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AUGUST - 2010
A strong order backlog at the beginning of the quarter will translate into healthy revenue growth for engineering and capital goods companies. IIP growth of 16.7% in January 2010 reflects an improving economic environment, which will translate into better earnings for players. With the industrial capex reviving, companies will experience an improvement in order inflow going forward.


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Engineering sector Heavy Engineering Light engineering Transport Capital goods Other machinery/Equipment Low-tech items like castings, forgings and Fasteners Highly sophisticated Microprocessor-based

Process control industries and the new projects being taken up in the power, railways, infrastructure development, and private sector investments fields amongst others. The industry attracted FDI inflows of US$ 1,196.7 million from August 1991-July 2006 India's exports of engineering goods are valued at US$ 27 billion during 2006-07 which represents a 6 per cent growth over the exports for 2005-06 (US$ 20 billion).

The engineering sector accounted for 14 per cent of the country's total exports. It is also noteworthy that 40 per cent of India's engineering export is from the small and medium enterprises (SME) sector. According to Engineering Exports Promotion Council (EEPC), engineering exports could touch US$ 30 billion by 2008-09. In such a scenario, India, driven by the engineering sector, will emerge as a key global manufacturing hub Industry demand is driven by investments in core sectors. The demand from this sector depends largely on GDP growth, which in turn is a function of expenditure in core segments like power, railways, and infrastructure development, private sector investments, and the speed at which projects are implemented. The power sector is the largest contributor to the revenues of engineering companies. Engineering majors like Bharat Heavy Electricals Limited (BHEL) and ABB Limited derive a significant chunk of their revenues (69 per cent and 60 per cent, respectively) through the supply of equipment to the power sector.

Infrastructure is another key area of operation. Larsen & Toubro Limited, for example, garners around 35 per cent of its sales from infrastructure activities like engineering, design and construction of industrial projects, social and physical projects like housing, hospitals, information technology (IT) parks, expressways, bridges, ports, and Water/effluent treatment projects. The industrial segment contributes to around 30 per cent of the total revenues of the engineering sector. While Indias engineering industry has capabilities in manufacturing the range of machinery required by the different user sectors, the rapid rise in demand has led to a large part of the machinery requirements being met through imports. This indicates the size of opportunity for investment in the engineering and capital goods sector in India.

Capacity creation and transformation in sectors such as infrastructure, power, mining, oil & gas, refinery, steel, automotive, consumer durables are driving growth in the engineering industry. The framework below captures some of the key factors that are contributing to domestic and international demand for engineering goods from India. Restructuring of the state electricity boards in different states, growth of private sector players and focus on capacity creation have driven growth in the power sector.


Capital Goods has been defined for the purpose of this study as any "product/ equipment of high value, durable (economic asset life 3 years), used as plant and machinery for agricultural, industrial and commercial (transportation etc.) purpose in production/ service delivery process". We have adopted "use-based" classification to segment Capital Goods. From the list of classified segments, we have shortlisted five most representative segments based on - market size of the segment and its user industry, and IIP weightage of the segment. The five representative segments identified are as follows:

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Textile Machinery Machine Tools Electrical and Power Equipment which includes Boilers, Turbines, Diesel Engines, Transformers, Switchgear, Motors and Generators. Earthmoving and Construction Equipment Process Plant Equipment which includes Pressure Vessels, Cooling Towers, Furnaces and Heat Exchangers

The Indian market underperformed over 1Q10 in local currency terms. However, currency strength saw the market outperform in USD. Current announced budget represented an opportunity missed for implementation of crucial structural reforms while leaving the central bank even more behind the curve as far as monetary policy is concerned. Thus, the inter-meeting hike was neither a surprise nor a one-off event, in our view. Liquidity conditions therefore, while reasonably benign today (although already past their peak), are likely to tighten going forward. That will matter for a market where an ambitious forward earnings yield ranks much below the prevailing bond yields.


The Engineering sectors future outlook is promising. Drivers like power projects, other infrastructure development activities, industrial growth and favorable policy regulations will drive growth in manufacturing. The Indian engineering industry has been witnessing significant level of capability enhancement over the years. As export markets open up, this will help India develop a strong presence in global engineering exports. Power sector contributes the largest to the engineering companies revenues.

