Fundamantal or EIC Analysis- Capital Goods Sector

EXECUTIVE SUMMARY

An investment is a commitment of funds made in expectation of some positive

rate of return in future. An investor makes some sacrifice in the present in the hope of

desiring benefits in future. Now the most common question that arises is, which stocks to

pick from the wide range of securities and sectors. This calls for Security Analysis and

Security valuation.

The Indian stock market is semi-strong and is very volatile. The economies of

different countries like USA & China have bearing on our economy. An example to

mention is US recession which caused crash in stock market. Excluding such systematic

risk, one can evaluate the future prospects of the company using fundamentals.

Kotak Mahindra is one of India's leading financial conglomerates, offering

complete financial solutions that encompass every sphere, from commercial banking, to

stock broking, to mutual funds, to life insurance, to investment banking, the group caters

to the financial needs of individuals and corporates. The group has a net worth of over

Rs. 5,609 crore, employs around 17,100 people in its various businesses and has a

distribution network of branches, franchisees, representative offices and satellite offices

across 344 cities and towns in India and offices in New York, London, Dubai, Mauritius

and Singapore. The Group services around 3.6 million customer accounts. It has won

awards like Best Performing Equity Broker in India – CNBC Financial Advisor Awards

2008, Avaya Customer Responsiveness Awards (2007) in Financial Services Sector and

so on.

In the light of all the above, I have undertaken a project on “E-I-C analysis of

Capital Goods Sector”. This is an effort put to know the intrinsic value of the Capital

goods companies like Bharat Heavy Electricals Limited and Larsen & Toubro. Here, I am

undertaking a study based on the fundamentals of the company through financial

statement analysis.

An investor should make thorough comparison of the prices of the security with

its true value. Value here refers to the intrinsic worth or the Value anchor. Only with the

help of such evaluation the investor can decide as to buy hold or sell.

K.L.E.Society’s Institute of Management Studies and Research, Hubli-31 1

Topic of the study:

“E-I-C Analysis of Capital Goods Sector”

Name of the organization : KOTAK SECURITIES, Hubli.

Main Objective:

“To evaluate the performance of Capital Goods companies under study using EIC

Analysis.”

Sub objectives:

1. Analyzing the environmental factors that affect the security prices.

2. Industry analysis of Capital goods Sector

3. To assess the fundamentals of the company in light of financial statements.

4. To arrive at intrinsic value of the company thus enabling the investor in assessing

the worth of the security.

5. I had keen interest to enrich my knowledge in stock market.

Framework of study:

The proper order to proceed in Fundamental analysis is,

First, to analyze the overall economy and securities markets.

Second, analyze the industry with in which a particular company operates.

Finally, analysis of the company should be considered.

The above analysis involves making a careful estimate of expected stream of benefits and

required return of common stock. The intrinsic value then can be obtained through P/E

ratio or earning multiplier approach.


Data Collection Approach:

Secondary Data:

The study is mainly based on analysis of financial statements of the company i.e. balance

sheet and profit and loss account. The same has been collected through;

Company websites and other related websites.

The information is also collected from various magazines like Indian survey 2008

by The Hindu

News papers

Sample Size:

Two large cap companies are taken for study. They are;

Bharat Heavy Electricals Limited

Larsen & Toubro

Need for the study:

Due to the present volatility in stock market, the biggest question that arises is whether to

invest in stocks or not? If yes, then which stocks to invest? How are the securities

valued? There is no precise answer to this and nobody can predict the stock movements

exactly. Fundamental analysis or EIC analysis is one of the approaches to security

valuation. EIC analysis gives the intrinsic value of the firm. An investor can compare the

present market price with the intrinsic value of the stocks and make his decisions

regarding investments in these stocks.

FINDINGS:

Economy:

When come to the economic factors the global economies are getting

interrelated, the Indian market will no longer be limited to domestic economic

situation. Especially the US market has a strong bearing on Indian stock market.


Industry – (Engineering – Heavy):

The demand driver for this sector is the Order book.

Most of these companies have an order book to sales ratio in the range of 2.5-4

times FY07 revenue. This implies that for the next two-to-three years, even if the

companies do not get fresh orders, they can still maintain revenue growth of 30-

40 per cent..

The IIP growth during April - January 2007-08 has declined to 8.7% when

compared to 11.2% IIP growth during 2006-7. Tight monetary policy has resulted

in high interest rates which have been the major factor contributing to the decline

in IIP growth.

Company:

When Liquidity ratios are concerned, BHEL has an upper hand over L&T. The

Current ratio, quick ratio and cash ratios of BHEL are better than L&T.

But Efficiency ratios show the other picture. Total assets turnover, fixed assets

turnover ratio, inventory days and debtors turnover of L&T are better than BHEL.

L&T is able to utillise its assets more efficiently.

When Solvency ratios are studied, we see that the debt component in BHEL has been

reduced to 0.1(FY07) from 0.8 (FY05). The debt of BHEL has substantially reduced

in FY07 to 0.1as a result of redemption of 8.85% Non-convertible, secured,

Redeemable Taxable Bonds worth Rs.500 crores

Profitability ratios: The GPM has been increasing and so is the NPM. This shows

that the companies are performing efficiently and are using the resources in an

optimum way. The EPS and DPS has consistently increased in BHEL because of

increased earnings and constant number of shares. Whereas in case of L&T, the EPS

has reduced in FY07 to Rs.48 due to increased number of shares arising from issue

of bonus.

Market based returns: the P/E ratio which shows investors expectations have

increased for both the companies. L&T has higher P/E ratio of 33.48 as compared

to 11.48 of BHEL.


When compared to the specific indicators like sales growth, the BHEL will be in

the first place then followed by L&T

The Volatility of returns is high in BHEL as compared to L&T. Hence L&T is better

because it is more consistent.

The value anchor for BHEL is Rs.2644 and for L&T is Rs.3996.2

Recommendations:

1. Intrinsic value of BHEL is Rs.2644 and the present market price is Rs.1870. Hence it

is recommended to buy BHEL stock as its current market price is lower than its fair

value range.

Market price < Value range

BHEL Rs.1870 < Rs.2600 to Rs.2700 BUY

2. Intrinsic value of L&T is Rs.3, 996.2 and the present market price is Rs.2981.85.

Hence it is recommended to buy L&T stock as its current market price is lower than

its fair value range.


L & T Rs.2981.85 < Rs.3950 to Rs.4050 BUY

3. After a close scrutiny of economy industries and companies in considering the risk, it

may be recommended that international economy might affects the firms export

prospects, the price competition it faces from competitors, or the profit it makes from

abroad. Investor should properly analyze both globally and domestically before

taking investment decision.

4. The investor also should consider the budget decision and present years forecast of

different sectors


COMPANY PROFILE

THE KOTAK MAHINDRA GROUP: Kotak Mahindra is one of India's leading financial conglomerates, offering complete

financial solutions that encompass every sphere of life. From commercial banking, to

stock broking, to mutual funds, to life insurance, to investment banking, the group caters

to the financial needs of individuals and corporates.

The group has a net worth of over Rs. 5,609 crore, employs around 17,100 people in its

various businesses and has a distribution network of branches, franchisees, representative

offices and satellite offices across 344 cities and towns in India and offices in New York,

London, Dubai, Mauritius and Singapore. The Group services around 3.6 million

customer accounts.

Kotak Group Products & Services:

Bank

Life Insurance

Mutual Fund

Car Finance

Securities

Institutional Equities

Investment Banking

Kotak Mahindra International

Kotak Private Equity

Kotak Realty Fund

KOTAK SECURITIES:


Kotak Securities Ltd. 100 % subsidiary of Kotak Mahindra Bank is one of the oldest and

largest broking firms in the Industry with a market share of 8.5 % (as on 30th

September).

Kotak Securities offerings include stock broking through the branch and Internet,

Investments in IPO, Mutual funds and Portfolio management service.

Its Accolades include:

Best Performing Equity Broker in India – CNBC Financial Advisor Awards 2008.

Avaya Customer Responsiveness Awards (2007) in Financial Services Sector.

Best Brokerage Firm in India by Asiamoney in 2007.

The Leading Equity House in India in Thomson Extel Surveys Awards for the

year 2007.

Euromoney Award (2006 and 2007) - Best Provider of Portfolio Management:

Equities.

Avaya Customer Responsiveness Awards (2006) in Financial Institution Sector.

Asiamoney Award (2006) - Best Broker in India.

Euromoney Award (2005) - Best Equities House in India.

Finance Asia Award (2005) - Best Broker in India.

Finance Asia Award (2004) - India's best Equity House.

Prime Ranking Award (2003-04) - Largest Distributor of IPO's.

Kotak Securities is the first in providing many products and services which have now

become industry standards. Some of them are:

Facility of Margin Finance to the customers.

Investing in IPO’s and Mutual Funds on the phone.

SMS alerts before execution of depository transactions.

Mobile application to track portfolios.


Auto Invest - A systematic investing plan in Equities and Mutual funds.

Provision of margin against securities automatically against shares in your Demat

account.

Kotak Securities has a full-fledged research division involved in Macro Economic

studies, Sectoral research and Company Specific Equity Research combined with a strong

and well networked sales force which helps deliver current and up to date market

information and news.

Kotak Securities is also a depository participant with National Securities Depository

Limited (NSDL) and Central Depository Services Limited (CDSL), providing dual

benefit services wherein the investors can avail brokerage services for executing the

transactions and the depository services for settling them. It process more than 600000

trades a day which is much higher even than some of the renowned international brokers.

Kotak Securities network spans over 310 cities with 867 outlets.

Kotak Securities Limited has over Rs. 4000 crore of Assets Under Management (AUM)

as of 31st December, 2007. The portfolio Management Service provides top class service,

catering to the high end of the market. Portfolio Management from Kotak Securities

comes as an answer to those who would like to grow exponentially on the crest of the

stock market, with the backing of an expert.

WHY KOTAK SECURITIES?

Kotak Securities sees investing from customer’s perspective, and make recommendations

based on their needs. The important goals of Kotak Securities is to simplify investing for

customers, along with that they also provide long term values to their customers.

Kotak Securities has a million reasons for customers to choose it. Listed below are a few:

STABILITY: We are a 100% subsidiary of Kotak Mahindra Bank and one of the oldest

and largest broking firms in the Industry. We have been the first and only NBFC to

receive the license to be converted into a bank.


INNOVATORS IN THE INDUSTRY: Kotak Securities has been the first in providing

many products and services which have now become industry standards.

First to provide Margin Financing to the customers.

First to enable investing in IPO’s and Mutual Funds on the phone.

Providing SMS alerts before execution of depository transactions.

Launching of Mobile application to track portfolio.

Auto Invest - A systematic investing plan in Equities and Mutual fund.

Provision of margin against securities automatically against shares in your Demat

account.

RELIABILITY: Kotak Securities accolades are a testimony to our services and high

standards. Kotak Securities has been awarded as:

Best Performing Equity Broker in India – CNBC Financial Advisor Awards 2008

Avaya Customer Responsiveness Awards (2007) in Financial Services Sector

Best Brokerage Firm in India" by Asiamoney in 2007

The Leading Equity House in India' in Thomson Extel Surveys Awards for the

year 2007.

Euro money Award (2006 & 2007) - Best Provider of Portfolio Management:

Equities.

VALUE: Whether you are a customer with a small or large wallet size, customers can

expect Kotak Securities to bring value to customers in every form.

Quality Research

Quick trade execution

Low brokerages

Accounts that suit your investment profile

Risk Profiler

Superior Customer Service

SERVICE: Kotak Securities believe in high standards of service and that's precisely

what they offer. It's an honor to be awarded the most customer responsive company


award in the Financial Institution sector by AVAYA Global Connect Award both in 2006

and 2007.

ROBUST TECHNOLOGY: Kotak securities developed proprietary trading platform

which is robust and among the best in the industry. It has more than 150 technology

professionals constantly working on upgrading and speeding up all systems.

CENTRALISED RISK MANAGEMENT SYSTEM: Unlike many other players Kotak

Securities has a centralized risk management system. This allows them to offer the same

levels of service to customers across all locations.

EXCEPTIONAL RESEARCH: Unlike most other competitors Kotak Securities has

their own in house research team. Their in house research team is among the best in the

industry and they have years of experience in the financial markets. They scan through

the plethora of stocks and find the scrip’s that have a high potential of providing you

good returns.

Our investors get research Technical, Fundamental, Derivatives, Macro-economic and

mutual fund research.

LARGE PRESENCE: Kotak Securities is present in 309 cities with 867 offices all over

the country. Its employee strength extends beyond 5000.

OFFERINGS OF KOTAK SECURITIES: Once customers invest with Kotak Securities, they can enjoy access to a wide range of

products and services to help them make the most of their investments.

Easy Equity

Easy Derivatives

Easy IPO.

Easy Mutual Fund

Easy Insurance

Kotak Portfolio Management.


EASY EQUITIES:

Investing in equities was never so easy. As the Best broker in India Kotak Securities

products and services are focused at making investments in equities as simple as writing a

cheque.

Research: "What do I Buy?" Isn't this a common question we all have while investing in

equities?

Kotak Securities in house research team is among the best in the industry and they have

years of experience in the financial markets. They scan through the plethora of stocks and

find the scrip’s that have a high potential of providing good returns.

