Strategy | I N D I A

2010 Outlook
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Prabhat Awasthi +91 22 4037 4180 And the India Research Team

prabhat.awasthi@nomura.com

TOP DOWN

A N C H O R

R E P O R T

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.

Stocks for action
Stock Tata Steel (TATA IN) SBI (SBIN IN) M&M (MM IN) NJCC (NJCC IN) Unitech (UT IN) Ranbaxy (RBXY IN) * PT under review Price (24 Dec) (INR) Rating BUY BUY BUY BUY REDUCE 615.6 2,215 165.85 82 779.95 520 Price target (INR) 926 2,590* 1,232 197 112 419 261

BUY 1,061.85

Tata Motors (TTMT IN) REDUCE

Analysts
Prabhat Awasthi +91 22 4037 4180 prabhat.awasthi@nomura.com Nipun Prem (Associate) +91 22 4037 5030 nipun.prem@nomura.com And the India Research Team (see inside front cover)

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
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.

Don’t miss our companion outlook reports on Asia and ASEAN, also published today.

Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 125 to 128.
Nomura 4 January 2010

CONTACTS
Asia Ex-Japan India India India Aatash Shah Alok Kumar Nemani (Associate) Amar Kedia Coverage Property Metals & Mining Electrical Equipment, Conglomerates India India India India India India India India India India India Anil Sharma Harish Venkateswaran (Associate) Harmendra Gandhi Jamil Ansari Kapil Singh Mahrukh Adajania Manish Jain Neeraja Natarajan (Associate) Nipun Prem (Associate) Pinku Pappan (Associate) Prabhat Awasthi Oil & Gas Infrastructure & Construction IT services Media, Basic materials Auto & Auto Parts Banks Consumer Telecoms India Strategy IT services India strategy, Auto & Auto Parts, Metals & Mining and Media India India Ravikumar Adukia (Associate) Saion Mukherjee Oil & Gas Pharmaceuticals / Infrastructure & Construction India India India Sanjay Kadam Sonal Varma Sreekanth Akula (Associate) Database analyst Economics Banks Telecoms Telecoms Financials +91 22 4037 4187 +91 22 4037 4087 +91 22 4037 4361 +65 6433 6961 +65 6433 6968 +65 6433 6957 sanjay.kadam@nomura.com sonal.varma@nomura.com sreekanth.akula@nomura.com broshan.raj@nomura.com sachin.gupta@nomura.com srikanth.vadlamani@nomura.com +91 22 4037 4232 +91 22 4037 4184 ravikumar.adukia@nomura.com saion.mukherjee@nomura.com +91 22 4037 4338 +91 22 4037 4028 +91 22 4037 4181 +91 22 4037 4192 +91 22 4037 4199 +91 22 4037 4157 +91 22 4037 4186 +91 22 6723 5231 +91 22 4037 5030 +91 22 4037 4360 +91 22 4037 4180 anil.sharma.1@nomura.com harish.venkateswaran@nomura.com harmendra.gandhi@nomura.com jamil.ansari@nomura.com kapil.singh@nomura.com mahrukh.adajania@nomura.com manish.jain@nomura.com neeraja.natarajan@nomura.com nipun.prem@nomura.com pinku.pappan@nomura.com prabhat.awasthi@nomura.com Telephone +91 22 4037 4194 +91 22 4037 4193 +91 22 4037 4182 Email aatash.shah@nomura.com alokkumar.nemani@nomura.com amar.kedia@nomura.com

Singapore Roshan B. Raj Singapore Sachin Gupta, CFA Singapore Srikanth Vadlamani

Strategy | I N D I A
Prabhat Awasthi +91 22 4037 4180 And the India Research Team prabhat.awasthi@nomura.com
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

TOP DOWN

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.

Stocks for action
Our 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.
Price as on Rating 24 Dec (INR) BUY BUY BUY BUY BUY REDUCE REDUCE 615.6 2,215 1,061.85 165.85 82 779.95 520 Price target (INR) 926 2,590* 1,232 197 112 419 261

Stock Tata Steel SBI M&M NJCC Unitech Tata Motors Ranbaxy

* Price target under review

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 Septemberend to 19,600 for December-end 2010F. Our new target implies ~13% upside.

Analysts
Prabhat Awasthi +91 22 4037 4180 prabhat.awasthi@nomura.com Nipun Prem (Associate) +91 22 4037 5030 nipun.prem@nomura.com And the India Research Team (see inside front cover)

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.

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Strategy | India

Prabhat Awasthi

Contents
The proverbial puddle: monetary rebalancing
Valuations not excessive, but not immune to monetary rebalancing Rising inflation is a short-term overhang on markets

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

4
5 5

Early rate tightening will curb core inflation and manage inflationary expectations 6

Growth rebalancing: investment to join the mix
Industrial capex suffered on account of the crisis Capacity shortages are back Stalled financial closures have restarted

7
7 7 9

Pick-up in capex will translate into greater capital inflows and rupee appreciation 10

Fiscal rebalancing – a marginal move towards consolidation
Revenue buoyancy and potential rollback of stimulus should help rein in the deficit Significant one-offs should roll off this year

11
11 11
Also see our ASEAN Strategy 2010 Outlook report, 4 January, 2010

Implications of better fiscal and monetary tightening – flattening of the yield curve 13

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

14
14 14

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

18
18

Key themes for 2010F Sector strategy Appendix India economic outlook India sector views
Autos Banks Building materials Consumer Electrical equipment Infrastructure & Construction Insurance IT Services & Software Media Metals & Mining Oil & Gas / Chemical Pharmaceuticals Property Telcos Transport Infrastructure

21 23 24 30
Also see our 2010 Global Economic Outlook report, 16 December, 2009

36 38 40 42 44 46 48 50 52 54 56 58 60 62 64

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Prabhat Awasthi

India stock picks
Mahindra and Mahindra Tata Motors State Bank of India Ambuja Cements ITC Limited Nagarjuna Construction HCL Technologies Zee Entertainment Tata Steel GAIL Dr. Reddy’s Laboratories Ranbaxy Unitech Ltd 66 70 74 78 82 86 90 94 98 102 106 110 114

Appendix

118

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4 January 2010

Strategy | India

Prabhat Awasthi

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.
Sensex target of 19,600 for December-end 2010 The market will have to navigate the proverbial puddle of inflation in the short term

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

Exhibit 1. Market underperforms during episodes of high inflation
(y-y %) 80 60 40 20 0 (20) (40) (60) 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 Sensex 6m-6m (LHS) WPI (RHS) (y-y %) 14 12 10 8 6 4 2 0 (2)

Exhibit 2. Banks underperform the market when inflation rises above 8%
(y-y %) 14 12 10 8 6 4 2 0 (2) Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 110 90 170 150 130 WPI (LHS) (Jan '02 = 100) Bankex/Sensex (RHS) 210 Circles highlight episodes of WPI > 8% and Banks underperformance 190

Circles highlight episodes of WPI > 8% and market underperformance

Source: Bloomberg, Nomura research

Source: Bloomberg, Nomura research

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Strategy | India

Prabhat Awasthi

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

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

Exhibit 4. Sensex earnings yield minus 10-year nominal govt bond yield
(%) 16 12 8 4 0 (4) (8) Overvaluation territory Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Undervaluation territory

(x) 30 25 20 15 10 5 0 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

Source: Bloomberg, Nomura research

Source: Bloomberg, Nomura research

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

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4 January 2010

Strategy | India

Prabhat Awasthi

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

Exhibit 5. Primary articles inflation and agri spot prices
370 350 330 310 290 270 250 230 210 190 170 Nov-08 Nov-07 Nov-06 Nov-05 Mar-06 Mar-07 Mar-08 Mar-09 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 1,000 1,500 2,000 2,500 Primary articles WPI Index (6 weeks fwd) (LHS) Agri spot index (RHS) 3,500 3,000

Exhibit 6. India CPI vs regional peers
India South Korea Indonesia China Thailand Malaysia

(%) 14 12 10 8 6 4 2 0 (2) (4) (6) Mar-07 Dec-06 Jun-07

Mar-08

Sep-07

Sep-08

Mar-09

Source: Bloomberg, Nomura research

Source: Bloomberg, Nomura research

Exhibit 7. Manufacturing WPI index and CRB commodity prices
(Y-Y %) 50 40 30 20 10 0 (10) (20) (30) (40) (50) (60) Jan-01 Jan-03 Jan-02 Jan-04 CRB index (RHS) Mfg WPI (LHS) (Y-Y %) 14 12 10 8 6 4 2 0

Exhibit 8. Raw material prices as % of net sales (BSE100 ex-banks and oil & gas)
(%) 30 29 28 27 26 25

3Q FY08

4Q FY08

1Q FY09

3Q FY09

4Q FY09

2Q FY09

1Q FY10

Source: Bloomberg, Nomura research

Source: Capitaline, Nomura research

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2Q FY10

(2) Jan-05 Jan-07 Jan-08 Jan-06 Jan-09

Sep-09

Dec-07

Dec-08

Jun-08

Jun-09

Strategy | India

Prabhat Awasthi

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

Exhibit 9. BSE500 ex-banks corporate capex
(INRbn) 3,000 2,500 2,000 1,500 1,000 500

Exhibit 10. India investment-to-GDP ratio
(%) 35 34 33 32 31 30 29

0 FY1993 FY1995 FY1997 FY1999 FY2001 FY2003 FY2005 FY2007 FY2009 28 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210

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

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Strategy | India

Prabhat Awasthi

Exhibit 11. Capacity utilisation (%)
(%) 95 90 85 80 75 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Manufacturing Industry Electricity Mining and Quarrying All industries (RHS) (%) 85 84 83 82 81 80 79 78

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

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.
Capacity shortages have returned

Exhibit 12. Cap utilisation and industrial production
(%) 85 84 83 82 81 80 79 78 77 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY08: Rising cap util and falling IP 6 4 2 0 Cap utilisation (LHS) IIP growth (RHS) (%) 14 12 10 8

Exhibit 13. Non-oil imports and cap utilisation
(%) 45 40 35 30 25 20 15 10 5 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Given capacity shortages, imports rose to fill the gap in FY08 Non oil import growth (LHS) cap utilisation (RHS) (%) 85 84 83 82 81 80 79 78 77

Note: We have assumed 9.5% IIP growth in FY10 Source: Business Beacon, Nomura research

Source: Business Beacon, Nomura research

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Strategy | India

Prabhat Awasthi

Exhibit 14. Non-oil imports
110 100 90 80 70 60 50 40 May-09 Nov-08 Mar-09 Jan-09 Sep-08 Sep-09 Jul-08 Jul-09 Non-oil imports are up sharply from the bottom Non-oil imports (Index Base Jul '08 =100)

Exhibit 15. Industrial production (y-y %)
(%) 12 10 8 6 4 2 0 -2 May-09 Nov-08 Sep-08 Mar-09 Jan-09 Sep-09 Jul-08 Jul-09 Despite sharply rising domestic supply IIP growth

Source: Business Beacon, Nomura research

Source: Business Beacon, Nomura research

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

Exhibit 16. Financial closures in the power sector
Project Rosa Power Bina Power Tuticorin Power Orissa Project Butibori Power Project GMR Kamalanga Energy Jhjjar Power Plant Salaya Power Plant Tiroda Phase I Mundra Phase IV Sasan Phata-Byung Amravati Talwandi Sabo Jegurupadu IPP
Source: Nomura research

Company Reliance Power Jaiprakash Power Ventures Coastel Energen Sterlite Power Reliance Power GMR Group CLP India Essar Power Adani Power Adani Power Reliance Power Lanco Indiabulls Power Sterlite Power GVK

Capacity (MW) 1,200 1,250 1,200 2,400 300 1,050 1,320 1,200 1,980 1,980 3,960 152 1,320 1,980 200

Date Jul-09 Nov-09 Jul-09 Jul-09 Jul-09 May-09 Oct-09 Oct-09 Jan-09 Jun-09 Apr-09 Aug-09 Jun-09 Dec-09 Nov-09

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Prabhat Awasthi

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

Exhibit 17. Net capital inflows and capex
(INRmn) 25,000 20,000 15,000 10,000 5,000 0 FY 1995 FY 1996 FY 1997 FY 1998 FY 1999 FY 2000 FY 2001 FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 Capex (LHS) Net capital inflows (RHS) (INRmn) 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 (5,000)

Exhibit 18. Investment and capital inflows
(%) 20 15 10 5 0 (5) FY 1995 FY 1996 FY 1997 FY 1998 FY 2000 FY 2001 FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 1999 FY 2009 CA/GDP (LHS) Capital flow/GDP (LHS) Investment/GDP (RHS) Gross capital inflow/ investment (%) 50 45 40 35 30 25 20 15 10 5 0

Note: Excludes portfolio flows Source: Business Beacon, Nomura research

Note: Excludes portfolio flows Source: Business Beacon, Nomura research

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Prabhat Awasthi

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

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.
Buoyancy in growth should impart a cyclical boost to revenues

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

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
(Y-Y %) 50 40 30 20 10 0 (10) (20) (30) (40) Sep-00 Sep-03 Sep-06 Dec-99 Dec-02 Dec-08 Sep-09 Dec-05 Jun-98 Jun-04 Mar-99 Jun-01 Mar-02 Mar-05 Jun-07 Mar-08 2 0 Central govt. revenue receipts (LHS) (Y-Y %) 14 IIP (RHS) 12 10 8 6 4

Exhibit 20. Central non-plan revenue expenditure

300 250 200 150 100 50 0

FY06 FY09

FY07 FY10

FY08

Nov

Aug

Sep

Source: Business Beacon, Nomura research

Note: April expenditure, Base = 100 Source: Business Beacon, Nomura research

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Dec

Feb

Mar

Apr

Jun

Jan

Jul

Oct

Strategy | India

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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
(INR/tonne) 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 FY96 FY99 FY02 FY97 FY98 FY00 FY01 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 Fert subs (RHS) Urea (LHS) DAP (LHS) (INRmn) 800,000 700,000 600,000 500,000 400,000 300,000 200,000 100,000 0

Source: Business Beacon, Nomura research

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

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Prabhat Awasthi

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.
We expect the yield curve to flatten

Exhibit 22. Slope of the yield curve (10-yr govt yield minus 1-yr govt yield)
(bps) 400 350 300 250 200 150 100 50 0 (50) (100) Sep-01 Sep-04 Nov-07 Aug-06 Nov-08 May-01 May-02 Aug-03 May-04 May-05 May-08 Mar-03 Mar-06 Sep-09
13

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

Govt 1-yr bond (RHS)

(%) 12 10 8 6 4 2 0

Oct-02

Dec-03

Oct-05

Jan-02

Jan-05

Jan-01

Source: Bloomberg, Nomura research

Nomura

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Jun-07

Apr-09

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Strategy | India

Prabhat Awasthi

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

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

Exhibit 23. Bank credit and deposit growth

Exhibit 24. Non-food bank credit growth (no. of weeks since beginning of fiscal year)
(%) 79 77 75 73 71 69 67 65

(Y-Y %) 32 29 26 23 20 17 14 11 8

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

135 130 125 120 115 110 105 100 95 90

FY06 FY09

FY07 FY10

FY08

Sep-08

Sep-09

Dec-07

Dec-08

Jun-08

Mar-08

Mar-09

Jun-09

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37
Source: Bloomberg, Nomura research Note: Base 100 = Total bank credit outstanding on the first week of the fiscal year

Source: Bloomberg, Nomura research

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Exhibit 25. Industry capex and cost in FY08 and FY09
FY08 FY09 No of % No of % projects share projects share 129 40.9 115 50.5 64 31.0 68 29.4 8 1.9 9 16.4 6 0.8 4 2.1 4 2.0 5 0.1 47 5.1 29 2.6 16 1.2 22 1.0 118 4.3 48 1.4 17 0.8 25 1.1 5 7.0 5 1.2 26 1.0 27 1.2 38 2.1 31 0.5 16 1.1 18 0.4 24 5.5 28 4.4 123 16.5 108 19.8 38 3.3 31 2.3 38 3.7 30 7.9 52 3.7 60 2.3 17 1.3 15 0.8 28 1.2 17 0.4 194 6.2 170 4.8 879 100.0 750 100.0

Exhibit 26. BSE500 ex-banks capex (y-y %)
(Y-Y %) 70 60 50 40 30 20 10 0 (10) (20) FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY08 FY09 FY09

Infrastructure Power Telecom Ports & Airports Roads, Storage & Water mgmt SEZ, Industrial, Biotech & IT Parks Sugar Textiles Paper & Paper Products Coke & Petroleum Products Chemicals & Petrochemicals Pharma & Drugs Rubber & Plastic Products Cement Metals & Metal Products Transport Equipment Construction Hotels & Restaurants Transport Services Hospitals Others Total

Source: Capitaline, Nomura research

Source: RBI, 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.
QIPs picked up in March 2009 after the markets bottomed

Exhibit 27. Higher leverage of companies that recapitalised through QIPs
(%) 160 140 120 100 80 60 40 20 BSE500 ex-fin Net Debt/Equity QIPs ex-fin Net Debt/Equity

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

(Y-Y %) 50 40 30 20 10 0 (10) FY00 FY01 FY02 FY03

Adj net PAT

FY04

FY05

FY06

FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009
Source: RBI, Nomura research

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.

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Prabhat Awasthi

Exhibit 29. Sectoral deployment of bank credit
% change of amount outstanding Sector Non-Food Gross Bank Credit (1 to 4) Agriculture & Allied Activities Industry (Small, Medium and Large) Personal Loans Housing Advances against Fixed Deposits Credit Cards Outstanding Education Consumer Durables Services Transport Operators Professional & Other Services Trade Real Estate Loans NBFCs
Source: RBI, Nomura research

As % of total as 19 Dec 08 until 27 27 Feb 09 until 22 22 May 09 until 28 28 May 08 until 28 of Aug 09 Feb 09 May 09 Aug 09 Aug 09 100.0 12.6 41.8 21.5 10.9 1.7 0.9 1.2 0.3 24.1 1.5 1.8 5.6 3.7 3.9 0.9 2.9 2.1 (2.3) 0.3 (8.5) (1.5) 4.0 (10.0) 1.0 1.3 (2.0) (1.4) 18.7 5.1 2.6 10.7 0.1 0.4 1.2 0.0 (6.7) 3.1 (2.6) 5.2 1.0 12.1 2.8 4.1 4.6 2.6 0.0 5.4 1.3 3.3 (2.3) (15.2) 11.6 (2.1) 0.3 0.6 3.8 3.7 2.3 7.0 13.3 25.6 17.9 2.3 5.4 0.7 (14.3) 34.5 (16.7) 11.0 9.1 20.5 13.9 41.5 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.
Corporates are raising growth capital

Exhibit 30. External commercial borrowings
(US$mn) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Apr-07 Others Refinancing of old loans / Repayment of ealier ECB Overseas acquisition Financial lease FCCB Buyback Capex

Exhibit 31. Primary market issuances
(INRmn) 250,000 QIPs Rights issues Public issues

200,000 150,000 100,000 50,000 0

Sep-08

Nov-08

Source: RBI, Nomura research

Source: SEBI, Nomura research

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May-09

Sep-09

Jan-08

Jan-09

Jul-08

Jan-08

Jan-09

Oct-07

Oct-08

Oct-09

Mar-08

Mar-09

Jul-07

Apr-08

Jul-08

Apr-09

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Strategy | India

Prabhat Awasthi

Exhibit 32. Uses of rights issues

Exhibit 33. Uses of IPO proceeds (actual and pipeline)
Uses of rights issues Repayment of loans Working Capital Capital adequacy Capex Acquisitions/Inter-corporate investments Others

1.2 1.0 0.8 0.6 0.4 0.2 0.0 Jul

Distribution of IPO proceeds in 2009 (Actual and pipeline) Capex Repayment of debt Working capital Acquisitions / Corp investments Expenses Issue expenses General corporate purposes Disinvestment

1.2 1.0 0.8 0.6 0.4 0.2 0.0

Aug

Sep

Oct

Nov

Dec

May

Jun

Aug

Sep

Oct

Nov

Source: SEBI, Nomura research

Source: SEBI, Nomura research

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

Exhibit 34. Retail loans slowed down before crisis
(INRbn) Consumer durables Housing Advances against fixed deposits Advances against shares/bonds Credit cards Education Other personal loans Total retail loans Growth (%) Total loan book of banks % of total loan book
Source: RBI, Nomura research

FY02 69 346 227 18 NA NA 261 920

FY03 72 366 227 20 NA NA 279 964 4.8

FY04 83 520 263 20 NA NA 352 1,238 28.4

FY05 91 1,287 299 41 58 51 624 2,451 98.0

FY06 88 1,864 349 51 92 101 993 3,538 44.4

FY07 92 2,310 408 49 183 152 1,334 4,528 28.0

FY08 88 2,578 450 42 264 205 1,507 5,134 13.4

FY09 82 2,770 487 23 280 286 1,698 5,625 9.6

6,169 14.9

6,695 14.4

7,644 10,409 14,458 18,482 22,473 26,485 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).

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

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

Exhibit 35. Centre and state deficits as % of GDP
as % of GDP FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 (RE) FY10 (BE) Centre 5.65 6.19 5.91 4.48 3.99 4.08 3.40 2.70 6.00 6.80 State 4.18 4.14 4.06 4.38 3.42 2.51 1.90 1.45 2.64 3.34 Consolidated 9.51 9.94 9.57 8.51 7.45 6.68 5.58 4.17 8.66 10.09 Oil, fertiliser, food and other bonds 0.04 0.46 0.09 0.09 0.01 0.50 0.98 0.81 1.76 0.17 Total liability 9.55 10.40 9.67 8.61 7.46 7.17 6.56 4.98 10.43 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

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

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.

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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

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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 ratecyclicals 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.

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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.

