July 2010

India Strategy

11

10

earnings

SENSEX

9

reforms

fund flow

8

6

7

interest

rates

5

consumption

capex

4

payouts

3

monsoons

2

1

corporate

events

valuations

global

markets

India 2010: Watch out for the 2

nd

half

Research Team (Rajat@MotilalOswal.com)

India Strategy

Contents

India Strategy

Sector & Companies

1. Automobiles

Bajaj Auto

Hero Honda

Mahindra & Mahindra

Maruti Suzuki India

Tata Motors

2. Banking

Andhra Bank

Axis Bank

Bank of Baroda

Bank of India

Canara Bank

Corporation Bank

Dena Bank

Federal Bank

HDFC

HDFC Bank

ICICI Bank

Indian Bank

LIC Housing

Oriental Bank

Punjab National Bank

Shriram Transport

South Indian Bank

State Bank

Union Bank

Yes Bank

3. Cement

ACC

Ambuja Cement

Birla Corporation

Grasim Industries

India Cements

Shree Cement

UltraTech Cement

4. Engineering

ABB

BHEL

Crompton Greaves

Larsen & Toubro

Siemens

Thermax

5. FMCG

Asian Paints

Britannia Industries

Colgate Palmolive

Dabur India

3-46

47-255

48-56

52

53

54

55

56

57-82

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

80

81

82

83-93

87

88

89

90

91

92

93

94-104

99

100

101

102

103

104

105-121

111

112

113

114

GSK Consumer

Godrej Consumer Products

Hindustan Unilever

ITC

Marico

Nestle India

United Spirits

115

116

117

118

119

120

121

6. Information Technology122-134

HCL Technologies

128

Infosys

129

MphasiS

130

Patni Computer

131

TCS

132

Tech Mahindra

133

Wipro

134

7. Infrastructure

Hindustan Construction

IVRCL

Jaiprakash Associates

Nagarjuna Construction

Simplex Infrastructure

8. Media

Deccan Chronicle

HT Media

Jagran Prakashan

Sun TV Network

Zee Entertainment

9. Metals

Hindalco

Hindustan Zinc

JSW Steel

Nalco

Sesa Goa

SAIL

Sterlite Industries

Tata Steel

10. Oil & Gas

BPCL

Cairn India

Chennai Petroleum

GAIL

Gujarat State Petronet

HPCL

IOC

Indraprastha Gas

MRPL

ONGC

Reliance Industries

135-143

139

140

141

142

143

144-153

149

150

151

152

153

154-166

159

160

161

162

163

164

165

166

167-183

173

174

175

176

177

178

179

180

181

182

183

11. Pharmaceuticals

Aventis Pharma

Biocon

Cadila Healthcare

Cipla

Divi’s Laboratories

Dishman Pharma

Dr Reddy’s Labs.

GSK Pharma

Glenmark Pharma

Jubilant Organosys

Lupin

Piramal Healthcare

Ranbaxy Labs.

Sun Pharmaceuticals

12. Real Estate

Anant Raj Industries

DLF

HDIL

Mahindra Lifespaces

Phoenix Mills

Unitech

13. Retailing

Pantaloon Retail

Titan Industries

184-205

192

193

194

195

196

197

198

199

200

201

202

203

204

205

206-216

211

212

213

214

215

216

217-222

221

222

14. Telecom

223-231

Bharti Airtel

228

Idea Cellular

229

Reliance Communication

230

Tulip Telecom

231

15. Textiles

Alok Industries

Arvind Mills

Bombay Rayon

Raymond

Vardhman Textiles

16. Utilities

CESC

NTPC

Power Grid Corp.

PTC India

Reliance Infrastructure

Tata Power

17. Others

Sintex Industries

United Phosphorus

232-241

237

238

239

240

241

242-253

248

249

250

251

252

253

254-255

254

255

Note:

All stock prices and indices for India Strategy as on 30 June 2010, unless otherwise stated

July 2010

2

2 July 2010

India Strategy

BSE Sensex:

17,701

S&P CNX:

5,313

As on:

30 June 2010

O use football parlance, Earnings remains a star striker for Team India. It should

remain in steady form in 1QFY11, with Sensex PAT growing 19% YoY. Second half

of 2010 for Indian equities depends on the interplay of 11 different drivers. Monsoons and

Global markets remain the near term triggers for market direction. Our model portfolio is

overweight on domestic plays -

Financials

(SBI, ICICI Bank),

Infrastructure & allied

sectors

(BHEL, ACC, Unitech) and

Oil & Gas

(BPCL, GAIL). Amongst the global

plays, we prefer

IT

and

Pharma

over cyclicals.

Steady 1QFY11 for the Indian corporate sector; Sensex PAT up 19% YoY

We expect MOSL Universe (excluding oil marketing companies) to report 1QFY11 earnings

growth of 17% YoY. This growth is a moderation compared to 31% YoY in 2HFY10,

when earnings were largely driven by low base. Telecom sector and ONGC are the two

key reasons for lower growth. Ex these, growth for rest of Universe would be 31%.

1QFY11 will also be a quarter, where absolute PAT will be lower QoQ (first time in last 4

years). This is driven by flat growth QoQ in Oil & Gas and drop in earnings in Metals and

Telecom sector. Sensex performance is marginally better than aggregate with PAT growth

of 19% YoY.

QUARTERLY EARNINGS PERFORMANCE - MOSL UNIVERSE (RS B)

SALES

SECTOR

(NO OF COMPANIES)

JUN-10

VAR %

YOY

VAR %

QOQ

JUN-10

EBITDA

VAR %

YOY

VAR %

QOQ

JUN-10

NET PROFIT

VAR %

YOY

VAR %

QOQ

T

Auto (5)

Banks (20)

Cement (7)

Engineering (6)

FMCG (11)

IT (7)

Infrastructure (5)

Media (5)

Metals (8)

Oil Gas & Petchem (11)

Pharma (14)

Real Estate (6)

Retail (2)

Telecom (4)

Textiles (5)

Utilities (6)

Others (2)

MOSL (124)*

MOSL Excl. RMs (121)

Sensex (29)

*Tata Steel Consolidated

317

267

114

218

185

283

72

19

713

2,210

130

35

33

197

35

238

24

5,090

3,821

2,520

36.6

28.8

1.0

20.5

14.8

13.3

15.9

25.1

26.4

28.0

10.5

32.0

29.1

0.9

33.3

11.8

3.3

23.0

25.1

28.0

-4.9

-4.1

-4.0

-34.8

1.6

5.1

-20.7

4.3

-6.8

-8.0

3.7

-7.5

-2.5

3.4

-2.1

13.2

-9.2

-6.7

-4.3

-4.8

43

228

32

25

37

71

11

8

140

234

27

15

3

66

8

66

4

1,017

982

622

29.7

22.9

-14.2

23.7

8.9

10.4

16.6

38.5

110.9

-4.2

14.9

14.6

34.7

-12.7

58.3

16.2

7.1

15.6

19.7

20.6

-7.9

-5.8

1.7

-59.0

2.6

1.9

-22.2

8.0

-16.2

-20.2

1.2

-6.8

-5.8

1.6

-6.5

21.6

-15.7

-11.2

-6.4

-4.7

27

115

19

16

25

55

4

5

82

111

18

7

1

26

2

36

2

551

534

29.7

16.4

-18.9

13.4

7.6

15.0

5.4

25.1

461.4

-26.3

30.1

3.1

81.0

-43.8

125.8

5.1

-0.1

8.9

17.0

-4.6

2.8

6.2

-59.7

4.1

-0.1

-23.2

25.2

-14.8

-34.2

-5.4

-15.6

-23.0

-26.7

-11.9

-5.8

-36.5

-16.4

-9.3

338

19.3

-7.8

Source: Company/MOSL

Navin Agarwal

(Navin@MotilalOswal.com)

/ Rajat Rajgarhia

(Rajat@MotilalOswal.com)

July 2010

3

India Strategy

India 2010: Watch out for the second half

Indian markets had a lackluster first half 2010, rising just 1-2%. However, just like the

ongoing football World Cup, Indian equities could throw up a few surprises in the second

half of the year. How the second half plays out for India depends on the interplay of 11

different forces that we have identified and lined up like a typical football team.

