7 September 2012
Update
Capital Goods
Key Beneficiaries
BHEL
Commodity price volatility: Identifying winners
BHEL, Thermax and Cummins key gainers; L&T relatively insulated
Thermax
The prices of industrial commodities have declined sharply in USD terms. In INR terms, the
price increases have moderated, and in several cases, prices have stabilized. This should
have a positive impact on the EBITDA margins of capital goods companies.
Given the backdrop of continuously increasing raw material prices till the end of Dec'11,
we believe capital goods companies would have factored in continued cost inflation at the
time of project bidding. Stable raw material prices will support profitability, especially of
long gestation projects.
BHEL, Thermax and Cummins gain the most from benign/softening industrial commodity
prices, given the higher manufacturing component. L&T is better positioned to manage
the volatility in international commodity prices, given its diversified raw material basket.
ABB/Siemens have a high component of traded/project business - unfavorable currency
movements have been offsetting a large part of the gains from softening international
commodity prices.
Over a longer term we believe that a scenario of increasing commodity prices is more
beneficial for capital goods companies, particularly those exposed to industrial commodities
as it results in an improvement in the demand environment. L&T remains our top pick.
Strong co-relation: RM costs have responded to drastic price changes, while gradual movements
are managed through adjustments in product prices
- RHS
Cummins
Source: Company,MOSL
BHEL & Cummins have highest manufacturing component - key beneficiaries
RM Cost (% of sales)
In our coverage universe, BHEL has the lowest raw material cost at 57%, indicating
increased manufacturing content and relatively higher value addition being captured
in-house. This competitive advantage is also reflected in its EBITDA margin being the
highest in our coverage universe at 20%. Cummins' raw material cost stands at 65% of
revenue, indicating higher share of manufacturing and is reflected in superior EBITDA
margins at 17-18%. We believe that the current scenario of declining commodity prices
in USD terms and INR depreciation has meaningfully improved the competitive
positioning of BHEL and Cummins. The competition's cost base is largely composed of
imported equipment, putting pressure on margins. In contrast, domestic value
addition constitutes a significant part of BHEL and Cummins' cost base, providing
support to margins.
1
Satyam Agarwal
(AgarwalS@MotilalOswal.com) +91 22 3982 5410
Deepak Narnolia
(Deepak.Narnolia@MotilalOswal.com) +91 22 3982 5126
Investors are advised to refer through disclosures made at the end of the Research Report.

