May 25, 2011

May 25, 2011

Highlights

Consumption Rises At Slower Pace

Higher Costs Dent Profits

Indian Cement Industry: Continues To Build

May 25, 2011 May 25, 2011

Indian Cement Industry

Cement despatches rose by 4.5% to 2088 lakh tonnes during the financial year ended March 2011, compared to the previous year, as

per data released by the Cement Manufacturers Association. Despatches during March were 13.9% higher than the February 2011 level.

These were the highest ever monthly despatch figures of cement.

A sharp growth in despatches was recorded by Ultra Tech Cement and Jaiprashakash Associates at 87.2% and 38.6%, respectively.

Both these companies added capacities during the previous year which resulted in a surge in their despatches.

Consumption figures released by CMA reflect a similar trend and growth rate as despatches.

It must be noted that the industry registered the lowest growth in production and despatches in the past 10 years. Subdued growth in

key cement consuming states, driven by lower infrastructure spending, slowdown in the realty sector, extended monsoon and non-

availability of railway wagons, resulted in slower growth.

The companies added 28 million tonnes of manufacturing capacity during the financial year 2011, in addition to 60 million tonnes in

the previous year. Cement manufacturing capacity in India has nearly doubled in the past five years. A thrust on infrastructure develop-

ment, lower interest rate scenario, rising demand for housing and a strong economic growth pushed by the stimulus package provided

by the government, enabled the industry to absorb the capacity increase. However, in the financial year 2010-11, slower growth in ce-

ment demand and rising capacities led to a surplus like situation.

Although growth in demand for cement has slowed down, cement companies have been raising prices since February 2011 on account

of higher raw material prices. A sharp rise in cost of raw materials, which account for 70-75% of the cost of cement production, has

been exerting downward pressure on profit margins of cement manufacturers.

During the quarter ended March 2011, higher coal and railway freight charges pushed up costs for the cement companies. Domestic

coal companies — like Coal India and Mahanadi Coalfields — raised prices between 40 and 55%. Also, cement manufacturers had to

shell out an additional Rs 8 per tonne for transportation of coal through the Indian Railways from December 2010.

120

130

140

150

160

170

180

190

200

210

220

Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

lakh tonnes All India Cement Despatches

2008-09 2009-10 2010-11

All India Cement Despatches for FY 2011

In '000 tonnes

% Y-o-Y growth

Ultratech Cement 32963 87.2

A C C 21840 2.9

Ambuja Cements 20429 6.5

Jaiprakash Associates 14684 38.6

India Cements 10283 -2.0

Shree Cement 9395 0.4

Century Textiles & Inds. 7723 2.3

Lafarge India Pvt. 6791 6.8

Birla Corporation 5923 4.6

Kesoram Industries 5432 -2.3

All India Total 208747 4.5

Note: The list of companies is not exhaustive; Source: CMIE

May 25, 2011 May 25, 2011

Average cement prices for the financial year 2010-11

remained stagnant compared to the year-ago level. Ce-

ment prices continued to rise in April 2011 after rising

sharply in March 2011.

Cement despatches record a fall in April each year after a

surge in March. This year, too, was no different.

Notwithstanding the fall in demand, cement companies

in April hiked prices by Rs.10-20 per 50-kg bag across

regions due to a sharp increase in costs.

Cement prices across cities in India rose by 1-5% over

the March 2011 level. Average monthly price in Mumbai

rose by 2.2% to Rs283 per 50 kg bag, while that in Kol-

kata rose to Rs305 per 50 kg bag during April 2011.

Increase in cement prices resulted in higher realisations

for the companies. However, it did not compensate fully for the rise in costs.

For example, ACC realisations in the fourth quarter of the last fiscal increased to Rs 194 a 50 kg bag, an increase of 11% quarter-on-

quarter, but it reported 13% drop in the fourth quarter net profit.

PRU View

Cement companies were able to raise prices as the demand picked up across the country. However, the demand for cement is likely to

subside during the monsoon season as construction activity slows down and interest on home loans rise. Also, with new capacities

likely to come on stream in the coming months, cement prices are expected to fall from the current levels. Prices are expected to gradu-

ally recover post-monsoon. Availability of rail wagons also affects despatches, post rains, as railway wagons get diverted to transport

fertilisers as a priority.

Cement production in the country is estimated to increase to 315-320 million tonnes by end of financial year 2011-12 from the current

300 million tonnes, according to CMA. This reflects nearly 6% year-on-year growth in production compared to FY 2011. CMA is tar-

geting to achieve 550 million tonnes capacity by 2020.