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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.
Short-term weakness, long-term strength

Exhibit 36. Relative strategy calls within the Indian market — tactical sector allocation
Strategy stance Sector Autos Headwinds Margin pressure from higher raw material prices and possible roll-back of excise duty cuts Higher inflation, short-term monetary rebalancing New capacity additions and pricing pressure, higher raw material prices (coal) Margin pressure from higher raw material prices and ad spends due to greater competition Margin pressure from increasing competition and higher raw material prices Execution risk; raw material price increases Lukewarm growth, very low persistency, operating cost overruns and regulatory risk Rupee appreciation, higher labour costs from tighter labour market conditions Tough competitive environment Delays in greenfield capacities Under-recoveries and sharing mechanism; gas litigation Rupee appreciation; regulatory risk Tailwinds Strong consumer incomes and improving labour market, industrial production Short-term NEUTRAL One-year NEUTRAL

Banks Cement

Strong credit growth on back of return of UNDERWEIGHT re-leveraging and growth capital A pick-up in infra-related activity

OVERWEIGHT

UNDERWEIGHT UNDERWEIGHT

Consumer

Strong rural and urban consumption

OVERWEIGHT

NEUTRAL

Electrical Equipment

Exposure to capex in power sector

NEUTRAL

OVERWEIGHT

Infra & Construction

Re-leveraging; a recovery in order inflows in infra (especially power and roads) and industrial capex Potentially positive regulation and listings of insurance companies Higher discretionary spending in the US upon economic recovery A recovery in advertising revenues Rising steel prices and volumes, captive raw materials Ramp-up of oil & gas production from new projects Patent expiries; increasing generic penetration; collaboration with big pharma Re-leveraging; improvement in residential volumes and a recovery in office leasing Strong subscriber growth A recovery in domestic and international growth and trade

NEUTRAL

OVERWEIGHT

Insurance

OVERWEIGHT

OVERWEIGHT

IT Services Media Metals & Mining Oil & Gas Pharma

NEUTRAL UNDERWEIGHT NEUTRAL OVERWEIGHT NEUTRAL OVERWEIGHT NEUTRAL OVERWEIGHT NEUTRAL OVERWEIGHT

Real Estate

Short-term monetary rebalancing

UNDERWEIGHT

OVERWEIGHT

Telcos

Tough competitive environment; regulatory risk

UNDERWEIGHT UNDERWEIGHT NEUTRAL OVERWEIGHT

Transport infrastructure Regulatory risk
Source: Nomura estimates

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Appendix

Appendix
Exhibit 37. Disinvestment proceeds from 1991-92 through 2009-10 (INR mn)
Receipts through sales of minority shareholding in CPSEs 30,377 Receipts through sale of majority shareholding of one CPSE to another CPSE Receipts through strategic sale Receipts from sale of residual shareholding in disinvested CPSEs/cos -

Year FY92

Budgeted receipts 25,000

Receipts from related transactions -

Total receipts Transactions 30,377 Minority shares sold in Dec 1991 and Feb 1992 by auction method in bundles of “very good”, “good” and “average” companies. 19,125 Shares sold separately for each company by auction method. - Equity of six companies sold by auction method but proceeds received in 94-95. 48,431 Shares sold by auction method. 1,685 Shares sold by auction method. 3,797 GDR – VSNL 9,100 GDR – MTNL 53,711 GDR-VSNL; Domestic offerings of CONCOR and GAIL; Cross purchase by 3 Oil sector companies ie, GAIL, ONGC and IOC. 18,601 GDR-GAIL; Domestic offering of VSNL; capital reduction and dividend from BALCO; Strategic sale of MFIL. 18,713 Sale of KRL, CPCL and BRPL to CPSEs; Strategic sale of BALCO and LJMC. 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. 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. 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. 27,649 Offer for Sale of NTPC and spill over of ONGC; sale of shares to IPCL employees. 15,697 - Sale of MUL shares to Indian public sector financial institutions & banks and employees 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. 42,599 (INR20,128.5mn - NHPC and INR22,470.5mn - OIL)

FY93 FY94

25,000 35,000

19,125 -

-

-

-

-

FY95 FY96 FY97 FY98 FY99

40,000 70,000 50,000 48,000 50,000

48,431 1,685 3,797 9,100 53,711

-

-

-

-

FY00

100,000

14,793

-

1,055

2,754

-

FY01

100,000

-

13,172

5,540

-

-

FY02

120,000

-

-

30,901

25,676

-

FY03

120,000

-

-

22,527

10,953

-

FY04

145,000

127,416

-

3,421

-

24,637

FY05

40,000

27,001

-

-

648

-

FY06 FY07

No target fixed No target fixed

-

-

-

21 -

15,676 -

FY08

No target fixed

18,145

-

-

-

23,669

FY09 FY10

No target fixed No target fixed

42,599

-

-

-

-

Source: Ministry of Disinvestment, Nomura research

Nomura

24

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Strategy | India

Prabhat Awasthi

Exhibit 38. Time-line of reforms from FY99-10
FY1999 • De-licensing of coal, lignite, petroleum, bulk drugs and sugar. Comments Major Major Major Minor Minor Major Major Minor Minor Major Minor Major

• • • • • • • • • • • • • •

Coal, lignite and mineral oils removed from sole purview of public sector. Announcement of disinvestment of IOC, GAIL, CONCOR, VNSL. Buybacks by corporates permitted. Automatic route FDI limits enhanced. 100% foreign equity permitted in electricity generation, transmission and distribution. 100% foreign equity permitted in construction & maintenance of roads, highways, bridges, ports and harbours. No prior approval of RBI for FDI/NRI/OCB after FIPB/Govt approval. Electricity Act of 1948 amended for private investment in power transmission. Setting up of central electricity regulatory commission, provisions for state ERCs. 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). 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. The Government announces that five cities will be identified for developing world class international airports. IDFC on par with other All India Public Financial Institutions regarding fiscal incentives and the fund raising benefits extended to these institutions. The repeal of the Urban Land (ceiling and regulation) Act, 1976.

Major Minor Major Comments Minor Minor Major Minor Major

FY2000 • RBI introduces an Interim Liquidity Adjustment Facility (ILAF) in place of the General Refinance Facility with effect from 21 April,1999. • Relaxation of listing requirement in respect of securities in the IT sector by reducing the stipulated minimum offering of securities from 25% to 10%. • 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. • Introduction of rolling settlement for 10 select scrips with effect from 10 January, 2000.

• • • • • • • • • • • • • • • • • • • • • • •

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. Reduction of long-term capital gains tax from 20% to 10% for resident Indians. 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. Free Trade Zones (FTZ) to replace export processing zones and to be treated as outside the country’s customs territory. Far-reaching rationalisation of the excise duty structure by reducing the existing eleven rates to only three. Tax incentives for facilitating industrial restructuring through mergers and amalgamations. Extension of infrastructure sector tax holiday to power transmission. The scope of the automatic approval scheme of the RBI significantly expanded. FDI up to 74%, under the automatic route, in bulk drugs and pharmaceuticals. Restructuring the US 64 scheme of UTI (Unit Trust of India), a favourable tax treatment of incomes earned through mutual funds. A new Department of Disinvestment created for expediting disinvestments in PSEs. Uniform tax holiday of 15 years for all infrastructure sector projects. Mega Power Project policy announced. Accelerated Power Development and Reforms Programme (APDRP) introduced. Restructuring of SEBs to be encouraged; new transmission and distribution systems to get fiscal benefits given to infrastructure sector. Domestic long distance calls to be opened up. Department of Telecom Services (DTS) to be corporatised by 2001. DTS/MTNL to enter as third cellular operators. TRAI (Telecom Regulatory Authority of India) reconstituted through an ordinance. Existing licence holders of basic and value added services allowed to switch over to a revenue sharing agreement. 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. Model Concession Agreement for BOT (Build Operate Transfer) for road project of more than INR100 crore and less than Rs. 100 crore finalised. Indian Railway Catering & Tourism Corporation (IRTC) Ltd. incorporated as a government company with the objective of upgrading and managing rail catering and hospitality. 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.

Minor Minor Minor Minor Minor Major Minor Minor Minor Major Major Major Major Major Major Major Minor Major Major Major

Major Minor Major

Nomura

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Exhibit 38. Time-line of reforms from FY99-FY10 (continued)
FY2001 • 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. • To fulfil critical needs of the rural people, a new scheme, “Pradhan Mantri Gramodya Yojna” launched with an outlay of INR5,000 crore. • 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. • States/Union Territories encouraged to implement their agreed programme for converting their sales taxes into VAT by 1 April, 2002. • The peak rate of import duty scaled down further from 40% to 35%. Comments Major Major Major Major Minor Major

• • • • • • • • • • •

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. 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. Legislative initiative to reduce the proportion of Government holding in the equity of nationalised banks. Permission to raise FII equity limit to 40% through a special resolution by shareholders. Removal of cap on investment in the power sector. 100% FDI permitted in oil refining. 100% FDI allowed in Special Economic Zones (SEZs) for all manufacturing activities. 100% FDI allowed in Telecom Sector for certain activities with some conditions. 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. A fourth cellular operator in all the circles permitted. Limited mobility to fixed service providers in the form of Wireless In local loop (WILL). 20 BOT road projects awarded.

Minor Major Minor Major Major Major Minor Follow up

Follow up Follow up Major

FY2002 • The coverage of service tax at the rate of 5% on the value of taxable service expanded to include fifteen new services. • Decision taken that all States and Union Territories will implement VAT from April, 2003.

Follow up Follow up Follow up 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. 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. Income tax at source made deductible at the rate of 10%. Freedom for banks to lend at interest rates below their respective PLRs (Prime Lending Rates) to exporters and other creditworthy borrowers (including public enterprises). VRS (Voluntary Retirement Scheme) implemented by 26 out of 27 public sector banks in 2000-2001 Clearing Corporation of India Limited (CCIL) set up. Negotiated Dealing System (NDS) introduced in phases to supplement or replace the current telephone mode used in trading on the fixed income market. Rolling settlement extended to all stocks and all exchanges. Cycle shortened to T+3. Peak level of customs duties to decline marginally from 38.5% to 35%. 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. Further impetus on SEZ. 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. 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. 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. 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 longterm capital gains from such investments fully exempt. Electricity Bill 2001 introduced in Parliament. 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. Competition introduced in all service segments of telecoms. The total outlay for the road sector enhanced. 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. Pradhan Mantri Gramin Yojna (PMGY) extended to cover rural electrification. Continued de-reservation for small scale industry.

Major Minor Follow up Minor Minor Follow up Follow up Minor Follow up Follow up Follow up Minor

Minor

Major Major

Major Follow up Major

Major Follow up

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Exhibit 38. Time-line of reforms from FY99-FY10 (continued)
FY2003 Comments Major

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. 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. Further enhancement of SEBI's power. Corporate disclosures made widely available through Electronic Data Information Filing and Retrieval. Further concession given to SEZs in terms of procurement of duty free equipment, raw materials and components. Continued de-reservation from small scale industry. Reduction in peak import duty from 35% to 30%. Significant reduction in ECB usage restrictions. 100% FDI permitted in advertising, film, tea, township development including housing, commercial premises, hotels, resorts and regional urban infrastructure, in manufacturing of SEZs. 26% FDI allowed in print media. Disinvestment of Hindustan Zinc, Maruti, IPCL, Modern Foods and eleven government-owned hotels. Infrastructure Equity Fund set up for providing equity investment in infra projects. IDFC to act as coordinating agency for coordinated debt syndication for infrastructure. 20 state government sign MOUs (Memorandum of Understanding) with centre for time bound reforms. State level electricity regulatory commissions start to function. SEB (State Electricity Board) de-bundling starts. APDRP (Accelerated Power Development and Reform Programme) given further thrust. Airport modernisation started. Mass rapid transport thrust introduced. Urban Delhi Metro project slated for completion in 2005.. Monitoring of government project strengthened to reduce delay. Starts to show results. Electricity distribution privatised in Delhi in July 2002. 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

• • • • • • • • • • • • • • • • • • • •

Follow up Follow up Follow up Follow up Follow up Follow up Follow up Follow up Major Major Minor Follow up Follow up Follow up Follow up Major Minor Minor Follow up Major (not completed)

FY2004 — change of the government takes place to UPA late in FY2004 Pre UPA with left

Comments Major

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. Shift from contribution pension system to defined pension benefit for central government employees Introduction of risk based supervision in the banking sector. Issuance of guidelines for "Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act. 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. Commodity futures trading allowed. Recognition granted to various commodity exchanges including MCX, NCDEX etc. 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. ECB policy liberalised further. All sectors except banks and financial institutions allowed in the ECB market. Five states enact fiscal responsibility legislations. Disinvestment in Maruti, Jessop, HZL, ICIL, IBP, IPCL, CMC, DCIL, GAIL, ONGC. Electricity act notified in June 2003. 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. Unified Access Service License regime introduced in October 2003. Pradhan Mantri Bharat Jodo Project for development of 10,000 kms of roads connecting state capitals with National Highways launched in January 2004. Rail Vikas Nigam set up in January 2003.

• • • •

Major Minor Follow up Follow up

• • • • • • •

Major Major Follow up Follow up Follow up Follow up Major

Pre UPA with left Pre UPA with left Pre UPA with left

Pre UPA with left Pre UPA with left Pre UPA with left

• • •

Follow up Follow up Major

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27

4 January 2010

Strategy | India

Prabhat Awasthi

Exhibit 38. Time-line of reforms from FY99-FY10 (continued)
FY2005 Comments Retrograde Follow up

• •

Disinvestment agenda largely scuttled. 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. 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. Three more states likely to enact fiscal responsibility legislations. States entered into debt swap to reduce the cost of debt. Process complete for 20 states. Agreement to implement State level VAT from 1 April, 2005. Development of mechanism for debt restructuring for medium enterprises on the lines of corporate debt restructuring. Resident individuals already permitted to remit freely up to US$ 25,000 per calendar year for any current or capital account transaction. 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). Indian corporates and partnership firms allowed to invest overseas up to 100% of their net worth. Banks to draw a road map for moving towards Basel II by 31 December, 2004. 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). 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.

Minor

• • • • • • • • •

Follow up Follow up Follow up Follow up Follow up Major Minor Minor Follow up

Follow up

FDI ceiling in telecom sector in certain services (such as basic, public mobile radio trunked services (PMRTS), Follow up 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%. Generally, profit-making companies not to be privatised. 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. Retrograde Follow up

• •

FY2006

Comments Follow up Minor Rural thrust Rural thrust Major Follow up Follow up Follow up Major Major Follow up

• • • • • • • • • • •

The corporate income tax rate for domestic companies and firms reduced from 35% to 30%. However, a surcharge of 10% applies. Service tax rate increased from 8% to 10%. Rural Electricity Infrastructure and Household Electrification introduced in April, 2005. National Rural Employment Guarantee bill passed in August 2005. Viability gap funding schemes introduced on generalised basis. Peak rate of customs duty for non-agricultural products reduced from 20% to 15%. The emphasis on infrastructure development continued with the decision to set up a special purpose vehicle (SPV) for large infrastructure projects. The Special Economic Zone (SEZ) Bill passed by Parliament in June 2005. 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. 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. 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.

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Strategy | India

Prabhat Awasthi

Exhibit 38. Time-line of reforms from FY99-FY10 (continued)
FY2007 Comments Follow up Rural Thrust Minor Minor

• • • •

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. 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. PAN has been made mandatory with effect from January 1, 2007, for operating a Beneficiary Owner account and for trading in the cash segment. 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. UMPP numbers expanded to 9 in total. 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. 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.

• • • •

Follow up Follow up Major

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

FY2008

• • • •

The peak rate of customs duty on non-agricultural products reduced from 12.5% in 2006-07 to 10% in 200708, with a few exceptions. Further increase in services eligible for service tax. De-tariffing of the general insurance industry.

Appointment by PFRDA (Pension Fund Regulatory and Development Authority) of three sponsors for pension Follow up 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. 3 UMPPs (Ultra Mega Power Plants) awarded. Follow up Comments Populist Populist Response to crisis Populist Response to crisis Populist Populist Follow up Follow up Follow up Follow up

FY2009 and interim budget for FY2010

• • • • • • • • • • •

Additional plan expenditure up to INR20,000 crore for social sector schemes during financial year 2008-09. An amount of INR85,942 crore authorised by way of bonds in 2008-09 for FCI, oil and fertilizer units. Across the board cut of 4pp in ad valorem CENVAT rate except for petroleum products. Farm loan waiver (0.3% of GDP). Significant customs duty exemptions announced to address the slowdown. Implementation of the Sixth Pay Commission award (0.65% of GDP). Higher levels of food and fertiliser subsidy (1.03% of GDP). 49% FDI in credit information companies allowed. FDI up to 26% and FII up to 23% in commodity exchanges, subject to no single investor holding more than 5% allowed. FDI up to 100% under the automatic route allowed both in setting up and in established industrial parks. 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. 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. One more UMPP awarded. Under NELP-VII, the award of 44 blocks has been approved.

• • •

Follow up Follow up Follow up

Note: 10 lakh = 1 million; 1 crore = 10 million Source: Budget documents, Nomura research

Nomura

29

4 January 2010

Strategy | India

Prabhat Awasthi

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”).
Consumer demand and infrastructure investment to drive this pick-up A rebound in private sector demand should offset lower fiscal stimulus in 2010F

Nomura

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Strategy | India

Prabhat Awasthi

Exhibit 39. Contribution to GDP growth
(%) 14 Government Others Private demand GDP Forecasts 10

Exhibit 40. Employment and private consumption
(%) 25 Employment survey (LHS) Real private consumption (3qma) (% y-y) 10

8 15

6 5 2

6

4

(2) Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

(5) Dec-02

Feb-04

Apr-05

Jun-06

Aug-07

Oct-08

2 Dec-09

Source: CEIC and Nomura Global Economics estimates

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.

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

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
Inflationary pressures are building up…

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

Nomura

31

4 January 2010

Strategy | India

Prabhat Awasthi

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
(%) 40 Share of infrastructure in incremental credit 30

Exhibit 42. WPI inflation projections
(% y-y) 14 11 8 Primary Manufacturing Fuel WPI Forecasts

20 5 10 2 (1) Mar-07

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

Dec-07

Sep-08

Jun-09

Mar-10

Dec-10

Source: CEIC and Nomura Global Economics

Source: CEIC and Nomura Global Economics estimates

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.
With continued large borrowings in FY11 and no RBI support, longterm yields could rise sharply Fiscal consolidation is likely to be left to revenue buoyancy rather than expenditure control

Nomura

32

4 January 2010

Strategy | India

Prabhat Awasthi

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
(% y-y) 15 12 9 6 Trimmed mean (20%) Core WPI (ex-food, fuel) Mean +/- 1.5 S.D

Exhibit 44. Centre’s market borrowings and yields
INR tr 5 4 3 7 2 6 1 0 FY01 FY03 FY05 FY07 FY09 FY11E 5 4 Gross market borrowing, lhs Net market borrowing, lhs 10-year bond yield, rhs (%) 10 9 8

3 0 (3) May-05 Feb-06 Nov-06 Aug-07 May-08 Feb-09 Nov-09
Source: CEIC and Nomura Global Economics estimates

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.

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

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

Nomura

33

4 January 2010

Strategy | India

Prabhat Awasthi

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-tomaturity 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.
RBI is likely to follow countercyclical prudential and capital liberalisation norms We expect 125bps of CRR hikes in 2010 to withdraw excess liquidity

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

Exhibit 45. Components of balance of payments
(US$bn) 110 90 70 50 Current account Debt capital Equity capital

Exhibit 46. Policy rate projections
(%) 9 CRR Repo rate Reverse repo Forecast

Forecast 8 7 6

30 10 (10) (30) FY01 FY03 FY05 FY07 FY09 FY11 5 4 3 Mar-03

Oct-04

May-06

Dec-07

Jul-09

Mar-11

Source: CEIC and Nomura Global Economics estimates

Source: CEIC and Nomura Global Economics estimates

Nomura

34

4 January 2010

Strategy | India

Prabhat Awasthi

Exhibit 47. Details of forecast
y-y- growth (%) unless otherwise stated Real GDP (sa, q-q, %, annualised) Real GDP Private consumption Government consumption Fixed investment Exports (goods and services) Imports (goods and services) M3 money supply Non-food credit Wholesale price index Consumer price index Merchandise trade balance (% GDP) Current account balance (% GDP) Centre’s fiscal balance (% GDP) Repo rate (%) Reverse repo rate (%) Cash reserve ratio (%) 10-year bond yield (%) Exchange rate (INR/US$) 4.75 3.25 5.00 7.34 48.0 4.75 3.25 5.25 7.00 45.8 5.00 3.50 5.50 7.25 46.2 5.25 3.75 5.75 7.30 45.0 5.50 4.00 6.00 7.50 43.7 6.00 4.50 6.25 7.75 42.3 6.25 4.75 6.50 8.00 40.5 3Q09 4Q09F 1Q10F 2Q10F 3Q10F 4Q10F 1Q11F 11.4 7.9 5.6 26.9 7.3 (15.0) (29.8) 19.8 14.7 (0.1) 11.8 (7.7) 2.4 6.5 5.0 5.0 6.0 3.0 (2.0) 18.6 11.1 4.0 11.5 (9.6) 9.7 7.5 6.0 5.0 8.0 6.0 9.0 18.1 14.8 7.5 11.3 (7.0) 8.5 7.9 6.5 5.0 7.8 14.5 14.0 18.0 15.2 7.4 10.4 (6.7) 10.9 8.1 7.0 3.5 8.2 14.9 8.4 18.5 17.3 6.3 5.8 (6.6) 4.7 8.3 7.0 6.0 9.2 9.5 11.5 18.4 19.7 6.7 5.3 (9.7) 6.9 7.7 7.6 5.0 9.5 9.0 10.5 17.3 21.1 7.0 5.5 (5.5) 6.7 2.9 20.2 8.2 12.8 17.9 18.8 17.4 8.4 10.9 (10.4) (2.6) (6.0) 5.00 3.50 5.00 7.04 51.0 7.0 4.6 9.9 6.4 (4.0) (11.2) 18.0 15.5 3.0 6.6 (7.8) (0.8) (6.8) 5.00 3.50 5.50 7.25 46.2 8.0 7.0 5.0 8.7 11.7 11.1 17.3 21.5 6.8 6.0 (6.9) (1.1) (6.2) 6.25 4.75 6.50 8.00 40.5 FY09F FY10F FY11F

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. Source: CEIC and Nomura Global Economics estimates

Nomura

35

4 January 2010

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
Stock

NEUTRAL
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.
Price target (INR) 1,232 419

Rating

Price (INR)

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.

Mahindra & Mahindra (MM IN)

BUY 1,061.85 779.95

Tata Motors (TTMT IN) REDUCE
Prices as of 24 December 2009

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%.

Analysts
Kapil Singh +91 22 4037 4199 kapil.singh@nomura.com Prabhat Awasthi +91 22 4037 4180 prabhat.awasthi@nomura.com

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 onefourth 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.