TEAM INDIA LINE-UP (SUMMARY ASSESSMENT IN BRACKETS)

Forward line or Strikers

11. Earnings (good visibility)

10. Reforms (gathering momentum)

9. Fund Flow (needs to improve)

Mid-field

8. Interest Rates (needs stability)

7. Capex Boom (key winger)

6. Consumption (story goes on …)

5. Payouts (getting better)

Defense

4. Monsoons (rainbow of hope)

3. Corporate events (lower uncertainty)

2. Global markets (weak link)

1. Valuations (time correction underway)

Overall assessment

The Indian market’s strikers seem to be in good form. The midfield has remained solid for

quite some time now. Amongst the defense, Monsoons and Global markets remain near

SENSEX

term triggers for market direction. If the defense holds out, and all drivers work in tandem,

the Indian market could well be higher from current levels by March 2011.

Markets to remain range-bound; stock-picking to drive portfolio

performance

Accelerating economic and corporate profit growth will limit downside in the markets. At

the same time, above-average valuations cap the upside. Expect benchmark indices to

remain with a range of 10% from current levels. Thus, 2010 will be a year of stock-

picking, with market contribution to aggregate performance being the lowest in three years.

We believe stocks in our model portfolio offer growth at reasonable valuations. We are

overweight on domestic plays -

Financials

(SBI, ICICI Bank),

Infrastructure & allied

sectors

(BHEL, ACC, Unitech) and

Oil & Gas

(BPCL, GAIL). Amongst the global

plays, we prefer

IT

and

Pharma

over cyclicals.

SENSEX EPS TREND: A NEW CYCLE OF EARNINGS GROWTH FOR INDIAN MARKETS

FY10-12:

25% CAGR

1,276

FY08-10E:

1,052

-0.6% CAGR

FY93-96:

45% CAGR

FY03-08:

25% CAGR

FY96-03: 1% CAGR

450

523

833 820 823

718

348

250 266 291 278 280 216 236 272

181

81 129

Source: MOSL

July 2010

4

India Strategy

India 2010: Watch out for the second half

The World Cup football fever has truly spread far and wide. As the tournament progressed,

surprises have continued to dominate the event. Indian markets have also surprised in

1HCY10 with their resilience to weak global cues. We draw a strong parallel between

football and how the Indian market is set up for the second half of 2010 and beyond.

The starting line-up

The BSE Sensex has ended the June quarter at 17,700, marking its third consecutive

quarter of consolidation, post the sharp ~100% appreciation during March-September

2009. For the Indian market, it was a lackluster first half 2010, with the major indices rising

only 1-2%. Yet, in relative terms, India was one of the best performing markets.

INDIA V/S WORLD: STOCK MARKET RETURNS

FY10

1HCY10

2QCY10

Russia

Brazil

India - Sensex

Taiw an

India - Nifty

Thailand

China

South Korea

MSCI - Asia

S&P 500

UK

Japan

US

129

83

81

78

76

63

62

50

29

23

22

19

19

Thailand

India - Nifty

India - Sensex

South Korea

MSCI - Asia

US

Russia

S&P 500

UK

China

Taiw an

Japan

Brazil

9

2

1

1

-4

-6

-7

-8

-9

-10

-10

-11

-11

India - Nifty

Thailand

India - Sensex

South Korea

-7

Taiw an

China

-8

-8

MSCI - Asia

-10

US

S&P 500

-12

Brazil -13

UK -13

Russia -15

Japan -15

1

1

1

0

Source: MOSL

How the second half plays out for India depends on the interplay of 11 different forces

that we have identified. And like a typical football team, these forces can be lined up in a

4-4-3 formation (corresponding to defense-midfield-forward line).

TEAM INDIA LINE-UP (SUMMARY ASSESSMENT IN BRACKETS)

Forward line or Strikers

11. Earnings (good visibility)

10. Reforms (gathering momentum)

9. Fund Flow (needs to improve)

Mid-field

8. Interest Rates (needs stability)

7. Capex Boom (key winger)

6. Consumption (story goes on …)

5. Payouts (getting better)

Defense

4. Monsoons (rainbow of hope)

3. Corporate events (lower uncertainty)

2. Global markets (weak link)

1. Valuations (time correction underway)

SENSEX

Overall assessment

The Indian market’s strikers seem to be in good form. The midfield has remained solid for

quite some time now. Amongst the defense, Monsoons and Global markets remain near

term triggers for market direction. If the defense holds out, and all drivers work in tandem,

the Indian market could well be higher from current levels by March 2011.

We proceed to separately assess each individual driver.

July 2010

5

India Strategy

Striker #11: Earnings - good visibility

11

Earnings growth has been the bedrock of Indian equities during the upcycle of FY03-08

(EPS CAGR of 25%). Post the global financial crisis, Indian earnings flattened for two

consecutive years. While 2HFY10 marked the beginning of earnings growth, markets

need more certainty about the resumption and sustenance of the trend. We estimate EPS

CAGR of 25% over FY10-12. Importantly, our FY11 EPS estimate has not witnessed any

major changes over the last one year, indicating greater confidence in the estimates.

SENSEX EPS TREND: A NEW CYCLE OF EARNINGS GROWTH FOR INDIAN MARKETS

earnings

FY10-12:

25% CAGR

1,276

FY08-10E:

1,052

-0.6% CAGR

FY93-96:

45% CAGR

FY03-08:

25% CAGR

FY96-03: 1% CAGR

450

523

833 820 823

718

348

250 266 291 278 280 216 236 272

181

81 129

TREND OF REVISION IN FY11 EPS ESTIMATE: MARGINAL UPGRADE IN 1QFY11

Earnings to grow at 25%

CAGR till FY12. No major

revisions in last 12 months.

FY 11 EPS

10.5

16.4

26.1

1,103

1,028

980

% Grow th Revision in FY11 EPS

32.1

1,076

1,042

29.5

27.9

1,052

Mar-09

Jun 09

EPS growth YoY (%)

Sep 09

Dec 09

Mar 10

Jun 10

Source: MOSL

Another feature of earnings growth in this cycle would be the rising contribution of domestic

sectors. We expect domestic plays to contribute 56% of aggregate earnings in FY12 v/s

52.6% in FY08. The contribution in FY10 appears high due to insignificant profits and

losses in few cases from global cyclicals. Domestic proportion of earnings would have

further risen, if one were to include the gas profits from Reliance, GAIL, ONGC, etc.

July 2010

6

India Strategy

MOSL UNIVERSE PAT MIX (FY10-12 EARNINGS AGGREGATES) - RS B

PAT (RS B)

SECTOR

FY06

FY08

FY10

FY12

FY06

% SHARE

FY08

FY10

FY12

PAT CAGR (%)

FY08-

FY10

FY10-

FY12

FY06-

FY12

Domestic Plays

Banking

508

199

86

36

49

30

51

25

9

9

545

431

278

153

113

84

29

1,033 1,300 1,855 48.3

334

494

736 18.9

111

65

72

134

71

80

123

18

930

727

410

317

204

148

56

157

103

106

152

98

88

38

27

889

617

420

197

272

211

61

247

161

191

115

135

94

8.2

3.4

4.6

2.8

4.8

2.3

52.6

17.0

5.6

3.3

3.7

6.8

3.6

4.1

6.3

0.9

47.4

37.0

20.9

16.1

10.4

7.5

2.8

59.4

22.6

7.2

4.7

4.8

7.0

4.5

4.0

1.7

1.3

40.6

28.2

19.2

9.0

12.4

9.6

2.8

55.8

22.1

7.4

4.8

5.7

3.5

4.0

2.8

1.9

1.6

44.2

33.0

21.1

11.9

11.2

8.3

2.9

12.2

21.7

19.0

26.0

21.6

6.4

17.5

4.7

-44.3

25.0

-2.3

-7.8

1.3

-21.1

15.4

19.3

4.3

5.6

19.5

22.0

25.6

25.1

34.0

-13.2

17.1

3.4

28.4

41.0

28.6

33.2

29.1

41.6

17.2

14.4

26.5

24.1

24.4

19.3

28.6

25.5

25.0

17.5

24.9

37.3

35.2

18.0

16.8

16.6

17.1

22.0

21.9

22.2

Rising share of domestic

plays will lead to higher

valuations

Utilities

Engineering

Auto

Telecom

FMCG

Cement

Real Estate

Infrastructure

Global Plays

Cyclical

Oil & Gas ex RMs

Metals

Non-Cyclical

IT

Pharma

MOSL Universe ex RMs

63

0.9

54

0.8

1,469 51.7

1,095 41.0

700 26.4

395 14.5

373

276

97

10.8

8.0

2.8

1,053 1,964 2,189 3,324 100.0 100.0 100.0 100.0

23.2 21.1

Source: MOSL

SENSEX

Assessment of role as Sensex driver

Earnings (growth and visibility) is the star striker, having returned to make a meaningful

contribution after being on holiday during FY08-10. Rising share of domestic plays provides

greater stability to aggregate earnings growth and also lead to higher market valuations.

