) (59.2) 92.0 93.9 Normalised FDEPS (28.0) (59.2) 92.0 93.9

Per shareReported EPS (INR) 10.2 7.4 3.0 5.8 11.2 Norm EPS (INR) 10.2 7.4 3.0 5.8 11.2 Fully diluted norm EPS (INR) 10.2 7.4 3.0 5.8 11.2 Book value per share (INR) 22.9 32.2 43.6 49.8 61.0Source: Nomura estimates



Cashflows should be strong in FY11-12F, enabling reduction in leverage

Cashflow (INRmn)Year-end 31 Mar FY08 FY09F FY10F FY11F FY12FEBITDA 20,678 14,392 11,151 20,744 39,036 Change in working capital (26,985) (10,784) (16,792) (1,613) (1,452)Other operating cashflow (4,035) (5,043) (1,974) (4,277) (8,391)Cashflow from operations (10,342) (1,435) (7,616) 14,854 29,194Capital expenditure (23,508) (1,988) 8,511 (2,140) (4,326)Free cashflow (33,850) (3,423) 896 12,714 24,868Reduction in investmentsNet acquisitions (3,409) (13,537) - - - Adjustments (4,957) 5,175 1,846 3,439 5,364 Cashflow after investing acts (42,216) (11,785) 2,742 16,153 30,232Cash dividends (475) (475) - - - Equity issue 53 3,825 46,832 8,640 Debt issue 45,935 1,263 (25,000) (10,000) (10,000) Convertible debt issueOthers 560 (463) (10,148) (8,473) (7,977)Cashflow from financial acts 46,073 4,151 11,684 (9,833) (17,977)Net cashflow 3,856 (7,634) 14,426 6,320 12,255Beginning cash 10,227 14,083 6,449 20,876 27,196Ending cash 14,083 6,449 20,876 27,196 39,451Ending net debt (71,657) (84,109) (44,683) (28,364) (6,108)Source: Nomura estimates

Balance sheet (INRmn)As at 31 Mar FY08 FY09F FY10F FY11F FY12FCash & equivalents 14,082.7 6,449.0 20,875.1 27,194.7 39,450.2 Total current assets 164,159.9 195,738.3 195,738.3 195,738.3 195,738.3 LT investments 14,164.5 15,808.1 15,808.1 15,808.1 15,808.1 Fixed assets 10,459.1 21,499.8 31,225.9 37,041.8 42,630.2 Goodwill 1,125.9 11,672.5 11,672.5 11,672.5 11,672.5 Other LT assets 20,983.4 11,757.7 Total assets 224,975.5 262,925.2 275,319.8 287,455.3 305,299.2Short-term debtAccounts payable 83,092.5 102,122.5 87,122.5 87,122.5 87,122.5 Other current liabilitiesTotal current liabilities 83,092.5 102,122.5 87,122.5 87,122.5 87,122.5 Long-term debt 85,523.7 90,558.4 65,558.4 55,558.4 45,558.4 Other LT liabilities 19,195.8 17,935.5 16,143.3 14,530.4 13,078.7 Total liabilities 187,812.0 210,616.4 168,824.2 157,211.3 145,759.6Minority interest 1,158.7 614.1 614.2 614.1 614.1 Common stock 3,246.8 3,246.8 4,888.4 5,228.9 5,228.9 Other equity and reserves 32,758 48,448 100,993 124,401 153,696Total shareholders' equity 37,164 52,309 106,496 130,244 159,539Total equity & liabilities 224,975.5 262,925.2 275,319.8 287,455.3 305,299.1

Liquidity (x)Interest cover 7.9 2.8 3.3 4.7 6.3





Valuations and risks

Appendix

Exhibit 116. Summary of price targets, valuation methodology and risks

Companies Ticker Share price

(24 Dec) Nomura

rating Price target

(INR) Valuation basis Investment risks ABB Ltd ABB IN 771 REDUCE 535 We have valued the stock on end CY10E

book value of INR145 and RoE of 22.3%. At our target price of INR535, ABB will be valued at 3.7x CY10E book.

