Infrastructure

March 22, 2011

Infrastructure Developers
THEMATIC

Scalable and Questionable

Indian infrastructure developers substantial capital requirements has over the years provided them the scale to attract investors looking to participate in the Indian infrastructure story. However, whilst chasing for scale, the developers have ambitiously assumed risks knowingly and unknowingly which are now mushrooming and impacting asset creation and value creation. Whilst we maintain our penchant for wellmanaged construction companies over developers, we sieve the developer landscape and highlight Power Generation as one of the better segments. In this segment, GVKs stock is relatively cheaper (despite superior competitiveness) and Adani Power as relatively expensive (inspite of weaker competitiveness). Infrastructure developer stocks have failed to perform (stocks down 19-57%) over the last six months for multiple reasons project availability, capital availability (quantity, quality and cost), execution, resource costs and shortfalls in economic offtake. Whilst these issues remain, valuations have become relatively cheaper. In this note we build a framework for the various developer segments and highlight the following: Power generation and ports are superior plays: A decent regulatory framework, improved revenue visibility and lower financial risk make power generation the best large scale infrastructure development opportunity for private developers. Whilst power distribution also has potential, the opportunity to gain scale here is marred by regulatory intent. Ports is another high return opportunity (Rs325bn) with a decent regulatory framework and fewer revenue visibility concerns. For private developers, Indian road development may be the 2nd biggest developer opportunity (after power), but it is also an opportunity characterized by lack of an adequate enabling environment, sporadic project awards and intense competition. Age and scale are the key factors governing competitiveness: Given that these are early days for Indian infrastructure developers and given their limited financial/operational track records, we highlight that scale followed by age impacts the competitiveness of a company in the sector. Scale and age also help the company to negotiate with regulators. Whilst Torrent Power and Tata Power are strong players in the power sector, IRB and ITNL are strong players in the roads sector. Amongst the large diversified players, GMR is competitively better placed than peers. GVK is relatively cheap (inspite of superior competitiveness) and Torrent Power deserves to trade at a higher premium: Developers with lower financial risks, longer duration assets and higher growth should trade at a multiple to others. Therefore, diversified players with power and airport assets should trade at a premium to road developers. Amongst the diversified players we find GVK to be undervalued on P/B, and amongst the power developers Adani Power looks to be relatively expensive. Whilst Torrent Power is trading at a slight premium, we believe that it should trade at a higher premium because it is a superb franchise with the best operational efficiency in the sector. Whilst GMR is also trading at a premium to other diversified entities, we believe that the premium is justified given that it has had relatively fewer issues in operationalising assets and generates comparatively higher returns.

Analyst contacts
Nitin Bhasin
Tel: +91 22 3043 3241 nitinbhasin@ambitcapital.com

Bhargav Buddhadev
Tel: +91 22 3043 3252 bhargav.buddhadev@ambitcapital.com

Chhavi Agarwal
Tel: +9122 3043 3203 chhaviagarwal@ambitcapital.com

Exhibit 1: Developers Summary table

Company/ Metric Overall Competitive ranking FY12E P/B (X)

Diversified Developers Reliance Infra JPA GMR GVK Gammon Infra Road Developers IRB ITNL Utilities Reliance Power Adani Power Lanco Tata Power Torrent Power CESC JSW Energy 2.1 1.6 0.7 1.6 1.8 1.1 1.7

1.8 2.8 1.6 1.9 1.9 0.8 1.6

Source: Company, Ambit Capital research, Bloomberg, Note P/B multiple data as on March 21, 2011 Note: Strong, Relatively strong, Relatively weak

Average,

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.

Infrastructure Developers

CONTENT
Multiple issues leading to disappointing returns .................. 3 The well-known infrastructure growth story continues........ . 7 Valuations are attractive........................................................ 8 Should investors buy infrastructure developer stocks? ......... 9 Key triggers to watch out for ................................................ 19

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Infrastructure Developers

Multiple issues leading disappointing returns

to

Whilst the BSE100 has declined by ~6% in the last six months, the infrastructure developers have been amongst the worst performers with stock prices declining by 19-57% (ex-Tata Power). We believe that besides the macro issues which are dragging the market down, infrastructure stocks are also bearing the brunt of multiple sector-specific regulatory issues (such as in airports, land and environmental clearances in power) alongside the impact of rising funding costs for debt and the inability to raise equity given the state of the stock market.

Poor stock market returns

Across sectors, infrastructure developers have not generated share price returns for the past six months, with road developers and diversified developers being the worst performers.
Exhibit 2: Developers have given poor share price returns
Returns (%) Diversified Developers Reliance Infrastructure JPA GMR Infra GVK Power Gammon Infra IVRAH Road Developers IRB Ashoka Buildcon Sadbhav ITNL Port Developers Mundra Gujarat Pipavav Utilities Reliance Power Adani Power Lanco Infratech KSK Tata Power Torrent Power CESC JSW Energy Indices BSE 30 Index BSE100 Index BSE200 Index CNX Infra. Index BSE Capital Goods Index 17,839 9,327 2,205 2,823 12,332 -3 -3 -3 -5 -7 -10 -10 -10 -16 -19 -3 -6 -7 -19 -18
th

CMP Rs 624 83 37 24 17 54 185 280 107 210 132 61 119 111 36 101 1,230 241 297 72

Mkt cap (Rs bn) 167 176 143 38 12 11 61 15 16 41 264 26 333 241 88 38 292 114 37 118

1m return 0 -5 -11 -11 -9 5 -2 2 6 -3 -8 3 4 -10 -7 -9 -2 7 -3 -5

3m return -23 -19 -20 -39 -18 -26 -17 -3 -12 -30 -9 3 -21 -12 -41 -27 -4 -13 -19 -27

6m return -40 -31 -41 -49 -33 -57 -40 NA -31 -35 -19 NA -23 -21 -51 -39 -5 -29 -26 -43

1yr return -39 -43 -36 -42 -31 -53 -30 NA -17 NA -10 NA -17 -3 -29 -44 -8 -20 -25 -34 2 1 1 -16 -11

