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INDIAN MANUFACTURING: PROFIT POTENTIAL AND … · The Indian automobile industry is the seventh-largest in the world. It forms an important part of the country’s manufacturing sector,

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Page 1: INDIAN MANUFACTURING: PROFIT POTENTIAL AND … · The Indian automobile industry is the seventh-largest in the world. It forms an important part of the country’s manufacturing sector,
Neeraj.Arya
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INDIAN MANUFACTURING: PROFIT POTENTIAL AND OPPORTUNITIES ACROSS THE VALUE CHAIN
Page 2: INDIAN MANUFACTURING: PROFIT POTENTIAL AND … · The Indian automobile industry is the seventh-largest in the world. It forms an important part of the country’s manufacturing sector,

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1. SNAPSHOT OF INDIA'S MANUFACTURING SECTOR
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CONTENTS
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2. INDUSTRY ANALYSIS
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2.1 Automotive and Auto Components
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2.2 Engineering goods
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3. CONCLUSION
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2.3 Oil and Gas
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2.4 Chemicals
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2.5 Textiles and Apparels
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Manufacturing sector accounts for nearly 16 per cent of India's GDP1. The government's NMCC2 envisages increasing the share of manufacturing to 25 per cent of the GDP by 2025. India's manufacturing sector consists of a number of industries. The major industries are engineering goods, automotive, oil and gas, chemicals, and textiles. Together these make up roughly 50 per cent of the sector. This report analyses the profitability of top players across the value chain and identifies opportunities for these five industries. The value chain of auto sector consists of auto components and automotive manufacturers. The profitability, as measured by five-year average EBITDA3 margin of major companies in the sector stood at 15.1 per cent. The automotive segment enjoys higher profitability, with its average five-year EBITDA margin standing at 19.5 per cent compared with 15.9 per cent for auto-components sector. The major demand driver of growth in the auto sector has been the rising per capita income, especially in semi urban and rural areas. The value chain of engineering goods sector consists of machine tools and heavy engineering. The extended value chain would have other manufacturing industries such as automotive, textiles and chemicals following the heavy engineering segment. The five-year average EBITDA margin of major companies in the sector stood at 12.9 per cent. The machine tool makers enjoy a higher profitability, with their average five-year EBITDA margin standing at 15.7 per cent compared with 10.6 per cent for heavy engineering companies. The government's emphasis on infrastructure development in recent years has been the major driver of growth for this sector. The value chain of the oil and gas sector is divided into three components: upstream, midstream and downstream. Exploration and production are considered upstream activities, while storage and transportation are midstream. Downstream comprises refining, processing and marketing of oil and gas. The five-year average EBITDA margin of major companies in the overall sector stood at 27.1 per cent. There is a marked contrast in profitability across the value chain, as the average EBITDA margin of upstream players stands at 48.2 per cent compared with just 4 per cent for downstream players.
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EXECUTIVE SUMMARY
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1 GDP is Gross Domestic Product 2 NMCC is National Manufacturing Competitiveness Council 3 EBITDA is Earnings Before Interest, Tax, Depreciation and Ammortisation
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The value chain of the chemicals sector begins with petrochemicals, which are converted into basic chemicals. These basic chemicals are used for polymer production; this is further converted into special chemicals. The five-year average EBITDA margin of major companies in the sector stood at 20.9 per cent. The average profitability of the low value-add chemical producers was found to be 43.2 per cent, while that of integrated players varied from 15 per cent to 23 per cent. The value chain of the textiles sector begins with fibre production, which is spun into yarn. The yarn is knit into fabrics, which are further used to manufacture garments. However, most of the large firms in the sector are integrated players operating on the entire value chain. The five-year average EBITDA margin of major companies in the sector stood at 16.4 per cent. Exports have been the major driver of growth in the sector.
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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 5

………………………………………………………………………………………………………………………….........

1. SNAPSHOT OF INDIA‟S MANUFACTURING SECTOR

Manufacturing holds a key position in the Indian economy, accounting for nearly 16 per cent of real GDP in FY12 and employing about 12.0 per cent of India’s labour force. Growth in the sector has been matching the strong pace in overall GDP growth over the past few years. For example, while real GDP expanded at a CAGR of 8.4 per cent over FY05-FY12, growth in the manufacturing sector was marginally higher at around 8.5 per cent over the same period. Consequently, its share in the economy has marginally increased during this time – to 15.4 per cent from 15.3 per cent.

Exhibit 1 Size of the manufacturing sector in India

Source: RBI, Aranca Research

Exhibit 2

Growth in real GDP and manufacturing in India (%)

Source: RBI, Aranca Research

Rapid growth in the manufacturing sector has been accompanied by the higher productivity and profitability of Indian manufacturing companies.

