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ASIA EX-JAPAN
Initiation of Coverage
SECTOR VIEW
New: Old: 1 - POSITIVE 0 - NOT RATED
Electrical Equipment
Power equipment: Fired up
We believe that the large amount of upcoming investment will be a growth driver for companies in the Indian electrical equipment sector. High top-line growth should lead to margin expansion for most companies, leading to better earnings growth, in our view. We initiate coverage of Crompton Greaves (CRG IN, 1-OW) and ABB India (ABB IN, 2-EW). India plans to upgrade its creaking power infrastructure over the next five years and large investments are planned. Total power capacity to be added in the Eleventh Five-Year Plan is close to 78,000 MW, and, unlike previous plans, we expect execution to be much better planned this time around. In addition to generation, we believe subsequent investments will be made in transmission and distribution (T&D). Historically, power T&D has been an underinvested sector in India, but things are looking up now. Large investments are planned in the national grid, along with the upgrading of distribution infrastructure in the country, which currently falls well below required levels. We estimate an opportunity of US$50 bn for generation equipment makers and US$45 bn for T&D equipment makers in the next five years. Out of this, we believe 80% is achievable, given the current buoyancy in investments. We believe this growth momentum will be sustained even after this period. We initiate coverage of ABB India and Crompton Greaves. These two companies are among the major players in the power T&D equipment industry in India. We rate Crompton Greaves as 1-Overweight with a 12-month target price of INR500, representing potential upside of 20% from current levels. We rate ABB India as 2-Equal Weight with a 12-month price target of INR1,730, representing potential upside of 10%; we believe most of the potential upside for ABB is captured in its current price.
Satish Kumar
91.22.4037.4183 satishku@lehman.com LBI, India
Abhinav Sharma
91.22.4037.4198 abhinsha@lehman.com LBI, India
Analyst Certification
We, Satish Kumar and Abhinav Sharma, hereby certify (1) that the views expressed in this research Industry Report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Industry Report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Industry Report.
Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2LEHMAN to request a copy of this research. Investors should consider this report as only a single factor in making their investment decision.
This research report has been prepared in whole or in part by research analysts employed by foreign affiliates of Lehman Brothers Inc. who, while qualified in their home jurisdictions, are not registered/qualified with the NYSE or NASD.
PLEASE SEE IMPORTANT DISCLOSURES INCLUDING FOREIGN AFFILIATE DISCLOSURES BEGINNING ON PAGE 27
Electrical Equipment
Table of Contents
Investment highlights ........................................................................................... 3 Investment risks .................................................................................................. 4 Power sector An overview................................................................................. 5 Power equipment - sector snapshot ........................................................................ 8 Power generation Stepping it up ...................................................................... 10 Equipment suppliers INR2, 000 bn opportunity ................................................... 12 T&D Time to wake up..................................................................................... 14 T&D equipment market Size and structure........................................................... 20 Global relative valuation matrix .......................................................................... 22 Power plant technology..................................................................................... 23 Transmission basics .......................................................................................... 25
Electrical Equipment
Investment highlights
Ambitious plans for the Indian power sector The power sector is a priority for the Indian government. India suffers from chronic power shortages with a peak power deficit as high as 14%. Per-capita consumption is only 660 units compared to a worldwide average of 2,400 units and 14,000 units in the US. The Indian government has embarked upon an ambitious target of Power for All by 2012. We believe this has led to a spurt in activity in the sector with huge investments planned in the near future. The government envisions an addition of approximately 78,000MW in the Eleventh Five-Year Plan. We expect this to be supplemented by similar investments in power T&D. Planning and regulations are in place, in our view While planning has always been there, we believe execution has been the main risk for the Indian power sector. There have been hiccups in the past, but now we believe that India is on a secular power investment trend. There have been a lot of positive changes in regulations, which has led to private players getting actively interested in the power sector. We believe all this spells high growth for power equipment makers The fortunes of the Indian power equipment industry are directly linked to investments in the power sector. The power equipment industry both generation and T&D have been reaping high growth benefits so far. We believe this momentum will continue through the Eleventh and Twelfth Five-Year plans, leading to sustained high growth rates for these companies. We estimate a huge market for power equipment We expect a US$50 bn market for power generation equipment and a US$45 bn market for power T&D equipment over FY08E-FY12E. Companies set to benefit from these investments include generation equipment makers such as Bharat Heavy Electricals Ltd (BHEL IN, not rated), and T&D equipment makers such as ABB India (ABB IN, 2-EW), Crompton Greaves (CRG IN, 1-OW) and Areva T&D India (ATD IN, not rated). Planned investments in the power sector in the Eleventh plan are a four-fold increase on the 10th five-year plan. Hence, high growth rates demonstrated by companies over the past three to four years should be sustainable, in our view. We initiate coverage of ABB India and Crompton Greaves We initiate coverage of two of the largest names in the Indian power T&D market ABB India and Crompton Greaves. We rate Crompton Greaves as 1-Overweight with a 12month price target of INR500, implying 20% potential upside from current levels. We believe the companys strong growth prospects will help it sustain current valuations of 28x one-year forward EPS of INR 15. We rate ABB India as 2-Equal Weight with a 12-month price target of INR1, 730. We believe that although the companys growth prospects are strong, current valuations at 45x one-year forward EPS factor in most of the upside potential.
