Mind of An Analyst

The Mind of a Business Analyst
Applied Lessons for Investment Bankers and Research Analysts
Manish Chokhani September 2004 1

Agenda
Components of an average recommendation
What requires to be validated
First Principles of Financial Analysis
Valuation Principles
Valuation Shortcuts and Market Cycles
Business Analysis – Circle of Competence Approach
Macro Economic, Political and Social Factors
Buyer Characteristics and Compulsions
Slotting the Recommendation
Recap the Valuation
ENAM Securities August 2004 2

An Average Recommendation
Here are the financials
¾ Past two years, next two years
¾ Current business trajectory is good
¾ This is the P/E , this is the EPS or something similarly cheap sounding
Here are some comparable valuations

¾ Local, regional, global
Occasionally:
¾ Chance to buy a good business…
¾ Unique Promoter …
¾ Great Shareholders/ Funds/Pvt Equity… Backing it
So Buy It

What Needs to be Validated?
Validity of business financials
¾ Forecast Validity
Key Business Drivers
Any hidden liabilities/ subsidiaries / etc
Business Competitiveness
Macro factors at play
Appropriate Valuation Tool
Relative validity
¾ What else is attractive
¾ Decompose by Country / Sector / Mktcap / Promoter
What is driving the deal?

¾ Why the deal?
¾ Why Now?
¾ Who is the intermediary?
¾ Whats in it for me?

Understand the Business Drivers
VOLUME
¾ Most loved Consumer focussed UVG stories: eg CellPhones, Retail, Hosing Loans, Media or large
addressable markets globally like ITand pharma (buzz on BPO, Textiles…)
PRICE
¾ Most loved Pricing Power stories: Brands, Oligopolies
¾ Excitable Commodity swings: Cement, Metals…
EFFICIENCY
¾ IMPROVING ASSET UTILISATION
Usually Cyclicals – Autos, Engineering due to operating leverage
¾ IMPROVING COST STRUCTURE/ ECONOMIES OF TECHNOLOGY

Usually Engineering, PSUs, Conglomerates…
RESTRUCTURING
¾ Catalysts such as Privatisation, M&A, Divestitures, Buybacks…

Case Studies
Lets Examine Sustainable Valuations for
¾ Cement
¾ Autos
¾ IT
¾ Pharma
¾ FMCG
Use 5 key measures that define peak valuations…

¾ Sales / G Block
¾ W Cap / Sales
¾ Sustainable or desirable OPM%
¾ Capex requirements
¾ Volume Growth Assumptions
¾ Help us to decide what we lay out and what we get back…

Now Lets Attempt a DCF

Markets continuously discount all of the above…
ROE : Use Bond Yield

25% Reciprocal
(100/8)=12.5x
P/E=20x
as benchmark
Value
ROE :
15%
P/E=12x
Value multiple
8% - Predictable
Bonds - Sustainable
P/E=12x - Scaleable
Cash
Time

Understand Market Cycles – I
“Virility” Symbols (Towers, diversification/ M&A)
Bad qlty of IPOs
Bubble Capex > near-future reqments
Interest rates spike. Huge Credit expansion
Retail euphoria
Shock/ Leaders in trouble
Fair to Over valuation
Capex/ IPO/ Credit cycle

revives
Asset & Cost inflation
Correction
Tourism/ Media attention
“Themes” emerge, New
Bear Phase
Valuation “Paradigms” Sharp fall followed by
pull back
“Left outers” jump in
Leadership narrows
Severe
Undervaluation
Ignored, stagnant
Cheap valuations
Negative press
Symptoms of each hump deceptively similar -- It is the
QUALITY which differs:
Undervaluation
Important commodities take off (Steel, Gold, etc.) Eg high quality IPOs & Capex at “Reasonable”
Catalyst/ Regulatory (eg Privatisation, LT Cap Valuation stage vs flood of bad IPOs & far-out-Capex Bust
gains exemption) at Bubble stage
Easy Liquidity

Resulting in a Swing in Valuation Approaches
BEAR MARKET BULL MARKET BUBBLE MARKET
Value GARP Momentum
• Dividend Yield • Payback • Technical Charts

• Price/BV • EV/EBIDTA • Reflexivity
• Replacement Cost • P/E • PE/G
• DCF • Option Value

Valuation Measures – CASH FLOW IS THE ONLY REALITY
DCF helps to make assumptions explicit;gives a good RANGE
¾ Use probability – don’t fudge the discount rate!
¾ Factor in uncertainties and risks
¾ Terminal Value is the key – Is all the value residing there?
¾ Wider the Optimistic-Pessimistic range – lower the valuation!
P/e = d/e / (k-g)