Extraordinary revival in corporate capex: the biggest risk to our price target will be a significant and swift recovery in corporate capex. Our economics team is forecasting GDP growth of 6.3% in FY10.

ACC ACC IN 859.7 REDUCE 609 We have valued the company at 1.73x CY10E book value of INR352. We get this multiple at ROE of 15.4% and cost of equity of 11% and perpetual growth rate of 5%.

Our call is based on the strong likelihood of cement prices falling because of a downturn in the cement cycle. If cement demand growth is higher than expected or there is a considerable delay in expansion of cement manufacturing capacities then the cycle can extend and strong pricing will continue. Company-specific risks: 1) strong pricing environment in 2H FY09; 2) if the company can get coal linkages then it can reduce its coal costs. We believe that there is a high probability that consensus will be negatively surprised on earnings. This may pull down the stock price and is a downside risk to our target price.

Ambuja Cement ACEM IN 99.45 REDUCE 67 We have valued the company on the basis of long-term expected return on replacement cost of assets. Long-term growth rate and pre-tax WACC have been assumed as 0% and 12%, respectively.

If cement demand grows more than expected or capacity expansion gets delayed then the cement up cycle can extend in FY09 and FY10. This would mean a sustained strong pricing environment for the company. The stock could appreciate in this scenario. Company-specific risks: 1) stronger-than-expected demand growth can lead to strong pricing environment and 2) the stock can find support if Holcim, the company's parent, goes for majority control.

Axis Bank AXSB IN 990 BUY 1,185 We value Axis Bank at 2.5x P/BV FY11 (sustainable RoE of 19.4% and growth rate of 7%).

A faster-than-expected rise in interest rates and higher delinquencies are key risks to our rating and price target for Axis Bank.

Bharti BHARTI IN 321 NEUTRAL 330 Our DCF-based price target of INR330 is based on a WACC of 11.1% and a terminal growth rate of 4%.

Risks to our price target include stronger-than-expected competition and unfavourable regulatory developments related to various fees and charges.

BHEL BHEL IN 2,368 REDUCE 1,850 We value the company using DCF methodology. Our key DCF assumptions are a terminal growth rate of 5% and a cost of equity of 11.45%. Our terminal operating margin estimate is 16.6%.

Upside risks emerge from an increase in BHEL's share in private sector projects.

Colgate-Palmolive

CLGT IN 663 REDUCE 600 Our 12-month price target of INR600 is based on a P/E multiple of 24x FY10E EPS estimate of INR25.00.

Cut in advertising and promotional spends: Colgate, relative to its size, is the biggest spender on advertising and promotion in the Indian consumer sector. The company spends ~16% of sales on A&P, compared with a sector average of 12%.

Container Corp CCRI IN 1,270 NEUTRAL 1,300 Our 12-month price target of INR1,300 is based on 15x trailing 12 months (December-11E) EPS of INR86.60. This also corresponds with an implied P/BV multiple of 3x one-year forward book, which is in line with the stock's mean traded level since FY04.

1) While CCRI's business model generates attractive cashflow, the company has not been paying rich dividends, leading to significant cash accumulation. As of FY09, almost 45% of assets were in the form of cash, leading to lower return ratios. A continued policy of low cash payout will likely further hurt return ratios. 2) CCRI is enjoying section 80IA benefits, which will gradually start tapering off from FY14, as the incremental eligible asset base for these benefits will be lower, in our view. We estimate this could push up tax rates by 3-4pp by FY16-17E. 3) We remain cautious about the long-term impact on CCRI's market share, as several private players have now entered the segment. Access to funds, warehouses at key locations and customer tie-ups are likely to pose a threat to CCRI in the long run. 4) We believe port capacity at JNPT is saturating and the fourth container terminal is still to be awarded. While we believe ports in Gujarat such as Mundra Port & SEZ and Pipavav will play a key role in leading growth, they may not be able to ramp up at a faster rate.

Cummins India KKC IN 405.5 BUY 450 We value the stock at 15x TTM December-10E EPS, which is in line with historical one-year forward multiples.