We see this as a key source of market re-rating over the next few years.

Striker #10: Reforms - gathering momentum

10

The Congress-led UPA (United Progressive Alliance) government is in its second year of

office following its re-election in 2009. The market had cheered the election of the

government in May 2009 with a big gain on hopes of several reforms. We believe the

stage is set for policy reforms to gather significant momentum with impact on both corporate

earnings and stock valuations.

Oil Sector Reforms: LONG AWAITED!

The first set of reforms have come in the Oil sector, with hike in GAIL’s pipeline tariff in

April 2010, followed by a hike in APM gas price in May, and rounding up the quarter with

a move towards deregulation of major oil products in June 2010.

The scope and further hopes of these reforms have already driven PSU Oil & Gas stocks

to significantly outperform the market indices in 1QFY11. India’s outperformance over

the global markets has been driven by a rising confidence in the government reforms post

the fuel price de-regulation. In this section, we explain the importance of the Oil sector

reforms and their implications on stocks.

reforms

July 2010

7

India Strategy

SIGNIFICANT OUTPERFORMANCE OF OIL STOCKS IN 1QFY11 …

… MAKES UP FOR MUCH OF THE PAST UNDERPERFORMANCE

Sensex

150

135

120

105

ONGC

HPCL

IOC

BPCL

149

135

129

122

162

144

126

108

100

90

Sensex

ONGC

HPCL

IOC

BPCL

151

149

146

125

121

113

90

Apr-10

May-10

Jun-10

Source: MOSL

2010 will be marked as a year of oil sector reforms in the Indian markets.

1. Reforms for the sector began with an independent regulator giving out the tariff for

the gas pipelines, resulting in earnings increase for GAIL over the coming years.

2. Then the APM gas price reforms: APM gas price had been stagnant for the last

several years. As against the expectation of gradual increase over the 2-3 years, in a

surprise move the government increased the APM gas price in a single instant from

US$2/mmbtu to US$4.2/mmbtu.

3. The reforms have reached the crescendo with the government now freeing petrol and

diesel prices.

Key announcements

Petrol:

Retail prices to be market-determined. As per the latest fortnight data, price

hike is ~Rs3.5/liter.

Diesel:

Though the Empowered Group of Ministers (EGoM) has decided to eventually

deregulate diesel prices, currently it has decided to increase price by just Rs2/liter.

LPG:

Domestic LPG cylinder price to be hiked by Rs35/cylinder (current loss is

Rs262/cylinder).

Kerosene:

PDS kerosene price to be hiked by Rs3/liter from Rs9/liter to Rs12/liter

(current loss is Rs17.9/liter). Previous hike was in March 2002.

UNPRECENDENTED PRICE HIKE: KEROSENE PRICE HIKE WAS HIGHEST AT 33%

PRODUCT

UNIT

BEFORE

AFTER

CHG

CHG (%)

LAST PRICE HIKE

KIRIT PARIKH RECO'S

Hike in fuel prices have

surprised positively

Petrol

Diesel

Kerosene

LPG

Rs/litre

47.93

51.43

40.10

12.23

345.35

3.5

2.0

3.0

35.0

7.3

5.2

32.5

11.3

Feb.2010

Feb.2010

Mar.2002

Jun.2008

To deregulate

To deregulate

6.0

100.0

Source: MOSL

Rs/litre

38.10

Rs/litre

9.23

Rs/Cylinder 310.35

Prices are at Delhi

These reforms have led to a significant reduction in the under-recoveries of the state-

owned oil companies. We analyze the impact of these reforms.

July 2010

8

India Strategy

FY09 under-recoveries reached unprecedented levels, forcing the

government to seek a sustainable solution

In FY09, with crude price touching historic highs, under-recoveries reached an

unprecedented level of Rs1t. This also resulted in the government doling out the highest

ever oil bond compensation of ~Rs700b.

Fiscal deficit climbed to a decade-high of 6.6% in FY10. Till FY09, the government

used to share the subsidy through oil bonds, reducing the impact on reported fiscal

deficit. From FY10, it decided to make cash payments for subsidies and include in

fiscal deficit - this paved the way for the thought of deregulation.

GOI FISCAL DEFICIT HAD INCREASED OVER THE LAST 2 YEARS

HIGHEST EVER OIL BONDS ISSUANCE BY THE GOI IN FY09 (RS B)

Fiscal Deficit (Rs b)

6.2

5.4

5.7

% of GDP

6.7

6.0

1,200

1,000

800

Oil Bonds

Upstream

Dow nstream

5.9

4.5

3.9

4.0

3.3

600

400

200

2.6

0

-200

FY06

FY07

FY08

FY09

FY10

Source: MOSL

*Prior to FY10 fiscal deficit excludes oil bonds to OMC's

FY11 - the year for deregulation

After a roller-coaster ride in FY09 and FY10, crude prices seem to be stabilizing in

FY11, albeit in a higher price band.

From the government's point of view, this was the best time to deregulate fuel prices,

given (1) largely stable crude oil price, (2) increased ability to withstand opposition

from political rivals, and (3) continued pressure to improve the country's energy security

(cannot allow financials of state-owned oil companies to suffer).

The government had set up the Expert Group to recommend a viable strategy for the

sector and the recent EGoM decision was based on the recommendations of the Expert

Group headed by Kirit Parikh.

FY11 is also the year when the government had windfall gains from the spectrum

auction of 3G and BWA (cash inflow of Rs1.06t).

Benign oil price would be positive for OMCs

We believe that the profits of state-owned oil marketing companies (OMCs) would be

favorably impacted (1) if oil prices remain benign i.e. below US$75/bbl, and (2) once

diesel prices are fully deregulated.

Diesel deregulation would provide a huge relief for the system: Higher oil prices result

in higher under-recoveries, and the sharing mechanism of the losses gets complicated

and delayed. We estimate gross under-recoveries (diesel, kerosene and LPG) of Rs433b

at an oil price of US$75/bbl. However, once diesel prices are freed, under-recoveries

would reduce to ~Rs347b.

July 2010

9

India Strategy

Impact of diesel price deregulation would be significant at higher oil prices (refer

exhibit below). A US$1/bbl change in crude price would increase the gross under-

recoveries by Rs42b. If we exclude diesel, a change of US$1/bbl in crude price would

impact under-recoveries by Rs11b (only LPG and kerosene).

Impact of deregulation on retail fuel prices: In a free price scenario, we estimate an

impact of Rs4/liter for petrol and Rs3.8/liter for diesel for a crude price increase of

US$10/bbl.

DIESEL DE-REGULATION WOULD MEAN A SIGNIFICANT REDUCTION IN SUBSIDY (RS B)

LPG

1,600

Kerosene

Diesel

Total

1,477

1,267

LPG

800

Kerosene

Total

618

1,200

850

800

413

400

0

185

0

119

65

60

239

0

138

101

65

293

0

157

136

70

66

175

172

75

641

395

240

194

207

80

212

243

85

1,059

859

704

550

231

278

90

250

314

95

268

349

600

347

175

172

75

401

194

455

293

185

239

138

101

65

157

136

70

509

563

400

212

231

250

268

200

119

0

65

60

207

80

243

278

314

349

100

85

90

95

100

Source: Kirit Parikh Report

Controlled pricing regime has eroded the financial strength of OMC's

significantly

During the period FY02-05, OMCs used to earn significantly higher RoE and RoCE

as shown in the exhibits below.

However, as the government began controlling prices, the under-recoveries mounted.

Since the subsidy compensation to the OMCs was on an ad-hoc basis and mostly

delayed, this resulted in working capital problems for the OMCs and hence higher

debt levels.

As compared to good return ratios of 20-27% during the period FY02-05, in the recent

years, return ratios have been dismal at 9-16%.

RETURN RATIOS HAVE ERODED SIGNIFICANTLY IN RECENT YEARS

RoE

24.3

19.8

11.7

11.8

26.9

21.8

24.4

RoCE

24.4

1.8

22.8

16.1

D/E

1.6

0.9

8.7

3.9

0.9

0.7

0.3

FY02- FY10 FY02- FY10 FY02- FY10

05

05

05

HPCL

BPCL

IOC

FY02- FY10 FY02- FY10 FY02- FY10

05

05

05

HPCL

BPCL

IOC

FY02- FY10 FY02- FY10 FY02- FY10

05

05

05

HPCL

BPCL

IOC

Source: MOSL

July 2010

10

India Strategy

The big deterioration in their earnings profile and uncertainty over their growth led to a

sharp de-rating for the OMCs. These stocks were completely ignored by global investors

during the best period of inflows to India. While FIIs brought US$52 into India over FY05-

10, their holding in OMCs declined from 9% to 5% during this period.