Increased focus of cement companies using alternate fuels for manufacturing has likely to result in lower fuel cost burden on the com-

panies in the medium term period. Cement companies are using alternate sources like tyre chips, rubber dust, coffee & rice husk, hazel-

nut shells or paper sludge among other inputs for producing energy. However, coal will continue to remain the primary source of fuel

for cement companies.

————————————————————————————————

230.0

235.0

240.0

245.0

250.0

255.0

260.0

265.0

270.0

275.0

280.0

Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

Rs./50 kg Average Wholesale Prices of Cement in

Mumbai

2008-09 2009-10 2010-11

Source: CMIE, Dhanbank PRU

May 25, 2011 May 25, 2011

Aviation: Flying High

Aviation needs $30 billion investment over 15 years: The aviation sector needs $30 billion worth of investment over the next 15

years to keep up with booming passenger and cargo traffic, Secretary Nasim Zaidi said. "We must have a long-term planning matched

with a vibrant regulatory framework as Indian aviation has all the necessary ingredients to grow exponentially," he said at an Assocham

event. (The Economic Times, May 16, 2011)

PRU Analysis

During the financial year 2010-11, nearly 142 million pas-

sengers were recorded at the airports in India. This reflects a

growth of 15% over the previous year. Both passenger and

cargo movement has been growing at a robust pace over the

past few years. According to the Aviation Ministry, passen-

ger movement on the airports is expected to reach 540 mil-

lion by 2025 and scheduled carrier fleet size is forecast to

more than treble from the current 430 to 1,500 aircraft.

Oil marketing companies (OMCs) have been raising aviation

turbine fuel (ATF) prices over the past several months.

OMCs revisit prices every fortnight. The ATF price ex-

Mumbai for the fortnight beginning May 1, 2011, surged by

40% to Rs 61,429 per kilolitre compared to the average price

in May 2010. Prices rose by nearly Rs 19,445 a kilolitre.

PRU View

While the rebound in global aviation industry has been strong in 2010, rising aviation turbine fuel (ATF) prices may adversely affect

financial prospects of the industry as a chuck of the cost comprises ATF. High interest costs are also estimated to have dented profit-

ability of the domestic airlines for the March 2011 quarter.

Foreign Tourist Arrivals (FTAs) in India during the April 2011 rose to 4.17 lakh as compared to 3.54 lakh during April 2010 and 3.48

lakh in April 2009. There has been a growth of 17.7% in April 2011 over April 2010, as compared to a growth of 2% registered in April

2010 over April 2009.

Higher tourist inflow could bring a respite to the bleeding Indian aviation industry. Airline industry in India is expected to record a

healthy overall growth given the improvement in foreign trade, construction of airports in non-metros and in Tier-II & Tier-III cities

which will make air transport more accessible.

The Indian Telecom Services Performance Indicators

Telecom Regulatory Authority of India (TRAI) has released its quarterly publication on service performance of telecom operators in

India for the quarter ended December 2010. TRAI releases this report with a lag of nearly 4-5 months.

Highlights of the report

Wireline subscribers recorded a 1.3% decline in December 2010 quarter compared to September 2010.

May 25, 2011 May 25, 2011

GSM subscribers of wireless services account for 85.3% of total

wireless subscriber base

Internet subscribers rose by 4.4% over the September 2010 quarter

A look at the financial parameters reflect a dim picture

Minutes of usage (MOU) per subscriber per month for GSM ser-

vice declined by 2.3%, from 368 in September to 360 in Decem-

ber

Both incoming and outgoing MOU declined during the quarter

Average revenue per user (ARPU) from GSM subscribers per

month fell from Rs 110 in September 2010 quarter to Rs 105 in

the December quarter

ARPU from GSM was a whooping 27% lower than December 2009 levels

Similarly, ARPU from CDMA subscribers dipped to Rs 68 in December quarter and is 17% lower than the year-ago level

PRU View

Falling tariff and reduced MOU resulted in a sharp decline in ARPU of wireline and wireless subscribers. This was in line with our

expectations. PRU in its earlier articles on telecom had indeed mentioned that the industry is likely to record a fall in ARPU during the

financial year 2010-11.

Going further, we do not expect cellular tariffs in India to fall given that tariffs here are amongst the lowest in the world and voice &

data charges in the telecom industry have reached rock bottom levels. So much so, that in the case of a few companies, operational ex-

penses are higher than revenues, because their inter-connect costs are greater than the tariff they are charging. Hence, there exists little

scope for further price reductions.

Yellow Metal Hitting New Records

Gold imports surge on high demand: India imported 286 tonnes of gold in the first quarter of 2011, according to the World Gold

Council’s (WGC) report on trends in demand, released on Thursday. (Business Standard, May 20, 2011)

PRU Analysis

According to a recent report released by World Gold Council (WGC), global demand for gold remained robust during Q1CY11.

