Institutional Equities Sector Report

Potential 5-baggers in 5 years

Analyst October 2006 Amar Ambani [email protected] 91-22-6749 1739

Institutional Sales Sandeepa Arora [email protected] 91-22-6749 1776 India Under ‘Construction’

Index

Particulars Page no. Investment summary 3 Our top picks 6 Need for investments in infrastructure development 8 Factors favoring India’s infrastructure boom 10 Industry classification 17 Investments in ‘infrastructure development’ to remain robust 18 Performance of construction stocks 19 Will this rise be sustainable? 20 Hefty order flows expected for construction majors 21 Funding issues reasonably under control 22 Overseas opportunity 25 Key success factors 26 Valuations in the sector 29 Concerns 32 Company section 35 - Gammon India Ltd 36 - Hindustan Construction Company Ltd 49 - Nagarjuna Construction Company Ltd 67 - IVRCL Infrastructures & Projects Ltd 78 - Patel Engineering Ltd 91 - Simplex Infrastructures Ltd 105 - Era Constructions (India) Ltd 115 - Valecha Engineering Ltd 126 Annexures Industry overview 137 Segmental overview 140 Infrastructure investments - Roads 141 - Power 145 - Water and irrigation 149 - Railways 153 - Airports 157 - Ports 161 Industrial investments - Oil and gas 164 - Pipelines 170 - Metals 172 Real estate investments 176 Notes 185

October 18, 2006 Construction Sector 2 India Under ‘Construction’

India is under construction and it is visible all over - houses, roads, ports, power plants et al. Favorable policy environment and easy flow of capital is helping India to build and improve its woefully poor and inadequate infrastructure. Order books of all construction companies are overflowing and we see a sustained revenues growth of 40-50% pa for at least next 5 years. Investors can have a double windfall, as rising EPS quarter after quarter invariably leads to P/E re-rating (see Case Study on Software Services IT sector on Page 4). We do not want to build- in euphoric re-rating of IT sector the way it happened in the late 90s, but even with a reasonable PEG of 0.8x, we have 8 companies that can potentially be 5- baggers over the next 5 years.

We met several companies and government officials and have attempted to present data and analysis as concisely as possible in this report. The buoyant mood prevalent was put in words quite well by a director of a large construction company ‘Just the requirements of DLF, already planned can keep Gammon, HCC, NCC and IVRCL fully booked for 2 years.’

Investment Summary

Woefully inadequate infrastructure requires investments We expect US$180bn of Infrastructure in India is woefully inadequate and manifests itself in myriad ways investments in infrastructure in our daily lives – be it traffic jams or jam-packed trains or delayed flights or load over next 3 years shedding or goods stuck in ports or roads with pot holes. Even Urban infrastructure is crumbling and needs rejuvenation. These calls for immediate investments, that too over the next 10 years if India has to realize its dreams of being an economic The construction sector is the power house. We expect US$180bn of investments in infrastructure over the biggest beneficiary of the next three years. The construction sector, accounting for 65% of the total capex spend investment on infrastructure development, has been the biggest beneficiary of the capex spend.

Conducive policy environment to boost infrastructure investments The political will and improved situation of central and state government finances have contributed to the rise in spend on infrastructure development. Political differences with reforms across political parties are reducing. The common man holds the local government answerable for fulfilling his needs for Bijli, Sadak, Pani (Power, Roads and Water). Media coverage and recent RTI Act has further empowered the common man. The Left bastion in West Bengal is also talking of infrastructure and economic development. Airport privatization in Mumbai and Delhi was pushed through in spite of opposition. We believe that current policy environment is conducive to infrastructure development and even if the political power equations change, investments will continue.

Overflowing order book position Construction companies have Most Indian construction companies have built engineering and project order books in the region of management skills to garner the lion’s share of this spend. The construction sector 3.5-6.5x turnover is expected to witness 10-12% growth in the coming years on the back of high investments on infrastructure development. We believe that India has barely A lot still needs to be done: scratched the surface. China has been spending over 6.5% of its GDP on China spends nearly 4x construction, for the last 10 years. In India’s case, construction spend stood at 4.5-5.8% of GDP prior to 1999-00 and reached 6% only in the last few years. India’s spend on construction China’s spend on construction is nearly 4x of India’s spend. The amount of development planned by real estate companies itself will entail extensive construction work, let aside government orders.

Funding – not a constraint Funding sources identified for With the rising share of construction in total bank credit and greater clarity having a major portion of emerged with sources identified for a major portion of investments, funding issues investments in most sectors are reasonably under control. Innovative measures like cess on petroleum products, privatization through BOT, budgetary support, borrowings from multilateral agencies and a buoyant capital market have helped. We do not envisage any funding bottlenecks to derail investments in infrastructure.

October 18, 2006 Construction Sector 3 India Under ‘Construction’

Valuations attractive – earnings visibility over a long period We are overweight on the construction sector and believe valuations to be attractive. The sector offers high visibility with huge investments in the pipeline and order book of companies at 3.5-6.5x current turnover. Construction companies in India are scaling up fast and are expected to attain considerable size going forward.

We believe that the sector is placed to exploit the infrastructure spend, just like software services in mid 90s exploited the Y2K bug. There is considerable scope for a second round of re-rating, just like what happened to software services in the last decade. In the beginning, software services was compared to low value, manpower contracting. Strong revenue growth not only led to EPS growth on a quarter on quarter basis, but also drove multiple expansion. We expect the same story to repeat in the construction sector also.

We recommend investors to overweigh this sector and build a portfolio of stocks in construction universe. Our top picks are Simplex Infrastructures (CMP Rs333), Hindustan Construction (CMP Rs128), Nagarjuna Construction (CMP Rs175), Gammon India (CMP Rs385), Patel Engineering (CMP Rs361) and IVRCL Infrastructures (CMP Rs287) among large caps and Valecha Engineering (CMP Rs208) and Era Constructions (CMP Rs358) in mid caps, in that order.

Case Study – Will IT repeat in construction?

Scope for continuous re-rating The comparison with software services is compelling. 15 years ago, the software services industry in India comprised small sized companies doing low value added “body shopping” - manpower contracting, with strong investor concerns on quality of management. When India Infoline Ltd (then Probity Research and Services Pvt Ltd) came out with our seminal report on Indian Software Services Industry in 1998, it was met with huge skepticism. Investors and analysts used to ask questions like: Ö How will Infosys manage 10,000 employees? Ö Is software services not a manpower multiplication game? Ö ICDs of Company X have bounced. Ö Shady management - This in fact was the most common refrain from investors not willing to buy the huge growth story.

Y2K changed the landscape Strong qoq performance led Thanks to the Y2K boom, IT companies scaled up aggressively. They not only to EPS and P/E expansion became “professional”, but also set standards for corporate governance and transparency. Strong quarter-on-quarter performance for years, not only led to an expansion in EPS, but also in P/E. From times, when the sector traded at a discount to the market index, it started trading at a premium.

A similar trend and sequence of events can be observed, taking place with the construction sector. A few years back, construction companies were trading at low multiples with reservations on management quality. Today, the opportunity at hand has worked in favor of these companies. They have geared up and possess the competitive ability and people to undertake complex jobs.

Earnings performance has already resulted in a re-rating in the sector over the last 2-3 years. Revenue visibility still continues to be high and we project EPS growth to drive a second round of P/E expansion. No doubt, these companies will raise capital, still they will be EPS accretive.

October 18, 2006 Construction Sector 4 India Under ‘Construction’

Sensex and Infosys P/E compared

P/E over 200x - Massive Out-performance

70.0 The meltdown Earlier days Infosys stock 60.0 Discount to Discovered fell sharply in Sensex Y2K 50.0 one day

(x) 40.0 30.0

20.0

10.0

- Jun-93 Jun-95 Jun-97 Jun-99 Jun-01 Jun-03 Jun-05 Sensex Infosys

Sensex and HCC P/E compared

50.0

40.0

30.0 We believe

(x) construction 20.0 sector poised for a re-rating 10.0

- Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Sensex HCC

Source: Bloomberg, India Infoline Research

October 18, 2006 Construction Sector 5 India Under ‘Construction’

Our Top Picks

We have covered eight companies that are poised for growth and are trading at attractive valuations. To factor in BOT ventures, land bank value and investment in subsidiaries along with the core construction business, a sum of parts valuation approach is used. A history of successful completion of projects indicates project execution skills of management. A diversified portfolio ensures continuity in order flow, in case a particular vertical goes out of favor.

Large BOT assets Gammon India is one of the oldest and largest construction companies in India with uninterrupted profitability for the last 32 years. It is one of the largest owners of infrastructure assets with nine BOTs. Its order book/sales at 6.6x is one of the highest among peers. We expect a CAGR of 54% in topline during FY06-08.

Large ticket order focus Hindustan Construction is one of the oldest and largest construction companies in the country. It’s order book jumped by 79.7% yoy during FY06 in line with its strategy of rapid augmentation of turnover and focus on large ticket orders. We expect the Lavasa project to be value accretive and assign Rs24.1 per share to this project. CAGR of 42.2% in net sales and 60.5% in PAT expected during FY06-08.

To benefit from roads and Nagarjuna Construction is expected to benefit from the high investment in road and water verticals. It was an early entrant in the BOT space and enjoys water verticals a good mix with eight BOTs, including two real estate ones. We expect a CAGR of 48.9% in turnover and 50% in net profit, backed by a well diversified order book/sales of 3.4x.

IVRCL Infrastructures has the best prequalifications in water and environment Best prequalifications in the segment. The acquisition of Hindustan Dorr-Oilver will enable IVRCL to leverage water segment capabilities in the water segment. The three toll based road projects in its portfolio are expected to earn an IRR of 21-23% and the IPO of IVR Prime Realty is likely to unlock value. We estimate IVRCL to witness a CAGR of 53.4% in topline and 55.6% in profit between FY06-08.

Patel Engineering is a dominant player in the hydropower space with a 22% Dominant hydropower player market share. It has an order book/sales of 4.2x and is moving up the value chain by bidding for independent power projects in hydropower and lumpsum turnkey projects in irrigation. It also won its maiden annuity project in roads. We expect a CAGR of 36.3% in sales and 45.4% in profit during FY06-08.

Simplex Infrastructures is a 82-year old company with a profit making record Big plans overseas since inception and a diversified portfolio of orders at Rs47bn. Along with new verticals that it plans to enter, the company targets 40% of its revenues from overseas in the next four years. We expect a CAGR of 45.4% in topline and 63.2% in bottomline, backed by an order book/sales of 3.5x.

Era Constructions is a mid-sized player with a high presence in the NCR region Subsidiaries to add value and Rs15bn order book, translating into 4.8x sales. It witnessed extensive order intake during the last 12 months, which is a sign of high growth to come. We expect a CAGR of 76.8% in turnover and 58.5% in PAT during FY06-08. ECIL’s two subsidiaries in pre-engineered buildings and real estate to add value.

Valecha Engineering is a mid-sized player primarily into road construction, Value BUY comfortably placed with an order book of 5.5x FY06 turnover. It has a strong investment portfolio in Jyoti Structures translating into Rs57 per share, checking any downside to the stock. Valuations attractive at 1.3x book value with a market cap/sales of 0.95x. We expect a CAGR of 57.4% in sales and 80.2% in PAT during FY06-08.

October 18, 2006 Construction Sector 6 India Under ‘Construction’

Recommendation and target price (Rs) CMP# Recommendation Core BOTs Investments Target Upside FY08E FY11E 5-Year Business +Land price (%) EPS EPS* Target Bank (Total) price** Gammon 385 BUY 396 58 - 454 17.9 18.0 44.4 1,243 HCC 128 BUY 132 2 26 160 24.9 8.5 21.0 587 NCC 175 BUY 170 25 11 206 17.6 11.3 27.8 779 IVRCL 287 MARKET PERFORMER 242 22 43 307 7.0 18.8 46.4 1,298 Patel 361 MARKET PERFORMER 402 8 - 411 13.6 26.0 64.0 1,793 Simplex 333 BUY 459 - - 459 37.8 25.8 63.4 1,774 Era 358 MARKET PERFORMER 381 21 10 411 14.9 28.7 70.6 1,978 Valecha 208 BUY 255 - 38 294 41.1 19.7 48.5 1,358 Source: India Infoline Research * Assumed EPS CAGR of 35% ** Assumed PEG of 0.8x, # Prices as on 13th Oct 2006

Financial and valuation summary Year Turnover EBIDTA PAT EPS Order book/ P/E EV/EBIDTA ROCE RONW Sales (Rs mn) (Rs mn) (Rs mn) (Rs) (x) (x) (x) (%) (%) Gammon India FY06 (15mts) 14,851 1,932 1,028 9.3 6.6 40.0 17.2 14.0 11.1 FY07E 20,458 1,914 1,089 12.3 3.8 30.2 18.0 11.4 10.6 FY08E 31,250 2,948 1,596 18.0 2.5 20.6 12.7 13.7 13.6 Hindustan Construction FY06 19,870 1,829 848 3.3 4.6 38.6 19.5 9.5 7.8 FY07E 28,348 2,533 1,432 5.6 3.2 22.8 14.8 14.2 8.6 FY08E 40,151 3,626 2,183 8.5 2.3 15.0 11.3 18.3 11.3 Nagarjuna Construction FY06 18,404 1,641 1,039 10.1 3.4 17.4 12.1 11.1 11.0 FY07E 28,437 2,524 1,555 7.5 2.2 23.2 15.7 13.2 14.6 FY08E 40,795 3,701 2,337 11.3 1.5 15.5 11.1 16.0 18.6 IVRCL Infrastructures FY06 14,957 1,343 930 8.7 4.5 33.0 26.1 12.1 19.5 FY07E 24,286 2,192 1,485 12.4 2.8 23.1 17.0 14.6 17.1 FY08E 35,205 3,280 2,251 18.8 1.9 15.2 11.6 17.9 21.0 Patel Engineering FY06 10,223 1,321 742 14.7 4.2 24.7 15.8 18.7 37.0 FY07E 14,031 1,735 1,070 17.7 3.1 20.4 12.2 13.4 14.8 FY08E 19,003 2,488 1,568 26.0 2.3 13.9 9.0 16.7 16.7 Simplex Infrastructures FY06 13,446 1,181 416 9.7 3.5 34.4 15.5 14.3 17.9 FY07E 20,297 1,801 784 18.2 2.3 18.3 10.4 18.9 25.9 FY08E 28,432 2,375 1,109 25.8 1.7 12.9 8.1 20.8 27.7 Era Constructions FY06 3,108 489 264 14.2 4.8 24.6 13.0 14.0 11.0 FY07E 6,106 763 398 17.2 2.5 20.2 11.1 14.7 11.9 FY08E 9,716 1,256 663 28.7 1.5 12.1 7.4 18.6 16.8 Valecha Engineering FY06 1,514 111 52 7.5 5.5 27.7 12.6 5.8 4.4 FY07E 2,265 162 95 11.1 3.6 18.7 10.2 7.3 6.0 FY08E 3,750 268 169 19.7 2.2 10.5 5.1 11.3 9.9 Source: India Infoline Research Gammon FY06 EPS annualized, NCC FY07 EPS ex bonus October 18, 2006 Construction Sector 7 India Under ‘Construction’

Need for investments in infrastructure development

Infrastructure development is an integral aspect for consideration, encompassing Infrastructure development is a wide spectrum of sectors and verticals including housing, roads, irrigation, a precondition to growth railways, airports, commercial set ups like malls, offices, telecom among others. In other words, infrastructure development becomes the basic input for socio- economic development.

The construction industry (accounting for 65% of the ‘infrastructure development’ spend) has a high trickle down effect and a positive domino effect on supplier industries, thereby pioneering economic development. Demand for a host of sub- industries like cement, steel, tiles, paint, chemicals, fixtures and fittings comes from the construction sector. It supports 32 upstream and 72 downstream industries. Construction is the second largest economic activity in India after agriculture, accounting for 6% of India’s GDP (current prices) and 50% of the gross fixed capital formation (GFCF).

Construction as percentage of GDP in India

6.5

6.0 5.5

5.0

(%) 4.5

4.0 3.5

3.0 1970-71 1972-73 1974-75 1976-77 1978-79 1780-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03 2004-05

Source: Centre for Monitoring Indian Economy, India Infoline Research

In the earlier years, the spend on infrastructure was low and led to a decline in the share of the construction to 34% in GFCF in 1990-91 from 60% in 1970-71, resulting in a low GDP growth of 3-4% during that period.

The year 1991 saw implementation of India’s first generation economic reforms. The key reforms undertaken by the government focused on fundamental economic reforms, deregulation of industry, privatization programme for disinvestment of public sector units and favorable policies encouraging foreign investment. This was followed by a host of other reforms, which catapulted India’s GDP growth to over 6% on an average, making it one of the fastest growing economies in the world over the past 10-12 years.

October 18, 2006 Construction Sector 8 India Under ‘Construction’

Average GDP growth comparisons during 1993-2003 India’s GDP growth trend

9.0 8.5 8.4 10.0 8.9 9.0 8.0 7.5 8.0 7.0 7.0 6.2 5.8 6.0 6.0 5.3 5.5 5.0 4.6 5.0 4.4

(%) 3.5 3.8 3.8 4.0 2.9 3.3 (%) 4.0 2.5 3.0 3.0 2.0 1.3 0.9 2.0 1.0 - 1.0 - UK USA India Chile FY01 FY02 FY03 FY04 FY05 FY06 Brazil China Japan Korea Russia Thailand Australia Malaysia

Source: United Nations Statistical Division Source: Central Statistical Organization

The government intends on maintaining this momentum during the 11th five year plan as well. This cannot be achieved without a substantial spend on infrastructure development. Else, a rising population will take a toll on the nation and the inadequate infrastructure will cause an over-burdening effect and a consequent systemic failure in the economy.

Infrastructure development creates the physical foundation of economic prosperity and the output becomes the asset of the nation. Infrastructure development improves the standard of living and is a pre-condition to achieve economic progress. Cases elsewhere in the world too, reveal that no world economy has seen a sustained period of economic development without a heavy and sustained dose of investment in infrastructure.

October 18, 2006 Construction Sector 9 India Under ‘Construction’

Factors favoring India’s infrastructure boom

Political will and improved state of affairs The inadequate spend on infrastructure development in the past was on account of the lack of political will. The realization has now dawned that a poor infrastructure would prove to be a key constraint to India’s progress. The reform process was kicked off a few years’ back with all parties commonly agreeing that it is the need of the hour. As a result, a change at the centre too, is not likely to hamper the rapid pace of ‘infrastructure development’.

The Fiscal Responsibility and Budget Management Act (FRBMA) aims to focus on improving the government’s financial situation. The act targets a reduction in Ratio of GFD/GDP has been the gross fiscal deficit (GFD) as a percentage of GDP, primarily through higher declining – signs of improving tax collections and containment of revenue expenditure. This ratio has witnessed finances an improvement over the last few years in line with the target set by the Prime Minister take the it to 3% of GDP by FY08.

Improvement in central government finances

6.5 GFD as a % of GDP 6.2 6.0 5.9 5.7 5.5 5.4 5.0 5.1

(%) 4.8 4.5 4.5 4.5 4.3 4.0 4.1 3.5 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2005-06 BE 2004-05 RE

Source: Centre for Monitoring Indian Economy RE – Revised Estimates, BE – Budget Estimates

State governments are initiating steps for improvement in their respective Financial situation of state finances as well. The state budgets for 2006-07 proposed various policy governments improving as initiatives to advance the practice of fiscal correction and consolidation through well broad basing and rationalization of the tax system. A change can be observed in the balance sheets of many state governments. Improving position of state governments in India

600600 1414 daysdays intermediateintermediate T-BillsT-Bills investmentinvestment 5.0 GFD of states as a % of GDP outstandingoutstanding 4.5 4.3 500500 4.0 3.5 3.5 400400 3.2 3.0 2.7 300300 2.5 (%)

(Rs bn) (Rs bn) 2.0 200200 1.5 100100 1.0 0.5 -- - MarMar MarMar MarMar MarMar MarMar AugAug 2000- 2004-05 2005-06 2006-07 0202 0303 0404 0505 0606 0606 2004 (Avg) RE BE

Source: Reserve Bank of India The improved position will enable the government to continue its focus on infrastructure development.

October 18, 2006 Construction Sector 10 India Under ‘Construction’

Policy roadmap in place, authorities nominated … To keep a check on the activity in each segment, the government has in the Steps taken to establish past, or is in the process of nominating authorities. The National Highway healthier policies with added Authority of India (NHAI), Ministry of Power, Ministry of Shipping, Telecom transparency for most sectors Regulatory Authority of India (TRAI), among others have been set up to oversee development in specific verticals.

The present government has unveiled the Bharat Nirman programme, the core activity being development of rural roads. Housing initiatives too, have been taken, which will lead to significant order flows for construction. The government has also taken up certain policy initiatives to boost the prospects of a number of segments. The New Civil Aviation Policy, Electricity Act 2003, National Maritime Development, New Exploration Licensing Policy and many more have been announced. The government has also taken steps to establish healthier policies with added transparency, giving players and investors, a higher timeline visibility.

Status of key infrastructure projects Sector Subject Regulator Key awaited Key ongoing FDI Limit policy project (%) Power Central/State Present National Tariff Policy APDRP/ RGGVY 100 Telecom Central Present National Telecom Policy - 74 Oil and Gas Central/ State Absent PNGRBB/ Gas Pipeline Policy - - Roads and Bridges Central/State Absent - NHDP, PMGSY 100 Urban Infrastructure State Absent - JNNURM, ARWSP,AUWSP 100 Railways Central Absent - IRMP, NRVY - Ports and Shipping Central/State Present Maritime Policy Port Connectivity Project 100 Civil Aviation Central Absent New Civil Aviation Policy - 49 Source: Indian Infrastructure, India Infoline Research PNGRBB – Petroleum Natural Gas Regulatory Board Bill, APDRP – Accelerated Power Development and Reform Programme, RGGVY – Rajiv Gandhi Grameen Vidyutikaran Yojana, NHDP – National Highway Development Programme, IRMP – Indian Railways Modernization Programme, NRVY – National Rail Vikas Yojana, PMGSY – Pradhan Mantri Gram Sadak Yojana, JNNURM - Jawaharlal Nehru National Urban Renewal Mission, ARWSP - Accelerated Rural Water Supply Programme, AUWSP - Accelerated Urban Water Supply Programme

… Project reach enlarged In-principal approval received The government has reviewed the progress of the various projects across in roads. Other areas like sectors and enlarged the scope for some of them. For instance, encouraged by privatization of airports, the success of the Golden Quadrilateral (GQ), the government has increased freight corridor for railways the scope of NHDP by involving seven phases entailing the building, upgradation taken up and maintenance of over 50,000kms of roads. The government at the centre had approved phase-I (GQ), phase-II, which is the North-South and East-West (NSEW) corridor and phase-IIIA, totaling 18,279kms. The cabinet has now given in-principle approval for phase-IIIB to phase-VII.

Other initiatives like privatization of the Mumbai and Delhi airports, steps to set up power plants and development of a freight corridor for railways, are taken up as well.

October 18, 2006 Construction Sector 11 India Under ‘Construction’

Commercial viability of establishments in focus Realization has dawned that a Political interference resulted in a wide gap between user charges and the cost blend of both is required: of running infrastructure utilities in the past, with the former levied far below social cause and profit motive the economic cost of the project. This was a result of a mindset that ‘infrastructure development’ was purely a public service. Subsidies resulted in losses and stiffening off funds was a widespread practice. The fact that development can only work successfully if a blend of both exists, ie social cause as well as profit motive, has now dawned upon the policy makers.

In line with this, efforts to improve the commercial viability of projects have been taken. This can be seen from the improving profitability of the railways, rise in revenues of port authorities and reduced state electricity board (SEB) losses. The central government has taken active steps to push through the concept of charging the user for services. Today, it is a well accepted practice with little or no resistance and has become the accepted style of functioning.

Financial snapshot of Indian Railways (Rs bn) 2003-04 2004-05 2005-06 (RE) 2006-07 (BE) Goods traffic 276 308 365 403 Passenger traffic 133 141 151 168 Others 20 25 31 29 Gross traffic receipts 429 474 547 600 yoy (%) 10.4 15.5 9.6 Net railway revenue 45 53 80 85 yoy (%) 17.8 51.2 7.2 Source: Centre for Monitoring Indian Economy

Financial snapshot of major ports (Rs mn) 2003-04 2004-05 yoy (%) Total income 4,723 5,444 15.3 Total expenditure (4,089) (4,659) 13.9 Net surplus 634 785 23.8 Net surplus margin (%) 13.4 14.4 Source: Centre for Monitoring Indian Economy Includes Chennai, Cochin, Jawarharlal Nehru, Kandla, Kolkata & Haldia, Mormugao, Mumbai, New Mangalore, Paradip, Tuticorin and Visakhapatnam

Novel funding schemes Levy of ‘user charges’ – Realizing that it was impossible to fund the total requirement on its own, the accepted practice government resorted to means like levy of cess, external assistance grants from international agencies like the World Bank, loans and market borrowings. Fuel cess used in road segment, multilateral Phase-I and phase-II in roads, which have witnessed major investments, are assistance provides timely to be funded by a cess on motor spirit and diesel for 37% of the total investment help in them.

We use roads and highways, as an example to drive home the point of innovative measures used. Investments in roads and highways have been funded, by more than 50% of total NHAI funding, by the levy of cess during the last 2-3 years. Funding was increased with a 50 paise rise on petroleum cess announced in the budget. Cess funding has witnessed a CAGR of 12.8% during the year 2000 to 2006.

October 18, 2006 Construction Sector 12 India Under ‘Construction’

NHAI funding pattern (Rs mn) Fuel cess External assistance Loan Market grant borrowings Year 2000 10,320 4,920 - - 2001 18,000 4,610 1,200 6,570 2002 21,000 8,870 1,130 8,040 2003 20,000 12,020 3,010 55,930 2004 19,930 11,590 2,900 - 2005 18,480 12,390 3,610 - 2006 (up to Nov 2005) 24,000 18,000 4,500 100 Source: National Highway Authority of India

While NHDP phase-I and phase-II were primarily funded by a cess, other funding PPP eases strain on methods like external assistance and loans are gaining importance. External government finances assistance grant formed 38.6% of the total NHAI funding in 2006 (up to November 2005), as compared to 13.2%, 33.7% and 35.9% in 2003, 2004 and 2005 respectively.

Another innovative method was roping in the private sector players through contracts awarded on Build Own Operate Transfer (BOOT) and Build Own Transfer (BOT) basis. Due to the initial success of the BOT concept, where toll is collected (in case of roads) from users, the government has revealed its intention to implement phase-III to phase-VI, excluding phase-IV on BOT basis. Similarly, in sectors like oil & gas, ports and telecom, majority of the investment is expected to be supported by use of a mix of debt and equity by the private and public sector companies. The government is now mulling over levy of a special tax on air travel for airports as another means of funding infrastructure.

Benign interest rate scenario Advent of soft interest rates The advent of soft interest rate regime improved the viability of most regime infrastructure projects, which seemed unviable, even for projects with an internal rate of return (IRR) of 13-17%, in the 1990s. Banks too, have increased their exposure to the infrastructure sector. Demand for housing picked up as well with rising income levels and easy access to loans at cheap interest rates.

Trend in 10-year government yields

16.0

14.0

12.0

10.0 (%) 8.0

6.0

4.0 9/30/1991 9/30/1992 9/30/1993 9/30/1994 9/30/1995 9/30/1996 9/30/1997 9/30/1998 9/30/1999 9/30/2000 9/30/2001 9/30/2002 9/30/2003 9/30/2004 9/30/2005

Source: Bloomberg

October 18, 2006 Construction Sector 13 India Under ‘Construction’

Rising private sector participation Opening up of verticals, clear The involvement of the private sector in infrastructure development has boosted objectives, concept of grants growth in quantum of investments. All measures mentioned above like political will, and viability gap funding nomination of authorities, policy initiatives, lower interest rates, efforts to bring about induces private sector commercial viability and innovative funding methods have led to keen interest in participation ‘infrastructure development’ by the private sector.

To encourage private sector participation, the government announced a number of measures like tax breaks on investments, return schemes like annuity payments, capital grants for road projects and viability gap funding. The government has tried to ensure financial visibility and a transparent management by stating its intentions and promoting public-private partnerships (PPP) in development; the most popular form being the BOOT/BOT route. Gammon India, NCC and IVRCL have been the early entrants in this space with a sizeable portfolio of BOTs in different verticals.

Some initiatives taken for the promotion of road sector development include: Ö Income Tax exemption under Sec 80 (IA) for 10 years but within 15 years Ö Certain equipment imports for highway construction to be allowed duty free Ö NHDP projects from phase-III onwards would be on BOT basis Ö Up to 30-year concession period for BOT projects Ö Viability gap funding up to 40% to be provided at the discretion of NHAI on a case- to-case basis

However, a lot still needs to be done as private sector participation is low in many sectors. . This is bound to increase in future with new policies like introduction of new civil aviation policy and national maritime development programme.

Expected private sector participation as a percentage Present level of private sector participation of total funding

Sector Level of privatization 100.0 90.0 Telecom High 80.0 Oil & gas Moderate 70.0 Power Low 60.0 Roads Low 50.0 (%) Urban Infrastructure Low 40.0 Ports Low 30.0 20.0 Railways Non-existent 10.0 Airport Non-existent -

Source: Indian Infrastructure Roads Water & Urban SEZ NMDP Irrigation Infra

Source: Industry, Plan Documents, India Infoline Research SEZ – Special economic zones, NMDP – National Maritime Development Policy Funding over FY06-10

State governments play their part … Weak organizational structure and financials were the There has been a deviation in trend post 2003-04, when 80-90% of revenues to a restraining factors in the past construction company were on account of projects initiated by the central government. Today, a number of state governments are contributing with investments in various sectors. The restraining factor for states in the past was a weak organizational structure of state public works departments (PWD), the implementing authority, weak financials and frequent interference from the centre and the bureaucracy that required states to get multiple consents and authorizations for any scheme.

October 18, 2006 Construction Sector 14 India Under ‘Construction’

Certain states like Andhra Pradesh (AP), Gujarat and Maharashtra have taken Initiatives taken by certain initiatives to develop infrastructure by setting up dedicated authorities for states especially in water and implementation, tapping various funding sources, levying motor vehicle taxes irrigation segments and cess and luring private sector players. Water and irrigation, state roads encouraging and bridges, oil and gas, ports, power, urban infrastructure, commercialization through setting up of IT parks, BPO centres, retail and residential initiatives are areas where states have taken the lead.

State initiatives in various segments Segment States Irrigation AP, Maharashtra, Gujarat, MP, Karnataka, Rajasthan Water sanitation and supply Karnataka, Gujarat, Kerala, UP, Delhi and Tamil Nadu Urban mass rapid transport systems Mumbai, Hyderabad and Bangalore River linking MP, UP, others Source: India Infoline Research

Companies like IVRCL, NCC and Madhucon Projects are benefiting from the initiatives by AP on water and irrigation. While some states are mobilizing funds to support development of rural roads, some housing boards are signing agreements with builders to develop properties for slum rehabilitation with basic amenities, through a joint venture with state governments.

Aggregate capital expenditure by states

120

100

80 60 (Rs bn) 40

20 0 AP MP Assam Punjab Jammu Gujarat Karnataka Rajasthan

FY04 FY06 Maharashtra

Source: Reserve Bank of India

… The glut of state action yet to take place State participation yet to take While on the subject, we would like to state that while certain states, mainly off. This is only the tip of the the western and southern ones, have initiated a lot of infrastructure work, iceberg financial imbalance of several state governments not only hampers their capacity to start new ventures, but also causes serious reservations among companies about their repayment capability. State road development corporations, for example, are weighed down by their weak balance sheets and fail to execute jobs on time. While a lot still needs to be done, initiatives by certain state initiatives are seen as encouraging signs and the pace of investments is picking

October 18, 2006 Construction Sector 15 India Under ‘Construction’

Doors to new verticals open A breakdown of the existing order book of the construction companies reveals Roads and irrigation dominate order books the predominance of roads and irrigation projects with little or zero orders from many other verticals, big or small. Over the next few years, we expect a tide of Over the next few years, we investment flow into other verticals like ports, airports, urban infrastructure expect a tide of investment and railways. The housing, commercial and retail boom and capex from the flow in other verticals like corporate world too, will gather healthy momentum in the coming years. More railways, urban and more investments are likely to be routed in new verticals and certain infrastructure, airports and segments like urban infrastructure and irrigation are expected to register higher ports as well. growth than road segment. Having said that, roads will still continue to dominate and enjoy the bulk of the spending. Not just the domestic market, but also demand from the Middle East will drive order books of many construction majors.

Share of verticals in infrastructure segment investment

FY03-FY05 FY06-FY08 Power- Power- Thermal Others Thermal Others 7% 5% Roads Power-Hydel 6% 7% Power-Hydel Roads 33% 6% 11% 34% Railways 8% Railways 9% Urban Irrigation Irrigation Infrastructure Urban 19% 17% 18% Infrastructure 20%

Source: Cris Infac, Plan Documents

Construction is the prime beneficiary of the infrastructure boom as its share forms a major component of the investment in ‘infrastructure development’. We attempt to evaluate the opportunities available for the industry from its various components. In order to do so, we first present our classification for the construction industry.

October 18, 2006 Construction Sector 16 India Under ‘Construction’

Industry classification

We classify investments in ‘infrastructure development’ into three segments namely, infrastructure vertical, industrial and real estate segments. Investments in these sectors will result in orders for construction companies depending on the construction component in each sector. The civil construction component differs from sector to sector. For instance, the proportion of construction component of the total investment in roads 95-100%, for irrigation is 60% and for thermal power is 20%.

Pictorial representation of construction classification

Construction Industry

Infrastructure Industrial Real estate

Roads Oil and gas Residential Irrigation Refineries Water supply Petrochemicals Commercial Airports Food processing Ports Pulp and paper mills Power Metals and mining Railways Pipelines Urban-infrastructure Textiles Telecom Fertilizers

Source: India Infoline Research This list is indicative

We look at the broad growth drivers for each segment and the amount estimated to be spent on each segment for ‘infrastructure development’.

October 18, 2006 Construction Sector 17 India Under ‘Construction’

Investments in infrastructure development to remain robust

The construction sector is expected to register a growth of around 12% for the next few years. The amount estimated to be spent on ‘infrastructure development’ in various sectors for the next three years is given in the table below. Each of these amounts will translate into orders for the construction segment depending on the construction component involved in that particular segment.

Investments in infrastructure development (Rs bn) % of total FY03-FY05 FY06-FY08 CAGR (%) FY03-FY05 FY06-FY08 Infrastructure 1,722 2,229 9.0 25.9 26.8 Roads 557 758 10.8 8.4 9.1 Urban Infrastructure 313 446 12.5 4.7 5.4 Irrigation 296 424 12.7 4.5 5.1 Railways 157 178 4.4 2.4 2.1 Others 400 424 2.0 6.0 5.1 Industrial 414 973 33.0 6.2 11.7 Real Estate 4,504 5,106 4.3 67.8 61.5 Total 6,640 8,308 7.8 Source: Cris Infac, Plan Documents

Infrastructure vertical to witness 9% CAGR Roads will drive bulk of the spending during the next three years as it did during FY03-05, with growth expected to witness a CAGR of 10.8%. With 92% of the GQ complete, the focus is on completion of NSEW by December 2008, only 12% of which is complete. We expect NSEW, phase-IIIA (process of awarding contracts has begun) and select state road projects to drive growth.

Expected CAGR of 33% for the industrial segment Industrial growth to be Spend on the industrial segment is estimated to witness a CAGR of 33% largely led by sectors like oil between FY06-08 led by investments in key manufacturing sectors like oil and and gas and metals gas and metals, resulting from a buoyant domestic and overseas demand and high capacity utilization in these sectors. The improved balance sheet strengths of Indian corporates too, will help further investments.

Real estate investment growth at a CAGR of 4.3% Favorable demographics, increasing urbanization trend and the gap between demand and supply along with rising affordability and fiscal benefits on availing of a home loan is expected to lead to an investment CAGR of 4.3% during FY06- 08.

October 18, 2006 Construction Sector 18 India Under ‘Construction’

Performance of construction stocks

Investments to the tune of Rs6,640bn on ‘infrastructure development’ made during FY03-05, have already led to a sharp rise in the prices of construction stocks in the past. Consistent order inflows in the sector resulted in a sharp re- rating, with stock prices in some cases, appreciating by over 3,000% in the last three years. We look at the performance of construction stocks in our coverage universe.

Stock returns over varying periods (%) Last 6 months Last 1 year Last 2 years Last 3 years Gammon India (21.5) 22.1 370.5 1,072.1 Hindustan Construction (21.5) 45.9 585.0 1,499.1 Nagarjuna Construction (4.2) 105.6 844.5 3,985.0 IVRCL Infrastructures 0.0 85.4 683.9 3,559.6 Patel Engineering (10.0) 95.3 563.2 2,666.5 Simplex Infrastructures (17.6) 28.6 1,041.1 3,449.0 Era Constructions 2.1 278.4 1,391.5 24,387.9 Valecha Engineering (39.6) 44.9 186.8 616.4 Sensex 5.8 61.4 124.5 159.6 Source: India Infoline Research

Barring the last six months that witnessed a fall in prices, mainly owing to the overall stock market conditions, all construction stocks have seen significant appreciation. This leads to the next logical question …

October 18, 2006 Construction Sector 19 India Under ‘Construction’

… Will this rise be sustainable?

As can be observed from the chart below, India (at the bottom left), has one of India’s GDP is the second the lowest spends on construction in the world. USA, Japan, China, Germany, fastest, yet construction France, Italy and UK lead the list of countries with the largest investments in spend one of the lowest, construction. India accounts for a mere 2% of the total construction spend by among top 55 countries the top 55 nations in the world. Considering that India’s GDP growth is second only to China, investments in construction need to be ramped up if this momentum is to be continued.

Construction spending by nations

1,400.0

1,200.0

1,000.0

800.0 600.0 (US$ bn) 400.0

200.0

- 2003 2004 2005 2006 2007 2008 India USA Japan China France Italy UK

Source: Global Insight Inc Figures in Global Insight Inc’s data higher than our estimates. This may be on account of difference in classification.

India is still far behind China, which spends over 6.5% of its GDP on construction Still far behind China whose and has been doing so for last 10 years. In India’s case, construction spend construction spend is nearly hovered around 4.5-5.8% of GDP prior to 1999-00 and reached 6% only during 4x India’s spend the last few years.

India is the largest democracy and the fourth largest economy in the world after India’s spend expected to be USA, China and Japan and ideally needs construction investments at 6-8% of 3rd highest in next 2 years, among top 15 nations in GDP by 2010, to sustain a high GDP growth. It is estimated by Global Insight Inc construction spending that among the top 15 nations in construction spending, India’s growth rate in construction spend over the next two years will be third highest, after China and Russia.

These investments will be channeled through a number of verticals. We have presented an overview and key developments in infrastructure, industrial and real estate segments and their key verticals under annextures.

Investments in these verticals will trickle into substantial construction orders for contractors depending on the construction component in each segment. We have attempted to ascertain the value of the opportunity at hand to give an indication of order flows in the construction space.

October 18, 2006 Construction Sector 20 India Under ‘Construction’

Hefty order flows expected for construction majors

Major construction companies like Gammon India, Hindustan Construction, Nagarjuna Construction, Punj Lloyd, IVRCL Infrastructures, Patel Engineering and Simplex Infrastructures are expected to witness substantial order flows on account of the high activity in infrastructure development.

Construction component in each vertical

100 90 80 70 60 50 (%) 40 30 20 10 0 SEZ Ports Roads power power Nuclear Tourism Thermal Housing Airports Telecom Irrigation Pipelines Railways Urban Oil and gas Power T&D Hydropower infrastructure

Source: Plan Documents, India Infoline Research

Construction order flows expected between FY06-08

All Simplex 800 IVRCL 720 Era 700 HCC Gammon Gammon 584 600 NCC HCC 500 Simplex Patel Patel Spend on infrastructure Era Gammon Simplex development over 3 years 400 267 254 likely to translate into (Rs bn) 300 Rs2,114bn construction 200 75 94 94 orders, excluding real estate 100 27 - Roads Others power Thermal Irrigation Railways Industrial Urban Hydropower Infrastructure

Source: India Infoline Research Excluding real estate

Construction contracts for companies will vary depending on the segments they operate in. Punj Lloyd for instance, will benefit primarily from investments in oil and gas, whereas IVRCL will largely depend on the spend on water and irrigation. A simple average of the orders estimated above, translates into an order inflow of Rs705bn every year, excluding real estate, for the next three years. Applying the 80:20 principal, if 80% of these orders were to be distributed evenly among the top 12 players, it would still mean an order inflow of Rs47bn every year (excluding real estate orders) for these companies for the next three years. The real estate sector too, will have high construction requirements with the likes of DLF and Unitech alone, needing more than 2 Gammons, HCCs and 5 NCCs and IVRCLs put together, to built their planned area for development.

October 18, 2006 Construction Sector 21 India Under ‘Construction’

Funding issues reasonably under control

Times have changed with the In the past, financing was a barrier to infrastructure development, preventing advent of benign interest a number of projects from taking off. Borrowings were unaffordable at 16-18% rates and willingness of banks pa in the 1990s and a project offering an IRR of 13-17% was also rendered to lend to construction unviable. The private sector stayed aloof and banks were unenthused about providing funding for infrastructure projects. However, times have changed with low interest rates and willingness of banks to lend for such projects. The last few years have witnessed an increase in banking credit to the construction industry.

Share of construction in total credit by scheduled commercial banks

6.0

5.0 5.1

4.0 3.9

3.0 (%) 2.7 2.0 2.3

1.2 1.0 1.3 1.2

- 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05

Source: Centre for Monitoring Indian Economy

Clarity over funding pattern In the roads segment, 80% of NSEW projects are on cash contract basis with funding arranged by NHAI. Funding issues are virtually non-existant on account of the Rs2 per litre cess on petrol and diesel. In the toll based format in BOTs, grant for up to 40% is given and the rest is to be brought in by the private players. Going forward, most contracts will be awarded in the BOT format, which will drive spend in this segment.

Financing pattern of NHDP phase-I&II

Sources (Rs bn) 1999 prices

Cess on petrol and diesel 200 External assistance 200 Market borrowings 100 Private sector participation 40 Total 540

Source: National Highway Authority of India

In other verticals like airports, privatization of airports will help ease funding Sources of funding for a major portion of investments pressures (Rs212bn during FY06-10). Ports too, are likely to witness increased identified for most verticals private sector participation (Rs385bn for ports and NMDP during FY06-10). In case of oil and gas and telecom verticals, most of the spend is through private and public sector companies that have healthy balance sheets to fund it through a combination of debt, internal accruals and equity issuances.

October 18, 2006 Construction Sector 22 India Under ‘Construction’

Funding pattern for key verticals

100.0

80.0

60.0

(%) 40.0

20.0

- SEZ Infra Ports Urban Power Roads NMDP Airports Water & Irrigation Railways Pipelines Budgetary grant Multilateral borrowings Market borrowings Internal accruals Privatisation (BOT) Funding not tied up

Source: Industry, Plan Documents, India Infoline Research Likely funding pattern over FY06-10

Multilateral agencies lend ample support The World Bank and the Asian Development Bank (ADB) are playing a vital role in infrastructure projects by funding a number of them on a large scale. Other agencies like the Japan International Bank for Cooperation (JIBC), which funded the Delhi Metro (Underground Railway) project are participating in the development as well. State governments are mobilizing funds from these agencies to support rural roads and sanitation projects in their respective states.

Active World Bank projects in India Percentage break-up of World Bank’s cumulative lending to top 20 countries Total (% of (US$ mn) total) 18.0 Energy 760 10.3 16.0 Roads and 14.0 highways 4,257 57.8 12.0 Railways 542 7.4 10.0 Urban and rural (%) 8.0 6.0 infrastructure 1,746 23.7 4.0 Telecom 62 0.8 2.0 Total 7,367 100.0 - Source: Indian Infrastructure As of September 2005 India Brazil China Turkey Others Mexico Korea Pakistan Russian Colombia Argentina Indonesia Federation Philippines Republic of Bangladesh

Source: Indian Infrastructure IBRD and IDA loans combined, As on June 2005

High institutional involvement - a booming capital market helps With the growth taking place, investor interest in infrastructure companies is A buoyant capital market on the rise. Raising funds, by tapping the primary market, follow on issues, facilitates raising monies GDRs and preferential placement of equity shares, has become a convenient option for most companies. Almost all construction majors have made multiple issuances, raising monies through equity, debt and hybrid instruments in the past and will continue to do so. The high equipment investments, working capital needs and required networth strength to prequalify financially for projects, will necessitate tapping of funds frequently.

October 18, 2006 Construction Sector 23 India Under ‘Construction’

Recent issuances by construction companies Companies Instrument Date Amount (Rs mn) Gammon India GDR Feb-06 4,400 Hindustan Construction FCCB Mar-06 4,456 Hindustan Construction GDS Mar-06 4,458 Nagarjuna Construction GDR May-06 5,400 IVRCL Infrastructures FCCB Jan-05 2,925 Patel Engineering Follow-on public issue May-06 4,300 Simplex Infrastructures Preferential allotment Oct-05 933 Era Constructions Preferential warrants Jan-06 606 Era Constructions GDR Feb-06 1,350 Valecha Engineering GDR Feb-06 545 Valecha Engineering Preferential warrants Mar-06 85 Source: India Infoline Research This list is indicative

MF and FIIs placing their bets on construction companies MF holdings (%) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 FY05 FY05 FY05 FY05 FY06 FY06 FY06 FY06 FY07 Gammon 2.5 2.5 3.3 3.6 4.4 5.9 8.3 10.5 14.2 HCC 1.4 5.0 8.3 11.9 12.3 12.0 11.2 9.7 12.0 NCC 3.3 4.7 16.7 7.5 8.0 9.1 7.5 8.3 7.9 IVRCL 1.8 5.4 7.6 9.9 24.4 24.0 24.4 27.2 25.9 Patel Eng - - - - - 5.3 6.2 5.5 6.0 Simplex 0.0 0.0 0.0 1.6 1.9 1.3 2.4 2.8 2.8 Era ------7.3 4.8 5.2 Valecha 1.2 1.8 2.7 6.6 6.6 6.8 6.4 5.1 4.6

FII holdings (%) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 FY05 FY05 FY05 FY05 FY06 FY06 FY06 FY06 FY07 Gammon 8.5 9.4 7.8 10.4 9.0 11.6 13.5 17.9 26.1 HCC 0.9 1.8 2.4 11.5 12.5 14.3 14.6 12.6 11.3 NCC 0.2 0.9 0.9 1.7 2.0 3.1 24.5 27.8 21.3 IVRCL 1.4 2.2 12.6 19.2 38.4 41.9 37.9 37.9 36.5 Patel Eng - - - 0.0 0.0 3.5 4.2 5.3 9.2 Simplex ------15.1 15.4 16.0 Era - 1.0 1.0 1.0 - 6.7 7.2 10.0 21.1 Valecha 1.3 1.3 - - - 0.1 0.1 3.9 19.0 Source: National Stock Exchange

Foreign investment permitted as well FDI up to 100% is permitted in construction and related engineering services under the Industrial Policy and FEMA. The Industrial Policy also permits FDI, under the automatic route, in projects for construction and maintenance of roads, highways, toll roads, vehicular bridges, ports and harbors. The policy is relatively new and the results will be visible over next few years. As we go along, FDI flows will bring new technology, competition and modern methods of construction.