VALUATIONS OF OIL PSUS OVER SENSEX

FIIS REDUCED THEIR HOLDINGS IN OIL PSUS DESPITE HUGE INFLOWS

OMC's & ONGC 1 Yr Fw P/E

25

20

15

10

5

Sensex 1 Yr Fw P/E

FII Net Investm ents (US$B)

FII Holding Indian Market (%)

FII Holding OMCs, ONGC & GAIL (%)

8.7

9.2

18.1

10.9

9.0

18.2

5.8

16.7

8.1

13.1

6.0

5.0

-10.4

14.2

15.6

9.4

16.1

9.2

16.1

23.4

FY05

FY06

FY07

FY08

FY09

FY10

Source: MOSL

What could be the best case earnings scenario for OMCs

Assuming, that OMC's will be compensated fully, we estimate the best case EPS at Rs55/

Rs77.7/Rs49 for HPCL/BPCL/IOC indicating an upside of 48%/20%/14% from our base

case scenario for FY12. (Our FY12 base case scenario assumes 11% sharing of total

under-recoveries by OMCs).

BEST CASE EPS FOR FY12 + LIKELY RE-RATING SCENARIOS INDICATE FURTHER ROOM FOR STOCK PRICE INCREASE

HPCL

BPCL

IOC

EPS (nil sharing)

55.0

8.0

440

87

527

470

12

55.0

10.0

550

87

637

470

35

55.0

12.0

660

87

747

470

59

77.7

8.0

622

148

770

663

16

77.7

10.0

777

148

925

663

40

77.7

12.0

932

148

1,080

663

63

49.0

8.0

392

90

482

399

21

49.0

10.0

490

90

580

399

45

49.0

12.0

588

90

678

399

70

Best case earnings for

OMCs leads to significant

returns in stocks

FY12E PE Multiple

Implied Price

Add: Investment Value

Likely Value

CMP (Rs)

Upside (%)

Source: MOSL

Valuation and view

We believe that full clarity on subsidy sharing would provide higher earnings predictability

for the state-owned oil companies. That, in turn, would be critical to the re-rating of state-

owned oil stocks. The process has begun and we expect clarity to improve in the days to

come. We have Buy ratings on ONGC, GAIL and the OMCs.

July 2010

11

India Strategy

OUR BASE CASE ESTIMATES ASSUME 11% SHARING BY DOWNSTREAM PLAYERS

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

Fx Rate (Rs/US$)

44.3

45.2

64.4

20

188

179

107

494

241

205

48

494

49

42

40.3

82.3

73

353

191

156

773

353

257

163

773

46

33

46.0

84.8

52

523

282

176

1,033

713

329

(9)

1,033

69

32

47.5

69.6

52

93

174

143

461

260

145

56

461

56

31

46.0

75.0

22

84

177

176

459

256

153

50

459

56

33

44.5

75.0

-

-

163

157

320

178

107

35

320

56

33

Brent (US$/bbl)

58.0

Gross Under recoveries (Rs b)

Petrol

27

Diesel

PDS Kerosene

Domestic LPG

Total

Sharing (Rsb)

Oil Bonds/Cash

Upstream

OMC's sharing

Total

Sharing (%)

Oil Bonds

Upstream

126

144

102

400

115

140

138

400

29

35

Clarity on subsidy sharing

will be key to further

changes in estimates

OMC's sharing

35

10

21

(1)

12

Total

100

100

100

100

100

*Nil diesel loss in FY12 is primarily due to lower exchange rate assumption

11

11

100

100

Source: MOSL

The Oil sector had been deprived of any major reforms for the past several years. The

bold measures in this sector will bestow confidence to investors regarding likely major

policy reforms in several other areas, even if there is some delay in the final implementation.

Direct Tax Code, expected to be implemented from FY12

Goods & Services Tax, also expected to be implemented from FY12

FDI relaxation in sectors like Insurance and Aviation

Clarity on 2G spectrum norms and M&A reforms in the Telecom sector

New licenses for Banks, relaxed norms for foreign banks, etc.

Assessment of role as Sensex driver

As seen in past situations, Reforms actually help Earnings perform better. Reforms

combined with Earnings growth makes a lethal combination for Indian markets to move

SENSEX

significantly higher over the next few years.

Striker #9: Fund Flow - needs to improve

9

The two important sources of fund flows to determine the direction of Indian markets in

the last few years have been (1) FIIs, and (2) Domestic Institutions, largely led by Insurance.

In 2HCY10 and beyond, Fund Flow is more critical than ever before due to three reasons:

1. Government norm of minimum 25% non-promoter holding for listed companies.

(Our calculations suggest that this could imply funds requirement of over US$30b

over the next five years).

2. Government's disinvestment program of Rs400b (US$8b) as per its FY11 budget,

much of it likely in 2HCY10. We expect similar targets in FY12, also.

3. Large fund raising plans of companies in capital intensive sectors like Real Estate and

Infrastructure, and also as part of a de-leveraging strategy in specific companies.

fund flow

July 2010

12

India Strategy

COMPANIES IN BSE 500 INDEX WHICH NEED TO DILUTE PROMOTER HOLDING (RS B)

COMPANY

MKT CAP

NON-

PROMOTER

STAKE (%)

YEAR 1

DILU-

TION

NON-

PROMOTER

STAKE (%)

YEAR 2

DILU-

TION

NON-

PROMOTER

STAKE (%)

YEAR 3

DILU-

TION

NON-

PROMOTER

STAKE (%)

YEAR 4

DILU-

TION

NON-

PROMOTER

STAKE (%)

YEAR 5

TION

NON-

STAKE (%)

DILU- PROMOTER

Hind.Copper

MMTC

HMT

Natl.Fertilizer

Neyveli Lignite

RCF

STC

Engineers India

Fres.Kabi Onco.

NMDC

Puravankar.Proj.

Power Fin.Corpn.

BOC India

Omaxe

Alfa Laval (I)

Gillette India

MRPL

IVRCL Assets

JP Power Ven.

Natl. Aluminium

NHPC Ltd

Power Grid Corpn

D B Corp

SAIL

Reliance Power

NTPC

United Bank (I)

Godrej Propert.

Atlas Copco (I)

Essar Shipping

Kwality Dairy

Mahindra Holiday

Ackruti City

BGR Energy Sys.

Oracle Fin.Serv.

Central Bank

Mundra Port

SCI

Indian Bank

Jet Airways

Wipro

Godrej Inds.

IOCL

DLF

Dredging Corpn.

Oil India

Tata Tele. Mah.

Thomas Cook (I)

Nirma

Sun TV Network

Bank of Maha

JSW Energy

Fortis Health.

Novartis India

Tata Comm

3M India

Gammon Infra.

Bharat Electron

Berger Paints

IL&FS Transport

Total

452

1,627

54

56

262

46

25

106

27

1,066

22

331

24

16

25

55

133

24

148

281

382

435

44

821

415

1,639

26

43

25

56

19

44

35

51

185

58

286

69

93

46

967

53

966

495

16

335

43

13

30

165

26

210

63

21

74

31

20

139

26

55

13,300

0.4

0.7

1.1

2.4

6.4

7.5

9.0

9.6

10.0

10.0

10.0

10.2

10.5

10.9

11.2

11.3

11.4

11.9

12.3

12.9

13.6

13.6

13.7

14.2

15.2

15.5

15.8

16.2

16.2

16.3

16.3

16.9

17.5

18.7

19.5

19.8

19.8

19.9

20.0

20.0

18.8

20.9

21.1

21.4

21.4

21.6

22.3

22.7

22.8

23.0

23.2

23.3

23.5

23.6

16.4

24.0

24.0

24.1

24.4

24.9

23

81

3

3

13

2

1

5

1

53

1

17

1

1

1

3

7

1

7

14

19

22

2

41

21

82

1

2

1

3

1

2

2

3

9

3

14

3

5

2

44

2

38

18

1

11

1

0

1

3

0

4

1

0

1

0

0

1

0

0

605

5.4

5.7

6.1

7.4

11.4

12.5

14.0

14.6

15.0

15.0

15.0

15.2

15.5

15.9

16.2

16.3

16.4

16.9

17.3

17.9

18.6

18.6

18.7

19.2

20.2

20.5

20.8

21.2

21.2

21.3

21.3

21.9

22.5

23.7

24.5

24.8

24.8

24.9

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

23

81

3

3

13

2

1

5

1

53

1

17

1

1

1

3

7

1

7

14

19

22

2

41

20

74

1

2

1

2

1

1

1

1

1

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

428

10.4

10.7

11.1

12.4

16.4

17.5

19.0

19.6

20.0

20.0

20.0

20.2

20.5

20.9

21.2

21.3

21.4

21.9

22.3

22.9

23.6

23.6

23.7

24.2

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

23

81

3

3

13

2

1

5

1

53

1

16

1

1

1

2

5

1

4

6

5

6

1

7

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

242

15.4

15.7

16.1

17.4

21.4

22.5

24.0

24.6

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

23

81

3

3

9

1

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

121

20.4

20.7

21.1

22.4

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

25.0

21

25.0

70

25.0

2

25.0

1

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

0

25.0

95

Source: Company/MOSL

July 2010

13

India Strategy

The above three factors are over and above

The usually robust pipeline of IPOs in India, and

Newer forms of fund raising like sale of treasury stock and stake divestment by minority

promoters.