Demand for gold has been driven by following factors.

Rising inflation rates and low deposit rates in emerging markets including India and China means negative real interest rates.

Hence money in the bank is worthless.

Ongoing problems in Europe which was highlighted by recent downgrade of credit rating of both Greece and Portugal. This con-

tributed to further uncertainty in the market.

Weakening of dollar. Gold is always used as a hedge against dollar movement. Central banks prefer to have gold reserve instead of

dollar reserve in weakening dollar situation. Central banks in different countries turned net buyers from net sellers of gold during

this quarter.

-During this quarter purchases totaled 129 tonnes which exceeded the combined total of net purchases during the first three

quarters of previous year. The main contributor was Mexico which increased its reserves by 90 tonnes.

Telecom Statistics As On December 31, 2010

Telecom Subscribers (Wireless & Wireline)

Total Subscribers 787.3 million

Urban Subscribers 67%

Rural Subscribers 33%

Market share of Private Operators 84.6%

Market share of PSU Operators 15.4%

Teledensity 66.2

Urban Teledensity 147.9

Rural Teledensity 31.2

Internet & Broadband Subscribers

Total Internet Subscribers 18.7 million

Broadband Subscribers 11 million

May 25, 2011 May 25, 2011

The global demand in volume terms witnessed a growth of

11% to 981 tonnes (Y-o-Y basis) driven mainly by invest-

ment demand.

Investment demand growth of 26% (Y-o-Y basis) was

largely attributed to significant (62% Y-o-Y basis) in-

crease in demand for gold bars.

* Provisional

In spite of the increasing average prices, jewellery demand

which accounted for 57% of the total Q1 demand regis-

tered a growth rate of 7%. India and China accounted for

63% of the total gold jewellery demand during this quar-

ter.

As far as investment demand is concerned, India ac-

counted for about 23% of the total demand. Demand for

gold coins and bars grew by 8% (Y-o-Y basis) to reach

85.6 tonnes.

India imported 286 tonnes of gold during Q1CY11, 10%

up Y-o-Y basis. Higher import was driven by strong de-

mand. During CY2010, India’s net import of gold was 958

tonnes.

India’s demand for gold jewellery accounted for significant

37% of the global total. This demand of 206.2 tonnes ( up

12% Y-o-Y basis) represents strong quarterly numbers

since Q3CY08. During January-February, local gold prices

dipped, providing retailers and wholesalers an opportunity to build stocks. Also, there was an anticipation of hike in customs duty in

the February FY11-12 budget.

Consumer demand was further fuelled by auspicious Makar Sankranti on January 14.

The second quarter demand will be further lifted due to onset of marriage season and Akshaya Tritiya festival. So, if this trend contin-

ues, import of gold might cross 1,000 tonnes during CY11.

Spot Gold price traded on Multi Commodity Exchange hit all time high of Rs 22,480 on May 2, and is currently hovering around Rs

22,300.

Note: ^ ( Q1CY10 Vs Q1CY11)

Total Gold Demand (tonnes)

Q1CY10 Q1CY11* Y-o-Y (%)

Investments 246 311 26

Jewellery 521 557 7

Technology 114 114 0

Total 881 981 11

Investment Demand (tonnes)

Q1CY

10

Q1CY

11

Y-o-Y

(%)

Investment 245.6 310.5 26.43

Total bars and Coins 240.9 366.4 52.1

Physical bars 173.2 280.4 61.89

Official Coin 45.2 62.7 38.72

Medals/Imitation Coin 22.5 23.3 3.56

ETF and Similar Products 4.7 -55.9

OTC Investments and Stock flows 7 -128

Indian Consumer Demand (tonnes)

Q1CY10 Q1CY11

Y-o-Y

(%)

Jewellery 184.1 206.2 12

Total bar and Coin Investment 79.3 85.6 7.94

Total 263.4 291.8 10.78

Indian Supply Estimates (tonnes)

Q1CY10 Q2CY10 Q3CY10 Q4CY10 CY2010 Q1CY11 Y-o-Y(%)^

Net Import 261.00 167.00 250.00 281.00 958.00 286.00 10.00

Domestic Supply from Recyled Gold 14.00 20.00 22.00 25.00 81.00 10.00 -28.00

Domestic Supply from Other Sources 3.00 3.00 3.00 2.00 11.00 3.00 0.00

Total Supply 278.00 190.00 275.00 308.00 1048.00 299.00 8.00

Source: World Gold Council

May 25, 2011 May 25, 2011

Despite the high price, gold imports are likely to

continue in the coming months of CY11 due to high

consumer demand. Any price dip in future will

lead to building of stocks.