2 yr CAGR 8 22 -9 6 26 74 51 NA 88 NA 43 NA 6 NA 69 -27 33 83 23.1 NA 38 40 42 11 44

3 yr CAGR -20 -15 -18 -11 NA -22 0 NA 0 NA 10 NA -16 NA 1 NA 6 34 -9.8 NA 6 6 6 NA -2

4 yr CAGR 8 4 0 -5 NA NA NA NA 27 NA NA NA NA NA 21 NA 25 41 -2.9 NA 9 10 10 NA 10

5 yr CAGR -1 5 NA -2 NA NA NA NA 30 NA NA NA NA NA NA NA 17 NA -2.3 NA 10 10 10 NA 9

Source: Ambit Capital research, Bloomberg, Note (a) Share prices and market cap data are as on 21 March, 2011

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Infrastructure Developers

Ambitious capex plans kept free cash flows negative

Whilst cash flows from operations are positive for most developers due to their low working capital requirements, substantial capex requirements have kept the free cash flows negative. Whilst high capex comes with the territory (given the nature of infra development), what concerns us is that several of the ongoing projects are facing time and cost overruns due to issues such as land acquisition problems, lack of capital, regulatory challenges, etc which seem to be ongoing issues.
Exhibit 3: Free cash flows* have remained negative for most developers (Rs mn)
Company Diversified Developers Reliance Infra JPA GMR GVK Gammon Infra Road Developers IRB Ashoka Sadbhav ITNL Port Developers Mundra Gujarat Pipavav Utilities Reliance Power Adani Power Lanco KSK Tata Power Torrent Power CESC 6 NA (20,832) NA (3,324) (10,260) NA (4,187) (243) (8,242) (5,995) (9,594) (8,604) (2,090) (40,913) (3,316) (10,808) (10,824) (23,118) (1,699) 9,170 (37,724) (21,188) (13,796) (33,540) (46,723) 9,688 7,595 (1,226) (1,912) (8,375) (2,082) (7,671) (1,721) (8,315) (3,413) (4,192) (1,847) (2,164) (223) (2,167) (555) (98) 1,438 (5,499) (1,572) (2,423) 513 (1,572) (3,224) (2,796) 2,698 5,877 (14,242) (12,846) 119 900 (7,442) 9,301 (44,460) (1,651) 1,078 (15,769) 4,571 (58,370) (8,980) 1,230 (20,364) (114,863) (56,214) (5,722) 1,158 FY07 FY08 FY09 FY10

Source: Company, Capitalline, Ambit Capital research. Note (a) * FCF is defined here CFO-Capex

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Multiple issues
Whilst the Public Private Partnership (PPP) initiative promoted by the Government is gaining momentum, (private sector share targeted to increase to 36% in XIth Five Year Plan v/s 20% in the Xth Five Year Plan), the projects under the PPP model are facing several challenges which have resulted in execution slippages. We have divided these challenges into two buckets: (a) generic issues that are common across all the sectors; (b) specific sector issues in roads, railways, airports and power, which have led to skewed private participation in these sectors.
Exhibit 4: Challenges in the PPP model

Generic Land acquisition problems, environmental and other regulatory issues clearances, lack of adequate capital (debt and equity), increasing cost of (applicable to capital (rising interest rates), delay in receiving financial closure.
all sectors)

Power Specific sector Issues

Roads

Ports

Airports

Intense competiton, Intense competition, poor traffic studies, non-availbility of NHAIs limited contractors to carry organisational out the project in bandwith, sporadic remote areas. project bids by developers.

Despite good MCAs, Uncertainty there is a lack of around tariffs support from State and returns Governments, potential, Land uncertainity on usage and sale connecting proceeds infrastructure sharing

Source: Ambit Capital research, Industry

Skewed private sector participation across segments

As highlighted in exhibit 5 below, sector-specific issues have led to a decline in private sector interest in the roads and the railways segments. Whilst the revised private sector contribution estimates in the XIth Five Year Plan are expected to be ahead of the earlier estimates in sectors like power, ports and storage; the revised estimates are far behind the earlier estimates in the railways and roads and bridges sectors.
Exhibit 5: Skewed private sector participation across segments
XIth Plan (Rs bn) (original estimates) Public Electricity Roads and Bridges Telecommunication Railways irrigation Water supply and sanitation Ports Airports Storage Gas Total 4,810 2,074 807 2,114 2,533 1,365 335 94 112 103 14,346 Private 1,855 1,068 1,778 503 0 54 545 216 112 65 Total 6,665 3,141 2,585 2,617 2,533 1,419 880 310 224 168 XIth Plan (Rs bn) (revised estimates) Public 3,711 2,328 615 1,925 2,462 1,112 81 130 4 745 13,113 Private 2,875 459 2,836 83 0 5 325 231 86 528 7,428 XI Plan XI Plan (original estimates)(%) (revised estimates)(%) Total Public Private Public Private 72 66 31 81 100 96 38 30 50 61 70 28 34 69 19 0 4 62 70 50 39 30 56 84 18 96 100 100 20 36 4 59 64 44 16 82 4 0 0 80 64 96 41 36
th th

6,586 2,787 3,451 2,008 2,462 1,117 406 361 90 1,273 20,541

6,196 20,542

Source: Planning Commission, Ambit Capital research

Issues are more acute in the roads segment

Our discussions with the primary data sources and other industry experts have indicated that guided project IRRs in the roads segment have reduced to 13-15% in FY10 and FY11E from the 18-20% IRRs guided to in FY07 and FY08. Besides the common challenges for Indian infra, the following sector-specific issues have resulted in significant time and cost overruns in the road projects:
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Infrastructure Developers

Structural problems at NHAI: NHAIs limited organizational bandwidth has resulted in poor project structuring, delayed awards and inadequate administration of the national highways. Moreover, our primary data contacts highlight a shortage of technical strength within the NHAI; and the Governments announcements of restructuring within NHAI are not visible at the ground level. Sporadic project bids: Most road developers still have a contractors mindset they place bids for projects with the construction opportunity in mind and with an objective to maximize current profits rather than focus on the life cycle of the road asset. Improper traffic studies and lower estimates of operations & maintenance (O&M) costs for the project (in order to be the lowest bidder) at the developers end, lower the project IRR. Intense competition: Increasing competition from the small and international players has lowered project returns in the sector. On the national and state highway projects, about 70 mid-to-large sized Indian and foreign contractors are working. Not only are the smaller Indian construction companies becoming developers but also international companies (from Israel, Japan and South Africa) are entering the Indian markets in hordes. Recently a number of European and Asian players such as Atlantis, Vinci and Orascom have announced JVs for their Indian road development ambitions.