FUND RAISING IN INDIA (RS B)

Domestic (Public & Rights)

QIP

645

576

1,065

232

38

326

319

CY05

222

529

316

CY06

CY07

304

Overseas (ADR / GDR / FCCB)

Stake Sale & Others

495

937

135

344

30

428

82

209

249

CY09

391

CY10 YTD

Source: MOSL

578

Fund raising is likely to

accelerate at higher

levels of markets

37

61

44

CY08

Of the key Fund Flow sources, domestic mutual funds have been net sellers for the last six

months. Fund Flow from insurance is fraught with some uncertainty due to new norms for

ULIPs (unit-linked insurance plans) mandating assured return for pension and annuity

plans. Thus, the onus of Fund Flow falls significantly on FII flows. FII inflows remained

robust in 1HCY10. However, sustenance of the same is critical as in the past, 2H flows

have tended to carry higher weight than 1H.

FII FLOWS INTO INDIA: 2H TENDS TO BE HIGHER THAN 1H

20

1st Half

10

2nd Half

12

0

1

0

2

0

0

5

1

5

4

6

5

6

3

6

-6

-6

13

5

7

2H flows is always higher

than 1H for past 7 years

0

-10

-20

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: MOSL

Assessment of role as Sensex driver

Of the three strikers, Fund Flow carries risk of running out of form. Even if Earnings and

Reforms combine well, non-performance of Fund Flow could lead to Sensex Goal 20,000

SENSEX

remaining elusive for quite some time.

July 2010

14

India Strategy

8

interest rates

Midfield #8: Interest Rates - stable rates key to upcycle

The government has given strong indications of returning to the path of fiscal correction

and has so far indicated its resolve to even better its budgeted fiscal deficit target from

5.5% of GDP for FY11 to 4.5% of GDP. A few factors add to our optimism in this regards.

First, the return of growth and the high buoyancy in corporate taxes that has now become

the single biggest source of revenue for the government. Second, since services occupy a

dominant part of the Indian economy and service sector tax net has been widened further

in FY11, higher service tax collection is a distinct possibility. Third, overall revenue projection

at 12.9% of GDP in FY11 compares well with the low of 12% in FY10 and is way below

the peak of 14.1% realized during FY08.

GOVERNMENT CAN RIDE BACK ON REVENUE BUOYANCY ON RETURN OF GROWTH

Income tax

Excise duties

Non-tax Revenue

15%

Corporate tax

Service Tax

Gross Tax Receipts

Customs duties

Other taxes

Gross revenue receipts

Revenue buoyancy will be

key to containment of

fiscal deficit

12%

9%

6%

3%

0%

Source: MOSL

However, a reduction in FY11 deficit still rests upon a few assumptions. First, the government

has set a disinvestment target of Rs400b (as compared with Rs260b and the peak of

Rs388b mobilized during FY08). Besides, the government also plans to effect major cuts

in subsidies (especially petroleum subsidies) and non-plan expenditure.

DETERMINATION IN THE AREA OF DISINVESTMENT, SUBSIDY REDUCTION AND NON-PLAN EXPENDITURE CRITICAL

FOR DEFICIT TARGETS AND THEIR BETTERMENT

20%

16%

12%

8%

4%

0%

Disinvestment

Gross fiscal deficit

Non-plan expenditure

Subsidies

Total expenditure

Source: MOSL

So far, the government has demonstrated its resolve to prune expenditure with early

indicators (for April-May) pointing towards lower than budgeted expenditure and increased

July 2010

15

India Strategy

revenue leading to a zero revenue deficit for the first two months of FY11. The 3G/BWA

auction together fetched a bounty of Rs1,062b against a budgeted Rs350b. Even if a

slippage of Rs300b is allowed on account of missed targets of disinvestment, subsidies and

non-plan expenditure, it would leave ~Rs350b (0.5% of GDP) as additional revenue by

which the government's borrowing requirement would be reduced.

GOVERNMENT'S FINANCES FOR APRIL-MAY

20%

Total Receipts

Fiscal Deficit (RHS)

Total Expenditure

Revenue Deficit (RHS)

140%

105%

70%

35%

0%

1QFY11 deficit levels will be

lowered, as revenues got a

boost from telecom sector

15%

10%

5%

0%

FY06

FY07

FY08

FY09

FY10

FY11

Source: MOSL

Reduced borrowing program is a clear outcome of the budgetary consolidation process

and the government's increased cash position is also reflected in recent measures such as

pruning of the treasury bill calendar, prepayment of debt and lower than notified (as per

the borrowing calendar) amount announced for the last tranche of dated securities auction.

Going forward, the reduced borrowing requirement may be reflected in a pruned borrowing

calendar for H2FY11; the second half being the busy season for credit provides the

government an opportunity to vacate the space for credit growth to pick up.

The firming up of short-term interest rates and the liquidity gap that exists now might be

bridged in the second half with lower government borrowing, higher deposit mobilization,

banks' recourse to borrowing and an expected decline in inflation in 2HFY10. While the

immediate inflationary outlook has deteriorated somewhat with increase/freeing of

petroleum prices, softening of food prices observed in latest week and expectation of

normal monsoon coupled with softening of oil prices abroad holds the prospect of declining

inflationary outlook for 2HFY10.

INFLATION TO DECLINE IN 2HFY11 BUT LIKELY TO REMAIN AT ELEVATED LEVELS

12%

11%

WPI inflation

Projection - After oil price hike

Projection - After oil price hike

and lower food inflation

Inflation will remain a

key driver of interest

rates in 2HCY10

10%

9%

Projection - Before oil price hike

8%

7%

Source: MOSL

July 2010

16

India Strategy

Assessment of role as Sensex driver

Interest Rates is a key midfielder for markets and is expected to remain in form in second

half of 2010. Deficit management and inflation will be key to direction of interest rates. The

economy will need stable interest rates in this period when the capex cycle is about to

SENSEX

begin. Stable interest rates will be a key to higher market indices.

Midfield #7: Capex Boom - key winger

7

We believe that India is at the cusp of a meaningful capex boom, driven by impending

large investments in infrastructure and industrial activities. The rapid economic growth

over the past decade has put a massive strain on the country's existing infrastructure.