Nomura

36

4 January 2010

Strategy | India

Kapil Singh

Exhibit 48. Relationship of IIP growth to automobile growth
(%) 100 80 60 40 20 0 (20) (40) FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10F FY11F 600 500 400 30,000 300 20,000 200 10,000 0 Malasiya Mexico Indonesia Sri Lanka Phillippines Germany (%) 5 0 (5) (10) (15) (20) (25) FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09
Source: Business Beacon, Nomura research

Cars (LHS) Commercial vehicles (LHS)

Two wheelers (LHS) IIP (RHS)

(%) 20 18 16 14 12 10 8 6 4 2

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

Exhibit 49. Relationship of GDP/capita and car penetration
50,000 40,000 GDP PPP in 2006 (LHS) Cars/1000 (RHS)

100 0 South Korea Thailand Japan China India Brazil USA UK

Source: Nomura research

Exhibit 50. Relationship of weak monsoons and auto demand in India
(%) 60 50 40 30 20 10 0 (10) (20) (30) (40) (50) 2W (LHS) MHCVs (LHS) Rainfall deviation (RHS) Cars (LHS) Exide (LHS)

Nomura

37

4 January 2010

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 shortterm 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.

NEUTRAL
Stocks for action
SBI is our preferred sector pick. Improving NIMs and a pick-up in loan growth are key catalysts.
Price (INR) 990 875 911 Price target (INR) 1,185 910 960

Stock Axis (AXSB IN) ICICI (ICICBC IN) PNB (PNB IN) SBI (SBIN IN)

Rating BUY BUY NEUTRAL BUY

2,215 2,590*

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

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.

Analysts
Mahrukh Adajania +91 22 4037 4157 mahrukh.adajania@nomura.com Sreekanth Akula (Associate) +91 22 4053 3685 sreekanth.akula@nomura.com

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

Nomura

38

4 January 2010

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
(%) FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10
Source: RBI

Nov (% y-y) 69.4 55.7 112.3 98.1 90.7 66.0 93.7 39.9

Apr-Nov 62.5 23.6 195.9 103.7 72.5 46.0 86.8 36.2

Apr-Sep 56.0 4.7 100.2 87.0 68.8 37.8 77.6 35.6

Apr-Jun 53.3 (48.9) 23.4 38.7 27.8 (37.1) 76.3 5.4

Jan-Mar 109.5 74.2 100.6 106.3 77.8 99.0 52.5 NA

Exhibit 52. India banks: valuation comparison
Axis Ticker Price (INR) Rating P/E core business (x) FY08 FY09 FY10F FY11F P/BV core business (x) FY08 FY09 FY10F FY11F P/adjusted BV core business (x) FY08 FY09 FY10F FY11F
Note: pricing as of 24 December 2009 Source: Company data, Nomura estimates

BOI BOI IN 363 REDUCE 9.5 6.4 9.6 7.2 2.2 1.8 1.6 1.3 2.5 1.9 1.7 1.4

HDFC HDFC Bank HDFC IN 2,609 REDUCE 24.7 26.4 23.3 20.2 12.3 9.7 5.6 4.9 12.3 9.7 5.6 4.8 HDFCB IN 1,693 NEUTRAL 37.7 32.1 26.5 20.3 5.2 4.8 3.6 3.2 5.2 4.8 3.6 3.2

ICICI ICICIBC IN 823 BUY 17.2 19.0 16.6 13.8 1.7 1.7 1.6 1.5 1.7 1.7 1.6 1.5

PNB PNB IN 891 NEUTRAL 13.7 9.1 8.4 7.1 2.6 2.1 1.8 1.5 3.2 2.5 2.0 1.6

SBI SBIN IN 2,153 BUY 20.0 14.9 13.4 11.4 1.9 1.7 1.5 1.4 2.2 1.9 1.7 1.5

Union Bank UNBK IN 263 NEUTRAL 9.6 7.7 7.1 5.9 2.3 1.8 1.5 1.3 3.2 2.4 1.9 1.5

AXSB IN 937 BUY 31.3 18.5 15.0 12.0 3.9 3.4 2.3 2.0 3.8 3.3 2.2 2.0

Nomura

39

4 January 2010

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.
Stock

BEARISH
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 top REDUCE.

Rating REDUCE REDUCE

Price (INR) 99.45 859.7

Price target (INR) 67 609

Ambuja Cement (ACEM IN) ACC (ACC IN)

Prices as of 24 December 2009

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.

Analyst
Jamil Ansari +91 22 4037 4192 jamil.ansari@nomura.com

Significant new capacity due to be added in 2010
Exhibit 53. Cement capacity additions
45 40 35 30 25 20 15 10 5 0 FY05 FY06 FY07 FY08 FY09 FY10F FY11F FY12F FY13F FY14F 7 2 4 12 5 20 17 31 29 42

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.

Nomura

40

4 January 2010

Strategy | India

Jamil Ansari

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

Exhibit 54. Cement prices: all-India average
(INR/bag) 300 250 200 150 100 50 0 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

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

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

Nomura

41

4 January 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.
Stock

BULLISH
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.
Price target (INR) 309 600

Rating BUY REDUCE

Price (INR) 256 663

ITC Ltd (ITC IN) Colgate-Palmolive (CLGT IN)

Prices as of 24 December 2009

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.

Analyst
Manish Jain +91 22 4037 4186 manish.jain@nomura.com

…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).

Nomura

42

4 January 2010

Strategy | India

Manish Jain

Exhibit 55. India consumer sector: sales growth remains strong
(%) 20 15 10.7 10 7.0 5 0 (5) FY00 3.7 (1.0) (2.5) FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 3.0 z 8.0 16.5 17.0 17.5

Source: Nomura research

Exhibit 56. India: steady agri output growth
(%) 12 8 4 0 (0.3) (4) (8) (12) FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 (2.6) (7.2) 6.3 2.7 (0.1) 6.3 10.0 5.9 3.8 4.6 1.6

Exhibit 57. India: minimum support prices
(INR/quintal) 1,300 1,200 1,100 1,000 900 800 700 600 500 400 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 May-09 Nov-08 Nov-09 Paddy Wheat Jute Jowar

Source: Business Beacon, Nomura research

Source: Ministry of Agriculture, Nomura research

Exhibit 58. India: domestic polymer prices
(INR/kg) 100 90 80 70 60 50 40 30 20 May-02 May-09 Nov-05 Mar-01 Sep-04 Dec-02 Mar-08 Feb-04 Jan-07 Dec-09 Oct-01 Jul-03 Apr-05 Jun-06 Aug-07 Oct-08

Exhibit 59. India: domestic LAB prices
(INR/te) 130,000 120,000 110,000 100,000 90,000 80,000 70,000 60,000 50,000 40,000 May-02 May-03 May-04 May-05 May-06 May-07 May-08 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07

Source: Bloomberg, Nomura research

Source: Bloomberg, Nomura research

Nomura

43

4 January 2010

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.
Stock BHEL ABB Ltd

BEARISH
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.

Rating REDUCE REDUCE

Price (INR) 2,368 771

Price target (INR) 1,850 535

Prices as of 24 December 2009

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.

Analyst
Amar Kedia +91 22 4037 4182 amar.kedia@nomura.com

Rating summary
Stock BHEL (BHEL IN) ABB Ltd (ABB IN) Cummins India (KKC IN) Thermax Ltd (TMX IN) Price (INR) 2,368.00 771.00 405.50 592.55 Price target (INR) 1,850 535 450 Rating REDUCE REDUCE BUY

515 NEUTRAL

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.

Source: Nomura estimates

Valuation summary
Stock BHEL (BHEL IN) ABB Ltd (ABB IN) Cummins India (KKC IN) Thermax Ltd (TMX IN) Source: Nomura estimates FY10F P/E FY11F P/E (x) (x() 28.9 26.3 20.0 28.9 23.5 21.0 15.9 20.5

… 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.

Nomura

44

4 January 2010

Strategy | India

Amar Kedia

Exhibit 60. Industrial activity on the rise
(% y-y) 16 IIP (3mma), (LHS) IIP (3mma) lhs lead) rhs OECD CLI for India (6-month lead), (RHS) (% m-m) 2

12

1

8

0

4

(1)

0 Mar-96

Jul-98

Nov-00

Mar-03

Jul-05

Nov-07

(2) Mar-10

Source: IPA, Nomura research

Exhibit 61. BHEL: order flows are peaking
order inflow (LHS) Order inflow order book coverage (RHS) Order book coverage

Exhibit 62. Thermax: benefitting from power orders
60,000 50,000 40,000 30,000 20,000 10,000 0 Mar-09 Mar-08 Jun-09 Jun-08 Sep-09 Sep-08 Sep-07 Dec-08 Dec-07 Jun-07 Mar-09 Jun-09 Sep-09 Orderbook - Consolidated Order inflow - Consolidated % YoY Growth inflow (RHS) (%) 200 150 100 50 0 (50) (100)

700,000 600,000 500,000 400,000 300,000 200,000 100,000 0 FY00 FY01 FY02

5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 FY09 FY10E

FY03

FY04

FY05

FY06

FY07

FY08

Source: BHEL, Nomura estimates

Source: Thermax, Nomura research

Exhibit 63. ABB: segmental revenue still declining …
(%) 100 80 60 40 20 0 (20) (40) Mar-07 Mar-08 Mar-09 Jun-07 Jun-08 Sep-07 Sep-08 Jun-09 Sep-09 Dec-07 Dec-08 Power systems Power products Process automation Automation products

Exhibit 64. … thus pressurising margins
(%) 20 18 16 14 12 10 8 6 4 2 Mar-06 Mar-07 Mar-08 Jun-06 Jun-07 Sep-06 Dec-06 Sep-07 Dec-07 Jun-08 Sep-08 Dec-08 Power systems Process automation Power products Automation products

Source: ABB India, Nomura research

Source: ABB India, Nomura research

Nomura

45

4 January 2010

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.
Stock

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

Rating BUY BUY BUY BUY REDUCE

Price (INR) 1,682 357 165.85 151 202 242

Price target (INR) 1,867 451 197 157* 228 193

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.

L&T (LT IN) IVRCL (IVRC IN) Nagarjuna (NJCC IN) HCC (HCC IN) IRB Infra (IRB IN)

Punj Lloyd (PUNJ IN) NEUTRAL

* PT under review; Prices as of 24 December 2009

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.

Analysts
Saion Mukherjee +91 22 4037 4184 saion.mukherjee@nomura.com Harish Venkateswaran (Associate) +91 22 4037 4028 harish.venkateswaran@nomura.com

Exhibit 65. Expected pick-up in award activity in road sector
Length (Km) 11,947 FY10E 14,000 12,000 10,000 8,000 3,476 6,000 4,000 895 262 310 105 2,000 0 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY11E 4,740 Contracts awarded (Km) Contracts completed (Km) 11,721

1,305 2351

1,726 636

342 1318

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

Nomura

671 391

480

639 2148

754

1,202 1614

46

4 January 2010

Strategy | India

Saion Mukherjee

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.

Nomura

47

4 January 2010

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.

BEARISH
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.

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.

Stock Reliance Capital (RCFT IN)

Rating REDUCE

Price (INR) 851

Price target (INR) 834

Prices as of 24 December 2009

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 multiyear 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%.

Analyst
Srikanth Vadlamani +65 6433 6957 srikanth.vadlamani@nomura.com

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

Nomura

48

4 January 2010

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

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

Using SOTP, we value RCFT at INR834/share

Exhibit 66. Persistency ratios
(%) 100 90 80 70 60 50 40 30 20 10 0 FY06 FY07 FY08 FY09 1Q10 2Q10 ICICI Prudential Reliance Life Bajaj Allianz Kotak SBI life Max HDFC Standard

Source: IRDA, company data, Nomura estimates

Nomura

49

4 January 2010

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.
Stock

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

Rating NEUTRAL BUY BUY BUY NEUTRAL NEUTRAL

Price (INR) 749 375 473 1,003 2,592 694

Price target (INR) 785 397* 540 1,250 2,600 740

TCS (TCS IN) HCL Tech (HCLT IN) Patni (PATNI IN) Tech Mahindra (TECHM IN) Infosys (INFO IN) Wipro (WPRO IN)

* PT under review; Prices as of 24 December 2009

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.

Analysts
Harmendra Gandhi +91 22 4037 4181 hagandhi@nomura.com Pinku Pappan +91 22 4037 4360 pinku.pappan@nomura.com

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.

Nomura

50

4 January 2009

Strategy | India

Harmendra Gandhi

Exhibit 67. Q-Q US$ revenue growth in +ve territory
(%) 6.0 4.0 2.0 0.0 (2.0) (4.0) (6.0) (8.0) 3Q FY09 4Q FY09 1Q FY10 2Q FY10 Infosys TCS Wipro

Exhibit 68. Net employee adds also trending upward
(Nos) 10,000 8,000 6,000 4,000 2,000 0 (2,000) (4,000) 2Q FY09 3Q FY09 4Q FY09 1Q FY10 2Q FY10 Infosys TCS Wipro

Source: Company data, Nomura research

Source: Company data, Nomura research

Exhibit 69. EBITDA margins have improved y-y

Exhibit 70. Valuation sensitivity to rupee appreciation
140 120 100 80 60 40 20 0 (20) Infosys premium (%) to Sensex P/E (LHS) US$/INR rate (RHS) 46 45 44 43 42 41 40 39 38 37 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 36 Jul-08

(%) 36 34 32 30 28 26 24 22 20 18 2Q FY09

Infosys

TCS

Wipro

3Q FY09

4Q FY09

1Q FY10

2Q FY10

(40) Jan-07

Source: Company data, Nomura research

Source: Bloomberg, Nomura research

Exhibit 71. One-year forward P/E trend for Infosys, HCL Tech and the Sensex in the past three years
(x) 32 28 24 20 16 12 8 4 May-07 May-08 May-09 Nov-06 Nov-07 Nov-08 Sep-07 Sep-08 Sep-09 Nov-09 Mar-07 Mar-08 Mar-09 Jan-07 Jan-08 Jan-09 Jan-10 Jul-07 Jul-08 Jul-09 16.2 15.7 23.0 Infosys Sensex HCL Tech.

Source: Bloomberg, Nomura research

Nomura

51

4 January 2009

Strategy | India

Jamil Ansari

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.

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

Stock Zee Entertainment (Z IN) Sun TV (SUNTV IN)

Rating BUY BUY

Price (INR) 265.5 336.25

Price target (INR) 292 355*

* PT under review; Prices as of 24 December 2009

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.

Analysts
Jamil Ansari +91 22 4037 4192 jamil.ansari@nomura.com Prabhat Awasthi +91 22 4037 4180 prabhat.awasthi@nomura.com

Exhibit 72. Zee Entertainment: ad-revenue growth
(%) 35 30 25 20 15 10 5 0 (5) (10) FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10F FY11F

Source: Nomura estimates

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.

Nomura

52

4 January 2010

Strategy | India

Jamil Ansari

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.
Weaker players getting bought out by stronger names

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.
Competition in the Hindi GEC space is increasing again

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.
Moderately positive on the sector

Nomura

53

4 January 2010

Strategy | India

Prabhat Awasthi

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.

BULLISH
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.
Price target (INR) 926 250

Stock TATA Steel SAIL

Rating BUY BUY

Price (INR) 615.6 237

Prices as of 24 December 2009.

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.

Analysts
Prabhat Awasthi +91 22 4037 4180 prabhat.awasthi@nomura.com Alok Kumar Nemani (Associate) +91 22 4037 4193 alokkumar.nemani@nomura.com

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.

Nomura

54

4 January 2010

Strategy | India

Prabhat Awasthi

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

Exhibit 73. Global steel production has picked up over the past six months
140 120 100 80 60 40 Jan08 Mar08 May08 Jul08 Sep08 Nov08 Jan09 Mar09 May09 Jul09 Sep09 USA EU CIS China World

Source: World Steel Organization

Exhibit 74. Domestic steel demand vs fixed asset investments
(%) 20 15 10 5 0 (5) 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
(Tonnes) 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 FY04 FY05 FY06 FY07 FY08 FY09 Capacity (LHS) Consumption (LHS) Crude steel production (LHS) Net imports (RHS) (Tonnes) 3,000 2,000 1,000 0 (1,000) (2,000) (3,000) (4,000)

Source: Ministry of Steel, Nomura research

Nomura

55

4 January 2010

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 endJanuary) 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.
Stock GAIL

NEUTRAL
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 rerating story, in our view.

Rating BUY

Price (INR) 420

Price target (INR) 500

Prices as of 24 December 2009.

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.

Analysts
Anil Sharma +91 22 4037 4338 anil.sharma.1@nomura.com Ravi Kumar Adukia (Associate) +91 22 4037 4232 ravikumar.adukia@nomura.com

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/nontransparency 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.

Nomura

56

4 January 2010

Strategy | India

Anil Sharma

Exhibit 76. India: at current retail prices, large under-recoveries are expected to continue
FY07 FY08 FY09 FY10F FY11F FY12F Brent price (US$/bbl) Exchange rate (INR/US$) Gross U/R per unit Petrol (INR/ltr) Diesel (INR/ltr) PDS Kerosene (INR/ltr) Domestic LPG (INR/cyl) Gross under-recoveries (INRbn) Petrol Diesel PDS Kerosene Domestic LPG Total 20 188 179 107 494 73 353 191 156 52 523 282 176 46 59 175 130 411 38 77 196 144 455 60 141 206 163 571 1.6 3.9 16 169 5.2 6.2 17 220 0.1 6.2 23 247 3.1 1.2 16 196 2.2 1.2 17 209 3.3 2.0 18 231 64.4 45.3 82.3 40.2 84.8 46.0 69.4 47.2 72.0 45.0 75.0 45.0

Exhibit 77. India: per unit under-recoveries and underlying Brent prices at current retail prices
Retail prices (INR) 44.5 32.9 9.1 321.3 Underrecoveries (INR) 2.6 2.3 16.8 304.0 Underlying Brent (US$/bbl) 67.0 68.0 18.0 35.0 58.5

Product MS Diesel PDS Kerosene Domestic LPG Overall

Unit per litre per litre per litre per cylinder

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

773 1033

Source: Petroleum Planning & Analysis Cell, Nomura estimates

Exhibit 78. India oil production: Cairn’s Rajasthan block and RIL’s KG-D6 contribute to large increase
(MMT) 50 45 40 35

Exhibit 79. India gas production: RIL’s KG-D6 to double gas production by FY11
(mmscmd) 200 175 150 125 100

30 25 FY10F FY11F FY12F FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09

75 50 FY10F FY11F FY12F
Dec-10 Oct-10 Apr-10 May-10

FY02

FY03

FY04

FY05

FY06

FY07

FY08

Source: Petroleum Planning & Analysis Cell, Nomura estimates

Source: Petroleum Planning & Analysis Cell, Nomura estimates

Exhibit 80. India’s refining capacity and consumption — product exports likely to increase
(MMT) 250 225 200 175 Refining capacity Product demand

Exhibit 81. India: key new projects in 2010
Capex (INRbn)

Project Gas transmission pipelines DVPL GREP upgradation - Dahej- Vijaipur P has e II (48") - Vijaipur - Dadri P pipeline (48") Dadri - Bawana - Nangal

FY01

Owner GAIL

FY09

Timeline

44

58 Dec 2009* GAIL BPCL IOCL 23 104 144

150 125 100 75 FY04
Bina Refinery Naphtha Cracker (800kta)
* October 2010 (With Compressor) Source: Company data, Nomura estimates Source: Petroleum Planning & Analysis Cell, Nomura estimates

FY06

FY08

FY10F

FY12F

Nomura

57

4 January 2010

Strategy | India

Saion Mukherjee

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.

BULLISH
Stocks for action
Among the stocks in our coverage universe, Dr. Reddy’s is our top pick.
Price target (INR) 1,329 261

Stock Dr. Reddy’s (DRRD IN)

Rating BUY

Price (INR) 1,186 520

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

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.

Analyst
Saion Mukherjee +91 22 4037 4184 saion.mukherjee@nomura.com

Exhibit 82. Clear intent to improve profitability
Company Dr. Reddy's Steps taken to improve profitability 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. Sharp cut-backs in acquisition-led growth (primarily in emerging markets) as management focuses on improving cashflows and lowering leverage. Outlicensing deals help limit innovation R&D spend. 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.

Glenmark

Lupin

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 Sun Pharma Focus on improving profitability in Western Europe, even at the cost of top-line growth. Divested innovation R&D venture into a separate company, SPARC. Management has been historically conservative and shied away from aggressive inorganic growth strategy.

Source: Company data, Nomura research

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.

Nomura

58

4 January 2010

Strategy | India

Saion Mukherjee

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
(US$ bn) 30 28 26 24 22 20 18 16 14 12 10 2008
Source: Glenmark

Patent expiries by value

2009

2010

2011

2012

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.

Nomura

59

4 January 2010

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.

BULLISH
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.

Stock Unitech (UT IN) Indiabulls Real Estate (IBREL IN) DLF Ltd (DLFU IN)

Rating BUY BUY REDUCE

Price (INR) 82 216.5 371

Price target (INR) 112 339 330

Prices as of 24 December 2009

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 highpriced/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.

Analyst
Aatash Shah +91 22 4037 4194 aatash.shah@nomura.com

Exhibit 84. Mumbai: good upturn in residential property transactions
(mn sqft) 9 8 7 6 5 4 3 2 1 0 May-08 May-09 Mar-08 Nov-07 Nov-08 Mar-09 Sep-08 Sep-07 Sep-09
60

Mumbai

(mn sqft) 98 92 86 80 74 68 62 56 50 44 Jan-09

Jan-08

Jul-07

Total absorption (LHS)
Source: Propequity, Nomura research

Jul-08

Unsold stock (RHS)

Nomura

Jul-09

4 January 2010

Strategy | India

Aatash Shah

Exhibit 85. Bangalore: poor recovery in residential property transactions
(mn sqft) 8 7 6 5 4 3 2 1 0 May-08 May-09 Mar-08 Nov-07 Nov-08 Mar-09 Sep-08 Jan-09 Sep-07 Jan-08 Jul-07 Jul-08 Jul-09 Bangalore (mn sqft) 84 80 76 72 68 64 60 56 52 48 44 40 Sep-09
61

Total absorption (LHS)
Source: Propequity, Nomura research

Unsold stock (RHS)

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.