Appreciation of rupee will not only impact the margins on exports but also dampen the growth outlook as the competitive advantage of cheap Indian products will be reduced to an extent. Diesel prices pose risk to the demand for back-up power.

DLF Ltd DLFU IN 371 REDUCE 330 Our 12-month price target of INR330 per share is based on the net asset value of the current landbank at INR330 per share at a 12.5% discount rate, without providing a discount to NAV.

Upside risks to our call: 1) faster execution of projects and landbank development, 2) prices increasing faster than we expected, and 3) the listing of DAL Properties as a REIT in Singapore at lower-than-estimated cap rates.



Exhibit 116. Summary of price targets, valuation methodology and risks (continued)


(24 Dec) Nomura

rating Price target

(INR) Valuation basis Investment risks Dr. Reddy’s DRRD IN 1,186 BUY 1,329 Our price target of INR1,329 is based on a

sum-of-the-parts valuation: we value DRRD's base business (ex-Betapharm, one-offs) at INR1,217/share, based on 18x one-year forward adjusted earnings (average of FY11F, FY12F adj earnings).

1) Regulatory hurdles adversely impacting current sales and future launches, 2) deterioration in sales in Russia and Germany greater than our expectations and 3) adverse movement in currencies.

GAIL GAIL IN 420 BUY 500 We have used sum of the parts as our primary tool to value the diversified business of GAIL. We have valued its gas transmission business (including gas trading) at 10x its FY11E EBITDA. We have assigned an EV/EBITDA multiple of 7x FY11 estimated EBITDA to petrochemical and 6x FY11 estimated EBITDA to LPG business. We also value E&P upside at a conservative INR15/share. Our PT is INR500/share.

Key downside risks: Lower transmission volume growth; sharp cut in tariffs by regulator (we do not assume any cut); sharper polymer price decline than our assumption and higher subsidy burden than our assumptions.

GMR Infrastructure

GMRI IN 67.15 REDUCE 47 We have valued all GMR projects individually to arrive at a fair value of INR44.4/share. We have assigned a 15% holding company discount to assets other than airports (and related real estate). Including the projected cash balance as of Mar-10 (net of investments into the valued projects) we arrive at our target price of INR47 for GMR.

1) An aero tariff regime that is more favourable than expected. DIAL and GHIAL have currently been allowed to levy ADF and UDF, respectively, to fund the development of the airport assets. Any upward revision in these charges poses risks to our valuations as does an extension in the tenure of the levy. 2) Upside from real estate development assets. We have currently assumed a bidder's cost of about INR750mn/acre for Delhi land and INR60mn/acre for Hyderabad area. Realisation beyond these numbers could pose an upside risk to our valuations. 3) Better rates. Non-aero revenue contracts at DIAL and GHIAL could be re-negotiated at better rates than we have assumed and pose an upside risk to our call. 4) Power projects. We have currently not factored in any of the power projects under development except Kamalanga due to lack of land acquisition, financial closure, etc. Any material development on any of these projects might necessitate a re-look into these assumptions posing an upward risk to our call. 5) Road projects: We have not assumed any new order win for road projects. While new order wins could pose an upward risk, they would require an equity commitment from GMR.

GVK Power and Infra

GVKP IN 47.60 REDUCE 24.3 We have valued all GVK projects individually to arrive at a fair value of INR24.30/share. GVK had approximately INR90mn cash at the standalone entity level as of March 2009, which it plans to use to fund the requirement of subsidiaries. We have accordingly adjusted for estimated equity requirement into the valued projects to arrive at our 12-month price target of INR24.30.

1) An aero-tariff regime that is more favourable than we expect. MIAL has been allowed to levy the ADF to fund the development of airport assets. Any revision in these charges poses risks to our estimates, as does an extension in the tenure of the levy. 2) Risks from real estate development assets. We have assumed a bidders' cost of INR550mn/acre for Mumbai airport land. Realisations different from these numbers could pose risks to our valuations. 3) Better or lower rates for non-aero revenue contracts. Non-aero revenue contracts at MIAL could be re-negotiated at better or even lower rates than we have assumed and thus, pose a risk to our call. 4) Power project developments. We have factored in two power projects under development, Goindwal Sahib and Alaknanda, for our valuation. Any material changes in the status of their development and similarly any development in the Goriganga power project would pose risks to our call. 5) Road project wins. We have not assumed any new order wins for road projects. Road project wins would pose upward risk, but would also entail equity commitment from GVK.