¾ P =d/(k-g)
d = dividend per share
k = shareholder return expectation
k = i + r + rp (inflation+real int+risk premium)
g = growth in dividend per share
¾ Hence Importance of payouts and cash flows for better valuation
¾ Close approximation of P/E to ROE
Other Methods are all variants for validation

¾ EVA – Economic Value Added - Excess return over WACC quantified
¾ EVA = ROIC – (IC x WACC)
¾ CFROI – Another smart way to do a DCF

MARGIN OF SAFETY
Cash flow v/s Bond Valuations
Growth prospects
Gap between Perception and Reality
Knowledge v/s Popularity
Limited downside/ lots of upside

UNDERSTAND “GOOD BUSINESSES”
THE CIRCLE OF COMPETENCE APPROACH

BUSINESSES APPRAISAL
Think long and hard about cycles
Life cycles
Business cycles
Think about sustainability and sources of advantage
Think about external pressures on profitability
Where does this business fit on a profitability distribution?
The financial litmus tests
Think about management and the majority partner

Think of Cycles!
Nature is cyclical, not linear!
Life Cycles
Business Cycles / Boom-Bust
Seasonality
Innovation / Schumpeter
Market Cycles

LIFE CYCLE ANALYSIS
JUTE
SALES
SOFTWARE
TIME

BUSINESS CYCLES
FMCG, SERVICES
INTERMEDIATES CAPITAL GOODS

CONSUMER DURABLES

BOSTON CONSULTING GROUP MATRIX
MANY
SOURCES OF ADVANTAGE
EMERGING/ SPECIALISED/
SMALL SCALE OLIGOPOLIES
MONOPOLY/
COMMODITY CONSUMER FRANCHISE
FEW LOW HIGH

SUSTABILITY OF ADVANTAGE

PORTER’S 5 FORCE ANALYSIS
NEW ENTRANTS/ IMPORTS
INTRA INDUSTRY
SUPPLIERS BUYERS
RIVALRY
SUBSTITUTE PRODUCTS

PROFITABILITY DISTRIBUTION
BANK
RATE
ROI

THE FINANCIAL LITMUS
Superior BUSINESSES
¾ Low asset requirements
¾ Low credit / inventory
¾ Many clients/ economic goodwill
¾ Defensible margins
¾ Pricing power ( inflation + )
¾ Sustainable growth
¾ Free cash flows
Most other businesses

¾ Capital intensive
¾ Working capital intensive
¾ Want premium valuation, do not deserve it
¾ Likely to be cyclical valuations and themes

Now lets talk Micro Focus
Costs
Capital Efficiency
People Issues
“Slack”

Costs
Are you aware of implications of:
¾ Inappropriate Amortisation
¾ R&D
¾ Technology
¾ Marketing Requirements
¾ Training ; Leadership!
¾ UNIT COSTS/ measures

Corporates have re-engineered costs
Cost cutting in Cement Industry
100
(%) 1998 2004
75
50 Cost of Producing Cement (Rs/tonne) 1,200 900
25 Energy Consumption (Units/tonne) 110 90
0 Coal Consumption (kg/tonne) 200 130
Cost of Producing Energy Coal
Source: ENAM Research
Cement Consumption Consumption
(Units/ton) (kg/ton)
1998 2003
2004
Cost cutting by TISCO
250
(%) 1997 2004
200
150
100 RMC (tons per ton of Steel produced) 4.3 3.1
50 Energy Consumption (GCAL/TCS) 8.7 7.2
0 Labour Productivity (tons/Man years) 119 264
RMC (tons per ton Energy Labour
of Steel) Consumption Productivity
(GCAL/TCS) (tons/Man years)
1997 2003
2004

Corporates have right-sized
Restructuring by Top 10 Corporates
400 12
(%) (Rs.m)
1995 2003
300 9
200 6 Revenue (Rs bn) 900 2,750
100 3 Labour Force (nos) 420,000 335,000

Revenue/Person (Rs m) 2.1 8.2
0 0
1995 2003
Revenue (LHS) Labour Force (LHS)
Revenue/Person (RHS)
Right-sizing across sectors

Company Staff shed Period (Yrs) % of Labour Force
BHEL 20,000 7 30
Tata Motors 10,000 5 29
Mahindra & Mahindra 6,500 5 34
Bajaj Auto 7,800 6 37
Tisco 30,000 8 40
ACC 6,000 8 38

Capital Efficiency
Are you well focussed on:
¾ Asset Turns: Gross Block, Working Capital?
¾ Lean Assets: Owned v/s Rented
¾ Flexible Structures: Outsourcing
¾ Impact of M&A, Restructuring?
¾ People…

