Sensex Outlook

TABLE OF CONTENTS
Page
Sensex 40,000
Stock # 1
Bharat Forge Ltd
11
Stock # 2
TCS Ltd
20
Stock # 3
HDFC Bank Ltd
29
Stock # 4
Larsen & Toubro Ltd
38
Disclosures under SEBI (Research Analysts) Regulations
48
Sensex 40,000
|2
Sensex 40,000
4 Stocks to Profit from the Coming Stock Market Wave
Many shall be restored that now are fallen and many shall fall that now are in honor.
Benjamin Graham put these words on the first page of Security Analysis. And in doing
so, gave the most prominent position in his seminal text to the idea that stocks
invariably go through cyclical ups and downs.
Take Warren Buffett for example.
There is no doubting Buffetts skills in value investing. But he was able to put his skills
to the best use only during the rare times - when the odds of outperforming were
heavily stacked in his favour. In other words, buying solid companies when they were
trading at historical lows paid off brilliantly for years to come. Whether it was while
buying Coke or American Express, Buffett relied not just on his skills but also on the
turn of fortunes for the companies.
Its not all about valuations
Now, most investors mistake the association of reversion to the mean concept with
valuations alone.
Its true that buying stocks at historically low valuations gives you a meaningful safety
net. So you can only expect valuations to get better from those levels.
But the earnings cycle of companies can be a big tailwind to the recovery in valuations.
Sensex 40,000
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More importantly, the opportunities to bet big on a reversal in valuations could be

rare in the case of most sound businesses. But the number of times you could bet on
a reversal in earnings could be far higher.
Take a look at the earnings growth pattern of BSE 200 companies over past 20 years.
The average year on year earnings (profit) growth during this period has been about
17.7%. But there have been several instances when the profit growth has been below
average and a reversion to the mean was a given.
Long term profit growth of the best Indian business
Profit growth (% YoY, BSE 200)
60
50
40
30
Avg YoY Profit growth 17.7%
20
10
0
1997
2000
2003
2006
2009
2012
2015
Source: Ace Equity
As against this, a broad call on reversion in valuations could have been taken only
during market crashes.
Sensex 40,000
|4
Long term price to earnings multiple of the best Indian business

P/E multiple (x, BSE 200)
30
25
20
15
Avg PE 18.3x
10
5
Apr-06
Apr-09
Apr-12
Apr-15
Source: Ace Equity
Yet another way to look at it is to think of it as the contribution of corporate

profitability to the economy as a whole.
If the corporate profit to GDP number is too low, then most businesses will be
unviable. Businesses will shut down, competition will reduce, and profitability will
start to rise.
What if the number is too high? The reverse will happen. Competition will come in to
earn the extra profits, capacities will go up, there will be a fight for market share, and
profitability will now start to fall.
And don't forget the public policy angle. If investors consume an ever-growing portion
of the GDP pie, some other group will have to settle for a smaller portion.
In short, enough corrective measures are in place to ensure that corporate
profitability stays neither too low nor too high. There is always a reversion to the
mean.
Whats the situation currently?
Corporate profitability in India today is at historical lows. Profits as a share of GDP are
Sensex 40,000
|5
currently below 4% compared to the long term average of about 6.2%. At its peak, the
number has been over 8%!
We have had virtually no corporate profit growth in the past two years. Therefore it is
reasonable to assume that even a slight up move in GDP growth and normalization
in profit margins will stoke significant earnings growth for the best businesses.
Plus, the capacity utilization levels have been low. Corporates have taken significant
cost-cutting and restructuring measures over the past few years. Interest costs are
unlikely to move significantly higher. And there is significant operating leverage in the
system.
The latest RBI data shows that capacity utilisation levels have moved up a notch.
However, any increases in utilisation levels need to be consistent for the volume
growth to reflect in earnings. And once the utilisation levels get close to where they
were in 2013, companies will enjoy higher pricing power in addition to volume growth.
The triggers that could lead to a sharp earnings recovery are therefore all in place.
Pricing power in the offing with better utilization rates
Capacity utilization (%)