14.8

15.0

15.2

15.4

15.6

15.8

16.0

16.2

16.4

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

Manufacturing sector (size in INR billion, constant prices)

Share in real GDP (%)

3

5

7

9

11

13

15

FY06 FY07 FY08 FY09 FY10 FY11 FY12

GDP Manufacturing Services

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 6

…………………………………………………………………………………………………………………………......... A study4 by the Reserve Bank of India (RBI) found that these companies’ productivity was 24 per cent higher in 2005 compared to that in 2000. It also derived that Indian companies achieved higher profit growth during the period. Despite expected dips in profits during the 2009 downturn, manufacturing industries have been resilient and are back on the recovery path towards pre-crisis levels or even higher. An example of the latter is the automotive industry, which has been reporting strong growth in business activity owing to high domestic and export demand. The rising competitiveness of India’s manufacturing companies is reflected in the country’s ranking as second in the world in terms of competitiveness as per the 2010 Global Manufacturing Competitiveness Index5 (GMCI) prepared by the US Council on Competitiveness and Deloitte. This index factors in market dynamics and policy issues that influence the sector. India is ahead of major developed and emerging economies such as the US, South Korea, Brazil and Japan. Going forward, the nation’s competitiveness would increase further with its index score set to improve to 9.01 (out of 10) in the next five years from the 2010 figure of 8.15.

Exhibit 3 2010 Global Manufacturing Competitiveness Index

Current Rank CountryIndex Score

Rank in 2015

1 China 10.00 1

2 India 8.15 2

3Republic of Korea

6.79 3

4United States of America

5.84 5

5 Brazil 5.41 4

6 Japan 5.11 7

7 Mexico 4.84 6

8 Germany 4.80 8

9 Singapore 4.69 11

10 Poland 4.49 9

New add* Thailand - 10 Source: Deloitte and US Council on Competitiveness *New addition among the top-10 countries. Currently Thailand is ranked 12th with an Index Score of 4.17

All these developments have significantly boosted India’s manufacturing prowess. After China, the country is currently the largest producer of textiles, chemical

4 “Profitability of Indian Corporate Sector: Productivity, Price or Growth?”, Reserve Bank of India Occasional Papers, Vol. 28, No. 3 5 based on the views of more than 400 senior manufacturing executives worldwide

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 7

…………………………………………………………………………………………………………………………......... products, pharmaceuticals, basic metals, general machinery and equipment, and electrical machinery, as per the United Nations Industrial Development Organisation (UNIDO). The sector’s importance to the domestic and global economy is set to rise even further in FY12 as a combination of supply-side advantages, policy initiatives, and private sector efforts set India on the path to become a global manufacturing hub. 2. INDUSTRY ANALYSIS

India’s manufacturing sector consists of a number of industries. The major industries are engineering goods, automotive, oil and gas, chemicals, and textiles. Together these make up roughly 50 per cent of the manufacturing sector’s weight in the IIP6. Some of the industries have pure play companies present only in one segment of the value chain, while others are characterised by presence of integrated players across the chain in order to achieve synergies associated with either backward or forward integration as the case maybe in a particular industry. The major industries listed above have been analysed in the research note. Porter’s Five Forces Model7 is used to determine the attractiveness of the industries concerned. In the analysis below, we use a colour code to indicate attractiveness in our diagrammatic representations; green indicates a favourable scenario, yellow is neutral and red denotes an unfavourable scenario. For instance, if the threat of new entrants is green, it means that there is low threat from new entrants to the industry, hence enhancing the attractiveness quotient of that segment. Profitability of the top companies across the value chain is analysed for each of the sectors by considering their five-year average EBITDA margin values, and opportunities are identified for each of the sectors. 2.1 Automotive and Auto Components

The Indian automobile industry is the seventh-largest in the world. It forms an important part of the country’s manufacturing sector, accounting for nearly 22 per cent of the total manufacturing GDP. The automobile industry generated a gross turnover of USD58.68 billion in FY11; volumes more than trebled over the last decade (FY00-10). The auto components industry has been a high-growth industry in the last decade, generating USD39.9 billion in revenues during FY119. The auto sector’s IIP10 (as indicated under motor vehicles, trailers & semi-trailers) expanded at a rate of 15.1 per cent during FY06–12*(Includes April – Feb 2012) to reach 256.3 from the base year FY05. This classifies the auto sector into the high-growth category (10–20 per cent). 6 The current IIP (with base year as 2004-05) 7 The forces of Porter‟s model are – threat of new entrants, threat of substitutes, competitive rivalry, bargaining power of suppliers and bargaining power of customers. Attractiveness in this context refers to the overall industry profitability, so an "attractive" industry is one in which the combination of these five forces acts to drive overall profitability levels. 8 Society of Indian Automobile Manufacturers (SIAM) 9 Automotive Component Manufacturers Association of India (ACMA) 10 IIP is the Index of Industrial Production

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 8

………………………………………………………………………………………………………………………….........