October 18, 2006 Construction Sector 24 India Under ‘Construction’

Overseas opportunity

Overseas opportunity large Activity in construction overseas is picking up and so is the demand for India’s with high capex activity, low cost, skilled labor and engineers. With the rise in capex activity in many particularly in Middle East regions is leading to work orders for construction companies in India. Middle East is the biggest market with major exports to Oman, Qatar, Kuwait and UAE.

Presence and plans overseas Company Presence % of revenues Strategy Gammon Middle East, Moscow, Libya, 13 Selective bidding for work abroad Iraq, Nepal, Bhutan, Bangladesh HCC Bhutan, Bangladesh, 8 15-20% revenues from projects Saudi Arabia abroad in the long run NCC Muscat 5-6 Established offices in Muscat and Dubai to focus on roads, buildings, water pipelines in Middle East and Asia. Targets 10% by FY08 IVRCL - - Will bid for selective water projects abroad Patel Eng USA 18-20 To focus on high margin projects in USA Simplex Russia, Africa, Dubai (UAE), 10 40% revenues from projects Libya, Yemen, Abu Dhabi, abroad in 3-4 years. Exploring Sri Lanka, Uzbekistan new markets Era - - - Valecha Middle East - Initiated talks with potential clients in Middle East, particularly in Dubai Source: India Infoline Research

Most players have revealed that the Indian market will remain their primary focus and would be comfortable earning 10-20% of their revenues from abroad. Simplex Infrastructures is the only company in our coverage, which has stated its intentions of a greater geographical diversification with a plan of 40% of revenues from overseas work in 3-4 years time.

We know that the opportunity is huge, both in India and abroad. However, with a large number of companies operating in this space, the key is to identify the ones that will sustain over the long term. We try to analyze the key success factors and present our basis for evaluation.

October 18, 2006 Construction Sector 25 India Under ‘Construction’

Key success factors

Being an experienced player is the key Track record essential: This is one of the key criteria’s for any construction company. In order to mitigate Comforts on the risk on the the risk of execution that projects face, it is important to select companies that execution front have had a long history of successful completion and reputed construction. Here, companies like Gammon India and Hindustan Construction have close to an 80-year history in the business with profitability over a long period of time. The other construction in our recommendation list too, have a respectable history of execution. Track record, technical qualifications and financial, muscle are required to win large ticket orders.

Networth ramp-up of construction majors

12,000

10,000

8,000

6,000 (Rs mn) 4,000

2,000

- SIL GIL PEL VEL HCC NCC ECIL IVRCL FY05 FY06 FY07E

Source: Company data, India Infoline Research

Among the larger players GIL Healthy order book and HCC have the highest A healthy order book position provides visibility in earnings for the following order book/sales; VEL among two to four years, depending on the gestation period of the orders at hand. the smaller players Among the mid sized players, Valecha Engineering has the highest order book/ sales and order intake/execution ratios. Among the larger players, Gammon India has a high order book/sales and order intake/execution followed by HCC.

Order comparisons in relation to turnover Order book (Rs bn) Order book/Sales (x) Order intake/Execution (x) Gammon 78 6.6 3.1 HCC 91 4.6 2.9 NCC 63 3.4 2.0 IVRCL 67 4.5 2.5 Patel Eng 43 4.2 2.5 Simplex 43 3.5 1.5 Era 15 4.8 3.0 Valecha 8 5.5 4.6 Source: India Infoline Research

Diversified players operating across verticals Diversification across verticals is required to enable switching between segments in case of slowdown in a particular segment. While GIL and HCC lead the pack, other large players are relatively well diversified as well, ensuring regular inflow of work from various verticals.

October 18, 2006 Construction Sector 26 India Under ‘Construction’

Segmental presence of players (Orders Rs bn) Gammon HCC NCC IVRCL Patel Eng Simplex Era Valecha Roads 29 42 23 14 9 9 5 8 Water & irrigation 9 15 20 31 15 x x x Power generation 24 37 Neg x 16 13 3 x Power T&D x x 2 8 x x x x Urban infra 3 Neg Neg Neg x 3 2 x Housing Neg Neg 9 9 x 9 1 Neg Tunneling 3 Neg Neg Neg 1 3 x 0 Industrial Neg Neg Neg Neg x 3 3 x Real estate Planning Neg Neg 1 Planning Planning Neg Neg Ports 1 Neg x x x 3 x x Airports Neg - - - - Neg 0 0 Source: India Infoline Research Value in present order book Neg - Negligible

Focus on margins along with turnover growth With a gush of orders, we It is of utmost importance that construction companies focus on bottomline believe that selective bidding performance going forward. There is no shortage of orders and all companies is of utmost importance can ramp-up their order books, almost at will. The important criteria is to pick up quality projects with high margins from the ones floating around.

Sales growth for construction companies (%) FY04 FY05 FY06 FY07E FY08E Gammon India 53.8 3.1 13.7 55.3 52.8 Hindustan Construction 56.2 40.6 33.6 42.7 41.6 Nagarjuna Construction 67.0 56.8 54.9 54.5 43.5 IVRCL Infrastructures 75.6 36.4 41.8 62.4 45.0 Patel Engineering 38.1 1.8 29.2 37.2 35.4 Simplex Infrastructures 19.1 53.0 34.6 51.0 40.1 Era Construction 7.9 42.7 98.9 96.5 59.1 Valecha Engineering 91.6 24.2 4.0 49.6 65.6 Source: India Infoline Research Quarterly adjustments have been made in case of FY05 and FY06 figures of Gammon to enable comparison

Turnover growth and margin comparisons

13.9

12.9 PEL ECIL

11.9

10.9

9.9 GIL HCC IVRCL OPM FY08E (%) 8.9 NCC SIL 7.9

6.9 VEL 30.0 40.0 50.0 60.0 70.0 80.0 Turnover CAGR FY06-08E (%)

Source: India Infoline Research

October 18, 2006 Construction Sector 27 India Under ‘Construction’

Era Constructions is expected to generate the highest growth in turnover on account of its low base and maintain high margins as most of its projects are on account of private sector players. Almost all large players offer high growth with similar margins. PEL is the only odd one out, which enjoys higher margins on account of focus on hydropower projects.

View on operating profit margins We have projected OPM on The industry players have a mixed opinion on operating profit margins. While the basis of our assumption some believe that margins are likely to improve on account of the growing of order book execution, demand for quality contractors and huge work orders being released in most segmental margin position verticals, others like HCC believe that margins are likely to remain under pressure and management guidance and would move in line with global peers (operating at 1% NPM) in the long run. For our calculations, we have projected operating profit margins for FY07 and FY08 on the basis of our assumption of order book execution, segmental margin position and management guidance.

OPM for construction companies (%) FY04 FY05 FY06 FY07E FY08E Gammon India 10.0 11.4 13.0 9.4 9.4 Hindustan Construction 13.5 10.5 9.2 8.9 9.0 Nagarjuna Construction 7.8 7.6 8.9 8.9 9.1 IVRCL Infrastructures 7.5 8.2 8.8 9.0 9.3 Patel Engineering 8.2 11.4 12.9 12.4 13.1 Simplex Infrastructures 6.7 7.0 8.8 8.9 8.4 Era Construction 7.7 9.0 15.7 12.5 12.9 Valecha Engineering 7.6 6.5 7.3 7.1 7.1 Source: India Infoline Research

Net profit growth for construction companies (%) FY04 FY05 FY06 FY07E FY08E Gammon India 62.9 25.8 71.4 21.1 46.6 Hindustan Construction 38.5 107.6 14.6 68.9 52.4 Nagarjuna Construction 71.7 81.2 81.4 49.7 50.2 IVRCL Infrastructures 152.8 44.7 63.9 59.7 51.6 Patel Engineering 135.6 47.8 76.1 44.2 46.6 Simplex Infrastructures 10.7 159.5 65.4 88.2 41.4 Era Construction 23.5 88.6 384.4 50.9 66.5 Valecha Engineering 25.5 22.2 (16.8) 82.7 77.8 Source: India Infoline Research

Peer comparisons on various parameters Company Track Diversification Turnover Margins Tax rate BOTs Risk to record CAGR FY06 (nos) estimates FY06-08E (%) (%) Gammon Excellent High 54.0 Average 7.5 9 Low HCC Excellent High 42.2 Average 9.7 2 Low NCC Good Good 48.9 Average 17.7 8 Medium IVRCL Good Good 53.4 Average 10.4 5 Medium Patel Good Average 36.3 High 8.1 1 Low Simplex Good Good 45.4 Average 28.3 0 Medium Era Average Good 76.8 High 29.5 1 High Valecha Average Low 57.4 Low 34.5 0 High Source: India Infoline Research

October 18, 2006 Construction Sector 28 India Under ‘Construction’

Valuations in the sector

With BOT ventures, land bank and investments through subsidiaries, all part of the outfit, along with the core construction business of the company, we choose to value the players on a sum of parts basis to arrive at our target price.

How we value each of them:

We value assigning target EV/ Core business of contracting EBIDTA multiple We value the construction business by assigning our target EV multiple to the EBIDTA of the companies. We are comfortable valuing the biggest of the lot (Gammon and HCC) at a EV multiple of 12x FY08E EBIDTA. The second pack comprising Nagarjuna Construction, IVRCL Infrastructures, Patel Engineering and Simplex Infrastructures are valued at a target multiple of 10x FY08E EBIDTA. The relatively smaller sized Era Constructions and Valecha Engineering are assigned a target multiple of 8x FY08E EBIDTA. We believe these valuations are commensurate to the size of these companies relative to each other and adequately factor the growth in earnings and risks going forward.

Land bank Valued at market price, post We value the land holdings with these companies available for development, 25% discount at the current market price of the current land, post a 25% discounting. We exclude the development profits realizable from these properties in future. In case of HCC, its nine acres land at Vikhroli is valued at the price at which TDR were transferred to its subsidiary.

BOT ventures On account of number of BOT ventures are governed by a number of variables like vehicle traffic, interest variables and lack of operating experience, we rates, change in financing structure and costs associated with maintenance of value at 1xBV of equity the project. The lack of operating experience in BOTs is another critical factor, infused which attaches significant risks to the project. We believe that certain projects may outperform the expected IRRs whereas others may generate lower than expected IRRs or even turn out to be loss making.

The government can also take a decision to reduce or prolong the concession Gammon, NCC and IVRCL period of a project by a few years depending on traffic turnout. Such a scenario lead on the BOT front could lead to serious disruption of cashflows and also make it difficult for banks and financial institutions to securitize the cashflows. Therefore, in spite of managements having indicated the revenues accruable from each of these projects, we have chosen to value these ventures at the book value of equity infused in them by the company. The only deviation from this practice has been with two real estate BOTs of Nagarjuna Construction, which have been valued at 2x book value of equity infused by the company. This is because of the shorter duration of these projects with land already available for development, providing clarity as compared to other BOTs.

Investments in subsidiaries Any noteworthy investment in subsidiaries that might result in substantial benefits in future has been valued at the book value of equity infused. Investments where the plan of action is still unclear or do not add meaningful numbers to the target price have been ignored. IVRCL’s strategic investment in HDO has been valued at the CMP of IVRCL’s holding in the company.

Valesha’s investment portfolio consisting of Jyoti Structures has been assigned a value at 50% discount to CMP. October 18, 2006 Construction Sector 29 India Under ‘Construction’

Comparisons between companies on various valuation parameters

16.0 15.0 15.0 GIL 13.0 GIL 14.0 NCC HCC IVRCL IVRCL 11.0 HCC NCC 13.0 PEL SIL 12.0 9.0 PEL ECIL SIL 11.0 ECIL P/E FY08 (x) 7.0 10.0 VEL

9.0 EV/EBIDTA FY08 (x) 5.0 VEL 8.0 3.0 30.0 35.0 40.0 45.0 50.0 55.0 60.0 65.0 30.0 35.0 40.0 45.0 50.0 55.0 60.0 65.0 EPS CAGR FY06-08E (%) EBIDTA CAGR FY06-08E (%) 16.0 2.5 15.0 GIL SIL 14.0 NCC 2.0 HCC SIL IVRCL IVRCL NCC 13.0 PEL PEL 1.5 HCC GIL 12.0 ECIL 11.0 ECIL 1.0 P/E FY08 (x) 10.0 EV/CE FY08 (x) 0.5 9.0 VEL VEL 8.0 - 6.0 11.0 16.0 21.0 26.0 31.0 36.0 10.0 12.0 14.0 16.0 18.0 20.0 22.0 ROE FY08E (%) ROCE FY08E (%)

Source: India Infoline Research

Global peer valuations We present a global peer comparison to glimpse how those companies are placed. However, a comparison may not be relevant as most of the construction businesses internationally operate at net profit margins of around 1%, whereas Indian peers are closer to 6-7%. Furthermore, one has to bear in mind that India is on a structurally positive investment cycle with high visibility and a good segmental mix.

PEG valuation of global peers

1.6 1.4 1.2 Lower PEG of Indian 1.0 companies in spite of being in (x) 0.8 a structurally positive 0.6 investment cycle with high 0.4 visibility and segmental mix 0.2 - SIL GIL IJM PEL VEL HCC NCC ECIL IVRCL Hyundai Eng Samsung Eng Kumagai Gumi

Source: India Infoline Research, Bloomberg consensus PEG of Indian and global peers over two years

October 18, 2006 Construction Sector 30 India Under ‘Construction’

Construction sector valuations attractive – high earnings visibility We are overweight on the construction sector and believe valuations to be attractive. The sector offers high visibility with huge investments in the pipeline and order book of companies at 3.5-6.5x current turnover. Construction companies in India are scaling up fast and are expected to attain considerable size going forward.

We believe that the sector is placed to exploit the infrastructure spend, just like software services in mid 90s exploited the Y2K bug. There is considerable scope for a second round of re-rating, just like what happened to software services in the last decade. In the beginning, software services was compared to low value, manpower contracting. Strong revenue growth not only led to EPS growth on a quarter on quarter basis, but also drove multiple expansion. We expect the same story to repeat in the construction sector also.

Case Study – Will IT repeat in construction?

Scope for continuous re-rating The comparison with software services is compelling. 15 years ago, the software services industry in India comprised small sized companies doing low value added “body shopping” - manpower contracting, with strong investor concerns on quality of management. When India Infoline Ltd (then Probity Research and Services Pvt Ltd) came out with our seminal report on Indian Software Services Industry in 1998, it was met with huge skepticism. Investors and analysts used to ask questions like:

Ö How will Infosys manage 10,000 employees? Ö Is software services not a manpower multiplication game? Ö ICDs of Company X have bounced. Ö Shady management - This in fact was the most common refrain from investors not willing to buy the huge growth story.

Y2K changed the landscape

Thanks to the Y2K boom, IT companies scaled up aggressively. They not only became “professional”, but also set standards for corporate governance and transparency. Strong quarter-on-quarter performance for years, not only led to an expansion in EPS, but also in P/E. From times, when the sector traded at a discount to the market index, it started trading at a premium.

A similar trend and sequence of events can be observed, taking place with the construction sector. A few years back, construction companies were trading at low multiples with reservations on management quality. Today, the opportunity at hand has worked in favor of these companies. They have geared up and possess the competitive ability and people to undertake complex jobs.

Earnings performance has already resulted in a re-rating in the sector over the last 2-3years. Revenue visibility still continues to be high and we project EPS growth to drive a second round of P/E expansion. No doubt, these companies will raise capital, still they will be EPS accretive.

October 18, 2006 Construction Sector 31 India Under ‘Construction’

Concerns

Slowdown in government spending Slowdown in economy, change in government at Any slowdown or delay in government spending on infrastructure would bring centre, among others can about a corresponding slowdown in the construction segment as well. A lower spend on development slowdown in the economy could result in lower investments in infrastructure. A change in the government at the centre will also result in delays in award of contracts. While ‘infrastructure development’ has been accepted by all as a prerequisite for sustaining high growth, a change at the centre causes a review of projects implemented and renaming of projects, before fresh contracts are awarded. It has been observed that such a procedure takes a years’ time approximately, resulting in slowdown of order flow during that period.

While smaller players might still survive a sudden hold up of orders, bigger players like HCC, GIL, NCC, IVRCL and others would be affected adversely in such an event. These companies heavily rely on government orders to maintain their high growth on a large turnover base.

Stretched implementation ability of the government Delays in land acquisition and While the plans for development of infrastructure are massive, they are also financial constraints may slow ambitious and would require serious efforts to implement and complete on down pace time. Delays in land acquisition have resulted in slow execution in the past. Financial constraints on the part of the government are also likely to play a part in slowing down the progress.

For instance, the last 12-15 months have witnessed major delays in execution of the NHDP and the PMGSY, leading to cost escalations. The GQ and NSEW phase-I and phase-II crawled at a construction rate of only 4.48kms per day. For the government to stick to its deadline of completing the NHDP by 2012, construction needs to be undertaken at a speed of 7,000kms per year.

Execution risk Failures of major projects and In today’s buoyant scenario, contractors have order positions of 3-5 times their penalties associated is a big turnovers. With demand for construction activity on the rise, getting orders is concern not a problem. The key risk is in execution of these orders. With companies handling a number of projects at a time (200 projects at a time in some cases), there is a significant execution risk that comes along with it.

The Bandra-Worli Sea Link is a classic example of delays taking place. Although, the delay in this project is on account of external factors (environmentalist protests), a delay nevertheless, which has led to cost escalations and disputes between client and contractor. In case of JVs, the liability of partners is joint and several and one company is liable to get the entire project completed in case the joint venture partner fails to perform its part of the project. Construction companies often carry substantial contingent liabilities as well, in the form of guarantees, in order to comply with specific client requirements.

Execution risk can be faced on account of manpower issues as well. A shortage or sudden attrition in workforce can lead to a delay in execution of contracts. In such a scenario, costs escalate and margins are eroded. These are inherent risks of this business and the liability associated with such delays and failures, on even on a single project is huge. Also, contingent liabilities on projects could be substantial.

October 18, 2006 Construction Sector 32 India Under ‘Construction’

Manpower issues Shortage of manpower and This is one of the biggest challenges faced by all players in the industry today. A capex boom in Middle East shortage of engineers and skilled workers is being seen as a major problem to reckon leading to poaching - another with. With the pick up in infrastructure spending, several large construction companies issue to reckon with have become poaching grounds. The software industry too, plays its part in creation of a shortage as engineers typically prefer a high paying software job than a civil, electrical or a mechanical engineering job. The shortage can be attributed partly to the lack of demand for construction specific skills and partly due to lack of institutions to help build required skills.

The capex boom in the Middle East too, is leading to increased pressure on Indian engineering and construction companies, as India is the preferred source of manpower for the MNC contractors working abroad. With high attrition levels, employee retention has become an important consideration. Therefore, companies like IVRCL have taken proactive steps to grant ESOPs to their employees for a number of years now.

Ambiguity of taxation under section 80I(A) Ambiguity on taxation laws Section 80I(A) of the Income Tax Act 1961 states that any company deriving profits prevails – A disallowance of by developing, constructing, and operating qualified infrastructure projects is eligible benefit claimed by many for tax exemption for a period of 10 years in the first 15 years of operation. The construction companies will ambiguity in the section has resulted in construction companies claiming the benefit result in huge tax liabilities and providing for lower taxes. While some believe that this exemption is applicable to those owning the infrastructure asset, as it was originally aimed at BOT operators, others believe this exemption is also applicable to those constructing the asset.

While some companies pay full corporate tax, many construction companies provide tax largely on minimum alternate tax (MAT) basis. Some construction companies have even gone into litigation against the authorities with Patel Engineering winning the judgment by the Income Tax Tribunal, upholding the tax benefits claimed.

If this judgment is overturned, this would increase the effective tax rate of construction companies, which would impact the earnings of these companies, who might have to provide for these taxes with retrospective effect.

Effective tax rate of construction companies (%) FY02 FY03 FY04 FY05 FY06 Gammon India 37.7 40.7 37.4 16.8 7.5 Hindustan Construction 26.6 36.6 41.0 1.3 9.7 Nagarjuna Construction 15.5 20.9 21.8 18.2 17.7 IVRCL Infrastructures 34.2 35.4 15.6 4.6 10.4 Patel Engineering 27.9 20.2 20.1 13.9 8.1 Simplex Infrastructures 43.4 (4.7) 31.9 26.8 28.3 Era Construction 44.8 29.3 32.0 26.6 29.5 Valecha Engineering 32.0 34.1 31.7 32.0 34.5 Source: India Infoline Research Some companies claim benefits under this section during FY05 and FY06

High capex and working capital requirements Frequent equity dilutions on Construction companies are required to frequently raise resources to fund their account of high fund increasing working capital requirements as payments from clients are linked to requirements completion. Funds are needed for their capex requirements for purchasing equipment and machinery as well. Companies also need to raise capital to boost their networth in order to financially qualify for bigger sized projects and BOT ventures. This has resulted in frequent dilutions in the equity capital of most construction companies.

October 18, 2006 Construction Sector 33 India Under ‘Construction’

Risks associated with BOT projects … Rising interest rates: threat to IRRs … BOT projects depress ROE initially BOT projects carry a lot of inherent value for the company owning them. However, the financial performance of companies operating BOT projects, in the initial years, is impacted due to higher capital charges and slower build up in traffic. BOT projects, during the initial gestation period, do not significantly contribute to profitability, resulting in lower return on equity during that period.

… Lack of operating experience in BOTs A BOT project is altogether different from a conventional cash contract. It not only involves constructing of the asset, but also owning and operating the same. Most construction companies have been in the cash contracting business for years, but have no experience in operating BOT projects. While the returns are attractive if run effectively, the ability to operate has yet to be seen.

… Risk of rising interest rates The interest rates, which were witnessing a decline over the last few years, have started rising and are expected to increase further. This is expected to affect operations to an extent. In case of toll based projects, returns would be affected as the debt component is 70-80% of the value of the project, however a higher growth may partly offset the rise. In case of annuities, although business remains profitable, IRRs are affected. Further investments may be impacted as the cost of projects may go up. It would marginally impact in the near term as bulk of the advances given by clients are on a fixed rate of interest.

Possibility of rise in input costs Any rise in the prices of key raw materials like steel and cement may affect profitability of construction companies. This however, is not a major concern considering that most of the contracts are covered with escalation clauses. The prices are linked to a particular index and escalations are allowed depending on the movement of the index. In some cases, the client agrees to supply steel and cement at a fixed price to the contractor for the project.

Excess availability of stocks/paper in the market This is a stock market concern and not an industry or a company specific concern. A booming primary and secondary market in securities has led to a number of construction companies tapping the market for funds through IPOs. Many construction companies have raised finances, while many others have plans to do so in the future. An excess supply of paper/stocks in the market may result in a lowered multiple for the sector as a whole.

We believe the opportunity for the sector is huge. Investments will be spread across verticals with infrastructure, industrial and real estate, all witnessing boom. Based on our analysis, we have hand picked companies, which qualify on most criteria’s and are trading at attractive valuations.

Recommendation and target price Company CMP (Rs) Recommendation Target price (Rs) Upside (%) Gammon 385 BUY 454 17.9 HCC 128 BUY 160 24.9 NCC 175 BUY 206 17.6 IVRCL 287 MARKET PERFORMER 307 7.0 Patel 361 MARKET PERFORMER 411 13.6 Simplex 333 BUY 459 37.8 Era 358 MARKET PERFORMER 411 14.9 Valecha 208 BUY 294 41.1 Source: India Infoline Research

October 18, 2006 Construction Sector 34 India Under ‘Construction’

Company Section

- Gammon India Ltd

- Hindustan Construction Company Ltd

- Nagarjuna Construction Company Ltd

- IVRCL Infrastructures & Projects Ltd

- Patel Engineering Ltd

- Simplex Infrastructures Ltd

- Era Constructions (India) Ltd

- Valecha Engineering Ltd

October 18, 2006 Construction Sector 35 BUY CMP Rs385 Gammon India Ltd COMPANY REPORT

Stock Data Order book/sales of 6.6x – among the highest in the space Target Price Rs454 Gammon India Ltd (GIL) is one of the oldest and largest construction companies Upside 17.9% in India with uninterrupted profitability for the last 32 years, displaying the Sensex 12,736 ability of the management to combat cyclicality. The order book at Rs78bn 52 Week H/L Rs589/276 presently, translates into 6.6x its FY06 annualized turnover, being one of the Average Vol.(6M) 93,581 highest ratios among peers. The order intake at 1.6x during FY05 annualized Market Cap Rs34bn turnover and 3.6x FY06 annualized turnover has shown a rising trend and will Face Value Rs2 help generate high growth rate in future. BSE Code 509550 Appropriate mix of BOT assets NSE Code GAMMONIND GIL, through its 82.5% subsidiary, Gammon Infrastructure Projects Ltd (GIPL), Reuters Code GAMM.BO is one of the largest owners of infrastructure assets in the country. GIPL holds Bloomberg Code GMON@IN Prices as on 13th Oct’06 nine BOTs, four operational and the rest in development phase, including four roads, two bridges, two power projects and a port project. The revenue stream is diversified too, with a mix of toll, annuity and grants. We value these BOTs at Share Holding Pattern Rs57.7 per share of GIL, which forms 15.5% of the CMP. June’06 (%) Promoters 32.3 GIPL IPO to unlock value Foreign 37.0 While we have valued the BOTs at the book value of equity infused by GIL, we Institutions 10.9 foresee significant unlocking of value with the listing of GIPL, which has filed its Non promoter corporate 13.5 draft red herring prospectus with the Securities and Exchange Board of India. Public & others 6.4 The IPO would also help resolve the varied and long term funding needs of GIPL for BOTs.

Expected CAGR of 54% in topline and 33.2% in bottomline during FY06-08 Share Price Chart Driven by an order book increase by Rs40.6bn between CY04 and Q1 FY07 and an order intake of 1.4x FY07E turnover, we expect GIL to witness a CAGR of 200 Gammon Sensex 54% in turnover between FY06 and FY08 and a 33.2% CAGR in net profit during 150 the same period. The transportation segment will drive revenues accounting 100 for an expected 52.4% of total revenues in FY07 and 50.7% in FY08. 50 0 Valuations

5 5 6 6 6 6 6 The GIL stock trades at a P/E of 20.6x and EV/EBIDTA of 12.7x FY08E earnings 0 0 0 0 0 0 0 ------t r t c b n g c c p

e with an EV/Order book of 0.4x. Adjusting for its BOT ventures, the P/E for FY08E e u u O A J O F D A stands at 17.4x, which makes the GIL stock attractive at current levels. We recommend a BUY on this stock on the basis of our sum of parts valuation with a one-year target price of Rs454, representing an upside of 17.9%.

Key financials and ratios FY04 CY04* FY06* FY07E FY08E (12) (9) (15) (12) (12) Net sales (Rs mn) Annualized 11,238 8,721 14,851 20,458 31,250 yoy (%) 53.8 3.5 2.2 72.2 52.8 Net profit (Rs mn) Annualized 293 428 1,028 1,089 1,596 yoy (%) 55.5 95.2 92.0 32.4 46.6 OPM (%) 9.6 11.0 13.0 9.4 9.4 EPS (Rs) Annualized 4.6 7.3 9.3 12.3 18.0 P/E (x) 81.6 50.7 40.0 30.2 20.6 P/BV (x) 10.7 7.3 3.6 3.2 2.8 EV/EBIDTA (x) 23.9 32.6 17.2 18.0 12.7 ROCE (%) 18.7 10.9 14.0 11.4 13.7 RONW (%) 13.2 10.9 11.1 10.6 13.6 * Net sales, net profit and EPS has been annualized to facilitate comparison

October 18, 2006 Construction Sector 36 India Under ‘Construction’

Investment rationale

Illustrious pedigree in the construction space Ideal proxy to play GIL is one of the oldest construction players in India with a 87-year old history infrastructure boom story of commendable implementation across verticals. This makes us believe that it is the perfect proxy for playing India’s infrastructure boom story. The company is a reputed player and has come to be known for its quality and timely execution. Having achieved prequalifications across verticals, it is companies like GIL who will lead from the front in effecting the huge capex planned in the infrastructure space.

GIL’s landmark projects Gateway of India, Mumbai The Prince of Wales Museum, Mumbai First pre-stressed concrete bridge in the country for Indian Railways Longest urban viaduct – J.J. Hospital, Mumbai (2.2km) First cable-stayed bridge – Akkar, Sikkim Longest river bridge in India, across Ganga, Patna (5,575 metres) Tallest road bridge in India – Kandroor Bridge, Himachal Pradesh (64 metres) Longest railway tunnel in India – Konkan Railway (6.5km)

Source: Company

Uninterrupted profit making Another notable feature is that the company has been successful in managing record for the last 32 years growth and profitability over the years, by tackling the high and low investment cycles well. GIL has an impressive track record in the contracting business with uninterrupted profitability for the last 32 years, which is reassuring in case of a slowdown in spending on infrastructure.

GIL’s turnover and profitability trend

35,000 Turnover 2,500 Net profit 30,000 2,000 25,000 20,000 1,500 15,000

(Rs mn) 1,000 (Rs mn) 10,000 500 5,000 - - FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY06 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY06 CY04 CY04 FY07E FY08E FY07E FY08E

Source: Company data, India Infoline Research CY04 is for 9 months, FY06 is for 15 months

Diversified portfolio, robust order backlog One of the highest order GIL, over the years, has successfully passed the transition from being a focused book/sales ratios player in energy, pipeline and tunneling projects to gaining prequalifications in other verticals besides venturing into overseas markets. GIL’s order book position as on Q1 FY07 is placed at Rs78bn, translating into 6.6x its FY06 annualized turnover. This ratio is one of the highest among peers as also for GIL, when compared to the earlier years, as can be seen from the chart below.

October 18, 2006 Construction Sector 37 India Under ‘Construction’

GIL’s order book trend GIL’s order book break-up

80.0 5.7 6.0 70.0 5.0 Marine 60.0 Hydel 4.4 1% 50.0 3.9 4.0 Pipeline 15% Transportation 3.0 3.2 5% 42% 40.0 2.7 3.0

2.6 (x)

(Rs bn) 2.3 30.0 2.0 Tunneling 20.0 4% 10.0 1.0 - - Energy Environment 20% Public Utility 5% 8% FY99 FY00 FY01 FY02 FY03 FY04 FY06 CY04 Order book (LHS) Sales (LHS) Order book/Sales (RHS)

Source: Company, India Infoline Research Source: Company data, India Infoline Research CY04 and FY06 turnover has been annualized

GIL had a rising order intake at 1.6x during FY05 annualized turnover and 3.6x FY06 annualized turnover to be executed over the next 2-3 years. This is 3.6x order intake during FY06 indicative of high growth in FY07 and FY08 estimated at 55.4% and 52.8% yoy to drive revenue growth of respectively. We estimate an increase of 10.5% yoy in GIL’s order book in FY07 55.4% and 52.8% in next 2 on the back of huge ramp-up in March 2006, as the company largely focuses on years execution and prefers to bid selectively. GIL continues to focus on big ticket orders, with its top 10 projects accounting for 65% of the order book.

Rising order intake/execution

45.0 4.0 40.0 3.6 3.5 35.0 3.0 30.0 2.8 2.5 25.0

2.0 (x) 20.0 1.8 (Rs bn) 1.6 1.6 1.5 15.0 1.6 1.6 1.1 1.2 10.0 1.0 5.0 0.5 - - FY98 FY99 FY00 FY01 FY02 FY03 FY04 CY04 FY06 Order intake (LHS) Order intake/Execution (RHS)

Source: Company, India Infoline Research CY04 and FY06 turnover has been annualized

October 18, 2006 Construction Sector 38 India Under ‘Construction’

One of the largest owners of infrastructure assets Good mix of 9 BOTs. Plans to GIL has been one of the most proactive players in bidding for BOT projects and enter new areas through this has a large portfolio of such projects on hand, with a mix of toll, grant and route annuity based ones. Besides its existing projects, it also plans to bid for BOTs in other verticals like urban infrastructure, SEZs, agricultural infrastructure, airports, power transmission lines, water and waste water management and railways in future. While GIL undertakes the construction work, it develops these assets through its 82.5% owned subsidiary, GIPL. Rs23.3bn worth of projects under the BOT format are under development stage and Rs8.6bn worth of projects are already operational.

Andhra Expressway Ltd (AEL) The SPV, AEL is entitled to semi-annual payments of Rs279.1mn during the Valued at Rs2.9 per share concession period. It achieved financial closure 30 days ahead of schedule resulting in a bonus of Rs46.5mn from NHAI. For the six-month period ending 31st March, 2005 the project earned a net profit of Rs111mn on revenues of Rs187mn. For the year ended March 2005, the project recorded revenues of Rs295.6mn and a net profit of Rs121mn. We assign a value of Rs2.9 per share of GIL to this project in our target price calculations.

Project details Segment Roads Description 47 kms Project type Annuity Equity holding (%) 87.25 Other partners Punj Lloyd Concession period 17.5 years including 2.5 years for construction Project cost (Rs mn) 2,481 Equity (Rs mn) 290 Debt (Rs mn) 2,191 GIL’s equity (Rs mn) 253 Status Operational on October 2004 Client NHAI Source: Company, India Infoline Research

Rajahmundry Expressway Ltd (REL) The SPV, REL is entitled to semi-annual payments of Rs296.1mn during the Rs2.9 per share is the value assigned to the project concession period. The SPV earned a 70-day bonus of Rs115.2mn, for early completion, from NHAI. The company has repaid 4.13% of the debt component in the project and received in principle sanction to refinance the entire debt from ICICI Bank at a significantly lower rate. For the year ended March 2005, the project recorded revenues of Rs313.7mn and a net profit of Rs83.7mn. We assign a value of Rs2.9 per share of GIL to this project.

October 18, 2006 Construction Sector 39 India Under ‘Construction’

Project details Segment Roads Description 53 kms Project type Annuity Equity holding (%) 87.25 Other partners Punj Lloyd Concession period 17.5 years including 2.5 years for construction Project cost (Rs mn) 2,564 Equity (Rs mn) 290 Debt (Rs mn) 2.274 GIL’s equity (Rs mn) 253 Status Operational on September 2005 Client NHAI Source: Company, India Infoline Research

Vizag Seaport Pvt Ltd (VSPL) Valued at Rs4.2 per share VSPL was established to operate two multi-purpose berths: East Quay-8 and East Quay-9, in the inner harbor of Visakhapatnam seaport. For the nine months ended December 2004, the project recorded revenues of Rs17.9mn and a net loss Rs69.1mn as only one berth had commenced operations in October 2004.

VSPL entered into a 3mn tons pa ‘Take or Pay’ agreement with SAIL, which has significantly reduced the risk associated with the project. SAIL is required to pay for cargo handling at the integrated terminal service charge (ITSC) of Rs189 per MT for actual usage, during the first year of operations. Use of the cargo handling facility in excess of 3mn tons would require payment of only 58.2% of the ITSC and the penalty for lesser offtake is 71.4% of the ITSC.

GIL has an option of buying 13% or 26% in the project, after three years. We estimate that Rs1.2bn will be the revenues earned from this project for each year of full operations by selling its 8mn tons capacity at an average of Rs150 per ton. We value this project at Rs4.2 per share of GIL in our calculations.

Project details Segment Ports Description 2 multipurpose berths Project type Part Traffic Equity holding (%) 42.22 Other partners Visakhapatnam (28.89), Lastin Holdings (28.89) Concession period 30 years including 2 years for construction Project cost (Rs mn) 3,250 Equity (Rs mn) 870 Debt (Rs mn) 2,100 GIL’s equity (Rs mn) 367 Status Operational on October 2004 Client Vizag Port Trust Source: Company, India Infoline Research

Cochin Bridge Infrastructure Company Ltd (CBICL) For the nine months ended December 2004, CBICL earned a net profit of Rs5.2mn on revenues of Rs42.8mn. It will continue to earn annuity payments of Rs15.4mn which began in January 2004, till the end of the extended concession period in April 2020. At present the bridge witnesses daily traffic of 18,000 passenger car units (PCU). Having securitized the toll earnings and the annuity component being small in proportion to the size of the project, we do not assign any value to this project in our target price calculations.

October 18, 2006 Construction Sector 40 India Under ‘Construction’

Project details Segment Bridge Description 700 metres Project type Annuity + Toll Equity holding (%) 97.65 Other partners Cochin Port Trust Concession period 19 years and 9 months including 28 months for construction Project cost (Rs mn) 257 Status Operational from January 2004 Client Government of Kerala Source: Company, India Infoline Research

Mumbai-Nasik Expressway Ltd (MNEL) We assign a value at Rs8.2 MNEL is the largest toll road BOT project in India and involves a grant to per share supplement the toll revenues. We assign a value of Rs8.2 per share of GIL for our target price calculations. This is a large project and an upside to the valuations leading to a re-rating, is on the cards once the project becomes operational.

Project details Segment Roads Description 99.5 kms Project type Grant + Toll Equity holding (%) 70 Other partners Sadbhav Engineering, BE Billimoria Concession period 20 years including 3 years for construction Project cost (Rs mn) 7,530 Equity (Rs mn) 1,030 (Including capital grant of Rs510mn) Debt (Rs mn) 6,500 GIL’s equity (Rs mn) 721 Status Development phase, expected to complete by April 2009 Client NHAI Source: Company, India Infoline Research

Rangit-II Hydroelectric Power Project Project contributes Rs15.3 An SPV, Sikkim Hydro Power ventures Ltd (SHPVL) holds full equity in this project. per share to our target price SHPVL is required to provide 12% of the net energy generated for the first 15 years and 15% of the net energy generated post that period, free of cost, to the Sikkim government. The balance is allowed to be either sold within and outside the state or used for captive consumption. We value this project at Rs15.3 per share of GIL. This project forms 4.3% of the CMP of GIL and 24% of the total BOT value derived for all projects.

Project details Segment Power Description 60MW Equity holding (%) 100 Concession period 41 years including 5 years for construction Project cost (Rs mn) 4,500 Equity (Rs mn) 1,350 Debt (Rs mn) 3,150 GIL’s equity (Rs mn) 1,350 Status Development phase, expected to complete by January 2011 Client Government of Sikkim Source: Company, India Infoline Research

October 18, 2006 Construction Sector 41 India Under ‘Construction’

Other projects in development phase The Kosi River Bridge project is entitled to a semi-annual annuity of Rs320mn, whereas the same for Gorakpur Bypass stands at Rs485mn. Value assigned to Punjab Biomass, Kosi River Bridge and Gorakpur Bypass is Rs0.8, Rs9.7, Rs14 per share of GIL respectively. Project details Punjab Biomass Kosi River Bridge Gorakpur Bypass Segment Power Bridge Roads Project type Tariff based, 13MW Annuity Annuity Equity holding (%) 50 100 100 Concession period 20 years 20 years including 3 years 19.5 years including 2.5 for construction years for construction Project cost (Rs mn) 450 4,300 6,500 Equity (Rs mn) 135 860* 1,300* Debt (Rs mn) 315 3,440* 5,200* GIL’s equity (Rs mn) 68 860 1,300 Status Development phase, Development phase, Development phase, expected to complete expected to complete expected to complete July 2007 in March 2009 in December 2008 Client Punjab State Electricity Board NHAI NHAI Source: Company, India Infoline Research * Estimates

GIPL IPO to unlock value in the company GIPL, incorporated in 2001, has filed its draft red herring prospectus with the Securities and Exchange Board of India (SEBI). We believe that an IPO of GIPL would unlock significant value for GIL’s shareholders. Even if the company decides to go in for a private placement instead of an IPO, it will ease the funding requirements for these long gestation projects. We value these BOTs at Rs57.7 per share, which is the book value of GIL’s equity, for our target price calculations. At this value, the BOTs account for 15.5% of GIL’s CMP.

GIPL’s financial snapshot FY06 (Rs mn) FY06 (Rs mn) Revenues 778 Networth 2,553 Operating expenses (188) Loans 5,117 EBIDTA 590 Total 7,670 Depreciation (193) Interest (231) Fixed Assets 5,830 PBT 182 Net working capital 1,975 Associate profits 102 Total 7,805 PAT 239 OPM (%) 75.8 Source: Company data

October 18, 2006 Construction Sector 42 India Under ‘Construction’

Expected earnings CAGR of 33.2% over two years Transportation segment to Driven by an order book increase by Rs40.6bn between CY04 and Q1 FY07 and dominate revenues. Expected an order intake of 1.4x FY07E turnover, we expect GIL to witness a CAGR of to be 39.5% of order book in 54% in turnover between FY06 and FY08. While we expect margins to remain FY07 under pressure (9.4% during both, FY07 and FY08 as compared to 13% in FY06), the net profit CAGR is expected to be respectable at 33.2% between FY06 and FY08.

While the company operates in a number of verticals, we expect the transportation segment to remain dominant, accounting for 39.5% of the order book in FY07. GIL is one of the handful of companies with the expertise to construct hydropower projects and one of the three construction companies in the country that have the necessary prequalifications to bid for nuclear power projects. We expect an order intake/execution of 3x from the hydropower vertical in FY07, comprising 17.3% of the order book. GIL’s revenue split

FY07E FY08E

7% 2% 10% 1% 8% 2% 7% 3%

15% 52% 51% 14% 6% 6% 8% 8% Transportation Environment Public Utility Transportation Environment Public Utility Energy Tunnelling Pipeline Energy Tunnelling Pipeline Hydel Marine Hydel Marine

Source: India Infoline Research

October 18, 2006 Construction Sector 43 India Under ‘Construction’

Valuations

GIL’s diversification across most segments with one of the best track records and a presence in the overseas market gives it an edge over its competitors. We expect a 55.3% yoy growth during FY07, over the adjusted turnover of FY06 and a 52.8% yoy growth in FY08. The stock trades at a P/E multiple of 20.6x and EV/EBIDTA of 12.7x FY08E earnings with an EV/Order book of 0.4x. Adjusting for its BOT ventures, the P/E for FY08E stands at 17.4x, making the GIL stock attractive at current levels.

We recommend a BUY on the stock on the basis of our sum of parts valuation with a one-year target price of Rs454, representing an upside of 17.9% from current levels.

Sum of parts valuation (Rs mn) Methodology EBIDTA (FY08E) 2,948 EV/EBIDTA (x) 12 Target multiple Enterprise value 35,377 Net debt (Debt-cash) FY08E 363 Market capitalization 35,014 AEL 253 1x Book value REL 253 1x Book value VSPL 367 1x Book value Cochin Bridge - 1x Book value MNEL 721 1x Book value Ranjit-II Hydroelectric 1,350 1x Book value Punjab Biomass 68 1x Book value Kosi River Bridge 860 1x Book value Gorakpur Bypass 1,235 1x Book value Total equity value 40,121 Diluted equity capital 177 Value per share (Rs) 454 CMP (Rs) 385 % upside 17.9

Growth matrix yoy (%) FY04 FY05 FY06 FY07E FY08E Net Sales 53.8 3.1 13.7 55.3 52.8 EBIDTA 33.8 305.6 28.6 39.2 55.6 Net profit 55.5 79.2 71.4 35.6 52.1 Source: India Infoline Research

October 18, 2006 Construction Sector 44 India Under ‘Construction’

Company background

GIL, established in 1919, is the flagship company of the 87-year old Gammon group. The company specializes in the design and construction in the areas of Gammon’s client profile transportation engineering, industrial structures, high rise structures, energy (%) projects, foundation engineering, bulk storage facilities, controlled demolition Central government 64 techniques, hydraulic works and irrigation projects. The company is the only AP 15 construction company in India to have been accredited with ISO 9001:1994 Foreign 6 certifications in all fields of civil engineering, including design. The company Non-government 4 was established by late Mr. J.C. Gammon, Mr. Abhijit Rajan took over as Managing Maharashtra 3 Director in 1991 and has been managing the company ever since. Gujarat 3 Other states 5 GIL recently submitted its bid for Rs63.7bn MRTS project in Hyderabad, as part Tamil Nadu 1 of a consortium comprising GVK, Alstom and IDFC. It has also bid for the Source: Company Automated People Mover (APM) project in Dubai to build its expertise in this segment, by gaining an early mover advantage.

Last five quarterly financials (Standalone) (Rs mn) Apr05-Jun05 Jul05-Sep05 Oct05-Dec05 Jan06-Mar06 Apr06-Jun06 Net sales 2,863 2,891 3,350 4,069 4,185 Operating expenditure (2,522) (2,444) (2,865) (3,716) (3,868) Operating profit 341 447 486 353 317 Other income 0 1 1 18 3 Interest (102) (102) (114) (55) (52) Depreciation (66) (63) (84) (97) (56) PBT 173 283 290 219 211 Tax (19) (36) (80) 69 (25) PAT 154 248 209 288 186 Equity 152 152 152 174 174

Quarterly OPM trend (Standalone)

18.0 15.5 16.0 14.5 13.6 14.0 Margin recognition 11.9 12.0 11.0 10.9 constrained by AS-7, as minimum threshold of 15-20% 10.0 9.2 8.7 8.7 not reached.

