India Equity Strategy - · PDF fileSTRATEGY NOTE India | Equity Strategy India 19 May 2014...

STRATEGY NOTE

India | Equity Strategy

India 19 May 2014

India Equity StrategyWhat Next? Growth Reset

EQU

ITY STRATEG

Y IND

IA

Govindarajan Chellappa *Equity Analyst

+91 22 4224 6111 [email protected] Nahar *

Equity Analyst+91 22 4224 6113 [email protected]

Nilesh Jasani §Equity Analyst

+65 6551 3962 [email protected] Agarwal, CFA *


Arya Sen *Equity Analyst

+91 22 4224 6122 [email protected] Goyal, CFA §

Equity Analyst+65 6551 3965 [email protected]

Lavina Quadros *Equity Analyst

+91 22 4224 6116 [email protected] Karfa *


Rajasa Kakulavarapu *Equity Analyst

+91 22 4224 6115 [email protected] Fitkariwala *

Equity Associate+91 22 4224 6125 [email protected]

Swagato Sourya Ghosh *Equity Associate

+91 22 4224 6114 [email protected]

* Jefferies India Private Limited § Jefferies Singapore Limited

MCI (P) 035/07/2013

Key Takeaway

The surprisingly clear and overwhelming mandate for BJP and its alternatevision of economic policies throws up a unique opportunity to enforce amuch needed mend to the pattern of economic growth. We expect the newgovernment to focus on fiscal consolidation through subsidy control and enablecapital formation through proactive administration and policy changes. Weexpect markets to yield c15% returns over the next one year led by domesticcyclical sectors.

Change in growth pattern inevitable: The turn in India’s growth pattern post-GFC,partly due to global factors and mostly due to domestic policy matters, resulted in aconsumption boom and deceleration in capacity formation, especially in infrastructure.This resulted in elevated fiscal imbalance, deterioration of an even otherwise weak externalbalance and persistent inflation. A change in growth pattern through slower consumption,especially government consumption and higher investments in infrastructure, is aprecondition for any sustainable acceleration in growth. The extraordinary mandate in thefavour of BJP/NDA eases the path to reforms in a manner unprecedented in recent history.BJP has a majority of its own in the Lower House of Parliament and with allies, has enoughnumbers to not heed to the vested interests in its own formation. While the NDA lacksthe numbers in the Upper House, it has a majority of the combined houses, which wouldmatter if certain legislation are rejected by the Upper House. As such, the political mandateis overwhelming.

How soon and quick can the recovery be? We expect “data holiday” to give rise toa spectacular statistical acceleration in the fast moving economic indicators like industrialproduction around the year-end aided by the current low base. Beyond the statisticalrecovery, improvement in business sentiment, heightened policy activity, a reactivatedgovernment and administrative machinery and the ongoing liquidity inflows should providea major cyclical fillip too to the economy even as the central bank stays stagnant on policyrates. We consequently make numerous changes to our estimates, target prices and ratings.We have raised FY16E estimates for over 27 companies, mostly in the domestic cyclicals, by1-101%. We have also upgraded four companies, again mostly in cyclicals, and downgradedone company.

Domestic cyclicals is the place to be in: Bottom-up fundamental analysts always findit difficult to forecast extent of turns in the economy and as such current forecasts two-years out are relatively irrelevant in times like these. A look at historical forecasts suggeststhat at points of recovery, analysts tend to underestimate one-year forward earnings aswell as growth in the second year. We believe returns in most stocks will be a function ofacceleration in earnings momentum beyond current forecasts rather than valuations basedon current forecasts. A look at ownership levels, valuations and forecasts relative to historywould suggest the maximum upside would possibly be in financials, especially in publicsector banks and industrials. These are our preferred investments now, with L&T, Axis Bank,BOB, ICICI Bank and NTPC being our top picks. While we are underweight consumptionat this juncture, we like Maruti for a cyclical recovery and like only ITC from the defensivesectors. We like ONGC as a play on subsidy reforms, Reliance for bottom-up cyclical recoveryand Tata Steel for increasing asset utilisation.

Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies may have aconflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investmentdecision. Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 125 to130 of this report.

Key Charts

Exhibit 1: Growth pattern pre and post GFC

Source: MOSPI

Exhibit 2: Share of consumer staples and industrials in Nifty

market cap

Source: Bloomberg

Exhibit 3: Fund raising could increase to deleverage…

Source: CMIE, Bloomberg, Jefferies estimates

Exhibit 4: …as leverage for corporate sector has increased


Exhibit 5: T+2 earnings could see significant upgrades in

case of a recovery

Source: Factset, Jefferies estimates

Exhibit 6: India PE valuations are at historical average

Source: Factset, Jefferies

0

2

4

6

8

10

12

14

16

18

Private consumption Government

consumption

GFCF

Growth CAGR (%)

FY03-08 FY08-13

0

2

4

6

8

10

12

Staples Industrials

0.0

0.5

1.0

1.5

2.0

2.5

3.0

FY01FY02FY03FY04FY05FY06FY07FY08FY09FY10FY11FY12FY13FY14

Domestic Equity Raising as % of total Market Cap

1.0

1.1

1.2

1.3

1.4

1.5

1.6

FY97 FY99 FY01 FY03 FY05 FY07 FY09 FY11 FY13

Leverage (CE/Networth)

(40)

(30)

(20)

(10)

0

10

20

30

40

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

MSCI India

FY1 Change in 1YR FY2 Change in 2YR

5

7

9

11

13

15

17

19

21

23

25

Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14

India 12M Fwd PE Avg.

Equity Strategy

India

19 May 2014

page 2 of 130 , Equity Analyst, +91 22 4224 6111, [email protected] Chellappa

Please see important disclosure information on pages 125 - 130 of this report.

Top picks

Exhibit 7: OW Financials, Industrials; UW Staples & IT

Sectors Stance Top stocks

Financials OW OW Axis Bank, ICICI Bank, SBI, Bank of Baroda

Industrials OW OW L&T, Cummins

Consumer Discretionary MW OW Maruti Suzuki

Energy MW OW Reliance, ONGC

Materials MW OW Tata Steel

Utilities MW OW Tata Power, NTPC

Healthcare MW OW Sun Pharma

Information Technology UW OW TCS

Consumer Staples UW

Telecom MW

Source: Jefferies

Exhibit 8: Top picks

P/E P/B

Company Name BB Code Rating Target Price

(Rs)

Price

(Rs)

FY15E FY16E FY14E FY15E

Axis Bank AXSB IN Buy 2,180 1,755 11.3 8.7 2.3 2.0

Bank of Baroda BOB IN Buy 1,140 934 7.6 5.7 1.3 1.1

ICICI Bank ICICIBC IN Buy 1,720 1,465 14.7 11.8 2.5 2.2

ITC ITC IN Buy 411 356 28.3 24.5 10.5 9.9

Larsen & Turbo LT IN Buy 1,640 1,426 18.8 16.4 2.8 2.6

Maruti Suzuki MSIL IN Buy 2,501 2,158 19.0 15.4 3.1 2.7

NTPC NTPC IN Buy 150 132 12.0 11.2 1.3 1.2

ONGC ONGC IN Buy 440 383 10.2 9.6 2.2 2.0

Reliance RIL IN Buy 1,236 1,075 13.6 13.7 1.9 1.8

Tata Steel TATA IN Buy 540 440 9.2 7.9 1.2 1.1

Source: Company Data, Jefferies estimates, closing prices as of 16 May 2014

Equity Strategy

India

19 May 2014



Table of Contents KEY CHARTS ................................................................................................................................ 2 TOP PICKS ................................................................................................................................... 3 TABLE OF CONTENTS ................................................................................................................... 4 CLEAR, UNAMBIGUOUS MANDATE .............................................................................................. 6

A mandate for an alternate economic vision ................................................................................ 6 The solution lies in government policies, partially ........................................................................ 9

IT’S A T+2 MARKET .................................................................................................................... 12 WHAT’S IN THE PRICE? .............................................................................................................. 14 TOP-DOWN VIEW ...................................................................................................................... 16

Financials .................................................................................................................................... 17 Industrials ................................................................................................................................... 19 Consumer Discretionary ............................................................................................................. 21 Energy ......................................................................................................................................... 23 Materials ..................................................................................................................................... 25 Utilities ....................................................................................................................................... 27 Healthcare .................................................................................................................................. 29 Information Technology ............................................................................................................. 31 Consumer Staples ....................................................................................................................... 33 Telecommunication Services ...................................................................................................... 35

BOTTOM-UP VIEW .................................................................................................................... 37 Financials – Go Long on Cycle and Governance .......................................................................... 38 Industrials – From Announcements to Orders to Execution… .................................................... 48 Autos – Poised for recovery ........................................................................................................ 55 Energy: Reforms to Continue, Faster Decision-Making in E&P ................................................... 60 Metals & Mining - Well Leveraged to a Macro Recovery ............................................................ 63 Steel – domestic demand boost .............................................................................................. 64 Mining – will the supply-side issues be addressed? ................................................................ 66 Cement Sector: Demand Outlook Improves ............................................................................... 72 Pharma – Prefer India Focus Over US ......................................................................................... 80 Consumer Sector – Trend Reversal ............................................................................................. 83 Real Estate – Sentiment Change Round the Corner but Issues Persist ....................................... 90

TOP PICKS ................................................................................................................................. 94 Axis Bank (AXSB IN, Buy) – Positive on Cyclical Recovery ........................................................... 95 Bank of Baroda (BOB IN, Buy) – Best within SOEs, governance change is positive ..................... 99 ICICI Bank (ICICIBC IN, Buy) – Positive on cyclical recovery ...................................................... 103 ITC (ITC IN, Buy) ........................................................................................................................ 107 L&T (LT IN, Buy): Still some way to go… .................................................................................... 110 Maruti Suzuki (MSIL IN, Buy) .................................................................................................... 113 NTPC (NTPC IN, Buy): PLF recovery buffer left in estimates… ................................................... 117 ONGC (ONGC IN, Buy) – Biggest Beneficiary of Reforms .......................................................... 120 Reliance (RIL IN, Buy) – Core Businesses Turning Around ........................................................ 121 Tata Steel Ltd. (TATA IN , Buy) .................................................................................................. 122

Equity Strategy

India

19 May 2014



Exhibit 1: Ratings/Target Price/Earnings changes in our coverage

Ticker Rating Target Price FY15E EPS FY16E EPS

Company Old New Old New Old New Old New

ONGC ONGC IN BUY BUY 355.0 440.0 37.3 37.6 39.5 40.0

Oil India Limited OINL IN BUY BUY 580.0 670.0 64.4 64.4 70.5 70.5

Bharat Petroleum Corporation Limited BPCL IN HOLD HOLD 400.0 560.0 25.2 45.9 n/a 46.0

Reliance Industries RIL IN BUY BUY 1,124.0 1,236.0 79.1 79.1 78.2 78.2

GAIL GAIL IN BUY HOLD 388.0 410.0 38.6 38.6 41.0 41.0

Indraprastha Gas Ltd. IGL IN BUY BUY 333.0 371.0 31.7 31.7 36.5 36.5

Coal India Limited COAL IN HOLD HOLD 281.0 305.0 27.7 26.7 30.4 28.1

JSW Steel Limited JSTL IN BUY BUY 1,168.0 1,406.0 92.2 95.8 123.0 127.2

India Cements ICEM IN HOLD HOLD 56.0 76.0 3.8 4.5 7.5 9.8

NMDC Ltd NMDC IN BUY BUY 149.0 178.0 16.8 16.8 17.0 17.6

Steel Authority of India Ltd. SAIL IN UNPF UNPF 54.0 63.0 5.7 4.5 6.2 5.4

NTPC NTPC IN BUY BUY 140.0 150.0 11.5 11.0 12.3 11.8

Larsen & Toubro LT IN BUY BUY 1,415.0 1,640.0 52.4 52.4 57.2 59.9

Bharat Heavy Electricals Limited BHEL IN UNPF UNPF 160.0 185.0 9.7 9.7 8.8 8.8

Power Grid Corporation of India Limited PWGR IN BUY BUY 135.0 150.0 9.9 9.9 11.5 11.5

Tata Power TPWR IN BUY BUY 100.0 105.0 7.0 6.1 7.6 6.7

Adani Ports and Special Economic Zone ADSEZ IN UNPF UNPF 160.0 180.0 9.8 10.3 10.4 11.1

Siemens Limited SIEM IN HOLD HOLD 610.0 730.0 12.0 12.0 13.3 14.1

ABB Limited ABB IN UNPF UNPF 570.0 650.0 10.3 10.3 13.1 15.3

Cummins India Limited KKC IN BUY BUY 620.0 670.0 24.0 22.7 26.3 26.5

Crompton Greaves Limited CRG IN UNPF UNPF 100.0 130.0 7.4 7.4 9.1 10.0

Thermax Limited TMX IN UNPF UNPF 510.0 650.0 29.7 29.7 31.9 36.1

Voltas Limited VOLT IN UNPF UNPF 100.0 140.0 7.5 7.5 8.3 9.3

Sun Pharmaceutical Industries Ltd SUNP IN BUY BUY 710.0 715.0 29.2 28.0 32.2 33.5

Cipla CIPLA IN BUY BUY 480.0 475.0 22.8 21.4 28.1 26.6

Ranbaxy Laboratories Ltd. RBXY IN BUY BUY 568.0 572.0 32.9 28.9 30.4 27.1

Dr. Reddy's Laboratories DRRD IN HOLD HOLD 2,500.0 2,550.0 132.4 132.4 147.4 147.9

Lupin Ltd. LPC IN HOLD HOLD 910.0 880.0 45.4 42.7 51.7 48.0

Titan Company TTAN IN BUY BUY 257.0 355.0 9.3 9.9 11.7 12.7

TTK Prestige TTKPT IN UNPF HOLD 2,991.0 3,393.0 120.0 111.0 150.0 138.0

Jubilant Foodworks JUBI IN HOLD HOLD 1,035.0 1,202.0 30.3 28.6 40.6 38.7

ITC Limited ITC IN BUY BUY 393.0 411.0 12.6 14.5 12.6 14.5

Tata Motors TTMT IN HOLD HOLD 392.0 415.0 49.7 52.0 52.2 53.4

Maruti Suzuki India Limited MSIL IN BUY BUY 2,282.0 2,501.0 113.7 113.7 134.2 140.1

Mahindra & Mahindra Limited MM IN UNPF BUY 804.0 1,296.0 59.5 62.6 66.1 76.8

Hero MotoCorp HMCL IN BUY BUY 2,354.0 2,738.0 143.2 141.4 169.8 169.6

Bajaj Auto Limited BJAUT IN HOLD HOLD 2,322.0 2,178.0 136.0 118.9 148.3 130.3

Ashok Leyland AL IN HOLD HOLD 19.0 25.5 -0.1 -0.4 0.5 1.1

Bharat Forge BHFC IN HOLD HOLD 287.0 428.0 19.1 19.5 23.7 27.2

DLF Limited DLFU IN UNPF UNPF 125.0 140.0 7.0 7.0 10.0 10.0

Godrej Properties Limited GPL IN HOLD HOLD 181.0 207.0 16.0 16.0 20.0 20.0

Prestige Estates Projects Limited PEPL IN BUY BUY 199.0 217.0 10.0 10.0 14.0 14.0

Sobha Developers Limited SOBHA IN BUY BUY 372.0 485.0 24.0 24.0 32.0 32.0

Axis Bank AXSB IN BUY BUY 1,800.0 2,180.0 152.9 154.8 198.7 201.8

Bank of Baroda BOB IN BUY BUY 1,080.0 1,140.0 122.2 122.2 162.6 162.6

ICICI Bank ICICIBC IN BUY BUY 1,470.0 1,720.0 99.9 99.9 123.9 124.2

Indus Ind Bank IIB IN BUY BUY 615.0 680.0 34.5 34.5 44.7 44.7

Kotak Mahindra Bank KMB IN HOLD HOLD 800.0 910.0 39.9 40.1 53.6 54.0

HDFC Bank HDFCB IN BUY BUY 870.0 960.0 45.9 45.9 57.2 57.2

Punjab National Bank PNB IN UNPF HOLD 690.0 865.0 130.2 127.8 154.7 170.9

State Bank of India SBIN IN UNPF BUY 1,325.0 2,875.0 161.8 162.8 243.4 274.0

Housing Development Finance Corp HDFC IN HOLD HOLD 910.0 935.0 39.7 40.1 48.0 48.6

Source: Jefferies estimates, Company Data

Equity Strategy

India

19 May 2014



Clear, unambiguous mandate The final numbers of the 2014 Lok Sabha (Lower House) are out and this is what they

signify:

BJP has a majority of its own in the Lower House (winning 282 out of 543 seats).

The ability of allies to arm-twist the government is therefore limited. This has

been a commonly stated excuse for policy mishaps in the recent past.

The NDA has won 335 seats. The ability of the alternate power centres within

the BJP to arm twist the prime minister is limited. This has been an unstated

reason for policy paralysis in the previous governments.

The NDA has 62/250 seats in the Upper House (Rajya Sabha). Every legislative

bill will have to be passed by both the houses. However, in case of a conflict:

In case of finance bills, Lower House’s view prevails.

In case of legislative changes, there is a joint sitting of both the houses.

The NDA has over 50% of the combined seats.

The lack of majority in the upper house is seen as a risk to policy-making, but

that clearly isn’t relevant any longer.

Suffice it to say that except in case of occasional constitutional amendments, that require

two-thirds majority of parliament, the NDA has the numbers to pursue its agenda.

A mandate for an alternate economic vision The poll promise of the BJP, as stated in its manifesto and through speeches, is in marked

contrast to the policies and electoral pitch of the outgoing UPA. The BJP, in short,

promises to drastically improve provision of basic infrastructure, such as providing 24X7

electricity to all households, roads to all villages, water connection to all farmlands and

households, broadband network etc., in addition to talking about ambitious projects such

as river linking. This contrasts with the UPA’s emphasis on subsidies, entitlements and

dole outs. This is not to say there is no overlap – NDA is unlikely to eliminate subsidies

and UPA wasn’t entirely defocussed from infrastructure creation – but the emphasis is

markedly different.

The alternate economic vision is an imperative as well. There has been a drastic change in

India’s growth pattern from pre-GFC to post GFC. In addition, to the extraneous factors

like drying up of external sources of funding, the manner of government’s response to

GFC has had a large bearing on the growth pattern. Like many other countries, India had

a large stimulus program post GFC but most, if not all, was designed to boost

consumption rather than create productive assets. Cut in tax rates and increased subsidies

accounted for bulk of the stimulus measures, which coincided with three major populist

moves – implementation of NREGA, farm loan waiver, rapid increase in crop procurement

prices and implementation of sixth pay commission which resulted in significantly higher

wages for government employees. The resultant impact has been felt across the fiscal

situation, external account and inflation.

The election has given BJP enough

seats to pass most legislation on its

own in the Lok Sabha and with its

allies in the Rajya Sabha

BJP’s economic vision emphasis is on

improving infrastructure and growth

vs. UPA’s emphasis on subsidies,

entitlements

UPA’s response to the GFC – tax

incentives, subsidies and populist

moves – sharply altered the growth

pattern, worsened the twin deficit

and led to rise in inflation

Equity Strategy

India

19 May 2014



The need for change in growth pattern

While the average GDP growth rate slowed down post GFC, all the slowdown has been in

investments. Government consumption actually accelerated while private consumption

grew at a pace similar to before.

Exhibit 9: Growth pattern pre and post GFC

Source: MOSPI

This pattern of growth is neither sustainable, nor desirable. Unless investments accelerate,

consumption will also slow down, resulting in further deceleration in the economy.

Rapid rise in fiscal deficit – it’s the quality that’s worrisome

Tax collection slowed down significantly post GFC, mostly due to tax incentives and cuts.

On the other hand, subsidies have ballooned. The government has tried to cut down the

fiscal deficit recently but cutting down expenditure, which we don’t think is sustainable.

Refer to our note ‚What next? No.1 Fiscal confession‛ for a detailed discussion on the

current situation but suffice it to say that fiscal situation is unsustainable

Exhibit 10: Fiscal situation – pre and post GFC

(% of GDP) FY04 FY08 FY14RE

Total receipts 12.3% 11.7% 9.4%

Revenue receipts 9.3% 10.9% 9.1%

- Net tax 6.6% 8.8% 7.4%

- Non Tax 2.7% 2.1% 1.7%

Capital receipts 3.0% 0.9% 0.3%

Total Expenditure 16.6% 14.3% 14.0%

Subsidies 1.6% 1.4% 2.3%

Interest 4.4% 3.4% 3.4%

Other revenue expenditure 6.8% 7.1% 6.7%

Capital expenditure 3.8% 2.4% 1.7%

Fiscal deficit 4.3% 2.5% 4.6%

Revenue deficit 3.5% 1.1% 3.3%

Source: MOSPI

Note from the table above that all the increase in fiscal deficit is due to rise in subsidies

and fall in tax collections. The higher government spending isn’t creating productive

assets in any manner.

0

2

4

6

8

10

12

14

16

18

Private consumption Government consumption GFCF

Growth CAGR (%)

FY03-08 FY08-13

A need to revert to pre-GFC growth

pattern – one which is investment

driven

Lower taxes and higher subsidies

have been the key reason for rising

fiscal deficit

Expenditure cuts have been mostly

focussed on the much needed

capital expenditure side

Equity Strategy

India

19 May 2014



http://bit.ly/1mHNmBw

Leading to persistently high inflation

Rising fiscal deficit and rural wages with no concurrent increase in productivity or

productive capacity of the economy have resulted in persistently high inflation. The

government and the central bank have been working to solve the demand side of the

equation but no efforts have been made yet to address the supply issues.

Exhibit 11: Rural wages have outpaced inflation in recent years

Source: CMIE, Jefferies

And rising external imbalances

India’s recent consumption boom, along with slowdown in investments (especially in

mining activity,) had led to current account deficit (CAD) ballooning to extraordinarily

unsustainable levels from marginally unsustainable levels. While there has been cut-back

of late, they have been due to draconian controls on gold imports as well as slowdown in

non-oil imports. The underlying issues remain unresolved.

Exhibit 12: CAD movement

(in USD mn) FY08 FY09 FY10 FY11 FY12 FY13 9MFY13 9MFY14

CAD -15,737 -27,915 -38,181 -45,945 -78,155 -88,163 -71,519 -31,056

Trade Deficit -91,467 -119,519 -118,203 -130,593 -189,759 -195,656 -150,276 -116,941

Petroleum crude & products -51,281 -64,584 -58,796 -64,502 -99,467 -113,694 -77,180 -78,493

Gold,Silver and Jewellery -5,494 -11,427 -16,779 -36,590 -44,919 -35,782 -23,568 -16,184

Electronics -17,712 -17,831 -17,190 -19,483 -25,348 -23,808 -17,710 -18,154

Capital Goods -33,113 -25,677 -24,578 -23,256 -30,096 -26,176 -21,868 -12,029

Coal, coke & briquettes -6,358 -9,930 -8,861 -9,550 -17,281 -15,687 -12,705 -11,526

Metals 1,753 -3,505 -1,678 27 -7,706 -10,768 -8,027 -4,432

Agriculture 11,473 9,919 5,620 11,358 20,360 21,903 14,159 17,705

Textile 20,594 20,937 20,457 24,666 28,619 28,025 20,001 23,866

Others -11,329 -17,421 -16,398 -13,264 -13,920 -19,670 -23,379 -17,694

Invisibles 75,731 91,605 80,022 84,648 111,604 107,493 80,028 85,885

Software Services 36,942 43,736 48,237 53,266 60,956 63,504 46,399 49,253

Remittances 41,706 44,567 52,056 53,124 63,469 64,342 48,554 49,282

Others -2,917 3,302 -20,271 -21,742 -12,821 -20,354 -14,925 -12,650

Source: RBI, CMIE, Jefferies

0

50

100

150

200

250

300

350

Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13

Men Rural Wages CPI - Rural Labor

Policy driven rural wage growth and

rising fiscal deficit has resulted in

persistently high inflation

Recent CAD correction due to

temporary measures as underlying

issues still remain

Equity Strategy

India

19 May 2014



The solution lies in government policies, partially Change in growth pattern by reviving investment cycle, encouraging increase in financial

savings and (indirectly) slowing consumption is an imperative for the new government, in

our view. The political instinct of the new government matches this imperative. We expect

policy and administrative changes in this direction. The efforts of the new government

will be to kick start the investment cycle through fiscal, administrative, political and legal

measures. We have listed several such possible measures in the note titled ‚What next? 7.

Modinomics‛.

Statistical recovery is easy

Statistical recovery in economic growth indicators like industrial production is almost a

given. Most fast moving indicators are at or near multi-year lows and some have already

shown signs of inching upwards. The low base could cause some of the data points such

as IIP, auto volumes, project announcements etc to accelerate massively from hereon.

Exhibit 13: IIP growth has been muted for past few

quarters


Exhibit 14: ... so has GDP growth


Exhibit 15: Project announcements are at its lows

Source: CMIE, Jefferies estimates

Exhibit 16: Steel production is seeing some improvement


-10

-5

0

5

10

15

20

25

Oct-02 Apr-04 Oct-05 Apr-07 Oct-08 Apr-10 Oct-11 Apr-13

IIP growth (%) 3m m.a. (%)

0

2

4

6

8

10

12

Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13

GDP growth (%)

0

1

2

3

4

5

6

7

8

9

Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14

New Investment Projects (Rs tn)

0

5

10

15

20

25

Finished Steel Production Growth % 3M M.A.

Expect measures to revive

investment cycle

Equity Strategy

India

19 May 2014



http://bit.ly/1qMFuTo

http://bit.ly/1qMFuTo

Exhibit 17: Railway freight traffic growth remains weak


Exhibit 18: CV tonnage growth has seen a sharp and

longest decline in past 20 years


Cyclical recovery probable

Heightened foreign inflows and return of business confidence will also likely result in a

sharp cyclical recovery that could last a few years. Given the buoyancy in the equity

markets, it will not be long before companies with debt-heavy balance sheets and

ambitious project plans hit the market to raise equity.

Exhibit 19: Fund raising has been muted in recent years…


Exhibit 20: ...especially as % of total market capitalization


Exhibit 21: Leverage for corporate sector has increased ….


Exhibit 22: …led by industrials and utilities


-4

-2

0

2

4

6

8

10

12

14

16

18

Feb-04 Feb-06 Feb-08 Feb-10 Feb-12 Feb-14

Railway Freight growth (%) 3m m.a.

-60%

-40%

-20%

0%

20%

40%

60%


Growth in tonnage addition

0

200

400

600

800

1,000

1,200

1,400

1,600


Domestic equity raised (in Rs bn)

0.0

0.5

1.0

1.5

2.0

2.5

3.0


Domestic Equity Raising as % of total Market Cap

1.0

1.1

1.2

1.3

1.4

1.5

1.6


Leverage (CE/Networth)

0.0

0.5

1.0

1.5

2.0

2.5

Indu Util Tel India

ex fin

Mat Disc Oil Ph Stap IT

Median Leverage (x) FY13 Leverage (x)

Expect fund raising activity to

increase

Equity Strategy

India

19 May 2014



But it isn’t just lack of funding that is holding back cyclical recovery in investments. Policy

paralysis, the phrase loosely used to describe the inaction of various parts of the

administration, including policy makers and policy implementers, has played its part in

slowing down activity levels. A cursory glance at various projects stuck at various levels of

completion would suggest a large number of issues that can be put down to policy

paralysis. They range from viable projects stuck for want of one signature to projects

being made unviable due to administrative delays.

A change in the process of administration, an acclaimed strength of the incoming prime

minister, could materially change the pace of project implementation as well as

confidence of investors to start new projects. With the kind of mandate the new

government has got, policy paralysis could easily turn into policy deluge. If the new

government gets the right bureaucrats in the right position, moribund bureaucracy could

become proactive decision makers.

Structural growth story is still in doubt

Structural growth, however, is still a question mark and will depend on whether the

underlying polity has actually moved on to accept free market economics. This is a

necessary precondition for fixing the broken profit model for new investors of big

projects.

For the moment, we only assume a sharp statistical and cyclical recovery in domestic

cyclical sectors.

Policy paralysis to policy deluge

Equity Strategy

India

19 May 2014



It’s a T+2 market Except in the recent past, ‘Slowdown Kings; (the set of high quality, cash flow rich

companies mostly from consumer staples, IT, pharma, two-wheelers and a few others)

have significantly outperformed the domestic cyclical stocks. If one takes a step back and

looks at the impact the change in growth pattern since 2008 has had on stocks from

various sectors, the shift in relative values of various sectors is quite big. It is best

demonstrated by two domestic sectors – consumer staples and industrials. The following

chart displays the share of these two sectors to the total Nifty market capitalisation – the

data points are visually, if not statistically, inversely correlated. And we would look at

absolute market values, rather than multiples, to make the case as shift in growth patterns

flow through to the values through earnings more than multiples.

Exhibit 23: Share of consumer staples and industrials in Nifty market cap

Source: Bloomberg

While domestic cyclical stocks have rallied hard since late 2013, it would be erroneous to

call for a halt. We are arguing for a course correction in the growth pattern and these

changes tend to last for a few years.

However, it is one thing for macro-analysts and economists to expect a sharp recovery in

sectors linked to domestic economic cycles but completely another for analysts and

investors to factor them into forecasts. A recovery post a prolonged period of slowdown

argues for a sharper recovery than usual but analysts used to earnings disappointments in

the recent past are unlikely to rush in to upgrade forecasts even if they believe in

economic recovery. We call this publishing bias – analysts, after all, have to justify the

forecasts they publish based on bottom up data rather than top down analysis.

A look at historical earnings expectations brings out the publishing bias of analysts. In

almost every year and for every sector, forecasts for two-year forward earnings tend to get

upgraded/downgraded over a two-year period more than forecasts for one-year forward

earnings. Put another way, not only do analysts underestimate (or overestimate) earnings

for year 1 but also underestimate (or overestimate) growth in year 2 at the beginning of

year 1.

0

2

4

6

8

10

12

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 Current

Staples Industrials

Changing growth pattern has

reflected in relative sector weightings

The extent of a recovery is usually

underestimated in analyst estimates

Equity Strategy

India

19 May 2014



Exhibit 24: T+2 earnings could see significant upgrades in

case of a recovery


Exhibit 25: Earnings change history for L&T


Exhibit 26: Earnings change history for SBI


Exhibit 27: Earnings change history for Grasim


The market is likely to price in the possibility of reversion to trend growth and above and

the concomitant earnings upgrades before they actually occur. Thus, cyclical sectors will

necessarily look expensive at this juncture on traditional valuation metrics. Instead, we

would look at what is priced in to the stocks at this juncture, an exercise we do in the next

section.

(40)

(30)

(20)

(10)

0

10

20

30

40

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

MSCI India


(50)

0

50

100

150

200

250

2002200320042005200620072008200920102011201220132014


(30)

(20)

(10)

0

10

20

30

40

50

2002200320042005200620072008200920102011201220132014


(60)

(40)

(20)

0

20

40

60

80

100

120

140

2002200320042005200620072008200920102011201220132014


Equity Strategy

India

19 May 2014



What’s in the price? In this section, we look at what is implied in the stock prices of various cyclical companies.