Exhibit 4 Growth in motor vehicles, trailers & semi-trailers (IIP)

Source: Central Statistical Organisation, Aranca Research; Note: *FY12 includes April – Feb 2012

Sector Composition: Organised sector dominates in Automotives; Auto Components is highly unorganised The automotive industry consists of well-established companies such as Maruti Suzuki, Tata Motors, Mahindra and Bajaj Auto, while the auto components industry is largely unorganised (accounts for over 90 per cent of the total companies). However, the smaller organised segment accounts for over 77 per cent of the overall production. Major growth drivers

Demand fundamentals: The rising per capita income over the last decade has been a major driver for this industry, especially with rural incomes also increasing at a decent pace in the same time frame. Demand for commercial vehicles also received a boost in the last few years due to roadway development in urban and rural areas, which leads to greater market access. Easier access to credit has been another major facilitator of the industry’s growth as private banks got into the business of auto financing and tapped into the huge and growing market.

Favourable policy: Favourable policy measures from the government have aided the sector’s growth. These measures permit the automatic approval of foreign equity in the sector and encouraged R&D by offering rebates on auto companies’ R&D expenditure. The Indian government also set up NATRiP11s at a cost of USD390 million to adapt and implement global performance standards. This initiative offers support to small car manufacturers as a reduction of excise duty on them was announced.

11 NATRiP is National Automotive Testing and R&D Infrastructure Project

-15

-10

-5

0

5

10

15

20

25

30

35

FY06 FY07 FY08 FY09 FY10 FY11 FY12*

Motor vehicles, trailers & semi-trailers

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 9

…………………………………………………………………………………………………………………………......... Attractiveness of the industry

Exhibit 5 Porter‟s five forces of the Indian auto sector

Source: Aranca Research

Value chain of automotive industry The industry’s value chain is consists of the auto components segment and automaker segment. The segment can be further divided into many sub-segments such as engine and parts, transmission and steering parts, suspension and braking parts, and others. The automotive segment comprises two-wheelers, three-wheelers, passenger vehicles and commercial vehicles.

Thre

at o

f new

ent

rant

s

•High startup

capital required

•Highly technology intensive

Thre

at o

f sub

stitu

tes

•Fairly mild

threat of substitutes in form of mass transit and bicycles

Com

petit

ive

riva

lry

•Two-three

large companies in each segment

•Entry of foreign players has increased competition

Bar

gain

ing

pow

er o

f sup

plie

rs

•Well-

established supplier base

•Large players can have controlling power over the suppliers

Bar

gain

ing

pow

er o

f cus

tom

ers

•Customers

have a wide variety to choose from

•Large customer-to-producer ratio favours automakers

High Medium Low

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 10

………………………………………………………………………………………………………………………….........

Exhibit 6 Value chain of the auto sector

Source: Aranca Research

Profitability across the value chain

The industry enjoys high levels of profitability as seen from the figures of major companies across the automotive and auto component segments given below. The scatter graph shows the average of the top companies’ EBITDA margins of the last five years. The average profitability of the considered set of major automotive companies12 was 19.7 per cent compared to 15.9 per cent of the auto component companies13, suggesting that an automotive manufacturer enjoys a higher profit margin than an auto component manufacturer.

Exhibit 7 Five-year average of the EBITDA margins of top Indian automotive and auto

component companies

Source: Thomson Reuters, Aranca Research

12 Maruti Suzuki, Tata Motors, Mahindra Motors, Bajaj Auto 13 Lumax Autos, Gabriel India Ltd., Rane Holdings Ltd., Omax Autos Ltd., Sona Koyo Steering

Systems Ltd.

Auto components

Suspension & braking parts Equipment

Electrical parts Others

Engine & engine parts

Transmission & steering parts

Automotive

Two-wheelers Three-wheelers

Passenger vehicles Commercial vehicles

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Rane Holdings Ltd

Gabriel India Ltd Omax Autos Ltd

Maruti Suzuki India Ltd

Mahindra Motors

Bajaj Auto Ltd

Sona Koyo Steering Systems Ltd Lumax Autos Ltd

Tata Motors

Page 11: INDIAN MANUFACTURING: PROFIT POTENTIAL AND … · The Indian automobile industry is the seventh-largest in the world. It forms an important part of the country’s manufacturing sector,

Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 11

………………………………………………………………………………………………………………………….........

Opportunities in the sector

The Indian automotive sector is at a very attractive stage of growth with the country emerging as a global R&D and small-car manufacturing hub.

Indian auto component manufacturers on the other hand are moving up the value chain and delivering complex products as per the needs of global clients; however, their focus still remains the growing domestic industry.

Maruti Suzuki – continuing strongly on its journey of success

Case Study Maruti Suzuki India Limited, headquartered at New Delhi, is a partial subsidiary of Suzuki Motor Corporation of Japan. It is India's largest passenger car company, accounting for over 45% of the domestic car market.

Exhibit 8

Continuing on the journey of success

Source: Maruti Suzuki, Aranca Research

2012 Roll out of 10

millionth car

Roll out of peoples car (Maruti 800)

Capacity expansion

Enhanced R&D capability

Increased productivity

Product portfolio expansion

Continuing market

leadership

1994 Production of

1 millionth

car

Expansion plans to produce 1.7 million cars by

2013

Product portfolio comprising 16

passenger vehicle models

55% market share in the

Indian car market

In the process of establishing Suzuki’s largest R&D facility

outside Japan

1983 1994 1997 2001 2004 2006 2007 2008 2009 2010 2011

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 12

………………………………………………………………………………………………………………………….........

