ambit - infrastructure developers- scalable and questionable

8/6/2019 Ambit - Infrastructure Developers- Scalable and Questionable

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Infrastructure

March 22, 2011

Infrastructure Developers

THEMATIC

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.

Analyst contacts

Nitin BhasinTel: +91 22 3043 [email protected]

Bhargav Buddhadev

Tel: +91 22 3043 [email protected]

Chhavi Agarwal

Tel: +9122 3043 [email protected]

Exhibit 1: Developers Summary table

Company/Metric

OverallCompetitive

ranking

FY12E P/B(X)

Diversified Developers

Reliance Infra 0.7

JPA 1.6

GMR 1.8

GVK 1.1

Gammon Infra 1.7

Road DevelopersIRB 2.1

ITNL 1.6

Utilities

ReliancePower

1.8

Adani Power

Lanco 1.6

Tata Power 1.9

Torrent Power 1.9

CESC 0.8

JSW Energy 1.6

Source: Company, Ambit Capital research,Bloomberg, Note P/B multiple data as on March

21, 2011

Note: Strong, Relatively strong,

Average, Relatively weak

Scalable and QuestionableIndian infrastructure developers substantial capital requirements hasover the years provided them the scale to attract investors looking toparticipate in the Indian infrastructure story. However, whilst chasing forscale, the developers have ambitiously assumed risks knowingly andunknowingly which are now mushrooming and impacting assetcreation and value creation. Whilst we maintain our penchant for well-managed construction companies over developers, we sieve thedeveloper landscape and highlight Power Generation as one of thebetter segments. In this segment, GVKs stock is relatively cheaper(despite superior competitiveness) and Adani Power as relativelyexpensive (inspite of weaker competitiveness).

Infrastructure developer stocks have failed to perform (stocks down 19-57%) overthe last six months for multiple reasons project availability, capital availability(quantity, quality and cost), execution, resource costs and shortfalls in economicofftake. Whilst these issues remain, valuations have become relatively cheaper.In this note we build a framework for the various developer segments andhighlight the following:

Power generation and ports are superior plays: A decent regulatoryframework, improved revenue visibility and lower financial risk make powergeneration the best large scale infrastructure development opportunity forprivate developers. Whilst power distribution also has potential, the opportunityto gain scale here is marred by regulatory intent. Ports is another high return

opportunity (Rs325bn) with a decent regulatory framework and fewer revenuevisibility concerns. For private developers, Indian road development may be the2nd biggest developer opportunity (after power), but it is also an opportunitycharacterized by lack of an adequate enabling environment, sporadic projectawards and intense competition.

Age and scale are the key factors governing competitiveness: Given thatthese are early days for Indian infrastructure developers and given their limitedfinancial/operational track records, we highlight that scale followed by ageimpacts the competitiveness of a company in the sector. Scale and age also helpthe company to negotiate with regulators. Whilst Torrent Power and Tata Powerare strong players in the power sector, IRB and ITNL are strong players in theroads sector. Amongst the large diversified players, GMR is competitively betterplaced than peers.

GVK is relatively cheap (inspite of superior competitiveness) and TorrentPower deserves to trade at a higher premium: Developers with lowerfinancial risks, longer duration assets and higher growth should trade at amultiple to others. Therefore, diversified players with power and airport assetsshould trade at a premium to road developers. Amongst the diversified playerswe find GVK to be undervalued on P/B, and amongst the power developersAdani Power looks to be relatively expensive.Whilst Torrent Power is tradingat a slight premium, we believe that it should trade at a higher premiumbecause it is a superb franchise with the best operational efficiency in thesector. 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 issuesin operationalising assets and generates comparatively higher returns.


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Ambit Capital Pvt Ltd 2

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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Multiple issues leading todisappointing returnsWhilst the BSE100 has declined by ~6% in the last six months, the infrastructuredevelopers have been amongst the worst performers with stock prices declining by19-57% (ex-Tata Power). We believe that besides the macro issues which are

dragging the market down, infrastructure stocks are also bearing the brunt ofmultiple sector-specific regulatory issues (such as in airports, land andenvironmental clearances in power) alongside the impact of rising funding costsfor 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 returnsfor the past six months, with road developers and diversified developers being theworst performers.

