EQUITY INSIGHTS

Higher IPO graded companies continue to command higher P/E: CRISIL Equities

Pravesh Rawat Analyst, CRISIL Equities Kamna Motwani Analyst, CRISIL Equities Chetan Majithia Head, CRISIL Equities

April 2011

Disclaimer CRISIL has taken due care and caution in preparing this report. Information has been obtained by CRISIL from sources which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors in transmission and especially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this report

Higher IPO graded companies continue to command higher P/E: CRISIL Equities
CRISIL Equities fourth consecutive analysis on listed initial public offerings (IPOs) graded by rating agencies concludes that companies with higher IPO grades continue to command higher price-to-earnings (P/E) multiples. This conclusion mirrors the results of similar studies conducted in May 2009, January 2010 and July 2010 (please visit www.crisil.com for detailed articles). The continuous linkage of the IPO grade and P/E multiples over the past three years endorses the importance of the assessment of fundamentals while investing in equities. CRISIL IPO grading is aimed at providing guidance to investors on fundamentals of companies that are targeting the primary market. Grades are meant to be used by investors in conjunction with their personal risk appetite, price and return considerations.

IPO grades and P/E multiples: The correlation remains strong

Grades assigned to companies during an IPO and the P/E multiples commanded by them continue to exhibit strong positive correlation. CY10 was the third full year since IPO grading was made mandatory. CRISIL Equities annual study on IPO grading indicates that the companies with higher IPO grades command higher P/E multiples and vice versa. This time the study was carried out on a larger database of 117 companies graded by all rating agencies compared to 71 and 56 companies taken in the studies done in July 2010 and January 2010, respectively. CRISIL Equities observes that companies with an IPO grade of 5/5 (indicating strong fundamentals relative to other listed securities in India) enjoy an average P/E multiple of 18.39x vis--vis 10.13x for companies with an IPO grade of 1/5 (indicating poor fundamentals). Companies with IPO grades of 2/5, 3/5 and 4/5 traded at average P/E multiples of 10.81x, 17.82x and 18.1x, respectively. It is interesting to note that 5/5 graded companies traded at almost 80% premium to 1/5 graded companies. Also, there is a significant differential in the P/E multiples assigned to companies with above average fundamentals (4/5 and 5/5 grades) vis-a-vis the companies graded below average fundamentals (2/5 and 1/5 grades) signaling that over time the market clearly differentiates the companies with good fundamental from those with below average fundamentals.
Table 1: Current P/E multiples
Average IPO grades 1/5 2/5 3/5 4/5 5/5 Total Source: CRISIL Equities P/E multiple (x) 10.13 10.81 17.82 18.10 18.39 Number of companies 11 32 46 26 2 117

For the purpose of this study, CRISIL Equities has considered the following parameters: All companies listed between May 2007 (IPO grading was made mandatory w.e.f. May 2007) and December 2010 have been considered in order to provide sufficient time for prices to stabilise post the listing. During this period, 139 IPO graded companies have been listed.

Stocks with negative P/Es (13 companies) and those trading at P/Es of more than 50x (five companies) were excluded from the analysis since they are considered as outliers. Four companies did not report their quarterly numbers.

The closing market price as on March 31, 2011 for the aforementioned companies was taken into account for P/E calculation. For the purpose of computation of earnings per share (EPS), diluted EPS reported by these companies for the trailing four quarters, i.e. quarter ending March 2010 to quarter ending December 2010 have been used.

How have P/E multiples moved over the past three years?
During the first study carried out by CRISIL in May 2009, average P/E multiples across all grades were lower compared to our second study (dated January 2010) as the markets were just emerging from one of the biggest global economic slowdowns. The S&P CNX NIFTY (NIFTY) was pegged at 4,270 as on 20 May 2009 (the date of the study). However, within seven months, the markets had recovered with NIFTY at 5,201 as on 31 December, 2009. The P/E multiples had improved by almost 30-35% across all grades; companies with 4/5 grade were trading at around 25.80x (refer second study dated January 2010). Our current study reveals that when compared to the multiples in May 2009, the average P/E multiple of lower graded companies (1/5 and 2/5 grades) is lower while that of higher graded companies (3/5 and 4/5 grades) is higher. CRISIL Equities believes that the investors have shown more confidence in the higher graded companies over a longer time horizon, which has resulted in such a trend.