In the case of manufacturing companies, we use sales and EV/sales for the evaluation and

in case financials, we look at BV and RoE. Since the slowdown is well captured in the P&Ls

of the manufacturing companies, acceleration in growth is the key stock price driver. In

the case of banks, the current valuations are similar to or lower than the respective

median and thus have valuation support.

Manufacturing companies: It’s all about growth – Our sample includes 19 large

companies under coverage in autos, industrials and cement. We assume debt remains

constant from now through the 3-year forecast period to arrive at the possible returns. We

assume that valuations revert to their median levels in three years and calculate what is

the required sales growth for the same.

Only four companies are trading at a (EV/Sales) valuation lesser than the last 15-

year median.

The implied three-year growth rate to justify current stock price (assuming 12%

hurdle rate and valuations trending to median in 2 years) is higher than the

median growth rate for 12 companies. Cement stocks, L&T, Hero, M&M, BHEL

and Crompton have lower than median growth expectations.

From a cyclical bottom, one ought to look at implied growth rate relative to

maximum, rather than medium. In that respect, most companies still factor in a

recovery slower than what is generally seen from bottom of the cycle to top.

Exhibit 28: Required sales growth for median valuations is below median for

most companies

EV/Sales (x) Sales growth (%)

Company Name Ticker Max Median Current Implied Median Max

Ashok Leyland AL IN 1.2 0.7 1.0 25.0 12.9 29.7

Bharat Forge BHFC IN 5.1 1.4 1.8 45.3 20.8 42.2

Bajaj Auto BJAUT IN 2.4 1.9 2.2 18.1 14.9 31.3

Hero HMCL IN 2.1 1.3 1.5 19.8 19.5 44.4

Mahindra MM IN 1.9 1.3 1.5 18.4 19.9 34.2

Maruti MSIL IN 1.7 0.9 1.2 25.5 16.1 26.0

ACC ACC IN 3.3 1.8 2.0 12.9 11.3 21.5

Ambuja ACEM IN 4.6 2.3 2.9 20.1 15.7 29.4

Grasim GRASIM IN 2.3 1.1 1.0 10.1 16.9 36.8

India Cements ICEM IN 2.8 1.4 1.1 -0.5 9.9 38.1

Ultratech UTCEM IN 2.9 2.0 2.8 28.1 29.0 41.7

L&T LT IN 4.0 1.7 2.4 15.4 16.2 32.0

BHEL BHEL IN 5.2 1.9 1.3 -6.4 13.2 29.1

Siemens SIEM IN 2.8 1.7 2.3 20.7 13.1 61.8

ABB ABB IN 3.9 1.9 2.2 15.0 7.0 39.8

Cummins KKC IN 3.4 2.3 3.3 27.1 15.6 30.8

Crompton

Greaves

CRG IN 2.0 1.1 0.8 -0.5 10.0 50.9

Thermax TMX IN 2.6 1.2 1.5 22.3 15.3 42.5

Voltas VOLT IN 2.6 0.8 0.9 19.1 15.5 30.3


Growth the key for manufacturing

companies

Banks have valuation support

Most companies factoring a recovery

slower than what is generally seen

from bottom of the cycle to top

Equity Strategy

India

19 May 2014



Financials – Our sample includes 13 large banks, 8 of which are under our coverage. We

use P/BV and RoE instead of EV/Sales and growth, respectively.

7 of the 13 banks are trading at PB valuations above historical median.

The required RoE to justify current stock price (assuming 12% hurdle rate and

valuations trending to median in 2 years) is lower than median RoE for all the

banks.

Exhibit 29: Required RoE for median valuations is below median for most

companies

P/B (x) RoE (%)

Company Name Ticker Max Median Curren

t

Required Median Max

Axis Bank Ltd. AXSB IN 4.1 2.3 1.9 5.3 37.4 24.9

Bank Of Baroda BOB IN 1.9 1.0 1.1 13.5 26.4 17.7

Bank Of India BOI IN 2.2 1.2 0.7 -8.7 32.0 19.0

Canara Bank CBK IN 1.7 1.0 0.7 -3.9 33.7 21.5

Federal Bank Ltd. FB IN 1.8 1.1 1.2 14.4 26.5 17.1

H D F C Bank Ltd. HDFCB IN 4.8 3.6 3.7 16.5 31.6 22.0

I C I C I Bank Ltd. ICICIBC IN 3.1 1.8 2.2 16.7 28.4 17.8

Indusind Bank Ltd. IIB IN 3.3 2.6 2.8 18.0 27.9 16.1

Kotak Mahindra Bank Ltd. KMB IN 6.7 2.9 3.2 18.4 26.4 16.7

Punjab National Bank PNB IN 1.9 1.2 1.0 -0.5 35.5 26.8

State Bank Of India SBIN IN 2.8 1.5 1.7 8.3 22.0 18.6

Union Bank Of India UNBK IN 1.6 1.1 0.7 -8.4 35.0 23.8

Yes Bank Ltd. YES IN 4.7 2.3 2.2 14.6 26.9 25.7

Source: Factset, CMIE, Jefferies

Equity Strategy

India

19 May 2014



Top-down View

Equity Strategy

India

19 May 2014



Financials Financials have seen the most stable RoEs in the last few years even though there is

enough evidence of stress in the system. The stable numbers, however, mask the

massively different performance of its constituents. State owned banks have seen a rapid

deterioration in their fundamentals while private banks have been remarkably resilient.

The salience of the sector has only been increasing as seen in the weightage in the index

as well as in institutional portfolios. This is partly because of many new entrants into the

index.

The underlying business fundamentals have borne the brunt of all that has gone wrong

with the Indian macro. By corollary, this sector would benefit the most in case of a cyclical

upturn in the economy. Given its importance to the economy, we also expect governance

reforms in the state-owned banks. We recommend financials, especially state-owned

banks, as the top overweight. Of the stocks we cover, we recommend BOB, Axis Bank,

ICICI Bank and SBI.

Exhibit 30: EPS integer to improve from current levels


Exhibit 31: RoEs has been in a stable band


Exhibit 32: NIMs have been impacted in recent years


Exhibit 33: Public sector banks have lost to private sector

Source: Bloomberg, Jefferies

0

50

100

150

200

250

300

350

400

450

Finance EPS

0

5

10

15

20

25 Financials RoE (%)

2.0

2.2

2.4

2.6

2.8

3.0

3.2

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Net interest income margins (%)

0

10

20

30

40

50

60

70

80

90

100

FY03 FY05 FY07 FY09 FY11 FY13 Current

% share in Banks market cap

Public Private

Equity Strategy

India

19 May 2014



Exhibit 34: EPS integer has seen downgrades

Source: Factset

Exhibit 35: Weight in Nifty has improved steadily

Note: Weight is market cap based without considering free float; Source: Bloomberg, Jefferies

Exhibit 36: Institutional holding has steadily increased


Exhibit 37: Weight in institutional portfolio at its peak


Exhibit 38: PE Valuation at its average

Source: Factset

Exhibit 39: Valuations relative to MSCI India

Source: Factset

200

250

300

350

400

450

500

550

600

Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13

2011 2012 2013

2014 2015

0

5

10

15

20

25

Financials weight in Nifty (%)

10

15

20

25

30

35

40

45

50

55

Institutional Holding in Financials

0

5

10

15

20

25

30

35

40

Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14

Weight in FII portfolio (%) Weight in DII portfolio (%)

0

1

2

3

4

5

6

0

5

10

15

20

25

30

35


Finance 12M Fwd PE Finance 12M Trailing PB - rhs

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6


12M Fwd PE rel. to India 12M Trailing PB rel. to India - rhs

Equity Strategy

India

19 May 2014



Industrials Having invested in expanding balance sheets in anticipation of sustained growth,

Industrials have borne the brunt of the slowdown in investment cycle since GFC. The

consequent fall in asset utilization, expanding working capital and higher interest costs,

have led to a fall in RoEs to all-time lows.

Institutional ownership is at its high even as its contribution to the market’s total value is

near all-time lows. Valuations on reported forecasts do not look cheap but watch out for

sharp earnings upgrades as this is the space that could see the sharpest cyclical recovery

in growth, margins and RoEs. Earnings forecasts are still being cut and current estimates

do call for sales growth but at a pace lesser than median and off a very low base.

We retain overweight. L&T is our preferred pick in the sector.

Exhibit 40: Sales growth is much below historical peaks


Exhibit 41: PBT margins declining sharply


Exhibit 42: Industrial EPS expected to recover from recent

declines

Note: EPS for MSCI Industrials index; Source: Factset, Jefferies estimates

Exhibit 43: Fwd RoEs are expected to recover to their

historical median


-10

-5

0

5

10

15

20

25

30

35

40

45

FY03 FY05 FY07 FY09 FY11 FY13 FY15E

Sales growth (%)

0

2

4

6

8

10

12

14

16

FY03 FY05 FY07 FY09 FY11 FY13

PBT Margins (%)

0

10

20

30

40

50

60

70

80

Industrials EPS0

5

10

15

20

25


Industrials RoE (%)

Equity Strategy

India

19 May 2014



Exhibit 44: There has been no earnings growth for past

three years

Source: Factset

Exhibit 45: Industrial weight in Nifty is at its lowest


Exhibit 46: Institutional holding in sector at historical

highs


Exhibit 47: Weight in institutional portfolio


Exhibit 48: Valuations are below their historical average

Source: Factset


Source: Factset

30

50

70

90

110

130


2011 2012 2013

2014 2015

0

2

4

6

8

10

12

Industrials weight in Nifty (%)

20

22

24

26

28

30

32


Institutional Holding in Industrials

0

5

10

15

20

25



0

1

2

3

4

5

6

7

8

9

10

0

5

10

15

20

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30

35

40


Industrials 12M Fwd PE Industrials 12M Trailing PB - rhs

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8



Equity Strategy

India

19 May 2014



Consumer Discretionary Consumer discretionary spends remained relatively strong post GFC led stimulus and the

sector actually witnessed its best growth in the FY09-12 period. The sudden acceleration

in growth post GFC also helped boost utilisation levels as most companies (autos

primarily) had slowed down capacity addition during the GFC. Only recently has the sales

slowed down. Margins and RoEs are close to cyclical highs and thus the scope for massive

upgrades is limited.

The sectors weight in the market is near highs as is institutional ownership. Valuations are

lower than median, largely due to change in composition within the sector. Earnings

forecasts have been consistently upgraded. Given the nature of the customers, we think

the recovery in consumer discretionary could be amongst the earliest. We stay neutral on

this space. Maruti is our preferred play in this segment.

Exhibit 50: Sales growth is much below historical peaks


Exhibit 51: PBT margins though is at its peak


Exhibit 52: EPS integer has seen steady growth


Exhibit 53: Fwd RoEs are expected to remain stable


0

5

10

15

20

25

30

35


Sales growth (%)

0

2

4

6

8

10

12


PBT Margins (%)

0

10

20

30

40

50

60

70

80

90

Discretionary EPS0

5

10

15

20

25

30


Consumer Discretionary RoE (%)

Equity Strategy

India

19 May 2014



Exhibit 54: EPS integer is seeing some upgrades

Source: Factset

Exhibit 55: Weight in Nifty is at its peak



highs


Exhibit 57: Weight in institutional portfolio


Exhibit 58: Valuations are below their historical average

Source: Factset


Source: Factset

30

40

50

60

70

80

90


2011 2012 2013

2014 2015

0

1

2

3

4

5

6

7

8

9

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY15

Consumer Discretionary weight in Nifty (%)

20

22

24

26

28

30

32

34

36

38


Institutional Holding in Disc

0

2

4

6

8

10

12

14



0

1

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3

4

5

6

7

0

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25


Discretionary 12M Fwd PE Discretionary 12M Trailing PB

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4



Equity Strategy

India

19 May 2014



Energy The energy sector has seen massive volatility in sales growth, especially since GFC. It is

hard to draw a conclusion from consolidated numbers as the sector is composed of

disparate companies. However, policy matters have had a meaningful impact on all the

companies and resolution of these issues, be it gas pricing, quantum and share of

petroleum subsidy burden, coal pricing issues, link all these companies to the policies of

the new government.

The policy muddle of the last few years has resulted in falling weight in institutional

portfolios though the weight of the sector in the market remains elevated. We are quite

optimistic on policy and subsidy reforms. While we remain equal weight on the sector, we

recommend owning Reliance and ONGC.

Exhibit 60: Sales growth is expected to decline


Exhibit 61: So are PBT margins


Exhibit 62: EPS integer sees steady improvement


Exhibit 63: Fwd RoEs to remain stable


-5

0

5

10

15

20

25

30

35


Sales growth (%)

0

2

4

6

8

10

12

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E

PBT Margins (%)

0

20

40

60

80

100

120

140

Energy EPS

0

5

10

15

20

25 Energy RoE (%)

Equity Strategy

India

19 May 2014



Exhibit 64: EPS integer has seen upgrades

Source: Factset

Exhibit 65: Weight in Nifty has remained stable


Exhibit 66: Institutional holding has improved in recent

year


Exhibit 67: Weight in institutional portfolio near its lows


Exhibit 68: Valuations at its historical lows

Source: Factset


Source: Factset

70

80

90

100

110

120

130

140

150


2011 2012 2013

2014 2015

0

5

10

15

20

25

30

Energy weight in Nifty (%)

10

12

14

16

18

20

22

24

Institutional Holding in Energy

0

5

10

15

20

25



0

1

1

2

2

3

3

4

4

5

0

5

10

15

20

25

30


Energy 12M Fwd PE Energy 12M Trailing PB - rhs

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

0.0

0.2

0.4

0.6

0.8

1.0

1.2



Equity Strategy

India

19 May 2014



Materials Materials companies have seen a massive deterioration in the underlying growth, which

remain depressed, as well as margins, which are near all-time lows. The metal companies

are worse off than cement, both due to the problems in the Indian economy as well as

due to issues with oversized foreign acquisitions. Bloated balance sheets have pulled

down PBT margins as well as RoEs. The cement companies have significantly better

balance sheets but have seen almost a similar slowdown in sales and margins.

The sector is still seeing cuts in earnings forecasts but that will likely change post the

elections, especially for the domestic businesses. The sector’s weight in the broader

market is at a historical mean. We are neutral on the sector. Tata Steel is our top pick.

Exhibit 70: Sales growth to remain stable


Exhibit 71: PBT margins though near their bottom


Exhibit 72: EPS integer to see some improvement




-20

0

20

40

60

80

100


Sales growth (%)

0

5

10

15

20

25

30


PBT Margins (%)

0

10

20

30

40

50

60

70

80

90

Materials EPS

0

5

10

15

20

25

30

35

40 Materials RoE (%)

Equity Strategy

India

19 May 2014




Source: Factset

Exhibit 75: Weight in Nifty is at average historical average



highs


Exhibit 77: Weight in institutional portfolio at lows


Exhibit 78: Valuations at historical average

Source: Factset


Source: Factset

40

50

60

70

80

90

100

110

120


2011 2012 2013

2014 2015

0

2

4

6

8

10

12

14

Materials weight in Nifty (%)

10

15

20

25

30

35


Institutional Holding in Materials

0

2

4

6

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10

12

14

16

18

20



0

1

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6

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14

16


Materials 12M Fwd PE Materials 12M Trailing PB - rhs

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9



Equity Strategy

India

19 May 2014



Utilities Utilities have seen a significant slowdown in growth post GFC, with the fiscal that has just

passed being the worst. The resultant fall in asset utilisation and further regulatory

mishaps through muddled tariff policies have led to fall in margins. The fall in margins

and RoEs have been limited by the fixed-RoE business model of some of the constituents.

However, earnings estimates are still being cut. While recovery in growth matters,

regulatory certainty will be a bigger driver of this sector. Resolution of tariff issues for few

of the power utilities will be a key task for the incoming government.

For reasons stated above, utilities weight in the market has seen a significant fall recently

as has its weight in institutional investors’ portfolios. We recommend overweight on this

sector on expectations of policy clarity. We recommend NTPC and Tata Power.

Exhibit 80: Sales growth expected to decline


Exhibit 81: So have PBT margins


Exhibit 82: EPS integer to see some improvement




0

5

10

15

20

25

30


Sales growth (%)

0

5

10

15

20

25


PBT Margins (%)

0

10

20

30

40

50

60

Utilities EPS

0

2

4

6

8

10

12

14 Utilities RoE (%)

Equity Strategy

India

19 May 2014



Exhibit 84: EPS integer has seen substantially downgrades

Source: Factset

Exhibit 85: Weight in Nifty has declined in recent years



highs


Exhibit 87: Weight in institutional portfolio at lows


Exhibit 88: Valuations below historical average

Source: Factset


Source: Factset

30

35

40

45

50

55

60

65


2011 2012 2013

2014 2015

0

2

4

6

8

10

12

14

16

Utilities weight in Nifty (%)

10

12

14

16

18

20

22

24

26

28

Dec-04 Dec-06 Dec-08 Dec-10 Dec-12

Institutional Holding in Utilities

0

2

4

6

8

10

12



0

2

4

6

8

10

12

0

5

10

15

20

25

30

35


Utilities 12M Fwd PE Utilities 12M Trailing PB - rhs

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6



Equity Strategy

India

19 May 2014



Healthcare While it is inherently a bottom-up sector, the macro has helped pharmaceutical

companies as weak currency has boosted growth and margins in the recent past. Margins

are at their all-time highs for almost all the companies, though the change in composition

has helped the sector average. RoEs for the sector are near highs and the sector continues

to see earnings upgrades.

Along with the other defensive sectors, the share of pharma companies in the total market

value has increased significantly since GFC. Institutional ownership is also near historic

highs. Currency is likely to turn into a headwind rather than a tailwind. Valuations are

near historic averages. We stay neutral on the sector. Sun Pharma and Cipla continue to

be our top pick.



Exhibit 91: PBT margins though to improve




Exhibit 93: Fwd RoEs to moderate


0

5

10

15

20

25

30

35

40


Sales growth (%)

0

5

10

15

20

25

30


PBT Margins (%)

0

10

20

30

40

50

60

70

80

Pharma EPS

0

5

10

15

20

25

30 Health Care RoE (%)

Equity Strategy

India

19 May 2014



Exhibit 94: EPS integer has seen upgrades

Source: Factset

Exhibit 95: Weight in Nifty has increased in recent years


Exhibit 96: Institutional holding in sector is stable


Exhibit 97: Weight in institutional portfolio near peaks



Source: Factset


Source: Factset

30

40

50

60

70

80

90


2011 2012 2013

2014 2015

0

1

2

3

4

5

6

7

8

9

10

Health Care weight in Nifty (%)

10

15

20

25

30

35


Institutional Holding in Health Care

0

1

2

3

4

5

6

7

8

9



0

1

2

3

4

5

6

7

8

0

5

10

15

20

25

30


Pharma 12M Fwd PE Pharma 12M Trailing PB - rhs

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0



Equity Strategy

India

19 May 2014



Information Technology IT sector has seen sharp recovery in growth in the recent past due to recovery in demand

primarily in North America. Favourable currency has helped rupee revenues as well as

margins. High cash balances with the companies have dented RoEs but not significantly.

Forecasts are still being increased. However, post the election results currency is likely to

be a headwind rather than tailwind.

Being one of the favourite themes of 2012 and 2013, the weight of the sector in the

market has increased significantly. Institutional ownership has also increased meaningfully

in the recent past. Valuations for the sector are neither expensive, nor cheap. We are

underweight on the sector. TCS is our preferred pick.



Exhibit 101: PBT margins at its peak




Exhibit 103: Fwd RoEs are expected to improve


0

10

20

30

40

50

60

70

80

90

100


Sales growth (%)

20

21

22

23

24

25

26

27


PBT Margins (%)

0

10

20

30

40

50

60

70

80

IT EPS

0

5

10

15

20

25

30

35

40 Information Technology RoE (%)

Equity Strategy

India

19 May 2014



Exhibit 104: EPS integer has seen steady upgrades

Source: Factset

Exhibit 105: Weight in Nifty has increased in recent years


Exhibit 106: Institutional holding in sector is stable


Exhibit 107: Weight in institutional portfolio near peaks



Source: Factset


Source: Factset

30

40

50

60

70

80


2011 2012 2013

2014 2015

0

5

10

15

20

25

Information Technology weight in Nifty (%)

10

15

20

25

30

35

40


Institutional Holding in Information Technology

0

5

10

15

20

25



0

1

2

3

4

5

6

0

5

10

15

20

25

30


IT 12M Fwd PE IT 12M Trailing PB - rhs

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8



Equity Strategy

India

19 May 2014



Consumer Staples Consumer staples companies have seen reasonably high growth post GFC as most of the

stimulus measures were favourable to their businesses. Rural sales have stayed strong due

to high nominal and real wage growth. Its only recently has the slowing rural real wage

growth started impacting the growth rates. We also note that the margins in the sector

are at their all-time highs and unlikely to increase any further. As such, we think sustaining

the high growth rates and margins will be hard and the sector will be the most impacted

by the change in growth pattern from being consumption led to being investment led.

The sector’s weight in the market has increased substantially since 2009 as high quality

and high cash flow companies (the case with most consumer staples companies)

significantly outperformed the market. The ownership levels are at near peak as are

absolute and relative valuations. We maintain Underweight on the sector. ITC is the only

large cap stock that we recommend at this moment.

Exhibit 110: Sales growth to recover but much below its

peak


Exhibit 111: PBT margins though is at its peak


Exhibit 112: EPS integer has seen steady growth


Exhibit 113: Fwd RoEs are expected to improve


0

5

10

15

20

25

30


Sales growth (%)

0

5

10

15

20

25


PBT Margins (%)

0

5

10

15

20

25

Staples EPS20

22

24

26

28

30

32

34

36


Consumer Staples RoE (%)

Equity Strategy

India

19 May 2014




Source: Factset

Exhibit 115: Weight in Nifty has increased substantially



highs


Exhibit 117: Weight in institutional portfolio at peak


Exhibit 118: Valuations are at their historical peaks

Source: Factset


Source: Factset

0

5

10

15

20

25


2011 2012 2013

2014 2015

0

5

10

15

20

25

Consumer Staples weight in Nifty (%)

25

27

29

31

33

35

37

39


Institutional Holding in Staples

0

2

4

6

8

10

12

14

16

18



0

2

4

6

8

10

12

14

0

5

10

15

20

25

30

35

40


Staples 12M Fwd PE Staples 12M Trailing PB

0

1

2

3

4

5

6

7

8

9

0.0

0.5

1.0

1.5

2.0

2.5

3.0



Equity Strategy

India

19 May 2014



Telecommunication Services Telcos have borne the brunt of competition and corruption scandals. While the sector has

seen some improvement in the competitive environment, the problems of the past still

weigh down the profitability of the sector. Overseas acquisitions and recent new entrants

have also weighed down the sentiment on the sector. However, we think policy issues are

now behind the sector as most of the processes have been set right with the active

involvement of the courts. The pace of earnings downgrades have subsided.

The weight of the sector in the total has come off significantly from its peak and is now is

at near all-time lows and so is its weight in institutional portfolios. Valuations seem

elevated but we note that that is due to depressed earnings. Maintain neutral stance.



Exhibit 121: PBT margins to remain stable


Exhibit 122: EPS integer to improve from current levels


Exhibit 123: Fwd RoEs to improve


-20

0

20

40

60

80

100

120

140

160

180

200


Sales growth (%)

0

5

10

15

20

25

30


PBT Margins (%)

0

1

2

3

4

5

6

7

8

9

Telecom EPS

0

5

10

15

20

25 Telecommunication Services RoE (%)

Equity Strategy

India

19 May 2014




Source: Factset

Exhibit 125: Weight in Nifty has seen sharp decline


Exhibit 126: Institutional holding has been stable


Exhibit 127: Weight in institutional portfolio near its lows


Exhibit 128: PE Valuation is near its peak

Source: Factset


Source: Factset

0

1

1

2

2

3

3

4

4


2011 2012 2013

2014 2015

0

2

4

6

8

10

12

14

Telecommunication Services weight in Nifty (%)

10

15

20

25

30

35

Institutional Holding in Telecommunication Services

0

1

2

3

4

5

6

7

8

9

10



0

1

1

2

2

3

3

4

4

5

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0

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15

20

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30

35


Telecom 12M Fwd PE Telecom 12M Trailing PB - rhs

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

0.0

0.5

1.0

1.5

2.0

2.5



Equity Strategy

India

19 May 2014



Bottom-up View

Equity Strategy

India

19 May 2014



Financials – Go Long on Cycle and Governance We are positive on banks post the massive mandate for NDA (BJP+), which

would allow the government to take quick decisions and put economic

growth back on track, and is +ve for loan growth and asset quality.

Governance change at SOE banks is likely and on the back of large valuation

gap, SOE banks could materially outperform. Our top picks – Axis Bank, ICICI

Bank and Bank of Baroda are predicated on cyclical recovery & governance

change.

Cyclical turnaround is positive for loan growth: GDP growth is expected to clock

6.5% in FY16 from ~4.5% in FY14. More importantly, the new project announcements

too seem to have bottomed around decadal lows, and the trend can only improve. We

forecast system loan growth at 18% for FY15 and 19% for FY16 (from sub-14% in FY14) or

roughly a 3x (average of last 18 years) nominal-loans-to-GDP multiplier.

Governance change in SOE banks a must and massively positive: With SOE banks

controlling 70%+ of assets, not being able to lend owing to slender capital is not an

option, if India has to grow. Recapitalisation options are few and the Government has to

dilute its stake in favour of deeper pockets. As we have analysed in our earlier reports and

as suggested by a recent RBI Committee, the bank boards need to be empowered, which

should take them closer to private sector banks, and lower the corporate governance

discount associated with SOE banks. And if required, the government can even bring

legislative changes easily, now that they have a majority in the Lower House. SOE Banks

trade at a massive discount to their private sector peers and to that extent, they can

materially outperform the broader sector.

Interest rates to come off: Notwithstanding the near-term risk from weaker monsoons

and higher food prices, we believe interest rates should be much lower over the medium

term. This will further enable consumption and drive the investment cycle. In the near

term, though, we do not expect any significant rate cuts.

Asset quality to improve: On the back of economic pickup and lower interest rates,

corporate interest burden should reduce and profitability should improve creating a

cyclical tailwind for banks’ asset quality. More importantly, banks’ true equity book

discounts the current NPAs and slippages from restructured assets. A cyclical recovery will

not only lower impaired assets, but lower the book value adjustments.

Upgrading stocks and top picks: We are extremely positive on banks, on the back of

cyclical recovery and need for governance reform at SOE banks. We upgrade State Bank of

India (SBIN IN) to Buy from UNPF and Punjab National Bank (PNB IN) to Hold from UNPF.

Within our coverage, the top picks are Axis Bank (AXSB IN), ICICI Bank (ICICIBC IN) and

Bank of Baroda (BOB IN). HDFC Bank (HDFCB IN), IndusInd Bank (IIB IN) and State Bank of

India (SBIN IN) are the other Buy rated stocks, while Kotak Bank (KMB IN) and HDFC

Limited (HDFC IN) are rated Hold along with Punjab National Bank (PNB IN). Details of

earnings and PT change can be found in Exhibit 1 inside.

Equity Strategy

India

19 May 2014



Changes to estimates/ratings/PTs – and valuation

rationale

Exhibit 130: Rating, Price target and Earnings changes –

Source: Jefferies estimates; * standalone, #consolidated

Exhibit 131: Valuation comps of stocks under coverage

Source: Jefferies estimates

Banks New Rating Old Rating New PT Old PT Year NII PPOP PAT Advances Deposits EPS BVPS

FY15E 0.6% 1.0% 1.2% 0.0% 0.0% 1.2% 0.2%

FY16E 1.0% 1.4% 1.6% 0.0% 0.0% 1.6% 0.5%

FY15E 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

FY16E 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

FY15E 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

FY16E 0.2% 0.3% 0.3% 0.0% 0.0% 0.3% 0.1%

FY15E 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

FY16E 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

FY15E 0.0% 0.6% 0.7% 0.0% 0.0% 0.7% 0.1%

FY16E 0.0% 0.8% 0.8% 0.0% 0.0% 0.8% 0.2%

FY15E 0.9% 0.3% 0.2% -1.0% 1.2% 1.0% 8.0%

FY16E -0.3% 0.2% 0.3% 0.5% 2.0% 1.1% 7.9%

FY14E -0.2% -0.1% 0.4% -1.5% -1.5% 0.4% 0.0%

FY15E -0.7% -0.3% 0.6% -1.5% -1.5% 0.6% 0.2%

FY16E 8.2% 7.5% 12.6% -1.5% -1.5% 12.6% 2.2%

FY15E 2.1% 6.2% -1.8% -0.4% 1.9% -1.8% -7.8%

FY16E 10.4% 14.1% 10.5% -0.4% 1.9% 10.5% -3.9%

FY15E 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

FY16E 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

SBIN

*PN

B

910

BUY UNPF 2,875 1,545

HOLD UNPF 865 690

HOLD 935

BO

BA

XSB

HD

FCB

ICIC

IBC

*H

DFC

*

BUY

BUY

HOLD

BUY BUY 1,140 1,080

BUY

BUY 1,720 1,470

1,800

BUY 960 870

BUY 2,180

IIB BUY BUY 680 615

KM

B#

HOLD HOLD 910 800

Name BB ticker Rating Target CMP Up / down Mkt Cap

(Rs) (Rs) (%) (Rs bn)

FY15 FY16 FY15 FY16 FY15 FY16 FY15 FY16 FY15 FY16

Axis Bank AXSB IN BUY 2,180 1,755 24.2 826 11.3 8.7 2.0 1.6 1.8 1.9 17.3 19.2 1.3 1.6

HDFC Bank HDFCB IN BUY 960 805 19.3 1,932 17.5 14.1 3.9 3.2 2.0 2.0 22.3 23.2 1.1 1.4

ICICI Bank ICICIBC IN BUY 1,720 1,465 17.4 1,693 14.7 11.8 2.2 2.0 1.8 1.9 14.6 16.2 1.8 2.3

IndusInd Bank IIB IN BUY 680 562 21.0 296 16.3 12.6 2.9 2.4 1.8 1.9 18.6 20.1 0.6 0.6

Kotak Bank KMB IN HOLD 910 906 0.5 698 36.9 32.8 5.1 4.5 1.9 1.9 14.2 14.0 0.1 0.1

Kotak - consol KMB IN HOLD 910 906 0.5 698 22.6 16.8 3.24 2.7 2.3 2.6 15.0 17.3 0.1 0.1

BOB BOB IN BUY 1,140 934 22.0 401 7.6 5.7 1.1 0.9 0.7 0.8 13.4 15.8 2.7 3.4

PNB PNB IN HOLD 865 918 -5.8 332 7.2 5.4 1.07 0.9 0.8 0.9 12.0 14.2 1.1 1.1

SBI SBIN IN BUY 2,875 2,417 18.9 1,805 14.9 8.8 1.9 1.5 0.6 0.9 9.7 14.7 1.4 1.9

SBI - consol SBIN IN BUY 2,875 2,417 18.9 1,805 11.1 6.8 1.46 1.2 0.6 0.9 10.6 15.6 1.4 1.9

HDFC HDFC IN HOLD 935 886 5.6 1,382 22.1 18.2 2.0 1.8 2.6 2.7 20.8 23.0 1.8 1.8

Private Banks

PSU Banks

NBFC

Dividend Yield

(x) (x) (%) (%) (%)

P/E P/BV RoA RoE

Equity Strategy

India

19 May 2014



Valuation / Risks

Axis Bank (AXSB IN, Buy). We have upped the PT from Rs1,800 to Rs2,180. This is

driven by <2% change in earnings and upping the valuation multiples. We believe a

strong government at the center will be able to pull through many stuck reforms and

blockades to industrial and infrastructure capex. This is cyclically positive for corporate-

heavy stock. At our PT, the stock is valued at 2.4x forward book and 14.1x forward

earnings. This compares to last 5yr and 8yr averages of 2.0x/11.6x and 2.9x/16.8x

respectively. Key risks: (1) Poor economic pickup, (2) worsening asset quality.