The company offers a range of cars across segments from the entry level to hatchbacks, sedans as well as the 'C' segment and SUV14 categories. The government had an ownership stake in it until 2007, when it sold its complete share to Indian financial institutions, thereby totally privatising it. Maruti Suzuki is widely credited for bringing along an automobile revolution in the country and has been the Indian car market’s leader for close to three decades. The company is launching new products across different segments to expand its customer base. These products include a low-cost low-emission Eeco model for the rural masses and small businesses, and a venture into the luxury sedan segment for the first time with Kizashi. Maruti Suzuki is also re-launching Swift, its best seller, with a design and features to make it appealing to a wider audience.

2.2 Engineering goods

Engineering goods is the largest segment of the overall Indian industrial sector. India is planning to spend over a trillion dollars during the next few years in infrastructure building. The machinery and capital goods industry is set to capitalise on this strong growth with most companies in the sector already reporting massive orders worth more than double or treble their annual revenues. India’s engineering industry also exports light engineering equipment worth several billion dollars, mostly to developing countries. The IIP of the engineering goods15 expanded at a CAGR of 20.4 per cent during FY05–12 (FY12 data covers April – Feb) to reach 367 from the base year FY05. This classifies it into the excellent growth category (>20 per cent).

Exhibit 9 Growth in Indian engineering goods excluding automotives (from IIP)

Source: Central Statistical Organisation, Aranca Research; Note: The proxy used to indicate the growth in the IIP of engineering goods include the following IIP heads: Machinery and equipment n.e.c, Office, accounting & computing machinery, Electrical machinery & apparatus n.e.c., Radio, TV and communication equipment & apparatus; FY12* includes April - Feb2012 data

14 SUV – Sports utility vehicle 15 IIP of Machinery and equipment n.e.c, Office, accounting & computing machinery, Electrical machinery & apparatus n.e.c., Radio, TV and communication equipment & apparatus together are used as a proxy for engineering goods

-20%

0%

20%

40%

60%

80%

100%

FY06 FY07 FY08 FY09 FY10 FY11 FY12*

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 13

………………………………………………………………………………………………………………………….........

Major growth drivers

Emphasis on infrastructure: Capacity additions for power generation and an increase in infrastructure spending in the country have been the industry’s major drivers.

Favourable policy: Favourable policy measures from the government have aided the sector’s expansion. The Indian government de-licensed the industry and allowed 100 per cent FDI in the sector. The government granted a significant number of SEZs for the engineering sector across the country.

Attractiveness of the industry

Exhibit 10 Porter‟s five forces of the engineering goods sector in India

Value chain of the engineering goods industry The industry’s value chain begins at machine tool manufacturers, who supply products to heavy engineering divisions and then make products that are used across other manufacturing industries such as automotive, textiles, chemicals, basic metals and food products. Many of the industries mentioned would also directly use basic machine tools, which are at the beginning of the value chain.

Thre

at o

f new

ent

rant

s

•Requires

significant investment and long-term outlook

•MNCs looking to expand/re-locate would find India attractive

Thre

at o

f sub

stitu

tes

•No threat of

substitutes

Com

petit

ive

riva

lry

•Large number

of domestic and global companies

•Highly fragmented

•High level of competition among organised players B

arga

inin

g po

wer

of s

uppl

iers

•Abundant

supply of raw materials

•Well-established supplier base

Bar

gain

ing

pow

er o

f cus

tom

ers

•Demanding customers who are significant players themselves

•High growth in demand across segments

High Medium Low

Source: Aranca Research

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 14

………………………………………………………………………………………………………………………….........

Exhibit 11 Value chain of engineering

Source: Aranca Research

Profitability across the value chain The industry enjoys high levels of profitability as seen from the figures of major companies across the machine tools and heavy engineering segments. The scatter graph shows the average of the top companies’ EBITDA margins of the last five years. It is interesting to note that machine tool manufacturers16 (15.7 per cent) enjoy a higher profitability (five-year average EBITDA margin) when compared to heavy engineering companies17 (10.6 per cent). In fact, the largest company in the machine tools market, Kennametal India, has an average EBITDA margin of 20.7 per cent. 16 Kennametal India, Kabra Extrusiontechnik, Austin Energy Co., Sterling Tools Ltd. 17 L&T, Punj Lloyd, Crompton Greaves, ABB

Machine tools Engineering

Heavy engineering

Light engineering

Other manufacturing

industries

Automotive Textiles

Chemicals Basic metals

Oil and gas Food products

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 15

………………………………………………………………………………………………………………………….........

Exhibit 12

Five-year average EBITDA margin of top Indian companies in engineering goods

Source: Bloomberg, Aranca Research

Opportunities in the sector

Growth in power generation, privatisation of distribution, and government initiatives to create a national distribution grid are set to contribute to the rise in transmission and distribution expenditure in the near future.

With the projected demand of the capital goods sector being high (especially the automobile and textile industry), there is going to be significant demand for machine tools.