Nomura

4 January 2010

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
Stock

NEUTRAL
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.

Rating Neutral Reduce

Price (INR) 321 175

Price target (INR) 330 154

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

Bharti RCOM

Prices as of 24 December 2009

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.

Analysts
Sachin Gupta, CFA +65 6433 6968 sachin.gupta@nomura.com B. Roshan Raj +65 6433 6961 broshan.raj@nomura.com Neeraja Natarajan (Associate) +91 22 6723 5231 neeraja.natarajan@nomura.com

Sector valuations
Stock Bharti RCOM Market cap (INRbn) 1,224 361 P/E (x) 15.3 13.5 EV/EBITDA (x) 8.6 7.1

Based on closing price on 8th December

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.

Source: Bloomberg, Nomura

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.

Nomura

62

4 January 2010

Strategy | India

Sachin Gupta, CFA

Exhibit 86. Bharti, RCOM — revenue outlook
Bharti (INRmn) 500,000 400,000 300,000 200,000 100,000 0 2006 2007 2008 2009 2010 2011 2012 Bharti y-y chg % RCOM RCOM y-y chg % (%) 70 60 50 40 30 20 10 0

Exhibit 87. Bharti, RCOM — margin outlook
(%) 45 40 35 30 25 20 2006 2007 2008 2009 2010 2011 2012 Bharti RCOM

Source: TRAI, Nomura research

Source: TRAI, Nomura research

Exhibit 88. India — subscriber and wireless revenue trends
(mn) 500 400 300 200 100 0 Mar-08 Mar-09 Dec-07 Dec-08 Sep-08 Sep-09 Jun-08 Jun-09 Subscribers (LHS) q-q change (RHS) (%) 14 12 10 8 6 4 2 0 (INRbn) 300 250 200 150 100 50 0
Mar-08 Mar-09 Sep-08 Dec-07 Dec-08 Sep-09
RCOM Vodafone Mar-09 Sep-09 Jun-09

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

(%) 12 10 8 6 4 2 0 (2) (4)

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

Exhibit 89. India — subscriber share, pricing and usage trends
HFCL 0.1% Tata Teleservices 10.0%
(INR) Bharti Idea RCOM Vodafone

Jun-08

Shyam 0.4% Reliance 18.5% BSNL 11.5% BPL 0.5% MTNL 0.9%

Vodafone 17.8%

450 400 350 300

(mins) 600 550 500 450 400 350 300

Bharti Idea

Bharti 23.7%

250 200 Mar-08 Sep-07 Dec-07 Sep-08 Dec-08 Mar-09 Jun-08 Jun-09 Sep-09

Sep-07

Dec-07

Mar-08

Aircel Idea 5.5% 11.0%

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

Nomura

63

4 January 2010

Dec-08

Sep-08

Jun-08

Jun-09

Strategy | India

Amar Kedia

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 macroeconomy 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.

BULLISH
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 bestcase scenario is already factored in.
Price target (INR) 615 47

Stock Mundra Port & SEZ (MSEZ IN) GMR Infrastructure (GMRI IN)

Rating BUY REDUCE

Price (INR) 560.50 67.15

Prices as of 24 December 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.

Analyst
Amar Kedia +91 22 4037 4182 amar.kedia@nomura.com

Recommendation summary
Stock Container Corp of India (CCRI IN) Mundra Port & SEZ (MSEZ IN) GMR Infrastructure (GMRI IN) GVK Power & Infrastructure (GVKP IN) Price as of 24 Dec Source: Nomura Price (INR) 1270.00 560.50 67.15 47.60 Target price (INR) Rating

1,300 NEUTRAL 615 47 24.3 BUY REDUCE REDUCE

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).

Nomura

64

4 January 2010

Strategy | India

Amar Kedia

Exhibit 90. Visible uptrend in industrial activity…

Exhibit 91. …leads to expectation of revival in air traffic
(mn pax) 30 25
2

(% y-y) 16 IIP (3mma) (LHS) OECD CLI for India (6-month lead) 12

(% m-m)

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

DEL (LHS) (% y-y) HYD (RHS) 50 BOM (RHS) 40 30 20

1

20
8 0

15 10 10 0 (10) (20) FY04 FY05 FY06 FY07 FY08 FY09F FY10F

4

(1)

5
0 Mar-96 (2) Mar-10

0

Jul-98

Nov-00

Mar-03

Jul-05

Nov-07

Source: OECD, CEIC and Nomura Global Economics

Source: Airports Authority of India, Nomura estimates

Exhibit 92. Both US and Euro zone PMI on the rise
60 55 50 45 40 35 30 May-08 May-09 Mar-08 Nov-08 Mar-09 Sep-08 Sep-09 Nov-09 Jan-08 Jan-09 Jul-08 Jul-09 US PMI Euro zone PMI

Exhibit 93. Port traffic has historically mirrored IIP
(%) 30 25 20 15 10 5 0 (5) (10) (15) Jul-02 Jan-03 Total commodity traffic at major ports ex oil (%) 18 IIP (RHS) 16 14 12 10 8 6 4 2 0 (2) Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jul-09

Source: Bloomberg

Source: Business Beacon, Nomura research

Exhibit 94. Container traffic at ports already rising…

Exhibit 95. …led by rising imports; exports to follow (indexed to 1)
1.1 1.0 0.9 0.8 0.7 0.6 0.5 May-09 Aug-08 Sep-08 Nov-08 Mar-09 Jan-09 Feb-09 Jun-09 Jul-08 Oct-08 Apr-09 Aug-09 Sep-09 Jul-09 Dec-08 Oct-09 Monthly Exports Monthly Non-oil Imports CRB Index

('000 TEUs) 800 700 600 500 400 300 200 100 0 May-08

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

(% y-y) 10 5 0 (5) (10) (15) (20) (25)

May-09

Mar-08

Nov-07

Nov-08

Mar-09

Sep-07

Sep-08

Source: IPA, Nomura research

Sep-09

Nov-09

Jan-08

Jan-09

Jul-08

Jul-09

Source: Bloomberg, Nomura research

Nomura

65

4 January 2010

Mahindra and Mahindra M M I N
AU TO S | I N D I A

Maintained
+91 22 4037 4199 kapil.singh@nomura.com +91 22 4037 4180 prabhat.awasthi@nomura.com
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Kapil Singh Prabhat Awasthi

BUY
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY11F net profit (INRmn) Difference from consensus
Source: Nomura

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.

INR1,061.85

INR1,232
(set on 30 Oct 09)

16.0% 10.5% 21,044 12.1%

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.

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 runrate (SAAR), ahead of our estimate of 15.6%.

Key financials & valuations
31 Dec (INR mn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Compa ny, Nomura e stimate s

FY08 FY09F FY10F FY11F
115,914 131,860 157,196 187,930 11,038 7,869 18,523 21,040 9,386 8,265 17,829 21,040 40.45 28.84 67.87 77.10 34.39 30.29 65.33 77.10 35.8 40.7 18.9 16.0 21.6 26.6 12.4 10.3 6.0 5.6 4.2 3.5 (1.2) (1.0) (1.8) (2.1) 27.9 16.4 29.6 26.3 39.7 47.1 26.6 21.1 8,265 28.84 17,829 67.87 21,040 77.10

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.

Share price relative to MSCI India
(Rs) 1,170 970 770 570 370 170 Jan09 Mar09 May09 Sep09 Dec08 Nov09 3m 23.4 26.9 17.9 6m 47.0 52.9 23.4 6,387 67 1,080/255.8 28.28 Hard 33.27 17.52 Jun09 Apr09 Feb09 Aug09 Oct09 Jul09
Price Rel MSCI India

220 200 180 160 140 120 100 80

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

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) M&M Group LIC
Source: Compa ny, Nomura e stimate s

1m (0.5) (1.1) (2.3)

Nomura

66

4 January 2010

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
(%) 70 60 50 40 30 20 10 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10-ytd 22.4 22.1 48.5 46.6 44.3 48.5 41.3 43.4 GM Toyota MM TTMT

58.3

20.0

20.0

20.8

19.8 12.8

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

Exhibit 97. MM: tractor SAAR
(Nos) 250,000 200,000 150,000

Exhibit 98. MM: UV + LCV SAAR
(Nos) 300,000 250,000 200,000 150,000

100,000 100,000 50,000 0 50,000 Nov-07 Nov-08 Nov-09 Mar-08 Mar-09 Jan-08 Jan-09 Oct-07 Oct-08 Oct-09 Apr-08 Apr-09 Jul-07 Jul-08 Jul-09 Jul-07 Jul-08 Jul-09 0

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

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

Nomura

67

4 January 2010

Mahindra and Mahindra

Kapil Singh

Financial statements
Income statement (INR mn) Y ear-end 31 Dec Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price targe Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (W)
Source: Nomura estimates

FY08 115,914 (79,648) 36,266 (15,882) (8,525) 11,860 14,248 (2,389) 11,860 (242) 803 12,420 (3,034) 9,386 9,386 1,652 11,038 3,211 14,249

FY 09F 131,860 (95,657) 36,202 (17,022) (10,246) 8,934 11,849 (2,915) 8,934 (453) 1,780 10,262 (1,997) 8,265 8,265 (396) 7,869 3,121 10,990

FY10F 157,196 (104,139) 53,057 (20,243) (11,783) 21,031 24,984 (3,954) 21,031 (194) 2,903 23,740 (5,906) 17,835 17,835 694 18,529 5,559 24,087

FY 11F 187,930 (125,350) 62,580 (24,012) (13,668) 24,900 29,908 (5,008) 24,900 (335) 3,320 27,886 (6,842) 21,044 21,044 21,044 6,313 27,357

Robust revenue growth of around 20% in FY11F

31.0 35.8 26.3 (1.2) 18.7 6.0 21.6 26.0 31.3 12.3 10.2 9.5 24.4 (29.1) 6.0 2.9 27.9 15.0

35.2 40.7 36.9 (1.0) 15.5 5.6 26.6 35.3 27.5 9.0 6.8 6.0 19.5 (39.7) 10.1 4.6 16.4 8.2

16.3 18.9 15.7 (1.8) 11.0 4.2 12.4 14.7 33.8 15.9 13.4 11.8 24.9 (30.0) 8.9 3.5 29.6 15.4

13.8 16.0 13.8 (2.1) 9.9 3.5 10.3 12.4 33.3 15.9 13.2 11.2 24.5 (30.0) 7.4 2.8 26.3 15.6

15.1 10.7 10.1 (1.3) (1.3)

13.8 (16.8) (24.7) (11.9) (11.9)

19.2 110.9 135.4 115.8 115.8

19.6 19.7 18.4 18.0 18.0

40.4 34.4 34.4 179.0 (13.2)

28.8 30.3 30.3 188.5 (11.2)

67.9 65.4 65.4 251.6 (19.3)

77.1 77.1 77.1 302.6 (21.9)

Nomura

68

4 January 2010

Mahindra and Mahindra

Kapil Singh

Cashflow (INR mn) Year-end 31 Dec EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 14,248 2,133 (822) 15,560 (6,923) 8,637 (19,776) (11,139) (3,211) 285 9,511 6,585 (4,554) 13,261 8,706 17,258

FY09F 11,849 8,524 (1,675) 18,698 (13,380) 5,318 (15,714) (10,396) (3,121) 361 20,461 17,701 7,306 8,612 15,918 24,783

FY10F 24,984 3,924 (2,575) 26,333 (14,000) 12,333 (8,333) 4,000 (5,559) 7,000 (9,082) (7,640) (3,640) 15,744 12,104 19,269

FY11F 29,908 3,454 (3,856) 29,505 (14,000) 15,505 (8,333) 7,172 (6,313) 1,569 (4,744) 2,427 12,177 14,604 18,411

Solid free cashflow growth

Balance sheet (INR mn) As at 31 Dec Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

FY08 8,612 10,049 10,841 7,052 36,554 42,151 23,609 (432) 101,881 22,871 9,639 32,510 25,871 58,381 2,431 41,070 43,501 101,881

FY09F 15,744 10,437 10,607 13,842 50,629 57,864 32,143 489 141,126 34,431 13,547 47,978 40,528 88,505 2,792 49,829 52,621 141,126

FY10F 12,177 12,493 14,098 11,957 50,726 66,197 42,190 489 159,602 32,511 23,054 55,565 31,446 87,011 2,886 69,705 72,590 159,601

FY11F 14,604 14,984 16,851 13,535 59,973 74,531 51,182 489 186,175 38,992 26,846 65,839 33,014 98,853 2,886 84,435 87,321 186,174

1.12 48.93

1.06 19.74

0.91 108.68

0.91 74.40

1.2 39.7

2.1 47.1

0.8 26.5

0.6 21.1

26.9 45.1 97.0 (25.0)

28.4 40.9 109.3 (40.1)

26.6 43.3 117.3 (47.4)

26.7 45.1 104.1 (32.4)

Nomura

69

4 January 2010

Tata Motors T T M T I N
AU TO S | I N D I A

Maintained +91 22 4037 4199 kapil.singh@nomura.com +91 22 4037 4180 prabhat.awasthi@nomura.com
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Kapil Singh Prabhat Awasthi

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.

Closing price on 24 Dec Price target Upside/downside Difference from consensus FY11F net profit (INRmn) Difference from consensus
Source: Nomura

INR779.95

INR419
(set on 30 Nov 09)

-39.2% -30.3% 25,082 54.8%

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

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.

Key financials & valu ations
31 Dec (INR mn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Co mpany, Nomura esti mates

FY 08 FY09F FY10F FY 11F
283,622 254,712 326,164 399,722 20,289 10,013 25,082 29,016 15,216 4,094 25,082 29,016 47.43 19.48 46.11 53.35 35.57 7.96 46.11 53.35 11.8 52.6 9.1 7.9 17.4 36.0 14.3 10.9 3.8 3.3 2.7 2.4 2.2 27.6 49.5 0.9 10.0 98.3 4,094 na 19.48 2.0 18.0 110.4 25,082 na 46.11 2.4 17.5 91.0 29,016 na 53.35

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.

Share price relative to MSCI India
(Rs) 865 765 665 565 465 365 265 165 65 J an09 Feb09 Dec08 Mar09
Pri ce R el MSC I Indi a

310 260 210 160 110 60

May09

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.

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Tata Sons LIC
Source: Co mpany, Nomura esti mates

1m 20.0 19.3 18.0

Nov09 3m 29.1 32.7 23.7

Aug09

Sep09

Oct09

Jun09

Apr09

Jul09

High R&D requirements to cut emissions; cashflow concerns

6m 118.3 127.0 97.5 8,018 40

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.

780/ 130.8 70.8 Hard 27.13 11.50

Nomura

70

4 January 2010

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 TTMT AL MSIL MM
Source: Companies, Nomura research

FY05 1.0 1.2 0.3 0.2

FY06 1.7 0.9 0.2 0.1

FY07 2.3 1.1 0.1 0.3

FY08 3.7 1.2 0.1 0.3

FY09 5.6 2.5 0.1 2.2

Exhibit 100. JD Power Initial Quality Study (IQS) rankings
2008 JD Power Survey Lexus Porsche Mercedes Benz Jaguar Land Rover Industry average
Source: JD Power, Nomura Research

2009 Rank (/ 37) 3 1 4 9 35 NA Defects/100 84 90 101 134 150 108 Rank (/ 38) 1 2 6 29 36 NA

Defects/100 99 87 104 112 161 118

Exhibit 101. JLR volumes in Europe
(Numbers) 25,000 20,000 15,000 10,000 5,000 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2007 2008 2009

Source: Auto data, Nomura research

Nomura

71

4 January 2010

Tata Motors

Kapil Singh

Financial statements
Income statement (INR mn) Year-end 31 Dec Revenue Cost of goods sold Gross profit S G&A E mployee share expense Operating profit E BITDA Depreciation A mortisation E BIT Net interest expense A ssociates & JCEs Other income E arnings before tax Income tax Net profit after tax Minority interests Other items P referred dividends Normalised NPAT E xtraordinary items Reported NPAT Dividends Transfer to reserves V aluation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yi eld (%) P ri ce/cashflow (x) P ri ce/book (x) E V/EBITDA (x) E V/EBIT (x) Gross margin (% ) E BITDA margin (%) E BIT margin (%) Net margin (%) E ffective tax rate (% ) Dividend payou t (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue E BITDA E BIT Normalised EPS Normalised FDEPS P er share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) B ook value per share (INR) DPS (W)
Source: Nomura estimates

FY08 283,622 (208,755) 74,867 (39,351) (15,446) 20,071 26,594 (6,523) 20,071 (2,824) 3,444 20,691 (5,476) 15,216 15,216 5,073 20,289 (6,597) 13,692

FY09F 254,712 (194,506) 60,207 (38,321) (15,514) 6,372 15,117 (8,745) 6,372 (6,737) 4,585 4,219 (125) 4,094 4,094 5,918 10,013 (3,457) 6,556

FY10F 326,164 (226,859) 99,305 (50,025) (17,743) 31,537 41,841 (10,304) 31,537 (9,907) 8,255 29,885 (4,804) 25,082 25,082 25,082 (8,660) 16,422

FY11F 399,722 (280,664) 119,058 (57,524) (19,773) 41,761 53,766 (12,004) 41,761 (9,214) 1,391 33,938 (4,923) 29,016 29,016 29,016 (10,018) 18,997

21.9 11.8 16.4 2.2 4.4 3.8 17.4 23.1 26.4 9.4 7.1 7.2 26.5 32.5 16.2 7.1 27.6 9.7

97.9 52.6 40.0 0.9 29.0 3.3 36.0 85.4 23.6 5.9 2.5 3.9 3.0 34.5 19.5 5.7 10.0 2.1

16.9 9.1 16.9 2.0 10.1 2.7 14.3 18.9 30.4 12.8 9.7 7.7 16.1 34.5 8.0 2.5 18.0 7.6

14.6 7.9 14.6 2.4 8.7 2.4 10.9 14.0 29.8 13.5 10.4 7.3 14.5 34.5 6.4 2.1 17.5 8.7

Substantial slowdown in EPS growth in FY11F

3.0 (8.2) (13.1) (13.4) (13.4)

(10.2) (43.2) (68.3) (77.6) (77.6)

28.1 176.8 395.0 479.0 479.0

22.6 28.5 32.4 15.7 15.7

47.4 35.6 35.6 203.3 17.1

19.5 8.0 8.0 237.9 6.7

46.1 46.1 46.1 287.0 15.9

53.3 53.3 53.3 322.0 18.4

Nomura

72

4 January 2010

Tata Motors

Kapil Singh

Cashflow (INR m n) Year-end 31 Dec E BITDA Change in working capital Other operating cashflow Cashflow from operations Capital expendi ture Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets A ddition in other LT liabilities A djustments Cashflow after investing acts Cash dividends E quity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow B eginning cash E nding cash E nding net debt
Source: Nomura estimates

FY08 26,594 48,163 219 74,976 (46,067) 28,909 (24,333) 40 40 4,657 (6,597) (3,995) 21,681 11,089 15,746 8,268 24,013 38,832

FY09F 15,117 (4,944) 3,641 13,814 (49,634) (35,821) (80,579) 1,682 40 (114,677) (3,457) 39,580 67,680 103,804 (10,873) 23,973 13,100 120,237

FY10F 41,841 6,423 (6,455) 41,810 (25,943) 15,866 (76,804) 40 (60,897) (8,660) 17,402 55,080 63,822 2,925 11,418 14,343 172,433

FY11F 53,766 7,521 (12,746) 48,541 (25,537) 23,004 23,004 (10,018) (10,501) (20,519) 2,485 14,303 16,788 159,447

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

Bala nce sheet (INR mn) As at 31 Dec Cash & equivalents Marketable securities A ccounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets S hort-term debt A ccounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest P referred stock Common stock Reta ined earnings P rop osed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

FY08 23,973 11,149 24,218 44,498 103,838 49,103 104,523 257,463 83,917 32,407 116,324 62,805 (61) 179,068 3,855 74,540 78,395 257,463

FY09F 11,418 15,499 22,298 47,701 96,917 129,681 145,993 372,591 87,313 29,701 117,013 131,656 1,621 250,290 5,141 117,161 122,302 372,591

FY10F 14,303 15,620 25,636 59,737 115,296 206,485 161,632 483,413 105,398 33,533 138,931 186,736 1,621 327,288 5,439 150,686 156,125 483,413

FY11F 16,788 18,334 29,433 66,056 130,612 206,485 175,165 512,262 122,574 36,709 159,283 176,235 1,621 337,139 5,439 169,684 175,123 512,262

0.89 7.11

0.83 0.95

0.83 3.18

0.82 4.53

1.5 49.5

8.0 98.3

4.1 110.4

3.0 91.0

11.9 43.2 123.6 (68.6)

19.1 43.6 160.7 (97.9)

17.4 38.6 155.0 (99.1)

15.5 35.8 148.2 (96.9)

Nomura

73

4 January 2010

State Bank of India S B I N I N
B AN K S | I N D I A

Maintained
+91 22 4037 4157 +91 22 4037 4361 mahrukh.adajania@nomura.com sreekanth.akula@nomura.com
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Mahrukh Adajania Sreekanth Akula (Associate)

BUY
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY10F net profit (INRmn) Difference from consensus
Source: Nomura Note: Price target under review

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.

INR2,215

INR2,590
(set on 8 Oct 09)

10.9% 16.9% 100,403 1.3%

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 noninterest income.

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.

Key financials & valu ations
31 Mar (INRmn)
PPOP Reported net profit Normalised net profit Normalised EPS (Rs) Norm. EPS growth (%) Norm. P/E (x) Price/adj. book (x) Price/book (x) Dividend yield (%) ROE (%) ROA (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Co mpany, Nomura esti mates

FY 08 FY09F FY10F FY 11F
131,076 179,152 196,437 240,312 67,291 91,212 100,403 118,156 67,291 91,212 100,403 118,156 106.5 143.7 158.1 186.1 53.0 34.8 10.1 17.7 20.2 15.0 13.6 11.6 2.8 2.4 2.1 1.8 2.8 2.4 2.1 1.8 1.0 16.7 1.0 1.3 17.0 1.1 0.8 16.3 0.9 0.8 16.9 0.9

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.

91,212 100,403 118,156 143.70 158.10 186.10

Share price relative to MSCI India
(Rs ) 2,730 2,230 1,730 1,230 Mar09 Apr09 May 09 F eb09 J un09 Nov09 730 Jan09 Dec 08 Aug09 Sep09 O ct09 Jul09
P ri ce R e l M SC I In di a

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 highcost 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.