80
78
76
74
72.5
72
70
3QFY13 1QFY14 3QFY14 1QFY15 3QFY15 1QFY16 3QFY16
Source: RBI
The math below will give you a good idea of what I am talking about.
If Sensex earnings per share were to grow at the historical rate of 15% and if profit
margins were to rise to the last 10-year average of 13.5% from the current 12.2%, an
EPS of Rs 100 can become Rs 168 by FY18, a nearly 70% jump. Therefore, if Sensex
Sensex 40,000
|6
follows suit, the index too can go up by as much as 70%, assuming the Sensex PE
multiple remains at the current level of around 19x.
An EPS of Rs 100 three years hence would be........
Sensex
Profit margin
3 year Earnings CAGR

5%
10%
15%
20%
12.2%
116
133
152
173
12.8%
121
140
160
181
13.2%
125
144
165
187
13.5%
128
147
168
191
Source: Equitymaster
The earnings wave is not restricted to the 30 Sensex companies alone!

Plenty of blue-chip stocks outside of the Sensex can fetch earnings growth in excess
of 15% per year over the next three years.
But if earnings were to grow at 15%, and if profit margins were to rise to their
ten-year average of 11% from the current 9.6%, an EPS of Rs 100 can become Rs
174 by FY19. Which means an upside of 74%.
And at least for few stocks, if the earnings growth goes to 20%, the earnings could
easily double from the current levels.
Sensex 40,000
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An EPS of Rs 100 three years hence would be........
BSE 100
3 year Earnings CAGR
Profit margin
15%
20%
25%
30%
9.6%
152
173
195
220
10.8%
171
194
220
247
11.0%
174
198
224
252
12.7%
201
229
258
291
So what do we conclude?
The fact that profitability of Indian companies will reverse to mean over a period of
two to three years is a given. As shown in the data earlier, there is a strong possibility
of the Sensex earnings growing by as much as 70% over the next three years. Now
taking that into account if the Sensex is valued even at its long term average price to
earnings multiple of 18x, you could see the Sensex touching nothing less than the
40,000 mark in three years.
The math is based on Sensex actual earnings for FY16 and does not take into account
any significant changes to macro-economic variables.
With 70% earnings growthwhere would Sensex be?
Earnings growth
30%
50%
70%
20,998
24,228
27,458
32,304
15
26,247
30,285
34,323
40,380
18
31,496
36,342
41,188
48,456
20
34,996
40,380
45,764
53,840
22
38,496
44,418
50,340
59,224
PE Multiple
12
100%
Sensex 40,000
|8
How will you benefit from Sensex 40,000?

If you are still wondering whether investing in stocks based on the possibility of
turnaround in corporate profitability, take a look at this chart.
While the earnings per share of Sensex has grown by 198% in the last eleven financial
years, the market capitalization of the benchmark index has grown by 458% during
this period. Therefore the odds of profiting from a surge in corporate profitability over
a period of time, are heavily stacked in your favour even if the markets are starting
from a fair valuation level.
Impact of Earnings growth on Shareholder Wealth

Growth in Earnings Vs Market cap
CAGR 14%
1,600
48,000
Sensex EPS (LHS)
1,200
Sensex Mkt cap (Rs billion)
CAGR 11%
36,000
800
24,000
400
0
12,000
FY06FY07FY08FY09FY10 FY11 FY12 FY13 FY14 FY15 FY16
Source: Ace Equity, Equitymaster
Of course, you need to act now.