Exhibit 2: Developers have given poor share price returns

Returns (%)CMP

RsMkt cap(Rs bn)

1 mreturn

3 mreturn

6mreturn

1yrreturn

2 yrCAGR

3 yrCAGR

4 yrCAGR

5 yrCAGR


Reliance Infrastructure 624 167 0 -23 -40 -39 8 -20 8 -1

JPA 83 176 -5 -19 -31 -43 22 -15 4 5

GMR Infra 37 143 -11 -20 -41 -36 -9 -18 0 NA

GVK Power 24 38 -11 -39 -49 -42 6 -11 -5 -2

Gammon Infra 17 12 -9 -18 -33 -31 26 NA NA NA

IVRAH 54 11 5 -26 -57 -53 74 -22 NA NA

Road Developers

IRB 185 61 -2 -17 -40 -30 51 0 NA NA

Ashoka Buildcon 280 15 2 -3 NA NA NA NA NA NASadbhav 107 16 6 -12 -31 -17 88 0 27 30

ITNL 210 41 -3 -30 -35 NA NA NA NA NA

Port Developers

Mundra 132 264 -8 -9 -19 -10 43 10 NA NA

Gujarat Pipavav 61 26 3 3 NA NA NA NA NA NA

Utilities

Reliance Power 119 333 4 -21 -23 -17 6 -16 NA NA

Adani Power 111 241 -10 -12 -21 -3 NA NA NA NA

Lanco Infratech 36 88 -7 -41 -51 -29 69 1 21 NA

KSK 101 38 -9 -27 -39 -44 -27 NA NA NA

Tata Power 1,230 292 -2 -4 -5 -8 33 6 25 17

Torrent Power 241 114 7 -13 -29 -20 83 34 41 NA

CESC 297 37 -3 -19 -26 -25 23.1 -9.8 -2.9 -2.3

JSW Energy 72 118 -5 -27 -43 -34 NA NA NA NA

Indices

BSE 30 Index 17,839 -3 -10 -3 2 38 6 9 10

BSE100 Index 9,327 -3 -10 -6 1 40 6 10 10

BSE200 Index 2,205 -3 -10 -7 1 42 6 10 10

CNX Infra. Index 2,823 -5 -16 -19 -16 11 NA NA NA

BSE Capital Goods Index 12,332 -7 -19 -18 -11 44 -2 10 9

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


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Ambitious capex plans kept free cash flows negative

Whilst cash flows from operations are positive for most developers due to their lowworking capital requirements, substantial capex requirements have kept the freecash flows negative. Whilst high capex comes with the territory (given the natureof infra development), what concerns us is that several of the ongoing projects arefacing 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 FY07 FY08 FY09 FY10


Reliance Infra 5,877 (7,442) (15,769) (20,364)

JPA (14,242) 9,301 4,571 (114,863)

GMR (12,846) (44,460) (58,370) (56,214)

GVK 119 (1,651) (8,980) (5,722)

Gammon Infra 900 1,078 1,230 1,158

Road Developers

IRB (4,192) (2,167) (5,499) (1,572)

Ashoka (1,847) (555) (1,572) (3

Sadbhav (2,164) (98) (2,423) (2,796)

ITNL (223) 1,438 513 2,698

Port Developers

Mundra (1,226) (8,375) (7,671) (8,315)

Gujarat Pipavav (1,912) (2,082) (1,721) (3,413)

Utilities

Reliance Power 6 (4,187) (40,913) (37,724)

Adani Power NA (243) (3,316) (21,18

Lanco (20,832) (8,242) (10,808) (13,796)KSK NA (5,995) (10,824) (33,540)

Tata Power (3,324) (9,594) (23,118) (46,723)

Torrent Power (10,260) (8,604) (1,699) 9,688

CESC NA (2,090) 9,170 7,595

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 Governmentis gaining momentum, (private sector share targeted to increase to 36% in XIth FiveYear Plan v/s 20% in the Xth Five Year Plan), the projects under the PPP model arefacing several challenges which have resulted in execution slippages. We havedivided these challenges into two buckets: (a) generic issues that are common

across all the sectors; (b) specific sector issues in roads, railways, airports andpower, which have led to skewed private participation in these sectors.

Exhibit 4: Challenges in the PPP model

Genericissues(applicable toall sectors)

Land acquisition problems, environmental and other regulatoryclearances, lack of adequate capital (debt and equity), increasing cost ofcapital (rising interest rates), delay in receiving financial closure.

Power Roads Ports Airports

Specificsector

Issues

Intense competition,non-availbility of

contractors to carryout the project inremote areas.

