INDIA Institutional Research

Cables & Conductors Sterlite Technologies Ltd Lightning technology connecting growth… Initiating Coverage

Analyst:  Backward integration ‐ a unique advantage: Sterlite Rating Buy Kanika Bihany Dugar Technologies Ltd (STL) is the solo integrated optical fiber Target Price Rs640 [email protected] manufacturer in India. The process of converting silicon CMP* Rs360 91 22 3951 7618 into glass and further to fiber helps the company to realize Date: 8th January 2010 Upside 77% 35‐40% OPMs only from this integration; in addition to 14‐ Sensex 17615 15% OPMs from manufacturing of fiber‐optic cables from the optical fibers.

 Golden goose ‐ Optical fiber and fiber‐optic cables: The Key Data company is currently the 5th largest manufacturer of Bloomberg Code SOTL IN Equity optical fiber and fiber‐optic cables globally and is moving rd Reuters Code STTE.BO towards 3 largest globally with increasing its capacity to 20mn Km for optical fiber and 10mn FKm for fiber optic NSE Code STRTECH cables by FY12E. This will assist the company to capture Current Share o/s (mn) 64.6 10% global market share from the current 5%. MktCap (Rsbn/USDmn) 23.5/510  Enduring growth in conductors backed by continuing 52 Wk H/L (Rs) 383.9/44.2 investments in T&D sector: The power conductor business Daily Vol. (3m NSE Avg) 255881 segment, contributing 63% to net sales in FY09, will Face Value (Rs) 5 maintain the growth trajectory with investments of about Beta 1.44 Rs315bn in conductors segment alone in the XIth plan out 1USD/INR 45.7 of total investments of Rs4.3tn on power T&D. STL having the largest domestic market share of 25% will benefit immensely from these T&D outlay as it gears up to meet Shareholding Pattern (%) the growing demand through planned capex from current Promoters 43.5 115K MT to 200K MT by FY12E. FII 2.8  Progressing return ratios: The ROCE and ROE have Others 53.6 improved from 7.5% and 10.4% in FY07 to 17.1% and 14.2% in FY09 respectively, on the back of 38% CAGR in turnover and reducing leverage. We expect STL to record Price Performance (%) 20% CAGR in net sales over FY09‐12E, ROCE at 23.2% and 1m 6m 1yr ROE at 21.3%, with further reduction in leverage and margin improvement. SOTL 10.4 67.9 159.5  NIFTY 3.3 5.0 69.5 Valuations: We remain bullish on STL, on the backdrop of a th unique integrated optical fiber manufacturing facility and Source: Bloomberg; *As on 7 Jan. 2010 improving OPMs and returns. We also see promising demand growth emanating from the expected increasing demand in faster wireless connections and higher number of data transfer capability. We value STL at Rs640, translating into 20x FY11E EPS of Rs32. The target price provides an upside of 77% from current levels. Hence we recommend ‘Buy’ on the stock.  Key Risks: Delay in expansion, slowdown in India and China, overcapacity and volatile commodity prices.

Y/E Mar (Rs Mn) Net Sales YoY (%) EBITDA YoY (%) PAT YoY (%) EPS (Rs) BV (Rs) RoE (%) RoCE (%) P/E (x) P/BV (x) FY08 16,858 40.7 1,929 72.2 1,007 132.1 15.6 186.6 18.7 13.5 23.0 1.9 FY09 22,892 35.8 2,342 21.4 883 (12.2) 13.7 173.2 14.2 17.1 26.4 2.1 FY10E 26,721 16.7 3,389 44.8 1,848 109.2 28.7 199.6 23.5 21.9 12.6 1.8 FY11E 33,250 24.4 4,365 28.8 2,506 35.6 32.1 209.1 21.4 22.4 11.2 1.7 FY12E 39,617 19.1 5,249 20.3 3,116 24.4 39.9 247.8 21.3 23.2 9.0 1.5 Source: Company, Networth Research

Sterlite Technology Ltd Networth Research is also available on Bloomberg and Thomson Reuters 1

Company Background

Sterlite Technologies Ltd (STL) formerly known as Sterlite Optical Technologies Ltd (SOTL) was incorporated in 2000 after it was hived off from Sterlite Industries. The company initially started with optic fiber and telecom cables. Later STL entered power conductor business through the acquisition of power transmission line division from Sterlite Industries.

Sterlite Technologies Ltd (STL) is a leading global provider of optical fibers, telecommunication cables and power transmission conductors. STL is the largest power conductor manufacturer in the world and the third largest fiber manufacturer globally.

The company is India's only integrated optical fiber manufacturer and is among the select few globally, with about 30% domestic market share.