Capital Goods | Update
Imports (% of RM)
Siemens, ABB have highest imports - currency movement mitigating gains
Siemens and ABB have the highest import content at 55% and 39% respectively of
total raw material out of which 65-75% are from their parent companies. We
understand that in such contracts the volatility in commodity prices is passed on
more spontaneously. However, the gains of lower commodity prices in USD terms are
mitigated by INR depreciation. These companies are making attempts to correct the
imbalances by expanding their manufacturing footprint in India.
BHEL has the highest inventory - benefits accrue with a time lag
Inventory (Days)
BHEL has the highest inventory at 169 days against an average of ~55 days for capital
goods companies. Raw material and work in progress accounts for 90% of the inventory
position at 153 days. Hence, the benefits of lower raw material prices accrue with a
time lag of 1-1.5 years v/s ~6 months in case of other companies.
Overseas projects are largely on fixed price contracts
Crompton Greaves has the highest share of overseas revenue (50%), followed by
Cummins (29%) and Siemens (22%). We understand that most overseas contracts are
on fixed price; hence, the benefits of lower commodity prices will be better visible.
Siemens / L&T (15%) will be important beneficiaries given the long cycle of execution.
Overseas Revenues (% of
sales)
Steel largely purchased at spot prices, non-ferrous commodities hedged
BHEL and Thermax are largely exposed to steel - ordinary steel constitutes 15-25% of
the consumption and is largely unhedged. Cummins is exposed to pig iron, also largely
procured on spot basis. Hedging is relatively easier for non-ferrous commodities, and
companies generally hedge their exposure to copper, aluminum etc.
Expect steel prices to decline sharply
Beneficiaries of commodity
price decline
High
BHEL
KKC
CRG
TMX
Medium
LT
Low
SIEM
ABB
Note: Please refer to our detailed report "Steel Downhill" dated 12 August 2012
Comparative valuation
Rating
MCap
(USD b)
CMP
(INR)
EPS (INR)
FY12 FY13E FY14E
13.9
25.0
9.1
23.4
85.4
23.1
27.1
19.1
20.4
12.4
24.5
91.4
31.3
31.5
82.4
11.5
18.5
23.5
18.5
40.7
15.1
P/E (x)
FY12 FY13E FY14E
51.6
8.0
11.7
19.9
15.4
29.8
18.0
37.6
9.8
8.5
19.0
14.4
22.0
15.5
52.8
7.3
13.3
16.3
14.3
22.7
8.9
EV/EBITDA (x)
FY12 FY13E FY14E
31.0
4.9
6.9
13.5
12.8
16.5
10.2
22.8
5.8
5.2
11.8
11.2
12.8
8.0
RoE (%)
FY12 FY13E FY14E
7.4
11.2 14.0
30.3
22.3 16.1
10.7
15.3 18.5
28.8
29.9 28.0
17.8
17.2 16.4
14.6
18.8 23.0
27.4
18.7 19.2
source: Bloomberg
2
ABB#
Neutral
2.7
718
8.7
BHEL
Neutral
8.8
201
28.2
Crompton
Neutral
1.2
106
5.7
Cummins
Neutral
2.3
466
19.8
L&T
Buy
14.3 1,317
78.0
Siemens## Neutral
4.1
688
16.9
Thermax
Neutral
1.0
488
33.9
# Year end December; ## Year end September
7 September 2012

Capital Goods | Update
EBITDA margins: Strong correlation with both raw material cost and
operating leverage
Historically, raw material costs have responded to drastic changes in steel prices. In
periods of gradual increase/decline, companies have passed on cost changes by
adjusting product pricing. EBITDA margins have had strong correlation with revenue
growth as well, given fixed cost operating leverage. In the current environment,
commodity prices are declining, but revenue growth is also moderating. Hence,
the benefits will be largely in terms of minimizing the quantum of decline in EBITDA
margins.
In FY06-07, EBITDA margins expanded meaningfully from ~9% to 12.5%,
supported by sharp decline in raw material prices (20-25%) coupled with
operating leverage (revenue CAGR at 30%).
In FY08-09, EBITDA margins were stable, despite continued strong revenue
growth (CAGR at 29%), as raw material cost increased meaningfully (30-35%),
offsetting the gains from operating leverage.
In FY10-11, EBITDA margins expanded from ~13.5% to 15%, with correction in
raw material prices (down 15%). However, the gains in terms of margin
improvement were modest given slowdown in revenue growth (16% CAGR).
Post FY11, EBITDA margins have been witnessing moderate decline, given lower
revenue growth (no operating leverage) and gradual increase in RM cost.
EBITDA margins leveraged to both commodity prices and revenue growth
Margin expansion
supported by very
high growth despite
steady rise in
Commodity prices
Margins stable
despite significant
RM cost pressure &
was offset by
operating leverage
Margins expanded
supported by sofeting
commodity prices;
growth slowed down
Margins impacted by
rising commdity
prices and faltering
growth
- RHS
Source: Company,MOSL
7 September 2012
3