Intense competiton,poor traffic studies,NHAIs limited

organisationalbandwith, sporadicproject bids bydevelopers.

Despite good MCAs,there is a lack ofsupport from State

Governments,uncertainity onconnectinginfrastructure

Uncertaintyaround tariffsand returns

potential, Landusage and saleproceedssharing

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 inprivate sector interest in the roads and the railways segments.Whilst the revisedprivate sector contribution estimates in the XIth Five Year Plan areexpected to be ahead of the earlier estimates in sectors like power, portsand 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)

XIth Plan (Rs bn)(revised estimates)

XIth

Plan(original estimates)(%)

XIth

Plan(revised estimates)(%)

Public Private Total Public Private Total Public Private Public Private

Electricity 4,810 1,855 6,665 3,711 2,875 6,586 72 28 56 44

Roads and Bridges 2,074 1,068 3,141 2,328 459 2,787 66 34 84 16

Telecommunication 807 1,778 2,585 615 2,836 3,451 31 69 18 82

Railways 2,114 503 2,617 1,925 83 2,008 81 19 96 4

irrigation 2,533 0 2,533 2,462 0 2,462 100 0 100 0

Water supply andsanitation 1,365 54 1,419 1,112 5 1,117 96 4 100 0

Ports 335 545 880 81 325 406 38 62 20 80

Airports 94 216 310 130 231 361 30 70 36 64

Storage 112 112 224 4 86 90 50 50 4 96

Gas 103 65 168 745 528 1,273 61 39 59 41

Total 14,346 6,196 20,542 13,113 7,428 20,541 70 30 64 36

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 thecommon challenges for Indian infra, the following sector-specific issues haveresulted in significant time and cost overruns in the road projects:


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Structural problems at NHAI: NHAIs limited organizational bandwidth hasresulted in poor project structuring, delayed awards and inadequateadministration of the national highways. Moreover, our primary data contactshighlight a shortage of technical strength within the NHAI; and the Governmentsannouncements 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 anobjective to maximize current profits rather than focus on the life cycle of the roadasset. Improper traffic studies and lower estimates of operations & maintenance(O&M) costs for the project (in order to be the lowest bidder) at the developersend, lower the project IRR.

Intense competition: Increasing competition from the small and internationalplayers has lowered project returns in the sector. On the national and statehighway projects, about 70 mid-to-large sized Indian and foreign contractors are working. Not only are the smaller Indian construction companies becomingdevelopers but also international companies (from Israel, Japan and South Africa)are entering the Indian markets in hordes. Recently a number of European andAsian 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 infradevelopers entered the Real Estate sector by acquiring large land banks for settingup the residential, commercial and SEZ units. Whilst developers like IRB, RelianceInfra and Lanco have directly entered the real estate business, developers such asGVK, GMR, JP Associates have real estate projects embedded in their other BOTprojects (airports, roads etc.). As highlighted in the exhibit 6, most of theseprojects are currently stalled and a large amount of capital is blocked inthese projects leading to additional risk for developers.

Exhibit 6: Real Estate aspirations of infrastructure developers

CompanyUse (commercial,residential, SEZ)

Direct/ embedded in other BOTassets

Comments

IRB Residential, commercial Direct holding No work taking place

GMR Commercial, SEZMixed, In Delhi airport(commercial),Hyderabad Airport(commercial and SEZ)and Krishnagiri SEZ

Part of Delhi Airport land monetised and thebalance facing issues on account of therecent regulatory uncertainties as expressedin AERA circular; SEZ not moving

Reliance InfraResidential, commercial,SEZ

Real estate part of the Mumbai Metro No progress

LancoResidential, commercial,SEZ

Direct holding No progress

GVK CommercialMixed Mumbai airport (commercial) andSEZ

MIAL land stuck in regulatory andoperational issues; no progress on SEZ

IVRAH Residential, commercial Direct holding Some of the real estate projects witnessing arevival

JPA Residential, commercialMixed (Embedded -through JaypeeInfratech across Yamuna expressway andalso through Jaypee Sports Intl Pvt. Ltd.)

Land closer to Noida being developed andsold

Source: Ambit Capital research, Industry, Company


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Valuations are attractiveGiven that stock prices have declined by 19-57% (ex-Tata Power) in the last sixmonths (exhibit 2), valuations of the entire infrastructure developers appearsattractive. As highlighted in the charts below, infrastructure companies arenow trading significantly below their past average multiples. Whilst

diversified players (shown in exhibit 8 below) are trading at a one-year forwardP/B multiple in the range of 0.7x-1.8x (which is 44-52% below their average of thelast four years), power companies (shown in exhibit 9 below) are trading at one-year forward P/B multiple in the range of 1.8-2.0X (which is 12-35% below theiraverage of the last four years).