Table 2: P/E multiple comparison

Study 1 Date of study Price as on NIFTY P/E ratio NIFTY IPO Grade 1/5 IPO Grade 2/5 IPO Grade 3/5 IPO Grade 4/5 IPO Grade 5/5 Source: CRISIL Equities * No IPO grade 5/5 company was listed 19.7 10.60 12.10 15.40 15.70 NA* 17.7 14.80 17.60 20.90 25.80 NA* 15.6 11.20 17.40 23.50 28.00 NA* 15.2 10.13 10.81 17.82 18.10 18.39 May 2009 May 20, 2009 4,270 Study 2 January 2010 December 31, 2009 5,201 Study 3 July 2010 June 30, 2010 5,312 Study 4 April 2011 March 31, 2011 5,834

Why higher IPO graded companies command higher P/E multiples?

IPO grading is an assessment of the fundamentals of a company relative to all the listed securities in India. Industry prospects, companys positioning in the industry, management quality as well the corporate governance practices are assessed before a grade is assigned. Higher IPO graded companies typically tend to operate in higher growth industries, have superior management strengths and follow good corporate governance practices. Such characteristics tend to command better valuations, as reflected in higher P/E multiples. The market price of a stock can be influenced by factors other than fundamentals, such as liquidity and market sentiments. Despite this, the positive

correlation consistently observed between IPO grades and P/E multiples reflects the broad similarity in the assessment of fundamentals by rating agencies and informed investors, thereby pointing to the efficacy of the grading exercise.

Has the quality of IPOs improved in CY10?

Since IPO grading was made mandatory, 139 companies have tapped the equity market as of December 2010. CY10 saw the highest number of IPO graded companies that got listed in any particular year post IPO grading being made mandatory. IPOs of 67 companies were listed in CY10 compared to 16 in CY09, 39 in CY08 and 17 in CY07 (May-December). CY10 also saw the first listing of an IPO grade 5/5 company - Coal India Ltd followed by MOIL Ltd. For assessing quality of the IPOs, we looked at the grades assigned to the IPOs as the grade showcases a companys fundamental strength. Fundamentals play a critical role in the long-term shareholders wealth and, hence, IPO grades are a critical input in the investors decision-making process In CY10, 30% of the total companies graded had an IPO grade higher than 3/5 compared to 19% in CY09 and 13% in CY08. Also, only 4.5% of the total companies listed in CY10 had an IPO grade of 1/5, down from 13% in CY09 and CY08.

Table 3: Year-wise distribution of IPO grades

No. of Year CY07 CY08 CY09 CY10 Total Source: CRISIL Equities * No IPO grade 5/5 company was listed prior to CY10 IPO grade 1/5 35.3% 12.8% 12.5% 4.5% IPO grade 2/5 11.8% 28.2% 18.8% 32.8% IPO grade 3/5 29.4% 46.2% 50.0% 32.8% IPO grade 4/5 23.5% 12.8% 18.8% 26.9% IPO grade 5/5* 0.0% 0.0% 0.0% 3.0% companies 17 39 16 67 139

Why P/E multiple

The following parameters are considered while assigning an IPO grade to a company: Industry prospects: The companys growth prospects in the industry for the next four-five years Business prospects: The companys expected returns from an equity perspective for the next four-five years Management Corporate governance

While no specific credence is assigned to any one parameter, a company operating in a growing industry would weigh higher on the grading scale, due to the expected benefits from the robust industry prospects, provided all other parameters are equal. A higher industry and earnings growth for the company would translate into a higher multiple that an investor would be willing to shell out. Hence, these companies will invariably command a higher P/E multiple. The only exception in the above analysis will be where the corporate governance structure is inadequate. Since corporate governance is a critical parameter in the overall grading exercise, a company with a poor

corporate governance structure will rank lower on the IPO grading scale despite a robust business and financial performance outlook. Conclusion The above analysis confirms that there is a strong correlation between the IPO grades and P/E multiples. Higher IPO graded companies will most likely command higher P/E multiples in the long run as fundamentals will overrule the quintessential emotions of greed and fear. While the two emotions will prevail, giving grades their due weightage is now a well articulated fact.