Electrical Equipment
Investment risks
A slowdown in power sector investments We believe the biggest risk to the power sector will be any significant slowdown in investments. The sector has witnessed a spate of regulatory changes and many have not been welcomed in some quarters. These reforms hold the key to the proposed pace of investments, in our view, and any slowdown or hesitancy in their implementation could impact the sectors growth adversely. We believe the threat is even more significant now when General Elections in India are around the corner and populist measures could outweigh economic reforms. Increased competition The power sector in India is a high growth sector. Equipment companies have a huge market to cater to, and such an attractive market is bound to attract competition. Increased competition, especially in the lower voltage segment and the highly concentrated generation equipment market, may pose a risk to some companies. The competition threat could also come from China. China has seen an investment binge in the power sector. We expect this investment to slow down over the next couple of years, and hence this excess capacity could come to India. Since the Chinese are low-cost producers, they could prove to be tough competitors, in our view. Non-ferrous and ferrous metal prices Power equipment use copper, aluminium and steel as raw materials. Prices of these commodities have been at all-time highs, and this has been observed in the increased rawmaterial-to-sales ratio for companies. While companies have been able to compensate through increased efficiency and price escalation clauses, any unexpected rise in global prices of these commodities would impact margins, in our view.
Electrical Equipment
but demand still exceeds supply Despite progress, the country still suffers from power shortages because demand has far outstripped supply. In the Tenth Five Year Plan (FY02-FY07), the average peak power deficit was 12.3%.
Peak Availability (MW) 71547 75066 77652 81792 86425 392482 Shortage (%) 12.2 11.2 11.7 12.3 14.0 12.3 Requirement (Million Units) 545983 559264 591373 631757 510223 2838600
Energy Availability (Million Units 497690 519398 548115 578819 465149 2609171 8.8 7.1 7.3 8.4 8.8 8.1 Shortage (%)
We think the main reasons behind the mismatch between demand and supply of power are as follows: Capacity additions not meeting plan targets; and High T&D losses.
Electrical Equipment
India has failed to meet target power capacity additions in the previous three five-year plans. In the Tenth Five-Year Plan, total capacity additions were only an estimated 21,000 MW, much below the envisioned 41,110 MW at the start of the plan. Reasons include the poor financial health of state electricity boards (SEB), the lack of support for independent power producers (IPP) and overstretched capacities of leading equipment manufacturers, such as BHEL.
India suffers from T&D losses as high as 50% in some states, which is way above worldwide accepted levels of 10%. The all-India average is close to 35%. Despite governmental efforts, the level of T&D losses has not come down. We think the reasons behind high T&D losses are as follows: Inadequate T&D infrastructure; and Rampant power theft.