Embedded real estate aspirations are an additional risk

In order to benefit from the Real Estate upturn over 2005-08, many infra developers entered the Real Estate sector by acquiring large land banks for setting up the residential, commercial and SEZ units. Whilst developers like IRB, Reliance Infra and Lanco have directly entered the real estate business, developers such as GVK, GMR, JP Associates have real estate projects embedded in their other BOT projects (airports, roads etc.). As highlighted in the exhibit 6, most of these projects are currently stalled and a large amount of capital is blocked in these projects leading to additional risk for developers.
Exhibit 6: Real Estate aspirations of infrastructure developers
Company IRB GMR Reliance Infra Lanco GVK IVRAH JPA Use (commercial, residential, SEZ) Residential, commercial Commercial, SEZ Residential, commercial, SEZ Residential, commercial, SEZ Commercial Residential, commercial Residential, commercial Direct/ embedded in other BOT assets Direct holding Mixed, In Delhi airport(commercial), Hyderabad Airport(commercial and SEZ) and Krishnagiri SEZ Real estate part of the Mumbai Metro Direct holding Mixed Mumbai airport (commercial) and SEZ Direct holding Mixed (Embedded -through Jaypee Infratech across Yamuna expressway and also through Jaypee Sports Intl Pvt. Ltd.) Comments No work taking place Part of Delhi Airport land monetised and the balance facing issues on account of the recent regulatory uncertainties as expressed in AERA circular; SEZ not moving No progress No progress MIAL land stuck in regulatory and operational issues; no progress on SEZ Some of the real estate projects witnessing a revival Land closer to Noida being developed and sold

Source: Ambit Capital research, Industry, Company

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The well-known infrastructure growth story continues

Given the current Indian infrastructure deficit, the Government of India has indicated increasing the infrastructure investment to US$1tn in XIIth Five Year Plan (FY12-17) from US$0.5tn in XIth Five Year Plan (FY07-12), doubling the overall infrastructure opportunity. This translates into an opportunity of at least US$0.36tn (Rs.16.5tn) for the private sector (assuming share of the private sector continues to remain at 36%, as in the XIth Five Year Plan).

Power and roads continue to form the largest share of the pie
Combined together the total Government spend in the two sectors is expected to be ~Rs20tn in XIIth Five year Plan (assuming share of each sector remains the same as the XIth Five year Plan), an opportunity of at least ~Rs7.4tn for the private sector (considering contribution of private participation to remain at 44% in power and 16% in the roads segment.)
Exhibit 7: Power and roads will continue to be the largest opportunities in XIIth plan
XIth Plan (revised est.) Sector/Metric Rs bn Electricity Roads and Bridges Telecommunications Railways Irrigation Water supply and sanitation Ports Airports Storage Gas Total 6,586 2,787 3,451 2,008 2,462 1,117 406 361 90 1,273 20,542 US$bn @ % Rs 45/$ share 165 70 86 50 62 28 10 9 2 32 514 32 14 17 10 12 5 2 2 0 6 XIIth Plan (estimates) Rs bn 14,630 6,190 7,667 4,460 5,470 2,481 903 803 199 2,828 US$bn @ Rs 45/$ 325 138 170 99 122 55 20 18 4 63 1,014 Opportunity for private sector in XIIth plan % share % based Rs bn share on XIth plan 32 14 17 10 12 5 2 2 0 6 100 6,387 1,019 6,300 184 0 11 723 514 190 1,173 16,501 44 16 82 4 0 0 80 64 96 41 36

100 45,630

Source: Planning Commission , Ambit Capital research Note: (a) Our estimates of sector allocation in the XIIth Five Year Plan are based on the % share of the respective sectors in XIth Five Year Plan (b)Opportunity for private sector is based on the private sector share in the XIth plan.

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Valuations are attractive

Given that stock prices have declined by 19-57% (ex-Tata Power) in the last six months (exhibit 2), valuations of the entire infrastructure developers appears attractive. As highlighted in the charts below, infrastructure companies are now trading significantly below their past average multiples. Whilst diversified players (shown in exhibit 8 below) are trading at a one-year forward P/B multiple in the range of 0.7x-1.8x (which is 44-52% below their average of the last four years), power companies (shown in exhibit 9 below) are trading at oneyear forward P/B multiple in the range of 1.8-2.0X (which is 12-35% below their average of the last four years).

Exhibit 8: Diversified players are trading at lower than their average one-year forward P/B multiples
7 6 5 4 3 2 1 0 Sep-07 May-09 Apr-07 Jul-08 Dec-08 Feb-08 Avg P/B multiple: Reliance Infra :1.3X GMR: 3.2X GVK: 2.3X

Exhibit 9: Power companies are trading at lower than their average one-year forward P/B multiples
6 5 4 3 2 1 Mar-10 Sep-07 Apr-07 Jul-08 May-09 Aug-10 Dec-08 Oct-09 Avg P/B multiple: Reliance Power : 2.6X Torrent: 2.1X Tata Power: 2.3X

Mar-10

Oct-09

Aug-10

Jan-11

Reliance Infra

GMR

GVK

Reliance Power Tata power

Feb-08

Torrent Power

Source: Company, Ambit Capital research, Bloomberg

Source: Company, Ambit Capital research, Bloomberg Note (a) Reliance power is included from Feb-08

Exhibit 10: Road developers are trading at lower than their one-year forward P/B multiples
4 3 2 1 Aug-08 Aug-09 Aug-10 Feb-08 Feb-09 Feb-10 Feb-11 Avg P/B multiple: IRB : 2.8X ITNL: 2.5X

Exhibit 11: Port developer, Mundra, is trading at lower than its one-year forward P/B multiple
12 10 8 6 4 2 Sep-08 May-10 Mar-11
8

Avg P/B multiple 6.8X

Mundra Apr-08 Feb-09 Dec-09 Oct-10 Jul-09

IRB

IL &FS Transport

Source: Ambit Capital research, Bloomberg Note(a) IL&FS Transport (ITNL) is included from April-10

Source: Ambit Capital research, Bloomberg

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Should investors buy infrastructure developer stocks?

