2 March 2012 Update

Capital Goods
NTPC bulk tender - Emergence of true competition in BTG space
New pricing regime emerging; margins on future bids to be lower than the history

BGR Energy Systems has emerged as the lowest bidder (L1) for the boiler package of NTPC's bulk tender 1 (11x660MW) with a 15% lower quote than Doosan's bid for boiler package of bulk tender 2 (9x800MW). NTPC's bulk tenders have brought to fore the emerging competition in power BTG space in India. Bidders, apart from BHEL, have bagged 64% of the combined order value of bulk tender s 1 and 2. L&T is the key loser, even as BGR Energy ha s emerged as a promising ne w player. The bulk tenders have also set new pricing benchmarks, which are not predatory, but would generate lower margins than in the past. We remain cautious on the power equipment space.

NTPC's bulk tenders - the USD8b mega order: NTPC had invited bids for bulk supply of boilers-turbinegenerators (BTG) in early 2010. Bulk tender 1 (11x660MW) was worth INR192b and bulk tender 2 (9x800MW) was worth INR1,902b. Both tenders are for super-critical power plants to be set up across various states. The price bidding for these tenders went through number of litigations resulting in the award being delayed. The litigations ended recently with the opening of price bids for the boiler package pertaining to bulk tender 1 following the Supreme Court's verdict in favor of NTPC against the Ansaldo-Gammon India JV, which had challenged its disqualification by NTPC. NTPC's conditions favored companies having (or in process of setting up) manufacturing bases in India: To support domestic players and bring supercritical technology to the country, one of the pre-requisites to bid for the bulk tenders was for that companies or JVs should have an indigenous manufacturing base or must have acquired land for setting up a manufacturing facility at the time of bidding. While this eliminated Chinese companies from the bidding process, several Indian companies formed JVs with global players. South Korea's Doosan is the only foreign company (apart from JVs) which has bagged orders and is also setting up a manufacturing facility in India. With NTPC and other state utilities favoring domestic manufacturing, other players like Dongfang are also considering setting up manufacturing bases in India.

Who won, who lost? BGR Energy, the Alstom-Bharat Forge JV and Doosan are the key beneficiaries of NTPC's bulk tenders, garnering 25%, 11% and 11%, respectively, of the combined order value of around INR390b. BGR, which won both the boiler and turbine generator (TG) packages, bid aggressively. Its bids were lower by 15% (for boilers) and 25% (for TGs). As a result, concerns have emerged on the margins that it will make on these orders, though the management seems confident of generating EBITDA of 12-13% and net profit margin of 67%. Although BHEL, which was assured of bagging a minimum number of units got 36% share, the company is a definitely loser as it would now have to match the L1 prices for all bids, which are lower by 7-12%. The L&TMitsubishi Heavy Industries JV is the biggest loser as it failed to win any bid. This raises questions about the JV's cost-structure and its future as it would run out of orders once its existing order-book (around 10GW) is exhausted by FY14. Bulk tenders bring to fore emerging competition in power BTG space: NTPC's bulk tenders have been a key catalyst for the significant change in the Indian power BTG manufacturing space. Domestic BTG manufacturing capacity would increase to nearly 38GW per annum by FY14 from just 10GW per annum in FY08. The prices quoted by BGR Energy and Doosan, though not predatory, are competitive and would generate lower margins that those enjoyed in the past (particularly by BHEL and lately by L&T). We believe NTPC's bulk tenders have set new pricing benchmarks and expect similar pricing in future bids.

Dhirendra Tiwari (Dhirendra.Tiwari@MotilalOswal.com) +91 22 3982 5127 Deepak Narnolia (Deepak.Narnolia@MotilalOswal.com) +91 22 3982 5126