SMS Alerts: Customers can get expert tips and recommendations as SMS on their

mobile phone so that customers know what to invest in at all times.

Trinity Account: A 3 in 1 account that integrates Trading, Bank and Demat account.

With Trinity Account transactions will be seamless and very convenient.

Competitive Brokerages: Kotak Securities brokerage rates are among the most

competitive in the industry. Low brokerage rates let customers concentrate on investing

their savings without worrying about the cost of investment.

Call and Trade: Customers can capitalize on market opportunities even when their

computer is inaccessible. Call & Trade essentially provides the convenience of trading in

equities by making a simple phone call.

KEAT: This superior trading platform to monitor market movements, view your gains

and losses and order placements instantaneously. Know more

M-Trade: It is exclusively designed to give instant access to the stock market through

mobile phone, thereby allowing to catch every little market movement when customers

are on the move.

Kotak Securities News: It provides access to all news related to a stock, right from its

results, earnings, bonus, share holding patterns etc. Also helps in knowing about market

developments, latest happenings, stock movements and lots more.

Twin Advantage : Customers can not only get exposure against the cash margin in their

trading account but can also automatically provide with exposure against the shares lying

idle in their DP account.


EASY DERIVATIVES:

If customers are not averse of taking risks, derivatives can prove to be a good investment

option especially with Kotak Securities research.

Kotak Securities has strived to make investing in derivatives simpler. It provides

derivatives seminars educate new entrants in the derivatives market to be more equipped

with knowledge and techniques. Once the customer has the knowledge of investing in

derivative instruments Kotak Securities daily derivative reports will provide customers

with strategies that may yield good returns.

Customers can also refer to the Kotak Securities Academy to learn more about

derivatives.

EASY IPOS:

Investing in IPO’s is not complex anymore; Kotak Securities has made investing in IPO’s

very simple. Customers have to do is one phone call, and that's all. No paperwork no

queues, simply pick the phone or log on to www.kotaksecurities.com and place their

order within seconds.

Kotak Securities also provide with you with information on IPO News, Forthcoming

IPO’s and a lots more.

EASY MUTUAL FUNDS:

No more paperwork, no more queues.Kotak securities have made investing in mutual

funds as simple as dialing a pizza.

Customers can now invest in over 1000 different mutual fund schemes through us. And

to make this choice of choosing between which mutual funds scheme to invest in, it

offers customers an exclusive research.

Investment in mutual fund can be made simply by logging on to

www.kotaksecurities.com or just making a phone call. No paperwork no queues. Simply

pick the phone or log on to www.kotaksecurities.com and place order.

EASY INSURANCE:


Kotak Securities brings customers a sure and secure insurance option without the hassles

and worries of a conventional insurance plan. With minimal paperwork and procedures,

customers get the dual benefit of a risk cover and savings. What's more, at the end of the

term, a minimum of premiums paid by customers will be returned depending on the

option they choose.

FINANCIAL PLANNING GROUP AND PORTFOLIO MANAGEMENT:

A structured portfolio is essential for reducing the risk of capital erosion as a result of

short-term volatility. With Kotak Financial Planning Group, these portfolios are more

than just structured-they're tailor-made, too.

In today's complex financial environment no one asset class tends to consistently

outperform another. Kotak Securities Financial Planning Group aims to help clients grow

exponentially on the crest of the stock markets.

And since the market is unpredictable by nature, the only way to beat it is constant

monitoring. That's where the integration with Kotak Securities proves invaluable. Clients

benefit from the in-depth research, the wide network of experts, the international

presence, and from the constant tab on the Indian and global financial scenario of Kotak

Securities.

About Financial Planning Group:

The financial planning and distribution arm of Kotak Securities is involved in defining

financial goals, identifying investment vehicles and achieving them. The group

commenced its operations in the year 2003. Present over 30 locations with a large team of

relationship managers, has always endeavoured in servicing clients; closely

understanding their needs, financial goals and advising ethically.

Products:

This is done through quality service and access to a wide range of products; products that

are customizable. The financial planners thoroughly discuss and understand the desires of

each client. Their financial goals. Their risk appetite. Their time constraints.


Products offered range from those promising aggressive returns (MFs and PMS) to those

that aid diversification (Commodities, Gold, Equities etc.) to those that aim for capital

protection like insurance and capital guarantee products.

Portfolio Management Service:

Kotak Securities brings with it years of experience, expertise, research and the backing of

India's leading stock broking house. The portfolio managers have over 10 years of

understanding diverse investment instruments and needs.

Kotak Securities is one of India's oldest portfolio management companies. It is also one

of the largest with an AUM worth Rs.2500 crore. And for those who wish to grow their

wealth exponentially-it is also one of the best.

The Portfolio Management Service combines competent fund management, dedicated

research and technology to ensure a rewarding experience for its clients.

Every investment portfolio is carefully engineered for clients in a phased manner.

Relationship managers help clients monitor, assess and tweak their portfolio at every

level. Relationship Managers dispense personalized advice and ensure clients receive

quarterly research reports, account performance statements and MIS at their doorstep. A

dedicated website and a customer service desk allow clients to keep a constant tab on

their portfolio's performance. All in all, it translates into zero paperwork.


INTRODUCTION TO THE TOPIC

INVESTMENT SCENARIO:

Investment is the employment of fund on assets with an aim of earning income on

capital appreciation. Investment means the present consumption is sacrificed to get return

in future.

Investment is good only for the purpose to get return from the selected or

choosing securities so; investors have to see the fundamental analysis. In fundamental

analysis, we can broadly classify into three types. One is Economic Analysis; Industry

analysis and company analysis. These three are very important base of the securities or

stock of market. We have to study about this fundamental analysis.

An Indian stock market has been no different. Memories of its crash of December

1990 are still there in the minds of many. After record rise in proceeding few years the

index fell precipitously and investor loss heavily. This phenomenon repeated every now

and then. Though the equity cult is fast spreading among the investor the hard fact is

majority of stocks continue to remain volatile to date. All these are pointers to the fact

that the investor market is no longer holding an olive branch to investor in equity. Much

of the danger associated with it can be avoided and it need not be such nerve raking

experience, provided one approaches it as a rational decision making process. In short

Security analysis and portfolio management are hard work, requiring discipline and

patience, and the work is not always rewarded with exceptional returns.


INTRODUCTION TO THE CONCEPT OF SECURITY ANALYSIS:

An investment is a commitment of funds made in expectation of some positive

rate of return in future. An investor makes some sacrifice in the present in the hope of

desiring benefits in future. The motive behind investment varies from person to person.

Some people invest in order to gain a sense of power or prestige. Often the control of

corporate enterprises is a driving motive. For most investor however their interest in

investment is largely pecuniary to earn a return on their money. But the return on stock

market security is subject to risk. Risk incase refers to the uncertainty surrounding actual

realization of the rate of return offered by an investment. The time element refers to

period of waiting required to reap the return. Accordingly early investment decision has

three key aspects.

They are,

Return

Risk

Time

There fore, investment process must be considered in terms above aspects. One should

approach any scheme of investment as a rational decision making process, in which he

should attempt to select a package of portfolio securities that meets predetermined set of

goals. These investors goal are usually expressed in terms of return. Almost all the cases,

the hard fact are that return and risk are inseparable. Further the maximum higher the

return the grater the risk.

Therefore the ultimate decisions to be made in the investment are two.

What securities to be held

How many rupees should be allocated to each.

These decisions are made in three steps.

1. Security analysis

2. Security evaluation


3. Portfolio analysis, selections and management.

Securities are marketable financial instruments that bestow on their owners the right to

make specific claims on particular assets. An individual security provides evidence of

their creditor ship or ownership depending on whether it is bond or stock, respectively. A

bond is loan that is paid off with interest; the investor lends money to the borrowing

company that issued bond. In contrast, stock ownership represents a cash investment a

future of a corporation; the investor owns a part of a corporation and share in its profits.

SECURITY ANALYSIS:

(a) Traditional investment analysis, when applied to securities, emphasizes projection of

prices and dividends. That is, the potential prices of a firm’s common stock and future

dividend stream are forecast, and then discounted back to the present.

b) Basically modern security analysis deeply rooted in the fundamental concept. But the

more modern approach to common stock analysis emphasizes risks and return estimate

rather than mere price and dividend estimates, of course dependent on share price and

accompanying the dividend stream.

SECURITY EVALUATION:

It refers to the act of assessing the true worth of security. Before committing the fund on

stock exchange securities, the investor should make thorough comparison of the prices of

the security with its true value. The price refers to the price quoted for the security at the

stock exchange at a given movement of time. Value refers to the intrinsic worth. Only

with the help of such evaluation the investor can decide as to buy hold or sell.

DIFFERENT APPROACHES TO EVALUATION:

There are essentially three approaches or school of thoughts on the matter of security

price evaluation, classified as


(a) Fundamental Approach:

The concept of time value of money is the business of this approach. Money has a time

value. A rupee now is worth more than rupee a year from now. For different securities,

future benefits may me received at different times. Even when the amount of future

payment is the same, differences in the speed of their receipt may create differences in

value. Time value of money suggests that earlier receipt is more desirable than later

receipt, even when the both are equal in the amount of certainty. Because, earlier receipt

can be re invested to generate additional returns before later receipt come in. The force

operating is the principle of compound interest.

Framework: The proper order in which to proceed in Fundamental analysis is, first to

analyze the overall economy and securities markets. Second, analyze the industry with in

which a particular company operates. Finally, analysis of the company should be

considered. The above analysis involves making a careful estimate of expected stream of

benefits and required return of common stock. The intrinsic value then can be obtained

through the present value analysis that is, the dividend discounts model. An alternative

method of valuation is the P/E ratio or earning multiplier approach.

ECONOMIC ANALYSIS

INDUSTRY ANALYSIS

COMPANY ANALYSIS


STRATEGIC CONSIDERATIONS OF ECONOMIC, INDUSTRY AND COMPANY

ANALYSES ARE AS FOLLOWS:

(1) Economic Analysis:

1. A study of economic trends as indicated by rate of growth in gross national product,

employment, aggregate corporate profits, interest rate, exchange rates, savings and

investments, monsoon positions.

2. An analysis of the relationship between economic trends and economic policies and the

stability of such relationships.

3. A study of world economic trends and their impact on Indian economy.

(2) Industry Analysis:

1. Implications of projected growth in gross national product for various industries.

2. Implications of plan priorities and plan expenditure for various industries.

3. Vulnerability of an industry for government regulations, and control of prices and

production.

4. Implications of industrial and fiscal policies of government for an industry.

5. Analysis of competitive conditions as reflected in any barriers to entry.

(3) Company Analysis:

1. Trend analyses of company’s market share.

2. An analysis of turn over of assets, operating and production efficiencies through ratio

analysis.

3. Leverage and coverage ratio analysis.

4. An analysis of book value per share.

5. An assessment of quality of management

6. An analysis of price .to .earning multiples.

7. An analysis of growth in sales and dividends.

The basis tenets of this approach are as follows:

Each share has an intrinsic value. It can be determined by discounting the future stream

of benefits that does accrue to the holder of the security. For instance if rupees 100 now is

= rupees 100 + R after one year. Where R is the rate of return then the next question is if


we get rupees hundred after one year how much is it worth now. Rupees 100 + R after

one year = 100 now. Therefore rupees 100 after one year = 100/100 + R and if R = 12 %

then 100/112 = .0893.

(b) Technical Approach:

Technical analysis is an alternative approach to predicting the stocks price behavior.

Technical analysis is frequently used as a supplement to fundamental analysis rather than

as a substitute for it. Thus technical analysis can frequently does, confirm findings based

on fundamental analysis. Technical analysis is viewed mainly through price and volume

statistics. It helps in measuring price . volume, supply . demand relationship for overall

market as well as for individual stocks. Technicians seldom rely upon a single indicator,

as no one indicator is infallible; they place reliance upon reinforcement provided by

groups of indicators.

(c) Modern Approach:

Markovitize led down the foundation for this approach in 1951. He studied capital market

with the help of fairly sophisticated method of investigation and in general arrived at the

following conclusions.

Stock markets are reasonably efficient in reacting quickly and rationally to the

flow of information.

Successive price changes are independent. As a result past price behaviour cannot

be used to predict future price behaviour.

In the capital market, there is a positive relation ship between the risk and return.

This indicates, in general, investment in several securities would reduce the

variability of return and hence the risk ness of a portfolio.


Insights of the topic:

The intrinsic value of an equity share depends on multitude of factors. The earnings of

the company, the growth rate and the risk exposure of the company have a direct bearing

on the price of the share. These factors in turn rely on the host of other factors like

economic environment in which they function, the industry they belong to, and finally

companies’ own performance. The fundamental school of thought appraised the intrinsic

value of shares through E-I-C Analysis. Let us now understand what is fundamental

analysis.

WHAT IS FUNDAMENTAL ANALYSIS:

Fundamental analysis is the analysis, wherein the investment decisions are taken on the

basis of the financial strength of the company. There are two approaches to fundamental

analysis, viz.

E-I-C analysis or the Top Down approach to Fundamental analysis, and

C-I-E analysis or the Bottom up approach.