Efficiency Saved India Inc.
Peak Rate of Custom Duty (%)
160 80
60
120
G rowth (% )
40
80 20
0
40
-20
0 -40
1996 1997 1998 1999 2000 2001 2002 2003
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Sales PBIT PBT
Working Capital / Sales (%)
12 25
20
10
G rowth (% )
15
8 10
5
6
0
4 -5
1996 1997 1998 1999 2000 2001 2002 2003 1996 1997 1998 1999 2000 2001 2002 2003
Cap Emp Borrowing GFA
Source: CMIE

Industry consolidation helped profitability
Market share (%)
Sector 1997 2004
Aluminium Top 3 players 77 100

Tyre Top 5 players 72 85
Cement Top 5 groups 32 61
Paper Top 5 players 32 38
Petrochemicals Top player 45 70
Media No. of players Multiple 3 large
Telecom No. of players Multiple 4 large

People Issues
How is the company managed?
¾ Lifetime Employment?
¾ How does it Hire? Train? Retain? Fire?
¾ How does it build skills? LEADERS?
¾ Are they Commandos? Soldiers? Mercenaries?
Succession Plans?
Empowerment?

Focus on Micro, Company specific factors
How is Product or Service Quality?

¾ Germany/Japan/China v/s India, v/s competition
How is Cost & Capital Efficiency?

¾ Frugality as a mindset v/s “professionally managed”
What are their Value Systems?

¾ Sugar in the milk
How is their Service to the Customer?

¾ The “goodwill” earned

Watch Out for Hidden Bombs
Conflict of Interest Structures
¾ Pvt Businesses
¾ Inter Party relationships
¾ Split Ownerships
¾ Loans & Advances
Off balance Sheet Libailities
¾ Unfunded Pensions
¾ Litigations
¾ Family Settlements
¾ … and many more creative reasons why CAVEAT EMPTOR

CHOOSING “BUSINESS PARTNERS”
Integrity / track record
Ability (not just lucky)
Understanding of key issues
Ambition tempered by reality
Commonality of objectives
Orientation towards minority

MACRO FACTORS TO BEAR IN MIND

Do you have Macro Pointers in Mind?
Do you have a point of view about:
¾ Politics as it affects the business
¾ Economics as it affects the business
¾ Demographic Trends
¾ What are Capital Markets Signalling?
¾ Each powerful trend can have disruptive or tidal wave effects on any business

Politics
Geo Politics affects addressable markets, terms of trade, cost of doing
business…
¾ Effect of SAFTA, ASEAN, WTO/GATT
¾ Risk Premium/Opportunity of Pakistan
¾ Emerging US-India axis ; NAM, ML
¾ Opportunities in “emerging” economies
¾ Outcry against/trends favouring outsourcing

Outsourcing to India : Brewing Trouble
Company Outsourcing for
IT Services
Infosys Goldman Sachs, Aetna, Northwestern Mutual, Am Ex, DHL, Verizon
Tata Consultancy GE, Honda, UBS, HSBC
Wipro Transco, HP- Compacq, Nortel, General Motors, Cisco, Sony
ITES
Mphasis BFL Citi Group, Acenture, Auto Zone, Capital One
Spectramind Dell, American Express, Capital One
Pharmaceuticals
Cipla Ivax, Watson Pharma, Eon Labs
Shashun Chemicals Eli Lily, GSK Pharma
Lupin Laboratories Apotex, APP, Watson Pharma
Engineering
Bharat Forge Meritor, Caterpillar, Toyota, Ford, FAW (China)
Tata Motors Rover
Moser Baer Imation, BASF
Essel Propack P&G, Unilever, Colgate

Increasing FDI reflects “openness”
Early entrants Recent entrants Likely entrants
Cost Savings GE, Citi IT, State Farm JP Morgan, HSBC, Prudential BPOs in throngs
(Production Hubs) Amex, Bank Am Accenture, CGE&Y Deloitte Consulting
IBM, HP Delphi
Teva Generic Pharma Cos
Research Services Texas Instruments, GE Microsoft, Sun, Intel

GSK, Pfizer, Eli Lily
COVANCE A number of CROs
Domestic Market Coke, Pepsi McDonalds, Pizza Hut

Opportunity Ford, Hyundai Honda, Toyota
LG, Samsung Nokia
Lafarge Michelin
Port of Singapore, P&O Dubai Port, Maersk
Morgan Stanley, HSBC MF, Duestche MF Fidelity MF, ABN MF
Templeton

Confident Indians going global
Large Groups Pharma
¾ Tata -Tetley, Daewoo , Rover tie-up ¾ Wochardt-Esparma (Germany)
¾ RIL - FLAG undersea cable,Trevira (Polyester ¾ Ranbaxy- RPG Aventis (France)
firm in Germany) ¾ Dr. Reddy’s - Meridian Healthcare
(UK),Trigenesis Therapeutics (USA)
¾ Birlas - AV Cell (Canada), Copper mines (Aus),
¾ Cadila – French operations of Alpharma (USA)
Carbon Black (China) etc
¾ Sterlite - Copper Mines in Australia, Listing on IT
LSE ¾ Wipro - Nervewire, Utilities consulting division
¾ ONGC - Stake in: Sakhalin oil fields (Russia), of AMS (USA)
GNOOC oil fields (Sudan) ¾ HCL Tech - BT’s call centre (Ireland)
Auto Parts Others