Hindustan Construction

HCC IN 151 BUY 157 (under review)

We value HCC using a sum-of-the-parts methodology. We value its core construction business at 13.5x one-year forward earnings to arrive at a one-year forward value of INR106. We have valued BOT projects at 2x equity invested, the Lavasa project at 2x equity invested and the 247 Park project using a DCF methodology. Our 12-month price target is INR157.

The key risks are: 1) a substantial slowdown in order inflows; 2) execution delays and lower-than-estimated margins; and 3) a rise in interest rates and risk premium.

HCL Tech HCLT IN 375 BUY 397 (under review)

Our DCF based price target is INR397 and is calculated using 11% discount rate and terminal growth rate assumption of 5%. The target price of INR397 also translates into a 14x one-year forward P/E, which is a 26% discount to the target price P/E multiple.

There are two risks to our target price: 1) lower revenue ramp-up from the order book and 2) greater-than-expected appreciation of the rupee against the US dollar.





(24 Dec) Nomura

rating Price target

(INR) Valuation basis Investment risks ICICI Bank ICICIBC IN 875 BUY 910 We value ICICI Bank's core business at 1.7x

P/BV FY11F, life insurance at 20x one-year forward new business profit, asset management at 7% of equity funds and 2% of debt funds, ICICI Ventures at 18x one-year forward earnings, general insurance at 10x one-year forward P/E, ICICI Securities at 18x one-year forward P/E and I-Sec PD at 5x one-year forward P/E. We also apply a 15% subsidiary discount to arrive at our final consolidated subsidiary value.

Faster-than-expected growth is an upside risk to our estimates. Downside risks include slower-than-expected economic growth, a rapid rise in bond yields owing to rising fiscal deficit, and increasing global stress that could hurt ICICI's international book.

Indiabulls Real Estate

IBREL IN 216.5 BUY 339 Our 12-month target price of INR339 is based on: a) gross asset value of the current landbank at INR190 per share with a discount rate of 12.5% b) cash of INR32 per share c) Indiabulls Power Ltd. being valued at INR117 per share at 2x post-money P/BV.

Downside risks include: 1) a reduction in liquidity and capital availability for developers, 2) stalled economic growth recovery, 3) rising interest rates, 4) power projects facing implementation issues, 5) Nasik, Gurgaon and Panvel SEZ not getting notified, and 6) an inability to convert ICDs into cash again. We are also apprehensive about the fact that the promoter's stake has gone down to about 17%.

Infosys INFO IN 2,592 NEUTRAL 2,600 Our 12-month price target of INR2,600 is based on a DCF calculation, assuming a terminal growth rate of 5% and an 11% cost of equity in rupee terms for Indian software companies.

There are two risks to our price target: 1) the appreciation of the rupee against the dollar more than what we expect; and 2) a double dip recession in the global economy.

IRB Infra IRB IN 242 REDUCE 193 We use DCF to value the BOT projects. We use a discount rate of 11.5%. We value the construction business at 8x one-year forward earnings. We are also assigning INR32 for future asset accretion opportunities, assuming 16% equity IRR and INR3bn of equity investment every year. The equity investment assumption is in line with the current yearly equity investment in BOT projects. Overall, our valuation for the existing BOT is INR87, INR70 for construction business, INR4 for real estate and INR32 for the growth factor. Our target price is hence INR193.

Key risk to our call: a) higher-than-estimated traffic; b) availability of cheap funding substantially increasing companies' ability to bid for new projects and c) fall in risk premium and interest rates.

