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A Grand project On Equity Research

SUBMITTED TO: AES POST GRADUATION INSTITUTE OF BUSINESS MANAGEMENT AHMEDABAD

In partial fulfillment of MBA 2nd year full time program of Gujarat University (Batch: 2006-08)

SUBMITTED BY: Pankti Shah (Roll No.46)

Project Guide: Prof. Falguni Pandya

CERTIFICATE

This is to certify that Pankti Shah has successfully completed her Grand Project titled Equity Research under the guidance of Prof. Falguni Pandya for the partial fulfillment of the M.B.A. program (batch 2006-2008) from AES Post Graduate Institute of Business Management, Gujarat University.

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Executive Director Dr. A. H. Kalro

Project guide Prof. Falguni pandya

Date: Place:Ahmedabad

Acknowledgement
First and foremost I would like to acknowledge my institute-Ahmedabad Education Society Post Graduate In Business Management (AESPGIBM)-for providing me an opportunity to work on Equity Research.

A study of such a subject would not have been possible without the help of a large number of people. To enlist them all would be disproportionate with relation to this project. However there are a few people who I would like to Thank for being an integral part of my study process.

I would like to thank my guide Prof Falguni Pandya for her guidance and inspiration.

For my practical work, I would like to express my gratitude to Prof Taral Pathak for supporting me at each and every phase.

On a personal note I would like to thank to all my friends who helped me in whatever possible ways during project and in completion of my report and also encouraged me during difficult times to carry on with my work.

Last but not the least I would like to thank my Family for standing by me. I would like to thank Almighty for providing me the confidence to face and overcome the hurdles. I wish to express my gratitude to all of them.

Pankti Shah

Executive Summary

This project report is about equity research that starts with the introduction of stocks, stock market, stock valuation, factor affecting stock valuation, valuation methods, about value and valuation techniques which are explained in detail in chapter 1. Macro Economic Factors affecting Indian Economy are explained in chapter 2. Industry analysis which contains introduction to industry, five force analysis, risk in industry, budget impact are covered in chapter 3. Chapter 4, 5, and 6 are parts of company analysis which includes Summary, P&L Account, Free cash flow calculation, discounted cash flow calculation and sensitivity analysis of Bhel, Siemens and Thermax respectively. Report ends with conclusion, recommendation, limitation, learning and bibliography.

Objectives
To learn how to do Equity Research. Doing analysis of the company on the basis of secondary data. Projecting their future on the basis of financial data and determining the reasons for their good or bad performance in the market and also to estimate its future market value. To determine whether the company stocks are worth buying or not and also what would be the probable market price if certain factor changes.

Operating Method
Below given steps are followed in their chronological order: Selection of Economy for investment Selection of Sector Selection of Company Collecting historical data Estimation of share prices using DCF in various possible circumstances.

Data required for Study

Company details Financial data Directors and Auditors report Current news about the company and sector

Scope of Work
Study was done on the basis of data available on net. Visit of the company was not feasible Newspapers, magazines and stock market scenario were also taken into consideration

Study based on literature

From available books, internet, newspapers. Basic Concepts Analysis Method

INDEX
Chapter 1: Introduction 1.1 About stocks 1.2 About stock market 1.3 Stock Valuation 1.4 Factors that affect stock Valuation 1.5 Stock Valuation methods 1.6 About Value 1.7 Valuation Techniques Chapter 2 Macro Economic Factors affecting Indian Economy Chapter 3 Industry Analysis 3.1 Introduction 3.2 Five force Analysis 3.3 Risk in capital good industry 3.4 Budget Impact Chapter 4 Company Analysis BHEL Summary of BHEL P&L Account Free Cash Flow Calculation Discounted Cash Flow Calculation Sensitivity Analysis Chapter 5 Company Analysis Siemens Summary of Siemens P&L Account Free Cash Flow Calculation Discounted Cash Flow Sensitivity Analysis Chapter 6 Company Analysis Thermax Summary of Thermax 01 02 04 05 07 08 11 12 34 40 41 43 44 48 49 50 51 64 65 66 67 70 71 72 79 80 81 82 85 86 87

P&L Account Free Cash Flow Calculation Discounted Cash Flow Calculation Conclusion Recommendation Limitation Learning Bibliography

94 95 96 100 100 100 100 101

CHAPTER 1

INTRODUCTION
1.1 About stocks
What Are Stocks? In finance, a stock represents a share in the ownership of an incorporated company. In industrial societies wealth used in production is owned in the aggregate mostly by corporations rather than by individuals because of the huge investments required. This trend began in 17th-century England when merchants formed JOINT-STOCK COMPANIES, pooling capital to be used jointly in trading and manufacturing. Participants then received dividends, shares of the common PROFIT proportionate to their original investments.

The Definition of a Stock : Plain and simple, stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. Whether you say shares, equity, or stock, it all means the same thing. The wealth of individuals includes claims against, or investments in, corporations. These are called securities, the two most common being bonds and stocks. Corporate bonds are evidences of corporate debt to the bondholder. Stocks are evidences of ownership, or equity. Investors buy stock in the hope that it will yield income from dividends and appreciate, or grow, in value.

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Different Types Of Stocks : There are two main types of stocks: Common stock Preferred stock

Common stock: When people talk about stocks they are usually referring to this type. In fact, the majority of stock is issued is in this form. Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investors get one vote per share to elect the board members, who oversee the major decisions made by management. Over the long term, common stock, by means of capital growth, yields higher returns than almost every other investment. This higher return comes at a cost since common stocks entail the most risk. If a company goes bankrupt and liquidates, the common shareholders will not receive money until the creditors, bondholders and preferred shareholders are paid.

Preferred Stock: Preferred stock represents some degree of ownership in a company but usually doesn't come with the same voting rights. (This may vary depending on the company.) With preferred shares, investors are usually guaranteed a fixed dividend forever. This is different than common stock, which has variable dividends that are never guaranteed. Another advantage is that in the event of liquidation, preferred shareholders are paid off before the common shareholder (but still after debt holders). Preferred stock may also be callable, meaning that the company has the option to purchase the shares from shareholders at anytime for any reason (usually for a premium). Some people consider preferred stock to be more like debt than equity. A good way to think of these kinds of shares is to see them as being in between bonds and common shares.

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1.2 About Stock Market

Why invest in the stock market? It is risky to invest in stock market as returns are not sure. Also it is difficult to say with surety whether they will make a profit or loss but the average investor buys stock hoping that the stock's price will rise, so the shares can be sold at a profit. They take the risk of the price falling because they hope to make more money in the market, than they can with safe investments such as bank CD's or government bonds.

What Stock Market Returns to Expect? Stock market returns rely solely on what types of investments you choose. The riskier the investments, the more you can gain or lose in any year. However, if you are investing for a long time horizon, then more risk will almost surely mean higher returns. Also note that this assumes you invest in a diversified portfolio (i.e. not just one stock). There is no hard and fast rule as to exactly what to expect when you invest. And because the amount of risk you take in your investments can also not be measured accurately, it is even harder to know what type of returns to expect.

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1.3 Stock Valuation

Stock valuation can be considered as a tool for picking out stocks that will bring you good returns. Imagine buying a car without knowing its value, or investing thousands of dollars in property with no potential. sounds scary? Yet, this is exactly what it amounts to if you put money into deals without assessing the value.

Intelligent investment needs a lot of effort. If you want to invest in stocks, the first thing to look out for is its valuation. Valuation of a stock means the price or 'actual' value it holds. If you are doing stock valuation then you need not study the stock chart every time or worry about the trend in the market or the interest rates of the stocks. Never invest in stocks without knowing the value, because that is like going up a blind alley where you have no idea what you will end up with.

Investment in stocks without valuation is like risking your money deliberately. While the fluctuations in the stock market cannot be avoided, with the accurate valuation of a stock, you can minimize the risk factor. It will ensure that you not shoot in the dark, and make sensible investments. Use the valuation of stocks to serve as a guide for buying and selling stocks.

Instead of pouring your hard earned money into stocks without valuation, it is better to be patient and carry out a thorough research to determine the worth of stocks before buying. You do not have to be a math genius, or a stock market guru either. All you need is basic mathematical skill, and the perseverance to look for all the valuation information available.

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You cannot make the most of valuation if you do not understand or appreciate its importance in the stock market. Spending a large amount in buying shares based on what others say may well result in losses. Neither should you buy based on media hype, as this may mislead you, and you may end up losing every penny you invested. Owning stocks of a company in the form of shares can be a very good wealth-building tool for you as it grants you claim on everything that the company owns. Hence, assessing the value of the company, the profit it is generating and how beneficial it can prove to you, is a worthwhile enterprise. Valuation can prove to be especially beneficial for middle class investors, as they have limited resources to overcome losses occurred in stock market.

Therefore, valuation can be considered the key factor in buying stocks. Just as one assesses the value of anything one buys on the basis of a specified standard, stocks too need to be valued to determine whether the investment will bring you returns or not. Be aware, there are companies in the stock market that are making huge profits, but their stocks are of no value. Hence, spending time on carrying out your own research will help you pick up the right stock for your portfolio.

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1.4 Factors that Affect Stock Valuation

Overall market: Often quoted is "all boats float up or down with the rise and fall of the tide", but the stock market is not pulled up or down by the moon (at least I don't think so). When the market is going up, 2 out of 3 stocks are rising. When the market is going down, 3 out of 4 are tanking with it.

Industry : There are market sectors, such as financial services and health care, that traditionally do well. One year it may be coal (yes, in 1964), another year technology (most of 1990s), or gold (2002).

Companies within an industry: When many companies within an industry are doing well, they tend to pull the rest of the companies in the industry up with them. When they are failing, they tend to pull related companies down with them.

News visibility: When a company is in the news with new, leading-edge products, its stock price will generally rise. But watch out for a quick reversal on ANY bad news.

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1.5 Stock valuation Methods

There are several methods used to value companies and their stocks. They attempt to give an estimate of their fair value, by using fundamental economic criteria. This theoretical valuation has to be perfected with market criteria, as the final purpose is to determine potential market prices.

Fundamental Analysis (fair value intrinsic value based) Fundamental analysis is seeking the reason for the price change or for its prediction. It is a logical method. Fundamental Analysis uses the financial statements of the company to investigate the value of the company with regard to its potential growth in earnings. It starts with abroad analysis of the economy: economy growth, inflation, unemployment, money supply and the level and direction of interest rates.

By considering the indicators that affect the economy, financial analysts can then forecast future levels of GDP. These forecasts are used as a basis for projecting the future sales and earnings of the companies within these industries. Fundamentalists then select the common stock with favorable sectors of the economy. This method of forecasting is called top- down approach. The other approach financial analyst use is the bottom- top approach, which starts with sales and earnings projections for companies in different sectors of the economy in which they are. The analyst look for certain characteristics of the companies as basis for selection as low sales- to price- earning ratio, low p/e ratio, or small or mid cap stocks.

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The procedure to do fundamental analysis is first select the country or economy for investment. Then select the sector on the basis of certain factors like most upcoming, current market scenario, future potential, government support, demand, past performance, etc. Then select the company on the basis as told above. In bottom-up approach sales is forecasted on the basis of current new, past of the company, certain triggers which can affect its sales or profit margin. Then other calculations are done on the sales basis or are budgeted and net profit is arrived. Finally the discounted cash flow statement is made to arrive at target price. Finally the ratios are calculated which tell about valuation of the company like ROE, EPS, P/E, etc.

The most theoretically sound stock valuation method is called discounted cash flow (DCF) method, involving discounting the profits (dividends, earnings, or cash flow) the stock will bring to the stockholder in the foreseeable future, and a final value on disposition. The discount rate normally has to include a risk premium which is commonly based on the capital asset pricing model.

Arguments against Fundamental Analysis: Those who do not use fundamental analysis have two major arguments against it. The first is that they believe that this type of investing is based on exactly the kind of information that all major participants in publicly traded markets already know, so therefore it can provide no real advantage. If you cannot get a leg up by doing all of this fundamental work understanding the business, why bother? The second is that much of the fundamental information is "fuzzy" or "squishy," meaning that it is often up to the person looking at it to interpret its significance. Although gifted individuals can succeed, this group reasons, the average person would be better served by not paying attention to this kind of information. Also it is difficult to quantify the qualitative factors that may affect a business.

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Technical Analysis(Market based)

Technical analysis is not at all concerned about the fundamental factors of the company and the economic environment. Instead, it focuses on the companys historical stock price movements and the trading volume of the stock. From the information technical analyst will predict future stock price of the stock. The technician focuses on shorter time horizon then fundamental analyst. Most large broking firms rely on technical analysis for their selection of the stock. As doing fundamental analysis of each and every firm would be difficult and tedious as it is time consuming and complex brokers rely mostly on technical details as they are easy to get and understand as compared to fundamental analysis. The methods used for technical analysis are Line charts, Bar charts, Point and Figure charts, Candle stick charts. The Market indicators are Dow theory which focuses on primary, secondary and tertiary price movements. Volume and new Highs and Lows are also used for indications. In the trend method daily moving average, 200 day average and 52 weeks high- low. 52 week high is considered resistance and 52 week low is considered support. If the company moves below support it is dangerous and if above resistance level means moving towards new highs.

Arguments against Technical Analysis. Technical analysis assumes that certain chart formations can indicate market psychology about either an individual stock or the market as a whole at key points. Much of the faith in technical analysis hinges on anecdotal experience, not any kind of long-term statistical evidence, unlike certain quantitative and fundamental methodologies that have been shown in many instances to be pretty predictive. Critics of technical analysis feel that it is basically as useful as reading tea leaves.

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1.6 About Value?