¾ Sundaram Fasteners - Gear casting business of ¾ Asian Paints - Berger International (Singapore)
Dana Spicer (UK), Plant in China ¾ Essel Propack - Propack Holdings
(Switzerland),Arista Tubes (UK)
¾ Bharat Forge – Dana Corp Forging business
¾ Moser Baer - Mmore International (Holland)
(UK), Forging business of CDP (Germany)
¾ Atlas Cycle, Ajanta Clocks - Plants in China

Macro Economic Indicators
Global and local economic cycles
Capital costs
¾ Interest rates, Currency rates, Inflation
¾ Cost pressures: RMC, Tarriffs, etc
Social Costs / development
Competition is a given

Eg: Complete Reversal in India
Forex reserves Forex reserves
60 120
(US$ bn) (US$ bn)
40 100
Re. depreciation 80
20
60
Interest rates 0
40
-20 20
External debt -40 0
94-95
95-96
96-97
97-98
98-99
99-00
00-01
01-02
02-03
03-04
Trade Balance (LHS) Invisibles (LHS)
Capital Receipts (LHS) Total Reserve (RHS)
External debt
Interest rates & Re. depreciation 100
15 17 (%)
(%) (%)
12 16 80
9 15
60
6 14
3 13 40
0 12
-3 11 20
-6 10 0
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Jul-04
96-97 97-98 98-99 99-00 00-01 2-Jan 3-Feb `03-04

Foreign Exchange Reserves as % of external debt
Rupee/ US$ (LHS) Prime Lending Rate (RHS) External Debt (% of GDP)
Source: RBI, CMIE

Soft interest rate bias nearing an end..
Room to grow advances vs investments Inflation making a comeback?
50 15
Investment Deposit Ratio (%)
12
45
9
6
40
3
35 0
Jan-95
Jul-95
Jan-96
Jul-96
Jan-97
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Forex reserves at a peak Rupee volatility on the cards
120,000 15 17
(US$m) (%) (%)
12 16
100,000
9 15
80,000
6 14
60,000 3 13
40,000 0 12
20,000 -3 11
-6 10
0
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Jul-04
93-94
94-95
95-96
96-97
97-98
98-99
99-00
00-01
01-02
02-03
03-04
Rupee/ US$ (LHS) Prime Lending Rate (RHS)
Source: Blloomberg, RBI, CMIE

Understand Market Cycles – II

US Interest Rates through cycles

Rising commodity prices reflect USD weakness
All Commodities Gold Steel
CRB All Commodity Index Gold AM Fix Prices MB HR Steel Prices
320 450 550
(USD/ troy ounce)
300
400 450
280
260 350 350
240
300 250
220
200 250 150

Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04
Non-ferrous Metals Alumina Aluminium

London Metals Exchange Index Europe Alumina Spot Price Aluminium Primary OP SPT
2,000 500 2,000
(USD) (USD)
1,800 400 1,800
1,600 300 1,600
1,400 200 1,400
1,200 100 1,200
1,000 0 1,000
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04
Source: Bloomberg

Consumption trends across Asia

Government P&L A/c AS IT REALLY IS
Centre’s P&L (2004-05E)
Particulars % of GDP
Total Receipts 11
-- Revenue Receipts 10
-- Capital Receipts 1
Total Expenditure 15
-- Interest 4
-- Defence & Subsidies 4
-- Transfer to States 3
-- Infrastructure & Capital Expenditure 1
-- Administrative, etc. 3
Deficit 4
Total debt (Internal + External) 64

Source: Government of India Interim Budget, ENAM Research
Deficit of 5-6% of GDP misleading! Receipts only 11%

States have joined the party!
Aggregate fiscal deficit of states
1,400 5.5
(Rs.bn)
(%)
1,200 5.0
1,000 4.5
800 4.0
600 3.5
400 3.0
200 2.5
0 2.0
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04 E
Source: RBI Fiscal Deficit (LHS) % of GDP (RHS)
Power subsidies (% of state fiscal deficit)

State (%)
Madhya Pradesh 74
Andhra Pradesh 51
Gujarat 65
Karnataka 65
Maharashtra 28
Tamil Nadu 40
Source: World Bank

Profligate Governments…weaken us all
Crowds out private sector
Upward pressure on interest rates
Rupee depreciation
Making us “poorer”, costlier, less competitive> poorer!
Total Central & State debt as a percentage of GDP

80%
Debt/GDP
70%
60%
50%
40%
1980-81
1982-83
1984-85
1986-87
1988-89
1990-91
1992-93
1994-95
1998-99
2000-01
2002-03 RE
1996-97
Source: RBI

Demographics
Income Shifts
Age Group Shifts
Social Shifts

Affordability has risen dramatically
Falling prices and low interest rates have made products easily affordable
1994 2003 Increase in affordability (x)

Housing (Ratio of Hsng Price/Annual Inc.) (x) 6 3 2.0
Housing EMI (Rs.) 1,690 1,250 1.4

10-year repayment / Rs.100,000 / month
Cost of (in Rs.)