Exhibit 1: Key Events 2000 Incorporated under the name of Sterlite Telecom Systems Ltd, after the demerger of the telecom business from Sterlite Industries; Name changed to Sterlite Optical Technologies Ltd 2005 Installed capacity of fiber optic cables increased from 14L FKm to 24L FKm 2006 Acquired power transmission line division from Sterlite Industries for a consideration of Rs1485mn; Commencement of telecom integration & managed services business 2007 Increased installed capacity for copper telecom cables from 75L CKm to 95CKm and for fiber optic cables from 24L FKm to 32.2L FKm; Change of company name to Sterlite Technologies Ltd 2009 Increased installed capacity for optical fiber to 12mn Km; fiber optic cable to 6mn FKm and conductor to 1.6L MT

Key Management Personnel Name Position Profile Mr. Anil Agarwal Non‐Ex Chairman He founded the Sterlite group in 1976 and has been overseeing its operations since its inception. He is the Executive chairman of Vedanta Resources Plc, Sterlite Industries (India) Ltd, BALCO and is a director of Hindustan Zinc Ltd and Vedanta Aluminium Ltd. Mr. Anand Agarwal CEO & Wholetime He completed his BTech. in metallurgical engineering from IIT Kanpur and was awarded director Masters and PhD from the Rensselaer Polytechnic Institute, USA. He has joined Sterlite in 1995 and has held various positions, including manufacturing, quality assurance and business development. Prior to joining Sterlite he worked with Siemens.

Source: Company, Networth Research

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Investment Rationale

Backward integration – a unique advantage STL is uniquely positioned as one of the very few fully integrated optical fiber manufacturer in the world (6‐7 players in total) and as the only one domestically. While most global fiber manufacturers procure glass and process it into fiber, STL starts by procuring silicon directly from the mines to convert it into glass and further into fiber. The process on conversion of silicon into glass is highly automated and requires advance techniques which is possessed by very few in the world. This integration helps the company to record 35‐40% operating margins. The optical fiber segment contributed about 5% to revenues in FY09, which is expected to increase to 7.3% by FY12E. STL further enjoys operating margins of 14‐15% by converting glass to fiber optic cables.

Exhibit 2: Fully integrated optical fiber manufacturing capacity – advantage margins

Source: Company, Networth Research

There are quite a few deterrents for other fiber optic cable manufacturer to go for backward integration. Some of them being: high end technology which is not easy to develop, high capex (about USD7/km for brown field expansion and USD12‐13/km for greenfield expansion) and high gestation period (about 7‐8 years for Greenfield project). The supply of fiber optic cables will be wholly defined by the supply of glass by the 6‐7 players in total, with STL being one of them. The other major integrated players are Corning (USA), Draka (Netherlands) and Prysmian (Italy).

Exhibit 3: Global integrated fiber manufacturing players

FY09 OPM (%) ROE (%) ROCE (%) Corning Inc (US) 20.2 21.0 10.4 Draka Holdings NV 3.2 15.8 10.1 (Netherlands) Prysmian SPA (Italy) 8.7 53.6 19.2 Sterlite Technologies (India) 10.2 14.2 17.1

Source: Bloomberg, Networth Research

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Corning Inc (US) is the pioneer in silicon to glass conversion technology and is the world leader for optical fiber manufacturing. However, only 16% of Corning’s revenue (FY09) was contributed by optical fiber and cables, while 46% of revenue (FY09) was contributed by LCD production which also uses the same glass conversion technology. Draka of Netherlands and Prysmian of Italy are other optical fiber and cables players having integrated silicon‐glass‐fiber facility, with 77% and 100% revenue contribution by optical fiber and cable business segment. As per our understanding, out of the current realization of USD8/km of optical fiber, STL incurs a total cost of about USD5/km (including the raw material cost of USD2.5‐3/km). This results in OPMs of about 38%. This is against the total cost of about USD6‐6.5/km for other players like Corning, Draka and Prysmian, translating into an OPM of about 25%. STL is among the lowest cost manufacturer globally, strengthened by having the largest fiber manufacturing facility at one location and having manufacturing presence in a low cost geography (India). With H1FY10 OPMs at 18% for STL, it is evident that with the increase in contribution from optical fiber and cables segment, the company will dominate the returns globally. Also with highest margins in the industry the company stands to be least affected by any pricing pressure. Also STL is positioned strongly in growing economies of India and China with recent entry into Europe and US as against the above stated peers who are more focused in Europe and US which have seen a slowdown in recent years.