ECONOMY-INDUSTRY-COMPANY ANALYSIS:

In the Top down approach, first of all the overall Economy is analyzed to judge the

general direction, in which the economy is heading. The direction in which the economy

is heading has a bearing on the performance of various industries. That’s why Economy

analysis is important. The output of the Economy analysis is a list of industries, which

should perform well, given the general trend of the economy and also an idea, whether to

invest or not in the given economic conditions.

MEASURING A COMPANY'S FINANCIAL HEALTH:

Gaining a true picture of a company's finances means not only scrutinizing the financial

statements but also analyzing relationships among various assets and liabilities, thus

highlighting trends in a company's performance and changes in its financial strength

relative to its competitors.


General Steps to Fundamental Evaluation:

Even though there is no one clear-cut method, a breakdown is presented below in the

order an investor might proceed. This method employs a top-down approach that starts

with the overall economy and then works down from industry groups to specific

companies. As part of the analysis process, it is important to remember that all

information is relative. Industry groups are compared against other industry groups and

companies against other companies. Usually, companies are compared with others in the

same group. For example, a telecom operator (Verizon) would be compared to another

telecom operator (SBC Corp), not to an oil company (ChevronTexaco).

Economic Forecast:

First and foremost in a top-down approach would be an overall evaluation of the general

economy. The economy is like the tide and the various industry groups and individual

companies are like boats. When the economy expands, most industry groups and

companies benefit and grow. When the economy declines, most sectors and companies

usually suffer. Many economists link economic expansion and contraction to the level of

interest rates. Interest rates are seen as a leading indicator for the stock market as well.

Below is a chart of the S&P 500 and the yield on the 10-year note over the last 30 years.

Although not exact, a correlation between stock prices and interest rates can be seen.

Once a scenario for the overall economy has been developed, an investor can break down

the economy into its various industry groups.

Group Selection:

If the prognosis is for an expanding economy, then certain groups are likely to benefit

more than others. An investor can narrow the field to those groups that are best suited to

benefit from the current or future economic environment. If most companies are expected

to benefit from an expansion, then risk in equities would be relatively low and an

aggressive growth-oriented strategy might be advisable. A growth strategy might involve

the purchase of technology, biotech, semiconductor and cyclical stocks. If the economy is

forecast to contract, an investor may opt for a more conservative strategy and seek out


stable income-oriented companies. A defensive strategy might involve the purchase of

consumer staples, utilities and energy-related stocks.

To assess a industry group's potential, an investor would want to consider the overall

growth rate, market size, and importance to the economy. While the individual company

is still important, its industry group is likely to exert just as much, or more, influence on

the stock price. When stocks move, they usually move as groups; there are very few lone

guns out there. Many times it is more important to be in the right industry than in the

right stock! The chart below shows that relative performance of 5 sectors over a 7-month

time frame. As the chart illustrates, being in the right sector can make all the difference.

Narrow Within the Group:

Once the industry group is chosen, an investor would need to narrow the list of

companies before proceeding to a more detailed analysis. Investors are usually interested

in finding the leaders and the innovators within a group. The first task is to identify the

current business and competitive environment within a group as well as the future trends.

How do the companies rank according to market share, product position and competitive

advantage? Who is the current leader and how will changes within the sector affect the

current balance of power? What are the barriers to entry? Success depends on an edge, be

it marketing, technology, market share or innovation. A comparative analysis of the

competition within a sector will help identify those companies with an edge, and those

most likely to keep it.

Company Analysis:

With a shortlist of companies, an investor might analyze the resources and capabilities

within each company to identify those companies that are capable of creating and

maintaining a competitive advantage. The analysis could focus on selecting companies

with a sensible business plan, solid management and sound financials.


Business Plan:

The business plan, model or concept forms the bedrock upon which all else is built. If the

plan, model or concepts stink, there is little hope for the business. For a new business, the

questions may be these: Does its business make sense? Is it feasible? Is there a market?

Can a profit be made? For an established business, the questions may be: Is the

company's direction clearly defined? Is the company a leader in the market? Can the

company maintain leadership?

Management:

In order to execute a business plan, a company requires top-quality management.

Investors might look at management to assess their capabilities, strengths and

weaknesses. Even the best-laid plans in the most dynamic industries can go to waste with

bad management (AMD in semiconductors). Alternatively, even strong management can

make for extraordinary success in a mature industry (Alcoa in aluminum). Some of the

questions to ask might include: How talented is the management team? Do they have a

track record? How long have they worked together? Can management deliver on its

promises? If management is a problem, it is sometimes best to move on.

Financial Analysis:

The final step to this analysis process would be to take apart the financial statements and

come up with a means of valuation. Below is a list of potential inputs into a financial

analysis.


OPERATIONAL DEFINITIONS:

Economic Analysis:

Economic analysis refers to analyze the factors or indicators of the economy that affects

the stock market. This is also called non-diversifiable risk analysis where the risk

associated with the securities can not be diversified.

Industry analysis:

Industry analysis refers to analyze the plan, priorities and vulnerability of an industry for

government regulations. The competitive conditions as reflected in any barriers to

industry also taken in to consideration.

Company Analysis:

Company analysis includes analyze the company as potentiality for growth, present

performance, risk associated with securities are considered as important.

Correlation:

Correlation is a statistical measure of the degree to which the security returns move

together. The positive correlation means the variables move together. The negative

correlation suggests that move in opposite direction and zero correlation shows that no

tendency to very either positive or negative direction.

Beta:

It measures the sensitivity of the return of a security to changes in returns to the market

portfolio. It may be positive or negative. The positive beta measures that if 1% changes

market index, more than 1% in individual security and vice versa.


PROJECT DETAILS

Topic of the study:

“E-I-C Analysis of Capital Goods Sector”

Name of the organization : KOTAK SECURITIES, Hubli.

Main Objective:

“To evaluate the performance of Capital Goods companies under study using EIC

Analysis.”

Sub objectives:

6. Analyzing the environmental factors that affect the security prices.

7. Industry analysis of Capital goods Sector

8. To assess the fundamentals of the company in light of financial statements.

9. To arrive at intrinsic value of the company thus enabling the investor in assessing

the worth of the security.

10. I had keen interest to enrich my knowledge in stock market.

Framework of study:

The proper order to proceed in Fundamental analysis is,

First, to analyze the overall economy and securities markets.

Second, analyze the industry with in which a particular company operates.

Finally, analysis of the company should be considered.

The above analysis involves making a careful estimate of expected stream of benefits and

required return of common stock. The intrinsic value then can be obtained through P/E

ratio or earning multiplier approach.


Data Collection Approach:

Secondary Data:

The study is mainly based on analysis of financial statements of the company i.e. balance

sheet and profit and loss account. The same has been collected through;

Company websites and other related websites.

The information is also collected from various magazines like Indian survey 2008

by The Hindu

News papers

Sample Size:

Two large cap companies are taken for study. They are;

Bharat Heavy Electricals Limited

Larsen & Toubro


ECONOMY ANALYSIS:

The level of economic activity has an impact on investment in many ways. If the

economy grows rapidly, the industry can also be expected to show growth and vice-versa.

The analysis of macro economic environment is essential to understand the behaviour of

the stock prices. The commonly analysed macro economic factors are as follows;

1. Global economy

2. Gross Domestic Product (GDP)

3. Industrial growth rates

4. Savings and investments

5. Government budget and deficit

6. Price level and inflation

7. Interest rates

8. Balance of payment(BOP), forex reserves,& exchange rates

9. Infrastructural facilities and arrangements.

10. Sentiments

1. Global economy

In recent years, globalization of capital flows hassled to the growing relevance of

emerging capital markets and India is one of the countries with an expanding stock

market that is increasingly attracting funds from the FIIs. In particular, deregulation and

market Liberalization measures, rapid developments in communication technology and

computerized trading systems, and increasing activities of multi national corporations

have accelerated the growth of Indian capital market.

From 1999 onwards, Indian firms are raising capital from the US market by listing

themselves in US exchanges. The economic dailies as well as official publications have

been full of stories of a newfound alliance between the NSE and the NASDAQ. Through

these news reports, market regulators, traders, and the general investing public in India

have become sensitized to the US stock market movements.


Finally, a quick examination of stock market movements of these two markets suggests

that there exists a substantial degree of inter dependence between the US and Indian stock

market indices.

Facts about FII activities for 2007-08:

There was a lot of turmoil in the stock market since January 2008.We can see that FII’s

have sold there stake significantly. Indian markets are semi-strong markets and hence

they are largely dependent on FII activity.

2. Gross domestic product:

GDP indicates the rate of growth of the economy. GDP represents the aggregate value of

the goods and services produced in the economy. It consists of Personal consumption

expenditure, gross private domestic investment and Government expenditure on goods

and services and net exports of goods and services. The estimates are available on annual

basis. The growth rate of economy points out the prospects for the industrial sector and

the return investors can expect from investment in shares. Higher growth rate is more

favourable to the stock market.


FII Activities (Monthly) * MF Activities (Monthly)

Date Purchase ( Rs

Crore ) Sale ( Rs Crore )

Investment ( Rs Crore)

Investment ($US mm)

Apr-2008

47624.50 46803.10 821.20 238.70

Mar-2008

71159.40 71289.90 -130.40 -32.20

Feb-2008

73776.60 72043.20 1733.30 429.80

Jan-2008

103678.20 116713.90 -13035.70 -3231.60

Dec-2007

85586.40 80007.10 5579.10 1383.00

Nov-2007

89035.90 96380.90 -7345.10 -1820.90

Oct-2007

21981.40 20749.80 1231.60 305.20

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Oct-2007

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Oct-2007

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Nov-2007

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Nov-2007

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Dec-2007

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Dec-2007

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Jan-2008

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Jan-2008

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Feb-2008

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Feb-2008

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Mar-2008

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Mar-2008

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Apr-2008

http://myiris.com/shares/market/marketPulse/fiiMonShow.php?datval=Apr-2008

http://myiris.com/shares/market/marketPulse/mfActShow.php

The GDP of industry sector is in a growing trend with an average of 8.5% whereas the

Chinese GDP has an average of 10.5%. Hence the biggest competition is faced by China.

FY01 FY02 FY03 FY04 FY05 FY06

3. Industrial growth rates:

The current phase of growth is as much due to the investment demand as consumption

demand. Capital goods industries are in a continuous growth phase for the last four years,

and there are no reports of any slackening yet. Intermediate goods (that go into the

manufacturing process like nuts and bolts, fittings and fixtures, yarn, etc) should see a

growth phase now, as the new capacities added over the last four years will start

producing. Basic goods consist of actual chemicals and minerals that are the feedstock of

all manufacturing process.

YOY% change

Basic Capital IntermediateConsumer

durablesConsumer

non-durablesIIP

weight 35.5 9.3 26.5 5.3 23.3 100.01994-95 9.6 9.2 5.3 16.2 11.2 9.11995-96 10.8 5.3 19.4 25.8 9.8 13.01996-97 3.0 11.5 8.1 4.6 6.6 6.11997-98 6.9 5.8 8.0 7.8 4.8 6.71998-99 1.6 12.6 6.1 5.6 1.2 4.11999-00 5.5 6.9 8.8 14.1 3.2 6.72000-01 3.7 1.8 4.7 14.5 5.8 5.02001-02 2.6 -3.4 1.5 11.5 4.1 2.72002-03 4.9 10.5 3.9 -6.3 12.0 5.72003-04 5.4 13.6 6.4 11.6 5.8 7.02004-05 5.5 13.9 6.1 14.4 10.8 8.42005-06 6.7 15.8 2.5 15.3 11.0 8.2

K.L.E.Society’s Institute of Management Studies and Research, Hubli-31

Agriculture (%) na 6.2 -6.9 10.0 0.7 3.9

Industry (%) 6.3 2.7 7.0 7.6 8.6 8.7

Services (%) 5.6 7.1 7.3 8.2 9.9 10.

30

2006-07 9.3 16.1 10.9 12.5 8.7 11.3

4. Savings and investments:

Saving and investment is the portion of amount that is saved and invested by the people

and corporate. Moderate level of saving and high investment is favourable to stock

market, but increase in savings rate indicates little scope for further improvement. It is

obvious that growth requires investment which in turn requires substantial amount of

domestic savings. The table below depicts the favourable trend in savings as well as

investments.

As % of GDP 2003 2004 2005 2006

Gross domestic savings rate 26.4 29.7 31.1 32.4

Gross domestic investment rate 25.2 28.0 31.5 33.8

Source: The Hindu (survey of Indian industry 2008)

5. Government budget and deficit:

The budget draft provides an elaborate account of the government revenues and

expenditure. Fiscal deficit measure the difference between government spending and

revenues. Since government borrowing must offset the budgetary shortfall, large amounts

of government borrowing can force up the interest rate by increasing the total demand for

credit in the economy.

Year Fiscal deficit(as % of GDP) Revenue deficit (as % of

GDP)

2003 5.9 4.4

2004 4.5 3.6

2005 4.0 2.5

2006 4.1 2.6

2007 3.7 2.0

Source: The Hindu (survey of Indian industry 2008)


6. Price level and inflation:

Along with the growth of GDP, if the inflation rate also increases, then the real rate of

growth would be very little. Especially the demand in the consumer product industry is

significantly affected. The industries which come under Government price control policy

may lose the market, for ex: Sugar. If there is a mild level of inflation, it is good for stock

market but high rate of inflation is harmful.