Major players in this sector like ABB and BHEL derive 60 per cent and 69 per cent of their revenues from supplying equipments to the power sector. Going forward, with the Government clearing the blueprint for adding 100,000 MW in the tenth (2002-07) and eleventh 2007-12) five-year plans, the potential are high for the engineering majors. Emerging trends such as outsourcing of engineering services can provide new opportunities for quantum

growth. Engineering and design services such as new product designing, product improvement, maintenance and

designing manufacturing systems are increasingly getting outsourced to countries like India and China. Indias engineering sector has significant potential for future growth, in manufacturing as well as services.

Performance of Capital goods players for the quarter ended March 2010 had been mixed. The players catering to power generation sector continued their strong growth momentum. But the electrical equipment (including conductors, transformers, insulators) sector continues to be faced with pressure on realization and margin on the back of surplus capacity and delay in order placement etc.

As regards construction players, their performance depends largely on the quality and diversity of the order book. Generally the execution of construction projects though have improved during the quarter, the problems associated with water projects in Andhra Pradesh and Madhya Pradesh continued forcing the players to go slow. While order execution and order book are positive factors, the industry is witnessing intensified competition especially in power equipment sector, which coupled with volatile commodity prices added pressure on margins. The aggregate sale of the 19 companies that forms part of BSE Capital Goods Index was higher by 11% to Rs 44350 crore. Operating margin contracted by 60 basis points (bps) to 14.7% thus limiting the growth at operating profit level to 7% to Rs 6528 crore.

The other income was higher by 40% to Rs 843 crore, the interest cost was higher by 22% to Rs 518 crore and the depreciation cost was lower by 37% to Rs 591 crore. Thus the PBT was higher by 7% to Rs 6262 crore. But spike in provision for taxation by 29% to Rs 2485 crore transformed 7% rise in PBT to 4% fall in the net profit to Rs 3777 crore.


Most of the index constituents reported subdued performance. Still the aggregates cover it up due to strong performance from both Bharat Heavy Electricals (BHEL) and Larsen & Toubro, which together account for over 60% of the aggregate sales of the BSE Capital Goods Index.
BHEL has registered 29% growth in revenue to Rs 13944.65 crore and at net-profit level it was even better with a growth rate of 42% to Rs 1909.58 crore. The company that has concluded the wage settlement during the fourth quarter ended March 2010 has incurred an additional cost of Rs 338.16 crore over and above the provision for arrears pending wage settlement due to short fall. Similarly the company has also provided Rs 453.10 crore towards pending approval of pension scheme as per new wage settlement. Strong bottom-line growth despite incremental expense towards wage settlement etc was largely on account of strong growth in revenues, savings in input costs and lower tax incidence.

During 1QFY2011, BHEL secured a single largest Rs6,300cr mega contract for 1,600MW (2x800MW) supercritical thermal power project in Karnataka from Raichur Power Corporation (RPCL). RPCL is a joint venture (JV) company of Karnataka Power Corp (KPCL) and BHEL, which has been set up to build, own and operate thermal power plants with supercritical parameters in Karnataka. Significantly, this is the first order for a power project, bagged by BHEL through a JV.

Larsen & Toubro was forced to go slow on certain project on account of client related reason. Still the company has seen improvement in execution especially the domestic orders driving the revenue as well as profits growth. The overseas market including Middle East is still subdued for the company.

The operational income for the quarter was up 28% to Rs 13585.10 crore. Strong topline growth was equally backed by 110 bps expansion in operating margin, which jacked up operating profit up by 38% to Rs 2050.76 crore. However limited by higher tax incidence the net profit (excluding the EO items) eventually was higher by 17% to Rs 1342 crore. But including the EO items the net profit was higher by 44% to Rs 1438.10 crore.