21" Color TV 18,000 11,000 1.6
Washing Machine 18,000 13,000 1.4
Refrigerator (165 Ltr) 12,000 8,000 1.5
Cordless Telephone 4,000 2,500 1.6
Cellular Phone 25,000 4,000 6.3
All this has led to a boom in retail lending and consumption

Wealth effect adds to consumer power
Strong rupee and low interest rates
15 17
(%) (%)
12 16
9 15
6 14
3 13
0 12
-3 11
-6 10
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Jul-04
Rupee/ US$ (LHS) Prime Lending Rate (RHS)
Gold: 20,000 tonnes = $100bn gain Market Cap gain = $75bn

450 7,000
(USD/troy ounce)
6,000
400
5,000
350
4,000
300
3,000
250 2,000
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2002 2003 2004
Source: Bloomberg

Income demographics = Secular consumption growth
TV: 1998 - 70m, 2003 - Cable TV Sub.: 1998 - 25m, 2003 - 48mn, 2007 - 80m
98m, 2007 - 130m
600 2 Wheelers: 1998 - 28m, 2003 - 46m, 2007 - 80m
500 Basic Telephone: 1998 – 22m, 2003 – 44m, 2007 - 65m
Tax Payers: 1998 - 10mn, 2003 - 40m, 2007 - 80m

400
Population (m)
Cellular Subscriber: 1998 - 1mn, 2003 - 14m, 2007 - 95m

300
Home Mortgage Outstanding: 1998 – Rs145bn,
2003 – Rs478bn, 2007 – Rs1367bn
200
Cars: 1998 - 3m, 2003 - 6m, 2007 - 9m
100
0 2007
100 2003 Value growth far exceeds
1000 volume growth
2000 1998
3000 Volumes Value
4000 Two Wheelers 12% 20%
Annual income (US$) >5000
Cars 13% 20%
1998 2003 2007 CAGR (1994 – 2003)

Consumers are under-leveraged
800 75% 80%

(USD bn)
700 70%
600 54% 60%

53%
500 50%
400 34% 40%
300 30%
17%
200 20%
100 2% 10%
0 0%
India Thailand Malaysia Taiwan Korea USA
Total consumer loans outstanding Consumer loans outstanding / GDP (%)
Source: ICICI Bank

Age profile points to secular growth in demand
Increasing consuming/producing age group World Age Population Projected To Decline
Total 1,211.6m
1,200
Total 1,012.4m
Overall
growth
19.7%
800
The rising
Growth consumer class
246.8m 331.6m
34.4%
400
0
2001 2013
0 to 19 20 to 34 35 to 60 & above
Source: Census 1991

BRICs : The growth engine of the world
Source: Goldman Sachs BRICs Report

Caveats
Leadership!
Macro economic stability
Infrastructure and Institutions
Openness
Education (and Health)

Political Contradictions reflect Social flux
CPM CONGRESS BJP
Muslim RJD NCP Telgu Desam

League Shiv Sena
BSP JD AIADMK
SP Samta party BJD
DMK
National
Conference

Capital Markets
Be aware of shifts
¾ In sectors
¾ In Leadership
¾ In Valuations?
Where we are in the cycle?

Flat markets cloud sectoral shifts!
Sectors (% of Nifty)
1998 1999 2000 2001 2002 2003 (July) 2004
Banking 8 6 5 7 8 10 12
Commodities 42 32 22 23 25 34 37
Cyclicals 19 15 8 7 9 9 15
FMCG 19 27 16 19 21 15 9
Pharma 4 5 7 6 8 7 6
TMT 8 15 43 38 29 25 21
Total 100 100 100 100 100 100 100
Source: CMIE
Share of corporate profit / GDP

Share of sector profit % v/s Share of market cap
Should always be at the back of the mind !