105 100 95 90 85 80 75 70

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.

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Govt of India
Source: Co mpany, Nomura esti mates

1m (3.8) (4.3) (5.5)

3m 2.4 5.3 (3.8)

6m 29.3 34.4 4.9 30,195 30.4

2,471/895 155.5 Easy 59.3

Nomura

74

4 January 2010

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 9M FY07 FY07 1Q FY08 1H FY08 9M FY08 FY08 1Q FY09 1H FY09 9M FY09 FY09 1Q FY10 2Q FY10
Source: Company data

Continued NIM improvement
NIM (%) 3.32 3.09 3.27 3.01 3.01 3.07 3.03 3.16 3.15 2.93 2.30 2.50

Exhibit 103. Home loan disbursements
(INRmn) ICICI Bank + ICICI Home Finance HDFC SBI Axis Bank HDFC Bank LIC Housing Finance 1Q FY10 11,000 86,800 48,000 9,200 12,000 24,300 FY09 102,000 396,500 138,400 NA NA 87,620 FY08 185,000 328,750 116,700 NA NA 70,715

Note: Disbursements for HDFC and LIC include developer loans Source: Company data

Nomura

75

4 January 2010

State Bank of India

Mahrukh Adajania

Financial statements
Profit and Loss (INRmn) Y ear-end 31st March Interest income Interest expense Net interest income Net fees and commissions Trading related profits Other operating revenue Non-interest income Operating income Depreciation Operating expenses Employee share expense Op. profit before provisions Provisions for bad debt Other provision charges Operating profit Amortisation Other non-operating income Associates & JCEs Pre-tax profit Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/book (x) Price/adjusted book (x) Net interest margin (%) Yield on interest earning assets (%) Cost of interest bearing liabilities (%) Net interest spread (%) Non-interest/operating income (%) Cost to income (%) Effective tax rate (%) Dividend payout (%) ROE (%) ROA (%) Operating ROE (%) Operating ROA (%) Growth (%) Net interest income Non-interest income Non-interest expenses Pre-provision earnings Net profit Normalised EPS Normalised FDEPS
Source: Nomura estimates

FY07 372,421 (230,580) 141,842 48,045 5,678 13,918 67,641 209,483 na (118,235) na 91,248 (14,295) (9,255) 67,697 na na na 67,697 (31,036) 36,661 na na na 36,661 na 36,661 (8,620) 28,041

FY08 489,503 (319,291) 170,212 59,143 16,498 11,308 86,949 257,162 na (126,086) na 131,076 (20,009) (4,490) 106,576 na na na 106,576 (39,285) 67,291 na na na 67,291 na 67,291 (15,235) 52,056

FY 09 637,884 (429,153) 208,731 76,172 25,673 25,063 126,908 335,639 na (156,487) na 179,152 (24,750) (2,045) 152,357 na na na 152,357 (61,145) 91,212 na na na 91,212 na 91,212 (20,892) 70,320

FY 10F 750,320 (515,046) 235,274 89,883 20,000 30,612 140,495 375,769 na (179,332) na 196,437 (52,080) 6,729 151,086 na na na 151,086 (50,683) 100,403 na na na 100,403 na 100,403 (20,892) 79,511

FY11F 884,345 (591,494) 292,851 103,366 10,000 33,118 146,484 439,335 na (199,023) na 240,312 (56,149) (5,770) 178,393 na na na 178,393 (60,237) 118,156 na na na 118,156 na 118,156 (20,892) 97,264

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

30.9 37.2 30.9 0.7 3.6 3.6 2.83 7.43 5.08 2.35 32.3 56.4 45.8 23.5 12.4 0.69 23.0 1.28

20.2 24.3 20.2 1.0 2.8 2.8 2.82 8.11 5.80 2.32 33.8 49.0 36.9 22.6 16.7 1.04 26.5 1.65

15.0 18.0 15.0 1.3 2.4 2.4 2.63 8.03 5.97 2.05 37.8 46.6 40.1 22.9 17.0 1.08 28.5 1.81

13.6 16.4 13.6 0.8 2.1 2.1 2.29 7.32 5.66 1.66 37.4 47.7 33.5 20.8 16.3 0.93 24.5 1.41

11.6 13.9 11.6 0.8 1.8 1.8 2.41 7.29 5.55 1.74 33.3 45.3 33.8 17.7 16.9 0.93 25.5 1.40

(9.0) (9.0) 0.8 (19.2) (16.8) (16.8) (16.8)

20.0 28.5 6.6 43.6 83.5 53.0 53.0

22.6 46.0 24.1 36.7 35.5 34.8 34.8

12.7 10.7 14.6 9.6 10.1 10.1 10.1

24.5 4.3 11.0 22.3 17.7 17.7 17.7

Nomura

76

4 January 2010

State Bank of India

Mahrukh Adajania

Balance Sheet (INRmn) As at 31st March Cash and equivalents Inter-bank lending Deposits with central bank Total securities Other interest earning assets Gross loans Less provisions Net loans Long-term investments Fixed assets Goodwill Other intangible assets Other non IEAs Total assets Customer deposits Bank deposits, CDs, debentures Other interest bearing liabilities Total interest bearing liabilities Non interest bearing liabilities Total liabilities Minority interest Common stock Preferred stock Retained earnings Proposed dividends Other equity Shareholders' equity Total liabilities and equity Non-performing assets (INRmn) Balance sheet ratios (%) Loans to deposits Equity to assets Asset quality & capital NPAs/gross loans (%) Bad debt charge/gross loans (%) Loss reserves/assets (%) Loss reserves/NPAs (%) Tier 1 capital ratio (%) Total capital ratio (%) Growth (%) Loan growth Interest earning assets Interest bearing liabilities Asset growth Deposit growth Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) DPS (INR) PPOP PS (INR) BVPS (INR) ABVPS (INR) NTAPS (INR)
Source: Nomura estimates

FY07 25,301 52,433 265,463 na 1,667,975 3,420,770 (47,405) 3,373,365 na 28,189 na na 252,923 5,665,649 4,355,211 58,198 500,531 4,913,939 438,728 5,352,667 na 5,263 na 307,723 na na 312,983 5,665,649 99,982

FY08 32,203 57,150 483,143 na 1,997,442 4,221,812 (54,130) 4,167,682 na 33,735 na na 444,170 7,215,525 5,374,039 128,025 602,142 6,104,207 620,730 6,724,937 na 6,316 na 484,012 na na 490,588 7,215,525 128,373

FY09 42,955 265,987 512,507 na 2,982,129 5,485,398 (60,366) 5,425,032 na 38,378 na na 377,333 9,644,321 7,420,731 36,783 803,798 8,261,312 803,532 9,064,844 na 6,349 na 573,128 na na 579,477 9,644,321 155,886

FY10F 54,320 362,132 555,430 na 3,895,688 6,577,295 (67,256) 6,510,038 na 44,135 na na 433,933 11,855,675 9,053,292 66,000 833,788 9,953,081 1,250,538 11,203,618 na 6,349 na 645,708 na na 652,057 11,855,675 215,561

FY11F 62,468 416,451 633,650 na 4,397,136 7,559,623 (73,079) 7,486,544 na 50,756 na na 499,023 13,546,028 10,411,286 66,000 867,167 11,344,453 1,454,808 12,799,261 na 6,349 na 740,418 na na 746,767 13,546,028 248,112

78.5 5.5

78.6 6.8

73.9 6.0

72.7 5.5

72.6 5.5

Balance sheet growth to pick up in FY11F

2.9 0.42 0.84 47.4 7.9 13.2

3.0 0.47 0.75 42.2 9.3 14.0

2.8 0.45 0.63 38.7 9.3 14.8

3.3 0.79 0.57 31.2 8.9 14.1

3.3 0.74 0.54 29.5 8.7 13.5

28.9 14.8 18.2 14.7 14.6

23.5 25.1 24.2 27.4 23.4

30.2 37.0 35.3 33.7 38.1

20.0 23.3 20.5 22.9 22.0

15.0 14.2 14.0 14.3 15.0

69.7 69.7 69.7 16.0 173.4 594.7 594.7 594.7

106.5 106.5 106.5 21.5 207.5 776.4 776.4 776.4

143.7 143.7 143.7 29.0 282.2 912.7 912.7 912.7

158.1 158.1 158.1 18.0 309.4 1,027.1 1,027.1 1,027.1

186.1 186.1 186.1 18.0 378.5 1,176.2 1,176.2 1,176.2

Nomura

77

4 January 2010

Ambuja Cements A C E M I N
B U I L D I N G M ATE R I AL S | I N D I A

Maintained
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Jamil Ansari

+91 22 4037 4192 jamil.ansari@nomura.com 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.

Closing price on 24 Dec Price target Upside/downside Difference from consensus FY09F net profit (INRmn) Difference from consensus
Source: Nomura

INR99.45

INR67
(set on 10 Jul 09)

-32.6% -25.0% 11,183 -11.0%

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.

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.

Key financials & valu ations
31 Dec (INRmn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Co mpany, Nomura esti mates

FY 08 FY09F FY10F FY 11F
62,347 14,023 10,939 7.2 11.2 13.8 7.5 2.7 2.2 21.2 (9.9) 68,400 11,183 11,183 7.3 2.2 13.5 7.2 2.4 2.2 18.5 (4.4) 11,183 7.3 70,400 9,264 9,264 6.1 (17.2) 16.3 8.2 2.2 2.2 13.9 (0.0) 9,264 6.1 na na na na na na na na na na na na na

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.

Share price relative to MSCI India
Pri ce

118 108 98 88 78 68 58 J an09

R el MSC I India

120 110 100 90 80 70 60

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.

May09

Dec08

Looks expensive relative to sector peers
Currently trading at an EV/tonne of US$140, Ambuja appears to be one of the most expensive cement stocks in India.
Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Holcim
Source: Co mpany, Nomura esti mates

1m 10.3 9.7 8.4

Nov09 3m 1.3 4.2 (4.9)

Aug09

Sep09

Feb09

Mar09

Oct09

Jun09

Apr09

Jul09

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-thanexpected demand growth could result in a strong pricing environment; 2) the stock could find support if parent Holcim goes for majority control.

6m 10.6 15.0 (14.5) 3,223 53.6

110.3/63.6 8.98 Hard 46.45

Nomura

78

4 January 2010

Ambuja Cements

Jamil Ansari

Financial statements
Income statement (INRmn) Year-end 31 Dec Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (INR)
Source: Nomura estimates

FY08 62,347 32,121 30,226 12,446 17,779 17,779 2,598 15,182 321 1,754 16,615 5,676 10,939 10,939 3,083 14,023

FY09F 68,400 35,072 33,328 14,317 19,012 19,012 3,067 15,945 657 1,555 16,843 5,659 11,183 11,183 11,183

FY10F 70,400 37,752 32,648 15,774 16,874 16,874 3,708 13,166 770 1,555 13,952 4,688 9,264 9,264 9,264

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

13.8 13.8 2.2 11.2 2.7 7.5 8.6 48.5 31.3 27.2 17.5 28.8 35.8

13.5 13.5 2.2 10.6 2.4 7.2 8.5 48.7 30.1 25.6 16.4 33.6 35.0

16.3 16.3 2.2 11.7 2.2 8.2 10.3 46.4 26.2 20.9 13.2 33.6 42.3

21.2 23.6

18.5 20.6

13.9 15.6

10.7 (12.7) (15.4) 11.2

9.7 5.3 3.3 2.2

2.9 (10.4) (15.9) (17.2)

9.2 7.2 7.2 37.2 2

7.3 7.3 7.3 42.0 2

6.1 6.1 6.1 45.5 2

Nomura

79

4 January 2010

Ambuja Cements

Jamil Ansari

Cashflow (INRmn) Year-end 31 Dec Pre-tax profit Depreciation Tax paid Chg in working capital Other operating activities Cash flow from operations (a) Capital expenditure Chg in investments Chg in associates Other investing activities Cash flow from investing (b) Free cash flow (a+b) Equity raised/(repaid) Chg in minorities Debt raised/(repaid) Dividend (incl. tax) Other financing activities Cash flow from financing (c) Net chg in cash (a+b+c) Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 19,698 2,598 (5,676) (2,464) 0 14,157 (17,263) 9,566 0 0 (7,698) 6,459 (0) 0 (418) (3,919) 0 (4,527) 1,932 6,508 8,518 (5,632)

FY09F 16,843 3,067 (5,659) (1,926) 0 12,324 (11,246) 0 0 0 (11,246) 1,078 0 0 6,918 (3,919) 0 2,483 3,561 8,518 12,595 (2,791)

FY10F 13,952 3,708 (4,688) 185 0 13,157 (12,000) 0 0 0 (12,000) 1,157 0 0 (2,500) (3,919) 0 (7,030) (5,873) 12,595 7,336 (31)

Balance sheet (INRmn) As at 31 Dec Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable
Source: Nomura estimates

FY08 8,518 0 2,246 9,398 234 20,396 3,324 51,400 0 0 2,999 78,118 10,032 4,706 14,738 2,887 0 (43) 17,582 0 0 3,045 53,680 0 3,811 60,536 78,118

FY09F 12,595 0 2,489 9,878 234 25,196 3,324 60,048 0 0 3,117 91,685 9,878 3,776 13,654 9,804 0 450 23,908 0 0 3,045 60,945 0 3,788 67,777 91,685

FY10F 7,336 0 2,697 10,705 234 20,972 3,324 68,981 0 0 3,420 96,697 10,705 4,472 15,178 7,304 0 1,093 23,575 0 0 3,045 66,289 0 3,788 73,122 96,697

2 53

3 27

2 19

Gearing is much more comfortable compared with earlier downcycles

(10)

(4)

(0)

13 55 82

13 53 73

14 56 73

Nomura

80

4 January 2010

Ambuja Cements

Jamil Ansari

This page has been intentionally left blank

Nomura

81

4 January 2010

ITC Limited I T C I N
CONSUMER | INDIA

Maintained
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Manish Jain

+91 22 4037 4186

manish.jain@nomura.com

BUY
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY10F net profit (INRmn) Difference from consensus
Source: Nomura

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.

INR256

INR309
(set on 28 Oct 09)

20.8% 7.0% 39,884 4.0%

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.

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.

Key financials & valuations
31 Mar (INRmn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Company, Nomura estimates

FY08

FY09 FY10F FY11F

147,877 164,655 178,186 207,881 31,578 33,246 39,884 47,962 30,255 32,411 39,884 47,962 8.38 8.81 10.57 12.71 10.5 7.0 23.1 20.3 31.9 29.8 24.2 20.1 19.1 17.3 14.3 11.8 7.8 6.8 6.0 5.4 1.4 1.4 1.9 2.7 26.1 24.4 26.4 28.3 na na na na 32,411 8.8 39,884 10.6 47,962 12.7

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.

Share price relative to MSCI India
(Rs) 280 260 240 220 200 180 160 140 Mar09 Jan09 Dec08 Feb09
Price Rel MSCI India

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

130 120 110 100 90 80 70 60 Aug09 Sep09 Nov09 3m 10.0 13.1 4.1 6m 28.7 33.9 4.4 20,789 67.0 268.9/158.4 24.78 Easy 13.59 11.84 Oct09

May09

Jun09

Apr09

Jul09

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.

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Life Insurance corp. of India Unit Trust of India
Source: Company, Nomura estimates

1m (3.0) (3.6) (4.8)

Nomura

82

4 January 2010

ITC Limited

Manish Jain

Financial statements
Income statement (INRmn) Y ear-end 31 Mar Revenue Cost of goods sold Gross profit SG&A Operating profit EBITDA Depreciation EBIT Net interest expense Other income Earnings before tax Income tax Net profit after tax Minority interests Normalised NPAT Extraordinary items Reported NPAT Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/book (x) EV/EBITDA (x) Gross margin (%) EBITDA margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) ROE (%) Growth (%) Revenue EBITDA Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (W)
Source: Nomura estimates

FY08 147,877 59,430 88,447 41,280 47,168 47,168 4,729 42,439 192 3,182 45,429 14,970 30,459 (204) 30,255 1,323 31,578

FY09 164,655 63,946 100,709 48,043 52,666 52,666 5,809 46,858 290 2,446 49,013 16,254 32,759 (348) 32,411 835 33,246

FY10F 178,186 62,892 115,294 52,569 62,725 62,725 6,516 56,209 196 3,515 59,529 19,644 39,884 39,884 39,884

FY11F 207,881 71,324 136,557 60,999 75,558 75,558 7,311 68,247 177 3,515 71,585 23,623 47,962 47,962 47,962

FY12F 236,259 79,229 157,030 68,824 88,206 88,206 7,974 80,233 177 3,215 83,271 27,479 55,791 55,791 55,791

Strong revenue growth aided by robust growth across all businesses

31.9 38.5 30.6 1.4 7.8 19.1 59.8 31.9 20.6 33.0 51.0 26.1

29.8 36.0 29.1 1.4 6.8 17.3 61.2 32.0 19.9 33.2 51.0 24.4

24.2 29.2 24.2 1.9 6.0 14.3 64.7 35.2 22.4 33.0 52.0 26.4

20.1 24.3 20.1 2.7 5.4 11.8 65.7 36.3 23.1 33.0 63.0 28.3

17.3 20.9 17.3 3.8 5.0 10.1 66.5 37.3 23.6 33.0 75.0 30.1

16.0 13.6 10.5 10.5

11.3 9.5 7.0 7.0

8.2 20.2 23.1 23.1

16.7 19.4 20.3 20.3

13.7 15.6 16.3 16.3

8 8 8 33 4

9 9 9 37 4

11 11 11 42 5

13 13 13 47 7

15 15 15 51 10

Nomura

83

4January 2010

ITC Limited

Manish Jain

Cashflow (INRmn) Year-end 31 Mar EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 47,168 (1,077) (10,657) 35,434 (23,051) 12,383 (1,020)

FY09 52,666 (2,888) (13,264) 36,514 (18,200) 18,315 1,008

FY10F 62,725 (1,852) (16,325) 44,548 (15,000) 29,548 -

FY11F 75,558 (3,906) (20,285) 51,367 (7,569) 43,798 -

FY12F 88,206 (3,909) (24,441) 59,856 (5,000) 54,856 -

Strong cashflow to sustain ambitious expansion plans

11,363 (15,568) 6 240 (148) (15,469) (4,107) 10,865 7,768 2,249

19,323 (16,452) 6 (383) (180) (17,009) 2,314 7,768 13,183 1,867

29,548 (20,640) (20,640) 8,908 13,183 22,091 1,867

43,798 (30,336) (30,336) 13,462 22,091 35,554 1,867

54,856 (41,704) 189 (304) (41,820) 13,036 35,554 48,705 1,867

Balance sheet (INRmn) As at 31 Mar Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets Fixed assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Total liabilities Minority interest Common stock Retained earnings Other equity and reserves Total shareholders' equity Total equity & liabilities
Source: Nomura estimates

FY08 7,768 26,079 1,577 42,683 21,312 99,419 78,193 177,611 2,249 29,708 16,213 48,170 48,170 1,132 3,769 119,105 5,436 129,442 177,611

FY09 13,183 25,071 2,326 47,943 21,669 110,192 91,258 201,450 1,867 32,147 17,252 51,266 51,266 1,300 3,774 136,504 8,606 150,184 201,450

FY10F 22,091 25,071 2,517 51,883 23,449 125,012 99,741 224,753 1,867 34,789 18,669 55,325 55,325 1,300 3,774 155,748 8,606 169,428 224,753

FY11F 35,554 25,071 2,937 60,371 27,357 151,289 99,999 251,288 1,867 40,587 21,781 64,234 64,234 1,300 3,774 173,374 8,606 187,054 251,288

FY12F 48,705 25,071 3,236 71,201 31,070 179,283 97,026 276,309 1,867 48,546 24,754 75,167 75,167 1,300 3,774 187,462 8,606 201,142 276,309

Nomura

84

4January 2010

ITC Limited

Manish Jain

This page has been intentionally left blank

Nomura

85

4January 2010

Nagarjuna Construction N J C C I N
E N G I N E E R I N G & C O N S TR U C TI O N | I N D I A

Maintained
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Saion Mukherjee

+91 22 4037 4184 saion.mukherjee@nomura.com

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.
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY10F net profit (INRmn) Difference from consensus
Source: Nomura

INR165.85

INR197
(set on 2 Oc t 09)

18.8% 7.6% 2,172 7.0%

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

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.