It can be mentioned here that supply from domestic

sources, especially recycled gold, has fallen by 28%

(Y-o-Y basis) to just 10 tonnes

It can be mentioned here that during Q1 CY11 total

global supply of gold had declined by 4% Y-o-Y to

872.2 tonnes. While total mine supply contributed

positively by increase of 9% (Y-o-Y basis) to total

supply. The supply of recycled gold declined by 6%

to 347.8 tonnes compared to corresponding period

last year.

Spinning Mills In Trouble Again

Low cotton prices may hit yarn millers' margins: The recent fall in raw cotton prices and subsequent decline in cotton yarn prices

seem to have hit yarn markers. Spinning mills across the country fear it would put their margins under pressure. (Business Standard,

May 18, 2011)

PRU Analysis

In a recent move on April 29, 2011, the government decided to withdraw the export incentive of 4% or duty drawback on cotton yarn.

Duty drawback aims at reimbursing the customs and excise duty on inputs that goes for export production.

According to the Ministry of Commerce, drawback is the refund of duties, taxes, and fees imposed on imported merchandise which is

subsequently exported.

Earlier on April 21, another export incentive on yarn known as the Duty Entitlement Pass Book (DEPB) scheme was also withdrawn.

Note: According to Department of commerce, Duty

Entitlement Pass Book (DEPB) scheme is offered by

the Indian government in order to encourage exports

from the country. It is meant to neutralise the inci-

dence of basic and special customs duty on import

content of export product. This is provided by way

of grant of duty credit against the export product at

specified rates. The DEPB allows import of any

items except the items which are otherwise restricted

for imports.

The withdrawal of the two incentive schemes has

had an adverse impact on exports, leading to an in-

ventory pile-up. This has resulted in subsequent

price drop. Yarn prices for hank 40S (Coimbatore) in

the domestic market have dropped to Rs 228 from Rs 280 per kg last month. The prices in the international mar-

18000

20000

22000

3-Jan 3-Feb 3-Mar 3-Apr 3-May

Domestic Gold Price(Rs/tonne)

Domestic Gold Price(Rs/tonne)

Source: Bloomberg

0

50

100

150

200

250

300 Raw Cotton and Cotton Yarn Price Movement(Rs/kg)

Shankar-6 : Kadi(Rs/kg) Cotton Hank Yarn 40s Prices : Coimbatore(Rs/kg)

Source: CMIE

May 25, 2011 May 25, 2011

kets have come down as well after hitting an all-time high in March.

According to the Confederation of Indian Textile Industry (CITI), spinning mills right now hold an inventory of 80-100 million kg of

cotton yarn. A huge inventory pile-up has left these mills with limited working capital for buying raw cotton. Most of the spinning mills

across the country are operating at 50-60% of capacity.

Raw cotton prices have fallen too. According to Cotton Association of India, the domestic cotton prices are currently hovering around

Rs 126 per kg (Rs 45,000 per candy) for the popular Shankar 6 (LS) kadi category, a fall of 21% compared to the preceding month.

Under the current situation, the margin of the spinning mills are severely squeezed.

In a meeting of all major regional associations, spinning mills have decided to cut production by 33% due to the steep fall in yarn prices

and dismal export prospects.

Double Whammy for Paints Industry

Indian paint companies see waning auto, housing demand hit growth: Indian paint makers are expected to see growth slowing in

the coming months as a dent in demand for homes, offices and cars is seen hurting the industry. (The Economic Times, May 16, 2011)

PRU Analysis

The paints industry, an ancillary to the construction and automobile industries, is expected to see low growth in the coming months due

to the arrival of monsoons which would slow the construction activity, the recent rise in interest rates that may reduce demand for auto-

mobiles and housing as consumers shy away from loans at higher rates and defer their purchases to a later stage. Also, a build-up in real

estate inventory (both in the residential as well as commercial space) would further reduce the demand for new projects and would

dampen the prospects of the paints industry in the coming months. The build-up of inventory has happened over a period of time as

demand had slowed but the builders were unwilling to reduce the prices of their properties.

The growth in the core six infrastructure industries index gives an indication of slowing down demand for the construction space in the

period June-September. During the same period last year, the indices had shown a slowdown in the Y-o-Y growth and the same trend is

expected this year also.

The paints industry is also facing incremental pressure on the margin front as raw material prices have been continuously increasing

over the past few months. The prices of main raw materials used in paints — pigments, resins, solvents and additives — have gone up

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-11

Y-o-Y growth In Core infrastructure Index & Cement Index

Infrastructure Cement Source: Bloomberg, Dhanbank PRU

May 25, 2011 May 25, 2011

while the paint companies have not been able to pass on the entire hike to the consumers. This has impacted the EBITDA margins of

companies.