Gammon India was affected by higher base, leading to netted 12% fall in revenue to Rs 1667.75 crore and 25% fall in net profit to Rs 54.79 crore. The company had booked full year figures of Associated Transrail, a subsidiary of the company in the quarter ended March 2009. Affected by continued project delays and cost overruns Punj Lloyd registered 45% fall in consolidated revenue to Rs 1776.53 crore and a net loss of Rs 300.87 crore (which rose 18%) even after accounting for a higher EO income on account of profit on sale of investment including its stake in Pipavav Shipyard amounting Rs 322.36 crore.

Crompton Greaves In continuation with its strategy of inorganic growth, during the quarter, Crompton Greaves concluded an arrangement for the acquisition of three businesses Traction Electronics, SCADA and Industrial Drives - of an Indian company Nelco on a slump sale basis. The approximate acquisition value of the abovementioned three businesses is Rs92cr. These acquisitions will enable Crompton to become a stronger and more comprehensive player in the railways business segment and build capabilities in drives by better leveraging on its existing product portfolio.

On the other hand the T&D equipment manufacturers, which are affected by surplus capacity and heightened competition driving down the margin in project business as well as product supply has registered tepid performance. Siemens registered 7% fall in sales to Rs 2226.08 crore and 20% fall in net profit to Rs 181.09 crore. Similarly ABB despite 5% jump in sales to Rs 1455.85 crore has registered 92% fall in net profit to Rs 6.63 crore on account of cost overruns and early exit cost from rural electrification projects.

Areva T&D has seen 93% fall in net profit to Rs 3.47 crore on lower sales of Rs 776.84 crore (down 11%). Crompton Greaves, which bucked the general trend, has registered 58% jump in its consolidated net profit even while the consolidated sales was higher by modest 2% to Rs 2507.89 crore. As its standalone sales grew by strong 19% to Rs 1618.21 crore and 46% rise in net profit to 190.71 crore, the subdued performance of overseas entities have dragged the consolidated performance to some extent.

Areva T&D: During the quarter, a consortium of Alstom Holdings and Schneider Electric also made an open offer to buy 20% in Areva T&D India at Rs295/share. The offer will open on July 22, 2010, and end on August 10, 2010. Notably, the offer comes after the French nuclear major, Areva SA, agreed to sell its entire equity in Areva T&D Holding SA, its global electric transmission and distribution business, to a consortium of Alstom Holdings and Schneider group of companies in January 2010.

By virtue of the global takeover, the new consortium will automatically get a 72.2% stake currently being held by the Areva group in its Indian subsidiary.

Thermax: During 1QFY2011, Thermax entered into a technology transfer license agreement with Lambion Energy Solutions, a German engineering company with expertise in converting waste to energy. The technology transfer will provide Thermax with high-efficiency combustion systems for using biomass, high in moisture content, for energy generation.

Besides, during the quarter, the company also received a major turnkey order valued at Rs580cr for a gas-based combined cycle power project from a petrochemical major in India for its aromatic complex in a SEZ.

BGR Energy: During the quarter, BGR Energy Systems, through its majority-owned subsidiary, BGR Boilers, entered into technical collaboration agreements with Hitachi Power Europe GmbH, Germany for 660MW, 800MW, 1,000MW and 1,100MW supercritical steam generators (boilers). Additionally, through another majority-owned subsidiary, BGR Turbines, it has entered into technical collaboration agreements with Hitachi Ltd., Japan, for 660MW, 700MW, 800MW and 1,000MW supercritical steam turbines and generators. Fig: Income Analysis for FY2009-10(12months)

Total Income

Operating Profit

Net Profit

3,931.0 3,309.8 2,6 91. 9 2,17 7.5 1,099.5 982.5



456 .4





Crompton Greaves Engineers India Thermax Kalpataru Power KEC Intl Elecon Engg

Indo Tech Trans

Table: Capital Goods Sector Aggregates


1003 (3) Sales OPM (%) Operating Profit 44350 14.7

Var. (%) 11

6528 8 4 3 7370


Other Income PBIDT

601 6705

40 10

Interest PBDT

5 1 8 6853 5 9 1

424 6281

22 9

Depreciation Profit Before Tax Tax Cash Profit Net Profit



6262 2485 4368 3777

5848 1926 4355 3922

7 29 0 -4

Figures in Rs crore; Source: Capitaline Databases

The demand for the capital goods set to grow at the back of growing industrial activities in the country. The banks and financial institutions are not in a hurry to hike interest rate in near term despite of RBI's tightening mode. These will add momentum to the index of capital goods. The power equipment sector, which witnessed slowing down of order inflows, is set to regain its premier position, as order inflows are set to rise in the last two years of the current five year plan. In short, near term outlook for the sector is positive.