Considering the increasing demand for higher productivity, superior precision and accuracy as well as low-cost manufacturing solutions, computer numerically controlled (CNC) machine tools are set to be in greater demand.

2.3 Oil and Gas

India is the fifth-largest energy consumer in the world. The Indian oil and gas industry acts as a significant catalyst in fuelling the country’s economic growth. Crude oil is the larger of the two segments and accounts for over 80 per cent of the industry’s revenues; natural gas accounts for the remainder. The nation has large coal, crude oil and natural gas reserves. Crude oil reserves remained stable at 757.4MMT in 2011, while natural gas reserves increased to 1,241 BCM in 2011 from 1,148.6 BCM in 2010, according to the Ministry of Petroleum. The Indian oil and gas industry ranks second after Australia in BMI’s18 composite business environment (BE) league table; the country is followed by China and Vietnam. The nation is ahead of Vietnam in BMI’s upstream BE ratings, and shares first place with China in downstream BE ratings. The oil and gas market was valued19 at USD54.9 billion in 2009 and is expected to reach USD69.1 billion by 2010, marking 18 BMI is Business Monitor International 19 India Oil and Gas report by Datamonitor

0.0

5.0

10.0

15.0

20.0

25.0

Kabra Extrusiontechnik

L&T

Crompton Greaves ABB

Kennametal India

Austin Energy Co

Punj LLyod

Gammon India Sterling Tools Ltd

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 16

…………………………………………………………………………………………………………………………......... a 25.9 per cent growth. The sector’s IIP20 expanded at a rate of 3.2 per cent during FY05–12 (FY12 data is for April – Feb) to reach 124.7 from the base year FY05. This classifies the oil and gas sector into the moderate growth category (0–10 per cent).

Exhibit 13 Growth in coke, refined petroleum products and nuclear fuel in India (IIP)

Source: Central Statistical Organisation, Aranca Research (*FY12 includes Apr-Feb 2012)

Major growth drivers

Industrial usage boosting demand: Several industries are increasing the usage of natural gas in operations; this has boosted natural gas demand in India. Some of the main industries that use natural gas are pulp and paper, metals, chemicals, glass, plastic and food processing. Since 2005, FDI worth USD3,338.75 million was invested (till February 2012) in the Indian petroleum and natural gas sectors. Investments worth USD563 billion were envisioned across the oil and gas value chain under the country’s Eleventh Five Year Plan (2007–12).

Favourable government policy: Favourable policy measures from the government have aided the sector’s growth. The government allows 100 per cent FDI in the production segment, while it allows 49 per cent for the refining segment. The New Exploration Licensing Policy (NELP) was conceived to attract the interest of domestic private sector companies and some foreign companies with eight rounds of bidding; Reliance Industries and Cairn have been particularly active in this arena.

20 IIP of „Coke, refined petroleum products & nuclear fuel‟ is used as proxy for the oil and gas industry as refined petroleum products form the major component of the classification

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

FY06 FY07 FY08 FY09 FY10 FY11 FY12*

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 17

………………………………………………………………………………………………………………………….........

Exhibit 14 Porter‟s five forces of the Indian oil and gas sector

Value chain of the oil and gas sector The industry’s value chain is divided into three components: upstream, midstream and downstream. Exploration and production are considered upstream activities, while storage and transportation is midstream. Downstream comprises refining, processing and marketing of oil and gas. The Indian oil and gas market is characterised by the presence of large, diversified companies with highly vertically integrated operations throughout the value chain. Most companies are state-owned, while private companies are marking their presence with the government following the de-regulation path.

Exhibit 15 Value chain of the oil and gas sector

Source: Aranca Research

Thre

at o

f new

ent

rant

s

•Requires high

capital investment

•Economies of scale is vital

•Access to distribution channels critical Th

reat

of s

ubst

itute

s

•Threat of

substitutes is very small for now

•Renewable energy may pose a threat over the years

Com

petit

ive

riva

lry

•Limited

number of companies owing to the nature of the industry

•Foreign and private players beginning to enter the scene B

arga

inin

g po

wer

of s

uppl

iers

•Oil industry

has small sub-suppliers from various industries, so bargaining power of suppliers is low

Bar

gain

ing

pow

er o

f cus

tom

ers

•Traded at global prices, so customers have no bargaining power

High Medium Low

Source: Aranca Research

Attractiveness of the industry

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Upstream
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Midstream
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Downstream
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Exploration and Production
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Storage and Transportation
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Refining, Processing and Marketing
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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 18

………………………………………………………………………………………………………………………….........

Profitability across the value chain The industry enjoys mixed levels of profitability as seen from the figures below. The scatter graph shows the average of the top companies’ EBITDA margins of the last five years. While the pure play downstream companies21 have low average EBITDA margins, the companies involved in downstream and midstream activities have good profitability levels while the upstream companies22 have the highest profitability in the industry commanding EBITDA margins in excess of 50 per cent in some cases.