PRU View

The monsoon season, coupled with the build-up in real estate inventory, is not good news for the paints industry as this segment com-

prises around 70% of the total industry. Moreover, the recent hike in interest rates would also act as a dampener to overall sales because

consumers are likely to be deferring their purchases. The hike in interest rates is also expected to dampen demand from the automobile

sector. As a result, the paints industry may be caught in a whirlpool of low demand and declining profitability in the coming months.

Pharma Sector - Regulations For Good?

Drug approvals halt as regulator puts in new clearance system: The country’s medicine regulator, the office of the Drugs Controller

General of India (DCGI), has temporarily stopped giving marketing approvals to new drugs in key therapeutic segments. (Business

Standard, May 23, 2011)

Details of patented drugs to be made public: To increase transparency, India’s patent regulator will soon make public details about

patented drugs which include whether domestic demand for these medicines is met at a reasonable price. (Mint, May 23, 2011)

PRU Analysis

The pharmaceutical industry is witnessing heightened activity from the

regulator. Whereas the DCGI is adding another layer to the process of

new granting marketing approval for new drugs, the patent regulator is

looking to be more transparent in providing statutory information to ease

the system.

As per DCGI, the number of approved drugs in the current calendar year

has almost come to a standstill. This is because the DGCI has stopped

granting marketing approvals to new drugs in the interim. In January to

April this year, a total of 37 new drugs were approved whereas the num-

ber stood at 74 and 86 in CY09 and CY10 respectively. The DCGI is

mulling a new approval system wherein a 10-member New Drug Advi-

Source: Cline, Dhanbank PRU Source: CMIE, Dhanbank PRU

0

5

10

15

20

25

30

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Number Of Approved Drugs

CY09 CY10 CY11

May 25, 2011 May 25, 2011

sory Committee (NDAC) of independent experts will be constituted and their opinion will be sought before the regulator decides

whether to approve a drug or not. An independent panel will be constituted for each key therapeutic categories. Key therapeutic cate-

gories include anti-invectives', gastro-intestinal, cardiac, respiratory, pain/analgesics, vitamins/minerals/nutrients, gynaec, neuro/CNS,

derma and antibiotics.

It may be noted that the main regulatory body in India is the Central Drug Standard Control Organization (CDSCO) under the Minis-

try of Health and Family Welfare. The Drug Controller-General of India (DCGI), who is in charge of approval of licenses for drugs at

both the Central and state levels, presides over CDSCO. Under DGCI, India currently follows a bifurcated drug regulatory system

wherein the regulatory functions are divided between the Centre and state authorities. The central authority issues marketing authori-

zation for new drugs, approves drug imports and clinical trials, and gives licences for vaccine and blood products. State drug control

departments issue licences for drug manufacturing units, drug stores and selling of older drugs that have completed four years of first

approval in the country.

A new drug, after drug discovery and pre-clinical studies, goes through several phases of clinical trials on human beings before it is

approved for marketing and production. These stages begin from Phase 0 and end at Phase V and with each phase the size of the hu-

man sample increases. A marketing approval can only be granted once a new drug is proven to be effective and safe on human beings

after Phase III clinical trials in the country. A Phase IV trial is conducted after a drug is given marketing nod to ensure that it doesn’t

have any harmful side effects. Phase V is post-marketing surveillance which signifies the integration of a new clinical treatment into

widespread public health practice.

A new drug takes any where between 15 to 20 years from the conceptualisation stage to hit the market. The clinical trials are a part of

this process which can take as much as 6 to 8 years to complete. Appropriate marketing approvals for any drug is an important stage

as it allows the drug manufacturer to market and sell its medicines. However, with the advent of NDCA, the authorities are adding

another layer to the existing procedural delays in granting marketing approvals. In spite of showcasing the right intentions in making

the medical profession responsible for the medicines approved for production and marketing, the new approval system soon to be

adopted by the DCGA may also lead to a further delays in marketing approvals. This would, in turn, impact the near term financials of

pharmaceutical companies as the revenue recognition will occur at a later stage. The consumer will also get affected as he will be de-

prived of newer and efficient medicines which would have been consumed sooner rather than later.

In contrast, the Indian patents regulator, the Controller General of Patents, Designs & Trade Marks (CGPDTM) is looking to make the

system more transparent and tighten the screws on the drug patent holders who are lax in disclosing certain mandatory information.

Key information — such as, quantity and value sold, production/imports of drugs along with a written declaration on the extent of

meeting public requirement at reasonable prices (mandatory disclosures in Form 27) — is critical in assessing supply of key drugs at

reasonable price in the domestic market and helps the generic drug manufacturers to file for compulsory licence applications. Since

the prices of patented drugs are exorbitant, transparency in these disclosures would enable domestic companies produce comparable

generic drugs to plug any demand-supply mismatch to keep prices affordable which will benefit the consumers.