Capital Goods | Update

NTPC's bulk tenders - mega orders for 14.4GW worth ~INR390b

Bulk tender 1 - TG package: The price bids for bulk tender 1 TG package were opened in early 2011. Bharat Forge-Alstom, BHEL and Toshiba-JSW were declared L1 (INR12.5m/MW), L2 and L3, winning 5, 4 and 2 units, respectively. The TG package was to be split among three bidders, with BHEL being considered L2, if it is not L1, and would have to match L1 price to get orders. Bulk tender 1 (boiler package): In July 2011, NTPC invited price bids from BHEL, L&T and BGR Energy for its bulk tender 1 (boiler package) and disqualified Ansaldo on technical grounds. Subsequently, Ansaldo challenged the decision in Delhi High Court which ruled in favor of Ansaldo. NTPC then appealed in the Supreme Court which decided in favor of NTPC. Following the Supreme Court's decision, the price bids were opened recently. BGR Energy was L1, beating BHEL (L2) and L&T (L3). The company quoted a price (read-out price) of INR14m/MW (INR102b for 11 sets of boilers), which is 15% lower than the price quoted by Doosan for the boiler package of NTPC bulk tender 2 (9x800MW). The evaluated price quoted by BGR was INR111b. According to the tender, the boiler package was to be split between two bidders. While the L1 winner would get 3 projects (6 or 7 units of 660MW each), L2 would get the remaining two projects (4 or 5 units). BHEL will be treated as L2 if it is not L1 and would have to match L1 price. Thus, BGR Energy (in a JV with Hitachi) would get 6 or 7 units (INR 5.5b or INR6.5b) and BHEL would get 4 or 5 units (INR3.7b or INR4.6b). Bulk tender 2 (boiler package): In September 2011, NTPC opened the price bids for the boiler package (bulk tender 2) of the 11x800MW tender. On the basis of 'read-out' prices, Doosan was L1 (INR16.4m/MW), followed by L&T-MHI (L2, 5% higher)) and BHEL (L3, 6% higher). The BGR-Hitachi JV and Thermax quoted higher prices. Doosan would get 5 units (4GW, INR66b), while BHEL would get 4 units (3.2GW, INR53b) if it matches L1 price. The price quoted by Doosan was in-line with BHEL's bids related to Bajaj Hindustan at INR29m/MW for a BTG package, implying INR16m/MW for the boiler package. Bulk tender 2 (TG package): In the TG package, BGR Energy was L1 with a quoted price of INR10m/MW, 2% lower than L&T and Toshiba and 10% lower than BHEL. BGR Energy would get 4 units (INR30b), while BHEL (INR16b) and Toshiba (INR24b) would get 2 units and 3 units, respectively. The prices quoted by BGR Energy were over 20% lower than the TG bid for 11x660 MW bulk tender. NTPC is yet to issue the letter of awards to successful bidders for bulk tender 2.

NTPC's bulk tender outcome

2 March 2012

Capital Goods | Update

Company-wise share (bulk tender 1 and 2)

Company BHEL BGR Doosan Alstom Toshi ba Total Order INR m 138,440 96,680 65,600 41,250 40,500 382,470 % share 36 25 17 11 11 100

Bulk tender 1 - project details

Bid prices for bulk tender 1 projects (INRm/MW)

TG Boiler

Bid prices for bulk tender 2 projects (INRm/MW)

TG Boiler
17.8 16.4 17.3 17.4 11.5 10.0 10.4 10.5 21.3

17.0 13.0 14.0 14.0

15.8

16.0

BHEL

BHEL

L&T

BGR

L&T

BGR

Al s tom

BHEL

Tos hi ba

BGR

BHEL

L&T

Note: These are approximate 'read out' prices based on inputs from the industry

Domestic BTG manufacturing capacity to rise to 36GW per annum by FY14

Domestic companies are aggressively building BTG capacities in the company. Apart from BHEL, all other new entrants are setting up supercritical BTG facilities. After BHEL and L&T, BGR Energy is setting up an integrated BTG manufacturing facility. While Thermax is setting up a boiler facility, the Bharat Forgel-Alstom and JSW-Toshiba JVs are setting up TG manufacturing facilities. Foreign players also trying make their presence strong. Doosan has already established itself as a credible player in India after successfully executing a few large projects, including supply of boilers for Tata Power's 4GW ultra-mega power plant. The company is also L1 for NTPC's 9x800MW bulk tender. Doosan is setting up a boiler manufacturing facility in the country and would remain a strong player in the foreseeable future. China's Dongfang Electric Machinery Company (DFEM) is considering the possibility of setting up a BTG manufacturing plant in India.
3

2 March 2012

Thermax

Toshiba

Doosan

Capital Goods | Update

Boiler manufacturing capacity (GW)

BHEL BGR Hi tachi Cethar Gammo n Ans al do L&T MHI Th erma x Bab co x Wi l cox Doos an 2 3 4 4 4 4 15 FY10 20

Turbine generator manufacturing capacity (GW)

BHEL BGR Hi tachi Ce thar Gammon - Ansa l do L&T - MHI Thermax - Bab co x Wi l cox Doo san 2 3 4 4 4 4 15 FY10 20