The time to invest in the best businesses before the earnings surge becomes evident
in financial performance quarter after quarter, will give you an edge. You may be able
to invest in the creamiest of the business before their valuations get beyond your
reach.
Make no mistake. Just like stock prices, corporate profits are never linear. There will
Sensex 40,000
|9
be temporary hiccups on the way up. But the most robust businesses and safest
stocks will outshine their past track record in the years to come.
To assist you in equipping your portfolio with companies that are certain to ride this
earnings wave, we have laid out four compelling stock ideas.
These are businesses that not only offer comfort in terms of fundamentals and
management quality, but are also the ones that we believe will capture the earnings
growth opportunity faster than others. The upside in their earnings potential is so
visible that most macro headwinds will hardly impact them. At the suggested buy
prices, these stocks are a must have in your portfolio in the journey to Sensex 40,000.
And as we come across more that qualify this criteria, rest assured, we will be the first
ones to alert you!
Happy investing!
Sensex 40,000
| 10
Stock # 1
Bharat Forge Ltd

A conscious strategy to focus on superior quality products and strong client
relationships
The fortunes of auto ancillary business are closely linked to that of the automobile
industry. When the economy is performing well, naturally auto companies benefit as
higher incomes lead to more vehicle purchases by consumers. This then has a
favourable impact on auto ancillaries as well. But when the economy slows down, the
scenario is just the opposite. Demand for automobiles slump and margins come
under pressure for auto manufacturers. In such a scenario, auto ancillary companies
feel the pressure as well and are unable to have much bargaining power given that
OEMs become highly resistant to any price increases.
That is why it is important for auto ancillary companies to have the competitive edge
in the area that they cater to. This atleast ensures that there is not much dent to their
market shares when the times are tough.
And we feel that Bharat Forge does have that kind of a strong competitive advantage.
Part of the Pune-based Kalyani Group, Bharat Forge has emerged as the world's
leading chassis component manufacturer. The company has grown rapidly through
a series of acquisitions and joint ventures, and has manufacturing facilities spread
across India, Germany, Sweden, and France.
The company manufactures unbranded, commoditised ancillary products for original
equipment manufacturers (OEM) in the auto space. Yes, it's a boring business. But let
us tell you, Bharat Forge is not your run-of-the-mill component manufacturer.
The company's management has differentiated itself by persistently focusing on
delivering quality and value-added products to its customers. Its scale and reach has
empowered it with solid project execution capabilities. In both the domestic and the
international markets, Bharat Forge boasts of strong clientele, the likes of which
include Tata Motors, Ashok Leyland, Eicher Motors, Mahindra & Mahindra, Maruti
Sensex 40,000
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Suzuki, Volvo, Caterpillar, Toyota, Renault, and Daimler Chrysler, to name a few. These
are relationships built over the years. This indicates that the company's customers
prefer Bharat Forge and its superior offerings over other players. That's the
company's competitive edge.
We also like that the company hasn't confined itself to being a leading manufacturer
of chassis components for the auto industry. The company also manufactures
specialised components for the aerospace, power, energy, oil and gas, rail and
marine, mining and construction equipment, and other industries. The company has
made a conscious effort to diversify across sectors and geographies to make the
business model more resilient.
How many ancillary component manufacturers do you know that boast of average
operating margins of 25% over a ten-year period? Through its three-pronged strategy
of aggressive export thrust, increasing the share of value added products, and
reducing production costs through automation and technology, the company's
management has carved out a durable, profitable business model with solid longterm fundamentals.
On the flip side, there are some medium-term growth challenges. The financial year
2015-16 was a tough period as both its business segments - auto and industrial faced headwinds. The crash in commodities was primarily responsible for the dip in
the industrial business.
However, going forward, the industrial business is expected to revive on the back of
orders from the government's Make in India initiative. The company has identified
four areas of focus - railways, power, mining, and defence. Abroad, the company is
catering to aerospace, and this too is expected to be an important growth driver.
In our view, Bharat Forge's leadership position in the chassis component market,
long-standing relationships with marquee clientele, superior product quality, a
proven long-term track record of healthy profitability makes it a tough business that
has the capability to sail through tough times.
Given such a strong business model and sound management, we believe that Bharat
Forge should form part of an investors portfolio. Hence, we recommend investors to
buy the stock of Bharat Forge at Rs 732 or lower.
Sensex 40,000
| 12
Risk Analysis
In order to further improve our risk analysis of companies we have come out with a
revised Equitymaster Risk Matrix (ERMTM). The ERMTM is broken down in to 4 sub
heads namely industry risk, performance risk, management risk and balance sheet
risk.
Regulatory risk: Some businesses are subject to regulations by external