FDI In Multi Brand Retail Soon?

Decision on FDI in multi-brand retail soon: The government is expected to take a call on allowing foreign direct investment in multi-

brand retail over the next three months. (The Telegraph, May 19, 2011)

PRU Analysis

The retail industry has been waiting for a very long time for an important regulation which, when implemented, is likely to alter the

retail landscape altogether — FDI in multi-brand retail. FDI in the retail industry can be dated as far as in the early 1990s. During this

time, FDI in retail was allowed but was later banned on political controversies. Since then, FDI has been gradually allowed in other

May 25, 2011 May 25, 2011

formats, with the exception of the multi-brand retail format.

Over the past few years, the industry has been waiting for the government to allow FDI. However, no formal policy has been finalised

yet since there are concerns over the extent of FDI to be allowed. And, as with all other policy issues, there is a lobby in favour of FDI

and there is another lobby against FDI in multi brand retail format.

Argument for FDI in multi-brand retail

Strengthen India's weak supply chain and reduce wastage: Around 40% of perishable items (fruits and vegetables) in

India get destroyed because of lack of storage and warehouse facilities. Large international chains — such as, Wal-Mart,

Tesco, Carrefour and Metro — have the financial strength, technology know-how and expertise to invest for the long term

in a growing economy like India and with their entry, investments will find their way in building such facilities that would

reduce the wastage and help in reducing the price of these items.

Reduction in prices of various goods: The large chains entering in the multi-brand retail segment would make the mid-

dlemen vanish from the entire chain of procurement. As these companies would procure goods directly from farmers, the

mark-up on goods would be limited that would lead to lower price to the consumers. They are also likely to introduce bet-

ter farming techniques to improve productivity, yield and the quality of the crop.

Ensure farmers right price for their produce: With the absence of middlemen, the large international chains would be

happy to offer the farmers the right price with better margins to ensure continuous availability of goods in their stores.

Argument against FDI in multi-brand retail

Wipe out existing small mom-and-pop stores: Many believe that the small mom-and-pop stores, commonly known as

kirana stores in India, would be wiped out as a result of the entry of large multi-brand retail outlets as they would offer the

same goods at much cheaper prices due to economies of scale. This might force the disappearance of kirana stores.

Pricing Control: The large international chains would resolve to unfair practices as they would have huge procurement

requirements and could be in a position to force farmers to sell at lower prices.

PRU View

Despite the evident advantages in allowing for FDI in multi-brand retail, the government has been reluctant so far in formulating any

concrete policies. The reluctance to open up the doors to FDI can be traced back to continuous protests by kirana stores. Sensing an

opportunity, certain political parties have also sought to leverage the situation by lobbying vociferously on behalf of the kirana stores,

which provides a large and ready vote bank.

However, we believe that the presence of domestic multi-brand retail outlets — such as, Big Bazaar, Reliance Retail, etc — renders the

argument against FDI in multi-brand retail invalid. These large outlets have been doing business for many years and have failed to af-

Timeline Regulation

1993 Permit FDI in retail trade.

1996 Banned on Political concerns

1997 FDI allowed in cash & carry segment upto 100%

2006 FDI allowed in cash & carry segment upto 100% brought under automatic route

2006 FBI in single brand retail upto 51% with government approval

May 25, 2011 May 25, 2011

fect the operations of kirana stores. As far as pricing control is concerned, no retailer can be expected to procure agricultural products

below the Minimum Support Price and, therefore, the interests of farmers are also be protected.

Some steps by the government — such as, considering FDI in a phased manner starting from larger cities where domestic large multi-

brand retail outlets and small mom-and-pop stores have co-existed for several years and investments in supply chain activities like cold

storage and warehouses — will be a welcome move for the sector as it would address the need of heavy investments required in infra-

structure and also attend to the present concerns raised by the kirana store owners. Also, the phased introduction would provide smaller

outlets the time to modernise their business model to enable them to compete with their larger counterparts.

We believe that the current dilemma has made regulatory measures the focal point of attention and they have to be well in place before

any decision is made to open up the sector.

Result Analysis of Capital Goods and Engineering Companies

Quarterly

We have analyzed the Q4FY10-11 results of the major players in the capital goods and engineering space.

Our analysis includes five companies — namely, Bharat Heavy Electricals Ltd (BHEL), Larsen & Toubro (L&T), Crompton Greaves,

ABB India and Siemens India .

It can be mentioned here that ABB India follows calendar year for reporting its results. Siemens India follows a October-September

financial year.