In general, the value of an asset is the price that a willing and able buyer pays to a willing and able seller Note that if either the buyer or seller is not both willing and able, then an offer does not establish the value of the asset Several Kinds of Value There are several types of value, of which we are concerned with four: Book Value The carrying value on the balance sheet of the firms equity (Total Assets less Total Liabilities) Tangible Book Value Book value minus intangible assets (goodwill, patents, etc) Market Value - The price of an asset as determined in a competitive marketplace Intrinsic Value - The present value of the expected future cash flows discounted at the decision makers required rate of return

Determinants of Intrinsic Value There are two primary determinants of the intrinsic value of an asset to an individual: The size and timing of the expected future cash flows. The individuals required rate of return (this is determined by a number of other factors such as risk/return preferences, returns on competing investments, expected inflation, etc.) .Note that the intrinsic value of an asset can be, and often is, different for each individual (thats what makes markets work).

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1.7 Valuation Techniques

Some companies do not pay dividends, or the dividends are unpredictable.

In these cases we have several other possible valuation models:

Earnings Model Free Cash Flow Model P/E approach Price to Sales (P/S)

The Earnings Model The earnings model separates a companys earnings (EPS) into two components: Current earnings, which are assumed to be repeated forever with no growth and 100% payout. Growth of earnings which derives from future investments. If the current earnings are a perpetuity with 100% payout, then they are worth:

VCE =

EPS1 k

VCE is the value of the stock if the company does not grow, but if it does grow in the future its value must be higher than VCE so this represents the minimum value (assuming profitable growth). If the company grows beyond their current EPS by reinvesting a portion of their earnings, then the value of these growth opportunities is the present value of the additional earnings in future years.

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The growth in earnings will be equal to the ROE times the retention ratio (1 payout ratio): Where b = retention ratio and r = ROE (return on equity). If the company can maintain this growth rate forever, then the present value of their growth opportunities is:

NPV1 PVGO = = kg

r r RE1 RE1 RE1 1 k k = kg kg

Which, since NPV is growing at a constant rate can be rewritten as:

The value of the company today must be the sum of the value of the company if it doesnt grow and the value of the future growth

VCS

r RE1 1 EPS1 NPV1 EPS1 k = + = + k kg k kg

Where RE1 is the retained earnings in period 1, r is the return on equity, k is the required return, and g is the growth rate

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The P/E Approach

The most common way to value a company is to use its earnings. Earnings, also called net income or net profit, is the money that is left over after a company pays all of its bills. To allow for apples-to-apples comparisons, most people who look at earnings measure them according to earnings per share (EPS).It divides market price per share(MPS). P/E = MPS EPS

Is the P/E the Holy Grail?

There is a large population of individual investors who stop their entire analysis of a company after they figure out the trailing P/E ratio. With no regard to any other form of valuation, this group of unFoolish investors blindly plunge ahead armed with this one ratio, purposefully ignoring the vagaries of equity analysis. Popularized by Ben Graham (who used a number of other techniques as well as low P/E to isolate value), the P/E has been oversimplified by those who only look at this number. Such investors look for "low P/E" stocks. These are companies that have a very low price relative to their trailing earnings. Also called a "multiple", the P/E is most often used in comparison with the current rate of growth in earnings per share. The Foolish assumption is that for a growth company, in a fairly valued situation the price/earnings ratio is about equal to the rate of EPS growth.

Are Low P/E Stocks Really a Bargain?

With the advent of computerized screening of stock databases, low P/E stocks that have been mispriced have become more and more rare. When Ben Graham formulated many of his principles for investing, one had to search manually through pages of stock tables in order to ferret out companies that had extremely low P/Es. Today, all you have to do is punch a few buttons on an online database and you have a list as long as your arm.

This screening has added efficiency to the market. When you see a low P/E stock these

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days, more often than not it deserves to have a low P/E because of its questionable future prospects. As intelligent investors value companies based on future prospects and not past performance, stocks with low P/Es often have dark clouds looming in the months ahead. This is not to say that you cannot still find some great low P/E stocks that for some reason the market has simple overlooked -- you still can and it happens all the time. Rather, you need to confirm the value in these companies by applying some other valuation techniques.

The PEG and YPEG

The most common Foolish applications of the P/E are the P/E and growth ratio (PEG) and the year-ahead P/E and growth ratio (YPEG). Rather than reinvent the wheel, as there is a wonderful series of articles already written on these very subjects in Fooldom, I will simply direct your attention to them and talk about them very briefly. The full article on the PEG and YPEG, titled "The fool ratio

While the PEG is most often used for growth companies, the YPEG is best suited for valuing larger, more-established ones. The YPEG uses the same assumptions as the PEG but looks at different numbers. As most earnings estimate services provide estimated 5year growth rates, these are simply taken as an indication of the fair multiple for a company's stock going forward. As always, one must view the PEG and YPEG in the context of other measures of value and not consider them as magic money machines.

Multiples
Although the PEG and YPEG are helpful, they both operate on the assumption that the P/E should equal the EPS rate of growth. Unfortunately, in the real world, this is not always the case. Thus, many simply look at estimated earnings and estimate what fair multiple someone might pay for the stock. For example, if XYZ Corp. has historically traded at about 10 times earnings and is currently down to 7 times earnings because it missed estimates one quarter, it would be reasonable to buy the stock with the

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expectation that it will return to its historic 10 times multiple if the missed quarter was only a short-term anomaly.

THE P/E IS hands down the most popular ratio among investors. It has its limitations (as we'll see in a minute), but it's also easy to calculate and understand. If you want to know what the market is paying for a company's earnings at any given moment, check its P/E.

The biggest weakness with either type of P/E is that companies sometimes "manage" their earnings earnings number the company reported to the Security and Exchange Commission. Its disadvantage is that those earnings will almost certainly change for better or worse in the future. By using an estimate of future earnings, a forward P/E takes expected growth into account. And though the estimate may turn out to be wrong, it at least helps investors anticipate the future the same way the market does when it prices a stock.

Pure hypothetical: Suppose you have two stocks with accounting wizardry to make them look better than they really are. A wily chief financial officer can fool with a company's tax assumptions during a given quarter and add several percentage points of earnings growth. It's also true that quality of earnings estimates can vary widely depending on the company and the Wall Street analysts that follow it. The bottom line is that despite its popularity, the P/E ratio should be viewed as a guide, not the gospel. As a rule of thumb, or simplified model, analysts often assume that a stock is worth some justified P/E ratio times the firms expected earnings. This justified P/E may be based on the industry average P/E, the companys own historical P/E, or some other P/E that the analyst feels is justified. To calculate the value of the stock, we merely multiply its next years earnings by this justified P/E

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The PEG approach

The PEG approach is a simple valuation tool, popularized by Peter Lynch and The Motley Fool among many others. Here is how Lynch puts it in One Up on Wall Street: "The p/e ratio of any company that's fairly priced will equal its growth rate." In other words, P/E = G where P/E is the stock's P/E ratio, and G is its earnings growth rate. One way people misuse PEG and get themselves into trouble is by taking earnings from two successive years off of an annual report, and using them to calculate the earnings growth rate: That's dangerous! Each year's earnings is a highly refined number, potentially including significant non-recurring items. That means the change between these two numbers can be very different from what you really want, namely, a conservative estimate for earnings growth that can be sustained over the next five years or more.

The P/S Approach

The trouble with the P/E ratio is that earnings is a complicated "bottom line" number, sometimes reflecting non-recurring events; so many people look at sales revenue as a more reliable indicator of a company's size and growth. The Price/Sales ratio, also called the "PSR", is a company's stock price divided by its annual sales per share.

Since P/S = P/E x (profit margin), you can find any of these quantities if you know the other two: One common way people abuse the Price/Sales ratio is by assuming that a PSR of 1.0 is right for all companies, and then hunting for "bargains" selling at a PSR of 0.5 or less. That simply doesn't work in general, since different industries have widely different profit margins, ranging from 2% for many discount retailers to 20% or more for some software companies; so a P/S of 1.0 would be on the pricey side for the retailer, but extremely cheap for the software company.

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A second problem with the PSR is that sales, unlike earnings, contains no information about a company's debt. It's easy to find lots of companies with no profits and huge debt selling at a PSR of 0.1 or less. Some of these are on the verge of bankruptcy; definitely not "bargains".

Use of psr While not quite as useful as the P/E ratio and the P/B ratio as a valuation measure, the price-to-sales ratio (P/S) comes in quite handy when evaluating unprofitable companies, which do not have P/S Ratio = Market cap (shares outstanding * market price per share)/Total sales

Total sales can be found at the top of the income statement. Some companies will list total sales (also called revenues) on the first line, while others will list revenues from different business segments first and then add them to get total sales. Some companies will use "net sales" instead of total sales, which is arrived at by subtracting cash discounts, goods returned for credit, and other allowances. It is fine to use net sales in calculating the P/S ratio.

The Positives of P/S

1. Unlike the P/E and P/B ratios, the P/S ratio doesn't involve accounting estimates that can be used by the company to inflate, or even deflate, earnings. That said, companies can still manipulate sales, so we must look carefully at how a company records its revenues.

2. For cyclical companies and turnarounds, we cannot use the P/E ratio when earnings are negative. But as long as the company is not headed for bankruptcy, we can use the P/S ratio to track what the market is willing to pay for its sales. If the company's P/S ratio is much lower than others in its industry, it may indicate a value opportunity. For young companies yet to make a profit, we often look for high sales growth, which we hope will translate into net earnings and, ultimately, free cash flow. The P/S ratio tells us how much the market is paying for sales and gives some indication of value.

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3. Some investors consider a relatively low P/S ratio with a rising stock price (high relative strength) to be a good basis to invest in growth stocks that have suffered a temporary setback.

4. As with P/E and P/B, the P/S ratio can help compare a stable company's current value to its past valuations. Websites such as MSN Money will display the price ratios for the past 10 years (after you enter in the ticker for the company you're interested in click "financial results" in the left-hand column, then "key ratios," then "10-year summary"). If the current P/S ratio is less than the 10-year average, it may indicate a value.

Flaws of P/S Ratio

1. Just as the P/E ratio should be considered with earnings growth and the P/B ratio with return on equity, the P/S ratio should be considered in tandem with net margin (also called net profit margin, it's net income divided by total sales). Both Wal-Mart (NYSE: WMT) and Microsoft (Nasdaq: MSFT) are fine companies with very strong competitive advantages, but a comparison of their P/S ratios alone tells us very little. Wal-Mart has a P/S ratio of 0.66, compared to Microsoft's 7.12. Earlier, I said that a P/S ratio under 1.0 generally has been used as a value benchmark, which would suggest that Wal-Mart is undervalued and Microsoft is considerably overvalued. Yet a check on their net margins explains this discrepancy: Microsoft's net margin is 30.8%, and Wal-Mart's is just 3.6%. Microsoft's greater profitability is reflected in its price, which accounts for its higher P/S ratio.

2. A company can book sales for which it has not yet provided the goods or services, or before a customer is obligated to pay. This is called channel stuffing and leads to inflated sales and earnings, and consequently, lower P/S and P/E ratios. In August 2004, the Securities and Exchange Commission settled a case against Bristol-Myers Squibb (NYSE: BMY) for improperly recognizing revenues and channel stuffing. To make sure this is not happening, look at the receivables on the balance sheet. If they are increasing a lot faster than sales, it is likely that some revenues are not being collected. Another 27

warning would be declining cash flows from operations on the cash flow statement even as net earnings rise.

3. Generally a company with higher debt will have a lower P/S ratio, because some of those sales, when converted to cash, have to go toward debt interest and paying down debt -- not to equity holders. When comparing companies with significantly different debt loads, it's best to compare enterprise value-to-sales (enterprise value = market capitalization + debt - cash). For an example, look at theme-park operator Six Flags (NYSE: PKS), which has a P/S ratio that seems to be in value territory at 0.64. However, Six Flags is carrying $2.31 billion in debt and just $116 million in cash.

Its market cap is $685 million, but its enterprise value is $2.88 billion. The EV/S ratio is 2.67, which does not indicate a value for a company that is not currently making a profit, and one that is not expected to do so next year either.

4. A company that earns commissions on total sales may book total sales on its income statement instead of commissions, thereby drastically lowering the P/S ratio. This is perfectly legitimate, but it distorts the P/S ratio. Consider online travel company Priceline.com (NASDAQ: PCLN). Its total trailing 12 months revenue is recorded on the income statement as $954 million, but the revenue flowing to the company is recorded as $253 million, with the difference reported as cost of goods sold. The current P/S ratio is shown on all financial websites as 0.96, generally indicating an undervalued company, but based on the actual commissions received by the company, the P/S ratio would be 3.64.

Competitive Analysis of Stocks

By far the most important way to value any company is to compare it to others. By using competitive analysis, you can put to use all of the ratios above and compare them to one another so that you can get a much more complete picture of the stock valuation of the company you are researching. To start a competitive analysis, follow these steps:

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1 - Find a list of comparable companies.

A comparable company is any company that is similar to the company you are valuingTo find a quick list of comparable companies you can search most financial sites by industry and get a list of all stocks that are included in that industry. I usually use Yahoo Finance. This is the easiest way to find comparable companies, however it is not a very comprehensive list and many companies are so unique that they do not have identical competitors. If this is the case, you need to use your imagination. Find companies that provide similar goods or services, or that have similar business models. Even if the companies don't do the same thing, if there growth and outlook is similar, the stocks will often be valued similar, and you can therefore compare them to each other.

Once you've compiled as comprehensive list of companies as possible, it's time to create your spreadsheet table for analysis.

2 - Create a spreadsheet.
Create a spreadsheet to organize your competitive stock analysis. List the comparable companies down the left side of the spreadsheet and the ratios and values you are computing along the top / columns. Suggested columns include Company Name, Ticker, Price, Fully Diluted Shares, Market Cap, Total Debt, Enterprise Value, LTM Sales, LTM EBITDA, LTM Net Income, LTM EPS, This Year Calendar EPS (estimated), Next Year Calendar EPS (estimated), 3 - 5 Yr Growth Rate (estimated), LTM P/E, This Year P/E, Next Year P/E, PEG Ratio, Price / Sales, EV / Sales, EV / EBITDA ratio and anything else you see fit to add. For examples of how each value is included, refer to the stock valuation section. If you'd like to use our Excel spreadsheet template, please click here to download.