6 FY06

10 FY08

6 FY14 FY06

10 FY08

FY14

Note: These are approximate 'read out' prices based on inputs from the industry

Competition unlikely to ease over next 2-3 years

With the entry of several players, the Indian power equipment space is increasingly becoming competitive. We expect competitive intensity to remain tough in the near future on account of new manufacturing capacity coming up. However, coal shortages have resulted in power producers delaying orders. The industry needs a significant pickup in demand, at least 15-20 GW of orders per annum, to partly absorb the upcoming manufacturing capacity. We believe demand would not pick-up any time soon until the government takes some speedy and concrete actions, particularly relating to coal blocks and land acquisition. Under this scenario, we believe that BTG players would have no option but to resort to aggressive pricing. This would have a negative impact on the profitability of established players like BHEL. On the positive side, BHEL is expected to maintain or increase its market share in the near-term because majority of order awards from NTPC and PSUs flow to it, which puts it in a relatively advantageous position.
BTG players market share during 11th plan
Si e men s SCMEC 2% 3% Dong Fa ng 14% SEPCO 2% SEC 12% L&T 1% BHEL 58% Others 8%

and 12th plan

Technopro Cethar m Ves s l s SCMEC 2% 1% 2% Dong Fa ng 11% SEPCO 3% Harbi n 10% SEC 10% Si emens 1% Others 2%

BHEL 46%

Total Chinese: 31%

Doos an 3%

L&T 9%

Note: These are approximate 'read out' prices based on inputs from the industry

2 March 2012

Capital Goods | Update

Outlook uncertain as demand slows; Maintain Neutral on the sector

The Indian power equipment market is going through a challenging phase impacted by the double whammy of slowing demand (from power producers) and increased competition. Lack of coal linkages and volatile merchant power prices, coupled with several other constraints like land availability have hit new project awards over the past one year. We believe that while the situation would possibly improve in FY13 with an order pipeline of over 20GW being awarded (led by PSUs like NTPC), the outlook for the following years is uncertain. We remain Neutral on the sector. Despite the significant correction in stock prices during last year, we believe BHEL's valuations would remain under pressure due to the following de-rating catalysts: (1) possible downside to our order intake assumptions in FY12/13 due to worsening external environment in the power sector; (2) downside risk to FY13 earnings estimate due to execution constraints and deteriorating working capital; and (3) uncertainty around the company's proposed FPO (follow-on public offer). Maintain Neutral. Though BGR Energy has been the biggest gainer of the NTPC bulk tender, the profitability on these orders remains a question mark. We believe that success in a few EPC orders could significantly boost the company's FY13-14 earnings outlook and result in a re-rating of the stock. At present, we maintain Neutral on the stock. Thermax continues to see poor order inflow and has failed win any BTG order so far. We remain Neutral on the stock.
Comparative valuation Rating M-Cap CMP EPS (INR) FY11 FY12E FY13E 8.7 25.5 29.3 7.1 19.8 75.6 22.9 34.4 28.9 17.0 25.8 26.0 10.6 24.3 83.5 30.6 34.5 35.8 272.6 12.9 7.8 9.9 22.1 18.3 32.3 16.5 24.3 P/E (x) FY11 FY12E FY13E 93.4 11.7 12.0 20.1 23.8 16.9 35.4 15.4 18.5 47.8 11.6 13.5 13.4 19.3 15.3 26.5 15.3 14.9 198.7 7.9 5.1 6.4 15.7 14.7 19.3 10.2 14.5 EV/EBITDA (x) FY11 FY12E FY13E 64.2 7.3 7.0 10.0 16.7 13.7 21.4 8.9 11.2 30.3 7.3 8.5 5.4 13.7 12.8 15.6 8.8 9.4 RoE (%) FY11 FY12E FY13E 2.6 7.4 13.4 31.4 28.1 23.8 38.9 20.8 16.4 30.5 14.6 18.0 35.5 29.8 34.0 18.3 17.7 15.6 23.2 19.2 23.0 31.9 28.1 23.6 42.0 38.0 33.8 source: Bloomberg USD INR/sh

ABB# Neutral 3.5 813 3.0 BHEL Neutral 14.8 299 23.1 BGR Energy Neutral 0.5 350 44.7 Crompton Neutral 1.9 142 14.3 Cummins Buy 2.6 471 21.3 L&T Buy 15.5 1,278 69.7 Siemens## Neutral 5.4 810 25.1 Thermax Neutral 1.2 529 32.0 Havells Buy 1.4 534 22.0 # Year end December; ## Year end September

BHEL: P/E band

BGR Energy: P/E band

2 March 2012

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