India Strategy – Detailed Report

5 January 2007

India Strategy

2006 has been the fifth

consecutive year of

positive returns

The fundamental factors

underpinning India's

growth story are intact

We expect Sensex EPS

to grow 16% to Rs810

in FY08...

… but further upgrades

are likely, as we

move forward

Sensex valuations are

in line with

historical averages

Expect focus to be on

earnings growth

R

ESULTS

P

REVIEW

Quarter ended December 2006

In Bloom

Research Team (Rajat@MotilalOswal.com)

Prices as of Friday, 29 December 2006

Contents

India Strategy

1. Automobiles

Ashok Leyland

Bajaj Auto

Bharat Forge

Eicher Motors

Hero Honda

Mahindra & Mahindra

Maruti Udyog

Punjab Tractors

Swaraj Mazda

Tata Motors

TVS Motor

2. Banking

Andhra Bank

Bank of Baroda

Bank of India

Canara Bank

Corporation Bank

HDFC

HDFC Bank

ICICI Bank

Indian Overseas Bank

J&K Bank

Karnataka Bank

Oriental Bank

Punjab National Bank

State Bank

Syndicate Bank

Union Bank

UTI Bank

Vijaya Bank

3. Cement

ACC

Birla Corporation

Grasim Industries

Gujarat Ambuja

Shree Cement

UltraTech Cement

4. Engineering

ABB

Alstom Projects

Bharat Electronics

BHEL

Crompton Greaves

Cummins India

Larsen & Toubro

Siemens

Thermax

29 December 2006

3-42

43-63

53

54

55

56

57

58

59

60

61

62

63

64-90

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91-101

96

97

98

99

100

101

102-115

107

108

109

110

111

112

113

114

115

5. FMCG

116-133

Asian Paints

123

Britannia Industries

124

Colgate Palmolive

125

Dabur India

126

GSK Consumer

127

Godrej Consumer Products

128

Hindustan Lever

129

ITC

130

Marico

131

Nestle India

132

Tata Tea

133

6. Information Technology134-153

Geometric Software

140

HCL Technologies

141

Hexaware Technologies

142

i-flex solutions

143

Infosys

144

Infotech Enterprises

145

KPIT Cummins

146

MphasiS

147

Patni Computer

148

Sasken Communication

149

Satyam Computer

150

TCS

151

Tech Mahindra

152

Wipro

153

7. Infrastructure

Gammon India

Hindustan Construction

IVRCL

Jaiprakash Associates

Nagarjuna Construction

Patel Engineering

8. Media

Zee Telefilms

9. Metals

Hindalco

Jindal Steel

JSW Steel

Nalco

SAIL

Tata Steel

10. Oil & Gas

BPCL

Chennai Petroleum

GAIL

HPCL

IOC

154-164

159

160

161

162

163

164

165-166

166

167-176

171

172

173

174

175

176

177-192

184

185

186

187

188

Indraprastha Gas

IPCL

ONGC

Reliance

189

190

191

192

11. Pharmaceuticals

Aurobindo Pharma

Aventis Pharma

Biocon

Cadila Healthcare

Cipla

Divi’ Laboratories

s

Dr Reddy’ Labs.

s

GSK Pharma

Jubilant Organosys

Lupin

Matrix Laboratories

Nicholas Piramal

Pfizer

Ranbaxy Labs.

Shasun Chemicals

Sun Pharmaceuticals

Wockhardt

12. Retailing

Pantaloon Retail

Shopper's Stop

Titan Industries

193-217

201

202

203

204

205

206

207

208

209

210

211

212

213

214

215

216

217

218-224

222

223

224

13. Telecom

225-232

Bharti Airtel

230

Reliance Communication

231

VSNL

232

14. Textiles

Alok Industries

Arvind Mills

Gokaldas Exports

Himatsingka Seide

Raymond

Vardhman Textiles

Welspun India

15. Utilities

CESC

NTPC

Neyveli Lignite

PTC India

Reliance Energy

Tata Power

16. Others

Concor

United Phosphorus

233-246

240

241

242

243

244

245

246

247-256

251

252

253

254

255

256

257-258

257

258

2

Results Preview

QUARTER ENDED DECEMBER 2006

India Strategy

BSE Sensex: 13,787

S&P CNX: 3,966

29 December 2006

2006 has been the fifth

consecutive year of

positive returns

2006 has been the fifth consecutive year of positive returns for the Indian capital markets.

While the Sensex moved in a wide range of 8,900-14,000, it rose 47% during the year to

close at 13,787. From the lows of 8,930 in June 2006, the Sensex has returned 56% by

the year-end. FIIs continued to be net buyers of Indian equities for the 8th year in a row,

while the magnitude of net buying by domestic mutual funds too has increased to US$3.4b

from US$3b last year.

The fundamental factors underpinning India’ growth story remain intact: (1) continued

s

strong growth and positive surprises in corporate earnings; (2) multiple growth engines

of consumption, investment and outsourcing driving consistent surprises in economic

growth; and (3) falling macro risks such as possible rise in oil prices and interest rates.