Exhibit 8: Diversified players are trading at lower thantheir average one-year forward P/B multiples

0

1

2

3

45

6

7

Apr-07

Sep-07

Feb-08

Jul-08

Dec-08

May-09

Oct-09

Mar-10

Aug-10

Jan-11

Reliance Infra GMR GVK

Avg P/B multiple:

Reliance Infra :1.3X

GMR: 3.2X

GVK: 2.3X

Source: Company, Ambit Capital research, Bloomberg

Exhibit 9: Power companies are trading at lower thantheir average one-year forward P/B multiples

-

1

2

34

5

6

Apr-07

Sep-07

Feb-08

Jul-08

Dec-08

May-09

Oct-09

Mar-10

Aug-10

Jan-11

Reliance Power Torrent Power

Tata power

Avg P/B multiple:

Reliance Power : 2.6X

Torrent: 2.1X

Tata Power: 2.3X

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

Exhibit 10: Road developers are trading at lower thantheir one-year forward P/B multiples

-

1

2

3

4

Feb-0

8

Aug-0

8

Feb-0

9

Aug-0

9

Feb-1

0

Aug-1

0

Feb-1

1

IRB IL &FS Transport

Avg P/B multiple:

IRB : 2.8X

ITNL: 2.5X

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

Exhibit 11: Port developer, Mundra, is trading at lowerthan its one-year forward P/B multiple

-

2

4

6

8

10

12

Apr-08

Sep-08

Feb-09

Jul-09

Dec-09

May-10

Oct-10

Mar-11

Mundra

Avg P/B multiple 6.8X

Source: Ambit Capital research, Bloomberg


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Should investors buy infrastructuredeveloper stocks?Despite an ever increasing infrastructure growth opportunity, infrastructuredeveloper 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 infrastructuresector or selectively choose stocks which are better placed?

We believe that investors should be cautious and follow a three-stage approach tofilter the stronger players from the rest. Investors should look at: (a) theinfrastructure sector with better asset development opportunities; (b)stronger companies across sectors; and (c) companies with attractive

valuations.

Filter I. Choose the better asset developmentopportunities

In order to identify superior companies in the infrastructure space, we first assessthe various sectors. Whilst power and roads offer the largest opportunities (exhibit12 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 variousparameters used in assessing the sector opportunities are:

The opportunity attracts competition: Given that roads and powergeneration require less capital and have a larger share in the totalinfrastructure spending, they suffer from stiff competition compared toother sectors. Ports, railways and power transmission and distribution havelower competition.

Revenue Visibility: Whilst power generation companies have assuredrevenues for a considerable period of time (due to long term powerpurchase agreements (PPAs)), toll roads suffer from the problem ofrevenue visibility in the long run. Moreover, poor traffic studies and risingO&M costs in the later years have accentuated the problem for the tollroad developers. Power transmission and annuity roads are assets whichreceive guaranteed payments from the Government. Increasing share ofmerchant power in the independent power producer (IPP) model reducesrevenue visibility in the power generation sector.

Better regulatory system: Sectors with established and well functioningregulatory bodies and clear contractual agreements have lower regulatory

risks versus others. We believe that power has lower regulatory riskscompared to roads, which are suffering from inefficiencies at the NHAI.

Financial risks: Assured off-take and pass though of interest costs (in thecase of a case II bidder) leads to the power generation sector beingloaded with low financial risks. Rising input costs and interest costs with nopass through agreements have increased the financial risks for the roadsand the railways (metros) sectors.

Project returns: Projects in the power generation sector have higherreturns driven by the incentive payments and increasing use of merchantpower with IPPs; toll returns are declining on account of lower-than-expected traffic growth and rising input and interest expenses.


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Exhibit 12: The Power sector offers better revenue visibility and higher returns

Sectors Competition Revenue Visibility Regulatory risks Financial risks Total returns Overall

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

Exhibit 13: Porter analysis of Indian power industry


Bargaining power of suppliers

MEDIUM

Competition has started increasingrecently with new entrants like L&T,Thermax, BGR and JSW. Put together,these players are planning to havecapacity in excess of 10GW compared

with BHELs 15GW

Demand for equipment from IPP,s onthe other hand, has remained constantat a run rate of 20GW on a per annumbasis.