Table: Index of Industrial Production of Capital Goods:

Month 2009 - 10 Inde x Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar LQ. Jan - Feb YTD.Apr - Feb FY. Apr - Mar 294.4 336.5 438.0 380.8 406.4 533.6 403.1 437.9 623.4 612.4 576.1 -594.3 458.4 -% Chg. -5.9 -3.6 13.4 1.7 9.3 13.5 10.2 11.1 39.1 55.4 44.4 0.0 0.0 18.2 -2008 - 09 Inde x 313.0 349.0 386.3 374.3 372.0 470.2 365.7 394.0 448.1 394.2 398.9 508.9 396.6 387.8 397.9 % Chg. 12.4 4.3 7.8 17.9 0.9 20.8 4.3 0.5 6.6 15.9 11.8 -6.4 0.0 9.2 7.3 2007 - 08 Inde x 278.4 334.7 358.3 317.4 368.6 389.1 350.8 392.1 420.5 340.0 356.8 543.4 348.4 355.2 370.8 % Chg. 10.9 22.4 23.1 12.3 30.8 20.9 20.9 24.2 17.6 2.6 10.7 20.3 0.0 17.7 18.0 2006 - 07 Inde x 251.0 273.5 291.1 282.7 281.9 321.9 290.1 315.7 357.6 331.3 322.3 451.7 326.8 301.7 314.2 % Chg. 19.6 21.5 21.7 18.3 16.6 9.5 6.5 29.4 26.2 16.3 18.0 18.1 0.0 18.3 18.2 2005 - 06 Inde x 209.8 225.2 239.3 238.9 241.7 294.1 272.3 243.9 283.4 284.8 273.1 382.6 279.0 255.1 265.8 % Chg. 14.6 13.4 13.5 14.9 12.9 22.9 24.3 11.5 12.9 27.0 10.7 11.9 0.0 16.3 15.7

Index = 100 in 1993-94; Source: Central Statistical Organisation

The scenario for the Indian Economy in general and that for the capital goods industry in particular has undoubtedly improved to a big extent, after the political stability in the country along with the easing liquidity situation and the offshoots of recovery in the global economy. Besides, although the capital goods companies catering to the power sector will continue to enjoy a degree of comfort owing to the government's thrust on this core sector, the sector has its own set of issues, with around 48% of the planned power projects for the eleventh plan already running behind schedule.


On the back of continued peak power deficit as to meet the needs of economic growth and social commitment of electricity to all by 2012, the country is accelerating power sector investments. India's installed power generation capacity is about 152148.41 MW (152 GWH) as of 31

August 2009. Besides, there are about 19509 MW of

captive power generation capacity connected to the Grid. But as per C S Verma, Director Finance, BHEL, India's power generation capacity has to significantly scale up to 1200 GW by year 2032, if the country has to sustain a GDP growth of 7%.

Of this, the capacity addition in the Eleventh five year plan (ending March 2012) would be about 78.7 GWH, in 12 five year plan would be about 100 GWH, and n 13

five year plan about 150 GWH, which will further surge to 197

GWH in the 14th Five year plan. Currently, the cost of setting up power plant ranges from Rs 4.5 to 5.5 crore per MW. With one rupee spent on generation capacity also entails equal amount of spending in Transmission & Distribution segment this represents huge order opportunity for the capital goods sector from power sector alone, over the next two decades.

Including the investments planned for power sector, India's investment requirement is estimated at US$ 567.2 billion over the next five years in various infrastructure projects. Currently, the infrastructure spend in India is

about 4.5% of GDP, which is targeted to be increased to 9% of GDP by 2014.