HDFC Bank (HDFCB IN, Buy). We have upped the PT from Rs870 to Rs960. We have

not made any change to earnings and the move is owing to change in valuation

multiples. We believe a strong government at the center is positive for industrial growth

and this will eventually play out with job stability, and drive consumption and consumer

loan growth, albeit with a slight lag. At our PT, the stock is valued at 4.3x forward book

and 18.0x forward earnings. This compares to last 5yr and 8yr averages of 3.5x/19.7x and

3.9x/19.8x respectively. Key risks: (1) Poor economic pickup, (2) job losses resulting in

worsening asset quality

ICICI Bank (ICICIBC IN, Buy). We have upped the PT from Rs1,470 to Rs1,720. There

is only a minor change in earnings of 0.3% and the move is owing to change in valuation

multiples. We believe a strong government at the center will be able to pull through

many stuck reforms and blockades to industrial and infrastructure capex. This is cyclically

positive for corporate heavy stock. At our PT, the stock is valued at 2.5x forward book and

17.2x forward earnings. This compares to last 5yr and 8yr averages of 1.8x/16.0x and

2.2x/16.3x respectively. Key risks: (1) Poor economic pickup, (2) worsening asset quality

IndusInd Bank (IIB IN, Buy). We have upped the PT from Rs615 to Rs680. We have


multiples. We believe a strong government at the center will be able to pull through

many stuck reforms and blockades to industrial and infrastructure capex. This is cyclically

positive for the CV cycle, which is a substantial portion of the book; while IIB is also

exposed to the consumer space, which should pick up pace over time. At our PT, the

stock is valued at 3.4x forward book and 19.7x forward earnings. This compares to last

5yr and 8yr averages of 2.5x/14.9x and 1.1x/8.2x respectively. Key risks: (1) Poor

economic pickup, (2) worsening asset quality especially in the CV businesses

Bank of Baroda (BOB IN, Buy). We have upped the PT from Rs1,080 to Rs1,140. We

have not made any change to earnings and the move is owing to change in valuation

multiples. We view the possibility of governance model change at SOE banks very

positively. More importantly, a majority government in BJP should face much less

pressure in initiating key legislative changes, if required to drive the necessary changes. At

our PT, the stock is valued at 1.5x forward book and 9.3x forward earnings. This compares

to last 5yr and 8yr averages of 1.1x/6.2x and 0.9x/6.4x respectively. Key risks: (1) Lack of

board governance structure, (2) Impending change in management, (3) slowing growth

and worsening of asset quality.

State Bank of India (SBIN IN, Buy). We do a double upgrade of SBIN to BUY from

UNPF, and have upped the PT from Rs1,545 to Rs2,875. We have upped FY16 earnings by

12.6% predicated on a cyclical recovery. Further, we view the possibility of governance

model change at SOE banks very positively. More importantly, a majority government in

BJP should face much less pressure in initiating key legislative changes, if required to drive

the necessary changes. At our PT, the stock is valued at 1.9x forward book and 13.2x

forward earnings on consolidated basis. This compares to last 5yr and 8yr averages of

1.4x/8.6x and 1.2x/8.7x respectively. Key risks: (1) Lack of board governance structure,

(2) Inability to manage expense ratio, (3) slowing growth & worsening of asset quality.

Equity Strategy

India

19 May 2014



Kotak Bank (KMB IN, Hold). We have upped the PT from Rs800 to Rs910. We have


multiples. KMB will benefit from an improvement in the financial sector with exposure to

lending, insurance, AMC, but most importantly the investment banking and advisory

service, which has the potential to propel the RoE significantly in a positive economic

cycle. At our PT, the stock is valued at 3.3x forward book and 22.7x forward earnings. This

compares to last 5yr and 8yr averages of 2.8x/19.7x and 3.3x/23.5x respectively. Key

risks: (1) Continued loan growth slowdown and fee income is negative, (2) Economic

uptick and improvement in investment banking/advisory service is positive.

HDFC Limited (HDFC IN, Hold). We have upped the PT from Rs910 to Rs935. We have

made a minor change to earnings (~0.1%) and balance of the change is owing to the

change in PT of its subsidiary, HDFC Bank. At our PT, the stock is valued at 4.8x forward

book and 23.3x forward earnings. This compares to last 5yr and 8yr averages of

4.6x/22.9x and 6.2x/21.9x respectively. Key risks: (1) Lack of loan growth and higher

interest rate regime will be negative, (2) Pickup in housing investment is positive.

Punjab National Bank (PNB IN, Hold). We upgrade PNB to HOLD from UNPF, and

have upped the PT from Rs690 to Rs865. On the back of weak FY14 earnings, we have cut

FY15 earnings by 1.8%, while giving it the benefit of cyclical upswing resulting in 10.5%

improvement in FY16 earnings. Further, we view the possibility of a governance model

change at SOE banks very positively. More importantly, a majority government in BJP

should face much less pressure in initiating key legislative changes, if required to drive the

necessary changes. At our PT, the stock is valued at 1.5x forward book and 6.8x forward

earnings. This compares to last 5yr and 8yr averages of 1.1x/5.7x and 1.4x/8.3x

respectively. Key risks: (1) Lack of board governance structure, (2) slowing loan growth

and continued worsening of asset quality.

Equity Strategy

India

19 May 2014



Go long on cycle and governance

We are extremely positive on bank stocks post the massive mandate for NDA (BJP+),

which would allow the government to take quick decisions and put economic growth

back on track. This is extremely positive for loan growth, and over time, for asset quality.

Further, a governance change at SOE banks is almost a certainty and on the back of a

large valuation gap, SOE banks could materially outperform. Our top picks – Axis Bank

(AXSB IN), ICICI Bank (ICICIBC IN) and Bank of Baroda (BOB IN) are predicated on cyclical

recovery and governance change.

Cyclical turnaround is positive for loan growth

GDP growth is expected to clock 6.5% in FY16 from ~4.5% in FY14. More importantly, the

new project announcements too seem to have bottomed around decadal lows and the

trend can only improve. We forecast system loan growth at 18% for FY15 and 19% for

FY16 (from sub-14% in FY14) or roughly a 3x (average of last 18 years) nominal-loans-to-

GDP multiplier.

Exhibit 132: Cyclical recovery to fuel loan growth

Source: Jefferies estimates, IMF

Exhibit 133: Pegging loan to GDP multiple on historical

avg.

Source: Jefferies estimates, RBI

Exhibit 134: Project announcements have bottomed

Source: Jefferies estimates, CMIE

6.5%

19%

10%

15%

20%

25%

30%

35%

40%

4%

5%

6%

7%

8%

9%

10%

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Jan

-13

Jan

-14

Jan

-15

Jan

-16

Real GDP (% yoy) Loans (% yoy, RHS)

3.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

7.0xJa

n-9

7

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Jan

-13

Jan

-14

Jan

-15

Jan

-16

Loan growth to Real GDP growth (x) Average (x)

-100%

-50%

0%

50%

100%

150%

-

5,000

10,000

15,000

20,000

25,000

Sep

-99

Mar-

00

Sep

-00

Mar-

01

Sep

-01

Mar-

02

Sep

-02

Mar-

03

Sep

-03

Mar-

04

Sep

-04

Mar-

05

Sep

-05

Mar-

06

Sep

-06

Mar-

07

Sep

-07

Mar-

08

Sep

-08

Mar-

09

Sep

-09

Mar-

10

Sep

-10

Mar-

11

Sep

-11

Mar-

12

Sep

-12

Mar-

13

Sep

-13

Mar-

14

New Announcements (Rs bn, rolling 4 qtrs) Growth (% yoy) - RHS

Equity Strategy

India

19 May 2014



Governance change in SOE banks a must and massively

positive

With SOE banks controlling 70%+ of assets, not being able to lend owing to slender

capital is not an option, if India has to grow. Recapitalisation options are few and the

Government has to dilute its stake in favour of deeper pockets. As we have analysed in our

earlier reports and as suggested by a recent RBI Committee, the bank boards need to be

empowered, which should take them closer to private sector banks and lower the

corporate governance discount associated with SOE banks. And if required, the

government can even bring legislative changes easily, now that they have a majority in

the Lower House. SOE Banks trade at a massive discount to their private sector peers and

to that extent, they can materially outperform the broader sector.

Interest rates to come off in the medium term

Notwithstanding the near-term risk from weaker monsoons and higher food prices, we

believe interest rates should be much lower over the medium term. This will further

enable consumption and drive the investment cycle. In the near term, though, we do not

expect any significant rate cuts.

As shown in the following exhibit, the spread of lending rate to AAA-rated corporate over

the real GDP growth is significantly high, almost akin to an overheated economy, which is

certainly not the case. This therefore suggests interest rates have significant room for

correction over the medium term.

Exhibit 135: Interest rates significantly higher than real GDP growth

Source: Jefferies, RBI

Asset quality to improve

On the back of economic pickup and lower interest rates, corporate interest burden

should reduce and profitability should improve, creating a cyclical tailwind for banks’

asset quality. More importantly, banks’ true equity book discounts the current NPAs and

slippages from restructured assets. A cyclical recovery will not only lower impaired assets,

but lower the book value adjustments.

Current consensus suggests pick up in sector margin and RoEs

The current consensus numbers already build in an improvement in corporate margin

and profitability across some of the stressed sectors – we view this as positive for asset

quality in the medium term.

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

Sep

-04

Jan

-05

May-

05

Sep

-05

Jan

-06

May-

06

Sep

-06

Jan

-07

May-

07

Sep

-07

Jan

-08

May-

08

Sep

-08

Jan

-09

May-

09

Sep

-09

Jan

-10

May-

10

Sep

-10

Jan

-11

May-

11

Sep

-11

Jan

-12

May-

12

Sep

-12

Jan

-13

May-

13

Sep

-13

1 year borrowing rate (AAA corporate) less GDP growth

Equity Strategy

India

19 May 2014



Exhibit 136: Margins picking up – Industrials

Source: Jefferies estimates, Factset

Exhibit 137: Profitability picking up – Industrials


Exhibit 138: Margins picking up – Materials


Exhibit 139: Profitability picking up – Materials


Exhibit 140: Margins picking up – Utilities


Exhibit 141: Profitability picking up – Utilities


0

2

4

6

8

10

12

14

16 Industrials PBT Margins (%)

0

5

10

15

20

25Industrials RoE (%)

0

5

10

15

20

25

30 Materials PBT Margins (%)

0

5

10

15

20

25

30

35

40 Materials RoE (%)

0

5

10

15

20

25 Utilities PBT Margins (%)

0

2

4

6

8

10

12

14 Utilities RoE (%)

Equity Strategy

India

19 May 2014



Exhibit 142: Falling corporate leverage should help impaired assets

Source: Jefferies estimates, company data

The adjustments to the book value to lower

The true book value of the banks has undergone significant erosion from the rising NPA

levels and the worries stemming from slippages from restructured assets. While this is the

right way to approach the asset quality issues, it is important to be cognizant that an

improvement in cycle will lower impairment ratios considerably and therefore the growth

in adjusted book value could exceed the growth in reported book value.

Exhibit 143: Impaired assets as % of Equity – historical perspective


Exhibit 144: Restructuring in SOE Banks


Exhibit 145: Restructuring in Old Pvt Banks


2.0%

4.5%

7.0%

9.5%

12.0%

14.5%

17.0%

1.0x

1.1x

1.2x

1.3x

1.4x

1.5x

1.6x

FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

correlation = 95% (with a years lag)

Leverage (x) Impaired assets - RHS

96.0%89.4%

70.9%

56.2%

37.7%32.2%

26.4%

39.3%

52.1%46.3%

59.2%

71.4%

Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13

Gross NPA Std RA GNPA+Std RA

105.7%

93.7%

76.8%

65.8%

46.3%39.5%

34.4%

51.5%

77.2%70.4%

90.2%

111.8%


106.2%

92.6%

79.5%

66.1%

45.4%

34.3%25.6%

41.7%45.5%38.4%

44.6%48.9%


Equity Strategy

India

19 May 2014



Exhibit 146: Restructuring in Private Banks


Exhibit 147: Restructuring in Foreign Banks


Exhibit 148: Impaired assets as % of common equity (as of Q3FY14)


Exhibit 149: Adjusted book value* is less than 50% of reported book, on average (as of Q3FY14)

Source: Jefferies estimates, company data *assuming 100% of net NPA and 30% of restructured assets are adjusted

106.8%

137.9%

84.8%

46.7%

27.1%27.6%21.0%25.9%21.0%15.6%16.1%15.5%


26.5%

22.2%21.2%

12.5%

8.9%7.4%

6.3%

14.2%

11.4%

6.6% 6.9% 7.8%


239.0%

214.4%

185.0%

159.0%

123.6%123.2%120.3%119.0%114.3%108.9%106.2% 98.4% 97.9% 91.1% 89.1% 86.4% 85.8% 82.5% 78.0% 70.3%

26.1%

UNTDB CBOI UCO ANDB DBNK ALBK BOMH IOB PNB SNDB VJYBK OBC INBK CRPBK UNBK IDBI CBK BOI BOB SBIN JKBK

Net NPA NOSRA

-68.1%

3.9%12.5%

23.0%32.2% 38.7% 41.6% 47.7% 48.7% 50.9% 51.4% 52.0% 53.7% 54.4% 55.0% 56.7% 57.9% 58.4% 59.5% 63.6%

91.0%

-40%

-20%

0%

20%

40%

60%

80%

100%

UNTDB CBOI UCO ANDB ALBK IOB BOMH PNB DBNK OBC VJYBK SNDB UNBK CRPBK SBIN INBK CBK IDBI BOI BOB JKBK

Adj. BV Adjustments

Equity Strategy

India

19 May 2014



Valuation – ample support for SOE Banks

We believe valuation, especially at SOE banks (on reported book value basis) to be terribly

cheap and at a large discount to their private bank peers. In the medium term, we expect

the valuation gap to come off in line with the last cycle seen between 2003-08.

Exhibit 150: SOE Banks trading at a large price-to-book discount to Private Banks


Exhibit 151: CNXBANK index trading marginally above historical price-to-

earnings discount with the broader market (NIFTY)

Source: Jefferies estimates, Bloomberg

Exhibit 152: Price-to-book versus RoE (coverage)


Exhibit 153: Price-to-earnings versus EPS growth

(coverage)


40%60%80%

100%120%140%160%180%200%220%240%260%280%

Ap

r-0

6

Jul-

06

Oct

-06

Jan

-07

Ap

r-0

7

Jul-

07

Oct

-07

Jan

-08

Ap

r-0

8

Jul-

08

Oct

-08

Jan

-09

Ap

r-0

9

Jul-

09

Oct

-09

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Jul-

11

Oct

-11

Jan

-12

Ap

r-1

2

Jul-

12

Oct

-12

Jan

-13

Ap

r-1

3

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4

P/B discount for SOE Banks versus Private Banks

-17.5%

-7.1%

-27.9%

-50%

-40%

-30%

-20%

-10%

0%

Jan

06

Ap

r 0

6Ju

l 0

6O

ct 0

6Ja

n 0

7A

pr

07

Jul

07

Oct

07

Jan

08

Ap

r 0

8Ju

l 0

8O

ct 0

8Ja

n 0

9A

pr

09

Jul

09

Oct

09

Jan

10

Ap

r 1

0Ju

l 1

0O

ct 1

0Ja

n 1

1A

pr

11

Jul

11

Oct

11

Jan

12

Ap

r 1

2Ju

l 1

2O

ct 1

2Ja

n 1

3A

pr

13

Jul

13

Oct

13

Jan

14

Ap

r 1

4Discount Average +1 sd -1 sd

AXSB

HDFCB

ICICIBC

IIB

KMB-P

KMB-C

BOBPNB

SBIN-P

SBIN-C HDFC

0.0

1.0

2.0

3.0

4.0

5.0

6.0

10.0 15.0 20.0 25.0

Pri

ce

to

bo

ok

(F

Y1

5,

x)

Average RoE FY15-16 (%)

AXSB

HDFCBICICIBC

IIB

KMB-P

KMB-C

BOB

PNB

SBIN-P

SBIN-C

HDFC

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%

Pri

ce

to

ea

rnin

gs

(x)

EPS CAGR (FY14-16)

Equity Strategy

India

19 May 2014



Industrials – From Announcements to Orders to Execution… The binary event of May 2014 has positively surprised with a complete NDA

majority. Slow decision-making and lower access to equity markets have held

up progress in the industrials/utility sectors for the last five years. We believe

rising corporate confidence will lead to announcements, which are at a multi-

year low, picking up over the next 12 months. We believe L&T, NTPC,

Cummins, Power Grid and Tata Power still offer upside.

Project announcements need little to pick up from multi-year lows: New

project announcements are down by 20% YoY in FY14. In absolute terms,

announcements are as low as 2002-2004 levels, and at levels in the '90’s, inflation

adjusted. Corporates have been waiting in the wings for a decisive election, to go ahead

with plans on the drawing board. As highlighted in our strategy report dated 16th May

2014 (‚What Next? 7. Modinomics‛), companies are likely to tap financial markets till

markets remain buoyant, boosting project announcements from them.

CCI project clearances could lead to execution pick-up as corporate

confidence returns: The government set up a Cabinet Committee on Investment (CCI)

and Project Monitoring Group (PMG) to fast-track clearances for stalled projects above

Rs10 bn. The PMG, headed by Anil Swarup, accepted 300+ projects with investment

value of Rs18trn for review. Over the last 12 months, CCI has cleared 100+ projects

valued at over Rs5 trn. CCI had indicated that the project execution of cleared projects

would be impacted by viability questions in case of a fractured mandate post elections.

Given the strong election result, we have factored some pick-up in execution on the

ground in our estimates over the next 18-24 months.

Power sector reforms expected to emerge strongly: Enough noise has been made

about the ailing power sector, especially private sector enterprises that are facing

substantial losses. We believe reforms, especially on tariff hike and SEB restructuring,

which are already underway, will be expedited. As power demand sees gradual recovery,

and deficit levels move up, over the next 12 months, we believe focus on this sector will

remain strong.

Stock S'election' the key for returns (Exhibit 1-2): Cyclical recovery is reflected in

our earnings expectations for companies, as we raise execution and growth assumptions

to reflect a more positive execution environment. However, we believe one should prefer

companies that will deliver earnings in-line or better than expectations (L&T, NTPC,

Cummins, Powergrid and Tata Power) and avoid companies where the run-up factors in

more than their fair share of recovery (Crompton Greaves, Voltas, Thermax, ABB, Adani

Port).

Equity Strategy

India

19 May 2014



Exhibit 154: Valuation Snapshot

Ticker Company Mkt. Cap. Reco CMP Target Price VOI Upside P/E (x) P/B (x)

(USD mn) (Rs) (Rs/shr) (Rs/shr) (%) FY14E FY15E FY16E FY14E FY15E FY16E

Nifty stocks

NTPC IN NTPC 18,392 BUY 132 150 14 10.0 12.0 11.2 1.3 1.2 1.1

LT IN L&T 22,518 BUY 1,426 1,640 443 15 20.6 18.8 16.4 2.8 2.6 2.3

BHEL IN BHEL 9,608 UP 232 185 (20) 19.1 23.8 26.3 1.8 1.7 1.6

PWGR IN Power Grid 10,583 BUY 119 150 26 13.9 12.0 10.3 1.9 1.7 1.6

TPWR IN Tata Power 4,155 BUY 91 105 16 30.8 14.8 13.6 2.0 2.1 1.8

Mkt Cap > USD1 bn

ADSEZ IN Adani Port 7,948 UP 225 180 26 (20) 21.2 19.2 17.9 4.4 3.6 3.1

SIEM IN Siemens 4,996 HOLD 828 730 (12) 81.4 69.2 58.9 7.1 6.8 6.5

ABB IN ABB 3,153 UP 878 650 (26) 105.0 84.9 57.3 6.9 6.6 6.1

KKC IN Cummins 2,653 BUY 565 670 19 26.2 24.9 21.3 6.1 5.6 5.1

CRG IN Crompton 1,818 UP 171 130 10 (24) 35.0 21.8 16.1 2.8 2.6 2.3

TMX IN Thermax 1,638 UP 811 650 (20) 34.6 27.3 22.4 4.8 4.3 3.7

VOLT IN Voltas 1,002 UP 179 140 (22) 29.5 24.0 19.2 3.3 3.0 2.7


Exhibit 155: Estimate Changes (Rs)

Ticker Company New TP Old TP Chg (%) New EPS estimate Old EPS estimates EPS estimate chg

(%)

TP Basis (new v/s old)

FY14E FY15E FY16E FY14E FY15E FY16E FY14E FY15E FY16E

NTPC IN NTPC 150 140 6.6 13.2 11.0 11.8 12.7 11.5 12.3 4.2 -4.6 -4.3 1.3x P/B FY16E v/s 1.2x P/B FY16E earlier, earnings

changes post 4QFY14 driven by other inc, not EBITDA

LT IN L&T 1,640 1,415 15.9 47.6 52.4 59.9 47.6 52.4 57.2 0.0 0.0 4.7 20x P/E FY16E v/s 17x FY16E earlier

BHEL IN BHEL 185 160 15.8 12.1 9.7 8.8 12.1 9.7 8.8 0.0 0.0 0.0 Lower COE and working capital assumptions

PWGR IN Power Grid 150 135 11.1 8.6 9.9 11.5 8.6 9.9 11.5 0.0 0.0 0.0 2.0x P/B FY16E v/s 1.8x FY16E earlier

TPWR IN Tata Power 105 100 4.9 2.9 6.1 6.7 3.4 7.0 7.6 -12.3 -12.3 -12.3 Lower COE assumptions; EPS change due to rights

completion done in April 2014

ADSEZ IN Adani Port 180 160 12.0 9.4 10.3 11.1 9.8 10.4 11.3 9.1 5.6 6.1 Lower COE assumptions; higher other income post

4QFY14 results

SIEM IN Siemens 730 610 19.6 10.2 12.0 14.1 10.1 12.0 13.3 0.4 -0.4 6.0 2x EV/sales FY16E v/s 1.5x EV/sales FY16E earlier

ABB IN ABB 650 570 14.0 8.4 10.3 15.3 8.4 10.3 13.1 0.0 0.0 16.7 4.5x P/B FY16E v/s 4x P/B FY16E earlier

KKC IN Cummins 670 620 8.0 21.6 22.7 26.5 21.6 24.0 26.3 0.0 -5.6 0.8 6x P/B FY16E v/s 5.5x P/B FY16E earlier

CRG IN Crompton 130 100 30.1 4.6 7.4 10.0 4.6 7.4 9.1 0.0 0.0 10.2 12x P/E FY16E v/s 10x FY16E earlier

TMX IN Thermax 650 510 27.5 23.4 29.7 36.1 23.4 29.7 31.9 0.0 0.0 13.3 18x P/E FY16E v/s 16x FY16E earlier

VOLT IN Voltas 140 100 39.8 6.1 7.5 9.3 6.1 7.5 8.3 0.0 0.0 12.8 15x P/E FY16E v/s 12x FY16E earlier


Equity Strategy

India

19 May 2014



Ownership and Valuation Patterns…

Slow decision-making, bureaucracy and lower access to equity markets has held up

progress in the industrials/utility sectors for the last 5 years. Earnings growth has dropped

dramatically, with some companies seeing 70%+ declines in earnings from peak levels.

This was reflected in valuations seeing a sharp correction. As expected, this trend was also

mirrored in ownership levels. Interestingly, since September 2013, both ownership levels

and valuations have moved upwards in anticipation of a good election result, reflecting in

capex cycle recovery. Going forward, we remain stock specific as we believe company-

specific earnings will begin to dominate over the basket trade at some point.

Exhibit 156: Industrials 12-month Forward PE valuation


Exhibit 157: Utilities 12-month Forward PE valuation


Exhibit 158: Institutional Holdings in Industrials


Exhibit 159: Institutional Holdings in Utilities


0

5

10

15

20

25

30

35

40


Industrials 12M Fwd PE Avg.

0

5

10

15

20

25

30

35


Utilities 12M Fwd PE Avg.

10

15

20

25

30

35

10

12

14

16

18

20

22

24

26

28

Equity Strategy

India

19 May 2014



Excerpts from report dated 13th March 2014, ‚S'election' the Key….‛

Gujarat has clearly progressed on infrastructure (Exhibit 7): The prospect of

Narendra Modi coming in with a majority at the centre has excited markets. Data on

development in Gujarat vs. the rest of India supports this enthusiasm. However, we

believe the speed of any such progress is being overestimated. Even in Gujarat, the State

Electricity Boards (SEBs) turned around only post FY05-06 i.e. nearly 5 years after Modi

became Chief Minister. Relatively, ports and power have seen a bigger thrust compared to

roads. It is also important to note that growth accelerated only post his first 5 years in

power, and did not start at express rates from Day 1.

Proportion of commissioned assets very critical: Given the prolonged nature of the

downturn from FY08-14E, we analysed companies on 6 parameters, to find out where

business models may be permanently damaged. Gross debt:equity, interest coverage,

cash conversion, asset basket, execution and corporate governance were the metrics we

tracked. Of these, we believe the asset basket, which reflects the proportion of operational

assets to overall asset portfolio, is very critical. This is important, as any uptick in the

economy or equity markets will benefit companies with low asset utilisation, and where

projects under implementation can be executed with some help from secondary markets.

Industrials – cyclical basket, close to top end of early valuation re-rating, in

context of previous cycle: In FY03, just before the beginning of the previous economic

recovery cycle, 1-year forward P/B valuations nearly doubled and then stabilised/dropped

for 9-12 months before their next move. We used P/B for our analysis as it removes the

noise of volatile earnings and estimates. In the last 6 months, the valuations of L&T,

Thermax, Crompton Greaves, Voltas and ABB have clearly performed this move already.

Hence, within industrials we are positive on L&T and Cummins, where earnings should

follow through, and remain cautious on the rest, where valuations capture a fair share of

the potential economic recovery.

Exhibit 160: infrastructure growth in Gujarat vs. India during the term of Narendra Modi as CM of Gujarat

2002 2008 2013 CAGR 02-08 CAGR 08-13 CAGR 02-13

GDP (USD bn)

India 412 649 914 7.9 7.1 7.5

Gujarat 25 47 72 11.0 8.9 10.0

Ports (mnt)

India 459 532 745 2.5 7.0 4.5

Gujarat 199 261 459 4.6 12.0 7.9

Power (GW)

India 103 143 223 5.6 9.3 7.3

Gujarat 9 11 26 4.3 18.7 10.6

Roads (mn km)

India 1.4 1.7 2.8 2.6 10.4 6.1

Gujarat 0.1 0.1 0.2 0.4 2.6 1.4

Source: Jefferies estimates, Government websites, CMIE

Exhibit 161: P/B valuation for Industrial goods companies

PB Chg (%)

Aug-13 Mar-14 Aug-03 Mar-04 Aug 2013-March2014 Aug 2003-March 2004

L&T 1.3 2.5 2.3 4.3 96 89

BHEL 0.9 1.4 1.2 2.6 61 120

Adani Port 2.1 3.1 N/A N/A 47 N/A

ABB 3.5 5.8 2.4 3.9 66 67

Siemens 3.7 5.6 2.1 5.1 54 148

Cummins 3.9 5.1 2.3 3.0 31 31

Crompton Greaves 1.3 2.3 1.1 2.0 81 91

Thermax 3.1 4.0 1.5 2.2 30 44

Voltas 1.2 2.4 1.3 1.7 101 35


Equity Strategy

India

19 May 2014



Exhibit 162: Scorecard of Industrial and Utility companies; Implications of last column - companies with a green circle

are financially healthy with strong business models despite downturn. Blank circles would need asset sales or equity

fund raising to get back into shape. Red circles would need a haircut on debt from bankers to survive.