Despite an ever increasing infrastructure growth opportunity, infrastructure developer companies have failed to generate share price returns for investors. However, at the currently attractive valuations (0.8-2.8X FY12 P/B (ex-Mundra)) the question arises: Should investors stay away from the entire infrastructure sector or selectively choose stocks which are better placed? We believe that investors should be cautious and follow a three-stage approach to filter the stronger players from the rest. Investors should look at: (a) the infrastructure sector with better asset development opportunities; (b) stronger companies across sectors; and (c) companies with attractive valuations.

Filter I. Choose the better asset development opportunities

In order to identify superior companies in the infrastructure space, we first assess the various sectors. Whilst power and roads offer the largest opportunities (exhibit 12 below), these sectors are also characterized with intense competition. However, we find that power generation and distribution have better revenue visibility and lower risks compared with the other sectors. The various parameters used in assessing the sector opportunities are:

The opportunity attracts competition: Given that roads and power generation require less capital and have a larger share in the total infrastructure spending, they suffer from stiff competition compared to other sectors. Ports, railways and power transmission and distribution have lower competition. Revenue Visibility: Whilst power generation companies have assured revenues for a considerable period of time (due to long term power purchase agreements (PPAs)), toll roads suffer from the problem of revenue visibility in the long run. Moreover, poor traffic studies and rising O&M costs in the later years have accentuated the problem for the toll road developers. Power transmission and annuity roads are assets which receive guaranteed payments from the Government. Increasing share of merchant power in the independent power producer (IPP) model reduces revenue visibility in the power generation sector. Better regulatory system: Sectors with established and well functioning regulatory bodies and clear contractual agreements have lower regulatory risks versus others. We believe that power has lower regulatory risks compared to roads, which are suffering from inefficiencies at the NHAI. Financial risks: Assured off-take and pass though of interest costs (in the case of a case II bidder) leads to the power generation sector being loaded with low financial risks. Rising input costs and interest costs with no pass through agreements have increased the financial risks for the roads and the railways (metros) sectors. Project returns: Projects in the power generation sector have higher returns driven by the incentive payments and increasing use of merchant power with IPPs; toll returns are declining on account of lower-thanexpected traffic growth and rising input and interest expenses.

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Infrastructure Developers Exhibit 12: The Power sector offers better revenue visibility and higher returns
Sectors Power Generation Power T&D Roads Toll Roads Annuity Airports Ports Urban Infrastructure Railways (Metro)
Source: Ambit Capital research, industry, Note: Strong, Relatively strong, Average, Relatively weak

Competition

Revenue Visibility

Regulatory risks

Financial risks

Total returns Overall

Exhibit 13: Porter analysis of Indian power industry Bargaining power of suppliers MEDIUM Competition has started increasing recently with new entrants like L&T, Thermax, BGR and JSW. Put together, these players are planning to have capacity in excess of 10GW compared with BHELs 15GW Demand for equipment from IPP,s on the other hand, has remained constant at a run rate of 20GW on a per annum basis. Competitive outlook POSITIVE From a competitive perspective, Indian power generation is an almost ideal sector characterised by excess demand on the back of headwinds in new capacity addition and high barriers to entry. Bargaining power of buyers LOW Buyer power is low as there is a huge shortage of power Industrial customers have no bargaining power against State Electricity Boards as their offtakes are meagre compared to the large corporates (who have some bargaining power at least)

Barriers to entry HIGH Power generation is a capex heavy industry (roughly $1m of capex required to install 1MW) and hence availability of finance acts as a barrier. Moreover, availability of fuel for thermal plants is also a big challenge especially after Coal India made a statement that they will not honour linkages. Hence large scale entry into Indian power generation is difficult and takes deep pockets, political connections and patience.
Source: Ambit Capital research, Industry

Threat of substitution LOW Neither solar nor hydropower has developed sufficiently in India to be a threat to thermal power. Alternative sources of energy in India are not available at low enough prices or large enough quantities to be a viable proposition for commercial buyers of power.

Improving Unchanged Deteriorating

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Infrastructure Developers Exhibit 14: Porter analysis of the Indian roads industry
Bargaining power of suppliers MEDIUM Competitive intensity HIGH Bargaining power of buyers MEDIUM

Capital providers of debt and equity (banks, funds PE, FIs etc.) have higher bargaining power given lack of liquidity in the financial market. Rising interest rates have also made the debt availability difficult. The construction companies providing the EPC work are large in number, hence have low bargaining power.
Barriers to entry MEDIUM

A large number of Indian/international players are bidding for limited road projects as NHAI has slowed the pace of awarding projects. A large number of European and Asian players such as Atlantis, Vinci and Orascom have announced JVs with Indian companies for their Indian roads development ambitions Experienced players like IRB, GMR with a large number of operational assets have gained the confidence of regulators and are superior to others.
Improving Unchanged Deteriorating

State/rural governments and NHAI are the main clients Given that Government needs to increase private sector participation, which has remained subdued over 2009 and 2010, the bargaining power of Government has reduced. However Governments new Model Concession Agreement (MCA) caps returns and limits the private sectors bargaining power

Low capital requirement compared with other infrastructure sectors has attracted many small and large EPC players who have entered in partnership with other big national/ international players/financial institutions. Large-sized road projects of NHAI requiring huge capital, limits the entry of small players with low balance sheet
Source: Ambit Capital research, Industry

Threat of substitution LOW

Given the Governments policy to promote private sector participation in the roads infrastructure, it will not execute the road projects on its own. Hence, road developers face a low threat of substitution.

Filter II. Choose stronger companies in different sectors

Given that the parameters for assessing competitive strength differ across sectors, we have analyzed the competitive positioning of the respective players on the parameters specific to their sectors. Whilst in the power sector, we have assessed the companies on qualitative and quantitative factors, in the other sectors (roads, railways (Metros), airports and ports) we assess the companies on their cost competitiveness, negotiating power, track record, etc. However, the overall theme across sectors remains the same i.e. the companies with a large number of operational assets, lower cost structure, higher balance sheet strength, and good bargaining power stand ahead of the others.