Similarly, be aware of relative country valuations
High and Stable RoE (EVA +ve), Size and Scalability, Variety and Growth
P/E (x) Interest RoE (%) EPS Growth (%)
2002 2003 2004 rates (%) 2002 2003 2004 2002 2003 2004
China 15 14 13 NA 12 14 15 14 11 6
India 18 15 13 4.5 18 21 24 34 13 16*
Indonesia 8 9 8 9.0 27 25 27 53 (7) 10
Korea 11 12 9 3.9 15 14 18 (5) (7) 33
Malaysia 20 16 15 3.1 10 12 13 14 20 9
Phillipines 26 17 13 7.8 6 9 11 (23) 50 30
Singapore 25 18 16 0.8 7 9 10 (19) 37 12
Taiwan 43 20 15 1.1 5 11 15 (9) 124 29
Thailand 16 12 11 1.3 16 21 23 86 35 9
Source: The Economist, Citi group. * Currently witnessing upgradation and growth to be sustained in 2005

Churn in Top 20 reflects underlying reality shifts
1998 As ofJune2004
Company Name Mkt Cap (Rs. bn) Company Name Mkt Cap (Rs. bn)
Oil & Natural Gas Corpn. Ltd. 402 Oil & Natural Gas Corpn. Ltd. 927
Hindustan Lever Ltd. 278 Reliance Industries Ltd. 625
Indian Oil Corpn. Ltd. 272 Indian Oil Corpn. Ltd. 464
Mahanagar Telephone Nigam Ltd 163 Infosys Technologies Ltd. 354
Reliance Industries Ltd. 158 Wipro Ltd 354
I T C Ltd. 153 Hindustan Lever Ltd. 286
State Bank Of India 129 Bharti Tele-Ventures Ltd. 278
Hindustan Petroleum Corpn. Ltd. 110 State Bank Of India 253
G A I L (India) Ltd. 106 I T C Ltd. 222
Bharat Heavy Electricals Ltd. 86 I C I C I Bank Ltd 194
Tata Motors Ltd. 77 Ranbaxy Laboratories Ltd 187
Bajaj Auto Ltd 73 Housing Development Finance Corpn. Ltd 151
Bharat Petroleum Corpn. Ltd. 63 G A I L (India) Ltd. 144
Industrial Development Bank of India 63 Tata Motors Ltd. 141
Hindalco Industries 56 Bharat Petroleum Corpn. Ltd. 131
Larsen & Toubro 51 Steel Authority Of India Ltd. 122
Tata Iron & Steel Co. Ltd. 50 Hindustan Petroleum Corpn. Ltd. 121
Castrol India 46 Maruti Udyog Ltd 119
Steel Authority Of India Ltd. 43 Bharat Heavy Electricals Ltd. 113
National Aluminium Co 39 Tata Iron & Steel Co. Ltd. 110
Total Market Cap 2,418 Total Market Cap 5,270

Source CMIE
Note: Names in red indicate exits, in blue indicate new entrants

… and the Index hides more than it shows!
200 6,500
180 6,000
160 5,500
140 5,000
120 4,500
100 4,000
80 3,500
60 3,000
40 2,500
20 2,000
0 1,500
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Indexed Sensex (LHS) Sensex (RHS)
IT Pharmaceuticals Banking Media & Auto

20,000 1,600 1,200 6,000
1,000
15,000 1,200
800 4,000
10,000 800 600
400 2,000
5,000 400
200
0 0 0 0
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Infosys Wipro Satyam Ranbaxy Dr Reddy's HDFC HDFC Bank Zee Hero Honda
Cipla Sun Pharma
All Figures indexed 100= price in 1994

Always disaggregate the market
Many
Emerging Business Global Outsourcers
Telecom IT
Sources of Advantage
Media Pharmaceuticals
Retail Engineering
Global Commodities Domestic Demographics
Oil FMCG
Metals Auto
Banking
Low
Sustainability of Advantage
Low High
Note : Companies may change characteristics over time!

PSS companies outperform markets over time!
RIL Vs Sensex Infosys Vs Sensex HDFC Vs Sensex
500 50,000 600
400 40,000 500

400
300 30,000
300
200 20,000
200
100 10,000
100
0 0
0
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Reliance Industries (LHS) Sensex (RHS) Infosys Sensex (RHS) HDFC Sensex (RHS)
HLL Vs Sensex MICO Vs Sensex

600 500
500 400
400
300
300
200
200
100 100
0 0
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
HLL Sensex (RHS) MICO Sensex (RHS)

Multibaggers of the last 10 years
Price as on 14/7/94 Price on 15/7/04 CAGR (%)
Satyam Computers 3 326 62

Infosys Technologies 13 1443 60
Wipro 6 525 56
Sun Pharmaceuticals 21 351 33
Hero Honda 33 460 30
Cipla 41 231 19
Ranbaxy 214 976 16
Zee Telefilms 30 126 15
HDFC 161 550 13
Dr Reddy's 248 749 12
Source: Bloomberg; Adjusted for bonuses and stock splits; NIFTY constituents only

Multibaggers since 9/11 : The REAL BSE-30!
Company Price as on Price on CAGR Company Price as on Price on CAGR