(%) 7.6 8.0 6.0 4.0 2.0 - Jan04- Apr04- Jul04- Oct04- Jan05- Apr05- Jul05- Oct05- Jan06- Apr06- Mar04 Jun04 Sep04 Dec04 Mar05 Jun05 Sep05 Dec05 Mar06 Jun06

Source: Company data

October 18, 2006 Construction Sector 45 India Under ‘Construction’

Financials

Income Statement (Standalone) Period to FY04 CY04 FY06 FY07E FY08E (Rs mn) (12) (9) (15) (12) (12) Net Sales 11,238 8,721 14,851 20,458 31,250 Operating expenses (10,159) (7,762) (12,919) (18,544) (28,302) EBIDTA 1,079 959 1,932 1,914 2,948 Depreciation (199) (165) (371) (358) (441) EBIT 879 795 1,561 1,556 2,508 Interest (340) (282) (471) (366) (714) Other Income 6 3 21 20 20 Profit before tax (PBT) 545 516 1,112 1,210 1,814 Tax (204) (87) (83) (121) (218) Profit after tax (PAT) 341 428 1,028 1,089 1,596 Extraordinary / prior period items (48) - - - - Adjusted profit after tax (APAT) 293 428 1,028 1,089 1,596

Balance Sheet (Standalone) Period to FY04 CY04 FY06 FY07E FY08E (Rs mn) (12) (9) (15) (12) (12) Sources Equity Capital 128 156 177 177 177 Reserves 2,095 3,788 9,081 10,082 11,545 Net Worth 2,223 3,943 9,258 10,259 11,722 Loan Funds 2,182 3,031 1,706 3,049 5,946 Def Tax liability 332 366 345 552 844 Total 4,737 7,340 11,309 13,860 18,512

Uses Gross Block 4,142 4,505 5,420 6,494 8,159 Accd Depreciation (1,237) (1,408) (1,723) (2,081) (2,521) Net Block 2,905 3,097 3,697 4,413 5,638 Capital WIP 48 128 73 44 56 Total Fixed Assets 2,953 3,225 3,771 4,457 5,694 Investments 805 896 1,162 1,185 1,196 Total Current Assets 6,181 8,258 11,469 15,385 22,521 Total Current Liabilities (5,215) (5,039) (5,092) (7,167) (10,899) Net Working Capital 967 3,219 6,377 8,218 11,622 Def Tax assets 12 - - - - Total 4,737 7,340 11,309 13,860 18,512

October 18, 2006 Construction Sector 46 India Under ‘Construction’

Cash Flow Statement Year to (Rs mn) CY04 FY06 FY07E FY08E Net profit before tax and extraordinary items 516 1,112 1,210 1,814 Depreciation 165 371 358 441 Interest expense 282 471 366 714 Operating profit before working capital changes 962 1,954 1,934 2,968 Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (617) (45) (928) (1,720) (Inc)/dec in inventories (807) (1,212) (1,835) (3,401) (inc)/dec in other current assets (26) 5 (1) 2 Inc/(dec) in sundry creditors 67 23 1,988 3,688 Inc/(dec) in other current liabilities (242) 30 86 44 Net change in working capital (1,626) (1,198) (690) (1,388)

Cash from operating activities (664) 756 1,244 1,581 Less: Income tax (87) (83) (121) (218) Inc/Dec in Def Tax Asset/liability 46 (21) 207 291 Net cash from operating activities (706) 652 1,330 1,654 Cash Profit (706) 652 1,330 1,654

Cash flows from investing activities (Inc)/Dec in fixed assets (436) (917) (1,045) (1,677) (Inc)/Dec in Investments (91) (266) (23) (11) Net cash from investing activities (527) (1,182) (1,068) (1,688)

Cash flows from financing activities Inc/(Dec) in debt 849 (1,325) 1,343 2,897 Inc/(Dec) in equity/premium 27 21 - - Direct add/(red) to reserves 1,303 4,319 (0) (0) Interest expense (282) (471) (366) (714) Dividends (38) (53) (88) (133) (inc)/dec in loans & advances (178) (1,345) (1,057) (1,916) Net cash used in financing activities 1,682 1,145 (168) 135

Net increase in cash and cash equivalents 449 615 94 101 Cash at start of the year 280 728 1,343 1,437 Cash at end of the year 728 1,343 1,437 1,538

October 18, 2006 Construction Sector 47 India Under ‘Construction’

Key Ratios Period FY04 CY04 FY06 FY07P FY08P (12) (9) (15) (12) (12) Per share ratios EPS (Rs) Annualized 4.6 7.3 9.3 12.3 18.0 Cash EPS (Rs) Annualized 7.7 10.2 12.7 16.4 23.0 Div per share (Rs) 0.5 0.5 0.6 1.0 1.5 Book value per share (Rs) 34.6 50.6 104.7 116.0 132.5 FV per share (Rs) 2.0 2.0 2.0 2.0 2.0

Valuation ratios P/E (x) 81.6 50.7 40.0 30.2 20.6 P/CEPS (x) 48.5 36.6 29.4 22.7 16.1 P/BV (x) 10.7 7.3 3.6 3.2 2.8 Dividend yield (%) 0.1 0.1 0.2 0.3 0.4 EV/sales (x) 2.3 3.6 2.2 1.7 1.2 EV/ EBIT (x) 29.3 39.3 21.3 22.2 14.9 EV/EBIDTA (x) 23.9 32.6 17.2 18.0 12.7

Profitability ratios OPM (%) 9.6 11.0 13.0 9.4 9.4 EBIT margin (%) 7.8 9.1 10.5 7.6 8.0 PBT margin (%) 4.8 5.9 7.5 5.9 5.8 Net profit margin (%) 2.6 4.9 6.9 5.3 5.1 Cash profit margin (%) 4.4 6.8 9.4 7.1 6.5 ROCE (%) 18.7 10.9 14.0 11.4 13.7 RONW (%) 13.2 10.9 11.1 10.6 13.6

Liquidity ratios Current ratio (x) 1.2 1.6 2.3 2.1 2.1 Debtors days 55.8 97.7 58.5 59.0 58.7 Inventory days 87.3 146.2 115.7 116.7 116.1 Creditors days 158.5 207.1 122.2 124.2 124.3

Turnover ratios Asset turnover (x) 2.4 1.2 1.3 1.5 1.7 Fixed Asset turnover (x) 3.9 2.8 4.0 4.6 5.5

Leverage ratios Debt / Total equity (x) 1.0 0.8 0.2 0.3 0.5

October 18, 2006 Construction Sector 48 BUY CMP Rs128 Hindustan Construction Company Ltd COMPANY REPORT

Stock Data Burgeoning order backlog to drive topline Target Price Rs160 Hindustan Construction Company Ltd (HCC) expected to witness a CAGR of 42.2% Upside 24.9% between FY06 and FY08 backed by a burgeoning order book position, which leaped by 79.7% yoy in FY06 and is presently at Rs91.4bn, 4.6x its FY06 turnover. Sensex 12,883 The average execution period stands at 3.5 years. The order intake at 2.9x its 52 Week H/L Rs1,020/82.9 execution in FY06 has been the highest in the last five years, giving an indication Average Vol.(6M) 455,424 of higher growth to come. Market Cap Rs 32.7bn Face Value Re1 HCC’s track record and proven capabilities leaves little room for concerns on the BSE Code 500185 execution front. Further, HCC’s strategy of executing fewer contracts (25 odd NSE Code HCC currently) and focusing on large ticket orders will help timely completion and Reuters Code HCNS.BO leaves resources in hand for further scale up. Bloomberg Code HCC@IN Prices as on 13th Oct’06 Immense value to accrue from Lavasa township We expect the Lavasa project to add significantly to HCC’s valuations post completion of phase-I, expected by March 2007. We value HCC’s equity holding Share Holding Pattern of 60.5% at Rs24.1 per share (18.9% of CMP), based on the market price of the June’06 (%) recent sale of land (Rs4mn per acre), post a 25% discount. As part of its other Promoters 46.9 real estate plans, the company has development plans for its nine acres land Foreign 23.7 (TDR at Rs400mn) in Vikhroli (W), Mumbai and is scouting for land bank to acquire Institutions 9.9 1,000 acres by March 2007. Non promoter corporate 8.5 Public & others 11.0 Moving further up the value chain HCC is awarded its maiden annuity and toll based projects in roads for Rs2,720mn and Rs280mn respectively, helping it test waters in the BOT format. The company is prepared to pitch for more BOTs in future. HCC is also planning a foray into the Share Price Chart EPC space in the hydropower segment, which commands high margins. It has 200 HCC Sensex received intimation for 1,200MW valued at Rs43.1bn; HCC’s share being Rs19.4bn. 150 Valuations 100 HCC’s stock trades at a P/E of 17.6x FY08E diluted EPS with its enterprise value 50 being 0.4x of the company’s present order book. Adjusting for the Lavasa project 0 and value of other investments, the P/E for FY08E on the fully diluted equity stands 5 5 6 6 6 6 6

0 0 0 0 0 0 0 at 13.8x, which makes the HCC stock attractive at current levels. The company has ------t r t c b n g c c p e e u u cash in the books amounting to Rs39.2 per share forming 30.7% of the CMP. O A J O F D A

We recommend a BUY on this stock on the basis of our sum of parts valuation – Rs132.2 for HCC’s core business, Rs24.1 to Lavasa and Rs3.4 to the Vikhroli land, BOTs and subsidiaries. Our 12-month target of Rs160, represents an upside of 24.9%.

Key financials and ratios(standalone) FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Net sales (Rs mn) 10,579 14,873 19,870 28,348 40,151 yoy (%) - 40.6 33.6 42.7 41.6 Net profit (Rs mn) 357 740 848 1,432 2,183 yoy (%) - 107.6 14.6 68.9 52.4 OPM (%) 13.5 10.5 9.2 8.9 9.0 EPS (Rs) 1.8 3.2 3.3 5.6 8.5 P/E (x) 71.5 39.5 38.5 22.8 15.0 P/BV (x) 15.6 8.3 3.7 3.2 2.7 EV/EBIDTA (x) 20.4 20.9 19.5 14.7 11.3 Order book/Sales (x) 8.6 6.1 4.6 3.2 2.3 ROCE (%) 15.4 13.6 7.8 8.6 11.3 RONW (%) 21.8 21.0 9.5 14.2 18.3

October 18, 2006 Construction Sector 49 India Under ‘Construction’

Investment rationale

Capable of timely project execution with superior construction 80-year track record of Being in the construction business for 80 years, HCC has developed the right successful execution know-how and skill to undertake complex projects within the scheduled time for execution. In fact, the company has earned a reputation due to completion Prequalifies for orders in of some major projects well before time: most sectors

Ö Delhi metro rail corridor project with a contract for 51 months was commissioned seven months before schedule.

Ö The excavation of the 6,000 metres Tala Hydroelectric project tunnel was completed nine months ahead of schedule.

Ö The Ennore Break water project with a contract of 36 months was completed eight months ahead of schedule.

The company has been known to use leading edge technologies for its projects, which has helped it win a good reputation and a number of awards. The company achieved this due to tie-ups with major international players like Van Oord, Hyundai, Skanska, CHEC, Samsung, Impregilo, Bechtel and Kumagai Gumi.

This experience has helped HCC prequalify across sectors. Over the years, HCC has participated in the construction of 15 hydropower projects, 43 dams and barrages, 300 bridges, 127kms of tunnels, 1,000kms of roads and 7 nuclear power stations.

Recently, HCC forayed into the gas pipeline business when it bagged its first gas pipeline contract worth Rs550mn on an EPC basis from Gujarat State Petronet Ltd in a JV with Nova Joint Stock Company, Russia. HCC has the manpower base with 45% technical personnel with over 10 years experience and the managerial bandwidth to built superior structures. We believe that HCC will be best positioned to take advantage of the huge spending planned in the infrastructure space. Marquee projects executed by HCC Segment Project Client Bridges Bandra-Worli Sea link MSRDC Bridges Godavari Bridge super structure, AP Chief Administrative, South Central Railway, Secunderabad Bridges Naini Bridge, UP NHAI Bridges Kaliabhomora Bridge, Assam NF Railway, Maligaon, Gauhati, Assam Roads Mumbai-Pune Expressway, Chowk to Sanjgaon and Adoshi MSRDC Roads West Bengal Road, Kolaghat to Kharagpur NHAI Railways Udhampur-Srinagar-Baramulla New B.G. Railway Line Project (Zone-IV & V), J & K Railways Udhampur-Srinagar-Baramulla New B.G. Railway Line Project & Pir Panjar Tunnel (Zone-VA & VB), J&K Hydel Power Chamera Hydroelectric Project, HP National Hydroelectric Power Corporation Ltd Hydel Power Tala hydroproject, Bhutan (contract package no. C1) Tala Hydroelectric Project Authority Gedu, Bhutan Hydel Power Nathpa Jhakri Hydro electric project, HP Nathpa Jhakri Power Corporation Hydel Power Koyna Hydel project Irrigation Dept., Koyna Dam Project Koyna, Maharashtra to be continued... October 18, 2006 Construction Sector 50 India Under ‘Construction’

Segment Project Client Metros New metro railway project, Kolkatta Metro Railway Metros Delhi metro Delhi Metro Rail Corporation Ltd Water supply and irrigation Gomti Aqueduct Works, UP XII Circle, Irrigation Works Water supply and irrigation Mumbai Water Supply Project Brihan Mumbai Municipal Corporation Water supply and irrigation Tirupur Water Supply Project, Tamil Nadu New Tirupur Area Development Corporation Ltd Marine Impounded Dock, Haldia Calcutta Port Trust, Calcutta Marine Oil Tanker Terminal, Cochin Cochin Port Trust, Kerala Marine Breakwaters for Ennore Port, Chennai Chennai Port trust, Chennai Barrages Farakka Barrage Project, West Bengal Farakka Barrage Division Barrages Hathnikund Barrage Chief Engineer (HKB), Haryana Irrigation Department Dams Idukki Dam Kerala State Electricity Board Dams Salal Dam National Hydroelectric Power Corporation Ltd Power Kudankulam Nuclear Power Project, Tamil Nadu Nuclear Power Corporation of India Ltd Source: Company

One of the major players in the hydropower space … HCC is one of the major players in the construction of hydropower projects in New orders in this space during FY06 will help sustain India. For a number of years in the past, this segment had been the largest margins in future contributor to HCC’s revenues (45% in FY04 and 35% in FY05), resulting in high margins too. While the company witnessed a fall in contribution to revenues from this segment during FY05 and FY06 respectively, four new orders in this segment during FY06 are expected to boost the contribution in future years.

We expect an increase in the proportion of hydropower, both in revenue (Rs8bn) as well in the order book (Rs48.6bn) during FY07. These projects command a higher margin due to complexity of execution, which should compensate for the lower margins earned in other verticals like roads.

Revenues from hydropower vertical

14,000 60.0

12,000 50.0 10,000 40.0 8,000 30.0 6,000 (%) (Rs mn) 20.0 4,000

2,000 10.0

- - FY04 FY05 FY06 FY07E FY08E Revenues (LHS) yoy (RHS)

Source: Company, India Infoline Research

… Admission into EPC in hydropower Foray into hydropower EPC - With its experience in construction of hydropower projects, it was only logical part of the elite league for HCC to move up the value chain by entering into EPC in hydropower, where only a few like Jaiprakash Associates and Larsen & Toubro have been able to execute orders.

October 18, 2006 Construction Sector 51 India Under ‘Construction’

HCC has received an intimation of approval by the Jammu & Kashmir government for execution of a 1,200MW hydro project on an EPC basis, valued at Rs43.1bn. Execution will be in 7.5 years through a JV with HCC’s share being Rs19.4bn. HCC’s plan in future is to selectively bid for more such projects on an EPC basis that command higher margins.

A growing order intake to go with a healthy order mix Order book leaped by 79.7% HCC’s order book grew by 18.8% in FY04 and 35.2% in FY05 and leaped by yoy in FY06 79.7% in FY06. The average execution period, for the order book of Rs91.4bn as on Q1 FY07 is 3.5 years. With the order book at 4.6x FY06 turnover, growth expectations for the next 2-3 years are high. HCC’s turnover is expected to rise by 42.7% and 41.6% yoy during FY07 and FY08 respectively.

Trend in order book segment wise

100.0 4.0 3.6 90.0 15.0 12.1 80.0 70.0 38.5 60.0 43.0 50.0 (%) 1.9 40.0 2.0 30.0 20.0 36.0 43.8 10.0 - FY02 FY03 FY04 FY05 FY06 FY07E Hydel power Nuclear power Transportation Water supply and irrigation Others

Source: Company data, India Infoline Research

HCC has seen a substantial rise in the order intake/execution during FY06 at Highest order intake by the 2.9x, which is the highest in the last five years. This is an indication of higher company in the last 5 years turnover in the coming years. The company has presently tendered bids for contracts worth Rs30bn approximately and will be submitting further bids during the course of the year. We have factored in an order intake of a little over Rs42.5bn during FY07 to be executed over FY08-FY10.

Trend in order intake to execution

100.0 3.0 2.8 2.9 80.0 2.5

60.0 2.0 1.8 1.7

1.5 (x)

(Rs bn) 40.0 1.3 1.0 20.0 0.5 - - FY02 FY03 FY04 FY05 FY06 Order book (LHS) Order intake/Execution (RHS)

Source: Company, India Infoline Research October 18, 2006 Construction Sector 52 India Under ‘Construction’

Projects awarded to HCC during FY06 Name of project Value (Rs bn) Lucknow-Muzaffarpur National Highway Project, Package LMNHP-EW II (WB) 1 1.98 Lucknow-Muzaffarpur National Highway Project, Package LMNHP-EW II (WB) 2 2.12 Lucknow-Muzaffarpur National Highway Project, Package LMNHP-EW II (WB) 3 2.50 Lucknow-Muzaffarpur National Highway Project, Package LMNHP-EW II (WB) 4 2.55 Mughal Road from Bafliaz (Poonch) to Shopian (Pulwama) in J&K 2.14 East-West Corridor Project Package-EW-II (RJ-7) 3.76 Four laning of NH-54, Package EW-II (AS-23), Assam 3.17 Pir Panjal Tunnel (Zone-VA) on Laole-Qazigund section of Udhampur-Srinagar-Baramulla New BG Railway Line Project in J&K 2.18 Pir Panjal Tunnel (Zone-VB) on Laole-Qazigund section of Udhampur-Srinagar-Baramulla New BG Railway Line Project in J&K 1.73 Uri-II Hydroelectric Project (Uri-II: Lot-1), J&K 5.75 Chamera Hydroelectric Project, stage-III, Lot-1, HP 5.05 Teesta Low Dam HEP Stage IV, 160MW, Lot 1, West Bengal 3.96 Sawalkote Hydroelectric Project, J&K 43.13 Kalol Mehsana Gas Pipeline Project, Gujarat 0.55 Source: Company

Real estate mega plans … HCC, through its 100% owned subsidiary, Hincon Realty, forayed into the real estate sector by leveraging on its existing strengths. Hincon Realty owns 60.5% stake in Lavasa Corporation Ltd, which is involved in the implementation of the Lavasa Township near Pune in Maharashtra. The company also holds 9 acres of land at Vikhroli (W) in Mumbai, transferred to it from HCC’s books during FY06 for Rs400mn.

… Immense value from the Lavasa township project Mega project: Development HCC is developing over 10,000 acres of land into apartments, hotels, educational of 10,000 acres centres, retail malls, convention centres, biotech and information technology parks and recreation facilities, which comprises the Lavasa township near Pune for Lavasa Corporation Ltd.

The location of Lavasa is between Mumbai and Pune, in the western ghats of India at 2,000-3,000 feet above sea level. It is a 3 hours’ drive from Mumbai and an hour from the proposed Pune International Airport. The natural surroundings and greenery with a 20kms long lake nearby is the key attraction of Lavasa.

Lavasa’s location map

Source: Company October 18, 2006 Construction Sector 53 India Under ‘Construction’

Lavasa development in phases The Plan of conceptualising the township is being done by HOK, USA. HCC has acquired 8,500 acres of land out of the total area of 10,000 acres. The entire project will be developed in three phases, to be completed by 2015:

Phase-I will involve development of 1,739 acres of land at Dasve as education, tourist and business destination. Time period: 4 years (to be completed by 2007). Total real estate released: 5%. Revenues will start flowing in from 2008-09.

Phase-II will involve development of 4,094 acres of land. Besides commercial construction, residential development will be undertaken as well. Time period: 5 years. Total real estate released: 30%.

Phase-III will involve development of 2,967 acres of land. Here too, residential development will be done. Time period: 9 th year onwards. Total real estate released: 65%.

Source: Company, India Infoline Research

Lavasa – Key participants Segment of the project Associate Master planning HOK, USA Project feasibility and research Accenture, AC Nielsen Branding and identity Landor Associates, Hong Kong Project and construction management HCC Engineering design Hincon Technoconsit Environmental management planning National Environmental Engineering Research Institute (NEERI) Legal advisors Little and Company Source: Company

Lavasa area and plan map

Source: Company October 18, 2006 Construction Sector 54 India Under ‘Construction’

Present status The infrastructure work including access roads and utilities is in progress. HCC has already addressed the key development risks in the project: Ö Regulatory clearances for development of the city sized at around 40 square kms are in place. Ö Land assembly process has been completed and over 8,500 acres has been acquired. Ö Financial closure was completed in September 2004. Ö Dasve dam, a permanent water body of nearly 80 acres, is being created. Ö Trunk roads and associated services are being developed. Ö Town centre, lodge and apartments are being built. Ö Phase-I project development is at an advanced stage of completion.

The 10,000 acres land at Lavasa was bought for Rs70,000-95,000 per acre in 40 acres sold recently at the year 2002. The company sold 20 acres of land to Ashiana Housing and 40 Rs4mn per acre acres to Symbiosis Institute, Pune at Rs2.4mn per acre some time back. 3-4 months ago, another deal was struck where 40 acres comprising 100 plots was sold for Rs4mn per acre. In another development, ITC Hotels signed a marketing and operating services agreement to manage the first 60 room hotel at Lavasa.

Investments and shareholding pattern In the first round of funding, promoters contributed close to Rs1bn as equity in Presently holds 60.5% of the project and Rs2bn was debt sanctioned by the banks. HCC originally had a Lavasa township 50% holding in the project. Post the rights issue of Rs320mn, HCC’s share in the venture rose to 60.5% in March 2006 as some of the promoters did not participate due to financial constraints.

Lavasa shareholding pattern (%) Initially Mar-06 HCC and Associates 50.0 60.5 Private real estate developers 25.0 11.8 Venkateshwara Hatcheries 12.5 12.3 BILT and Associates 12.5 15.4 Total 100.0 100.0 Source: Company

As on date, promoters have contributed approximately Rs1.3bn while banks have sanctioned debt of Rs2bn. The total investment in Lavasa is expected to be Rs9bn; with Rs3.5bn having already come in till June 2006, Rs1.5bn would be invested by FY07 and the balance would be invested during FY08. Another Rs3bn of debt is being sanctioned by banks for this project. As the development of the project is spread over a 15-year time horizon, we believe that financing should not prove to be a constraint for the company.

Revenue and profitability We value developable 4,000 Most of the revenues will be post development of land, in the form of sale of acres at current market price residential and commercial units. Out of the 8,500 acres of land acquired, the post 25% discount management estimates that 4,000 acres would be available for development purpose, while the rest would be free space. We value HCC’s 60.5% stake in the 4,000 acres on the basis of the price received from recent transactions (Rs4mn per acre), post a 25% discount, giving us a value of Rs12bn translating into Rs24.1 per share of HCC (18.9% of the CMP). Post the completion of phase- I, we expect a significantly higher land value per acre.

October 18, 2006 Construction Sector 55 India Under ‘Construction’

The floor space index (FSI) permitted for the project is 0.4x, however, only FSI permitted - 0.4x 0.12x is being developed. A marginal increase in the FSI too, can enhance Utilized - 0.12x shareholder returns significantly. Even if HCC chooses not to use more FSI Marginal increase can lead to available, it can avail of TDR elsewhere. high gain for shareholders

… Development plans for the land bank at Vikhroli We value 9 acres land at HCC owns over nine acres of land at Vikhroli (W), Mumbai, where its head office Vikhroli (W) at Rs400mn (TDR is situated. Leaving aside the area occupied by HCC’s head office, the TDR for value) the balance nine acres land was transferred to Hincon Realty in FY06 at a price of Rs400mn, as calculated by an independent valuer in 2005-06.

The development potential of this land is of 325,000 square feet and the company is considering various options like developing an IT park or mall. We value this land in our target price calculations at the price at which development rights were transferred to Hincon (Rs400mn), translating into Rs1.3 per share of HCC.

HCC also has 14 acres land at Vikhroli (E) bought for an insignificant amount many years ago. However, this land is encroached by slums and will take time for any development to take place. We therefore, do not assign any value to this land in our calculations. The company is scouting for land particularly in Panvel, Nasik and Pune and expects to have a land bank of 1,000 acres by March 2007.

Couple of BOTs under its fold … Two BOTs in roads taken up HCC maintained an approach of bidding for BOT projects with high internal IRR to test waters calculations, letting most projects pass, rather than bidding aggressively. After a cautious approach for long, HCC picked up a small toll based project connecting Lavasa, to test waters in this segment. The company is also declared L1 for an annuity road project.

… Pune-Paud toll road The Pune-Paud toll road is a small road connecting to Lavasa. The company expects to make an equity IRR of 15-16% on the project.

Project details

Project Pune-Paud Toll Road HCC’s share (%) 100 Segment Roads Description 20.8 kms Project type Toll Project cost (Rs mn) 280 Equity (Rs mn) 40 Debt (Rs mn) 240 HCC’s equity (Rs mn) 40

Source: Company, India Infoline Research

October 18, 2006 Construction Sector 56 India Under ‘Construction’

… AP road annuity project HCC has been declared L1 for an annuity project for the 4-6 laning of a road in AP. The company will receive semi-annual payments of Rs238mn for 36 months. The value works out to be Rs1.8 per share of HCC at one time book value of the equity contribution.

Project details

Project AP Road HCC’s share (%) 100 Segment Roads Description 30 kms Project type Annuity Concession period 20 years including 2 years construction Project cost (Rs mn) 2,720 Equity (Rs mn) 544 Debt (Rs mn) 2,176 HCC’s equity (Rs mn) 544

Source: Company, India Infoline Research

Bandra-Worli sea link may spring up a positive surprise A settlement at some stage is HCC was awarded the Bandra-Worli sea link in 2001 from Maharashtra State likely. However, we continue Road Development Corporation (MSRDC), valued at Rs4bn to be completed in to factor in losses 30 months’ time. However, protests from environmentalists and fishermen forced MSRDC to change the design, the cost escalations (Rs2.65bn) for which, were not accepted, stalling the project in 2003.

HCC has been providing for the losses as part of its normal expenditure and already booked expenses of Rs3.25bn, whereas billing accepted was for Rs1.81bn. HCC expects to complete the project by March 2008 and estimates the final cost to be in excess of Rs10bn.

We have factored in losses of Rs450mn and Rs650mn from this project in FY07 and FY08 respectively in our calculations. We believe that an announcement regarding settlement between the client and HCC could bring in a positive surprise. Even if MSRDC rejects HCC’s cost escalations or terminates the contract, there will be limited impact on HCC’s profitability.

International exposure target of 15-20% Proportion of turnover: 10% HCC is presently executing a couple of orders overseas; the Tala 1,020MW Target: 15-20% hydroelectric power dams and tunnels in Bhutan and the restoration of the pier for Royal Saudi Naval Forces, valued at Rs1.5bn. The company has decided to increase its overseas presence and is actively looking at hydropower projects in Middle East and Africa. Presently, approximately 10% of its total turnover is derived from works overseas and it plans to increase this proportion to 15- 20% over the next few years.

October 18, 2006 Construction Sector 57 India Under ‘Construction’

HCC’s future strategy …

… Rapid augmentation of turnover HCC believes that margins in the construction business in India will shrink in line with global trends. The company has therefore, focused its efforts towards augmenting the turnover of the company, to compensate for any fall in margins by increased quantum of profits.

… Focused on large ticket orders HCC plans to bid for bigger projects for quality, timeliness and efficiency in Average order size is Rs3.4bn construction. During FY05, HCC executed only 23 projects, translating into an average order size of Rs2.34bn, while the same for its FY06 order book stood at around Rs3.44bn. This indicates continued focus towards high-value projects.

… High investments in capital equipment HCC over the years, has been continuously investing in assets to strengthen its presence and enhance its execution capabilities. Today, the company possesses one of the youngest fleets of specialised equipments in the field of construction in India. In future too, the company plans to stick to this practice of replacing its old fleet, which gives it flexibility to undertake a large number of varied and complex projects at short notice.

HCC’s gross block trend and fixed asset turnover

14.0 6.0

12.0 5.0 4.5 5.0 10.0 4.0 3.8 4.0 8.0 2.9 3.0 6.0 (x) (Rs bn) 2.0 4.0

2.0 1.0

- - FY04 FY05 FY06 FY07E FY08E Gross block (LHS) Fixed assets turnover (RHS)

Source: Company data, India Infoline Research

During FY06, the company issued US$100mn FCCBs and US$100mn GDS to bring funds into the company. The bondholders have the option to convert the FCCBs into equity at a conversion price of Rs248.08 per share, up to February 2011 and the GDS at Rs169.39 per share. We have included these into as part of debt in the books. However, our target price calculations are done taking the fully diluted equity of Rs301mn into consideration.

October 18, 2006 Construction Sector 58 India Under ‘Construction’

Valuations

HCC has a 80-year history of project execution and a strong order book position of Rs91.4bn presently, comprising only 25-odd projects. The order book of the company grew by 79.7% yoy during FY06, at 4.6x its FY06 turnover and an order intake at 2.9x execution. We expect a turnover growth of 42.7% and 41.6% yoy during FY07 and FY08 respectively.

The stock trades at a P/E of 17.6x FY08E diluted EPS. Adjusting for the Lavasa project and value of other investments, the P/E for FY08E on the fully diluted equity stands at 11.7x, which makes the HCC stock attractive at current levels. We feel that the enterprise value, which is just 0.4x of the company’s order book, is low.

The company also has cash in the books amounting to Rs39.2 per share, which forms 30.8% of the CMP. This huge cash is on account of the recent GDS and FCCB issue of US$200mn cumulatively, the benefits of which will accrue in the coming years.

We recommend a BUY on this stock on the basis of our sum of parts valuation factoring the core business of the company as well as its BOT ventures, land bank and the Lavasa township. Our 12-month target of Rs160 for HCC, represents an upside of 24.9%.

Sum of parts valuation (Rs mn) Methodology EBIDTA (FY08E) 3,626 EV/EBIDTA (x) 12 Target multiple Enterprise value 43,516 Net debt (Adj Debt-cash) FY08E 3,685 Market capitalization 39,831 Equity value of BOT 544 1x Book value HCC’s equity in Lavasa Township 7,260 60.5% of 4,000 acres x Rs4mn post 25% discount Subsidiary valuation 91 1x Book value Land at Vikhroli (W) 400 Rate at which TDR given Total equity value 48,126 Diluted equity capital 301 Value per share (Rs) 160 CMP (Rs) 128 % upside 24.9

Growth matrix yoy (%) FY05 FY06 FY07E FY08E Net Sales 40.6 33.6 42.7 41.6 EBIDTA 8.8 17.3 38.5 43.2 Net profit 107.6 14.6 68.9 52.4 Net Worth 115.4 152.1 13.2 18.6 Gross Block 13.2 24.5 25.9 27.0 Net Working Capital (7.1) 585.3 (4.5) 6.8 Capital employed 29.3 165.0 0.4 11.7 Source: India Infoline Research

October 18, 2006 Construction Sector 59 India Under ‘Construction’

Concerns

Margins to remain under pressure Higher contribution from Although, the turnover growth for the company has been high, the operating roads and losses on Bandra- profit margins for HCC have been declining during the last few years as shown Worli depress margins in the chart below. The company has guided that pressure on margins may continue in future and it will take efforts to improve efficiencies in asset utilisation to arrest this decline. Booking losses on the Bandra-Worli Sea Link project also contributed to the fall in margins. Excluding this project, operating margins would be in the region of 10.5% for the company.

Declining trend in HCC’s operating profit margins

15.0 14.0 13.5 13.0 12.0 11.0 (%) 10.5 10.0 9.2 8.9 9.0 9.0 8.0 7.0 FY04 FY05 FY06 FY07E FY08E

Source: Company data, India Infoline Research

Marketing risk for Lavasa project The Lavasa project is being developed to be marketed as a destination brand. While there is no doubt on HCC’s and HOK’s ability to develop this project, the marketing success will decide on the demand for the project. HCC, however, does not consider marketing as a big risk as Lavasa is close to important cities of Mumbai and Pune.

October 18, 2006 Construction Sector 60 India Under ‘Construction’

Company background

HCC is a 80-year old construction company founded in 1926 by industrialist Mr. Walchand Hirachand. The company is a leading construction major and one of the HCC’s client profile oldest private sector company engaged in civil engineering and construction activity (%) for the power sector (hydroelectric, nuclear, thermal), roads and bridges, water State Government/PSU 47 supply, dams, barrages, industrial buildings, environmental projects, ports and Central Government/PSU 25 other marine works. World Bank/ADB 13 Others 9 HCC was the first construction company in the country to be certified for ISO Foreign projects 6 9001, ISO 14001 and OHSAS 18001 for its quality, occupational and environmental Source: Company health and safety management system. The company is run by Mr. Ajit Gulabchand and is known for construction of some of the best structures in the country. Productivity per employee

2.6 The company has also undertaken a number of projects in Sri Lanka, Bhutan, 2.5 Tanzania, Qatar, Iraq and Myanmar among others. HCC presently has a workforce 2.4 of 8,100 people including 5,660 contract labourers and 1,580 engineers and owns 2.3 one of the largest and most sophisticated equipment fleets in India.

(Rs mn) 2.2 2.1 HCC is run by Mr. Ajit Gulabchand, Chairman and Managing Director, since 1983. 2.0 Mr. Gulabchand was a scion of the Walchand family and took charge of HCC FY04 FY05 FY06 operations after having successfully managed other large public limited companies

Source: Company promoted by the Walchand family.

High level employee retention Last five quarterly financials (Standalone) (Rs mn) Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07 0 to 5 Net sales 4,610 3,022 4,557 7,681 5,735 years Operating expenditure (4,201) (2,767) (4,071) (7,006) (5,282) Over 22% 10 Operating profit 409 255 486 675 454 years 6 to Other income 35 432 10 20 69 53% 10 Interest (83) (120) (126) (85) (74) years Depreciation (118) (129) (130) (147) (162) 25% PBT 243 438 239 463 287 Tax (16) (81) (12) (25) (36) Source: Company PAT 227 357 227 438 251 Extra ordinary items (27) (354) - (12) (6) APAT 200 3 227 426 245 Equity 229 229 229 256 256

Quarterly OPM trend

12

10

8

6 (%)

4

2

0 Q1 FY05 Q2 FY05 Q3 FY05 Q4 FY05 Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07

Source: Company data

October 18, 2006 Construction Sector 61 India Under ‘Construction’

Financials

Income statement (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Net Sales 10,579 14,873 19,870 28,348 40,151 Operating expenses (9,146) (13,315) (18,041) (25,815) (36,525) EBIDTA 1,433 1,559 1,829 2,533 3,626 Depreciation (438) (453) (524) (642) (815) EBIT 995 1,106 1,304 1,891 2,811 Interest (376) (395) (414) (369) (418) Other Income 17 56 461 50 45 Share of turnover from JV (32) (17) 31 37 43 Profit before tax (PBT) 605 750 1,383 1,609 2,481 Tax (248) (10) (135) (177) (298) Profit after tax (PAT) 357 740 1,248 1,432 2,183 Extraordinary / prior period items - - (400) - - Adjusted profit after tax (APAT) 357 740 848 1,432 2,183

Balance sheet (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Sources Equity Capital 200 229 256 256 256 Reserves 1,439 3,300 8,642 9,818 11,693 Net Worth 1,639 3,530 8,898 10,074 11,950 Loan Funds 4,195 4,257 12,978 11,697 12,197 Def Tax liability 748 725 677 879 1,164 Total 6,582 8,511 22,554 22,650 25,311

Uses Gross Block 5,482 6,208 7,728 9,728 12,355 Accd Depreciation (1,874) (2,305) (2,807) (3,449) (4,265) Net Block 3,609 3,903 4,921 6,279 8,090 Capital WIP 86 478 1,074 463 339 Total Fixed Assets 3,694 4,380 5,995 6,741 8,428 Investments 486 1,899 1,265 1,300 1,283 Total Current Assets 6,321 7,721 23,067 25,229 29,195 Total Current Liabilities (3,918) (5,489) (7,773) (10,620) (13,595) Net Working Capital 2,403 2,232 15,294 14,609 15,600 Total 6,582 8,511 22,554 22,650 25,311

October 18, 2006 Construction Sector 62 India Under ‘Construction’

Cash Flow Statement Year to (Rs mn) FY05 FY06 FY07E FY08E Net profit before tax and extraordinary items 750 1,383 1,609 2,481 Depreciation 453 524 642 815 Interest expense 395 414 369 418 Operating profit before working capital changes 1,597 2,321 2,620 3,714 Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (18) 3 (12) (17) (Inc)/dec in inventories (620) (5,154) (4,725) (6,599) (inc)/dec in other current assets 4 (1) 1 (1) Inc/(dec) in sundry creditors 1,511 2,194 2,442 3,445 Inc/(dec) in other current liabilities 60 89 405 (470) Net change in working capital 937 (2,868) (1,888) (3,642)

Cash from operating activities 2,534 (547) 732 72 Less: Income tax (10) (135) (177) (298) Inc/Dec in Def Tax Asset/liability (23) (47) 201 286 Net cash from operating activities 2,501 (729) 756 60 Extraordinary inc/(exp) - (400) - - Cash Profit 2,501 (1,129) 756 60

Cash flows from investing activities (Inc)/Dec in fixed assets (1,139) (2,139) (1,389) (2,502) (Inc)/Dec in Investments (1,414) 634 (35) 17 Net cash from investing activities (2,553) (1,504) (1,424) (2,485)

Cash flows from financing activities Inc/(Dec) in debt 62 8,722 (1,281) 500 Inc/(Dec) in equity/premium 29 27 - - Direct add/(red) to reserves 1,278 4,698 (0) (0) Interest expense (395) (414) (369) (418) Dividends (157) (205) (256) (308) (inc)/dec in loans & advances (298) (1,009) (438) (347) Net cash used in financing activities 520 11,819 (2,345) (573)

Net increase in cash and cash equivalents 468 9,185 (3,012) (2,998) Cash at start of the year 407 875 10,060 7,048 Cash at end of the year 875 10,060 7,048 4,050

October 18, 2006 Construction Sector 63 India Under ‘Construction’

Ratios FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Per share ratios EPS (Rs) 1.8 3.2 3.3 5.6 8.5 Fully diluted EPS (Rs) 1.8 3.2 3.3 4.8 7.2 Cash EPS (Rs) 4.0 5.2 5.4 8.1 11.7 Fully diluted CEPS (Rs) 4.0 5.2 5.4 6.9 10.0 Div per share (Rs) 0.5 0.6 0.7 1.0 1.2 Book value per share (Rs) 8.2 15.4 34.7 39.3 46.6 FV per share (Rs) 1.0 1.0 1.0 1.0 1.0

Valuation ratios P/E (x) 71.5 39.5 38.5 22.8 15.0 P/E (x) (fully diluted) 71.5 39.5 38.5 26.8 17.6 P/CEPS (x) 32.1 24.5 23.8 15.7 10.9 P/CEPS (x) (fully diluted) 32.1 24.5 23.8 18.5 12.8 P/BV (x) 15.6 8.3 3.7 3.2 2.7 Dividend yield (%) 0.4 0.5 0.5 0.8 0.9 EV/sales (x) 2.8 2.2 1.8 1.3 1.0 EV/ EBIT (x) 29.4 29.5 27.3 19.7 14.5 EV/EBIDTA (x) 20.4 20.9 19.5 14.7 11.3 Order book/Sales (x) 8.6 6.1 4.6 3.2 2.3

Profitability ratios OPM (%) 13.5 10.5 9.2 8.9 9.0 EBIT margin (%) 9.4 7.4 6.6 6.7 7.0 PBT margin (%) 5.7 5.0 7.0 5.7 6.2 Net profit margin (%) 3.4 5.0 4.3 5.1 5.4 Cash profit margin (%) 7.5 8.0 6.9 7.3 7.5 ROCE (%) 15.4 13.6 7.8 8.6 11.3 RONW (%) 21.8 21.0 9.5 14.2 18.3

Liquidity ratios Current ratio (x) 1.6 1.4 3.0 2.4 2.1 Debtors days 0.4 0.8 0.5 0.5 0.5 Inventory days 179.9 143.2 201.8 202.3 202.8 Creditors days 127.5 127.8 135.9 126.7 120.8

Turnover ratios Asset turnover (x) 1.6 1.7 0.9 1.3 1.6 Fixed Asset turnover (x) 2.9 3.8 4.0 4.5 5.0

Leverage ratios Debt / Total equity (x) 2.6 1.2 1.5 1.2 1.0

Component ratios Construction expenses (%) 74.4 79.4 80.6 81.3 82.1 Staff cost (%) 7.3 6.4 6.6 6.5 6.4 Other expenditure (%) 4.8 3.7 3.6 3.2 3.2

October 18, 2006 Construction Sector 64 BUY CMP Rs175 Nagarjuna Construction Company Ltd COMPANY REPORT

Stock Data Play on road and water verticals Target Price Rs206 Nagarjuna Construction Company Ltd (NCC) to benefit from the high investment Upside 17.6% in road and water verticals, expected to together account for 35.6% of revenues Sensex 12,736 in FY07 and 19.5% in FY08. The current order book at 3.4x FY06 turnover is 52 Week H/L Rs404.5/148.3 healthy, given NCC’s average execution period of 27 months. With order intake during FY06 at 2x turnover, NCC is set for high growth in the next two years, Average Vol.(6M) 190,883 with an expected topline increase of 54.5% and 43.5% during FY07 and FY08 Market Cap Rs36.2bn respectively. Face Value Rs2 BSE Code 500264 Early entrant in the BOT space NSE Code NAGARCONST NCC was one of the early entrants into the BOT space and enjoys a good mix Reuters Code NGCN.BO with two annuity road projects, two toll based ones and two projects in the Bloomberg Code NJCC@IN power vertical. The company plans to bid for new BOTs on its own having raised Prices as on 13th Oct’06 the finances. At the book value of NCC’s equity, these six projects translate into Rs15.8 per share of NCC, which is 9% of the CMP. Share Holding Pattern Real estate ventures to make a noteworthy contribution June’06 (%) NCC will sell 88% of the 50 acres land, in lieu of 12% of the developed area to Promoters 25.6 be given to the government, post the National Games 2007. NCC also has 89% Foreign 29.8 equity stake in the AP Housing project for development of 85 acres. We value Institutions 10.1 these two projects at Rs9.1 per share of NCC at 2x book value of equity infused, Non promoter corporate 5.7 Public & others 28.9 comprising 5.2% of the CMP.

We also assign a value of Rs10.9 per share to the 130 acres land bank, over and above the two projects above, with a current market value of Rs3bn, post Share Price Chart a 25% haircut. We foresee enormous value unlocking on the development and sale of these properties in future. 200 NCC Sensex

150 Valuations 100 NCC trades at a P/E of 15.5x, EV/EBIDTA of 11.1x its FY08E earnings and P/ 50 CEPS of 13.3x during the same period. Adjusted for the price of its BOT ventures and real estate, the P/E for FY08E stands at 12.3x, which we believe is highly 0

5 5 6 6 6 6 6 attractive for a growth story like NCC. The market capitalization is low too, at 0 0 0 0 0 0 0 ------t r t c b n g 0.6x the company’s present order book. c c p e e u u O A J O F D A We recommend a BUY on the stock with a 12-month price target of Rs206, which represents an upside of 17.6% from current levels.

Key financials and ratios (Standalone) FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Net sales (Rs mn) 7,582 11,885 18,404 28,437 40,795 yoy (%) - 56.8 54.9 54.5 43.5 Net profit (Rs mn) 316 573 1,039 1,555 2,337 yoy (%) - 81.2 81.4 49.7 50.2 OPM (%) 7.8 7.6 8.9 8.9 9.1 EPS (Rs) 5.5 7.2 10.1 7.5 11.3 P/E (x) 31.5 24.2 17.3 23.1 15.4 P/BV (x) 6.1 4.2 1.9 3.4 2.9 EV/EBIDTA (x) 18.4 16.7 12.1 15.6 11.1 Order book/Sales (x) 8.3 5.3 3.4 2.2 1.5 ROCE (%) 16.8 14.2 11.1 13.2 16.0 RONW (%) 19.5 17.6 11.0 14.6 18.6 Source: Company data, India Infoline estimates

October 18, 2006 Construction Sector 65 India Under ‘Construction’

Investment rationale

Well diversified portfolio NCC is one of the leading construction majors with a diversified presence; successful handling the evolution from a road and building constructor a few years back, to execution in complex verticals like water and irrigation today. The table below reveals NCC’s entry into new verticals over the years. This diversification ensures that the company is prepared for a sudden spurt in investments in a particular vertical and is poised to take advantage quickly.

Expanding into new verticals FY02 FY03 FY04 FY05 FY06 FY07 FY08 Roads Ö Ö Ö Ö Ö Ö Ö Buildings Ö Ö Ö Ö Ö Ö Ö Water Ö Ö Ö Ö Ö Ö Power (T&D) Ö Ö Ö Ö Ö Ö Irrigation Ö Ö Ö Ö Ö Real estate Ö Ö Ö Oil and gas pipelines Ö Ö Source: Company, India Infoline Research

Road and water verticals to Roads and water projects dominate NCC’s revenues. The company derived drive growth 22% and 30% of its revenues from roads and water verticals respectively during FY06. NCC’s skill in road projects is almost unrivaled as it completes most projects 5-7 months ahead of schedule. In the water segment too, NCC has the competence of carrying out turnkey projects from concept to commissioning.

Roads and water segments contribution to NCC’s topline

20,000 3.5 6,000 3.5 3.0 3.0 5,000 2.9 16,000 2.9 2.6 2.5 2.5 4,000 12,000 2.0 2.0 2.1 2.0

3,000 (x) 1.6 (x) 1.5 8,000 1.5 1.5 (Rs mn) (Rs mn) 2,000 1.0 1.0 0.8 4,000 1,000 0.5 0.5 - - - - FY03 FY04 FY05 FY06 FY03 FY04 FY05 FY06 Revenues (LHS) Order intake/Execution (RHS) Revenues (LHS) Order intake/Execution (RHS)

Source: Company data, India Infoline Research

Robust order book position Order book of 3.4x FY06 NCC’s order book position as on 31st March 2006 stood at over Rs54bn. The turnover to drive 48.9% present order book translates into 3.4x its FY06 turnover, which is healthy given CAGR in next 2 years the company’s average execution period of 27 months.