Company Gross D:E Interest

Coverage

Cash

Conversion Asset Basket Execution

Corporate

Governance

Cumulative

Score

NTPC

Power Grid

Tata Power

Reliance

Power

Adani Power

JSW Energy

JP Power

NHPC

IRB

ITNL

IVRCL

Nagarjuna

Construction

Sadbhav

Engineering

Gammon

Infra

Simplex

Infrastructure

Adani Ports

Gujarat

Pipavav

Essar Ports

Marg

Construction

L&T

Reliance Infra

JaiPrakash

Associates

Adani

Enterprises

GMR

GVK

Source: Jefferies, company data; Cumulative score – 0-20 red and 25-40 green

Equity Strategy

India

19 May 2014



Exhibit 163: Parameters considered for Scorecard

Gross debt:equity

(x)

Net debt:equity

(x)

Interest

coverage

ratio (x)

Conversion Ratio

FY12 FY13 FY12 FY13 FY12 FY13 FY12 FY13

Power

NTPC 0.7 0.7 0.4 0.5 7.7 8.1 19 22

Power Grid 2.3 2.6 2.2 2.5 3.2 3.2 58 59

Tata Power 3.0 3.5 2.6 3.3 2.4 1.8 8 9

Reliance Power 0.8 1.4 0.7 1.2 4.2 3.0 49 26

Adani Power 6.0 8.8 5.4 8.4 1.0 -0.1 7 -15

JSW Energy 1.6 1.5 1.5 1.4 1.5 2.4 13 19

JP Power 2.9 3.2 2.7 3.1 1.5 1.3 39 30

NHPC 0.6 0.6 0.4 0.3 8.5 7.2 58 57

Road

IRB Infra 2.4 2.4 1.8 2.0 2.2 2.1 25 27

ITNL 3.3 3.6 3.2 3.4 2.1 1.7 10 9

IVRCL 2.0 2.3 1.9 2.2 0.8 0.5 1 -1

NCC 1.8 1.3 1.7 1.2 1.1 1.2 5 4

Sadbhav Engg 2.9 3.7 2.7 3.6 2.3 0.9 7 6

Gammon Infrastructure

Projects

4.3 5.2 4.0 5.1 0.9 1.1 13 27

Simplex Infrastructure 1.7 2.0 1.7 2.0 1.6 1.3 3 3

Ports

Adani Ports 3.6 1.8 3.4 1.7 4.1 4.0 63 62

Gujarat Pipavav Port - Dec

Y/E*

0.8 0.3 0.8 0.2 1.7 2.1 29 31

Essar Ports 2.3 1.9 2.2 1.8 1.6 1.8 40 40

Marg Construction 6.8 14.0 6.5 13.5 1.8 0.3 5 24

* taken standalone

numbers

Conglomerates

L&T 1.6 1.8 1.2 1.5 7.3 4.4 10 9

Reliance Infrastructure 0.7 0.8 0.6 0.7 2.4 2.1 11 16

JaiPrakash Associates 4.0 4.4 3.7 4.2 1.5 1.2 11 10

Adani Enterprises 3.4 2.9 3.0 2.5 2.4 1.3 8 7

GMR Infrastructure 4.3 5.0 3.7 4.3 0.6 0.8 5 6

GVK Power 4.0 5.4 3.4 4.7 1.1 0.6 12 1

Source: Jefferies, company data

Equity Strategy

India

19 May 2014



Exhibit 164: Asset Basket of the companies (%)

Commissioned Under implementation for FY14E-18E (5

years)

Planned for

future

Power

NTPC 39 29 32

Power Grid 37 42 21

Tata Power 68 15 17

Reliance Power 12 65 23

Adani Power 87 13 0

JSW Energy 26 46 28

JP Power 18 25 57

NHPC 13 17 70

Road

IRB Infra 52 48 0

ITNL 33 43 24

IVRCL 23 77 0

NCC 27 73 0

Sadbhav Engg 55 45 0

Gammon Infrastructure Projects 35 39 26

Simplex Infrastructure 0 100 0

Ports

Adani Ports 70 15 15

Gujarat Pipavav Port - Dec Y/E* 53 32 15

Essar Ports 39 20 42

Marg Construction 24 76 0

Conglomerates

L&T 29 71 0

Reliance Infrastructure 26 61 13

JaiPrakash Associates 21 18 61

Adani Enterprises 81 16 3

GMR Infrastructure 41 32 27

GVK Power 19 74 7


Equity Strategy

India

19 May 2014



Autos – Poised for recovery The auto industry has gone through one its worst periods of demand. We

expect sharp cyclical recovery in all segments, though truck demand could

grow the most, followed by cars and then two-wheelers. History suggests two-

wheelers will recover earlier than cars. Competitive dynamics across the space

have worsened through the slowdown and could remain a headwind, except

in small cars. Valuations are comfortable but not cheap. We like Maruti,

Mahindra and Hero.

Two-wheelers most stable but could still accelerate: As is to be expected, two-

wheeler demand has eased but not collapsed. However, recent growth rates have been

lower than trend and will likely recover along with rest of the economy. Two-wheelers

will also likely be the first segment to recover. We forecast two-wheeler demand to grow

9.5% in FY15E and 11.3% in FY16E. Scooters will likely continue to outpace motorcycles,

though by smaller margins. While the acceleration to growth may not be immense, its

impact on pricing and margins can be more meaningful. Competitive environment in the

industry has been as severe as it ever has been with Honda consistently gaining share,

primarily at the expense of Bajaj but marginally at the expense of Hero as well. Hero

remains our preferred stock in the segment as it is better positioned in the domestic

market and has margin levers.

Passenger vehicles have seen the longest slowdown: PV demand has remained flat

over the last 3 years and has undergone its longest period of slowdown. Urban demand

has been weaker than rural demand, small cars worse than large cars and UVs, diesels

have outperformed petrol over this period. Some of this is reversing but the total demand

is still weak. We forecast PV demand to grow 8% in FY15E and 20% in FY16E. Competitive

dynamics have eased marginally in small cars and will likely be benign over the next 2-3

years while competition in sedans and UVs is likely to intensify. Maruti is our preferred

stock in the segment as it is best poised to benefit from recovery in small petrol car

demand off a very low base.

Commercial vehicles have seen the sharpest slowdown: On a capacity added basis

(tonnage), the CV market has declined 42% in FY12-14 period, the sharpest in recent

memory. Truck operators' profitability remains weak as utilization levels are low.

However, this could recover sharply as industrial activity picks up, which is our base case

over the next 2 years. We forecast domestic CV industry to grow 8.1% in FY15E and 22%

in FY16E, with the sharpest pick up forecast in medium and heavy trucks (c30% growth in

FY16E). Ideally, such a sharp pickup in demand should lead to margins expanding to close

to previous peaks. We think the increase in competitive intensity, with the aggression seen

from Mahindra, Eicher-Volvo, Bharat Benz, would prevent such an outcome. We therefore

remain neutral on this space.

Tractor demand strong and could remain okay in near-term: We have long

argued that the Indian tractor market is too large to sustain, an argument that still holds

valid for us in the medium term. However, in the short-term, the industry will likely grow

7% pa in FY14-16E as it benefits from recovery in construction activity. Overall, our view

on autos is neutral as the sector hasn’t seen as much of a de-rating as other domestic

cyclicals have.

Equity Strategy

India

19 May 2014



Exhibit 165: LT growth trends in autos– truck demand could grow the most, followed by cars and then two-wheelers

Source: Jefferies, company data, CMIE

Exhibit 166: Long term demand trend in PVs ('000 units)


Exhibit 167: UV as % of the PV market


-60%

-40%

-20%

0%

20%

40%

60%


2-w PVs Trucks Tractors

0

500

1,000

1,500

2,000

2,500

3,000

3,500

FY92 FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14 FY16E

0%

5%

10%

15%

20%

25%


UV as % of PV

Small cars have performed worse

than large cars and UVs, and diesels

have outperformed petrol

PV demand has remained flat over

the last 3 years and has undergone

its longest period of slowdown

Equity Strategy

India

19 May 2014



Exhibit 168: Market share trend in PVs


Exhibit 169: Two-wheeler long term demand trend


Exhibit 170: Market share trends in two-wheelers


0%

10%

20%

30%

40%

50%

60%


Maruti M&M

0

2

4

6

8

10

12

14

16

18

20

FY92 FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14 FY16E

(mn units)

0%

10%

20%

30%

40%

50%

60%

FY02 FY04 FY06 FY08 FY10 FY12 FY14

Bajaj Hero Honda

Honda has gained share, primarily at

the expense of Bajaj but marginally

at the expense of Hero as well

Recent growth rates have been lower

than trend and will likely recover

along with rest of the economy

Maruti is our preferred stock in the

segment as it is best poised to

benefit from recovery in small petrol

car demand off a very low base

Equity Strategy

India

19 May 2014



Exhibit 171: Scooters as % of two-wheelers


Exhibit 172: Long term growth in CV tonnage (‘000 MT)


Exhibit 173: Market share trends in CVs


0%

5%

10%

15%

20%

25%

30%


Scooter as % of TW

0

500

1000

1500

2000

2500

3000

3500

4000

4500

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

0%

10%

20%

30%

40%

50%

60%

70%


AL TTMT

Scooters will likely continue to

outpace motorcycles, though by

smaller margins

On a capacity added basis (tonnage),

the CV market has declined 42% in

FY12-14 period, the sharpest in

recent memory

Increase in competitive intensity in

CVs could prevent the typical

improvement in profitability

associated with a demand recovery

Equity Strategy

India

19 May 2014



Exhibit 174: Tractor demand trends (units)


Exhibit 175: Competitive intensity in PVs (HHI Index)


Exhibit 176: Competitive intensity in two-wheelers (HHI Index)


-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

-

0.05

0.10

0.15

0.20

0.25

0.30

0.35


PV HH

0.23

0.24

0.25

0.26

0.27

0.28

0.29

0.30

0.31

0.32


TW HH

In the short-term, the tractor

industry will likely grow 7% pa in

FY14-16E as it benefits from recovery

in construction activity

Competitive dynamics have eased

marginally in small cars and will

likely be benign over the next 2-3

years while competition in sedans

and UVs is likely to intensify

Competitive environment in the

industry has been as severe as it ever

has been with Honda consistently

gaining share

Equity Strategy

India

19 May 2014



Energy: Reforms to Continue, Faster Decision-Making in E&P We expect election impact to be positive for oil & gas sector as reforms that

are underway, such as diesel subsidy elimination and gas price hike, are likely

to continue and decision-making, particularly in E&P, is likely to be

expedited. While not our base case, the real boost would come if the new

government were to take up more bold steps such as full elimination of fuel

subsidy or privatisation of PSUs. ONGC remains our top pick followed by

Reliance.

Fuel subsidy reforms to continue - Elimination of diesel subsidies by FY16. We

expect fuel subsidy reforms which have been going on over the past 18 months to

continue under the new BJP government. The policy of small diesel price hikes of Rs0.5

per liter is likely to be continued given its acceptability and success so far. This should lead

to elimination of diesel subsidy by FY16, reducing the overall fuel subsidy burden to

Rs750-800bn, from Rs1,610bn in FY13. Upstream and oil marketing companies which

bear a part of the fuel subsidy burden should be the key beneficiaries.

Gas price hike likely to go through post elections. We expect the gas price hike to

go through under the new government. Although some members of the BJP have

indicated the possibility of a review in the Rangarajan formula, we believe there is little

downside risk to our base case assumption of US$5.7/mmbtu to ONGC and Oil India and

US$8 to Reliance vs US$4.2 currently. We believe ONGC and Oil India would be the

biggest beneficiaries of the gas price hike followed by Reliance.

Expect faster decision making on key E&P issues. A number of key decisions are

pending in the E&P sector such as policy on PSC extension, resolution of DST issues,

approvals for budgets and investment proposals, new PSC model for future NELP rounds.

We expect decision making on these and other issues to be expedited under the new

government. Cairn India and Reliance are likely to be the key beneficiaries if the new

government delivers.

What more could the new government do? While not our base case, the new

government could potentially do more to boost the oil & gas sector such as: 1) deregulate

LPG and kerosene over time to fully eliminate fuel subsidies, 2) privatisation of oil PSUs,

particularly some of the oil marketing companies; 3) roll-out of city gas distribution across

more cities in India; 4) work towards improving gas availability and infrastructure in the

country in the near and long term; 5) improve production efficiency of the public sector

upstream companies

ONGC our top pick; Downgrade GAIL to Hold. ONGC remains our top pick in the

sector, as we expect it to be one of the biggest beneficiaries of reforms in the sector and

valuations are still relatively attractive. We prefer BPCL amongst OMCs, although we note

that it has already moved up 59% YTD. We prefer Reliance over Cairn among the private

sector companies. We downgrade GAIL to Hold as we see limited upside from current

levels given the many uncertainties for the stock.

Equity Strategy

India

19 May 2014



Chart 1: We expect complete elimination of diesel subsidy by FY16E


Table 1: Calculation of domestic natural gas price based on Rangarajan formula Benchmark Price (US$/mmbtu) Wt. (%) Comments

Henry Hub 3.7 20 Based on CY13 actual price data

NBP 10.6 27 Based on CY13 actual price data

Japan imports netback price 9.5 3 Assuming cif price of US$14/mmbtu

Rasgas LNG - netback price 8.5 29 Based on CY13 actual price data

Other LNG imports to India - netback price 10.0 21 Assuming cif price of US$14/mmbtu

Domestic gas price 8.4 100

Scenarios

Domestic gas price assuming price of other Indian imports at US$15/mmbtu 8.6

Domestic gas price assuming price of other Indian imports at US$13/mmbtu 8.2


Table 2: Sector Valuation P/E P/B ROE (%)

Company BB

Ticker

Mktcap

(US$bn)

Shares o/s

(mn)

Rating TP (Rs) CMP

(Rs)

FY14E FY15E FY16E FY14E FY15E FY16E Div yield

(%)

FY14E FY15E FY16E

ONGC ONGC IN 55.7 8,555 Buy 440 384 13.2 10.2 9.6 2.2 2.0 1.7 2.5 14.8 17.1 16.3

Oil India OINL IN 5.8 601 Buy 670 567 10.2 8.8 8.0 1.8 1.6 1.4 3.2 15.7 16.3 16.1

BPCL BPCL IN 6.8 723 Hold 560 552 13.9 12.0 n/a 2.4 2.2 1.9 2.3 15.5 16.1 14.7

Reliance Industries RIL IN 59.1 3,231 Buy 1,236 1,079 15.5 13.6 13.8 1.9 1.8 1.6 0.9 11.3 11.5 10.4

Cairn India CAIR IN 11.0 1,910 Hold 370 341 5.5 6.4 6.5 1.4 1.1 1.0 3.7 20.7 15.7 13.6

GAIL GAIL IN 8.8 1,268 Hold 410 410 10.2 10.6 10.0 1.8 1.6 1.5 2.8 15.8 13.8 13.3

Indraprastha Gas IGL IN 0.7 140 Buy 371 315 11.4 9.9 8.6 3.0 2.5 2.1 1.9 21.6 20.9 20.2

PLNG PLNG IN 1.8 750 Hold 134 141 14.8 14.1 10.3 2.4 2.1 1.9 1.4 14.3 13.6 16.1

Source: Jefferies estimates, company data, closing prices as of 16 May 2014

0

400

800

1,200

1,600

2,000

FY13 FY14 FY15E FY16E

Under-recovery (Rs bn) in Kerosene Domestic LPG Diesel

Equity Strategy

India

19 May 2014



Key Changes

Table 3: Changes in Rating/Target price/EPS estimates (Rs) New New New EPS Old Old Old EPS % change EPS

Company Rating TP FY14E FY15E FY16E Rating PT FY14E FY15E FY16E TP FY14E FY15E FY16E

ONGC Buy 440 29.2 37.6 40.0 Buy 355 30.0 37.3 39.5 24 (3) 1 1

Oil India Buy 670 55.7 64.4 70.5 Buy 580 55.7 64.4 70.5 16 - - -

BPCL Hold 560 39.6 45.9 46.0 Hold 400 24.9 25.2 n/a 40 59 82 n/a

Reliance Industries Buy 1,236 69.6 79.1 78.2 Buy 1,124 69.6 79.1 78.2 10 - - -

Cairn India Hold 370 62.2 53.6 52.2 Hold 370 62.2 53.6 52.2 - - - -

GAIL Hold 410 40.2 38.6 41.0 Buy 388 40.2 38.6 41.0 6 - - -

Indraprastha Gas Buy 371 27.5 31.7 36.5 Buy 333 27.5 31.7 36.5 11 0 0 0

Petronet LNG Hold 134 9.5 10.0 13.6 Hold 134 9.5 10.0 13.6 - - - -


Table 4: Key changes & rationale Company Comments

ONGC Change in TP driven by increase in P/E to 11x from 9.5x and roll forward of valuation basis to FY16E EPS

Oil India Change in TP driven by increase in P/E to 9.5x from 9x and roll forward of valuation basis to FY16E EPS

BPCL Change in earnings driven by lower government subsidy contribution and lower petrol losses; Increase in TP based on 1.3x on FY15E BPS against 0.9x on FY14E BPS earlier

Reliance Industries Change in TP driven by change in multiple for petrochemical to 7x against 6x earlier & non-core businesses valued at book against 0.8x earlier

Cairn India No change in TP

GAIL Downgrade to Hold as we believe the stock is fairly valued with limited upside from current levels; Change in TP driven by roll forward of valuation basis to FY16E

Indraprastha Gas Change in TP driven by reduction in CoE to 12.5% from 13.5% earlier

Petronet LNG No change in TP


Equity Strategy

India

19 May 2014



Metals & Mining - Well Leveraged to a Macro Recovery The steel and mining sectors are well positioned to benefit from a change in

government. Not only would demand pick-up lead to pricing power but also

the streamlining of approvals and auctioning of mines would give steel

producers much better visibility on raw material availability. The mining

sector could benefit from investments in logistics, streamlining of approval

process and private participation in coal mining. Tata Steel, NMDC and JSW

are our top picks.

Steel – domestic demand boost: On the back of the positive outcome in the general

elections, we expect GDP growth to accelerate to 5.5% in FY15E and 6.5% in FY16E and

consequently and revise our domestic steel consumption growth assumption higher to

3.5% (3.0% earlier) in FY15E and 7.0% (6.0% earlier) in FY16E. While the domestic steel

consumption growth was only 0.6% YoY in FY14, the finished steel production growth

recorded a much healthy 4.3% YoY growth in FY14 as India turned a net exporter helped

by the rupee depreciation. However, with the rupee beginning to appreciate, there is a

growing concern that imports would start rising once again, thereby putting pressure not

only on domestic prices but also the producer volumes. We believe that a pick-up in

domestic demand is expected to offset the falling exports and steel production is expected

to continue at a strong pace. Given our expectation of INR at Rs60/USD and a pick-up in

domestic consumption demand, we remain confident that the current steel spreads in the

domestic markets would also sustain.

Mining - will the supply-side issues be addressed? The mining sector in India has

been hampered by logistics bottlenecks and coal allocation scams and mining bans. Lack

of investment in improving the rail infrastructure has impacted mining companies ability

to increase production besides also putting pressure on the road infrastructure in India

and increasing the logistics cost for most power producers. If the new government could

bring focus on railway investment, faster completion of the two Freight corridors and take

up the execution of a few critical railway lines on a priority basis, India could substantially

reduce its huge material import bill ($20bn in FY14E) thereby lowering its current account

deficit. While Coal India would benefit from the improvement in railway infrastructure and

the streamlining of the approval process, it could also be negatively impacted by the

auctioning of new mines by the Government.

Our top picks in the sector: Tata Steel remains our top pick in the metal sector as its

India business is set to see strong volume growth in FY15 and FY16 as infrastructure

related activity under the new government picks up. The stock is currently trading at one

year forward EV/EBITDA multiple of 6.1x and a one-year forward P/BV multiple of 0.9x,

which we believe provides an attractive entry point. NMDC remains our top pick in the

mining sector as the company could see strong earnings upside if the new government

streamlines environmental and forest clearance process and invests in infrastructure

heavily, which would debottleneck both NMDC’s production and evacuation. The stock is

trading at 5.4x 1-yr rolling EV/EBITDA multiple against the historical average of 6.3x and

at 2.1x 1-yr forward book value against the historical average of 2.6x. Valuations coupled

with dividend yield of c7% make the stock attractive at current levels.

Equity Strategy

India

19 May 2014



Steel – domestic demand boost We expect domestic steel demand growth to pick up in the coming months on the back

of increased economic activity under the governance of BJP-led NDA party. This demand

growth should drive volumes for steel producers in FY15 and FY16 as opposed to FY14,

when exports were the main growth drivers. On the back of our domestic demand

growth assumptions, we maintain our non-consensus view that sustaining margins at

current levels should not be an issue while the consensus expectation is for a fall in

domestic prices given the supply pressure from new capacities.

A strong election result creates possibility of a volume recovery in FY16E…

The steel sector has been struggling for the last two years due to slowing economic

activity. Domestic steel consumption in FY14 grew by only 0.6% YoY in FY14 after a

lacklustre 3.3% YoY growth in FY14 as infrastructure-related spending came to a near halt

due to the policy paralysis at the centre.

However, the decisive mandate received by the BJP-led NDA party in the general elections

yesterday has created the possibility of an economic revival. BJP, in its 2014 election

manifesto, has stated its intention of kick-starting the economic growth by focusing on

infrastructure creation and building 100 new ‘Smart Cities’. As highlighted in our recent

note ‚What Next? No. 6 Smart Cities‛ published on 6th May 2014, this creation of 100 new

smart cities could trigger a US$2 trillion investment opportunity which by itself could add

~1-1.5% to the GDP growth over the next 30 years. On the back of the positive outcome

in the general elections, we now expect GDP growth to accelerate to 5.5% in FY15E and

6.5% in FY16E and consequently also revise our domestic steel consumption growth

assumption higher to 3.5% (3.0% earlier) in FY15E and 7.0% (6.0% earlier) in FY16E.

Exhibit 177: Steel demand growth picked up slightly in

April 2014…

Source: Bloomberg, JPC, Jefferies

Exhibit 178: …after remaining below trend for the last two

years


…and negate the risk from rising imports on the back of appreciating rupee

While the domestic steel consumption growth was only 0.6% YoY in FY14, the finished

steel production growth recorded a much healthy 4.3% YoY growth in FY14 as India

turned a net exporter helped by the rupee depreciation. FY14 imports saw a 31% YoY

decline while exports were up 4% YoY helped by the INR depreciation and an

improvement in global HRC prices turning India into net exported or 0.2mn tonnes in

FY14 against net import of 2.6mn tonnes in FY13.

However, with the rupee beginning to appreciate, there is a growing concern that

imports would start rising once again, thereby putting pressure not only on domestic

prices but also the producer volumes. We believe that a pick-up in domestic demand is

expected to offset the falling exports and steel production is expected to continue at a

strong pace. Against our domestic steel consumption growth estimates of 3.5% for FY15

and 7.0% for FY16, we expect the producer volume growth to be 3.6% YoY in FY15 and

6.5% in FY16.

-15%

-10%

-5%

0%

5%

10%

15%

4,500

4,900

5,300

5,700

6,100

6,500

6,900

Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14

Finished Steel Consumption YoY Change (%) - RHS 0%

5%

10%

15%

20%

FY01 FY03 FY05 FY07 FY09 FY11 FY13 FY15E

Production growth strong in FY14

due to surge in exports

Domestic steel consumption growth

3.5% in FY15E and 7.0% in FY16E

Equity Strategy

India

19 May 2014



Exhibit 179: Steel Production grew 4.3% YoY in FY14


Exhibit 180: …on the back of strong exports (mn MT)


Sustaining margins at current levels shouldn’t be an issue

The increase in domestic prices over the last few months and appreciation of the INR to

~Rs60 levels (vs. its August lows of Rs68/USD) coupled with international prices

remaining flat has led to the domestic prices moving back into premium over the import

parity prices. Domestic prices have in the past usually remained at a 5-10% premium to

import parity prices barring in 2014 when they slipped into a discount to import parity

prices as domestic steel consumption stagnated. We maintain our non-consensus view

that sustaining domestic prices at current levels should not be an issue while the

consensus expectation is for a fall in domestic prices given the supply pressure from new

capacities. Given our expectation of INR at Rs60/USD and a pick-up in domestic

consumption demand, we remain confident that the current steel spreads in the domestic

markets to sustain.

Exhibit 181: Import landed prices have gone below

Rs40,000 per tonne levels


Exhibit 182: Domestic prices are at a 9% premium

compared with the historical average of 1% discount


In addition, steel producers should also benefit from a benign raw material prices. Steel

producers have already seen some margin expansion recently due to falling raw material

prices and if the steel prices do hold up at current levels then there can be further margin

upsides. Coking coal contract prices have been on the declining trend which should be

positive for steel makers’ margins. The 2Q2014 coking coal contract has been settled at

US$120/MT as against US$172/MT for the 2Q2013 period. And with the appreciation of

the INR to below Rs60 levels, coking coal prices have given huge relief in terms of input

cost pressures. Also, domestic iron ore prices have been largely stable in the months even

as international iron ore prices have seen a sharp decline recently to levels of US$105/MT.

0%

2%

4%

6%

8%

10%

12%

14%

FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E

0

1

2

3

4

5

6


20,000

25,000

30,000

35,000

40,000

45,000


China HRC Landed Price Domestic HRC-40.0%

-20.0%

0.0%

20.0%

40.0%


Import parity prices are at a 9%

discount

Coking coal prices providing input

cost relief

Equity Strategy

India

19 May 2014



Exhibit 183: Declining trend in international coking coal

prices continue


Exhibit 184: Domestic iron ore prices have been stable

Source: Bloomberg, Jefferies, Company Data

.Mining – will the supply-side issues be addressed? The mining sector in India has been hampered by logistics bottlenecks and coal allocation

scams and mining bans. Lack of investment in improving the rail infrastructure has

impacted mining companies ability to increase production besides also putting pressure

on the road infrastructure in India and increasing the logistics cost for most power

producers. If the new government could bring focus on railway investment, faster

completion of the two Freight corridors and take up the execution of a few critical railway

lines on a priority basis, India could substantially reduce its huge material import bill

($20bn in FY14E) thereby lowering its current account deficit.

Further, investigations into the coal allocation scam and the Supreme Court directed

illegal iron-ore mining bans have also constrained India’s mineral output. With a new

government in place, we believe that one of the first steps it would take is to lay down a

transparent policy for auctioning mining concessions thereby encouraging private sector

participation in the sector.

Coal India

Coal India’s output has suffered due to a number of external factors viz., a) delay in forest

and environment clearances, b) poor rake availability, c) absence of railway logistics at

some of its critical mines, and d) rehabilitation and resettlement issues. Leaders of the BJP

party have talked about the need for streamlining the environmental and forest clearance

process and investing in infrastructure to kick-start the economy. Coal India could be a big

beneficiary

If the new government can speed up the execution of the three ambitious inter-state rail

corridor projects dedicated to coal evacuation, then majority of Coal India’s supply

bottleneck would be reduced. The three corridors are the c100km Tori-Shivpur-

Hazaribagh line (CCL), the Gopalpur-Manoharpur line (IB Valley) coupled with the

Kalinga-Angul link in Talcher (MCL) and a new rail line in the Mand-Raigarh coalfield

(SECL). But these projects have moved at a very slow pace till now and the total cost of

setting up the three projects has escalated from Rs20bn when they were initially planned

before the beginning of the Eleventh Plan period in 2007 to Rs70bn now. These three rail

lines together can free up 300mn MT of coal supply locked due to logistical constraints.

While Coal India would benefit from the improvement in railway infrastructure and the

streamlining of the approval process, it could also be negatively impacted by the

auctioning of new mines by the Government due to:

5,000

7,500

10,000

12,500

15,000

17,500

100

150

200

250

300

350

Sep-09 Sep-10 Sep-11 Sep-12 Sep-13

Coking Coal (Rs/tonne) - RHS Coking Coal ($/tonne)

$30

$60

$90

$120

$150

$180

2000

3000

4000

5000

6000

7000

Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14

NMDC Fines (Rs) NMDC Lumps (6-40 mm) (Rs)Int Fines Prices ($) - RHS

Lack of investment in improving the

rail infrastructure has impacted

mining companies

Equity Strategy

India

19 May 2014



Competition from the private sector: Coal India has had a near monopoly

in coal production over the years and caters to 80% of India’s annual coal

production. However, the entry of the private sector gets into coal mining could

be negative for Coal India over the longer-term. Private players with significantly

lower cost of mining (vs. Coal India’s high wage bills) could impact the demand

for Coal India’s supplies eventually. This however, is at best a long-term risk

given the large coal imports (170mn tonnes in FY14E) into India but

nevertheless a key risk that we have seen playing out in other sectors where

private players have been allowed to come in.

Cost of new mine acquisition: Hitherto, Coal India used to get the mines free

of cost from the Government. However, once the Central Government starts

auctioning coal mines, we expect Coal India would also be required to pay for

any new mine allocations which would lower its RoIs from the earlier levels and

also use up much of its Rs610bn (Rs96/share) cash on hand.

In the near term however, we see significant risk of an earnings disappointment. Coal

India has benefited from the economic slowdown as demand for FSA coal from the power

sector (low margin) has reduced which has enabled the company to sell more in e-

auction (high margin). An improving economic growth would once again trigger demand

from the power sector and with little headroom to increase output given the logistics

constraints, Coal India’s profitability might take a big hit. Given the fair valuations

(currently trading at 8.6x 1-yr rolling EV/EBITDA multiple against historical average of 8.7x

and 5x one-year forward book value against historical average of 4.8x), there is little room

for upside in the stock.

NMDC

As pick-up in domestic steel demand leads to higher iron ore demand in FY15 and FY16,

NMDC is all set on a strong growth path if it can address its despatch bottlenecks. If the

new government can streamline environmental and forest clearance process and invest in

infrastructure heavily, then both NMDC’s production and evacuation stand to see

debottlenecking. We forecast domestic steel consumption growth to be 3.5% in FY15E

and 7.0% in FY16E. On the back of this strong demand iron ore volumes can see similar

strong growth and NMDC given its scale and quality of iron ore mined, can substantially

benefit from it. Coupled with this if logistical bottlenecks like issue of rake availability and

ramping up of Essar pipeline are taken care of, then volumes from NMDC’s Chattisgarh

operations can see significant upside. Management has guided for 35mn MT of dispatch

volumes in FY15 (vs 30.5mn MT in FY14).

The Supreme Court judgement on Odisha mining ordering for temporary closure of 26

mines in Orissa which had been operating on ‘deemed second or subsequent renewal’,

can be another big positive for NMDC as it would stop dumping from fringe players

which would lead to stability in pricing going forward and the steel producers who had

captive mines in Odisha would be forced to purchase iron ore from the market which

would provide further upside to prices.

The stock is trading at 5.4x 1-yr rolling EV/EBITDA multiple against historical average of

6.3x and at 2.1x 1-yr forward book value against historical average of 2.6x. Valuations

coupled with dividend yield of c7%, make the stock really attractive at current levels.