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.

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 forthermal plants is also a big challenge

especially after Coal India made astatement that they will not honourlinkages.

Hence large scale entry into Indianpower generation is difficult and takesdeep pockets, political connections andatience.

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)

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 notavailable 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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Exhibit 14: Porter analysis of the Indian roads industry


Filter II. Choose stronger companies in different

sectorsGiven that the parameters for assessing competitive strength differ across sectors, we have analyzed the competitive positioning of the respective players on theparameters specific to their sectors. Whilst in the power sector, we have assessedthe companies on qualitative and quantitative factors, in the other sectors (roads,railways (Metros), airports and ports) we assess the companies on their costcompetitiveness, negotiating power, track record, etc. However, the overall themeacross sectors remains the same i.e. the companies with a large number ofoperational 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, 2011The Good, The Bad & The Ugly, had mentioned that on a qualitative basis, TataPower and GVK Power are the clear winners, as both have the right mix ofexperience, aggression, offtake and raw material linkages tied up. It is alsopertinent to note that both of these companies have zero reliance on Chineseequipment. 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 asa winner on the back of strong cash flow generation coupled with high returnratios. Besides Torrent Power,Tata Power, JSW Energy and CESC too score well on these parameters signifying the underlying strength of their balance

sheets.

Bargaining power of suppliersMEDIUM

Capital providers of debt and equity(banks, funds PE, FIs etc.) have higherbargaining power given lack of liquidityin the financial market. Rising interest

rates have also made the debtavailability difficult.

The construction companies providingthe EPC work are large in number,hence have low bar ainin ower.

Competitive intensityHIGH

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.

Barriers to entryMEDIUM

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

Bargaining power of buyersMEDIUM

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

Threat of substitutionLOW

Given the Governments policy topromote private sector participationin the roads infrastructure, it will notexecute the road projects on its own.Hence, road developers face a lowthreat of substitution.

Improving

Unchanged

Deteriorating


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Exhibit 15: Competitive based positioning

Company/Metric

Experience

Aggression

Fuel tieups

Equipment

quality

LongtermPPAs

OverallScore

JSW Energy

Adani

CESC

India bulls

TorrentPower

Lanco Infra

Tata Power

ReliancePower

GVK

GMRSource: Company, Ambit Capital research, Industry

Note: Strong, Relatively strong, Average, Relatively weak

Exhibit 16: Balance sheet (financial) positioning

Company/Metric

Debt/Equity

CFO/EBITDA

EBIT/interest

RoCE RoEOverall

score

JSWEnergy

Adani

CESC

TorrentPower

Lanco Infra

Tata Power

GVK

GMRSource: Company, Ambit Capital research, Industry

Roads, airports and ports sectors

For the roads, airports and ports sectors, we have based our assessment of thecompanies on the following parameters:

Exhibit 17: Key competitive assessment metric (Road, ports and airports sectors)

Metric Description Metric used

Political proximityAbility of the company to influence the government/bureaucratic machinery whilebagging the projects, as government is the main party awarding the infrastructureproject.

Positioning of the

company on thepolitical powerinfluence square

Financial control

Given that infrastructure development is a highly capital intensive industry andgiven the lack of a developed financial system in India, financial strength of thecompany becomes an important parameter. Companies with low debt:equity andlower financial expenses are stronger than companies with higher debt:equity.

Debt:Equity ratio andfinancial expenses as% of sales

Past track record

We have ranked developers based on their years of experience in each segmentand operational assets. Good track record and efficient management of theexisting assets enables a developer gain confidence of the regulatory authorities(NHAI/State Government).

Operational assetsand years ofexperience in thesegment.

Cost efficiency

Control over the construction and operational costs can improve the projectsequity returns, thus differentiating one player from the other. Though, non-availability of data on comparative construction costs (due to the large number of

road assets) limits a detailed assessment of the companies on this parameter, weuse EBITDA margin as a proxy for comparing cost efficiency.

EBITDA margin in therespective segment



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Positioning on the political influence square:

We prefer Central Government relationships and the presence of a Member ofParliament on a companys board over State level political relationships.