7. Interest rates:

Interest rate is the cost of borrowing depends on nature of instruments, which will be

decided by demand and supply of money and controlled by RBI. It indicates the

attractiveness of future investment opportunity and it is key determinant of business

expenditure. High interest rate reduces the value of future cash flow as well as

opportunities for investment.

8. Balance of payment (BOP), forex reserves, & exchange rates:

Exchange rate measures the value of the rupee over the foreign currency. Exchange rate

decides international competitiveness of domestically produced goods and it can affect

import export, import and the rate of inflation domestically.

The BOP (balance of payment) is the record of a country’s money receipts from and

payments abroad. The difference between receipts and payments may be surplus or

deficit. The BOP is a measure of the strength of rupee on external account. If the deficit

increases, the rupee may depreciate against other currencies, thereby affecting the cost of

imports.

The Forex reserves are also increasing year on year which shows a positive sign. The

reserves as on March 05 were Rs. 619116 crore and have been growing. On June 07 the

forex reserves stood at Rs. 869449. This reserve amount includes SDR’s, Gold, Foreign

currency assets, Reserve tranche position in IMF.

9. Infrastructural facilities and arrangements:


The capital goods industry is driven by this factor. Investment in infrastructure

developments indicates positive signal to the sectors in the economy, especially

manufacturing companies related to transportation. In order to gain from the trade the

transaction costs should be low. So the better facility reduces the cost of trade and

enables the companies for making profit.

More specifically to mention are:

Adequate and regular supply of electric power at a reasonable tariff

A well developed transportation and communication system

Assured supply of basic industrial raw material

Responsive financial support for fixed assets and working capital.

With reference to such importance of infrastructure, our finance minister

Shri.P.Chidambaram mentioned that, to sustain 9 percent GDP growth, investment in

infrastructure should be increased from 4.6 percent to around 8 percent of GDP over the

Eleventh Plan period (2007/12). Hence the capital goods industries will play a major role

in providing for this.

10. Sentiments:

The sentiments of consumers and businessmen have an important bearing on economic

performance. Sentiments influence consumption and investment decisions and have a

bearing on the aggregate demand for goods and services

Thus to sum up: ‘India is not on autopilot to greatness. But it would take an incompetent

pilot to crash the plane'. These words of Mr. Edward Luce very aptly define the contours

of the Indian economy. The economy has been growing at an average annual growth rate

of nearly 6% since the 1980s, and at over 8% during the last three years. Besides, India

has also shown considerable resilience during the recent years and avoided adverse

contagion impact of several shocks. This has precipitated to increased confidence in the

country's financial markets with a consistent increase in gross domestic investment rate

from 25% of GDP in FY03 to 33% in FY06. The gross domestic saving rate has also

improved from 26% to 32% over the same period, contributed by a significant turn


around in public sector saving. A case in this point is that the inflows into mutual funds

alone have multiplied 10 times in the last decade and is currently at all time highs!

For this buoyancy to sustain, the country will have to tide over several stumbling blocks.

Inherent flaws...

First, the poor state of the physical infrastructure, both in terms of quantity and quality.

While with the healthy fundamentals of the domestic financial sector and the enhanced

interest of foreign investors, funding should not pose a problem, issues relating to

regulatory framework and rapid execution need to be addressed by the government.

Second, the fiscal consolidation. The recent budget of the central government targets a

gross fiscal deficit of 3% of GDP by 2009. This requires fiscal empowerment, which is

possible through two routes (i) elimination of subsidies or (ii) elimination of tax

exemptions. While in any economy fiscal consolidation is hard, it is particularly so in our

setting

Third, India is set to remain one of the youngest countries in the world in the next few

decades. This 'demographic dividend' cannot be used to the economy's advantage unless

prerequisites such as skill upgradation and sound governance to realize it are put in place.

Fourth, there is a need to shift the emphasis from foreign institutional investment to

attracting foreign direct investment, which is less volatile. This requires a more favorable

investment climate in general both for domestic and foreign capital.

Global Imbalances...

As India does not depend on the international capital market for financing the fiscal

deficit, the extent of adverse consequences of the global developments would be muted.

However, there could be a spillover effect of global developments on domestic interest

rates and thus on fiscal position. Also, a faster rise in rates overseas could lead to a shift


in investor confidence to the international markets. Further, should there be a reversal of

capital flows, asset prices may decline. With this there is a risk that rise in interest rates in

general could impact the housing market and expose the balance sheet of the households

to interest rate risk, increasing the risk of loan delinquencies for banks. Banks in India

have invested significantly in government debt and other fixed income securities. If a rise

in international rates gets reflected in domestic interest rates, banks will also have to

mark down the value of their investment portfolio.

Multilateral confidence...

Finally, there needs to be the confidence of the investor community on multilateral

aspects such as political stability, terrorism combating ability and significance at global

economic platforms (such as the IMF and World Bank).

While we do not intend to sound pessimistic about the continued resilience of the

economy to global and internal shocks, investors investing in the India story should

assess these grounds before judging the 'market risk' to be assigned to a stock. Weighing

this with the premium expected to be earned over and above the risk free rate (10 year

GSec yield), will help you correctly align your portfolio as per your risk profile.


IMPACT OF BUDGET 2008-09 ON ENGINEERING:

From a policy perspective, however, there has been a growing consensus that a private-

public partnership is required to remove difficulties concerning the development of

infrastructure in the country. The realization finally seems to be setting in. This makes the

future of the Indian engineering sector extremely bright. Apart from highway

development and construction and modernization of airports, the potential for the sector

lies in the oil and gas space, where high global demand has led to increased action in

exploration and production activities. However, scale and execution capabilities remain

the mantras for success.

Budget Measures:

Fourth UMPP at Tilaiya to be awarded shortly; Chhattisgarh, Karnataka,

Maharashtra, Orissa and Tamilnadu urged to bring five more UMPPs to the

bidding stage by extending the required support.

Rajiv Gandhi Grameen Vidyutikaran Yojana to be continued during the Eleventh

Plan period with a capital subsidy of Rs 280 bn; allocation of Rs 55 bn for FY09.

Rs 8 bn to be provided for Accelerated Power Development and Reforms Project

(APDRP) in FY09.

Exemption from 4% additional duty of customs has been withdrawn on power

generation projects (other than mega power projects), transmission, sub


transmission and distribution projects, and specified goods for high voltage

transmission projects.

Custom duty on project imports reduced from 7.5% to 5%

Defence allocation to be increased by 10%.

Excise duty being exempted on end-use basis, on refrigeration equipment

(consisting of compressor, condenser units, evaporator, etc) above 2 TR (tonne

refrigeration) utilising power of 50 KW and above.

Parent company allowed to set-off the dividend received from its subsidiary

company against dividend distributed by the parent company; provided that the

dividend received has suffered DDT and the parent company is not a subsidiary of

another company.

Budget Overview:

Key Positives:

Power play: Since power utilities are one of the biggest consumers (generation,

transmission and distribution) for engineering companies, reforms introduced in the

power sector like privatisation of SEBs will help in strengthening the order book size.

Huge addition in power generation capacity, in order to meet the demand supply gap will

be a big positive for the sector.

Infrastructure development: The government is focusing on development of

infrastructure like housing, airports, roads and ports. This will be big positive for

engineering and construction companies.

Industrial ‘act’: Industrial divisions of engineering companies are likely to benefit from

the increased focus on automation and capacity addition plans drawn by the India Inc.

Key Negatives:


Captive competition: Duty free import of T&D equipments by captive power generation

units, if allowed by government, can have some impact on margins of the T&D majors

because of competition.

People problem: Engineering companies, across the board, are facing troubled times

retaining key employees. This is due to increased levels of competition for talent from

MNCs, who have deep pockets and thus better paying capabilities. As a result of

increasing levels of attrition, some companies are facing execution issues.

COMPANY IMPACT:

Allocation of UMPPs to support growth if equipment and service providers like

BHEL, L&T and Siemens.

Greater focus on the T&D front to be beneficial for ABB, Siemens, Crompton

Greaves, Emco, Bharat Bijlee. Also, companies providing T&D project services

like Jyoti Structures and Kalpataru Transmission to benefit.

Removal of exemption from additional customs duty on power generation,

transmission and distribution projects to benefit domestic companies like BHEL,

L&T, Siemens and Reliance Energy.

Skill development initiatives to pare pressure of attrition from companies like

L&T and BHEL.

Increase in defense allocation to aid prospects of Tata Power, L&T and Bharat

Electronics.


INDUSTRY ANALYSIS:

If one were to consider one of the biggest beneficiaries from any country’s infrastructure

sector development, engineering companies have a vital role to play. As in any other

sector, choices for a retail investor are high for an equity investment. However, it does

that mean each stock in the sector is a BUY? In this article, we have tried to discuss the

dynamics of this sector and the key aspects that one should look in, before selecting an

engineering stock.

PROFILE:

Engineering, as a sector, has many facets. A company from this sector can be an

equipment manufacturer (like transformers and boilers), execution specialist (say BHEL,

L&T, Engineers India) or a niche player (like Thermax in environmental solutions,

Voltas in electro-mechanical projects, ABB for automation technologies and so on). To

define the user industries in broad terms are power utilities, industrial majors (refining,

automotive and textiles), government (public investment) and retail consumers (pumps

and motors). Thus, every company has a specific role to play in the industry and is

looking forward to cater a specific target market. Given this backdrop, prospects of a

particular company in the engineering sector have to be viewed with respect to the

specific user industries. So, if the engineering sector does well, not all companies stand to

benefit in equal proportion.

When will an engineering company grow?

It is highly dependent on the level of private and public sector investment in the

economy. When investments in capacities and infrastructure gains momentum, more jobs

are created and demand for goods in general increases. This in turn leads to higher

economic growth. Historically, the growth of the engineering sector has been sensitive to

economic performance (as is evident from the graph below). The industry is relatively

less fragmented at higher end, as competencies required are high. It is therefore that the

barriers to entry are also high. But in some cases, competition is also global in nature

(like dam construction, roads, refineries and power plants).


Let’s have a look at the demand drivers for this sector:

Order Book:

An engineering company can derive revenues from domestic as well as global markets.

Usually, there is something-called order book that is declared by most of the companies

in its annual report. This is nothing but the quantum of projects that have been won, but

are still to be executed. Therefore, order book position indicates the future growth

prospects.


Most of these companies have an order book to sales ratio in the range of 2.5-4 times

FY07 revenue. This implies that for the next two-to-three years, even if the companies do

not get fresh orders, they can still maintain revenue growth of 30-40 per cent.

Domestic market:

The power sector accounts for approximately 60% of total revenues for this sector.

Therefore, growth in power capacities is very important for engineering companies. So

let’s have a brief look at key fundamental factors that influences power sector

performance.

Historically, politics have played a vital role in shaping the power sector as opposed to

economics (profitability in easy terms). What a retail investor has to keep in mind is that

power capacities will only increase when there is a political will to charge consumers for

what they consume. Industrial sector pays higher tariffs while agricultural sector derives

power free of cost. This is the root cause for the poor financial health of the SEBs (state

electricity boards).

SEBs are financially weak and private sectors have been reluctant to invest, as they are

apprehensive of receiving money for the quantity of power supplied to the SEBs. Retail

investors have to keep in mind that India is power deficient (demand is more than

supply). The simple way to gauge growth of a engineering company that is targeting the

power sector is to understand what kind of capacity SEBs and private sector players are

planning.

It costs Rs 30-35 m to set up one MW of power capacity. If a player is planning to set up

a 1,000 MW plant, then the project size could be around Rs 30 bn to Rs 35 bn. This could

be assumed roughly as the potential addition to the order book. If public sector power

majors are expanding capacity, then it has to be borne in mind that public sector

engineering companies benefit the most (as a matter of preference).


Industrial and Infrastructure spending:

The industrial sector contributes around 30% of the total revenues of engineering sector.

The demand from this segment largely depends on GDP growth, which in turn is a

function of the quantum of infrastructure spending and capacity expansion plans of

corporate India.

A lot depends on government policies. Formulation of policies favorable to industrial

sector can boost the investments and expansion plans for both private and public sector

companies. Talking of policies, when government increases participation of foreign

companies in infrastructure development, the sector gets a fillip. Demand growth in this

sector is fuelled by expenditure in core sectors such as power, railways, infrastructure

development, and private sector investments and the speed at which the projects are

implemented.

The top line trends of major engineering companies since last five years have shown a

high degree of correlation with the IIP (Index of Industrial Production) growth. Thus a

fair idea can be taken about the sector looking at the IIP growth. Let’s look at the

correlation in the graph below.

Exports:

While an engineering company from India could tap global markets for contracts, there is

a vast difference when it comes to competitors. Players like Bechtel and GE have muscle

power and have executed projects on a global scale. This is one of the reasons increasing


contribution from international markets is not easy for any company. Retail investors

have to tread with caution on this front. Due to intense competition in the international

arena, suppliers do not enjoy much bargaining power.