2001-02 33.98
2002-03 32.54
2003-04 32.53
2004-05 31.25
Inadequate investments in T&D While the government has directed most of its attention towards expanding generation capacity, it has neglected power T&D, in our view. Worldwide, for every rupee invested in generation, an equivalent amount is spent in T&D. But, in India this ratio is only 50% or less. This neglect has led to high distribution losses in the country. T&D losses in India are among the highest in the world. We believe the good thing is that the government is aware of the need and has launched a spate of initiatives to try to resolve this issue. The impact of these initiatives remains to be seen. Key initiatives are as follows: Creation of a national grid, linking the power surplus eastern region to deficit regions of the country; The Accelerated Power Development and Reforms Program (APDRP), which is aimed at reducing distribution losses and corporatisation of SEB; and The Rajiv Gandhi Gramin Vidyutikaran Yojna (RGGVY) This initiative is aimed at rural electrification and improvement of rural power infrastructure in the country.
Electrical Equipment
The National Power Grid Generation resources in India are unevenly placed, with hydro in the northern and northeastern states and coal mainly in the eastern part of the country. The development of a strong national inter-regional grid would ensure reliable supply of power to all, in our view. The formation of a strong National Power Grid has been recognized as a flagship endeavour by the Indian government. A strong all-India grid would enable the use of unevenly distributed generation resources in the country, in our view.
Electrical Equipment
Major Equipments
Boiler, Turbine, Generator, Transformer, Circuit breaker, Control and automation equipments
Current and voltage Transformers, Switch Gears, Circuit breakers, Insulators, Surge arresters, Control and automation equipments
BHEL, ABB India, Siemens India, Crompton Greaves ltd., Areva T&D India, Havells India, Emco transformers, Unorganized players (particularly in distribution)
Sector financials between 1997 and 2002 The period between 1997 and 2002 witnessed few investments in the power sector and this was reflected in the sales growth of the sector. We have analyzed the ten largest companies in India in this sector and their combined performance during this period reveals the following; Low sales growth; and Poor operating margins.
FY98
FY99
FY00
FY01
FY02
Electrical Equipment
Sector financials between 2003 and 2006 The period between 2003 and 2006 witnessed strong sales growth and much improved operating margins despite the fact that prices of non-ferrous metals touched record highs during the same period. This performance, we believe, was because of: Change in investment trajectory in the power sector with the passage of the Electricity Act and programs like APDRP and RGGVY; Better utilization of assets and higher operating leverage; and Ability to pass on cost hikes to customers.
Figure 8 shows the return on equity (ROE) for the sector over the past seven years which has picked up 2003 onwards reflecting the change in investment climate in India.
Electrical Equipment
11th Plan size as per assessment made by CEA based on the status of projects (MW) 15,585 50,124 3,160 8,000 76,869
Out of a total of 68,869MW addition through conventional sources, 31,345MW is already under construction according to the CEA.
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Electrical Equipment
Eleventh Plan requires huge investments Large capacity addition plans will inevitably require huge funds. The Indian government wants greater participation from private players to share costs. The power generation sector requires funds to the tune of INR 3900 bn or US$100 bn. We believe this investment will provide a huge opportunity for power sector players across the value chain. Ultra-mega power projects Besides the projects planned under the Eleventh Plan, the government has also initiated the concept of ultra mega power projects (UMPPs). These projects are estimated to be very large projects of 4,000MW each to be awarded on a tariff-based bidding process. Two projects Sasan UMPP and Mundra UMPP have already been awarded to developers. Tariffs quoted in the bidding of these two projects were extraordinarily low and the success of these projects could open up doors to a large amount of private participation in the sector, in our view. The government has planned an additional five projects, and their benefits would only be realized in the Twelfth Plan. Twelfth Five-Year Plan We expect momentum to continue Demand for electricity is expected to remain robust in the Twelfth Plan (2012-17) as well. Demand projections for the Twelfth Plan are listed below.
Electricity generation required (BU) 1,415 1,470 1,470 1,532 1,525 1,597
The Working Group report has recommended the addition of 82,200 MW of power for the Twelfth Plan, which is even higher than the Eleventh Plan.