As market valuations are around historical averages, stock returns will track earnings

growth. Hence, we expect earnings growth to be the area of focus in 2007.

We expect Sensex EPS to grow 33% to Rs695 in FY07 and 16% to Rs810 in FY08. We

continue to base our Sensex target on our FY08 earnings estimates, although we have

raised our target multiples. Our 12-month Sensex target range is now based on 15-18x

FY08E earnings (in December 2007, these multiples will be tracking just one quarter

forward earnings). Adding the embedded value of businesses of the Sensex companies

that are non-earnings contributors, we arrive at a target Sensex range of 13,000-15,500.

The key risk to this target is any disappointment in earnings growth and inflation concerns.

FY07 – another year of significant earnings upgrades

Motilal Oswal’ Universe of 129 stocks is now expected to report profit growth of 28%

s

in FY07, against the growth expectation of 18% at the same time last year. We reiterate

that strong corporate performance will continue to be the bedrock of the ongoing bull

market. For the quarter ended December 2007 (3QFY07), our universe is likely to report

profit growth of 46% against 20% in 1QFY07 and 45% in 2QFY07. Earnings growth

has accelerated over the last couple of quarters, in turn driving significant upgrades

across a number of sectors. We believe that Indian markets entering 2007 with a quarter

of very strong earnings growth is a positive sign. We are also impressed with the fact

that the strong earnings growth in FY07 is primarily being driven by strong topline growth.

Forecasting 16% earnings growth in FY08; upgrades likely

We estimate 15% earnings growth for our Universe for FY08. For the Sensex, we

estimate 16% growth in EPS to Rs810. Over the last four quarters, there have been

significant upgrades in our forward earnings estimates. A year ago, our Sensex EPS

The fundamental factors

underpinning India’ growth

s

story remain intact

We expect Sensex EPS to

grow 33% to Rs695 in

FY07 and by 16% to

Rs810 in FY08

Our EPS estimates for FY07

and FY08 have seen

consistent upward revisions

in the last 12 months…

Navin Agarwal (Navin@MotilalOswal.com)/Rajat Rajgarhia (Rajat@MotilalOswal.com)

29 December 2006

3

India Strategy

… and further upgrades are

likely in our FY08 EPS

estimate, as we move forward

estimate for FY08 was Rs709; this has been upgraded by 14% in the last 12 months.

Given the momentum of the economy and corporate performance, we believe that there is

a strong possibility of earnings upgrades as we move forward. We have factored flat

growth in FY08 profits for global commodities, which constitute almost 1/3rd of the earnings

of our Universe. As we gain greater visibility of the various commodity cycles during the

year, we would revise our estimates.

Consumerism, Infrastructure – the two driving themes for 2007

FY07 will be the fourth consecutive year of ~8% GDP growth. The Indian consumers'

confidence is on an accent. Per capita GDP has increased from ~US$450 in FY01 to

~US$790 in FY07; purchasing power has increased even faster. With the benefits of

economic reforms only now trickling down to rural India, we expect India’ rural economy

s

to also join the consumption boom hereon. We believe that the Indian economy is at the

cusp of a major consumption boom.

Infrastructure spending has witnessed sharp acceleration, with most of the segments in

the economy constrained in terms of capacity availability. Riding on the back of the fourth

consecutive year of 8%+ GDP growth, we believe that the next three years would be

eventful. The Government is pushing through investments in infrastructure (ports, roads,

airports, electricity, etc.), which is the biggest bottleneck in the sustainability of growth.

Beginning 2007 with lower macro risks...but increased risk of fresh issuance

The first six months of 2006 were marked by two key risks to equities – rising interest

rates and rising oil prices. These two risks played a major role in the market correction in

May 2006. Since then, both these risks have abated. While oil prices have remained stable

at ~US$60/barrel (after declining from highs of ~US$78/barrel), 10-year bond yields in

India have remained in a range of 7.4-7.6% (after declining from highs of 8.4%). With no

signs of concerns on these two macro variables, focus of investors will largely remain on

earnings growth.

The price to book multiple of Sensex has shot up from 1.5x in 2001 to 4x now. This

expansion in valuation multiple is now driving several listed as well as unlisted entities to

raise capital from the markets. This process has been aided by the introduction of several

new avenues of capital raising like the QIP (Qualified Institutional Placement), AIM listings

and a significant expansion in private equity market. This, we believe, could lead to a

deluge of paper from both listed and unlisted companies in 2007. While this could lead to

an expansion in the number and type of investors for Indian equities, these primary issuances

will have to be well spread out to avoid any overhang on the secondary markets.

Growing investable universe likely to keep inflows strong

In 2006, net FII investment in Indian equities was US$7.9b as against US$10.8b in 2005

and US$8.5b in 2004. Domestic mutual funds have invested US$3.4b in 2006 against

US$3b in 2005. Indian capital markets have been attracting strong inflows from both

foreign and local investors (collective investment of US$33.4b by FIIs and domestic mutual

4

We believe that consumerism

and infrastructure would be

the driving themes for 2007

While risks relating to rise in

interest rates and oil prices

have abated…

… there is increased risk of

fresh equity issuance

We expect strong inflows

into India’ equity markets

s

to continue…

29 December 2006

India Strategy

funds in the last 3 years). Several new classes of investors have entered (India-dedicated

funds raised in Japan, Asian countries and the Continent; AIM listings of Indian REITs;

large sponsored ADS of Indian equities to targeted investors). Market capitalization has

increased to US$812b from US$549b in 2005 and US$281b in 2003. The number of >US$1b

market cap companies have increased from 53 in 2003 to 93 in 2005 to 127 in 2006.