Power sector
Our Power analyst, Bhargav Buddhadev, in his thematic dated January 19, 2011 The Good, The Bad & The Ugly, had mentioned that on a qualitative basis, Tata Power and GVK Power are the clear winners, as both have the right mix of experience, aggression, offtake and raw material linkages tied up. It is also pertinent to note that both of these companies have zero reliance on Chinese equipment. Other companies that stand out in the analysis are Torrent Power, CESC and GMR Infra. On the quantitative balance sheet parameters, Torrent Power clearly emerges as a winner on the back of strong cash flow generation coupled with high return ratios. Besides Torrent Power, Tata Power, JSW Energy and CESC too score well on these parameters signifying the underlying strength of their balance sheets.

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Exhibit 15: Competitive based positioning

Company/ Metric JSW Energy Adani CESC India bulls Torrent Power Lanco Infra Tata Power Reliance Power GVK GMR Source: Company, Ambit Capital research, Industry Note: Strong, Relatively strong, Average, Relatively weak Equip Experie Aggressi Fuel tie ment nce on ups quality Long term PPAs Overall Score

Exhibit 16: Balance sheet (financial) positioning

Company/ Metric

Debt/ CFO/ EBIT/ Equity EBITDA interest

RoCE

RoE

Overall score

JSW Energy Adani CESC Torrent Power Lanco Infra Tata Power GVK GMR
Source: Company, Ambit Capital research, Industry

Roads, airports and ports sectors

For the roads, airports and ports sectors, we have based our assessment of the companies on the following parameters:
Exhibit 17: Key competitive assessment metric (Road, ports and airports sectors)
Metric Political proximity Description Ability of the company to influence the government/bureaucratic machinery while bagging the projects, as government is the main party awarding the infrastructure project. Given that infrastructure development is a highly capital intensive industry and given the lack of a developed financial system in India, financial strength of the company becomes an important parameter. Companies with low debt:equity and lower financial expenses are stronger than companies with higher debt:equity. We have ranked developers based on their years of experience in each segment and operational assets. Good track record and efficient management of the existing assets enables a developer gain confidence of the regulatory authorities (NHAI/State Government). Control over the construction and operational costs can improve the projects equity returns, thus differentiating one player from the other. Though, nonavailability of data on comparative construction costs (due to the large number of road assets) limits a detailed assessment of the companies on this parameter, we use EBITDA margin as a proxy for comparing cost efficiency. Metric used Positioning of the company on the political power influence square Debt:Equity ratio and financial expenses as % of sales Operational assets and years of experience in the segment. EBITDA margin in the respective segment

Financial control

Past track record

Cost efficiency

Source: Ambit Capital research, Industry

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Positioning on the political influence square:

We prefer Central Government relationships and the presence of a Member of Parliament on a companys board over State level political relationships.
Exhibit 18: Political relationship of the developers (Level I is the best place to be in)
Level I. Politician on the companys board: Lanco, CESC Level II. Family relationship of the promoter with the politician: GVK, Sadbhav

Level III. Strong association of the promoter with one or more politician: GMR, Reliance Infra, Reliance Power, Gammon, JPA, KSK, Adani and IRB, ITNL, Ashoka Buildcon, IVRAH, Gujarat Pipavav, Sadbhav

Level IV. Ex-members of ministry or Government bodies as directors or senior management: GVK, Jaiprakash, Mundra port, Tata Power, Reliance Power, Gammon, KSK, ITNL, Ashoka Buildcon, IVRAH, Gujarat Pipavav, Sadbhav

Source: Ambit Capital research, Industry

Roads sector With a large number of operational assets, better operational management and strong relationships we find that IRB, GMR and IL&FS Transport Network (ITNL) are the strongest players in the roads sector.
Exhibit 19: Positioning of listed players in the road segment
Cos ITNL IRB Ashoka Buildcon GMR L&T Infra Sadbhav IVRAH Gammon Infra Reliance Infra GVK Lanco JPA Experi ence (yrs) 11 13 14 10 10 6 6 10 5 8 3 1 Operatio nal (kms) 1527 701 454 421 315 297 97 142 97 90 0 0 Under devp. (kms) 2435 549 446 309 789 369 410 100 873 83 163 1239 D/E (x) 1HFY11 2.1 1.7 1.8 1.6 0.1 0.9 0.3 2.8 0.5 1.5 1.0 2.2 EBITDA Margins (%) (9MFY11) 31% 87% 80% 83% NA NA NA NA 29% 66% NA NA

Exhibit 20: Competitive positioning amongst players (this is taken from the adjacent table)
Companies ITNL IRB Ashoka Buildcon GMR L&T Infra Sadbhav IVRAH Gammon Infra Reliance Infra GVK Lanco JPA Source: Company, Ambit Capital research, Industry Note: Strong, Relatively Strong Average

listed

Market Managing Cost of Negotiating share Finance operations Power Overall (35%) (20%) (25%) (20%)

Source: Company, Ambit Capital research, Industry, Notes: (a) Experience is taken based on the number of years company has been in the road BOT segment (b)Debt:Equity is calculated for the entire business (c) EBITDA margins are the margins in the roads segment , we have taken EBIT margins for Reliance Infra and ITNL in roads

Relatively weak

Airports and Ports Due to the substantial capital requirements, there are very few players in the airports and roads segments. Whilst GMR is the strongest player in the airports sector with three operational airports, Mundra is a leading player in the ports sector. Given that the Government itself upgrades the existing assets or creates smaller assets through private participation, airports and ports will continue to remain relatively smaller opportunities.
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Exhibit 21: Positioning Airports sector

Experie nce (yrs) 7 3 0

of

different

players

in

the

Exhibit 22: Competitive positioning amongst the listed players (this is taken from the adjacent table)
Companies GMR GVK IRB
Source: Company, Ambit Capital research Note: Strong, Relatively Strong Average Relatively weak