Moreover, in order to win big contracts you need to have big balance sheet size, because

only some part of entire contract money is paid up front and rest comes after installation

of project. Moreover, in some cases, the engineering company buys stake in the projects

during the financial closure.

Key points to be kept in mind before investing…

Order book and operating margins: Order book, as we had said earlier,

indicates a company’s standing in a year in terms of future growth in revenues. A

consistent rise in order book on a year on year basis (and not quarter on quarter) is

also vital. Though order book may be huge for a company, it has to be

remembered that operating margins are low in projects. In a downturn, operating

margins of an engineering company comes under pressure. If a company acts as

an engineering agency (i.e. buys and installs equipment), margins tend to be on

the higher side.

Balance sheet size: One should look at the balance sheet size of the company. It

will tell you whether company is capable of bagging and executing big contracts.

In order to win big contracts and execute them, company needs huge working

capital. In this case, past track record of projects executed could be useful

(available in the balance sheet).

Revenue growth: Usually, an engineering company derives a large share of

revenues in the third and fourth quarter. So, quarter on quarter comparisons is

meaningless in this sense.

Valuation ratios: One of the key factors used when it comes to putting a value

for an engineering company is market capitalization to sales. Why the emphasis

of assigning a value to revenues and not to earnings? The ability to grow for any


engineering company is dependent on the kind of order book, which then

translates into revenues. Internationally, the average of 0.4 times to 0.5 times is a

benchmark. If price to earnings is used, it has to be remembered that the sector is

highly dependent on the economy. So, a P/E in line with the long-term economic

growth could be useful.

Apart from what all has been said above, investor needs to look at the past record of the

management, its vision and its focus on business. After all it’s the management of the

company who is the final decision-maker and the future of the company solely depends

on the decisions taken by it


PORTER’S FIVE FORCE MODEL:

Supply:

Abundant supplies is available across most segments, except for technology

intensive executions.

Demand:

Demand growth in this sector is fuelled by expenditure in core sectors such as

power, railways, infrastructure development, private sector investments and the

speed at which the projects are implemented. The Govt. has been spending

heavily on this sector and this has fuelled the growth of capital goods industry

Barriers to entry:

Barriers to entry are high at upper end of the industry as skilled manpower and

technologies, and ability to fund large projects are a prerequisite. However at the

lower end, the industry is more fragmented.

Bargaining power of suppliers:

Bargaining power of suppliers is low because of intense competition. However, in

technology driven high-end segments, suppliers have the upper hand.


Bargaining power of customers:

Bargaining power for technology driven segments is low as there are very few

producers of engineering goods. And moreover the customer has very less

bargaining power in such industry as compared to FMCG

Competition:

Majority of the companies compete in terms of pricing, experience in specific

field, product differentiation and timely completion of projects. The sector is less

fragmented at top because the competencies required are high.

The other competitor is China which is providing equally good competition.

.


COMPANY ANALYSIS

Company Analysis is the leg in the EIC analysis sequence. It may be organized into two

parts,

1] Study of Financials.

2] Study of other factors.

The companies taken for EIC Analysis in this project are’

1] Bharath Heavy Electricals Limited [BHEL]

2] Larsen and Toubro [L&T]


PROFILE OF THE COMPANIES UNDER STUDY:

BHARAT HEAVY ELECTRICALS LIMITED [BHEL]:

OVERVIEW:

BHEL is the largest engineering and manufacturing enterprise in India in the energy-

related/infrastructure sector, today. BHEL was established more than 40 years ago,

ushering in the indigenous Heavy Electrical Equipment industry in India - a dream that

has been more than realized with a well-recognized track record of performance. The

company has been earning profits continuously since 1971-72 and paying dividends since

1976-77.

BHEL has acquired certifications to Quality Management Systems (ISO 9001),

Environmental Management Systems (ISO 14001) and Occupational Health & Safety

Management Systems (OHSAS 18001) and is also well on its journey towards Total

Quality Management.


BHEL has,

Installed equipment for over 90,000 MW of power generation -- for Utilities,

Captive and Industrial users.

Supplied over 2,25,000 MVA transformer capacity and other equipment operating

in Transmission & Distribution network up to 400 kV (AC & DC).

Supplied over 25,000 Motors with Drive Control System to Power projects,

Petrochemicals, Refineries, Steel, Aluminum, Fertilizer, Cement plants, etc

Supplied Traction electrics and AC/DC locos to power over 12,000 kms Railway

network.

Supplied over one million Valves to Power Plants and other Industries.

BHEL's operations are organised around three business sectors, namely Power,

Industry - including Transmission, Transportation, Telecommunication & Renewable

Energy - and Overseas Business. This enables BHEL to have a strong customer

orientation, to be sensitive to his needs and respond quickly to the changes in the market.

BHEL's vision: “To become a world-class engineering enterprise, committed to

enhancing stakeholder value”.

The greatest strength of BHEL is its highly skilled and committed 42,600 employees.

Every employee is given an equal opportunity to develop himself and grow in his career.

PRODUCT PROFILE:

Established in the late 50’s, Bharat Heavy Electricals Limited (BHEL) is, today, a

name to reckon with in the industrial world.

It is the largest engineering and manufacturing enterprise of its kind in India and

one of the leading international companies in the power field.


BHEL offers over 180 products and provides systems and services to meet the

needs of core sectors like: power, transmission, industry, transportation, oil & gas,

non-conventional energy sources and telecommunication.

A wide-spread network comprising 14 manufacturing divisions, 8 service centres,

4 power sector regional centres, 18 regional offices, besides a large number of

project sites spread all over India and abroad, enables BHEL to be close to its

customers and cater to their specialised needs with total solutions - efficiently and

economically.

An ISO 9000 certification has given the company international recognition for its

commitment towards quality. With an export presence in more than 60 countries,

BHEL is truly India’s industrial ambassador to the world.

OVERSEAS BUSINESS:

BHEL, ranking among the major power plant equipment suppliers in the world, is one of

the largest exporters of engineering products & services from India. Over the years,


BHEL has established its references in around 60 countries of the world, ranging from

the United States in the West to New Zealand in the Far East. BHEL's export range

covers individual products to complete Power Stations, Turnkey Contracts for Power

Plants, EPC Contracts, HV/EHV Sub-stations, O&M Services for familiar technologies,

specialized after-market services like Residual Life Assessment (RLA) studies and

Retrofitting, Refurbishing & Overhauling, and supplies to manufacturers & EPC

contractors.

RESEARCH AND DEVELOPMENT:

To remain competitive and meet customers' expectations, BHEL lays great emphasis on

the continuous upgradation of products and related technologies, and development of new

products. BHEL's commitment to advancement of technology is reflected in its

involvement in the development of futuristic technologies like fuel cells and

superconducting generators. BHEL's investment in R&D is amongst the largest in the

corporate sector in India. Products developed in-house during the last five years

contributed about 7% to the revenues in 2005-06.


COMPANY MANAGEMENT:

Board of Directors:

Name Designation

Mr. Ashok K Aggarwal Director

Mr. Anil Sachdev Director

Mr. S K Jain Director

Dr. Surajit Mitra Director

Mr. Sanjay M Dadlika Director

Mr. Shekhar Datta Director

Mr. K Ravi Kumar Chairman and Managing director

Mr. B S Meena Part Time Director

Mr. Madhukar Director

Mr. C S Verma Director

Mr. A K Mathur Director

Mr. S Ravi Part Time Director

Mr. B P Rao Director

Mr. C P Singh Director

Mr. Manish Gupta Director


COROPORATE NEWS:

Power equipments built by state-run Bharat Heavy Electricals (BHEL) registered

a record generation of 454.6 billion units of electricity in 2007-08, compared to

432.6 billion units in the year-ago period.

State-run power plant equipment maker BHEL has won orders worth around Rs

20.30 billion from Bharathiya Rail Bijlee Company (BRBCL).

The power ministry agreed to give power equipment manufacturer Bharat Heavy

Electricals (BHEL) a few of NTPC`s supercritical 660mw and 800mw projects on

a negotiated basis.

The government-owned Bharat Heavy Electricals (BHEL) has secured the state-

run Chhattisgarh State Electricity Board`s (CSEB`s) contract to set up two power

plants in Korba district quoting Rs 19.6 million per Mw, the lowest it has ever

quoted for a power plant in the country,

State-run BHEL and Nuclear Power Corporation on Friday signed a memorandum

of understanding (MoU) to float a joint venture (JV) company for executing

nuclear power projects in India and abroad

Bharat Heavy Electricals (BHEL) will sign a memorandum of agreement (MoA)

with Nuclear Power Corporation of India to float a joint venture for

manufacturing equipment for nuclear power plants.

Bharat Heavy Electricals (BHEL), India`s biggest power equipments maker has

further enlarged its global footprint with a foray into a new market New

Caledonia, with a prestigious export contract for environment friendly circulating

fluidized bed combustion (CFBC) boilers.


Bharat Heavy Electricals (BHEL) is likely to spend nearly Rs 50 billion over the

next three years in its yet-to-be-formed joint venture companies with power utility

NTPC and Nuclear Power Corporation of India (NPCIL)

Bharat Heavy Electricals (BHEL) bagged orders worth around Rs 20.30 billion

for the supply and installation of the main plant package at the upcoming 1,000

MW Nabinagar Thermal Power Project in Bihar, involving four units of 250 MW

each.

Bharat Heavy Electricals (BHEL) plans to buy a local engineering company to

expand capacity. The power-equipment maker may buy a company of a size of

about Rs 4 billion.Bhel is seeking to expand capacity to help the country’s effort

to add at least 600 gig watt of electricity by 2030.


LARSEN AND TUBRO [L&T]:

CORPORATE OFFICE:

OVERVIEW:

Larsen & Toubro Limited (L&T) is a technology, engineering, construction and

manufacturing company. It is one of the largest and most respected companies in India's

private sector. Seven decades of a strong, customer-focused approach and the continuous

quest for world-class quality have enabled it to attain and sustain leadership in all its

major lines of business. L&T has an international presence, with a global spread of

offices. A thrust on international business has seen overseas earnings grow significantly.

It continues to grow its overseas manufacturing footprint, with facilities in China and the

Gulf region. The company's businesses are supported by a wide marketing and

distribution network, and have established a reputation for strong customer support. L&T

believes that progress must be achieved in harmony with the environment. A

commitment to community welfare and environmental protection are an integral part of

the corporate vision

Strategic Mission - LAKSHYA (Hindi for Target) To compete and grow in a globalised

business environment, L&T is implementing a strategic plan (LAKSHYA) for 2005-10.

The plan has been drawn up in consultation with a leading international strategy

consultant. It has set ambitious growth targets for each business. Also included are

opportunities for diversification of L&T's business portfolio


ORGANIZATION STRUCTURE:


HISTORY:

The evolution of L&T into the country's largest engineering and construction

organization is among the most remarkable success stories in Indian industry.

L&T was founded in Bombay (Mumbai) in 1938 by two Danish engineers,

Henning Holck-Larsen and Soren Kristian Toubro. Both of them were strongly

committed to developing India's engineering capabilities to meet the demands of

industry.

Beginning with the import of machinery from Europe, L&T rapidly took on

engineering and construction assignments of increasing sophistication. Today, the

company sets global engineering benchmarks in terms of scale and complexity..

GLOBAL PRESENCE:

L&T has a global presence. A thrust on international business over the years has seen

overseas revenues growing steadily. The company has manufacturing facilities in India,

China, Oman and Saudi Arabia. It has a global supply network with offices in 10

locations worldwide, including Houston, London, Milan, Shanghai, and Seoul.

Customers include global majors in over 30 countries.

SUBSIDIARIES AND ASSOCIATES:

The L&T Group has a number of subsidiaries & associates worldwide.

Engineering and Construction

Machinery and Industrial Products

Information Technology

Financial Services


TECHNOLOGY:

In every sphere of L&T's operations, technology is the key enabler, reinforcing its

leadership position, and sustaining its competitive strengths. While for some, technology

is a means to an end, for L&T, technology represents endless possibilities

ENGINEERING AND CONSTRUCTION:

In engineering and construction, L&T's technology capabilities include a strategic mix of

in-house strengths and the expertise of its joint venture partners. Engineering Centers at

Mumbai, Vadodara and Delhi carry out process design and simulation, analysis of

computational fluid dynamics, mechanical design, failure analysis and trouble shooting.

L&T has set up an engineering and project management centre in Abu Dhabi, to

undertake oil and gas related projects as well as engineering and consultancy services.

An engineering centre in Sharjah is an extended arm in the Gulf. This is supplemented

through collaborations with key partners: L&T-Valdel for engineering services in the

upstream hydrocarbon sector, L&T-Chiyoda for the mid and down stream sectors, and

L&T Sargent & Lundy for the power sector.

The engineering services provided by L&T's Engineering Design Research Centers at

Chennai and Kolkatta include feasibility studies, project reports, system engineering,

architectural, structural and civil design for infrastructure development projects.


L&T-Ramboll Consulting Engineers provides civil engineering and consultancy services

for a wide range of projects in the transportation sector - ports, airports, highways and

bridges.