Golden goose ‐ optical fiber and fiber optic cables….. At the capacity of 9mn Kms and 3.2mn FKms for optical fiber and fiber optic cables respectively, STL is the 5th largest global manufacturer. With the huge capex (about Rs3bn over FY10E‐12E) planned to increase capacity to 20mn Kms and 10mn FKms by FY12E for optical fiber and fiber optic cables respectively, the company targets to enter the league of top 3 global manufacturers.

Exhibit 4: Capacity expansion and utilization in optical fiber Exhibit 5: Capacity expansion and utilization in fiber optic cables

mn Kms mn FKms 25 120% 12 100%

20 100% 10 80% 80% 8 15 60% 60% 6 10 40% 40% 4 5 20% 2 20% 0 0% 0 0% FY07 FY08 FY09 FY10E FY11E FY12E FY07 FY08 FY09 FY10E FY11E FY12E Capacity (LHS) Capacity utilization (RHS) Capacity (LHS) Capacity utilization (RHS) Source: Company, Networth Research Source: Company, Networth Research

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.... in a pollinating industry…

The global fiber market demand continues to grow in tandem with growth in both world mobile cellular subscribers as well as world internet users.

Exhibit 6: Global fiber market demand in tandem with global mobile subscribers & internet users

Source: International Telecommunication Union, Networth Research

Also with increase in demand for faster wireless connections and higher number of data transfer capability, there has been an exponential increase in demand for bandwidth. As voice is being taken over by data/video and downloading of movies/music/etc. has become more popular, we are seeing bandwidth doubling every 20 months, since last 5 years. With the persistent growth in bandwidth demand, the need for fiber cable networks also multiplies. According to Gartner, a research firm, fiber‐based services will grow steadily over the next few years, with FTTH (fiber‐to‐the‐home), FTTP (fiber‐to‐the‐premises) and Ethernet connections accounting for about 20% of the global consumer broadband market by 2013. Exhibit 7: Demand for bandwidth increasing exponentially Exhibit 8: Reasons for increase in demand for bandwidth

Tbps 20.0 17.7 International bandwidth traffic 15.0 10.1 10.0 7.2 4.9 3.0 5.0 1.8 2.3

0.0 2002 2003 2004 2005 2006 2007 2008

Source: Company, Networth Research Source: Company, Networth Research

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China besides India – key growth drivers STL is focused in China and India for the sale of its optic fiber and cables and we believe that these two geographies will drive growth for the company. Exhibit 9: China – wireless subscribers to fuel fiber growth Exhibit 10: India – wireless subscribers to fuel fiber growth

Source: Company, Networth Research Source: Company, Networth Research India has less than 1 broadband connection per 100 inhabitants with mere 6.8mn connections in August 2009. Among BRIC nations, India lags behind both Brazil and China in terms of number of broadband connections as well as per capita penetrations. Though India is far behind the national broadband target of 20mn connections by 2010 set to be achieved by the Indian government in its Broadband Policy 2004, with growing importance of knowledge and services in today’s globalizing economies across the world, broadband penetration has become a mandatory infrastructure condition that aids economic growth. Based on detailed analysis of demand side opportunities, a very ambitious target of 214mn broadband connections by 2014 is proposed ‐ a 30 fold increase from the current level (~7mn). This translates to similar increase in fiber cable network in the country.

Broadband connections in China stand at 83.4mn as of June 2009. The total number of Chinese broadband subscribers is growing at a rate of 6.8% per quarter with 23.1% of Chinese broadband households using fiber.

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Exhibit 11: Categories of internet applications in China Rank Application Use Rate 1 Online music 85.50% 2 Internet news 78.70% 3 Instant messaging 72.20% 4 Search engine 69.40% 5 Online video 65.80% 6 Online game 64.20% 7 E‐mail 55.40% 8 Blog 53.80% 9 Forum/BBS 30.40% 10 Online shopping 26.00% 11 Online payment 22.40% 12 Online stock 10.40% 13 Travel reservation 4.10% Source: China Internet Network Information Center, Networth Research As seen from exhibit 11 we find that latest internet entertainment has higher usage than normal use of internet for e‐mail. As this requires higher bandwidth, as seen from exhibit 8, we believe that the demand for optic fiber and cables from China is going to foresee constant growth. While the optical fiber and cables demand from China and India is expected to continue the momentum, STL has also started attempting to enter the developed markets (US and Europe) which though experiencing slower growth are large in size. The company also plans to enter Middle East markets, which have experience about 920% growth in internet usage in the period 2000‐2007, as per internet world statistics. This region (Middle East) is directly going to developing wireless technology with high bandwidth capability, which again augers well for STL. The other markets which hold promise for optical fiber and cables demand are South East Asian and African markets, though small in size are experiencing accelerated growth. With the growth seen in China and India and in other geographies, we believe the company will record 52% CAGR in net profit over FY09‐FY12E. This will also help the company to increase its global market share from current 5% to 10% by FY12E. Exhibit 12: Optical fiber to record a CAGR of 33% in turnover… Exhibit 13: Fiber optical cables to record a CAGR of 24% in turnover