Capital Goods | Update
BHEL: Highest manufacturing content
Expect earnings to be favorably impacted
Bloomberg
BHEL IN
Equity Shares (m)
2,447.6
52-Week Range (INR) 368/198
1,6,12 Rel. Perf. (%) -12/-27/-45
M.Cap. (INR b)
492.0
M.Cap. (USD b)
8.8
Stock performance (1 year)
BHEL's raw material costs have a very strong co-relation with the CRB BLS industrial commodity
index, with a time lag of ~1-1.5 years. The long time lag is largely given two factors: i) inventory
levels at 169 days in the value chain (imported materials at ~7-9 months inventory, while
indigenous materials at ~5-6 months) ii) Certain components, specialty steels, etc are mostly
tied up as back-to-back contracts with suppliers as the orders are received and thus BHEL is not
significantly exposed to commodity price movements on several of these components. We
believe that moderating commodity prices will enable BHEL to partly offset the margin
pressures arising from increased share of super-critical projects and poor operating leverage.
Financial & valuation summary
BHEL: Raw material consumption basket
Non Ferrous
Metals
2%
Components
46%
BHEL: Material costs have strong co-relation with Raw Industrial commodity
index, with a time lag of ~1-1.5 years
- RHS
Ferrous
Metals
22%
Others
15%
Sub
Contracting
charges
15%
Source: Company/MOSL
Exposed to volatility in steel prices; forex risk largely a pass through:
Ordinary
steel constitutes 20-25% of raw material cost and is generally procured on spot
basis. Fixed price contracts typically account for 50% of BHEL's order book, exposing
it to price fluctuations in ordinary steel. Imports constitute 36% of raw material,
and are largely towards specialty steels/components. Components contribute
45% of the raw material consumption, including outsourcing to vendors. Forex
risk is largely a pass-through, and we understand that BHEL's exposure to currency
fluctuations is limited.
Even contracts with price variation clauses have certain fixed components:
Contracts with price variation clauses generally stipulate: (i) Steam Generator -
15% fixed component, 25% labor and 60% base metals & alloys; (ii) Turbine
Generator - 15% fixed component, 35% labor and 50% base metals & alloys. Thus,
even for contracts with price variation clause, there is a fixed component,
positively impacting margins in periods of stable/lower commodity prices.
7 September 2012
4

Capital Goods | Update
Highest share of manufacturing in our capital goods coverage:
BHEL's raw material
cost stands at 57% of revenue, the lowest among capital goods companies (average
at 70%). This indicates the increased quantum of manufacturing, which is a high
margin activity. This is also reflected in BHEL's EBITDA margin of 20%, by far the
highest in our capital goods universe (average at 14.3%).
Focus on improving operational efficiencies:
Over the past few years, BHEL has
been focusing aggressively on improving operational efficiencies - lean
manufacturing, increased localization, design optimizations, etc. The company
has also opened an office in China for sourcing of raw material. The benefits from
several of these initiatives should accelerate, going forward.
Expect earnings to be favorably impacted:
We believe that moderating commodity
prices will enable BHEL to partly offset the margin pressures arising from increased
share of super-critical projects and poor operating leverage. Our models currently
build in a decline in BHEL's EBITDA margin from 20.2% in FY12 to 18.3% in FY13 and
15.6% in FY14. We estimate EPS at INR24.7 for FY13 (down 12.3%) and INR19.7 for
FY14 (down 20.4%). We believe that with stable/declining trend in commodity
prices, BHEL's earnings will be favorably impacted. Maintain Neutral
7 September 2012
5