MANUFACTURING:

L&T's design & engineering capabilities in manufacturing enable it to set new

benchmarks in terms of scale, sophistication and speed. The Company has dedicated

engineering centres at the manufacturing locations. Two 'Technology Development

Centres' have been set up to develop new products and manufacturing technologies. L&T

also collaborates with the organisations like ISRO to bolster its capabilities in the

strategic sectors of aerospace, defence and nuclear power. L&T's Electrical and

Electronics Division, is a pioneer in the design of switchgear and switchboards that are

engineered for tropical conditions. It has built further on this experience, and has

leveraged its R&D strengths to develop a host of new products and features. In 2006-07,

the division filed applications for over 80 patents. Cumulatively, L&T's Electrical &

Electronics Division has applied for and secured 247 patents - a landmark for an Indian

company. Patent applications cover innovations made on a variety of low voltage

indigenously developed switchgear products like the air circuit breakers (ACBs) and

moulded case circuit breakers (MCCBs), medical products, petroleum dispensing pumps,

tooling solutions and switchboards

TECHNOLOGY SERVICES:

L&T provides its global clients with the winning edge through the development of

optimal solutions. L&T's e-engineering services leverage the Company's own engineering

heritage and experience. The Embedded Systems unit provides technological assistance

across a broad spectrum - design, maintenance, re-engineering, testing, prototyping and

industrial design.


Board of Directors:

Name Designation

Mr. Subodh Bhargava Additional Director

Lt. Gen. Surinder Nath Non Executive Director

Mr. K Venkataramanan Whole Time Director

Mr. Y M Deosthalee Whole Time Director

Mr. J P Nayak Whole Time Director

Mrs. Bhagyam Ramani Director

Mr. K V Rangaswami Whole Time Director

Mr. A M Naik Chairman and Managing director

Mr. N Mohan Raj Nominee Director

Mr. M V Kotwal Whole Time Director

Mr. Thomas Mathew T Nominee Director

Mr. U Sundararajan Non Executive Director

Mr. R N Mukhija Whole Time Director

Mr. S N Talwar Non Executive Director

Mr. V K Magapu Whole Time Director

Mr. M M Chitale Non Executive Director


CORPORATE NEWS:

L&T to develop Rs 35 bn integrated commercial complex at Navi Mumbai.

L&T to bag Rs 480 bn order in Joint Venture with Mitsubishi Heavy Industries.

L&T secures Rs 20 bn contract from Bombay Dyeing for developments at the

Textile Mills & Spring Mills complexes at Worli and Wadala regions of Mumbai

respectively.

Cairn had awarded a Rs 6 billion contract to L&T in February for the laying of a

heated pipeline for transporting crude oil from Barmer in Rajasthan to Salaya in

Gujarat.

Larsen & Toubro (L&T) bagged four orders worth Rs 16.87 billion from the

Government of Rajasthan, Bhushan Steel-Orissa, SAIL Bokaro Steel Plant and

the Damodar Valley Corporation (DVC). The orders are for water supply projects,

sinter plant and cold roll mill and a coal handling plant

Larsen & Toubro`s (L&T) through its E&C division`s refinery projects business

unit received Rs 5.76 billion order from Hindustan Petroleum (HPCL).

Larsen & Toubro (L&T), India`s biggest engineering company, has made public

its plans to ramp up its manufacturing capacity of super-critical boilers and super-

critical turbine generators to 4,000 mw per annum. The foundation stone for the

upgraded facility was laid at Hazira on Mar. 19, 2008.

The Heavy Engineering Division of India`s largest engineering company Larsen

& Toubro (L&T) bagged a contract valued at Euro 28 million (Rs 1.70 billion)

for supply of the Coal Gasifier and Syngas Cooler assembly to Hebi Coal and

Electricity Co of China.

Larsen & Toubro (L&T), a USD 5 billion technology, engineering and

construction company with global operations, announced on Tuesday, that the

electrical & electronics division (EBG) of the company bagged Rs 747 million

contracts to supply SCADA system for onshore control centers (OCC) for


offshore operations of Oil and Natural Gas Corporation (ONGC). L&T has been

awarded this project by outbidding international competitors.

ANALYSIS OF COMPANY FINANCIALS

B. LIQUIDITY RATIOS

These ratios measure the firm’s liquidity position. It is firm’s ability to meet its short term

obligations. There are three types of ratios through which the liquidity position can be

assessed. They are

Current ratio

Quick/acid-test ratio

Absolute cash ratio.

1. CURRENT RATIO:

It is calculated as following

Current Ratio = Current Assets / Current Liabilities

Relevance:

• Current Liability coverage: Higher the current ratio, greater is the assurance

we have that current liabilities will be paid.

• Buffer against losses: Current Ratio shows the margin of safety available to cover

shrinkage in non cash current asset values when ultimately disposing off or liquidating

them

• Reserve of liquid funds: It is the measure of margin of safety against uncertainties and

random shocks to the company’s cash flows.

Limitations:


It is static measure of resources available at a point in time to meet the current

obligations. The current reservoir of cash does not have a logical or causal relation to its

future cash flows. These cash flows depend on factor excluded from the ratio i.e sales,

expenditure, cash, profits.

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

Current assets133430.00 16330.78 21062.97 8795.41 9535.45 11884.66

Current liabilities84459.00 10320.02 14420.11 5556.57 6910.55 9337.26

Current Ratio1.58 1.58 1.46 1.58 1.38 1.27


Interpretation:

BHEL- The cash and cash equivalents have increased from Rs.4133.97 crore in 2005-06

to Rs. 5808.91 crore in 2006-07 reflecting the sound liquidity of the company. On the

other hand, this increase has been set off by decrease in loans and advances.

L&T- The ratios of current assets to liabilities is in decreasing trend. The ratio signifies

how much assets are available with them for every rupee of obligation. The company had

24% (2006 to 2007) increase in current assets whereas the liabilities increased by 39% in

FY07. This was on account of advances to customers and unpaid expenses

Based on current ratio we can say BHEL is better–off than L&T as far as liquidity

is concerned.

2. QUICK RATIO:

A more stringent test of the liquidity uses the Liquidity ratio, also known as the Quick or

the Acid Test Ratio which includes the assets most quickly convertible to cash. This is a

better test of liquidity as it handles issues of window dressing.


Quick (Acid Test) Ratio = (Current Assets – Inventory) / Current Liabilities

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

CA-Inv 130519.0

012586.41 16845.30 8795.41 9535.45 11884.66

CL 84459.00 10320.02 14420.11 5556.57 6910.55 9337.26

Quick ratio 1.55 1.22 1.17 1.18 1.06 0.95

Interpretation:

Quick ratio is also called as acid test ratio. The industry standards say 1:1 ratio is

preferable. Both the companies have maintained except for L&T in the FY07 this is

because of large amounts due to customers and it also shows that greater amount of assets

is tied up in inventory. BHEL stands strong as compared to L&T.

ABSOLUTE CASH RATIO:

This ratio tests the liquidity on an immediate basis as it tests for liquidity with the cash

and near cash items only. Absolute cash ratio indicates whether a firm has enough short-

term assets to cover its immediate liabilities without selling inventory. This ratio is also


known as acid-test ratio. Companies with ratios of less than 1 cannot pay their current

liabilities and should be looked at with extreme caution. Furthermore, if the acid-test ratio

is much lower than the liquid ratio, it means current assets are highly dependent on

inventory. It is expressed as

Absolute Cash Ratio = (Current Assets – Stock – Debtors)/ Current Liabilities

Interpretation:

Again in cash ratio, L&T falls behind BHEL. The later being a PSU was able to maintain

its liquidity better than L&T. especially in the FY06 the value is very low. The reason for

this is, the balance of fixed deposits with scheduled banks is less as compared to other

years. This amount is utilized to meet the expenses of the company


B. TURNOVER RATIOS

Efficiency or Turnover Ratios measures the efficiency of asset management. Each

turnover ratio defines the asset differently. These ratios are based on the relationship

between the level of activity, represented by sales or cost of goods sold and levels of

various assets.

FIXED ASSETS TURNOVER RATIO:

The firm may wish to know its efficiency of utilizing fixed assets. This ratio measures

sales per rupee of investment in fixed assets and is given by,

Fixed assets turnover Ratio=Net sales/Gross block

Sometimes Net fixed assets (depreciated value) are used for computing the turnover ratio.

As a result the ratio may be higher in the case of an old established company as compared

to new one, other things being equal. This may render comparison of firm’s over a period

or with other firms meaningless.


Interpretation:

Gross Block and capital Work in progress increased by Rs. 312.99 crore, and Rs. 117.97

crore during the year 07 due to Capital expenditure incurred on ongoing capacity

augmentation programme at various manufacturing units and the erection and

commissioning facilities at project sites has lead to increase in the ratios of BHEL. The

capital expenditure on capacity addition has lead to increase in the ratio of BHEL.

On the other side L&T has been able to maintain stable ratio of around 6 times which is

far more than BHEL. Interpreting the reciprocals, we may say that for generating a sale

of Re.1, BHEL needs Rs.0.24 investment in fixed assets as compared to L&T which

needs investment of Rs.0.16.

TOTAL ASSETS TURNOVER RATIO:

This ratio shows the firm’s ability in generating sales from all financial resources

committed to total assets. The ratio is also known as the investment turnover ratio. The

higher the turnover ratio, the more efficient is the management and utilization of assets


while low turnover ratio is indicative of underutilization of available resources and

presence of idle capacity

Total Assets turnover ratio= Net Sales/total assets

Where;

Total assets = Net fixed Assets + Current Assets

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

Net sales 9527.14 13374.03 17237.53 13049.79 14734.80 17578.84

Total assets 14387.00 17313.06 22051.71 9855.35 11113.11 14028.70

Total assets turnover 0.66 0.77 0.78 1.32 1.33 1.25

Interpretation:

L&T is more efficient than BHEL in utilizing the assets. L&T has been efficient enough

to generate sales more than a rupee for every one rupee invested in fixed and current

assets together. BHEL over the 3 years have increased the sales per rupee invested. The

BHEL’s vision for 2012 insists the company to improve its efficiency .


INVENTORY DAYS:

A financial measure of a company's performance that gives investors an idea of how long

it takes a company to turn its inventory (including goods that are work in progress, if

applicable) into Sales.

Inventory turnover ratio = Cost of Goods Sold/Average inventory

Inventory Days = Inventory turnover ratio/360

Cost of goods sold include material cost, labour cost and other manufacturing expenses

such as fuel & power, repairs & maintenance, consumable stores, insurance on goods,

and so on. Average inventory is taken as

= (Opening inventory + closing inventory)/2

Generally a high inventory turnover is indicative of good inventory management. A low

inventory turnover implies excessive inventory levels than warranted by production and

sales activities, or a slow moving or obsolete inventory. A high level of sluggish

inventory amounts to unnecessary tie-up of funds, reduced profits and increased costs. A

high turnover ratio is to be carefully analysed. A high inventory turnover may be result of

a very low level of inventory which results in frequent stock-outs; the firm may be living

from hand to mouth

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

COGS 8681.63 11195.08 14046.92 11239.16 12452.88. 14336.45

Avg inv 226.34 295.87 316.07 237.34 221.33 218.68

Inv Turnover 38.36 37.84 44.44 47.35 56.26 65.56

Inventory days 9.39 9.51 8.10 7.60 6.40 5.49


Interpretation:

In terms of efficiency, L&T outlasts BHEL. But very high ratio of L&T may become a

problem for it. The turnover ratio tells how many times the inventory of finished goods is

converted to sales in a year. The ratios of both the companies reveal a good turnover of

sales and reduced inventory holding period. Since these companies have huge orders in

hand, we can expect the companies to perform better.

DEBTORS TURNOVER

A ratio used to work out how many days on average it takes a company to get paid for

what it sells. It is calculated by dividing the figure for trade debtors shown in its accounts

by its sales, and then multiplying by 360.

Debtor days = (debtors ÷ Sales) ×360

This indicates whether debtors are being allowed excessive credit. A high figure (more

than the industry average) may suggest general problems with debt collection or the

financial position of major customers.


BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

Sales 10336.40 14525.49 18738.95 13254.56 14883.68 17900.59

Debtors 6726.71 7168.07 9695.82 6726.71 4814.16 5504.64

Drs Turnover 1.54 2.03 1.93 1.97 3.09 3.25

Debtors days 234.28 177.65 186.27 182.70 116.44 110.70

Interpretation:

Collection of debtors is more efficient in case of L&T. In case of L&T, there has been a

decrease in the in debtors days. In case of BHEL, Debtors in absolute terms increased by

Rs. 2527.75 crore mainly due to increase in turnover. In terms of days of turnover it

increased from 177 days in 2006-07 to 187 days in 2006-07. The price of capital goods in

high and the payments are usually made in parts hence the collection period is more as

compared to the inventory turnover.


C. SOLVENCY RATIOS:

TOTAL DEBT RATIO:

This ratio depicts the proportion of the interest bearing debt in the capital structure. This

ratio is given by;

Total debt ratio = Total Debt/Total Debt+Networth

Total debt will include short and long term borrowings from financial institutions,

debentues, deferred payment arrangements for buying capital equipments and bank

borrowings, public deposit and any other interest bearing loan.