Rs mn Rs mn 33% CAGR 27% CAGR 3500 7000 3000 6000 2500 5000 2000 4000 1500 3000 1000 2000 500 1000 0 0 FY08 FY09 FY10E FY11E FY12E FY08 FY09 FY10E FY11E FY12E Source: Company, Networth Research Source: Company, Networth Research

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Enduring growth in conductor business With aggressive addition in power generation and intensifying of national grids, 2007‐2017 is projected to be the decade of growth for the power sector in India. Over the XIth and XIIth FYP, about 178,000 MW generation capacity is targeted to be added with about Rs4.3tn to be spent in T&D alone in the XIth plan. Out of this about Rs315bn is to be spent on conductors alone.

Exhibit 14: Rs315bn to be spent on conductors in XIth plan, India

Transmission & Distribution (Rs4270bn)

Transmission Distribution (Rs1400bn) (Rs2870bn)

Meters Cables LV equipment EPC projects

Transmission Line Substation (Rs910bn) (Rs490bn)

Transformer Substation EPC Insulator

Tower Package Conductors Insulator Rs550bn Rs315bn Rs45bn Source: CEA, Company, Networth Research

Globally, over the next few years, the targeted T&D investment is about USD150bn. STL already holds 25% market share for conductors in India (the largest player in the space) and holds 14% market share in Africa.

Exhibit 15: T&D spending across major economies globally USD bn 550 500 500 Infra Investments Grid Investments 450 400 350 300 250 221 170 200 150 112 150 90 70 100 48 50 12 9 0 India USA West Europe China Global

Source: Company, Networth Research

With power conductors being the major revenue contributing segment (63% in FY09), STL has the 3rd largest global manufacturing capacity (115k MT), and is in the process of scaling the capacity to the largest in the world (2L MT) by FY12E. Given the significant scope of opportunity in the T&D space, we believe the company is going to see a steady growth from this business segment.

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Exhibit 16: Capacity expansion to become the global leader Exhibit 17: Expected ‐ 20% CAGR in revenues over FY09‐12E

MT Rs bn 20% CAGR 210000 30

180000 25

150000 20 120000 15 90000 10 60000 5 30000 0 0 FY09 FY10E FY11E FY12E FY09 FY10E FY11E FY12E Source: Company, Networth Research Source: Company, Networth Research The outstanding order book for the conductor segment is Rs12bn, 85% of which the company expects to convert by FY10E. The largest customer for STL is PGCIL contributing about 35‐40% of order book. Apar Industries is the competitor for the company holding a market share of 15%, while the remaining market remains fragmented.

Exhibit 18: Peer comparison for conductor segment

FY09 Consolidated Conductor revenue OPM (%) ROE (%) ROCE (%) D/E (x) Values contribution (%) Apar Industries 80.9 1.9 1.9 9.8 0.3 STL 63.4 10.2 14.2 17.1 0.8

Source: Company, Networth Research

Comparing Apar Industries with Sterlite, we find that the former’s operating margin is much lower than STL. We believe that lower OPM for Apar is due to the significant loss in the transformer oil segment. However, on comparing the EBIT margins, we found STL recording 8% vis‐a‐vis 7% by Apar Industries in FY09.

Broadband solutions – complementing optic fiber and cable business STL has initiated broadband solutions like Fiber to the Home (FTTH), Multiprotocol Label Switching (MPLS), DSL broadband networks, Next Generation Networks (NGN), Wimax, etc in FY06, foreseeing the growth of telecom markets. Presently, the company undertakes Integrated and Managed Services (IMS) for telcos (Mainly BSNL and MTNL) and undertakes the role of program manager in project execution. Market opportunity is in excess of USD2.5bn in India, and this segment is expected to add to the revenue growth for STL.

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Exhibit 19: IMS execution track record Business MPLS NGN Metro Ethernet OSS/BSS Vertical Client MTNL BSNL MTNL MTNL

Project Turnkey project for Turnkey project for Turnkey project Turnkey supply, integration, supply, integration, for supply, installation of commissioning & commissioning & integration, OSS/BSS for 200K maintenance of maintenance of commissioning & broadband lines MPLS network of 200KC IP MPLS maintenance of network MTNL (Delhi & based IPTAX 500K broadband (Mumbai) Mumbai) network lines network (Delhi & Mumbai) Scope of service Design, planning, Design, planning, Design, planning, Design, planning, supply, installation supply, installation supply, supply, & commissioning, & commissioning, installation & installation & O&M of complete O&M of complete commissioning, commissioning, network network O&M of complete O&M of complete network network Hardware Huawei ZTE Corporation, Huawei Huawei partners Technologies, Sun Sun Microsystems Technologies Technologies, Sun Microsystems Microsystems Software Elitecore, Metasolv ZTE Corporation partners