Key financials & valuations
31 Mar (INRmn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Company, Nomura estimates

FY08 FY09F FY10F FY11F
34,729 1,619 1,619 6.40 8.0 25.92 14.9 2.7 0.8 10.4 42.0 41,514 1,539 1,539 6.00 (6.2) 27.65 14.4 2.5 0.7 9.1 65.8 1,539 na 6.00 47,989 2,578 2,172 8.47 41.2 19.58 11.2 1.9 0.7 9.5 42.5 2,172 na 8.47 54,453 2,546 2,546 9.92 17.2 16.71 9.9 1.7 0.7 10.2 45.2 2,546 na 9.92

Exhibit 104. Orderbook - diversified across segments
(%) 100 % 80 Power % 60 % 40 % 20 % 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09
Source: Nomura estimates

International Metals Oil & gas

Share price relative to MSCI India
(Rs) 223 173 123
Price Rel MSCI India

150 130 110 90

Real estate
73

Irrigation & hydropower
23 May09 Dec08 Aug09 Sep09 Nov09 3m 14.1 17.3 8.2 Mar09 Jan09 Feb09 Jun09 Oct09 Apr09 Jul09

70 50

Electrical Water & environment Transportation Industrial structures & housing

1m (1.9) Absolute (INR) (2.4) Absolute (US$) (3.7) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) AVS Raju and related enitities Blackstone GPV Capital Partners Mauritius V Ltd HDFC Trustee Company Ltd A/c HSBC Global Investment Funds A/c
Source: Company, Nomura estimates

6m 32.9 38.3 8.8 912 79.5 177.7/37.10 7.41 Hard 20.50 8.33 6.05 6.00

Nomura

86

4 January 2010

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 10.2510.5%, 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

Nomura

87

4 January 2010

Nagarjuna Construction

Saion Mukherjee

Financial statements
Income statement (INRmn) Year-end 31 Mar Revenue Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (INR)
Source: Nomura estimates

FY08 34,729 3,171 3,598 (482) 3,116 (719) 56 2,452 (811) 1,641 (22) 1,619 1,619 (348) 1,271

FY09 41,514 3,245 3,737 (533) 3,204 (964) 42 2,282 (743) 1,539 1,539 1,539 (295) 1,244

FY10F 47,989 4,203 4,799 (626) 4,173 (982) 30 3,222 (1,049) 2,172 2,172 406 2,578 (295) 2,284

FY11F 54,453 4,764 5,445 (711) 4,734 (989) 30 3,776 (1,230) 2,546 2,546 2,546 (295) 2,251

FY12F 64,161 5,650 6,416 (797) 5,620 (1,172) 30 4,478 (1,458) 3,020 3,020 3,020 (295) 2,725

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

25.9 30.8 26.3 0.8 21.9 2.7 14.9 17.2 10.4 9.0 4.7 33.1 21.5 4.6 3.3 10.4 8.5

27.7 32.8 27.7 0.7 22.4 2.5 14.4 16.7 9.0 7.7 3.7 32.6 19.1 3.9 3.0 9.1 7.4

19.6 23.3 16.5 0.7 16.4 1.9 11.2 12.9 10.0 8.7 4.5 32.6 13.6 2.3 1.7 9.5 8.0

16.7 19.8 16.7 0.7 14.1 1.7 9.9 11.3 10.0 8.7 4.7 32.6 11.6 1.8 1.4 10.2 8.5

14.1 16.7 14.1 0.7 12.0 1.5 8.4 9.5 10.0 8.8 4.7 32.6 9.8 1.6 1.3 10.9 9.0

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

21.0 33.4 29.9 8.0 8.0

19.5 3.9 2.8 (6.2) (6.2)

15.6 28.4 30.3 41.2 41.2

13.5 13.5 13.4 17.2 17.2

17.8 17.8 18.7 18.6 18.6

6.31 6.40 6.40 61.3 1.3

6.00 6.00 6.00 65.7 1.1

10.05 8.47 8.47 88.9 1.1

9.92 9.92 9.92 97.7 1.1

11.77 11.77 11.77 108.3 1.1

Nomura

88

4 January 2010

Nagarjuna Construction

Saion Mukherjee

Cashflow (INRmn) Year-end 31 Mar EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 3,653 (4,292) (2,778) (3,416) (1,588) (5,004) (2,104) (0) (7,108) (228) 4,050 2,569 6,390 (718) 2,434 2,330 6,608

FY09 3,778 (4,485) (4,559) (5,266) (1,613) (6,879) (1,290) 1,538 0 (6,631) (348) 0 3,501 3,153 (3,478) 2,330 1,345 11,094

FY10F 4,829 (2,211) (2,714) (96) (1,082) (1,178) (1,210) (2,388) (295) 3,673 3,379 991 1,345 2,754 9,685

FY11F 5,475 (2,207) (2,597) 671 (1,000) (329) (1,000) (1,329) (295) (295) (1,623) 2,754 1,113 11,325

FY12F 6,446 (3,315) (3,920) (789) (1,000) (1,789) (1,000) (2,789) (295) 2,000 1,705 (1,084) 1,113 819 13,620

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

Balance sheet (INRmn) As at 31 Mar Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

FY08 2,330 1,898 8,677 5,493 11,888 30,286 3,750 5,339 1,898 41,274 1,750 6,025 10,419 18,194 7,188 167 25,549 460 15,208 54 15,723 41,274

FY09 1,345 2,223 10,260 7,495 12,291 33,615 5,180 4,873 2,223 45,891 3,575 6,357 10,051 19,983 8,864 188 29,035 458 16,398 16,855 45,891

FY10F 2,754 1,683 11,861 8,664 14,913 39,875 6,930 5,330 1,683 53,817 3,575 7,349 11,029 21,952 8,864 188 31,004 513 22,300 22,813 53,817

FY11F 1,113 1,683 13,458 9,832 16,717 42,803 7,930 5,619 1,683 58,034 3,575 8,338 12,005 23,918 8,864 188 32,970 513 24,551 25,064 58,034

FY12F 819 2,683 15,858 11,584 18,334 49,277 7,930 5,822 2,683 65,712 5,575 9,825 13,471 28,871 8,864 188 37,922 513 27,276 27,789 65,712

1.66 4.3

1.68 3.3

1.82 4.3

1.79 4.8

1.71 4.8

1.84 42.0

2.97 65.8

2.02 42.5

2.08 45.2

2.12 49.0

91.2 57.7 63.3 79.3

90.2 65.9 55.9 104.9

90.2 65.9 55.9 116.2

90.2 65.9 55.9 117.2

90.2 65.9 55.9 115.2

Nomura

89

4 January 2010

HCL Technologies H C L T I N
S O F TW AR E & I T S E R V I C E S | I N D I A

Maintained hagandhi@nomura.com pinku.pappan@nomura.com
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Harmendra Gandhi Pinku Pappan (Associate)

+91 22 4037 4181 +91 22 4037 4360

BUY
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY11F net profit (INRmn) Difference from consensus
Source: Nomura Note: price target under review

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.

INR375

INR397
(set on 28 O ct 2009)

5.8% 19.2% 18,955 14.5%

Nomura vs consensus
Our forecasts are above consensus, since we expect HCL Tech’s top line growth to be better than its peers’.

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.

Key financials & valuations
30 Jun (INRmn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Company, Nomura estimates

FY08 FY09F FY10F FY11F
74,772 106,311 122,354 138,037 11,136 12,784 12,973 18,955 11,136 12,784 12,973 18,955 16.7 19.1 19.4 28.3 (20.3) 14.4 1.5 46.1 22.5 19.6 19.4 13.3 15.0 11.8 10.1 8.9 4.8 4.4 3.7 3.0 2.5 2.8 1.2 1.2 21.8 23.5 20.8 25.0 net cash 45.0 32.2 15.7 12,784 na 19.1 12,973 na 19.4 18,955 na 28.3

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.

Share price relative to MSCI India

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.

(Rs) 411 361 311 261 211 161 111 61 Mar09 Dec08 Feb09 Jan09

Price Rel MSCI India

190 170 150 130 110 90 70 Oct09 Nov09 3m 8.1 11.1 2.0 6m 96.2 104.0 74.5 5,127 30.0 374.9/89.7 10.12 Easy 60.00 Aug09 Sep09 1m 10.4 9.7 8.5 Jul09

May09

Apr09

BUY reaffirmed
HCL Tech is trading at discounts of 35% and 40% to Infosys on oneyear 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.

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Shiv Nadar
Source: Company, Nomura estimates

Nomura

90

Jun09

4 January 2010

HCL Technologies

Harmendra Gandhi

Financial statements
Income statement (INRmn) Y ear-end 30 Jun Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (W)
Source: Nomura estimates

FY07 60,332 (39,616) 20,716 (9,887) 10,829 13,361 (2,532) 10,829 985 3,441 15,255 (1,521) 13,734 (58) (11) 13,666 13,666 (5,853) 7,813

FY08F 74,772 (48,285) 26,487 (12,903) 13,584 16,549 (2,965) 13,584 1,672 (2,842) 12,414 (1,258) 11,156 (20) 11,136 11,136 (6,375) 4,761

FY09F 106,311 (69,071) 37,240 (18,260) 18,980 23,467 (4,487) 18,980 1,626 (5,298) 15,308 (2,544) 12,764 29 (10) 12,784 12,784 (7,156) 5,628

FY10F 122,354 (82,083) 40,271 (18,701) 21,569 27,083 (5,514) 21,569 (738) (4,926) 15,905 (2,919) 12,987 (14) 12,973 12,973 (3,138) 9,835

FY11F 138,037 (91,502) 46,535 (22,343) 24,192 29,938 (5,747) 24,192 (154) (900) 23,138 (4,165) 18,973 (18) 18,955 18,955 (3,138) 15,817

Significant improvement in Net profit for FY11F

17.9 17.9 2.4 22.8 4.9 18.6 23.0 34.3 22.1 17.9 22.7 10.0 42.8 7.2 1.7 na na

22.5 22.5 2.5 17.7 4.8 15.0 18.3 35.4 22.1 18.2 14.9 10.1 57.3 8.3 2.1 21.8 20.0

19.6 19.6 2.8 25.2 4.4 11.8 14.6 35.0 22.1 17.9 12.0 16.6 56.0 6.0 1.4 23.5 19.1

19.4 19.4 1.2 9.7 3.7 10.1 12.7 32.9 22.1 17.6 10.6 18.4 24.2 5.7 1.3 20.8 17.0

13.3 13.3 1.2 8.7 3.0 8.9 11.0 33.7 21.7 17.5 13.7 18.0 16.6 5.8 1.4 25.0 17.4

37.5 41.0 46.0 73.9 73.9

23.9 23.9 25.4 (20.3) (20.3)

42.2 41.8 39.7 14.4 14.4

15.1 15.4 13.6 1.5 1.5

12.8 10.5 12.2 46.1 46.1

21 21 21 77 9

17 17 17 78 10

19 19 19 85 11

19 19 19 102 5

28 28 28 125 5

Nomura

91

4 January 2010

HCL Technologies

Harmendra Gandhi

Cashflow (INRmn) Y ear-end 30 Jun EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY07 13,361 (3,296) 685 10,750 (4,320) 6,430 (2,068) 4,362 (5,853) 2,080 710 (3,063) 1,299 2,288 3,587 (3,587)

FY08F 16,549 2,227 (4,598) 14,178 (6,200) 7,978 (1,520) (2,714) 4,667 8,411 (6,375) 409 (2,192) (8,158) 253 3,587 3,840 (3,840)

FY09F 23,467 401 (13,902) 9,966 (6,400) 3,566 5,718 (30,932) (3,542) 1,675 (23,515) (7,156) 202 27,060 3,771 23,878 363 3,840 4,203 25,568

FY10F 27,083 (1,099) 25,984 (7,000) 18,984 197 (7,661) 1,420 12,940 (3,138) (7,071) (10,209) 2,731 4,203 6,934 21,895

FY11F 29,938 (1,058) 28,881 (8,000) 20,881 (7,055) 1,543 15,369 (3,138) (3,481) (6,619) 8,750 6,934 15,685 13,144

Debt-to-equity position to improve in FY11F

Balance sheet (INRmn) As at 30 Jun Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (day s) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

FY07 3,587 19,264 12,278 7,117 42,246 96 10,495 8,061 2,349 63,247 7,696 3,964 11,660 1,292 12,952 145 1,327 48,823 50,150 63,247

FY08F 3,840 20,779 18,940 8,713 52,272 101 13,317 9,585 5,063 80,338 14,616 7,529 22,145 5,959 28,104 57 1,333 50,844 52,177 80,338

FY09F 4,203 14,792 27,083 10,699 56,777 370 15,862 45,325 8,605 126,939 21,566 11,110 32,675 29,771 7,634 70,080 16 1,341 55,503 56,843 126,939

FY10F 6,934 14,596 28,889 9,935 60,354 369 17,445 44,111 16,266 138,545 21,528 11,090 32,618 28,829 9,054 70,501 16 1,341 66,687 68,027 138,545

FY11F 15,685 14,596 33,813 11,628 75,722 369 19,698 42,373 23,321 161,483 25,197 12,980 38,178 28,829 10,598 77,604 16 1,341 82,522 83,862 161,483

3.62 na

2.36 na

1.74 na

1.85 29.2

1.98 157.3

net cash net cash

net cash net cash

1.09 45.0

0.81 32.2

0.44 15.7

78.0 85.0 (7.0)

76.4 84.6 (8.2)

79.0 95.6 (16.6)

83.5 95.8 (12.3)

82.9 93.2 (10.3)

Nomura

92

4 January 2010

HCL Technologies

Harmendra Gandhi

This page has been intentionally left blank

Nomura

93

4 January 2010

Zee Entertainment Z I N
I N TE R N E T & M E D I A | I N D I A

Maintained
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Jamil Ansari Prabhat Awasthi

+91 22 4037 4192 jamil.ansari@nomura.com +91 22 4037 4180 prabhat.awasthi@nomura.com

BUY
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY10F net profit (INRmn) Difference from consensus
Source: Nomura

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.

INR265.5

INR292
(set on 30 O ct 2009)

10.0% 11.0% 4,832 11.0%

Nomura vs consensus
We believe the street is underestimating the recovery in advertising rates and the effectiveness of ZEEL’s cost management.

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.

Key financials & valuations
31 Mar (INRmn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Company, Nomura estimates

FY09F FY10F FY11F FY12F
21,773 5,124 3,673 8.5 (4.9) 31.4 16.9 3.3 0.5 11.4 11.0 23,722 4,832 4,832 10.8 27.9 24.5 14.3 3.2 0.4 13.3 (5.9) 4,832 na 10.8 33,139 6,719 6,719 13.9 28.2 19.1 10.2 3.2 0.5 17.2 (11.7) 6,719 na 13.9 38,695 7,976 7,976 16.5 18.7 16.1 8.6 2.9 0.5 18.7 (14.8) 7,976 na 16.5

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.

Share price relative to MSCI India
(Rs) 322 272 222 172 122 72 May09 Dec08 Aug09 Sep09 Nov09
3m 16.9 20.2 11.1 6m 56.8 63.1 33.6 2,452 58.5 272.0/90.5 8.18 Hard 41.50
Price Rel MSCI India

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 fastgrowing 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.

110 100 90 80 70 60

Feb09

Mar09

Jan09

Apr09

Jun09

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) higherthan-anticipated competition in the Hindi GEC space.

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Subhash Chandra
Source: Company, Nomura estimates

1m 0.9 0.4 (0.9)

Nomura

94

4 January 2010

Oct09

Jul09

Zee Entertainment

Jamil Ansari

Financial statements
Income statement (INR mn) Y ear-end 31 Mar Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (W)
Source: Nomura estimates

FY08 18,354 7818 10,536 5113 5,423 5,423 232 5,191 516 5 1,138 5,818 1,627 4,191 (333) 3,858 -26 3,833

FY09F 21,773 9810 11,963 6483 5,480 5,480 310 5,170 1,339 1 1,572 5,405 1,633 3,771 (99) 3,673 1,451 5,124

FY10F 23,722 10176 13,546 7570 5,976 5,976 348 5,628 391 0 1,562 6,799 2,057 4,742 (120) 4,623 0 4,623

FY11F 33,139 12463 20,676 13262 7,414 7,414 383 7,032 360 0 1,719 8,390 2,517 5,873 (140) 5,733 0 5,733

FY12F 38,695 14331 24,364 15553 8,811 8,811 421 8,390 360 0 1,890 9,920 2,976 6,944 (180) 6,764 0 6,764

Impact of R-GEC restructuring will be fully visible in FY11

29.8 32.8 29.8 0.4 28.1 3.9 17.9 18.6 57.4 29.5 34.5 22.8 28.0 22.5 2.8 2.3 15.3 19.8

31.4 34.5 31.4 0.5 28.9 3.3 16.9 17.7 54.9 25.2 31.0 17.3 30.2 47.3 12.4 8.7 12.0 18.2

24.5 27.0 24.5 0.4 22.6 3.2 14.3 15.1 54.8 26.6 31.9 21.1 30.3 46.9 4.4 2.9 13.5 17.6

19.1 21.1 19.1 0.5 17.5 3.2 10.2 10.9 54.9 26.9 31.7 21.3 30.0 45.4 1.8 1.3 15.5 20.8

16.1 17.7 16.1 0.5 14.9 2.9 8.6 9.0 55.3 27.5 32.1 21.7 30.0 44.9 1.6 1.2 16.8 23.0

21.1 66.0 68.0 62.4 62.4

18.6 7.5 6.5 (4.9) (4.9)

9.0 12.1 11.1 27.9 27.9

39.7 36.5 35.6 28.2 28.2

16.8 17.6 18.2 18.7 18.7

8.9 8.9 8.9 68.6 2.0

8.5 8.5 8.5 80.5 4.0

10.8 10.8 10.8 84.0 5.0

13.9 13.9 13.9 84.2 6.0

16.5 16.5 16.5 92.2 7.0

Nomura

95

4 January 2010

Zee Entertainment

Jamil Ansari

Cashflow (INR mn) Year-end 31 Mar Pre-tax profit Depreciation Tax paid Chg in working capital Other operating activities Cash flow from operations (a) Capital expenditure Chg in investments Chg in associates Other investing activities Cash flow from investing (b) Free cash flow (a+b) Equity raised/(repaid) Chg in minorities Debt raised/(repaid) Dividend (incl. tax) Other financing activities Cash flow from financing (c) Net chg in cash (a+b+c) Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 5,792 232 (1,627) (1,551) 0 2,847 (923) (190) 5 0 (1,107) 1,740 0 299 640 (498) (168) 272 2,012 955 1,652 2,214

FY09F 6,856 310 (1,633) (5,719) 0 (186) (2,757) 1,244 1 0 (1,511) (1,697) 0 (169) 1,891 (538) 0 1,185 (513) 1,652 1,926 3,831

FY10F 7,098 414 (2,057) 3,599 0 9,054 (481) 0 0 0 (481) 8,574 (0) 120 (2,257) (503) 0 (2,640) 5,934 1,926 5,708 (2,208)

FY11F 9,799 633 (2,517) (600) 0 7,315 (500) 0 0 0 (500) 6,815 0 140 (1,000) (594) 0 (1,454) 5,361 5,708 7,260 (4,760)

FY12F 11,651 681 (2,976) (1,726) 0 7,630 (750) 0 0 0 (750) 6,880 0 180 (1,000) (673) 0 (1,493) 5,388 7,260 8,112 (6,612)

ZEEL expected to generate significant free cash in the next few years

Balance sheet (INR mn) As at 31 Mar Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

FY08 1,652 5907.2 31.9 13917.2 21,508 2,515 15,605 243.1 39,872 4152 2127 6,279 3866 10,144 1117 433.6 28177 28,611 39,872

FY09F 1,926 6436.5 43.9 18619.6 27,026 1,271 18,093 112.8 46,503 4318 1486 5,803 5757 11,560 948 434.0 33561 33,995 46,503

FY10F 5,708 7158.3 59.7 14951.8 27,878 1,271 18,225 112.8 47,487 4772 1700 6,472 3500 9,972 1067 434.0 36014 36,448 47,487

FY11F 7,260 8385.6 61.7 14880.8 30,588 1,271 18,342 112.8 50,314 4933 2098 7,030 2500 9,530 1207 434.0 39143 39,577 50,314

FY12F 8,112 10060.4 75.6 16418.8 34,666 1,271 18,671 112.8 54,721 6051 2480 8,531 1500 10,031 1387 434.0 42869 43,303 54,721

3.4 12.3

4.7 5.0

4.3 19.2

4.4 28.2

4.1 33.4

0.3 7.4

0.5 11.0

(0.3) (5.9)

(0.5) (11.7)

(0.6) (14.8)

117 1 83

119 1 80

120 1 80

136 1 80

133 1 80

Nomura

96

4 January 2010

Zee Entertainment

Jamil Ansari

This page has been intentionally left blank

Nomura

97

4 January 2010

CONVICTION CALL

CONVICTION CALL

CONVICTION CALL

CONVICTION CALL

Tata Steel T A T A I N
S TE E L | I N D I A

Maintained +91 22 4037 4180 +91 22 4037 4193 prabhat.awasthi@nomura.com alokkumar.nemani@nomura.com
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Prabhat Awasthi Alok Kumar Nemani (Associate)

BUY
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY10F net profit (INRmn) Difference from consensus
Source: Nomura

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.

615.6

INR926
(set on 16 Dec 09)

50.4% 66.8% -23,487 -165.4%

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.

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.

Key financials & valuations
31 Dec (INRmn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Compa ny, Nomura e stimate s

FY09
1,512,646 50,509 91,510 125.2 21.9 4.9 5.3 1.6 3.3 34.8 190.8

FY10F

FY11F

FY12F

1,067,038 1,236,746 1,390,256 (23,487) 79,721 107,396 (6,461) 79,721 107,396 (7.3) 89.9 121.0 (105.8) 11.6 1.7 2.6 (2.1) 142.8 (23,487) na (7.3) n/a 6.9 4.9 1.4 2.5 22.0 111.1 79,721 na 89.9 34.7 5.1 3.7 1.1 2.5 24.4 72.8 107,396 na 121.0

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.

Share price relative to MSCI India
(Rs) 700 600 500 400 300 200 100 Aug09 Apr09 May09 Dec08 Nov 09 3m 20.1 23.4 14.4 Jan09 Jun09 Sep09 Mar09 Feb09 Oct09 Jul09
Price Rel MSCI India

170 150 130 110 90 70

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.