Capital Goods | Update
Financials and Valuation
7 September 2012
6

Capital Goods | Update
L&T: Diversified RM basket cushions volatility
30-35% order book on fixed price basis
Bloomberg
LT IN
Equity Shares (m)
608.9
52-Wk Range (INR) 1,720/971
1,6,12 Rel. Perf. (%)
-6/5/-23
M.Cap. (INR b)
801.9
M.Cap. (USD b)
14.4
Stock performance (1 year)
L&T is relatively cushioned from any sharp movements in prices of industrial commodities.
This is largely given: i) diversified raw material basket which includes specialty steels / project
components / traded goods (in several cases, the prices are largely contracted at the time of
order receipt), construction materials (includes domestic materials like cement, aggregates,
etc) and sub-contracting charges (which also includes a large labour component) ii) fixed price
contracts are ~30-35% of the order book, and in several of these contracts the risks are
hedged through back-to-back arrangements.
Financial & valuation summary
*Consolidated; EPS is fully diluted
L&T: Raw material consumption basket
Purchase of
trading goods
7%
RM &
Components
27%
L&T: Limited correlation of raw material cost with steel prices
- RHS
Sub-
Contracting
Charges
30%
Construction
materials
36%
Source: Company/MOSL
Diversified raw material basket:
L&T's raw material basket comprises of Raw
Materials & Components (25%), Construction Materials (34%) and Subcontracting
Charges (29%). We understand that 75% of the raw material and components are
for Power Plants, Machinery, Nuclear Plants, Chemical Plants, etc, where the
element of value engineering is high and there is no direct linkage with
international commodity prices. Direct steel purchases constitute just 2% of raw
material cost and non-ferrous metals constitute 0.3%. However, steel usage as a
percentage of material consumption is higher. Inventory in the chain stands at
just 12 days.
Overseas orders are largely fixed price contracts:
Imports constitute 14% of
material consumption; and excluding sub-contracting charges at 20%. We
understand that these are largely specialty steels (used in Heavy Engineering,
Electronics, etc) and project components. Exports and revenue from international
7 September 2012
7

Capital Goods | Update
geographies contribute 15% of overall revenue. We understand that a large part
of the order book (particularly in the Middle East) is fixed price contracts. Hence,
the company will be a beneficiary of benign/lower commodity prices.
Conservative accounting policies could lead to quarterly aberrations:
L&T builds a
commodity price reserve of 3-4% on projects, which is written back only when the
projects are substantially completed. Completion of large projects in a declining
commodity price scenario can lead to meaningful margin contribution. Also, in
contracts with price variation clauses, the variation in commodity prices is
accounted for only when the 'Progress Bill' has been approved by the customer.
This may result in some time lag, impacting quarterly performance.
Valuation and view:
For FY13 / FY14, we expect standalone EPS (net of dividend
from subsidiaries) to increase at 11% CAGR till FY14 (INR75 in FY13/ INR82 in FY14);
as we factor in revenue CAGR of 15% / margins decline of 25bp over FY12- 14E.
Consolidated EPS stands at INR78 for FY12 (+13% YoY) and we estimate FY13E at
INR86 (+9%) / FY14 at INR93/sh (+9%). There exists headwinds to consolidated
numbers given poor business visibility for manufacturing JVs like Power BTG,
Shipbuilding, Forgings, etc; we believe that our estimates largely captures the
possible impact of capacity under utilization in the initial periods. We maintain
Buy given strong execution skills, diversified portfolio and robust balance sheet.
7 September 2012
8

Capital Goods | Update
Financials and Valuation
7 September 2012
9

Capital Goods | Update
Cummins: Stable pig iron prices likely to benefit margins
Incresed localisation helping margins
Bloomberg
KKC IN
Equity Shares (m)
277.2
52-Week Range (INR) 505/322
1,6,12 Rel. Perf. (%)
1/0/6
M.Cap. (INR b)
129.2
M.Cap. (USD b)
2.3
KKC's raw material costs have historically demonstrated a very direct co-relation with
movement in pig iron prices (accounting for bulk of the raw material consumption). Pig iron
prices currently stands at INR33,000/ton (at highest levels), but they have been largely stable
over the last one year. This should lead to savings in raw material consumption costs, given the
ongoing efficiency improvement programme. Also, given the limited inventory in the chain
(50 days), the benefits should start getting reflected from 2Q/3QFY13 onwards.
Stock performance (1 year)
Financial & valuation summary
Cummins: Raw material consumption basket
Others
19%
Cummins: Direct correlation of raw material cost with pig iron prices
- RHS
Purchase
of traded
goods
10%
Engines
9%
Components
62%
Source: Company/MOSL
Profitability supported by cost optimization - a widening moat:
In FY12, Cummins
curtailed EBITDA margin decline at 200bp to 16.9%, despite slowing sales (up 3%)
and rising input costs. Raw material (RM) cost increased just 3% despite 16% rise
in prices of pig iron, which constitutes over 50% of RM cost. This commendable
achievement is a result of increased indigenization and cost optimization
measures. In the last decade, the company has been able to bring down its raw
material cost from 69% of revenue to 65%.
RM imports down from 29-30% of revenue in FY07-08 to 20% in FY12:
Components
have declined to 69% of RM consumed from 77% in FY08. The share of semi-
finished components has increased to 19% from 5% in FY08. This indicates the
increased value addition captured in India.
7 September 2012
10