The company is accustomed to handling a large number of orders for 8-9 years now and presently has around 90 contracts. The management believes this will help in future when size of contract increases, enabling it to manage a bigger order book. NCC witnessed high order intake/execution of 2.9x and 2x in FY05 and FY06 respectively, which along with our estimated 1.5x for FY07 will drive CAGR of 48.9% during the next two years.

October 18, 2006 Construction Sector 66 India Under ‘Construction’

NCC’s order book trend

80.0 3.5 70.0 3.0 2.9 60.0 2.5 50.0 2.0 2.0 40.0 1.6 1.5 1.5 1.5 (X)

(Rs bn) 30.0 20.0 1.0 10.0 0.5 - - FY03 FY04 FY05 FY06 FY07E

Order book (LHS) Order intake/Execution (RHS)

Source: Company, India Infoline Estimates

The share of roads in the order book has been on the rise since the last two Will benefit from AP’s years (35.9% in FY05 and 43% in FY06) and we expect this trend to continue in irrigation focus FY07, rising to 47.6%. NCC is based in AP and is the beneficiary of the numerous tenders released in the water and irrigation segments. The water segment will continue to enjoy the second largest proportion of NCC’s order book in FY07 (22.4%), helping sustain margins.

Segmental split in NCC’s order book

100.0 11.0 11.3 80.0 16.5 14.3 4.0 4.4 60.0 25.5 22.4 (%) 40.0

20.0 43.0 47.6

- FY03 FY04 FY05 FY06 FY07E Roads Water Power (T&D) Buildings Irrigation/Others

Source: Company data, India Infoline Research

Early entrant into BOT Good mix of 8 BOTs in roads, NCC is one of the early entrants in the BOT space. The company started by power and real estate pitching for annuity projects and later moved on to other forms. Presently, the company has a good mix of toll and annuity projects in roads, couple of projects in power and another couple in real estate development.

The company initially bid for BOTs in joint ventures with other players. Having gained the required experience and funds, it plans to bid for such projects on its own in future. It may float a subsidiary for the development part of these projects like Gammon India has done. We expect NCC’s BOT presence to grow considerably over the next two years.

October 18, 2006 Construction Sector 67 India Under ‘Construction’

Bangalore-Madhur road project Annuity payment of Rs297mn The Bangalore-Madhur Expressway involves construction of a 4-lane highway semi-annually for 8 years for the government of Karnataka. The project will fetch 16 semi-annual installments of Rs297mn each, post the construction period. The project has been completed ahead of schedule and will commence commercial operation soon. Therefore, the consortium would be eligible for bonus of four months amounting to Rs297mn, increasing the expected ROE to 25% from 18% targeted earlier. We assign a value of Re1 per share of NCC to this project.

Project details NCC’s share (%) 33.3 Segment Roads Description 62.6 kms Project type Annuity Other partners Maytas Infrastructure, KMC Construction Concession period 10 years including 2.5 years for construction Project cost (Rs mn) 2,500 Equity (Rs mn) 625 Debt (Rs mn) 1,875 NCC’s equity (Rs mn) 208

Source: Company, India Infoline Research

Meerut-Muzzafarnagar road project Expected IRR of 18%. Valued The Meerut-Muzzafarnagar road project involves construction, operations and at Rs3.2 per share management of 79kms stretch in UP. This project is being executed in a JV, where Gayatri Construction has a 40% share and Maytas Infrastructure has a 30% share. An SPV, Western UP Tollway limited, will implement the project and NCC is expecting an IRR of 18% from this project. We assign a value of Rs3.2 per share of NCC to this project.

Project details

NCC’s share (%) 50 Segment Roads Description 79 kms Project type Toll Other partners Maytas Infrastructure, Gayatri Construction Concession period 20 years including 3 years for construction Project cost (Rs mn) 5,300 Equity (Rs mn) 1,325 Debt (Rs mn) 3,975 Grant (Rs mn) 1,278 NCC’s equity (Rs mn) 663 Source: Company, India Infoline Research

October 18, 2006 Construction Sector 68 India Under ‘Construction’

Bangalore-Hosur road project Expected IRR of 18%. Assign The Bangalore-Hosur road project involves construction of an elevated value of Rs3.1 per share expressway from Silk Board Junction of Electronic City. The consortium partners have incorporated a SPV, Bangalore Elevated Tollway Ltd, for implementing the project. NCC is expecting an IRR of 18% from this project. We assign a value of Rs3.1 per share of NCC to this project.

Project details

NCC’s share (%) 33.5 Segment Roads Project type Toll Other partners Maytas Infrastructure, Soma Construction Concession period 20 years including 2 years for construction Project cost (Rs mn) 7,640 Equity (Rs mn) 1,910 Debt (Rs mn) 5,730 NCC’s equity (Rs mn) 640

Source: Company, India Infoline Research

Orai-Bhognipur road project Annuity of Rs448.2mn semi- The Orai-Bhognipur road project involves the design, engineering, construction, annually for 30 months development, operation and maintenance of a 35kms stretch on the Orai- Bhognipur section and a 28kms stretch on Bhognipur-Barah section in UP. The consortium will receive Rs448.2mn, as annuity, semi-annually for 30 months. We assign a value of Rs4 per share of NCC to this project.

Project details

NCC’s share (%) 64 Segment Roads Project type Annuity Other partners KMC Construction Concession period 17.5 years including 2.5 years for construction Project cost (Rs mn) 5,200 Equity (Rs mn) 1,300 Debt (Rs mn) 3,900 NCC’s equity (Rs mn) 832

Source: Company, India Infoline Research

October 18, 2006 Construction Sector 69 India Under ‘Construction’

Himachal Sorang power project Valued at Rs2.4 per share The 100MW Himachal Sorang hydroelectric project involves a run-of-the-river development on the Sorang Khad, a tributary of the Sutlej River in the Kinnaur district, HP, for a lease period of 40 years by Himachal State Electricity Board. The detailed feasibility report for this project is under preparation. We assign a value of Rs2.4 per share of NCC to this project.

Project details

NCC’s share (%) 33 Segment Power Description 100MW Other partners Maytas Infra, SSJV Projects Concession period 40 years including 3 years for construction Project cost (Rs mn) 4,990 Equity (Rs mn) 1,497 Debt (Rs mn) 3,493 NCC’s equity (Rs mn) 494

Source: Company, India Infoline Research

Gautami Power Project We assign a value of Rs3.2 Gautami Power is a 464MW gas based combined cycle plant located in AP in per share of NCC which NCC holds 10% equity stake. The project cost is Rs14bn with an equity component of Rs4204mn. GVK, Maytas Infrastructure and IJM are the other partners in the consortium. We assign a P/BV of 1x to NCC’s equity contribution of Rs420mn in our calculation, translating into Rs3.2 per share.

Real estate venture - set to attain size …

NCC’s revenues from real estate development

1,050

900 CAGR 52.7% 750

600

(Rs mn) 450

300

150

- FY05 FY06 FY07E

Source: Company data, India Infoline Research

October 18, 2006 Construction Sector 70 India Under ‘Construction’

… National Games Village, Ranchi NCC, through its 100% SPV, is developing a housing complex with 1,800 dwellings Project valued at Rs2,760mn on 50 acres of land for the National Games, Ranchi in Jharkhand in 2007. As and revenues expected in per the agreement between the state and NCC, the SPV is given land free in FY08 and FY09. Valued at lieu of 12% of the developed area, ie 216 vilas, to be given to the government. Rs4.8 per share On conclusion of the games, NCC can sell off all of the balance 88% dwelling units in the open market.

1,200 units will be completed by June 2007 and the balance nine months hence. The estimated built up area would be 2.4mn square feet for the project valued at Rs2,760mn. NCC has guided on an operating profit margin of 20%. We value this project at 2x NCC’s equity (Rs4.8 per share) since revenues will be flowing in the foreseeable future and expect huge value unlocking on sale of the developed property.

… AP Housing project NCC and Uppal Housing are developing 85 acres in Visakhapatnam, a contract Estimated project cost of awarded by the AP Housing Board (APHB). 75% of the land is for construction Rs4bn. 89% of NCC’s stake of residential houses and the balance 25% for commercial use. The consortium valued at Rs4.3 per share will have to pay a development fee of Rs9.32mn per acre and also share some percentage of gross revenues with APHB (we estimate it to be in the region of 3-5% of turnover). The estimated project cost for the development of the township is approximately Rs4bn. We value 89% of the book value of NCC’s equity at 2x, translating into Rs4.3 per share.

… SPV for property at Hyderabad NCC with Mytas and ICICI Ventures acquired 6 acres land in a prime locality in 130 acres land bank with Hyderabad for Rs3.4bn to set up a five star deluxe hotel, commercial complex market price of Rs3bn. We and a luxury mall at an estimated cost of Rs8bn. The hotel would be offered on value at Rs10.9 per share management contract to global hoteliers. ICICI Ventures, NCC and Mytas hold 60%, 25% and 15% of the equity respectively.

The company also has a land bank of 130 acres in Hyderabad, Chennai, Cochin valued at Rs3bn against a book value of Rs300mn. We value this at the market price, post a 25% discount of Rs10.9 per share, 6.3% of the CMP. On the back of these plans, NCC’s real estate business is set to pick up pace in FY07 and FY08 and would be highly margin accretive.

Plans to increase presence in international market Proportion of turnover: 5-6% NCC is considering expanding its presence in the international arena, especially Target: 9-10% in Gulf. It already has a regional office in Dubai. It presently derives 5-6% of its revenues from overseas work and targets to increase this share to 9-10% in FY08. The company’s track record of completing most projects before the scheduled date in India should help ease efforts to win work overseas.

Expected CAGR of 49% in topline and bottomline between FY06-08 NCC has been a major beneficiary of the infrastructure boom in the country and has successfully emerged as a leading player with performance comparable with other large peers in the space. The company witnessed a CAGR of 34.5% in topline between FY97 and FY06. The same during the last five years, ie between FY01 and FY06, stands at 49.5%, with 83.2% CAGR net profit during that period.

October 18, 2006 Construction Sector 71 India Under ‘Construction’

We expect NCC to witness a CAGR of 48.8% in topline and 48.9% in bottomline between FY06 and FY08 primarily on account of execution of its present order book. The order intake is likely to remain healthy (1.5x FY07 revenues) and will ensure stable growth beyond FY08 as well.

Balance sheet strengthened to enable to bid on its own The GDR issue done by NCC for US$120mn helped boost up its networth to Rs9.45bn in FY06 as compared to Rs3.25bn in FY05. The company now has a networth, 15% of its order book size, which has increased the bidding capacity significantly.

NCC has invested the money raised through the GDR issue for its capex and working capital requirements, investments in real estate and BOT projects. The strength of the balance sheet will enable the company to bid for large sized projects on its own, which it earlier did through consortiums. We believe that NCC is now comfortably placed at a D/E of 0.5x and will not need to further dilute any further equity in the medium term.

NCC’s margins to remain stable BOT construction and real We expect NCC’s operating profit margins to remain stable in FY07 as shown estate business to help below and witness a marginal rise of 20bps yoy in FY08. A healthy mix of works sustain margins for in water, power T&D and irrigation will help sustain margins. Road orders in the consolidated entity BOT format accounting for Rs20.6bn together command high margins during construction period. NCC’s entry into real estate development, where margins at the operating level are likely to be 20% due to dual benefits of construction and development, will also help sustain margins in future for the consolidated entity. While the building segment is a large contributor accounting for 29% of the revenues in FY06, we see the share of this lower margin segment declining over the next two years.

NCC’s OPM and NPM trend (Standalone)

9.5 OPM 6.0 NPM 9.1 5.7 9.0 5.5 8.9 8.9 5.6 5.5 8.5 5.0 8.0 4.8 (%) (%) 4.5 7.5 7.8 7.6 4.2 7.0 4.0

6.5 3.5 FY04 FY05 FY06 FY07E FY08E FY04 FY05 FY06 FY07E FY08E

Source: Company data, India Infoline Research

October 18, 2006 Construction Sector 72 India Under ‘Construction’

Valuations

NCC is one of the leading construction companies with a diversified presence and a healthy order book. Based on its present order book position and 1.5x order intake/execution in FY07, we estimate a topline growth of 54.5% and 43.5% yoy during FY07 and FY08 respectively.

The stock is trading at a P/E of 15.4x FY08E earnings and an EV of 11.1x its EBIDTA for the same period. The company has cash in the balance sheet of Rs13.6 per share and the order book stands at 1.7x its present market capitalisation. The company recently announced a bonus of 1:1 for its equity shareholders (Stock still trading ex bonus). We recommend a BUY with a 12- month target of Rs206 based on our sum of parts valuation. Our target price represents an appreciation of 17.6% from current levels.

Sum of parts valuation (Rs mn) Methodology EBIDTA (FY08E) 3,701 EV/EBIDTA (x) 10 Target multiple Enterprise value 37,006 Net debt (Debt-cash) FY06 1,820 Market capitalization 35,187 Bangalore-Madhur BOT 208 1x Book value Meerut-Muzzafarpur BOT 663 1x Book value Orai-Bhognipur BOT 832 1x Book value Bangalore-Hosur BOT 640 1x Book value Gautami Power BOT 420 1x Book value Hydro power, HP BOT 494 1x Book value AP Housing 890 2x Book Value National Games Village 1,000 2x Book Value Land Bank 2,250 130 acres x Rs23mn post 25% discount Total equity value 42,584 Diluted equity capital 413 Value per share (Rs) 206 CMP (Rs) 175 % upside 17.6

Growth matrix yoy (%) FY05 FY06 FY07E FY08E Net Sales 56.8 54.9 54.5 43.5 EBIDTA 54.3 80.9 53.8 46.6 Net profit 81.2 81.4 48.7 49.3 Net Worth 100.8 190.4 13.9 18.2 Gross Block 17.8 54.3 58.4 30.7 Net Working Capital 92.1 159.0 24.9 24.1 Capital employed 86.3 137.0 28.2 23.6 Source: India Infoline Research

October 18, 2006 Construction Sector 73 India Under ‘Construction’

Company background

NCC was incorporated in the year 1990 and took over the business of the erstwhile partnership concern, Nagarjuna Construction Company. The company NCC’s client profile was promoted by Mr. AVS Raju and associates and commenced its construction (%) activity in 1978. The company is a leading player in the construction space in Central government 47.0 India with a major presence in roads and water segment. It also operates in State government 48.0 other verticals like power T&D, buildings, irrigation, among others. NCC came Private sector 5.0 out with its maiden public issue in 1992. It is an ISO 9001: 2000 certified company Source: Company data with 29 years experience in this field.

Last five quarterly financials (Rs mn) Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07 Net sales 3,594 3,682 4,724 6,405 6,517 Operating expenditure (3,316) (3,303) (4,267) (5,873) (5,968) Operating profit 278 379 457 532 550 Other income 5 15 17 5 8 Interest (35) (89) (97) (44) (57) Depreciation (34) (41) (53) (54) (58) PBT 214 264 324 440 443 Tax (22) (55) (56) (90) (59) PAT 192 209 268 349 384 Equity 159 159 200 207 207

Quarterly OPM trend

12.0 10.3 9.7 10.0 8.3 8.3 8.4 8.0 7.7 8.0 7.4 7.1

6.0 (%)

4.0

2.0

- Q1 FY05 Q2 FY05 Q3 FY05 Q4 FY05 Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07

Source: Company data

October 18, 2006 Construction Sector 74 India Under ‘Construction’

Financials

Income Statement (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Net Sales 7,582 11,885 18,404 28,437 40,795 Operating expenses (6,994) (10,978) (16,764) (25,913) (37,094) EBIDTA 588 907 1,641 2,524 3,701 Depreciation (91) (109) (182) (282) (364) EBIT 497 798 1,459 2,242 3,337 Interest (134) (147) (310) (480) (616) Other Income 41 49 113 128 163 Profit before tax (PBT) 404 700 1,262 1,890 2,885 Tax (88) (127) (223) (334) (548) Profit after tax (PAT) 316 573 1,039 1,555 2,337

Balance Sheet (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Sources Equity Capital 115 159 207 413 413 Reserves 1,507 3,096 9,245 10,223 12,143 Net Worth 1,621 3,255 9,451 10,636 12,556 Loan Funds 1,540 2,648 4,629 7,171 9,187 Def Tax liability 43 66 66 114 163 Total 3,204 5,969 14,146 17,921 21,907

Uses Gross Block 1,414 1,665 2,569 3,969 5,120 Accd Depreciation (507) (576) (720) (1,002) (1,365) Net Block 907 1,089 1,849 2,968 3,755 Capital WIP 12 9 67 46 34 Total Fixed Assets 919 1,098 1,916 3,014 3,789 Investments 5 462 877 877 877 Total Current Assets 4,306 7,462 15,699 21,270 27,328 Total Current Liabilities (2,029) (3,087) (4,368) (7,239) (10,087) Net Working Capital 2,277 4,375 11,331 14,030 17,241 Miscellaneous expenditure 3 34 22 - - Total 3,204 5,969 14,146 17,921 21,907

October 18, 2006 Construction Sector 75 India Under ‘Construction’

Cash Flow Statement Year to (Rs mn) FY05 FY06 FY07E FY08E Net profit before tax and extraordinary items 700 1,262 1,890 2,885 Depreciation 109 182 282 364 Interest expense 147 310 480 616 Operating profit before working capital changes 956 1,754 2,652 3,864 Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (1,073) (1,101) (1,689) (1,976) (Inc)/dec in inventories (504) (2,369) (1,557) (2,305) (inc)/dec in other current assets (4) (17) (24) - Inc/(dec) in sundry creditors 944 1,129 2,542 2,806 Inc/(dec) in other current liabilities 113 152 330 41 Net change in working capital (524) (2,206) (399) (1,434)

Cash from operating activities 432 (452) 2,253 2,430 Less: Income tax (127) (223) (334) (548) Inc/Dec in Def Tax Asset/liability 23 (1) 48 49 Misc expenditure w/off (31) 12 22 - Net cash from operating activities 297 (664) 1,988 1,931 Cash Profit 297 (664) 1,988 1,931

Cash flows from investing activities (Inc)/Dec in fixed assets (288) (1,000) (1,379) (1,139) (Inc)/Dec in Investments (457) (414) (0) - Net cash from investing activities (746) (1,414) (1,379) (1,139)

Cash flows from financing activities Inc/(Dec) in debt 1,108 1,981 2,542 2,016 Inc/(Dec) in equity/premium 45 48 207 - Direct add/(red) to reserves 1,125 5,298 (207) (0) Interest expense (147) (310) (480) (616) Dividends (108) (188) (370) (417) (inc)/dec in loans & advances (859) (3,313) (1,485) (1,263) Net cash used in financing activities 1,164 3,515 206 (279)

Net increase in cash and cash equivalents 715 1,437 815 514 Cash at start of the year 657 1,372 2,809 3,624 Cash at end of the year 1,372 2,809 3,624 4,138

October 18, 2006 Construction Sector 76 India Under ‘Construction’

Ratios FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Per share ratios EPS (Rs) 5.5 7.2 10.1 7.5 11.3 Cash EPS (Rs) 7.1 8.6 11.8 8.9 13.1 Div per share (Rs) 0.8 1.2 1.6 1.6 1.8 Book value per share (Rs) 28.3 40.9 91.5 51.5 60.8 FV per share (Rs) 2.0 2.0 2.0 2.0 2.0

Valuation ratios P/E (x) 31.5 24.2 17.3 23.1 15.4 P/CEPS (x) 24.5 20.3 14.7 19.6 13.3 P/BV (x) 6.1 4.2 1.9 3.4 2.9 Dividend yield (%) 0.5 0.7 0.9 0.9 1.0 EV/sales (x) 1.4 1.3 1.1 1.4 1.0 EV/ EBIT (x) 21.8 18.9 13.6 17.6 12.3 EV/EBIDTA (x) 18.4 16.7 12.1 15.6 11.1 Order book/Sales (x) 8.3 5.3 3.4 2.2 1.5

Profitability ratios OPM (%) 7.8 7.6 8.9 8.9 9.1 EBIT margin (%) 6.6 6.7 7.9 7.9 8.2 PBT margin (%) 5.3 5.9 6.9 6.6 7.1 Net profit margin (%) 4.2 4.8 5.6 5.5 5.7 Cash profit margin (%) 5.4 5.7 6.6 6.5 6.6 ROCE (%) 16.8 14.2 11.1 13.2 16.0 RONW (%) 19.5 17.6 11.0 14.6 18.6

Liquidity ratios Current ratio (x) 2.1 2.4 3.6 2.9 2.7 Debtors days 40.6 58.8 59.8 60.4 59.8 Inventory days 49.1 46.8 77.2 69.9 69.4 Creditors days 88.4 85.4 77.5 82.8 82.8

Turnover ratios Asset turnover (x) 2.4 2.0 1.3 1.6 1.9 Fixed Asset turnover (x) 8.4 10.9 10.0 9.6 10.9

Leverage ratios Debt / Total equity (x) 1.0 0.8 0.5 0.7 0.7

Component ratios Construction expenses (%) 87.1 87.6 85.9 85.9 85.9 Staff cost (%) 2.6 2.6 2.6 2.6 2.6 Other expenditure (%) 2.5 2.2 2.6 2.7 2.5

October 18, 2006 Construction Sector 77 MARKET PERFORMER CMP Rs287 IVRCL Infrastructures & Projects Ltd COMPANY REPORT

Stock Data Best prequalifications in water and environment segment Target Price Rs307 IVRCL is the biggest player in the water management vertical in India, accounting Upside 7% for 46% of the company’s revenues in FY06. With continued focus on this vertical Sensex 12,736 by certain states, we expect this vertical to contribute to 50.5% of IVRCL’s turnover in FY07 and 53.1% in FY08. The award of India’s first desalination project to be 52 Week H/L Rs1,589/164 constructed in Chennai, is testimony of IVRCL’s strong position in the segment. Average Vol.(6M) 640,777 We assign a value of Rs6 per share to this project. Market Cap Rs30.7bn Face Value Rs2 Hindustan Dorr-Oliver acquisition complementary BSE Code 530773 IVRCL’s 51.4% controlling stake in Hindustan Dorr-Oliver (HDO) enables access NSE Code IVRCLINFRA to HDO’s expertise to be leveraged for EPC projects in the water segment, Reuters Code IVRC.BO completing the value chain in this segment. We include this investment in our Bloomberg Code IVRC@IN target price calculations at the present market value of IVRCL’s equity of Prices as on 13th Oct’06 Rs1,640mn, translating into Rs13.7 per share, forming 4.8% of IVRCL’s CMP.

Healthy order intake across verticals Share Holding Pattern IVRCL has a well diversified portfolio with an order backlog of Rs67bn at present, June’06 (%) translating into 4.5x its FY06 sales, which is among the highest in the construction Promoters 12.9 space. The order intake/execution is at a healthy 2.5x, signifying high growth in Foreign 38.4 FY07 and FY08. Institutions 27.4 Non promoter corporate 6.9 Going with the toll based format in road BOTs Public & others 14.4 With three toll based road BOTs valued at Rs10.8bn, either having achieved or nearing financial closure, IVRCL plans to bid for some more and foray in BOTs in power T&D as well. We foresee IVRCL as a major player in the BOT space in future and value these three projects at Rs15.6 per share of IVRCL. Share Price Chart 250 IVRCL Sensex Real estate development benefits to accrue over three years 200 The sale of the balance 25% residential land in Hyderabad is expected to fetch 150 Rs1.65bn in FY07. Around 40% of the 11.83 acres commercial portion is expected 100 to be sold in FY08 and the balance in FY09. We value the commercial portion at 50 the market price of unsold land post 25% discount, giving Rs29.7 per share of 0 IVRCL, which is 10.3% of IVRCL’s CMP. 5 5 6 6 6 6 6 0 0 0 0 0 0 0 ------t r t c b n g c c p e e u u Valuations O A J O F D A The stock is trading at a P/E of 15.2x FY08E EPS. Adjusted for its investments and BOTs, it trades at 11.8x FY08E EPS. We find the stock attractive at an order book/ market cap of 2.2x and at 11.6x FY08E EV/EBIDTA and assign a MARKET PERFORMER rating with a one-year price target of Rs307, representing an upside of 7%.

Key financials and ratios (Standalone) FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Net sales (Rs mn) 7,735 10,547 14,957 24,286 35,205 yoy (%) - 36.4 41.8 62.4 45.0 Net profit (Rs mn) 392 567 930 1,492 2,249 yoy (%) - 44.7 63.9 60.5 50.7 OPM (%) 7.5 8.2 9.0 9.0 9.3 EPS (Rs) 7.4 6.7 8.7 12.4 18.8 P/E (x) 38.9 43.0 33.0 23.1 15.2 P/BV (x) 7.1 6.0 6.4 3.9 3.2 EV/EBIDTA (x) 26.9 25.8 26.1 17.0 11.6 Order book/Sales (x) 8.7 6.4 4.5 2.8 1.9 ROCE (%) 14.1 13.4 12.1 14.6 17.9 RONW (%) 18.3 14.1 19.5 17.1 21.0

October 18, 2006 Construction Sector 78 India Under ‘Construction’

Investment rationale

Dominant player in water and environmental projects IVRCL is the biggest player in the water management vertical in India providing Water segment expected to integrated solutions in water management, lumpsum turnkey contracts and contribute 50.5% to turnover front end engineering and design contracts. Structural trends like rising in FY07 urbanization, industrialization and better awareness of health and hygiene are likely to drive India to focus on water infrastructure. The continued focus of many state governments like Gujarat, AP, Karnataka and Rajasthan on water and irrigation is expected to contribute 50.5% to turnover in FY07 and 53.1% in FY08 for IVRCL, which has the best prequalifications in this vertical.

Contribution of water segment to IVRCL’s revenues

8,000 80.0 7,000 70.0 6,000 60.0 5,000 50.0 4,000 40.0 (%)

(Rs mn) 3,000 30.0 2,000 20.0 1,000 10.0 - - FY02 FY03 FY04 FY05 FY06 Revenues (LHS) % of revenues (RHS)

Source: Company, India Infoline Research

Healthy mix between verticals While the water segment has been the main stay for the company, IVRCL has a well diversified portfolio in roads, buildings and industrial structures and power T&D verticals. During FY06, the company earned 22%, 24% and 8% of its revenues from the roads, building and power segments respectively.

IVRCL’s revenue mix IVRCL’s order book mix

100.0 100.0 8.0 13.0 12.3 17.0 80.0 80.0 15.0 13.5 19.0 20.4 60.0 60.0 23.0 (%) (%) 40.0 40.0 56.0 49.0 53.8 20.0 20.0

- - FY03 FY04 FY05 FY06 FY07E FY08E FY05 FY06 FY07E Water Roads Buildings Power Water Roads Building Power

Source: Company, India Infoline Research Source: Company, India Infoline Research

In the power segment, which forms 13% of the order book, the company is primarily Power (T&D) to be another into transmission and distribution segment and is engaged in the construction of focus area transmission lines and sub-stations. The company is increasing its exposure to this segment, expected to account for 12.8% of the revenues in FY07 from 8% in FY06.

October 18, 2006 Construction Sector 79 India Under ‘Construction’

IVRCL has declared its plans to integrate backwards by setting up a steel fabrication and galvanizing unit for manufacture of transmission line tower parts to be commissioned by December 2007 with a capacity of 24,000 tons at an investment of Rs100mn. This will complete the value chain in its power T&D segment. IVRCL also plans to foray into new verticals like railways, metro rail, ports and hydropower to further diversify in future.

High order intake across verticals High order book/sales of 4.5x IVRCL’s order backlog as on March 2006 stands at Rs62.5bn, including the EPC value of its BOT projects worth Rs10bn, to be executed in 2.5 years. Its order book during Q1 FY07 translates into 4.5x its FY06 sales, which is among the highest in the construction space. The order intake/execution during FY06 too, is at a healthy 2.5x.

The order intake has been well distributed among all its verticals. Roads and the power segment’s proportion in the total order intake has risen in FY06 as compared to FY05. We foresee a declining share of buildings and growing share of power T&D in the company’s order intake in future. This will help sustain margins as buildings enjoy lower margins than the other segments.

Segment wise order intake/execution

20,000 Water 3.5 12,000 Roads 3.5 3.0 16,000 10,000 3.0 2.5 2.5 8,000 12,000 2.0 2.0

(x) 6,000 (x) 8,000 1.5 1.5 (Rs mn) (Rs mn) 4,000 1.0 1.0 4,000 2,000 0.5 0.5 - - - - FY03 FY04 FY05 FY06 FY03 FY04 FY05 FY06 Order intake (LHS) Order intake/Execution (RHS) Order intake (LHS) Order intake/Execution (RHS)

8,000 Buildings 4.0 7,000 Power T&D 9.0 7,000 3.5 6,000 8.0 6,000 3.0 7.0 5,000 5,000 2.5 6.0 4,000 5.0

4,000 2.0 (x) (x)

(Rs mn) 3,000 4.0 (Rs mn) 3,000 1.5 3.0 2,000 2,000 1.0 2.0 1,000 0.5 1,000 1.0 - - - - FY03 FY04 FY05 FY06 FY03 FY04 FY05 FY06 Order intake (LHS) Order intake/Execution (RHS) Order intake (LHS) Order intake/Execution (RHS)

Source: Company, India Infoline Research

Increasing share of BOT projects … IVRCL has a BOT portfolio of Rs15.5bn, comprising three road projects and one water desalination project. It has won all the three road projects on its own, the water BOT being the only one with a partner.

October 18, 2006 Construction Sector 80 India Under ‘Construction’

With all its BOTs, either having achieved or nearing financial closure and construction activity on all projects close to getting started (Jalandhar-Amritsar Highway already underway), the company plans to bid for more such projects soon. Besides roads, IVRCL also plans to bid for BOT projects in the power T&D segment through the JV route. We foresee IVRCL as a major player in the BOT space in future with a large portfolio of such projects.

… Going with the toll based model in roads Owns 3 toll based BOTs All the three road projects that IVRCL has been awarded in the BOT format, are toll based. The company seems comfortable with the toll based format and is expected to bid for more projects of this type going forward.

Jalandhar-Amristar Highway Expected IRR of 21.4% This project has achieved financial closure and the construction activity has commenced. In the first year of operations, the project is expected to generate toll revenues of Rs200mn. The IRR expected is 21.4% and we value this project at Rs3.4 per share of IVRCL.

Project details

Project Jalandhar-Amritsar IVRCL’s share (%) 100 Segment Roads Description 49 kms Project type Toll Concession period 17.5 years including 2.5 years for construction Project cost (Rs mn) 2,370 Equity (Rs mn) 410 Debt (Rs mn) 1.570 Grant (Rs mn) 400 IVRCL’s equity (Rs mn) 410

Source: Company, India Infoline Research Two roads on Salem and Kumarapalayam The Salem Highway project is expected to generate an IRR of 23% and earn Both project IRRs expected to Rs300mn revenues during the first year of operations. The Kumarapalayam be 23% project too, is expected to earn an IRR of 23% overall and Rs320mn worth revenues, during the first year of operations. We value these two projects at Rs12.1 per share of IVRCL.

Project details

Project Salem Highway Kumarapalayam Highway IVRCL’s share (%) 100 100 Segment Roads Roads Description 48.5 kms 53 kms Project type Toll Toll Concession period 20 years including 3 years 20 years including 2 years for construction for construction Project cost (Rs mn) 3,400 4,215 Equity (Rs mn) 800 650 Debt (Rs mn) 1,300 3,390 Grant (Rs mn) 1,300 175 IVRCL’s equity (Rs mn) 800 650

Source: Company, India Infoline Research October 18, 2006 Construction Sector 81 India Under ‘Construction’

… Awarded India’s first water desalination project We assign a value of Rs6 per IVRCL was awarded India’s first desalination project, involving design, share of IVRCL construction, operation and maintenance of a 100mn litres per day (MLD) plant, to be constructed in Chennai. The JV will operate the plant on a joint basis and the partner will provide IVRCL with access to desalination and other water treatment technologies. We value this project at Rs6 per share of IVRCL.

Project details

Project Water Desalination Location Chennai IVRCL share (%) 75 Project type Two part tariff Partner Befesa, Spain Project cost (Rs mn) 4,730 Equity (Rs mn) 950 Debt (Rs mn) 3,780 IVRCL equity commitment (Rs mn) 712.5

Source: Company, India Infoline Research

Hindustan Dorr Oliver acquisition adds value During FY06, IVRCL acquired 70% controlling stake in HDO at a consideration of HDO will help leverage expertise in water verticals Rs539mn to gain access to HDO’s expertise in primary chemical treatment, biodegradation studies, advanced chemical oxidation, tertiary treatment and membrane filtration studies. HDO’s manufacturing and design capabilities will be leveraged by IVRCL to bid for EPC projects in the water segment, completing the skill sets required for this vertical. HDO’s formidable design and manufacturing capability and low cost manufacturing base also provides an opportunity as a supplier to players in the global market.

HDO profile

HDO’s business activities include designing, manufacturing, supplying and installing equipment, systems and processes for liquid-solid separation and pollution control in a wide variety of industries like pulp and paper, foods and pharma, refineries and petrochemical, mineral benefication, breweries, chemicals and industrial municipal waste water. The company has a robust design capability with over 200,000 drawings of various process and equipment designs.

Source: Company

For funding the expansion of the manufacturing facility, design engineering facility Currently holds 51.4% of and to meet working capital requirements, HDO made a preferential allotment HDO, valued at current of 1.57mn shares at a price of Rs320 per share. Post allotment, the shareholding market value of Rs13.7 per of IVRCL in HDO has reduced to 51.4%. share

HDO’s financials, post acquisition, have witnessed a substantial improvement. Its order backlog at the end of March 2006 stood at Rs1.5bn and the management has guided on a CAGR of 40-50% during the next few years. The HDO acquisition, has not only added to IVRCL’s expertise in water treatment, but also led to a huge appreciation in the market value. We value HDO at Rs13.7, which is the current market value of IVRCL’s investments in the company.

October 18, 2006 Construction Sector 82 India Under ‘Construction’

HDO’s latest financials (Rs mn) Q1 FY07 Q1 FY06 yoy (%) FY06 FY05 yoy (%) Net sales 329 231 42.6 1,414 838 68.7 Operating expenditure (309) (220) 40.2 (1,352) (823) 64.3 Operating profit 21 11 92.5 63 15 305.8 Other income 3 2 52.9 25 27 (7.8) Interest 6 (4) (245.0) (6) (17) (64.5) Depreciation (3) (1) 172.7 (7) (5) 54.2 PBT 26 7 256.2 74 21 260.0 Tax (11) (4) 202.8 (9) (9) (2.2) PAT 15 4 308.1 65 11 477.7 Equity 58 42 37.1 58 42 37.1 EPS (Rs) 10.4 3.5 197.6 11.2 2.6 321.3 OPM (%) 6.3 4.6 4.4 1.8 Face value (Rs) 10.0 10.0 10.0 10.0 Source: Company data Stock split done with face value presently at Rs2 per share

National Games Village – Benefits to accrue over the next three years IPO of IVR Prime Urban IVRCL, through its 100% subsidiary, IVR Prime Urban Developers, ventured Developers to unlock value. into real estate development, acquiring 50 acres in Hyderabad in FY01. Of the We assign Rs29.7 per share total area, 38.17 acres was planned for residential construction of 450 to this subsidiary apartments and 123 villas and the balance 11.83 acres was for commercial construction.

The developable area for the residential part was close to 1.8mn square feet, 75% of which was sold in FY06 and the balance is to be sold in FY07, expected to bring in revenues to the tune of Rs1,650mn. On the remaining 11.83 acres, the company is setting up a shopping mall, commercial complex and a five star hotel, 40% of which is expected to be sold in FY08 and the balance in FY09.

The company bought the 50 acres land at Rs2.9mn per acre, the present market value being Rs400mn per acre. We choose to value the commercial property (11.83 acres) at the current market price with a 25% discount, translating into Rs29.7 per share, which is 11.3% of the CMP.

IVR Prime Urban financials (Rs mn) FY06 FY05 yoy (%) Revenues 1,360.0 218.0 523.9 Net profit 118.0 6.9 1,610.1 NPM (%) 8.7 3.2 - Source: Company

The company recently announced that it got 43 acres of land in Noida, UP and plans to develop 2.8mn square feet of housing area. It expects revenues to flow in from Q4 FY07 onwards. This is a new project not factored in our target price. IVR Prime Urban Developers plans to carry out property development in various cities like Chennai, Pune, Bangalore and Hyderabad to emerge as a noteworthy player in this segment through joint development and not through owning of a land bank.

October 18, 2006 Construction Sector 83 India Under ‘Construction’

53.4% CAGR in turnover over next two years; expect margins to rise The company has maintained a turnover CAGR of 40.3% between FY02-06. Backed by a healthy order backlog that grew by 60% yoy during FY06 and the estimated order intake of Rs29.5bn during FY07, we estimate IVRCL to witness a CAGR of 53.4% in topline between FY06 and FY08 on a standalone basis.

IVRCL’s turnover trend

40,000 120.0 35,000 100.0 30,000 80.0 25,000

20,000 60.0 (%)

(Rs mn) 15,000 40.0 10,000 20.0 5,000 - - FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07E FY08E Turnover (LHS) yoy (RHS)

Source: Company data, India Infoline Research

We expect margins to improve in FY07 and FY08. Stable raw material prices and in-built escalation clauses will help sustain margins for the company. Earnings CAGR of 55.6% expected between FY06 and FY08.

Operating and net profit margin trend

Expansion 10.0 9.3 9.0 9.0 in margins 9.0 8.2 8.0 7.5 7.0 6.2 6.1 6.4 5.4 6.0 5.1 5.0 (%) 4.0 3.0 2.0 1.0 - FY04 FY05 FY06 FY07E FY08E OPM NPM

Source: Company data, India Infoline Research

October 18, 2006 Construction Sector 84 India Under ‘Construction’

Valuations

IVRCL is expected to register a topline growth of 62.4% and 45% during FY07 and FY08 respectively. During the same period, net profit growth is expected at 59.7% and 51.6% respectively. Valuations seem attractive for a stock trading at a P/E of 15.2x FY08E EPS and 11.6x FY08E EV/EBIDTA. Adjusted for its investments and BOTs, it trades at 11.8x FY08E EPS. The market capitalization is at 0.4x its order book and the company has Rs22.8 cash per share in its books. We recommend a BUY with a one-year price target of Rs307, representing an upside of 7%.

Sum of parts valuation (Rs mn) Methodology EBIDTA (FY08E) 3,280 EV/EBIDTA (x) 10 Target multiple Enterprise value 32,802 Net debt (Debt-cash) FY08E 3,855 Market capitalization 28,947 Jallandhar BOT 410 IVRCL’s equity share at 1x Book value Salem Highway BOT 800 IVRCL’s equity share at 1x Book value Kumarapalayam BOT 650 IVRCL’s equity share at 1x Book value National Games Village 3,549 11.83 acres x Rs400mn post 25% discount Chennai Disalination 713 IVRCL’s equity share at 1x Book value HDO’s holding 1,640 IVRCL’s 51.4% stake at the market value of investment Total equity value 36,709 Diluted equity capital 239 Value per share (Rs) 307 CMP (Rs) 287 % upside 7.0

Growth matrix yoy (%) FY05 FY06 FY07E FY08E Net sales 36.4 41.8 62.4 45.0 EBIDTA 48.1 55.3 63.2 49.7 Net profit 44.7 63.9 59.7 51.6 Net worth 88.4 18.4 82.3 23.1 Gross block 14.8 42.7 40.0 34.0 Net working capital 66.6 41.8 37.9 28.4 Capital employed 66.0 77.5 24.7 22.6 Source: India Infoline Research

October 18, 2006 Construction Sector 85 India Under ‘Construction’

Concerns

Low promoter holding The promoter holding in the company has been declining over the years on IVRCL’s client profile account of regular equity dilutions to fund the mounting capex and working (%) capital needs of the company to keep up its high growth. Presently, the promoter Central government 12.0 holding in IVRCL is around 12% and is expected to fall further to around 11- Central government 11.5% post the proposed GDR issue. affiliated 25.0 State government 40.0 Company background PSU/Others 15.0 Multilateral agencies 8.0 IVRCL was incorporated in 1987 as I. Venku Reddy Constructions (P) Ltd. The Source: Company data name was again changed a couple of times before being renamed as IVRCL Infrastructures and Projects Ltd. The company started by undertaking small projects for hospital buildings, roads in the interiors and buildings for industrial purposes before graduating to become one of the leading infrastructure companies in the country. Its operations can be divided into four broad segments, namely water supply and irrigation, roads and bridges, buildings and industrial structures and power T&D. Mr. E. Sudhir Reddy has been the Managing Director of the company since inception.

IVRCL’s holding structure

IVRCL

Hindustan IVRCL Road IVR Prime Urban IVRCL Water Dorr Oliver Ltd Toll Holding Developers Ltd Infrastructure (51.4% stake) Ltd (100% stake) Ltd

Jalandhar- Kumarapalayam- Kumarapalayam- Chennai Amritsar Road Chengalpalli Salem Road Desalination Ltd (100% stake) (100% stake) (100% stake) (75% stake)

Source: Company, India Infoline Research

Last five quarterly financials (Standalone) (Rs mn) Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07 Net sales 3,007 2,567 4,151 6,026 4,340 Operating expenditure (2,774) (2,356) (3,807) (5,468) (3,982) Operating profit 233 210 344 558 358 Other income 10 4 4 43 17 Interest (45) (72) (86) (49) (83) Depreciation (22) (24) (27) (36) (38) PBT 175 118 235 516 254 Tax (11) (6) (13) (78) (36) PAT 165 112 222 438 217 Equity 210 214 214 214 218

October 18, 2006 Construction Sector 86 India Under ‘Construction’

Quarterly OPM trend

12.0 9.7 10.0 9.3 8.2 8.3 8.2 7.5 7.7 7.8 8.0 7.1

6.0 (%)

4.0

2.0

- Q1 FY05 Q2 FY05 Q3 FY05 Q4 FY05 Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07

Source: Company data

October 18, 2006 Construction Sector 87 India Under ‘Construction’

Financials

Income statement (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Net Sales 7,735 10,547 14,957 24,286 35,205 Operating expenses (7,151) (9,682) (13,614) (22,094) (31,925) EBIDTA 584 865 1,343 2,192 3,280 Depreciation (98) (80) (110) (161) (216) EBIT 486 785 1,233 2,030 3,064 Interest (214) (279) (363) (428) (521) Other Income 67 89 168 85 106 Profit before tax (PBT) 339 595 1,037 1,687 2,649 Tax 53 (28) (108) (202) (397) Profit after tax (PAT) 392 567 930 1,485 2,251

Balance sheet (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Sources Equity Capital 106 170 214 239 239 Reserves 2,033 3,861 4,556 8,455 10,467 Net Worth 2,139 4,030 4,770 8,694 10,706 Loan Funds 1,721 2,472 6,786 5,711 6,946 Def Tax liability 74 31 41 61 88 Total 3,935 6,533 11,598 14,466 17,740

Uses Gross Block 964 1,107 1,580 2,212 2,963 Accd Depreciation (291) (366) (473) (634) (851) Net Block 673 741 1,107 1,578 2,112 Capital WIP 8 216 266 150 98 Total Fixed Assets 681 957 1,374 1,728 2,210 Investments 96 316 2,765 2,453 2,324 Total Current Assets 5,542 11,607 13,003 19,380 26,168 Total Current Liabilities (2,384) (6,347) (5,543) (9,095) (12,962) Net Working Capital 3,158 5,260 7,460 10,285 13,206 Total 3,935 6,533 11,598 14,466 17,740

October 18, 2006 Construction Sector 88 India Under ‘Construction’

Cash Flow Statement Year to (Rs mn) FY05 FY06 FY07E FY08E Net profit before tax and extraordinary items 595 1,037 1,687 2,649 Depreciation 80 110 161 216 Interest expense 279 363 428 521 Interest income (65) (110) (59) (78) Operating profit before working capital changes 889 1,400 2,218 3,308 Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (1,555) (1,700) (2,812) (3,220) (Inc)/dec in inventories 7 (107) (168) (195) (inc)/dec in other current assets (1,354) (1,303) (2,568) (2,768) Inc/(dec) in sundry creditors 3,944 (869) 3,370 3,942 Inc/(dec) in other current liabilities 19 65 182 (75) Net change in working capital 1,061 (3,914) (1,996) (2,316)

Cash from operating activities 1,950 (2,514) 222 992 Less: Income tax (28) (108) (202) (397) Inc/Dec in Def Tax Asset/liability (43) 11 19 27 Net cash from operating activities 1,879 (2,611) 38 622 Cash Profit 1,879 (2,611) 38 622

Cash flows from investing activities (Inc)/Dec in fixed assets (356) (527) (516) (699) (Inc)/Dec in Investments (220) (2,448) 312 129 Interest received 65 110 59 78 Net cash from investing activities (512) (2,865) (145) (492)

Cash flows from financing activities Inc/(Dec) in debt 750 4,315 (1,075) 1,235 Inc/(Dec) in equity/premium 64 44 25 - Direct add/(red) to reserves 1,332 (128) 2,593 0 Interest expense (279) (363) (428) (521) Dividends (72) (106) (179) (239) (inc)/dec in loans & advances 130 (369) (463) (324) Net cash used in financing activities 1,925 3,392 473 151

Net increase in cash and cash equivalents 3,293 (2,083) 367 281 Cash at start of the year 1,234 4,527 2,443 2,810 Cash at end of the year 4,527 2,443 2,810 3,091

October 18, 2006 Construction Sector 89 India Under ‘Construction’

Ratios FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Per share ratios EPS (Rs) 7.4 6.7 8.7 12.4 18.8 Cash EPS (Rs) 9.2 7.6 9.7 13.8 20.6 Div per share (Rs) 1.0 0.7 1.0 1.5 2.0 Book value per share (Rs) 40.3 47.5 44.6 72.8 89.6 FV per share (Rs) 2.0 2.0 2.0 2.0 2.0

Valuation ratios P/E (x) 38.9 43.0 33.0 23.1 15.2 P/CEPS (x) 31.1 37.6 29.5 20.8 13.9 P/BV (x) 7.1 6.0 6.4 3.9 3.2 Dividend yield (%) 0.3 0.3 0.3 0.5 0.7 EV/sales (x) 2.0 2.1 2.3 1.5 1.1 EV/ EBIT (x) 32.3 28.4 28.4 18.3 12.5 EV/EBIDTA (x) 26.9 25.8 26.1 17.0 11.6 Order book/Sales (x) 8.7 6.4 4.5 2.8 1.9

Profitability ratios Gross margin (%) OPM (%) 7.5 8.2 9.0 9.0 9.3 EBIT margin (%) 6.3 7.4 8.2 8.4 8.7 PBT margin (%) 4.4 5.6 6.9 6.9 7.5 Net profit margin (%) 5.1 5.4 6.2 6.1 6.4 Cash profit margin (%) 6.3 6.1 7.0 6.8 7.0 ROCE (%) 14.1 13.4 12.1 14.6 17.9 RONW (%) 18.3 14.1 19.5 17.1 21.0

Liquidity ratios Current ratio (x) 2.3 1.8 2.3 2.1 2.0 Debtors days 71.3 106.1 116.3 113.9 111.9 Inventory days 8.7 6.2 7.0 6.8 6.7 Creditors days 109.3 216.6 131.6 131.7 131.7

Turnover ratios Asset turnover (x) 2.0 1.6 1.3 1.7 2.0 Fixed Asset turnover (x) 11.5 14.2 13.5 15.4 16.7

Leverage ratios Debt / Total equity (x) 0.8 0.6 1.4 0.7 0.6

Component ratios Construction expenses (%) 87.4 87.7 86.7 87.6 87.6 Staff cost (%) 2.2 2.2 2.5 2.2 2.2 Other expenditure (%) 2.8 1.9 1.8 1.2 1.1

October 18, 2006 Construction Sector 90 MARKET PERFORMER CMP Rs361 Patel Engineering Ltd COMPANY REPORT

Stock Data Dominant player in hydropower Target Price Rs411 Patel Engineering Ltd (PEL), with a dominance in the hydropower segment Upside 13.6% (40.3% of its order book and 61.7% of revenues), commands a 22% share in Sensex 12,736 this vertical. We estimate spend of Rs500bn on hydropower during the 10th and 52 Week H/L Rs635/198.25 11th plan. Maintaining its share would mean Rs10bn order flow (simple average) Average Vol.(6M) 92,903 to PEL from this vertical each year, ensuring a comfortable position for the next Market Cap Rs18bn 6-7 years. Face Value Re1 BSE Code 531120 PEL’s OPM at 12.9%, is one of the highest among peers on account of complexity of work in this vertical and capabilities that only a handful of players possess. NSE Code PATELENG We expect an increased share of hydropower in PEL’s order book (43.2%) in Reuters Code PENG.BO FY07, helping sustain margins. Bloomberg Code PEC@IN Prices as on 13th Oct’06 Moving up the value chain PEL’s initiative, to move up the value chain by bidding for independent power Share Holding Pattern projects in hydropower and lumpsum turnkey projects in the irrigation segment, June’06 (%) is a value accretive one. PEL is awarded its maiden annuity project valued at Promoters 64.5 Rs4.1bn, wherein its share is 60%. We assign a value of Rs8.2 per equity share Foreign 5.5 of PEL to this annuity project, expecting an IRR of 12-14%. Institutions 5.5 Non promoter corporate 1.3 Order book of 4.2x FY06 turnover Public & others 231 PEL’s order book at Rs4.3bn translates into 4.2x FY06 turnover, offering visibility for a 3-year period. Order intake at 2.5x its FY06 consolidated revenues and the expected increase of 35% in order book in FY07 to drive growth.