ITC Limited ITC IN 256 BUY 309 We value the company using a sum-of-the-parts valuation methodology. We value the core cigarette business at INR227 per share based on a P/E multiple of 19x FY11F earnings of INR11.9. The other core businesses are valued at around INR71 per share. We have valued the net cash (after deducting corporate expenses) at book value.

Any structural change in regulations could hamper the growth trajectory of the core cigarette business.

IVRCL IVRC IN 357 BUY 451 We value IVRCL using a sum-of-the-parts methodology. The core construction business is valued at 13.5x one-year forward earnings, at 40% discount to L&T, which we value at 22.5x. We have valued BOT projects at 2x equity invested and IVR Prime and HDO at the market cap (24 September 2009). Our 12-month price target is INR451.

The risks to our call are a) deterioration in the macro environment resulting in rise in interest rates and risk premium, adversely impacting base business and subsidiary valuations and b) slowdown in order inflows and execution.

L&T LT IN 1,682 BUY 1,867 We value L&T's standalone business at 22.5x one-year forward EPS (INR71.8 as on September 2010) and subsidiaries at INR252/share.

In our view, rise in interest rates and risk premium are the key risks to our valuations.

Mahindra & Mahindra

MM IN 1,061.85 BUY 1,232 We have valued the core business at a multiple of 12x FY11F EPS of INR66.9. We value the listed subsidiaries at a discount of 20% to their market cap. We have rolled forward our price target at 11.6% cost of equity.

Slower-than-estimated volume growth in utility vehicles. In case volume growth in UVs is lower than our estimates, MM could see its earnings fall as the company is in high capex mode.

Mundra Port & SEZ

MSEZ IN 560.5 BUY 615 Our 12-month price target of INR615 is based on a sum-of-the-parts analysis. We have valued the core port business at INR391 per share, using a cost of equity of 11%, the Container Terminal 2 (CT2) at INR79 per share, SEZ at INR108 per share (at a cost of equity of 18%) and the Dahej Port at INR6 per share (1x P/BV). Projected cash on books adds another INR31/share. We have yet to assign any value to the logistics business, as it is in its infancy.

MSEZ's sub-concession agreement with MICT for CT1 is under dispute; this could also have repercussions on the right to operate CT2. A substantial share of traffic is dependent on promoter group companies and other few customers. MSEZ's tax liability could be different if it is allowed benefits under section 80IAB. The payout ratio assumed might not be maintained, impacting implicit assumptions of the DCF model.





(24 Dec) Nomura

rating Price target

(INR) Valuation basis Investment risks Nagarjuna Construction

NJCC IN 165.85 BUY 197 We value NJCC using a sum-of-the-parts methodology. The core construction business is valued at 13.5x one-year forward earnings to arrive at the value of INR146. We value NJCC's construction business in line with other mid-tier construction companies and at 40% discount to L&T. We have valued BOT projects at 2x equity invested NJCC Urban at its current book value. We have separately valued the current order book in its international operations. Our 12-month target price is INR197.

The key risks to our call are a deterioration in the macro environment; execution delays and a fall in subsidiary valuations.

Patni PATNI IN 473 BUY 540 Our price target of INR540 is based on a 12x one-year forward P/E, which we believe is a suitable multiple for an IT services company of Patni's size and customer base. It is also at a 40% discount to our one-year forward P/E multiple for Infosys' price target and at the lower end of the 30-75% discount to Infosys at which it has traded in the recent past.

High geographical and client concentration, and possibility of a large-scale value destructive acquisition and steep appreciation of the rupee against major currencies such as the US dollar.

Punj Lloyd PUNJ IN 202 NEUTRAL 228 Based on the sum-of-the-parts (SOTP) valuation, we arrive at a 12-month price target of INR228. We value the company's core E&C business at 11x FY10F earnings, 20% discount to mid-cap peers. We value its stake in Pipavav Shipyard at current market price and investments in Punj Lloyd upstream and aviation at 1x invested capital.

The key upside risk to our call is a) greater-than-expected order inflows; b) higher-than-expected margins — a 50bp increase in EBITDA margin would increase our EPS estimates by 8% and c) higher valuation for subsidiaries. The key downside risks are a) project-specific execution issues adversely impacting margins; b) increase in interest rate and risk premium and c) adverse ruling on arbitrations related to payments from customers, which the company has not yet accounted for and classified as good receivables.