Several emerging sectors such as wireless, media, real estate, and infrastructure have

provided significant investment opportunities. Going forward, we expect such investment

opportunities to expand, which will drive newer investors into India.

Reforms, Budget could be key catalysts in 2007

There is also a possibility of the government pressing the accelerator on reforms, with just

2 years of the current 5-year term remaining. As the UP state elections get over in February,

the government will have a time period of 9 months before next major state election. Also,

strong tax collections has helped the government finances considerably. This could

encourage tax cuts, which can further fuel consumption boom and corporate profits. Among

the key areas of pending reforms are Infrastructure, which requires huge funding, FDI

limits, which are likely to be raised in Insurance, Telecom, financial sector reforms, etc.

Valuations at historical averages; focus will remain on growth

While valuations at 17x FY08E EPS for Sensex are in line with historical averages, we

reiterate that surprises in earnings growth will be a key driver to market returns in 2007,

notwithstanding the interim volatility. We believe that a stock-specific approach could

generate strong returns even if the markets were to consolidate in the near term. We also

see huge appetite for new discoveries, new catalysts in stocks; early investing in such

plays is advisable. Our investment strategy for 2007 revolves around the following key

themes:

?

Strong growth visibility beyond 2008:

Stocks in this category will trade at the

highest multiples. As investors turn wary of markets at higher levels, stocks that offer

strong visibility of earnings growth will be favored. Our top picks here are

Maruti,

ICICI Bank, Bharti Airtel, M&M, Gujarat Ambuja, Wipro, PNB

and

L&T.

?

Underperformers of 2006, catalyst in 2007 could revive performance:

We believe

that some of the stocks that have underperformed in 2006 are now quite attractive.

The risk-return equation is a lot more favorable for investing in these stocks. Moreover,

specific catalysts could result in strong positive returns in these stocks. Our top picks

here are

ONGC, Ranbaxy, IDFC, Bank of Baroda, ITC,

and

Hindalco.

?

Quality mid-caps to generate strong returns:

In 2006, almost all the mid-cap

indices underperformed the large-cap indices. With earnings momentum fairly strong

and mid-caps being beneficiaries of soft commodity prices and interest rates, we believe

that quality mid-caps could generate strong returns in 2007. Our top mid-cap bets are

Patel Engineering, Sintex, Nicholas, Amtek Auto, HCC, Shree Cement,

Kesoram, JSW Steel, IOB,

and

Sasken.

… and increased thrust on

reforms, positive budget

announcements could be the

catalysts in 2007

Sensex valuations are in line

with historical averages;

expect focus to be on

earnings growth

29 December 2006

5

India Strategy

Earnings surprises continue; remain bedrock of bull market

2006 has been the fifth

consecutive year of

positive returns

2006 has been the fifth consecutive year of positive returns for the Indian capital markets.

While the Sensex moved in a wide range of 8,900-14,000, it rose 47% during the year to

close at 13,787. From the lows of 8,930 in June 2006, the Sensex has returned 56% by the

year-end. FIIs continued to be net buyers of Indian equities for the 8th year in a row, while

the magnitude of net buying by domestic mutual funds too has increased to US$3.4b from

US$3b last year.

YEARLY RETURNS ON BSE SENSEX

Annual Sensex Return (%) - LHS

105

CAGR of 19.3%

70

35

0

-35

Trend in Sensex - RHS

5th consecutive year

of positive return

14000

10500

7000

3500

0

QUATERLY RETURNS ON BSE SENSEX (%)

40

20

0

-20

-40

Source: Company/Motilal Oswal Securities

The fundamental factors

underpinning India’ growth

s

story remain intact

The fundamental factors underpinning India’ growth story remain intact: (1) continued

s

strong growth and positive surprises in corporate earnings; (2) multiple growth engines of

consumption, investment and outsourcing driving consistent surprises in economic growth;

and (3) falling macro risks such as possible rise in oil prices and interest rates. As market

valuations are around historical averages, stock returns will track earnings growth. Hence,

we expect earnings growth to be the area of focus in 2007.

6

29 December 2006

India Strategy

We expect Sensex EPS to

grow 33% to Rs695 in

FY07 and by 16% to

Rs810 in FY08

We expect Sensex EPS to grow 33% to Rs695 in FY07 and 16% to Rs810 in FY08. We

continue to base our Sensex target on our FY08 earnings estimates, although we have

raised our target multiples. Our 12-month Sensex target PE range is now based on 15-18x

FY08E earnings (in December 2007, these multiples will be tracking just one quarter

forward earnings). Adding to this the embedded value of businesses of the Sensex companies

that are non-earnings contributors, we arrive at a target Sensex range of 13,000-15,500.