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Promoters
Source: Compa ny, Nomura e stimate s

1m 10.2 9.6 8.3

6m 51.3 57.3 27.8 11,706 72.8 616/151.8 124.1 Easy 27.20

Nomura

98

4 January 2010

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.
Current valuations provide an attractive opportunity, in our view

Exhibit 105. Tata Steel: consolidated earnings forecast
(INRmn) Tata Steel India Corus SE Asia business Total consolidated profit EPS (INR)
Source: Company data, Nomura estimates

FY08 46,870 24,630 7,994 79,494 108.8

FY09 52,017 547 (2,056) 50,509 69.1

FY10F 41,128 (63,482) (1,133) (23,487) (26.5)

FY11F 52,359 27,161 200 79,721 89.9

FY12F 81,847 25,185 364 107,396 121.0

Exhibit 106. Tata Steel: sum-of-the-parts valuation
Value TATA steel standalone (INRmn) EV of Corus (US$mn) Corus equity value (US$mn) South East Asia business (US$mn) Price target (INR) FY11F P/E (x)
Source: Company data, Nomura estimates

Value/share (INR) 735 173 19 926 10.3

651,876 8,293 2,882 364

Exhibit 107. Tata Steel: change in value of domestic business vs steel price
Steel price (US$/tonne) (INR/share) 12 11 P/E multiple 10 9 8
Source: Company data, Nomura estimates

750 1,148 1,053 957 861 765

700 980 898 816 735 653

650 811 744 676 608 541

600 643 589 535 482 428

550 474 435 395 356 316

Nomura

99

4 January 2010

Tata Steel

Prabhat Awasthi

Financial statements
Income statement (INR mn) Y ear-end 31 Dec Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (W)
Source: Nomura estimates

FY08 1,316,463 1,182,621 133,842

FY09 1,512,646 1,372,647 140,000

FY10F 1,067,038 1,036,890 30,149

FY11F 1,236,746 1,104,068 132,678

FY12F 1,390,256 1,223,972 166,284

Turnaround at Corus should drive FY11F EBITDA growth, while 3mn tonne expansion should drive FY12F EBITDA growth

133,842 174,618 40,776 62,658 37,267 3,350 99,925 24,903 75,021

140,000 184,352 44,352 77,228 32,927 3,083 110,155 18,645 91,510

30,149 75,749 45,600 (20,826) 27,488 4,000 6,661 13,122 (6,461)

132,678 177,363 44,685 83,949 26,364 4,000 110,314 30,593 79,721

166,284 213,037 46,753 121,922 24,181 4,000 146,103 38,707 107,396

75,021 4,473 79,494 13,714 65,781

91,510 (41,001) 50,509 13,830 36,679

(6,461) (17,026) (23,487) 13,572 (37,059)

79,721 79,721 13,495 66,226

107,396 107,396 13,495 93,901

6.0 9.0 5.7 3.1 3.9 1.8 5.4 7.0 10.2 13.3 10.8 6.0 23.9 17.5 23.2 7.5 38.8 19.0

4.9 7.4 8.9 3.3 3.3 1.6 5.3 6.9 9.3 12.2 6.7 3.3 27.0 3.5 1.2 34.8 12.0

n/a n/a n/a 2.6 14.0 1.7 11.6 27.0 2.8 7.1 1.6 (2.2) n/a n/a 5.3 1.2 (2.1) 2.9

6.9 10.3 6.9 2.5 4.4 1.4 4.9 6.5 10.7 14.3 11.1 6.4 27.7 5.6 1.5 22.0 11.8

5.1 7.6 5.1 2.5 3.5 1.1 3.7 4.7 12.0 15.3 12.2 7.7 26.5 3.8 1.1 24.4 13.9

14.9 5.6 23.3 21.9 (36.5)

(29.5) (58.9) (127.0) (105.8) (146.5)

15.9 134.1 n/a n/a n/a

12.4 20.1 45.2 34.7 34.7

109 103 90 336 16

69 125 57 383 16

(26) (7) (26) 373 13

90 90 90 445 13

121 121 121 549 13

Nomura

100

4 January 2010

Tata Steel

Prabhat Awasthi

Cashflow (INR mn) Year-end 31 Dec EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 174,618 (134,277) (79,722) (39,382) (305,746) (345,128) 5,809 (180,500) 760 (519,058) (13,936) 96,660 402,124

FY09F 184,352 84,447 (94,411) 174,387 (52,960) 121,427 (134,226) 5,185 (7,614) (14,925) (2,790) 73,165

FY10F 75,749 29,173 (57,636) 47,287 (56,163) (8,876) (5,326) 11,453 (2,749) (14,028) 24,203 (33,868)

FY11F 177,363 (9,035) (56,957) 111,370 (69,223) 42,147 2,368 2,734 47,249 (13,495) (0) (44,816)

FY12F 213,037 (4,235) (62,888) 145,914 (52,408) 93,506 647 3,007 97,160 (13,495) (0) (30,000)

484,848 (34,210) 78,594 44,384 508,918

55,450 47,837 44,384 92,221 534,246

(23,693) (26,442) 92,221 65,779 472,094

(58,311) (11,061) 65,779 54,718 438,339

(43,495) 53,666 54,718 108,384 354,673

Company will generate operating cash of INR110150bn in FY11-12F, which even after capex should be enough to pre-pay debt significantly

Balance sheet (INR mn) As at 31 Dec Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

FY08 44,384 174,945 200,520 65,669 485,518 55,253 375,896 180,500 38,073 1,135,239 238,553 62,635 301,188 498,577 33,531 532,108

FY09F 92,221 121,160 191,915 45,780 451,076 189,478 384,504 180,500 37,572 1,243,129 240,514 62,842 303,356 571,742 32,193 603,935

FY10F 65,779 81,797 141,809 36,430 325,816 194,804 395,066 180,500 39,245 1,135,431 171,854 61,857 233,711 537,874 32,193 570,067

FY11F 54,718 96,851 163,733 36,430 351,732 192,436 419,604 180,500 38,255 1,182,527 199,109 62,544 261,653 493,058 32,193 525,251

FY12F 108,384 107,145 186,025 36,431 437,986 191,789 425,259 180,500 37,750 1,273,284 226,456 63,549 290,005 463,058 32,193 495,251

7,308 65,781 13,714 215,141 301,943 1,135,239

7,308 36,679 13,830 278,022 335,838 1,243,129

8,874 (37,059) 13,572 346,266 331,654 1,135,431

8,874 66,226 13,495 307,029 395,624 1,182,527

8,874 93,901 13,495 371,758 488,028 1,273,284

2.04 3.7

1.88 4.3

1.90 1.2

1.77 5.2

1.93 7.0

2.91 207.2

2.90 190.8

6.23 142.8

2.47 111.1

1.66 72.8

48.5 55.6 76.3 56.2

29.2 46.3 66.1 28.6

28.0 48.5 63.3 30.2

28.6 48.3 68.6 28.9

28.1 48.8 70.2 27.1

Nomura

101

4 January 2010

GAIL G A I L I N
O I L & G AS | I N D I A

Maintained anil.sharma.1@nomura.com ravikumar.adukia@nomura.com
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Anil Sharma +91 22 4037 4338 Ravi Kumar Adukia (Associate) +91 22 4037 4232

BUY
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY11F net profit (INRbn) Difference from consensus
Source: Nomura

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.

INR420

INR500
(set on 16 Dec 09)

19.0% 39.0% 41 18.0%

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.

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.

Key financials & valuations
31 Mar (INRbn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Company, Nomura estimates

FY08
180 26 26 21 27 20 13 4 2 20 (25) 26 21

FY09 FY10F FY11F
238 28 28 22 8 19 13 4 2 19 (15) 28 22 255 31 31 25 11 17 11 3 2 19 4 31 25 365 41 41 32 32 13 9 3 3 22 8 41 32

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.

Share price relative to MSCI India
Price

460 410 360 310 260

Rel MSCI India

130 120 110 100 90 80

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.

210 160 May09 Aug09 Sep09 Dec08 Nov09
3m 17.8 21.1 12.1

Mar09

Jan09

Feb09

Jun09

Apr09

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 sharperthan-expected decline in polymer prices and a higher subsidy burden.

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Government of India Life Insurance Corporation of India
Source: Company, Nomura estimates

1m 4.1 3.6 2.3

Oct09

Jul09

6m 49.3 55.3 25.8 11,396 35.0 429.8/184.8 15.77 Easy 57.34 5.43

Nomura

102

4 January 2010

GAIL

Anil Sharma

Exhibit 108. GAIL: gas transmission volume
160 140 120 100 80 60 40 20 0 2HFY10E FY11E 1QFY10 2QFY10 FY12E FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 mmscmd

Now in a rapid growth phase

Next 3 yea r CAGR of 21%

Last 9 years CAGR of 3.7%

Source: Company data, Nomura estimates

Exhibit 109. GAIL: subsidy sharing
INR bn FY06 FY07 FY08 FY09 1QFY10 2QFY10 54.4 5.6 10% 0.7 1.4% 13.3% 104.2 34.4 33% 4.6 4.4% 13.3% Gross Under-recoveries 400.0 493.9 773.0 1032.9 Upstream share % share GAIL's share % of Gross U/R % of Upstrem share 140.0 205.2 257.1 35% 10.6 42% 14.9 33% 12.9 329.4 32% 17.8 1.7% 5.4% Subsidy burden on GAIL has increased from ~5%of total upstream share in FY08/09 to ~13% in 1HFY10.

Lower sharing could offer respite

2.7% 3.0% 1.7% 7.6% 7.3% 5.0%

Source: Company data, Nomura estimates

Exhibit 110. GAIL: EBIT breakdown
FY09A EBIT Break-down (%) Transmisson & Trading Petrochemicals LPG & Liquid HC
Source: Company data, Nomura estimates

Increasing utility-type earnings

FY10E 68% 24% 8%

FY11E 68% 15% 17%

FY12E 70% 14% 16%

51% 29% 20%

Exhibit 111. GAIL: SOTP valuation
Gas Transmission Petrochemicals LPG & Liquid HC E&P Upside Investments Enterprise Value Less: Net Debt Equity Value Target Price
Source: Nomura estimates

INRbn 437 71 63 18 56 645 15 630

US$ bn 9.7 1.6 1.4 0.4 1.2 14.3 0.3 14.0

INR / Share 345 56 49 15 44 509 12 496 500

Com m ents 10x FY11 EBITDA 7x FY11 EBITDA 6x FY11 EBITDA

FY11E Implied FY11 P/E multiple of 15.5x

Nomura

103

4 January 2010

GAIL

Anil Sharma

Financial statements
Income statement (INRbn) Year end 31 March Revenue Operating cost EBITDA Depreciation Amortisation EBIT Net interest expense Others income Earnings before tax Income tax Net profit after tax Minorities Normalised NPAT Exceptionals Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at fair value (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROCE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT PAT Normalised EPS Normalised FDEPS Per share Reported EPS Norm EPS Fully diluted norm EPS Book value per share DPS
Source: Nomura estimates

2008 180.1 140.6 39.5 5.7 0.0 33.8 0.8 5.6 38.5 12.5 26.0 0.0 26.0 0.0 26.0 9.9 16.1

2009 237.8 197.2 40.5 5.6 0.0 34.9 0.9 8.0 42.0 14.0 28.0 0.0 28.0 0.0 28.0 10.4 17.6

2010F 255.2 207.6 47.6 6.5 0.0 41.1 1.1 5.0 45.0 13.8 31.1 0.0 31.1 0.0 31.1 12.7 18.4

2011F 365.0 306.0 58.9 7.8 0.0 51.1 1.9 5.5 54.7 13.7 41.0 0.0 41.0 0.0 41.0 16.8 24.2

2012F 420.8 356.3 64.5 9.4 0.0 55.0 2.3 6.0 58.8 14.7 44.1 0.0 44.1 0.0 44.1 18.1 26.1

20.5 20.5 2% 15.6 4.2 12.7 14.8 22% 19% 14% 33% 33% 7% 2.2 20% 24% 16%

19.0 22.6 19.0 2% 20.6 3.7 12.6 14.6 17% 15% 12% 33% 32% 12% 5.0 19% 23% 14%

17.1 20.4 17.1 2% 15.9 3.2 11.3 13.1 19% 16% 12% 31% 35% 20% 7.7 19% 20% 15%

13.0 15.5 13.0 3% 8.6 2.8 9.3 10.7 16% 14% 11% 25% 35% 15% 6.8 22% 21% 15%

12.1 14.4 12.1 3% 9.1 2.5 8.6 10.1 15% 13% 10% 25% 35% 12% 5.3 21% 20% 15%

12% 32% 39% 27% 27% 27%

32% 3% 3% 8% 8% 8%

7% 17% 18% 11% 11% 11%

43% 24% 24% 32% 32% 32%

15% 9% 8% 8% 8% 8%

20.5 20.5 20.5 101 6.7

22.1 22.1 22.1 114.7 7.0

24.5 24.5 24.5 129.2 8.6

32.3 32.3 32.3 148.3 11.3

34.8 34.8 34.8 168.9 12.2

Strong earnings growth in FY11F, mainly on growth in gas transmission volumes

Nomura

104

4 January 2010

GAIL

Anil Sharma

Cashflow (INRbn) Year end 31 March EBITDA Change in WC Other operating cashflow Cashflow from operations Capex Free cashflow Other Investing cash flow Cashflow after investing acts Cash dividends Equity issue Debt issue Others Cashflow from financial acts Net cash flow Beginning cash Ending cash Ending net debt Balance sheet (INRbn) Year end 31 March Cash & equivalents Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Other LT assets Total assets Accounts payable Other current liabilities Total current liabilities Long-term debt Other LT liabilities Total liabilities Minority interest Common stock Retained earnings Other equity & reserves Total shareholder's equity Total equity & liabilties Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

2008 39.5 (0.4) (5.0) 34.1 (12.7) 21.4 4.2 25.6 (5.9) 0.0 (0.7) (0.8) (7.5) 18.1 26.6 44.7 (32.1)

2009 40.5 (5.6) (9.2) 25.8 (28.0) (2.2) 5.5 3.3 (11.9) 0.0 (0.7) (0.9) (13.4) (10.2) 44.7 34.6 (22.6)

2010F 47.6 (4.0) (10.0) 33.5 (50.1) (16.5) 0.0 (16.5) (12.7) 0.0 10.0 0.0 (2.7) (19.3) 34.6 15.3 6.7

2011F 58.9 12.8 (10.1) 61.7 (53.5) 8.2 0.0 8.2 (16.8) 0.0 15.0 0.0 (1.8) 6.4 15.3 21.7 15.3

2012F 64.5 4.8 (10.9) 58.4 (50.1) 8.3 0.0 8.3 (18.1) 0.0 1.0 0.0 (17.1) (8.7) 21.7 12.9 25.1

2008 44.7 10.7 5.7 42.9 104.1 14.9 97.5 0.0 216.5 18.0 42.6 60.6 12.7 13.2 86.5 0.0 8.5 119.5 2.1 130.0 216.5

2009 34.6 15.0 6.0 66.8 122.4 17.4 114.8 0.0 254.5 19.7 61.8 81.5 12.0 13.3 106.8 0.0 12.7 132.9 2.1 147.7 254.5

2010F 15.3 13.8 6.6 67.0 102.6 17.4 158.2 0.0 278.3 26.8 50.2 77.0 22.0 13.2 112.2 0.0 12.7 151.3 2.1 166.1 278.3

2011F 21.7 18.2 7.2 67.2 114.2 20.9 200.4 0.0 335.5 41.1 54.0 95.1 37.0 13.2 145.2 0.0 12.7 175.5 2.1 190.3 335.5

2012F 12.9 20.7 7.8 67.5 108.9 21.0 241.0 0.0 370.9 47.0 56.3 103.3 38.0 13.2 154.5 0.0 12.7 201.5 2.1 216.4 370.9

Strong balance sheet and flexibility in capital structure

1.7 42.5

1.5 40.2

1.3 37.7

1.2 26.9

1.1 24.5

(0.8) -25%

(0.6) -15%

0.1 4%

0.3 8%

0.4 12%

21.8 11.5 36.4 (3.1)

23.1 9.2 30.3 2.0

19.7 9.4 38.4 (9.3)

18.2 7.2 41.1 (15.8)

17.9 6.8 40.8 (16.1)

Nomura

105

4 January 2010

Dr. Reddy’s Laboratories D R R D I N
H E AL T H C AR E & P H AR M AC E U TI C AL S | I N D I A

Maintained
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Saion Mukherjee

+91 22 4037 4184 saion.mukherjee@nomura.com

BUY
Closing price on 24 Dec Price target Upside/downside Difference from consensus FY09F net profit (INRmn) Difference from consensus
Source: Nomura

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.

INR1,186

INR1,329
(set on 27 Nov 09)

12.0% 18.0% 8,410 3.0%

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.

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 IVrelated exclusivities or difficult-to-develop products presenting limited competition. Patent expiries are set to jump in the US over 20102012F. 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.

Key financials & valu ations
31 Mar (INRmn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Co mpany, Nomura esti mates

FY 08 FY09F FY10F FY 11F
50,006 3,846 6,947 41.2 (40) 28.8 23.5 4.2 0.4 8.0 25 69,441 (5,168) 8,855 52.5 27 22.6 14.2 4.8 0.6 (12.0) 34 na na na 71,203 8,410 8,410 49.9 (5) 23.8 13.8 4.1 0.6 17.0 11 na na na 82,578 11,972 11,972 71.0 42 16.7 10.1 3.3 0.6 20.0 (4) na na na

Share price relative to MSCI India

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.

(Rs) 1,280 1,080 880 680 480 280 Mar09

Pri ce R el MSC I Indi a

150 140 130 120 110 100 90 80 70 Aug09 Sep09 Oct 09 Nov09 3m 32.7 36.4 27.4 Jul09

May09

Jan09

Feb09

Dec08

Jun09

Apr09

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Anji Reddy and related entities Life Insurance Corporation of India
Source: Co mpany, Nomura esti mates

1m 6.7 6.1 4.9

6m 59.2 65.6 36.1 4,282 74.2

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

1,222/ 374.0 14.58 Easy 25.80 12.80

Nomura

106

4 January 2010

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.
A strategic retreat and a strategic tie-up make for a far more profitable structure

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

Nomura

107

4 January 2010

Dr. Reddy’s Laboratories

Saion Mukherjee

Financial statements
Income statement (INRmn) Year-end 31 Mar Revenue Cost of goods sold Gross profit SG&A Other expenses Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (INR)
Source: Nomura estimates

FY08 50,006 24,598 25,408 15,247 3,131 7,030 8,804 1,774 1,588 5,442 218 (2) 739 5,965 (972) 6,937 (10)

FY09F 69,441 32,941 36,500 19,517 4,291 12,692 15,003 2,311 1,503 11,189 552 (24) (634) 10,027 1,172 8,855 -

FY10F 71,203 34,373 36,830 20,680 4,130 12,021 14,890 2,870 1,500 10,521 324 (26) 160 10,382 1,973 8,410 -

FY11F 82,578 39,690 42,888 22,186 4,656 16,046 19,512 3,466 1,500 14,546 (208) (26) 14,780 2,808 11,972 -

FY12F 95,695 46,891 48,804 24,833 5,244 18,727 22,646 3,919 1,500 17,227 (745) (26) 17,998 3,420 14,578 -

Our estimates build in upside from Prilosec OTC, Arixtra. We have not built in upside from Lotrel and other potential launches with low competition

6,947 (3,101) 3,846 738 3,108

8,855 (14,023) (5,168) 1,232 (6,400)

8,410 8,410 1,232 7,178

11,972 11,972 1,232 10,740

14,578 14,578 1,232 13,346

28.8 32.3 52.0 0.4% 19.4 4.2 23.5 38.1 51% 18% 11% 14% -16% 19% 13% 3.8 8% 7%

22.6 25.3 (38.7) 0.6% 15.8 4.8 14.2 19.1 53% 22% 16% 13% 12% -24% 12% 3.6 -12% 12%

23.8 26.7 23.8 0.6% 15.7 4.1 13.8 19.5 52% 21% 15% 12% 19% 15% 8% 2.1 17% 12%

16.7 18.7 16.7 0.6% 11.8 3.3 10.1 13.6 52% 24% 18% 14% 19% 10% 5% 1.3 20% 16%

13.7 15.4 13.7 0.6% 10.0 2.7 8.3 10.8 51% 24% 18% 15% 19% 8% 4% 1.0 20% 17%

-23% -45% -58% -40% -40%

39% 70% 106% 27% 27%

3% -1% -6% -5% -5%

16% 31% 38% 42% 42%

16% 16% 18% 22% 22%

22.8 41.2 41.2 281 4.4

(30.6) 52.5 52.5 249 7.3

49.9 49.9 49.9 292 7.3

71.0 71.0 71.0 355 7.3

86.4 86.4 86.4 435 7.3

Nomura

108

4 January 2010

Dr. Reddy’s Laboratories

Saion Mukherjee

Cashflow (INRmn) Year-end 31 Mar EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 8,804 (2,675) 399 6,528 (6,716) (188) (2,651)

FY09F 15,003 (8,267) (2,231) 4,505 (8,224) (3,719) 4,752

FY10F 14,890 2,978 (1,787) 16,082 (6,000) 10,082 475

FY11F 19,512 (3,451) (2,782) 13,279 (4,500) 8,779 800

FY12F 22,646 (4,262) (3,394) 14,990 (4,000) 10,990 1,050

We expect cashflows to remain strong resulting in DRRD becoming net debt-free by FY11

(2,651) (737) 15 (6,015) (1,128) (7,865) (10,704) 18,588 7,421 11,931

4,752 (738) 5 (662) (1,132) (2,527) (1,494) 7,421 5,596 14,105

475 (1,232) (3,501) (799) (5,532) 5,025 5,596 10,621 5,579

800 (1,232) (4,135) (592) (5,959) 3,619 10,621 14,240 (2,175)

1,050 (1,232) (5,740) (305) (7,277) 4,763 14,240 19,003 (12,678)

Balance sheet (INRmn) As at 31 Mar Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

FY08 7,421 4,753 6,823 11,133 3,858 33,988 237 16,765 16,997 16,756 891 85,634 6,654 5,767 7,180 19,601 12,698 5,985 38,284

FY09F 5,596 530 14,592 13,226 5,066 39,010 262 20,882 7,300 14,879 1,459 83,792 9,569 6,619 10,365 26,553 10,132 5,062 41,747

FY10F 10,621 530 9,804 15,180 5,066 41,200 262 24,012 7,300 13,379 1,459 87,613 10,203 6,768 10,360 27,331 5,997 5,062 38,390

FY11F 14,240 530 11,412 17,782 5,066 49,030 262 25,046 7,300 11,879 1,459 94,976 11,808 7,527 10,360 29,695 257 5,062 35,014

FY12F 19,003 530 13,622 20,911 5,066 59,132 262 25,128 7,300 10,379 1,459 103,660 6,077 8,604 10,360 25,041 248 5,062 30,351

841 24,211 22,298 47,350 85,634

842 18,305 22,898 42,045 83,792

842 25,483 22,898 49,223 87,613

842 36,222 22,898 59,962 94,976

842 49,568 22,898 73,308 103,660

1.73 25.0

1.47 20.3

1.51 32.5

1.65 NA

2.36 NA

1.36 25%

0.94 34%

0.37 11%

(0.11) -4%

(0.56) -17%

49.8 81.3 42.1 89.0

76.7 69.5 34.8 111.4

50.3 77.8 34.7 93.4

50.4 78.6 33.3 95.8

52.0 79.8 32.8 98.9

Nomura

109

4 January 2010

Ranbaxy R B X Y I N
H E AL T H C AR E & P H AR M AC E U TI C AL S | I N D I A

Maintained
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Saion Mukherjee

+91 22 4037 4184 saion.mukherjee@nomura.com

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 exclusivityrelated 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.

Closing price on 24 Dec Price target Upside/downside Difference from consensus FY09F net profit (INRmn) Difference from consensus
Source: Nomura

INR520

INR261
(set on 17 Sep 09)

-50.0% -32.0% 1,110 -51.0%

Nomura vs consensus
We believe we are conservative on base business valuation vis-à-vis consensus.

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.