3 - Gather the data.

Now it's time to fill the spreadsheet in by gathering all of the financial data for each of the comparable companies. You can find the information from several sources, but if you want to do the most accurate job, then you should look for numbers directly from the

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companies and then adjust them yourself if necessary. At first it will seem a little confusing, but once you've looked at a few dozen companies you'll begin to understand more and more about what their numbers and ratios mean. To start, go to each company's website and look for their investor section. They usually have quarterly and annual financial statements, as well as press releases, recorded conference calls and webcasts, and sometimes they'll even have product updates and more. Read as much information as you can. If you can't find much historical information on the company's website, visit any finance site for more info (I like Yahoo Finance for information and BigCharts.com for charting). Begin filling in the columns of your spreadsheet with the information you are gathering.

To get the estimated fields (like future EPS and EPS growth) you'll have to create estimates by doing your own stock research. When you've finished doing that, you'll be ready to compute the ratios.

4 - Compute the ratios.

Computing the stock valuation ratios can be tricky, so make sure that you double check each figure to see that it makes sense. The example comparable stock analysis spreadsheet we've compiled has many of the ratios computed for you.

5 - Look for Outliers and Adjust the Ratios.

Now look closely at all of the stock valuation ratios you've computed. Do any of them stand out? You should look for any outliers and then try to adjust them so that they are comparable to the other companies. When you find a number that doesn't make sense or seems too high or low there is always a reason behind it. It could be that earnings are negative, that the company's asset structure is different, or that the figures you're using to compute it are wrong. Even if you can't adjust or correct the valuation ratios it is just as important to understand why they are different. Now that your spreadsheet is complete, it's time to compare the companies' stock valuations.

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6 - Compare the Companies.

Look at each stock valuation ratio and compare it to the other companies. Then, look at all of the ratios for each company and compare all of them to the other companies. Study the differences and valuations long and hard. Go away and then come back to them in a few days when you have fresh eyes. Begin to form an opinion as to which company offers the best value and growth prospects. Begin to think about whether the company you are investigating is worth buying, or if you should perhaps wait until its valuation becomes more attractive.

7 - Account for Differences.

Explain each difference between the companies to yourself. If one company has higher growth, then it likely has a higher valuation. Use the PEG ratio to determine which company's growth is price more attractively. Look at the company's overall market cap to determine it's liquidity and size. Larger companies are often priced at a premium because of the strong historical growth record and stability, while smaller companies often get a premium because they can grow faster than large companies. Companies that are barely profitable or going through the early stages of restructuring often have depressed earnings and therefore their P/Es sometimes look astronomically high. In summary, each ratio is high or low for some reason. Find that reason and you will learn one more thing about the company you wish to value.

8 - Decision.
The final step is to make your decision as to whether or not the stock you valued is worth buying. To do that, you'll want to take this competitive stock valuation into account, but you'll also want to do your own investment research and make sure that the stock fits your investment philosophy, strategy and style. Once you've read the other sections of this website, you should be able to make your decision. If you are still unsatisfied and feel like you need to do more, there are tons of investment books and magazines that will help you make decisions and find new investments

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About Dividend Discount Model

The dividend discount model can be a worthwhile tool for equity valuation. Financial theory states that the value of a stock is the worth all of the future cash flows expected to be generated by the firm discounted by an appropriate risk-adjusted rate. We can use dividends as a measure of the cash flows returned to the shareholder. There are several dividend discount models (DDMs), and this article will address two of the more basic forms of the DDM -- the stable model and the two-stage model.

Inputs into the DDM

Several inputs are required to estimate the value of an equity using the DDM.

* *

DPS(1) = Dividends expected to be received in one year. Ks = The required rate of return for the investment. The required rate of return can be estimated using the following formula: Risk-free rate + (Market risk premium) * Beta

The rate on t-bills can be used to determine the risk-free rate. The market risk premium is the expected return of the market in excess of the risk-free rate. Beta can be thought of as the sensitivity of the stock compared with the market. g = Growth rate in dividends

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Stable Model
Value of stock = DPS(1) / Ks-g Caveats: The stable model is best suited for firms experiencing long-term stable growth. Generally, stable firms are assumed to grow at the rate equal to the long-term nominal growth rate of the economy (inflation plus real growth in GDP). In other words, the model assumes it is impossible to grow at 30% forever, otherwise, the company would be larger than the economy.

If the growth rate of the firm exceeded the required rate of return, you could not calculate the value of the stock. This is because if g>Ks, the result would be negative, and stocks do not have a negative value.

Another caveat is that models are often very sensitive to the assumptions made regarding growth rates, time frame, or the required rate of return.

Finally, the dividend discount model generally understates the intrinsic value of the firm. Important considerations such as the value of patents, brand name, and other intangible assets should be used in conjunction with the DDM to assess the value of a firm's equity. These intangibles should be added to the result of a DDM calculation to arrive at a more appropriate valuation.

The Two-Stage Model

The two-stage model attempts to cross the chasm from theory to reality. The two-stage model assumes that the company will experience a period of high-growth followed by a decline to a stable growth period.

Caveats: The first issue to deal with when using the two-stage model is to estimate how long the high growth period should last. Should it be 5 years, 10 years, or maybe longer?

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The next caveat is that the model makes an abrupt transition from high growth to low growth. In other words, the model assumes that the firm may be growing at 30% for five years only to then grow at 6% (stable growth) until eternity. Is this realistic? Probably not. Most firms experience a gradual decline in growth rates as their business matures (hence, using a three-stage dividend discount model may be more appropriate, yikes!).

Finally, just like the stable growth model, the two-stage dividend discount model is very sensitive to the inputs used to determine the value of the equity.

What Is the Usefulness of the DDM?

It depends on how you apply the model. Since the model is highly sensitive to the assumptions of an equity, but it is not the Holy Grail. Intel (Nasdaq: INTC) has a substantial percentage of its value explained by intangible assets like the brainpower of its employees. Using the DDM may result in ridiculously low estimates of Intel's value. Finally, the DDM is a good thinking exercise. It forces the investors to begin thinking about different scenarios in relation to how the market is pricing the stock.

Gordons Dividend Capitalization Model

Myron Gordon developed a model, which shows how the dividend policy affect the stock price of a security. The model is based on following assumptions. The firm will be an all equity firm with the new investment proposals being financed solely by the retained earnings. Return on investment and cost of equity capital remain constant. Firm has an infinite life. The retention ratio remains constant and hence the growth rate also remains constant. Cost of equity capital is greater than the growth rate.

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Gordons model assumes that the investors are rational and risk averse. They prefer certain returns to uncertain returns and thus put a premium to the certain returns and discount the uncertain returns. Thus, investors would prefer current dividends and avoid risk. Retained earnings involve risk and so the investor discounts the future dividends. This risk will affect the stock value of the firm.

Since a bird in hand is better than two in the bush, the investors would prefer the income that they earn currently to that income in future which may or may not be available. Thus, investors would prefer to pay a higher price for the stocks, which earn them current dividend income and would discount those stocks, which either postpone or reduce the current income.

Gordons dividend capitalization model gave the value of the stock as follows:

P = E (1-b)/ke br
Where, P = share price E = Earnings per share b = Retention ratio 1 b = dividend pay out ratio ke = cost of equity capital br = Growth rate (g) in the rate of return on investment.

The following implications can be drawn from the model:

When the cost of equity exceeds the return on investment, the pay- out ratio should rise to increase the market price; When the cost of equity equals the return on investment, the changes in pay-out ratio will have no impact on the market price; When the cost of equity is less than the return on investment, the pay- out ratio should be reduced to increase the market price.

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Limitations of Gordon Dividend Capitalization Model:

When cost of equity is less than growth rate in dividend it is not possible to use this model. This model cannot be applied to the companies, which are not paying dividends or whose dividend policies are highly volatile. It assumes that dividend grows at a constant rate through the life of the company, which is unrealistic. This model does not deal with risk. It does not take risk into consideration. The assumption of exclusive financing by retained earnings make the model suitable only for all-equity firms. Gordon model assumes that the return on investments to be constant. This again will not be true for firms making high investments. This model ignores the business risk of the firm, which has a direct impact on the value of the firm. Thus, k cannot be assumed to be constant.

Alternate Model to Gordon Model

According to one school of thought in a perfect market situation investment and financing decisions are independent and thus, the dividend decisions become irrelevant. The model given by Miller and Modigliani belongs to this school of thought

Critical assumptions:

The first assumption is the existence of the perfect market in which all investors are rational. Flotation and transaction cost do not exist. The securities are infinitely divisible. There are no taxes.

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There is constant investment policy of the firm, which will not change the risk complexion nor the rate of return even in cases where the investments are funded by the retained earnings.

It was also assumed that the investors are able to forecast the future earnings, the dividends and the share value of the firm with certainty.

Arbitrage can be applied to the investment function of the firm. The has two options for utilizing its after tax profits a) to retain the earnings and plough back for investment purposes and b) distribute the earnings as cash dividends.

If the firm selects the second option and declares dividend, then it will have to raise capital for financing its investment decisions by selling new shares. Here, the arbitrage process will neutralize the increase in the share value due to the cash dividends by the issue of additional shares. This makes the investor indifferent to the dividend earnings and the capital gains since the share value of the firm depends more on the future earnings of the firm, than on its dividend policy.

Symbolically it can be represented as,

Np0 = (n + m)p1 I + x/1+p.

Where, n = Number of shares at the beginning of the period p0 = Market price per share at the beginning of year 0 m = Number of shares issued at the end of the period p1 = Market price per share at the end of year 1. p = is the capitalization rate for the firms in that risk class I = Value of total investment X = Earnings of the firm during the period t.

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There are many limitations to this model. Most of the limitations are because of the assumptions made in the model.

Investors are risk averse and prefer current dividend to future earnings. Further, with maximization of shareholder wealth being the most important issue, the dividend policies will vary for the firms, depending on the operational environment.

The Free Cash Flow Model

Free cash flow is the cash flow thats left over after making all required investments in operating assets: Where NOPAT is net operating profit after tax Note that the total value of the firm equals the value of its debt plus preferred plus common: V = V + V + V D P CS We can find the total value of the firms operations (not including non-operating assets), by calculating the present value of its future free cash flows: FCF0 (1 + g ) V = VOps + VNonOps = + VNonOps kg Now, add in the value of its non-operating assets to get the total value of the firm: Now, to calculate the value of its equity, we subtract the value of the firms debt and the value of its preferred FCF0 (1 + g ) VCS = + VNonOps VD VP kg Since this is the total value of its equity, we divide by the number of shares outstanding to get the per share value of the stock.

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Capital Asset Pricing Model:

The CAPM developed by William F Sharpe, John Lintner and Jan Mossin establishes a linear relationship between the required rate of return and beta of a security.

Assumptions: Investors are risk-averse and use the expected rate of return and standard deviation of return as appropriate measures of risk and return for their security. Investors make their investment decisions based on a single period horizon that is the next immediate time period. Transaction cost in financial cost are low enough to ignore and assets can be bought and sold in any unit desired. Taxes do not affect the choice of buying assets. All individuals assume that they can buy assets at the going market price.

The CAPM is represented mathematically by Kj = rf +bj (km rf)

Where, Kj = Expected or required rate of return on security j Bj = Systematic risk of security j Rf = Risk free rate of return Km = Return on market portfolio.

CAPM shows how trade-offs between risk and return are determined in financial market. The expected rate of return is the return from an asset that investors anticipate or to expect to earn over some future period. The required rate of return for a security is minimum expected rate of return needed to induce an investor to purchase it. As investors are risk averse, they will expect a risk premium to compensate them for the risk they take in investing in a risky asset. It is assumed that investing in a number of securities known as portfolio can diversify unsystematic or unique risk of a security. Therefore investors receives risk premium only for systematic risk denoted by beta. Beta shows how much a 39

security is sensitive to the market. If the risk of the asset is greater than the market risk, that is beta exceeds one, the investor assigns a higher risk premium to asset than to market. If a securitys beta is more is more than one it means that security is aggressive and if a securitys beta is less than one it means that security is defensive.

Limitations of Capital asset pricing model:

The model makes unrealistic assumptions: Transactions cost in financial market are not low enough so that it can be ignored. Taxes affect the buying of an asset. There will be low tax on capital gain than taxes on dividend income. Risk consider by each individual will be different. Beta is calculated on historical data. How much data should we use to estimate beta? The farther we go back in time, the higher the statistical precision of the estimate, but bigger the possibility of introducing some olddata bias.

It is difficult to estimate beta for illiquid stock. This is because if we are considering weekly data then changes are simply between the bid and ask prices, which introduces additional error in estimation.

It is difficult to choose risk free asset. It is really difficult to find an asset which has zero beta. But one has to rely on Treasury bill rate. CAPM says nothing about the expected market return, and estimating the equity premium is difficult. Market return will be based on the index chosen by the investor.

CAPM does not say anything about the company. It is only simple calculations using historical data of market and stock prices. As Warren Buffet has written, one company might make Barbie dolls and the other Pet rocks, if they have the same beta, then CAPM says that one is as good as other.

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CAPM says nothing about the price one should pay for the stock. Current stock price effect the calculation of beta. The higher the stock prices the higher the beta. So if one wants to buy high beta stock, buy at a higher price.

Although there are many limitations of CAPM model it is highly used model. Many have criticized CAPM model but no one has still come up with better model than CAPM. Companies like HLL uses CAPM model to know the required rate of return by its investor.

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CHAPTER 2

42

Macro economics factor affecting Indian Economy

Overall Economy:
The first advance estimates released by the CSO on the countrys GDP reveals near 9% growth in the current fiscal. The growth rate is estimated to touch 8.7% in 2007-08. Industry is estimated to grow at 8.9% in FY0. This comprises manufacturing to 9.4% currently. Share of the manufacturing sector remains stable at 15.5% and is unchanged compared to the share a year before.

