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Industry update| Infrastructure| 7th July 2010

Indian urban infrastructureWashing and housing half a bn peopleRapid urbanisation means that India needs heavy investment in urbanwater, transportation and (affordable) housing infrastructure. Public

reports suggest that in next 20 years Indias investment in urban

infrastructure will be 20X its investment in the past decade. We

believe unless funding, governance and policy challenges are

addressed, investments could be lower than the required US$1.2 tn.

Construction companies and technology providers (in

water/transportation) will be the key beneficiaries.

Urbanisation amplifies infrastructure deficit

Whilst the degree of urbanization in India is one of the lowest in the world

(~30%), Indias urban population is growing at a rapid pace340 mn in 2008

(290 mn in 2001) expected to grow to 536-590 mn by 2026-30 (source:

National Institute of Urban Affairs and World Bank). This pace of urbanisation

has not only exposed Indias urban infrastructure deficit but also highlighted that

the deficit backlog is increasing at a rapid pace. Government (GoI) sponsored

and UN studies highlight that the severe supply deficits in basic urban services

(water, sanitation, transportation and affordable housing) will rise 2-4X if

investments continue at the current pace.

What does this mean for infrastructure companies?

GoIs commitment to urban infra will increase materially. GoI embarked on an

urban renewal mission (JNNURM) in 2005 and raised investment plans for

urban water supply, sanitation (WSS), transportation and housing by 20X to

Rs6.2 tn (US$133 bn) in XIth plan from the Xth plan. Whilst the plan appears

large, actual investment has been dismally low at US$17 per capita/ annum in

comparison to Chinas US$116. McKinseys report, Indias Urban Awakening,highlights that India needs to invest US$1.2 tn (US$130/capita/annum) in its

cities over 2010-30, 20X the amount spent over the last decade.

Investment will be the highest in urban transportation and affordable

housing. As per the GoI and McKinsey studies, 82% of the capital spend on

urban infrastructure will be on urban roads (17%), mass transit (33%) and

affordable housing (33%). Whilst JNNURM presently gives WSS and slum

development high importance, urban investment plans under the XIth plan,

actually allocate 58% of funds to housing and 21% each to WSS and

transportation. Affordable housing will continue to be a key focus area given

that every 7th person in urban India is a slum dweller.

Urban PPPs not a worthy bet, opportunity largest for construction and

technology providers. PPP opportunities in urban mass transit/transportationhave unattractive risk-reward balance given the limitations of charging for

public good services. However, PPP in smaller WSS schemes may be

profitable for developers as citizens accept to pay for the improving quality of

civic amenities. Hence, he main business opportunity from urban investments

will be for construction companies (US$14 bn annually for next five years) and

technology providers building WSS/transportation projects.

Challengesthe usual evils: funding, governance, planning and policies.

We continue to prefer builders over diversified developersWe reiterate our preference for construction and ancillary companies over

diversified developers given that the former have better visibility on earnings

(vis-a-vis developers who are bidding for projects with risks outside their

control). Our top picks amongst construction are CCCL (20% upside), IVRCL(16% upside) and HCC (38% upside). As the higher backlogs get translated to

revenues and return ratios improve for these companies, we expect construction

business to trade in the range of 12-15X one-year forward earnings. Potential

equity placements/raisings by these companies at the asset level could also act

as positive stock price catalysts for the parent.

Infrastructure companies under coverage

Company name PUNJ.IN

Recommendation SELL, 11% downside

Current price (Rs) 136

Valuation (Rs) 121

Market Cap (Rs bn) 45.3

Company name IVRC.IN

Recommendation BUY, 16% upside


Valuation (Rs) 215


Company name NJCC.IN



Valuation (Rs) 190


Company name HCC.IN



Valuation (Rs) 162


Company name SINF.IN

Recommendation BUY,4% upside


Valuation (Rs) 479


Company name CCCL.IN

Recommendation BUY,20% upside


Valuation (Rs) 108


Company name GVKP.IN

Recommendation SELL,11% downside


Valuation (Rs) 39


Source: Bloomberg, , Execution Noble research

AnalystNitin Bhasin+91 22 4211 0909

[email protected]

Binoy [email protected]

SalesPramod Gubbi, CFA

+91 22 4211 0902pramod.gubbi@ execution-noble.com

Sarojini Ramachandran

+44 (0) 20 3364 6736sarojini@ execution-noble.com


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Execution Noble is authorised and regulated by the Financial Services Authority and is a member of the LondonStock Exchange, Xetra, Virt-x and EuroNext. Page 2 of 15

Unprecedented scale of urbanisation

Whilst the degree of urbanization in India is one of the lowest in the world (~30%),

Indias urban population is growing at a rapid pace340 mn in 2008 from ~300 mn in

2001. During the last fifty years, whist Indias population has grown 2.5x but Indias

urban population has grown by 5x. Studies (sources: GoI, Mckinsey, World Bank)

highlight that the rate of urbanisation in India will further increase to 40% by 2030 the

urban population reaching nearly 575-590 mn (2X the current population of the US).The scale and speed of urbanisation that India may go through has not happened

anywhere before except in China. This scale of urbanisation will mean that by 2030

India will have 68 cities with population of a mn plus compared to 42 cities today

(Europe today has 35 cities).