15/7/04 11/9/01 (%) 15/7/04 11/9/01 (%)
Oriental Bank 240 34 92 National Aluminium Co Ltd 139 48 43

Mahindra & Mahindra 476 68 91 HPCL 288 111 38
SAIL 33 5 87 Tata Tea 386 150 37
Tata Motors 407 75 76 Hero Honda 460 183 36
ONGC 654 136 69 Tata Power 254 101 36
Shipping Corp Of India Ltd 117 24 68 Sun Pharma 351 141 35
Tata Iron & Steel Co Ltd 327 84 57 Ranbaxy 976 415 33
BHEL 527 135 57 ICICI Bank 238 103 32
IPCL 157 40 57 SBI Bank 431 187 32
Grasim 952 274 51 Glaxo 603 282 29
GAIL 182 53 51 Indian Hotels 370 175 28
Reliance Energy 571 176 48 BPCL 314 159 26
ABB 730 225 48 Satyam Computers 326 175 23
Bajaj Auto 841 266 47 ACC 232 128 22
Tata Chemicals Limited 121 39 45 Gujarat Ambuja 275 155 21
Source: Bloomberg; Adjusted for bonuses and stock splits; NIFTY constituents only

AOL, Time Warner merger – A lesson to remember
Stock Price of Time Warner: now AOL Time Warner

100
(US$)
80 Announcement of Merger
60
40
20
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
Lets Summarise TILL THIS POINT
Value is created through an interplay of:
¾ Macro Trends
¾ Micro Focus
¾ Subtler Nuances
¾ Business Leaders must constantly be on top of these ; good leaders and investors
continuously value these.
¾ Real winners understand this and play to create enduring value.
May run out of luck, never out of wisdom !

NOW: BUYER BEHAVIOUR

Understand Fund Manager Behaviour!
Approaches to Portfolio Construction
¾ Top Down v/s Bottom Up
¾ Value v/s Growth
¾ Think of Where we are in the Market Cycle!
Client Requirements
¾ Match Needs, Requirements and Abilities
Your OWN Portfolio?

Elements of Valuation
Top Down
Value Growth Momentum
Bottom Up

KYC and Thyself!
Relative Pvt. Banks / Pension Funds /

Asset Allocation Macro Funds/ Fund of Funds
Country Allocation
Regional Funds
Sector Allocation
Country Funds/ Mutual Funds

Large Cap
Small
Cap HNW / PMS / Absolute Return
Absolute Funds/ “Hedge” Funds

Key Success Factors : Match Your Pitch!
• Institutional Marketing CAPITAL

Pvt. Bankers / Pension Funds / Macro Funds • Deployment of Large Pools UBS, GAM
GSIC, ADIA
• Capital Preservation
PICTET
• Marketing Scale & Scope JANUS
Regional Funds
• Economist GMO
LLYOD GEORGE
• Fund Manager HSBC, , CIBC, JF

Country Funds ICICI, HDFC, UTI
• Technician
Absolute
• Stock Picker SLOANE
Return
ABERDEEN
Funds
ARISAIG
EMIC
OPPENHEIMER

Decomposing Approaches
Top Down
Asset Class Country Sector
• Equities • Developed Markets • FMCG

• Bonds • Emerging Markets • Pharma
• Currencies • Regional markets • Services
• Property • TMT
• Commodities • Manufacturing
– Oil • Cyclicals
– Precious metals
– Natural Resources

Valuation – MegaCap bias
Category 1980 1990 1999

30 Largest 9 15 46
Remaining 9 14 23
S&P 500 9 15 30

Some Lessons from History
Japan V/s UK in 1944
Korea V/s India in 1950
Singapore!
Hero Honda V/s Kinetic Honda
Bharti V/s IDEA
Infosys V/s HCL
HDFC Bank V/s SBI
There is NO trade-off between Top- Down and Bottom up

Valuation Approaches based on Sentiment Swings
Value Growth Momentum
• Illiquid • Institutional Favorites • Max Volume
• Misunderstood • UVG Stories • News Flow
• Hated/Uncovered • Imagine it! • Volatile
• Appraised value • DCF or Option value • Technicals
In Reality, there is no distinction. Growth and Momentum are

LongTerm/Short Term Value catalysts

Think Client Management
WHO is the CLIENT?
WHAT does he want from you?
HOW are you shaping his expectations & mindset?
WHY should he stick to you?
“Most clients would rather have their fund manager fail

conventionally than succeed unconventionally.”
— Marc Faber

Decompose | Decompose | Decompose
Sectors Large Cap Medium Cap Small Cap Total

FMCG
Pharma
Banks
IT
Telecom
Media
Engg
Autos
Commodities
Total

SUMMARY
UNDERSTAND YOURSELF OBJECTIVELY
¾ Everybody is not Schumacher or Tendulkar: TAKE HELP, BE SELF AWARE
UNDERSTAND THE INVESTMENT LANDSCAPE

¾ A grip of Macro, Micro, Accounting and Street Smartness is REQUIRED
UNDERSTAND THE UNDERLYING INVESTMENT

¾ What will make it tick or explode?
UNDERSTAND THE MARKET PARTICIPANTS

¾ Who are you playing against and how does he play?
FOLLOW BASIC PRINCIPLES AND STICK TO THEM!
BE HAPPY!