For instance the aggregate estimated investment in all segments of power sector namely generation, transmission and distribution is Rs 1135083 crore. Of which the share of generation is Rs 495083 crore, transmission is Rs 240000 crore and distribution is Rs 400000 crore. Such huge investments, as and when they materialize, is set to bring enormous opportunities for the Indian capital goods sector.


Transmission & Distribution segment which has been one the grey area with long history of neglect (especially in sub transmission and Distribution segment) with inadequate flow of investment leading to high AT & C (aggregate transmission and commercial) losses of 32.07% in 2006-07. Power Grid, the central transmission utility which spend about Rs 14600 crore in the first 2 years of 11

five year plan is expected to spend Rs 40000 crore between 2009-2012

in upgrading and strengthening of its transmission network and inter regional transmission grid.

At the same time Government of India through RGGVY and APDRP targets to provide electricity to all by 2012 as well as reduce T&D losses. The GOI targets to reduce the AT&C losses to 15% at-least in areas under APDRP scheme by 2012. On the back of strong investment under pipeline the heavy electrical equipment manufacturers such as transformers, insulators, conductors etc has seen strong capacity creation in the recent past. As the transmission projects linked to the progress of generation projects the electrical equipment procurement has been delayed/ deferred with generation projects behind schedule. Resultantly the T&D equipment production in the country (according to IEEMA statistics) in 2008-09 came down by 2.7% as compared to 15% growth in the previous year on the back of postponement or reduction of procurement.

Moreover the increase in new capacity across various product segments has resulted in increased competition for a share in the stagnant pie and this has impacted the prices. Players' such as Areva T &D has reported about 1520% drop in prices in transmission segment and about 25-30% in the distribution segment. The price slump is across all products types. With negative growth in infrastructure and industrial segment the competition is surely hotter impacting prices. However the second round of order finalization for T&D equipments pertaining to 11 year plan period projects have not started yet. As we entering the second half of the 11
th th


five-year plan this is

imminent and that will provide strong order inflow for the industry players facilitating enough business for all.

BALANCE OF PLANT EQUIPMENTS Balance of plant (BoP) is one of the crucial group of equipment/service that makes a power

project complete and up for operation. The examples of Balance of plant equipments/services are those
such as coal and ash handling systems, water treatment plants, cooling water systems, cooling towers, construction equipment, civil works and services etc. Some of the major players in operating in this space of engineering segment are Larsen & Toubro, Gammon India, BGR Energy, Sunil Hitech, Ion Exchange, Mcnally Bharat, Elecon Engineering, TRF etc.

While the main plant equipment such as Boiler, Turbine and Generator accounts for 40-50% of the total thermal power plant cost the rest was accounted by BoP equipments. The share of thermal power projects out of the planned target in the 11

and 12


five year plan being 75-76% the opportunity is huge for the BoP players in the

country. Order for main plant equipment for all the 11 other hand the order BOP for all the 11

Five Year plan projects has been already placed but on the

Five Year Plan projects have not fully placed. Order for significant

number of BoP equipments are yet to placed i.e. orders are yet to placed for 11 coal handling systems out of the total requirement of 68 numbers totally estimated for the 11 (i.e. 64215 MW). five year plan projects which under construction

Similarly about 10 ash handling system are yet to be ordered out of the total requirement of 69 numbers, 13 of total 117 chimeys, 19 of total 145 cooling towers, 12 of total 69 DM plants etc. Similarly major part of BoP equipments are yet to be ordered for 12 for commissioning in the 12
th th

Five Year Plan period. Projects aggregating about 32000 MW scheduled

five year plan is currently under execution.


The demand for construction equipment is correlated to the level of construction activity in the country. Despite economic slowdown, the infrastructure development was not affected unlike the realty sector, which was hit hard. Within infrastructure sector, construction of roadways and
highways were impacted primarily due to inordinate delay in awarding highway projects in PPP sector. The issues relating to model RFQ document and concession agreements etc also added to delay in finalization of roadway and highway projects. This has affected the demand for construction equipment.