Figure 1 The addition to the urban population over the next

two decades to be equal to the present urban population

Figure 2 Population split across different tiers of cities13

tier 1 and 55 tier 2 cities to account for 44% of urban population

Source: Ministry of Urban Affairs, McKinsey Global Institute Source: McKinsey Global Institute

is exposing Indias urban infrastructure deficit

Whist India is beginning to catch up on its existing deficit in infrastructure, the

backlog is increasing at a rapid pace. Across all major civic amenities, Indias cities fall

well behind in delivering even the basic. These gaps can further increase as the urban

population and incomes increase leading to rising demand for every key infrastructure

service. Government (GoI) sponsored and UN studies highlight that the severe gaps

between present supply and the basic demand in urban services (for water, sanitation,

transportation and affordable housing) will rise 2-4X over next 20 years if investments

continue at the current pace.

Table 1 The urban services deficit is high across segments

Table 2 On current trends, supply-demand gaps in urban

services will increase sharply

units Current Basic services

standard

Best in

class

Water supply ltrs/capita/day 105 150 220

Share of publictransportation

%, total trips 30 50 82

Parks & open space sq mtrs/capita 2.7 9 16

Sewage treated %, sewagegenerated

30 100 100

Solid waste collected %, total wastecollected

72 100 100

Slum population %, totalpopulation in

cities

24 0 0

Piped water coverage % population 74 100 100

(units)

2007 2030

Supply Basicservicedemand

Supply Basicservicedemand

Water supply bn ltrs/day 56 83 95 189

Sewage bn ltrs/day 13 66 42 151

Solid waste mn tonsp.a

51 71 295 377

Privatetransportation

000 lanekms

430 640 540 980

Rail based masstransit

Directionalroute kms,

kms

990 3,000 1,990 8,400

Affordablehousing

mn units 5 30 12 50

Source: UN, Planning Commission, McKinsey Global Institute Source: UN, Ministry of Urban Development, McKinsey Global Institute , NCAER

0

5

10

15

20

25

30

35

40

45

0

100

200

300

400

500

600

700

1961 1971 1981 1991 2001 2008 2030

Urban population (mn)

(LHS)

Percentage of Urban to total

population (RHS)

195

331

52

104

93

155

2008 2030

Tier 1 cities: Population > 4 mn

Tier 2 cities: Population 1 - 4 mn

Tier 3 & 4 cities: Population


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India is waking up to the need for urban infrastructure

investment

Considering the gaps in urban infrastructure services, the GoI embarked on an urban

renewal mission (including Jawaharlal Nehru National Urban Renewal Mission

(JNNURM)) in 2005 and raised investment plans for urban water supply, sanitation

(WSS), transportation and housing 20X to Rs6.2 tn (US$133 bn) in the XIth five year

plan from Rs 297 bn tn in the Xth five year plan. The importance of investment in urbaninfrastructure can also be assessed by its high 29% share of the XI th plan as compared

to 3.3% in the Xth plan. Senior Government officials, in recent discussions, highlight

that the investments in urban infrastructure will be materially higher in the decade to

come as demand from the higher level of urbanisation further increases. Whilst the XIth

plan clearly details the investments in WSS and urban transportation, it also highlights

the deficiency in affordable housingduring the XIth plan, the total housing

requirement, including the backlog, is estimated at 26.5 mn units. As per the XIth plan,

the total investment requirement for meeting the housing requirement would be of

the order of Rs3.6 tn (US$77 bn) consisting of Rs 1.5 tn required for mitigating housing

shortages at the beginning of the XIth plan and Rs2.1 tn for new additions to be made

during the XIth plan.

Table 3 Planned investments on urban infrastructure increase 20X in XIth

plan from Xth

plan

Xth plan

(Rs bn)

XIth plan

(Rs bn)

increase Investment as a %ageof total investment inurban infrastructure

XIth plan

Investment as a %ageof total investment in

XIth plan

Investment needs for urban water supply andsanitation, sewerage, drainage, and solid wastemanagement sectors

20 1,292 6,360% 21% 6%

Financial requirement to cater to the growingdemand for Urban Transport

27 1,326 4,811% 21% 6%

Total investment requirement for meeting thehousing requirement

250 3,613 1,345% 58% 17%

Total investment planned in urban infrastructure 297 6,231 1,998% 29%

Total investment planned for the plan period 8,932 21,566 141%

Source: Planning Commission

JNNURM vehicle for the national urban renewal and reforms

Whilst the five-year plans carry the detailed plans for investments across various

segments, the GoI embarked on a national urban renewal missionJawaharlal Nehru

National Urban Renewal Mission (JNNURM)in December 2005 to give focused

attention to the integrated development of urban infrastructure and services in 65

select cities benefiting 60% of the total population. JNNURM lasts for a period of 7

years, coinciding with the end of the XI th plan in 2012. The total investment initially

envisaged in urban areas during the seven year mission period is over Rs1.2 tn (US$25

bn), of which the Central Governments contribution is about Rs610 bn, while the rest

is being contributed by states, cities and other sources such as PPP.

