Satyam Agarwal (AgarwalS@MotilalOswal.com); +91 22 3982 5410

Amit Shah (Amit.Shah@MotilalOswal.com) / Nirav Vasa (Nirav.Vasa@MotilalOswal.com)

15 January 2015

T&D spend accelerates, led by high-end technology areas ‘Make in India’ an important resolve; indigenizing GIS products - next on agenda n During 9MFY15, PWGR’s ordering activity stood at INR127b (up 49% YoY) led by high-end technology areas of HVDC, GIS and SVC (at

44% of project awards, dominated by MNC players). Conventional T&D segment awards have remained flat YoY. Even during FY16, we

expect high-end technology products like HVDC/STATCOM to drive ordering.

n ‘Make in India’ is a serious initiative. Over the last four years, 765kv AIS products have been indigenized and the success is

commendable, given the first such attempt by PWGR to improve the share of domestic manufacturing. We believe that indigenizing

GIS products is next on the agenda, with domestic manufacturing clauses being introduced by PWGR.

n MNC players, mainly Alstom T&D (Not Rated) and ABB India (Neutral), are best positioned to capture the upsides from high-end

products. CRG (Buy) has been expanding its presence in the chain.

High-end technology segment and Substation ordering drive T&D spend During 9MFY15, PWGR’s ordering activity has shown meaningful improvement from the lows in FY14, with ordering activity at INR127b (up 49% YoY). Key takeaways are: i) bulk of the project awards (at 44%) are from high technology segments like HVDC, STATCOM, GIS etc where the competition was largely restricted to MNC players and ii) conventional T&D segment (conductors, insulator, substation, transformer, transmission line) has witnessed ordering of INR72b, flat YoY. During FY16 too, we expect project awards to be again dominated by such projects, including: i) Raigarh – Poglur (~INR250b, +/-600kv, 6gw) HVDC project, and at ~2,500kms is one of the longest transmission networks globally, ii) ~12-14 STATCOM ordering is expected by Dec 2015 (cost ~USD1.2b).

Make in India: a serious initiative; equipment manufacturers - the key beneficiary ‘Make in India’ is a serious initiative of the government to improve the contribution of manufacturing in India through ‘import substitution’ and ‘increased exports’. PWGR has stated that it is fully committed to this initiative of the government and has made it mandatory for T&D players to manufacture certain components in India for orders tendered out in key high-end technology products such as SVC/STATCOM, GIS, 765kv transformers and reactors, HTLS conductors, OPGW and HVDC. Over the last four years, 765kv AIS products have been largely indigenized, and the success is commendable, given the first such attempt by PWGR to improve the share of domestic manufacturing. TBEA commissioned the 765kva transformer/reactor facility in end-CY13 and Toshiba T&D India has commenced construction for the 765kva range products (to be completed by mid-CY15).

Most players are also targeting the export market, and thus India is becoming a manufacturing hub for such equipments. We believe that indigenizing GIS products is next on the agenda, with domestic manufacturing clauses being introduced. Both Alstom T&D India and ABB India have commissioned factories in India, for manufacturing up to 400kva GIS products.

2QFY15 revenue growth in positive territory, margins improve Mid-cap power product companies have reported 22% YoY revenue increase (ttm, as at end-2QFY15); margins have also improved from lows of ~1-1.1% ttm in 1HFY14 to 2.7% ttm in 2QFY15. Margins had peaked at 17-18% in FY08/09 and thus the decline has been substantial, largely led by intense pricing pressure and negative operating leverage. Segmental analysis for large cap companies indicate that ttm revenue growth stood at 8% and ttm EBIT margin stabilizing at 6.6% (versus peak levels of 15% in FY08/09). With product prices bottoming out and competitive environment becoming more disciplined, margins should improve, in our view.

ABB, CRG, Alstom T&D best positioned We believe that there are multiple levers at play, including increased share of high technology products and also the need to correct under-investments in intra-state transmission/distribution segment. MNC players, mainly Alstom T&D (Not Rated) and ABB India (Neutral) are best positioned to capture the upsides from high-end products, given the continuous focus on indigenization. CRG (Buy) has been expanding its presence in the chain, including 765kva Circuit Breakers, Substation Automation, GIS etc and also has a market share of 18% in distribution segment in India.