Capital Goods | Update
Cost optimization measures in place:
Cost optimization measures like ACE III
(Accelerated Cost Efficiency) should help generate savings of INR2.3b till 2014 by
reducing the total cost of ownership of direct materials by 20%. TRIMs (Total
Reduction in Indirect Materials and Services) targets to reduce the direct cost of
ownership in indirect materials by 10% over three years.
Sufficient near-term cushion to sustain margins:
DG engine is a short-cycle product.
Hence, the variations in commodity prices can typically be passed on. However,
competitive intensity has increased over the last one year, with MNCs like MTU,
Perkins, Volvo Penta, MHI, Kohler, Navistar, etc becoming more aggressive. The
recent trend of INR depreciation and stable pig iron prices provides sufficient
cushion for Cummins in the interim period, as these factors have further eroded
the capabilities of competitors to aggressively price their products.
Maintain Neutral, as DG set industry faces structural headwinds:
We expect
Cummins to report revenue CAGR of 12% over FY12-14 (18% CAGR in exports and
12% CAGR in domestic power gen sales). We model EBITDA margin improvement
of 144bp till FY14 to factor in savings from stable raw material prices. We expect
Cummins to report an EPS of INR23.4 in FY13 (up 18%) and INR24.5 in FY14 (up 5%).
We maintain
Neutral,
given headwinds to demand and increasing competitive
intensity.
7 September 2012
11

Capital Goods | Update
Financials and Valuation
7 September 2012
12

Capital Goods | Update
Crompton Greaves: Overseas business largely on fixed
price contracts
Bloomberg
CRG IN
Equity Shares (m)
641.5
52-Week Range (INR) 175/102
1,6,12 Rel. Perf. (%) -8/-22/-32
M.Cap. (INR b)
68.0
M.Cap. (USD b)
1.2
Power business exposed to volatility in commodity prices
Crompton Greaves raw material costs have a strong co-relation to commodity prices: this is
largely in the power segment which contributes ~65% of consolidated revenues; while industrial
/ consumer business are short cycle and thus it is possible to pass on the cost variations.
Overseas business contributes to 47% of the consolidated revenues, and most of these are
fixed price contracts. Hence, we believe that CRG will be an important beneficiary of any
decline in commodity prices, particularly for the overseas business.
Stock performance (1 year)
Financial & valuation summary
Crompton Greaves: Raw material consumption Crompton Greaves: Strong correlation of raw material cost with industrial
basket (%)
commodities
Others Wires, Pipes
Ferrous
14% and tubes 3%
Sub-
Metals
contracting
12%
charges
4%
Non-
ferrous
metals
14%
Chemicals,
Oils and
paints 3%
Components
24%
Source: Company/MOSL
Cost of
traded
goods 26%
Overseas power projects to be the key beneficiary:
Within the Power segment
(65% of consolidated revenue), Crompton Greaves is largely focused on the Power
Transmission business and is increasing presence in the HV segments. These
projects typically have an execution period of 8-12 months and are fixed price
contracts (particularly in overseas markets). Hence, margins are exposed to
commodity price fluctuations. A scenario of stable to declining commodity prices
should positively impact margins in the overseas business. In domestic Power
Transmission, contracts from PGCIL and SEBs largely have price escalation clauses
(for copper and CRGO steel). Thus, the margin impact is limited.
Industrial business can absorb commodity price increases:
Industrial business
(16% of consolidated revenue) also works on fixed price contracts. However, given
that the cycle period is shorter at 2-4 months, it is possible to pass on the cost
variations through periodic price revisions.
7 September 2012
13