Cos

Operati onal airports 3 2 0

Under develop ment airports 1 0 1

D/E (x) 1HFY 11 1.6 1.5 1.7

EBITDA Margins (%) 9MFY11 38% 68% NA

Market Managi Cost of Negotiati position ng Overa operatio on power ing Finance ll rank ns (30%) (20%) (30%) (20%)

GMR GVK IRB

Source: Company, Ambit Capital research, Industry, Notes: (a) Experience is taken based on the number of years company has been in the airports BOT segment (b) Debt:equity is calculated for entire business

Exhibit 23: Ports- Positioning of the companies

Operational Under devp. EBITDA Experie (Cargo -mn (Cargo -mn D/E (x) mgins Cos nce TPA, TPA, 1HFY11 (%) (yrs) Containers - Containers (9MFY11) mnTEUs) mnTEUs) Containers Mundra 9 2.5 cargo: Cargo:93 0.8 68% 145 Gammon Cargo:10 9 Cargo:9 2.8 NA infra container :1.4 Gujarat 23 Cargo: 5 0.5 41% Pipavav Source: Ambit Capital research, Industry

Exhibit 24: Competitive positioning amongst the listed players (this is taken from the adjacent table)
Cos Mundra Gammon infra Gujarat Pipavav Source: Ambit Capital research, Industry Note: Strong, Relatively Strong Average Relatively weak Market Managing Cost of Negotiati Overall positioning Finance Operations on power rank (30%) (20%) (30%) (20%)

Diversified players In order to assess the overall competitive advantage of the diversified players, we have considered three parameters: (a) the companys exposure to the respective sector (based on total project cost); (b) competitive positioning of the company in the respective sector; and (c) the asset creation opportunity of the sector. GMR is the strongest diversified developer followed by GVK & L&T Infra.
Exhibit 25: Diversified different sectors
Diversified Developers Reliance Infra GMR GVK Gammon Infra L&T Infra

players'

exposure

to
Total 100% 100% 100% 100% 100%

Exhibit 26: Overall ranking of the diversified players (this is taken from the adjacent table) xx
Company/Metric Reliance Infra GMR GVK Gammon Infra L&T Infra NA NA NA Power (30%) Roads Airports (15%) (25%) Ports (30%) NA NA NA Overall Ranking

Power Roads Airports Ports 28% 58% 42% NA 53% 70% 11% 6% 80% 33% 2% 31% 52% NA NA NA NA NA 20% 13%

Source: Ambit Capital research, Company, Notes: (a) Exposure to a particular sector is based on the total cost of all projects undertaken by the company in that sector

Source: Ambit Capital research, Company, Notes: (a) We have assigned percentages to respective infrastructure sectors based on opportunities in that sector Note: Strong, Relatively Strong Average Relatively weak

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Summary of competitive positioning

We prefer players with a presence in the sectors that present a bigger-sized opportunity with a higher number of operational assets. Amongst the diversified players we find GMR followed by GVK to be stronger than others based on experience and larger operational portfolio. IRB and ITNL are strong players in the roads sector. Torrent Power and Tata Power stands out as strong power companies.
Exhibit 27: Preferred players across sectors
Companies Power Generation Power T&D Roads Toll Roads Annuity Airports Ports Railways (Metro)
Note: Strong, Relatively Strong

Overall

Strongest players Torrent Power, Tata Power Torrent Power, Tata Power, Reliance Power, GVK IRB, GMR, ITNL IRB, ITNL GMR, GVK Mundra Reliance Infra, L&T Infra

Source: Ambit Capital research, Industry, Company Average Relatively weak

Filter III. Choose valuations

companies

with

attractive

Whilst DCF is the best valuation method to value a public infrastructure asset (long duration assets with unique characteristics), lack of data for a number of inputs required for each BOT project makes the DCF valuation difficult. Therefore, we have used relative valuations to compare the infrastructure companies across sectors. We have used EV/EBITDA and P/B multiples to value these companies as we believe that EV/EBITDA reflects the infrastructure asset duration and the risk associated with it. For companies in the roads and the power sectors, P/B multiple is preferred, as it captures the equity returns (RoEs) which are more predictable and easy to calculate for these BOT assets. Overall, companies with lower risk, lower tax rates, longer duration assets and higher growth should trade at a multiple to others. Therefore, we believe that diversified players with power and airport assets should trade at a premium to road developers.

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Infrastructure Developers Exhibit 28: Relative valuation of infrastructure developers across different sectors
CMP Mkt cap Mkt cap Company Diversified Developers Reliance Infra JPA GMR GVK Gammon Infra Average Road Developers IRB ITNL Average Port Developers Mundra Utilities Reliance Power Adani Power Lanco KSK Tata Power Torrent Power CESC JSW Energy Average All Average 119 111 36 101 1,230 241 297 72 333 241 88 38 292 114 37 118 7,388 5,352 1,950 837 6,486 2,528 825 2,616 43.0 36.8 13.5 18.0 15.5 12.0 12.4 12.6 21.6 29.7 44.1 10.0 9.0 10.4 12.9 9.7 9.7 7.7 15.1 14.5 17.4 7.0 6.8 8.3 11.5 9.6 7.0 8.2 9.6 8.5 99.6 27.5 7.6 14.6 10.5 7.0 7.7 9.9 24.9 14.3 30.5 7.2 4.8 8.9 7.8 6.1 6.9 5.4 10.3 8.2 8.1 4.4 3.6 7.2 6.6 6.1 4.6 5.4 5.8 5.7 1.9 3.8 2.2 1.3 2.2 2.4 0.8 2.1 2.1 1.9 1.8 2.8 1.7 1.2 1.9 1.9 0.8 1.6 1.7 1.6 1.5 2.0 1.3 1.0 1.7 1.6 0.8 1.4 1.4 1.3 132 264 5,855 30.2 19.6 14.9 22.3 15.1 11.9 6.4 5.1 3.9 185 210 61 41 1,362 907 12.7 10.2 11.4 11.3 7.9 9.6 10.6 6.2 8.4 8.1 7.6 7.8 6.4 5.7 6.0 5.2 4.1 4.7 2.5 2.0 2.2 2.1 1.6 1.8 1.7 1.3 1.5 624 83 37 24 17 167 176 143 38 12 3,708 3,921 3,178 853 271 10.5 18.7 319.6 22.1 83.8 90.9 9.2 15.3 61.8 15.2 47.9 29.9 8.0 11.2 17.8 9.9 29.9 15.4 15.4 13.7 19.7 15.6 16.7 16.2 10.7 8.9 15.2 12.2 7.7 10.9 8.1 6.7 10.0 7.3 5.7 7.6 0.7 1.9 1.8 1.1 1.8 1.5 0.7 1.6 1.8 1.1 1.7 1.4 0.6 1.2 1.3 0.9 1.6 1.1 Rs P/E (x) EV/EBITDA (x) P/B (x) Rs bn US$ mn FY11E FY12E FY13E FY11E FY12E FY13E FY11E FY12E FY13E