Source: Company, Networth Research Consistent revenue growth to continue with improving margins We expect a moderate 20% CAGR in revenues during the period FY09‐12E, over the 38% CAGR recorder during FY07‐09 period, due to the base effect coming in. With increasing contribution from the optic fiber and cable segments and reducing contribution from the copper telecom cable segment over FY09‐12E, we expect the operating margins to improve to about 13.2% in FY12E from 10.2% in FY09. Exhibit 20: Consistent revenue growth Exhibit 21: Changing revenue mix to improve margins

Rs bn 100% 14% 90% 45 45% 12% 40 40% 80% 70% 10% 35 35% 60% 8% 30 30% 50% 6% 25 25% 40% 30% 20 20% 4% 20% 2% 15 15% 10% 10 10% 0% 0% 5 5% FY08 FY09 FY10E FY11E FY12E ‐ 0% Broadband access networks Conductors Copper Telecom Cables Fiber Optic Cables FY08 FY09 FY10E FY11E FY12E Optical Fiber OPM (RHS) Turnover (LHS) Growth (RHS) Source: Company, Networth Research Source: Company, Networth Research

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Progressing return ratios STL has displayed significant improvement in both ROE and ROCE from 10.4% and 7.5% in FY07 to 14.2% and 17.1% in FY09 respectively, owing to reducing leverage (from 1.4 in FY07 to 0.8 in FY09) and 38% CAGR in top line during the period. We expect the company to record 52% CAGR in PAT over FY09‐12E, backed by 20% CAGR in revenues and improvement in margins from 10.2% in FY09 to 13.2E in fY12E. With the company expected to generate sufficient cash flows and the capex being done through internal accruals, we further expect leverage to reduce from 0.8 (FY09) to 0.3 (FY12E). The company is expected to register improved ROE and ROCE of 21.3% and 22.4% in FY12E from FY09 levels of 14.2% and 17.1% respectively. The fall in ROE from 23.5% in FY10E to 21.4% in FY11E is due to 21% equity dilution from the expected conversion of 13.75mn warrants. Exhibit 22: Improving return ratios… Exhibit 23: … backed by improving OPM and leverage position

25% 23.5% 1.6 12.7% 13.1% 13.2% 14% 22.4% 21.3% 11.5% 1.4 18.7% 1.4 10.2% 12% 20% 23.2% 17.1% 21.9% 21.4% 1.2 9.3% 10% 1.2 1.0 15% 8% 10.4% 14.2% 0.8 10% 13.5% 6% 0.6 0.8 0.6 4% 0.4 5% 7.5% 0.4 2% 0.2 0.3 0% 0.0 0% FY07 FY08 FY09 FY10E FY11E FY12E ROE ROCE FY07 FY08 FY09 FY10E FY11E FY12E D/E (LHS) OPM (RHS) Source: Company, Networth Research Source: Company, Networth Research Copper Telecom Cables segment to remain stagnant The copper telecom cable which was earlier contributing about 50% of revenues in FY05 has been gradually reducing and the contribution stood at 11.3% in FY09. The demand for copper cables has been falling with fiber optical cables gaining popularity due to its superiority over copper cables. We expect the contribution to fall further from 11.3% in FY09 to 7.5% in FY11E. Margins for copper cables are in the range of 8‐9% as compared to 14‐15% for fiber optic cables.

Exhibit 24: Copper telecom cable revenues to remain stagnant with reducing contribution Rsmn 3.5 18% 3.0 16% 16.3% 14% 2.5 13.8% 12% 2.0 10% 11.3% 1.5 8% 8.7% 6% 1.0 7.5% 6.3% 4% 0.5 2% ‐ 0% FY07 FY08 FY09 FY10E FY11E FY12E Revenues (LHS) Revenue contribution (RHS)

Source: Company, Networth Research

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Valuation Analysis:

Presence in growing industry with strong fundamentals; Buy with a target price of Rs640 STL is the only domestic player having an integrated optical fiber and cable manufacturing facility. Further the fiber optic cable business is expected to record significant demand for the products owing to the surge in demand for faster wireless connections and higher number of data transfer capability. With the huge investments expected in the T&D segment, the conductor business is also expected to show consistent growth. The new initiative of providing broadband solutions complements the company’s optical fiber and cable business and provides an opportunity in excess of USD2.5bn in India. STL is also expected to register improving ROCE and ROE, with lower leverage and improved profitability. We value STL at Rs640, translating into 20x FY11E EPS of Rs32. The target price provides an upside of 77% from current levels. Hence we recommend ‘Buy’ on the stock.