Investment ratio (defined as percentage of GDP to the GDP growth rate) has declined

from 50 for 1988-1997 to 38 for 1998-2007. Under-investments in a period of high economic

growth have further aggravated the constraints. India, in our opinion, is now among the

leading global destinations for infrastructure and investment spending over the next decade.

capex boom

INDIA'S INFRASTRUCTURE LAGS BEHIND GLOBAL PEERS, INCLUDING MANY DEVELOPING COUNTRIES…

ROAD DENSITY

PAVED ROAD/1,000 KM

ARABLE AREA

RAIL DENSITY

RAIL / 1,000 KM

ARABLE AREA

AIR PASSENGERS

1,000 PASSENGERS/MILLION

URBAN CAPITA

TELECOM

SUBSCRIPTIONS/100 PEOPLE

Japan

UK

Sri Lanka

Italy

France

S. Korea

Malaysia

Bangladesh

US

Germany

Poland

China

Indonesia

Canada

India

Russia

Mexico

S. Africa

Thailand

Brazil

19.8

6.5

6.1

5.5

5.4

5.1

4.4

2.5

2.2

2.0

2.0

1.2

1.1

1.1

0.9

0.6

0.5

0.4

0.4

0.2

Japan

UK

Bangladesh

Germany

S. Korea

Italy

France

S. Africa

Poland

US

Sri Lanka

Malaysia

Canada

Mexico

Russia

Braxil

China

India

Indonesia

Thailand

430

335

309

289

198

189

159

136

135

123

111

103

98

69

68

55

49

35

34

28

USA

Canada

UK

Thailand

Malaysia

Germany

France

Japan

Italy

S. Korea

Sri Lanka

S. Africa

Indonesia

China

Mexico

Russia

Brazil

Poland

India

Bangladesh

1

,595

1

,587

1

,520

1

,225

1 41

,1

1

,003

91

7

906

840

530

370

283

282

268

243

231

1

40

72

42

2,896

UK

Italy

Germany

France

Spain

US

Japan

Canada

Russia

Malaysia

Poland

Mexico

China

S. Korea

Thailand

S. Africa

Indonesia

Sri Lanka

India

Bangladesh

182

172

171

138

135

134

125

120

110

105

87

76

72

68

65

65

36

24

19

7

Source: World Bank

… AND IS NOW DRIVING A NEW WAVE OF INVESTMENTS: TWELFTH PLAN TARGET INFRASTRUCTURE SPENDING…

AT 4.5X OF TENTH PLAN

ACCOUNTS FOR 10% OF GDP

PRIVATE SECTOR SHARE TO GO UP FROM 25%

4.5x

2.3x

514

227

10th plan

actual

11th plan

revised

1,025

7.6%

5.1%

10.0%

IN TENTH PLAN TO 50% IN TWELFTH PLAN

US$b

25

56

% of total

36

186

11th plan

revised

50

512

12th plan

target

10th plan

actual

11th plan

revised

12th plan

target

10th plan

actual

12th plan

target

Source: IPA

July 2010

17

India Strategy

Eleventh Plan (FY08-12) targeted infrastructure spend on track at US$514b,

~2.3x of Tenth Plan (FY02-07) spend

Revised estimate [based on the mid-term appraisal for Eleventh Plan (FY08-12) by

the Planning Commission] for infrastructure investments under Eleventh Plan stands

at US$514b, and is similar to the original target.

Within the sector-wise composition, targeted investments in Telecom and Oil & Gas

(given inclusion of Oil pipeline within definition of Infrastructure) have now increased

v/s original estimates; sectors like Roads, Ports, Railways, etc have witnessed slippages.

Excluding Telecom and Oil & Gas, targeted infrastructure investments in the Eleventh

Plan now stand at US$393b (slippage of just 11.6% v/s original target), which is

commendable.

Actual investments in Infrastructure for the initial two years of the Eleventh Plan

period (FY08 and FY09) have been higher than initial estimates by 12.4% and 11.7%,

respectively.

Initial estimate for Twelfth Plan (FY13-17) at US$1t, ~2x of Eleventh Plan

target and 4.4x of Tenth Plan spending

Based on initial estimates by Planning Commission for the Twelfth Plan period (FY12-

17), total investment in Infrastructure is estimated at US$1,025b.

For the Twelfth Plan period, the target of private sector investment has been kept at

"at least" 50% of the total investment at US$500b, which is nearly the entire

infrastructure spending in the Eleventh Plan.

Corporate capex also at an inflexion point

Industrial capex is also at an inflexion point, as is evident from a V-shaped recovery in

terms of new projects announced. According to CMIE, an estimated Rs50t worth of

projects are under various stages of implementation and another Rs5t worth of projects

are being added every quarter.

PRIVATE CAPEX IS TURNING UP WITH A PHENOMENAL QUEUEING UP OF PROJECTS - PINK TO BE MADE A BAR

Project investments outstd at the end of the quarter

All industries project investments under implementation

Project investments added during the quarter (RHS)

Project investments completed during the quarter (RHS)

120,000

90,000

60,000

30,000

0

10,000

7,500

5,000

2,500

0

Source: MOSL

A further evidence of capex cycle in play can be obtained from the runaway growth

witnessed in the capital goods sector of IIP and eventual coming up of basic goods industry

to record near double-digit growth in 2010 (up to April). A continuation of these trends

would create the necessary condition for growth to inch up toward the double-digit level.

July 2010

18

India Strategy

IIP-VERY STRONG SHOWING FROM THE CAPITAL GOODS SECTOR AND THE BASIC GOODS SECTOR ALSO HAS

TURNED UP

IIP

90%

60%

30%

0%

-30%

Basic goods

Capital goods

Source: MOSL

Assessment of role as Sensex driver

Aside from the glare, Capex Boom will quietly - and yet rapidly - wing its way up the field,

paving the way for significant growth opportunities across industries. Over the next few

SENSEX

years, capex will be amongst the most important drivers of both earnings and market

valuations.

6

Midfield #6: Consumption - story goes on …

India's private final consumption expenditure (PFCE) accounts for 55-60% of GDP and

remains the bedrock of the economy's resilience. The share of PFCE has steadily declined

from 80%+ in the 1970s to the current levels; however, this is due to the faster growth of

capital formation. In recent years, however, share of PFCE has stabilized, translating into

significant growth in consumer-facing sectors.

consumption

LONG-TERM TREND OF PFCE AND GCF AS % TO GDP

Private final consumption exp (% of GDP)

Gross capital formation (% of GDP)

100%

80%

60%

57%

40%

35%

20%

0%

Pvt Final consumption expenditure has

been relatively stable in the last 5-years

59%

58%

58%

57%

58%

57%

FY05

FY06

FY07

FY08

FY09

FY10

Source: MOSL

July 2010

19

India Strategy

In absolute terms, the consumer sector continues to display steady growth over a fairly

long period. This is true in both categories - (1) Non-durables and (2) Durables.

KEY INDICATORS OF TREND IN CONSUMER NON-DURABLES

FMCG SECTOR SALES (AC NIELSEN - RS B)

PAINT VOLUMES TREND ('000 TONS)

1,161

8-year CAGR - 12%

711

468

494

504

542

585

331

369

400

446

406

1,016

864

10-year CAGR - 11%

702

457

523

609

899

775

2001

2002

2003

2004

2005

2006

2007

2008

2009

KEY INDICATORS OF TREND IN CONSUMER DURABLES

TWO-WHEELER SALES TREND (MILLION)

PASSENGER CARS SALES TREND ('000)

10-year CAGR - 11%

6.6

7.6

10.5

8.5

8.1

8.4

10-year CAGR - 13%

1,354

882

639

591

621

664

1,047 1,120

1,517

1,660

2,120

3.8

3.7

4.3

5.0

5.6

Source: MOSL

The cross-substitution effect

In the last 5-7 years, there has emerged a unique phenomenon of cross-substitution by

Indian consuming households. This substitution is of two kinds:

1. Substitution of products by new services, mainly Telecom; and

2. Substitution of products/services by EMIs, mainly for Housing and Durables.

TELECOM SUBSCRIBERS V/S CONSUMPTION GROWTH

HOUSING LOANS V/S CONSUMPTION GROWTH

5,000

4,000

3,000

2,000

1,000

0

FY 03 FY04

FY 05 FY 06 FY 07 FY 08 FY 09 FY 10

(13)

(35)

(55)

(96)

Wireless subscriber base - indexed

(Figures in brackets is actual subs

in millions)

(392)

(261)

(166)

Pvt final consumption

exp - indexed

(584)

600

Retail bank loans - indexed

(5,054) (5,521)

(Figures in brackets is actual

(4,342)

450

loans in Rs b)

(3,527)

300

(1,787)

150

0

FY 03

FY 04

FY05

FY 06

(1,142)

Pvt final consumption

exp - indexed

FY 07

FY08

FY 09

(2,558)

Source: MOSL

July 2010

20

India Strategy

The strong consumption boom has enabled the economy to withstand the global meltdown.

Autos, FMCG, Engineering, Banks, etc have made record profits in FY10, despite flat

earnings growth for the aggregates. While the return of capex cycle and industrial growth

will be a source of rebound in profits in FY10-12, consumption themes will provide stability

to the aggregate profit growth.

Assessment of role as Sensex driver

Consumption is Team India's most dependable midfield force. It has helped the economy

to maintain its growth momentum over the last two years, when the industrial and external

SENSEX

sectors were under stress. We expect the consumption theme to remain strong as the

benefits of the Next Trillion Dollar opportunity will provide several growth avenues.

Midfield #5: Payouts - getting better

5

In FY10, corporate dividend payouts, both in absolute terms and as percentage of profits,

bounced back after a sluggish trend for the previous three years in a row. FY09 also saw

a surge of buyback offers.