Electrical Equipment
Figure 11: Key components as % of total project cost for thermal power plant
Preliminary expenses, land cost and civil works Boiler turbine generator package Balance of plant (ash-handling plant, plant water system and piping) Power works Control & instrumentation works Cost of transmission system Interest during construction Others
Source: Lehman Brothers estimates
As a rule of thumb, the cost of setting up a thermal power plant is INR40 mn per MW, the cost of setting up a hydro plant is INR60 mn per MW and the cost of setting up a nuclear plant is INR80 mn per MW. Consequently, we have worked out the total equipment demand from generating stations for the Eleventh Plan below.
Capacity planned (MW) Total investment (INR bn) Equipment component as % off Total equipment component total investment 50,124 15,585 3,160 8,000 76,869 2,005 935 253 400 3,593 65 20 75 80 (INR bn) 1,303 187 190 320 2,000
Major players Companies, which may benefit from this investment, are listed below along with their area of expertise.
Area of expertise Boilers, turbine generators, EPC contracts for the whole plant Wind turbines
ABB, Areva T&D India, Siemens India Transformers, circuit breakers, turnkey substation project
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Electrical Equipment
BHEL is the leader in conventional generation equipment BHEL is the leader in power generation equipment in the country. The company is a public sector undertaking (PSU) and the countrys sole domestic vendor for utility boilers and turbines for thermal power plants. BHEL has installed 65% of the total installed capacity in India. The company has seen a huge upswing in fortunes from large investments in the power sector in the country. But, at the same time, this may have led to execution delays due to overstretched capacity. More players are looking to tap the opportunity With the gradual opening of the power sector to private participation and the successful bidding of two UMPPs, the equipment manufacturing space is attracting more players. Large Indian conglomerates have plans to set up a manufacturing facility for supercritical boilers and turbines. There are Chinese players, such as Dong Feng Electric (1072 HK, not rated) and Harbin Power (1133 HK, not rated), which are eyeing the Indian market. leading to a possible increase in competition BHEL has been the only manufacturer in the country of generation equipment. India is planning to add huge capacity over its Eleventh and Twelfth plans. There is a growing realization that relying only on BHEL may not suffice, and the government may need to turn to more players in this industry. Stress on more efficient technologies supercritical is the way ahead Most Indian thermal power plants operate on sub-critical technology, with units ranging from 125 MW-500 MW. This technology is relatively inefficient compared to supercritical technology, which is currently being promoted. All UMPPs and a large portion of the Twelfth Plan requirements are being planned on this technology.
Electrical Equipment
14
Electrical Equipment
The first option of setting up more power plants near load centers has been ruled out simply because it is more economical to produce power near the pit head (fuel source), which is why we see power plants mushrooming in the coal-rich eastern region. Hence, interregional transfer of power becomes crucial to the success of the governments vision Power for All by 2012. The government has committed huge investment to transmission through PGCIL, besides taking various policy initiatives. It also introduced draft regulations for inter- and intraregional transmission, which may open up select transmission routes to private sector investment. Furthermore, the Indian government has drawn up a staggered capacity augmentation blueprint, which if adhered to will achieve targets set in the Eleventh plan for inter-regional transmission capacity.
Planned investment in transmission Since various new generating initiatives have been outlined in the Eleventh Plan, investments will have to be made in T&D for the proper evacuation of power. This along with investment in inter-regional transmission will drive investments in T&D in the eleventh plan.
Total investment planned in transmission infrastructure includes investment in inter--regional long distance transmission as well as inter- and intra-state transmission. This investment includes investment in electric lines, towers and equipment.
Electrical Equipment
Figure 16 lists the transmission line lengths. On the basis of this information, we can estimate that total investment in laying cables and towers would be INR900 bn (assuming an average of INR9 mn per km). Total investment in inter- and intra-state transmission is INR1,400 bn. Hence, the rest of the money INR500 bn would be spent on equipment. Eleventh plan targets - distribution In India, distribution is solely undertaken by SEB except in Delhi and Orissa where it has been privatized. Distribution is the last link in the power supply chain and serves as the interface between the consumer and the utility. Poor distribution network leads to huge power losses India incurs T&D losses of 35% one of the highest rates in the world and we estimate that more than 75% of these losses occur during distribution. We believe that this is largely attributed to power theft at the final stage of supply to consumers. Allowing for conditions peculiar to India such as far flung rural areas, nature of loads and system configuration, we estimate the reasonable level of such losses to be just 10-15%. While losses in the extra high voltage (EHV) network are lower at about 4-5%, it is the sub-T&D system operated by SEBs, which bears the brunt of power theft. Out of the total energy generated, only 55% is billed and 41% is realized by the utility. The mounting pressure of huge losses, coupled with poor management of utilities, has severely eroded the financial stability of state utilities.