Industrial Growth :
Industrial growth reduces to 7.6% in December 2007-08 compared to high growth in the same month of the previous fiscal. During the month this slowdown was witnessed in all the three sectors, mining, manufacturing and electricity that posted 3.8%, 8.4% and 3.0% respectively in December 2007-08 compared with 9.1% , 14.5% and 6.1% respectively in the corresponding month of previous year. The lackluster performance was also seen in the use-based classification. Basic , intermediate and capital goods sectors slowed in the month of this fiscal. Consumer goods too were seen to decelerate, on account of slowdown in nondurables category. Growth in the durables sector has however picked up by a margin. During the April-December period of 2007-08, growth of the main driver of industrial growth, manufacturing sector, remains low as compared to the growth of the previous year, In the first three quarters of 2007-08 growth in the basic and intermediate goods was lower than the growth registered in the corresponding period of 2006-07, while that of capital goods remained ahead. Growth in consumer goods decelerated to 5.8% in the nine-month period of 200708 compared to 9.9% in the corresponding period of the previous year. During the period the consumer durables still continues to post negative growth.

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In December 2007 all the industry sectors have posted a positive growth except for wool, leather, non-metallic products, metal products. During the period we found only production of metal products decline.

Core Infrastructure Industries:

In the ninth month of the year the six-core infrastructure industries witnessed a slippage in growth numbers, a low growth rate of 4.0% as against the 9% previously. Growth remained subdued even during three quarters of the year, it stood at 5.7% as against the 8.9% a year ago. In December 2007 the growth rate of finished steel, cement and powered was almost half of that of the previous year and slipped even below that in the case of petroleum refinery. Crude petroleum turned negative, however growth of coal continues to post a higher growth since August 2007.

Inflation Trends :
Speedy rise in the price index has been curbed below 4%, however the Inflationary pressures remain. Monetary instruments and partly the high base effect in last year also aided to reduced inflation numbers. Ban on the exports of some of the food items too were responsible in bringing down inflation. There has been a slight bounce back in the inflation numbers. Inflation went up again from an average of 3.1% in November 2007, to 3.6% in December 2007 and now nearing to an average of 4.0% (3.9%) in January 2008. Weekly numbers show this gradual rise in inflation, began in the last week of November 2007. The rise in the overall index has been mainly due to increase in the fuel, oil and lubricants (coal mining) and manufacturing products (food products and transport equipments).

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Monetary Indicators:
Money supply has picked up ( percentage change is from March 2007 to the December 2007). The increase in M3 is much more than what has been targeted ( 17-17.5%) for the current fiscal. FY08 when calculated in Y-o-Y terms. Government and commercial borrowings in December this fiscal suffers from a slowdown, 0.3% and 9.8% respectively from 3.2% and 14.0% recorded in the corresponding month of previous fiscal. While the net foreign exchange assets of the banks continue to rise ahead (21.4%) of the previous years increase of 16.7%.The growth in net non-monetary liabilities remained at a low 2.3% against 20.6% in the previous year. Investments in the government and other approved securities picked up sharply by 16.8% compared to 3.6 % in the corresponding period a year ago. High interest rates led to a slowdown in the total credit off take, a rise of 11.4% in December 07-08 as against 17.4% in FY07. The increase was seen only in the non-food credit.

Stock Market Trends:

In February 2008 Indian stock market indices have taken a dip. Sensex was witnessed to melt by 10.1 percentage points and Nifty by 13.5 percentage points. Sensex dropped from above 20k points to near 18K points. During the period we saw overseas investments being taken away from Indian as well as global markets due to the fear over US recession, which will not see recovery soon. Domestic institutional investors too pulled back from the Indian Market and moreover IPO fever diverted most investments. Volatility in the Indian stock market will remain in the near-term, however the long-term outlook curve looks positive.

Fiscal Trends:
Gross tax collected in the end of third quarter (cumulative) of FY08 rose by 27.0% to Rs 389345 crores . Percentage of taxes from the direct sources crosses 50% compared to about 45 % previously. Corporation tax mops Rs 128698 crores in December 2007, its growth continues to chase the high growth rate of 55% achieved in the previous fiscal.

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There has been speed-up in the income tax collected since July 2007 it increased by 42.7 percent , in December 2007 against 27.0 percent recorded in the previous year. Taxes from the indirect sources have shown a gradual decline accounting for remaining half of the total tax collected. Customs and Excise collection have slowed to 16.9% and 5.1% in the ninth month of this financial year as against 32.9% and 6.8% respectively in the corresponding month of previous year. Government total spend is running steady, 69.7% of the targeted for FY08 spent in the first nine months and so has been the case of receipts, 74.9%.

Foreign Trade:
Merchandise exports has slowed to 21.7 % ( in US dollar terms) during the first three quarters of 2007-08 compared to 21.9 % in the corresponding period of previous year . In December 2007 our cumulative exports for the three quarters stand at USD 111049 million and imports have increased by 25.9% to USD 168871 million, widening trade deficits to USD 57821 million. In Rupee terms the numbers show an acute slowdown in exports. Detailed numbers available up to September 2007 show Indian exports speed-up in value (USD) terms seen in commodities such as Rice and Spices among the Agricultural and allied products, Iron ore in ores and minerals category, and Gems and Jewelry in the case of manufactured products. Growth in markets for Indian exports namely UK, USA, UAE and China suffered a slowdown and export growth to Singapore turned negative. Three markets that emerged strongly were Belgium, Netherlands and Hong Kong. On the other hand Indias imports accelerated by 27.7% , the commodities of high value mainly contributing to the increase are edible oil , pulses, iron and steel, pearls, precious and semiprecious stones, gold and silver, coal coke and briquettes. Growth in imports from main partners has slowed. It has been seen that imports from Belgium and Netherlands are on the rise proving to be potential trading partners.

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Capital Inflows:
Indias total foreign investments inflated to US$ 48.9 billion in December 2007-08 with about US$ 33.3 billion coming from portfolio sources and the rest US$15.3 billion as foreign direct investments. During the same period of previous year total foreign investments stood at US $15.7 billion of which 67% about US$10.5 billion was received as FDI and the rest as portfolio.

Foreign Exchange Reserves:

Present foreign exchange reserves are enough to cover roughly 18 months of imports, but such high reserves comes with a cost that it incurs. Forex reserves increased by a margin in a months time when reserves in December 2008 were compared with that of the previous months. Indias foreign exchange reserves touched USD 275.9 billion in December 2007, where USD 266.7 billion (96%) comes as foreign currency assets and the rest from Gold , SDR and reserve tranche position in IMF.

Trends in the Exchange Rates:

Rupee stays stable in the third consecutive month of the fiscal. Despite intervention from the central bank Rupee traded at a high if Rs 39.27 as against the USD. In the initial trading sessions Rupee was seen to trade strong before weakening in the concluding trading sessions. It averaged at Rs 39.37 to a $ in January 2008. However during the month Rupee stays firm in its battle against Euro. It remained volatile throughout the trading sessions of December 2007 and showed firmness towards the last few sessions.

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CHAPTER 3

48

Industry analysis
3.1 Introduction

Capital Goods Definition, Classification and Selection

Capital Goods has been defined for the purpose of this study as any "product/ equipment of high value, durable (economic asset life 3 years), used as plant and machinery for agricultural, industrial and commercial (transportation etc.) purpose in production/ service delivery process". Here "use-based" classification to segment Capital Goods is adopted. From the list of classified segments, and have shortlisted five most representative segments based on market size of the segment and its user industry, and IIP weightage of the segment. The five representative segments identified are as follows: Textile Machinery Machine Tools Electrical and Power Equipment which includes Boilers, Turbines, Diesel Engines, Transformers, Switchgear, Motors and Generators Earthmoving and Construction Equipment Process Plant Equipment which includes Pressure Vessels, Cooling Towers, Furnaces and Heat Exchangers

Competitiveness Analysis of Indian Capital Goods sector

The study of the performance of the Capital Goods sector reveals that its fortunes are inextricably linked with that of the overall Indian industry. High degree of correlation between the performance of the two sectors is further accentuated by high elasticity of Capital Goods industry to changes in industry growth.

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The Capital Goods value added contributes a fairly constant proportion (9-12 percent) of the total manufacturing value added, thus establishing that manufacturing as the key enduser sector of Capital Goods drives the performance of the latter.

Another key determinant of the demand for Capital Goods is the gross investment undertaken in the economy. The apparent consumption of Capital Goods constitutes a constant share (17-21 percent) of the total Gross Domestic Investment in the country. On the supply side the output of Capital Goods is determined by investments in Capital Goods sector and capacity utilization.

The investments in the Capital Goods sector have declined with the decline in the relative profitability of the Capital Goods sector with respect to other sectors. The export performance corroborates the inward focus of Capital Goods industry as less than one-tenth of its sales is directed to exports. Except for few segments within the Capital Goods sector, almost all of them have single digit exports as percentage of sales figures.

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3.2 Five Force Analysis

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Cyclicality
Heavy engineering industry is an intermediate industry and its demand depends on a variety of end-user industries such as power, mining, oil and gas, consumer goods, automotive and the general manufacturing sector. A diverse mix of industries in the enduser segment results in low volatility in revenues in a normal business cycle. But, beginning of a widespread economic slowdown leads to cancellation of investments on capital goods across the industries. Thus, a slowdown adversely impacts the heavy engineering industry much before it affects other sectors. On the other hand, the heavy engineering industry is among the last to benefit from an upturn since capacity creation occurs after end-user industries fully utilize their own capacities and feel positive about the long-term demand scenario.

3.3 Risk in Capital goods industry

Product innovation is a subtle process, frequently leading to shifts in the competitiveness of firms. Developing products in an environment undergoing technological change is given to frequent failure, even in well-established and sophisticated organizations. In order to tackle competitiveness and to deal with innovation uncertainty, firms develop diverse innovation processes. Two modes of innovation are suggested in recent literature:

1) Science, Technology and Innovation (STI) mode, which is based on the production and use of codified scientific and technical knowledge; and

2) Doing, Using and Interacting (DUI) mode, which relies on informal processes of learning and experience-based know-how. In this paper we analyse product innovation at firm level. We perform an exploratory analysis in four leading equipment and machinery producers from the Aveiro region, in Portugal.

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Doing so, we explore the main features of the capital goods industry with implications for innovation, and analyse the dominant uncertainties associated to the innovation process. and modes of innovation. Key findings include the complete absence of DUI mode in the cases studied, and even a low learning characteristic in one company. The paper concludes by considering the implications for firms competitiveness and for innovation policy.

Business Environment Competitiveness Issues

Labour in the Indian Capital Goods sector is highly cost competitive, even after discounting a comparatively low labour productivity. The labour cost efficiency (which captures the cost and productivity aspects of labour) for Indian Capital Goods sector is 1.32 times that of Chinas and 1.38 times that of Taiwans. Among the reference set of countries only Korea (whose labour cost efficiency is 1.31 times that of Indias) outscores India on this count. But since the labour factor proportion is low (approximately 7 to 21 per cent) in the total factor usage, this does not translate into a significant relative advantage. Inflexible labour policies have also eroded this advantage partly.

The raw materials used are largely domestic in origin. With the dismantling of various price controls on key inputs, Indian Capital Goods manufacturers now procure raw materials at market prices, which move in line with international prices. The raw material price indices have risen faster than the machinery price index. It is difficult for the Indian Capital Goods manufacturers to pass on the rise in prices to the customers, thereby impacting their profitability. However the rising cost of raw materials has prodded only a few Indian manufacturers to resort to value engineering techniques for efficient raw material usage and cost reduction. The quality of raw materials is also not up to the international standards in terms of dimensional tolerances and metallurgical properties, and this, in turn, affects the quality of the final product.

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Exportable Capital Goods and Destinations

There is a huge potential market even outside India and to leverage the strengths of the Capital Goods sector and work on the opportunities available, the Indian Capital Goods Sector needs to focus on those products that show potential. In addition to this, these products have to be targeted at select promising markets to enhance the chances of success. The basket of exportable products is shown below: Exportable Products from Capital Goods basket

Textile Machinery
Textile Yarn Machinery Weaving, felt manufacturing machinery etc Sewing Machinery & Parts Auxiliary textile machinery and parts etc

Machine Tools
Metal working lathes Parts of metal working machine-tools Metal Forming Machine Tools

Electrical and Power Equipment

Piston engines including diesel engines High Voltage Electrical Machinery Electrical Transformers Electrical Power Equipment other than Transformers Steam Turbines Parts of Internal Combustion Engines Steam Boilers Parts of rotating electric plant

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Earthmoving and Construction Equipment

Earthmoving and Boring Machines

Process Plant Equipment

Commercial refrigerating equipment Gas generator, air liquefier Centrifuges

Other Machinery and Equipment

Cultivating Machinery Centrifugal Pumps Metal Rolling Mills Parts of Pump and Liquid Elevators Parts of air pumps, fans etc

In general, the favourable export destinations (defined as high value importing and having growth rates higher than world average growth rates) for the above Capital Goods include European Union, USA, North America, ASEAN and China. Similarly, with certain exceptions, the potential destinations (defined as currently low value importing and having growth rates higher than world average growth rates) for these Capital Goods include Middle East, CIS, South America and Eastern Europe. Surprisingly Japan does not figure high on the potential exportable destinations; this is understandable given the closed nature of Japanese Capital Goods market.

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Chapter 4

57

Company analysis

58

Summary of BHEL HOLD

CMP (Rs.) 2282 Target(Rs.) 2614 Stock return 15% Nifty Sensex 4739.55 15626.62

Order spree continues

BHEL has secured a mega contract for setting up 2 units of 500 MW each at Anpara D Thermal Power Station (TPS) in Uttar Pradesh and the units are slated for commissioning during 2011-12. The order value stands at Rs33.9 bn and the scope of work envisages design, engineering, manufacture, supply, erection and commissioning of Boiler Turbine Generator Package along with associated auxiliaries, Balance of Plant and Civil Works.