Table 4 Urban sector investment requirement as per the original JNNURM plan Table 5 JNNURM sub-missions

Category No of cities Investment over2005-12 (Rs bn)

Annual fundrequirements

Cities with over 4 mn population 7 571 82

Cities with 1-4 mn population 28 571 82

Selected cities with < 1 mn population 28 63 9

Total 63 1,205 173

Sub-mission 1

(Responsibility ofMinistry of UrbanDevelopment)

Urban Infrastructure andGovernance (UIG)

Urban InfrastructureDevelopment Scheme forSmall and Medium Towns(UIDSSMT)

Sub-mission 2

(Responsibility ofMinistry of Housingand Urban povertyAlleviation)

Basic Services to the UrbanPoor

Main thrust will be onintegrated development ofslums

Source: JNNURM website Source: JNNURM website

20x increase in the Governments

spending plans for urban infra

Total investment envisaged in urban

areas during the seven year mission

period is over Rs1.2 tn (US$25 bn)


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Under JNNURM, water supply and sanitation (WSS) have been accorded highest

priority in sub-mission 140% of total spend. Based on the approved project costs of

Rs1 tn, nearly 36% of the sanctions have been for sub-mission 2 with a focus on

creating affordable housing.

JNNURM progress reports highlighting investment and service levelshortfalls

Whilst the JNNURM approval and sanctions data highlight significant progress,

looking at the cumulative Additional Central Assistance (ACA), it seems that the

mission may fall short of its planned investments by 2012. Our discussions with the

senior Government officials indicate that the shortfall could be in the range of 25-30%

on account of limited manpower and financial capacities in state and urban local

bodies, delays in releasing funds, shortage of contractors and due to lack of proper

project packaging and tendering. Moreover, service levels in most JNNURM cities

continue to be poor. In the case of WSS, coverage is still significantly below 100% and

in the case of sewerage coverage is still only 61%. In the case of solid waste

management (SWM), household coverage is 48% and only in one of the 28 cities

waste is disposed off in a scientific manner.

Table 6 Progress report of JNNURM shows that there will be

shortfalls in investments

Table 7 Urban Infrastructure and Governance (UIG) sanction

patterns shows that water supply and sewerage will account for

a larger share of spend in the near-term

Sub-mission 1 Sub-

mission 2Total

UIG UIDSSMT

Projects approved (no.) 524 753 1,422 2,699

Total approved project cost(Rs bn)

583 128 361 1,071

Additional Central Assistance(ACA) committed (Rs bn)

272 103 199 575

% of ACA committed 46.7% 80.9% 55.2% 54%

Cumulative ACA released (Rsbn) 111 61 84 257

Progress as visible from ACAreleased as a proportion toACA committed

41% 59% 42% 45%

Sanctioned

(Rs bn)% Disbursed

(Rs bn)%

Water Supply 196 34% 44 40%

Sewerage 135 23% 24 22%

Drainage/Storm water Drainage 85 15% 15 14%

Solid Waste mgmt 22 4% 4 4%

Roads/ Flyovers 76 13% 9 8%

Public Transport System 48 8% 11 10%

Other Urban Transport 8 1% 2 2%

Urban renewal 5 1% 1 1%

Dev of heritage areas 2 0% 1 1%

Preservation of Water Bodies 1 0% 0 0%

Parking 6 1% 0 0%

Total 583 111Source: JNNURM website, Ministry of Housing and Urban Poverty Alleviation Source: JNNURM website

The GoIs commitment to urban infra will have to increase

materially

India has been investing ~5% of its GDP in infrastructure for the last 7-8 years with

investments in urban infrastructure being not more than 0.5% of GDP. India will have

to materially increase this level of infrastructure spending to meet the challenge of

urbanisation.

Whilst the GoI plans indicate a 20X increase in urban investments in the XIth plan over

the Xth plan, a recently released McKinseys study, Indias Urban Awakening,

highlights that India significantly under invests not only in capital spend but also in

ongoing operational spend in its cities. Furthermore, India spends only US$17 per

capita per annum on urban capital investment as compared to US$116 for China and

US$127 for South Africa. Also, Indias current urban spending varies dramatically

according to the size of the city: a tier 1 city spends US$59/capita/annum as

compared to US$1/capita in the case of tier 3 and 4 cities. McKinseys study highlights

that India needs to invest US$1.2 tn in its cities over next two decades, 20X the

amount spent over the last decade. Over and above this capital spend, the country will

have to spend an equal amount of money on operational expenses in the next twodecades. We expect this to take the total spend on urban infrastructure to 2% of GDP.

In 2007, India made urban capital

investments of only US$17 per capita

compared to US$116 spent by China


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Table 8 Indias per capita spend on urban infra is dismally

low in comparison to other developing countries (2007), US$

per capita per annum

Figure 3 Urban transportation and affordable housing will

account for nearly 82% of the expected capex in urban infra

India China South

AfricaUK

Opex 33 246 381 1381

Capex 17 116 127 391

Total 50 362 508 1,772

Per capita spend in tier 3&4 cities in India is significantly lower than tier 1

Tier 1 Tier 2 Tier 3 & 4

Opex 72 24 11

Capex 58 14 1

Total 130 38 12

Per capita spending in India will have to rise substantially (US$)

Current Required Increase

Capital expenditure 17 134 7.9X

Operational expenditure 33 116 3.5X

Total 50 250 5X

Source: Factiva, Finance Commission, GoI budgets, McKinsey Global Institute Source: McKinsey Global Institute

Largest investment segments: Urban transportation and

affordable housingWhilst JNNURM presently gives WSS and slum development high importance (see

table 5), urban investment plans under the XIth plan, actually allocate 58% of the funds

to housing and 21% each to WSS and transportation (see table 3 on page 3).