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Electrical Equipment
Investments and reforms planned in distribution The government has envisaged various distribution reforms aimed at improving the performance of SEBs and reducing power losses. The reforms, which include corporatisation of SEBs and privatization of distribution, are underpinned by schemes like APDRP and RGGVY.
120,000 2,493,683
Electrical Equipment
APDRP APDRP was formulated by the government in 2002 with the objective of slashing T&D losses to around 15%, reducing power outages and raising collection efficiency. Under this program, the government provides financial assistance to upgrade distribution infrastructure, besides offering incentives to SEBs for performance scale-ups as follows: The central government funds 50% of project costs to upgrade and strengthen the subT&D system while the balance comes from respective state governments. North-eastern states, J&K, Himachal Pradesh and Uttaranchal Pradesh fall under a special category of states eligible for 100% financial assistance. For every INR2 of cash loss reduction by SEBs, a grant of INR1 is given to the respective utility by the government. Total funds planned for APDRP, apart from cash grants, are INR191.8 bn. About INR126.2 bn has already been disbursed, of which 52% has been utilized at the SEB level.
Privatization of distribution
Source: Lehman Brothers research
RGGVY The government introduced RGGVY to enhance rural electricity distribution. The scope of the program is as follows: Provision of 33/11 kV (or 66/11 kV) sub-stations of adequate capacity and lines in blocks where they are currently non-existent (backbone network); Electrification of un-electrified villages and habitations; Provision of distribution transformers in electrified villages; and Decentralized generation-cum-distribution from conventional sources for villages where grid connectivity is neither feasible nor cost-effective.
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Electrical Equipment
Progress so far
RGGVY targets for the Eleventh Plan The investment envisaged at the beginning of this scheme was INR160 bn, but the amount has now increased to INR400 bn based on current project costs. Total investments made in the Tenth Plan were INR72 bn, and, hence, we expect overall investment in the plan to be INR328 bn.
Electrical Equipment
Physical (2007-12)
Hence, the total market size works out to INR1,800 bn for equipment suppliers. Market structure in power T&D equipment The T&D market is categorized on the basis of voltage classes. Most major equipment can be classified into three voltage ranges: High voltage (220kV and above) For long-distance and inter-regional power transfer; Medium voltage (11kV-220kV) For medium distance intra-regional power transfer and to transfer of power to industrial consumers; and Low voltage (220V-11kV) Last link to domestic consumer.
20
Electrical Equipment
High voltage low competition High voltage (HV) equipment is used to transmit power over very long distances. In India, HV power transmission takes place mainly at 220kV and 440kV levels. Though 765kV power transmission is now being promoted because of lower power losses. High voltage direct current (HVDC) transmission has also been used for very long distance power transfer. Major players in this space include ABB India, Siemens India, Areva T&D India, Crompton Greaves Ltd and BHEL.
HVDC converter stations, high voltage AC equipment, turnkey substation projects HVDC converter stations, high voltage AC equipment, turnkey substation projects High voltage AC equipment and turnkey substation projects High voltage AC equipment HVDC converter stations, high voltage AC equipment, turnkey substations projects
ABB is the largest player in this space followed by Siemens and Areva T&D. These three companies have access to high end technology and have expertise of taking up these projects on an international level. Thus the competitive intensity is lower in this segment. Customers are mainly power utilities. Medium voltage high competition Medium voltage transmission is used to transfer power within a region or a state. The range of voltage is from 11kV to 220kV. Within this voltage range, competition is higher because technology barriers arent too high, in our view. There are a large number of Indian vendors present in this space. Some of them are ABB India, Siemens India, Areva T&D India, Crompton Greaves Ltd, BHEL, Emco Transformers, Voltamp Transformers and a large number of unorganized players. Their customers are power utilities and industrial customers for captive requirements. Low voltage high competition Low voltage power equipment is available in the range of 220kV11kV. This equipment is used in last-mile connectivity to the domestic user. In addition, many are used in households and commercial buildings. The drivers of this market are investments in distribution infrastructure as well as development of commercial real estate in the country. The competitive landscape is crowded, in our view, and there are a host of players vying for a piece of the market.