Exhibit 16 Five-year average of EBITDA margin of top Indian oil and gas companies

Source: Bloomberg, Aranca Research (* FY10 figure for Oil India Ltd; ** average of FY09 and FY10 for Cairn India)

Opportunities in the sector

Of the country’s total sedimentary area, 78 per cent is yet to be explored; this translates into an exciting opportunity for companies engaged in upstream activities (exploration and production).

In light of mounting LNG production, huge opportunities have been created for LNG terminal operation, engineering, procurement and construction services.

21 HPCL, BPCL 22 ONGC, Cairn India, Selan Exploration, Oil India Ltd.

0

10

20

30

40

50

60

70

Oil India Ltd*

ONGC

Selan Exploration

Cairn India**

Indian Oil Corporation

Reliance Industries

GAIL

HPCL BPCL

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 19

………………………………………………………………………………………………………………………….........

ONGC – Leading from the front

Case Study ONGC is an Indian state-owned oil and gas company headquartered at Dehradun, Uttaranchal. The company accounted for approximately 72 per cent of India’s crude oil output and 48 per cent of natural gas production in FY11. It is Asia's largest and most active company involved in oil exploration and production with more than 11,000 kilometres of pipelines in the nation. ONGC is one of India’s highest profit making corporations. The company underwent partial privatisation in 1994 with the government holding back 80 per cent ownership; this subsequently fell to 74.2 per cent as of August 2011. ONGC posted revenues of USD14.5 billion in FY11, growing at a rate of 12.2 per cent over FY10 and posted its highest annual profit of USD3.9 billion in the same year, which is 25.8 per cent over the FY11 figure of USD3.1 billion.

Exhibit 17

ONGC‟s revenue growth (USD billion)

Source: ONGC, BMI, Aranca Research

Exhibit 18 ONGC‟s profit growth (USD billion)

Source: ONGC, BMI, Aranca Research

12.3

12.8

13.6

12.9

14.5

11.0

11.5

12.0

12.5

13.0

13.5

14.0

14.5

15.0

FY07 FY08 FY09 FY10 FY11

3.4 3.6 3.3

3.1

3.9

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

FY07 FY08 FY09 FY10 FY11

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 20

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The company’s international operations are carried out through its wholly owned subsidiary ONGC Videsh Ltd. (OVL), which has projects in Vietnam, Myanmar, Sudan, Russia (Sakhalin-I project), Iran, Iraq, Syria and Libya. According to company officials, ONGC has three major strategic aims over the coming years: improving its recovery factor, intensifying exploration activities and increasing involvement in foreign projects via OVL.

2.4 Chemicals

The chemical industry is one of the oldest industries in India. It contributes significantly to the country’s industrial and economic growth and is the backbone of Indian industrial and agricultural development. This industry also provides building blocks for downstream industries. The sector accounts for around 3 per cent23 of India’s GDP and contributes roughly 14 per cent to the nation’s industrial activity. As per UNIDO, the Indian chemical industry was the sixth-largest in world and the third-largest in Asia during 2008.

Exhibit 19 Growth in chemicals (IIP)

Source: Central Statistical Organisation, Aranca Research (*FY12- Apr-Feb 2012 growth rate)

Major growth drivers

Favourable demographics and high economic activity drive growth: Since FY09, the total production in the Indian chemical industry has increased at an annual pace of 10 per cent. Favourable demographics and strong economic growth have been the main drivers of activity in the sector. Apart from this, external demand has also contributed strongly to the industry’s expansion.

Favourable government policy: The government announced a number of measures to improve the competitiveness of the Indian chemical industry. It has abolished industrial licensing for chemical sub-sectors, except a small list of hazardous chemicals. An FDI of up to 100 per cent has been

23 Annual Report 2010-11, Ministry of Chemicals & Fertilizers, Government of India

1.01

9.3

7.2

-2.9

5

1.7 -0.5

-4

-2

0

2

4

6

8

10

FY06 FY07 FY08 FY09 FY10 FY11 FY12*

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 21

………………………………………………………………………………………………………………………….........

approved under the automatic route in the chemical sector. Apart from this, the government is continuously reducing the list of reserved chemical items for production in the small scale sector. This facilitates greater investment in technology upgrades and modernisation. The government has also initiated policies for setting up of integrated Petroleum, Chemicals and Petrochemicals Investment Regions (PCPIR). All these initiatives are likely to attract major domestic and foreign investment into the regions, enabling infrastructure that would provide a conducive and competitive environment to set up manufacturing units.

Attractiveness of the industry

Exhibit 20 Porter‟s five forces of the Indian chemicals sector

Value chain of the chemicals industry The main chemicals produced in India are alkali chemicals, inorganic and organic chemicals, pesticides, and dyes. The value chain of the industry begins with petrochemicals, which are converted into basic chemicals. These basic chemicals are used for polymer production; this is further converted into special chemicals.