Affordable housing has been a focus area given that every 7th person in urban India is

a slum dweller and the increasing urbanisation is leading to more migration to a few

cities. Whilst we expect that investments in WSS will remain high in the near-term,

gradually urban transportation will become the largest investment segment as the GoI

takes steps to reduce strain on urban roads and increase the share of public

transportation. We In order to do so, GoI will have to set up rail-based mass-transit

and bus rapid transit systems (BRTS) in tier 1 cities and tier 2 cities.

GoI and McKinsey studies show that 82% of the capital spend on urban infrastructure

will be on urban roads (17%), mass transit (33%) and affordable housing (33%) (see

figure 3 on page 5). Further, the McKinsey study highlights that such a high

investment in urban transportation and affordable housing is on account of a high

backlog in urban roads and affordable housing (due to insufficient investments in the

past) and due to high growth capex required in mass transit systems.

Significantly high investment in affordable housing will be required to make Indian

cities slum free. As per the Mckinsey study, demand for affordable housing could rise

from 25 mn households today to more than 38 mn households in 2030. The XI th plan

also highlights that total housing requirement up to 2012, including the backlog, is

estimated at 26.5 mn.

Table 9 High backlog and growth expenditure will keep

share of urban transportation and affordable housing high

Table 10 McKinseys funding requirements for these segments are

linked to target service levels

(US$ bn) Backlog capex Growthcapex

Total capexover 2010-30

Urban roads 151 48 199

Mass transit 98 294 392

Affordable housing 243 152 395

Criteria Units Currentdelivery

Basic servicestandard

Road transportation Vehicularcongestion

Peakvehicles/lane km

170 112

Mass transit Share of publictransportation

30 50

Cities with rail-basedmass-transit system

Nos 4 35

Affordable housing Slum

population

% total

population

24 0

Source: McKinsey Global Institute Source: UN, Ministry of Urban Development, McKinsey Global Institute , NCAER

96 5315

32

199

392

395

1,182

Water

Sewage

Solidwaste

Storm

water

drains

Urban

roads

Mass

transit

Affordable

housing

Totalcapex

Segment-wise capex over 2010-30 (US$ bn)

82% of the capital spend on urban

infrastructure will be on urban roads

(17%), mass transit (33%) and

affordable housing (33%)


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So, how can the infrastructure companies participate?

Whilst most of the opportunity for the infrastructure companies in the urban

infrastructure will arise from the construction component, there will be a demand for

technology and equipment in some segments, as it has done elsewhere, apart from

pure construction and equipment supply contracts, the GoI is also planning to bring

private investment into urban infrastructure through the PPP mode.

The construction opportunity from urban infrastructure

Whilst construction services will be the key demand segment in urban infrastructure

creation, there will also be requirement of technology in water and sewage treatment

plants, automated parking systems and mass rapid transportation systems. Whilst

most of the urban infra segments are civil work intensive, water treatment and mass

rapid transport require technology/equipment and this will be the other key

opportunity segment for Indian and international companies.

Table 11 Urban infrastructure opportunity segments: work scope and characteristics

Segment Scope of work Equipment

intensity

Technology

intensity

Civil

intensity

Water supply Water supply, preservation of water bodies, replacement of old & worn outpipes with new & higher capacity ones

Moderate Low High

Water treatment Water treatment including desalination, purification, High High Moderate

Sewage transportation Renewal of old sewage disposal system, setting up new sewage transportationsystem

Moderate Low High

Sewage/waste watertreatment

Constructing and operating sewage water treatment plants Moderate High Moderate

Solid wastemanagement

Constructing and operating solid waste management systems, renewal of oldsolid waste disposal system

Low Moderate Moderate

Storm water drains Construction and improvement of drains and storm water drains Moderate Moderate High

Urban roads Construction and improvement of roads, bridges, flyover, expressways, etc. Low Low High

Rail-based Mass transitsystems

Development and improvement of metro rail (public transport systems) High High High

Bus rapid transit

systems

Development and improvement of bus network, (public transport systems) High Low Low

Affordable housing Integrated development of slums creating new housing Low Low High

Others Street lighting, civic amenities like community halls, child care centres,constructing parking lots on a PPP basis, development of heritage centres, etc

Moderate Low Moderate

Source: JNNURM projects, Execution Noble research

Note: Equipment intensity signifies the equipment absorption potential of a segment such as wagons for metros and buses for bus rapid transport system

Crisil reports suggest that urban infrastructure segment will create an Rs1.2 tn

construction opportunity for the Indian construction companies over 2008-13,

translating into a Rs245 bn (US$5.3 bn) annual opportunity from WSS and urban

transport segments. Whilst, this opportunity is large, we highlight that this does not

include the opportunity from the affordable housing segment, which has high civil

intensity. For FY11, Crisil highlights that construction opportunity from urban

infrastructure (WSS and transport) will be about Rs247 bn (US$5.4 bn).

Source:

Urban infrastructure PPP unattractive risks versus rewards

The conventional path that cities have trodden to date has been to attempt all

infrastructure jobs in the traditional manner of awarding contracts from year to year,

ie. just like traditional construction contracts. Even with the help of government

grants cities cannot use the traditional budgetary method to fund their entire

infrastructure, hence the need for PPP.