This quarter was marked by increased top line growth but margins were under pressure due to increased competition and high raw ma-

terial prices. However, ABB India managed to improve margins due to cost optimization. L&T was able to reduce the ratio of raw ma-

terial cost to net sales during this quarter.

BHEL: Top line witnessed 32.2% growth (Y-o-Y basis) to Rs 17,921 crore. Q4 revenue growth is led by 36% Y-o-Y growth in power

segment revenue (80% of the total revenue). The other industrial segment grew by 18% (Y-o-Y basis) constituting 20% of the total

revenue.

During this quarter, the company witnessed significant margin changes due to impact of policy changes relating to warranty provision,

employee benefit, depreciation and lower raw material cost as % of sales.

Operating Profit Margin stands at 21.4%, a 305 bps increase (Y-o-Y basis). Net margin reported a growth of 150 bps (Y-o-Y basis) to

15.6%. Marginal increase in raw material cost is attributed to the low cost inventory that the company was carrying.

ABB India: ABB is a global leader in power transmission and distribution and process automation space. ABB India is a 52% subsidi-

ary of ABB. It focuses mainly on automation products and process automation. T&D contributes to about 60% of the revenue and rest

is contributed by process automation.

ABB India bounced back with strong set of numbers for Q1CY2011 after reporting disappointing results for last few quarters. The

company reported a top line growth of 21.5% to Rs1,793 crore, Y-o-Y basis. PAT also increased by 796% (Y-o-Y basis) to Rs 60

crore on a low base.

Revenue growth was driven mainly by 49.6% Y-o-Y growth in the power systems segment. Other segments — process automation and

low voltage products — grew by 15.1% and 33.3% respectively.

The company suffered losses during the last few quarters due to rural electrification projects. However, the management has completely

May 25, 2011 May 25, 2011

exited from this line of business from CY2011. It can be mentioned here that the company started the exit process in 2008 due to addi-

tional costs incurred and project delays which created cash flow concerns. Margins improved across all segments, especially in power

systems. Operating margins witnessed a marked improvement by 417 bps to 5.7% during this quarter despite an increase in raw mate-

rial prices, due to cost optimization.

Margins will be under pressure going ahead due to pricing pressure arising from increased competition in the transmission and distribu-

tion segment. It can be mentioned here that the company is localising manufacturing of 756 KV transformers, HV circuit breakers and

other high voltage equipment in order to counter domestic completion.

Siemens India: Siemens is global player manufacturing a wide range of consumer and industrial products. It operates in energy, indus-

try, real estate and health care sectors.

Siemens Q2FY11-12 revenue jumped 40% Y-o-Y basis to Rs 3,033 crore driven by energy segment. This segment grew by 73%, Y-o-

Y basis due to execution of large cycle orders from Qatar and Torrent group. Within energy segment product, transmission and oil and

gas sub-segments grew by 34%, 63% and 119% respectively.

Quarterly Financial Results ( In Rs Crore)

Profitability was impacted by high raw material cost during this quarter. Raw material cost as % of revenue rose by 360 bps Y-o-Y

which negatively affected the margins.

Consolidated revenue grew by 16% led by 29% growth of top line of overseas subsidiaries led by large one off order in T&D space.

Crompton Greaves: Crompton Greaves is a leading global engineering corporation in the high technology electrical products and

power generation, transmission and distribution space. The company operates in three business verticals — power systems, industrial

systems and consumer products. The company derives 47% revenue from overseas subsidiaries

Stand-alone revenue grew by only 9% and PAT witnessed a decline of around 6% for this quarter.

BHEL L&T ABB India

Q4FY10 Q4FY11 YoY(%) Q4FY10 Q4FY11

YoY

(%) Q1FY11 Q1FY12

YoY

(%)

Net Sales 13559 17921 32.2 13374 15078 12.7 1455 1781 22.4

Raw Material

Cost 8052 8293 3.0 2912 3250 11.6 976 1294 32.5

Operating Profit 2487 3834 54.2 1842 2035 10.4 2.89 86.96 999

PBT 2898 4288 47 2229 2565 15.07 8.34 87.75 952

PAT 1909 2798 46.5 1438 1686 17.3 6.64 59.55 796

Siemens India Crompton Greaves

Q2FY11 Q2FY12 YoY(%) Q4FY10 Q4FY11

YoY

(%)

Net Sales 2212 3033 37.1 1618 1765 9.1

Raw Material Cost 1266 1776 40.2 782 901 15.3

Operating Profit 250 326 30 332 264 -20

PBT 274 424 55 328 261 -20

PAT 181 277 53.3 231 217 -5.8

May 25, 2011 May 25, 2011

Growth in the domestic business was driven mainly

by consumer products and industrial segments

which witnessed a growth rate of 19.6% and 19.2%

respectively (Y-o-Y basis). The marginal stand-

alone top-line growth was offset by high raw mate-

rial cost which eroded the company’s margins. For

example, margins of the industrial segment was

slashed by 720 bps to 16% for this quarter. This

segment carried short cycle orders, hence was un-

able to pass on the increase in commodity prices.