Share Price Chart Attractive valuations 300 Patel Sensex PEL is fairly diversified and expected to witness a CAGR of 36.3% in turnover 250 between FY06 and FY08. Its overseas subsidiaries and the recent acquisition 200 150 in the urban infrastructure segment to add value going forward. 100 50 The stock is trading at a P/E of 13.9x, P/CEPS of 10.7x and EV/EBIDTA of 9x its 0 FY08E earnings. With an order book of 2.4x its current market capitalization, 5 5 6 6 6 6 6 0 0 0 0 0 0 0 ------t r t

c valuations appear attractive. We assign a MARKET PERFORMER with a one year b n g c c p e e u u O A J O F D A price target of Rs411, representing an upside of 13.6% based on our sum of parts valuation.

Key financials and ratios (Consolidated) FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Net sales (Rs mn) 7,772 7,912 10,223 14,031 19,003 yoy (%) - 1.8 29.2 37.2 35.4 Net profit (Rs mn) 285 421 742 1,070 1,568 yoy (%) - 47.8 76.1 44.2 46.6 OPM (%) 8.2 11.4 12.9 12.4 13.1 EPS (Rs) 11.5 8.5 14.7 17.7 26.0 P/E (x) 31.5 42.3 24.7 20.4 13.9 P/BV (x) 6.6 10.7 8.0 2.9 2.4 EV/EBIDTA (x) 15.6 20.6 15.8 12.2 9.0 Order book/Sales (x) 5.5 5.4 4.2 3.1 2.3 ROCE (%) 15.6 18.7 18.7 13.4 16.7 RONW (%) 28.2 31.6 37.0 14.8 18.1

October 18, 2006 Construction Sector 91 India Under ‘Construction’

Investment rationale

Dominant player in the high margin hydropower segment … PEL’s core competency lies in the construction of civil structures for the hydropower Enjoys 22% market share in segment, deriving 61.7% (Rs6.3bn) of its consolidated revenues from this vertical hydropower in FY06. Margins are high at 17-19% at the operating level on account of the complexity of the job, restricting participation to only a handful of players.

PEL is the second largest civil contractor for hydropower projects in India and has executed over 7,000MW of projects with a market share of 22% since independence (Jaiprakash Associates is the leader). Hydropower contracts account for 40.3% of PEL’s FY06 order book and we expect this proportion to rise to 43.2% in FY07’s estimated order book of Rs54.1bn.

… Spend on hydropower expected to remain high Efforts taken to improve The 10th and the 11th five year plans envisage a substantial capacity addition in hydropower mix to 40% in power in an effort to ensure ‘Power for all by 2012’. The trend in the Indian total power in India scenario over the past five years shows that hydropower accounted for around 25% of the total installed capacity in power.

Trend in hydropower capacities in India

35,000 26.5 26.3 26.1 30,000 26.0 25,000 25.5 20,000 25.0 25.0 15,000 24.9 (%) (MW) 24.7 24.5 10,000 5,000 24.0 - 23.5 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Installed hydropower capacity (LHS) % of total installed capacity (RHS)

Source: Central Electricity Authority Executive Summary March 2005

The accepted ratio for hydropower to thermal power generation internationally is 40:60, much higher than the one existing in India. With high requirements for coal and gas, alternate forms of energy are being sought. The government is therefore, intensifying its efforts to improve hydropower generation due to the inherent benefits of this form of power generation.

Advantages of hydropower capacity

Ö Hydropower plants are capable of handling variations in frequencies, requirements during peak and non-peak hours without significant added cost, which is not the case with other modes of generation.

Ö Hydropower is a cost effective source of generation as water is abundantly available at zero cost.

Ö Operating costs are lower in case of hydropower generation as compared to thermal power.

Ö From a social perspective too, hydropower plants are desirable as they offer integrated solutions for power, irrigation and drinking water without damaging the environment. Source: Company, Industry, India Infoline Research

October 18, 2006 Construction Sector 92 India Under ‘Construction’

The government plans to install over 34,000MW of additional capacity of hydropower generation by the end of the 11th plan as shown in table below, which is higher than the total installed capacity of 30,936MW in 2005, indicating that investments in this segment are expected to remain high.

Envisaged capacity additions in power Targeted v/s actual additions achieved in hydropower

80,000 16,000 50.0 46.2 70,000 Hydropower 67,000 Hydropower 40.0 60,000 35% of total 29.9% of total 12,000 50,000 30.0 41,110 30.0 40,000 8,000 26.2 (%) (MW)

30,000 (MW) 20.0 20,000 4,538 4,315 20,000 14,393 4,000 2,428 10.0 10,000 0 0 - 10th plan 11th plan 8th plan 9th plan 10th plan*

Total power capacity Hydropower Actual (MW) Target (MW) Actual as % of target

Source: Plan Documents Source: Planning Commission * Implementation of the 10th plan is not complete. Chart shows achievement till March 2005

In the past, the actual capacity expansions have fallen short of targets as shown in the chart above. We take the average of the percentage hydropower We expect Rs500bn to be additions achieved during the 8 th and 9 th five year plans to conclude that close spent on hydropower by end to 12,500MW of incremental hydropower capacity is likely to be added by the of 11th plan end of the 11th five year plan. Based on this figure, we estimate that investments to the tune of Rs500bn would go into building these capacities. Investments of Rs170bn have already been made during the 10th five year plan.

According to CEA, close to 50,000MW of hydropower capacity will be added MOP has already identified over the next 20 years, which is estimated to result in an outlay of Rs2,000bn 162 projects in 16 states and for civil construction. The ministry of power (MOP) has identified 162 projects in 103 are finalized 16 states that will make available 50,000MW; feasibility reports for 132 projects have been received and 103 projects have been finalized. PEL is confident of maintaining its share of 22%, which ensures a comfortable position for the company for a number of years.

Some hydropower projects executed by PEL in India Project MW Location Completion date Mettur Hydro Electric (H.E.) Project 200 Tamil Nadu 1964 Balimela H.E. Project 480 Orissa 1969 Koyna H.E. Project Stage III 320 Maharashtra 1975 Baira Sul H.E. Project 180 HP 1981 Koyna H.E. Project Stage IV (contract I) 1,000 Maharashtra 1999 Tons H.E. Project 375 MP 1999 Teesta H.E. Project Stage V 510 West Bengal 2002 Srisailam Left Bank Hydropower Station 900 AP 2003 Srisailam Right Bank Hydropower Station 770 AP 2003 Source: Company

October 18, 2006 Construction Sector 93 India Under ‘Construction’

Major projects in hydropower under execution by PEL Project Region Client Parbati H.E. Project (4x200MW) HP NHPC Sewa H.E. Project stage II Jammu & Kashmir NHPC Teesta H.E. Project stage III West Bengal NHPC Parbati Project for construction spillway tunnels, rockfill dam, part head III (4x130MW) HP NHPC Kameng H.E. Project Arunachal Pradesh NEEPCO Ghatghar Pumped Storage Scheme Maharashtra Irrigation Department of Maharashtra State Koyna H.E. Project stage IV - Extension of HRT Maharashtra Irrigation Department of Maharashtra State Source: Company

PEL to move up the value chain in the hydropower space In the past, PEL restricted itself to civil construction of hydropower projects. The company’s strategy, going forward will be to move from a pure item rate contractor to an EPC contractor. Certain state and central government entities have begun to float tenders in the independent power project (IPP) mode, inviting bids on an item rate/EPC contract basis. Since the government is relaxing the norms for this sector, PEL plans on entering this space.

PEL has already given expressions of interest for an IPP and plans to commence with projects ranging from 50MW to 100MW, gradually moving towards 500MW projects. These projects are likely to fetch better margins compared to pure contractor margins.

Order book healthy – proportion of hydropower to further increase Margins to remain high with PEL’s present order book stands at around Rs4.3bn, which translates into a healthy 78% of order book order book of 4.2x FY06 turnover. With 78% of this order book comprising comprising hydropower and hydropower and irrigation segments, margins are likely to remain higher than its irrigation peers.

The order book offers visibility for a 3-year period, and the order book intake of PEL expects order growth at 2.5x its FY06 consolidated revenues is indicative of higher execution in the coming 40% CAGR for next 2 years years. PEL expects its order book to witness a CAGR of 40% in the next two years. We expect contribution of hydropower and irrigation in order book to rise in FY07 as shown in the chart below.

Trend in PEL’s order book Order book break-up

80 100.0 1.0 0.4 1.7 70 80.0 60 40.0 50 60.0 37.7 38.6

40 (%)

(Rs bn) 40.0 30 55.6 20 20.0 40.3 43.2 10 - - FY05 FY06 FY07E FY02 FY03 FY04 FY05 FY06 FY07E FY08E Hydropower Irrigation Transportation Others

Source: Company, India Infoline Research Source: Company, India Infoline Research

October 18, 2006 Construction Sector 94 India Under ‘Construction’

Foray into lumpsum lift irrigation turnkey projects Civil construction in irrigation accounted for 21.1% (Rs2.2bn) of PEL’s consolidated Focus on AP lift irrigation projects revenues in FY06. The company recently entered into the EPC and lumpsum turnkey (LSTK) implementation of lift irrigation projects driven by its plan of replicating its expertise in hydropower projects to this segment as well.

Prominent irrigation projects under execution by PEL Project Location Client Bhima Lift Irrigation, Lift-I AP Irrigation & CAD Department, AP Kalwakurthy Lift Irrigation, stage-I AP Irrigation & CAD Department, AP Jawahar Lift Irrigation, stage-I & II AP Irrigation & CAD Department, AP Source: Company

Lift irrigation contracts have been given impetus by various state governments from 2004-05 onwards to enhance the agricultural infrastructure in their respective states. The government has sizeable plans for the interlinking of rivers because of the tremendous advantages that can be accrued from this development: Ö Results in improved water supply, Ö Helps boosting the irrigation potential, and Ö Has the potential for generating hydropower with the help of storage dams.

PEL has started with projects focused primarily in AP and may later, move to other states. PEL’s track record of execution of hydropower and irrigation contracts puts the company in a position of strength. Irrigation contracts form 37.7% of PEL’s order book as on March 31, 2006 and we expect this segment to help sustain margins in future.

PEL revenues from irrigation segment

8,000 7,000 6,000 5,000 4,000

(Rs mn) 3,000 2,000 1,000 - FY03 FY04 FY05 FY06 FY07E FY08E

Source: Company data, India Infoline Research

To focus on selective bidding in the transportation segment … In the transportation segment, PEL’s focus has remained on roads and tunneling work for railways for a number of years now. This segment accounted for 4.8% (Rs0.5bn) of the consolidated revenues in FY06. Based on the orders in hand worth Rs8.7bn in this segment as on March 2006, we expect 40.5% and 25.6% of the consolidated revenues in FY07 and FY08 respectively. Going forward, the company plans to bid selectively in this segment with profit margins in mind and can choose to do so due to its stronghold in hydropower and to some extent in irrigation.

October 18, 2006 Construction Sector 95 India Under ‘Construction’

… Maiden annuity project in roads Will earn Rs330mn semi- PEL was awarded its first road BOT project on an annuity basis from NHAI and annually for 18 years construction work is expected to start from December 2006 onwards. The company expects an IRR of 12-14% from the project. In future too, the company will bid for road BOTs with a preference towards annuity projects. We value this project at Rs8.2 per equity share of PEL. The company will earn Rs330mn semi-annually from this projects.

Project details

Project NH-7 highway in Karnataka PEL’s share (%) 60 Segment Roads Project type Annuity Other partners KNR Construction Concession period 20 years including 2 years construction Project cost (Rs mn) 4,100 Equity (Rs mn) 820 Debt (Rs mn) 3,280 PEL’s equity (Rs mn) 492

Source: Company, India Infoline Research

Overseas subsidiaries add significant value Subsidiaries provide access to PEL, through its wholly-owned subsidiary, Patel Engineering Inc., owns two technology and aid in companies in the US, namely Westcon Microtunneling Inc. and ASI RCC Inc. These business development in US companies have provided PEL with access to their sophisticated technology; and Europe microtunneling technology from Westcon and roller compacted concrete (RCC) from ASI, which puts PEL in an advantageous position. The US subsidiaries also provide PEL with a network for development of business in USA and Europe. The two subsidiaries recorded a combined revenue of around Rs2bn.

Subsidiary overview Westcon Microtunneling Inc. Westcon Microtunneling is one of the pioneering microtunneling contractors in USA, specialising in mechanised tunneling of small diameter tunnels that are used for sewerage system, water supply and laying underground cables without the need to dig roads, post concretisation. The company has executed the largest microtunneling project valued at US$30mn in USA. PEL acquired 51% stake in this company in 2001 and enjoys a 100% voting rights in the company.

ASI RCC Inc. ASI RCC Inc. is a general contractor focused on the use of RCC technology for dam construction and rehabilitation. The company is also engaged in construction management services for global projects. Works undertaken by ASI RCC include dams, power and treatment plants, tunnels, mines, environmental remediation and highways.

RCC technology for dams is accepted internationally though still not common in India. Currently, ASI RCC Inc. enjoys a 5% market share globally. It won the 2005 Aon Build America Award in the Federal and Heavy Renovation category for the Standley Lake Dam Project in Westminster worth US$31mn. PEL was the first Indian company to acquire the RCC technology with the acquisition of ASI RCC Inc. with 85% stake in 1997 and 100% voting rights in the company.

Source: Company

October 18, 2006 Construction Sector 96 India Under ‘Construction’

PEL is focusing on the use of microtunneling and RCC technology in the Indian markets, since they are cost effective and give the company a competitive edge over its peers.

Microtunneling in India is at a low scale at present, but expected to play a major role in future. The conventional methods of laying pipes cause traffic blockage, resulting in huge loss of public money, which is not the case with microtunneling. Increasing concretization of roads too, is likely to trigger microtunneling use in India. Increasing demand for pipelines in the country will boost revenues from this vertical.

PEL has brought this technology to India and will benefit when this vertical opens up. PEL has a total of five microtunneling machines; one in India and four in US. The company has commenced execution of a microtunneling project in India for Brihan Mumbai Mahanagar Palika valued at Rs191.9mn and received another order through its JV by the Municipal Corporation of Greater Mumbai valued at Rs371mn.

Microtunneling explained

Microtunneling technology involves tunneling in a mechanised form of small diameter tunnels for applications like drainage systems, underground cabling and water supply, without requiring to dig into the concrete or other roads.

A launch shaft is created at the beginning point of the tunnel and the excavation equipment is inserted into the shaft that burrows its way under the road to other end where the tunnel is required to end. As the shaft, which is controlled by a remote, digs its way towards the other end, a series of pipelines occupy the path created by it. The machine is then removed from target shaft across the road. This is a useful method as the conventional method of digging the surface would be time consuming and expensive.

Source: Company, India Infoline Research

PEL has also announced acquisition of a controlling stake in a Mumbai-based infrastructure company, Michigan Engineers Pvt Ltd, to help it provide the complete range of solutions in urban infrastructure and sewer rehabilitation. This acquisition being a recent one and the amount paid not made public as yet, we have not factored this into our estimates.

RCC technology is commonly used for dams in the West, China and Japan as it helps save up around 30% of costs and makes construction faster by 40%. This is because it replaces up to 70% of the cement used in conventional methods with fly ash, which brings down the soothing period without compromising on quality or client specifications. The RCC technology was first used in India by PEL for its Ghatghar hydropower project in Maharashtra and is also used for its Srisailam project in AP. RCC use will help PEL bid competitively for projects due to the cost and time savings that it will gain.

October 18, 2006 Construction Sector 97 India Under ‘Construction’

RCC explained

In the RCC process, high capacity mixing plants are used to make dry mix concrete and transported through a series of belt conveyor system on the dam body by placing horizontal layers. This is unlike the conventional method in which the dam is raised in vertical blocks. A dozer, fitted with laser guidance system, is then used to spread the concrete of 300mm thickness and vibrating rollers are used for compacting the concrete. This is done several times and the subsequent layers bond to the one spread out before.

Fly ash helps in reducing the heat of hydration and improves durability. Use of large quantity of fly ash also helps in preserving the environment.

Source: Company

Follow on public issue to nurse funding requirements PEL recently raised close to Rs4.3bn through a follow on public issue to be used for its BOT foray, repay certain debts and for capital expenditure and working capital needs. The dilution will take the equity of the company to Rs59.7mn and we will see the full results from deployment of these funds in the coming years.

Valuations

PEL is a dominant player in the hydropower segment, which is currently enjoying a high spend. The company enjoys high margins and fairly diversified into other segments as well. We expect PEL to witness a CAGR of 36.3% in topline and 45.4% in bottomline between FY06 and FY08 on the back of an order book of 4.2x FY06 revenues, offering good visibility for the next three years.

Positives that might lead to upside in future: Ö The management has guided on an OPM expansion of 50-100bps during FY07. We have projected a decline of 60bps yoy in FY07 and an increase of 70bps yoy in FY08 based on our execution assumptions. An expansion in margins as per the management’s guidance leaves scope for upside to the net profit figure.

Ö Improvement in subsidiary financials and savings on account of higher use of RCC will help the margin cause.

Ö PEL owns some land, which it may develop in future. However, no announcement has been made of a real estate foray and has not been factored into our estimates.

The stock is trading at a P/E of 13.9x, P/CEPS of 10.7x and an EV/EBIDTA of 9x its FY08E earnings. The company has an order book of 2.5x its current market capitalization. We believe these are attractive valuations and assign a MARKET PERFORMER rating with a one year price target of Rs411, representing an upside of 13.6% based on our sum of parts valuation.

October 18, 2006 Construction Sector 98 India Under ‘Construction’

Sum of parts valuation (Rs mn) Methodology EBIDTA (FY08E) 2,488 EV/EBIDTA (x) 10 Target multiple Enterprise value 24,876 Net debt (Debt-cash) FY08E 853 Market capitalization 24,023 Equity value of Karnataka Annuity project 492 1x Book Value Total equity value 24,515 Diluted equity capital 60 Value per share (Rs) 411 CMP (Rs) 361 % upside 13.6

Growth matrix yoy (%) FY05 FY06 FY07E FY08E Net Sales 1.8 29.2 37.2 35.4 EBIDTA 41.6 46.7 31.4 43.4 Net profit 47.8 76.1 44.2 46.6 Net Worth 24.2 37.4 232.1 19.3 Gross Block 9.3 12.8 23.0 22.4 Net Working Capital 50.5 113.1 126.7 13.3 Capital employed 28.1 54.2 83.1 16.5 Source: India Infoline Research

Concerns

Issues in case of delay in spending on hydropower Although, PEL also has a good presence in the irrigation and transportation segments, hydropower is the driving vertical for the company. Presently, the hydropower segment is witnessing increasing award of projects. In case delays were to take place, our estimates would be affected to that extent. This would also affect the company’s margins, which are higher in hydropower.

October 18, 2006 Construction Sector 99 India Under ‘Construction’

Company background

Patel Engineering Ltd (PEL) was incorporated in the year 1949 and is engaged in civil engineering and construction of hydropower projects, water supply and Patel’s client profile irrigation projects, microtunneling and the transportation segment. PEL came (%) out with its maiden public issue in 1986 and a follow on offer in May 2006. The Central government bodies 43.0 company, in its 57 years of experience, has been involved in the construction of State government 44.0 75 dams, 30 multipurpose water supply and power projects, 70 roads and Central government 4.0 bridges, 30 microtuneling projects and over 160kms of tunnels in India and World Bank/Others 9.0 abroad. Source: Company data

In the past, the company has also undertaken construction works of industrial complexes, buildings and marine works, oil refineries, chemical plants, foundries and machine shops and steel plants. The company has an employee strength of around 1,100 in India and over a 100 in its US subsidiaries in addition to a large number of contract workers at its project sites. Around 77% and 64% of its employees in India and abroad respectively are technically qualified.

Some of the highlights of PEL are as follows: Ö Record holder for the fastest tunneling, by conventional method, for Koyna project in the world. Ö First company in India to build a dam based on RCC technology. Ö Construction of the largest underground Cavern, ie surge chamber in Asia for Sirsailam project. Ö First in Asia to carry out Double Lake Tap Works for Koyna project. Ö First Indian company to penetrate the US market as a construction contractor.

Management profile

Mr. Pravin Patel, aged 70 years, is the non-executive Chairman of PEL. He has graduated in town planning from USA and studied financial management from the London School of Economics. He has a wide experience of 45 years in financial management, town planning and architecture and was instrumental in the acquisition of two companies in the US to establish a presence for PEL at the global level. He has also been instrumental in introducing and implementing pioneering techniques in the field of construction in India.

Mr. Rupen Patel, aged 39 years, is the Managing Director of PEL. He is a graduate in commerce from University of Mumbai and holds a MBA degree from the Babson College, USA. He has an experience of 14 years in the construction industry and is an active member of the company, supervising all the sites and identifying and improving on PEL’s core competencies.

Ms. Sonal Patel, aged 42 years, is the Chief Operating Officer of PEL. She is a graduate in commerce from University of Mumbai and a MBA from Babson college in USA. Her responsibilities include handling of the overseas operations of PEL through its two subsidiaries incorporated abroad.

October 18, 2006 Construction Sector 100 India Under ‘Construction’

Last five quarterly financials (Standalone) (Rs mn) Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07 Net sales 1,898 1,408 1,697 3,014 2,900 Operating expenditure (1,692) (1,186) (1,335) (2,744) (2,582) Operating profit 206 222 361 270 318 Other income 38 15 46 101 26 Interest (51) (23) (60) (72) (46) Depreciation (60) (71) (72) (63) (65) PBT 133 143 276 236 233 Tax (21) (16) (25) (23) (33) PAT 113 126 251 212 200 Equity 49 49 49 50 60

Quarterly OPM trend (Standalone)

25.0 21.3

20.0 15.7 14.2 14.7 15.0 12.0 10.9 11.0 (%) 10.0 8.9 7.4

5.0

- Q1 FY05 Q2 FY05 Q3 FY05 Q4 FY05 Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07

Source: Company data

October 18, 2006 Construction Sector 101 India Under ‘Construction’

Financials

Income statement (Consolidated) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Net Sales 7,772 7,912 10,223 14,031 19,003 Operating expenses (7,136) (7,012) (8,903) (12,297) (16,515) EBIDTA 636 900 1,321 1,735 2,488 Depreciation (252) (266) (311) (383) (471) EBIT 384 634 1,009 1,352 2,017 Interest (118) (239) (314) (290) (339) Other Income 91 94 113 126 125 Profit before tax (PBT) 357 489 808 1,189 1,803 Tax (72) (68) (66) (119) (234) Profit after tax (PAT) 285 421 742 1,070 1,568 Minority Interest (6) (6) (9) (11) (15) Net profit 279 416 733 1,059 1,554

Balance sheet (Consolidated) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Sources Equity Capital 24 49 50 60 60 Reserves 987 1,282 1,957 7,184 8,619 Minority Interest 314 315 254 266 280 Net Worth 1,325 1,646 2,261 7,510 8,959 Loan Funds 1,572 2,076 3,578 3,292 3,610 Def Tax liability 145 175 168 196 247 Total 3,043 3,896 6,007 10,998 12,816

Uses Gross Block 2,898 3,168 3,574 4,397 5,383 Accd Depreciation (1,009) (1,169) (1,190) (1,572) (2,043) Net Block 1,889 1,999 2,384 2,824 3,339 Capital WIP 41 46 49 76 Total Fixed Assets 1,889 2,040 2,430 2,873 3,415 Investments 125 322 284 750 1,042 Total Current Assets 3,863 5,816 8,035 13,970 17,262 Total Current Liabilities (2,851) (4,292) (4,789) (6,609) (8,922) Net Working Capital 1,013 1,524 3,246 7,361 8,340 Miscellaneous expenditure 3 1 32 - - Def Tax assets 13 10 14 14 19 Total 3,043 3,896 6,007 10,998 12,816

October 18, 2006 Construction Sector 102 India Under ‘Construction’

Cash Flow Statement Year to (Rs mn) FY05 FY06 FY07E FY08E Net profit before tax and extraordinary items 489 808 1,189 1,803 Depreciation 266 311 383 471 Interest expense 239 314 290 339 Interest income (17) (53) - - Operating profit before working capital changes 977 1,380 1,861 2,613 Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (630) (364) (693) (1,038) (Inc)/dec in inventories (747) (1,237) (1,273) (1,721) (inc)/dec in other current assets (0) (0) 0 (1) Inc/(dec) in sundry creditors 1,435 508 1,810 2,301 Inc/(dec) in other current liabilities 6 (11) 10 12 Net change in working capital 64 (1,105) (145) (448)

Cash flows from operating activities 1,041 275 1,716 2,165 Less: Income tax (68) (66) (119) (234) Inc/Dec in Def Tax Asset/liability 32 (12) 29 46 Misc expenditure w/off 2 (31) 32 - Net cash from operating activities 1,007 167 1,658 1,977 Cash Profit 1,007 167 1,658 1,977

Cash flows from investing activities (Inc)/Dec in fixed assets (417) (702) (826) (1,013) (Inc)/Dec in Investments (197) 39 (466) (292) Interest received 17 53 - - Net cash from investing activities (597) (610) (1,292) (1,305)

Cash flows from financing activities Inc/(Dec) in debt 504 1,502 (286) 318 Inc/(Dec) in equity/premium 24 1 10 - Direct add/(red) to reserves (70) (51) 4,258 (0) Interest expense (239) (314) (290) (339) Dividends (55) (77) (90) (119) (inc)/dec in loans & advances 55 (971) (1,027) (1,438) Net cash used in financing activities 220 90 2,576 (1,579)

Net increase in cash and cash equivalents 630 (353) 2,942 (907) Cash at start of the year 445 1,075 722 3,664 Cash at end of the year 1,075 722 3,663 2,757

October 18, 2006 Construction Sector 103 India Under ‘Construction’

Ratios FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Per share ratios EPS (Rs) 11.5 8.5 14.7 17.7 26.0 Cash EPS (Rs) 21.8 14.0 20.9 24.1 33.9 Div per share (Rs) 1.0 1.0 1.3 1.5 2.0 Book value per share (Rs) 54.5 33.9 45.2 125.8 150.1 FV per share (Rs) 1.0 1.0 1.0 1.0 1.0

Valuation ratios P/E (x) 31.5 42.3 24.7 20.4 13.9 P/CEPS (x) 16.6 25.8 17.3 15.0 10.7 P/BV (x) 6.6 10.7 8.0 2.9 2.4 EV/sales (x) 1.3 2.3 2.0 1.5 1.2 EV/ EBIT (x) 25.8 29.3 20.7 15.7 11.1 EV/EBIDTA (x) 15.6 20.6 15.8 12.2 9.0 Order book/Sales (x) 5.5 5.4 4.2 3.1 2.3

Profitability ratios OPM (%) 8.2 11.4 12.9 12.4 13.1 EBIT margin (%) 4.9 8.0 9.9 9.6 10.6 PBT margin (%) 4.6 6.2 7.9 8.5 9.5 Net profit margin (%) 3.7 5.3 7.3 7.6 8.3 Cash profit margin (%) 6.8 8.6 10.2 10.3 10.7 ROCE (%) 15.6 18.7 18.7 13.4 16.7 RONW (%) 28.2 31.6 37.0 14.8 18.1

Liquidity ratios Current ratio (x) 1.4 1.4 1.7 2.1 1.9 Debtors days 33.8 62.3 61.2 62.6 66.2 Inventory days 49.1 82.7 108.2 112.0 115.7 Creditors days 132.5 196.3 170.1 171.0 170.5

Turnover ratios Asset turnover (x) 2.6 2.0 1.7 1.3 1.5 Fixed Asset turnover (x) 2.7 2.5 2.9 3.2 3.5

Leverage ratios Debt / Total equity (x) 1.2 1.3 1.6 0.4 0.4

Component ratios Construction expenses (%) 84.4 81.5 77.6 78.0 77.6 Staff cost (%) 3.0 3.1 3.4 3.3 3.3 Other expenditure (%) 4.4 4.0 6.1 6.3 6.0

October 18, 2006 Construction Sector 104 BUY CMP Rs333 Simplex Infrastructures Ltd COMPANY REPORT

Stock Data Profit making since inception Target Price Rs459 Simplex Infrastructures Ltd (SIL) is a 82-year contracting company with a profit Upside 37.8% making track record since inception. The reveals the quality of management Sensex 12,736 and its focus on consistent bottomline generation. The company has also had 52 Week H/L Rs2,725/304.8 the same auditor, ‘Price Waterhouse’, since the year 1947 when the Mundhras’ took charge, which could be seen as an indication of healthy accounting Average Vol.(6M) 7,798 practices. Market Cap Rs14.3bn Face Value Rs2 Well diversified with Rs47bn order book BSE Code 523838 SIL’s order book is a well diversified one with no vertical accounting for more NSE Code SIMPLEXINF than 30% of the company’s turnover. The order book/FY06 sales at 3.5x offers Reuters Code SMCP.BO visibility given the average execution period of 1.5 years. Backed by a healthy Bloomberg Code SCP@IN order book and an estimated order intake/execution of 1.7x in FY07, we expect Prices as on 13th Oct’06 SIL to witness a CAGR of 45.4% in topline during FY06-08.

Share Holding Pattern Big plans for the overseas market SIL earns close to 10% of its total revenues from work overseas and plans to June’06 (%) increase this proportion to 40% in the next four years, in order to diversify Promoters 46.5 geographically as well. It also expects margins to be higher by 100-200bps Foreign 17.3 Institutions 2.8 overseas. The company is presently executing orders in Doha, West Indies and Non promoter corporate 21.3 Bahrain and has presence in many other countries too. Public & others 12.1 Targeting new verticals SIL is planning a foray into road BOTs, mainly for annuity projects. It will also work on the feasibility of BOT/EPC projects in power T&D, power generation, Share Price Chart ports, railways, real estate development and industrial construction, in its bid 250 Simplex Sensex to become a US$1bn company in the next five years. 200 150 The company raised close to Rs1bn through a preferential allotment to Chrys 100 Capital and plans for another GDR/FCCB worth US$200mn, not factored into 50 our workings, to meet its future fund requirements. 0 5 5 6 6 6 6 6

0 0 0 0 0 0 0 Valuations ------t r t c b n g c c p e e u u The SIL stock is trading at a P/E of 12.9x FY08E earnings and 8.1x FY08E EV/ O A J O F D A EBIDTA. These are attractive valuations for a company expected to witness a CAGR of 63.2% during FY06-08. The market capitalization is at 0.3x its order book, which is low and leaves scope for an increase. We recommend a BUY with a one-year price target of Rs459, representing an upside of 37.8%.

Key financials and ratios FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Net sales (Rs mn) 6,527 9,990 13,446 20,297 28,432 yoy (%) 19.1 53.0 34.6 51.0 40.1 Net profit (Rs mn) 97 252 416 784 1,109 yoy (%) 10.7 159.5 65.4 88.2 41.4 OPM (%) 6.7 7.0 8.8 8.9 8.4 EPS (Rs) 2.7 6.9 9.7 18.2 25.8 P/E (x) 125.5 48.5 34.4 18.3 12.9 P/BV (x) 14.4 11.5 6.1 4.7 3.6 EV/EBIDTA (x) 32.6 22.1 15.5 10.4 8.1 Order book/Sales (x) 7.2 4.7 3.5 2.3 1.7 ROCE (%) 12.0 13.2 14.3 18.9 20.8 RONW (%) 11.4 23.7 17.9 25.9 27.7

October 18, 2006 Construction Sector 105 India Under ‘Construction’

Investment rationale

Consistent track record of profits since inception SIL is an 82-year old company with an impressive profit making track record since inception. The company started as a piling major and diversified into other segments over the years, with a focus on profitability along with increased scale of operations. The consistent performance with a profit making record since inception is an inducing attribute for investment in SIL.

The company witnessed a CAGR of 19% in turnover over the past 11 years and 26% over the past six years. SIL has had the same auditor, ‘Price Waterhouse’ for 59 years, since the Mundhras’ took over control in 1947. This could be seen as an indication of healthy accounting practices by the company.

SIL’s topline trend SIL’s bottomline trend

30,000 1,200 Topline Net profit 25,000 CAGR 45.4% 1,000 CAGR 68.6% 20,000 800 CAGR 34.6% 15,000 600 CAGR 81.2% (Rs mn) (Rs mn) 10,000 400

5,000 200

- - FY02 FY03 FY04 FY05 FY06 FY07E FY08E FY02 FY03 FY04 FY05 FY06 FY07E FY08E

Source: Company data, India Infoline Research Source: Company data, India Infoline Research

Derisked earnings model will benefit SIL The company strived to enter a new vertical and has been doing so for a number No single vertical accounts for over 30% of revenues of years, to derisk its earnings model. Today, SIL is a diversified player in the construction space and has seven strategic business units. None of SIL’s verticals account for more than 30% of the company’s turnover, the highest being the power segment, forming 27.7% of SIL’s revenues in FY06.

SIL’s revenue mix

100.0 10.9 90.0 19.1 20.6 16.8 80.0 8.0 12.0 70.0 8.9 60.0 20.6 13.9 24.9 50.0 6.6 (%) 8.9 40.0 14.2 8.1 4.6 30.0 27.7 20.0 18.9 20.0 10.0 12.9 12.6 9.9 - FY03 FY04 FY05 FY06 FY07E FY08E Piling Power Marine Industrial Road Urban utilities Building and housing

Source: Company, India Infoline Research

October 18, 2006 Construction Sector 106 India Under ‘Construction’

With a track record of 82 years, the company gets prequalified for most projects. This diversification will ensure that the in case spending in certain verticals goes out of favor, the orders keep flowing in from other segments.

Healthy order book position offers visibility Order book/sales at 3.5x SIL’s order book position presently stands at Rs47bn, which translates into offers high visibility 3.5x FY06 sales. This offers good visibility over the next few years, given its average execution period of 1.5 years. While orders in certain segments like piling are executed in three to eight months, others like hydel power projects would have a gestation period of up to three years. The company has a healthy mix in various segments including urban utilities, industrial segment, housing and roads.

Order book break-up

Building and Piling housing 5% 20% Power 28%

Urban utilities 10% Marine Road Industrial 7% 20% 10%

Source: Company, India Infoline Research

We have assumed a strike rate of 12% success for orders presently bid for by the company. We have factored these assumed orders into our FY08 estimates. The company is currently executing orders to the tune of Rs1.5bn per month on an average.

SIL’s order intake to execution trend

40,000 3.5 35,000 3.0 3.0 30,000 2.5 25,000 2.2 2.0

20,000 (x) 1.7 1.5 (Rs mn) 15,000 1.5 1.0 10,000 0.8 5,000 0.5 - - FY03 FY04 FY05 FY06 FY07E New jobs secured (LHS) Order intake/execution (RHS)

Source: India Infoline Research

October 18, 2006 Construction Sector 107 India Under ‘Construction’

The ratio of order intake/execution at 1.5x is a healthy one and gives an indication of a rise in turnover in the coming years. The chart below reveals SIL’s order book in the past and our estimates for FY07. SIL’s order book, which grew by 18.8% yoy during FY06, is expected to grow by 33.3% yoy in FY07 to Rs56.7bn.

SIL’s order book trend

60.0 56.7

50.0 42.5 40.0 35.8

30.0 (Rs bn) 20.0 16.1

8.2 10.0

- FY03 FY04 FY05 FY06 FY07E

Source: Company, India Infoline Research

Targeting 40% revenues from overseas Proportion of turnover: 10% SIL is planning to increase the proportion of revenues from projects abroad Target 40% from around 10% presently to 40% of the total turnover in the next four years, in order to minimize the impact of the domestic business cycle. SIL also stated Margins overseas likely to be that overseas projects give the company strong prequalification experience, higher by 100-200bps which would be helpful in the domestic market and command better margins by 100-200bps as well.

SIL has already executed close to Rs15bn worth of projects overseas in the past. Currently, it is executing projects to the tune of Rs6bn in Doha, building a cricket stadium in West Indies and performing piling operations in Manama (Bahrain). The company also has a presence in Russia, Africa, Dubai, Libya, Yemen, Abu Dhabi, Sri Lanka and Uzbekistan.

Target to become US$1bn company in five years’ time SIL has completed over Rs100bn worth of projects since inception and has set for itself, a target to become a US$1bn company in the next five years. For achieving this target, the company has charted a two-pronged strategy through organic and inorganic route. It would grow organically by concentrating on specific sectors like power, marine, industrial and water management. On the inorganic front, the company is looking for acquisitions, in India or abroad, that would be synergistic to its business. It will also seek joint ventures that would enable bidding for larger projects domestically and in the overseas market.

Entry into new verticals SIL is targeting EPC, O&M and BOT projects in various sectors and will look for alliances with international players. In the roads BOT space, the company will primarily bid for annuity projects and target an IRR of 15-20%. The BOT/EPC route in power T&D, power generation, ports, railways, real estate development and industrial construction is also an option being considered.

October 18, 2006 Construction Sector 108 India Under ‘Construction’

Preferential issue and GDR to satisfy fund requirements SIL issued 12,85,000 equity shares of face value of Rs10 at a price of Rs726.3 per share to Chrys Capital (Beethoven Ltd) on a preferential allotment basis, being 14.99% of post issue equity share capital. The funds raised are to be utilized to repay debt and to pre-qualify for larger sized projects. The company has also announced its intentions of a GDR/FCCB worth US$200mn, which is not factored into our workings.

SIL’s networth ramp-up

4,500 4,000 3,500 3,000 2,500 2,000 (Rs mn) 1,500 1,000 500 - FY02 FY03 FY04 FY05 FY06 FY07E FY08E

Source: India Infoline Research

Expect turnover CAGR of 45.4% between FY06-08 SIL has emerged as a well diversified player, registering a CAGR of 35% in topline between FY02-06 and a net profit CAGR of 81.5% during the same period. On the back of a healthy order book of Rs47bn and an expected order intake/execution of 1.7x in FY07, we expect the company to witness a CAGR of 45.4% in topline and 63.2% in bottomline between FY06 and FY08.

SIL’s principal projects during FY06 Project (Rs mn) Client Gorakhpur-Gopalganj 2,598 NHAI Power plant, Raigarh 2,080 Jindal Power Alumina smelter and power plant, Jharsuguda 1,515 NA Capital Complex, Imphal 1,414 Government of Manipur Multistoried Towers, Bangalore 1,280 NA NH-57 on Simrahi-Kosi 1,156 NHAI Hilton Hotel, Doha at Qatar 1,074 Hilton Chennai Bypass 946 Som Dutt -SIL JV Guwahati Fly-over 747 PWD Brides over River Mahanadi 675 Rail Vikas Nigam Power plant at Surat, Gujarat 500 NA Airport Complex, Udaipur 466 AAI Source: Company

October 18, 2006 Construction Sector 109 India Under ‘Construction’

Valuations

SIL is expected to register a topline growth of 51% and 40.1% during FY07 and FY08 respectively. During the same period, net profit growth is expected at 88.2% and 41.4% respectively. Valuations seem attractive for a stock trading at a P/E of 12.9x FY08E EPS and 8.1x FY08E EV/EBIDTA. The market capitalization is at 0.3x its order book, which is low and leaves scope for an increase. We recommend a BUY with a one-year price target of Rs459, representing an upside of 37.8%.

Sum of parts valuation (Rs mn) Methodology EBIDTA (FY08E) 2,375 EV/EBIDTA (x) 10 Target multiple Enterprise value 23,747 Net debt (Debt-cash) FY06 4,007 Market capitalization 19,741 Total equity value 19,741 Diluted equity capital 86 Value per share (Rs) 459 CMP (Rs) 333 % upside 37.8

Growth matrix yoy (%) FY04 FY05 FY06 FY07E FY08E Net Sales 19.1 53.0 34.6 51.0 40.1 EBIDTA 26.4 59.9 68.3 52.4 31.9 Net profit 10.7 159.5 65.4 88.2 41.4 Net Worth 11.1 25.2 119.2 29.9 32.3 Gross Block 20.4 16.8 53.4 23.6 22.7 Net Working Capital 26.9 65.1 41.8 19.4 23.1 Capital employed 24.0 48.3 46.4 18.8 21.7 Source: India Infoline Research

October 18, 2006 Construction Sector 110 India Under ‘Construction’

Company background

Simplex Infrastructure (India) Ltd (SIL), formerly known as Simplex Concrete Piles (I) Ltd, was incorporated in 1924 by a British engineer in Calcutta, pioneering the development of piling practices in India. The company was taken over by the Late Mr. M.D. Mundhra in 1947 and his family has been the running the company since. The company is based in Kolkata and has transformed itself into a diversified infrastructure major engaged in foundation work, general civil construction and turnkey services.

SIL has a good mix of clientele including NHAI, BHEL, Delhi Metro Railway Corporation, Jindal Steel and Reliance Energy. The company also absorbed foreign technology in a number of areas over the years. The employee strength of around 3,500 professionals with close to 2,200 technical staff. The company has executed over 2,000 projects all over India and abroad. Some of its prestigious works include Reliance Industries’ Jamnagar refinery, the Supreme Court, Jamshedpur and Burnpur steel plants and the Howrah Bridge. The company was rated as overall ‘Best Managed Company’ (Small Capitalization) by Asia Money for 2005.