Dividends and buybacks put cash into the hands of shareholders. This cash is typically

ploughed back into purchase of stocks or into higher consumption, both of which are

positive for the market. Simultaneously, higher payouts also reflect superior free cash flow

generation of companies, and hence are a positive for valuation multiples.

Over the last few months, there have been several announcements of buyouts, buybacks

and open offers by corporates. Prominent amongst them have been ABB, Piramal, Hindustan

Unilever, Areva, etc. We believe these events would also boost funds flow into the market.

DIVIDEND PAYOUT (%): RECOVERING IN FY10

BUYBACK OFFERS IN FY09 WERE AT AN ALL-TIME HIGH (RS B)

payouts

Dividend (Rs b)

31

28

30

29

30

Payout (%)

36

42

28

26

25

24

437

206

239

279

334

336

3

13

24

22

22

20

10

1

4

3

9

49

62

81

121

148

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10

Source: MOSL

Payouts are computed for Nifty companies on standalone basis, excluding dividend tax

Assessment of role as Sensex driver

Payouts has more of a supportive role in the line-up. It combines well with Consumption

on one hand and with Valuations on the other. Improvement in payouts along with growth

SENSEX

will enable the market indices to move higher.

July 2010

21

India Strategy

Defense #4: Monsoons - rainbow of hope

4

After the setback received in FY10 with 22% deficit in rainfall over the long period average

(LPA) there has been some setback in the monsoon this year as well with June recording

a 16% deficit. However, IMD has raised its forecast for the current year from 98% to

102% in its latest update for South West Monsoon. A few factors that provide us reason

for optimism are: (1) lower weightage (18%) of June in overall monsoon, (2) expectation

of La Nina conditions (60% probability) that are associated with either excess or normal

rainfall, and (3) rare occurrence of drought in successive years (no occurrence of successive

years of severe drought; moderate drought has occurred only thrice in the past century).

INITIAL SETBACK OF JUNE CAN BE MADE UP BY SUBSEQUENT MONTS BECAUSE OF THEIR HIGHER WEIGHTAGE

AND GREATER IMPORTANCE FOR CROP SOWING

monsoons

Normal Rainfall (mm)

Actual/Expected Rainfall

98%

101%

% of Normal in FY10-11 (RHS)

125%

84%

294

160

135

July IMD Est.

Aug IMD Est.

288

258

261

178

225

June Actual

Sep Implied in IMD Est.

Source: MOSL

Monsoons will be critical to

the growth, inflation and

interest rates in FY11

Monsoon has significant impact on the foodgrain production and food inflation in India. In

general, years of drought have been succeeded by higher rainfall and agricultural production.

Although the broader head of "agriculture and allied activities" (with 16-17% share of

GDP) is now fairly diversified with horticulture, livestock and fisheries contributing close

to 60% of the GDP originating from the broader agri-sector, and "cereals, pulses and

oilseeds" grown during kharif season accounting for only 20% of the total agricultural

output, an overwhelming percentage of the population (~55%) is dependent upon agriculture

for livelihood. Besides, rainfall feeds the irrigation network and significantly affects hydro-

electricity generation and lessens fiscal burden for agricultural support and food management

operations for the government. The softening of food prices in the latest week augurs well

for the outlook of food prices, going ahead. The softening of international prices could also

keep a check on domestic prices.

HIGHER FORECAST (102% OF LPA) BY IMD HAVE RAISED THE ODDS OF HIGHER FOODGRAIN OUTPUT

30%

15%

0%

-15%

-30%

Increase in Foodgrains production

Food inflation (WPI)

% deviation from LPA

Source: MOSL

July 2010

22

India Strategy

Assessment of role as Sensex driver

Monsoons is a key defender, albeit with a bit of unpredictability. When in form, it plays

well for Consumption to take matters forward. Current indications suggest that such will

be the case in second half 2010. However, any slip-ups here could be a setback for the

SENSEX

market in 2HFY11.

Defense #3: Corporate Events - source of performance differential

3

Corporate developments have been a key valuation driver over the last few years. While

cross-border M&As in the past have been a major reason behind underperformance in

stocks, India Inc's plans to expand globally continue.

A big uncertainty has been terminated with the Supreme Court judgment in favor of Reliance

as regards gas pricing, over-ruling the family MoU. Given the high weightage of Reliance

in the benchmarks, clarity on this issue was critical to the markets.

Over the next couple of years, we expect more Indian companies to announce global

deals and partnerships. Moreover, interest of global companies in India will also rise, driving

returns in specific sectors and stocks.

GLOBAL DEALS HAVE LED TO UNDERPERFORMANCE OF STOCKS

corporate events

258

Price Change Current Vs Announced (%)

91

20

41

0

6

23

45

41

9

79

19

-8

19 22

81

8 0

-16

-27

-77

Source: MOSL

Assessment of role as Sensex driver

Global acquisitions have resulted in underperformance for most of the corporates. Indian

markets like certainty on growth, and hence domestic businesses get significant premium

SENSEX

over others. Uncertainty is best avoided for markets to move higher.

July 2010

23

India Strategy

Defense #2: Global markets - weak link

2

Post the lows made in March 2009, global markets have recovered well, with average

returns of 75-100%. Indian benchmarks have outperformed almost every other market

over this time period (this was also driven by a 20% move post the election results). Since

September 2009, global markets have held on to their levels well, despite adverse

newsflowon Europe and recent concerns on China.

INDIAN MARKETS HAVE OUTPERFORMED GLOBAL MARKETS FROM LOWS OF 2009

global markets

Sensex

Hang Seng China ENT

2.4

2.2

2.0

1.8

1.6

1.4

1.2

1.0

S&P 500

KOSPI

FTSE 100

Brazil Bovespa

2.1

1.7

1.7

1.6

1.5

1.4

Source: MOSL

Given the strong correlation of Indian equities with global markets, any sharp sell-off will

also impact the domestic market. In the last couple of months, global markets have again

showed signs of weakness. While Indian equities have remained stable, further weakness

in global markets could impact Indian equities too.

GLOBAL MARKETS HAVE WELL CONSOLIDATED IN LAST 3 QUARTERS

Sensex

Hang Seng China ENT

1.21

1.12

1.03

0.94

0.85

S&P 500

KOSPI

FTSE 100

Brazil Bovespa

1.0

1.0

1.0

1.0

1.0

While global markets have

well consolidated in last

three quarters, recent trends

have turned weak

RECENT CORRECTION IN GLOBAL MARKETS HAS NOT YET IMPACTED INDIA

Sensex

Hang Seng China ENT

1.05

1.00

0.95

0.90

0.85

0.80

S&P 500

KOSPI

FTSE 100

Brazil Bovespa

1.0

1.0

0.89

0.86

0.85

0.84

Source: MOSL

July 2010

24

India Strategy

Assessment of role as Sensex driver

Global markets need to stabilize for Indian markets to move higher. In the immediate

term, any threat to global equities will also adversely impact flows into India.

SENSEX

Defense #1: Valuations - time correction underway

1

With market indices being flat for the last three quarters, growth in earnings has led to a

correction in valuations. From a premium of over 20% to 15-year averages in September

2009, the Sensex P/E has now corrected as earnings have grown. Consolidation for another

couple of quarters will bring valuations in line with long-term averages.

valuations

P/E OF INDIAN EQUITIES TRENDING BACK TO LONG-TERM AVERAGES

P/E

P/BV

Sensex P/E ( LHS)

18.7

17.4

16.1

14.8

Sensex ( RHS )

17,900

17,300

16,700

16,100

3.2

3.0

2.8

2.6

Sensex P/B (x)

Sensex ( RHS )

17,900

17,300

16,700

16,100

15 Year Average 14.4x

13.5

15,500

2.4

15 Year Average 2.5x

15,500

15-YEARS SENSEX P/E V/S SENSEX

15-YEARS SENSEX P/B V/S SENSEX

Sensex P/E ( LHS)

27

22

17

12

7

Sensex ( RHS )

21,700

16,700

4.8

3.9

3.0

2.1

1.2

Sensex P/B (x)

Sensex ( RHS )

21,700

16,700

15 Year Average

14.4x

11,700

6,700

1,700

15 Year Average

2.5x

11,700

6,700

1,700

Source: MOSL

July 2010

25

India Strategy

SENSEX PER BAND

SENSEX EARNINGS YIELD TO BOND YIELD

24,200

18,200

12,200

6,200

200

23x

20x

17x

14x

11x

8x

2.2

1.7

1.2

15 Year Avg is 0.88x

0.7

0.2

0.4

2.0

1.6

0.83

Source: MOSL

Assessment of role as Sensex driver

Valuations need to be supportive for market indices to resume their upward journey. With

SENSEX

another quarter of consolidation, market indices will start trending towards the long-term

averages. This along with good growth prospects will help to take the markets higher.