Crisil reports suggest that urban

infrastructure segment will create a

US$5.3 bn annual construction

opportunity


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Table 12 Scope of PPP opportunities in urban infrastructure

Sectors Scope of work PPP mode Opportunitypotential

Returnpotential

Water Projects Construction, Operation and Maintenance ofWater treatment plant, Management ofExisting Water Distribution System, Expansionof Water distribution network

Performance based mgmt & service contracts

Lease contract

BOT/Concession

High Moderate

Solid WasteManagement

Segregation, Collection; Transportation andDisposal

Service Contracts; Management contracts Community Participation for Collection and

Segregation of Waste

PPP formats for solid waste management

High Moderate

Sewerage/ StormWater drainageSystem

Renovation in Old City Areas and new Systemin unserved areas

Annuity Contracts

Performance based contracts for constrn & O&M

Other PPP models such as Design, BuildFinance, Transfer (DBFT)

High Low tomoderate

Traffic &Transportation

Constructing Bus Terminals, New Ring Roads/Bypass/ Bridge, Laying/Improvement/Widening, Parking Lots, Warehouse, TruckParking, Fuel Station, Service Center, Officecomplex

PPP (BOT/BOLT/DBFO)

BOT model with tolls/shadow tolls and O&Mcontracts

EPC + O&M contracts

BOT (Lease/ DBFO)

High Low tomoderate

Urban Renewal Shifting of non-conforming commercial/industrial uses, renovation of water/sewerage/SWM system

BOT models for commercial projects

Service/Management contracts for upgradingexisting system

Moderate Moderate

Social Infrastructure Community Halls, Public Spaces, Slaughter

Houses, etc

Management/Service contracts

Annuity ModelsLow High

Street Lighting Self explanatory Performance based Contract for Supply,installation, O&M for 2/5 years period

Low Moderate

Source: JNNURM projects, Execution Noble research

JNNURM over the last 4 years has been able to award 66 PPP projects with a total

project cost of Rs77 bn. This headway in PPP in urban infrastructure is due to the

availability of Viability Gap Funding (VGF) under JNNURM and financial and

administrative reforms at the Urban Local Body (ULB) level. JNNURM under its

schemes allows for 70-90% of the project cost as grant (VGF) for water projects so

as to make PPP viable and to restrict the incidence of major tariff revisions for users.

We find that PPP opportunities in urban infrastructure not only suffer from the usual

challenges of design, structuring, planning but also from the user charge issue

wherein due to the public good component, it is not easy to recover costs as user

charges in services like WSS and urban transportation.

Moreover, tariffs continue to be governed by political considerations instead of the

cost of service provision. In a recent meeting with an MD of a water supply board of a

south eastern city, we were informed that price of water is undervalued for all

segments of users and metering is below 50% and service providers do not even

recover 2/3rd of their operation and maintenance expenditure.

Whilst there are examples of successful PPP water supply projects, these projects

show that success is dependent upon micro-level planning, well structured projects

and the support of state governments as a key facilitator. In particular a strong

regulatory framework, a good information base about the existing system and a sound

tariff policy, can make PPPs successful in WSS segments. Whilst urban transportation

has had the highest number of PPP projects, we find bus rapid transit system (BRTS)

and, to some extent, roads to be the better opportunities as compared to highly

capital intensive rail-based mass-transit systems currently being rolled out in large

cities such Delhi, Bangalore, Gurgaon, Hyderabad, Chennai and Mumbai.

Table 13 PPP projects under JNNURM

Sector No. Projectcost

(Rs bn)

Water Supply 5 7.3

Sewerage 2 0.7

Solid Waste Management 40 21.4

Mass rapid transport system/roads/flyovers/bridges

19 47.7

Total 66 77.1Source: JNNURM projects, Execution Noble research

PPP opportunities in urban

infrastructure suffer from the user

charge issue


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Mapping the infrastructure opportunity across the infrastructure cos

Table 14 Company mapping in urban infrastructure

Company Name Market Cap

(Rs bn)

Revenues(Rs bn)

Water/Sewage

treatment& Supply

Solid WasteManagement

Transport AffordableHousing

Expertise

Urban roads Mass transit EPC PPP TechnologyProvider

L & T 1,083 435

Reliance Infra 293 145

GMR Infra 234 46

Thermax 89 33

GVK Power 69 18

Voltas Limited 67 48

IVRCL 49 58

Nagarjuna 48 58

Punj Lloyd 44 104

Sintex Industries 43 33

Blue Star 39 25

Era Infra 37 34

HCC 36 40

Patel Engineering 29 31

Gammon India 28 52

Simplex Infra 23 46

Gammon Infra 20 3

CCCL 17 20

ARSS Infra 17 10

Sadbhav 17 13

Man Infra 15 5

Maytas Infra 12 11

Shriram EPC 12 14 Madhucon 11 13

HDO 9 9

Unity Infra 8 15

Subhash Projects 7 16

Pratibha 7 10

J. Kumar 6 7

Ion Exchange 2 5

Source: Company data, Execution Noble research

Challenges for the urban infrastructure investment plans

Whilst project implementation is gathering pace albeit at a lower than expectedspeed, urban infrastructure plans face challenges from the usual evils: funding,governance, planning and policies. Amongst these, we find funding and thegovernance issues to be the key ones.

A. Funding Whilst the 74th constitutional amendment calls for the transfer of

financing powers and assets to local governments in line with their functions, the

fact remains that Indias performance on utilising urban funding sources remains

poor. Barring property taxes/user charges, Indian cities have been unable to fund

urban investments through land monetisation, use of debt, PPP and through

creation of city development funds (municipal development funds, SPVs).