government agencies. These companies are subject to regulatory risk since
they do not have the liberty to operate in a free environment. Excessive
regulations can create bureaucratic hassles and impede growth. Thus, higher
the regulation, higher is the risk for any business. As such there are no
regulations for the auto ancillaries industry. Based on these parameters, we
assign a risk rating of 6 to the stock.
Cyclicality risk: An industry cycle is characterized by an upturn as well as

downturn. Businesses whose fortunes typically swing with industry cycles are
known as cyclical businesses. Cyclical businesses do well during an industry
upturn and vice versa. On the other hand, there are some businesses based
on consumption stories that are non-cyclical. These businesses are immune
to industry cycle changes and have less risk. In short, if the business is cyclical
higher is the risk. The fate of the auto ancillaries industry depends a lot on the
performance of the auto sector. And the auto industry is highly cyclical in
nature and is closely linked to GDP growth as well as disposable incomes of
people. Based on this, we assign a high score of 2.
Competition risk: Every industry is characterized by competition. However,

some industries where entry and exit barriers are typically low have higher
competition risk. Low barriers means more players can enter into the industry
there by intensifying competition. Low product differentiation also intensifies
competition risk. Competition in the sector has intensified in the past and is
expected to continue going forward too. This will not only be from existing
players but new players entering the market as well. We thus assign a score of
Sensex 40,000
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4 to the stock on this parameter.
Sales growth: Over the eight-year period (actual history of past 5 years and
explicit forecast for the next 3 years) we expect sales CAGR of 12%. We assign
a high risk rating of 4 to the stock on this parameter.
Net profit growth: Over the eight-year period (actual history of past 5 years
and explicit forecast for the next 3 years) we expect net profit CAGR of 19.7%.
We assign a medium risk rating of 6 to the stock on this parameter.
Operating margins: Operating margin is a measurement of what proportion

of a company's revenue is left over after paying for variable costs of
production such as raw materials, wages, and sales and marketing costs. A
healthy operating margin is required for a company to be able to pay for its
fixed costs, such as interest on debt. The higher the margin, the better it is for
the company as it indicates its operating efficiency. The average operating
margins over the 8-year period (actual history of past 5 years and explicit
forecast for the next 3 years) stand at 27.8%, which is healthy. We assign a
score of 7.
Net margins: Net margin is a measurement of what proportion of a

company's revenue is left over after paying for all the variable and fixed costs
inclusive of interest and depreciation charges. Net margin is the final measure
of profitability. It reflects the total profits the company takes home. Higher the
margin, better it is for the company as it indicates better pricing power and
effective cost management. The average net margins over the 8-year period
(actual history of past 5 years and explicit forecast for the next 3 years) stand
at 14.7%. We assign a score of 6.
Return on net worth (RoNW): RoNW is an important tool to assess a

company's potential to be a quality investment by determining how well the
management is able to allocate capital into its operations for future growth. A
RoNW of above 15% is considered decent for companies that are in an
expansionary phase. The average RoNW over the 8-year period (actual history
of past 5 years and explicit forecast for the next 3 years) stands at 13.3% which
Sensex 40,000
| 14
is on the lower side. We assign a score of 6.
Earnings quality: This measure helps us assess the quality of earnings

reported by the company. For instance, some companies may follow
aggressive accounting practices and recognize revenues earlier than
warranted. Earlier recognition of revenues boosts profits. However, at the
same time they do not generate sufficient operating cash flow (OCF). This
signifies debtors are not liquidated on time as sales were booked in advance.
Such companies face working capital issues and their quality of earnings is
poor. We assess earnings quality by dividing operating cash flow to net profits.
Higher the ratio better is the quality of earnings. The average OCF/net profit
ratio over the 8-year period (actual history of past 5 years and explicit forecast
for the next 3 years) stands at 1.4 which is robust. We assign a score of 8.
Transparency: Transparency is the key to any business. Transparency can be