The key risk to this target is any disappointment in earnings growth and inflation concerns.

SENSEX EPS (RS)

950

810

750

550

348

350

201

150

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07E

FY 08E

272

523

450

695

891

FY 09E

SENSEX EPS GROWTH (%)

40

36

33

28

29

30

20

17

16

10

0

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07E

FY 08E

FY 09E

Source: Company/Motilal Oswal Securities

Top performers / underperformers of 2006

In the table, we have illustrated the relative performance of the Nifty constituents v/s the

Nifty Index. 13 of the 50 Nifty stocks have outperformed the benchmark in each of the

last 3 years. Incidentally, 6 of our top 8 bets feature in this list. A common feature of most

of these 13 stocks is very strong earnings growth for the last 3 years. Most of these

companies have consistently witnessed upgrades (we expect possibility of this continuing

for these companies even going forward). Stocks that have underperformed in each of

last 3 years are mainly commodity stocks or the ones that have been adversely impacted

by government policies.

29 December 2006

7

India Strategy

RELATIVE PERFORMANCE OF NIFTY STOCKS

COMPANY

NAME

2006

RELATIVE PERFORMANCE (%)

2005

2004

ACC

Grasim Inds.

ABB

Zee Telefilms

Reliance Inds.

Bharti Airtel

Guj. Ambuja Cem

M&M

Dr Reddy’ Labs.

s

BHEL

SAIL

Siemens

Larsen & Toubro

ICICI Bank

HDFC Bank

Infosys Tech.

Suzlon Energy

Maruti Udyog

Sun Pharma.

TCS

Cipla

Dabur India

Tata Motors

St Bk of India

HDFC

Satyam Computer

Bajaj Auto

Wipro

Tata Power Co.

Tata Steel

ITC

IPCL

Hindalco Inds.

HCL Technologies

ONGC

VSNL

Hind. Lever

Pun. Natl. Bank

Ranbaxy Labs.

GSK Pharma

MTNL

GAIL (India)

Natl. Aluminium

Hero Honda Motor

Reliance Energy

HPCL

Oriental Bank

BPCL

Jet Airways

Outperformers in each of 3 years

Underperformers in each of 3 years

63

61

53

47

46

42

38

37

26

25

17

12

11

10

6

4

3

2

0

-2

-3

-5

-9

-11

-13

-16

-17

-18

-20

-29

-30

-31

-32

-36

-41

-42

-51

-54

-55

-56

-62

-86

21

-31

63

-45

30

24

12

52

-23

44

-50

137

51

21

0

7

-

2

-13

-9

3

90

-7

3

21

44

40

-12

-25

-38

26

-7

-13

21

7

29

1

-21

-78

9

-43

-21

-27

14

-21

-54

-55

-42

-

27

21

33

3

-18

94

21

29

-50

41

12

76

15

31

40

-

12

76

-

10

-5

1

10

8

1

-11

18

14

20

22

-30

-9

1

-8

46

-41

57

3

23

2

-22

-8

17

-8

-19

20

-9

-

Source: Motilal Oswal Securities

29 December 2006

8

India Strategy

CHANGE IN RECO AND INITIATED COVERAGE DURING THE QUARTER ENDED DECEMBER 2006

COMPANY

CURR RECO

PREVIOUS RECO

Bajaj Auto

Britannia

Divis Labs

Godrej Consumer

i-flex solutions

IPCL

MphasiS

Reliance

Reliance Comm

Siemens

Syndicate Bank

Tech Mahindra

Titan Industries

Wockhardt

Initiated coverage during the quarter

Sasken Communication

Patel Engineering

Cadila Healthcare

Sintex

Neutral

Buy

Neutral

Sell

Neutral

Buy

Neutral

Buy

Neutral

Under Review

Buy

Under Review

Buy

Not Rated

Buy

Not Rated

Buy

Source: Motilal Oswal Securities

29 December 2006

9

India Strategy

FY07 – another year of positive earnings surprise

Our EPS estimates for FY07

and FY08 have seen

consistent upward revisions

in the last 12 months…

Motilal Oswal’ Universe of 129 stocks is now expected to report profit growth of 28% in

s

FY07, against the growth expectation of 18% at the same time last year. We reiterate that

strong corporate performance will continue to be the bedrock of the ongoing bull market.

For the quarter ended December 2006 (3QFY07), our universe is likely to report profit

growth of 46% against 20% in 1QFY07 and 45% in 2QFY07. Earnings growth has

accelerated over the last couple of quarters, in turn driving significant upgrades across a

number of sectors. We are also impressed with the fact that the strong earnings growth in

FY07 is primarily being driven by strong topline growth (estimated at 29%).