analysis

.Annexure

1: List of IPO graded companies used by CRISIL Equities for the

Price on IPO Grading agency CARE ICRA CRISIL / CARE CRISIL ICRA CRISIL ICRA ICRA CARE ICRA CRISIL CARE CRISIL CARE CARE CARE CARE CRISIL ICRA CARE CARE CARE ICRA ICRA CARE ICRA ICRA ICRA CARE CRISIL CRISIL CARE CARE CRISIL Fitch ICRA ICRA Fitch CARE CARE CRISIL ICRA CRISIL CRISIL / ICRA CRISIL Date of listing 17-May-07 10-Jul-07 17-Jul-07 22-Nov-07 23-Nov-07 23-Jul-07 15-Oct-07 21-Nov-07 26-Nov-07 31-Dec-07 31-Dec-07 21-Aug-07 12-Dec-07 19-Dec-07 28-Dec-07 19-Jun-08 8-Jul-08 1-Sep-08 13-Oct-08 20-Feb-08 7-Apr-08 7-May-08 4-Jun-08 27-Jun-08 24-Jul-08 6-Nov-08 3-Jan-08 1-Feb-08 13-Feb-08 18-Feb-08 20-Feb-08 25-Feb-08 12-Mar-08 13-Mar-08 21-Apr-08 4-Jun-08 4-Jul-08 14-Jul-08 30-Jul-08 11-Aug-08 27-Aug-08 3-Oct-08 11-Jan-08 11-Feb-08 19-Feb-08 31-Mar2011 104.45 20.55 29.5 184.3 2.93 12.19 49.15 484.1 107.3 89.15 639.35 138.35 38.8 219.5 244.35 33.65 20.5 0.75 5.02 34.45 5.8 9.61 3.08 44 15 47.9 480.45 137.75 30.25 98.9 158.4 17.3 245.5 162.05 327.3 98.1 16.9 100.65 0.6 9.1 12.2 38.7 92.25 124.4 245.25 Trailing 12-M EPS 3.3 6.3 2.0 11.2 0.6 0.6 5.0 11.7 8.5 4.2 25.8 23.4 3.1 10.2 40.0 6.44 3.41 0.32 1.04 2.56 0.54 2.91 0.88 1.55 1.32 6.42 27.98 9.33 3.66 23.45 10.65 5.09 27.06 8.53 32.00 2.92 3.59 4.92 0.08 8.50 5.29 4.19 9.70 2.85 7.36 P/E (x) 31.3 3.2 14.9 16.4 4.9 19.3 9.9 41.5 12.6 21.1 24.8 5.9 12.7 21.4 6.1 5.23 6.01 2.32 4.83 13.47 10.74 3.30 3.50 28.34 11.37 7.46 17.17 14.77 8.26 4.22 14.87 3.40 9.07 18.99 10.23 33.54 4.70 20.46 7.50 1.07 2.30 9.23 9.51 43.60 33.33

Sr.No. Name of the company 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 Bhagwati Banquets And Hotels Ankit Metal & Power Limited Celestial Labs Limited Varun Industries Limited Allied Computers Intertiol (Asia) Ltd Suryachakra Power Corporation Ltd Consolidated Construction Consortium Ltd Religare Enterprises Limited Empee Distilleries Limited Brigade Enterprises Limited eClerx Services Limited Central Bank of India Edelweiss Capital Limited Jyothi Laboratories Limited Transformers and Rectifiers India Niraj Cement Structurals Ltd First Winner Industries Limited Resurgere Mines & Minerals India Ltd Chemcel Biotech Ltd Bang Overseas Limited Sita Shree Food Products Ltd Aishwarya Telecom Anu's Laboratories Ltd Baf Pharmaceuticals Limited Somi Conveyor Beltings Limited Alkali Metals Ltd BGR Energy Systems Limited Future Capital Holdings Limited Cords Cable Industries Limited KNR Constructions Limited Shriram EPC Limited Tulsi Extrusion Ltd Rural Electrification Corporation Ltd V-Guard Industries Limited Titagarh Wagons Limited Gokul Refoils and Solvent Limited Archidply Industries Limited KSK Energy Ventures Limited Birla Cotsyn (India) Limited Vishal Information Technologies Ltd Nu Tek India Limited 20 Microns Limited Precision Pipes and Profiles Company Ltd Reliance Power Limited OnMobile Global Limited

grade 1/5 1/5 1/5 1/5 1/5 2/5 3/5 3/5 3/5 3/5 3/5 4/5 4/5 4/5 4/5 1/5 1/5 1/5 1/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 4/5 4/5 4/5