July 2010

26

India Strategy

1QFY11 earnings preview

Cement, Oil & Gas and telecom impact YoY earnings growth

We expect MOSL Universe (excluding RMs) earnings growth to be 17% in 1QFY11.

This growth is a moderation from the 2HFY10, when earnings grew by 31%, largely

driven by low base. 1QFY11 will also be a quarter, where absolute PAT will be lower QoQ

(first time in last 4 years). This is driven by flat growth QoQ by Oil & Gas and drop in

earnings in Telecom and Engineering.

Metals (up 461% YoY), Textiles (up 126% YoY), Retail (up 81% YoY), Pharma (up 30%

YoY) and Auto (up 30% YoY) contribute significantly to the overall earnings growth of

MOSL universe. Other sectors would however have relative muted earnings growth, Viz.

Banks – up 16% YoY, IT – up 15% YoY, Engineering – up 13% YoY, FMCG – up 8%.

Telecom sector would report highest negative earnings growth (down 44% YoY), followed

by Cement (down 19% YoY) and Oil & Gas excl RMs (down 7% YoY).

1QFY11 will also see margin pressures at the aggregate level. While sales is expected to

grow at 25%, EBITDA growth at 19.7% and PAT growth at 17% will witness a slow

growth. Margins will decline in Autos, Cement, FMCG, IT, Oil & Gas and Telecom.

QUARTERLY EARNINGS PERFORMANCE - MOSL UNIVERSE (RS B)

SALES

SECTOR

(NO OF COMPANIES)

JUN-10

VAR %

YOY

VAR %

QOQ

JUN-10

EBITDA

VAR %

YOY

VAR %

QOQ

JUN-10

NET PROFIT

VAR %

YOY

VAR %

QOQ

Auto (5)

Banks (20)

Cement (7)

Engineering (6)

FMCG (11)

IT (7)

Infrastructure (5)

Media (5)

Metals (8)

Oil Gas & Petchem (11)

Pharma (14)

Real Estate (6)

Retail (2)

Telecom (4)

Textiles (5)

Utilities (6)

Others (2)

MOSL (124)*

MOSL Excl. RMs (121)

Sensex (29)

*Tata Steel Consolidated

317

267

114

218

185

283

72

19

713

2,210

130

35

33

197

35

238

24

5,090

3,821

2,520

36.6

28.8

1.0

20.5

14.8

13.3

15.9

25.1

26.4

28.0

10.5

32.0

29.1

0.9

33.3

11.8

3.3

23.0

25.1

28.0

-4.9

-4.1

-4.0

-34.8

1.6

5.1

-20.7

4.3

-6.8

-8.0

3.7

-7.5

-2.5

3.4

-2.1

13.2

-9.2

-6.7

-4.3

-4.8

43

228

32

25

37

71

11

8

140

234

27

15

3

66

8

66

4

1,017

982

622

29.7

22.9

-14.2

23.7

8.9

10.4

16.6

38.5

110.9

-4.2

14.9

14.6

34.7

-12.7

58.3

16.2

7.1

15.6

19.7

20.6

-7.9

-5.8

1.7

-59.0

2.6

1.9

-22.2

8.0

-16.2

-20.2

1.2

-6.8

-5.8

1.6

-6.5

21.6

-15.7

-11.2

-6.4

-4.7

27

115

19

16

25

55

4

5

82

111

18

7

1

26

2

36

2

551

534

338

29.7

16.4

-18.9

13.4

7.6

15.0

5.4

25.1

461.4

-26.3

30.1

3.1

81.0

-43.8

125.8

5.1

-0.1

8.9

-4.6

2.8

6.2

-59.7

4.1

-0.1

-23.2

25.2

-14.8

-34.2

-5.4

-15.6

-23.0

-26.7

-11.9

-5.8

-36.5

-16.4

17.0

-9.3

19.3

-7.8

Source: MOSL

July 2010

27

India Strategy

1QFY11 PAT YOY GROWTH ACROSS SECTORS

1QFY11 PAT QOQ GROWTH ACROSS SECTORS

461

126

81

30 30 25 19 17 16

15 13 8

5

5

3

-7 -19

25

6

4

3

0

-4 -5 -5 -6 -8 -9

-12 -15 -16

-23 -23 -27

-60

-44

Source: MOSL

QUARTERLY PAT TREND MOSL UNIVERSE EX RMS (RS B)

PAT GROWTH MOSL UNIVERSE EX RMS

70

45

20

-5

-30

QoQ Grow th (%)

YoY Grow th (%)

Source: MOSL

QUARTERLY PAT TREND - MOSL UNIVERSE (RS B)

SECTOR

JUN

2006

SEP

2006

DEC

2006

MAR

2007

JUNE

2007

SEP

2007

DEC

2007

MAR

2008

JUNE

2008

SEP

2008

DEC

2008

MAR

2009

JUNE

2009

SEP

2009

DEC

2009

MAR

2010

JUN

2010E

Automobiles

Banking

Cement

Engineering

FMCG

IT

Infrastructure

Media

Metals

Oil & Gas Ex RMs

Pharma

Real Estate

Retail

Telecom

Textiles

Utilities

Others

MOSL Univ Excl RMS

12.4

39.2

14.2

6.1

14.2

26.1

1.8

1.7

53.1

79.3

10.5

1.0

0.2

13.8

1.0

18.8

0.8

294

12.8

53.5

12.1

8.6

15.4

31.4

1.5

1.8

66.2

77.9

13.3

1.4

0.5

17.8

1.5

21.4

1.0

338

12.6

55.0

15.9

13.5

16.7

34.4

2.0

2.5

70.8

86.2

13.9

5.5

0.5

22.8

1.4

25.7

0.6

380

15.1

60.3

16.6

21.9

14.8

37.5

2.7

2.4

70.3

66.5

14.8

4.6

0.7

26.0

1.2

39.6

1.9

397

13.8

56.5

19.0

8.0

17.9

35.0

2.5

3.2

72.8

15.2

68.5

16.9

14.5

18.4

37.8

1.9

3.1

69.6

16.9

80.8

16.9

16.5

19.8

39.9

2.9

3.8

64.7

94.7

13.8

30.9

0.6

34.1

1.4

27.7

1.1

466

17.1

83.7

16.3

23.7

17.5

40.2

15.3

66.1

17.1

13.8

19.6

39.1

13.7

7.4 12.0

90.0 112.4 107.6

14.3 14.7 18.7

16.5

19.9

45.6

19.7

21.0

48.1

3.4

2.5

35.1

51.0

10.6

10.8

0.8

39.1

0.6

29.6

1.4

408

31.8

20.6

46.4

5.2

2.5

16.2

20.7 26.4 25.7 28.2

98.5 107.1 117.5 111.6

23.5 22.3 16.4 17.9

14.5

23.1

48.2

3.4

3.9

14.6

18.4

24.7

51.2

2.6

4.3

26.7

22.3

26.3

53.9

4.5

4.3

61.1

87.0

7.6

9.1

1.3

36.4

2.0

32.3

1.4

509

40.8

23.9

55.5

4.7

3.8

96.2

98.3

19.2

8.7

1.4

35.4

2.0

26.9

114.7

19.0

16.4

24.8

55.4

3.6

4.8

82.0

94.0

18.2

7.4

1.1

26.0

1.8

4.1

2.7

3.3

2.4

3.6

3.0

99.1 102.3 110.7

80.1 138.0 105.2

14.0 14.2 12.5

35.1 26.3 27.4

0.8

37.6

1.5

28.6

2.7

505

0.7

39.7

0.6

27.9

2.0

529

1.2

39.2

1.2

28.0

2.1

534

94.7 101.2

13.0 14.5

28.7 27.9

0.2

30.7

0.8

25.5

1.1

423

0.8

32.0

1.5

24.6

1.3

450

77.6 101.0 103.2

3.6 14.0 17.7

3.1

7.2

8.8

0.8

39.8

1.1

36.7

2.6

426

0.6

46.2

0.8

34.4

2.2

457

1.2

34.2

1.8

31.0

1.7

483

38.4

36.2

3.4

2.2

589

534

Source: MOSL

July 2010

28