Thre

at o

f new

ent

rant

s •Fragmented

industry •Supportive

policies •Growing

domestic market, need for fresh capacity

Thre

at o

f sub

stitu

tes

•Increasing

imports

Com

petit

ive

riva

lry

•Moderately

competitive industry

•Presence of companies that cater to diversified product base

Bar

gain

ing

pow

er o

f sup

plie

rs

•Abundant

supply of raw materials

•Logistics and supply chain costs are high

Bar

gain

ing

pow

er o

f cus

tom

ers

•User

industries driving demand

•Demand linked to industrial growth

High Medium Low

Source: Aranca Research

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 22

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Exhibit 21 Value chain of chemicals

Source: Aranca Research

The industry comprises small and large scale units and provides valuable chemicals for various end-use products such as textiles, paper, paints and varnishes, and leather, which are required in almost all walks of life. The major chemicals produced in India include alkali chemicals, inorganic and organic chemicals, pesticides, dyes, and stuff. Major companies in the country’s chemical sector are Coromandel International Ltd, TATA Chemicals, Pidilite Industries Ltd, United Phosphorous Ltd, Gujarat Fluorochemicals Ltd, Rashtriya Chemicals and Fertilizers Ltd, Chambal Fertilisers and Chemicals Ltd, and National Fertilizers Ltd. Profitability across the industry The industry enjoys high profitability as visible from the figures below. The scatter graph below shows the average of the top companies’ EBITDA margins of the last five years. The five-year average EBITDA margin of major companies in the sector stood at 20.9 per cent. The average profitability of the low value-add chemical producers was found to be 43.2 per cent, while that of integrated players varied from 15 per cent to 23 per cent.

Neeraj.Arya
Rectangle
Neeraj.Arya
Polygon
Neeraj.Arya
Text Box
Petrochemicals
Neeraj.Arya
Rectangle
Neeraj.Arya
Polygon
Neeraj.Arya
Rectangle
Neeraj.Arya
Polygon
Neeraj.Arya
Rectangle
Neeraj.Arya
Text Box
Basic Chemicals
Neeraj.Arya
Text Box
Polymers
Neeraj.Arya
Text Box
Specialities
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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 23

………………………………………………………………………………………………………………………….........

Exhibit 22 Five-year average of the EBITDA margin of top chemical companies

Source: Bloomberg, Aranca Research

Opportunities in the sector

Being largely an intermediate product, strong economic growth is an important factor to sustain chemical demand.

The per capita consumption of most finished products under this sector is far below the world average, suggesting a high potential growth for the industry in the future.

2.5 Textiles and Apparels

The textile and apparel industry is one of the leading segments of the Indian economy. The sector accounts for roughly 4 per cent of the country’s GDP, 14 per cent of the industrial output and around 17 per cent of total exports. The textile and apparel sector also provides direct employment to more than 35 million people; this makes it the second-largest employer in the country after agriculture. During the period from FY06 to FY11, the industry has grown at an average annual rate of around 6 per cent.

Exhibit 23 Growth in textiles and apparel (IIP)

Source: Central Statistical Organisation, Aranca Research

Coromandel International Ltd

TATA Chemicals

Pidilite Industries Ltd

United Phosphorous Ltd

Gujarat Fluorochemicals Ltd

Rashtriya Chemicals & Fertilizers

Chambal Fertilizers & Chemicals Ltd

National

Fertilizers Ltd

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

-20

-10

0

10

20

30

FY06 FY07 FY08 FY09 FY10 FY11 FY12*

Textile Apparel

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 24

…………………………………………………………………………………………………………………………......... Major growth drivers

Exports drive growth: Exports has been the textile industry’s prime driver in the recent years. India’s textile exports have grown at a CAGR of around 7.3 per cent over FY06-11, aided by the removal of quotas under the Multi Fibre Agreement (MFA) in December 2004. The Government of India has a vision to substantially increase the country’s share in the global textile trade. To realise this vision, the government has taken various steps to strengthen the textile sector.

Favourable government policy: In recent years, the government has been taking serious steps to significantly raise India’s share in worldwide textile exports. It has restructured the Technology Upgradation Funds Scheme (TUFS) to improve the technology used in textile production. The government also introduced the scheme for integrated textile parks to encourage the launch of world-class infrastructure facilities for the textile sector. Apart from this, it has provided fiscal incentives to encourage textile exports under various provisions of the Foreign Trade Policy 2009–14.

Attractiveness of the industry

Exhibit 24

Porter‟s five forces of the textile sector in India

Value chain of the textile and apparel industry The Indian textile industry has a mix of the hand-spun and hand-woven sector and the capital intensive, sophisticated mill sector. This makes the industry capable to provide a wide variety of products to meet different market needs.