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

TD 536.98 558.24 89.33 1859.06 1453.57 2077.75

TD+NW 6563.88 7859.62 8877.59 5228.19 6093.74 7846.18

Total debt ratio 0.08 0.07 0.01 0.36 0.24 0.26


Interpretation :

The debt component in BHEL is very low, almost nil that is because the Secured loan of

Rs. 500 crore towards bonds were redeemed during the year and repaid on its maturity.

Unsecured Loan represents assets taken on lease. The company being a PSU is funded

mostly by equity.

The debt ratio of L&T is more when compared to BHEL this component is used to

finance the growth plans.

DEBT EQUITY RATIO:

It is a measure of a company's financial leverage calculated by dividing its total liabilities

by stockholders' equity. It indicates what proportion of equity and debt the company is

using to finance its assets.

DER = long-term debt / Shareholder's Equity


A high debt/equity ratio generally means that a company has been aggressive in financing

its growth with debt. This can result in volatile earnings as a result of the additional

interest expense. If a lot of debt is used to finance increased operations (high debt to

equity), the company could potentially generate more earnings than it would have

without this outside financing. If this were to increase earnings by a greater amount than

the debt cost (interest), then the shareholders benefit as more earnings are being spread

among the same amount of shareholders. However, the cost of this debt financing may

outweigh the return that the company generates on the debt through investment and

business activities and become too much for the company to handle. This can lead to

bankruptcy, which would leave shareholders with nothing.

The debt/equity ratio also depends on the industry in which the company operates.

Interpretation:

There is just a nominal component of debt in BHEL. The sharp decrease in the ratio

during the FY07 is due to redemption of bonds worth Rs.500crs. the company further

plans to increase its authorized capital to Rs.2000crs from the present level of Rs.325crs

On the other hand, decrease in debt due to conversion of FCCB’s.. The ratio is again

more in the FY07. The increase was due to sharp increase in unsecured loans, both short-


term and long term to finance its present activities and also to supplement the growth

plans.

INTEREST COVERAGE RATIO:

The interest coverage ratio is a measurement of the number of times a company could

make its interest payments with its earnings before interest and taxes. The interest

coverage ratio shows the number of times the interest charges are covered by funds that

are ordinarily available for their payment. The lower the ratio, the higher the company’s

debt burden and embarrassment to the firm regarding its payment of the interest charges

ICR = EBDIT / Total Interest Expense

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

EBDIT 1663.03 2623.10 3779.40 1340.13 1388.72 2038.82

Interest expenses 81.41 58.75 43.33 53.99 75.07 33.93

Interest coverage ratio 20.43 44.65 87.22 24.82 18.50 60.09


Interpretation:

The coverage reveals the margin with which the firm can meet its financial obligations.

The coverage ratios of BHEL have been increasing due to the reduced debt component in

their capital structure. Whereas the ratio of L&T reveals that coverage is low due to the

increased interest and brokerage payments in the year 2006. The ratio of BHEL are high

as compared to L&T due to less obligations

D. PROFITABILITY RATIOS

The profit margin ratios state how much profit the company makes for every dollar of

sales. The net profit margin ratio is the most commonly used profit margin ratio. A low

profit margin ratio indicates that low amount of earnings, required to pay fixed costs and

profits, is generated from revenues. A low profit margin ratio indicates that the business

is unable to control its production costs.

The profit margin ratio provides clues to the company's pricing, cost structure and

production efficiency. The profit margin ratio is a good ratio to benchmark against

competitors.


GROSS PROFIT MARGIN:

The gross profit margin reflects the efficiency with which management produces each

unit of product. This ratio indicates the average speed between the COGS and the sales

revenue. When we subtract the GPM from 100%, we obtain the ratio of COGS to sales.

Both these ratios show profits relative to sales after the deduction of production cost and

indicate the relation between production cost and selling price.

=Gross Profit/net sales

A high GPM implies that the firm is able to produce at relatively lower costs.

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

Gross Profit (EBIT)1663.03 2623.10 3779.40 1340.13 1388.72 2038.82

Net sales9527.14 13374.03 17237.53 13049.79 14734.80 17578.84

GPM0.17 0.20 0.22 0.10 0.09 0.12

Interpretation


The Gross Profit Margin for both the companies is in increasing trend. This is a positive

sign.BHEL has better Gross Profit Margin as compared to L & T. The COGS has been

decreased to the extent of 2% and 3% for BHEL and L & T respectively. Though there

was an increase in operating expenses, this was set-off by more sales. This reason holds

good to both the companies.

NET PROFIT MARGIN:

Net Profit Margin Ratio establishes a relationship between net profit and sales and

indicates management’s efficiency in manufacturing, administering and selling the

products. This ratio is the overall measure of firm’s ability to turn each rupee sales into

net profit. This ratio is more important to shareholders. A high net profit margin is

advantageous. It is taken as a percentage.

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

Net Profit (PAT) 953.41 1679.16 2414.70 983.85 942.39 1403.02

Net sales 9527.14 13374.03 17237.53 13049.79 14734.80 17578.84

GPM0.10 0.13 0.14 0.08 0.06 0.08


Interpretation:

The interpretation has more meaning when the ratios are analysed jointly. In case of both

the companies, the GPM has been increasing and so is the NPM. This shows that the

companies are performing efficiently and are using the resources in an optimum way

OPERATING EXPENSE RATIO:

It is calculated by taking the ratio of operating expenses to sales for a period. The percentage

that remains after deducting the operating expense ratio, is the percentage of revenue that is

available to cover interest, taxes, earnings to owner

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

Operating 8681.63 11477.83 14218.78 12376.68 13697.31 15835.60


BHEL L&T

exp

Net sales 9527.14 13374.03 17237.53 13049.79 14734.80 17578.84

Op exp ratio0.91 0.86 0.82 0.95 0.93 0.90

Interpretation:

The operating expense ratio is decreasing for both the companies. This implies that the

company is left with more income to cover its obligations and also give good returns to

its stakeholders. BHEL expense ratio is impressive as it is left with 18% of its sales to

meet its expenses of interest, taxes and earnings.

RETURN ON EQUITY

RONW essentially checks the return on investment (ROI) of the owners’ fund also

known as the Net Worth or NW. RONW assess the Profit Distributing Ability(PDA) of

the company, i.e. how much profit will the owners/shareholders get for every unit of

investment they have made.

Return on Net worth = PAT/ Net worth

BHEL L&T


2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

PAT 953.41 1679.16 2414.70 983.85 942.39 1403.02

Net Worth 6026.89 7301.38 8788.26 3369.13 4640.17 5768.43

ROE0.16 0.23 0.27 0.29 0.20 0.24

Interpretation:

The Return on Equity is showing favourable trend. In case of L&T, the ROE has reduced

in the FY06 but that was due to increased borrowings to finance the growth of the

company. in the FY07 , the returns are again increased.

RETURN ON CAPITAL EMPLOYED (ROCE) RATIO

ROCE explains the overall utilization of funds by a business enterprise. It says how much profits

we earn from the amount invested by the Shareholders. Capital Employed means the long-term

funds employed in the business and includes the shareholder s fund, debentures and long-term

loans. Profit before Interest and Tax is considered for computation of this ratio to make

numerator and denominator consistent.

It is calculated as –

ROCE=Profit before Interest and Tax (PBIT) / Capital Employed x 100 %

BHEL L&T


2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

PBIT 1663.04 2623.10 3779.40 1340.13 1388.72 2038.82

Capital employed 6563.88 7859.62 8877.59 5228.19 6093.74 7846.18

ROCE0.25 0.33 0.43 0.26 0.23 0.26

Interpretation:

Here the returns are studied in comparison with capital employed i.e. Debt plus Net

worth. The sharp increase in the ratio of BHEL in FY07 was due to substantial increase

in PBIT(44%) which is not met by proportional increase in Capital employed(12%).

Whereas L&T saw an increase of 46% in PBIT which was partially set off by increase in

capital employed (30%).

RETURN ON TOTAL ASSETS:

ROTA tells us how well management is performing on all the firm's resources. However,

it does not tell how well they are performing for the stockholders. The ROTA of a

company determines its ability to utilize the Assets employed in the company efficiently

and effectively to earn a good return. The ratio measures the percentage of profits earned

per Rupee of Asset and thus is a measure of efficiency of the company in generating

profits on its Assets. It is calculated as -

ROTA=Profit before Interest after Tax (PBIT) / Total Assets x 100 %

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

PBIT 1663.03 2623.10 3779.40 1340.13 1388.72 2038.82

Total assets 14387.22 17313.00 22051.71 9855.35 11113.11 14028.70

ROTA 0.12 0.15 0.17 0.14 0.12 0.15


Interpretation:

The sales generated for every rupee invested in fixed assets is more or less same for both

the companies. BHEL gives 12%, 15% and 17% returns on total assets for FY05,FY06

and FY07 resp. and L&T has given returns of 14%, 12% and 15% resp. BHEL has been

able to generate 2% more returns than L&T in FY07.

EARNINGS PER SHARE

The portion of a company's profit allocated to each outstanding share of common stock.

EPS serves as an indicator of a company's profitability. Companies often use a weighted

average of shares outstanding over the reporting term. EPS can be calculated for the

previous year ("trailing EPS"), for the current year ("current EPS"), or for the coming

year ("forward EPS"). Note that last year's EPS would be actual, while current year and

forward year EPS would be estimates. The EPS is of two types, one Basic and the other

Diluted(which considers the potential shareholders on account of convertible bonds).

It is calculated as

EPS = PAT/ Number of shares outstanding.

Where,

EPS= earnings per share


PAT= Profit after tax

Interpretation:

BHEL: Since the number of shares has remained constant, the rise can be fully attributed

to the increased earnings over the years. The earnings has increased by 153% over the

period of three years

L&T: The EPS is in downward trend. This is due to the change in the number of shares

outstanding as a result of convertibles.

The basic EPS is always more than diluted it considers only the existing outstanding

shares and not the convertibles, potential stock option etc.

DIVIDEND PER SHARE:

A performance metric used to gauge the quality of a company's earnings per share (EPS)

if all convertible securities were exercised. Convertible securities refer to all outstanding

convertible preferred shares, convertible debentures, stock options (primarily employee

based) and warrants. Unless the company has no additional potential shares outstanding

(a relatively rare circumstance) the diluted EPS will always be lower than the simple

EPS.

DPS = Total Earnings/ (No of Shares outstanding + No of possible convertible


shares)

This is a conservative metric because it indicates somewhat of a worst-case scenario.

On one hand, everyone holding options, warrants, convertible preferred shares, etc.

is unlikely convert their shares all at once. At the same time, if things go well, there

is a good chance that all options and convertibles will be converted into common

stock.

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

Dividends 195.81 354.90 599.66 357.21 302.25 368.25

Shares outstanding 24.48 24.48 24.48 12.67 13.30 27.94

DPS8.00 14.50 24.50 28.19 22.73 13.18

Interpretation:

BHEL: The dividend per share has increased from Rs.8 in the FY05 to Rs.24.5 in FY07

i.e. 206% growth. This phenomenal growth is due to the increased earnings and constant

equity share capital. The Board of Directors in January, 2007 recommended the issue of

Bonus Shares in the ratio of 1:1 to the Shareholders of the company.

L&T: The dividend paid is more than BHEL. In FY07, the number of outstanding shares

was increased to 27.94 as compared to FY06, 13.03.


DIVIDEND PAYOUT RATIO:

It is also known as payout ratio. It measures relationship between the earnings belonging

to the ordinary shareholders and the dividend paid to them. In otherwords, D/P ratio

shows what percentage share of PAT or preference dividend is paid to the owners by the

total profits/earnings available to them.

D/P ratio =Dividend per share/EPS*100

If the D/P ratio is subtracted from 100, retention ratio is obtained. This ratio shows what

percentage of the net profits are retained in the business

Retention ratio = 100 - D/P ratio

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

DPS 8.00 14.50 24.50 28.19 22.73 13.18

EPS 38.95 68.60 98.66 70.85 67.53 48.36

Pay-out ratio 0.21 0.21 0.25 0.40 0.34 0.27

Retention ratio 0.79 0.79 0.75 0.60 0.66 0.73


Interpretation:

Both the company’s payout ratios met the industry standard which was 20% for FY07.

Thus, the companies are good in paying dividends.

.

MARKET BASED RETURNS:

These are several common stock ratios that convert key bits of information about the

company; to a per share basis. They are used to assess the performance of the company

for stock valuation purposes and helps investors take investment decisions.

PRICE EARNING RATIO:

P/E ratio = Market Value per Share / Earnings per Share

P/E is a valuation ratio of a company's current share price compared to its per-share

earnings. A high P/E suggests that investors are expecting higher earnings growth in the

future compared to companies with a lower P/E.

BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

MPS 383.70 1123.48 1130.38 497.58 1216.30 1619.15

EPS 38.95 68.60 98.66 70.85 67.53 48.36

P/E ratio9.85 16.38 11.46 7.02 18.01 33.48


The market price per share may be the price prevailing on a certain day or the average

price over a period of time. The EPS is simply the PAT less preference dividend divided

by number of shares outstanding.

The P/E ratio is used to value the firm’s performance as expected by investors. P/E ratio

reflects investor’s expectations about the growth of the firm’s earnings. Industries differ

in growth prospects; accordingly, the P/E ratios for industries vary widely.