gauged by assessing the past dealings of the company with various stake
holders be it the customers, suppliers, distributors or shareholders. The
easiest way to gauge the same is checking the level of disclosures in the
company's quarterly financial updates and communication with minority
shareholders. Most importantly, the management's willingness to explain its
stance if there is a negative development in the company or stock shows its
forthrightness. Transparent managements would get a higher rating. We have
found that Bharat Forge is quite transparent and thus we assign a rating of 7.
Capital allocation: Apart from honesty, capital allocation skills are equally
important in assessing management quality. By capital allocation we mean
how the management chooses to deploy capital in the business or across
businesses. Managements that have in the past destroyed shareholder wealth
by diversifying in unrelated, unviable businesses or make expensive
acquisitions would rank low on this parameter. Further managements that
focus on capital intensive growth at the cost of profitability would also fetch a
low rating. The management of Bharat Forge has been reasonably successful
in capital allocation. We assign a score of 7 to Bharat Forge on this parameter.
Promoter pledging: Promoters typically pledge their shares to take a loan

which is generally infused in the company. This exercise is generally resorted
Sensex 40,000
| 15
to when all other sources of external liquidity dry out. The risk with this
strategy arises when share price falls. This triggers margin calls. If
management is unable to provide some sort of a collateral to the lending party
from whom the money is borrowed that party may sell the shares to recover
its money. This accentuates the share price fall. Hence, higher the promoter
pledging higher is the risk. Since none of the promoters' equity have been
pledged we assign the score of 10.
Debt to equity ratio: A highly leveraged business is the first to get hit during
times of economic downturn, as companies have to consistently pay interest
costs, despite lower profitability. We believe that a debt to equity ratio of
greater than 1 is a high-risk proposition. The average D/E ratio over the 8-year
period (actual history of past 5 years and explicit forecast for the next 3 years)
has been 0.5x. We assign a score of 8.
Interest coverage ratio: It is used to determine how comfortably a company

is placed in terms of payment of interest on outstanding debt. The interest
coverage ratio is calculated by dividing a company's earnings before interest
and taxes (EBIT) by its interest expense for a given period. The lower the ratio,
the greater are the risks. The interest coverage ratio for Bharat Forge (actual
history of past 5 years and explicit forecast for the next 3 years) stands at 14.9,
which is healthy. Hence, we assign a score of 8.
It may be noted that leverage, return generating capability, earnings quality
and management risk get the highest weight in our matrix. Hence, scores
assigned to these factors influence the overall score.
Considering the above analysis, the total ranking assigned to the company is 89
that, on a weighted basis, stands at 6.8. This makes the stock a medium-risk
investment from a long-term perspective.
Sensex 40,000
| 16
ERMTM
Riskiness (A)
Company Specific Parameters
High - Medium - Low
Points
1 2
Industry risk
Weightage (B) Weighted (A*B)
9 10
Regulatory risk $
5.0%
0.3
Cyclicality risk $
5.0%
0.1
Competition risk $
5.0%
0.2
Sales growth
5.0%
0.2
Net profit growth
5.0%
0.3
Operating margins
5.0%
0.4
Net margins
5.0%
0.3
RoIC / RoNW
10.0%
0.6
Earnings Quality (OCF/PAT)
10.0%
0.8
10.0%
0.7
Capital allocation $
10.0%
0.7
Promoter pledging $
10
10.0%
1.0
10.0%
0.8
Interest coverage ratio
5.0%
0.4
Final Rating#
89
Performance risk
Management risk
Transparency $
Balance Sheet risk