ANNUAL EARNINGS GROWTH OF MOSL UNIVERSE

32%

25%

18%

11%

4%

FY 05

FY 06

9.8%

24.3%

28.4%

15.2%

FY 07E

FY 08E

QUARTERLY EARNINGS GROWTH OF MOSL UNIVERSE

50%

40%

30%

21.0%

20%

10%

Mar-06

June-06

19.6%

45.2%

46.1%

Sep- 06

Dec-06

Source: Company/Motilal Oswal Securities

The Sensex earnings are estimated to grow at 33% in FY07 after a 27% CAGR during

FY02-06. We also estimate a 16% growth in Sensex EPS to Rs810 in FY08 and are now

introducing our FY09 Sensex EPS of Rs891 – a growth of 10%. Over the last 4 quarters,

we have witnessed a definite acceleration in earnings growth, which has resulted in

consistent upgrades. We believe that Indian markets entering 2007 with a quarter of very

strong earnings growth is a positive sign.

29 December 2006

10

India Strategy

Forecasting moderate growth in FY08 & FY09, upgrades likely

… and further upgrades are

likely in our FY08 EPS

estimate, as we move forward

We estimate 15% earnings growth for our Universe of 129 companies for FY08. For the

Sensex, we estimate 16% growth in EPS to Rs810. Over the last four quarters, there have

been significant upgrades in our forward earnings estimates. We had revised our Sensex

EPS estimate to Rs647 for FY07 and Rs732 for FY08 post 1QFY07 results. Post 2QFY07,

we had further upgraded our EPS estimates by 6% for FY07 and 7% for FY08. With

improving visibility on earnings, we have further revised our EPS estimates to Rs695 (up

by 2%) for FY07 and Rs810 (up 4%) for FY08. We are also introducing our FY09 Sensex

EPS estimate of Rs891.

TREND IN FY07 SENSEX EPS OVER LAST FEW QUARTERS (RS)

700

Upgrade of 11%

654

647

686

695

650

626

600

550

500

Dec-05

Mar-06

June-06

Sep- 06

Dec-06

TREND IN FY08 SENSEX EPS OVER LAST FEW QUARTERS (RS)

830

Upgrade of 14%

790

780

810

750

709

710

733

732

670

Dec-05

Mar-06

June-06

Sep- 06

Dec-06

Source: Company/Motilal Oswal Securities

We have factored flat growth in FY08 profits for global commodities, which constitute

almost 1/3rd of the earnings of our Universe. As we gain greater visibility of the various

commodity cycles during the year, we would revise our estimates. Even for other sectors,

given the momentum of the economy and corporate performances, we believe that there

is a possibility of earnings upgrades as we move forward. Softening of global commodity

29 December 2006

11

India Strategy

prices (to some extent factored in the earnings of commodity companies) could also aid

margin expansion, triggering further earnings growth.

Composition of earnings moving in favor of high growth sectors

The earnings contribution of high growth sectors such as IT, Telecom and Autos has

increased considerably over the last 6 years. These sectors command valuations better

than the markets, indicating that the Indian markets should trade above historical averages.

SECTOR-WISE CONTRIBUTION TO OVERALL SENSEX PROFIT (%)

SECTOR

FY02

FY08

Automobiles

Banking

Cement

Engineering

Global Cyclicals

IT

Others

Pharma

Telecom

Utilities

Total

4.1

17.9

3.6

4.2

32.9

8.3

16.2

5.2

6.3

1.4

100.0

6.7

13.1

5.2

4.7

32.1

14.5

4.9

2.0

9.6

7.3

100.0

Global Cyclicals comprises of ONGC, Reliance, Tata Steel and Hindalco.

29 December 2006

12

India Strategy

Consumerism, infrastructure the key themes to play

We believe that consumerism

and infrastructure would be

the driving themes for 2007

Theme 1: Growing consumerism

Indian economy is at the cusp of a big consumption boom

We believe that the Indian economy is at the cusp of a big consumption boom. We expect

discretionary income to more than double in the coming five years. Heightened competition

and globalized environment will increase consumer affordability significantly in the coming

years. The combination of rising incomes and competitive prices will result in demand

growing at a fast clip. We remain very positive on companies, which are likely to benefit

from this big consumption boom. Our top bets in this space are Maruti, Bharti Airtel, ICICI

Bank, ITC, and M&M.

FY07 will be the fourth consecutive year of ~8% GDP growth. The Indian consumers'

confidence is on an accent. Per capita GDP has increased from ~US$450 in FY01 to

~US$790 in FY07; purchasing power has increased even faster. With the benefits of

economic reforms only now trickling down to rural India, we expect India’ rural economy

s

to also join the consumption boom hereon. We believe that the Indian economy is at the

cusp of a major consumption boom.

RISING PER CAPITA INCOME (US$)

The Indian economy is at the

cusp of a big consumption

boom, in our opinion…

1,800

Per Capita GDP expected to grow to

US$1,500 in 2014 from US$790 in 2007

Acceleration in Per

Capita GDP from 2003

1,400

1,000

600

%

CAGR of 2.7

200

Source: Motilal Oswal Securities

While overall prosperity has increased considerably…

India’ per capita income has grown at a CAGR of 9.5% during the last six years, from

s

~US$450 in FY01 to ~US$790 in FY07. With ~8% GDP growth expected to sustain, we

believe that per capita GDP will continue to rise at ~10%.