Electrical Equipment
LB Rating
P/E (x) 2009E 31.1 29.1 44.5 31.0 43.6 17.0 28.1 32.1
EV/EBITDA (%) 2009E 19.8 19.0 27.3 18.9 20.6 8.9 15.8 18.6
ROE
Operating margins
1072 HK
034020 KS 010120 KS
M7011 JP M6501 JP
496.0 765.0
8.8 7 7.9
1 OW 1 OW 1 OW 1 OW
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Electrical Equipment
Temperature and pressure are much higher at >221 bar and >570 degrees Celsius. Boilers do not require any boiler drum CO2 emission from a typical super-critical plant will be 17% lower than subcritical plant for the same amount of power produced Metallurgy of the material at such high temperature and pressure is critical, and, hence, limited companies have access to this technology
Boiler drum is the integral part of boiler turbine system High CO2 as well as SOx and NOx emissions
Non-drum operation results in quick and efficient operations and fast response Cannot adapt to fast-changing loads to load changes Heat rate of plants can be as low as 2,100 Kcal/unit In India, at present one of the best operating sub-critical plants operates at the heat rate of around 2,300 Kcal/unit
Electrical Equipment
Gas-based power plants A gas-based power plant uses natural gas or naphtha as fuel. There are three main components in a standard gas cycle power plant: the compressor, combustion chamber and gas turbine (GT). The compressor is used to compress gas at high pressure, which is fed into the combustion chamber, where the gas is ignited and then expanded in the gas turbine. The turbine and the compressor are mounted on a single shaft. Usually, the expanded gas is fed into a waste heat recovery boiler, where steam is generated and fed into the steam turbine. Hydroelectric power plants Hydroelectric power comes from potential energy of stored water driving a water turbine and a generator; though less common variations use water's kinetic energy or sources such as tidal power. The major advantage of a hydro system is elimination of fuel costs. Hydroelectric plants are immune to price increases among fossil fuels such as oil, natural gas or coal, and they do not need imported fuel. Hydroelectric plants tend to have longer lives than fuel-fired ones, and some plants have been around about 100 years. Usually, the operating labor costs are low since plants are automated and have few onsite personnel during normal operations. However, hydroelectric projects can be disruptive to the surrounding aquatic ecosystem. The generation of hydroelectric power impacts downstream river environment. Nuclear power plants Nuclear power is the controlled use of nuclear reactions to release energy for work, including propulsion, heat and electricity generation. Nuclear energy is produced when a fissile material such as Uranium-235 is concentrated to such an extent that nuclear fission takes place in a controlled chain reaction. The heat generated could be used to boil water, produce steam and drive a steam turbine. The turbine could be used for mechanical work and generate electricity. The heart of the nuclear power plant is the reactor. The nuclear fission reactor produces heat through a controlled chain reaction in a critical mass of fissile material. All modern nuclear power plants are critical fission reactors. The output of fission reactors is controllable. There are several sub-types of critical fission reactors, which can be classified as: Generation I, Generation II and Generation III. The most standard design is the pressurized water reactor (PWR).
24
Electrical Equipment
Electrical Equipment
Substation components Main components of a substation include a surge arrester, wave trap, capacitive voltage transformer and circuit breakers. A non-switching substation will also have a current transformer.
Steps down the high transmission voltage to a lower voltage. Used in non-switching substations
26
Electrical Equipment
Important Disclosures:
Mentioned Company
ABB India ABB Ltd Alstom Crompton Greaves Schneider Electric Siemens AG Suzlon Energy Limited
Ticker
ABB.NS ABBN.VX ALSO.PA CROM.NS SCHN.PA SIEGn.DE SUZL.BO
Price (27-Nov-2007)
INR 1572.20 SFR 30.46 EUR 144.65 INR 420.50 EUR 89.05 EUR 97.50 INR 1912.35
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