Thre

at o

f new

ent

rant

s •Fragmented

industry •Supportive

policies •Growing

domestic and export opportunities Th

reat

of s

ubst

itute

s

•No significant

threat

Com

petit

ive

riva

lry

•Dominated by

the unorganised sector

•Highly fragmented

•Entry of multi-national companies

Bar

gain

ing

pow

er o

f sup

plie

rs

•Abundant

supply of raw materials

•Well-established supplier base

Bar

gain

ing

pow

er o

f cus

tom

ers

•Growing

domestic and exports demand

•Wide range of products

High Medium Low

Source: Aranca Research

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 25

…………………………………………………………………………………………………………………………......... The nation’s textile and apparel industry can be broadly divided into two segments: a) yarn and fibre (including natural as well as man-made fibre and yarn), and b) processed fabrics (including woollen textiles, silk textiles, jute textiles, cotton textiles and technical textiles), readymade garments (RMGs) and apparel. The industry comprises mostly small scale, non-integrated spinning, weaving, finishing, and apparel-making enterprises. The figure below depicts the industry’s overall value chain. As depicted in the figure below, the industry’s value chain begins with fibre production, which is spun into yarn. The yarn is knit into fabrics, which are further used to manufacture garments.

Exhibit 25 Value chain of the textile and apparel industry

Source: Aranca Research

Fibre Production Spinning

Weaving & Knitting

Dyeing & Finishing

Garment Confection

Garments Fabric Yarn Raw Fibre

Dyeing & Finishing

Product

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 26

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Profitability of major companies across the value chain India’s textile and apparel industry comprises mostly small scale, non-integrated spinning, weaving, finishing, and apparel-making enterprises. The nation’s top companies in the textile industry are Welspun Industries, Vardhman Group, Alok Industries Ltd, Raymonds Ltd, Arvind Mills, Bombay Dyeing and Manufacturing Company Ltd; these are present across the value chain.

The industry enjoys a decent profitability as visible from the figures below. The scatter graph below indicates the average of the top companies’ EBITDA margins in the last five years. As shown in the graph, the EBITDA margins of the companies are quite high and range between 10 per cent and 27 per cent. Alok Industries Ltd enjoys the highest EBITDA margin of 27 per cent.

Exhibit 26 Five-year average of the EBITDA margin of top textile and apparel companies

Source: Thomson Reuters, Aranca Research

Opportunities in the sector

The Indian textile industry is set for strong growth, buoyed by positive domestic consumption and export demand.

The technical textile market is an emerging area for investment with good growth potential as the market is expected to treble over 2010–20.

3. CONCLUSION The Indian manufacturing sector has been witnessing high profit margins. More than 80 per cent of top players across the industries analysed in this report earn profit margins of 15 per cent or higher, which is high as per global standards. It has been possible due to a combination of the inherent competitive advantages of Indian manufacturing, and the transformation witnessed in their operations in the past decade.

Welspun India Ltd

Vardhman Group

Arvind Mills Ltd

Alok Industries Ltd

Bombay Dyeing

Raymond Ltd

0.0

5.0

10.0

15.0

20.0

25.0

30.0

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 27

…………………………………………………………………………………………………………………………......... Among the inherent advantages of Indian manufacturing sector, the most prominent is availability of a vast pool of skilled manpower. India adds over 6,000 PhDs, 500,000 postgraduates, and 2,100,000 other graduates to its workforce annually. The workforce costs 50-70 per cent less than candidates with similar profiles in the US and Europe. Manpower advantage has proved to be one of the key pillars for the nation’s industrial development. On the other hand, Indian manufacturers are increasingly adopting transformational methods to achieve operational excellence. Lean manufacturing has helped optimise their operations, while following TQM24 has led to a sharper focus on quality and a reduction in non-value add activities. Automating systems on the shop floor and decentralising their energy requirements have also helped them achieve high levels of efficiency. There are significant opportunities for upstream players in the oil and gas sector which enjoys a high EBITDA margin of 48 per cent. The sector also has huge untapped potential, as more than 78 per cent of the country’s sedimentary area is yet to be explored. Automakers have an average EBITDA margin of 19.7 per cent, and are at an attractive stage of growth, with the country emerging as a global R&D centre and small-car manufacturing hub. The manufacturing sector’s growth is set to continue, and perhaps accelerate, as the government aims to increase the share of manufacturing to 25 per cent of the GDP by 2025. The profit potential across the value chains of the manufacturing industries is, therefore, expected to be robust in the coming years.

24 TQM is Total Quality Management

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Indian Manufacturing: Profit Potential and Opportunities Across The Value Chain 28

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DISCLAIMER India Brand Equity Foundation (IBEF) engaged Aranca to prepare this report and the same has been prepared by Aranca in consultation with IBEF. All rights reserved. All copyright in this report and related works is solely and exclusively owned by IBEF. The same may not be reproduced, wholly or in part in any material form (including photocopying or storing it in any medium by electronic means and whether or not transiently or incidentally to some other use of this presentation), modified or in any manner communicated to any third party except with the written approval of IBEF. This report is for information purposes only. While due care has been taken during the compilation of this report to ensure that the information is accurate to the best of Aranca and IBEF’s knowledge and belief, the content is not to be construed in any manner whatsoever as a substitute for professional advice. Aranca and IBEF neither recommend nor endorse any specific products or services that may have been mentioned in this report and nor do they assume any liability or responsibility for the outcome of decisions taken as a result of any reliance placed on this presentation. Neither Aranca nor IBEF shall be liable for any direct or indirect damages that may arise due to any act or omission on the part of the user due to any reliance placed or guidance taken from any portion of this report.