As the discretionary incomes has been rising at an even faster pace, the Indian consumer

has upped its spending significantly over the last few years. The 3 segments which are

amongst the best evidence of this consumption boom are Wireless (falling tariffs of

29 December 2006

13

India Strategy

telecommunication services and lower handset prices), Autos (marginal increase in cost

of ownership of vehicles) and Mortgages. These services and products have become

more affordable.

EXPLOSIVE GROWTH IN WIRELESS SUBSCRIBER BASE

500

400

300

200

100

0

Wireless Subscriber Base - LHS

EffectiveTariff (Rs/Min) - RHS

5.0

4.0

3.0

2.0

1.0

0.0

Source: TRAI/Motilal Oswal Securities

PASSENGER VEHICLES HAVE BECOME MORE AFFORDABLE

TWO WHEELER

FY00

FY06

FY11E

FY00

PASSENGER CAR

FY06

FY11E

Average Cost of 2W

Finance (%)

Loan Amount

Interest Rate (%)

Duration (months)

Monthly EMI

Per Day Usage (km)

Fuel Efficiency (km/lt

Petrol Price (per lt)

Fuel Cost (per month)

Annual Maintainance Cost

Monthly Maintainance Cost

Ownership Cost (per mon)

Increase (%)

Per Capita Income

Increase (%)

36,000

70

25,200

24

36

989

30

45

30

600

3,600

300

1,889

19,569

32,000

70

22,400

16

36

788

30

50

49

886

6,000

500

2,173

15.1

31,901

63.0

35,000

70

24,500

16

36

861

30

45

49

984

8,400

700

2,545

17.1

51,377

61.1

272,333

85

231,483

18

60

5,878

30

12

30

2,250

9,600

800

8,928

19,569

272,333

85

231,483

11

60

5,033

30

12

49

3,690

12,000

1,000

9,723

8.9

31,901

63.0

290,000

85

246,500

11

60

5,360

30

12

49

3,690

14,400

1,200

10,250

14.8

51,377

61.1

Source: Motilal Oswal Securities

EVEN OWNING HOMES IS MORE AFFORDABLE NOW, DESPITE THE RUN-UP IN REAL ESTATE PRICES

Property Cost (Lac)

32

24

16

8

0

Annual Income (Rs)

Affordability

24

18

12

6

0

Source: HDFC Presentation/Motilal Oswal Securities

29 December 2006

14

India Strategy

The impact of growing prosperity is evident in the shift in consumption pattern. The share

of food and grocery has fallen from 50% in FY00 to 39% in FY06 while the share of

transport and communication has risen from 13% to 19% during the same period.

CONSUMER DISCRETIONARY SPENDING HAS INCREASED…

CONSUMER INCOME SPEND – FY00

CONSUMER INCOME SPEND – FY06

Transport

& Comm

1

3%

Medical

Care

7%

Entertain

ment &

Education

4%

Personal

Care &

Services

8%

Food

50%

Entertain

ment &

Education

4%

Personal

Care &

Services

1

2%

Food

39%

Transport

& Comm

1

9%

Clothing

5%

M edical

Care

Durables

6%

3%

Rent &

Fuel

1

2%

Clothing

5%

Durables

3%

Rent &

Fuel

1

0%

Source: Marketing White Book/Motilal Oswal Securities

… rural India is only beginning to catch up

Rural India is yet to participate as big beneficiaries of economic reforms so far. As can be

seen from the data on consumer product penetration presented below, there is still a

considerable urban-rural divide. With the benefits of economic reforms trickling down to

rural India, we expect them to also participate in the consumption boom.

… BUT THERE IS STILL A CONSIDERABLE URBAN-RURAL DIVIDE

FMCG PRODUCTS PENETRATION (%)

ALL INDIA

URBAN

RURAL

Deodorants

Instant Coffee

Skin Cream

Utensil Cleaner

Toothpastes

Shampoo

Washing Powder

Detergent Bar

Toilet Soap

2.1

6.6

22.0

28.0

48.6

38.0

86.1

88.6

91.5

5.5

15.5

31.5

59.9

74.9

52.1

90.7

91.4

97.4

0.6

2.8

17.8

14.6

37.6

31.9

84.1

87.4

88.9

Source: HLL Presentation/Motilal Oswal Securities

Recent policy changes in contract farming and APMC Act, and organized retail are all set

to transform the Indian agriculture scene in the coming few years.

?

The National Horticulture Mission targets doubling of production by 2011, to 350m

ton. We estimate that 10% improvement in productivity and realizations will boost the

farm incomes by Rs500b.

?

Entry of big corporates like ITC, Reliance, Bharti and AV Birla group in corporate

farming and organized retailing will open up a new vista for rural growth. Higher

productivity, assured offtake and better realizations will boost farm income.

29 December 2006

15

India Strategy

?

In addition, concepts like Choupal Sagar and Harayali Kissan Bazaars will expose the

rural masses to branded goods of genuine quality and reasonable prices thus boosting

demand for goods in rural India.