Debt to equity ratio
6.8
*Excluding extraordinary gains. For qualitative factors, denoted by $ sign, lower the risk, higher the
rating. For any risk parameter if the score is below or equal to 4 it indicates high risk. The risk score of
these parameters is highlighted in red color. For risk parameters where the score is above 4 riskiness is
low. The risk score of such parameters is highlighted in grey.
Sensex 40,000
| 17
Financials at a glance
Standalone (Rs m)
FY12
FY13
FY14
FY15
FY16UA
Sales
36,860
31,512
33,993
45,481
43,054
Sales growth (%)
28.9%
-14.5%
7.9%
33.8%
-5.3%
Operating profit
9,168
7,156
8,637
13,300
12,830
Operating profit margin (%)
24.9%
22.7%
25.4%
29.2%
29.8%
Net profit
3,621
3,056
3,999
7,190
7,011
Net profit margin (%)
9.8%
9.7%
11.8%
15.8%
16.3%
Current assets
23,581
15,617
20,229
29,003
22,217
Fixed assets
20,853
22,216
21,568
21,638
24,395
Investments
8,848
9,306
13,409
11,038
14,298
Other assets
4,287
1,778
2,079
2,768
Total Assets
53,282
51,427
56,985
63,758
63,678
Current liabilities
13,734
11,731
13,283
10,309
10,024
Net worth
21,431
23,111
26,933
34,957
36,405
Loans
16,845
14,880
14,670
16,525
14,615
Other liabilities
1,272
1,705
2,099
1,968
2,635
Total liabilities
53,282
51,427
56,985
63,758
63,678
Balance Sheet
Sensex 40,000
| 18
Market Data
732
Price on 16th June 2016 (Rs)
1,292 / 705
52-week High/Low (Rs)
BHARATFORG
NSE Symbol
500493
BSE Code
232.9
No. of shares (m)

Face value (Rs)
2.0
FY16 dividend/share (Rs)
7.5
Free float (%)
53.3
Market cap (Rs m)
170,483
Avg. 52-week liquidity (No. of shares) (BSE+NSE combined)
922,050
Price to sales* (times)
4.0
Price to earnings* (times)
24.1
*Based on trailing 12-month numbers
Annexure for Bharat Forge Ltd: Shareholding (%, Mar-16)

Category
(%)
Promoters
46.7
Banks, MFs and FIs
16.6
Other institutions
15.9
Indian public
11.7
Others
9.0
Total
Sensex 40,000
100.0
| 19
Stock # 2
TCS Ltd
The Only Indian Software Company That Is Truly Responding To The Digital
Revolution.
The long-term earnings growth driver for Indian software firms is the offshoring
opportunity. It is a proven and predictable business model. The opportunity remains
large in our rapidly changing world. This is true despite Indian IT firms having grabbed
about 55% of the software offshoring market already.
To thrive in the information age, it is important for global firms to not only keep their
costs low. They also have to reach out to their customers faster and more effectively.
A company with a good software back-bone will be able to respond to changes in the
marketplace much faster than its competitors.
Tata Consultancy Services (TCS) has proven to be the software partner of choice of
large multi-nationals. During the last decade, TCS has quietly gone from strength to
strength. The companys revenues and profits have both grown by 23.4% CAGR in the
last ten years. During this time, operating margins too have remained strong
averaging 28.1%. A potent combination of operational flexibility, de-centralised
operations, and excellent service quality is responsible for this performance.
The speed and skill of its service delivery has won TCS immense client loyalty and
respect around the world. The management has converted this goodwill into very
sticky long-term client relationships, by transforming itself from a software partner
into a business partner. Thus, the management has successfully established a strong
moat around the business via high switching cost and the companys brand name.
The company is fortunate to have a very experienced and capable team at the helm
of affairs. The senior management is known for anticipating trends in the industry
well in advance and responding proactively. This visionary and ethical team has led
TCS through thick and thin. Their ability to deploy cash at high rates of return over
the years, across various geographies, is truly commendable.
Sensex 40,000
| 20
They have also managed to attract and retain the best talent in the industry over the
years. This is crucial in an industry where success depends on the skill and depth of a
companys human resources.
Thankfully, the management is not resting on its laurels. True to form, they
anticipated the digital revolution. To prepare for the same, they invested in these new
technologies over the last two years. These investments are now yielding results. The
companys order book reached an all-time high recently. This on the back of high
growth in the digital space. Revenues from these newer services already contributes
about 15.5% of the companys topline. This trend bodes well for the future.
We believe TCS can sustain this business momentum. The company has proven its
ability to invest cash profitably in high growth markets across the world. The
management's focus on non-linear growth bodes well for the future. In this era where
software firms are moving away from linear (i.e. employee based growth), we believe
TCS is in the best position among large Indian IT firms to benefit from the same.
Considering company s growth prospects, we recommend investors to Buy stock of
TCS at Rs 2,556 or lower.
Sensex 40,000
| 21
Risk Analysis
The ERMTM is broken down in to 4 sub heads namely industry risk, performance risk,
management risk and balance sheet risk. (For details please refer to the ERMTM at the
end of the report).
Regulatory Risk: Some businesses are subject to regulations by external