Investors are advised to refer through disclosures made at the end of the Research Report.

CAPITAL GOODS INSIGHTS

Fulcrum aims to capture and analyze the emerging trends in different sub-segments of the Capital Goods sector. The discussion encompasses various products, companies, and segments that are likely to be impacted or touched by these emerging trends.

15 January 2015 2

CAPITAL GOODS INSIGHTS

Make in India: a serious initiative; equipment manufacturers - the key beneficiary Make in India is a serious initiative of the government to improve the contribution of manufacturing in India, through ‘import substitution’ and ‘increased exports’. PWGR has stated that it is fully committed to this initiative of the government and has made it mandatory for T&D players to manufacture certain components in India for orders tendered out in key high-end technology products such as SVC/STATCOM, GIS, 765kv transformers and reactors, HTLS conductors, OPGW and HVDC. Over the last four years, 765kv AIS products have been largely indigenized and the success is commendable, given the first such attempt by PWGR to improve the share of domestic manufacturing. We believe that indigenizing GIS products is next on the agenda, with domestic manufacturing clauses being introduced. Exhibit 1: PWGR: revisions to procurement clauses to support Make in India initiative Products PWGR: Make in India clause

SVC and STATCOM packages At least one SVC/STATCOM to be sourced from India

765KV class Transformer/Reactor

Foreign bidders to supply at least one transformer/Reactor from India

GIS Equipment 400kv: Indian subsidiaries of MNCs may also supply from their Indian factories

765kv bidders to set up manufacturing facilities in India

HTLS Conductors, OPGW and HVDC

Thrust on indigenization/Indian collaboration

Source: MOSL, PWGR

765kva AIS products have been successfully indigenized; India can be an export hub for such products n 765kva products were initially introduced in India during FY09, and in the initial

three years till FY11, imported products (particularly from Koreans and Chinese players) had a dominant market share of ~70%+. The mandatory domestic manufacturing clause was introduced by PWGR in FY11, and since then the manufacturing has been largely indigenized.

n Over the last four years, several companies have set up such facilities including ABB, CRG, Alstom T&D, TBEA etc. In CY11, ABB had improved the localization content for 765kva products, while TBEA commissioned the manufacturing facility in Vadodara in end-CY13. Toshiba T&D India has also started construction of a new line to manufacture 765kva transformers and the facility is expected to be commissioned in mid-CY15. The success is commendable, given the first such attempt by PWGR to improve the share of domestic manufacturing.

n Post the imposition of mandatory domestic manufacturing clause, Korean players like Hyundai and Hyosung had completely withdrawn from the market since end-CY12. Siemens had also withdrawn from the 765kva transformer space, post the initial unsuccessful bids in FY08/09.

n Over the last three years, pricing in both reactors and transformers have also bounced back sharply from the low levels in CY12 (when competitive intensity was severe) and have now stabilized. In the past, CRG maintained that the Bhopal factory (765kva) contributed ~12-14% EBITDA margin, and thus profitability levels based on domestic manufacturing has also reached healthy levels.

15 January 2015 3

CAPITAL GOODS INSIGHTS

Exhibit 2: Key bidders for 765kva/500mva transformers; Koreans have vacated the market

Source: MOSL, PWGR

Exhibit 3: 765kva transformer prices are stabilizing, up from the low levels in 2012 (INRM/mva)

Source: MOSL, PWGR

Attempt to indigenize GIS products - next on agenda n GIS has witnessed increased traction, with project awards of INR27b in FY13/14

and another INR18b in 9MFY15, contributing to 11% of the cumulative project awards by PWGR. Of this, bulk of the orders has been bagged by Korean and Chinese players: Hyosung (Korea) at INR20b, Pinggao (Korea) INR7b and North East Electric Group (China) INR5b.

n PWGR had recently revised PQ norms: i) 400kv products - Indian subsidiaries of MNCs can supply from their Indian factories and ii) 765kv products - mandatory domestic manufacturing is being insisted. This should support domestic manufacturing, going forward.