Equity Strategy

India

19 May 2014



Estimate and Target price changes

Exhibit 185: Earnings Estimate Changes

EBITDA (Rs mn) EPS (Rs)

FY2015E FY2016E FY2015E FY2016E

Old New % Chng Old New % Chng Old New % Chng Old New % Chng

Steel

Tata Steel* 183,465 183,465 - 213,742 213,742 - 47.8 47.8 - 55.8 55.8 -

JSW Steel 94,542 95,875 1.4 105,782 107,327 1.5 92.2 95.8 3.9 123.0 127.2 3.4

SAIL 56,733 50,941 (10.2) 72,176 68,225 (5.5) 5.7 4.5 (21.7) 6.2 5.4 (13.1)

Mining

Coal India 189,000 180,701 (4.4) 214,000 194,527 (9.1) 27.7 26.7 (3.7) 30.4 28.1 (7.4)

NMDC 81,000 84,502 4.3 86,000 92,159 7.2 16.8 16.8 (0.0) 17.0 17.6 3.3

Source: Jefferies estimates *Tata Steel numbers already updated in our note published on 15th May 2014

Exhibit 186: Target Price Changes Summary

New Rating Old Rating New TP Old TP Comment

Tata Steel BUY BUY 540 540 -

JSW Steel BUY BUY 1,406 1,168 Roll Forward to FY16

SAIL UNPF UNPF 63 54 Roll Forward to FY16

Coal India Limited HOLD HOLD 305 281 Roll Forward to FY16

NMDC Ltd BUY BUY 178 149 Roll Forward to FY16

Source: Jefferies

Exhibit 187: Jef. vs Consensus Estimates

FY15E FY16E

EBITDA (Rs mn) Jef Est Cons Est % Dev Jef Est Cons Est % Dev

Steel

Tata Steel 183,465 178,903 2.5 213,742 194,727 9.8

JSW Steel 95,875 96,094 (0.2) 107,327 102,734 4.5

SAIL 50,941 64,067 (20.5) 68,225 79,009 (13.6)

Mining

Coal India 180,701 187,489 (3.6) 194,527 208,328 (6.6)

NMDC 84,502 81,136 4.1 92,159 85,083 8.3

EPS (Rs)

Steel

Tata Steel 47.9 44.9 6.7 55.9 52.5 6.5

JSW Steel 95.8 97.8 (2.0) 127.2 110.4 15.3

SAIL 4.5 6.3 (29.6) 5.4 6.8 (21.2)

Mining

Coal India 26.7 26.5 0.7 28.1 29.0 (3.0)

NMDC 16.8 16.8 0.1 17.6 17.3 1.3


Equity Strategy

India

19 May 2014



Valuation

Exhibit 188: Global steel sector valuation comparison

Ticker Rating TP Price Mcap EV D/E EV/EBITDA (x) P/BV (x) ROE (%)

lcy lcy USD mn USD mn (x) 12 13E 14E 12 13E 14E 12 13E 14E

Tata Steel TATA IS BUY 540 441 7,314 17,145 1.1 8.3 6.2 5.7 1.3 1.1 1.1 (19) 10 11

JSW Steel JSTL IS BUY 1,406 1,177 4,861 9,203 1.0 8.5 6.2 5.8 1.5 1.4 1.3 6 9 11

SAIL SAIL IS UP 63 78 5,513 8,875 0.3 10.0 9.9 7.6 0.8 0.7 0.7 6 5 6

JSPL JSP IS NC NC 270 4,218 9,944 0.8 10.2 7.6 6.5 1.1 1.0 0.9 9 11 12

India Avg 0.8 9.4 7.9 6.6 1.1 1.0 0.9 2 8 9

Thyssen TKA GY BUY 23.5 22 17,258 22,460 1.0 6.4 13.3 7.3 5.2 4.3 3.9 6 (50) 9

Arcelormittal MT NA BUY 15.0 12 26,641 48,456 0.4 7.5 8.2 6.1 0.6 0.5 0.6 0 (4) 3

Posco 005490 KS NC NC 310,500 26,442 50,739 0.4 8.5 9.3 8.3 0.6 0.6 0.6 6 4 4

Nippon Steel 5401 JP HOLD NC 277 25,945 52,469 0.5 17.0 8.4 7.7 1.0 0.9 0.9 0 8 9

JFE 5411 JP HOLD NC 1,876 11,361 26,053 1.1 11.4 8.0 7.0 0.7 0.6 0.6 3 7 8

Angang 347 HK HOLD 5.8 5 3,462 6,070 0.6 24.2 6.8 5.2 0.6 0.6 0.6 (9) 1 2

Baoshaan 600019 CH BUY 5.8 4 10,225 21,101 0.4 7.8 7.1 6.2 0.6 0.6 0.5 4 6 6

Nucor Corp NUE US NC NC 52 16,605 20,018 0.3 12.0 13.0 9.6 2.2 2.2 2.1 7 7 9

Gerdau GGBR4 BZ NC NC 14 10,428 17,024 0.4 9.1 8.0 6.7 0.9 0.8 0.8 5 6 6

Severstal CHMF RX NC NC 306 7,386 10,913 0.5 5.1 5.3 5.1 1.1 1.1 1.0 10 1 9

Global Avg 0.6 10.9 8.8 6.9 1.3 1.2 1.2 4 (1) 7

Source: Bloomberg, Jefferies, Closing prices as of 16th May,2014, consensus estimates for NC companies * 2013E implies year ended Sep-13/Dec-13/Mar-14/Jun-14 and 2014e implies year ended Sep-14/Dec-14/Mar-15/Jun-15

Exhibit 189: Global mining sector valuation comparison

Ticker Rating TP Price Mcap EV D/E EV/EBITDA (x) P/BV (x) ROE (%)

lcy lcy USD mn USD mn (x) 12 13E 14E 12 13E 14E 12 13E 14E

NMDC NMDC IN Buy 178 162 10,964 7,370 (0.8) 5.6 5.5 5.1 2.3 2.2 2.0 24 22 21

Coal India COAL IS Hold 305 345 37,266 26,752 (1.4) 7.7 8.8 8.1 4.5 5.1 4.5 39 35 36

Rio Tinto RIO LN Buy 4,100 3,287 103,486 127,225 0.3 8.0 6.7 6.0 2.2 2.2 1.9 13 22 20

AngloAmerican AAL LN Hold 1,550 1,562 36,703 52,492 0.2 6.8 5.8 6.2 1.0 1.2 1.0 8 8 7

BHP Bilton BLT LN Buy 2,200 1,953 183,981 216,535 0.3 6.7 6.5 6.3 2.2 2.0 1.8 19 17 16

Vale VALE3 BZ Hold 14 30.4 71,026 95,174 0.3 6.2 4.5 4.7 1.0 1.0 1.1 15 18 15

Fortescue FMG AU Y NA 6 4.6 13,358 21,995 1.6 3.5 3.6 4.2 1.7 1.3 1.1 48 32 23

Cliffs l CLF US NC NC 16.9 2,583 7,058 0.7 5.6 4.7 8.0 0.5 0.5 0.4 (1) 14 1

Kumba KIO SJ NC NC 37,004 11,520 12,284 0.2 5.2 4.2 4.4 7.9 5.7 4.5 79 86 65

Source: Bloomberg, Jefferies, Closing prices as of 16th May,2014, consensus estimates for NC companies * 2013E implies year ended Sep-13/Dec-13/Mar-14/Jun-14 and 2014e implies year ended Sep-14/Dec-14/Mar-15/Jun-15

Equity Strategy

India

19 May 2014



Exhibit 190: Tata Steel is trading at 6.1x 1-yr rolling

EV/EBITDA multiple against historical average of 5.2x

Source: Jefferies, company data, Bloomberg

Exhibit 191: Tata Steel is trading at 0.9x 1-yr forward book

value against historical average of 1.4x


Exhibit 192:JSW Steel is trading at 6.4x 1-yr rolling

EV/EBITDA multiple against historical average of 6x


Exhibit 193: JSW Steel is trading at 1.2x 1-yr forward book



Exhibit 194:SAIL is trading at 10.6x 1-yr rolling EV/EBITDA

multiple against historical average of 6.6x


Exhibit 195: SAIL is trading at 0.7x 1-yr forward book value

against historical average of 1.6x


-

2

4

6

8

10

12


-

0.5

1.0

1.5

2.0

2.5

3.0

3.5


2

4

6

8

10

12

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

-

2

4

6

8

10

12

14

Apr-03 Apr-05 Apr-07 Apr-09 Apr-11 Apr-13

-

1

2

3

4

5


Equity Strategy

India

19 May 2014



Exhibit 196:Coal India is trading at 8.6x 1-yr rolling



Exhibit 197: Coal India is trading at 5x 1-yr forward book



Exhibit 198:NMDC is trading at 5.4x 1-yr rolling EV/EBITDA

multiple against historical average of 6.3x


Exhibit 199: NMDC is trading at 2.1x 1-yr forward book



4

6

8

10

12

14

Nov-10 May-11 Nov-11 May-12 Nov-12 May-13 Nov-13 May-14

2

3

4

5

6

7

Nov-10 May-11 Nov-11 May-12 Nov-12 May-13 Nov-13 May-14

2

4

6

8

10

12

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14

1

2

3

4

5

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14

Equity Strategy

India

19 May 2014



Cement Sector: Demand Outlook Improves Our concerns on the sector stem from the lack of pricing power due to weak

demand growth and low capacity utilisation. While the BJP-led government

raises the possibility of a demand revival as the infrastructure and housing

related spending picks up, persisting low utilisation levels in the mid-70s

would restrict the gains. With the sharp rally in cement stocks YTD, we

believe most of the upside is already factored. Maintain our cautious view on

the sector.

A strong election result creates possibility of a volume recovery in FY16E: On

the back of the positive outcome in the general elections, we now expect GDP growth to

accelerate to 5.5% in FY15E and 6.5% in FY16E and consequently also revise our cement

volumes growth assumption higher to 7% (6% earlier) in FY15E and 10% (8% earlier) in

FY16E. As a result, we have revised our volume growth assumptions for the stocks under

our coverage. However, we still continue to build the volume growth for the larger

cement companies to be lower than the industry volume growth (as has been seen over

the last 2 years) as the larger players have to sacrifice some volumes in order to maintain

the production discipline in the industry. Consequently, against an industry volume

growth of 7% in FY15E we are building a 5-6% growth for our coverage stocks and

against 10% industry growth in FY16E we are building in a 7-9% volume growth for the

coverage stocks.

60mn tonnes of capacity addition to restrict the gains: Cement industry has seen

large capacity additions over the last 5 years which has pushed the effective utilization

from a peak to 103% to multi-year lows of 73% in FY14E. Consequently, earnings and

EBITDA/MT for the sector has taken a beating as the industry lost its pricing power.

Average EBITDA/MT dropped to Rs600/MT in FY14 from over Rs1000/MT in FY07 which

coupled with the increase in the cost of setting up new capacities (US$120-140/MT today)

has led to a sharp fall in the RoEs. Cement companies need to be making an EBITDA/MT of

in excess of Rs1500/MT for new capacity additions to earn a 12% cost of capital. However,

with the overcapacity situation expected to persist (75% utilization levels expected in

FY15E), the ability of cement companies to pass on the cost inflation has been limited.

Therefore while a sharp improvement in volume growth will definitely help cement

companies take on some price hikes, we do not expect cement companies profitability to

near the 12% cost of capital (based on replacement cost) anytime soon.

Recent outperformance means stocks are fairly valued: The cement stocks have

seen a sharp rally in 2014YTD (up by 20-40% YTD) and have outperformed the Sensex

(up 13% YTD). Cement stocks are currently trading at a significantly higher 1-year forward

EV/ EBITDA multiple when compared to the historic average. Given that we are possibly

coming out of a downcycle and consequently the earnings of cement companies are

depressed, there could be an argument for the stocks to trade at higher than average

multiples. However, both on a current multiple and on FY16E numbers, the stocks are

trading more than +1 std deviation away from the historical averages, which we believe

leaves little room for further upside. Consequently, while we like the sector over the long-

term, we maintain our cautious stance on the sector given the current high valuations and

would rather wait for a correction in valuations before entering the sector.

Equity Strategy

India

19 May 2014



A strong election result creates possibility of a volume recovery in FY16E…

The Cement sector has been struggling for the last two years due to the twin problems of

weak demand and low capacity utilization on the back of continuing capacity additions.

Cement demand in FY14 is estimated to have grown by only 3% YoY as infrastructure

related spending came to a near halt due to the policy paralysis at the Centre and rural

demand also taking a breather on the back of a high persistent inflationary environment.

With Industry utilization levels dropping to 73% in FY14, cement companies lost all

pricing power leading to c30% decline in EBITDA/MT and 19-30% fall in FY14 earnings.

However, the decisive mandate received by the BJP led NDA party in the general elections

yesterday has created the possibility of an economic revival. BJP, in its 2014 election

manifesto, has stated its intention of kick-starting the economic growth by focusing on

infrastructure creation and building 100 new ‘Smart Cities’. As highlighted in our recent

note ‚What Next? No. 6 Smart Cities‛ published on 6th May 2014, this creation of 100 new

smart cities could trigger a US$2 trillion investment opportunity which by itself could add

~1-1.5% to the GDP growth over the next 30 years. On the back of the positive outcome

in the general elections, we now expect GDP growth to accelerate to 5.5% in FY15E and

6.5% in FY16E and consequently also revise our cement volumes growth assumption

higher to 7% (6% earlier) in FY15E and 10% (8% earlier) in FY16E.

Exhibit 200: Cement industry growth set to pick up from

FY15…

Source: Jefferies Estimates

Exhibit 201: …with an improvement in GDP growth


As a result, we have revised our volume growth assumptions for the stocks under our

coverage. However, we still continue to build the volume growth for the larger cement

companies to be lower than the industry volume growth (as has been seen over the last 2

years) as the larger players have to sacrifice some volumes in order to maintain the

production discipline in the industry. Consequently, against an industry volume growth

of 7% in FY15E we are building a 5-6% growth for our coverage stocks and against 10%

industry growth in FY16E we are building in a 7-9% volume growth for the coverage

stocks.

Exhibit 202: Changes to volume and realization assumptions

Volume (mn MT) Realisation (Rs/MT)

CY2014E/FY2015E CY2015E/FY2016E CY2014E/FY2015E CY2015E/FY2016E

Name Old New % YoY Old New % YoY Old New % YoY Old New % YoY

ACC 24.6 24.7 5 26.2 26.4 7 4,841 4,840 6 5,067 5,122 6

Ambuja 22.0 22.1 5 23.2 23.6 7 4,489 4,516 7 4,708 4,793 6

Ultratech 43.2 43.8 6 46.1 47.7 9 5,020 5,028 7 5,277 5,326 6

India Cements 10.6 10.7 6 11.3 11.4 7 4,802 4,808 6 5,035 5,096 6 Source: Jefferies estimates

8 8 8

15

(2)

10 9

6

8

10 10 10

9

12

6

8

6

3.0

7.0

10.0

-4

0

4

8

12

16


Industry growth rate (%) Historical cagr (%)

0%

4%

8%

12%

16%

FY99 FY01 FY03 FY05 FY07 FY09 FY11 FY13 FY15E

3-yr rolling GDP growth 3-yr rolling cement demand growth

Equity Strategy

India

19 May 2014



…~60mn tonnes of capacity addition to restrict the gains

Cement industry has seen large capacity additions over the last 5 years which has pushed

the effective utilization from a peak to 103% to multi-year lows of 73% in FY14E.

Consequently, earnings and EBITDA/MT for the sector has taken a beating as the industry

lost its pricing power. Average EBITDA/MT dropped to Rs600/MT in FY14 from over

Rs1000/MT in FY07 which coupled with the increase in the cost of setting up new

capacities (US$120-140/MT today) has led to a sharp fall in the RoEs. Cement companies

need to be making an EBITDA/MT of in excess of Rs1500/MT for new capacity additions to

earn a 12% cost of capital. However, with the overcapacity situation expected to persist

(75% utilization levels expected in FY15E), the ability of cement companies to pass on the

cost inflation has been limited.

Cement players have resorted to production discipline from time to time in order to earn

some economic returns but the same has been fraught with frequent disruptions due to

the different financial needs of various players. Therefore while a sharp improvement in

volume growth will definitely help cement companies take on some price hikes, we do

not expect cement companies profitability to near the 12% cost of capital (based on

replacement cost) anytime soon.

Exhibit 203: Over capacity situation is expected to continue

for some more time


Exhibit 204: …which will keep margins under pressure

(EBITDA/tn for ACC + ACEM + ICEM)


As a result of our changes to volume growth and pricing assumptions, our FY16E earnings

estimates have increased by 8-10% for ACC, ACEM, UTCEM and Grasim and by 30% for

ICEM (due to its higher operating and financial leverage). Earnings are expected to grow

19% and 14% in CY14 and CY15 respectively for ACC. For Ambuja they are expected to

increase 18% and 19% for CY14 and CY15 respectively. Ultratech will see it’s FY14 and

FY15 earnings grow by 23% and 32% respectively.

Exhibit 205: Earnings Estimate Changes

EBITDA (Rs mn) EPS (Rs)

CY2014E/FY2015E CY2015E/FY2016E CY2014E/FY2015E CY2015E/FY2016E

Name Old New % Chng Old New % Chng Old New % Chng Old New % Chng

ACC 17,649 17,735 0 21,128 22,738 8 69.1 69.5 1 72.6 79.0 9

Ambuja 20,399 21,129 4 25,084 27,423 9 9.5 9.8 4 10.6 11.7 10

Ultratech 44,866 46,040 3 54,084 58,523 8 93.7 96.4 3 115.4 126.8 10

India Cements 8,040 8,378 4 9,844 10,852 10 3.8 4.5 19 7.5 9.8 30

Grasim 56,280 57,451 2 69,736 74,575 7 254.9 260.8 2 317.4 342.3 8


100 103 103

100

95

84

79

76 73 73

75

60

70

80

90

100

110

FY06 FY08 FY10 FY12 FY14E FY16E

0

200

400

600

800

1,000

1,200

FY94 FY97 FY00 FY03 FY06 FY09 FY12 FY15E

Equity Strategy

India

19 May 2014





ACC Limited HOLD HOLD 1,400 1,254 Increasing target premium from -15% to -5%

Ambuja HOLD HOLD 218 203 Increasing target premium from 15% to 25%

Grasim BUY BUY 3,532 3,196

India Cements HOLD HOLD 76 53 Increasing target premium from -55% to -50%

Ultratech HOLD HOLD 2,346 2,186 Increasing target premium from 15% to 25%

Source: Jefferies

We are 12-14% ahead of consensus for FY16E

Our estimates for FY16E are now 11-14% ahead of consensus estimates for ACC, ACEM

Grasim and Ultratech and 35% ahead of consensus for ICEM.


CY14E/FY15E CY15E/FY16E


Ambuja 21,129 20,617 2 27,423 24,966 10

ACC 17,735 17,364 2 22,738 21,709 5

Ultratech 46,040 47,206 (2) 58,523 56,593 3

India Cements 8,378 7,669 9 10,852 9,048 20

Grasim 57,451 58,950 (3) 74,575 70,965 5

EPS (Rs.)

Ambuja 9.2 8.6 7 11.7 10.2 14

ACC 63.5 57.5 10 79.0 70.5 12

Ultratech 96.4 91.2 6 126.8 110.9 14

India Cements 4.5 4.1 10 9.8 7.2 35

Grasim 260.8 253.7 3 342.3 307.1 11


Recent outperformance means stocks are fairly valued

While the cement stocks have seen a sharp rally in 2014YTD (up by 20-40% YTD) and

have outperformed the Sensex (up 13% YTD), the earnings have failed to keep pace

thereby pushing up the valuations for the sector which implies that most of the potential

positive from the general elections is already factored in.

Exhibit 208: Most cement stocks have underperformed

the market in the last 12 months

Source: Bloomberg, company data, Jefferies estimates

Exhibit 209: But YTD the stocks have outperformed…


Cement stocks are currently trading at a significantly higher 1-year forward EV/EBITDA

multiple when compared to the historic average. Given that we are possibly coming out

of a downcycle and consequently the earnings of cement companies are depressed, there

could be an argument for the stocks to trade at higher than average multiples. However,

both on a current multiple and on FY16E numbers, the stocks are trading more than +1

std deviation away from the historic averages, which we believe leaves little room for

further upside. Consequently, while we like the sector over the long-term, we maintain

-20 -10 0 10 20 30 40 50

ICEM

MC

GRASIM

ACC

UTCEM

SENSEX

ACEM

SRCM

0 5 10 15 20 25 30 35 40 45

GRASIM

SENSEX

ACEM

MC

ACC

UTCEM

ICEM

SRCM

Equity Strategy

India

19 May 2014



our cautious stance on the sector given the current high valuations and would rather wait

for a correction in valuations before entering the sector.

Exhibit 210: 1 yr fwd EV/EBITDA comparison

Current Average +1std dev -1std dev FY15EV/EBIDTA FY16EV/EBIDTA

ACC 12.5 9.8 13.3 6.3 14.2 11.1

Ambuja 13.1 9.4 12.3 6.4 14.5 11.2

Ultratech 13.9 7.8 10.9 4.7 13.8 10.8

ICEM 6.1 10.6 20.4 0.7 6.6 5.1


Exhibit 211: Valuation Summary

Rating PT Price MCap EV EV/ MT EPS (Rs) P/E(x) EV/EBITDA (x) P/BV(x)

$mn $mn US $ FY14E FY15E FY14E FY15E FY14E FY15E FY14E FY15E

ACC Ltd Hold 1,400 1,430 4,560 4,189 140 47 57 31 25 18 14 3.4 3.2

Ambuja Hold 218 224 5,893 5,210 186 6 9 36 26 20 15 3.7 3.4

Grasim Buy 3,532 3,069 4,785 5,459 n.a. 212 254 14 12 7 5 1.3 1.2

Ultratech Hold 2,346 2,334 10,871 10,862 186 78 91 30 26 18 14 3.7 3.3

India Cements Hold 76 80 418 954 68 1 4 90 19 9 7 0.6 0.6

Shree Cements NC NC 6,200 3,668 3,462 239 278 356 22 17 12 9 4.0 3.3

Ramco Cement NC NC 240 970 1,414 113 6 12 40 21 13 10 2.3 2.1

Mangalam NC NC 143 65 61 31 18 34 8 4 3 2 0.7 NA

Dalmia Cement NC NC 259 357 878 73 14 28 18 9 8 6 0.7 0.7

Orissa Cement NC NC 182 176 287 43 20 24 9 8 3 4 0.7 NA

Birla Corp NC NC 315 412 361 39 17 28 19 11 8 6 1.0 0.9

JK Cements NC NC 254 302 460 62 7 17 34 15 9 5 1.1 1.0

Century NC NC 419 662 1,475 173 4 16 105 26 10 8 1.7 NA

Heidelberg NC NC 47 181 336 56 (2) 1 n.m 45 17 8 1.3 1.2

JK Lakshmi NC NC 132 264 425 80 7 10 19 14 9 6 1.2 1.1

Sagar Cement NC NC 182 56 90 22 12 14 15 13 11 7 1.1 NA

Kesoram NC NC 66 122 918 127 NA NA NA NA NA NA NA NA

Prism Cement NC NC 55 468 769 137 (4) (1) n.m n.m 26 11 NA NA

Source: Bloomberg; Price as of 16th May 2014

Valuation and key risks

ACC: We maintain Hold on ACC and value it at 5% discount to replacement cost to arrive

at revised TP of Rs1400 (Rs1254 earlier). Risks: negative surprise in cement prices and

cement volumes.

Ambuja: We maintain Hold on ACEM and value it at 25% premium to replacement cost

to arrive at revised TP of Rs218 (Rs203 earlier). Key downside risks are subdued demand

growth and negative surprises in prices. Key upside risks are better than expected demand

and pricing.

Ultratech: We maintain Hold on Ultratech and value it at 25% premium to replacement

cost to arrive at revised TP of Rs2,346 (Rs2,186 earlier). Key downside risks to our

estimates and price target are: 1) subdued demand growth; 2) negative surprises in

prices; and 3) adverse impact on the industry long-term profitability on account of the

negative CCI order on cartelization. Key upside risks are 1) better than expected demand

and 2) better than expected pricing.

India Cements: We maintain Hold on ICEM and value it at 50% discount to replacement

cost to arrive at revised TP of Rs76 (Rs53 earlier). Key downside risks are: 1) subdued

demand growth; 2) negative surprises in prices; 3) inability to pass on the unexpected

cost increases.

Grasim: We maintain our Buy rating with a revised PT of Rs3,532 (Rs3,196 earlier) based

on 6x EV/EBITDA to VSF business, 5x multiple to chem business. Risks: 1) negative surprise

in cement and VSF prices, 2) inability to pass on unexpected cost pressures, and 3) delays

in commissioning of new plants.

Equity Strategy

India

19 May 2014



Valuation charts

EV/tonne vs. Replacement cost valuations

Exhibit 212: ACC is trading at US$127/tonne against

historical average of US$98/tonne


Exhibit 213: Ambuja is trading at US$173/tonne against



Exhibit 214:UTCEM is trading at US$167/tonne against



Exhibit 215: ICEM is trading at US$58/tonne against



-

50

100

150

200

250

300

Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11 Jan-14

ACC (EV/fwd t)

-

50

100

150

200

250

300


Ambuja (EV/fwd t)

30

60

90

120

150

180

210

Aug-04 Aug-06 Aug-08 Aug-10 Aug-12

Ultratech (EV/tonne)

-

50

100

150

200

250


ICEM (EV/tonne)

Equity Strategy

India

19 May 2014



1-year forward P/E multiples

Exhibit 216: ACC is trading at 20.7x 1-yr rolling P/E

multiple against historical avg of 23x (last 10-yr avg

14.8x)


Exhibit 217: Ambuja is trading at 22.1x 1-yr rolling P/E

multiple against historical avg of 15x


Exhibit 218: UTCEM is trading at 23.3x 1-yr rolling P/E

multiple against historical avg of 13.6x


Exhibit 219: ICEM is trading at 14.3x 1-yr rolling P/E

multiple against historical avg of 10.2x


5

10

15

20

25

30


5

10

15

20

25

30

35

Jun-95 Jun-98 Jun-01 Jun-04 Jun-07 Jun-10 Jun-13

0

5

10

15

20

25

30

0

100

200

300

400


Price 6x 9x 12x 15x

Equity Strategy

India

19 May 2014



1-year forward EV/EBITDA multiples

Exhibit 220: ACC is trading at 12.5x 1-yr rolling

EV/EBITDA multiple against historical avg of 11.2x (last

10-yr avg 9.8x)


Exhibit 221: Ambuja is trading at 13.1x 1-yr rolling

EV/EBITDA multiple against historical avg of 9.4x


Exhibit 222: UTCEM is trading at 13.9x 1-yr rolling



Exhibit 223: ICEM is trading at 6.1x 1-yr rolling



3

6

9

12

15

18


0

4

8

12

16

20

Jun-95 Jun-98 Jun-01 Jun-04 Jun-07 Jun-10 Jun-13

2

4

6

8

10

12

14

16

0

20

40

60

80

100

120


EV 3x 5x 7x 9x

Equity Strategy

India

19 May 2014



Pharma – Prefer India Focus Over US Post a strong US driven FY14 we expect growth drivers to shift to EM as lack of

significant launches, increased competition and currency appreciation

impact US business. Election results are, in our view, negative for US business

and positive for domestic business. We expect India business growth to revive

going forward. Our preference remains for Cipla on its EM driven growth and

turnaround in business.

US business growth to decline after strong FY14 - FY14 saw strong growth in US

business revenues and margins for most companies led by launch of limited competition

products. FY15 though would see muted growth and margins come under pressure for

most US focused companies, in our view. There are no significant launches in FY15 for

most of our coverage; and with increased competition in key products (Tricor, Trilipix,

Cymbalta, Doxil, Dacogen, Vidaza), margins and revenues would come under pressure.

Lupin is the most at risk, in our view.

EM and India growth to improve - We expect the focus on EM including India to

increase as growth revives in these markets. India growth would, in our view, revive in

FY15 led by both economic recovery and also as the impact of the pricing policy is in the

numbers. The benefit would be more for large cap companies with presence in acute

therapy and rural/semi-urban areas. These areas were the most impacted in the past year.

Further, if the new government initiates any large scale projects to increase healthcare

coverage in rural areas it would boost growth over the medium term. The key beneficiary

would be Cipla, Ranbaxy, in our view, given their presence in these areas.

Rising R&D to pressure margins; benefits uncertain - R&D expenses are increasing

across the sector with R&D as % of sales breaching 10% for DRRD and LPC. This is one of

the highest R&D spend among global generic peers. The R&D spend is expected to

remain elevated over the medium term, which would pressure margins. More importantly

the increased investment for DRRD and Lupin is in biosimilars or NCEs where risks are high

and returns would accrue only in the long term. Further, Lupin is playing catch-up to

Indian and global peers in all of its targeted therapies, which could limit benefits.

Election impact marginally negative for the sector - The 2014 election results are

marginally negative for the pharma sector, in our view. Given the decisive mandate,

currency could appreciate from current levels creating headwinds for the US business,

which would pressure margins and reported sales growth. The results though could be a

positive for the domestic business if the new government announces any reforms

especially those aimed towards increasing healthcare coverage. The reforms would be

beneficial for companies with significant presence in semi-urban and rural areas. Cipla

and Ranbaxy could be the beneficiary, in our view.

Prefer companies with India and EM focused as US growth slows - Going

forward, we prefer companies with India and EM focus given the expected slowdown in

US, currency appreciation and revival in domestic growth. Any reform announcement on

boosting healthcare access would provide boost to domestic focused company especially

Cipla. Our preferred pick remains Cipla while we are most cautious on Lupin given the

valuations

Exhibit 224: Valuations Table

P/E P/B

Price TP Rating FY14 FY15E FY16E FY14E FY15E

Sun Pharma 614 715 Buy 22.6 21.9 18.3 7.3 5.8

Cipla 388 477 Buy 21.6 18.2 14.6 3.0 2.7

Dr Reddy 2,407 2550 Hold 18.9 18.2 16.3 4.5 3.7

Lupin 959 880 Hold 23.4 22.4 20.0 6.2 5.0

Ranbaxy 452 572 Buy 217.3 81.7 26.2 5.9 4.3

Source: Company Data, Jefferies estimates

Equity Strategy

India

19 May 2014



Exhibit 225: FY14 saw launch of large number of limited

competition generics boosting growth

Source: USFDA, Jefferies estimates

Exhibit 226: Going forward though US growth to see sharp

deceleration even as EM growth remains strong


Exhibit 227: R&D spend is expected to see sharp

acceleration going forward impacting margins


Exhibit 228: R&D spend for Lupin/DRRD the highest among

peers


Exhibit 229: Valuations are at historical average


Exhibit 230: ...both PE and PB


0

5

10

15

20

25

30

35

40

0

5

10

15

20

25

30

FY10 FY11 FY12 FY13 FY14

Limited competition approval for Indian companies Share (%) - rhs

0

10

20

30

40

50

US EM

Earnings growth FY12-14 CAGR (%)

Earnings growth FY14-16 CAGR (%)

5.0

5.5

6.0

6.5

7.0

7.5

8.0

FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E

R&D as % of sales

0

2

4

6

8

10

12

Hikma Valeant RBXY CIPLA SUNP TEVA MYLAN LPC DRRD

R&D spend (as % of sales)

10

12

14

16

18

20

22

24

26

28

30


Pharma 12M Fwd PE Avg.

2

3

4

5

6

7

8


Pharma 12M Trailing PB Avg.

Equity Strategy

India

19 May 2014



Earnings change

Post the election, we have made some changes to our macro assumptions. We have

changed our currency assumption of USDINR to 60/$. We have increased domestic

growth in FY16/FY17 to 16%. We have reduced risk premium to 4.5% from 5.5% earlier.

Exhibit 231: Cipla earnings changes

FY15 FY16

Old New Old New

Assumptions Currency @ 60; India growth improves to 17% vs 16% in FY16

Sales 123,579 120,761 143,636 140,669

EBITDA 28,715 27,208 34,317 32,673

PAT 18,284 17,154 22,579 21,341

EPS 22.8 21.4 28.1 26.6

TP 480 477


Exhibit 232: Dr Reddy’s earnings changes

FY15 FY16

Old New Old New

Assumptions Currency @ 60; FY16 India growth improved to 16% vs 14.9%

Sales 148,417 148,417 166,353 166,564

EBITDA 32,854 32,854 36,716 36,823

PAT 22,520 22,520 25,066 25,149

EPS 132 132 147 148

TP 2,500 2,550


Exhibit 233: Lupin earnings changes

FY15 FY16

Old New Old New

Assumptions Currency to 60; India growth at 16% vs 15% earlier

Sales 135,108 131,484 154,972 150,199

EBITDA 33,013 31,226 36,935 34,469

PAT 20,363 19,157 23,197 21,535

EPS 45.4 42.7 51.7 48.0

TP 910 880


Exhibit 234: Sun Pharma earnings changes

FY15 FY16

Old New Old New

Assumptions Currency @ 60; Added Gleevec exclusivity

Sales 184,499 178,224 203,237 204,702

EBITDA 79,521 76,177 84,031 86,967

PAT 60,447 57,894 66,721 69,371

EPS 29 28 32 33

TP 710 715


Exhibit 235: Ranbaxy earnings changes

FY15 FY16

Old New Old New

Assumptions Currency @ 60; India growth improves to 16.2% vs 15%

Sales 148,992 143,147 149,080 143,719

EBITDA 25,740 23,446 23,788 21,799

PAT 14,104 12,381 13,041 11,597

EPS 33 29 30 27

Core EPS 8 6 20 17

TP 568 572


Equity Strategy

India

19 May 2014



Consumer Sector – Trend Reversal We believe the consumption cycle is in the incipient stages of a slowdown.