Price on IPO Sr.No. Name of the company 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 IRB Infrastructure Developers Ltd Gammon Infrastructure Pvt Ltd Edserv Softsystems Ltd Excel Infoways Ltd Raj Oil Mills Ltd Thinksoft Global Service Ltd Astec Lifesciences Ltd NHPC Ltd Jindal Cotex Ltd Globus Spirits Ltd Euro Multivision Den Network Ltd Mahindra Holidays & Resorts India Ltd Oil India Ltd Cox and Kings (India) Ltd Tarapur Transformers Ltd Sea TV Network Ltd MBL Infrastructure Infinite Computers Syncom Healthcare Ltd DB Realty Emmbi Polyarns Ltd ARSS Infrastructure Projects Ltd Texmo Pipes & Products Ltd Pradip Overseas Ltd Goenka Diamond & Jewels Limited Aster Silicates Ltd Midfield Industries Ltd Prakash Steelage Ltd Microsec Financial Services Ltd Cantabil Retail India Ltd Bedmutha Industries Limited Commercial Engineers & Body Builders Co BS Transcomm Ltd Gyscoal Alloys Ltd RPP Infra Projects Ltd Ravikumar Distilleries Limited Parabolic Drugs Limited Vascon Engineers Ltd Thangamayil Jewellery Ltd Aqua Logistics Ltd Rural Electrification Corporation Ltd Man Infraconstruction Ltd DQ Entertainment (Intertiol) Ltd Shree Ganesh Jewellery House Ltd Intrasoft Technologies Limited Talwalkars Better Value Fitness Ltd grade 4/5 4/5 1/5 1/5 2/5 2/5 2/5 3/5 3/5 3/5 3/5 3/5 4/5 4/5 4/5 1/5 1/5 1/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 2/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 Grading agency Fitch CARE CARE CARE ICRA ICRA CARE ICRA Brickwork CARE CARE ICRA Fitch CRISIL CARE CRISIL ICRA CRISIL / ICRA CRISIL CARE CRISIL CARE CARE CARE ICRA ICRA Brickwork Brickwork CARE CRISIL ICRA ICRA CRISIL ICRA CARE Fitch CARE CARE / Brickwork 84 85 86 87 88 89 90 91 92 CRISIL Brickwork Brickwork CRISIL CRISIL Fitch CARE CARE CARE 12-Feb-10 19-Feb-10 23-Feb-10 8-Mar-10 11-Mar-10 29-Mar-10 9-Apr-10 12-Apr-10 10-May-10 87.9 161 17.7 251.5 143.05 59.1 156.55 67.5 218.55 6.71 16.48 12.30 27.06 19.97 4.42 36.18 8.00 4.43 13.10 9.77 1.44 9.30 7.16 13.38 4.33 8.43 49.33 Date of listing 25-Feb-08 3-Apr-08 2-Mar-09 3-Aug-09 12-Aug-09 26-Oct-09 25-Nov-09 1-Sep-09 22-Sep-09 23-Sep-09 15-Oct-09 24-Nov-09 16-Jul-09 30-Sep-09 11-Dec-09 18-May-10 14-Oct-10 11-Jan-10 3-Feb-10 15-Feb-10 24-Feb-10 24-Feb-10 3-Mar-10 10-Mar-10 5-Apr-10 16-Apr-10 28-Jul-10 4-Aug-10 25-Aug-10 5-Oct-10 12-Oct-10 14-Oct-10 18-Oct-10 27-Oct-10 27-Oct-10 6-Dec-10 27-Dec-10 1-Jul-10 31-Mar2011 200.5 17.65 134.45 30.2 31.7 56.45 45.2 23.65 103.35 142.25 13.5 80.15 358.6 1291.35 408.3 23.45 20.3 178 162 32.25 114.9 13.4 517.1 31.8 81.85 57.25 24.9 51.8 143.45 38.9 38.05 112.15 46.65 89.9 14.65 66.35 37.1 42.4 Trailing 12-M EPS 11.60 0.35 14.94 7.14 7.97 8.83 10.98 1.84 3.80 14.64 0.43 2.69 14.34 113.78 26.13 1.49 0.87 28.12 20.18 3.29 10.36 1.07 70.48 6.01 22.27 18.44 5.14 9.78 15.84 12.58 17.40 8.29 4.48 16.65 6.93 5.24 1.36 15.48 P/E (x) 17.29 49.80 9.00 4.23 3.98 6.39 4.12 12.88 27.21 9.72 31.51 29.83 25.01 11.35 15.63 15.74 23.39 6.33 8.03 9.80 11.09 12.52 7.34 5.29 3.67 3.10 4.85 5.29 9.06 3.09 2.19 13.53 10.42 5.40 2.12 12.67 27.19 2.74