Punjab National Bank

PNB IN 911 NEUTRAL 960 We value Punjab National Bank's core business at 1.8x P/BV based on a sustainable RoE of 15.7% and a COE of 11.7%, which brings us to a price target of INR960.

Faster-than-expected loan growth and a slower-than-expected rise in rates are key upside risks to our price target and earnings forecasts. Higher formation of new NPLs, poor performance of restructured loans and tighter-than-expected liquidity are downside risks.

Ranbaxy RBXY IN 520 REDUCE 261 Our 12-month price target of INR261/share is based on a sum-of-the-parts valuation: a) base business valuation at INR141/share, using DCF valuation; and b) one-off product specific upsides at INR120/share.

Realisation of product specific opportunities, above our expectation.

Reliance Capital RCFT IN 851 REDUCE 834 Using SOTP, we value RCFT at INR834/share. We value the life insurance business at 15x FY11 NBAP, asset management business at 4.5% FY11 AUM and RMoney at 14x FY11 earnings.

The key upside risk to our valuation is if margins in the insurance business come in higher than we are forecasting.

Reliance Comm RCOM IN 175 REDUCE 154 Our DCF-based price target of INR154 is based on a WACC of 12.7% and a terminal growth rate of 4%.

Key upside risks to our ratings include competitive activity that is more benign than anticipated and faster-than-anticipated stability in pricing.

State Bank of India

SBIN IN 2,215 BUY 2,590(under

review)

We value SBI at 1.8x FY11F P/BV for the core banking business, based on sustainable ROE of 17%. Our fair value for the core business works out to INR2,356. We have valued subsidiaries at INR231 per share. The subsidiary valuation is driven by life insurance, which have valued at 18x NBAP FY11F.

A faster-than-expected rise in rates or slower-than-expected loan growth are key risks to price target and earnings forecast.

Steel Authority of India Limited

SAIL IN 237 BUY 250 We have valued SAIL at 10x FY12F core earnings and discounted it back. We have added total capex expected until FY12 less net debt at its book value.

Steel prices remain weak: 1) If steel prices remain weaker than our expectation, there could be a risk to our earnings estimates. 2) Raw material prices rise significantly: We have built in a 30% increase in iron ore prices and a 50% increase in coking coal prices next year. If the price increase is higher, there could be a risk to our numbers. 3) Delay in expansion plans: We expect a full expansion and modernisation plan to be completed by FY14. In case of a delay in capex, there could be downside risk to our estimates.

Sun TV SUNTV IN 336.25 BUY 355 (under review)

We use a DCF method to value SUN TV and arrive at our 12-month price target of INR355. Some of our key assumptions are: 1) an explicit earnings forecast from FY09-FY12, FCFE growth of 12% during FY13-FY19F, a terminal growth rate of 5% from FY20F and 2) a discount rate of 11.5%.

The risks are: 1) the radio business is an area of concern for us, 2) the sub-optimal use of the high cash generated by the core business is also a cause for concern, 3) new competition emerging across markets and 4) an increase in fees paid to directors.

Tata Motors TTMT IN 779.95 REDUCE 419 We have used normalised EV/EBITDA (for comparison with other OEMs), assuming 2% of sales as normalised R&D expense. We have used an EV/EBITDA multiple of 8.5x, which is close to the upper end of the stock’s trading band

We have assumed the growth rate of IIP grows at 7% in FY10F. If IIP growth is slower than this, there may be downside risks to our estimates.





(24 Dec) Nomura

rating Price target

(INR) Valuation basis Investment risks TATA Steel TATA IN 615.60 BUY 926 We value TATA Steel at INR926/share using

sum-of-the-parts valuation. We value TATA Steel's India business at 9x FY12F EPS of INR92.3. We have discounted it back by a year to arrive at a valuation of INR735/share. We have valued Corus at 5x FY11F EV/EBITDA at US$8.3bn, contributing INR172/share and the SE Asia business at 5x EV/EBITDA at INR19/share.