Last five quarterly financials (Rs mn) Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07 Net sales 3,113 2,745 3,747 3,963 3,520 Operating expenditure (2,814) (2,507) (3,476) (3,629) (3,203) Operating profit 298 238 271 334 317 Other income 0 5 7 29 11 Interest (97) (91) (80) (118) (121) Depreciation (47) (51) (57) (53) (86) PBT 155 102 140 192 121 Tax (39) (12) (30) (86) (16) PAT 116 90 110 106 104 Equity 73 73 86 86 86

Quarterly OPM trend (Standalone)

12.0

9.4 9.6 10.0 9.0 8.8 8.7 8.4 8.0 7.2 6.1 6.0 6.0 (%)

4.0

2.0

- Q1 FY05 Q2 FY05 Q3 FY05 Q4 FY05 Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07

Source: Company data

October 18, 2006 Construction Sector 111 India Under ‘Construction’

Financials

Income Statement Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Net Sales 6,527 9,990 13,446 20,297 28,432 Operating expenses (6,089) (9,288) (12,265) (18,496) (26,057) EBIDTA 439 702 1,181 1,801 2,375 Depreciation (75) (89) (229) (266) (315) EBIT 363 613 952 1,535 2,060 Interest (240) (281) (404) (457) (513) Other Income 19 12 33 15 15 Profit before tax (PBT) 142 344 581 1,093 1,562 Tax (45) (92) (165) (309) (453) Profit after tax (PAT) 97 252 416 784 1,109 Extraordinary / prior period items 0 - - - - Adjusted profit after tax (APAT) 97 252 416 784 1,109

Balance Sheet Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Sources Equity Capital 73 73 86 86 86 Reserves 776 991 2,246 2,944 3,923 Net Worth 850 1,064 2,332 3,030 4,009 Loan Funds 2,263 3,543 4,452 4,910 5,580 Def Tax liability 68 111 123 264 398 Total 3,181 4,718 6,906 8,204 9,988

Uses Gross Block 1,621 1,894 2,905 3,590 4,404 Accd Depreciation (476) (561) (682) (948) (1,263) Net Block 1,145 1,333 2,223 2,642 3,141 Capital WIP 50 111 48 31 39 Total Fixed Assets 1,194 1,444 2,270 2,673 3,179 Investments 1 0 3 - - Total Current Assets 4,221 6,682 8,998 12,523 17,365 Total Current Liabilities (2,242) (3,414) (4,365) (6,991) (10,556) Net Working Capital 1,979 3,268 4,633 5,532 6,809 Def Tax assets 7 7 - - - Total 3,181 4,718 6,906 8,204 9,988

October 18, 2006 Construction Sector 112 India Under ‘Construction’

Cash Flow Statement Year to (Rs mn) FY05 FY06 FY07E FY08E Net profit before tax and extraordinary items 344 581 1093 1562 Depreciation 89 229 266 315 Interest expense 281 404 457 513 Operating profit before working capital changes 714 1214 1816 2390 Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (1414) (1430) (2558) (3520) (Inc)/dec in inventories (643) (239) (810) (1149) (inc)/dec in other current assets 0 (421) (39) (5) Inc/(dec) in sundry creditors 1148 939 2589 3522 Inc/(dec) in other current liabilities 25 11 37 43 Net change in working capital (884) (1139) (780) (1109)

Cash from operating activities (170) 74 1035 1281 Less: Income tax (92) (165) (309) (453) Inc/Dec in Def Tax Asset/liability 44 18 141 134 Net cash from operating activities (218) (72) 867 962 Cash Profit (218) (72) 867 962

Cash flows from investing activities (Inc)/Dec in fixed assets (338) (1056) (668) (821) (Inc)/Dec in Investments 1 (3) 3 0 Net cash from investing activities (338) (1059) (665) (821)

Cash flows from financing activities Inc/(Dec) in debt 1280 909 458 670 Inc/(Dec) in equity/premium 0 13 0 0 Direct add/(red) to reserves (5) 882 (0) 0 Interest expense (281) (404) (457) (513) Dividends (33) (43) (86) (129) (inc)/dec in loans & advances (322) (12) (36) (89) Net cash used in financing activities 640 1344 (120) (62)

Net increase in cash and cash equivalents 83 213 82 79 Cash at start of the year 148 232 445 527 Cash at end of the year 232 445 527 606

October 18, 2006 Construction Sector 113 India Under ‘Construction’

Ratios FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Per share ratios EPS (Rs) 2.7 6.9 9.7 18.2 25.8 Cash EPS (Rs) 4.7 9.3 15.0 24.4 33.1 Div per share (Rs) 0.3 0.9 1.0 2.0 3.0 Book value per share (Rs) 23.2 29.0 54.2 70.4 93.1 FV per share (Rs) 2.0 2.0 2.0 2.0 2.0

Valuation ratios P/E (x) 125.5 48.5 34.4 18.3 12.9 P/CEPS (x) 70.7 35.8 22.2 13.7 10.1 P/BV (x) 14.4 11.5 6.1 4.7 3.6 EV/sales (x) 2.2 1.6 1.4 0.9 0.7 EV/ EBIT (x) 39.4 25.3 19.3 12.2 9.4 EV/EBIDTA (x) 32.6 22.1 15.5 10.4 8.1 Order book/Sales (x) 7.2 4.7 3.5 2.3 1.7

Profitability ratios OPM (%) 6.7 7.0 8.8 8.9 8.4 EBIT margin (%) 5.6 6.1 7.1 7.6 7.2 NPM (%) 1.5 2.5 3.1 3.9 3.9 Cash profit margin (%) 2.6 3.4 4.8 5.2 5.0 ROCE (%) 12.0 13.2 14.3 18.9 20.8 RONW (%) 11.4 23.7 17.9 25.9 27.7

Liquidity ratios Current ratio 1.9 2.0 2.1 1.8 1.6 Debtors days 145.3 146.6 147.7 143.8 147.9 Inventory days 51.4 57.0 48.9 46.9 48.3 Creditors days 124.7 123.4 117.2 124.2 133.9

Turnover ratios Asset turnover (x) 2.1 2.1 1.9 2.5 2.8 Fixed Asset turnover (x) 5.7 7.5 6.0 7.7 9.1

Leverage ratios Debt / Total equity (x) 2.7 3.3 1.9 1.6 1.4

October 18, 2006 Construction Sector 114 MARKET PERFORMER CMP Rs358 Era Constructions (India) Ltd COMPANY REPORT

Stock Data We initiated coverage on Era Constructions (India) Ltd (ECIL) in December Target Price Rs411 2005 as we believed that this small sized construction player was poised to Upside 14.9% attain size. ECIL did meet its guidance recording a turnover of Rs3.1bn in FY06, almost doubling from FY05 levels. The stock currently is up 119.3% Sensex 12,736 since our recommendation. We assign a market performer rating. 52 Week H/L Rs541.9/102 Average Vol.(6M) 410,246 Extensive order ramp-up in the last 12 months Market Cap Rs6.5bn ECIL’s order book at Rs15bn, translates into 4.8x its FY06 standalone turnover. Face Value Rs10 Substantial order intake in the past 12 months, led to an order intake/execution BSE Code 530323 of 3x, which is a sign of high growth to come for ECIL, whose average gestation NSE Code ERACONS period is two years. Reuters Code ERCI.BO Bloomberg Code ERC@IN Group companies to add value Prices as on 13th Oct’06 The company’s pre-engineered buildings foray through its 65% owned subsidiary, Era Metals, will be complementary to ECIL, in industrial and commercial verticals, taking advantage of the growing trend for such structures. We assign a value of Share Holding Pattern Rs9.7 per share, taking ECIL’s holding at 0.5x Era Metals’ topline of Rs687.5mn June’06 (%) during FY06. Promoters 20.3 Foreign 32.2 ECIL has entered the real estate business, holding 51% in Era Infrastructures; 17 Institutions 52 projects have already begun on 1,000 acres land. We do not factor this investment Non promoter corporate 12.6 and ECIL’s 400 acres land bank, which leaves scope for upside. Public & others 29.8 Foray into BOTs with maiden annuity in roads ECIL has won its maiden annuity project, entitled to Rs270mn semi-annually for 35 months. The project accounts for 22% of ECIL’s order book and 73% of its Share Price Chart infrastructure segment orders. We value this 20-year project of Rs3.3bn at Rs21 per share, which is book value of the equity infused. The value assigned amounts 500 Era Sensex to 6% of the current market price. 400 300 Attractive valuations 200 ECIL to benefit from the huge corporate capex and residential and commercial 100 construction planned. A sizeable player in the north, particularly the NCR region, 0 we expect a topline CAGR of 76.8% and 58.3% in bottomline for the standalone 5 5 6 6 6 6 6

0 0 0 0 0 0 0 entity between FY06 and FY08. ------t t r c b n g c c p e e u u O A O J F D A The stock is trading at a P/E of 12.1x and EV/EBIDTA of 7.4x its FY08E earnings with an order book/market capitalization of 2.3x. Adjusting for its BOT project and value assigned to Era Metals, it trades at 8.9x FY08E EPS. We recommend a BUY with a one year price target of Rs411, representing an upside of 14.9%.

Key financials and ratios (Standalone) FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Net sales (Rs mn) 1,095 1,562 3,108 6,106 9,716 yoy (%) 7.9 42.7 98.9 96.5 59.1 Net profit (Rs mn) 29 55 264 398 663 yoy (%) 24.0 88.6 384.4 50.9 66.5 OPM (%) 7.7 9.0 15.7 12.5 12.9 EPS (Rs) 6.7 8.4 14.2 17.2 28.7 P/E (x) 52.4 41.7 24.6 20.2 12.1 P/BV (x) 6.2 7.8 2.7 2.4 2.0 EV/EBIDTA (x) 19.3 18.1 13.0 11.1 7.4 Order book/Sales (x) 13.7 9.6 4.8 2.5 1.5 ROCE (%) 15.2 17.8 14.0 14.7 18.6 RONW (%) 11.8 18.6 11.0 11.9 16.8

October 18, 2006 Construction Sector 115 India Under ‘Construction’

Investment rationale

Extensive order intake during the past 12 months Order intake of 3x mainly ECIL, a major player in the NCR region, is awarded most of its projects (53.4% from the private sector of its orders in value terms and 71.8% in number terms), from private sector players. ECIL’s order book stands at Rs15bn currently, up from Rs7.6bn, when we initiated coverage on the company in December 2005. The past 12 months has seen significant ramp up in ECIL’s order book position with order intake between June 2005 and June 2006 at Rs9.5bn, resulting in a high order intake/ order execution ratio of 3x during the period. These are good signs for a company striving to achieve size in the next two years.

The order book of the company translates into 4.8x its FY06 turnover on a standalone basis, which is healthy given its average execution period of two years. The company enjoys a healthy mix of orders from the different segments in which it operates.

Order book break-up

Hospitals & Others Infrastructure Housing 12% 44% 10%

Industrial 17% Thermal power 17%

Source: Company Infrastructure segment includes roads, railways and airport projects. Hospital and others includes commercial construction of malls, multiplexes and institutions like auditorium and academic buildings, besides hospitals.

The strong order book position, along with our assumption of 30% growth in FY07, translates into a high revenue visibility for the next three years. ECIL has also prequalified for projects worth Rs50bn, which will add to the order book, on award of contract.

Maiden BOT venture by the company Maiden BOT entitled to ECIL has won its maiden BOT project awarded by NHAI on an annuity basis for annuity of Rs270mn semi- annually for 35 months the Gwalior stretch, where it is entitled to Rs270mn semi-annually for 35 months as annuity payments. The execution is through a SPV, in technical collaboration with Ramkey & Shriram Group, which will be paid a fee for their services. This We value ECIL’s stake at project is a large one for ECIL, given its size. The project accounts for 22% of Rs21 per share ECIL’s total order book and 73% of its order book in the infrastructure segment. We value this project at Rs21 per share of ECIL, which is the book value of the equity infused. The value assigned amounts to 6% of the current market price.

October 18, 2006 Construction Sector 116 India Under ‘Construction’

Project details

ECIL’s share (%) 49 Segment Roads Description 42 kms Project type Annuity Technical collaboration Ramkey & Shriram Group Concession period 20 years including construction period of 2.5 years Project cost (Rs mn) 3,300 Equity (Rs mn) 990 Debt (Rs mn) 2,310 ECIL’s equity (Rs mn) 485

Source: Company, India Infoline Research Group companies to add value …

Era group holding structure

Era Constructions (India) Ltd

51% 65% 10%

Era Infrastructures Era Metal Building Era Financial Services (India) Ltd Systems Ltd (India) Ltd*

* Name changed to Ezone along with scope of business

Source: Company, India Infoline Research

… Era Metals Building Systems for pre-engineered buildings Era Metals Building Systems Ltd (EMBSL) is a 65% owned subsidiary of ECIL engaged in pre-engineered buildings (PEB), which includes pre-engineered metal buildings, industrial racks, electric towers, crash barriers and steel bridges. The balance 35% in EMBSL is held by the promoters and associates of ECIL.

The advantages of PEB over conventional structures are as follows: Ö Speed of construction Ö Economy Ö Versatile Ö Energy efficient Ö Ease to design/manufacturing and factory controlled quality

Multinationals in the west have preferred steel buildings for a long time and an increasing number of new industrial complexes in India are now using steel structures. ECIL, through EMBSL, is investing Rs1bn for setting up a plant in Uttaranchal, with a D/E of 1.4x. EMBSL will use PEB material for ECIL’s EPC contracts for buildings as well as supply to other companies.

The group has already completed five projects and work on four more projects is underway. In FY06, EMBSL registered a turnover of Rs687.5mn with PBT and PAT at October 18, 2006 Construction Sector 117 India Under ‘Construction’

Rs15.2mn and Rs10.1mn respectively. Being a new venture in a relatively We value project at Rs9.7 per unexplored market, we have valued 65% of ECIL’s holding in the project, at half share EMBSL’s turnover in FY06, translating into Rs9.7 per share of ECIL.

… Real estate foray through Era Infrastructures Era Infrastructures (India) Ltd (EIIL), 51% held by ECIL, was incorporated for a foray into real estate development. The balance shareholding is held by the ECIL promoters and associates.

17 projects at 10 locations EIIL will focus on real estate development in the National Capital Region (NCR), have already begun tier-II and tier-III cities in India. EIIL has started 17 projects at 10 locations in five states spanning an area of around 1,000 acres land.

Ongoing projects in real estate Project type No. of projects Area (acres) Townships 8 817.0 Group Housing 6 145.0 IT Parks 1 15.4 Malls/Multiplexes 2 2.6 Total 17 980.0 Source: Company, India Infoline Research

Revenues will start flowing in from EIIL from FY07 onwards. EIIL is targeting revenues to the tune of Rs50bn cumulatively, over the next 3-5 years with 15- 20% profitability target. The existing land bank with the company is close to 400 acres. We have not factored this venture into our estimates till further details are available on each project under execution.

Significant OPM expansion in FY06 ECIL has been witnessing high expansion in margins at the operating level for OPM expansion mainly due to the last three years in a row. The company witnessed significant expansion of completion of a number of 670bps yoy in its OPM to 15.7% during FY06 as compared to 9% in FY05. A large private sector projects in Q4 part of this margin expansion was on account of completion of a number of private FY06 sector projects in the fourth quarter of FY06.

ECIL is likely to continue to witness higher margins than its peers as most of its orders are from the private sector. While the company is confident of maintaining these margins, we have factored in a 320bps yoy decline in margins during FY07 and a increase of 40bps yoy in FY08, as we believe that such high margins may not be sustained in the long run.

ECIL’s OPM trend

16.0 15.7

14.0 12.9 12.5 12.0

10.0 9.0 (%) 8.2 7.7 8.0 7.2

6.0

4.0 FY02 FY03 FY04 FY05 FY06 FY07E FY08E

Source: Company data, India Infoline Research October 18, 2006 Construction Sector 118 India Under ‘Construction’

Diversified client base ECIL has a diversified client base, comprising 27 clients in the 39 projects that make up the order book. Most of its projects are awarded from private sector players, particularly in the industrial segment. The company has executed contracts in 18 states across India with its client base more than doubling in 2005-06 from 15 in number, in 1999-00.

ECIL’s diversified client base Revenue mix from public and private sector

Client (%) 100 Private NHAI 21.9 80 sector, 20 Private Rail Vikas Nigam 13.0 sector, 48 NTPC 11.5 60

BHEL 5.3 (%) Public 40 Aksh broadband 5.25 sector, 80 Public Nalco 3.8 20 sector, 52 New Delhi PWD 3.3 Others 35.9 0 Total 100.0 FY05 FY06

Source: Company Source: Company

Targeting new verticals From primarily being an industrial construction player, ECIL made its entry in the road sector in 2005 and into railways recently. Today, the company operates in roads, airports, highways, power, industrial projects, housing, railways, commercial complexes, hospitals and institutional segments. It has won for itself an annuity project in roads and forayed into real estate development and PEB’s through its subsidiaries. It is now looking to venture into the irrigation segment, sea ports and hydel electric power plants.

Well poised to attain size ECIL is on a high growth path witnessing a turnover increase of 42.7% and 98.9% yoy during FY05 and FY06 respectively. The order book intake during the past 12 months has been at a soaring pace, well surpassing order execution, Expected to witness CAGR of which is an indication of high growth to follow. The company surpassed its guidance 76.8% between FY06-08 for FY06 by posting a turnover of over Rs3.1bn on a standalone basis and close to Rs3.8bn on a consolidated basis and is expected to witness a CAGR of 76.8% between FY06-FY08. Our estimates are based on the execution of the current order book and an assumption of 30% yoy growth in the same in March 2007.

ECIL’s turnover and growth

10,000 120.0

8,000 100.0 80.0 6,000 60.0 4,000 (%) (Rs mn) 40.0 2,000 20.0 - - FY03 FY04 FY05 FY06 FY07E FY08E Turnover (LHS) Yoy growth (RHS)

Source: Company data, India Infoline Research October 18, 2006 Construction Sector 119 India Under ‘Construction’

Funds raised for fulfillment of its plans Post its follow-on public offer in June 2005, raising close to Rs500mn, ECIL allotted 4.49mn warrants at Rs135 per warrant on a preferential basis in December 2005. The company also raised money through a US$30mn GDR issue in February 2006 for investments in BOT projects, investments in subsidiaries and for meeting its capex and working capital requirements. The company’s networth stands at Rs2.4bn as on March 2006 as compared to Rs292mn as on March 2005 and is sufficient for the company’s plans in the medium term and no further fund raising is likely soon. We will see the full benefit from the use of these funds in FY07 and FY08.

ECIL’s networth ramp-up

Follow on public offer – June 2005 4,000 Warrants – December 2005 3,500 GDR – February 2006 3,000 2,500 2,000

(Rs mn) 1,500 1,000 500 - FY02 FY03 FY04 FY05 FY06 FY07E FY08E

Source: India Infoline Research

Valuations

ECIL is a sizeable player in the north, particularly in the NCR region with 71.8% of its orders, in number terms, awarded from private sector players. The boom in corporate capex, residential and commercial construction, along with certain central and state government works, will continue to drive revenues in future.

The ECIL stock is trading at a P/E of 12.1x FY08E standalone earnings on the fully diluted equity, with potential upside from its two subsidiaries, EIIL and EMBSL. Adjusting for its BOT project and the value assigned to EMBSL, the stock trades at 11.1x FY08E EPS. These are attractive valuations for a company with high growth potential.

The order book stands at 4.8x FY06 sales and 2.1x its current market capitalization. We like this construction midcap company, available at an EV/ EBIDTA of 7.4x FY08 estimates. Our sum of parts valuation method throws up a price target of Rs411 for the stock. We assign a market performer rating on the stock with a potential upside of 14.9% in a year’s time.

October 18, 2006 Construction Sector 120 India Under ‘Construction’

Sum of parts valuation (Rs mn) Methodology EBIDTA (FY08E) 1,256 EV/EBIDTA (x) 8 Target multiple Enterprise value 10,048 Net debt (Debt-cash) FY08E 1,257 Market capitalization 8,792 Equity value of BOT 485 1x Book value Value of EMBSL 223 65% holding @ 0.5x FY06 turnover Total equity value 9,500 Diluted equity capital 231 Value per share (Rs) 411 CMP (Rs) 358 % upside 14.9

Growth matrix yoy (%) FY04 FY05 FY06 FY07E FY08E Net Sales 7.9 42.7 98.9 96.5 59.1 EBIDTA 14.8 67.5 248.1 56.0 64.7 Net profit 24.0 88.6 384.4 50.9 66.5 Net Worth 10.8 19.2 721.8 39.9 17.7 Gross Block 8.3 27.8 125.5 75.8 27.9 Net Working Capital 38.7 70.3 550.3 30.8 37.1 Capital employed 18.6 50.3 362.7 42.8 32.8 Source: India Infoline Research

Concerns

Small sized projects ECIL has a large order book as compared to its current turnover with size of the contracts being small, averaging Rs386mn per project. The company may face problems in bidding for bigger projects in future.

Manpower constraints Although, this is a concern for the industry as a whole, we believe this aspect might be more of a constraint for ECIL due to the number of projects it is undertaking in different states. ECIL is operating in 17 states currently, with 39 projects in the order book. With such a diverse presence, it may be difficult to manage its resources or pick up additional orders in future.

October 18, 2006 Construction Sector 121 India Under ‘Construction’

Company background

ECIL is into diversified construction activities such as institutional and industrial complexes, residential buildings, power projects, runways and integrated cargo complex for airports, sewerage, roads under infrastructure, drainage and multiplexes.

The company was incorporated as Era Constructions (India) Pvt Ltd in 1990 and was subsequently converted into a public limited company and the name was changed to the present one in 1992. ECL is an ISO 9001:2000 certified company and has completed over 70 projects valued at around Rs7bn cumulatively in a span of 16 years. Its employee strength stands at over 1,000 presently, up from 350 in 1999-00, employing over 300 engineers.

Mr. H. S. Bharana , Chairman and Managing Director of ECIL, is a civil engineer and has 26 years of experience in the field of construction and administration. He is the founder promoter of ECIL. He began his career in 1981 as a civil engineer in Willard India Ltd after which, he moved to Ahuja Kashyap Pvt Ltd as a senior civil engineer in 1982. He formed a proprietary firm in the field of civil construction in 1985, before partnering in Era Engineers (India), a partnership firm engaged in civil construction business, in 1986.

Mr. P.P. Mainra, Executive Director of ECIL, is a civil engineer with around 36 years of experience in the construction industry. He started his career as a design engineer in 1970 and was part of various structures like multi-storied complexes, cinema halls, housing projects and factory buildings. He joined NBCC in 1972 and was promoted to the post of chief project manager, where he had been looking after the construction of roads, buildings and bridges. He joined ECIL in 1995 as General Manager before being designated Executive Director in 2004.

Last five quarterly financials (Standalone) (Rs mn) Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07 Net sales 526 700 843 1,039 1,212 Operating expenditure (474) (617) (704) (824) (996) Operating profit 52 83 139 215 216 Other income 3 3 4 12 13 Interest (20) (22) (28) (32) (36) Depreciation (6) (7) (10) (11) (15) PBT 29 57 106 183 177 Tax (8) (17) (26) (60) (51) PAT 21 40 80 123 126 Equity 65 134 134 186 186

ECIL’s quarterly OPM trend (Standalone)

22.0 20.7 20.0 17.8 18.0 16.5 16.0 14.0 11.6 11.9 (%) 12.0 9.9 10.0 8.6 9.0 7.4 8.0 6.0 4.0 Q1 FY05 Q2 FY05 Q3 FY05 Q4 FY05 Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07

Source: Company data October 18, 2006 Construction Sector 122 India Under ‘Construction’

Financials

Income Statement (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Net Sales 1,095 1,562 3,108 6,106 9,716 Operating expenses (1,011) (1,422) (2,619) (5,344) (8,460) EBIDTA 84 140 489 763 1,256 Depreciation (18) (22) (35) (56) (72) EBIT 66 119 454 706 1,184 Interest (32) (57) (101) (147) (251) Other Income 9 12 22 10 15 Profit before tax (PBT) 43 74 374 569 947 Tax (14) (20) (110) (171) (284) Profit after tax (PAT) 29 55 264 398 663

Balance Sheet (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Sources Equity Capital 43 65 186 231 231 Reserves 202 227 2,216 3,129 3,723 Net Worth 245 292 2,402 3,360 3,954 Loan Funds 179 373 891 1,280 2,149 Def Tax liability 65 71 111 220 350 Total 490 736 3,404 4,860 6,453

Uses Gross Block 371 474 1,070 1,881 2,406 Accd Depreciation (97) (103) (126) (183) (255) Net Block 275 371 944 1,698 2,151 Capital WIP - 1 32 - - Total Fixed Assets 275 373 976 1,698 2,151 Investments 5 5 125 150 173 Total Current Assets 514 810 2,920 4,182 5,918 Total Current Liabilities (306) (456) (618) (1,170) (1,789) Net Working Capital 208 354 2,303 3,012 4,129 Miscellaneous expenditure 0 2 - - - Def Tax assets 1 2 - - - Total 490 736 3,404 4,860 6,453

October 18, 2006 Construction Sector 123 India Under ‘Construction’

Cash Flow Statement Year to (Rs mn) FY05 FY06 FY07E FY08E Net profit before tax and extraordinary items 74 374 569 947 Depreciation 22 35 56 72 Interest expense 57 101 147 251 Operating profit before working capital changes 153 510 773 1,271 Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (155) (594) (869) (1,027) (Inc)/dec in inventories (71) (220) (359) (424) (inc)/dec in other current assets - (3) 3 - Inc/(dec) in sundry creditors 141 119 500 577 Inc/(dec) in other current liabilities 10 42 53 43 Net change in working capital (75) (655) (672) (831)

Cash from operating activities 78 (145) 101 440 Less: Income tax (20) (110) (171) (284) Inc/Dec in Def Tax Asset/liability 5 42 109 130

Misc expenditure w/off (2) 2 - - Net cash from operating activities 61 (211) 39 286 Cash Profit 61 (211) 39 286

Cash flows from investing activities (Inc)/Dec in fixed assets (120) (638) (779) (525) (Inc)/Dec in Investments - (120) (24) (23) Net cash from investing activities (120) (758) (803) (548)

Cash flows from financing activities Inc/(Dec) in debt 194 518 389 869 Inc/(Dec) in equity/premium 22 121 45 - Direct add/(red) to reserves (23) 1,753 561 (0) Interest expense (57) (101) (147) (251) Dividends (7) (28) (46) (69) (inc)/dec in loans & advances (46) (385) (198) (243) Net cash used in financing activities 83 1,877 604 305

Net increase in cash and cash equivalents 25 908 (161) 43 Cash at start of the year 78 103 1,011 850 Cash at end of the year 103 1,011 850 893

October 18, 2006 Construction Sector 124 India Under ‘Construction’

Ratios FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Per share ratios EPS (Rs) 6.7 8.4 14.2 17.2 28.7 Cash EPS (Rs) 10.9 11.7 16.0 19.7 31.8 Div per share (Rs) 1.0 1.0 1.5 2.0 3.0 Book value per share (Rs) 56.5 44.8 129.1 145.5 171.2 FV per share (Rs) 10.0 10.0 10.0 10.0 10.0

Valuation ratios P/E (x) 52.4 41.7 24.6 20.2 12.1 P/CEPS (x) 32.1 29.9 21.7 17.7 11.0 P/BV (x) 6.2 7.8 2.7 2.4 2.0 Dividend yield (%) 0.3 0.3 0.4 0.6 0.9 EV/sales (x) 1.5 1.6 2.0 1.4 1.0 EV/ EBIT (x) 24.7 21.4 14.0 12.0 7.9 EV/EBIDTA (x) 19.3 18.1 13.0 11.1 7.4 Order book/Sales (x) 13.7 9.6 4.8 2.5 1.5

Profitability ratios OPM (%) 7.7 9.0 15.7 12.5 12.9 EBIT margin (%) 6.0 7.6 14.6 11.6 12.2 PBT margin (%) 3.9 4.8 12.0 9.3 9.8 Net profit margin (%) 2.6 3.5 8.5 6.5 6.8 Cash profit margin (%) 4.3 4.9 9.6 7.4 7.6 ROCE (%) 15.2 17.8 14.0 14.7 18.6 RONW (%) 11.8 18.6 11.0 11.9 16.8

Liquidity ratios Current ratio (x) 1.7 1.8 4.7 3.6 3.3 Debtors days 83.3 94.5 117.3 111.6 108.7 Inventory days 40.5 44.9 48.4 46.1 44.9 Creditors days 96.4 100.4 64.5 62.7 61.1

Turnover ratios Asset turnover (x) 2.2 2.1 0.9 1.3 1.5 Fixed Asset turnover (x) 4.0 4.2 3.3 3.6 4.5

Leverage ratios Debt / Total equity (x) 0.7 1.3 0.4 0.4 0.5

October 18, 2006 Construction Sector 125 BUY CMP Rs208 Valecha Engineering Ltd COMPANY REPORT

Stock Data We recommend a BUY on Valecha Engineering Ltd (VEL), a mid-sized Target Price Rs294 construction company, poised for high growth in the next few years backed Upside 41.1% by a healthy order book position. Sensex 12,736 Comfortably placed with an order book of 5.5x FY06 turnover 52 Week H/L Rs410/125 VEL’s order book position at Rs8bn is a healthy 5.5x its FY06 sales. The company Average Vol.(6M) 51,364 is awarded a significant part of its orders during the last nine months with Market Cap Rs1.4bn order inflow rising to 4.6x FY06 sales. The company ramped up its networth Face Value Rs10 through a preferential issue and GDR. Any announcement of an award of a BOT BSE Code 532389 project on account of its increased financial muscle would lead to a positive NSE Code VALECHAENG surprise. Reuters Code VALE.BO Bloomberg Code VLCE@IN Expected revenue CAGR of 57.4% during the next two years We expect an order intake in the region of Rs4bn during FY07, translating into an order intake of 1.8x its execution. Based on the present order book and the expected ones, we estimate VEL’s turnover to rise by 49.6% and 65.6% during Share Holding Pattern FY07 and FY08 respectively. June’06 (%) Promoters 39.9 Trading at book value with a healthy investment portfolio Foreign 22.5 VEL holds equity shares of Jyoti Structures, which translate into Rs76.9 per Institutions 4.8 share of VEL diluted equity capital, which is 37.1% of the CMP. Besides, the Non promoter corporate 13.4 stock is currently trading at its book value with a market capitalization of 0.9x Public & others 19.4 its FY06 sales. This checks any significant downside to the stock from current levels.

Attractive valuations Share Price Chart The stock is trading at a P/E of 10.5x and a Price/CEPS of 8.3x its FY08E earnings Valecha Sensex 200 and an EV/EBIDTA of 5.7x for the same period, which makes it a compelling buy. 150 These estimates leave scope for upside from the company’s real estate foray. 100 50 VEL, which generates 70% of its revenues from roads, offers good value, limited downside and high visibility for the next 2-3 years. The company has been 0 consistent with dividend payments and 36% of the present equity is on account 5 5 6 6 6 6 6 0 0 0 0 0 0 0 ------t t r c

b n g of bonus. We recommend a BUY with a one year price target of Rs294, based c c p e e u u O O A J F D A on a target enterprise value of 8x its FY08E EBIDTA and 50% discount to the two stocks held in its investment portfolio. This represents an upside of 41.1% from current levels.

Key financials and ratios (Standalone) FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Net sales (Rs mn) 1,171 1,455 1,514 2,265 3,750 yoy (%) 91.6 24.2 4.0 49.6 65.6 Net profit (Rs mn) 51 62 - 95 169 yoy (%) 25.5 22.2 - - 77.8 OPM (%) 7.6 6.5 7.3 7.1 7.1 EPS (Rs) 11.3 13.9 7.5 11.1 19.7 P/E (x) 18.3 15.0 27.7 18.7 10.5 P/BV (x) 3.2 2.8 1.2 1.1 1.0 EV/EBIDTA (x) 13.1 13.0 12.6 10.2 5.7 Order book/Sales (x) 7.0 5.7 5.5 3.6 2.2 ROCE (%) 14.6 14.9 5.8 7.3 11.3 RONW (%) 17.8 18.9 4.4 6.0 9.9

October 18, 2006 Construction Sector 126 India Under ‘Construction’

Investment rationale

Significant growth in order inflow during the past nine months VEL’s present order book position at Rs8bn translates into an order book of 5.5x FY06 sales with an average execution period of 2.5 years. While order Order book grew by 230.5% inflow has been respectable in the past three years on the whole, the last nine yoy during FY06 months have seen intake at a swift pace. VEL’s order book grew by 230.5% yoy during FY06 with order intake/execution of 4.6x, as compared to 1.7x and 1.3x in FY04 and FY05 respectively. The company witnessed an order intake of nearly Rs7bn in FY06, 3.7 times higher than the order intake during FY05. These are indications of high growth in turnover in FY07 and FY08.

VEL’s order book trend VEL’s order book break-up

10,000 Foundation Engineerin Airports Flyovers 8,000 g 1% 7% Others 4% 2% 6,000 Bridges

(Rs mn) 8% 4,000 Tunnel / 2,000 Canal / Roads Dams 77% - 1% FY03 FY04 FY05 FY06 FY07E

Source: Company, India Infoline Research Source: Company, India Infoline Research

We have assumed a 21% yoy increase in order book for the company in March 2007 as we believe that the company will focus on execution of the huge ramp- up during the past nine months. We have not assumed any revenues from the company’s road project in Assam during FY07, where VEL’s share is valued at close to Rs1.6bn, since the company is yet to receive the letter of commencement. Timely execution of the Assam project leaves scope for upside to our estimates for FY07 as it accounts for 19.4% of the company’s present order book.

Key projects undertaken by VEL Segment Project Client/Funding Total value VEL’s share in project (Rs mn) (%) Roads Guwahati Byepass NHAI 600 100 Roads 4 laning of Satara-Kolhapur III MSRDC 900 100 Roads Assam NHAI 2,250 70 Piling Kahalgaon, Bihar NTPC 180 100 Fly-over 710m Borivali fly-over MSDRC 172 100 Dams Upper Wardha World Bank 200 100 Dams Warna Manonry World Bank 236 100 Tunnel Kanher Tunnel MKVDC, Satara 250 100 Airports Mumbai airport runway Airport Authority of India 97.9 100 Airports Chennai airport runway Airport Authority of India 149.9 100 Piling Piling for Super Thermal power NTPC 350 100 Source: Company

October 18, 2006 Construction Sector 127 India Under ‘Construction’

VEL to witness a 57.4% CAGR in the next two years VEL delivered a nearly flat performance in FY06 with the topline growing by mere 4% yoy on account of a number of reasons. A large part of the present order book (close to 70%) was awarded to the company post December 2005, which led to virtually zero billing during FY06 on account of these orders. VEL suffered due to delays in approval for work done, on the part of the authorities for VEL’s Chitorgarh and Poona projects during the year, totally valued at Rs1,289.8mn. The heavy down pour during the monsoons added to low construction activity during the year as well. The VEL stock, which touched a 52-week high of Rs410.3 in March 2006, has corrected to present levels of Rs207.

Given its healthy order book position, we expect VEL to witness a CAGR of 57.4% between FY06 and FY08. We expect the topline to rise to Rs2,265mn in FY07 and to Rs3,750mn in FY08 from Rs1,514mn in FY06. These projections are Management has guided on for the standalone entity without factoring in the company’s real estate foray. 70% CAGR over next 2 The management has guided on a CAGR of 70% for the next two years, which years, higher than our is higher than our projections and if achieved, renders the valuations all the estimates more attractive.

VEL’s turnover trend

4,000 Stock may be rerated on 3,500 attaining size 3,000 2,500 2,000

(Rs mn) 1,500 1,000 500 - FY02 FY03 FY04 FY05 FY06 FY07E FY08E

Source: India Infoline Research

Real estate plans through Valecha Infrastructures Ltd VEL plans on making an entry into the real estate sector and has acquired 50,000 shares of the face value of Rs10 each of Valecha Infrastructure Ltd (VIL), which is a wholly-owned subsidiary of the company. VEL has worked on a few real estate projects in the past, however, has inactive in this segment for some time now. The company now plans to be more focused on this vertical.

VEL transferred 400,000 shares, face value Rs10 each of Jyoti Structures from its books to VIL at a price of Rs540.5 per share. This resulted in a one time gain of Rs216.2mn in the books of VEL in FY06. VEL will look to raise money to part finance its real estate venture. Since operational activities are yet to begin, we have not factored any revenues from this venture into our estimates.

October 18, 2006 Construction Sector 128 India Under ‘Construction’

History of rewarding shareholders 36% of VEL’s equity capital is Around 36% of VEL’s present equity capital of Rs69.2mn, is by way of bonus on account of bonus given by the company. The company has been consistent in paying dividends and has been on the dividend paying list since 1993, ie for the past 14 years. In FY06, the company announced an equity dividend of 30% translating into Rs3 per equity share.

Networth ramp up for entry into new verticals and BOT VEL has set its sight on entering new verticals as well as the BOT segment in GDR issue done in the past. Another one planned for roads. In the past, although technically prequalified, VEL lacked the financial attaining financial strength muscle to bid for large projects or BOTs. The company therefore, raised resources by issuing 2,048,900 warrants on a preferential basis at Rs199.55, of which 423,900 have been fully paid.

It also made a GDR issue for US$12.1mn (2,000,000 GDRs at US$6.05) on the Luxembourg Stock Exchange, which has increased the financial strength of the company. It is also looking at the hydel power and wind power segments to give healthier margins and reduce risks. The company is once again planning to raise resources through GDRs or a FCCB issue and raise its FII limit to 49%.

VEL’s networth ramp up

Networth ramp up to qualify for BOT and enter new verticals 1,800 1,600 1,400 1,200 1,000 800 (Rs mn) 600 400 200 - FY02 FY03 FY04 FY05 FY06 FY07E FY08E

Source: India Infoline Research

Plans to increase share of foundation engineering VEL is one of the known players in India for pile foundation on account of its skills and the equipment that it possesses. VEL recently completed two prestigious piling projects and has successfully carried out the single largest piling contract in the country for NTPC, consisting of 220,000 running metres (rmt) at Kahalgaon, Bihar.

It plans to initiate talks with potential clients in Middle East, particularly in Dubai to bid for piling contracts there. With these efforts, the company hopes to increase its share and open up substantial opportunities for itself in future.

October 18, 2006 Construction Sector 129 India Under ‘Construction’

One of the low priced construction stocks … VEL is one of the low priced construction stocks listed on the Indian bourses. The counter is trading at a multiple of 10.5x FY08E fully diluted EPS and 8.3x FY08E fully diluted cash EPS.

Market capitalization/Sales of At the current market price, which is nearly equal to the book value of the 0.9x and trading at nearly its company in FY06 and market capitalization/sales of 0.9x, the downside to the book value – negates any stock is limited. The enterprise value for VEL during FY07E and FY08E stands at major downside risk to the 10.2x and 5.7x its operating EBIDTA respectively, which is extremely low for a stock company in a booming sector.

… Investment portfolio offers the required cushioning VEL’s consolidated balance sheet for FY06, besides other investments, comprises Investments in Jyoti of 1,086,280 shares of Jyoti Structures Ltd of the face value of Rs10 each. At Structures translate in Rs76.9 the current market price on the exchanges where these shares trade, the value per share of VEL held by VEL in these stocks amounts to Rs657mn approximately. This translates into Rs76.9 per share of VEL’s diluted equity capital.

Adjusting for the value of these holdings, VEL trades at a P/E of 8.6x its FY08E earnings. VEL also has other investments in real estate and unquoted equities at a book cost of Rs55.6mn during FY06. These investments act as a cushion to any downside to the stock.

Recommendation The share of roads is the highest in the total infrastructure development spend and accounted for 32.3% and 8.4% of the total spend in the infrastructure vertical and total infrastructure development respectively during FY03-05. The spend on roads is expected to witness a CAGR of 10.8% between FY06-08.

The road segment is the driving force for VEL as well accounting for 77% of its order book. While margins will continue to remain depressed, no shortage is expected in work in this vertical. VEL is confident of maintaining its margins at current levels and achieve healthy profits through topline growth. VEL has a respectable track record and a healthy order book position with plans to enter new verticals as also road BOT projects.

Valuations are the most striking feature of the VEL stock, with limited downside risk on account of its investment portfolio and trading at its book value. We recommend a BUY with a one year price target of Rs294 based on our sum of parts valuation, representing an upside of 41.1% from current levels. At our target price, the stock would trade at a P/E of 12.8x FY08E earnings.

Sum of parts valuation (Rs mn) Methodology EBIDTA (FY08E) 268 EV/EBIDTA (x) 8 Target multiple Enterprise value 2,142 Net debt (Debt-cash) FY08E (39) Market capitalization 2,181 Investments in Jyoti Structures 122 50% dicount to market price Total equity value 2,303 Diluted equity capital 85 Value per share (Rs) 294 CMP (Rs) 208 % upside 41.1

October 18, 2006 Construction Sector 130 India Under ‘Construction’

Growth matrix yoy (%) FY04 FY05 FY06 FY07E FY08E Net Sales 91.6 24.2 4.0 49.6 65.6 EBIDTA 32.9 5.6 17.3 46.3 65.6 Net profit 25.5 22.2 329.7 (64.6) 77.8 Net Worth 12.9 14.9 256.8 33.4 8.5 Gross Block 14.8 7.7 25.5 38.3 16.6 Net Working Capital (16.4) 34.1 409.9 13.3 3.9 Capital employed 9.5 12.4 123.4 25.5 7.3 Source: India Infoline Research Concerns

Small Size Although, the company has raised resources to ramp up its networth to qualify for bigger projects, the size of the company is still small when compared to the likes of L&T, Gammon India, Hindustan Construction, Nagarjuna Construction and IVRCL. This may prove to be a deterrent in winning large sized projects.

Primarily into roads VEL derives close to 60-70% of its revenues from activities in road construction. The competition in this segment is high and restricts any scope for margin expansion. Unless the company diversifies into other verticals with better margins, any OPM expansion is ruled out.

October 18, 2006 Construction Sector 131 India Under ‘Construction’

Company background

VEL is a mid-sized construction company, based in Mumbai, Maharashtra. It was established in 1957 as a partnership firm in the name of Gopaldas Vasudev Valecha’s client profile & Company before changing the name to VEL in 1993 on becoming a public limited company. The company is presently led by Mr. J.K. Valecha. (%) Maharashtra 16.0 Assam 19.0 VEL is an ISO 9001:2000 certified company primarily engaged in the construction MP 21.0 of roads, bridges and fly-overs. Till date, it has completed over Rs4bn worth of J&K 10.0 road projects in various parts of India. The company is also engaged in the Haryana 9.0 construction of irrigation dams, power, railways, airports, reservoirs and piling. Rajasthan 8.0 Its employee strength stands at close to 200 people with 60-70% comprising Mizoram 7.0 of engineers operating in a number of states across the country. Others 10.0 Source: Company data Its major clientele includes NHAI, Maharashtra State Road Development Corporation (MSRDC), MMRDA, Konkan Railway Corporation, National Thermal Power Corporation, PWD and MCGM.

State-wise distribution of order book

Others MP Mizoram 10% 7% 21% Rajasthan 8%

Haryana Assam 9% 19% J&K Maharashtra 10% 16%

Source: Company

Mr. Jagdish K. Valecha, Managing Director of VEL, is 47 years old and has done his graduation in commerce. He started his career by working in various departments in the company to gain hands on experience in every aspect of the business. Today, he heads VEL and has over 22 years of experience in the construction sector. He was instrumental in providing a strategic vision and direction to the company. VEL operations in the past were restrained to the state of Maharashtra before Mr. J.K. Valecha undertook works for the company in various parts of the country and abroad. The company also associated itself with a number of joint ventures to execute projects under his leadership.

October 18, 2006 Construction Sector 132 India Under ‘Construction’

Last five quarterly financials (Standalone) (Rs mn) Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07 Net sales 356 249 407 501 522 Operating expenditure (321) (229) (377) (476) (482) Operating profit 35 20 30 25 39 Other income 8 9 8 209 8 Interest (6) (7) (5) (2) (5) Depreciation (7) (7) (7) (8) (9) PBT 30 15 26 224 34 Tax (9) (6) (8) (5) (10) APAT 22 10 18 24 24 Equity 45 45 45 69 69

VEL’s OPM trend (Standalone)

12.0 9.8 10.0 8.1 8.0 8.0 7.3 7.5 7.5

6.0 5.4 5.2 5.0 (%) 4.0

2.0

- Q1 FY05 Q2 FY05 Q3 FY05 Q4 FY05 Q1 FY06 Q2 FY06 Q3 FY06 Q4 FY06 Q1 FY07

Source: Company data

October 18, 2006 Construction Sector 133 India Under ‘Construction’

Financials

Income Statement (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Net Sales 1,171 1,455 1,514 2,265 3,750 Operating expenses (1,082) (1,361) (1,403) (2,103) (3,482) EBIDTA 89 94 111 162 268 Depreciation (21) (24) (29) (39) (46) EBIT 69 70 82 122 222 Interest (25) (23) (20) (22) (21) Other Income 31 44 17 35 40 Profit before tax (PBT) 75 92 79 135 241 Tax (24) (29) (27) (41) (72) Profit after tax (PAT) 51 62 52 95 169 Extraordinary / prior period items - - 216 - - Adjusted profit after tax (APAT) 51 62 268 95 169

Balance Sheet (Standalone) Period to FY04 FY05 FY06 FY07E FY08E (Rs mn) (12) (12) (12) (12) (12) Sources Equity Capital 45 45 69 85 85 Reserves 243 286 1,110 1,487 1,622 Net Worth 288 331 1,179 1,573 1,707 Loan Funds 325 356 461 473 432 Def Tax liability 71 83 78 111 176 Total 684 769 1,718 2,157 2,315

Uses Gross Block 483 521 653 903 1,053 Accd Depreciation (99) (113) (140) (179) (225) Net Block 384 408 513 724 828 Capital WIP 48 45 2 12 16 Total Fixed Assets 433 452 515 736 844 Investments 88 97 82 150 150 Total Current Assets 476 460 1,562 1,924 2,342 Total Current Liabilities (312) (240) (440) (653) (1,021) Net Working Capital 164 220 1,122 1,272 1,321 Total 684 769 1,718 2,157 2,315

October 18, 2006 Construction Sector 134 India Under ‘Construction’

Cash flow statement Year to (Rs mn) FY05 FY06 FY07E FY08E Net profit before tax and extraordinary items 92 79 135 241 Depreciation 24 29 39 46 Interest expense 23 20 22 21 Operating profit before working capital changes 139 128 197 308 Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (52) (287) (183) (226) (Inc)/dec in inventories 6 (6) (25) (41) Inc/(dec) in sundry creditors (49) 192 208 359 Inc/(dec) in other current liabilities (23) 8 4 10 Net change in working capital (118) (93) 5 101

Cash flows from operating activities 21 34 201 409 Less: Income tax (29) (27) (41) (72) Inc/Dec in Def Tax Asset/liability 11 (4) 33 65 Net cash from operating activities 2 3 193 402 Extraordinary inc/(exp) - 216 - - Cash Profit 2 219 193 402

Cash flows from investing activities (Inc)/Dec in fixed assets (44) (91) (260) (154) (Inc)/Dec in Investments (9) 15 (68) - Net cash from investing activities (53) (76) (329) (154)

Cash flows from financing activities Inc/(Dec) in debt 31 105 12 (41) Inc/(Dec) in equity/premium - 24 16 - Direct add/(red) to reserves (4) 580 308 0 Interest expense (23) (20) (22) (21) Dividends (15) (24) (26) (34) (inc)/dec in loans & advances 38 (374) (64) (62) Net cash used in financing activities 26 292 225 (159)

Net increase in cash and cash equivalents (24) 435 90 89 Cash at start of the year 90 65 500 590 Cash at end of the year 65 500 589 679

October 18, 2006 Construction Sector 135 India Under ‘Construction’

Ratios FY04 FY05 FY06 FY07E FY08E (12) (12) (12) (12) (12) Per share ratios EPS (Rs) 11.3 13.9 7.5 11.1 19.7 Cash EPS (Rs) 15.9 19.2 11.6 15.7 25.1 Div per share (Rs) 3.0 3.0 3.0 3.0 4.0 Book value per share (Rs) 63.9 73.5 170.3 184.0 199.7 FV per share (Rs) 10.0 10.0 10.0 10.0 10.0

Valuation ratios P/E (x) 18.3 15.0 27.7 18.7 10.5 P/CEPS (x) 13.0 10.8 17.8 13.2 8.3 P/BV (x) 3.2 2.8 1.2 1.1 1.0 Dividend yield (%) 1.4 1.4 1.4 1.4 1.9 EV/sales (x) 1.0 0.8 0.9 0.7 0.4 EV/ EBIT (x) 17.0 17.4 17.1 13.5 6.9 EV/EBIDTA (x) 13.1 13.0 12.6 10.2 5.7 Order book/Sales (x) 7.0 5.7 5.5 3.6 2.2

Profitability ratios OPM (%) 7.6 6.5 7.3 7.1 7.1 EBIT margin (%) 5.9 4.8 5.4 5.4 5.9 PBT margin (%) 6.4 6.3 5.2 6.0 6.4 Net profit margin (%) 4.4 4.3 3.4 4.2 4.5 Cash profit margin (%) 6.1 5.9 5.3 5.9 5.7 ROCE (%) 14.6 14.9 5.8 7.3 11.3 RONW (%) 17.8 18.9 4.4 6.0 9.9

Liquidity ratios Current ratio (x) 1.5 1.9 3.5 2.9 2.3 Debtors days 38.6 44.1 111.7 104.1 84.9 Inventory days 12.7 8.8 10.0 10.7 10.5 Creditors days 85.3 56.4 100.5 100.7 95.8

Turnover ratios Asset turnover (x) 1.7 1.9 0.9 1.1 1.6 Fixed Asset turnover (x) 3.0 3.6 3.0 3.1 4.5

Leverage ratios Debt / Total equity (x) 1.1 1.1 0.4 0.3 0.3

Component ratios Construction expenses (%) 88.8 90.2 88.8 89.0 89.0 Staff cost (%) 1.7 1.6 1.9 1.9 1.9 Other expenditure (%) 1.9 1.7 2.0 2.0 1.9

October 18, 2006 Construction Sector 136 India Under ‘Construction’

Annexures

Industry overview The construction sector in India has been growing at 12-15% pa and its present industry size is estimated at Rs4,000bn pa. Close to 96% of construction companies are small and medium enterprises. The main entities in the sector are construction contractors, material and equipment suppliers and solution providers. The sector is the second largest provider of employment after agriculture in India and employs around 18mn people, up from close to 11.5mn in 1993-94. It registered the highest rate of growth in employment generation in the past two decades, doubling its share in total employment. The construction sector is estimated to witness a CAGR of 10% between 2006-2020. The construction industry internationally is estimated at US$3.4tn, whereas India’s share is projected at a meager US$0.5bn.