Expect rural India to join the consumption boom

We expect rural India to act as a demand growth catalyst in the economy. We believe that

the emerging demand scenario can be really interesting, as rural India has extremely low

penetration of consumer goods. Even within the rural areas, there is great disparity –

penetration levels in the poorer states like Rajasthan, UP, MP and Bihar are 1/2 to 1/3

rd

of

the rural penetration levels. We believe that consumer demand is at an inflexion point and

growth could surprise on the upside.

Theme 2: Infrastructure – visibility for multi-year growth

We believe that the Indian economy can add few percentage points of growth on the back

of strong investments in infrastructure. The corporate sector is also planning to make

significant investment to expand capcities. In the meanwhile, we expect number of industries

to benefit, as they will be the key executors of this capex. Companies involved in

infrastructure, construction, real estate development, cement, power sector, etc. will witness

strong visibility of business growth sustaining for the next few years. From the investors’

point of view, the build-up in order books of these companies and ability to extract better

margins will be the key catalyst for stock performances. Our preferred bets here are

L&T, Crompton Greaves, HCC, Patel Engineering, Gammon, Gujarat Ambuja,

Grasim, Reliance Energy,

and

Bharat Electronics.

Infrastructure spending has witnessed sharp acceleration, with most of the segments in

the economy constrained in terms of capacity availability. Riding on the back of the fourth

consecutive year of 8%+ GDP growth, we believe that the next three years would be

eventful. The Government is pushing through investments in infrastructure (ports, roads,

airports, electricity, etc.), which is the biggest bottleneck in the sustainability of growth.

Infrastructure spending gaining momentum

Despite the desperate need, India’ annual spending on infrastructure (excluding housing)

s

as a share of GDP in 2003 was just 3.5%, or US$22b. In comparison, the number for

China stands at US$150b (10.6% of GDP). We observe a pick-up in infrastructure spending

in the economy, driven by strong political will and ease of project financing. An urgency to

ensure commercial viability is now apparent across the board, and is being reflected across

sectors. For instance, SEB losses are reducing, bottomline of Indian Railways is improving

and income of port authorities is rising. The momentum of private sector participation is

also picking, with innovative financing concepts like ‘

Public Private Partnerships’ and

‘

Viability Gap Funding’

.

… and infrastructure plays

offer visibility for

multi-year growth

29 December 2006

16

India Strategy

TREND IN INFRASTRUCTURE SPENDING (RS B)

IX PLAN

X PLAN

XI PLAN

Airports

Irrigation

Ports

Power

Railways

Roads

Telecom

Tourism

Urban Infrastructure

Total

66

574

50

866

464

546

801

6

586

3,959

99

972

47

1,452

694

1,329

579

25

991

6,188

350

1,258

329

3,870

840

1,500

870

29

1,250

10,296

Source: Planning Commission

Corporate capex at an inflexion point

Even for the capital goods sector, the outlook seems encouraging. Since January 2005,

there has been a sustained increase in actual and intended investments in the corporate

capex, fuelled by a buoyant growth in domestic and industrial demand. The 47

th

CMIE

capex survey indicated that 1,158 new projects were planned during the quarter ended

October 2006, involving an investment of Rs6,573b. Excluding the construction segment

(SEZ projects), the number stands at Rs4,486b, which compares with Rs2,128b during

quarter ended July 2006 and Rs1,238b during quarter ended April 2006. The growth is

being primarily driven by key sectors like hydrocarbons, where upstream and mid-stream

oil companies are making large investments. Further, in the commodities, chemicals, mining

and electricity segments, various companies have announced massive capex plans.

Aggregate outstanding investments as at end-Oct. 2006 stand at Rs37,605b, up 58% YoY.

CMIE CAPEX SURVEYS (RS B)

APR-04

JUN-04

OCT-04

JAN-05

APR-05

JUL-05

OCT-05

JAN-06

APR-06

JUL-06

OCT-06

Manufacturing

Construction / Real Estate

Crude Oil and Natural Gas

Electricity

Services

Others

Total

39.5

1.6

0.0

1.6

14.4

2.3

59.4

22.2

0.7

0.0

6.9

12.1

0.7

42.5

90.8

1.5

0.0

20.6

14.4

2.6

129.9

31.0

2.5

1.4

15.8

28.1

5.3

84.1

44.5

5.6

3.7

7.2

42.1

3.0

106.0

104.8

2.2

0.8

34.3

16.0

1.9

160.1

101.5

7.2

6.0

53.1

34.4

7.8

209.9

86.5

31.8

8.8

109.3

53.1

5.6

295.1

62.8

21.5

2.5

39.2

18.0

1.3

145.3

75.5

11.8

3.2

70.3

53.2

10.7

224.7

157.1

207.7

17.4

147.5

118.8

8.9

657.3

Source: CMIE

TREND IN QUARTERLY FRESH INVESTMENTS (RS B)

7,000

5,250

3,500

1,750

0

Source: CMIE

29 December 2006

17

India Strategy

CAPEX IN KEY INDUSTRIAL SEGMENTS (RS B)