Exhibit 18: Political relationship of the developers (Level I is the best place to bein)

Level I. Politician on the companysboard:

Lanco, CESC

Level II. Family relationship of the promoterwith the politician:

GVK, Sadbhav

Level III. Strong association of thepromoter 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 orGovernment bodies as directors or seniormanagement:

GVK, Jaiprakash, Mundra port, Tata Power,Reliance Power, Gammon, KSK, ITNL, AshokaBuildcon, IVRAH, Gujarat Pipavav, Sadbhav


Roads sector

With a large number of operational assets, better operational management andstrong 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 roadsegment

CosExperience

(yrs)

Operational

(kms)

Underdevp.

(kms)

D/E (x)1HFY11

EBITDAMargins

(%)

(9MFY11)

ITNL 11 1527 2435 2.1 31%

IRB 13 701 549 1.7 87%AshokaBuildcon 14 454 446 1.8 80%

GMR 10 421 309 1.6 83%

L&T Infra 10 315 789 0.1 NA

Sadbhav 6 297 369 0.9 NA

IVRAH 6 97 410 0.3 NAGammonInfra 10 142 100 2.8 NARelianceInfra 5 97 873 0.5 29%

GVK 8 90 83 1.5 66%

Lanco 3 0 163 1.0 NAJPA 1 0 1239 2.2 NA

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

Exhibit 20: Competitive positioning amongst listedplayers (this is taken from the adjacent table)

CompaniesMarketshare(35%)

ManagingFinance(20%)

Cost ofoperations

(25%)

NegotiatingPower(20%)

Overall

ITNL

IRB

AshokaBuildcon

GMR

L&T Infra

Sadbhav

IVRAH

Gammon Infra

Reliance Infra

GVK

Lanco

JPA

Source: Company, Ambit Capital research, Industry

Note: Strong, Relatively Strong Average 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 airportssector with three operational airports, Mundra is a leading player in the portssector. Given that the Government itself upgrades the existing assets or createssmaller assets through private participation, airports and ports will continue toremain relatively smaller opportunities.


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Exhibit 21: Positioning of different players in theAirports sector

CosExperience(yrs)

Operationalairports

Underdevelopmentairports

D/E(x)1HFY11

EBITDAMargins(%)9MFY11

GMR 7 3 1 1.6 38%

GVK 3 2 0 1.5 68%

IRB 0 0 1 1.7 NA

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

Exhibit 22: Competitive positioning amongst the listedplayers (this is taken from the adjacent table)

Companies

Marketposition

ing(30%)

Managing

Finance(20%)

Cost ofoperations (30%)

Negotiation power

(20%)

Overall rank

GMR

GVK

IRB

Source: Company, Ambit Capital research


Exhibit 23: Ports- Positioning of the companies

CosExperie

nce(yrs)

Operational(Cargo -mn

TPA,Containers -

mnTEUs)

Under devp.(Cargo -mn

TPA,Containers -

mnTEUs)

D/E (x)1HFY11

EBITDAmgins

(%)(9MFY11)

Mundra 9Containers2.5 cargo:

145Cargo:93 0.8 68%

Gammoninfra

9 Cargo:9Cargo:10

container :1.42.8 NA

GujaratPipavav

23 Cargo: 5 0.5 41%


Exhibit 24: Competitive positioning amongst the listedplayers (this is taken from the adjacent table)

CosMarket

positioning(30%)

ManagingFinance

(20%)

Cost ofOperations

(30%)

Negotiation power

(20%)

Overallrank

Mundra

Gammoninfra

GujaratPipavav



Diversified players

In order to assess the overall competitive advantage of the diversified players, wehave considered three parameters: (a) the companys exposure to the respectivesector (based on total project cost); (b) competitive positioning of the company inthe respective sector; and (c) the asset creation opportunity of the sector. GMR isthe strongest diversified developer followed by GVK & L&T Infra.

Exhibit 25: Diversified players' exposure todifferent sectors

DiversifiedDevelopers

Power Roads Airports Ports Total

Reliance Infra 28% 70% 2% NA 100%

GMR 58% 11% 31% NA 100%

GVK 42% 6% 52% NA 100%Gammon Infra NA 80% NA 20% 100%

L&T Infra 53% 33% NA 13% 100%

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

Exhibit 26: Overall ranking of the diversified players (this istaken from the adjacent table) xx

Company/MetricPower(30%)

Roads(15%)

Airports(25%)

Ports(30%)

OverallRanking

Reliance Infra NA

GMR NA

GVK NAGammon Infra NA NA

L&T Infra NA

Source: Ambit Capital research, Company, Notes: (a) We have assignedpercentages to respective infrastructure sectors based on opportunities in thatsector