Break-up of construction costs (%) Materials Construction Labor Finance Enabling Admin Surplus equipment expenses expenses Building 58-60 4.5 11-13 7-8 5.5-6.5 3.5-4.5 5-6 Roads 42-45 21-23 10-12 7-8 5.5-6.5 3.5-4.5 5-6 Bridges 46-48 16-18 11-13 7-8 5.5-6.5 3.5-4.5 5-6 Dams 42-46 21-23 10-12 7-8 5.5-6.5 3.5-4.5 5-6 Power 41-43 21-24 10-12 7-8 5.5-6.5 3.5-4.5 5-6 Railway 51-53 6-8 16-18 7-8 5.5-6.5 3.5-4.5 5-6 Mineral plant 41-44 20-22 12-14 7-8 5.5-6.5 3.5-4.5 5-6 Medium industry 50-52 7-9 16-18 7-8 5.5-6.5 3.5-4.5 5-6 Transmission 49-51 5-7 19-21 7-8 5.5-6.5 3.5-4.5 5-6 Source: Construction Industry Development Council Survey

Characteristics of the industry

Cyclical/ delayed revenue recognition Investments in the construction industry undergo cycles; spurt in investments for some years and a slowdown in the next few years. This is especially true in case of industrial construction, where the construction activity is dependent of capex spend by manufacturing companies. Even within verticals, revenue inflow might be realized in the later part of a project. In case of hydropower projects, for instance, the gestation period is around four years. Revenues during the initial few months are low and pick up in the second and third year. In real estate, revenue recognition can be considerably delayed depending on the accounting policy followed by the company.

Highly fragmented in nature The sector is highly fragmented in nature with numerous players operating both, in the organized as well as the unorganized sector. The low fixed capital requirement in some verticals like roads has led to a plethora of players in this space. Reportedly in the year 2004, there were 3mn construction entities in India, of which only around 28,000 odd were registered. The industrial and infrastructure space is relatively less populated due to the technical expertise required as against real estate, where 75% of the housing segment is filled with unorganized players. These players construct one-off bungalows or buildings and are not sizeable players.

Delayed payments, order lumpiness The construction sector is working capital intensive on account of the long gestation period of projects. The government being a major client, results in delayed payments (especially from state governments), further increasing the need for working capital. Work done needs to be certified by consultants, which causes a lag in receipt of payments. Order lumpiness is another feature in this industry as there could be periods during which no contracts are awarded and other periods when excess work is available.

October 18, 2006 Construction Sector 137 India Under ‘Construction’

Types of contracts

Item rate contracts Item rate contracts, also known as schedule or unit price contracts, require contractors to quote rates for individual items of work on the basis of the schedule of bill of quantities (BOQ) as per the client’s classification, design and drawings.

Percentage rate contracts In this contract, the client provides the percentage of costs to be incurred in the project as per its design, drawings and specifications. The contractor is required to quote higher or lower percentages as compared to the estimates mentioned in the contract.

Front end engineering and design Front end engineering and design (FEED), as the name suggests, is carried out before floating the tender for construction work. Companies provide FEED data to the project owner, generally as part of consultancy work, to enable them to take a decision on the layout of the project. FEED services are also a pre-requisite, in this case, to bid for EPC contracts.

Lumpsum turnkey/ EPC In lumpsum turnkey (LSTK) or EPC contracts, a fixed sum, ie cost plus profits, for execution of the complete project is quoted by the contractor. The drawing and design and other specifications are approved by the client and covered under the sum agreed upon. The department will provide the tentative quantities involved and any increase or decrease in the same, will have to be borne by the contractor.

Operation and maintenance Operation and maintenance (O&M) contracts, as the name suggests, are for operation and maintenance of the capital facilities. The routine maintenance to be carried out at pre-determined intervals is specified before hand at quoted rates and any breakdown maintenance is compensated on a cost plus basis.

Build-Operate-Transfer The BOT format is a type of contract where the private players finance, build, operate and maintain a particular project for a pre-determined number of years, known as the concession period, and then transfer the project back to the government. In a toll based project, the contractor collects user charges (toll) from the users to compensate for the investment in the project and earn their profits. The contractor also benefits from other sources of revenues like advertising billboards. In an annuity format, the government pays a fixed annuity to the contractor semi-annually for a fixed number of years. There are variations like Build-Transfer-Lease-Operate and Rehabilitate-Operate-Transfer, however annuity and toll are the most popular formats. The government may also give or demand for grants depending on the project type.

Characteristics of BOTs vis-à-vis conventional cash contracts

Cash contracting BOT Less capital intensive Highly capital intensive Volume driven Value driven Lower margins Higher margins Average contract period: 3-4 years Average contract period: 20 years

October 18, 2006 Construction Sector 138 India Under ‘Construction’

Tendering process for contracts

Project identification

Two months

Qualification and bid submission request Two months

Technical qualification assessment

One month

Proposal and submission request One month

Proposal evaluation

One month

Call for bids

One month

Declaration of L1

Letter of acceptance One month

Bank guarantee given by contractor

Signing of contract

Notice to proceed Six to nine months from client

Execution of contract

Source: India Infoline Research

October 18, 2006 Construction Sector 139 India Under ‘Construction’

Segmental Overview

Infrastructure investments - Roads - Power - Water and irrigation - Railways - Airports - Ports

Industrial investments - Oil and gas - Pipelines - Metals

Real estate investments

October 18, 2006 Construction Sector 140 India Under ‘Construction’

Roads

India has the second largest road network in the world with a total length of approximately 3.3mn kms. However, this network is insufficient and lacks quality when compared to the high use on account of passenger and freight traffic. While national highways carry nearly 40% of the total traffic, they account for less than 2% of the total network. Even more intriguing is the fact that only 2- 3% of the primary network is four-laned. With 15% of the primary network being single-laned, there are severe capacity constraints and sluggishness in mobility.

Length of the Indian road network (Kms) National Highways 65,569 State Highways 131,899 Major district roads 467,763 Village and other roads 2,650,000 Total 3,315,231 Source: National Highway Authority of India

State highways form merely 4% of the total network. The major district roads account for 14.1% of the total network whereas villages and other roads form the majority share of 79.9% of the network.

Need for development of roads Roads account for 85% of Roads in India account for 85% of the total passenger traffic and 70% of the total passenger traffic in India total freight movement. Industrialization has resulted in a traffic growth of 8- 12% per year on many sections of the national highways. Improvement in the Costs higher by 20% due to network will result in savings on the use of vehicles (including fuel and poor quality maintenance), the cost of which is 20% higher currently, due to poor roads conditions. A well-connected road network becomes imperative to sustain the strong economic growth of the country.

Poor road network and connectivity Out of the total national The road network in the country and the connectivity between major states, highways, only 12% are four cities and other important places is lacking. Out of the total national highways or more laned in the country, only 12% are four or more laned, 56% are two-laned and 32% are single-laned. India’s spend on road development is 1/10th compared to China, who spends US$25bn pa since the mid 1990s. Low service and slow speed are among the other issues with Indian roads. Barring a few quality stretches, the average speed on Indian roads is less than 50kms/hour. Further, a large number of traffic deaths are attributed to poor and choked roads in the country.

Rising vehicle population With a rising vehicle population, both commercial vehicles and passenger cars, the burden on the existing network is growing. India has one of the lowest penetration in automobiles, which is only set to rise in future. With demand for two-wheelers and three-wheelers on the rise as well, the urgency in development of roads cannot be overstated.

Rising tourism in the country Foreign tourist arrivals grew The growth in tourism in India will continue to increase the road passenger by 13.5% yoy during January traffic. Tourist inflows for business as well as leisure is on the rise. Several 2006 to August 2006 initiatives have been taken by the government to promote tourism in India like increase in the budgetary allocation for the same. The tourism industry registered a growth rate of 13.5% yoy in foreign tourist arrivals during January 2006 to August 2006 as per provisional figures.

October 18, 2006 Construction Sector 141 India Under ‘Construction’

The government realized that a well-developed highway network has many advantages: Ö Reduced operating costs of vehicles Ö Faster, safer and comfortable travel Ö Savings on fuel consumption Ö Trade benefits, especially in movement of perishable items Ö Lower maintenance costs

To give a boost to the development of national highways, a National Highways Authority of India (NHAI) was formed to implement important projects. The onus of developing national highways lies with the central government authorities while all other roads are the responsibility of the concerned state governments and the local state bodies.

National Highways Authority of India NHAI was constituted by an Act of Parliament in 1988 with the mandate for the time and cost bound development, maintenance and management of the national highways. The authority was operationalized in February 1995 with the appointment of a full time Chairman and other members.

National Highway Development Programme (NHDP) The central government initiated the NHDP in the year 2000 in an effort to improve the highway infrastructure with NHAI being the implementing authority. Two key programmes were highlighted for completion, which are now known as phase-I and phase-II. Later, another five programmes were added to the list for upgrading about 45,000kms of national highways and other road networks.

Summary of the NHDP programme Project Details (Kms) Phase-I Golden Quadrilateral (GQ) connecting four metro cities 5,846 Phase-II North-South-East-West (NSEW) corridor connecting four extreme points of India 7,300 Phase-III Upgrade national highways to 4/6-lanes on BOT basis 10,000 Phase-IV Converting single-laned highways not part of phase-I, II, III into 2-laned with paved shoulders 21,000 Phase-V 6-lanning of 4-laned highways 5,000 Phase-VI Connecting expressways that would connect major commercial and industrial towns on BOT 1,000 Phase-VII Building ring roads, flyovers and bypasses on BOT basis - Source: National Highway Authority of India, Industry Status of NHDP NHDP Total GQ NSEW NHDP NHDP Port Others by phase I&II phase IIIA Total connectivity NHAI Total length (Kms) 5,846 7,300 4,015 17,161 380 945 18,486 Already 4-laned (Kms) 5,415 836 30 6,281 111 287 6,679 Under implementation (Kms) 431 5,057 1,090 6,578 248 638 7,464 Contracts under implementation (No.) 36 137 17 190 8 16 214 Balance length for award (Kms) - 1,306 2,889 4,195 21 20 4,236 Source: National Highway Authority of India

October 18, 2006 Construction Sector 142 India Under ‘Construction’

Port connectivity and other projects The 10 major ports in the country are to be connected to the GQ by widening 380kms of roads. Another 945kms are to be widened too, as part of other road projects. Another initiative taken by the government, not forming part of the NHDP, was the Pradhan Mantri Gram Sadak Yojana (PMGSY).

Pradhan Mantri Gram Sadak Yojana PMGSY estimated to cost PMGSY launched in December 2000, as a 100% centrally sponsored scheme, it Rs1320bn aims at providing connectivity to 172,000 rural roads and villages with a population of 500 persons or more by the end of the 10th five year plan (2007). The project is estimated to cost Rs1,320bn, to be funded by a diesel cess in the central road fund and borrowing from financial institutions and multilateral funding agencies.

Status of PMGSY

Total value of proposals cleared (Rs bn) 184.8 Amount released (Rs bn) 124.6 No. of road works cleared 39,589.0 No. of road works completed 27,112.0 % expenditure 83.0 % of road works completed 68.0 Expenditure incurred (Rs bn) 103.3

Source: Indian Infrastructure As of June 2005

Private sector participation Private sector partnership in roads has been necessary due to the deficiency of financial resources by the central government and states. In order to promote involvement in the construction and maintenance of roads, the government offered projects on BOT basis, where a particular stretch is operated by the private sector player for 20-30 years and toll is collected. Other variations like annuity and grants have also been given to induce participation.

Private sector participation under NHDP Length (Kms) No. Cost (Rs bn) BOT (toll) 1,968.9 37 124.0 BOT (Annuity) 695.0 11 38.6 SPV 405.0 12 23.8 Total 3,068.9 60 186.4 Source: Indian Infrastructure As of January 2006

Funding Besides its own generation, the government introduced cess on fuel that provided impetus to improvement and expansion of the road network.

Financing mix for NHDP phase-I&II Sources (Rs bn) Cess on petrol and diesel 200 External assistance 200 Market borrowings 100 Private sector participation 40 Total 540 Source: National Highway Authority of India At 1999 prices October 18, 2006 Construction Sector 143 India Under ‘Construction’

NHAI existing and proposed spending

2,000 1,871 1,800 1,600 1,400 1,200 1,000 781

(Rs bn) 800 540 550 600 400 200 - Phase I&II Phase III Phase IV to Total VII

Source: National Highway Authority of India, India Infoline Research

Construction beneficiaries Ö Larsen and Toubro Ö Gammon India Ö Hindustan Construction Ö Nagarjuna Construction

October 18, 2006 Construction Sector 144 India Under ‘Construction’

Power

Generation scenario The power generation business is mainly carried out by players viz NTPC, NHPC, Supply unable to match Reliance Energy, Tata Power, NPCIL, Torrent Power and CESC along with a number demand of companies with captive power plants that supply their surplus power to the grid. India’s generating capacity witnessed a CAGR of 8.1% over 1947-2006 and is currently placed at 126,839MW, making it the fifth largest power market in the world. Despite this, the country is grappling with 12,274MW of peak demand shortage and 19,471mn units of energy shortage due to high T&D losses, which often disguise large-scale theft, low billing and collection efficiency.

Total generating capacity Fuel Capacity (MW) % of total CAGR (%) 1971-2006 Thermal 83,772 66.0 7.0 -Coal 68,988 54.4 6.5 -Gas 13,582 10.7 13.4 -Oil 1,202 0.9 4.8 Hydro 32,976 26.0 4.8 Nuclear 3,900 3.1 6.6 Renewable 6,191 4.9 - Total 126,839 100.0 6.3 Source: Ministry of Power As on 31st July 2006

Power supply position as on 31st July 2006 Demand Met Surplus/ (Deficit) (%) Energy (MU) 222,936 203,465 (8.7) Peak Demand (MW) 95,583 83,309 (12.8) Source: Ministry of Power MU = Million Units, MW = Megawatts

“Power for all by 2012” The government is planning an investment of about Rs3tn for enhancing the generating capacity to just over 200,000MW by 2012 under this mission. The Target to add 100,000MW Ministry of Power, Central Electricity Authority (CEA) and Power Finance over 10th and 11th plans Corporation (PFC) are working together for adding about 100,000MW over the 10th and 11th five year plans.

Plan-wise break up of capacity addition (MW) 10th Plan Commissioned* Under execution 11 th Plan (revised) Total central sector 17,225** 8,325 8,900 36,785 Total state sector 11,901 4,071 7,830 10,600 Total private sector 4,899 1,379 3,519 13,500 Overall capacity addition 34,024 13,775 20,249 60,885 Source: Ministry of Power *During 11 th plan **Includes 2,520MW nuclear projects under construction

October 18, 2006 Construction Sector 145 India Under ‘Construction’

Ultra Mega Power Projects 7 mega power projects of The government intends to set up seven mega power plants of 4,000MW each. 4,000MW each to be set up All these projects will be under tariff based competitive bidding route and will operate on Build-Own-Operate-Maintain (BOOM) basis. In the first phase, two projects at coal pit heads and three at coastal locations have been identified. Government approval for five projects shown in the table below, have already been received.

Ultra Mega Power Projects Project Location Allocation MW Rs bn Coastal Maharashtra Ultra Power Maharashtra Rajasthan, MP, Chattisgarh, Maharashtra Project Co and Karnataka 4,000 150

Coastal Karnataka Power Ltd Karnataka Rajasthan, TN, Kerala, Maharashtra, Karnataka 4,000 150

Coastal Gujarat Power Ltd Gujarat UP, Punjab, Rajasthan, Haryana, Gujarat and Maharashtra 4,000 150

Sasan Power Ltd MP UP, Uttaranchal, Delhi, Punjab, Rajasthan, Haryana, MP, Chattisgarh 4,000 150 Source: Cris Infac There are two new ultra mega power projects announced, one each in Orissa and AP, taking the total investment in the projects to about Rs1.1tn. These projects are funded by Asian Development Bank and PFC has evinced interest in funding one of them. Recently, Tamil Nadu has evinced interest in setting up a mega power plant.

Focus on hydro projects The government is also planning to enhance contribution to total power from hydro projects as they are cost efficient. India plans to rectify the thermal:hydro mix in line with the global standards of 60:40.

Hydro:Thermal Mix Hydel Potential - Global Scenario

0 0 2 2 3 350,000 70 100 310,000 300,000 58 60 35 29 27 80 46 41 250,000 50 200,000 41 40 60 160,000 150,000 (%) (MW) 150,000 31 30 (%) 40 18 69 70 100,000 65,678 52,427 17 20 65 47,000 56,000 54 57 50,000 27,360 17,000 23,488 10 20 - 0 0 NorwayCanada Brazil China India I plan II plan 5 plan 7 plan Presently Exploitable Potential (LHS) Installed Capacity (LHS) Thermal Hydro Nuclear % of potential Utilised (RHS)

Source: Ministry of Power Source: Ministry of Power

Primary Feasibility Reports of 162 identified hydro electric schemes with an aggregate installed capacity of 47,930 MW located in 16 states of the country have been prepared.

October 18, 2006 Construction Sector 146 India Under ‘Construction’

Construction beneficiaries Ö Larsen and Toubro Ö Gammon India Ö Hindustan Construction Ö Jaiprakash Associates Ö Patel Engineering Ö Simplex Infrastructures

Transmission and distribution (T&D) T&D development critical in The T&D system in the country is a three tier structure comprising distribution network, formation of National Grid state grids and regional grids. The major players in the transmission and distribution (T&D) segment are KEC International, Jyoti Structures, Kalpataru Power Transmission and RPG Transmission.

As most of the power generating units are located near the source of raw materials, it is necessary to have a strong T&D system in place to help transfer power from generation sites to load centers, thereby strengthening and creating the National Grid. The government had not focused on developing the T&D segment earlier, which resulted in concentration of power in certain regions. This brought about a shift in the government’s strategy from generation evacuation planning system to an integrated planning system.

Transmission lines under 10th and 11th plan

25,000

20,000

15,000

cKm 10,000

5,000

- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- 2010- 03 04 05 06 07 08 09 10 11

Source: Company ckm = Circuit kilometers

The country’s transmission plan focuses on adding over 60,000ckm of transmission Focus on adding over 60,000ckm of transmission line by 2012. Such an integrated grid shall enable the evacuation of the additional lines by 2012 100,000MW and carry about 60% of the power generated in the country. The existing inter-regional power transfer capacity stands at 9,000MW, which will now be enhanced to 37,150MW by 2012 through creation of “Transmission Super Highways”. This will require an investment of Rs705bn of which, Powergrid will invest 70% and remaining 30% will be contributed by the private sector.

Investment plan (Rs bn) 10th plan 11 th plan Total Powergrid’s outlay 213.7 282.6 496.3 Private sector participation 97.1 111.9 209.0 Total central sector 310.8 394.4 705.2 Source: Ministry of Power

October 18, 2006 Construction Sector 147 India Under ‘Construction’

Details of transmission lines and sub-stations

Existing Under construction Region Transmission lines (ckm) Sub-stations Transmission lines (ckm) Sub-stations HVDC 400KV 220KV 132KV (MVA) 800KV 400KV 220KV 132KV MVA Northern Region 817 7,952 3,248 - 6,620 920 1,607 975 - 2,520 Western Region - 8,113 852 - 1,575 - 222 - - 630 Southern Region - 5,634 220 - 5,355 - - 147 - - Eastern Region - 3,722 952 333 7,035 - - - 95 - N. E. Region - 2,311 491 1,145 1,126 - 333 18 658 - Total All India 817 27,732 5,763 1,478 21,711 920 2,162 1,140 753 3,150 Source: Ministry of Power KV – Kilo volt, HVDC – High voltage direct current, MVA – Mega volt ampere, ckm - circuit kilometres

APDRP and RGGVY The government approved the Accelerated Power Development and Reform Programme (APDRP), focusing on distribution reforms with the objective of reducing aggregate technical and commercial losses to bring about commercial viability in the sector, reduce outages and interruptions and increase consumer States with substantial number of satisfaction. The programme has an outlay of Rs400bn as additional central villages to be electrified assistance to state governments during the 10th five year plan. State Number (%) of villages In April 2005, the government introduced the Rajiv Gandhi Grameen to be Vidhyutikaran Yojana (RGGVY) for developing rural electricity infrastructure and electrified household electrification. Twenty-seven states have signed the MoU to Uttar Pradesh 40,389 42.0 implement the RGGVY under which, electrification of 10,000 villages have been Bihar 20,449 53.0 targeted for FY07 and 40,000 to be electrified thereafter. There are 119,570 West Bengal 7,694 20.0 villages covered under this scheme spanning across 780mn households. The Uttaranchal 2,785 18.0 scheme would be implemented through the Rural Electrification Corporation Jharkhand 22,920 78.0 (REC). Orissa 9,682 21.0 Assam 5,640 23.0 Total investment planned Meghalaya 2,754 50.0 Source: Ministry of Power Sector 10 th Plan 11 th Plan (Rs bn) Central State Private Total Central State Private Total sector sector sector sector sector sector Generation 1,563 560 355 2,478 1,664 640 750 3,054 Transmission 214 260 97 571 283 300 112 695 Distribution - 450 - 450 - 500 - 500 Rural Electrification - 399 - 399 - 600 - 600 Repairs and maintenance - 100 - 100 - 150 - 150 Total funds required 1,777 1,769 452 3,998 1,946 2,190 862 4,998 Source: Ministry of Power

Construction beneficiaries Ö IVRCL Infrastructures Ö Nagarjuna Construction

October 18, 2006 Construction Sector 148 India Under ‘Construction’

Water and irrigation

Need to preserve water resources Requirement for water resources for human consumption is constantly on the rise with the growing population, rapid urbanization and improved standard of India accounts for 16% of the living. While India accounts for 16% of the world’s population, it holds only 4% world’s population but holds only 4% of the world’s fresh of the world’s fresh water resources. Most of its fresh water needs are met th water resources. through rainfall, 3/4 of which occurs between June and September each year on account of southwest monsoon.

Mere 17% of the average annual precipitation available for utilization

Average annual precipitation 4,000BCM

Loses due to infiltration and evaporation

Average annual flow out 1,869BCM

Loses due to topographical and other constraints

Available to be utilised 690BCM

Source: Industry BCM - Billion cubic metres

Irrigation comprises 84% of the total water use. However, with a growing population, the per capita availability of water is declining. The same stands at 2,000 cubic metres pa presently from 5,000 cubic metres at the time of independence. Urbanization and industrialization too, result in high water needs. The fact that each day’s requirement is not fully being met is raising concerns over the quality of ground and surface water. No major Indian city has access to 24-hour water supply every day.

Average water availability comparisons

24.0 22.0 20.0 18.0 16.0 14.0 12.0

(Hrs per day) 10.0 8.0 6.0 4.0 India Asia-Pacific Bangkok Beijing

Source: 10th five year plan, India Infoline Research

October 18, 2006 Construction Sector 149 India Under ‘Construction’

Investment issues Raising institutional finance was an issue as companies like HUDCO financed water projects against state guarantees. However, the financial position of most state governments to meet their share of the project cost, willingness and capacity to provide guarantees for institutional finance was lacking.

However, things are changing for the better for this sector. The financial situation of certain states is improving and the awareness about the need to invest in this vertical has come about. With the budget too, assigning priority to Initiatives taken by states like investments in this segment, many state governments like AP, Gujarat, AP, Gujarat, Rajasthan to improve water supply and Rajasthan, Karnataka and UP have taken initiatives to improve the water supply irrigation facilities and irrigation facilities in their respective states. A number of projects have been started in various metros to alleviate the water supply situation with most projects focusing on pumping in water from distant sources.

Investments in water supply and sanitation Water supply projects are mainly for industrial and residential entities and are therefore, city specific. The 10th plan period draws attention to the requirement for building additional infrastructure amenities to increase the access to water supply facilities and sewage and sanitation facilities for the urban population. The following chart displays the actual urban population covered and the target for the 10th plan.

Water supply and sanitation access to India’s urban population

100 100 89 90 80 75 70 63 60 50 (%) 40 30 20 10 0 2004-05 Target at end of 10th plan period Access to water supply Access to sanitation facilities

Source: Economic Survey 2004-05, India Infoline Research

The Central Public Health and Environmental Engineering Organisation (CPHEEO) has estimated that the urban population in the country is expected to be 363mn by end of the year 2007. To achieve the targeted figure given in the chart above, the investments that need to be made during this period are given below.

Investments needed to achieve segmental targets in urban areas Segment Funds (Rs bn) Water supply 282.4 Sanitation 231.6 Solid waste management 23.2 Total 537.2 Source: 10th five year plan

October 18, 2006 Construction Sector 150 India Under ‘Construction’

Targets for government’s Millennium Development Goals Ö 100% access to drinking water in rural areas by the year 2012. The corresponding indicator for basic water is proposed to be increased to 53% from 20% in the year 2001. Meeting this target in rural areas is estimated to entail an investment of Rs370bn and Rs330bn in the 11th and 12th plan respectively.

Ö Piped water supply to be increased to 86.5% of the population in urban areas by the end of the 12th plan (year 2014-2017) from 74% in 2001. Preliminary estimates suggest that the investment required for meeting the target will be Rs425bn during the 11th plan (year 2008-2013) and Rs500bn during the 12th plan.

Current schemes under the water supply sector are as under: Ö Rajiv Gandhi Drinking Water Mission, aiming to provide drinking water to 75,000 homes.

Ö Accelerated Rural Water Supply Programme (ARWSP), focusing on renewal of water sources and serving uncovered and partially covered homes.

Ö Urban Water Supply Programme, targeting 2,151 towns.

Irrigation initiatives The uncertainty and uneven distribution of rainfall restricts tapping the complete potential of agriculture in the country. Realizing this fact, the government has initiated major schemes to ensure adequate supply of water for irrigation and other purposes.

Accelerated Irrigation Benefit Programme The programme identified Introduced in the year 1996-97, the scheme has identified 178 projects to be 178 projects with a target of implemented over the next few years. The outlay under this scheme in FY07 is 600,000 hectares for irrigation Rs71.2bn, a 58% yoy increase over FY06. A target of 600,000 hectares for irrigation is envisaged under this scheme.

Restoration of water bodies 500,000 natural and man- It is estimated that out of the millions of natural and man-made structures like made structures need urgent lakes and ponds in India, about 500,000 need urgent repairs post which, they repairs can be effectively used for irrigation purposes.

A process has been initiated for repairs, renovation and impounding of new reservoirs and a pilot project in 13 states within 23 districts is being implemented, in consultation with states. Phase-I has identified 20,000 water bodies with an area of 1.47mn hectares at an estimated cost of Rs44.8bn to be funded through multilateral agencies.

AP alone is expected to spend We expect irrigation and water supply investments, primarily by state Rs460bn in water and government allocations, to be a major contributor to total infrastructure irrigation in the next 5 years. investment over the next three years. Many states have taken initiatives in this regard. The state of AP alone is expected to spend Rs460bn in water and irrigation over the next five years.

October 18, 2006 Construction Sector 151 India Under ‘Construction’

The increasing urbanization in the country will lead to increased demand for water supply and sewage services, creating ongoing opportunities for construction companies in this segment.

Plan expenditure by different states in irrigation

60

50

40

30

(Rs bn) 20

10

0 03-04 plan 04-05 plan 05-06 plan Punjab Tamil Nadu Chhattisgarh Bihar Rajasthan Gujarat MP UP Karnataka AP

Source: Reserve Bank of India

Construction beneficiaries Ö IVRCL Infrastructures Ö Nagarjuna Construction Ö Jaiprakash Associates Ö Patel Engineering Ö Larsen and Toubro Ö Hindustan Construction Ö Gammon India

October 18, 2006 Construction Sector 152 India Under ‘Construction’

Railways

Indian Railways (IR) has the largest rail network in Asia the second largest rail network under one management in the world. The IR is a multi-gauge, multi- traction system with a network that spans 63,000kms of which, 70% is broad- gauge, carrying 14mn passengers and 1.5MT of freight daily. It operates more than 9,000 passenger trains and over 5,000 freight trains on a daily basis. For years, the IR has been plagued by poor infrastructure. Today, the government and IR have realized the importance of developing a strong rail network in the country. We first look at the issues that weighed down the sector in the past and then at the various initiatives taken by the government and IR.

Issues that weighed down the sector

Low investments in the past Poor financial situation and In 1990’s the financial situation of IR weakened and it was not able to keep political influence denied any terms with changing technology and safety standards. Political influence denied initiative to make IR any move initiated towards making the organization profitable. In spite of being profitable one of the largest employers in the country, investments failed to keep pace with the level of modernization required. Majority of the spend, in the past, was incurred on account of regular maintenance, introduction of a few trains and upgrading tracks to facilitate movement of faster trains on important sectors. Moves like cross subsidization (discussed below) and low spend on expansion of network weighed down the growth for the sector.

Cross subsidization in rates Tariff rationalization was not initiated by the IR in the past due to political pressures from the government. To preserve their vote banks, passenger fares were cross-subsidized by overburdening freight traffic with higher charges. This has led to a situation where passenger services, which comprised the major portion of the transport cost, contributed far less to revenues as compared to the freight traffic, which accounts for a lower percentage of the total traffic.

Cost and revenue comparisons between passenger services and freight

80 67 70 58 60 50 42 40 33 (%) 30 20 10 0 Cost Revenue Cost Revenue

Passenger services Freight traffic

Source: Industry, India Infoline Research

October 18, 2006 Construction Sector 153 India Under ‘Construction’

There is a clear need for removal of the prevalent cross subsidization by IR. If the government feels that subsidies for passengers should continue, then a subsidy provision should be made in the budget itself and not through charging higher freight. The practice of cross subsidization has led to India having one of the lowest ratios of passenger fares to freight charges among emerging markets.

Ratio of passenger fares to freight chares

1.6 1.4 1.2 Ratio among the lowest 1.0 (x) 0.8 0.6 0.4 0.2 - Pakistan India China Korea Indonesia

Source: World Bank, Industry

Declining share of railways in freight traffic As mentioned above, cross subsidization led to high tariff charges for freight Poor service quality and low movement through railways. Along with this, poor service quality of railways, productivity of freight cars low productivity of freight cars, among others pushed industrial users away from IR and towards roads. This led to a decline in share of railways in freight transport as can be seen from the chart below.

Share of railways in traffic movement

100

80

60

(%) 40

20

0 1950-51 2004-05 Freight traffic Passenger traffic

Source: Industry, India Infoline Research

October 18, 2006 Construction Sector 154 India Under ‘Construction’

Low labor productivity The IR is one of the largest employment generators, employing around 1.54mn people. Salary therefore, forms one of the major input costs and accounts for Labor efficiency low when 40-50% of the total gross expenditure. In spite of reduction in workforce over compared to China the years, the labor efficiency of IR is way lower when compared to other similar networks like China. The railways are feeling the pinch, also because of a rising pension burden, with pensioners population slated to go up to 13mn by 2006- 07. Payments towards pension have risen significantly to 14.5% of gross traffic receipts in 2002-03 from 6.3% in 1985-86.

China v/s India – a comparison China’s aggressive additions to capacity have taken its railway network 18% India’s output in traffic units is higher than India’s network at 63,000kms from times in the 1990’s, when India’s 0.4x of China, whereas costs network was 8% bigger than China’s. India’s output in traffic units is 0.4x that are 3x of China. of China, whereas the costs are 3x of China. The railways of the two countries carried nearly the same volume of passenger kilometres in 1992-2002, however China carried 4.5x the freight that India carried during the same period.

India v/s China comparison 2004-05 India China % of electrified network 28.8 30.0 % of double line network 25.7 40.8 Employees (Mn) 1.54 3.30 Locomotives (Nos) 7,772 17,022 Wagons (Nos) 216,717 526,894 Coaches (Nos) 39,236 41,353 Passengers (Mn) 5,112 1,118 Source: Media reports

The last two years have seen improved focus on improvement of the railway network. Some of the initiatives undertaken are as follows:

Rail Vikas Nigam Limited (RVNL) RVNL, is a SPV formed to undertake development of projects for the GQ and port connectivity, mobilize the necessary finances and for implementation of projects, largely through non-budgetary resources.

RVNL investment plan

45 40 40 35 35 30 30 25 20 (Rs bn) 15 10 10 5 5 0 FY04 FY05 FY06E FY07E FY08E

Source: Rail Vikas Nigam Ltd

October 18, 2006 Construction Sector 155 India Under ‘Construction’

National Rail Vikas Yojana The National Rail Vikas Yojana (NRVY) is a non-budgetary initiative to eliminate Rs145bn investments planned in next 5 years all the bottlenecks in critical sections of the network over the next five years at an investment of Rs145bn.

Break-up of investments

(Rs bn) % of total Golden quadrilateral 80 55.2 Mega bridges 35 24.1 Hinterland connectivity 30 20.7 Total 145 100.0 Source: Ministry of Railways

Freight corridor The railway ministry’s freight corridor project, which will have an axle load of 30tons per wagon for 200 wagons, entails an investment of Rs230bn in phase- Japanese government has I, expected to be completed in 2012. The Japanese government has agreed to agreed to fund 30% through fund 30% of the project through a long-term loan for Rs184bn. The trains will a long-term loan operate at a speed of 120-150kms per hour, as compared to 25kms per hour presently.

With phase-I over 90% completed, phase-II of the Delhi metro rail project (Rs82.8bn investment) has been initiated scheduled for completion in 2010. Other projects like the Hyderabad Metro, Bangalore Metro and Mumbai Metro have also been initiated.

Construction beneficiaries Ö Gammon India Ö Hindustan Construction Ö Era Construction

October 18, 2006 Construction Sector 156 India Under ‘Construction’

Airports

There are 450 airports/civil enclaves in the country. The Airport Authority of India (AAI) owns and manages 129 airports including 12 international airports, 88 domestic airports and 29 civil enclaves at defence airfields.

Although, it seems that the country has a large number of airports, it is interesting to note that traffic is highly concentrated among the 12 international airports, Traffic highly concentrated which carry 86% of the air passenger traffic and 96% of the air cargo traffic. Even among the 12 international more interesting is the fact that Mumbai and Delhi together account for 56% of airports the total air passenger traffic.

Mumbai and Delhi together account for 56% of the total Lack of infrastructure at Indian airports th air passenger traffic Air travel is extremely low for a country which is the 4 largest economy in the world comprising 16% of the world population. In spite of Mumbai and Delhi carrying most of the traffic, their rankings among airports stand at 80th and 109th in the world respectively. The average air travel in India per person per year stands at 0.014 trips versus 2.02 trips in USA. India has been unsuccessful in Average air travel per person making the most of its tourism potential. It attracts only 0.4% of world tourists per year stands at 0.014 trips and 1% of the total tourism spend. The reasons include inadequate airport facilities, versus 2.02 trips in USA lack of hotels, severe congestion on roads and unreliable power sources.

Some of the issues with Indian airports are as follows: Ö Inadequate and ageing infrastructure Ö Inadequate terminals Ö Expansion potential at many airports is non-existent Ö Traffic skewed towards few metros due to lack of connectivity at other airports Ö Absence of long runways causing inability to handle international traffic Ö Expansion potential is non-existent at many airports Ö Limited parking due to the emergence of new airlines Ö Delay in passenger clearances Ö Bunching up of flights Ö Lack of cargo handling facilities Ö Lack of modern ground handling facilities Ö Lack of night-landing systems Ö Under-developed commercial revenue sources

The lack of adequate infrastructure and facilities at airports is the reason for the majority of revenues of Indian airports being derived from aeronautical activities as against leading international airports, that earn more than 50% of their revenues from non-aeronautical activities like catering and restaurants, real estate, duty free shopping, parking fees and other airport service related fees.

Civil aviation sector witnessing high growth in recent times The civil aviation sector has witnessed high growth during the last two years. Positive developments for the sector and entry of new airlines, have led to the high growth. In FY05, the total passenger traffic at the Indian airports grew by 21.7% to 59.3mn and the total cargo handled grew by 19.9% to 1.28mn tons. The growth during 2005-06 was a healthy one for the sector as well. In fact, the Passenger traffic growth of 23.7% yoy - highest ever passenger traffic growth of 23.7% yoy is the highest ever recorded in the country recorded in the country for this segment. for this segment.

October 18, 2006 Construction Sector 157 India Under ‘Construction’

Traffic movement at Indian airports 2005-06 2004-05 yoy (%) Aircraft (‘000) 838.3 717.6 16.8 Passenger (Mn) 73.3 59.3 23.7 Freight (‘000 tons) 1,403.9 1,280.3 9.7 Source: Indian Infrastructure

The four major airports, namely, Mumbai, Delhi, Kolkata and Chennai witnessed a CAGR of 4.6% and 4.3% over the last ten years in domestic and international air passenger traffic respectively (including transit passengers). The industry expects the domestic and international air passenger segments to grow by 12% pa and 7% pa respectively in the coming years. Growth for international cargo is likely to be 12% pa during the same period.

The growth in this sector has taken place on account of a number of reasons

1. Government initiatives Ö Open-sky policy during peak season Ö Private sector participation in airports with 74% private ownership permitted with cap of 49% on foreign shareholding Ö Legal framework for operational flexibility to private operator’s Infrastructure Ö A host of low cost carriers appearing on the scene Ö Abolition of Foreign Travel Tax (FTT) on international fares and Inland

Air Travel Tax (IATT) on domestic fares Ö Addition of new international routes and overseas expansion plans announced by private airlines Ö Progressive liberalization of bilateral agreements Ö FDI hike in the budget 2004-05 Ö Leasing of existing airports to private operators

2. A number of new carriers have entered the business and more are in line to make a foray, in anticipation of high demand. Air Deccan pioneered in providing low cost services in the industry. Four new airlines, Spice Jet, Go Air, Paramount Airways and Air India Express began low cost services in 2005.

3. Other reasons Ö Swing in the economy Ö Outsourcing boom Ö Growth in tourism Ö Travel liberalization

Airline companies in the country are set to strengthen their fleet to meet the growing demand. At least 280 new planes are expected to be bought by these Airbus’ estimates potential for companies by the year 2010, worth estimated at US$15bn. A similar figure is 800-1,000 new planes from expected to be spent on purchasing planes in the next decade as well. Airbus’ India over next two decades market estimates reveal a potential for 800 to 1,000 new planes from India over the next two decades.

In line with this growth, there is an urgent need for investment in modernizing existing airports and for developing new ones to match this expected rise in traffic, both passenger and cargo. The government has realized the importance of building a strong network of airports with global quality infrastructure. The focus is on developing the existing airports at Mumbai and Delhi and for setting up Greenfield airports at Bangalore and Hyderabad. Other regional airports will be upgraded too, to meet international standards.

October 18, 2006 Construction Sector 158 India Under ‘Construction’

Airports at Mumbai and Delhi The AAI signed an operation management and development agreement (OMDA) with the GVK led group and the GMR led group for the development of the Mumbai and Delhi airports respectively in January 2006.

The agreement holds operational guidelines, duties and extent of control of the respective shareholders in the two government-private ventures over the two airports. This PPP vehicle will see a 74% equity stake in the respective airports held for 30 years by private parties, with AAI holding the balance 26%.

Estimated investment of The first phase of modernization of these two airports is expected to be Rs26bn and Rs28bn to go into completed by 2009. An estimated investment of Rs26bn and Rs28bn will go upgrading Mumbai and Delhi into upgrading the Mumbai and Delhi airports respectively. airports respectively Greenfield project at Hyderabad The greenfield international airport at Shamshabad, Hyderabad will be developed by the GMR Malaysian Airports Holdings Berhad consortium along with the government of AP and the AAI. The Malaysian consortium will hold 74% equity First phase is expected to stake in the project and 26% will be equally shared between the government cost around Rs14bn of AP and AAI. The first phase is expected to cost close to Rs14bn.

The advance development fee of US$23.8mn has been paid by the government of AP and will be recouped by levying an additional tax on the existing airport at Hyderabad. The government also recently cleared an interest free loan of US$70mn. A concession agreement between the Indian government and the developer will follow state support and shareholders agreement.

Greenfield project at Bangalore The greenfield project at Bangalore, estimated to cost Rs13bn with a D/E mix of 2:1, is expected to be completed by 2008. The Siemens-led consortium comprising L&T and Unique Zurich Airport holds 74% of the equity with balance 26% equally shared between the Karnataka government through Karnataka State Industrial Investment & Development Corporation and AAI. The project has achieved financial closure and construction has begun.

Other projects Apart from the four key metro projects, the government plans revamping about Government plans revamping 35 non-metros airports at an estimated cost of Rs45bn. Some of the projects 35 non-metros airports at an taken up include modernisation of Madurai, Trichy and Coimbatore. A new airport estimated cost of Rs45bn is also planned in New Mumbai through the Maharashtra Airport Development Company, which will take three years’ to complete after work commences.

The Civil Aviation Policy awaited The sector is waiting for the new civil aviation policy to be introduced. The policy aims to deal with various issues such as enhancing the infrastructure at airports, making air travel affordable, improving access to unserviced areas, making FDI norms flexible, among others. The final draft policy is ready and some minor issues are being sorted out before it goes for cabinet approval.

October 18, 2006 Construction Sector 159 India Under ‘Construction’

Investments in the sector Backed the strong demand in the sector, investments are expected to be high. The development is not only restricted to runways and terminals. Investments will also be made on development of thousands of acres of land comprising, hotels, malls, golf courses, convention centres, office space and entertainment centres at the Kolkata, Hyderabad and Bangalore airports. This sector is Sector is expected to witness expected to witness an investment of around Rs350bn over the next 5-6 years. an investment of Rs350bn over next 5-6 years The capital investment for Delhi and Mumbai airports itself is estimated to cost Rs79.6bn and Rs61.3bn respectively, over the next 20 years.

Construction beneficiaries Ö Larsen & Toubro Ö Gammon India Ö Era Constructions Ö Valecha Engineering Ö Simplex Infrastructures

October 18, 2006 Construction Sector 160 India Under ‘Construction’

Ports

India presently has around 197 ports overall; 12 major ones, six each on the west and the east coast, and about 185 minor and intermediary ones. Only 48 of the non-major ports are operational. These ports extend along India’s coastline of approximately 7,517kms on the western and eastern shelves of the mainland and along the islands as well. The importance of India’s maritime sector can be judged from the fact that about 95% of international trade by volume and 70% of it by value is done from these ports. This makes development of this sector, a crucial part of the country’s infrastructure.

Major ports carry bulk of the trade 75% of the total traffic in The major ports are getting burdened with the quantity of trade that is carried volumes is done by major out through them. The volume handled is significantly higher than that handled ports by the non major ports, as can be inferred from the chart below. 75% of the total traffic in volumes in the maritime sector is done by the major ports of the country.

Share of major and non-major ports in India

120 100 19 24 25 25 26 80 60 (%)

40 81 76 75 75 74 20 0 1999-00 2000-01 2001-02 2002-03 2003-04 Share of major ports Share of other ports

Source: National Maritime Development Policy

High operating rates at major ports neccesiate expansion Operating rates at around Operating rates at major ports are high and close to their optimum capacity levels. 90% In fact, up to 2000-01, most of the ports were operating nearly at saturation levels; some even exceeding their capacity limits, leading to high pre-berthing detention and a high turn round time of vessels. Although, some capacities were added, resulting in higher aggregate port capacity than the volume of cargo handled from 2000-01 onwards, a lot still needs to be done to match the rising volume of trade.

Capacities and operating rates at major ports

500 120 400 100 80 300 60 (%) (MT) 200 40 100 20 - - 1999-00 2000-01 2001-02 2002-03 2003-04 Capacity (LHS) Operating rates (RHS)

Source: National Maritime Development Policy, India Infoline Research

October 18, 2006 Construction Sector 161 India Under ‘Construction’

High demand needs matching capacity The traffic at the major ports that witnessed a CAGR of 5.5% between 1950-51 Traffic growth at major ports and 2003-04, saw the same rise to 6.1% between 1999-00 and 2003-04. The witnessed CAGR of 10.8% last two years witnessed an even higher rate of growth. Traffic growth at major between 2003-04 and 2005-06 ports witnessed a CAGR of 10.8% during 2003-04 and 2005-06. This puts severe pressure on the ports that are already operating at high rates of around 90%.