Steel prices remain weak: 1) If steel prices remain weaker than our expectation, there could be a risk to our earning estimates. 2) Economic recovery is delayed: We are building in a significant improvement in steel prices and capacity utilisation at Corus in FY11E. If this does not happen, there could be risk to our price target. Raw material prices rise significantly: We have built in a 30% increase in iron ore prices and a 50% increase in coking coal prices next year. If the price increase is higher, there could be a risk to our numbers.

Tata Consultancy

TCS IN 749 NEUTRAL 785 Our 12-month price target of INR785 is based on a DCF calculation assuming a terminal growth rate of 5%, and 11% cost of capital in rupee terms for Indian software companies.

There are two risks to our target price 1) greater-than-expected appreciation of the rupee against the US dollar and 2) a double dip recession in the global economy.

Tech Mahindra TECHM IN 1,003 BUY 1,250 Our 12-month price target is INR1,250 based on 13x one-year forward P/E, a 30% discount to our target one-year forward P/E for Infosys and in line with the historical average discount between the multiples of two companies.

The three key investment risks to our price target are: 1) greater-than-expected appreciation of the rupee against the US dollar and GBP, 2) lower ramp-up in BTGS and other large deals and 3) restated financials of Satyam leading to lower revenue and margin figures than we have assumed.

Thermax Ltd TMX IN 592.55 NEUTRAL 515 Our price target is based on a DCF with 11.45% cost of equity, second stage growth of 10% during FY13-17E and terminal growth rate of 6%.

(1) A slowdown in industrial capex would lead to a slowdown in revenue growth. (2) A higher-than-anticipated increase in raw material costs could lead to a decline in margins. (3) Appreciation in Indian rupee could hurt the company's exports.

Unitech UT IN 82.00 BUY 112 Our 12-month price target is INR112. We value the company in two parts: 1) net asset value of current land bank at INR103 per share; and 2) telecom stake valued at INR9 per share.

Downside risks include: 1) a reduction in liquidity and capital availability for developers, 2) stalled economic growth recovery, 3) an inability to successfully sell projects or construct them, and 4) rising interest rates.

Wipro WPRO IN 694 NEUTRAL 740 Our 12-month price target of INR740 is derived using a sum-of-the-parts valuation for its various businesses. This includes INR700 for the global IT services segment, and the rest from its other businesses (INR10 for IT product, INR29 for consumer care and lighting and INR1 for others). We assume a cost of equity of 11% and a terminal growth rate of 5% after FY20F.

There are two risks to our target price: 1) greater-than-expected appreciation of the rupee against the US dollar and 2) a double dip recession in the global economy.

Zee Entertainment

Z IN 265.5 BUY 292 We value ZEEL on a relative P/E multiple based valuation technique. Our target multiple of 21x FY11 EPS of INR13.9 is roughly a 30% premium to the broader market multiples.

Some of the key risks to our positive call on Zee include: a) a slowdown in economic activity in India, leading to slower-than-expected growth in advertising spending; b) higher-than-anticipated competition in the Hindi GEC space; c) any further deterioration in the ratings of ZEEL's flagship channel Zee TV; and d) the stability of top management at the helm of Zee Entertainment.

Note: local currency, 24 December closing

Source: Bloomberg, Nomura International (Hong Kong) Ltd







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The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities.

Distribution of Ratings: Nomura Global Equity Research has 1724 companies under coverage. 41% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 42% of companies with this rating are investment banking clients of the Nomura Group*. 40% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 50% of companies with this rating are investment banking clients of the Nomura Group*. 19% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 8% of companies with this rating are investment banking clients of the Nomura Group*. As at 30 September 2009. *The Nomura Group as defined in the Disclaimer section at the end of this report.



Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America for ratings published from 27 October 2008: The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. Analysts may also indicate absolute upside to price target defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc.