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Exhibit 28: Relative valuation of infrastructure developers across different sectors

CMP Mkt cap Mkt cap P/E (x) EV/EBITDA (x) P/B (x)

Company Rs Rs bn US$ mn FY11E FY12E FY13E FY11E FY12E FY13E FY11E FY12E FY13E


Reliance Infra 624 167 3,708 10.5 9.2 8.0 15.4 10.7 8.1 0.7 0.7 0.6

JPA 83 176 3,921 18.7 15.3 11.2 13.7 8.9 6.7 1.9 1.6 1.2

GMR 37 143 3,178 319.6 61.8 17.8 19.7 15.2 10.0 1.8 1.8 1.3GVK 24 38 853 22.1 15.2 9.9 15.6 12.2 7.3 1.1 1.1 0.9

Gammon Infra 17 12 271 83.8 47.9 29.9 16.7 7.7 5.7 1.8 1.7 1.6

Average 90.9 29.9 15.4 16.2 10.9 7.6 1.5 1.4 1.1

Road Developers

IRB 185 61 1,362 12.7 11.3 10.6 8.1 6.4 5.2 2.5 2.1 1.7

ITNL 210 41 907 10.2 7.9 6.2 7.6 5.7 4.1 2.0 1.6 1.3

Average 11.4 9.6 8.4 7.8 6.0 4.7 2.2 1.8 1.5

Port Developers

Mundra 132 264 5,855 30.2 19.6 14.9 22.3 15.1 11.9 6.4 5.1 3.9

Utilities

Reliance Power 119 333 7,388 43.0 44.1 17.4 99.6 30.5 8.1 1.9 1.8 1.5

Adani Power 111 241 5,352 36.8 10.0 7.0 27.5 7.2 4.4 3.8 2.8 2.0

Lanco 36 88 1,950 13.5 9.0 6.8 7.6 4.8 3.6 2.2 1.7 1.3

KSK 101 38 837 18.0 10.4 8.3 14.6 8.9 7.2 1.3 1.2 1.0

Tata Power 1,230 292 6,486 15.5 12.9 11.5 10.5 7.8 6.6 2.2 1.9 1.7

Torrent Power 241 114 2,528 12.0 9.7 9.6 7.0 6.1 6.1 2.4 1.9 1.6

CESC 297 37 825 12.4 9.7 7.0 7.7 6.9 4.6 0.8 0.8 0.8

JSW Energy 72 118 2,616 12.6 7.7 8.2 9.9 5.4 5.4 2.1 1.6 1.4

Average 21.6 15.1 9.6 24.9 10.3 5.8 2.1 1.7 1.4

All Average 29.7 14.5 8.5 14.3 8.2 5.7 1.9 1.6 1.3Source: 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 beundervalued on the P/B multiple. Whilst GMR is trading at a premium both onP/B and EV/EBITDA multiple, we believe that GMR deserves to trade at apremium given that it has a large number of higher RoE generatingoperational assets v/s peers. Also, JPA and Gammon infra are overvalued onthe P/B multiple, they are undervalued on the EV/EBITDA multiple.

Amongst the power players, we find that whilst Adani power is trading ata significant premium to peers, Torrent Power and Tata Power are tradingat a slight premium to peers. As highlighted by our Power analyst, Bhargav

Buddhadev, in his thematic dated January 19, 2011 The Good, The Bad & TheUgly, Torrent Power deserves to trade at a premium as it is an attractivefranchise and has the best operational efficiency. However, he believes whilst

Adani Power is trading at a premium; consensus is not factoring in thepotential execution slippages and low PLF levels of the company.

Our key takeaways from the relative valuation exhibits of diversified players andpower companies shown on the next page are:

Diversified players

1) On P/B compared to ROE, Gammon Infra appears over valued andReliance Infra appears undervalued

2) On Revenues/Capital employed compared to EV/EBITDA , RelianceInfra is at a premium and GVK is undervalued


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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 returnsfor developers companies are inversely related to interest rates. Given that

interest rates have shot up by ~300bps in the last 9-10 months, developers arefacing 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 weexpect average interest rates to rise by 50-75bps in the near term, easing ofinterest rates will drive the capital flow and the stock prices.