68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83

Price on IPO Sr.No. Name of the company 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 Mandhana Industries Ltd Jaypee Infratech Ltd Technofab Engineering Ltd Career Point Infosystems Ltd Ramky Infrastructure Ltd Prestige Estates Projects Ltd Gravita India Ltd Claris Lifesciences Ltd United Bank of India JSW Energy Ltd Godrej Properties D B Corp Ltd IL&FS Transportation Networks Ltd Persistant System Ltd Satluj Jal Vidyut Nigam Ltd SKS Microfinance Ltd Bajaj Corp Ltd Eros International Media Ltd Tecpro Systems Ltd VA Tech Wabag Limited Ashoka Buildcon Limited Oberoi Realty Ltd A2Z Maintenance & Engineering Services Ltd Coal India Ltd MOIL Ltd grade 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 3/5 4/5 4/5 4/5 4/5 4/5 4/5 4/5 4/5 4/5 4/5 4/5 4/5 4/5 4/5 5/5 5/5 Grading agency CRISIL ICRA /CARE Fitch CARE CRISIL ICRA Brickwork Fitch ICRA / CARE CARE ICRA CARE Fitch CRISIL CARE CARE CRISIL CARE CRISIL ICRA CRISIL CRISIL CARE CRISIL CARE Date of listing 19-May-10 21-May-10 16-Jul-10 6-Oct-10 8-Oct-10 27-Oct-10 16-Nov-10 20-Dec-10 18-Mar-10 4-Jan-10 5-Jan-10 6-Jan-10 30-Mar-10 6-Apr-10 20-May-10 16-Aug-10 18-Aug-10 6-Oct-10 12-Oct-10 13-Oct-10 14-Oct-10 20-Oct-10 23-Dec-10 4-Nov-10 15-Dec-10 31-Mar2011 240 57.1 147 341 288.5 126.95 342.15 167.1 108.3 72.35 671 250.6 229.7 375.25 21.25 542.95 468.4 131.35 268.5 1215.3 290.55 237.95 280 347.5 401 Trailing 12-M EPS 18.21 4.33 25.45 14.71 26.07 5.61 11.78 22.16 2.53 5.16 19.50 10.62 20.08 35.74 2.37 32.98 33.57 11.53 25.10 52.79 17.59 15.64 17.71 15.55 27.76 P/E (x) 13.18 13.18 5.78 23.18 11.07 22.62 29.06 7.54 42.85 14.02 34.41 23.61 11.44 10.50 8.98 16.46 13.95 11.40 10.70 23.02 16.52 15.21 15.81 22.34 14.45

Source: CRISIL Equities Note: Lowest IPO grade is taken for companies which were assigned different grades by different agencies

Annexure 2: IPO grading

The IPO grading methodology includes an assessment of industry and business prospects, financial performance, corporate governance and management quality. As a part of the IPO grading exercise, CRISIL also looks at the shareholding structure, board composition, typical board processes, disclosure standards and related party transactions. The IPO grading process is a qualitative and relative assessment of a companys fundamentals broadly based on the below parameters:
Table: Broad parameters on which companies fundamentals are assessed
Industry and Business Prospects Industry dynamics, demand-supply outlook Companys position in the industry and growth prospects Key risks and mitigants

Financial Performance and Outlook

Past financial performance Key sensitivities Scenario and stress analysis Earnings forecast

Management Capabilities

Track record of the management Evaluation of business strategy Track record of market domination, product innovation, successful diversification

8
Corporate Governance Assessment of companys disclosure norms and transparency of reporting Board practices and quality of discussions Profile of the board members Assessment of the independence of the board from the management

The grade is assigned on CRISIL Equities assessment of the company on the aforementioned parameters. Though there are no pre-defined weights assigned to the parameters, if a company scores below the minimum acceptance level in any one of the parameters, it may be assigned a lower grade. For e.g., if the company has excellent business prospects but inadequate corporate governance structure, then the overall grade may be low. Post the rigorous evaluation, companies are assigned grades on a five-point scale where the highest grade of 5/5 signifies that fundamentals of the company are strong relative to the listed securities in India and vice versa.
Table: Five-point scale
Grade 1/5 2/5 3/5 4/5 5/5 Fundamentals Poor Below average Average Above average Strong

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