How is your Portfolio Tilted?
OWN
CLIENT TIME
INTERESTS
PROFESSIONAL
COLLEGUES
WORK
FAMILY COLLEAGUES
BUILD A CONSCIOUS LIFESTYLE !

HEAVEN AND HELL
AMERICAN SALARY AMERICAN WIFE
ENGLISH HOME ENGLISH CAR
GERMAN CAR GERMAN FOOD
CHINESE FOOD CHINESE HOME
INDIAN WIFE INDIAN SALARY
YOUR REAL WEALTH = YOUR HAPPINESS = YOUR STATE OF

MIND = WITHIN YOU

Mind of An Analyst

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The Mind of a Business Analyst

Applied Lessons for Investment Bankers and Research Analysts

Manish Chokhani September 2004 1

 What requires to be validated

 First Principles of Financial Analysis

 Valuation Shortcuts and Market Cycles

 Business Analysis – Circle of Competence Approach

 Macro Economic, Political and Social Factors

 Buyer Characteristics and Compulsions

 Slotting the Recommendation

 Recap the Valuation

ENAM Securities August 2004 2

 Here are some comparable valuations

ENAM Securities August 2004 3

 What is driving the deal?

ENAM Securities August 2004 4

¾ IMPROVING COST STRUCTURE/ ECONOMIES OF TECHNOLOGY

ENAM Securities August 2004 5

 Use 5 key measures that define peak valuations…

ENAM Securities August 2004 6

ENAM Securities August 2004 7

ROE : Use Bond Yield

ENAM Securities August 2004 8

 Capex/ IPO/ Credit cycle

 “Left outers” jump in

ENAM Securities August 2004 9

BEAR MARKET BULL MARKET BUBBLE MARKET

Value GARP Momentum

• Dividend Yield • Payback • Technical Charts

ENAM Securities August 2004 10

 P/e = d/e / (k-g)

¾ Hence Importance of payouts and cash flows for better valuation

¾ Close approximation of P/E to ROE

 Other Methods are all variants for validation

ENAM Securities August 2004 11

 Gap between Perception and Reality

 Knowledge v/s Popularity

 Limited downside/ lots of upside

ENAM Securities August 2004 12

THE CIRCLE OF COMPETENCE APPROACH

Manish Chokhani September 2004 13

 Think about sustainability and sources of advantage

 Think about external pressures on profitability

 Where does this business fit on a profitability distribution?

 The financial litmus tests

 Think about management and the majority partner

ENAM Securities August 2004 14

 Business Cycles / Boom-Bust

ENAM Securities August 2004 15

ENAM Securities August 2004 16

INTERMEDIATES CAPITAL GOODS

ENAM Securities August 2004 17

FEW LOW HIGH

ENAM Securities August 2004 18

NEW ENTRANTS/ IMPORTS

ENAM Securities August 2004 19

ENAM Securities August 2004 20

 Most other businesses

ENAM Securities August 2004 21

ENAM Securities August 2004 22

¾ UNIT COSTS/ measures

ENAM Securities August 2004 23

What requires to be validated

First Principles of Financial Analysis

Valuation Shortcuts and Market Cycles

Business Analysis – Circle of Competence Approach

Macro Economic, Political and Social Factors

Buyer Characteristics and Compulsions

Slotting the Recommendation

Recap the Valuation

Here are some comparable valuations

What is driving the deal?

Use 5 key measures that define peak valuations…

Capex/ IPO/ Credit cycle

“Left outers” jump in

P/e = d/e / (k-g)

Other Methods are all variants for validation

Gap between Perception and Reality

Knowledge v/s Popularity

Limited downside/ lots of upside

Think about sustainability and sources of advantage

Think about external pressures on profitability

Where does this business fit on a profitability distribution?

The financial litmus tests

Think about management and the majority partner

Business Cycles / Boom-Bust

Most other businesses

How is Product or Service Quality?

How is Cost & Capital Efficiency?

What are their Value Systems?

How is their Service to the Customer?

Off balance Sheet Libailities

Ability (not just lucky)

Understanding of key issues

Ambition tempered by reality

Orientation towards minority

Research Services Texas Instruments, GE Microsoft, Sun, Intel

Domestic Market Coke, Pepsi McDonalds, Pizza Hut

Auto Parts Others

Social Costs / development