Orders worth Rs67.3 bn won in last 5 weeks

Key Stock Data BSE id 500103 NSE id BHEL No of Shares 48.95 (in Cr.) Market Cap 111703.9 (Rs cr) Daily Volume 1010224 (No of shares) Stock Performance 52 Week Highs Lows 2925 970
BHEL has also won the Rs8.66 bn captive power plant order from Reliance Industries and Rs24.75 bn 600 mw order from TNEB. This takes the tally of orders to Rs67.3 bn won in the month of Jan and February 2008. With BHEL already being the sole bidder for NTPC Barh stage II 660X2 MW plant and with the order 800X2 MW from of its JV with TNEB we believe that the short-medium term order flow momentum will be strong for BHEL.

BHEL capacity expansion and modernization plans gathering steam

In order to meet the countrys ambitious power generating capacity addition target in the 11th and 12th FYPs, BHEL has already expanded its capacity to 10000 MW. The capacity is being further enhanced to 15,000 MW per annum in the next two years at a total investment of Rs32 bn. In the first stage BHEL is upgrading its Boiler manufacturing facility at its Trichy plant. The company has already invested Rs.1.9 bn on the boiler shops and is now investing another Rs.7.36 bn to upgrade the production capacity of Boilers. In addition to the above BHEL is setting up a new Fabrication Plant and a Central Stamping Unit at Jagdishpur in Uttar Pradesh. The Fabrication Plant is being set up to meet the burgeoning requirement of fabricated components and assemblies required by BHELs major units. The plant will produce around 25,000 MT per annum including about 16,000 MT of structures for Boilers for direct dispatch to power plant sites in the eastern and northern regions. The Central Stamping Unit is being set up to meet the increased requirement of stampings, a critical part of electrical machines, due to the growth in business and market demand for Generators and Electrical Motors. The new centralised facilities are expected to entail initial investment of Rs.3 bn aimed at speedy. BHEL has secured a mega contract for setting up 2 units of 500 MW each at Anpara D Thermal Power Station (TPS) in Uttar Pradesh and the order value stands at Rs33.9 bn . Apart from this order, BHEL has also won the Rs8.66 bn captive power plant order from Reliance Industries and Rs24.75 bn 600 mw order from TNEB. This takes the tally of orders to Rs67.3 bn won in the month of Jan and February 2008. With BHEL already being the sole bidder for NTPC Barh stage II 660X2 MW plant and with the order 800X2 MW from of its JV with TNEB we believe that the short-medium term order flow momentum will be strong for BHEL.

Share Holding Pattern Foreign Holding 19.7% Financial 7.7% Institutions Corporate 3.0% (excluding above institutes) Promoters 67.7% Free Floating 1.9%

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Details about the company

Introduction
(BHEL) is the largest engineering and manufacturing enterprise of its kind in India and is one of the leading international companies in the field of power equipment manufacture. The first plant of BHEL, set up at Bhopal in 1956, signalled the dawn of the Heavy Electrical Industry in India. In the sixties, three more major plants were set up at Haridwar, Hyderabad and Tiruchirapalli that form the core of the diversified product range, systems and services that BHEL offers today. BHELs range of services extends from project feasibility studies to after-salesservice, successfully meeting diverse needs through turnkey capability. The company has 14 manufacturing units, 4 power sector regions, 8 service centers and 15 regional offices, besides project sites spread all over India and abroad. BHEL has a well recognised track record of performance, making profits continuously since 1971-72 and paying dividends since 1976-77. BHEL manufactures over 180 products under 30 major product groups and caters to core sectors of the Indian economy viz., Power Generation and Transmission, Industry, Transportation, Renewable Energy etc. The quality and reliability of its products is due to the emphasis on design, engineering and manufacturing to international standards by acquiring and adapting some of the best technologies from leading companies in the world, together with technologies developed in its own R&D centers.

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Strengths:
The company has 180 products under 30 major product groups that cater to the needs of the core sector like power, industry, transmission, transportation, defence,

telecommunications and oil business. BHEL's ability to acquire modern technology and make it suitable to Indian conditions has been an exceptional strength of the company. Strong relationship with NTPC is a strength as NTPC is planning a capacity expansion of Rs. 52 bn and based on the past, 85% of NTPC projects have been bagged by BHEL. The company also enjoys purchase price preference.

Weaknesses:
PSU status is a big weakness for BHEL as it is subject to their rules and regulations and is forced to carry a huge amount of labor force, which it is not able to retrench. The company offers very stringent credit facilities to the customers and this is a weakness when compared in the face of rising competition. On the other hand their customers in the power segment, SEBs, have a huge amount of receivables standing against their name in the company's balance sheet. This is a major weakness for the company. The company is vertically integrated, which could have been avoided by outsourcing
its components for power generation and transmission. This could have reduced the cost.

Opportunities:
The power sector reforms are expected to pick up in the near future in India, which would directly benefit BHEL. Increase in defence budget will increase the topline for the company. NTPC is planning additional capacities to the tune of 2,800 MW, at a cost of Rs 52 bn. BHEL could benefit a lot as it has happened in the past that significant portion of the project of NTPC is handled by BHEL. Nearly 85% of the NTPC projects were assigned to BHEL only.

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The business of modernization and renovations of power plants is expected to grow in India.

The disinvestment plans of the government would bring in new resources and experience into the company. Joint Venture with Siemens in the name of Powerplant Performance Improvement Ltd. (PPIL), is a major strength for the company. This tie-up will be beneficial as there is a lot of scope for business. During FY00 the PPIL received orders worth Rs. 320 crore.

Threats:
The global trend of consolidation has already resulted in a fall in turnover of the company and this will prove to be a major threat in the years to come as well. The company is dependent on NTPC to a great extent. Recently, the government has permitted the import of second hand capital goods that are 10 years old without the need for a license. This move will definitely increase competitive pressures for BHEL.

BUSINESS SECTORS
BHELs operations are organised around three business sectors, namely Power, Industry including Transmission, Transportation & Renewable Energy, and International Operations. This enables BHEL to have a strong customer orientation and respond quickly to the changes in the market.

POWER SECTOR
Power is the focal area for BHEL and comprises thermal, nuclear, gas, diesel and hydro businesses. BHEL has taken India from a position of total dependence on overseas sources to complete self-reliance in power plant equipment. Today, BHEL sets account for nearly 65% of the total installed power generating capacity in the country. Significantly these sets contribute 73% of the total power generated in the country.

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BHEL has contracted for boilers and auxiliaries, turbo generator sets and associated controls, piping and station Control & Instrumentation of up to 500 MW unit rating and has the technology and capability to produce thermal sets of higher unit ratings including 1000 MW. BHEL has access to technology for higher size gas turbines and can supply gas turbines of up to 279 MW unit size.

INDUSTRY SECTOR

INDUSTRIES
BHEL manufactures and supplies major capital equipment and systems like captive power plants, centrifugal compressors, drive turbines, industrial boilers and auxiliaries, waste heat recovery boilers, gas turbines, pumps, heat exchangers, electric machines, valves, heavy castings and forgings, electrostatic precipitators, ID/FD fans, seamless pipes etc. These serve a number of industries like metallurgical, mining, cement, paper, fertilizers, refineries and petro-chemicals, etc. in addition to power utilities. BHEL has also emerged as a major supplier of controls and instrumentation systems, especially distributed digital control systems for various power plants and industries.

OIL & GAS

BHEL has the capability to supply complete onshore drilling rigs, super deep drilling rigs, desert rigs, mobile rigs, workover rigs and sub sea well heads. It supplies equipment / sub-assemblies for onshore drilling rigs viz. drawworks, rotary-table, travelling block, swivel, mast & sub structure, mud systems and rig electrics.

TRANSMISSION

BHEL supplies a wide range of products and systems for transmission & distribution applications. The products manufactured by BHEL include power transformers, instrument transformers, dry type transformers, shunt reactors, capacitors, vacuum and SF6 switchgear, gas

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insulated switchgear, ceramic insulators, etc. BHEL has developed and commercialized the countrys first indigenous 36 kV Gas Insulated Substation (GIS) and has also bagged first order for its indigenously developed 145 kV GIS. For enhancing the power transfer capability and reducing transmission losses in 400 kV lines, BHEL has indigenously developed and executed fixed series compensation schemes and has developed thyristor controlled series compensation scheme, involving thyristor controlled reactors, popularly known as Flexible AC Transmission System (FACTS). BHEL has indigenously developed state of the art controlled shunt reactor for reactive power management of long transmission lines. With a strong engineering base, the company undertakes turnkey execution of substations upto 400 kV and has capability to execute 765 kV substations. High Voltage Direct Current (HVDC) systems have been supplied for economic transmission of bulk power over long distances. During the year, BHEL successfully bagged another order for installation of BaliaBhiwadi HVDC link of 2500 MW capacity.

TRANSPORTATION
Most of the trains in the Indian Railways, whether electric or diesel powered are equipped with BHELs traction propulsion systems and controls. The systems supplied are both with conventional DC drives and state of the art AC drives. Indias first underground metro at Kolkata runs on drives and controls supplied by BHEL. The company also manufactures complete rolling stock i.e. electric locomotives up to 5000 HP, diesel electric locomotives from 350 HP to 3100 HP for both mainline and shunting duty applications. Further, BHEL undertakes retrofitting and overhauling of rolling stock. In the area of Urban transportation, BHEL is geared up for turnkey execution of electric trolley bus systems, light rail systems and metro systems. BHEL is contributing to the supply of electrics for EMUs for 1500V DC & 25 kV AC to Indian Railways. Almost all the EMUs in service are with electrics manufactured and supplied by BHEL. The company has also diversified into the area of track maintenance machines. BHEL is well poised to meet the emerging requirements of Indian Railways for higher horsepower locos for freight and passenger applications.

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RENEWABLE ENERGY
BHEL has been manufacturing & supplying various Renewable Energy systems and products. It includes Solar Energy systems namely PV modules, PV power plants, solar lanterns, street lighting, solar pumps and solar water heating systems. The Wind power generation business based on higher rating WEGs is being explored.

INTERNATIONAL OPERATIONS
BHEL has over the years established its references in 68 countries of the world spanning across all the six-inhabited continents. These references encompass almost the entire range of BHEL products and services covering turnkey Power projects of Thermal, Hydro and Gas-based, Transmission Substation projects, Rehabilitation projects for Boilers, Power Stations etc., besides a wide variety of products, like Transformers, Reactors, Compressors, Valves and Oil field equipment, Electrostatic Precipitators, Photo Voltaic equipments, Insulators, Switchgears, Heat Exchangers, Castings & Forgings . Some of the major successes achieved by BHEL have been in Gas based power projects in Oman, Saudi Arabia, Iraq, Libya, Bangladesh, Malaysia, Sri Lanka, China, Kazakhstan; Thermal power projects in Cyprus, Malta, Egypt, Malaysia, Sudan, Indonesia, Thailand; Hydro power plants in New Zealand, Azerbaijan, Bhutan, Nepal, Taiwan, Malaysia, Afghanistan, Tajikistan and Substation Projects & equipment in various countries of Africa, Europe, South & South East Asia. The company is taking a number of strategic business initiatives to fuel further growth in overseas business. This includes firmly establishing itself in target export markets, positioning of BHEL as a regular EPC Contractor in the global market and, exploring various opportunities for setting up overseas joint ventures etc.

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RESEARCH & DEVELOPMENT

The Corporate R&D Division at Hyderabad leads BHELs research and development efforts, suitably supported by Engineering and R&D groups at the manufacturing divisions. BHELs technology policy promotes a judicious mix of indigenous efforts and selective collaboration in essential areas. The company continuously upgrades its technology and products to contemporary standards. BHEL is one of the few companies worldwide involved in the development of Integrated Gasification Combined Cycle (IGCC) technology which will usher it in clean coal technology. BHEL has set up Asias first 6.2 MW IGCC power plant with a indigenously designed pressurised fluidised bed gasifier. Presently, development efforts are underway to set up a 125 MW IGCC power plant. Four Centres of Excellence for Computational Fluid Dynamics, Simulators, Permanent Magnet Machines and Surface Engineering have been established at BHELs Corporate R&D Division, which has led to enhancement of BHELs design and analysis capability and also enabled development of new and improved products. BHELs R&D efforts have produced several new products. Some of the recent successful R&D products are: advanced software package for Performance Analysis, Diagnostics and Optimisation (PADO) of power plants to optimize power plant operations during varying operating conditions; High Velocity Oxy Fuel coating process to increase life of hydro turbine components, and other industrial products prone to erosion; an indigenously designed Bowl Mill of 91 tons per hour capacity for pulverising coal in thermal power stations; the largest size 60 MWe Bubbling Fluidised Bed Boiler for power generation; a new eco- friendly, cost effective and less hazardous chemical cleaning system process for boilers using an organic chemical Ethylene Diamine Tetra Acetic Acid; a six jet Pelton hydro turbine with a head of 789 metres for the 4x200 Parbati hydro electric project; the first totally impregnated turbo generator stator for a 250 MW turbo generator; a 260 MW steam turbine designed to suit combined cycle power plant application; Smart wall blowing system for cleaning of boiler tubes during operation; Sonic system for detecting tube leaks in boilers; a By-pass Over Fire Air (BOFA) system which reduces NOx emission from coal fired power stations by upto 50%.

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Growth Prospects
The Company secured orders worth Rs. 35643 crore and closed the year with outstanding orders in hand at Rs. 55000 crore. It continued on International foot print expansion by entering new markets and building up existing ones. Physical exports reached Rs.1071 crore. _ R&D spend was Rs. 238 crore, 66% higher than the previous year.

Meeting Challenges
The country is planning to add 78,000 MW in the XI Plan and over 85,000 MW in the XII Plan period. This means average capacity additions of around 15,000 to 17,000 MW per annum during these two plan periods. Higher rating thermal sets with super critical parameters, advanced class Gas Turbines and higher rating Nuclear Power Plants are planned to be introduced during the XI, XII Plan and beyond. All these mean exciting opportunities in the core business for your Company.