Capital Goods | Update
Key metals partially hedged:
Crompton Greaves' raw material basket comprises
of: Ferrous Metals (12%), Non-ferrous Metals (14%), Components (24%), and
Traded Goods (predominantly for consumer business, 26%). We understand that
an important part of the ferrous metals is CRGO steel (procured typically under
quarterly contracts) and ordinary steel (largely unhedged). Copper prices
contribute the most to the volatility in transformer pricing. To manage this, the
company has a hedging policy in place.
Benefits to be visible with a time lag of six months:
Inventory in the chain stands
at 40 days (Raw Material: 14 days, Work in Progress: 19 days). The benefit from
stable / declining commodity prices will be visible with a time lag of ~6 months;
copper/CRGO is generally covered under quarterly contracts/hedging.
Attempting to expand EBITDA margin by 200bp by lowering material costs:
Over
FY07-10, Crompton Greaves' raw material consumption as a percentage of revenue
declined from 73% to 69%, given the implementation of initiatives like 'UniPower
/ DesDT', which led to standardization in designs, global sourcing, etc. Going
forward, the attempt is to capture a 450bp improvement in EBITDA margin over
three years, of which 200bp will be from improved sourcing (150bp) and
operational efficiency improvement (50bp). The International Procurement office
commenced in China in June 2012; key commodity managers have been appointed
for sourcing of raw materials like copper, aluminum, steel, etc. Thus, the Global
Sourcing Organization has been strengthened.
Maintain Neutral:
We expect Crompton Greaves to report standalone EPS of INR8.9
in FY13 (up 13%) and INR10.9 in FY14 (up 22%). After losses of INR2/share in FY12,
international subsidiaries should break even in FY13; we expect EPS of INR1.5 in
FY14. The risk-reward appears favorable; successful operational turnaround of
overseas subsidiaries will drive stock returns. The macro environment remains
challenging and we believe that this remains the key risk.
7 September 2012
14

Capital Goods | Update
Financials and Valuation
E: MOSL Estimates; Standalone financials unless otherwise
stated
7 September 2012
15

Capital Goods | Update
Thermax: exposed to steel price volatility
Likely to be benefited from almost entire order book on fixed price basis
Bloomberg
TMX IN
Equity Shares (m)
119.2
52-Week Range (INR) 569/388
1,6,12 Rel. Perf. (%)
-2/-5/-5
M.Cap. (INR b)
58.1
M.Cap. (USD b)
1.0
Thermax is a major consumer of steel plates and tubes of various grades as well as bought-out
items including motors, pumps and valves. Hence, the raw material basket has shown a very
strong co-relation with steel prices. While a large part of the specialty steel is being contracted
at the time of order receipt, the company is exposed to price movements in ordinary steel
which is generally being procured on spot basis.
Stock performance (1 year)
Financial & valuation summary
Thermax: Raw material composition (%)
Ferrous
metals 7%
Fabricated
items
17%
Thermax: Raw material cost strongly linked to steel prices
- RHS
Chemicals
3%
Brought
out Items
73%
Source: Company/MOSL
Margin impact to be curtailed at 100-150bp given various mitigating factors:
Almost
the entire order book of Thermax is on fixed price contract basis. For majority of
the order book, specialty steel, which goes into boiler making high pressure parts
equivalent is covered, and is already phased as orders at the time of order receipt.
Even the currency fluctuation against imported components is covered by forward
cover taken. Components which are in the long lead items like the high pressure
pumps, valves, instrumentation, etc are also covered within 2-3 months of order
receipt. Open categories are predominantly conventional steel like structural's,
HR foils, sheet steel, aluminum, etc (approx contribution at 15 to 18% of the total
RM basket). Thermax also has some exposure to copper because of the cabling,
motors and absorption chillers business. Hence, the management has stated that
the impact on margins on either side is expected to be curtailed at ~100-150bp.
16
7 September 2012