government agencies. These businesses are subject to regulatory risk since
the regulation, higher is the risk of volatility in profit and growth for any
business. Though the regulatory framework in India is conducive for IT
companies, however the companies are subject to the regulations in their
client countries. As seen in recent times, most of the changes in regulations in
the client countries (e.g. Visa regulations etc) have had an impact on the Indian
IT companies. As a result, we have assigned a rating of 4 to the company.
Cyclicality Risk: A business cycle is characterized by an upturn as well as

upturn and vice versa. On the other hand, there are some businesses that are
not very cyclical. These businesses are more immune to changes in industry
cycles in the sector and have less risk. In short, if the business is cyclical higher
is the risk. In short, if the business is cyclical, the risk is higher. Given that the
IT sector is not a cyclical business, we assign a low risk score of 8 to the
company on this parameter.
Competition Risk: Every industry is characterized by competition. However,

competition risk. Low barriers means more players can enter into the industry
there by intensifying competition. The competition in the IT services sector is
intense and global in nature. Therefore, we assign a rating of 2 to the
company.
Sales Growth: Over the 8 year period (actual history of past 4 years and
explicit forecast for the next 4 years), the growth is estimated at a CAGR of
20.7%. We assign a risk rating of 6 to the stock on this parameter.
Sensex 40,000
| 22
Net Profit Growth: Over the 8 year period (actual history of past 4 years and
explicit forecast for the next 4 years), the growth is estimated at a CAGR of
20.8%. We assign a risk rating of 6 to the stock on this parameter.
Operating Margins: Operating margin is a measurement of what proportion

of a company's revenue is left over after paying for variable costs of
production such as raw materials, wages, and sales and marketing costs. A
healthy operating margin is required for a company to be able to pay for its
fixed costs, such as interest on debt. The higher the margin, the better it is for
the company as it indicates its operating efficiency. The average operating
margins for TCS over the 8 year period (actual history of past 4 years and
explicit forecast for the next 4 years) stands at 26.8%. We therefore assign a
score of 8 on this parameter.
Net Margins: Net margin is a measurement of what proportion of a

effective cost management. The average net margins over the 8 year period
at 22.5% for TCS. We assign a score of 8 on this parameter.
Return on Net Worth (RoNW): RoNW is an important tool to assess a

expansionary phase. The average RoNW over the 8 year period (actual history
of past 4 years and explicit forecast for the next 4 years) stands at 34.5% for
TCS. Thus, we assign a score of 9 on this parameter.
Earnings Quality: This measure helps us assess

reported by the company. For instance, some
aggressive accounting practices and recognize
warranted. Earlier recognition of revenues boosts
Sensex 40,000
the quality of earnings

companies may follow
revenues earlier than
profits. However, at the
| 23
same time they do not generate sufficient operating cash flow (OCF). This
signifies debtors are not liquidated on time as sales were booked in advance.
Such companies face working capital issues and their quality of earnings is
poor. We assess earnings quality by dividing operating cash flow to net profits.
Higher the ratio better is the quality of earnings. The average OCF/net profit
ratio over the 8 year period (actual history of past 4 years and explicit forecast
for the next 4 years) stands at 0.85 times. TCS has a good quality of earnings.
Hence, we assign a high score of 9 on this parameter.