The policy-driven redistribution of wealth redistribution, which has bolstered

low end consumption in recent years, is behind us. Discretionary

consumption, on the other hand, is showing signs of bottoming out. With the

new government in place, investment-driven policies are likely to take centre

stage, enhancing the reversal in consumption pattern that has already set in.

Reversal of trends: Lower end consumer demand has been extremely strong through

the last five years while consumption by the middle-income group has slowed down. An

extended period of largely policy-driven wealth redistribution from the middle income

group to net food producers and to rural & urban laborers has played a key role. Income

growth for the middle class in the last three years has probably lagged inflation in cost of

living. We believe this pattern of consumption growth is unsustainable. We are already

seeing signs of these trends reversing with rural wage inflation in real terms starting to

fade.

Discretionary bottoming out, Staples at risk: Staples segments have been the

biggest beneficiaries of the pattern of consumption so far, as can be seen in the

tremendous growth in sales of consumer staples companies over the last few years. The

inflationary environment in the past few years has also equipped consumer staples

companies with considerable pricing power. On the other hand, most discretionary items

across categories have slowed to varying degrees. In recent months, however, we are

beginning to see these trends reversing. Management commentary across consumer

companies indicates a significant slowdown in rural demand, while discretionary

consumption is showing signs of bottoming out.

Valuations and stock views: Although valuations in consumer staples, relative to the

market have come off in recent months, the premium (~100%) is still well above the levels

seen during the 2005-2007 period (0-20%) as well as long term historical average

(~60%). Given our expectation of subdued earnings momentum, we see further

downside risk to valuations. Within the sector, we prefer discretionary stocks that provide

greater scope for positive earnings surprises. Titan (TTAN IN, Buy) remains our top pick in

the discretionary space. We upgrade TTK Prestige (TTKPT IN, Hold) where early signs of

demand revival are visible, but the path to earnings recovery is likely to be slow. ITC (ITC

IN, Buy) is our top pick in the staples segment

Exhibit 236: Summary table of stock recommendations

Price TP Mkt Cap EPS P/E

Company Rating Rs./share Rs./share Rs. Bn FY15E FY16E FY15E FY16E

ITC Buy 357 411 2,790 12.6 14.5 28.3 24.6

HUL Hold 581 595 1,255 18.0 19.8 32.3 29.3

Asian Paints UNPF 536 476 514 15.8 19.8 34.0 27.0

Titan Buy 307 355 273 9.9 12.7 31.1 24.2

GCPL UNPF 833 662 283 25.4 31.0 32.8 26.9

Marico Hold 228 225 147 8.3 10.2 27.5 22.4

Jubilant FoodWorks Hold 1161 1,202 76 28.6 38.7 40.6 30.0

TTK Prestige Hold 3,200 3,393 37 110.8 137.9 28.9 23.2


Equity Strategy

India

19 May 2014



Consumer Sector

We believe the consumption cycle is in the incipient stages of a slowdown. An extended

period of mostly policy-driven wealth redistribution from the middle income group to net

food producers and to rural & urban labourers, has led to extremely strong growth in

consumption, especially at the lower end. On the other hand, discretionary consumption

across categories has suffered to varying degrees in recent years. We believe this pattern

of consumption is set to reverse. We are already witnessing signs of reversal, with rural

wage inflation in real terms starting to fade. Management commentary across consumer

companies also indicates a significant slowdown in rural demand. With the new

government in place, investment-driven policies are likely to take centre stage, enhancing

the change in consumption pattern that has already set in.

Reversal of trends

The biggest improvement in prospects for rural labourers occurred in 2006, when the

government started a rural employment guarantee scheme (NREGA), even as

employment opportunities in alternate sectors like construction slowed down. In

addition, farmers’ relative terms of trade have improved significantly in the last few years.

Food price inflation has offset ex-food inflation, implying higher profitability for farmers in

general. The urban middle class, on the other hand, has seen unfavourable terms of trade.

Inflation (food and labour) was tolerable until such time that overall growth in the

economy was strong. However, with the recent slowdown, this has no longer been the

case. It is quite likely that income growth for the middle class in the last three years has

lagged inflation in cost of living.

As a result, lower end consumer demand has been very strong through the last five years

while consumption by the middle-income group has slowed down. The high wage

growth for the lower income group has also resulted in consistently high food inflation.

We believe this pattern of consumption growth is unsustainable, and are already seeing

signs of these trends reversing.

Exhibit 237: Rural wage growth has been strong in recent

years

Source: CSO, Company data, Jefferies

Exhibit 238: …and has likely outpaced corporate wages in

real terms

Note: TCS salary growth is used as proxy of Corporate wage growth; Source: CSO, Company data, Jefferies

0.0

5.0

10.0

15.0

20.0

25.0

FY08 FY09 FY10 FY11 FY12 FY13 FY14 YTD

Rural Wage growth (%) Real Rural wage growth (%)

(4)

(2)

0

2

4

6

8

Corporate employee Rural labor

FY09-13 Real Wage CAGR(%)

Rural labourers and farmers have

benefited in recent years, while

urban middle class has had to bear

the higher cost of labour and food

The policy-driven redistribution of

wealth redistribution, which has

bolstered low end consumption in

recent years, is behind us.

Equity Strategy

India

19 May 2014



Exhibit 239: Split of consumption in rural...

Source: NSSO

Exhibit 240: ...and urban

Source: NSSO

Discretionary bottoming out, Staples at risk

Staples segments have been the biggest beneficiaries of the pattern of consumption so

far, as can be seen in the tremendous growth in sales of consumer staples companies over

the last few years. On the other hand, most discretionary items across categories have

slowed to varying degrees. In recent months, however, we are beginning to see these

trends reversing. Management commentary across consumer companies indicates a

significant slowdown in rural demand, while discretionary consumption is showing signs

of bottoming out. We expect the slowdown in low end consumption to deepen through

the year, and expect discretionary items to revive as and when the investment cycle

improves.

Exhibit 241: Growth rates across segments


0%

10%

20%

30%

40%

50%

60%

70%

Income levels

Food & HPC

Others

0%

10%

20%

30%

40%

50%

60%

70%

80%

Income levels

Food & HPC

Others

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Staples

Cons. Durables

Paints/Chemicals

Retail

QSR

5-yr CAGR FY14E

Management commentary across

consumer companies indicates a

significant slowdown in rural

demand, while discretionary

consumption is showing signs of

bottoming out

Equity Strategy

India

19 May 2014



Exhibit 242: Growth trends in the FMCG sector


Exhibit 243: Recent growth trend in staples – relatively

resilient


Exhibit 244: SSSG trends in retail businesses – signs of

bottoming out


Pricing power and margins at risk

Gross margins in the FMCG sector have been fairly strong all through the period of slow

demand so far. The inflationary environment in the past few years has also equipped

consumer staples companies with considerable pricing power. As a result, most consumer

companies managed to hold onto margin gains, despite an increase in ad spends and

weakening premiumisation trend. We believe pricing power is at risk in the face of a

prolonged slowdown and rising input costs.

0%

5%

10%

15%

20%

25%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

0%

4%

8%

12%

16%

20%

2Q12 4Q12 2Q13 4Q13 2Q14 4Q14

-20%

-10%

0%

10%

20%

30%

40%

2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14

Titan - Watches Titan - Jewellery Shoppers

Pricing power could be at risk in the

face of a prolonged slowdown

Equity Strategy

India

19 May 2014



Exhibit 245: EBITDA margins in staples companies have

remained strong…


Exhibit 246:...even though ad spends have risen


Valuations and stock views

Valuations in the consumer sector continue to be expensive relative to historical levels.

While valuations on a relative basis have come off in recent months, the premium is still

well above historical average. Given our expectation of subdued earnings momentum in

the staples sector, we see further downside to valuations. Our preference for discretionary

stocks is premised on the stage of consumption cycle (early stages of revival), providing

greater scope for positive earnings surprises.

Exhibit 247: Valuations in the staples sector


10%

12%

14%

16%

18%

20%

22%


6%

7%

8%

9%

10%

11%

12%

13%

14%

15%


20 22 24 26 28 30 32 34 36

Nestle

Colgate

HUL

GSK

Dabur

GCPL

ITC

Marico

Emami

5-yr avg Current P/E

Current valuations for most staples

companies is significantly above last

5-year averages

Equity Strategy

India

19 May 2014



Exhibit 248: Valuation premium of the staples sector relative to MSCI India

Source: Factset

Exhibit 249: Valuations for retail companies


Exhibit 250: Valuations in paints/chemicals segment


-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Aug-03 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13

Premium Avg

15 25 35 45 55 65 75

Shoppers*

JUBI*

Bata

Titan


15 20 25 30 35 40

Asian Paints

Berger

Pidilite

Kansai

Akzo


Valuation premium to market has

come off in recent months, but still

remains considerably higher than

historical average

Valuations for discretionary

companies are also fairly high, but

the early stages of revival provide

scope for positive earnings surprises

Equity Strategy

India

19 May 2014



Exhibit 251: Valuations in consumer durables


Titan (TTAN IN, Rs307, Buy, TP Rs355)

We remain positive on Titan as we believe the worst of demand weakness and regulatory

action may be behind us. Jewellery demand has been much below trend for nearly two

years now, impacted by general weakness in demand as well as an adverse regulatory

environment. Titan’s revenues grew c.11% p.a. during FY13-14, much below the 20-35%

p.a. growth in the 3-5 years prior to that. We believe Titan’s key segments should recover

some time in the next 12 months, aided in part by gradual easing of regulatory measures.

Meanwhile, the company’s efforts on retail expansion continue at a strong pace (c.14-

15% p.a.), which should help Titan gain market share. We forecast Titan’s revenues and

earnings to grow 20-23% p.a. over FY15E-16E, but believe the risk to this assumption is

on the upside given the growth potential in the industry. We raise our earnings 6-9% on

the back of stronger-than-expected performance in 4Q14 and increase our medium term

growth assumptions. We roll forward our DCF-based TP and cut our COE assumption by

50bps. We now value Titan at Rs.355/share (28x FY16E EPS).

ITC (ITC IN, Rs357, Buy, TP Rs411)

In a demand environment that will likely remain weak especially for staples categories, we

expect ITC's retail sales growth also to be slow next year. However, despite the likelihood

of a third consecutive year of tax increases (we factor in 10% duty hike with 1.5% volume

growth), we believe ITC’s profits should remain resilient. The new small size cigarette

category has contributed meaningfully to this growth, in our view, and is likely to emerge

as a key driver for share gains from the illicit market in the medium term. We value ITC at

an SOTP-based TP of 411, based on 28x FY16E earnings for the cigarette business.

Exhibit 252: Changes to company earnings, target prices and stock views

New

Rating

Old

Rating

New TP Old TP Change FY15E EPS

(+/-)

FY16E EPS

(+/-)

Valuation

method

Change in valuation inputs

ITC IN Buy Buy 411 393 5% 0% 0% SOTP Roll over to FY16E

TTAN IN Buy Buy 355 257 38% 6% 9% DCF Roll over to FY16E, earnings raised, COE cut

TTKPT IN Hold U/P 3,393 2,991 13% -8% -9% DCF Roll over to FY16E, earnings cut, 50bps COE cut

JUBI IN Hold Hold 1,202 1,035 16% -6% -5% DCF Roll over to FY16E, earnings cut, 50bps COE cut

APNT IN U/P U/P 476 445 7% 0% 0% DCF 50bps cut in COE


10 12 14 16 18 20 22 24 26 28

TTK

Whirlpool

Bajaj Electricals

Havells


Equity Strategy

India

19 May 2014



Real Estate – Sentiment Change Round the Corner but Issues Persist The positive election results could provide the much needed sentiment

change for the sector but unaffordable property prices and elevated interest

rates would keep demand subdued until recovery becomes a full blown one.

Even then execution, churn and strong b/s will remain the key to success.

Sobha PEPL and Oberoi remain our top pick while DLF Is our top

Underperform.

A much needed sentiment change: Most developers (barring the Bangalore

developers) have reported a 20-30% decline in presales in FY14 as buyers have deferred

their decisions to purchase homes and the leasing in the commercial sector has remained

muted on the back of a slowing economic growth. Given the positive outcome in the

general elections and if GDP growth were to accelerate from hereon we could see a

pickup in both housing and commercial demand which could lead to a re-rating of the

sector.

Unaffordable property prices and elevated interest rates remain a dampener:

Both property prices and interest rates in India remain at elevated levels which have forced

end users to stay away. The ability of developers to cut prices is low given the high land

cost and rising construction costs while a persisting high inflation level is also making it

difficult for the RBI to cut interest rates anytime soon. The recovery therefore will depend

on the timing of when the economy grows and the positive cycle of job creation and

larger wage hikes starts to kick in followed by an eventual cut in interest rates. Unless that

happens the initial spurt driven by investors in expectation of price increases would be

difficult to sustain.

100 new ‘Smart Cities' in BJP's manifesto- A US$0.8 trillion opportunity: BJP,

has stated its intention of kick-starting the economic growth by focusing on infrastructure

creation. As highlighted in our recent note ‚What Next? No. 6 Smart Cities‛ published on

6th May 2014, the creation of 100 new smart cities could trigger a US$0.8 trillion

investment opportunity in the real estate sector through addition of c1.7mn household

units every year. To put it into context the annual absorption in the top seven cities in

India where most of the organised real estate development takes place is only ~0.3-0.4mn

units. However, given the large upfront investment required, only the developers with a

strong balance sheet and execution capability will be able to benefit from such an

opportunity.

Execution, churn and balance sheet management remain the key to success:

Execution capability has already become an important differentiating factor and could

become even more so especially as the economy grows and other sectors start vying for

the same pool of manpower for completing the projects. Developers which have little/ no

backlog of older projects and those with inhouse execution capability would be at an

advantage. Cash flows and churn would continue to remain important an important tool

for value creation from minority shareholders. Developers with a strong balance sheet

would also be in a position to benefit from the new opportunities that are likely to be

presented.

Sobha, PEPL and Oberoi remain our top pick: We like Sobha for its inhouse

execution capability, positive cashflows and growing presence in multiple cities and PEPL

for its faster churn, strong presales growth and growing rental income. We also like

Oberoi for its Mumbai city-centre landbank and strong b/s. DLF is our top UNPF as we

expect the company would need to raise equity to reduce debt given its ~Rs4bn quarterly

negative operating c/f generation and our dislike for its model of focusing on margins

rather than volumes.

Equity Strategy

India

19 May 2014




FY15E FY16E


DLF Limited 37,743 36,464 4 45,071 43,507 4

GPL 6,304 5,883 7 7,992 10,158 (21)

Oberoi Realty 8,763 8,054 9 12,359 11,644 6

Prestige Estates 9,952 9,506 5 12,801 11,634 10

Sobha Developers 7,176 7,335 (2) 8,355 8,576 (3)

EPS (Rs)

DLF Limited 6.8 6.4 6 9.8 9.2 7

GPL 16.1 15.1 7 20.2 17.8 13

Oberoi Realty 18.2 17.0 7 25.4 24.5 3

Prestige Estates 14.1 13.5 5 19.4 17.7 9

Sobha Developers 31.9 33.7 (5) 39.4 40.8 (3)




DLF Limited UNPF UNPF 140 125 Roll Forward to March 2015NAV

GPL HOLD HOLD 207 181 Roll Forward to March 2015NAV

Oberoi Realty* BUY BUY 258 258 -

Prestige Estates BUY BUY 217 199 Roll Forward to March 2015NAV

Sobha Developers BUY BUY 485 372 Roll Forward to March 2015NAV

Source: Jefferies *Target price for Oberoi Realty updated in our recent note dated 12th May, 2014

Exhibit 255: Most real estate stocks have underperformed

the market in the last 12 months


Exhibit 256: But YTD most of the stocks have

outperformed or performed in line with the market


(40)

(20)

0

20

40

60

(20)

0

20

40

60

Equity Strategy

India

19 May 2014



Exhibit 257: Valuation Summary

Rating PT Price MCap EPS (Rs) P/E(x) EPS Growth (%) P/B(x) RoE(%)

$mn FY14E FY15E FY14E FY15E FY14E FY15E FY14E FY15E FY14E FY15E

DLF UNPF 140 170 5,143 4 6 40 27 2 48 1.1 1.0 3 4

GPL Hold 207 219 743 9 12 25 19 (48) 36 2.3 2.0 10 11

Oberoi Realty Buy 258 225 1,258 9 17 24 13 (38) 79 1.7 1.5 7 12

Prestige Estates Buy 217 184 1,096 10 13 18 14 19 32 2.1 1.9 12 14

Sobha Buy 485 426 710 25 34 17 13 13 35 1.8 1.7 11 13

IBREL UNPF 52 78 564 8 10 9 8 126 22 0.4 0.4 5 6

Unitech Hold 33 19 863 1 1 22 16 (27) 37 0.4 0.4 2 3

HDIL Hold 53 84 598 5 12 18 7 172 154 0.3 0.3 3 5

Source: Bloomberg; Price as of 16th May 2014

Valuation Charts

Exhibit 258: DLF is trading at 23% discount to our NAV

against its historical average of 0.5% premium

Source: Bloomberg, Jefferies estimates

Exhibit 259: DLF is trading at 1.1x forward book against its

historical average of 1.8x forward book


Exhibit 260: GPL is trading at 17% discount to our NAV

against its historical average of 15% discount


Exhibit 261: GPL is trading at 1.8x forward book against its

historical average of 3.6x forward book


-60%

-40%

-20%

0%

20%

40%

60%

NAV (Disc)/Prem Average NAV (Disc)/Prem

0

1

2

3

4

Fwd P/BV Mean

-40%

-20%

0%

20%

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14


0

1

2

3

4

5

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14

Fwd P/BV Average fwd P/BV

Equity Strategy

India

19 May 2014



Exhibit 262: Oberoi is trading at 30% discount to our NAV



Exhibit 263:Oberoi is trading at 1.5x forward book against

its historical average of 1.9x forward book


Exhibit 264: Prestige is trading at 40% discount to our NAV



Exhibit 265:Prestige is trading at 1.8x forward book

against its historical average of 1.7x forward book


-60%

-50%

-40%

-30%

-20%

-10%

0%



1.0

1.5

2.0

2.5

3.0



-80%

-60%

-40%

-20%

0%



0

1

2

3

4



Equity Strategy

India

19 May 2014



Top Picks

Equity Strategy

India

19 May 2014



Axis Bank (AXSB IN, Buy) – Positive on Cyclical Recovery We believe an equitable balance sheet mix, strong CASA support and large

Tier 1 buffer are the stepping stones to the next level of profitability. Its

strong capability in project financing and any turnaround in capex cycle

make AXSB the ideal beta stock. Still, asset quality pressure is likely to remain

elevated but with high provision coverage ratio and a sizeable contingency

provision buffer, the risk to profitability emanating from asset quality is

mostly covered. Axis Bank is our top pick in the sector.

Balance sheet set for next stage of growth. AXSB has managed a decent

turnaround in its balance sheet with the share of retail assets and retail deposits rising

sharply to 32% of total loans and 75% of total deposits, respectively. Within retail assets,

the focus has moved to better yielding products and the share of mortgages has come off

to 63%. CASA ratio has improved to 45% on period end basis and 39% of daily average

basis, an improvement of 1% yoy. The balance sheet mix change is amply visible in the

composition of fees, where the share of retail fees has improved to 32%.

Asset quality to remain largely under control. AXSB guides for Rs65bn in total

impairments for FY15, following its guidance of Rs60bn for FY14, against which it

delivered Rs56.9bn, which we believe is extremely positive. Further, it has built a

contingency buffer of 34bps of loans, which should help reduce pressure on profitability.

Profitability and capital are big pluses. Profitability ratios are strong with RoA of

1.8% and RoE of 18.2% in FY14. AXSB is adequately capitalised with Tier 1 of 12.62%.

Branch expansion continues with 23% newer branches in FY14.

Estimate and PT changes. We have tweaked earnings estimates upwards for FY15 and

FY16 by 1.2%/1.6% respectively. This is primarily driven by a marginal improvement in

NIM (2-3bps) and a reduction in expense ratio (30/40bps). This translates to an EPS CAGR

of 23.5% over FY14-16. We have upped price target to Rs2,180 (from Rs1,800).

Valuation / Risks. We value AXSB using a blended equal weighted average of price-to-

book, price-to earnings and DCF. Our Cost of Equity assumption is based on 8% risk-free

rate and 4.5% risk premium and beta of 1.15. At our PT, the stock is valued at 2.4x

forward book and 14.1x forward earnings. This compares to last 5yr and 8yr averages of

2.0x/11.6x and 2.9x/16.8x respectively. Key risks: (1) Poor economic pickup, (2)

worsening asset quality

Exhibit 266: Financial Snapshot

Rs Bn FY11A FY12A FY13A FY14A FY15E FY16E

NII 66 80 97 120 138 169

Core PPOP 59 71 85 108 124 154

Net profit 34 42 52 62 73 95

Loans 1,424 1,698 1,970 2,301 2,780 3,445

Deposits 1,892 2,201 2,526 2,809 3,441 4,249

RoA 1.68% 1.68% 1.70% 1.78% 1.75% 1.86%

RoE 20.16% 21.22% 20.51% 18.23% 17.30% 19.19%

PE 21.5 17.2 14.8 13.3 11.3 8.7

PB 4.0 3.4 2.6 2.3 2.0 1.6


Equity Strategy

India

19 May 2014



Exhibit 267: Valuation methodology based on triangulation

Methodology Weight Valuation

Adj. book value (Q4FY15E) 927.0

P/BV multiple 1.69x

Value per share 1,570 33% 523

Earnings per share (12m to Q4FY15E) 154.8

P/E multiple 14.00x


DCF 2,813 33% 938

Blended value per share (rounded) 2,180


Exhibit 268: Loan book mix has improved

FY14A FY13A FY12A FY11A FY10A FY09A

Net advances 100% 100% 100% 100% 100% 100%

Agri 7.8% 7.5% 10.2% 12.2% 12.2% 10.1%

Industry 59.9% 65.1% 67.7% 68.3% 67.8% 70.2%

SME & MSME 15.4% 15.2% 14.0% 15.0% 17.5% 19.7%

Large & mid corp 44.4% 49.9% 53.6% 53.3% 50.3% 50.5%

Retail 32.4% 27.4% 22.1% 19.5% 20.0% 19.7%

Housing 20.4% 17.8% 16.6% 13.3% 14.1% 12.8%

Personal 2.6% 1.9% 1.3% 2.7% 1.9% 2.4%

Cards 0.6% 0.5% 0.4% 0.4% 0.4% 0.8%

Non-scheme 1.9% 1.4% 0.9% 1.0% 0.8% 1.0%

Auto Loans 3.9% 3.8% 2.9% 2.1% 2.7% 2.8%


Exhibit 269: Fee income composition – contribution from all verticals

FY14A FY13A FY12A FY11A FY10A

Fee income 100% 100% 100% 100% 100%

Large & mid corporate 30% 32% 36% 35% 30%

Treasury & debt capital market 22% 21% 20% 21% 19%

Agri & SME 7% 6% 6% 6% 8%

Business banking 8% 8% 9% 10% 13%

Capital market 1% 1% 1% 2% 2%

Retail business 32% 31% 27% 26% 29%


Exhibit 270: Liability profile has improved


19.9% 19.2% 22.9% 21.1% 22.8% 19.5% 18.1% 19.1% 17.3%

20.1% 20.6%22.8% 22.0%

24.0%21.6% 23.5% 25.2% 27.7%

25.1%17.1%

18.3% 19.9%19.0%

17.7%21.7%

23.6%30.0%

65.1%

57.0%

64.0% 63.0%65.7%

58.8%63.3%

67.9%

75.0%

FY06A FY07A FY08A FY09A FY10A FY11A FY12A FY13A FY14A

Demand Savings Retail TD CASA+Retail

Equity Strategy

India

19 May 2014



Exhibit 271: Corporate book rating


Exhibit 272: SME book rating


Exhibit 273: Impaired asset formation should slow


Exhibit 274: High provision coverage ratio


Exhibit 275: Profitability ratios improving


Exhibit 276: High Tier 1 capital


5% 10% 7% 8% 9% 11%

22% 18% 25% 19% 16% 15%

54% 47% 43%40%

37% 35%

16% 22% 23%30%

32% 30%

3% 3% 2% 3% 6% 9%


AAA AA A BBB <BBB or unrated

1% 2% 5% 5% 6% 7%12% 13%

18% 18% 16% 15%

64% 62%59% 57% 58% 58%

15% 13%11% 12% 12% 13%

8% 10% 7% 9% 8% 7%


SME 1 SME 2 SME 3 SME 4 SME 5 to 8

6.1%7.7%

4.9% 4.6% 4.2% 3.9%5.1% 4.6%

0.0%

7.0%

1.2%3.2%

5.2% 6.2%5.2%

1.0%

6.1%

14.7%

6.1%

7.8%

9.3%10.0% 10.3%

5.7%

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Slippages* Restructured assets* Stressed assets*

40%

50%

60%

70%

80%

90%

100%

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Provision coverage (ex. AUCA) Provision coverage (incl. AUCA)

15%

17%

19%

21%

23%

25%

27%

1.0%

1.1%

1.2%

1.3%

1.4%

1.5%

1.6%

1.7%

1.8%

1.9%

2.0%

FY0

5A

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

RoA RoE (RHS)

6%

8%

10%

12%

14%

16%

18%

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Tier 1* (%) CRAR* (%)

Equity Strategy

India

19 May 2014



Exhibit 277: Adjusted price-to-book (historical)

Source: Jefferies estimates, company data, Bloomberg

0.7x

2.1x

1.5x

2.7x

0

500

1,000

1,500

2,000

2,500

3,000

Mar-

06

Jul-

06

No

v-0

6

Mar-

07

Jul-

07

No

v-0

7

Mar-

08

Jul-

08

No

v-0

8

Mar-

09

Jul-

09

No

v-0

9

Mar-

10

Jul-

10

No

v-1

0

Mar-

11

Jul-

11

No

v-1

1

Mar-

12

Jul-

12

No

v-1

2

Mar-

13

Jul-

13

No

v-1

3

Mar-

14

Price Min Median - 1 sd Median Median + 1 sd

Equity Strategy

India

19 May 2014



Bank of Baroda (BOB IN, Buy) – Best within SOEs, governance change is positive BOB is the best in class within SOE banks, given its better Tier 1 position and

an ever better asset quality position, expense ratio management and

underlying profitability. More importantly, we view the probable change in

governance structure at SOE banks as positive. BOB is our top pick within the

SOE bank space.

Governance change optionality not in price. As we have analysed in our earlier

reports and as suggested by a recent RBI Committee, the bank boards need to be

empowered, which should take them closer to private sector banks and lower the

corporate governance discount associated with SOE banks. And if required, the

government can even bring legislative changes easily, now that they have a majority in

the Lower House. SOE Banks trade at massive discount to their private sector peers and to

that extent, they can materially outperform the broader sector.

Asset quality – best within SOEs, and pressure diminishing. BOB has reported

progressively better asset quality numbers, much better than sector peers. We view this as

extremely positive as BOB would exit the downturn with the least amount of damage to

its loan book. The primary reason we believe is the composition of loan book with a third

in lower risk foreign loans (of which 50% if buyer’s credit), and very low exposure to the

large and mid-corporate sector. BOB is also focusing on improving its share of SME/MSME

assets, although as a proportion its exposure to retail has come off.

One of the better capitalised SOEs. BOB’s Tier1 at 9.3% is one of the better ones

within the SOE space. We believe this provides strong base to grow the loan book without

worrying about dilution risks.

Estimate and PT changes. We make no changes to estimates, having upgraded the

stock recently to a Buy. We up the PT further to Rs1,140 from Rs1,080.

Valuation / Risks. We value BOB using a blended equal weighted average of price-to-

book, price-to earnings and DCF. Our Cost of Equity assumption is based on 8% risk-free

rate and 4.5% risk premium and beta of 1.15. At our PT, the stock is valued at 1.5x

forward book and 9.3x forward earnings. This compares to last 5yr and 8yr averages of

1.1x/6.2x and 0.9x/6.4x respectively. Key risks: (1) Lack of board governance structure,

(2) Impending change in management, (3) slowing growth and worsening of asset

quality.