Interpretation:

The ratio is higher incase of L&T. This means that investors are expecting a lot from

L&T when compared to BHEL. Though BHEL is equally good the investors are

expecting more from L&T and this has lead to decrease of P/E ratio.

The P/E ratio reflects the growth prospects, risk characteristics, shareholder orientation,

corporate image, and degree of liquidity.

PRICE TO BOOK VALUE

Price to book Ratio =Market price per share /book value per share

Where, Book value = Share capital + Reserves &surplus/ No.of shares

Price to Book Ratio is used to compare a stock's market value to its book value. A

lower P/B ratio could mean that the stock is undervalued. However, it could also mean

that something is fundamentally wrong with the company.

In a way this ratio reflects the contribution of a firm to the wealth of society when this ratio

exceeds 1, it means that the firm has contributed to the creation of wealth in the society.


BHEL L&T

2004-05 2005-06 2006-07 2004-05 2005-06 2006-07

MPS 383.70 1123.48 1130.38 497.58 1216.30 1619.15

BV 246.24 298.31 359.06 256.94 335.61 202.65

PBR1.56 3.77 3.15 1.94 3.62 7.99

The ratio of both the companies is showing a positive trend i.e. the ratio is more than 1

which is favorable and which means the company has contributed significantly to the

creation of wealth of society.


COMPOUNDED ANNUAL GROWTH RATE:

To measure the historical growth, the compounded annual growth rate (CAGR) is

calculated.

SALES

CAGR= [Sales for 2007/Sales for 2005] 1/2 - 1

BHEL L&T

= [17237.53 / 9527.14] ½ -1

=1.345 – 1

= [17578.84/ 13049.79] ½ -1

=1.16 – 1

= 0.345 or 34.5% = 0.16 or 16%

Thus the historical growth of BHEL is more than that of L&T. the reason for huge

growth is the result of growing infrastructure facilities and the orders in hand.

EARNINGS PER SHARE

CAGR (EPS) = [EPS for 2007/EPS for 2005] 1/2 – 1

BHEL L&T

= [98.66/ 38.95] ½ -1

=1.591 – 1

= [48.36/70.85] ½ -1

= 0.83 – 1

= 0.591 or 59.10% = (0.17)or 17%(decrease)


There has been consistent growth in the EPS of BHEL due to the increased earnings and

constant number of shares. The EPS of L&T has decreased over a period of three years as

a result of increased number of shares due to conversion (diluted EPS).

DIVIDEND PER SHARE

CAGR (DPS) = [DPS for 2007/DPS for 2005] 1/2 - 1

BHEL L&T

= [24.50/ 8.00] ½ -1

=1.75 – 1

= [13.18/28.19] ½ -1

= 0.68– 1

= 0.75 or 75% = (0.32)or 32%(decrease)

There has been consistent growth in the DPS of BHEL due to the increased earnings and

constant number of shares. The DPS of L&T has decreased over a period of three years

as a result of increased number of shares due to conversion in FY06 and FY07 (diluted

EPS).

VOLATILITY OF ROE:

It is calculated with the help of the following

=Range of ROE over the period of 2005-07/ Average ROE

BHEL L&T

= (0.27-0.16)/0.22 = (0.29-0.20)/0.25

= 0.5 = 0.36

The volatility in returns of L&T is low when compared to that of BHEL.


SUSTAINABLE GROWTH RATE (EXPECTED GROWTH RATE):

The get a handle over the kind of growth that can be maintained, sustainable growth rate

is calculated. It is the maximum rate at which the firm can grow by using internal sources

(retained earning) and additional external debt without increasing its Debt-equity ratio.

= Average Retention ratio * Average ROE

BHEL L&T

= 77.67 * 0.22 = 66.33 * 0.25

= 0.1708 or 17.1% = 0.1658 or 16.58%


CALCULATION OF EXPECTED SHARE PRICE

(VALUE ANCHOR):

The valuation is inherently an uncertain and imprecise exercise. It would be naïve to put

great faith in a single point intrinsic value estimate. Hence it would be wise to define an

intrinsic Value range ex: Rs.30 to 38. Given this value range , the decision rule may be

as follows;

The expected share price is calculated by

Intrinsic value = P/E Ratio * Expected EPS

Where,

Projected EPS = Current EPS + g (20.25 %)

Ex: The projected EPS is Rs.5 and the appropriate PE multiple is 6.87. The value anchor

is Rs.34.35. Now take a value range, assume Rs30 to Rs38. Given this range, the decision

rule may be as follows;

K.L.E.Society’s Institute of Management Studies and Research, Hubli-31

Market price Decision

Less than Value range Buy

Between value range Hold

More than Value range Sell

Market price Decision

Less than Rs.30 Buy

Between Rs.30 to Rs.38 Hold

More than Rs.38 Sell

94

BHEL

BHEL

Weighted average price - FY08 (annexure) 2,111.83

Current share price (as on 25.4.2008) 1,870.00

P/E ratio (as on 25.4.2008) 37.91

Present EPS # (post bonus, FY08 provisional) 58*

Expected growth 20.25

Projected EPS {EPS+(EPS*g)} 69.75

EXPECTED SHARE PRICE (Projected EPS*P/E ratio) 2644*Taken from company performance highlights

Interpretation :

Value anchor (intrinsic value) = Rs. 2644

Value range= Rs.2600 to Rs.2700

Current market price (25-4-08) = Rs 1870

Since market price is less than intrinsic value, the stock is worth buying

The expected share price for BHEL is Rs.2644. Based on the fundamentals, the EPS is

calculated and growth of 20.25% is added for the subsequent FY09.


L&T:

L&T

Weighted average price - FY08 (annexure) 3,002.59

Current share price (as on 25.4.2008) 2,981.85

P/E ratio (as on 25.4.2008) 62.13

Present EPS # (post bonus, FY08 provisional) 53.6

Expected growth 20%

Projected EPS {EPS+(EPS*g)} 64.32

EXPECTED SHARE PRICE 3,996.2

Interpretation:

Value anchor (intrinsic value) = Rs. 3996.2

Value range = Rs.3900 to Rs.4050

Current market price (25-4-08) = Rs 2981.25

Since market price is less than intrinsic value, the stock is worth buying. Once the

market price exceeds intrinsic value, it is to be sold

Thus the expected share price of L&T is more than that of BHEL. This is due to the high

P/E ratio.


FINDINGS:

ECONOMY:

When come to the economic factors the global economies are getting

interrelated, the Indian market will no longer be limited to domestic economic

situation. Especially the US market has a strong bearing on Indian stock market.

The important factors that have bearing on stock market are FII inflows, exchange

rates. The most important being the GDP, infrastructure facilities, IIP, etc which

have a direct bearing on price of the stock.

INDUSTRY – ( Engineering – Heavy ) :

The demand driver for this sector is the Order book.

Most of these companies have an order book to sales ratio in the range of 2.5-4

times FY07 revenue. This implies that for the next two-to-three years, even if the

companies do not get fresh orders, they can still maintain revenue growth of 30-

40 per cent..

The IIP growth during April - January 2007-08 has declined to 8.7% when

compared to 11.2% IIP growth during 2006-7. Tight monetary policy has resulted

in high interest rates which have been the major factor contributing to the decline

in IIP growth.

COMPANY:

When Liquidity ratios are concerned, BHEL has an upper hand over L&T. The

Current ratio, quick ratio and cash ratios of BHEL are better than L&T.

But Efficiency ratios show the other picture. Total assets turnover, fixed assets

turnover ratio, inventory days and debtor’s turnover of L&T are better than

BHEL. L&T is able to utillise its assets more efficiently.

When Solvency ratios are studied, we see that the debt component in BHEL has

been reduced to 0.1(FY07) from 0.8 (FY05). The debt of BHEL has substantially

reduced in FY07 to 0.1as a result of redemption of 8.85% Non-convertible,


secured, Redeemable Taxable Bonds worth Rs.500 crores. Incase of L&T, also

the debt has decreased. The bonds have been redeemed in FY06 but

simultaneously Zero coupon bonds were issued. This decrease has lead to

increased interest coverage ratio.

Profitability ratios: The GPM has been increasing and so is the NPM. This shows

that the companies are performing efficiently and are using the resources in an

optimum way. The returns on equity and capital employed have been rising due to

increased earnings.

The EPS and DPS have consistently increased in BHEL because of increased

earnings and constant number of shares. Whereas in case of L&T, the EPS has

reduced in FY07 to Rs.48 due to increased number of shares arising from issue of

bonus.

Market based returns: the P/E ratio which shows investors expectations have

increased for both the companies. L&T has higher P/E ratio of 33.48 as compared

to 11.48 of BHEL.

Fundamentals of those companies are quite strong. None of the fundamental

signals for disinvestments for moving out of computer and software industry.

CAGR SALES 34.5% 16%

CAGR EPS 59.1% -17%

CAGR DPS 75% 32%

SUSTAINABLE GROWTH RATE 17% 16.58%

VOLATILITY 0.5 0.36

When compare to the specific indicators like sales growth, the BHEL will be in

the first place then followed by L&T

The CAGR EPS for L&T has come negative due to reduced EPS on account of

bonus issue.

The Volatility of returns is high in BHEL as compared to L&T. Hence L&T is

better because it is more consistent.

The value anchor for BHEL is Rs.2644 and for L&T is Rs.3996.2


RECOMMENDATIONS

1. The valuation is inherently an uncertain and imprecise exercise. It would be naïve to

put great faith in a single point intrinsic value estimate. Hence it would be wise to

define an intrinsic Value range. Ex: 2600-2700.

2. Intrinsic value of BHEL is Rs.2644 and the present market price is Rs.1870. Hence it

is recommended to buy BHEL stock as its current market price is lower than its fair

value range.


BHEL Rs.1870 < Rs.2600 to Rs.2700 BUY

3. Intrinsic value of L&T is Rs.3, 996.2 and the present market price is Rs.2981.85.

Hence it is recommended to buy L&T stock as its current market price is lower than

its fair value range.


L & T Rs.2981.85 < Rs.3950 to Rs.4050 BUY

4. After a close scrutiny of economy industries and companies in considering the risk, it

may be recommended that international economy might affects the firms export

prospects, the price competition it faces from competitors, or the profit it makes from

abroad. Investor should properly analyze both globally and domestically before

taking investment decision.

5. The investor also should consider the budget decision and present years forecast of

different sectors

6. However, there are such things as a final answer to security values, a dozens experts

arrive at twelve different conclusions. Market values are fixed only in part by balance

sheet and income statement; much more by hopes and fears of humanity; by greed, by


act of god, where the investor should carefully consider the emotional factors

influence the market.

7. Of all the systems, the researcher is of the view that fundamental analysis even today

holds good. It demands, may insist on information about the company. It requires

subjecting a company’s performance and its financial statements to in-depth scrutiny.

It also calls for the company and industry in which the company operates

8. Fundamental analysis is the effective tool to differentiate penny stocks from

fundamentally good company with good growth prospects.

9. It is to be kept in mind that to gain maximum returns, fundamental analysis is to be

studied in combination with technical analysis


CONCLUSION

In current market scenario all stocks have been valued at discounted price and hence the

current market price is very low for most of the stocks. They really fluctuate badly

without any scientific reasons and the reasons given in the news are just market

perception, which has no base. Indian stock market is not matured and hence the

fluctuation in the share prices is tremendous.

When the example of L&T and BHEL who are really performing well up to the

expectations is considered,. L&T's 52 weeks high and low prices are - Rs 4,690 and Rs

1,539 at NSE.& BHEL's 52 weeks high and low prices are - Rs 2,930 and Rs 1,178 at

NSE

In Indian share market, the share price movement does not show the performance of the

Company. In case of L&T and BHEL, under fundamentals, the share price data primarily

fluctuate due to -

Present performance,

Guidance of future performance given by the company (In case of L&T the same

is not available),

Present order book,

Contracts won by these Companies. When they win any big ticket contracts the

share prices generally goes up.

New contracts expected to win (under negotiation)

These are the basic fundamental reasons for share price movement apart from various

economic factors like demand-supply of securities, market liquidity, FII inflows, etc.

these economic factors also have the bearing on the stock market.

Indian market is a Semi-strong market and other economic factors have a bearing on it.

Investment in securities is more fruitful when it is done for a long period. While investing

in any of the securities one should look into fundamentals of the company but should not

ignore technical analysis completely.

Investment in stocks is serious business. Hence all the homework is to be done before

plunging onto anything.

Bibliography


Websites :-

www.equitymasters.com

www.indiaearnings.com

www.bseindia.com

www.nseindia.com

www.finance.yahoo.com

www.myiris.com

Magazines and Newspapers:-

Money Today

Indian survey for 2008

Business world

Business Line

Business Standard

Books:-

Essentials of Financial Management-I M Pandey

Financial Management 4th Edition-Khan & Jain

Investment Analysis & Portfolio Management-Prassana Chandra

ANNEXURES


BHEL:





For 2005 & 2006

For 2006 & 2007:

Post bonus EPS = Rs. 98.66*1/2 = Rs. 49.33



LARSEN AND TOUBRO:





For 2005 & 2006

For 2006 & 2007


Documents

Fundamantal or EIC Analysis- Capital Goods Sector