Order inflow was muted at Rs 3,200 crore due to

lower than expected order inflow in the power seg-

ment.

Larsen and Toubro : L&T witnessed a subdued growth of top-line by 12.7% (Y-o-Y basis) during this quarter to Rs 15,078 crore.

This was mainly on account of a lower than expected pick-up in revenue of the engineering and construction (E&C) segment (up only

12.8% YoY).

The electrical and electronics (E&E) division reported a flattish revenue on a yearly basis due to sluggish projects. The machinery and

industrial products (MIP) division reported a robust growth of 29.9% YoY, led by a robust growth in the construction and mining busi-

ness.

Order inflow for L&T remained robust during the quarter at Rs 30,281 crore (up by 27% Y-o-Y basis ) due to a good order booking in

the E&C division (up 29% Y-o-Y basis ). L&T’s current order backlog stands at Rs 130,217 crore.

The profit was helped by a one-time gain of Rs 230 crore due to the sale of an investment in an associate company and the partial sale

of a "strategic investment" .

Outlook

This quarter revenue growth was driven by better order execution. However, margins eroded due to increased raw material prices

(strong commodity prices and crude oil price) and higher financing cost.

In terms of order book position , power transmission and distribution recorded a healthy order inflow. Going forward, capex led orders

can moderate in the short run as the manufacturing industry might defer capacity addition plans due to increased financing costs, given

the rising interest rates. Demand might slow down in the short run. But, this is expected to revive in the long run due to the need for

infrastructure spending in order to sustain the economic growth trajectory. In future, companies with strong pricing power and efficient

supply chain management should be able counter the margin pressure.

Annual Results

BHEL’s top line witnessed 27% Y-o-Y growth during FY11 to Rs 41,578 crore. However, Rs 2,770 crore of rise in turnover is attribut-

able to changes in the warranty provision.

During FY11, profit after tax witnessed a growth of 40%, compared with the corresponding period of last year. The company managed

to restrict the raw material price to only marginal increase of 13% (Y-o-Y basis). The company saw an inflow of Rs 60,400 crore for

FY11 translating into total order book of Rs 164,000 crore.

ABB India’s topline registered a marginal growth of 5% (Y-o-Y basis) driven by power systems segment. However, it incurred losses

due to the exit from the rural electrification projects over the last four quarters. PAT witnessed a decline of almost 50% over the corr-

Source: Capital Line

May 25, 2011 May 25, 2011

ABB India Siemens India

FY11 FY12 YoY(%) FY11 FY12 YoY(%)

Net Sales 6298 6611 5 21323 27945 31

Raw Material

Cost 4283 4829 13 5240 6813 30

Operating

Profit 715 228 68 2537 3165 25

PBT 640 493 23 3106 3802 22

PAT 605.12 319.8 47 2079 2499 20

corresponding to during the same period last year.

Siemens India reported 31% growth Y-o-Y basis to Rs27,945 crores driven by energy segment. Raw material cost grew by significant

30% (Y-o-Y basis) which affected the margins. However, company still managed to register a PAT growth of 20% (Y-o-Y basis). In

fact among the five companies taken for analysis ABB India registered the highest growth in raw material cost.

Crompton Greaves delivered a net sales and PAT growth of 12.6 % to Rs5,951 crores and 694 crores respectively. For FY11, growth

in domestic business was mainly consumer products and industrial segment which grew by 25.4% and 19.8% respectively. However,

power systems segment contributed to around 46% of the top line.

For FY11, L&T top line registered a subdued growth rate of 18% and PAT declined by 10% to Rs3,957 crores. The electrical and elec-

tronics (E&E) division reported a flattish revenue on a yearly basis due to sluggish projects. FY11 Operating Profit Margin (OPM)

stands at 11.7%.

Annual Financial Results (In Rs Crore)

BHEL L&T Crompton Greaves

FY10 FY11 YoY(%) FY10 FY11 YoY(%) FY11 FY12 YoY(%)

Net Sales 32880 41578 26.5 36675 43495 18.6 5283 5951 12.63

Raw Material

Cost 20094 22670 12.8 7859 10064 28.1 2657 3048 14.7

Operating Profit 5565 8046 44.56 4366 5074 18.07 857 932 8.71

PBT 6590 9005 36.64 4805 5570 15.9 910 927 1.8

PAT 4310 6011 39.45 3957 4398 9.54 617 694 12.47

May 25, 2011 May 25, 2011

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