Traffic at major ports and growth rates

Rising demand needs matching 450 12 11.3 capacities 400 10.0 10.4 10 350 9.0 300 8 250 6 (%)

(MT) 200 150 4 3.4 100 2.3 2 50 0 0 1999- 2000- 2001- 2002- 2003- 2004- 2005- 00 01 02 03 04 05 06

Traffic (LHS) Growth (RHS)

Source: National Maritime Development Policy, India Infoline Research

Growth in traffic is expected to stay high in the coming years as well due to the improved export competitiveness and on account of the persistent increase in export volumes with revival of growth in the manufacturing sector.

Investments need to be made to match traffic for certain commodities Some key commodities like petroleum crude enjoy about 35% share of the total traffic handled at major ports with others like coal, iron ore and containers accounting for 15%, 17% and 15% respectively. Rising demand for these commodities puts further pressure on the working of ports. The sector therefore, needs to add capacities to match the demand for certain type of commodities, which form a major proportion of the trade and whose demand is on the rise.

Share of key commodities at major ports

2003-04 Others Petroleum 16% Fertilizer crude 2% 35%

Coal 15%

Container Iron ore 15% 17%

Source: National Maritime Development Policy October 18, 2006 Construction Sector 162 India Under ‘Construction’

Trend towards bigger vessels needs to be addressed There is a rising trend of bigger sized vessels across the world. The bigger size helps achieve economies of scale by saving on time and costs and carries a higher volume of trade on international routes. To accommodate bigger sized vessels, ports need to deepen their draft. Raising our infrastructure to international standards is the only way to compete with ports in other regions.

Investments are a must to Investments in the maritime sector are a must since the government has set an meet export target of ambitious export target of US$150bn by 2008-09 with an aim of doubling the US$150bn by 2008-09 country’s share in world exports to 1.5% from nearly 0.8% presently.

Private sector participation in ports Port privatization has gained momentum with 100% FDI allowed in the sector. The government has approved 17 private and captive projects worth Rs61bn of which, 13 projects with a capacity addition of 38.8mn tons pa and an investment of Rs26.32bn are now operational.

The National Maritime Development Programme launched The NMDP has planned an The government launched the National Maritime Development Programme (NMDP) investment of Rs1,003bn in December 2005. The plan is to improve service quality, promote competitiveness spread over 20 years and facilitate enhanced private investment in the sector. The NMDP has planned an investment of Rs1,003.4bn spread over 20 years, to be spent in 387 identified projects across ports, shipping and inland waterways.

NMDP plan Sector Investments Fund arrangement Additions No. of Targeted by (Rs bn) (MTPA) projects (date) Ports (12 major ones) 558.0 PPP 422.5 276 2011-12 Shipping & inland water Budgetary support & internal/external transport 445.4 budgetary resources - 111 2024-25 Source: National Maritime Development Policy,

Investments at 12 major ports are targeted to enhance the aggregate cargo handling capacity to 820mn tons pa from 397.5mn tons presently. The programme seeks to implement 76 projects for construction of berths and jetties, 25 projects to aid in deepening port channels, 52 projects comprise procurement, replacement and upgradation of port equipment, 45 projects to develop port connectivity to the hinterland and 78 other related schemes to expand storage capacities and internal circulation systems.

The investment in shipping and inland water transport includes activities such as vessel acquisition by Shipping Corporation of India, setting up of navigational aids and shipyards maritime training activities and promoting inland water transport.

In March 2006, the cabinet referred the draft maritime policy to the committee of secretaries seeking further revisions before clearing it for implementation. Once implemented, it will result in large investments for the port sector and will translate into healthy order position for the construction sector.

Construction beneficiaries Ö Simplex Infrastructures Ö Gammon India Ö Hindustan Construction

October 18, 2006 Construction Sector 163 India Under ‘Construction’

Oil and Gas

A significant proportion of the construction activity, local and global, is concentrated in the oil and gas industry. The energy sector accounted for 30% of US$264bn global construction market (excluding building construction) in 2004. The demand for construction in the energy industry is dependent on investments made by companies in exploration, production, storage, refining and marketing activities. Construction contracts in the oil and gas sector comprise of exploration rigs and IEA estimates total global platforms, refineries and other process facilities, tanks and terminals for storage investment of US$16 trillion and derivative products and pipelines for transportation of these products. till 2030 in the energy sector for building infrastructure. The International Energy Agency (IEA) has estimated a total global investment of India will receive US$900bn US$16 trillion till 2030 in the energy sector for building infrastructure. Out of this, over the next 25 years 60% will be for electricity, 19% for gas, 19% for oil, and 2% for coal. India will receive investment of approximately US$900bn over the next 25 years, according to IEA.

Factors that affect capital expenditure in oil and gas Ö Fluctuations in oil and gas prices Ö Discovery rate as well as development of new oil and gas reserves Ö Demand for oil and gas and derivative products across the world Ö Political and economic conditions all over the world Ö The ability to set and maintain production levels and prices by the Organization of the Petroleum Exporting Countries (OPEC) Ö The level of oil and gas production by non-OPEC regions Ö Costs associated with exploration, extraction, production and transportation Ö Sale and expiration dates of leases and concessions granted for exploration activities Ö Governmental regulations and policies relating to the exploration, production and development of its oil and natural gas reserves Ö Geopolitical tensions across the world Ö Trends in environmental legislation

Global demand scenario Oil fields are ageing and the Crude oil and natural gas together amount to nearly 60% of the primary energy production levels have consumption in the world. With developing economies like China and India growing peaked out leading to major at a rapid pace over the last few years, the demand for energy (especially crude investments oil) has increased significantly. The oil fields are ageing and the production levels have peaked out, leading to major investments in the development of these fields. No major discovery has been made in the recent past leading to a tight demand- supply gap, and burgeoning crude oil prices. A surge in prices has always been followed with increased investments for exploration and production (E&P). Although, prices have cooled off from their highs, they continue to remain above historical averages.

Rising crude oil prices (WTI)

90 80 70 60 50 40 30

US$/bbl 20 10 0 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06

Source: Bloomberg October 18, 2006 Construction Sector 164 India Under ‘Construction’

Global oil demand Region Demand Annual change Annual change 2005 2004 2005 2006 2004 2005 2006 Million Barrels Per Day (Mn B/D) Growth (%) North America 25.42 0.81 0.09 0.20 3.3 0.3 0.8 Europe 16.32 0.21 - 0.01 1.3 - - OECD Pacific 8.63 (0.16) 0.10 0.01 (1.9) 1.2 0.1 China 6.59 0.86 0.15 0.38 15.4 2.4 5.7 Other Asia 8.81 0.59 0.16 0.08 7.3 1.8 0.9 Subtotal Asia 24.03 1.28 0.41 0.47 5.7 1.8 2.0 FSU 3.80 0.17 0.05 0.05 4.7 1.3 1.2 Middle East 6.13 0.40 0.32 0.33 7.4 5.6 5.4 Africa 2.87 0.10 0.08 0.07 3.7 3.0 2.4 Latin America 5.08 0.27 0.13 0.12 5.9 2.7 2.3 World 83.66 3.25 1.08 1.24 4.1 1.3 1.5 Source: International Energy Agency (IEA), Oil Market Report, June 2006 Mn B/D - Million Barrels per day As seen from the table above, global oil demand is estimated to have grown by 1.5% in 2006 to 84.9mn barrels per day (Mn B/D). Non-OECD oil demand growth clearly dominates in the global scenario. Between 2003 and 2006, China is estimated to have witnessed the highest CAGR growth of 5.7% followed by Middle East with 5.4%. North America and Europe, which form 50% of the total global oil demand, have witnessed a falling share in the total global oil demand and will continue to register a drop in the proportionate demand. Asian demand, as a percentage of the total, has been rising continuously since 2003 and the trend is expected to continue with high growth rates. Other regions like Africa and Latin America too, are expected to witness healthy growth.

The Indian scenario Current per capita The maximum available hydrocarbon (oil and gas) reserves in India are estimated consumption of Indian to be around 32bn tons, comprising 0.4% of the global hydrocarbon reserves. population stands at 180kgs - This is extremely low considering that India shelters around 16% of the world less than 1/3rd of world population. Middle East accounts for bulk of the reserves estimated at 60% of average of 550kgs the total world reserves.

The current per capita consumption of the Indian population stands at 180kgs, which is less than 1/3 rd of the world average of 550kgs. With the growing energy needs of the nation, investment in the oil and gas sector is a must. One has to bear in mind however, that India will never be self sufficient in oil and gas. Every incremental one kg rise in per capita energy consumption when multiplied a billion times (which is the size of India’s population) gives the total oil and gas requirement of the country.

New Exploration Licensing Policy (NELP) In 1997-98, the Indian government introduced NELP to create a level playing field for all players to compete for the award of exploration acreage. This was done to increase the exploration potential of the country.

October 18, 2006 Construction Sector 165 India Under ‘Construction’

Salient features of NELP

Ö Possibility of the seismic option in the first phase of the exploration period. Ö Up to 100% foreign participation. Ö No minimum expenditure commitment during the exploration period. Ö No signature, discovery or production bonus. Ö State participation is not mandatory. Ö No carried interest by national oil companies. Ö Income Tax holiday for seven years from start of commercial production. Ö Option to amortise exploration and drilling expenditure over a period of 10 years from first commercial production. Ö Royalty for onland areas payable at the rate of 12.5% for crude oil and 10% for natural gas. For offshore areas, royalty payable at the rate of 10% for oil and natural gas. Royalty for discoveries in deep water areas beyond 400 metres iso- bath chargeable at half the applicable rate for offshore areas for the first 7 years of commercial production. Ö No customs duty required on imports for petroleum operations. Ö Up to 100% biddable cost recovery limit. Ö Sharing of profit petroleum based on pre-tax investment multiple achieved by the contractor and is biddable. Ö A provision for fiscal stability in the contract. Ö Freedom for marketing of oil and gas to the contractor in the domestic market. Ö Provision for assignment. Ö Arbitration and Conciliation Act, 1996, based on UNCITRAL model, applicable. Ö A petroleum tax guide (PTG) in place to facilitate investors.

Source: Directorate General of Hydrocarbons

The government is presently awarding exploration acreage under NELP VI. Fifty- five blocks are on offer for bidding in this licensing round (24 in deep water, 25 onshore and 6 blocks in shallow water).

Area covered and investments in E&P by NELP Period Area to be covered Investment (Sq km) (US$ mn) NELP I Jan-99 168,340 1,252 NELP II Dec-00 189,503 716 NELP III Mar-02 204,670 1,038 NELP IV May-03 192,810 1,100 NELP V May-05 109,210 867 NELP VI Current 355,000 7,000 Source: Petroleum Ministry, Media reports E&P – Exploration and production

ONGC aiming to discover 6bn Many oil and gas majors in India are investing heavily in exploration and tons of hydrocarbons during production. ONGC is currently spending close to US$1.75mn each day, on an 2001-20, equal to the amount average, on its exploration campaign, aiming to discover 6bn tons of it discovered in the first 45 hydrocarbons during 2001-20, which is equal to the amount it discovered in years since its inception the first 45 years since its inception.

Recent discoveries by Reliance Industries in the KG basin and by Cairns Energy in Rajasthan have evoked interest in the hydrocarbon sector. Development of these finds will require huge capital spending by these companies in years to come. Reliance Industries recently issued expressions of interest (EOI) for developing their fields.

October 18, 2006 Construction Sector 166 India Under ‘Construction’

The Directorate General of Hydrocarbons (DGH), a government arm under the Ministry of Petroleum and Natural Gas, believes that the relatively unexplored deep water in the east coast has as much potential as the west coast, which is currently the largest contributor to India’s oil and gas production.

Focus on the refining space India presently has 18 oil refineries with a total capacity of 129mn tons pa. India has a dual advantage of cost competitiveness and location in the refining space, which will promote investments in refineries.

India’s advantage in refining

Cost competitiveness Locational advantage

Capital costs of Indian refineries Bulk of the petroleum product are as much as 30% lower as exports from Middle East to Far compared to other countries, with East routed through the Indian operating costs at comparable Ocean and Arabian Sea levels

Rising demand for petroleum products has led to many Indian refineries declaring capacity addition plans. As per our indicative list given below, 74.5mn metric tons per annum (MMTPA) capacity is being planned in the coming years with investments totaling to Rs785bn.

Refinery capacity additions by Indian majors Name Capacity Investment Commissioning Type (MMTPA) (Rs bn) date IOC, Paradip 9.0 83.1 March 2010 Greenfield BPCL, Bina 9.0 100.0 September 2009 Greenfield BPCL, Kochi 2.5 25.9 September 2009 Brownfield HPCL, Bhatinda 6.0 98.1 December 2006 Greenfield HPCL, Mumbai 2.4 11.52 December 2006 Brownfield HPCL, Vishakhapatnam 0.8 16.4 December 2006 Brownfield RPL, Jamnagar 29.0 270.0 December 2008 Greenfield Essar Oil 10.5 100.0 September 2006 Greenfield MRPL 5.3 80.0 NA Brownfield Total 74.5 785.0 Source: Petroleum Ministry, Media reports Indian Oil – IOC, British Petroleum Company Ltd – BPCL This list is indicative

Apart from capacity expansion projects, these companies will also invest to make refineries compatible with the new environmental norms and to comply with Bharat Stage-II, Euro-III, Euro-IV norms.

October 18, 2006 Construction Sector 167 India Under ‘Construction’

Marketing investments planned With heightened activity in exploration and refining, investment in marketing infrastructure through expansion of retail outlets is imperative. Major companies Various players have planned like Reliance Industries, Hindustan Petroleum and BPCL have planned significant over 6,000 retail outlets, additions to their marketing network in the coming years. Various players have which is more than 20% of planned over 6,000 retail outlets, which is more than 20% of the existing number the existing number of of outlets. This addition will entail a cumulative investment of over Rs100bn by outlets. these companies.

Investments in retail outlets (Nos) Existing Additions Total Incremental Investment (Rs bn) Reliance 1,200 800 2,000 12 Essar 700 1,800 2,500 27 HPCL 7,000 850 7,850 13 BPCL 6,850 650 7,500 10 IOC 13,600 2,000 15,600 30 Source: Industry This list is indicative

Natural gas: An alternate energy source Natural gas forms a vital component in the energy basket across the world today. It is easy to transport, use, cheap and relatively cleaner form. Hence, the demand for natural gas has been on a steady rise and will continue to increase in future. India is the sixth largest energy consumer in the world dominated by coal, followed by oil and natural gas.

The share of natural gas in India’s energy mix has increased, from 2.5% in the Share of natural gas in India’s early 1980s to around 8.5% in 2005. It is expected to increase to 20% by energy mix expected to rise 2025. Discovery of gas in the KG Basin off the eastern coast has given a major to 20% by 2025 from 8.5% boost to the Indian gas industry. About 45mn metric standard cubic metres per day (MMSCMD) of gas is expected to be produced from 2008 onwards from these wells. At present, India produces just over 88mmscmd of gas overall and imports another 19mmscmd in the form of LNG.

Reasons why natural gas is attracting investment Ö Given the growing demand supply gap, alternative sources of gas have to be explored. A combination of increased domestic production and imports of LNG and gas through transnational pipelines is the only alternative.

Ö The current average of seven years from discovery to production of natural gas has now reduced to five years and will further go down to three years in the near future. Enhanced recovery techniques are making it easier and more lucrative for investors in this space. Besides coal bed methane and coal gasification options are also being explored for natural gas.

Ö Gas prices are gradually being freed from regulation, the trendsetter being LNG prices. Industrial sectors appear to be adjusting to international pricing and market trends. Further, the Petroleum & Natural Gas Regulatory Board Act has been put in place.

October 18, 2006 Construction Sector 168 India Under ‘Construction’

Investments to rise Gas demand and supply centers need to be better connected and hence, many companies have planned or implemented projects for the same. GAIL plans to lay a 8,400kms national gas grid, which will connect the western, southern and eastern regions of India. Reliance Industries, through its subsidiary, is also implementing a 3,300km gas pipeline in order to connect its KG basin gas field with the demand centers in south and west. Joint ventures have already been set up for undertaking gas distribution in some cities.

The GOI is trying to strike alliances to import piped gas from gas surplus countries in the vicinity such as Iran and Turkmenistan in Central Asia, Qatar and Oman in West Asia and neighboring Bangladesh. Hence, we can expect to see a lot of action in this sector in the coming years.

Increase in domestic gas supplies Mmscmd 2005 2006E 2007E 2008E 2009E 2010E OIL 5.3 5.2 5.1 5 4.9 4.8 ONGC -Onshore 15.1 14.8 14.5 14.2 13.9 13.6 ONGC - Offshore 48.7 48.2 47.7 47.3 46.8 46.3 ONGC-Total 63.8 63 62.2 61.4 60.7 59.9 Panna-Mukta & Tapti 9.6 11 14 15.4 16.9 18.6 KG Basin 7.5 30 40 Others 7.9 8.3 9.6 11 12.7 14.6 JVs/Private 17.5 19.3 23.6 33.9 59.6 73.2 Petronet LNG-Dahej 8.9 18.8 18.8 18.8 23.5 40.4 Petronet LNG-Kochi 2.3 8.8 Shell Hazira 2.3 8.8 8.8 8.8 8.8 Dabhol 4.5 16.2 16.2 16.2 Ennour 4.7 LNG 8.9 21.1 32 44 51 79 Total 95.6 108.6 123 144.1 176 216.8 Flared 3.7 3.7 3.7 3.7 3.7 3.7 Available 91.9 104.9 119 140 172 213 Internal Consumption 11.5 13.5 14.5 15.5 15.5 15.5 Supply 80.4 91.4 104.8 124.9 156.8 197.6 % APM Gas 72.3 62.8 54.7 46.1 37.3 29.9 % Market linked 27.7 37.2 45.3 53.9 62.7 70.1 Source: Industry APM - Administered Price Mechanism

Construction beneficiaries Ö Punj Lloyd Ö Larsen & Toubro

October 18, 2006 Construction Sector 169 India Under ‘Construction’

Pipelines

Huge investments planned across the hydrocarbon value chain will result in increased demand for pipeline infrastructure in the country. Incremental spend on developing the irrigation infrastructure through water supply projects will Demand for pipelines in India also contribute to surge in demand for pipelines. Over the next five years, the is expected to witness18% demand for pipelines in India is expected to witness approximately 18% CAGR. CAGR approximately Large oil and natural gas companies in India including IOC, RIL, Essar Oil, BPCL and ONGC have already commenced significant oil and transportation infrastructure projects.

Reasons for increased investments in pipeline infrastructure Ö Recent discovery of large oil and gas reserves and significant investments in the refining space have resulted in increased demand for pipelines.

Ö Supply of natural gas in India is only 88mmscmd while demand is 117mmscmd and is set to grow to 166mmscmd by 2007.

Ö Oil and gas pipeline infrastructure in India has been minimal at about 15,000kms as compared to 170,000kms in France and 329,600kms in US. Pipelines in India move only 25% of oil products as against 59% in the US.

Ö Government’s decision to permit oil retailing by the private sector will provide the thrust to this segment.

Ö Proposed national pipeline grid formulated by GAIL and development projects by many private players.

Ö Pipelines are most cost-effective way of transporting petroleum products. It costs approximately Rs1.3/km to move a ton of oil by pipeline while train transport costs Rs2.2/ton and road transport costs Rs3.02/ton. The cost of inter-continental transportation of oil via tanker is about Rs2 per litre/km while it is Re0.4 per litre/km via pipeline.

Ö Water supply and irrigation initiatives will require pipeline infrastructure..

October 18, 2006 Construction Sector 170 India Under ‘Construction’

Upcoming projects Out of the existing capacity of crude and product pipelines, IOC holds about 70% while HPCL, BPCL, ONGC, OIL and Petronet LNG own the rest. The existing gas transmission infrastructure in India can handle distribution of more than 133mmscmd of gas, with large investments coming up as shown in the table below.

Investments planned in pipelines Pipeline Length Capacity Owner Capital cost Estimated (km) (mmtpa) (Rsbn) completion Crude pipelines Paradip-Haldia 330 - IOC 7 - Mundra-Kandla - - IOC - - Product pipelines Branch pipeline to Chittaurgarh from Sidhpur- Sanganer pipeline 160 1.1 IOC 0.83 Aug-06 Koyali-Dahej 112 2.6 IOC 0.91 Jul-06 Koyali-Ratlam 274 2 IOC 2.25 Mar-07 Extension of Mumbai-Pune 343 1.18-2.14 HPCL 3.35 Sep-06 Mundra-Delhi 1048 4.2-5.8 HPCL 16.24 May-07 Extension of Mumbai-Manmad to Piyala 774 2.2 BPCL 8.07 Dec-06 Numaligarh-Siliguri 660 1.72 OIL 4.69 Sep-07 Central India pipeline (Vadinar-Ratlam-Rewari) 1,206 7.5 Essar Oil 18.9 - Kota-Kanpur 484 1.34 Essar Oil 4.52 - Jamnagar-Abu 410 2.62 GTICL 4.05 Mar-09 Source: Infrastructure Magazine Construction beneficiaries Ö Punj Lloyd Ö Larsen & Toubro Ö Gammon India Ö Hindustan Construction Ö Nagarjuna Construction Ö Simplex Infrastructures

October 18, 2006 Construction Sector 171 India Under ‘Construction’

Metals

Steel Global scenario

Demand, supply and capacity utilization Period 2001 2002 2003 2004 2005 Global crude steel production (mn tons) 850 904 969 1,067 1,132 Yoy (%) - 6.4 7.2 10.1 6.1 Global apparent steel demand (mn tons) 771 820 873 974 1,013 Yoy (%) - 6.4 6.5 11.6 4.0 Global capacity utilization (%) 79 84 88 90 90 Source: International Iron and Steel institute and India Infoline Research

Buoyed by the recovery in global GDP growth, mainly driven by strong economic momentum in developing nations like China and India, the global steel industry 5% CAGR witnessed by the witnessed over 5% CAGR in production and consumption, consecutively for the global steel industry last three years. In terms of geography, it has been driven mainly by China, consecutively for the last three where production and consumption witnessed a CAGR of over 20% during the years same period. World Bank predicts global GDP to grow by 3.2% in 2006 (at similar levels of 2005) with strong growth anticipated in US, China, Russia and India. International Iron and Steel institute (IISI) projects global crude steel production to grow by 5.8% to 1,198mn tons and apparent steel demand to increase by 7.3% to 1,087mn tons in 2006.

Domestic scenario

Demand and supply Period FY01 FY02 FY03 FY04 FY05 FY06 Apparent steel production (mn tons) 30 31 34 37 40 43 Yoy (%) 11.2 3.1 9.9 9.8 8.4 6.4 Apparent steel consumption (mn tons) 27 27 29 31 34 38 Yoy (%) 7.4 3.4 5.3 7.9 10.3 10.9 Source: steel.nic.in

Per capita consumption

500 400 400

300 226 242

(Kgs) 200 150 103 100 33 0 India Brazil Russia China Developed Worldwide nations average average

Source: Industry and India Infoline Research

October 18, 2006 Construction Sector 172 India Under ‘Construction’

Manufacturing (especially capital goods and automotive) and construction have displayed double-digit growth rate. With steel forming the basic feed for the above industries, the apparent steel consumption in the country received a fillip in the last three years. Given the robust outlook for the above industries, the demand for steel is anticipated to remain strong over the longer term.

India’s National Steel Policy - 2005 The ‘National Steel Policy - 2005’ (NSP) announced by the Indian government last year outlined the growth estimations for demand and supply until 2020 as shown in the following table.

NSP 2005 estimates Period Production Imports Exports Consumption 2004-05 (mn tons) 38 2 4 36 2019-20E (mn tons) 110 6 26 90 CAGR (%) 7.3 1.1 13.3 6.9 Source: Government of India

Indian government expects The Indian government expects steel production to increase to over 100mn tons steel production to increase to pa by 2019-20 from 38mn tons in 2004-05 (CAGR of 7.3%). The global steel over 100mn tons pa by 2019- production is expected to increase from 1bn tons in 2004 to 1.4bn tons in 2015 20 - CAGR of 7.3% (CAGR of 3%).

On the demand side, the growth would be driven by increasing usage of steel in the urban areas. The urban region consumption would be driven by the growth in construction, automobile and oil and gas transportation. This would lead to an increase in the per capita consumption of steel in urban areas from the current 77kgs to 165kgs in 2019-20. Efforts would also be made to promote steel usage in rural areas and thus push the per capita consumption from the existing 2kgs to 4kgs by 2019-20. Exports would be promoted by encouragement of strategic alliances with buyback arrangements and dedicated export production through 100% export oriented units.

Upcoming major steel capacity in India Company Expansion Location Capex (mn tons) (Rs bn) SAIL 8 Bhilai, Rourkela, Durgapur & Bokaro 370 Tata Steel 23 Orissa, Chattisgarh & Jharkhand 650 JSPL 11 Orissa & Jharkhand 250 Mittal Steel 12 Jharkhand 434 POSCO 12 Orissa 510 Source: India Infoline Research List is indicative

Huge capacity is anticipated to be added by mid-sized and smaller players as well. Global steel players, besides the ones mentioned in the table, are also looking at India to set up their steel manufacturing facility due to country’s rich iron ore reserves.

Aluminum Over the past couple of years, demand for aluminum has outstripped supply, The industry is expected to converting the global industry from a surplus of 599,000 tons in CY02 to a deficit come into surplus of 391,000 of 469,000 tons in CY04. This deficit is expected to reduce to 144,000 tons for tons by CY09E CY05E, which is a result of more smelters coming on-stream during the period. The industry is expected to come into surplus of 391,000 tons by CY09E. October 18, 2006 Construction Sector 173 India Under ‘Construction’

Global aluminum and copper production Period 2001 2002 2003 2004 2005 Jan-Aug Jan-Aug 2005 2006 Primary aluminum production (‘000 tons) 20,551 21,199 21,935 22,592 23,463 15,497 15,834 yoy (%) 3.2 3.5 3.0 3.9 2.2 Refined copper production (‘000 tons) 15,583 15,269 15,234 15,823 16,446 n/a n/a yoy (%) 5.6 (2.0) (0.2) 3.9 3.9 n/a N/a Source: International Aluminum Institute, ICSG

Global primary aluminum production capacity As at the end of: Dec-04 Jun-05 Dec-05 Jun-06 Dec-06E Jun-07E Dec-07E Jun-08E Dec-08E Jun-09E Primary aluminum capacity (‘000 MT) 24,649 25,472 25,578 25,649 25,837 26,177 26,376 26,686 26,904 26,948 Source: International Aluminum Institute

Asia contributed to about 10.9% of the total aluminum production during CY01, which increased to 13.4% for CY05 and is currently at about 14.5% for January- August 2006 period. This has been due to higher contribution from China and rising contribution from India.

Consuming industries of aluminum and copper in India (%) Aluminum Copper Electricals 36.0 52.0 Transport 22.0 8.0 Construction 13.0 7.0 Packaging 11.0 5.0 Cons Durables 8.0 7.0 Industrial 6.0 5.0

Source: Media Reports, Hindustan Copper

Domestic demand for non-ferrous metals has remained strong for over a year with the continuing buoyancy in the economy. Higher demand for aluminum from Higher demand for aluminum construction, automobiles and power led a sharp rise of 19.6% in production of from construction, aluminum despite increasing prices. Similarly, demand for copper, zinc and lead automobiles and power led a sharp rise of 19.6% in too, remained strong during the period. Despite this, per capita consumption of production aluminum in the country stands to be the lowest at a meager 1kg as compared to USA (25kgs), Europe (25kgs), Japan (15kgs), Taiwan (10kgs) and China (3kgs).

Domestic demand supply scenario for copper and aluminum (‘000 MT) FY03 FY04 FY05 FY06E FY07E FY08E Copper Capacity 363 363 478 848 848 848 Production 378 392 412 600 728 798 Consumption 356 367 386 413 434 455

Aluminum Capacity - 883 940 1,190 1,270 1,270 Production - 817 875 1,005 1,130 1,210 Consumption - 680 744 804 872 946 Source: CRU, CRIS Infac, Industry

October 18, 2006 Construction Sector 174 India Under ‘Construction’

With robust investments being planned in power and automobile industry, demand is expected to remain firm in the future. In order to cater to this demand for all non ferrous metals, huge capacity expansion plans are on charts by the major players.

Capacity expansion plans of prominent players Expansion (tons) Location Capex amount FY07 Hindalco Industries Ltd -Alumina 340,000 Muri Rs8bn Vedanta Alumina 1,400,000 Orissa US$800mn

FY08 Hindalco Industries Ltd -Alumina 2,300,000 Belgaum, Orissa (2) Rs 53.3bn -Aluminum 341,000 Hirakud, Orissa Rs 58.7bn Hindustan Zinc 170,000 Rajasthan US$300mn Vedanta Alumina 500,000 Orissa US$2100mn National Aluminum Company Rs42bn -Bauxite 1,500,000 Rs1bn -Alumina 500,000 Rs13bn -Aluminum 115,000 Rs18bn -Power (MW) 240 Rs10bn Source: Company

In addition to the above, Jindal Aluminum is also setting up an alumina refinery and an aluminum smelter at Vizag of 1.5mn tons and 250,000 tons capacity respectively.

Construction beneficiaries Ö Simplex Infrastructures Ö Era Constructions Ö Gammon India Ö Larsen & Toubro Ö Hindustan Construction

October 18, 2006 Construction Sector 175 India Under ‘Construction’

Real estate

The real estate sector in India, comprising residential and commercial segments, Real estate sector in India enjoys the largest share at over 60% of the total investments in infrastructure enjoys the largest share at development. While residential construction includes housing, as the name over 60% of the total investments in infrastructure suggests, ie construction of bungalows and buildings, commercial construction development. comprises offices, hospitals, theatres, hotels and restaurants, malls, stadiums, multiplexes and schools.

Of the total real estate development that takes place in the country, 80-90% is in the form of residential construction and the balance is accounted for by the The market is highly commercial segment. This segment is highly fragmented, especially the housing regionalized segment with a large number of small players in the unorganized sector. The market is retail dominated with little control over specifications and standards.

The small players form 70% of the residential market and construct single bungalows and one-off buildings, co-existing with large players. Among the larger players too, the market is regionalized; Rahejas in Mumbai, DS Kulkarni Developers in Pune and DLF and Unitech in the National Capital Region (NCR). The commercial segment is also fragmented, although not as much as the housing segment. Most large builders from the residential segment have entered the commercial space as well.

Issues that the sector faced in the past Ö Lack of uniformity in local laws and their application Ö Non-existence of a centralized title registry offering guarantee of title Ö Ambiguity in transaction values Ö Impedance of transfer taxes

Times are changing for the sector especially during the last few years after the sector displayed a trend towards relatively better organization and transparency to go along with the various regulatory reforms. The last three years have witnessed a buoyant real estate market after a severe recession between 1995 and 1999. Going forward, this growth is likely to continue with a number of drivers in favor.

We look at the factors that will drive growth for the sector in the coming years.

Changing demographics India has a population 1,094.1mn people with an acute shortage of housing. India’s young population with India has a young population with around 52% being below the age of 25. This around 52% below age of 25 will translate into new will translate into new residential demand in the coming years. Presently, 28.3% residential demand in future of the country’s population is in the 25-44 age bracket. This figure represents the working population of the country and a rise in this number would imply a rise in housing demand, owing to a bigger earning population.

The population in the age bracket of 25-44 in India is expected to witness a CAGR of 2.6% and rise to 30.5% of the total population between the years 2006-2013 as compared to a CAGR of 1.5% for the total population during the same period. This will mean an increase in the population between 25-44 years by 8.5mn people on an average each year and will need matching housing requirements.

October 18, 2006 Construction Sector 176 India Under ‘Construction’

Changing demographic profile of India

1,400 31.0 1,200 30.0 1,000 29.0 800 28.0 (%) (Mn) 600 27.0 400 26.0 200 25.0 - 24.0 1991 1996 2001 2006 2010 2013 Total population % of population between 25-44 years

Source: Statistical outline of India 2002

Rising incomes levels Higher incomes translate into increased ability to spend. India has been on a high growth path with GDP growth in the region of 6.5% to 8%. Rising salary levels and incremental employment growth in population has resulted in higher per capita income. This rise is expected to continue with a growing demand for Indian products and services and Indian professionals.

Rising per capita income

25,000

20,000

15,000 (Rs) 10,000

5,000

- 1950-51 1960-61 1970-71 1980-81 1990-91 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

Source: Statistical Outline of India 2004-05

Benign interest rates and easy availability of finance As mentioned elsewhere in our report, benign interest rates and the easy availability of finance with fewer formalities have helped boost the real estate market, both residential and commercial. It is believed that rising income levels and low interest rates justify higher property prices in the realty sector.

October 18, 2006 Construction Sector 177 India Under ‘Construction’

Growing urban middle class population A growing urban middle class population leads to growth in spending. The Indian urban middle class is defined as one with an annual income level between Rs90,000 and Rs500,000 pa. India has been witnessing a rise in its urban Share of urban middle class middle class population, whose share in the total urban households increased population in urban to over 50% in FY02, which is more than 500bps higher than the level in FY99. households expected to This proportion is expected to increase to over 60% of the total urban increase to over 60% of the households in the next 5-6 years. The average annual income of the urban total urban households in the middle class increased to nearly Rs169,000 in 2001-02 from Rs163,000 in 1998- next 5-6 years 99 and is likely to rise by nearly 15% by 2009-10.

Change in mindsets

Ö Concept of nuclear families Result of independent India is gradually witnessing a trend of nuclear families emerging from a joint thinking and change in family system in the past. Independent thinking and change in societal attitudes societal attitudes lead to separate houses for each branch of the family. Furthermore, migration to cities and towns for work from semi-urban and rural areas and increasing urbanization will lead to additional demand for homes. This, coupled with a rising population, will lead to increased investments in the real estate segment.

Declining trend in average size of Indian households

5.9

5.7 Fewer number of 5.5 people per family 5.3

(Nos) 5.1 4.9

4.7

4.5 1970-71 2000-01 2010-11E

Source: Census 2001, Industry

Ö Shift in attitude towards spending and willingness to borrow The last few years have witnessed a psychological shift towards viewing credit KSA Technopak: Home loan as a means of fulfilling individual and familial aspirations. Earlier, when there market in India witnessed a was an aversion towards borrowing and was thought to be a social stigma. CAGR of 40% over the last Today, with a change in attitude towards borrowing, housing finance companies four years are witnessing healthy growth. According to KSA Technopak, the home loan market in India has witnessed a CAGR of 40% over the last four years. More than US$11bn worth of home loans were disbursed in the year 2004 and the same for the year 2005 is estimated at US$15bn.

October 18, 2006 Construction Sector 178 India Under ‘Construction’

What’s even more interesting is that the average age of borrowers has declined over the years. From the times in the 1990s, when one would borrow during the age of 35-40 years, today loans are taken by people in their late 20s.

Trend in Indian home loan borrower age

50 43 45 40 35 33 35 30 25 (%) 20 15 10 5 0 1999 2004 2010E

Source: LIC Housing

Ö Trend towards owned houses vis-à-vis rented ones A gradually declining shift can be observed over the years, if one looks at the proportion of households staying in rented premises. Rise in income levels and lower interest rates have led to a trend towards owning homes. Low rentals in the past resulted in diminishing supply of apartments available on rent. Today, with rising rentals, people are finding the option of owning a home more feasible. Rising aspiration levels has also fueled this demand.

Distribution of households in India

100 Urban areas Rural areas 96 100 94 80 70 80 60 54 46 60 (%)

40 (%) 30 40

20 20 6 4 - - 1961 1971 1981 1991 2001 1961 1971 1981 1991 2001

Owned Rented Owned Rented

Source: Census reports, Cris Infac, Industry

October 18, 2006 Construction Sector 179 India Under ‘Construction’

Ö Larger median size of houses Another phenomenon on the rise is the demand for large-sized houses. A combination of factors – growing income levels, rising aspirations and easy financing have led to an increase in median size of homes. Customers are upgrading from basic apartments between 900-1,000 square feet to an average of 1,500 square feet with high quality construction, leisure amenities and services. As can be seen from the table below, the number of two and three room flats/apartments, as a proportion of the total households, has been on the rise both, in urban areas and for the country as a whole.

Proportion of households by size of dwelling units occupied Urban All India* (%) 1981 1991 2001 1981 1991 2001 <1 to 1 room 45.8 39.5 35.1 45.4 40.5 38.5 2 rooms 27.9 30.4 29.5 28.6 30.6 30.0 3 rooms 12.2 14.8 17.1 12.2 13.9 14.3 4 rooms and above 14.1 15.3 18.3 13.8 15.1 17.2 Total 100.0 100.0 100.0 100.0 100.0 100.0 Source: Census of India, 2001 * The data excludes the state of Jammu and Kashmir

Ö Trend of buying multiple properties The concept of purchasing multiple properties is catching up too. This is restricted to the upper middle class and the rich class who buy more than one house for fulfilling their aspirations. Buying multiple properties is seen by some as a status symbol and has little to do with movement of interest rates, whereas others buy the same as an alternate investment to stocks and bonds.

Property prices on the upswing The real estate sector returned to normalcy post 2001, after a severe recession in the 1990s. With rising prices of land, construction companies with large land banks rushed in to develop these properties to cash in, bringing in substantial investments in the sector. The average residential property prices during 2005 in key cities like Mumbai, Delhi and Bangalore have risen substantially as can be verified from the chart that follows. The last few years of growth, especially during the year 2004 and 2005 is driving investments in the real estate sector.

Growth in average residential property prices in 10 cities

30 24.2 25 23.3

20

15 (%) 10.1 10 6.3 5 0.4 0 2001 2002 2003 2004 2005

Source: Express Estates India Properties Survey 10 cities - Mumbai, Delhi, Bangalore, Chennai, Kolkata, Hyderabad, Pune, Chandigarh, Goa, Jaipur

October 18, 2006 Construction Sector 180 India Under ‘Construction’

The booming property market has also resulted in corporates, that turned sick a few years ago, to sell their land or develop it jointly with a construction company. Many properties belonging to mill owners and salt pans are being made available for development.

High rise buildings in urban areas The concept of high rise buildings has emerged in cities like Mumbai that are constrained due to lack of space to develop new properties. On account of migration to urban areas for employment opportunities, prime cities like Bangalore, Mumbai, Pune, and Gurgaon and some others like Kolkata, Chennai and Hyderabad are witnessing high rise structures due to their proximity to offices in IT/BPO parks. Such a concept is also affordable due to lower maintenance, low security and overall cost of ownership.

Development in new areas and suburbs taking place Besides major cities like Mumbai, Bangalore and NCR, construction activity is Construction activity is moving to tier-II and tier-III cities. This is because of a flurry of activities in IT, moving to tier-II and tier-III ITES and BPO space, are taking place in other areas such as Chennai, Hyderabad, cities Pune and tier-II and tier-III cities like Mangalore, Vizag, Coimbatore and Chandigarh. This has led to heightened construction activity in these places.

Within established markets as Within established markets as well, the real estate activity is penetrating into well, the real estate activity is suburban business districts from central districts to gain from low property prices penetrating into suburban and higher availability of space that offers larger centralized office area. Slums business districts too, are being developed and rehabilitation scheme is undertaken to develop the area. With business centres opening up in newer cities as well as in the suburbs of established markets, commercial construction followed.

Retailers, for instance, had initially launched their projects in metros and mini metros. However, gradually, the retail phenomenon spread over to smaller cities and to the suburbs in established markets. Commercial players are entering these locations early to win the first mover advantage of a bigger customer base and a sizeable share of loyal customers. It is estimated that Mumbai, NCR, Bangalore, Hyderabad and Pune will have a share close to 75% out of the total malls space to be available by 2010, with the balance coming up in cities notably, Chennai, Ahmedabad, Jaipur, Ludhiana, Kolkata, Nagpur among others.

Entry of international players The government has allowed foreign direct investment (FDI) of up to 100% in the housing and real estate sector under the automatic route, subject to fulfillment of certain conditions. This eases procedures and fastens the investment flow since no Foreign Investment Promotion Board (FIPB) approval is required. The government has also lowered the minimum development size to 25 acres (10 hectares) from 100 acres previously.

Some global construction giants have already entered into strategic partnership in select cities for township development. According to Knight Frank India, players from USA, Southeast Asia and Europe have evinced interest in the sector. Entry of these players will help boost development in this space.

October 18, 2006 Construction Sector 181 India Under ‘Construction’

However, there are some impediments at the state level that need to be addressed: Ö Absence of a single window clearance Ö Zoning regulations need to be reworked Ö Extended delays in giving planning permission Ö Stiff floor space index (FSI) rules Ö Infrastructure in cities is a major hurdle

Rising demand for IT/ITES Within the office space construction activity, 70-75% of the demand is derived from IT, BPOs and Call centres. The last few years witnessed a huge rise in demand for office space from companies mainly due to the emergence of India as a preferred outsourcing destination for IT and ITES. India, with its skilled, English speaking and low cost workers has benefited from the growing international trend towards offshoring of work in these sectors. Investment in telecommunications infrastructure too, helped boost Indian competitiveness. According to Knight Frank India, the increased demand from BPO, IT and ITES sectors, have led to a 20-40% rise in capital values for office space in the past 15 months across major metros.

IT export revenues ITES export revenues

35 25.0 28.7 30 19.8 23.6 20.0 25 19.1 20 15.4 15.0 15 11.8

(US$ bn) 10.0 7.0 8.9 (US$ bn) 5.2 10 3.7 5.0 2.4 5 1.4 0 - 2004 2005 2006E 2007E 2008E 2009E 2004 2005 2006E 2007E 2008E 2009E

Source: Software Annual Review (2005) Source: IT Enabled Services Annual Review (February 2006)

Major cities are preparing to face the rise in demand due to IT and ITES sector growth, which will supplement both, growth in residential and commercial properties. The secondary cities too, are getting a facelift due to their proximity to the major cities and enhanced connectivity levels.

Rapid growth of organized retailing Real estate activity will also get a boost from rapid expansion in the retailing sector. Organized retailing, which was 1% of the total retailing sector a few Organized retailing at 3% is years ago, presently stands at approximately 3% and is expected to rise to expected to rise to about 8- about 8-10% by 2010. This is another instance of change in customer mindset 10% by 2010 and rising aspirational levels. A one-stop solution is sought by customers and demand for branded products is on the rise.

October 18, 2006 Construction Sector 182 India Under ‘Construction’

Pantaloon, Shoppers Stop, Tata-Trent and the RPG group are the major organized retailers in the country along with international names like Metro, Shoprite, Lifestyle and Dairy Farm International. Other major business groups like Reliance, Industries, Hindustan Lever, Bennett & Coleman, Bharti group and the Hero group has also announced plans of a major retail foray.

Retail consultancy KSA Technopak has estimated that 40mn square feet of retail space in total will be added in the next 2-3 years. Mr. Mukesh Ambani, Chairman and Managing Director of Reliance Industries has stated that organized retailing will do for rural India the same what IT did for urban India.

Demand for hotels Over the last two years, the hospitality industry has been growing at about 15% pa. The robust growth is expected to continue as can be inferred from the rise in the number of tourist arrivals, which stood at around 2.5mn (provisional) for the first seven months in the year 2006 as against 2.2mn in the same period, previous year.

With most categories of hotels registering robust growth in average room rates and occupancies, the trend is expected to continue with all major metros expected to grow on the back of increased business travel.

Room additions in premium segment City Existing capacity New additions by 2011 Total rooms by 2011 Bangalore 1,581 2,780 4,361 Delhi 7,146 1,849 8,995 North Mumbai 4,418 1,378 5,796 South Mumbai 2,134 235 2,369 Chennai 1,541 2,333 3,874 Hyderabad 1,017 1,049 2,066 Kolkata 1,428 808 2,236 Pune 508 1,430 1,938 Source: Company reports, India Infoline Research This list is indicative

The additions mentioned in the table above will entail an estimated investment of over Rs100bn over this period, excluding the cost of land, leading to substantial demand for construction contractors. Similarly, the demand for special economic zones (SEZ) too, which are specifically delineated duty free enclaves for promotion of exports, is on the rise and will lead to considerable construction activity. Other commercial constructions like multiplexes will also add to investments in this segment.

Real estate – an alternative investment class People invest in residential or commercial property just as they do in stocks, bonds and gold. Earnings in real estate can come on account of the following: Ö Profit / loss from appreciation in land value Ö Rent income Ö Profit / loss from land development and its subsequent sale

A host of realty funds are being formed to mop up large funds for investments in the property market in India. With the easing of FDI norms, NRI interest in realty funds is rising too. These funds typically, enter the market with a lifecycle of 8-10 years and target a 30% yield. This will enhance realty development in the country. October 18, 2006 Construction Sector 183 India Under ‘Construction’

Government initiatives for the sector Government initiatives have aided the real estate sector in a big way. We look at some of the initiatives taken to boost the sector:

Ö Rationalized stamp duties Ö Income Tax benefits to consumers availing home loans Ö Rationalization of property taxes in a number of states Ö Tax and other benefits applicable to SEZ Ö Interest payments up to a certain level on housing loans can be claimed as a deduction from the taxable income Ö Annual principal repayment up to a particular level eligible for rebate from tax liability Ö Exemption from long term capital gains in case of re-investment in second property Ö Opening up of FDI for real estate under the automatic route Ö Permitting real estate investment trusts (REITs) to operate Ö Government support for the repealing the Urban Land Ceiling Act (ULCA), with nine state governments having already repealed the act Ö Modifications in the rent control act to provide better protection to house owners wanting to rent out their properties Ö Proposed computerisation of land records

Investments in real estate ASSOCHAM: Demand for Clearly, investments in the real estate sector are expected to remain high in dwelling units in India is the coming years. According to an ASSOCHAM report on real estate expected to rise to 90mn by development, the demand for dwelling units in India is expected to rise to the year 2020, needing 90mn by the year 2020, which in turn would necessitate a minimum investment investments of US$890bn of US$890bn over this period. This will lead to substantial demand for the over this period construction sector in the coming years. Similarly commercial developments in the form of retail outlets, malls, multiplexes and offices will also add to the construction activity in the sector.

Construction beneficiaries Ö Simplex Infrastructures Ö IVRCL Infrastructures Ö Era Constructions Ö Nagarjuna Construction Ö Gammon India, Patel Engineering and Simplex planning a enter

October 18, 2006 Construction Sector 184 India Under ‘Construction’

Notes

October 18, 2006 Construction Sector 185 India Under ‘Construction’

Notes

October 18, 2006 Construction Sector 186 India Under ‘Construction’

Notes

October 18, 2006 Construction Sector 187 Our Recent Publications

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