Stocks:

• A rating of "1", or "Buy", indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. • A rating of "2", or "Neutral", indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. • A rating of "3", or "Reduce", indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. • A rating of "RS-Rating Suspended", ” indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Benchmarks are as follows: United States/Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks (accessible through the left hand side of the Nomura Disclosure web page: http://www.nomura.com/research); Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology.

Sectors:

A "Bullish" stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A "Neutral" stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A "Bearish" stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX® 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia.

Explanation of Nomura’s equity research rating system for Asian companies under coverage ex Japan published from 30 October 2008 and in Japan from 6 January 2009: Stocks:

Stock recommendations are based on absolute valuation upside (downside), which is defined as (Price Target – Current Price) / Current Price, subject to limited management discretion. In most cases, the Price Target will equal the analyst’s 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. • A "Buy" recommendation indicates that potential upside is 15% or more. • A "Neutral" recommendation indicates that potential upside is less than 15% or downside is less than 5%. • A "Reduce" recommendation indicates that potential downside is 5% or more. • A rating of "RS" or "Rating Suspended" indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. • Stocks labelled as "Not rated" or shown as "No rating" are not in Nomura's regular research coverage. Sectors:

A "Bullish" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A "Neutral" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A "Bearish" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Explanation of Nomura's equity research rating system in Japan published prior to 6 January 2009 (and ratings in Europe, Middle East and Africa, US and Latin America published prior to 27 October 2008): Stocks:

• A rating of "1", or "Strong buy", indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next six months. • A rating of "2", or "Buy", indicates that the analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the next six months. • A rating of "3", or "Neutral", indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 5% over the next six months. • A rating of "4", or "Reduce", indicates that the analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% over the next six months. • A rating of "5", or "Sell", indicates that the analyst expects the stock to underperform the Benchmark by 15% or more over the next six months. • Stocks labeled "Not rated" or shown as "No rating" are not in Nomura's regular research coverage. Nomura might not publish additional research reports concerning this company, and it undertakes no obligation to update the analysis, estimates, projections, conclusions or other information contained herein. Sectors:

A "Bullish" stance, indicates that the analyst expects the sector to outperform the Benchmark during the next six months. A "Neutral" stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months. A "Bearish" stance, indicates that the analyst expects the sector to underperform the Benchmark during the next six months. Benchmarks are as follows: Japan: TOPIX; United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe, by sector — Hardware/Semiconductors: FTSE W Europe IT Hardware; Telecoms: FTSE W Europe Business Services; Business Services: FTSE W Europe; Auto & Components: FTSE W Europe Auto & Parts; Communications equipment: FTSE W Europe IT Hardware; Ecology Focus: Bloomberg World Energy Alternate Sources; Global Emerging Markets: MSCI Emerging Markets ex-Asia.



Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published prior to 30 October 2008: Stocks:

Stock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price)/Current Price, subject to limited management discretion. In most cases, the Fair Value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. However, if the analyst doesn't think the market will revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from the intrinsic fair value. In most cases, therefore, our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fair value. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within this horizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. • A "Strong buy" recommendation indicates that upside is more than 20%. • A "Buy" recommendation indicates that upside is between 10% and 20%. • A "Neutral" recommendation indicates that upside or downside is less than 10%. • A "Reduce" recommendation indicates that downside is between 10% and 20%. • A "Sell" recommendation indicates that downside is more than 20%. Sectors:

A "Bullish" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A "Neutral" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A "Bearish" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Explanation of CNS rating system for Thailand companies under coverage published from 2 March 2009: Stocks:

Stock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price) / Current Price, subject to limited management discretion. In most cases, the Fair Value will equal the analyst’s assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. However, if the analyst doesn’t think the market will revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from the intrinsic fair value. In most cases, therefore, our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fair value. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within this horizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. • A "Buy” recommendation indicates that potential upside is 15% or more. • A "Neutral" recommendation indicates that potential upside is less than 15% or downside is less than 5%. • A "Reduce" recommendation indicates that potential downside is 5% or more. Price targets Price targets, if discussed, reflect in part the analyst's estimates for the company's earnings. The achievement of any price target may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates.



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