NII 88 103 113 120 147 182

Core PPOP 65 80 84 86 108 135

Net profit 42 50 44 45 52 70

Loans 2,287 2,874 3,282 3,970 4,692 5,669

Deposits 3,054 3,849 4,739 5,689 6,707 8,084

RoA 1.33% 1.24% 0.90% 0.75% 0.74% 0.82%

RoE 21.48% 19.04% 14.59% 13.00% 13.43% 15.77%

PE 8.6 7.7 8.6 8.7 7.6 5.7

PB 1.8 1.5 1.3 1.3 1.1 0.9


Equity Strategy

India

19 May 2014



Exhibit 279: Valuation methodology based on triangulation

Methodology Weight Valuation

Adj. book value (Q4FY15E) 775.7

P/BV multiple 1.56x


Earnings per share (12m to Q4FY15E) 122.2

P/E multiple 8.00x

Value per share 978 33% 326

DCF 1,230 33% 410

Blended value per share (rounded) 1,140


Exhibit 280: Loan mix in favour of SME/MSME, exposure to large and mid-size corporates falling


Net Advances - Global 100% 100% 100% 100% 100% 100%

International 31.4% 31.7% 29.7% 25.9% 24.8% 24.2%

Domestic 68.6% 68.3% 70.3% 74.1% 75.2% 75.8%

Agriculture & Allied 7.0% 8.6% 9.9% 10.6% 12.2% 11.7%

Industry 35.9% 39.1% 39.0% 39.1% 38.0% 34.7%

SME / MSME 13.9% 13.5% 11.8% 11.8% 11.9% 10.1%

Large & mid 22.0% 25.6% 27.2% 27.3% 26.1% 24.6%

Retail 11.4% 11.3% 12.2% 13.9% 13.7% 13.6%

Housing/Mortgage 4.9% 4.9% 4.9% 5.5% 5.9% 5.8%

Personal 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Education 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Other Retail 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Others 14.3% 9.3% 9.1% 10.4% 11.4% 15.8%


Exhibit 281: CASA ratio to improve


Exhibit 282: NIMs have likely bottomed


8.7

%

8.0

%

7.5

%

7.6

%

8.0

%

7.4

%

7.3

%

6.4

%

7.1

%

7.3

%

7.5

%

33

.3%

30

.6%

28

.5%

27

.3%

27

.6%

27

.0%

25

.9%

24

.0%

24

.6%

25

.3%

25

.9%

42

.0%

38

.7%

35

.9%

34

.9%

35

.6%

34

.4%

33

.2%

30

.4%

31

.8%

32

.6%

33

.4%

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Demand Saving

2.0%

2.2%

2.4%

2.6%

2.8%

3.0%

3.2%

3.4%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Yield on assets* Cost of funds* NIM (RHS)

Equity Strategy

India

19 May 2014



Exhibit 283: Impaired asset formation coming down


Exhibit 284: Provision coverage should improve


Exhibit 285: Profitability has bottomed


Exhibit 286: Ample Tier 1 capital for near term


Exhibit 287: Branch expansion continues


1.3%1.9%0.8%0.7%1.5%1.3%1.2%1.8%2.3%2.1%2.4%3.0%2.9%3.0%2.7%2.0%1.3%

0.9%0.5%

0.4%1.6%

1.5%1.0%1.4%

4.1%

8.7%

1.3%1.6%2.4%

6.0%

2.8%2.0%

1.4%1.8%

2.1%2.3%

1.2%

2.3%3.0%

2.2%2.6%

5.9%

11.0%

3.5%4.0%

5.5%

9.0%

5.8%4.7%

3.4%3.2%

Q4

FY1

0A

Q1

FY1

1A

Q2

FY1

1A

Q3

FY1

1A

Q4

FY1

1A

Q1

FY1

2A

Q2

FY1

2A

Q3

FY1

2A

Q4

FY1

2A

Q1

FY1

3A

Q2

FY1

3A

Q3

FY1

3A

Q4

FY1

3A

Q1

FY1

4A

Q2

FY1

4A

Q3

FY1

4A

Q4

FY1

4A

Slippages* Restructured assets*

0

20

40

60

80

100

120

140

160

180

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

PCR PCR (incl. AUCA) Credit cost (RHS)

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

0.7%

0.8%

0.9%

1.0%

1.1%

1.2%

1.3%

1.4%

FY0

5A

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

RoA RoE (RHS)

6%

7%

8%

9%

10%

11%

12%

13%

14%

15%

16%FY

05

A

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Tier 1* (%) CRAR* (%)

2700 2704 2732 2853 2926 31003364

39044276

4874

170 0 0 0

1179 13151561

2012

2630

6254

0 0 0 0 0 0 0 0 0 0

FY05A FY06A FY07A FY08A FY09A FY10A FY11A FY12A FY13A FY14A

Branches ATMs No. of cities

Equity Strategy

India

19 May 2014





0.5x

1.0x

0.7x

1.2x

100

300

500

700

900

1,100

1,300

Mar

06

Mar

07

Mar

08

Mar

09

Mar

10

Mar

11

Mar

12

Mar

13

Mar

14


Equity Strategy

India

19 May 2014



ICICI Bank (ICICIBC IN, Buy) – Positive on cyclical recovery

While the recent quarter saw large asset quality impairments, we believe this

is unlikely to be the trend. A well-seasoned corporate book, and thrust on

retail assets means credit cost will be at a similar level as last year. The aim

clearly seems to be bringing capital in to the domestic bank where the

margins are higher – capital repatriation whether by dividends from foreign

subsidiaries or recognising FX translating gains from foreign branches – is

RoE positive. We expect standalone RoE of 16% in FY16 and consolidated RoE

of 16-17%. High Tier 1 is another positive; its subsidiaries have turned

dividend payers, putting less recapitalization pressure on the bank.

Retail asset pickup and CASA is positive. ICICI Bank has come around to grow its

retail assets once again with the share of retail assets at 39%, but growing mostly in

secured products like mortgage and auto loans. The share of CASA has also stabilised at

43% for the last few years and that should help protect NIM volatility going forward.

Asset quality to remain largely under control. Q4FY14 saw large addition to

impaired assets, although most of that was guided to. But we don’t believe this is the start

of a new trend. Further, management remains optimistic of lesser asset quality risks going

forward. We build in credit cost of 90bps for FY15/FY16. We also expect the impaired

asset formation ratio to come off from 3% in FY14 to 2.5% in FY15 and 1.4% in FY16.

Profitability uptick and ample Tier 1 to drive the growth. ICICI Bank is sitting

with 12.8% Tier 1 capital providing ample headroom to fuel growth without worrying

about a near term capital raising. Further, we expect profitability ratios to continue to

improve with FY16 RoA at 1.9% and RoE at 16.2%.

Estimate and PT changes. We make a very marginal change of 0.3% in FY16 earnings

owing to a small change in our expense ratio assumptions. We up PT to Rs1,720.

Valuation / Risks. We value ICICIBC using SOTP. We value the standalone bank ex of

equity investment in subsidiaries at 2.6x book, foreign subsidiaries at 1.5x book, Life

insurance using Appraisal Value (EV+18.8x NBAP), General Insurance at 15x earnings. At

our PT, the stock is valued at 2.5x forward book and 17.2x forward earnings. This

compares to last 5yr and 8yr averages of 1.8x/16.0x and 2.2x/16.3x respectively. Key

risks: (1) Poor economic pickup, (2) worsening asset quality



NII 90 107 139 165 207 263

Core PPOP 93 104 127 156 188 234

Net profit 52 65 83 98 116 144

Loans 2,164 2,537 2,902 3,387 4,134 5,064

Deposits 2,256 2,555 2,926 3,319 3,995 4,828

RoA 1.35% 1.44% 1.66% 1.76% 1.79% 1.89%

RoE 9.60% 11.10% 12.90% 13.70% 14.62% 16.23%

PE 32.5 26.2 20.4 17.3 14.7 11.8

PB 3.3 3.0 2.7 2.5 2.2 2.0


Equity Strategy

India

19 May 2014



Exhibit 290: Sum of the parts valuation methodology Valuation basis (in mns) FX rate Stake Multiple per share

Domestic banking Book value (adj) Rs. 6,65,708 1.00 100.0% 2.6x 1,305

Foreign bank subsidiaries

UK Book value $662 62.00 100.0% 1.5x 53

Canada Book value CAD 990 63.00 100.0% 1.5x 81

Russia Book value $57 62.00 100.0% 1.5x 5

Domestic subsidiaries

Life Appraisal value Rs. 2,27,966 1.00 74.0% EV + (15% margin, 18.8x multiple, APE growth FY13-15: 15% CAGR) 145

General PAT (12m rolling) Rs. 3,544 1.00 74.0% 15.0x 34

AMC Avg. AuM Rs. 11,57,560 1.00 51.0% 5.0% 26

HFC Book value Rs. 16,921 1.00 100.0% 2.0x 29

Isec PD PAT (12m rolling) Rs. 1,452 1.00 100.0% 15.0x 19

Isec PAT (12m rolling) Rs. 1,001 1.00 100.0% 15.0x 13

Venture AuM $2,000 62.00 100.0% 8.0% 9

Value of subsidiaries 413

Fair value for ICICI Bank 1,720


Exhibit 291: Loan book mix – retail back in focus

FY14A FY13A FY12A FY11A FY10A

ADVANCES, NET 100% 100% 100% 100% 100%

Priority sector 0.0% 0.0% 0.0% 9.7% 10.0%

Retail 39.0% 37.0% 38.0% 38.7% 43.0%

Housing 20.9% 19.8% 19.2% 24.9% 25.8%

Personal 1.2% 0.6% 0.4% 1.1% 2.6%

Cards 1.0% 0.9% 1.0% 1.3% 2.2%

Vehicle loan 8.2% 8.9% 10.5% 10.4% 11.6%

CV 3.7% 5.1% 7.0% 6.8% 6.9%

Auto 4.5% 3.8% 3.5% 3.6% 4.3%

Two-wheeler 0.0% 0.0% 0.0% 0.0% 0.4%

Others 5.5% 4.6% 4.2% 1.0% 0.9%

Corporate & Commercial 34.5% 37.7% 34.6% 26.1% 22.0%

SME 4.4% 5.2% 6.0% 4.8% 4.0%

Corporates 30.1% 32.5% 28.6% 21.3% 18.0%

International 26.5% 25.3% 27.4% 25.5% 25.0%


Exhibit 292: CASA has shaped up well


Exhibit 293: NIM should hold up


10

.0%

9.3

%

10

.1%

9.9

%

15

.3%

15

.4%

13

.7%

12

.6%

13

.0%

13

.0%

13

.2%

12

.7%

12

.5%

16

.0%

18

.8% 2

6.3

%

29

.6%

29

.8%

29

.3%

29

.9%

29

.9%

30

.1%

22

.7%

21

.8%

26

.1%

28

.7%

41

.7%

45

.1%

43

.5%

41

.9%

42

.9%

42

.9%

43

.3%

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Demand Saving

2.0%

2.2%

2.4%

2.6%

2.8%

3.0%

3.2%

3.4%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

FY0

5A

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Yield on assets* Cost of funds* NIM (RHS)

Equity Strategy

India

19 May 2014



Exhibit 294: Fee income to pick up


Exhibit 295: Decent provision coverage ratio


Exhibit 296: Total impaired assets to decline


Exhibit 297: Reflecting in lower formation ratio


Exhibit 298: Profitability to improve


Exhibit 299: Amply capitalised


1.2%

1.3%

1.4%

1.5%

1.6%

1.7%

1.8%

1.9%

2.0%

FY0

5A

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

Fee as % of avg. IEA

0

50

100

150

200

250

50%

55%

60%

65%

70%

75%

80%

85%

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Provision coverage Total credit cost (RHS)

36.950.6

64.2

28.7 29.9 37.247.3 55.5

70.515.8

11.1

51.9

12.1

35.9 18.1

61.1 45.0

-2.0

52.761.7

116.1

40.7

65.855.3

108.4100.5

68.5

FY08A FY09A FY10A FY11A FY12A FY13A FY14A FY15E FY16E

Slippages Restructured assets

1.8% 2.1%2.7%

1.3% 1.1% 1.2% 1.3% 1.4% 1.4%

0.8% 0.5%

2.2%

0.6% 1.3%0.6%

1.7%1.1%

0.0%

2.5% 2.5%

4.8%

1.9%

2.4%

1.8%

3.0%

2.5%

1.4%

FY08A FY09A FY10A FY11A FY12A FY13A FY14A FY15E FY16E

Slippages* Restructured assets*

6%

8%

10%

12%

14%

16%

18%

20%

0.9%

1.1%

1.3%

1.5%

1.7%

1.9%

2.1%

FY0

5A

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

RoA RoE (RHS)

6%

8%

10%

12%

14%

16%

18%

20%

22%

FY0

5A

FY0

6A

FY0

7A

FY0

8A

FY0

9A

FY1

0A

FY1

1A

FY1

2A

FY1

3A

FY1

4A

FY1

5E

FY1

6E

Tier 1* (%) CRAR* (%)

Equity Strategy

India

19 May 2014





0.6x

1.9x

1.4x

2.3x

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

Mar

06

Mar

07

Mar

08

Mar

09

Mar

10

Mar

11

Mar

12

Mar

13

Mar

14


Equity Strategy

India

19 May 2014



ITC (ITC IN, Buy) ITC’s revenue growth is likely to remain weak in FY15E, given the subdued

demand environment evident in staples categories and the added likelihood

of tax increases for a third year in a row. However, we believe ITC’s earnings

trajectory should remain resilient despite the headwinds in the near future,

given the nature of price elasticity in the category and ITC’s pricing power.

ITC remains our top pick in staples.

Taxes likely to be raised again

Cigarette taxes have gone up > 20% p.a. (per stick) in the last two years, mostly led by

hikes in central excise duties as well as increase in state VAT rates. Given the dire fiscal

situation that the new government is set to tackle, we believe cigarette taxes will be raised

yet again for a third consecutive year. Possibly in a similar expectation, ITC has raised

prices of some its cigarette brands by 15-20% in early April. We factor in an excise duty

increase of 10% in FY15E.

Volumes to remain weak but profit growth should be resilient

ITC’s cigarette volume growth has understandably weakened in the past two years on

account of the steep tax increases. The impact, however, was particularly severe in FY14

(volumes down 2.5-3%) under the added weight of a broader slowdown in consumption,

in our view. This ties in with historical trends which show a remarkable correlation

between ITC’s cigarette retail sales and other consumption growth metrics such as PFCE

or nominal GDP. Given our view that the slowdown in staples categories is likely to last

over the next one year, we expect the growth in ITC’s cigarette retail sales also to remain

below trend growth in FY15E. Profitability, however, should remain resilient in the near

term, supported by low price elasticity of the segment, strong competitive positioning

and a cost structure that is largely immune to volume trends. We expect ITC’s profits to

grow at a steady pace 15-16% over FY15E-16E.

Long term concerns

Demand for cigarettes in India has grown at c.1-1.3% p.a. in the past three decades, only

slightly ahead of the global demand, unlike the vastly superior growth in most other

consumer items. Taxation, absolute and relative (to alternate tobacco products), has

played its part. Prevalence of smoking is also down, in line with global trends. While ITC

has managed strong earnings growth due to share gains, price increases and mix and will

likely do so in the near term, long-term risks are real.

Valuation/Risks

We tweak our earnings and roll forward our SOTP-based TP to FY16E. We now value ITC

at Rs.411/share (28x FY16E cigarette profits). Maintain Buy. Risks: a) slowdown more

severe than anticipated; b) introduction of ad valorem taxes at the centre or sharp increase

state-level ad valorem taxes; and c) meaningful deterioration in product mix.

Exhibit 301: ITC summary financials

Rs bn FY13 FY14E FY15E FY16E

Revenues 289.2 330.7 379.1 444.9

EBITDA 103.3 117.7 139.1 160.6

Margin 35.7% 35.6% 36.7% 36.1%

PAT 74.2 85.9 100.2 115.4

EPS (Rs./share) 9.4 10.8 12.6 14.5

P/E (x) 38.0 33.0 28.3 24.5

BVPS (Rs./share) 28.2 31.8 35.9 40.5

P/B (x) 12.7 11.2 9.9 8.8

ROE 33.3% 34.1% 35.2% 35.9%


Given our view that the slowdown in

staples categories, is likely to last

over the next one year, we expect

the growth in ITC’s cigarette retail

sales also to remain below trend

growth in FY15E

Demand for cigarettes in India has

grown at c.1-1.3% p.a. in the past

three decades, only slightly ahead of

the global demand, unlike the vastly

superior growth in most other

consumer items

Equity Strategy

India

19 May 2014



Exhibit 302: Sharp increase in taxes in recent years

Source: Central and state government budgets

Exhibit 303: Growth in ITC's cigarette retail pricing (indexed to FY05)


Exhibit 304: ITC's cigarette retail sales correlated with growth in PFCE

Source: CMIE, company data, Jefferies estimates

0%

5%

10%

15%

20%

25%

30%

35%

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09* FY10 FY11 FY12 FY13 FY14

Tax increase LT average

0

50

100

150

200

250

300

350

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E

Net ASP Excise duty Trade margin VAT

0%

5%

10%

15%

20%

25%

FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14E

ITC retail sales growth PFCE growth

ITC’s cigarette retail sales have been

remarkably correlated with PFCE in

the past

Cigarette taxes have gone up >20%

p.a. in the last two years

Equity Strategy

India

19 May 2014



Exhibit 305: Growth in cigarette volumes in the last few decades (CAGR)

Source: FAO, WHO, Ministry of Commerce, Company Data, Jefferies estimates

Exhibit 306: ITC's share of organized industry volumes


Exhibit 307: Changes to estimates

Previous New Change

Rs bn FY15E FY16E FY15E FY16E FY15E FY16E

Cigarette segment

Volumes (bn sticks) 90.9 96.1 87.3 92.3 -4.0% -3.9%

Revenues 328.7 371.4 326.5 368.9 -0.6% -0.7%

EBIT 112.1 129.0 112.7 129.5 0.5% 0.4%

EBIT margin 34.1% 34.7% 34.5% 35.1% 39 bp 39 bp

Total

Revenues 381.3 447.4 379.1 444.9 -0.6% -0.6%

EBITDA 138.5 160.0 139.1 160.6 0.4% 0.4%

Margin 36.3% 35.8% 36.7% 36.1% 35 bp 33 bp

PAT 99.8 115.0 100.2 115.4 0.4% 0.3%

EPS (Rs) 12.6 14.5 12.6 14.5 0.4% 0.3%


0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

1950-60 1960-70 1970-80 1980-90 1990-00 2000-10

India World

50%

55%

60%

65%

70%

75%

80%

85%

1991 1994 1997 2000 2003 2006 2009 2012

Cigarette volumes in India have

grown only slightly ahead of global

volumes in the last three decades

ITC’s volume growth has been much

ahead of industry as it has

consistently gained share in the last

several years

Equity Strategy

India

19 May 2014



L&T (LT IN, Buy): Still some way to go… Larsen & Toubro (L&T) is India’s unparalleled leader in engineering,

procurement construction (EPC) driven by infrastructure spend and capex –

integral to India’s GDP growth. With the election euphoria, the company has

given strong absolute returns, apart from being an outperformer. Project

announcements, sector reforms and fund raising by corporates for capex at

the macro level will keep valuations stable for the company. However, we

believe monetisation of subsidiaries in a buoyant environment at better

valuations is the angle that keeps risk:reward favourable. We maintain Buy,

with a revised TP of Rs1,640, valuing the core E&C business at 20x PE FY16E,

vs. 17x earlier.

Dhamra Port sale completed (Exhibit 13): L&T has sold its Dhamra Port asset on

the east coast, to Adani Port (ADSEZ IN, Rs223, Underperform) for Rs55 bn. L&T had a

stake of 50% in the project, and has sold the asset at a P/B of over 2.5x on its initial

investment. Increasing investments in subsidiaries had put pressure on L&T’s standalone

ROEs during FY08-13, leading to some valuation de-rating. We expect this de-rating cycle

to reverse over the next 12-18 months, as ROEs show signs of trending upwards with

monetisation of long gestation projects. FIPB approval of Rs10 bn investment in L&T IDPL

and listing of road assets in Singapore give further credibility to scope of monetisation.

Raised 11% revenue CAGR of FY13-16E marginally to 13% (Exhibit 14): Ex-

hydrocarbon, L&T’s order flow has risen at a CAGR of 3% during FY11-13, and order book

at a CAGR of 19%. L&T’s revenue CAGR has a 4-quarter lag to its order book. Ex-

hydrocarbon, its order book has seen a sharp spike and risen by 30% in 2Q and 3QFY14.

Given our sector outlook of better execution pick-up as corporates gain confidence in a

buoyant environment, we have marginally raised our revenue CAGR expectations.

Comprehensive play on any potential recovery (Exhibit 15-16): L&T’s scale and

balance sheet strength is reflected in its 15-20% ROEs, with peers at sub-10%. In addition,

lower leverage at under 0.5x vs. peers closer or above 2.0x gives it the benefit of

increasing market share in both good and difficult environments. L&T’s diversified

presence has seen its order book rising across cycles, driven by different segments. Hence,

it remains the most comprehensive play on any potential recovery in the capex cycle.

Valuations give additional comfort on risk/reward (Exhibits 17-19): Our

estimate of a 9% EPS CAGR during FY13-16E (12% CAGR during FY14-16E) factors in

20%+ order flow CAGR in FY12-14E and deteriorating working capital, from 22% to 25%

of sales. We maintain Buy with a revised TP of Rs1,640 valuing the core E&C at 20x PE

FY16E (5% discount to historical average PE) vs. 17x FY16E earlier. Risks: 1) Slowdown in

Middle East.

Exhibit 308: Financial summary

(Rs mn) FY11 FY12 FY13 FY14E FY15E FY16E

Opening order book 1,002,390 1,302,170 1,442,300 1,536,040 1,975,263 2,446,608

Net Sales 439,049 531,705 515,709 572,777 641,856 738,296

EBITDA 55,985 62,639 55,787 64,724 72,530 83,427

EBITDA (%) 12.8 11.8 10.8 11.3 11.3 11.3

Adjusted PAT 36,671 43,968 42,431 44,372 48,842 55,786

EPS (Rs) 39.4 47.2 45.5 47.6 52.4 59.9

EPS Growth (%) 20.9 19.9 (3.5) 4.6 10.1 14.2

ROCE (%) 24.1 21.6 20.2 18.4 18.0 18.6

RONW (%) 18.3 18.7 15.6 14.4 14.4 14.8

PE (x)* 25.0 20.8 21.6 20.6 18.8 16.4

PBV (x)* 4.2 3.6 3.1 2.8 2.6 2.3

EV/EBITDA (x)* 16.0 14.8 16.7 14.7 13.0 11.2


Equity Strategy

India

19 May 2014



Exhibit 309: incremental investment in subsidiaries to reduce going forward (Rs mn)

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E

L&A to

subsidiaries 3,446 2,986 3,488 23,581 32,719 48,692 51,208 46,653 55,000 58,000 63,000

Investments-

Liquid 11,549 19,440 26,396 33,841 57,408 74,008 90,847 105,227 117,227 129,227 141,227

Overall 14,995 22,426 29,884 57,422 90,127 122,701 142,056 151,880 172,227 187,227 204,227

Incremental 3,568 7,430 7,459 27,537 32,705 32,574 19,355 9,824 20,347 15,000 17,000

% of balance

sheet 24.3 28.4 22.6 30.1 35.8 41.9 40.3 39.7 39.7 39.9 39.9

Incremental % of

balance sheet 5.8 9.4 5.7 14.4 13.0 11.1 5.5 2.6 4.7 3.2 3.3

Incremental % of

PAT 45.1 54.1 36.6 103.4 107.8 88.8 44.0 23.2 45.9 30.7 30.5

ROE (%) 19.8 26.4 26.6 24.2 19.7 18.3 18.7 15.6 14.4 14.4 14.8

ROCE (%) 25.0 29.6 30.4 31.1 29.5 24.1 21.6 20.2 18.4 18.0 18.6

Core ROCE (%) 32.5 40.4 40.5 42.6 44.2 39.5 36.7 33.6 30.5 29.9 31.0


Exhibit 310: Revenue growth typically lags order flow growth by 4 quarters


Exhibit 311: L&T’s market share in hydrocarbons


-10

0

10

20

30

40

50

60

70

order book ex-hydrocarbon growth (% YoY) Revenue growth 4 qtr lag (% YoY)

L&T's market share,

57%

Other Players, 43%

Equity Strategy

India

19 May 2014



Exhibit 312: L&T’s market share in other capex


Exhibit 313: SOTP Valuation

Particulars Stake Value (Rs/share) Old value Basis

L&T Parent 1,198 786 20x PE FY16E excl. hydrocarbon v/s 17x PE FY16E

L&T Hydrocarbon 69 63 10x PE FY16E v/s 10x PE FY15E

L&T InfoTech 100 90 74

10x PE FY16E - around 35% discount to HCL Tech target PE v/s 10x

PE FY15E earlier

L&T Finance Holdings 82 99 91 20% hold co discount to CMP of Rs82 - implied ~1.7x FY16E P/B

L&T IDPL 97 94 79

Valued IDPL at 50% premium to Rs186/share - price L&T increased

stake in FY11-12 - implied P/B is ~2x FY16E; v/s 26% premium

earlier

L&T-MHI BTG 51 3 3 Valued investment at 1x P/B - BTG outlook remains difficult

Other investments 89 43

Valued at 1.5x book as on March 2015; multiple expansion as

monetisation visibility improves

Target Price 1,640 1,140


Exhibit 314: PE Valuation


Exhibit 315: PB valuation chart


L&T's market

share, 31%

Other Players,

69%

0

15

30

45

60


Rolling PE Mean PE Median

0

3

6

9

12

15


Rolling PBV Mean Median

Equity Strategy

India

19 May 2014



Maruti Suzuki (MSIL IN, Buy) We believe Maruti is the best play on economic recovery in India as the car

industry, which has gone through its longest slowdown in FY11-14, could be

amongst the earliest to recover. The shift from diesels to petrol continues,

boosting Maruti’s market share but hurting margins. Steady indigenisation

should help reduce volatility, but demand recovery remains key to margin

improvement. Maintain Buy.

Well positioned for a cyclical recovery

The car industry, especially small cars, has seen nearly 3 years of decline and looks poised

for recovery given the significant latent demand. Competitive intensity has eased in small

cars and should remain benign over the next few years. However, the sedan segment

could continue to face competitive pressure in the medium term. Maruti gained 300bps

market share in FY14 as the market shifted back to petrol cars (diesel cars 53% of industry

compared to 58% in FY13) as well as due to successful new car launches. With a solid

launch pipeline in place relative to its peers, we believe Maruti is well positioned for a

cyclical recovery. We raise our FY16E volume estimate by 4% and now forecast Maruti’s

volumes to grow 15%pa in FY14-16E. Exports declined sharply (-16%) in FY14 due to

slowdown and changes in regulations in certain end markets. We forecast a 15% growth

of a low base.

Margin outlook mixed, currency-induced volatility should moderate

Product mix shift in favour of petrol cars will likely keep Maruti’s margins under pressure

in the near term. Demand recovery, therefore, is key to margin improvement, in its impact

on capacity utilization (currently low at 70% assembly, 65% powertrain) and discount

levels (up ~40% in FY14). At the same time, steady progress on indigenisation should

mitigate currency-led volatility to some extent. Maruti has cut down component imports

from 19% in end FY13 to 16% in end FY14 and will likely continue to benefit from the

resultant cost savings. Currency remains benign and we expect EBITDA margins to

increase 60bps each year over FY14-16E.

High capex plans despite recent arrangement

Maruti has guided to capex of Rs40b, despite new capacity being put up by Suzuki. The

high capex spend for marketing infrastructure is surprisingly high and we are unsure how

much of this is recurring in nature.

Valuation/Risks

We incorporate the above changes to our assumptions and raise FY16E earnings by 4%.

We now value Maruti at Rs.2501/share, based on 18x core earnings plus cash (vs.17x

earlier and 20% premium to its long term historic average). Key risks: Currency volatility.

Exhibit 316: Maruti summary financials

Rs bn FY13 FY14E FY15E FY16E

Revenues 435.9 438.4 499.2 581.1

EBITDA 42.3 52.3 62.6 75.9

Margin 9.7% 11.9% 12.5% 13.1%

PAT 23.9 29.3 34.3 42.3

EPS 79.2 96.9 113.7 140.1

P/E (x) 27.2 22.2 18.9 15.4

BVPS 615.0 697.4 800.7 930.5

P/B (x) 3.5 3.1 2.7 2.3

ROE 12.9% 13.9% 14.2% 15.1%


The car industry, especially small

cars, has seen nearly 3 years of

decline and looks poised for recovery

given the significant latent demand

Shift in product mix will hurt

margins in the near term. Demand

recovery remains key to margin

improvement

Equity Strategy

India

19 May 2014



Exhibit 317: Diesel vehicles as % of total industry


Exhibit 318: Maruti's domestic volume and market share

Source: Jefferies estimates, CMIE, company data

Exhibit 319: Capacity utilisation trend


0%

10%

20%

30%

40%

50%

60%

70%

FY08 FY09 FY10 FY11 FY12 FY13 FY14

35%

37%

39%

41%

43%

45%

47%

49%

0

200

400

600

800

1,000

1,200

1,400

1,600

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E

MSIL domestic volumes ('000 units) Market share

50%

60%

70%

80%

90%

100%

110%


The shift from diesel to petrol and

Maruti’s launch pipeline should drive

Maruti’s volumes and market share

in the next few years

Dieselization trend has started to

reverse

A recovery in demand should help

Maruti’s profitability given the low

capacity utilization levels currently

Equity Strategy

India

19 May 2014



Exhibit 320: Trend in gross profit and EBITDA per car (Rs.)


Exhibit 321: EBITDA per car build-up over FY13-16E (Rs./vehicle)


Exhibit 322: Maruti 12m fwd P/E


Exhibit 323: Maruti 12m trailing P/B


0

20,000

40,000

60,000

80,000

100,000

120,000

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E

GP/Car EBITDA/Car

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

FY13 EBITDA Pricing/mix R.M. costs Other costs FY16E EBITDA

0

5

10

15

20

25

Apr-03 Oct-04 Apr-06 Oct-07 Apr-09 Oct-10 Apr-12 Oct-13

P/E Mean -1 Std.Dev +1 Std.Dev.

0

1

2

3

4

5

6

Apr-03 Oct-04 Apr-06 Oct-07 Apr-09 Oct-10 Apr-12 Oct-13

P/B Mean -1 Std.Dev +1 Std.Dev.

Equity Strategy

India

19 May 2014



Exhibit 324: Changes to estimates

New Previous Changes to est

FY15E FY16E FY15E FY16E FY15E FY16E

Volumes (mn) 1.31 1.53 1.31 1.48 0% 4%

Growth 13% 17% 13% 13%

Rs bn

Net Sales 499.2 581.1 499.2 567.1 0% 2%

Growth 14% 16% 15% 14%

EBITDA 62.6 75.9 62.6 73.4 0% 3%

Margin 12.5% 13.1% 12.5% 13.0% 0 bp 11 bp

PAT 34.3 42.3 34.3 40.5 0% 4%

EPS 113.7 140.1 113.7 134.2 0% 4%

Growth 17% 23% 17% 18%


Equity Strategy

India

19 May 2014



NTPC (NTPC IN, Buy): PLF recovery buffer left in estimates… New CERC norms announced in February 2014, reward above-average

operational performance, where NTPC has a good track record. However,

NTPC is now also a play on economic and power demand recovery, as rise in

PLF levels implies higher incentives. We believe power sector reforms,

anticipation of power demand recovery and news flow on state electricity

board (SEB) reforms will help valuations. At 1.1x P/B FY16E, regulated ROE of

15.5% and 11% earnings CAGR during FY15-19E, we maintain Buy with a

revised TP of Rs150, as we marginally revise our multiple to 1.3x P/B FY16E

from 1.2x P/B FY16E earlier.

Power demand recovery – potential upside of 6% (Exhibit 25): With the new

regulation, NTPC is now also a play on economic and power demand recovery. Earlier,

NTPC did not benefit from a pick-up in power demand. Here on, if there is downside to

power demand, NTPC will be unaffected as Annual Fixed Charges are linked to PAF, but if

power demand recovers, it will enjoy incentives, which are linked to PLF. It earns a flat

rate of Rs0.5/unit, over and above 85% PLF. For now we assume incentives based on

FY14E plant performance (year of flat power demand growth vs. long-term average of

6%). However, we see potential upside of 6% on earnings as power demand recovers.

Lower capacity addition adjusted – FY17E-19E to see spurt at 75% CAGR

(Exhibit 32): NTPC has seen delays in capacity addition vs. its plans, which has been

one of our primary concerns. For our assumptions, we have factored in delay in Koldam,

and indefinite postponement of the Bongaigaon plant (750 MW) given civil unrest.

Additionally, based on our vendor checks, we believe FY17E-19E will see a spurt in

capacity accretion at over - 16,300 MW. These mainly include the bulk tender bids, and

even two-year delays in the Orissa plant, which has been ordered out but is facing land

acquisition delays. Capacity addition spurt will lead to earnings CAGR pick up.