But the bad news ends there for construction equipment manufacturers. The players have indicated that with steady infrastructure demand and marginal pickup in realty sector, there are increased enquiries for construction equipment especially from original users (i.e. Construction service providers) who accounts for about 70-80% of the total demand for construction equipment. Especially the demand for high tech products such as boom concrete pumps, high capacity batching plants etc has seen some improvement in demand. Though the equipment hiring segment that account for the balance of the demand has not picked up yet, that will also expected to follow suit with pickup in construction activity. With NHAI accelerating award of NH projects the construction activity will further pick the momentum.

As part of its calibrated exit from the stimulus measures announced earlier, the Reserve Bank of India (RBI) has raised the repo rate and the reverse repo rate by 25 basis points each to 5.5% and 4% respectively in an interim meeting. The rate hikes are applicable with immediate effect. Additionally, due to the temporary liquidity tightening resulting from the outflows due to 3G/BWA auctions and the advance tax payments, the RBI had introduced temporary liquidity boosting measures. These were to expire on July 2, 2010, but now these have been extended by almost a fortnight till July 16, 2010.


Inflation has been a concern over the past few months, breaching into double-digit levels to 10.16% in May 2010 from 9.6% in April 2010. Additionally, over the months, the inflation has become more generalised, no more restricted to food items, as depicted by a strong uptick in the non-food manufacturing inflation that is up to 6.6% in May 2010 from 5.4% in March 2010 and -0.4% in November 2009. The increasing generalisation of inflation coupled with a further upward pressure on the price levels as a result of the recent increase in fuel prices (The RBI expects the fuel price hikes to result in an immediate impact of ~1% on the wholesale price index [WPI]) builds a strong case for the central bank to step in to stem inflation as well as anchor inflationary expectations.

The visibility also seems to be strengthening gradually, with foreign investments in India continuing their momentum, with relatively smooth financial closure of several projects and quite a few companies across sectors having successfully tapped the financial markets.
Fig1: Foreign investments into India (US $bn)

Fig2: Trend in inflation rates:

onwards, the wake the financial meltdown,

in of

Howev had begun reversing its easy monetary er, since as my to show signs of stance in a calibrated manner. The RBI had projected a strong gross domestic


2010, product (GDP) growth of 8% for FY2011 thewith an upside bias,based on the robust production industrial growth(strong production [IIP] index of econo industrial

the RBI had made a series of policy rate cuts as part of

Source: SEBI

began reading), a revival in exports and an accelerating credit growth. With the economic data pointing towards a recovery, which is well underway, the aRBI has shifted its focus to curbing

its to

Source: RBI

measures economic growth.

stimulate the economic 2008 Fig4: Trend in

coupled recovery

with From


revival, inflation than to boost the economic the RBIgrowth. cre export growth: dit,


Fig3: Trend in IIP reading:

T h




infrastructure development particularly in the power

sector. equipment expected from grid the to new

Power players is benefit power that


mandate the companies to have manufacturing facility in India, hereby giving Chinese existing power the domestic players respite from the competition. the domestic equipment to like is continue, pricing during the Nonetheless,

competition for certain transformers expected exerting pressure quarter.

Fig5: Capacity addition (MW)-11th plan (till May 2010)

Source: CEA Fig6: Capital Goods component growth

Source: Bloomberg

Current Infrastructure development is largely on public sector spending. But of late, there is encouraging investment interest on the part of private players especially in power, road sector etc. Moreover with increased economic activity the sectors relying on domestic consumption have either revived their investment plans. Also, despite having strong order book, the players were confronted with execution delays on client side issues.

The momentum is picking up in order book conversion (to sales) ratio. Further the T&D industry, which expanded the capacity in anticipation of huge 11th plan orders, is suffering from surplus capacity on account of delay in order placement. As penultimate year of 11

five-year plan commenced the order placement activity is expected

to pickup auguring well for this segment too. Though most of the tender based business comes with price escalation clause the ability of the industry player to control the material cost plays crucial role in profitability. Overall, the industry will remain in limelight with lots of domestic order wins in the current quarter.

Mr. Amit Gupta Ms. Binal Vora Ms. Sandhya Tungatkar

Disclosure by the Analyst: Analyst holding in the stock: Nil.

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