Hitherto the funding streams have been the municipal budget, government grants

and loans. Cities must also figure out what the financial instruments, other than

the traditional resource base, can provide a sound revenue stream. This essentiallymeans shifting infrastructures from being funded by taxes to funding them

through user charges, different varieties of fees and land instruments.

Furthermore, lack of deep and robust bond markets also keep the fund raising low


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through municipal bonds which have been used by countries such as USA to

develop urban infrastructure.

B. Governance: The lack of a single point authority in Indian cities and disjointed

relationship between the metropolitan authorities and the local municipalities are

the key reasons for the poor state of governance in Indian cities. Despite the fact

that the 74th amendment to Indias constitution devolved power and

responsibility from state governments to cities on key functions, state policymakers have been mostly silent on the implementation of these functions. Whilst

JNNURM has set forth a specific set of governance and accountability

mechanisms for state and city governments, the progress remains tardy. Tardy

progress on these fronts leads to poor service delivery, slow decision making and

lack of accountability and transparency in urban bodies. Whilst there are a few

examples of good governance in India (Mumbais BEST and Kolkata Municipal

Corporation), we believe there is a lot to be done on the urban governance issues

before investments in infrastructure bear returns.

How real is the urban opportunity?

Whilst the sheer scale of deficiency in urban infrastructure will require heavy

investments, funding and governance issues will keep the investments staggered overthe next couple of decades. Considering the fact that the urban infrastructure

investments are also falling behind plans, we do not expect the US$1.2 tn envisaged

by McKinsey study to be invested over next two decades. However, even if we

consider a 75% implementation ratio to the suggested investment plans, we expect

Rs1 tn (US$23 bn) to be invested annually in the next five years (2010-15) followed by

Rs1.6 tn (US$35 bn) to be invested annually over the next five years (2015-20). These

numbers are achievable and these are much closer to the investments suggested in

the XIth plan: Rs6.2 tn (US$133 bn) over 2007-12 i.e., Rs1.25 tn (US$27 bn) annually.

Given the high civil intensity of segments such as transportation and housing (which

may also account for ~80% of total investments), we believe that urban infrastructure

can create a construction business opportunity (considering 60% construction

intensity) of Rs7.8 tn (US$173 bn) over the next decade or US$14 bn annually for next

five years followed by another five years of demand for US$21 bn annually ofconstruction services.

Nature of urban opportunity raises importance of relationships

Figure 4 Circle of influence of Indian infrastructure players

Source: Company data, press reports, Execution Noble research

I - Politician

on the board

of the

company

GMR, IVRCL,

Sadbhav, Maytas,

Unity Infra, Sew,Soma, Madhucon,

Patel, Indu, HCC,

Gammon

Sadbhav

Engineering,

Nagarjuna, PatelEngineering,

CCCL, IVRCL

GVK,

Gayatri Construction

Lanco, Madhucon,

Progressive

Constructions

II - Close

relationship of

the promoters

with

politicians

III - Strong

association of

the promoters

with

politicians

IV - Ex-

members of

ministry or

government

bodies as

directors or

senior

management

Lack of single point authority in

Indian cities and the disjointed

relationship between metropolitan

authorities and local municipalities

We expect Rs1 tn (US$23 bn) to be

invested annually in the next five

years (2010-15)

Considering 60% construction

intensity, opportunity for

construction industry can be US$14

bn annually for next five years

followed by another five years ofannual demand of US$21 bn


10/15


Recommendation summary in the infrastructure universe

Table 15 Summary of our recommendations and estimates in Indian infrastructure

Company MarketCap

Stance Embeddedvalue

Constructionbusiness

value

Fair value Upside/(downsi

de)

Constructionbusiness

P/E

Compstanding

Comments

(US$mn) (Rs/share) (Rs/share) (Rs/share) (%)

FY10 FY11

Punj Lloyd 957 SELL - 121 121 -10% 15.0 9.9 2nd

largest Indian constructioncompany with presence across Asia.Dismal operational and businessperformance hit its competitivenessin its mainstay oil & gas E&C business

IVRCL 1,067 BUY 63 152 215 15% 15.0 12.2 IVRCL is not only the 3rd

largestIndian construction company but alsothe fastest growing and the leadingirrigation construction company

Nagarjuna 1,024 BUY 57 134 190 2% 17.3 14.6 5th

largest construction company withwell diversified business segmentsand increasing exposure in the MiddleEast. Currently facing pressure on its

investments in DubaiHCC 761 BUY 85 77 162 38% 8.1 5.4 Despite having one of the strongest

prequalifications, a relatively weakerconstruction company. However,valuation upgrades of embeddedassetLavasa can improve valuations

Simplex 486 BUY - 479 479 4% 14.7 12.1 A pure play construction companywith highly competitive cost structureand a leader in industrial segments

CCCL 356 BUY - 108 108 20% 18.2 12.7 A pure play construction companywith highly competitive cost structureand a leader in industrial andcommercial segments looking toexpand into urban infrastructure

GVK Power 1,478 SELL - - 39 -11% NA NA One of the most diversifiedinfrastructure developers but facing

challenges in funding ambitiousacquisitions

Source: Company data, Industry, Execution Noble research

We havent rated Punj Lloyd amongst the Indian players as most of its operations are outside India

TOP PICKS AMONGST CONSTRUCTION COMPANIES

CCCL (CCCL.IN, BUY, market cap US$356 mn) - Undiscovered industry

leader

CCCLs industry leading cost structure and highly professional organisation make it

one of the top Indian construction companies. Whilst business performance in FY09

months was disappointing, we believe its strengths in turnkey structural (industrial

and building) projects will make it a beneficiary of the corporate capex upswing.