Building Capacity and Capability for the future

Expansion of our activities in the market segments that BHEL operate in is the core element that will drive their growth strategy in future. In line with this, the Company has drawn up a Strategic Plan 2012 for ensuring a sustainable profitable growth over the next five years with the objective of reaching a turnover level of US $ 10 billion by 2011-12. The implementation of the Plan is being taken up with full vigor. With the establishment of 10,000 MW p.a. manufacturing capacity by the end of 2007, BHEL is on its way to enhance this further to 15,000 MW p.a. by Dec 2009. This enhancement of manufacturing capacity is possible only because of the availability of basic infrastructure and qualified and trained technical manpower in BHEL. The enhanced manufacturing capacity, together with state-of-theart technology to produce higher rating supercritical thermal sets and a skilled workforce will further strengthen the position of the company in the domestic and international markets.

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Over the next five year period, in the pursuit of achieving globalization aspirations of the company, it aims to grow the physical exports by six times the current size. Spares & services business is expected to be the next growth plan for the Company where revenues are expected to increase four-fold from present levels. R&D spend will be increased by at least four times the size of 2006-07. BHEL has been continuously bagging orders in the current year resulting in a backlog of Rs 72,700 crore, about 3.4 times its expected revenue for FY 2008. The increased order flow is mainly due to the upcoming deadline for utilities to award orders under the Eleventh Plan. Further, BHEL timed its first phase of capacity expansion (from 6,000 MW to 10,000 MW) to go on stream by January 2008, thus enabling it to accept new orders Once the Eleventh Plan target is met, there may be some lull in orders before projects under the Twelfth Plan are awarded. The ordering of power equipment to achieve the 11th Five-year Plan target of 78.5GW continues, with 69% of the total capacity ordered, including 62% of thermal capacity. BHEL had a success rate of 55% for overall orders, and 69.4% for thermal capacity. These order wins have resulted in BHELs order backlog growing to c Rs 724billion (58% y-oy), 4.1x FY07 revenue. We expect BHEL to win another 12.3GW of orders over FY08-09e, translating into new order wins of Rs 675billion. The strong order backlog, coupled with new order wins, should provide good revenue visibility post FY10e. This may result in some momentary slowdown in order flows in FY-09. However, the orders on hand would ensure that revenue growth remains healthy. BHEL is also preparing to meet long-term demand. Its second phase of expansion to 15,000 MW is slated to be ready by December 2009. The company also plans to double its transformer capacity to 38,500 MVA over the same period. While there would be more private players in the utility space, Central and State utilities will continue to be the major contributors towards achieving the Twelfth Plan target. As BHEL still remains a favoured supplier for the Government, the company is likely to continue bagging orders, especially in the sub-critical boiler segment.

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Financials & valuation

Increase in BHEL earnings is estimated by 5.6% and 10% for FY09e and FY10e respectively, based on the strong order inflow, roll over the target price to September 08 and expect BHEL to outperform the market due to strong order book and potential success in supercritical projects. BHEL will continue to trade at a MACC range of 8.4-10.3% vs. its earlier estimate of 8.0-11% MACC range, due to increase in revenue visibility post FY10e. Based on this, it have increased the target price to Rs 2500, a 20.5% potential total return from current levels. Maintain Overweight rating.

Financials and valuation

The recent spate of order wins have put aside concerns of increased competition and provide good earnings visibility for BHEL. The current order backlog of more than c Rs 724billion (c4xFY07 revenue, a historic high), should help BHEL sustain revenue growth. BHELs capacity addition to 10GW by December 2007 should help the company execute its current order backlog and drive revenue growth. Based on the current order backlog, we increase our earnings estimates by 5.6% and 10% for FY09e and FY10e respectively. We expect BHEL to report an EPS of Rs 92 and Rs 124 for FY09e and FY10e respectively, an EPS CAGR of 36% over FY0710e.

The order backlog coupled with new orders should provide good revenue visibility post FY10e. We use our proprietary Market Assessed Cost of Capital (MACC) valuation methodology for valuing BHEL shares. The MACC model seeks to overcome some of the shortcomings of the capital asset pricing model (CAPM) for assessing a stocks cost of capital. MACCs valuation approach reverses conventional CAPM valuation methodology by comparing return on capital with market value to arrive at an estimate of the markets assessment of risk (MACC). This MACC value can then be compared with historical observations for the same stock, or with contemporary observations for peer stocks.

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BHEL plans acquisitons; aims at Rs 45,000 crore turnover of by 2012 news

Public sector power equipment maker Bharat Heavy Electricals Ltd (BHEL) is looking at mergers and acquisitions to fuel inorganic growth and has targeted a turnover of Rs 45,000 crore by 2012. BHEL has drawn up a 'Strategic Plan 2012' to ensure sustainable profitable growth over the next five years, reaching a turnover of Rs 45,000 crore, BHEL chairman and managing director AK Puri told a shareholders meeting. Company will pursue the merger and acquisition route to avail inorganic growth opportunities and enlarge operations both in domestic as well as export markets. BHEL's growth planks for the next five years will be driven by capacity and capability enhancement that will leverage the company's core areas of power supported by industry, transmission, exports and spares and services businesses. BHEL's turnover hit an all-time high of Rs 18,739 crore, registering a growth of 29 per cent, while net profit increased by 44 per cent to touch Rs 2,415 crore in 2006-07. The company declared a final dividend of 60 per cent on the enhanced paid-up share capital consequent to 1:1 bonus issue. BHEL paid the highest ever dividend of nearly Rs 600 crore for 2006-07, which is 245 per cent of the paid-up capital pre-bonus, he said. With an order book position of Rs 55,000 crore, BHEL expects to achieve robust growth in 2007-08 and beyond. The company is well on its way to increasing its size of operations supported by phased manufacturing capacity expansion where a capacity of 10,000 MW per annum will be completed by December 2007 and 15,000 MW per annum by December 2009, he added. The company booked export orders worth Rs 1,903 crore in 2006-07 against an average yearly order book of Rs 1,275 crore of the last five years.

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New domains
In the sub-critical space, the company continues to dominate the industry in terms of order flows. BHEL now produces 270 MW and 600 MW boilers targeted to compete with Chinese boilers in the sub-critical space. This apart, the company has forayed successfully into the advanced class gas turbine segment, winning its firm commercial order from Reliance Industries. It has since, in quick succession, won two more such orders in Gujarat. BHEL also has capability to produce equipment and sub-assemblies for onshore drilling rigs. It recently won a three-year contract from ONGC to supply wellhead assemblies and other critical spares for oil exploration. With increasing activity in this area, we expect BHEL to supplement its income from these allied activities.

Risks
The first phase of expansion by BHEL witnessed some delay. Any such drag in implementing the second phase could slow revenue growth. BHELs market share in the private utilities space has been about 25 per cent, essentially indicating that its strength remains in Government utilities orders. With increasing private participation, BHEL faces the risk of intense competition and possible slowdown in order flows.

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Valuation of BHEL PROFIT & LOSS A\C

P&L Net Sales Other Income Stock Adjustments 2007 17320.74 575.2 181.19 2008(E) 25115.07 428.27 205.87 2009(E) 36416.86 442.07 256.44 2010(E) 50983.60 456.38 313.86 2011(E) 68827.86 456.98 268.67 2012(E) 89476.21 471.78 245.21

Total Income Total Expenditure Operating Profit Interest Gross Profit Depreciation Profit Before Tax Tax paid Reported Net Profit Extraordinary Items Adjusted Net Profit PAT

18077.13

25749.21

37115.37

51753.83

69553.51

90193.20

14024.83 4052.3 43.33 4008.97 272.97 3736 1549.16 2414.7 0.71 2413.99 2633.76

19873.37 5875.84 43.33 5832.51 396.82 5435.69 1817.40371 3991.68 -147.46 4139.14 4,432.95

28011.15 9104.21 43.33 9060.88 575.39 8485.50 2864.5903 6258.79 -213.81 6472.60 8,499.13

39007.93 12745.90 43.33 12702.57 805.54 11897.03 4035.9775 8794.79 -299.34 9094.13 15,101.31

48905.15 20648.36 43.33 20605.03 1087.48 19517.55 6652.5675 14459.59 -404.11 14863.70 27,368.29

63350.33 26842.86 43.33 26799.53 1413.72 25385.81 8667.5011 18821.83 -525.34 19347.17 43,997.51

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Free Cash Flow Calculation

Free Cash Flow Calculation

2008E Rs cr

2009E Rs cr 9104.214

2010E Rs cr 12745.9

2011E Rs cr 20648.357

2012E Rs cr 26842.864

2013E Rs cr 37580.01

EBIT Plus: Depreciation EBITDA

5875.835

396.81815 6273

575.38632 9680

805.54085 13551

1087.4801 21736

1413.7242 28257

1696.469 39276

Less: Capex Tax rate EBITDA Less Capex Less: Taxes on EBIT Add: Taxes on Interst

841 30%

1195 30%

1607 30%

2100 30%

2685 30%

2965 30%

5431

8485

11945

19636

25571

36311

-1763

-2731

-3824

-6195

-8053

-11274

13

13

13

13

13

13

Less: Changes in Working Capital Unlevered Free Cash Flow Terminal value PVIF Discounted cash flow Total DCF value

4092

-1148

-1479

-1812

-2097

-1817

7774

4619

6655

11642

15435

23233

230487 0.8397716 0.7052163 0.5922206 0.49733 0.4176436 0.3507253

6528.521

3257.4182

3941.0965

5790.0174

102707.54

122224.59

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DCF Calculation

Total discounted cash flows WACC calculations Less Debt

122,225

(89)

Risk Free rate

9.0%

Add cash

5,809

Add Investments Risk Premium 9.0% Equity Value

127,952

Beta

1.12

Shares in issue

48.95

DCF per share Cost of Equity 19.1% Share Price(feb closing)

2,614

2,282

WACC

19.1%

Upside/(Downside)

15%

Assumption: Rm=18% Growth assumed is 45% for first two years then 40% for a year 35% for a year after that & then 30% and 20% for last estimated year.

Analysis:
Comparing with current price Bhels Expected price on the basis of DCF comes higher and is expected to give a return of 15% but it is not very high i.e. it is not worth investing but if you already have purchased it you can HOLD it till it reaches this price level.

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Sensitivity Analysis

(1) If Growth rate changes to 30% for first three years then 2 years by 25% and last year by 20% with a market Return=18% Expected price of share changes as follows

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price(feb closing) Upside/(Downside)

81,921 (89) 5,809 8 87,648 48.95 1,791 2,282 (22%)

Analysis:
Growth rate decreases drastically it falls below its CAGR of 39.2% (approximately)and it having high Beta value of 1.12 its Ke(i.e) its expected return increases so is its discounting value and may result in ROE<Ke So in this situation(i.e. if BHEL records its growth rate of 30% or lower)recommendation is to Sell.

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(2) If Rm=26.3% Growth assumed is 45% for first two years then 40% for a year 35% for a year after that & then 30% and 20% for last estimated year.

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price Upside/(Downside)

55,106 (89) 5,809 8 60,834 48.95 1,243 2,282 (46%)

Analysis:
Growth rate is high but because it having high Beta value of 1.12 its Ke(i.e its expected return) increases so is its discounting value and may result in ROE<Ke and also the market return is very high so it indicates that by investing in other firms one can earn higher returns and if invested at such high rate may lead to loss of capital. So in this situation(i.e when market gives abnormally high return) recommendation is to Sell.

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(3) If Growth rate changes to 30% for first three years then 2 years by 25% and last year by 20% with a market Return=26.3% Expected price of share changes as follows

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price Upside/(Downside)

38,657 (89) 5,809 8 44,385 48.95 907 2,282 (60%)

Analysis:
It is the worst situation and suggestion is SELL.

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Chapter 5

78

Company Analysis
Siemens

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Summary of SIEMENS BUY

Nifty Sensex 4739.55 15626.62

Order spree: Automation and Drives (A&D) Division: Key orders:

Single largest order from Dresser. Rand for Large Drive products worth Rs.240 million. Order received from Jaiprakash Associates for supply of LV switchboards worth Rs.215 million. Repeat orders from Suzlon and Vestas for wind mill generators worth Rs.1018 million. Siemens Building Technologies (SBT) Division: Key Orders: Rs.400 mn order from Reliance Retail for installing Integrated Loss Prevention Solutions at their retail outlets across India. Rs.300 mn order from IBM for Integrated Security & Safety Solutions. Rs.38 mn order from HPCL for installing integrated Building Management Solution (IBMS) at their Data Centre in Hyderabad.

CMP (Rs.) 1393 Target(Rs.) 617 Stock return 126% Key Stock Data BSE id 500550 NSE id SIEMENS No of Shares 16.9 (in Cr.) Market Cap 10427.3 (Rs cr) Daily 155453 Volume (No of shares) Stock Performance 52 Week Highs Lows 2285 600.20

Share Holding Pattern Foreign 7.53% Holding Govt./Financial 19.08% Institutions Corporate 2.91% (excluding above institutes) Promoters 55.18% Free Floating 15.28%

Enterprise Communications Pvt. Ltd Key Orders:

ASCON order worth Rs.118 mn for Hi Path 4000 21 systems & accessories HiPath Manager upgrade and MCU. Order for product expansion of HiPath 4000 in the Defense Sector worth Rs.28 mn.