Capital Goods | Update
Attempting to reduce variability at bidding stage:
While quoting for large projects,
Thermax factors in provisions for escalation of input costs to help make up for any
spurt in prices. In addition, before such quotes are furnished, it obtains committed
quotes for critical inputs from its vendors. This way, variability can be reduced, as
the finalization of many projects takes time.
Air pollution business most exposed:
The air pollution business is witnessing
margin pressure, as the company is exposed to spot prices of standard steel.
Weakening of steel prices may lead to margin expansion.
Valuation and View:We
maintain
Neutral
as we expect order intake to be muted
in FY13 although YoY growth could be better at 20% YoY over a low base in FY12.
The BTG facility has also not received any order as of now which is likely to be a
drag on profits.
7 September 2012
17

Capital Goods | Update
Financials and Valuation
7 September 2012
18

Capital Goods | Update
Siemens: Project bought-outs and Traded Goods
purchased are 74% of RM basket
Bloomberg
SIEM IN
Equity Shares (m)
337.0
52-Week Range (INR) 898/627
1,6,12 Rel. Perf. (%) 0/-17/-25
M.Cap. (INR b)
231.9
M.Cap. (USD b)
4.2
RM content at 76% - highest among peers
Siemens RM cost has a very strong co-relation with the industrial commodities index. Traded
goods purchased in raw material basket stands at 27% and thus including project bought-outs
at 48%, the share of in-house manufacturing (including bought-out components) is just 25%.
This structure has led to increased volatility. Siemens also has amongst the highest raw material
costs in our capital goods coverage at 76%, given the lower manufacturing component and
increased revenues from traded products / project business.
Stock performance (1 year)
Financial & valuation summary
* Standalone, Year end - September
Siemens: Raw material consumption (%)
Traded Good
Purchased
27%
Siemens: Raw material cost strongly linked to industrial commodities
- RHS
Raw
Material,
Bought Out
Components,
etc 24%
Project
Boughtouts
49%
Source: Company/MOSL
Revenue contribution from Projects business at 40-45%:
The Projects business
contributes 40-45% of Siemens' revenue. We understand that a large part of these
contracts, particularly from overseas markets, are on fixed price basis. While a
part of the risks are passed on through a back-to-back arrangement, margins are
exposed to commodity price volatility. This has resulted in sharp volatility in the
reported quarterly EBIT margins in the Energy segment.
Purchases from parent company at 37% of material consumption:
Purchases from
Siemens AG stand at 37% of material consumption. Excluding revenue from the
Projects business (which accounts for ~48% of material consumption), the share
of purchases from Siemens AG in the Product business increases further. We
understand that in such sourcing arrangements, the impact of commodity price
fluctuations is possibly being passed on to Siemens India more quickly. Imports
contribute ~55% of the material consumption basket for Siemens India, and
purchases from Siemens AG constitute 65-70% of imports.
7 September 2012
19