Key financials & valu ations
31 Dec (INRmn)
Revenue Reported net profit Normalised net profit Normalised EPS (INR) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%) Earnings revisions Previous norm. net profit Change from previous (%) Previous norm. EPS (INR)
Source: Co mpany, Nomura esti mates

FY 08 FY09F FY10F FY 11F
69,822 7,745 7,745 18.1 (33) 28.7 26.2 7.8 1.7 27 69 70,852 (9,513) (1,811) (4.2) (123) (122.6) 90.5 5.1 0.0 (22) (5) (1,811) na (4.2) 71,471 1,110 2,231 5.2 (223) 99.5 54.9 5.0 0.0 2 (13) 2,231 na 5.2 84,571 7,888 7,888 18.5 254 28.2 16.5 4.2 0.0 15 (21) 7,888 na 18.5

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.

Share price relative to MSCI India
(Rs) 595 495 395 295 195 95 May09 Dec08 Nov 09 3m 32.1 35.8 26.8 Jan09 Feb09 Jun09 Aug09 Sep09 Mar09 Apr09 Jul09 Oct09
P rice R e l MS CI Indi a

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.

150 130 110 90 70 50

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

Absolute (INR) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (US$mn) Stock borrowability Major shareholders (%) Daiichi Sankyo Company Ltd Life Insurance Corporation of India
Source: Co mpany, Nomura esti mates

1m 23.5 22.8 21.6

6m 90.2 97.9 68.3 4,686 36.1

530/ 134.7 20.34 Hard 63.90 7.03

Nomura

110

4 January 2010

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
(US$mn) 160 140 120 100 80 60 40 20 0 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09

Note: Emerging market (excludes India, includes Romania) Source: Company data

Nomura

111

4 January 2010

Ranbaxy

Saion Mukherjee

Financial statements
Income statement (INRmn) Y ear-end 31 Dec Revenue Cost of goods sold Gross profit SG&A Other expenses Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (INR)
Source: Nomura estimates

FY08 69,822 30,570 39,252 16,907 13,199 9,147 9,147 1,752 431 6,964 1,412 4,434 9,985 2,119 7,867 122

FY09F 70,852 35,188 35,664 19,311 13,983 2,370 2,370 2,232 593 (455) 2,055 (4,788) (7,298) (5,650) (1,649) 84 78 (1,811) (7,702) (9,513) (9,513)

FY10F 71,471 31,100 40,370 20,969 15,563 3,839 3,839 2,108 643 1,088 1,087 2,612 2,614 299 2,315 84

FY11F 84,571 34,569 50,002 20,997 16,564 12,442 12,442 2,213 643 9,586 1,087 1,466 9,965 1,993 7,972 84

FY12F 89,941 37,428 52,513 22,655 17,636 12,222 12,222 2,292 643 9,287 1,714 2,627 10,200 2,040 8,160 84

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

7,745 7,745 3,711 4,034

2,231 (1,121) 1,110 1,110

7,888 7,888 7,888

8,076 8,076 8,076

28.7 14.4 28.7 1.7% 22.4 7.8 26.2 34.4 56% 13% 10% 11% 21% 48% 12% 4.8 27% 11%

(122.6) (61.5) (23.3) 0.0% 219.1 5.1 90.5 (471.2) 50% 3% -1% -3% 77% 0% 8% 2.6 -22% -6%

99.5 50.0 200.1 0.0% 44.6 5.0 54.9 193.8 56% 5% 2% 3% 11% 0% 3% 1.2 2% 2%

28.2 14.1 28.2 0.0% 20.7 4.2 16.5 21.4 59% 15% 11% 9% 20% 0% 2% 0.7 15% 7%

27.5 13.8 27.5 0.0% 20.2 3.6 18.3 24.1 58% 14% 10% 9% 20% 0% 2% 0.7 13% 7%

14% 4% -8% -33% -33%

1% -74% -107% -123% -123%

1% 62% -339% -223% -223%

18% 224% 781% 254% 254%

6% -2% -3% 2% 2%

18.1 18.1 18.1 67 8.7

(22.3) (4.2) (4.2) 102 -

2.6 5.2 5.2 105 -

18.5 18.5 18.5 124 -

18.9 18.9 18.9 143 -

Nomura

112

4 January 2010

Ranbaxy

Saion Mukherjee

Cashflow (INRmn) Year-end 31 Dec EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 13,581 573 (3,921) 10,232 (8,406) 1,826 (2)

FY09F (2,418) (2,387) 3,257 (1,549) (5,751) (7,299) (1,217)

FY10F 6,451 1,447 (2,347) 5,552 (2,500) 3,052 1,540

FY11F 13,908 (4,374) (3,176) 6,358 (1,500) 4,858 1,800

FY12F 14,849 (2,746) (4,230) 7,873 (1,500) 6,373 2,190

Expect cashflow to remain strong on back of productspecific upside
(2) (3,642) 92 4,333 (1,176) (392) 1,433 2,951 4,379 19,692 (1,217) (2,620) 35,944 (4,497) (1,942) 26,885 18,369 4,379 23,956 (2,222) 1,540 (0) (1,087) (1,087) 3,505 23,956 27,461 (5,726) 1,800 (0) (1,087) (1,087) 5,571 27,461 33,032 (11,297) 2,190 0 (1,714) (1,714) 6,849 33,032 39,881 6,952

Balance sheet (INRmn) As at 31 Dec Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
Source: Nomura estimates

FY08 4,379 2,403 14,931 16,409 1,616 39,737 45,619

FY09F 23,956 5,432 13,310 19,643 2,283 64,624 49,607

FY10F 27,461 5,432 12,855 18,293 2,120 66,161 49,357

FY11F 33,032 5,432 15,330 20,950 2,428 77,172 48,001

FY12F 39,881 5,432 16,319 23,410 2,713 87,754 46,566

7,426 92,782 8,556 12,771 21,327 24,071 17,345 1,434 64,178 571 1,865

7,729 121,961 8,183 39,256 47,438 21,735 21,380 (12,229) 78,323 675 2,102

13,314 128,831 9,250 44,374 53,623 21,735 20,872 (12,229) 84,000 759 2,102

15,696 140,868 9,844 47,227 57,071 21,735 21,488 (12,229) 88,065 843 2,102

16,379 150,699 9,510 45,622 55,131 46,834 (12,229) 89,736 928 2,102

26,169 28,604 92,782

40,861 43,637 121,961

41,970 44,831 128,831

49,858 52,803 140,868

57,933 60,963 150,699

1.86 4.9

1.36 (0.2)

1.23 1.0

1.35 8.8

1.59 5.4

2.15 69%

(0.94) -5%

(1.49) -13%

(0.91) -21%

0.57 11%

78.1 85.8 44.7 119.1

68.6 101.2 42.2 127.6

65.6 93.4 47.2 111.8

66.2 90.4 42.5 114.1

66.2 95.0 38.6 122.6

Nomura

113

4 January 2010

Unitech Ltd U T I N
P R O P E R TY | I N D I A

Maintained
NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED

Aatash Shah

+91 22 4037 4194 aatash.shah@nomura.com

BUY
Closing price on 24 Dec Price target Upside/dow nside Difference from consensus FY10F net profit (INRmn) Difference from consensus
So urce: No mura

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.

INR82

INR112
(set o n 2 No v 09)

32.4% 10.0% 7,355 -20.0%

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.

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.

Key financials & valuations
31 Mar (INRm n)
Revenue Repo rted net pro fit No rmalised net pro fit No rmalised EP S (INR) No rm. EP S gro wth (%) No rm. P /E (x) EV/EB ITDA (x) P rice/bo o k (x) Dividend yield (%) ROE (%) Net debt/equity (%) E a rnings re v is io ns P revio us no rm. net pro fit Change fro m previo us (%) P revio us no rm. EP S (INR)
Source: Company, Nomura est imat es

FY09 FY10F FY11F FY12F
29,265 1 ,964 1 1 ,964 1 7.37 (28.0) 1 .1 1 3.1 2.5 0.3 22.9 1 60.8 22,509 7,355 7,355 3.01 (59.2) 27.3 1 3.6 1 .9 0.0 6.9 42.0 7355 0.01 48,201 1 08 5,1 1 08 5,1 5.78 92.0 1 4.2 8.8 1 .6 0.0 1 .6 1 21 .8 1 08 51 5.78 81 9 ,51 29,296 29,296 1 .21 1 93.9 7.3 5.3 1 .3 0.0 1 8.4 3.8 29296 1 .21 1

Share price relative to MSCI India

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.

(Rs) 135 115 95 75 55 35 15

Price Rel MSCI India

200 180 160 140 120 100 80 60 Aug09 Sep09 Nov09
3m (25.0) (22.9) (31 .9)

May09

Dec08

Mar09

Jan09

Feb09

Jun09

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.

1m A bso lute (INR) A bso lute (US$ ) Relative to Index M arket cap (US$ mn) Estimated free flo at (%) 52-week range (INR) 3-mth avg daily turno ver (US$ mn) Sto ck bo rro wability M ajo r shareho lders (%) Ramesh Chandra and family
Source: Company, Nomura est imat es

Oct09

Apr09

Jul09

6m 5.2 9.4 (20.1 ) 4,1 99 52.0

2.8 2.2 0.9

1 5.1 1 /24.80 1 6.0 1 Hard 48.00

Nomura

114

4 January 2010

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.
Attractive valuation considering improving residential volumes and upcoming improvement in commercial leasing

Exhibit 113. Unitech: valuation summary
(as of Sep 2010) NAV Existing commercial assets on book + retail assets 33% stake in Unitech Wireless Price target Implied discount to NAV
Source: Nomura estimates

Value (INR mn) 258,865 10,000 24,893 293,758

Value (INR/share) 99 4 9 112 0%

Exhibit 114. Unitech: NAV breakdown by geography
Mohali 6% Bangalore Others 2% 3% Mumbai 14%

Exhibit 115. Unitech: NAV breakdown by segment
Retail 13%

Kochi 4% NCR-Noida 6% NCR-Delhi 6%

NCRGurgaon 26%

Residential 49%

Kolkata 8% NCRGreater Noida Hyderabad 3% 11%
Source: Nomura estimates

Chennai 11%

Commercial 38%

Source: Nomura estimates

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.

Nomura

115

4 January 2010

Unitech Ltd

Aatash Shah

Financial statements
Income statement (INRmn) Y ear-end 31 Mar Revenue Cost of goods sold Gross profit SG&A Operating profit EBITDA Depreciation EBIT Net interest expense Other income Earnings before tax Income tax Net profit after tax Minority interests Normalised NPAT Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR)
Source: Nomura estimat es

FY08 41,826 (12,887) 28,939 (6,649) 22,291 22,291 (205) 22,085 (2,804) 1,397 20,678 (3,986) 16,692 (79) 16,613 16,613

FY09F 29,265 (6,650) 22,615 (6,727) 15,888 15,888 (209) 15,679 (5,546) 4,259 14,392 (2,424) 11,968 (4) 11,964 11,964

FY10F 22,509 (10,263) 12,246 (800) 11,446 11,446 (295) 11,151 (3,373) 1,846 9,624 (2,270) 7,355 7,355 7,355

FY11F 48,201 (25,872) 22,329 (1,200) 21,129 21,129 (385) 20,744 (4,413) 3,439 19,770 (4,662) 15,108 15,108 15,108

FY 12F 81,519 (40,792) 40,727 (1,199) 39,528 39,528 (492) 39,036 (6,222) 5,364 38,178 (8,883) 29,296 29,296 29,296

Targeted sale volumes of 20mn sqft in FY10F should support FY11-12F revenue

8.0 10.9 8.0 0.3 (12.9) 3.6 2.8 2.8 69.2 53.3 52.8 39.7 19.3 44.7 9.8

11.1 15.2 11.1 0.3 (92.8) 2.5 3.1 3.1 77.3 54.3 53.6 40.9 16.8 22.9 6.0

27.3 37.2 27.3 (26.3) 1.9 13.6 14.0 54.4 50.9 49.5 32.7 23.6 6.9 4.1

14.2 19.4 14.2 14.4 1.6 8.8 9.0 46.3 43.8 43.0 31.3 23.6 11.6 7.2

7.3 10.0 7.3 7.3 1.3 5.3 5.3 50.0 48.5 47.9 35.9 23.3 18.4 12.8

(30.0) (28.7) (29.0) (28.0) (28.0)

(23.1) (28.0) (28.9) (59.2) (59.2)

114.1 84.6 86.0 92.0 92.0

69.1 87.1 88.2 93.9 93.9

10.2 10.2 10.2 22.9

7.4 7.4 7.4 32.2

3.0 3.0 3.0 43.6

5.8 5.8 5.8 49.8

11.2 11.2 11.2 61.0

Nomura

116

4 January 2010

Unitech Ltd

Aatash Shah

Cashflow (INRmn) Year-end 31 Mar EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
Source: Nomura estimates

FY08 20,678 (26,985) (4,035) (10,342) (23,508) (33,850) (3,409) (4,957) (42,216) (475) 53 45,935 560 46,073 3,856 10,227 14,083 (71,657)

FY09F 14,392 (10,784) (5,043) (1,435) (1,988) (3,423) (13,537) 5,175 (11,785) (475) 3,825 1,263 (463) 4,151 (7,634) 14,083 6,449 (84,109)

FY10F 11,151 (16,792) (1,974) (7,616) 8,511 896 1,846 2,742 46,832 (25,000) (10,148) 11,684 14,426 6,449 20,876 (44,683)

FY11F 20,744 (1,613) (4,277) 14,854 (2,140) 12,714 3,439 16,153 8,640 (10,000) (8,473) (9,833) 6,320 20,876 27,196 (28,364)

FY12F 39,036 (1,452) (8,391) 29,194 (4,326) 24,868 5,364 30,232 (10,000) (7,977) (17,977) 12,255 27,196 39,451 (6,108)

Balance sheet (INRmn) As at 31 Mar Cash & equivalents Total current assets LT investments Fixed assets Goodwill Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Other LT liabilities Total liabilities Minority interest Common stock Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%)
Source: Nomura estimates

FY08 14,082.7 164,159.9 14,164.5 10,459.1 1,125.9 20,983.4 224,975.5 83,092.5 83,092.5 85,523.7 19,195.8 187,812.0 1,158.7 3,246.8 32,758 37,164 224,975.5

FY09F 6,449.0 195,738.3 15,808.1 21,499.8 11,672.5 11,757.7 262,925.2 102,122.5 102,122.5 90,558.4 17,935.5 210,616.4 614.1 3,246.8 48,448 52,309 262,925.2

FY10F 20,875.1 195,738.3 15,808.1 31,225.9 11,672.5 275,319.8 87,122.5 87,122.5 65,558.4 16,143.3 168,824.2 614.2 4,888.4 100,993 106,496 275,319.8

FY11F 27,194.7 195,738.3 15,808.1 37,041.8 11,672.5 287,455.3 87,122.5 87,122.5 55,558.4 14,530.4 157,211.3 614.1 5,228.9 124,401 130,244 287,455.3

FY12F 39,450.2 195,738.3 15,808.1 42,630.2 11,672.5 305,299.2 87,122.5 87,122.5 45,558.4 13,078.7 145,759.6 614.1 5,228.9 153,696 159,539 305,299.1

Cashflows should be strong in FY11-12F, enabling reduction in leverage

7.9

2.8

3.3

4.7

6.3

3.21 192.8

5.29 160.8

3.90 42.0

1.34 21.8

0.15 3.8

Nomura

117

4 January 2010

Strategy | India

Prabhat Awasthi

Valuations and risks

Appendix
Exhibit 116. Summary of price targets, valuation methodology and risks
Companies ABB Ltd Ticker ABB IN Share price (24 Dec) Nomura Price target rating (INR) Valuation basis 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. 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%. Investment risks 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. 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. 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-thanexpected 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.

771 REDUCE

ACC

ACC IN

859.7 REDUCE

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.

Axis Bank

AXSB IN

990

BUY

A faster-than-expected rise in interest rates and 1,185 We value Axis Bank at 2.5x P/BV FY11 (sustainable RoE of 19.4% and growth rate of higher delinquencies are key risks to our rating and price target for Axis Bank. 7%). 330 Our DCF-based price target of INR330 is based on a WACC of 11.1% and a terminal growth rate of 4%. 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%. Risks to our price target include stronger-thanexpected competition and unfavourable regulatory developments related to various fees and charges. Upside risks emerge from an increase in BHEL's share in private sector projects.

Bharti

BHARTI IN

321 NEUTRAL

BHEL

BHEL IN

2,368 REDUCE

ColgatePalmolive

CLGT IN

663 REDUCE

600 Our 12-month price target of INR600 is based Cut in advertising and promotional spends: Colgate, on a P/E multiple of 24x FY10E EPS estimate relative to its size, is the biggest spender on of INR25.00. advertising and promotion in the Indian consumer sector. The company spends ~16% of sales on A&P, compared with a sector average of 12%. 1,300 Our 12-month price target of INR1,300 is based on 15x trailing 12 months (December11E) 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 34pp 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. 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. 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.

Container Corp

CCRI IN

1,270 NEUTRAL

Cummins India

KKC IN

405.5

BUY

450 We value the stock at 15x TTM December10E EPS, which is in line with historical oneyear forward multiples.

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.

Nomura

118

4 January 2010

Strategy | India

Prabhat Awasthi

Exhibit 116. Summary of price targets, valuation methodology and risks (continued)
Companies Dr. Reddy’s Ticker DRRD IN Share price (24 Dec) 1,186 Nomura Price target rating (INR) Valuation basis 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). 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. 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. Investment risks 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. 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.

GAIL

GAIL IN

420

BUY

GMR Infrastructure

GMRI IN

67.15 REDUCE

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. 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. The key risks are: 1) a substantial slowdown in order inflows; 2) execution delays and lower-thanestimated margins; and 3) a rise in interest rates and risk premium.

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.

Hindustan Construction

HCC IN

151

BUY 157 (under We value HCC using a sum-of-the-parts review) 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. BUY 397 (under Our DCF based price target is INR397 and is review) 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.

HCL Tech

HCLT IN

375

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.

Nomura

119

4 January 2010

Strategy | India

Prabhat Awasthi

Exhibit 116. Summary of price targets, valuation methodology and risks (continued)
Companies ICICI Bank Ticker ICICIBC IN Share price (24 Dec) 875 Nomura Price target rating (INR) Valuation basis 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 oneyear forward P/E. We also apply a 15% subsidiary discount to arrive at our final consolidated subsidiary value. 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. Investment risks Faster-than-expected growth is an upside risk to our estimates. Downside risks include slower-thanexpected 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

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%. 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. 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.

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. 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.

IRB Infra

IRB IN

242 REDUCE

ITC Limited

ITC IN

256

BUY

309 We value the company using a sum-of-theAny structural change in regulations could hamper parts valuation methodology. We value the the growth trajectory of the core cigarette business. 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. 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 12month 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.

IVRCL

IVRC IN

357

BUY

L&T

LT IN

1,682

BUY

1,867 We value L&T's standalone business at 22.5x In our view, rise in interest rates and risk premium one-year forward EPS (INR71.8 as on are the key risks to our valuations. September 2010) and subsidiaries at INR252/share. 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. 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. 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.

Mahindra & Mahindra

MM IN

1,061.85

BUY

Mundra Port & SEZ

MSEZ IN

560.5

BUY

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.

Nomura

120

4 January 2010

Strategy | India

Prabhat Awasthi

Exhibit 116. Summary of price targets, valuation methodology and risks (continued)
Companies Nagarjuna Construction Ticker NJCC IN Share price (24 Dec) 165.85 Nomura Price target rating (INR) Valuation basis 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. 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. 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. Investment risks 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

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

The key upside risk to our call is a) greater-thanexpected 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. Faster-than-expected loan growth and a slowerthan-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. Realisation of product specific opportunities, above our expectation.

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.

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. 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. 154 Our DCF-based price target of INR154 is based on a WACC of 12.7% and a terminal growth rate of 4%. 2,590 We value SBI at 1.8x FY11F P/BV for the (under core banking business, based on sustainable review) 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. 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.

Reliance Capital

RCFT IN

851 REDUCE

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

Key upside risks to our ratings include competitive activity that is more benign than anticipated and faster-than-anticipated stability in pricing. A faster-than-expected rise in rates or slower-thanexpected loan growth are key risks to price target and earnings forecast.

State Bank of India

SBIN IN

2,215

BUY

Steel Authority of India Limited

SAIL IN

237

BUY

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. 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.

Sun TV

SUNTV IN

336.25

BUY 355 (under We use a DCF method to value SUN TV and review) 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%. 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

Tata Motors

TTMT IN

779.95 REDUCE

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.

Nomura

121

4 January 2010

Strategy | India

Prabhat Awasthi

Exhibit 116. Summary of price targets, valuation methodology and risks (continued)
Companies TATA Steel Ticker TATA IN Share price (24 Dec) 615.60 Nomura Price target rating (INR) Valuation basis 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. Investment risks 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. There are two risks to our target price 1) greaterthan-expected appreciation of the rupee against the US dollar and 2) a double dip recession in the global economy. 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. (1) A slowdown in industrial capex would lead to a slowdown in revenue growth. (2) A higher-thananticipated increase in raw material costs could lead to a decline in margins. (3) Appreciation in Indian rupee could hurt the company's exports. 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. There are two risks to our target price: 1) greaterthan-expected appreciation of the rupee against the US dollar and 2) a double dip recession in the global economy.

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. 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. 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%. 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. 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. 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.

Tech Mahindra

TECHM IN

1,003

BUY

Thermax Ltd

TMX IN

592.55 NEUTRAL

Unitech

UT IN

82.00

BUY

Wipro

WPRO IN

694 NEUTRAL

Zee Entertainment

Z IN

265.5

BUY

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

Nomura

122

4 January 2010

Strategy | India

Prabhat Awasthi

Nomura

123

4 January 2010

Strategy | India

Prabhat Awasthi

Nomura

124

4 January 2010

Strategy | India

Prabhat Awasthi

Any Authors named on this report are Research Analysts unless otherwise indicated
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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.

Nomura

125

4 January 2010

Strategy | India

Prabhat Awasthi

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 (exAsia): 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.

Nomura

126

4 January 2010

Strategy | India

Prabhat Awasthi

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.

Nomura

127

4 January 2010

Strategy | India

Prabhat Awasthi

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Nomura

128

4 January 2010

Nomura Asian Equity Research Group
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