n Both Alstom T&D India and ABB India have commissioned factories in India to manufacture up to 400kva GIS products. Alstom T&D has recently received an order of INR2.3b for 400/220kv Betul GIS substation project in Dec 2014 and is the first large-sized project wins in GIS from PWGR. Also, ABB commissioned the GIS factory in Nov 2013 and supplied the first 420kva GIS in 1QFY15. Company is still not prequalified by PWGR for bidding, with three instances of bids being rejected over the last year. Going forward, we believe that Hyosung, TBEA etc may also set up manufacturing facilities in India for GIS products. Toshiba globally has a market share of 28% in GIS products, and thus could add a manufacturing facility in India.

n Given the land availability constraints (for expansion of substations) and also lower price levels for GIS products, we expect demand to improve meaningfully. Several SEBs should also start to award GIS products and that could be an important trigger.

0.24

0.27

0.22 0.

23

0.21

0.17

0.22

0.21

0.23

0.20 0.20

0.23 0.24

Mar

08

Mar

09

Mar

11

Sep

11

Oct

11

Feb

12

Mar

12

Jun

12

Nov

12

Dec

12

Jan

13

Apr

13

Jan

14

Stabilizing prices

15 January 2015 4

CAPITAL GOODS INSIGHTS

Exhibit 4: Ordering traction picks up in high technology areas, GIS contributes ~13-15% of PWGR awards in FY14/9MFY15 (% share in PWGR awards)

Source: MOSL, PWGR

Exhibit 5: Hyosung has dominated the GIS market segment; imported products have a market share of ~80%+ (market share during FY13-9MFY15)

Source: MOSL, PWGR

Market share of imported products decline in PWGR orders We believe with the implementation of Make in India clause by PWGR, domestic players and MNC companies with local manufacturing facilities stand to benefit. Increased imports, particularly from China/Korea over the last five to six years, have been an area of concern in several product segments. Key beneficiaries include ABB, Alstom, BHEL etc.

Exhibit 6: Recent high technology product wins (like HVDC etc) have also been bagged by European players in JV with local arms

Source: MOSL, PWGR

Exhibit 7: Market share of Chinese/Korean players has declined in 9MFY15 (% of PWGR awards)

Source: MOSL, PWGR

1 2 1 2 7 15 13

- -

29

-

15 -

26

1 -

0

-

0

-

4

FY09 FY10 FY11 FY12 FY13 FY14 FY15 YTD

GIS HVDC SVC

Hyosung 45

Pinggao, 13

New Northeast,

24

Others, 18

0

20

40

60

80

100

FY09 FY10 FY11 FY12 FY13 FY14 9m FY15

China Korea Europe (incl JVs) Others India

0.9

10.2

2.27.1 9.2 8.3

6.03.6

4.5

1.3

1.71.9

9.3

3.6

FY09

FY10

FY11

FY12

FY13

FY14

9m

FY15

China Korea

15 January 2015 5

CAPITAL GOODS INSIGHTS

PWGR project awards improve, led by high technology areas During 9MFY15, PWGR’s ordering activity has shown an improvement, with project awards at INR127b (up 49% YoY), largely aided by the base effect and also high-end technology products (GIS, HVDC, SVC etc). While the acceleration has been encouraging, ttm project awards at INR150b, is still down 47% from peak levels of INR284b (ttm, 1QFY13). Key takeaways are: n Order awards led by high technology areas: Key project awards in 9MFY15 have

been: i) Champa - Kurukshetra HVDC order of INR33b to Alstom Grid, ii) STATCOM orders of INR4.9b to Siemens AG (first such project award), iii) GIS products of INR17.6b. Cumulatively, these segments contributed to 44% of project awards during 9MFY15. Thus, incrementally a large part of the ordering is skewed towards high technology projects including HVDC, STATCOMs, WAM, GIS etc. In the recent concall, Alstom T&D stated that the growth in PWGR awards in FY15 will be led by high technology areas; excluding them, the awards will be muted and similar to FY14 levels.

n Transmission tower order awards at INR40b (stable YoY), competitive intensity remains stable: Transmission tower packages project awards stand at INR40b in 9MFY15 (stable YoY) and are largely towards private IPPs like Lalitpur (1,320mw), NCC Power (1,320mw), IL&FS (1,200mw) etc. Competitive intensity remains stable with six bidders averaging in most bids versus high levels of 12-14 bids in FY12. Most companies have been guiding for stable margins in the segment.