Operational track record healthy - 62% capacity consistently above 85% PLF

in last decade (Exhibit 25-29): Four operational parameters are viewed as

‚controllable‛ by the CERC – Station Heat Rate (calorific value reqd. to make one unit of

power), Secondary Fuel Oil Consumption, Auxiliary Energy Consumption (units

generated internally used by the plant) and loan re-financing. NTPC has earned

controllable parameters linked incentives consistently over the last decade. This also

reflects in the company’s PAF and PLF levels. We believe CERC changes have stressed on

NTPC maintaining and improving its operational norms. The company’s past track record

is therefore important and gives us comfort it will be in a position to execute the same.

Maintain Buy (Exhibit 33): At 1.1x P/B FY16E, regulated ROE of 15.5% and 11%

earnings CAGR during FY15-19E, we maintain Buy with a revised TP of Rs150, as we

marginally revise our multiple to 1.3x P/B FY16E (40% discount to historical average PB)

from 1.2x P/B FY16E earlier.

Exhibit 325: Financial Summary (Rs mn)

Y/E March FY11 FY12 FY13 FY14E FY15E FY16E

Net Sales 548,818 609,130 639,192 696,166 743,272 829,010

Growth (%) 18 11 5 9 7 12

EBITDA 125,848 126,790 153,296 174,454 162,432 178,768

EBITDA (%) 23 21 24 25 21.9 21.6

Adjusted PAT 78,647 85,792 103,695 108,971 90,645 97,210

EPS (Rs) 9.5 10.4 12.6 13.2 11.0 11.8

EPS Growth (%) (9.2) 9.1 20.9 5.1 (16.8) 7.2

ROCE (%) 13.3 11.9 14.0 11.0 9.3 9.2

RONW (%) 12.1 12.2 13.5 13.1 10.3 10.5

PE (x)* 13.8 12.6 10.5 10.0 12.0 11.2

PBV (x)* 1.6 1.5 1.3 1.3 1.2 1.1

EV/EBITDA (x)* 10.8 11.1 9.7 9.2 10.1 10.1


Equity Strategy

India

19 May 2014



Exhibit 326: NTPC’s PLF has consistently been above All India levels


Exhibit 327: NTPC’s PLF has consistently been above All India levels


Exhibit 328: PLF of NTPC Coal Plants








4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

0

200

400

600

800

1,000

1,200

1,400

Demand Supply deficit (%)

0.0

20.0

40.0

60.0

80.0

100.0

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

NTPC Coal PAF NTPC Coal PLF All India PLF

50

60

70

80

90

100

110

Dadri Thermal Farakka STPP

Kahalgaon Talcher Kaniha STPP

50

60

70

80

90

100

110

Talcher TPS Tanda TPS

Sipat STPP Singrauli TPS

50

60

70

80

90

100

110

Ramagundam TPP Rihand STPP

Simhadri TPS Unchahar TPS

50

60

70

80

90

100

110

Vindhyachal TPS Korba STPP

Badarpur TPS Mauda TPS

Equity Strategy

India

19 May 2014



Exhibit 332: Approximate incentive split for NTPC (Rs mn)

Incentives FY13 FY14E FY15E FY16E FY17E FY18E FY19E

Likely PAF/PLF incentives 7,179 15,134 3,408 3,408 3,408 3,408 3,408

MW eligible 3,215 4,635 7,077 7,546 7,966 10,441 11,062

Rs mn/MW 0.6 0.6 0.8 0.8 0.8 0.9 1.0

Special allowance 1,899 2,895 5,308 6,019 6,757 9,419 10,613

Fuel Efficiency/UI charges/Other incentives 12,459 9,331 3,732 3,732 3,732 3,732 3,732

Total 21,538 29,361 13,494 14,257 15,424 18,087 19,893


Exhibit 333: FY15E-19E CAGR to recover to 11% levels


Exhibit 334: Plant-wise capacity addition for FY15E-19E

FY15E FY16E FY17E FY18E FY19E Plant MW Plant MW Plant MW Plant MW Plant MW

Barh-II 660 Vindhyachal – V 500 Kudgi 800 Mauda-II 1,320 Nabinagar TPS 1,980

Nabinagar JV 500 Kudgi 800 Barh-I 1,320 Solapur STPP 1,320 Rajasthan Vidyut Nigam 1,320

Kanti - Subsidiary 195 Nabinagar JV 500 Meja JV TPP 1,320 Darlipali 1,600

Koldam 800 Raghunathpur II 1,320 Gajmara 1,600

Barh-I 660 Kudgi 800

Tapovan Hydel 520 Lara 1,600 Overall 1,355 3,780 2,120 7,680 6,500


Exhibit 335: NTPC’s sharp de-rating prices in lower earnings CAGR


-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

0

20

40

60

80

100

120

140

160

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E FY17E FY18E FY19E

PAT YoY Growth

0

1

2

3

4

5

Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13

Rolling PBV Mean Median

Hike in capacity addition targets

improved valuations in this period

De-rating driven by slippage in execution

and deteriorating health of SEBS

Acknowledgement of fuel risk

and regulation changes led to

further de-rating in the stock

Equity Strategy

India

19 May 2014



ONGC (ONGC IN, Buy) – Biggest Beneficiary of Reforms ONGC remains our top pick in the Indian oil & gas sector, as we expect it to be

the biggest beneficiary of reforms. ONGC is a major beneficiary of the gas

price hike that is likely to go through post elections, in our view. We expect

elimination of diesel subsidy through small price hikes to lead to re-rating of

the stock as it should cap upside to ONGC’s subsidy burden. We raise ONGC’s

fair value to Rs440 from Rs 355 previously.

Biggest Beneficiary of gas price hike. We expect the gas price hike to go through

post elections. ONGC would be the biggest beneficiary of gas price hike, in our view. In

our base case, we assume ONGC’s realized gas price to be only US$5.7/mmbtu vs

US$8/mmbtu as per the Rangarajan formula. Even in this case, ONGC’s EPS improves by

Rs5/share; if ONGC were to get the full gas price hike, our FY15/16 EPS estimate would

rise to Rs44/47 from Rs38/40 currently.

Elimination of diesel subsidy should lead to re-rating of the stock. We expect

the small diesel price hikes to continue under the new government, which could

completely eliminate diesel subsidy by as early as February, 2015. In our base case, we

conservatively expect the entire benefit of under-recovery reduction to accrue to

government finances and ONGC (and upstream) subsidy share to be capped at the

current level of Rs650bn. Even in this case, we expect the stock to re-rate as one of the

biggest reasons for ONGC’s historical discounted valuations has been its subsidy share

risk. In a positive case, ONGC’s subsidy contribution could decline in line with reduction

in under-recovery, leading to FY15/16 EPS rising to Rs46/57 from our base case.

Scepticism remains high on benefits to ONGC. Scepticism on benefits to ONGC

from the gas price hike and subsidy reforms remains high. However, we note that 1) the

government has historically ‚allowed‛ ONGC’s to grow its earnings despite rising subsidy

burden and 2) the gas price hike upside is too large to be completely and permanently

appropriated by the government.

Production remains a concern. ONGC’s production has been declining over the past

10 years and the company has often missed against guidance/target. Continued miss

against production growth targets is the biggest concern on ONGC.

Raise price target to Rs 440. We raise price target for ONGC to Rs440 from Rs355

previously based on 11x FY16 EPS. We expect elimination of diesel subsidies to drive a re-

rating of the stock from its historic median range of 9-10x. Key risks: 1) policy 2) adverse

decision in Gujarat royalty case 3) production issues.

Table 5: Significant upside possible for ONGC from gas price hike and subsidy

reforms Rs/share Base case Full upside of gas price hike Upside of subsidy reduction Combined upside

FY15 EPS 37.6 44.2 45.9 52.8

FY16 EPS 40.0 46.7 56.8 64.0


Table 6: Key Financials INR FY13A FY14E FY15E FY16E

Rev (B) 1,615 1,818 1,983 2,076

EBITDA (B) 562 593 714 762

Net Profit (B) 242 249 321 342

BV/Share 178 196 220 245

P/B 2.2 2.0 1.7 1.6

ROE (%) 15.9 14.8 17.1 16.3

DPS 9.5 9.6 12.3 13.0

Div. Yield (%) 2.5 2.5 3.2 3.4

EPS 28.3 29.2 37.6 40.0

P/E 13.6 13.2 10.2 9.6


ONGC is out top pick in the sector;

we raise price target to Rs440

ONGC is likely to be the biggest

beneficiary of gas price hike, which

we expect to go through post

elections

Elimination of diesel subsidy should

lead to re-rating of the stock even if

upstream subsidy contribution

remains flat

ONGC’s FY16 EPS could more than

double to Rs54 if it gets full benefit

of gas and diesel price hikes

Equity Strategy

India

19 May 2014



Reliance (RIL IN, Buy) – Core Businesses Turning Around We recently upgraded Reliance to Buy as we expect core earnings to double

over the next 4 years, driven by upside from large downstream investments,

gas price hike and gradual recovery in domestic upstream output. While

earnings growth is back-ended with a sharp surge in FY17 and telecom is a

drag, we believe the turnaround in downstream is underappreciated and will

drive significant upside over the next 2 years as we move closer to start. We

raise Reliance’s fair value to Rs1236 from Rs1124 previously.

Downstream investments to drive significant earnings upside. We expect

Reliance's ongoing large downstream investments of US$13bn in pet coke gasifier and

petrochemical expansions including the off-gas cracker to add US$3bn to EBITDA and Rs

34 per share to EPS by FY17 with incremental ROCE of 20%. We expect the pet coke

gasifier to add US$2.5/bbl to GRM starting in FY17; petrochemical expansions should add

US$1.9bn to EBITDA with over 60% of potential upside coming from off-gas cracker & PX.

Upstream – Bottomed out but recovery to be slow. Reliance's domestic upstream

output has likely bottomed though material increase could take till FY18 when new fields

in KG-D6 would be brought under production. In the near term, a gas price hike – likely

post elections - and new discoveries could be the key upside triggers.

Telecom a drag, Shale & retail to improve. We expect telecom to be a drag over the

next few years as Reliance takes time to ramp up and fixed costs are likely to be high with

US$6bn already invested. The decline in FY16E EPS is mainly to factor in telecom losses.

Reliance's other major investments are in shale (US$7bn invested) and retail (US$1.6bn).

We expect strong earnings improvement in both these businesses over the next 3-4 years.

Raise price target to Rs1236. We raise our price target for Reliance Industries to

Rs1236 from Rs1124 previously driven by higher multiple for its petrochemical business

(7x EV/EBITDA vs. 6x earlier) which is in line with global peers and lower discount for its

non-core investments (0.9x book vs. 0.8x earlier). Key risks: 1) downstream margins 2)

currency 3) delays and cost over-runs in new projects 4) adverse regulation particularly in

domestic upstream.

Table 7: Segment-wise performance over FY14-18E EBITDA

(US$bn)

EPS

(Rs/share)

Capex (US$bn)

Segment FY14 FY18E FY14 FY18E FY13-17 Comments

Refining 2.9 4.3 28 42 4.0 Pet coke gasifier in FY17 likely to add US$2.5/bbl to GRM

Petchem 1.8 3.7 18 38 9.0 Off-gas cracker and other expansions

Domestic upstream 0.6 2.2 3 18 4.8 Gas price increase in FY15; volume increase in FY18

Others (0.2) (0.5) 19 26 n/a

Standalone 5.1 9.7 68 124 17.8

Shale 0.6 1.6 3 8 7.8 Production to reach 350BCFe by FY18 from 150 in FY14

Telecom - 1.0 - 1 6.0 18% data market-share, 6% voice market-share by FY18

Retail & others 0.0 0.6 (1) 6 1.9 Retail revenues at US$8bn in FY18 from 2.4bn in FY14

Consolidated 5.8 12.9 70 139 15.7


Table 8: Key Financials INR FY14A FY15E FY16E FY17E

Rev (B) 4,345 4,605 4,631 4,840

EBITDA (B) 348 403 439 650

Net Profit (B) 225 256 253 370

BV/Share 615 688 755 853

P/B 1.8 1.6 1.4 1.3

ROE (%) 11.3 11.5 10.4 13.4

DPS 9.5 10.2 11.0 14.7

Div. Yield (%) 0.9 0.9 1.0 1.4

EPS 69.6 79.1 78.2 114.3

P/E 15.5 13.6 13.8 9.4


We expect RIL’s core earnings to

double over the next 4 years, driven

by upside from large downstream

investments, gas price hike and

some recovery in gas output

We estimate EBITDA to double from

US$6bn to US$13bn over FY14-18E

Pet coke gasifier and petrochemical

expansions should add US$3bn to

EBITDA against capex of US$13bn

Telecom likely to remain a drag and

is the key reason behind a possible

decline in EPS in FY16

Equity Strategy

India

19 May 2014



Tata Steel Ltd. (TATA IN , Buy) Tata Steel’s India business is set to see strong volume growth in FY15 and

FY16 as infrastructure related activity under the new government picks up.

Improvement TSE’s performance would largely stem from internal cost saving

measures. Debt levels should start to taper from FY16 onwards on improving

cash flows and asset sales. Maintain Buy.

Growth opportunity aplenty for India business: Tata Steel’s India business volumes

grew 14% YoY in FY14 although India’s total apparent steel consumption grew by only

0.6% YoY. With the domestic steel demand expected to pick up in FY15 and FY16 as a

result of increased infrastructure related activity under the new government, we believe

Tata Steel stands to benefit from a higher volume growth for its India business.

Management has guided for FY15 finished steel deliveries to be 9.2mn MT (+8% YoY) as

the recently commissioned Jamshedpur expansion achieves full utilization. Thereafter

volume growth in FY16 would be driven by the completion of Kalinganagar greenfield

project in Q4FY15.

Internal efficiency measures holds the key in European business: Eurozone is

beginning to show signs of a recovery and key steel consuming sectors like automotive,

machinery and construction have started witnessing growth. While this volume growth

coupled with the recent fall in input costs (coking coal and iron ore) should ideally be

supportive of increase in steel spreads, the same might not really happen given the

overcapacity in Europe. Therefore management expects improvement in performance for

TSE to largely stem from internal cost saving measures and expects to try and break even

at EBIT level in FY15 against a loss of Rs1.6bn in FY14. Savings in operating costs equalled

GBP200mn in FY14 and management expects these initiatives to continue in FY15.

Temporary closure of Orissa mines should have no impact beyond six months:

The Supreme Court has ordered for temporary closure of 26 mines in Orissa which had

been operating on ‘deemed second or subsequent renewal’ and has asked the State Govt.

to decide on the renewal of these mines within six months considering captive miners on

a priority basis. Seven of these mines belong to Tata Steel which could impact its

production/profitability given that 75% of Tata Steel’s domestic iron ore consumption

comes from its Orissa mines. Management believes that the mines have all the requisite

clearances Environment Clearance, Forest Clearance etc., and therefore the matter should

get resolved shortly. While this could have some short-term impact for Tata Steel, we are

not unduly worried as the issue here is not about illegal mining but only of renewal.

Net debt to peak in FY15 on improving cash flows and asset sales: Management

expects a maximum debt increase of ~Rs40bn in FY15 with peak net debt of ~Rs700bn

(presently Rs665.7bn). We believe there could be positive surprise to this debt number on

the back of improving cash flows from operations and proceeds from recent Rs39bn asset

sales viz., Mumbai land (11.55bn) and Dhamra port (Rs27.5bn being its share).

Our top pick in the Steel space: The stock is currently trading at one-year forward

EV/EBITDA multiple of 6.1x and a one-year forward P/BV multiple of 0.9x which we

believe provides an attractive entry point. Our EBITDA estimates are higher than

consensus by 10% for FY16E. Maintain Buy with a target price of Rs540. Key downside

risks: Slower-than-expected revival in European and India steel demand.

Exhibit 336: Key Financials INR FY13A FY14E FY15E FY16E

Rev (B) 1,347 1,486 1,526 1,585

EBITDA (B) 123 164 183 214

Net Profit (B) (70.6) 35.9 46.4 54.2

BV/Share 352 417 449 486

ROE (%) (19.2) 9.8 11.1 11.9

EPS (72.7) 37.0 47.8 55.8

P/E n.a. 11.9 9.2 7.9

P/B 1.3 1.1 1.0 0.9


Equity Strategy

India

19 May 2014



Exhibit 337: Tata Steel India to drive total volume growth

Source: Company data, Jefferies estimates

Exhibit 338: Margin upside for the group would stem from

TSE’s performance improvement


Exhibit 339: Consolidated EBITDA to see steady growth


Exhibit 340: Net debt to peak in FY15


Exhibit 341: Free cash flow generation from FY16e


-30%

-20%

-10%

0%

10%

20%

30%

0

5

10

15

20

25

30

FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E

Tata Steel India Sales (mn MT) Tata Steel excluding India Sales (mn MT)

YoY Domestic Sales Growth (%) - RHS YoY Total Sales Growth (%) - RHS

0

3,000

6,000

9,000

12,000

15,000

18,000


Tata Steel India EBITDA/tonne (Rs) Total EBITDA/tonne (Rs)

-80%

-40%

0%

40%

80%

120%

0

50

100

150

200

250

FY10 FY11 FY12 FY13 FY14E FY15E FY16E

EBITDA (Rs bn) YoY Growth (%) - RHS

0.5

1

1.5

2

2.5

100

300

500

700

900

FY11 FY12 FY13 FY14E FY15E FY16E

Net Debt (Rs bn) Gearing Ratio (x) - RHS

(200)

(150)

(100)

(50)

0

50

100

FY11 FY12 FY13 FY14E FY15E FY16E

Free Cash flow after investing activities (Rs bn)

Equity Strategy

India

19 May 2014



Exhibit 342: Tata Steel valuation summary

Particulars FY16E Comments

India-

FY16E EBITDA (Rs mn) 158,209

Target Multiple (x) 6.0 In line with global steel valuation multiples

India EV (Rs mn)- (A) 949,255

Tata Steel Europe-


Target Multiple (x) 5.0 At a discount to Tata Steel India valuation to factor in the low margin business

Tata Steel Europe EV (Rs mn)- (B) 231,000

Tata Steel Asia and others-


Target Multiple (x) 4.5

Tata Steel Asia and others EV (Rs mn)- (C) 41,998

Target EV (Rs mn)- (A+B+C) - (D) 1,222,253

Less:

Net debt- FY16E (Rs mn)- (E) (726,800)

Add:

Capital work in progress FY15E (Rs mn) - On the 3mn MT Kalinganagar Steel plant in Orissa

Discount applied (%) 35%

Implied cwip value (Rs mn)- (F) -

Steel Business Equity value (Rs mn)- (D+E+F) 495,453

Add:

Investments in Listed entities 44,311 Holdings in Tata Power and Tata Motors

Applied discount (%) 35%

Value of investments- post discount 28,802

Equity value (Rs mn)- SOTP 524,255

fully diluted shares o/s (mn) 971

Equity value- Per share (Rs) 540


Exhibit 343: Tata Steel is trading at 6.1x 1-yr rolling



Exhibit 344: Tata Steel is trading at 0.9x 1-yr forward book



-

2

4

6

8

10

12


-

0.5

1.0

1.5

2.0

2.5

3.0

3.5


Equity Strategy

India

19 May 2014



Analyst CertificationI, Govindarajan Chellappa, certify that all of the views expressed in this research report accurately reflect my personal views about the subjectsecurity(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specificrecommendations or views expressed in this research report.I, Piyush Nahar, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) andsubject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendationsor views expressed in this research report.I, Nilesh Jasani, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) andsubject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendationsor views expressed in this research report.I, Anand Agarwal, CFA, certify that all of the views expressed in this research report accurately reflect my personal views about the subjectsecurity(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specificrecommendations or views expressed in this research report.I, Arya Sen, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subjectcompany(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or viewsexpressed in this research report.I, Atul Goyal, CFA, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) andsubject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendationsor views expressed in this research report.I, Lavina Quadros, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) andsubject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendationsor views expressed in this research report.I, Nilanjan Karfa, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) andsubject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendationsor views expressed in this research report.I, Rajasa Kakulavarapu, certify that all of the views expressed in this research report accurately reflect my personal views about the subjectsecurity(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specificrecommendations or views expressed in this research report.I, Ankit Fitkariwala, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) andsubject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendationsor views expressed in this research report.I, Swagato Sourya Ghosh, certify that all of the views expressed in this research report accurately reflect my personal views about the subjectsecurity(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specificrecommendations or views expressed in this research report.Registration of non-US analysts: Govindarajan Chellappa is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and isnot registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, andtherefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, publicappearances and trading securities held by a research analyst.

Registration of non-US analysts: Piyush Nahar is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore maynot be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearancesand trading securities held by a research analyst.

Registration of non-US analysts: Nilesh Jasani is employed by Jefferies Singapore Limited, a non-US affiliate of Jefferies LLC and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore maynot be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearancesand trading securities held by a research analyst.

Registration of non-US analysts: Anand Agarwal, CFA is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and is notregistered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, andtherefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, publicappearances and trading securities held by a research analyst.

Registration of non-US analysts: Arya Sen is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore maynot be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearancesand trading securities held by a research analyst.

Registration of non-US analysts: Atul Goyal, CFA is employed by Jefferies Singapore Limited, a non-US affiliate of Jefferies LLC and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore maynot be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearancesand trading securities held by a research analyst.

Registration of non-US analysts: Lavina Quadros is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and is notregistered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, andtherefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, publicappearances and trading securities held by a research analyst.

Registration of non-US analysts: Nilanjan Karfa is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore maynot be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearancesand trading securities held by a research analyst.

Equity Strategy

India

19 May 2014



Registration of non-US analysts: Rajasa Kakulavarapu is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and is notregistered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, andtherefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, publicappearances and trading securities held by a research analyst.

Registration of non-US analysts: Ankit Fitkariwala is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and is notregistered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, andtherefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, publicappearances and trading securities held by a research analyst.

Registration of non-US analysts: Swagato Sourya Ghosh is employed by Jefferies India Private Limited, a non-US affiliate of Jefferies LLC and isnot registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, andtherefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, publicappearances and trading securities held by a research analyst.

As is the case with all Jefferies employees, the analyst(s) responsible for the coverage of the financial instruments discussed in this report receivescompensation based in part on the overall performance of the firm, including investment banking income. We seek to update our research asappropriate, but various regulations may prevent us from doing so. Aside from certain industry reports published on a periodic basis, the large majorityof reports are published at irregular intervals as appropriate in the analyst's judgement.

Company Specific DisclosuresFor Important Disclosure information on companies recommended in this report, please visit our website at https://javatar.bluematrix.com/sellside/Disclosures.action or call 212.284.2300.

Meanings of Jefferies RatingsBuy - Describes stocks that we expect to provide a total return (price appreciation plus yield) of 15% or more within a 12-month period.Hold - Describes stocks that we expect to provide a total return (price appreciation plus yield) of plus 15% or minus 10% within a 12-month period.Underperform - Describes stocks that we expect to provide a total negative return (price appreciation plus yield) of 10% or more within a 12-monthperiod.The expected total return (price appreciation plus yield) for Buy rated stocks with an average stock price consistently below $10 is 20% or more withina 12-month period as these companies are typically more volatile than the overall stock market. For Hold rated stocks with an average stock priceconsistently below $10, the expected total return (price appreciation plus yield) is plus or minus 20% within a 12-month period. For Underperformrated stocks with an average stock price consistently below $10, the expected total return (price appreciation plus yield) is minus 20% within a 12-month period.NR - The investment rating and price target have been temporarily suspended. Such suspensions are in compliance with applicable regulations and/or Jefferies policies.CS - Coverage Suspended. Jefferies has suspended coverage of this company.NC - Not covered. Jefferies does not cover this company.Restricted - Describes issuers where, in conjunction with Jefferies engagement in certain transactions, company policy or applicable securitiesregulations prohibit certain types of communications, including investment recommendations.Monitor - Describes stocks whose company fundamentals and financials are being monitored, and for which no financial projections or opinions onthe investment merits of the company are provided.

Valuation MethodologyJefferies' methodology for assigning ratings may include the following: market capitalization, maturity, growth/value, volatility and expected totalreturn over the next 12 months. The price targets are based on several methodologies, which may include, but are not restricted to, analyses of marketrisk, growth rate, revenue stream, discounted cash flow (DCF), EBITDA, EPS, cash flow (CF), free cash flow (FCF), EV/EBITDA, P/E, PE/growth, P/CF,P/FCF, premium (discount)/average group EV/EBITDA, premium (discount)/average group P/E, sum of the parts, net asset value, dividend returns,and return on equity (ROE) over the next 12 months.

Jefferies Franchise PicksJefferies Franchise Picks include stock selections from among the best stock ideas from our equity analysts over a 12 month period. Stock selectionis based on fundamental analysis and may take into account other factors such as analyst conviction, differentiated analysis, a favorable risk/rewardratio and investment themes that Jefferies analysts are recommending. Jefferies Franchise Picks will include only Buy rated stocks and the numbercan vary depending on analyst recommendations for inclusion. Stocks will be added as new opportunities arise and removed when the reason forinclusion changes, the stock has met its desired return, if it is no longer rated Buy and/or if it underperforms the S&P by 15% or more since inclusion.Franchise Picks are not intended to represent a recommended portfolio of stocks and is not sector based, but we may note where we believe a Pickfalls within an investment style such as growth or value.

Risk which may impede the achievement of our Price TargetThis report was prepared for general circulation and does not provide investment recommendations specific to individual investors. As such, thefinancial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions basedupon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Past performance ofthe financial instruments recommended in this report should not be taken as an indication or guarantee of future results. The price, value of, andincome from, any of the financial instruments mentioned in this report can rise as well as fall and may be affected by changes in economic, financialand political factors. If a financial instrument is denominated in a currency other than the investor's home currency, a change in exchange rates mayadversely affect the price of, value of, or income derived from the financial instrument described in this report. In addition, investors in securities suchas ADRs, whose values are affected by the currency of the underlying security, effectively assume currency risk.

Equity Strategy

India

19 May 2014



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Other Companies Mentioned in This Report• ABB Limited (ABB IN: INR877.95, UNDERPERFORM)• ACC Limited (ACC IN: INR1,430.15, HOLD)• Adani Ports and Special Economic Zone (ADSEZ IN: INR225.00, UNDERPERFORM)• Ambuja Cements Limited (ACEM IN: INR224.35, HOLD)• Ashok Leyland (AL IN: INR26.90, HOLD)• Axis Bank (AXSB IN: INR1,755.00, BUY)• Bajaj Auto Limited (BJAUT IN: INR1,931.70, HOLD)• Bank of Baroda (BOB IN: INR934.15, BUY)• Bharat Forge (BHFC IN: INR458.35, HOLD)• Bharat Heavy Electricals Limited (BHEL IN: INR231.60, UNDERPERFORM)• Bharat Petroleum Corporation Limited (BPCL IN: INR552.10, HOLD)• Cairn India (CAIR IN: INR340.65, HOLD)• Cipla (CIPLA IN: INR388.25, BUY)• Coal India Limited (COAL IN: INR345.40, HOLD)• Crompton Greaves Limited (CRG IN: INR171.10, UNDERPERFORM)• Cummins India Limited (KKC IN: INR565.50, BUY)• DLF Limited (DLFU IN: INR169.70, UNDERPERFORM)• Dr. Reddy's Laboratories (DRRD IN: INR2,406.90, HOLD)• GAIL (GAIL IN: INR409.70, BUY)• Godrej Properties Limited (GPL IN: INR219.20, HOLD)• Grasim Industries Limited (GRASIM IN: INR3,068.60, BUY)• HCL Technologies (HCLT IN: INR1,365.15, BUY)• HDFC Bank (HDFCB IN: INR804.70, BUY)• Hero MotoCorp (HMCL IN: INR2,397.65, BUY)• Housing Development & Infrastructure Ltd (HDIL IN: INR83.90, HOLD)• Housing Development Finance Corp. Ltd. (HDFC IN: INR885.80, HOLD)• ICICI Bank (ICICIBC IN: INR1,465.30, BUY)• Indiabulls Real Estate Limited (IBREL IN: INR78.25, UNDERPERFORM)• India Cements Limited (ICEM IN: INR80.15, HOLD)• Indraprastha Gas Ltd. (IGL IN: INR315.45, BUY)• IndusInd Bank Limited (IIB IN: INR561.95, BUY)• Infosys (INFO IN: INR3,177.55, BUY)• ITC Limited (ITC IN: INR356.95, BUY)• JSW Steel Limited (JSTL IN: INR1,177.20, BUY)• Jubilant Foodworks (JUBI IN: INR1,160.90, HOLD)• Kotak Mahindra Bank Limited (KMB IN: INR905.65, HOLD)• Larsen & Toubro (LT IN: INR1,427.70, BUY)• Lupin Ltd. (LPC IN: INR958.65, HOLD)• Mahindra & Mahindra Limited (MM IN: INR1,114.70, UNDERPERFORM)• Maruti Suzuki India Limited (MSIL IN: INR2,152.15, BUY)• NMDC Ltd (NMDC IN: INR161.90, BUY)• NTPC (NTPC IN: INR131.60, BUY)• Oil India Limited (OINL IN: INR567.05, BUY)• ONGC (ONGC IN: INR384.15, BUY)• Petronet LNG Ltd. (PLNG IN: INR140.55, HOLD)• Power Grid Corporation of India Limited (PWGR IN: INR119.50, BUY)• Prestige Estates Projects Limited (PEPL IN: INR184.00, BUY)• Punjab National Bank (PNB IN: INR917.95, UNDERPERFORM)• Ranbaxy Laboratories Ltd. (RBXY IN: INR452.15, BUY)• Reliance Industries (RIL IN: INR1,079.25, BUY)• Siemens Limited (SIEM IN: INR839.05, HOLD)• Sobha Developers Limited (SOBHA IN: INR425.75, BUY)• State Bank of India (SBIN IN: INR2,417.20, UNDERPERFORM)• Steel Authority of India Ltd. (SAIL IN: INR78.15, UNDERPERFORM)• Sun Pharmaceutical Industries Ltd (SUNP IN: INR613.50, BUY)• Tata Consultancy Services (TCS IN: INR2,160.75, BUY)• Tata Motors (TTMT IN: INR449.85, HOLD)• Tata Power (TPWR IN: INR90.90, BUY)• Tata Steel Ltd. (TATA IN: INR440.90, BUY)• Tech Mahindra (TECHM IN: INR1,822.55, BUY)• Thermax Limited (TMX IN: INR815.20, UNDERPERFORM)• Titan Company (TTAN IN: INR307.00, BUY)• TTK Prestige (TTKPT IN: INR3,182.90, UNDERPERFORM)• Ultratech Cement Limited (UTCEM IN: INR2,334.15, HOLD)• Voltas Limited (VOLT IN: INR178.30, UNDERPERFORM)• Wipro (WPRO IN: INR502.80, HOLD)

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Distribution of RatingsIB Serv./Past 12 Mos.

Rating Count Percent Count Percent

BUY 901 49.78% 246 27.30%HOLD 762 42.10% 126 16.54%UNDERPERFORM 147 8.12% 5 3.40%

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19 May 2014



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