Valuation looks positive: Using DCF the value of the company comes to 1393 which is very high compared to present value. So recommendation is to BUY

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Introduction
A hundred and sixty years of success
On October 12, 1847, Werner von Siemens and his partner Johann Georg Halske founded Tele-graphen-Bauanstalt von Siemens & Halske in Berlin, laying the cornerstone for a unique success story. From the very beginning, Werner von Siemens aspired to market his innovations beyond Germanys borders. Envisioning a global enterprise, he opened the companys first representative office in London in 1850. Just three years later, he expanded his business eastward to begin the construction of the Russian telegraph network. Further international activities followed. In 160 years, Siemens has grown from its two founders to some 400,000 employees all around the world, from a backyard workshop in Berlin to a global player with a worldwide business volume of approximately 80 billion a truly unparalleled success story. Werner von Siemens personal characteristics a drive to innovate, an international focus and, above all, a keen sense of responsibility continue to shape the Company today. Responsible, excellent, innovative these are the values that define Siemens.

A successful fiscal 2007

Despite the challenges confronting us, we generated outstanding income from continuing operations in fiscal 2007 48 percent above the already impressive prior-year figure. New orders rose 12 percent to 83.9 billion, and sales climbed nine percent to 72.4 billion, with double-digit organic growth in both of these areas.

Siemens was able to optimally tap into the diverse opportunities provided by the infrastructure segment. The Power Generation (PG) Division showed a healthy growth despite industry challenges, while the Power Transmission and Distribution (PTD) division posted an exemplary performance with huge export order wins. The business volume of the power segment alone grew by 32%.

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The Transportation Systems Division reinforced its leading position by Leveraging the growth opportunities presented by the Railways.

The Industry segment grew at an impressive rate of 10.9%. The cumulative growth for the period April-August 2007 was 9.8% over the corresponding period of the pervious year. This strong growth momentum continues to be dominated by the buoyant manufacturing sector. The capital and consumer goods sector sustained a good performance in 2006-07. Riding on the back of robust performances from sectors such as automobile, coal, cement, mining and metals, the business volume for the combined Industry segment of Siemens grew at an impressive 44%. The Indian Software and Services industry continued to register a stupendous performance during 2006-07.The sector also witnessed major M&A activities across geographies as leading players leveraged their core competencies. In this environment, Siemens Information Systems Ltd. (SISL) and Siemens Information Processing Services Pvt. Ltd. (SIPS) revenues grew satisfactorily.

INDUSTRY Presence:
Automation and Drives (A&D) Division: Highlights
Retained leadership position in most market Segments. Forayed into new market segments.

Key orders:
Single largest order from Dresser. Rand for Large Drive products worth Rs.240 million. Order received from Jaiprakash Associates for supply of LV switchboards worth Rs.215 million. Repeat orders from Suzlon and Vestas for wind mill generators worth Rs.1018 million.

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In 2006-07, the market for Automation and Drives grew healthily by 19% due to sustained investments Chemicals & towards capacity building and expansions in Cement, Automotive and Textiles

Pharmaceuticals, Food &

Beverages,

industries. Continued investments in commercial complexes and malls, residential buildings spurred requirement for electricals in buildings. incentives for green power generation resulted in a greater demand for wind generators and other associated electricals. Enhanced awareness and

Outlook: With the Indian economy poised to sustain its growth, the market scenario for
Siemens is expected to remain optimistic. The strong local demand for goods and services will continue to attract large investments in basic industries and infrastructure. The modernization of Airports and Seaports coupled with investments in the Oil & Gas and Mining sector will continue to translate into a good business potential for the division. Further, due to enforcement of stricter environmental laws both in the Industries and Municipal sector, the Division also foresees a good growth opportunity in the water sector it is well positioned to take advantage of the market opportunities with its leadership and domain expertise in Metal, Power solutions and Airport modernization segments.

Siemens Building Technologies (SBT) Division: Highlights:

Acquired 77% stake in iMetrex Technologies. From 1st Oct, 2007 the business moved out into a separate legal entity Siemens Building Technologies Pvt. Ltd.

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Key Orders:
Rs.400 mn order from Reliance Retail for installing Integrated Loss Prevention Solutions at their retail outlets across India. Rs.300 mn order from IBM for Integrated Security & Safety Solutions. Rs.38 mn order from HPCL for installing integrated Building Management Solution (IBMS) at their Data Centre in Hyderabad.

The booming Indian economy and significant investments in the Retail, IT, ITES, Infrastructure, Hospitality and Manufacturing segments have been demand drivers for growth in the Building Technologies business, which grew by approximately 28%. With the need for corporates to ensure continuity of business, data security, comfort and energy optimization, the need for safety, security and automation solutions is rising continually.

With the acquisition of iMetrex Technologies, Siemens has gained a strategic business advantage in the building technologies sector. In the last fiscal, the SBT

business grew faster than the markets and registered 20% growth in Order value and 35% growth in Sales turnover. During this period, SBT retained its leadership position in the traditional market base comprising of the IT/ITES, Pharmaceuticals, Hospitality and Healthcare segments. It was successful in consolidating its position in emerging markets like Retail as well as High technology Manufacturing plants and also made strategic inroads in the Airports sector and the niche Defence segment.

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Power Generation Division:

Despite a challenging market, the Power Generation (PG) Division witnessed a healthy performance in 2006-07. Sales increased by 44%, Order value rose by 23% after adjusting the large order of Rs. 8.7 billion received from Torrent in the previous year. With the new industrial turbine factory commencing its production in January 2007, Siemens edged-up to become the leading supplier of industrial turbines. In the

automation sector, due to hi-tech innovative solutions, Siemens increased its market share against fierce competition and achieved its highest ever order value, besides

maintaining a double digit profitable growth. The service business also witnessed significant improvement.

Enterprise Communications Pvt. Ltd

Business retained its no. 1 market position.

Key Orders:
ASCON order worth Rs.118 mn for Hi Path 4000 - 21 systems & accessories, HiPath Manager upgrade and MCU. Order for product expansion of HiPath 4000 in the Defense Sector worth Rs.28 mn.

The enterprise communications market grew at approximately 16% with the SME segment registering the highest growth. The continued modernization of India's public telecommunication infrastructure had a positive influence on the enterprise

communications market. More reliable and more economical bandwidth was made available to Indian enterprises nationwide. In order to improve efficiencies and cost control measures, their operational

85

Enterprises continued to invest in upgrading their existing telecom & enterprise infrastructure. The Division achieved record sales for its HiPath 3000/4000 range and consolidated its dominance in the high and mid-end voice market segments. It also broadened its portfolio with the HiPath 1100 series and gained significant market share in the SOHO/ SME segment. While doing so, the division also participated strongly in the emerging non-metro low-end segment dominated by low cost/low tech local manufacturers. As such, the last year saw the division bag several major orders such as ASCON (Rs.118 million) and Headquarters 5 Signal Group (Rs.28 million) in the defense sector, ICICI Bank (Rs.22 million), Reserve Bank Of India (Rs.15 million) in the banking sector, South Western Railway (Rs.19 million), North Central Railway (Rs.11 million) in the Transportation sector and Infosys Technologies (Rs.21

million) in the IT sector. It's Call Center solution portfolio was received very well with multiple project wins in both domestic and international Call Center markets.

86

Valuation of SIEMENS
PROFIT & LOSS A\C

P&L Net Sales Other Income Stock Adjustments Total Income Total Expenditure Operating Profit Interest Gross Profit Depreciation Profit Before Tax Tax Fringe Benefit Tax Deferred Tax Net Profit before Minority Interest Minority Interest Net Profit after Minority Interest Extraordinary Items Adjusted Net Profit Adjst. below Net Profit P & L Balance brought forward PAT

2008(E) (Rs in cr.) 13167.5625 351.41 271.25 13790.2225 11946.7637 1843.45875 11.59 1831.86875 197.037481 1634.83127 490.44938 17.55 -29.1 1155.93189 1.14 1154.79189 64.23 1090.56189 -1.14 209.22 1364.012

2009(E) (Rs in cr.) 18487.2691 351.41 271.25 19109.9291 16521.7114 2588.21767 11.59 2576.62767 276.640793 2299.98688 689.996064 17.55 -29.1 1621.54082 1.14 1620.40082 64.23 1556.17082 -1.14 584.468544 2204.87

2010(E) (Rs in cr.) 25956.1418 351.41 271.25 26578.8018 22685.3805 3893.42126 11.59 3881.83126 388.403913 3493.42735 1048.02821 17.55 -29.1 2456.94915 1.14 2455.80915 64.23 2391.57915 -1.14 986.476709 3442.28

2011(E) (Rs in cr.) 33742.9843 351.41 271.25 34365.6443 29304.1966 5061.44764 11.59 5049.85764 504.925086 4544.93256 1363.47977 17.55 -29.1 3193.00279 1.14 3191.86279 64.23 3127.63279 -1.14 1584.55322 4776.42

2012(E) (Rs in cr.) 43865.8796 351.41 271.25 44488.5396 37469.9988 7018.54073 11.59 7006.95073 656.402612 6350.54812 1905.16444 17.55 -29.1 4456.93368 1.14 4455.79368 64.23 4391.56368 -1.14 2222.11136 6677.91

87

Free Cash Flow Calculation

Free Cash Flow Calculation

2008E Rs in cr.)

2009E Rs in cr.) 2588.218 276.6408

2010E Rs in cr.) 3893.421 388.4039

2011E Rs in cr.) 5061.448 504.9251

2012E Rs in cr.) 7018.541 656.4026

2013E Rs in cr.) 8948.639 787.6831

EBIT Plus: Depreciation

1843.459 197.0375

EBITDA Less: Capex Tax rate EBITDA Less Capex Less: Taxes on EBIT Add: Taxes on Interst Less: Changes in Working Capital Unlevered Free Cash Flow Terminal value PVIF Discounted cash flow Total DCF value

2040 502 30% 1539 -553 3

2865 706 30% 2159 -776 3

4282 989 30% 3292 -1168 3

5566 1172 30% 4395 -1518 3

7675 1580 30% 6095 -2106 3

9736 1701 30% 8035 -2685 3

-296 693

-416 970

-584 1544

-609 2271

-791 3201 38581

-686 4668

0.853971 591.6922 22444.75

0.729266 707.6742

0.622772 961.6391

0.531829 1207.736

0.454167 18976.01

88

DCF Calculation
WACC calculations Total discounted cash flows Less Debt Risk Free rate 9.0% Add cash Risk Premium 9.0% Add Investments Equity Value Beta 0.9 Shares in issue Cost of Equity 17.1% DCF per share Share Price WACC 17.1% Upside/(Downside) 126% 16.9 1,393 617 857 194 23,492 22,445 (4)

Assumption:

Rm=18% Growth assumed is 41% for first three years then 30% for two years and 20% for last estimated year.

Analysis: Comparing with current price of Siemens Expected price on the basis of DCF comes very high and is expected to give a return of 126% so suggestion is BUY.

89

Sensitivity Analysis
(1)If Growth rate changes to 30% for first three years then 2 years by 25% and last year by 20% with a market Return=18% Expected price of share changes as follows

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price Upside/(Downside)

15,979 (4) 857 194 17,026 16.9 1,010 617 64%

Analysis:
Growth rate decreases drastically it falls below its CAGR of 40.4% (approximately)but it having lower Beta value of 0.09 its Ke(i.e) its expected return decreases so is its discounting value and may result in ROE>Ke. So even in this situation (i.e. if Siemens records its growth rate upto 30%) recommendation is BUY as it is expected to provide growth of 64%.

90

(2)If Rm=26.3% Growth assumed is 41% for first three years then 30% for two years and 20% for last estimated year.

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price Upside/(Downside)

11,943 (4) 857 194 12,991 16.9 771 617 25%

Analysis:
Growth rate is high and also it having lower Beta value of 0.09 its Ke(i.e its expected return) decreases comparatively so eventhough its discounting increases value it results in ROE>Ke and also it is higher than the market return so it indicates that by investing in this firms one can earn higher returns compared to market. So in this situation (i.e when market gives abnormally high return) recommendation is to BUY.

91

(3)If Growth rate changes to 30% for first three years then 2 years by 25% and last year by 20% with a market Return=26.3% Expected price of share changes as follows

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price Upside/(Downside)

8,759 (4) 857 194 9,806 16.9 582 617 (6%)

Analysis:
Growth rate decreases drastically, it falls below its CAGR of 40.4% (approximately) and so expected return increases so is its discounting value and may result in ROE<Ke So in this situation (i.e. if Siemens records its growth rate of 30% or lower and market provides higher return) recommendation is to Sell and invest in other scripts or Index fund which will provide return equal market return.

92

Chapter 6

93

Company Analysis
Thermax

94

Summary of Thermax BUY

CMP (Rs.) 612 Target(Rs.) 816 Stock return 33% Nifty Sensex 4739.55 15626.62
Energy segment drives sales by 72% YoY in Q4FY07: For Q4FY07, Thermax reported robust standalone net sales growth of 72% YoY to Rs 8,182 million, which was mainly driven by superb performance from both energy and environmental divisions. Its energy division and environment division grew by 74% YoY and 54% YoY respectively for Q4FY07. Thermax witnessed good demand growth for boilers and heaters from oil & gas, power, steel, pharma, chemicals and sugar sectors. For FY07, standalone net sales grew by 47% YoY to Rs 21, 730 million, mainly on account of 50% YoY growth in energy division and 31% YoY growth in environment division. Thermax reported export revenue growth of 30% YoY to Rs 4 billion. On a consolidated basis, Thermaxs net sales grew by 43% YoY to Rs 23, 266 million, which was driven by both energy division (at 46% YoY) and environmental division (32% YoY. Net profit grows impressively by 52% YoY in Q4FY07: Thermaxs standalone net profit for Q4FY07, increased by 66% YoY to Rs 697million and reported an EPS of Rs 5.85 for the period. The interest cost for the quarter went up by 38% YoY to Rs 5.1 million, mainly on account of additional finance charges. For FY07, standalone net profit grew by 52% YoY to Rs 1, 878 million and reported an EPS of Rs 15.8 for the period. On a Consolidated basis for FY07, Thermax reported a net profit jump of 89% YoY to Rs 1, 937million and reported EPS of Rs 16.3 for the period. Strong order book position On consolidated basis, Thermax order book position at the end of Q4FY07 was stood at Rs 31billion, supported by Rs 28 billion from energy division and Rs 3 billion from environment division. On a standalone basis the order backlog went up by 78% YoY to Rs 27.68 billion, supported by Rs 25 billion from energy division and Rs 3 billion from environment division. The co-gen order book currently stood at Rs 9.25 billion. The order inflows during the year remained strong at Rs 33.2 billion, up by 58% YoY. We expect the order book position to remain strong in near future, driven by strong capex announced by refineries, chemical, steel, paper and sugar companies. Expansion palns: Thermax s plant in China is likely to become operational by June 2008 and the company expects this plant to report turnover USD 10million in the third year of operation. Thermax has also plans to export from its China plant to overseas. Its Baroda plant is expected to become operational by March 2008 and plant has potential to deliver turnover of Rs 15-20 billion going ahead. Thermax has planned total capex of Rs 1.75 billion for these expansions.