Exhibit 25: Peer Comparison

FY09 Aksh Optifiber Universal Cables Finolex Cables Sterlite Technologies Net Sales 2400 5711 13521 22892 EBITDA ‐300 502 411 2342 EBITDA Margin ‐12.5% 8.8% 3.0% 10.2% PAT ‐480.32 70 ‐355 883 PAT Margin ‐20.0% 1.2% ‐2.6% 3.9% No of Shares 58.0 23.1 153.0 64.5 EPS ‐8.3 3.0 ‐2.3 13.7 CMP 19.8 83.0 61.6 353.0 PER NA 27 NA 26 ROCE 3.5% 6.1% 8.94% 17.1% ROE 0.6% 4.1% 6.30% 14.2% BVPS 35 75 39 372 D/E 0.6 0.9 0.5 0.8 P/BV 0.6 1.1 1.6 0.9 Mcap 1145 1917 9422 22782 Mcap/Sales 0.5 0.3 0.7 1.0 EV 2035 3328 12099 24000 EV/EBITDA NA 6.6 29.5 10.2 H1FY10 Net Sales 843 2415 7183 9020 EBITDA 2 273 919 1665 EBITDA Margin 0.2% 11.3% 12.8% 18.5% PAT ‐140 89 838 1002 PAT Margin ‐16.6% 3.7% 11.7% 11.1% Annualized EPS ‐4.8 7.7 11.0 31.0 PER NA 10.7 5.6 11.4 Source: Company, Bloomberg, Networth Research

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The stock has been trading in the one year forward P/E range of 11‐20x since April 2005.

Exhibit 26: One year forward P/E band Rs 800 700 600 500 400 300 200 100 0 09 08 07 06 09 08 07 06 05 09 08 07 06 05 09 08 07 06 05 09 08 07 06 05 09 08 07 06 05 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ Jun Jun Jun Jun Jun Oct Oct Oct Oct Oct Apr Apr Apr Apr Apr Feb Feb Feb Feb Aug Aug Aug Aug Aug Dec Dec Dec Dec 2 Dec 5 8 11 14 17 20 23 STL

Source: Bloomberg, Networth Research

Rerating on the cards… as the company deserves a premium over its peers STL was mostly traded at a premium to its peers owing to the integrated business model for the optical fiber and cables business as compared to the peers which cannot boast of the same. However we have seen that in recent times, the company has been traded at a discount to its peers. We firmly believe that some rerating is on the cards for STL, backed by its better performance as compared to its peers and having a comparatively higher profitable business model.

Exhibit 27: PE(x) premium / discount to peers 5 STL/UVC STL/FNXC 4 3 2 1 0 ‐1 07 08 09 08 09 07 08 09 10 08 09 07 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ Jul Jul Jul Jan Jan Jan Oct Oct Oct Apr Apr Apr Source: Bloomberg, Networth Research

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Exhibit 28: Porter’s Five force model for Optical fiber industry

New Market Entrants: High technology acts as entry barrier High payback period (7‐8 years) for greenfield project Some economies of scale High barrier to entry

Buyer Power: Supplier Power: Competitive Large no of buyers High degree of differentiation Rivalry: Dependent on a few (6‐7) of inputs (silicon) Few large firms players globally Absence of substitute inputs present in the industry Difficult to integrate backward Few suppliers High product with high end technology High bargaining power of differentiation Uniqueness of optical fiber suppliers Neutral competitive and cables rivalry Low bargaining power of buyers

Threat of substitutes: Demand for optical fiber and cables in line with demand for higher bandwidth services High level of product differentiation as compared to copper cables

Source: Company, Networth Research

Porter’s five force analysis: New market entrants – The optical fiber industry requires significant capex for full integration, about USD7/km for a brownfield project and USD12‐13/km for greenfield project. Hence the payback period for new entrants would be about 7‐8 years. Also the technology used is not easy to develop indigenously. Thus the entry barrier is high for this industry. Bargaining power of buyers – There are a large no of buyers who are dependent on only 6‐7 global players. Since it is difficult to integrate backwards for fiber optic cable players, the demand for their product will percolate to these few global players. Thus the buyers have low bargaining power. Bargaining power of suppliers – The input, silicon and silicon tetrachloride, has high degree of differentiation and cannot be substituted. Also the no of suppliers being few, they have a high bargaining power. Threat of substitutes ‐ The demand for optical fiber and cables grow in line with the demand for higher bandwidth services. Also since copper telecom cables cannot be used for higher bandwidth services, there is a high level of differentiation between the two. Thus the industry has very low threat of substitutes. Competitive rivalry – The high product differentiation will mitigate the presence of large international players to bring competitive rivalry to a neutral scale. Based on our analysis of Porter’s Five Force Model we find the industry being very attractive Hence the company’s presence should carry a premium over peers.