With consensus building in modest growth expectations, we expect CCCL to surprise

on the upside as its EBITDA margins improve sharply and company reports strong

revenue growth after a dismal FY09 and better FY10. Despite the poor liquidity of the

stock, we believe the stock price to outperform its larger, more liquid peers on

account of: (a) EBITDA growth being ahead of its peers over FY10-12 due to a

combination of private and public orders; (b) low risk of equity dilution; and (c) much

sharper increase in return ratios (RoE and RoIC) vis-a-vis its peers. Using a DCF-

model, we value CCCL at Rs108 (implying 35% upside and 15X FY11 earnings). Whilstthe stock currently trades in line with its largest peers, its stronger prospects justify

buying it. For more details please refer to our note dated 8 th Jan 2010.

CCCL will outperform its larger, more

liquid peers


11/15


HCC (HCC.IN, BUY, market cap US$761 mn) - Everything hinges on Lavasa

Whilst macro factors are driving order momentum in the construction business for

HCC, valuation upgrades for Lavasa will be the key driver for the stock. We believe

that a further lift in unit sales in Lavasa and its likely IPO will be the main triggers for

the stock even if the construction business does not grow as rapidly as management

expects (Rs100 bn of revenues by FY13). We value Lavasa at Rs31 bn as against theascribed Rs100 bn valuation implied by each of the last seven transactions since Jun-

08. Key risks to our call are a drop in sales at Lavasa and higher-than-expected equity

issuance.

Real estate investments (247 Park and Lavasa) and BOT assets account for 52% of our

SOTP-based value of Rs162. We value the construction business at Rs77/share, i.e., 13X

FY11 earnings, implying a 10% discount to its peers. Lavasas valuation is the key risk.

For more details, please refer to our note dated 30th Nov 2009.

IVRCL (IVRC.IN, BUY, market cap US$1,067 mn) Uncertain times for a proven

player

Challenges in IVRCLs dominant business segmentirrigationled to uninspiring

financial performance in FY10 and similarly uninspiring stock performance over the

last six months (up 4%). However, recent order inflow and improved execution (visiblein Q4FY10) indicate robust revenue growth over the next couple of years. We find the

core business valuations attractive (12X FY11 eps) and do not see any cash

requirements arising from subsidiaries which could have possibly impacted parent

valuations. We value construction business at Rs152/share and subsidiaries at

Rs63/share. For more details, please refer to our note dated 19th April 2010.

Relative valuations of construction companies

Nearly all of the leading Indian EPC companies have taken up the role of developer in

the last 3-4 years with some of them having large portfolios of roads, power assets

and real estate. Roads remain the most common, followed by real estate and power

projects. Given that the embedded valuation from these BOT assets may vary

amongst these companies, comparing them on relative valuations sometimes doesnot make sense. Moreover, if the BOT assets have contracted the EPC business to the

parent EPC company, that may not be a true reflection of the competitive standing of

these companies. We provide the relative valuations for these companies on a stand-

alone basis after deducting the embedded value derived from holdings in listed

entities and unlisted BOT or real estate assets. We use consensus estimates to

calculate embedded value for all the companies.

Table 16 Relative valuations (based on consensus) on a stand-alone basis

Company Price Marketcap

Embeddedvalue

Embeddedvalue

Price excl.embedded

value

Embeddedvalue as%age of

market cap

P/E (X) P/B (X) EV/EBITDA (X)

(Rs) (Rs bn) (Rs/share) (Rs bn) (Rs/share) FY11 FY12 FY11 FY12 FY11 FY12

L&T 1,787 1,086 365 222 1,422 20% 23.4 19.0 4.2 3.6 15.7 12.3

Punj Lloyd 136 45 0 0 136 0% 14.0 11.3 1.3 1.2 7.3 6.6

IVRCL 187 50 65 17 122 35% 11.4 9.0 1.3 1.2 6.3 6.8

Nagarjuna 185 47 41 11 144 22% 15.1 12.2 1.5 1.4 7.2 7.4

HCC 118 36 68 21 49 58% 11.0 9.0 0.9 0.9 5.5 5.9

Patel 422 29 163 11 258 39% 10.3 9.0 1.2 1.0 5.8 5.8

Simplex 461 23 0 0 461 0% 14.1 11.5 2.0 1.7 6.5 5.7

Gammon 214 27 112 14 103 52% 7.5 6.7 0.6 0.5 4.4 4.2

CCCL 90 17 0 0 90 0% 14.4 11.7 2.4 2.0 8.4 6.8

Madhucon 146 11 103 8 44 70% 5.4 3.9 0.5 0.5 0.7 0.6

Sadbhav 1,310 17 731 9 579 56% 9.8 8.3 1.6 1.4 4.3 5.0

Average (excluding L&T and Punj) 37% 11.0 9.0 1.3 1.2 5.5 5.4

Average 32% 12.4 10.1 1.6 1.4 6.6 6.1Source: Bloomberg, Company data, Industry, Execution Noble researchNote: For calculation of embedded value we use consensus estimates

Valuation upgrades for Lavasa will be

the key driver for the stock

Improvement in execution with the

improving order flow momentum willdrive further valuation re-rating

We provide the relative valuationsfor these companies on a stand-alone

basis after deducting embedded

value


12/15


Figure 5 IVRCL appears undervalued whilst Patel appears

overvalued

Figure 6 Simplex and Nagarjuna appear overvalued

Source: Bloomberg, Company data, Execution Noble researchNote: Size of the bubble denotes stand-alone earnings CAGR over FY08-10