Source: Company, Ambit Capital research, Bloomberg , Note (a) We have taken consensus data as on March 21,2011

Amongst the diversified players we find GVK and Reliance Infra to be undervalued on the P/B multiple. Whilst GMR is trading at a premium both on P/B and EV/EBITDA multiple, we believe that GMR deserves to trade at a premium given that it has a large number of higher RoE generating operational assets v/s peers. Also, JPA and Gammon infra are overvalued on the P/B multiple, they are undervalued on the EV/EBITDA multiple. Amongst the power players, we find that whilst Adani power is trading at a significant premium to peers, Torrent Power and Tata Power are trading at a slight premium to peers. As highlighted by our Power analyst, Bhargav Buddhadev, in his thematic dated January 19, 2011 The Good, The Bad & The Ugly, Torrent Power deserves to trade at a premium as it is an attractive franchise and has the best operational efficiency. However, he believes whilst Adani Power is trading at a premium; consensus is not factoring in the potential execution slippages and low PLF levels of the company. Our key takeaways from the relative valuation exhibits of diversified players and power companies shown on the next page are: Diversified players 1) On P/B compared to ROE, Gammon Infra appears over valued and Reliance Infra appears undervalued 2) On Revenues/Capital employed compared to EV/EBITDA , Reliance Infra is at a premium and GVK is undervalued

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Power Companies 3) On P/B compared to ROE, appears undervalued Adani appears overvalued and CESC

4) On Revenues/Capital employed compared to EV/EBITDA, Tata power is trading at a premium while Lanco is undervalued
Exhibit 29: Gammon Infra appear overvalued
2.0 1.7 P/B FY12E 1.4 1.1 0.8 0.5 0% 4% 8% 12% 16% 20% ROE(FY10)
Source: Company, Capitalline, Ambit Capital research, Bloomberg Note: Size of the bubble denotes capital employed at FY10-end

Exhibit 30: Reliance Infra Power business places it at a premium, GVK appear undervalued

1.6
Gammon Infra GMR GVK Reliace Infra

Revenue/CE (FY10)

JPA

1.2 0.8 0.4 JPA 6 8 Gammon Infra

Reliance Infra

GMR

GVK

10 12 EV/EBITDA (FY12E)

14

16

Source: Company, Capitalline, Ambit Capital research, Bloomberg Note: Size of the bubble denotes ROCE at FY10-end

Exhibit 31: Adani Power appears overvalued and CESC appears undervalued
3.5
P/B FY12E

Exhibit 32: Tata power is trading at a premium while Lanco is undervalued

3.0 2.5 2.0 1.5 1.0 0.5 0% 4%

Revenue/CE (FY10)

1.6 1.2 0.8 0.4 4 5 6 7

JSW Energy Adani Lanco Torrent Power CESC KSK Tata Power

Adani

Tata Power

Torrent Power JSW

KSK CESC 8% 12%

Lanco

16%

20%

24%

28%

10

ROE(FY10)
Source: Company, Capitalline, Ambit Capital research, Bloomberg Note: Size of the bubble denotes capital employed at FY10-end

EV/EBITDA (FY12E)
Source: Company, Capitalline, Ambit Capital research, Bloomberg Note: Size of the bubble denotes ROCE at FY10-end

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Our overall analysis

Based on our above framework, we find that GVK is trading relatively cheap and Torrent Power deserves to trade at a higher premium. Whilst Torrent is trading at a marginal premium to peers on the FY12 P/B multiple, we believe Torrent deserves to trade at a higher multiple. Torrents superior cash flow (FY10 CFO/EBITDA was 94% v/s 45% for peers), stellar RoEs (FY10 RoE was 23% v/s 11% for peers) and higher return on assets makes it stand ahead of the other power companies. Furthermore, our interaction with primary data sources also suggests an improving visibility on the Dahej Power project, which we believe should serve as a positive catalyst. We believe that GVK is currently trading at an attractive multiple and offers an upside potential. Whilst the company has relative competitive advantages over other players, its near-term value creation is dependent on its power asset and the MIAL airport project, which are being impacted by regulatory issues. However, we believe that these issues are transient, given the long lifecycle of the infrastructure project. Whilst we do not expect the stock to fly from current levels, we expect the stock to perform well when the uncertainty around resource availability (fuel) for power projects improves and tariff issues for MIAL get sorted through certainty in the regulations.

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Key triggers to watch out for

The main catalysts to watch out for the developer stocks are:
Decline in cost of capital: As highlighted in the chart below, stock price returns for developers companies are inversely related to interest rates. Given that interest rates have shot up by ~300bps in the last 9-10 months, developers are facing the heat of rising cost of borrowing which could affect their project IRRs. Hence they are bidding for a limited number of new BOT projects. Whilst we expect average interest rates to rise by 50-75bps in the near term, easing of interest rates will drive the capital flow and the stock prices.
Exhibit 33: Stock prices of developers are inversely linked to interest rates
500 400 300 200 100 0 Apr-07 Apr-08 Apr-09 Apr-10 Jul-07 Oct-07 Jul-08 Oct-08 Jul-09 Oct-09 Jul-10 Oct-10 Jan-08 Jan-09 Jan-10 Jan-11 8 12 10 14

GMR IRB BBB 10 year borrowing rates (%) (RHS)

GVK Reliance Infra

Source: Ambit Capital research, Company, Bloomberg Notes: (a) Share prices have been indexed to 100., IRB share prices are available from 22 Feb 2008 (b) We have used BBB 10-year corporate bond rates because we find that most of the BOT asset are BBB-rated; (c) We have not used SBI PLR because we believe it is not a true indicator of the interest rates at which developers borrow funds for their BOT assets