Exhibit 8: Project awards (ttm, INR b) have improved from low levels

Source: MOSL, PWGR

Exhibit 9: 9MFY15 awards are up 48% YoY (quarterly awards, INR b)

Source: MOSL, PWGR

Incremental awards led by high technology areas; competition restricted n We expect Raigarh – Poglur (Tamil Nadu, +/-600kv, 6gw) project to be possibly

awarded in FY16, and at ~2,500kms is one of the longest transmission networks globally. Also, few more projects are expected in the next two to three years, which includes the 2.5gw West – North Connection and Sri Lanka - India connection. Since FY11, PWGR has awarded three HVDC projects aggregating INR111b, with two projects being won by Alstom T&D and one by ABB-BHEL. We note that the localization levels in both projects are likely at ~35-45%, given the pre-qualification norms, and the quantum is expected to improve. Bidders for the last project were ABB, Alstom T&D and BHEL.

142

133

124

119

117

119

116

184

177 19

724

822

7 284

277

247

162

130

123

107

109

107 14

015

0

1QFY

10

3QFY

10

1QFY

11

3QFY

11

1QFY

12

3QFY

12

1QFY

13

3QFY

13

1QFY

14

3QFY

14

1QFY

15

3QFY

15

15

27

36 67

12

18

27

63

10

20

24

130

3 39 76

108

61

32 47

22

29

24

32

24

27

58

42

1QFY

09

3QFY

09

1QFY

10

3QFY

10

1QFY

11

3QFY

11

1QFY

12

3QFY

12

1QFY

13

3QFY

13

1QFY

14

3QFY

14

1QFY

15

3QFY

15

15 January 2015 6

CAPITAL GOODS INSIGHTS

n In SVC, Siemens AG won the first such order for three substations by PWGR at INR4.9b. PWGR plans to award 12-14 STATCOM projects by Dec 2015, with each at ~USD100m, and thus the opportunity pie is significant. PWGR had rejected the bids of Hyosung, Toshiba, China EPRI Science & Technology and Rongxin Power for SVC project, and thus the bidders were ABB, Siemens and Alstom T&D.

n Power Ministry has recently nominated PWGR to implement eight transmission projects worth INR360b, instead of inviting competitive bids, to execute the projects "under compressed time schedule". The key project is the Raigarh – Poglur (Tamil Nadu, +/-600kv, 4gw) HVDC at a cost of INR250b+. In addition, another INR180-200b of projects will be awarded through the competitive route.

Exhibit 10: PWGR ordering: segmental composition (% share, 9MFY15), ordering led by high technology areas

Source: MOSL, PWGR

Exhibit 11: PWGR ordering: Indian/European players (with local arms) dominate (% share, 9MFY15)

Source: MOSL, PWGR

Transmission tower order awards improve, competitive intensity stable Exhibit 12: Transmission tower: competitive intensity remains stable with 6 bidders averaging in most bids, v/s high levels of 12-14 bids in FY12

Source: MOSL, PWGR

HVDC, 26

Towers, 32

SVC, 4Substation,

10

GIS, 14

Others, 29China, 7

India, 58

Korea, 5

Europe (incl JV), 30

0

2

4

6

8

10

12

30

50

70

90

110

130

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Aug

-10

Dec

-10

Apr

-11

Aug

-11

Dec

-11

Apr

-12

Aug

-12

Dec

-12

Apr

-13

Aug

-13

Dec

-13

Apr

-14

Aug

-14

Dec

-14

Awards (ttm, INR B, LHS) Avg Bidders (Nos/month)

15 January 2015 7

CAPITAL GOODS INSIGHTS

Exhibit 13: 9MFY15 project wins largely by frontline players (% of total)

Source: Company, PWGR

Exhibit 14: Transmission tower awards at ~30-40% of PWGR awards

Source: Company, PWGR

Substation ordering indicates strong traction, competitive intensity stable

Exhibit 15: 9MFY15 project wins indicate BHEL as the key player (% of total)