Source: Company data, Execution Noble researchNote: Size of the bubble denotes Investment in subsidiaries as %age of networth

Figure 7 Patel appears overvalued and Gammon appears

Undervalued on EV/order book

Figure 8 HCC and Nagarjuna appear overvalued;

Sadbhav appear undervalued

Source: Bloomberg, Company data, Execution Noble research

Note: Size of the bubble denotes book-to-bill ratio based on last reported order books

Source: Company data, Execution Noble research

Note: Size of the bubble denotes EBITDA CAGR over FY08-10

Relative valuations for developers

In order to compare valuations of infrastructure companies across sectors we useEV/EBITDA and P/B. We believe EV/EBITDA multiples of the company should reflect

the infrastructure asset duration, risk, tax rates and growth; companies with long

duration assets, lower risk, lower tax rates and higher growth should trade at higher

multiples.

Given that airports have one of the highest remaining asset lives amongst

infrastructure assets, these should trade at higher multiples. Road assets with lower

durations should trade at lower multiples to energy and airports (although, tax

exemptions on roads provide support to EV/EBITDA multiples). However, (a) the lack

of a historical risk profile for most kinds of assets; and (b) the under construction

status of most assets, are limitations to using EV/EBITDA multiples religiously in the

context of the Indian infrastructure developers.

CCCL

Gammon

IVRCL

Madhucon

Nagarjuna

Patel

Sadbhav

Simplex

4

8

11

15

18

10% 20% 30%

PricetoEarningsFY11E

PAT CAGR FY10-12E

CCCL

Gammon

HCC

IVRCL

Patel

Nagarjuna

Madhucon

Sadbhav

Simplex

0

1

2

5% 10% 15% 20%

P/BF

Y11E

(X)

RoE FY10

CCCL Gammon

HCC

IVRCL

Madhucon

Nagarjuna

Patel

Sadbhav

Simplex

(20)

(10)

0

10

20

30

40

50

60

70

80

90

0 50 100 150 200 250 300

EV(Rsbn)

Latest order book (Rs bn)

CCCL

Gammon

HCC

IVRCL

Madhucon

Nagarjuna

Patel

Sadbhav

Simplex

0

3

5

8

10

5% 10% 15% 20% 25%

EV/EBITDAFY11E(X)

EBITDA CAGR FY10-12E

We believe asset duration is a critical

element of valuation for

infrastructure assets


13/15


P/B vs RoE. We expect companies with higher ROE to trade at higher multiples.

However, with all of the companies having majority of their assets under construction

this may not be a true representative. A company with higher assets under

construction may have lower net earnings and larger equity in CWIP thus depressing

the reported ROE.

Table 17 Relative valuation of infrastructure developers

Company CMP Mkt Cap Mkt Cap P/B P/E EV/EBITDA

(Rs bn) (US$ mn) FY11 FY12 FY11 FY12 FY11 FY12

Reliance Infra 1,201 294 6,393 1.5 1.4 19.1 16.3 19.1 14.3

JPA 125 265 5,755 2.8 2.4 20.9 15.6 16.2 12.1

GMR 59 230 4,992 2.5 1.9 75.5 45.3 20.7 16.2

GVK 43 68 1,483 1.9 1.6 26.6 17.9 14.2 10.8

Gammon Infra 27 19 420 2.7 NA 133.0 133.0 15.5 10.6

Average 2.3 1.8 55.0 45.6 17.1 12.8

Road developer

IRB 261 87 1,885 3.3 2.6 17.9 15.6 9.4 7.6

ITNL 292 57 1,232 NA NA 12.4 NA NA NA

Port developer

Mundra 731 293 6,367 6.9 5.5 29.8 19.7 22.2 16.5

All average 3.1 2.6 46.1 37.6 16.8 12.6

Source: Bloomberg, Company data, Execution Noble research


14/15


Contact details

Saurabh Mukherjea,Head of Indian Equitiest. +91 22 4211 0901 e: [email protected]

Sales

Pramod Gubbi t +91 22 4211 0902 e:[email protected] Ramachandran t +44 20 3364 6736 e: [email protected]

Sector leads

Banks and Financial Services:

Aditi Thapliyal t +91 22 4211 0904; e [email protected]

Pankaj Agarwal t +91 22 4211 09213; e [email protected]

Consumer:

Ashwin Shetty t +91 22 4211 0905; e [email protected]

Infrastructure:

Nitin Bhasin t +91 22 4211 0909; e [email protected]

Binoy Jariwala t +91 22 4211 0909; e [email protected]

Power:

Bhargav Buddhadev t 91 22 4211 0910; e [email protected]

Technology:

Ankur Rudra t +91 22 4211 0906; e [email protected]

Soumitra Chatterjee t +91 22 4211 0906; e soumitra.chatterjee @execution-noble.com

Economy and Country Research:

Ritika Mankar t +91 22 4211 0920; e [email protected]

701 Powai Plaza 120 Old Broad Street

Hiranandani Gardens London

Mumbai 400076 EC2N 1AR

t: +91 22 4211 0999 t: +44 20 7763 2200f: +91 22 25701154 f: +44 20 7763 2397

e: [email protected]


15/15

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