Key Stock Data BSE id 500411 NSE id THERMAX No of 11.9 Shares (in Cr.) Market Cap 7282.8 (Rs cr) Daily 33516 Volume (No of shares) Stock Performance 52 Week Highs Lows 945 336

Share Holding Pattern Foreign 7.23% Holding Govt./Financial 13.97% Institutions Corporate 3.88% (excluding above institutes) Promoters 61.98% Free Floating 12.94%

95

Introduction
Projects Business Group: Boiler & Heater:
It was a year of significant growth for the boiler & heater business unit as it registered an impressive growth of 52.7 percent over the previous year. It posted an income of Rs. 707.2 crore. This business grew with major orders from the iron & steel, petrochemical, sugar and captive power generation. Its association with global EPC majors in project execution continued during the period. In its thrust to provide industry with higher capacity boilers fired on solid fuels, it is supplying the largest bagasse fired boilers to one of the sugar units.

As energy management remains a top priority with industry, the outlook for this business remains positive.
Net sales and percentage of export figures for 2006-07 and four previous years are given below:

Boiler & Heater

Net Sales (excl. excise duty) Rs. crore

Growth % YOY

% Exports

Exports Growth %

2002-03 2003-04 2004-05 2005-06 2006-07

167.7 242.2 348.9 463.0 707.2

14.5 44.4 44.1 34.2 52.7

13.7 16.8 27.3 25.3 22.8

31.3 78.0 133.3 23.2 37.7

96

Power (Cogen):
Company's power business was one of the main drivers of the overall growth of the company. It continues to maintain its leadership position in the mid-size captive power market. During the year, it generated a total income of Rs. 471.6 crore, an increase of 95.3 percent by the previous year. With several captive power plants commissioned, this SBU has emerged as the preferred EPC contractor for the cement sector. To give the desired focus to the under 10 MW small power plant segment, which offers good business potential, a dedicated team has been formed for business development.

To expand its business, this SBU is now addressing larger power plants in the range of upto 150 MW. With this end in view, it has repositioned itself as the Power division of Thermax.

With the continuing power shortage faced by Indian industry, the business outlook remains positive.

Net sales figures for 2006-07 and four previous years are given below:

Power (Cogen)

Net Sales (excl. excise duty) Rs. crore

Growth % YOY

2002-03 2003-04 2004-05 2005-06 2006-07

85.6 17.0 136.9 241.5 471.6

0,92.6 (80.1) 705.3 76.4 95.3

97

Environment (Air pollution control):

Net sales figures for 2006-07 and four previous years are given below:

Enviro

Net Sales (excl. excise duty) Rs. crore

Growth % YOY

2002-03 2003-04 2004-05 2005-06 2006-07

30.4 58.0 118.0 146.2 161.7

(9.0) 90.8 103.4 28.1 10.6

Cooling:
GROWTH PROSPECTS

With GDP growing at 9.2 percent, the year saw vibrancy in all sectors.

The

manufacturing sector grew by 12 percent and capital goods registered a robust growth of 18 percent - with capital goods accounting for 30 percent of total engineering exports. New power and infrastructure projects along with continuing investments in the iron & steel, cement, petrochemical and textile sectors brought in steady business for your company in both its energy and environment segments. For capital goods manufacturers availability of raw material such as alloy steel could pose difficulties. There is also a concern about increased competition from imports due to reduction in customs duty and the strengthening of the rupee. Reduced customs duty could narrow the difference of parity between imported and domestic capital goods, tempting

98

domestic industries to opt for second hand imported

machines.

This

could have

repercussions on the price competitiveness of the Indian capital goods industry. In spite of these concerns, the outlook for your company remains positive. Driven by heightened industrial activity, fresh investments in cement, power, metals, oil and gas and petrochemicals and the continued spending on infrastructure, the buoyancy in the capital goods sector is expected to continue in 2007-08 and beyond. Ongoing efforts by several industrial houses to add to their capacities will also have positive spin-offs for the engineering sector.

Review of Operations:
It was a very upbeat year for the company. With the sustained economic boom and continuing industrial upswing, your company's total income touched Rs. 2210 crore. Profit after tax increased by 52.4 percent to Rs 187.8 crore. Exports were up at Rs. 401.7 crore, from Rs. 307.6 crore in the previous year. Based on the current market capitalisation of the company, which has crossed USD 1 billion, an investment magazine rated your company at the top among the 21 super wealth creators of the country, over the last five years. Thermax ended the year with carry forward orders worth Rs. 2769 crore.

During the year the three restructured business groups of Thermax Projects, Cooling & Heating and Chemical & Water - registered impressive growth. The Projects Business Group (boilers & heaters, captive power and air pollution control) accounted for nearly 62.7 percent of the company's turnover, while the. Cooling & Heating Group contributed 23.8 percent and Chemical & Water Group 13.5 percent.

The process improvements begun under Project Evergreen for a company wide transformation continued steadily. The drive for operational excellence concentrated on manufacturing and supply chain processes. There was overall improvement in the throughput at all levels. However, increased business volumes did put pressure on the delivery and execution schedules of the company.

99

So it can improve it operating margin over the time due to bulk orders and learning experience. To meet the growing business volumes, the company invested in capacity expansion during the year. Work on the additional manufacturing facility at Baroda for boilers and heaters is in progress and the plant will be fully commissioned by March 2008.

Strong order book position

On consolidated basis, Thermax order book position at the end of Q4FY07 was stood at Rs 31billion, supported by Rs 28 billion from energy division and Rs 3 billion from environment division. On a standalone basis the order backlog went up by 78% YoY to Rs 27.68 billion, supported by Rs 25 billion from energy division and Rs 3 billion from environment division. The co-gen order book currently stood at Rs 9.25 billion. The order inflows during the year remained strong at Rs 33.2 billion, up by 58% YoY. We expect the order book position to remain strong in near future, driven by strong capex announced by refineries, chemical, steel, paper and sugar companies.

Expansion plans:
Thermax s plant in China is likely to become operational by June 2008 and the company expects this plant to report turnover USD 10million in the third year of operation. Thermax has also plans to export from its China plant to overseas. Its Baroda plant is expected to become operational by March 2008 and plant has potential to deliver turnover of Rs 15-20 billion going ahead. Thermax has planned total capex of Rs 1.75 billion for these expansions.

New products:
During the year the company introduced new products and applications - Energen, a waste heat recovery boiler for combined heating and cooling applications; a skid mounted containerised reverse osmosis unit for business units with multiple water treatment requirements; and a number of ion exchange resins and speciality chemicals. Another notable new product was the award-winning lithium bromide absorption system

100

that extended

the cooling range of conventional chillers. In a breakthrough, your

company has also supplied the first solid fuel fired, closed loop heater (thermosyphon) to an edible oil major.

Energy Segment:
New commercial complexes in growing towns opened up opportunities in the area of large capacity cooling. Since many of these are going to rely on captive power, there is good opportunity for chillers fired on genset exhaust and for systems that fit into cogeneration and CHPC systems.

Environment Segment:
In the present scenario, where both water availability and quality are issues, the company's chemical and water business has big potential.

101

Valuation of THERMAX PROFIT & LOSS A\C

P&L 2008(E) (Rs. In cr.) Net Sales Other Income Stock Adjustments Total Income Total Expenditure Operating Profit Interest Gross Profit Depreciation Profit Before Tax Tax Fringe Benefit Tax Deferred Tax Net Profit before Minority Interest Minority Interest Net Profit after Minority Interest Extraordinary Items Adjusted Net Profit Adjst. below Net Profit P & L Balance brought forward Appropriations(PAT) 3104.192 72.98 72.85 3250.022 2784.393 465.6288 8.06 457.5688 27.3 430.2688 129.0806 2.31 1.24 2009(E) (Rs. In cr.) 4345.869 72.98 72.85 4491.699 3839.818 651.8803 8.06 643.8203 38.22 605.6003 181.6801 2.31 1.24 2010(E) (Rs. In cr.) 5866.923 72.98 72.85 6012.753 5132.714 880.0384 8.06 871.9784 51.597 820.3814 246.1144 2.31 1.24 2011(E) (Rs. In cr.) 7920.346 72.98 72.85 8066.176 6798.921 1267.255 8.06 1259.195 69.65595 1189.539 356.8618 2.31 1.24 2012(E) (Rs. In cr.) 10296.45 72.98 72.85 10442.28 8691.883 1750.396 8.06 1742.336 90.55274 1651.784 495.5351 2.31 1.24

297.6382 0

420.3702 0

570.717 0

829.1276 0

1152.699 0

297.6382 -9.96 307.5982 21.66

420.3702 -9.96 430.3302 21.66

570.717 -9.96 580.677 21.66

829.1276 -9.96 839.0876 21.66

1152.699 -9.96 1162.659 21.66

211.7 509.3382

204.6172 624.9874

320.2665 890.9835

575.2531 1404.381

1088.65 2241.349

102

Free Cash Flow Calculation

Free Cash Flow Calculation EBIT Plus: Depreciation EBITDA Less: Capex Tax rate EBITDA Less Capex Less: Taxes on EBIT Add: Taxes on Interst Less: Changes in Working Capital Unlevered Free Cash Flow Terminal value PVIF Discounted cash flow Total DCF value

2008E Rs cr. 465.6288 27.3 493 264 30% 229

2009E Rs cr. 651.8803 38.22 690 371 30% 319

2010E Rs cr. 880.0384 51.597 932 503 30% 429

2011E Rs cr. 1267.255 69.65595 1337 700 30% 637

2012E Rs cr. 1750.396 90.55274 1841 945 30% 896

2013E Rs cr. 2100.476 108.6633 2209 1151 30% 1059

-140

-196

-264

-380

-525

-630

62

86

106

143

165

143

153

212

273

402

539 5940 0.504451 3268.082

574

0.872095 133.8441 3976.688

0.76055 161.3222

0.663272 180.9537

0.578436 232.4867

0.439929

103

DCF Calculation

Total WACC calculations

discounted 3977 (89) 5,809 8 9705 11.9

cash flows Less Debt

Risk Free rate

9.0%

Add cash Add Investments

Risk Premium

9.0%

Equity Value Shares in issue

Beta

0.6296 DCF per share 816

Cost of Equity

14.7% Share Price 612 33%

WACC

14.7%

Upside/(Downside)

Assumption:
Rm=18% Growth assumed is 40% for first two years then 30% for two years and 20% for last two estimated year.

Analysis: If the market is providing return of 18% it will provide a high return of 33% if purchased even at current price. So my recommendation would be to BUY

104

Sensitivity Analysis

(1)Rm=18% Growth assumed is 30% for first three years then 25% for two years and 20% for last estimated year.

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price Upside/(Downside)

1404 (89) 5,809 8 7132 11.9 599 612 (2)%

Analysis: If thermax books growth rate of 30% which is its current CAGR for five years so it is priced correctly and may record a marginal decline of 2% or may not change. So it would be a better price to SELL.

105

(2) Rm=26.3% Growth assumed is 40% for first two years then 30% for two years and 20% for last two estimated year.

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price Upside/(Downside)

2402 (89) 5,809 8 8130 11.9 683 612 12%

Analysis: If thermax grows at 40% which is expected growth of industry and if it market provides abnormal return of 26% approximately if purchased at current price will provide a return of 12% which is very less compared to market so suggestion is to HOLD.

106

(3) Rm=18% Growth assumed is 30% for first three years then 25% for two years and 20% for last estimated year.

Total discounted cash flows Less Debt Add cash Add Investments Equity Value Shares in issue DCF per share Share Price Upside/(Downside)

923 (89) 5,809 8 6651 11.9 559 612 (9)%

Analysis: If the market is providing return of 26.3% and also if it continue to grow at current CAGR its stock are over valued. So decision is to SELL.

107

Conclusion
India is expected to grow and for its growth infrastructure facilities are required. For such facilities Capital Goods Industry will provide facilities. India has large requirements for infrastructure facility so this industry has high growth prospect.

Recommendation
Considering the present price levels and growth prospect of BHEL, SIEMENS and THERMAX it is suggested to HOLD BHEL, and BUY Siemens and Thermax. But suggestions changes with changing environment like change in sales or change in expected return or market return.

Limitation
Only secondary data is used. It was difficult to get primary data. Also to justify the findings is difficult. It is the situation of WAIT and WATCH. There are certain factors which may change drastically and affect prices of stock also they cannot be avoided and are practically not possible to predict.

Learnings
It was a great experience to learn how to do Fundamental analysis and to determine what would be the change in market prices if certain factors changes.

108

Bibliography
Company website: BHEL, Siemens, Thermax

EquityResearch.in Equity Research WWW Database www.google.com www.valuenotes.com www.bseindia.com www.nseindia.com www.icicidirect.com www.geojit.com www.moneycontrol.com www.sify.com www.crisil.com/research/research-global-equity-research.htm www.gov.in http://www.crisil.com http://www.securities.com/ http://www.sp.advisorinsight.com http://www2.standardandpoors.com for research methodology http://news.indiamart.com/capital-goods-news.html http://www.domain-b.com/industry/engineering/index.html for industry news

Capitaline database

Books referred: Financial Management by Prasana Chandra

109