Exhibit 33: Stock prices of developers are inversely linked to interest rates

0

100

200

300

400

500

Apr-07

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

8

10

12

14

GMR GVK IRB Reliance InfraBBB 10 year borrowing rates (%) (RHS)

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

Procedural acceleration: Land acquisition issues, environmental clearanceproblems and lengthy approval procedures have resulted in long execution cyclesfor infrastructure projects, especially in the power and the roads sectors. Over 65%of the NHAIs projects have been impacted by time and cost overruns. Anysignificant improvement in the currently stalled projects due to speed up in theprocedural formalities can improve the revenue visibility and cash flow generationfrom existing projects.

Development of a long-term bond market: Creation of a long-term bondmarket can increase the availability of funds for the sector and reduce thedependence on banks. Given that infrastructure projects have long gestationperiods of 25-30 years, the average debt tenure for the infrastructure sectorshould 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 isaround 50-70% of most of the concession agreements.

Moreover, the restricted investment guidelines on the pension funds and lifeinsurance companies limit the funds to be channelized to the infrastructure sector.The Government in its FY11-12 budget has announced an increase in thebudgetary allocation to the infrastructure sector to Rs2.14tn (up 23% YoY),issuance of tax-free infra bonds worth Rs300bn by Government undertakings andincrease in the FII limit for investment in corporate bonds issued in infrastructuresectors to US$40bn (earlier US$20bn). In our opinion these measures shouldincrease 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 inexecution slippages in the BOT assets. Given the lack of sufficient cash flows fromoperations, asset developers have continued to depend on equity markets forfunds. However, given the current liquidity crunch in the Indian markets and thedisappointing financial performance of the developers, it is becoming difficult for


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developers to get capital for their projects. Therefore any improvement in themacro environment resulting in credit offtake can improve funds availability withthe 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 companiesover the developers. Whilst the developers have their cash flows blocked in thecapital intensive projects over a long period of time, construction companies havea shorter cash conversion cycle.

Whilst we are aware that construction companies such as IVRCL, Nagarjuna, HCCand Gammon India have mismanaged their balance sheets and cash flowpositions in order to fulfill their asset ambitions, they do have a fall back option interms of their core construction business. However, amongst the EPC players, weprefer companies that have available balance sheet capacity to withstand near-term challenges, and also have limited BOT ambitions. We find that companieslike 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

-40%

0%

40%

80%

120%

160%

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 andSimplex 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

Managing Director - Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Amit K. Ahire Telecom / Media & Entertainment (022) 30433202 [email protected]

Ankur Rudra, CFA IT/Education Services (022) 30433211 [email protected]

Ashish Shroff Technical Analysis (022) 30433209/3221 [email protected]

Ashvin Shetty Consumer/Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power/Capital Goods (022) 30433252 [email protected]

Chandrani De, CFA Metals & Mining (022) 30433210 [email protected]

Chhavi Agarwal Construction / Infrastructure (022) 30433203 [email protected]

Gaurav Mehta Derivatives Research (022) 30433255 [email protected]

Krishnan ASV Banking (022) 30433205 [email protected]

Nitin Bhasin Construction / Infrastructure (022) 30433241 [email protected]

Pankaj Agarwal, CFA NBFCs (022) 30433206 [email protected]

Parikshit Kandpal Real estate (022) 30433201 [email protected]

Poonam Saney BFSI (022) 30433216 [email protected]

Puneet Bambha Power/Capital Goods (022) 30433259 [email protected]

Rajesh Kumar Ravi Cement (022) 30433274 [email protected]

Ritika Mankar Economy (022) 30433175 [email protected]

Ritu Modi Construction / Infrastructure (022) 30433292 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Subhashini Gurumurthy IT/Education Services (022) 30433264 [email protected]

Vijay ChughConsumer (incl FMCG, Retail,

Automobiles)(022) 30433054 [email protected]

Sales

Name Designation Desk-Phone E-mail

Deepak Sawhney VP - Ins Equity (022) 30433295 [email protected]

Dharmen Shah VP - Ins Equity (022) 30433289 [email protected]

Dipti Mehta Senior Manager Equities (022) 30433053 [email protected]

Pramod Gubbi, CFA VP - Ins Equity (022) 30433228 [email protected]

Sarojini Ramachandran Director, Sales +44 (0) 20 7614 8374 [email protected]


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Explanation of Investment Rating

Investment Rating Expected return(over 12-month period from date of initial rating)

Buy >15%

Hold 5% to 15%

Sell

ambit - infrastructure developers- scalable and questionable

Documents