Source: MOSL, PWGR

Exhibit 16: Substation awards at ~8-17% of PWGR awards

Source: MOSL, PWGR

Exhibit 17: Competitive intensity reduces significantly in recent time with average 3-4 bidders per project

Source: MOSL, PWGR

Gammon 13

KEC , 9

Others, 13

L&T, 13Kalpataru, 7

Tata projects, 21

EMC Ltd, 7

32.836.9 35.2

42.6 43.0 40.231.6

47,4

02

44,0

03

64,5

26

96,4

54

69,4

83

43,6

06

39,8

36

FY09

FY10

FY11

FY12

FY13

FY14

ytd

FY15

% of Total INR M

Techno Electric, 9

BHEL, 22

Alstom T&D, 14

EMCO, 19

Mcnally Bharat, 10

Others, 25

23,809 18,522 15,994

27,164

14,670 9,545 12,212

16.5 15.5

8.7

12.0

9.1 8.8 9.6

FY09 FY10 FY11 FY12 FY13 FY14 FY15 YTD

INR m % of Total T&D spend

0

5

10

15

20

-

5,000

10,000

15,000

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

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-09

Apr

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Aug

-10

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-11

Aug

-11

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Apr

-12

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-12

Dec

-12

Apr

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Aug

-13

Dec

-13

Apr

-14

Aug

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Dec

-14

Project awards (INR M) Bidders (Nos)

15 January 2015 8

CAPITAL GOODS INSIGHTS

T&D spend to accelerate: SEBs/grid efficiency provides avenues Emerging new growth areas to support T&D spending While PWGR’s ordering is likely to plateau at ~INR170-200b pa in the medium term, after bouncing back from the lows of INR109b in FY14, we believe there exists upside possibilities from i) Green Energy Corridors (investment plan INR425b, process initiated for technical and financial assistance) and expect few renewable energy grid project awards in FY15, ii) Intra-state transmission projects (as strengthening of the sub-transmission network in states is an important part of the chain, and investments during the Eleventh Plan has been just ~45-50% of the requirements) and iii) Substation automation (particularly post the blackouts in July 2012) including concentrators/PMUs, FACTS etc for grid stability. Desert 2050 Plan also entails renewable energy capacity addition of 300gw, and transmission spending of INR4.5t, of which INR198b is targeted in the Thirteenth Plan (FY18-22). We note that few of these project awards should possibly accelerate. Several of these projects will necessitate the need for technology upgradation by Indian companies, while MNC players would benefit on the back of technological edge. In 4QFY14, PWGR awarded orders for supply of ~1,300 PMUs to Alstom (INR3.6b) and in 1HFY15 awarded SVC for three substations to Siemens (INR4.9b). Another important demand driver, particularly for large players, is that the share of ultra-high voltage segment in the Twelfth Plan is increasing to 30-32% from 5-7% earlier, and given that there are few players pre-qualified in this segment, the business economics should possibly improve.

Exhibit 18: HT Switchgears have witnessed traction, led by PWGR spending (ttm, % YoY)

Source: IEEMA, MOSL

Exhibit 19: Distribution Transformers growth rates higher than Power Transformers (ttm, % YoY)

Source: IEEMA, MOSL

2QFY15 revenue growth in positive territory, margins improve n Mid-cap power product companies have reported 22% YoY revenue increase

(ttm, as at end-2QFY15); margins have also improved from a lows of ~1-1.1% ttm in 1HFY14 to 2.7% ttm in 2QFY15. Margins had peaked at 17-18% in FY08/09 and thus the decline has been substantial, largely led by intense pricing pressure and negative operating leverage.

n Segmental analysis for the large cap companies indicates that ttm revenue growth stood at 8%, and ttm EBIT margins stabilizing at 6.6% (versus peak levels of 15% in FY08/09). With product prices bottoming out and competitive environment becoming more disciplined, margins should improve.