Capital Goods | Update
Gaining from global procurement:
Siemens India uses commodity futures contracts
to hedge against fluctuation in commodity prices, particularly Copper, Nickel and
Silver. The company also gains from the expertise and scale of Siemens AG in
terms of raw material sourcing. Siemens has a Strategic Procurement Organization
(SPO) staffed with experts on various commodities that need to be sourced. The
SPO is integrated with the global procurement organization, which provides
Siemens access to information on the cheapest source for a commodity across the
world.
Valuation and view:
The stock quotes at 43x FY12E and 32x FY13E EPS. Maintain
Neutral
with price target of INR600 (26x FY13E EPS). A large part of the business
portfolio of Siemens India comprises of early and mid-cycle products; hence, the
impact of slowdown has started becoming more pronounced. Key components of
revenue include: Products 56%, Projects 31% and Services 12%. Siemens is
exposed to several segments of the Indian economy, and offers one of the best
plays on long-term recovery. However, for the near term, valuations appear
demanding.
Siemens: EBIT margins in Energy business volatile, given increased share of projects business
Source: Company/MOSL
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20

Capital Goods | Update
Financials and Valuation
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21

Capital Goods | Update
ABB: Lower in-house manufacturing increases volatility
High import content from parent
Bloomberg
ABB IN
Equity Shares (m)
211.9
52-Week Range (INR) 915/541
1,6,12 Rel. Perf. (%) -8/-14/-18
M.Cap. (INR b)
152.2
M.Cap. (USD b)
2.7
ABB has a very strong co-relation with the industrial commodities index; and is partly due to
i) project business which contributes ~40% of the revenues ii) imports contribute to 39% of
the material consumption and largely includes purchases from ABB Global (28% of the material
consumption). Thus, the quantum of in-house manufacturing as a percentage of consolidated
revenues is comparatively limited, exposing to volatility in commodity prices. Similar to Siemens,
ABB also has amongst the highest raw material costs in our capital goods coverage at 74%.
Stock performance (1 year)
Financial & valuation summary
ABB: Material consumption basket
Others 5%
ABB: Raw material cost strongly correlated with prices of industrial commodities
Erection
and
Engineering
46%
Components
49%
Source: Company/MOSL
Projects business contributes 40% of revenue:
The Projects business, comprising
of Process Automation and Power Projects contributes 40% of ABB India's revenue.
We understand that large parts of these contracts, particularly Process Automation,
are on fixed price basis. While the company can mitigate a part of the impact
through hedging, these segments remain exposed to commodity price
movements.
Purchases from parent company at 28% of material consumption:
Purchases from
the parent stand at 28% of material consumption. Excluding revenue from Projects
business (which accounts for ~40% of material consumption), the share of
purchases from ABB Global in the Product business increases further. We
understand that in such sourcing arrangements, the impact of commodity price
fluctuations is possibly being passed on to ABB India more quickly. Imports
constitute ~39% of the material consumption basket for ABB, and purchases from
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22

Capital Goods | Update
ABB Global contribute ~75% of the imports. The Royalty & Trademark fee payment
in CY11 had also increased meaningfully to INR2.1b from INR1.6b in CY10.
Cost rationalization:
Material costs and services have now settled at 72%, declining
from 75-76% in the last few quarters. ABB India had undertaken various initiatives
like improving operational efficiency, supply chain, etc and the savings have been
meaningful. Being part of the global network, ABB India also benefits in terms of
raw material sourcing.
Attempt to increase manufacturing exports from India:
ABB India has successfully
tapped overseas markets. Exports currently contribute ~15% of revenue v/s 2.5%
in CY05. The company is tripling its MCB capacity in Bangalore (operational in
3QCY12) and has recently announced plans to further double the capacity. ABB
India is also setting up a new plant at Vadodara for power products, at a capex of
INR2.5b. We believe that these attempts to increase the manufacturing content
and capture value addition in India will enable savings in material costs, going
forward.
Maintain Neutral:
We believe that for ABB India, there are initial signs of
profitability improvement as (1) ABB has largely exited RE works, and (2) the
benefits of cost reduction measures have started to flow-in. Valuations are rich,
we remain
Neutral.
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23

Capital Goods | Update
Financials and Valuation
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24

Capital Goods | Update
N O T E S
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25

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