FY02-FY06

FY07-FY11

% INCREASE

Oil and Gas

Automobiles

Textiles

Steel

Cement

Petrochem

Aluminium

Others

Total

1,203

274

253

148

84

42

21

84

2,111

2,364

417

904

2,016

348

209

556

139

6,953

96.5

52.0

256.8

1,264.5

311.7

394.1

2,535.0

64.7

229.4

Source: CRISIL

29 December 2006

18

India Strategy

Growing investable universe likely to keep inflows strong

We expect strong inflows

into India’ equity markets

s

to continue…

Indian capital markets have been attracting strong inflows from both foreign and local

investors (collective investment of US$33.4b by FIIs and domestic mutual funds in the last

3 years). Several new classes of investors have entered (India-dedicated funds raised in

Japan, Asian countries and the Continent; AIM listings of Indian REITs; large sponsored

ADS of Indian equities to targeted investors).

In 2006, net FII investment in Indian equities was US$7.9b as against US$10.8b in 2005

and US$8.5b in 2004. Domestic mutual funds have invested US$3.4b in 2006 against

US$3b in 2005. We expect continued strong inflows from global investors, driven by strong

economic and corporate profit growth while domestic mutual funds will continue to witness

inflows due to the significant under-investment in equities and falling yields on debt

instruments.

FII NET INVESTMENT (US$B)

2.2

1.1

0.0

-1.1

-2.2

MUTUAL FUND NET INVESTMENT (US$B)

2.0

1.0

0.0

-1.0

Source: SEBI/Motilal Oswal Securities

29 December 2006

19

India Strategy

Market capitalization has increased to US$812b from US$549b in 2005 and US$281b in

2003. The number of >US$1b market cap companies have increased from 53 in 2003 to

93 in 2005 to 127 in 2006. Several emerging sectors such as wireless, media, real estate,

and infrastructure have provided significant investment opportunities. Going forward, we

expect such investment opportunities to expand, which will drive newer investors into

India.

NUMBER OF COMPANIES WITH MARKET CAP OVER US$1B

135

127

105

93

68

53

75

45

27

15

2002

2003

2004

2005

2006

Source: Company/Motilal Oswal Securities

29 December 2006

20

India Strategy

Reforms, budget could be key catalysts in 2007

… and increased thrust on

reforms, positive budget

announcements could be the

catalysts in 2007

With the central elections just 2 years away, there is a high probability of the government

pushing forward for reforms. As the state election of UP gets over in February, the

government has a time period of 9 months before next big state election. We believe that

India’ growth story would hinge a lot on government initiatives to facilitate quicker starts

s

for infrastructure development projects. While we believe that the private sector is ready

to contribute its share, the government needs to create a sustainable environment for

growth. Increase in FDI in insurance, telecom, financial sector reforms, etc. could be on

the agenda. While coalition compulsions would still be a major roadblock, incrementally

news flows could be more positive.

The Union Budget in February 2007 will be an important event to watch for. Tax revenue

has been growing at ~20% CAGR for the last couple of years. In FY07 YTD, direct tax

collections have been strong at 43% YoY, with corporate tax collections higher by 52%.

The government has already collected almost 70% of its annual estimates v/s 58% in the

same period last year. We believe that total tax collections in FY07 would be significantly

higher than estimates. This will provide significant room for the government to manage its

finances well within the deficit targets that it has aimed for. Strong buoyancy in revenue

collections would also enable the government to reduce the tax rates in the economy. Any

reduction in tax rates for individuals and corporates will be viewed very positively by the

markets.

IMPRESSIVE TAX COLLECTIONS (RS B)

APRIL-DECEMBER

FY07

FY06

% CHG.

BUDGETED

FY07

ACHIEVED

(%)

BUDGETED

FY06

ACHIEVED

(%)

Direct Tax

Corporate Tax

Income Tax

1,464

938

487

1,026

618

386

42.7

51.6

26.2

2,104

1,330

774

69.6

70.5

62.9

1,768

1,106

662

58.0

55.9

58.2

Source: Company/Motilal Oswal Securities

29 December 2006

21

India Strategy

Beginning 2007 with lower macro risks...

While risks relating to rise in

interest rates and oil prices

have abated…

The first six months of 2006 were marked by two key risks to equities – rising interest

rates and rising oil prices. These two risks played a major role in the market correction in

May 2006. Since then, both these risks have abated. While oil prices have remained stable

at ~US$60/barrel (after declining from highs of ~US$78/barrel), 10-year bond yields in

India have remained in a range of 7.4-7.6% (after declining from highs of 8.4%). With no

signs of concerns on these two macro variables, focus of investors will largely remain on

earnings growth. Further, we believe that any decline in these two indicators could aid

higher earnings growth and better valuations for the Indian markets.

10-YEAR BOND YIELDS (%)

14.5

14

12.0

9.5

7.6

7.0

5.1

4.5

11.7

CRUDE PRICES

International Crude Oil Prices US$/BL (RHS)

8.5

7.5

6.5

5.5

4.5

10-Year G-Sec Yield (%) (LHS)

80

65

50

35

20

Source: Bloomberg/Motilal Oswal Securities

29 December 2006

22

India Strategy

...but increased risk of fresh issuance