-20

-10

0

10

20

30

40

50

Jan-

09M

ay-0

9Se

p-09

Jan-

10M

ay-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2Se

p-12

Jan-

13M

ay-1

3Se

p-13

Jan-

14M

ay-1

4Se

p-14

HT - Switchgear LT - Switchgear

-20

-10

0

10

20

30

40

-20

-10

0

10

20

30

Dec

-08

Mar

-09

Jun-

09Se

p-09

Dec

-09

Mar

-10

Jun-

10Se

p-10

Dec

-10

Mar

-11

Jun-

11Se

p-11

Dec

-11

Mar

-12

Jun-

12Se

p-12

Dec

-12

Mar

-13

Jun-

13Se

p-13

Dec

-13

Mar

-14

Jun-

14Se

p-14

Distribution Transformers, ttm- % YOY [LHS]Power Transformer, ttm- % YoY

15 January 2015 9

CAPITAL GOODS INSIGHTS

Management commentary has been positive and the industry should bounce back to a much more normative growth level. Also, transformer prices have stabilized, albeit at lower levels. Competitive intensity is showing signs of moderation, given the poor execution track record of new entrants/stringent evaluation by PWGR, which includes a two-stage bidding process/decline in participation by Koreans, given the requirement of domestic manufacturing.

Exhibit 20: Power products revenue improve, for both large cap/mid- cap companies (% YoY, ttm basis)

Source: Company, MOSL

Exhibit 21: Margins have also shown signs of stabilization, improvement will be a function of operating leverage

Source: Company, MOSL

Exhibit 22: Valuation summary Mcap CMP EPS (INR) P/E (x) EV/EBITDA (x) RoE (%) Company USD INR FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E

ABB# 4.3 1,261 11.2 17.1 27.4 112.7 73.8 46.1 47.9 36.3 25.7 8.6 12.5 18.2

BHEL 10.5 267 7.9 12.7 18.2 33.6 20.9 14.7 18.9 11.2 7.3 5.8 8.7 11.5

Crompton 1.9 187 5.3 10.3 14.5 35.1 18.1 12.8 17.3 11.8 8.4 8.7 15.3 18.8

Cummins 4.0 885 23.8 27.2 33.1 37.2 32.5 26.8 31.5 27.8 22.9 24.1 25.2 28.1

L&T 23.4 1,564 45.0 57.2 80.1 34.8 27.3 19.5 21.0 18.4 14.0 13.6 14.0 16.2

Siemens## 5.4 945 8.7 14.1 18.7 108.5 66.9 50.6 54.7 34.8 27.7 7.4 11.2 13.9

Thermax 2.0 1,031 22.9 32.7 48.4 44.9 31.5 21.3 27.7 19.5 13.5 13.0 17.1 22.1

Havells 2.7 265 8.6 10.2 13.1 30.9 26.0 20.2 19.7 15.4 12.2 27.8 28.1 30.1

Voltas 1.3 252 10.3 13.6 16.6 24.4 18.6 15.1 19.4 14.4 11.2 15.6 17.9 19.0

BEL 4.2 3,268 120.5 143.6 167.9 27.1 22.8 19.5 22.0 16.9 13.9 12.4 13.3 13.9

KEC Internatl. 0.4 92 5.8 9.1 13.2 16.0 10.1 7.0 7.1 4.9 3.9 10.1 14.3 17.9

VA Tech Wabag 0.7 1,587 48.1 64.4 85.0 33.0 24.6 18.7 16.7 12.6 9.7 13.5 15.9 17.9

# Year end December; ## Year end September Source: Company, MOSL

-30%-15%

0%15%30%45%60%

2QFY

08

4QFY

08

2QFY

09

4QFY

09

2QFY

10

4QFY

10

2QFY

11

4QFY

11

2QFY

12

4QFY

12

2QFY

13

4QFY

13

2QFY

14

4QFY

14

2QFY

15

Large Caps Mid Caps

0.0%

5.0%

10.0%

15.0%

20.0%

2QFY

08

4QFY

08

2QFY

09

4QFY

09

2QFY

10

4QFY

10

2QFY

11

4QFY

11

2QFY

12

4QFY

12

2QFY

13

4QFY

13

2QFY

14

4QFY

14

2QFY

15

Large Caps Mid Caps

15 January 2015 10

CAPITAL GOODS INSIGHTS

N O T E S

15 January 2015 11

CAPITAL GOODS INSIGHTS

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