Procedural acceleration: Land acquisition issues, environmental clearance problems and lengthy approval procedures have resulted in long execution cycles for infrastructure projects, especially in the power and the roads sectors. Over 65% of the NHAIs projects have been impacted by time and cost overruns. Any significant improvement in the currently stalled projects due to speed up in the procedural formalities can improve the revenue visibility and cash flow generation from existing projects. Development of a long-term bond market: Creation of a long-term bond market can increase the availability of funds for the sector and reduce the dependence on banks. Given that infrastructure projects have long gestation periods of 25-30 years, the average debt tenure for the infrastructure sector should be ~10-15 years. However, the Indian banks are reluctant to lend for such a long duration, thereby reducing the average loan tenure to 5-6 years, which is around 50-70% of most of the concession agreements. Moreover, the restricted investment guidelines on the pension funds and life insurance companies limit the funds to be channelized to the infrastructure sector. The Government in its FY11-12 budget has announced an increase in the budgetary allocation to the infrastructure sector to Rs2.14tn (up 23% YoY), issuance of tax-free infra bonds worth Rs300bn by Government undertakings and increase in the FII limit for investment in corporate bonds issued in infrastructure sectors to US$40bn (earlier US$20bn). In our opinion these measures should increase funds availability for the sector. Availability of equity capital: Our primary data checks have highlighted that more than the rising interest rates, lack of availability of the capital has resulted in execution slippages in the BOT assets. Given the lack of sufficient cash flows from operations, asset developers have continued to depend on equity markets for funds. However, given the current liquidity crunch in the Indian markets and the disappointing financial performance of the developers, it is becoming difficult for
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Infrastructure Developers

developers to get capital for their projects. Therefore any improvement in the macro environment resulting in credit offtake can improve funds availability with the developers.

Developers v/s EPC players

Given that the developers projects cash flows and completions are facing issues not directly in control of the developers, we prefer construction companies over the developers. Whilst the developers have their cash flows blocked in the capital intensive projects over a long period of time, construction companies have a shorter cash conversion cycle. Whilst we are aware that construction companies such as IVRCL, Nagarjuna, HCC and Gammon India have mismanaged their balance sheets and cash flow positions in order to fulfill their asset ambitions, they do have a fall back option in terms of their core construction business. However, amongst the EPC players, we prefer companies that have available balance sheet capacity to withstand nearterm challenges, and also have limited BOT ambitions. We find that companies like Simplex, KNR and CCCL are among the few construction companies with strong competitive advantages and manageable asset ambitions.
Exhibit 34: Construction companies are less risky than developers
160% 120% 80% 40% 0% -40% 3 years 2 years 1 year 6 months 3 months EPC companies Developer companies

Source: Ambit Capital research, Bloomberg, Notes: (a) We include L&T, Punj Lloyd, IVRCL, NCC, HCC and Simplex in model portfolio for EPC companies (weighted by market cap) and GMR, GVK, JP Associates, Reliance Infra, Tata Power and CESC in model portfolio (weighted by market cap) for developer companies

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Institutional Equities Team

Saurabh Mukherjea, CFA Research Analysts Amit K. Ahire Ankur Rudra, CFA Ashish Shroff Ashvin Shetty Bhargav Buddhadev Chandrani De, CFA Chhavi Agarwal Gaurav Mehta Krishnan ASV Nitin Bhasin Pankaj Agarwal, CFA Parikshit Kandpal Poonam Saney Puneet Bambha Rajesh Kumar Ravi Ritika Mankar Ritu Modi Industry Sectors Telecom / Media & Entertainment IT/Education Services Technical Analysis Consumer/Automobile Power/Capital Goods Metals & Mining Construction / Infrastructure Derivatives Research Banking Construction / Infrastructure NBFCs Real estate BFSI Power/Capital Goods Cement Economy Construction / Infrastructure Consumer IT/Education Services Consumer (incl FMCG, Retail, Automobiles) Desk-Phone (022) 30433202 (022) 30433211 (022) 30433209/3221 (022) 30433285 (022) 30433252 (022) 30433210 (022) 30433203 (022) 30433255 (022) 30433205 (022) 30433241 (022) 30433206 (022) 30433201 (022) 30433216 (022) 30433259 (022) 30433274 (022) 30433175 (022) 30433292 (022) 30433246 (022) 30433264 (022) 30433054 E-mail amitahire@ambitcapital.com ankurrudra@ambitcapital.com ashishshroff@ambitcapital.com ashvinshetty@ambitcapital.com bhargavbuddhadev@ambitcapital.com chandranide@ambitcapital.com chhaviagarwal@ambitcapital.com gauravmehta@ambitcapital.com vkrishnan@ambitcapital.com nitinbhasin@ambitcapital.com pankajagarwal@ambitcapital.com parikshitkandpal@ambitcapital.com poonamsaney@ambitcapital.com puneetbambha@ambitcapital.com rajeshravi@ambitcapital.com ritikamankar@ambitcapital.com ritumodi@ambitcapital.com ritumodi@ambitcapital.com subhashinig@ambitcapital.com vijaychugh@ambitcapital.com Managing Director - Institutional Equities (022) 30433174 saurabhmukherjea@ambitcapital.com

Shariq Merchant
Subhashini Gurumurthy Vijay Chugh Sales Name Deepak Sawhney Dharmen Shah Dipti Mehta Pramod Gubbi, CFA Sarojini Ramachandran

Designation VP - Ins Equity VP - Ins Equity Senior Manager Equities VP - Ins Equity Director, Sales

Desk-Phone (022) 30433295 (022) 30433289 (022) 30433053 (022) 30433228 +44 (0) 20 7614 8374

E-mail deepaksawhney@ambitcapital.com dharmenshah@ambitcapital.com diptimehta@ambitcapital.com pramodgubbi@ambitcapital.com sarojini@panmure.com

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Explanation of Investment Rating

Investment Rating Expected return (over 12-month period from date of initial rating) >15% 5% to 15% <5%

Buy Hold Sell

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