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STL has outperformed BSE Midcap index post July09 period owing to good quarterly performance. Exhibit 29: STL has outperformed BSE Midcap index since July09 250

200

150

100

50

0 09 09 08 08 09 07 07 08 09 09 08 08 09 07 07 08 07 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ Jun Jun Jun Oct Oct Oct Apr Apr Apr Feb Feb Dec Dec Dec Aug Aug Aug BSE Midcap index STL

Source: Bloomberg, Networth Research

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Key risks and concerns

 Delay in expansion of wireless and higher bandwidth requiring services, may lead to a lower demand for the company’s products.  Slowdown in China and India, where the company is currently focused, will result in slower growth in revenues than expected.  Overcapacity in the conductor segment, may lead to a pressure on prices.  Volatile commodity prices and currency fluctuation may result in depressed profits.

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Financial Summary

Income Statement (Rs.mn) Ratios Y/E March FY08 FY09 FY10E FY11E FY12E Y/E March FY08 FY09 FY10E FY11E FY12E Net Sales 16,858 22,892 26,721 33,250 39,617 Per share data Growth(%) 35.8 16.7 24.4 19.1 EPS (Rs) 15.6 13.6 28.7 32.3 40.4 Dividend Per Share (Rs) 1.0 1.3 1.5 1.8 2.0 Operating Expense 14,929 20,551 23,331 28,886 34,368 Inc/(Dec) in Stock (214) 550 (802) (333) (1,307) Dividend Payout Ratio (%) 0.1 0.1 0.1 0.1 0.1 Sales per share (Rs) 261.5 354.7 413.6 424.4 505.6 Cost of Materials 12,393 16,525 19,506 23,708 28,920 Cash per share (Rs) 13.8 12.1 16.2 36.7 77.5 Employee Expenses 419 491 668 898 1,070 BV per Share (Rs) 186.6 173.2 199.6 209.1 247.8 Selling & Distribution 575 756 989 1,297 1,505 EV per Share (Rs) 462.1 437.9 434.2 395.7 356.2 Administration & General 370 556 721 898 1,070 Profitability (%) Research & Development 48 60 70 87 103 OPM 11.5% 10.2% 12.7% 13.1% 13.2% Other Expenses 1,338 1,612 2,179 2,332 3,007 NPM 6.0% 3.8% 6.9% 7.6% 7.9% EBITDA 1,929 2,342 3,389 4,365 5,249 ROI 13.5% 17.1% 21.9% 22.4% 23.2% Growth 21.4 44.8 28.8 20.3 ROE 18.7% 14.2% 23.5% 21.4% 21.3% Turnover Depreciation & Amortisation 372 425 564 691 737 Days Payable 70.3 57.3 70.0 70.0 70.0 EBIT 1,620 1,916 2,825 3,674 4,513 Days Receivable 112.4 87.0 87.0 80.0 70.0 Interest 360 880 450 419 428 Days Inventory 65.8 21.5 20.0 20.0 20.0 EBT 1,260 1,036 2,376 3,255 4,085 Fixed Asset Turnover (x) 3.0 3.5 3.2 3.4 4.0 Other Income 43 42 94 116 139 Inventory Turnover (x) 7.7 22.8 26.1 26.0 26.2 PBT 1,303 1,078 2,469 3,372 4,223 Leverage Current Tax 297 193 617 843 1,056 D/E (x) 1.2 0.8 0.6 0.4 0.3 PAT 1,006 885 1,852 2,529 3,167 Interest Coverage (x) 4.5 2.2 6.3 8.8 10.5 Exceptional Items ‐ ‐ ‐ ‐‐ Valuation P/E (x) 23.0 26.4 12.6 11.2 9.0 PAT after Exceptional Items 1,006 885 1,852 2,529 3,167 P/BV (x) 1.9 2.1 1.8 1.7 1.5 Growth (12.0) 109.2 36.6 25.3 EV/EBITDA (x) 15.0 11.7 8.0 6.9 5.1 Minority Interest (0.4) 1.9 4.0 5.4 6.8 EV/Sales (x) 1.7 1.2 1.0 0.9 0.7 PAT after Minority Interest 1,007 883 1,848 2,523 3,161 Dividend Yield (%) 6.4 9.2 5.2 5.5 5.0

Balance Sheet (Rs.mn) Cash Flow Statement Y/E March FY08 FY09 FY10E FY11E FY12E Y/E March FY08 FY09 FY10E FY11E FY12E Sources of Funds: 12,433 11,764 13,590 17,191 20,301 Cash & Cash Eq.at Beg of the yr 1,110 892 882 1,048 2,891 Net Worth 5,395 6,212 7,894 11,735 14,712 Net Cash from Oper. Act. 582 3,832 2,473 2,650 3,785 Equity Capital 322 323 323 392 392 Net Cash Used in Invest. Act. (1,342) (2,149) (2,074) (1,788) (605) Upfront payment against ‐ Net Cash Used in Fin. Act. 651 (1,763) (131) 981 (78) share warrants ‐ ‐ 369 ‐ ‐ Net Inc/(Dec)in Cash & Cash Eq. (109) (79) 269 1,843 3,103 Employee stock option ‐ Cash & Cash Eq .at end of the yr 892 779 1,048 2,891 5,994 outstanding 57 53 ‐ ‐‐ Reserves & Surplus 5,015 5,837 7,571 11,343 14,320 Minority Interest 25 27 31 36 43 Borrowings 6,632 4,966 4,997 4,655 4,754 Deferred Tax Liability 381 560 668 765 792 Application of Funds: 12,433 11,764 13,590 17,191 20,301 Gross Block 9,189 9,762 12,262 15,012 16,012 Depreciation & Amortisation 3,950 4,309 4,873 5,564 6,300 Capital WIP 362 1,114 1,045 380 250 Net Block 5,601 6,567 8,434 9,829 9,962 Goodwill 24 24 24 24 24 Investments 61 927 662 482 355 Current Assets 9,963 9,251 10,820 14,341 18,498 Inventories 2,194 1,004 1,025 1,281 1,513 Debtors 5,191 5,459 6,369 7,288 7,598 Cash & Bank Balances 892 779 1,048 2,891 5,994 Loans & Advances 1,686 2,009 2,378 2,881 3,394 Current Liabilities & 3,218 5,005 6,352 7,485 8,539 Provisions Liabilities 3,035 4,791 6,110 7,185 8,207 Provisions 182 214 242 300 332 Net Current Assets 6,745 4,246 4,468 6,856 9,960 Misc Expenses 1 1 0 0 0

Source: Company, Networth Research

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Networth Research: E‐mail‐ [email protected] Satish Pasari Head‐ Institutional Business [email protected] 022‐22823225/22840219

Institutional Research Team

Anand Dama Banking & Financial Services [email protected] 022‐30286391 Sanjeev Hota IT / Education [email protected] 022‐30286407 Ashwani Sharma Power / Capital Goods [email protected] 022‐30286389 Kanika Bihany Engineering / Capital Goods [email protected] 022‐39517618 Gaurav Soni Cement [email protected] 022‐39517618 Chintan Mehta Metals/mining [email protected] 022‐30281580 Rupali Nambiar Economy [email protected] 022‐39517620

Derivative & Technical Team

Akshata Deshmukh Sr. Technical & Derivatives Analyst [email protected] 022‐39517632 Manoj Karnani Sr. Manager – Derivatives [email protected] 022‐22840219 Amol Shrivastava Derivatives Analyst [email protected] 022‐39517638 Ankit Bhat Research Associate [email protected] 022‐39517638 Quantitative Research

Shubha Aggarwal Research Analyst [email protected] 022‐30281580 Ritesh Jain Research Analyst [email protected] 022‐30281580

Networth Institutional Sales: E‐mail‐ [email protected]

Prakash Diwan Head‐Institutional Sales & Strategy [email protected] 022‐30286403/30286389 Nilesh Sangani AVP – Institutional Sales and Dealing [email protected] 022‐30286403/39517635 Ronak Maniar Institutional Sales and Dealing [email protected] 022‐30286403/39517635 Shalaka Jadhav Sr. Manager ‐ Institutional Sales & Dealing [email protected] 022‐22840217/39517636 Key to NETWORTH Investment Rankings Buy: Upside by>15, Accumulate: Upside by +5 to 15, Hold: Upside/Downside by ‐5 to +5, Reduce: Downside by 5 to 15, Sell: Downside by>15

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Regd. Office:‐ 2nd Floor, D. C. Silk Mills Compound, Kondivita Road, Opp J.B. Nagar Market, Andheri (E), Mumbai ‐ 400059. Tel Phone nos.: 022 – 30641600

Corporate Office: ‐ 1/A/A, Ground Floor, Mittal Court, “A” Wing, 224, Nariman Point, Mumbai – 400021. Tel Phone nos.: 022 ‐ 30286389 Fax nos.: 022 ‐ 22836306

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