gauged by assessing the past dealings of the company with various
stakeholders, the way it displays its financial information and the frequency of
management's desire to communicate with external shareholders whenever
some unfortunate incident happens. The easiest way to gauge the same is
checking the level of disclosures in the company's quarterly financial updates
and annual reports. Transparent managements would get a higher rating. TCS
has been fairly transparent with respect to divulging details about growth,
operations and challenges. We assign a score of 8 to the company on this
parameter.
Capital Allocation: Apart from honesty, capital allocation skills are equally
important in assessing management quality. By capital allocation we mean
how the management chooses to deploy capital in the business. There are
many instances where growth is given priority over returns on the investment.
This results in a company with larger size but with poor returns.
Management's are enticed to increase the size since their compensation is tied
to the size of organization they manage. Also, they sometimes destroy
shareholder wealth by making expensive acquisitions or by diversifying into
unrelated areas. Hence, capital allocation skills assume great importance in
gauging management quality. Capital allocation skills are good when return
ratios depict resilience. In short, more stable/higher the return ratios better
the capital allocation skills. The return ratios for TCS have been good over the
years but have declined a recently. We assign a score of 8 to the company on
this parameter.
Promoter Pledging: Promoters typically pledge their shares to take a loan

Sensex 40,000
| 24
to when all other sources of external liquidity dry out. The risk with this
strategy arises when share price falls. This triggers margin calls. If
management is unable to provide some sort of a collateral to the lending party
from whom the money is borrowed that party may sell the shares to recover
its money. This accentuates the share price fall. Hence, higher the promoter
pledging higher is the risk. In case of TCS, there is no promoter pledging. We,
therefore, assign the lowest risk rating of 10.
Debt To Equity Ratio: A highly leveraged business is the first to get hit during
greater than 1 is a high-risk proposition. The average D/E ratio of TCS over the
8 year period (actual history of past 4 years and explicit forecast for the next
4 years) stands at 0. As such; we assign a score of 10 to the company.
Interest Coverage Ratio: Interest Coverage Ratio is used to determine how

comfortably a company is placed in terms of payment of interest on
outstanding debt. It is calculated by dividing a company's earnings before
interest and taxes (EBIT) by its interest expense for a given period. The lower
the ratio, the greater are the risks. The company's debt to equity ratio is well
within comfort levels and expected to remain so. At over 30 times, TCS'
average interest coverage ratio over the 8 year period (actual history of past 4
years and explicit forecast for the next 4 years) is more than comfortable.
Thus, we assign a score of 10 on this parameter.
It may be noted that leverage, return generating capability, earnings quality
and management risk get the highest weight in our matrix. Hence, scores
assigned to these factors influence the overall score.
Considering the above analysis, the total ranking assigned to the company is
106. On a weighted basis, it stands at 8.0. This makes the stock a low-risk
Sensex 40,000
| 25
ERMTM
Riskiness (A)
High - Medium - Low
Points
1 2
Industry risk
9 10
Regulatory risk $
5.0%
0.2
Cyclicality risk $
5.0%
0.4
Competition risk $
5.0%
0.1
Sales growth
5.0%
0.3
Net profit growth
5.0%
0.3
Operating margins
5.0%
0.4
Net margins
5.0%
0.4
RoIC / RoNW
10.0%
0.9
10.0%
0.9
10.0%
0.8
10.0%
0.8
Promoter pledging $
10
10.0%
1.0
10
10.0%
1.0
10
5.0%
0.5
Final Rating#
106
Performance risk
Management risk
Transparency $
Balance Sheet risk

8.0
Sensex 40,000
| 26
Consolidated (Rs m)
FY12
FY13
FY14
FY15
488,938
629,895
818,094
946,484
1,086,462
Sales growth (%)
31.0%
28.8%
29.9%
15.7%
14.8%
Operating profit
144,353
180,399
251,528
244,817
305,898
29.5%
28.6%
30.7%
25.9%
28.2%
104,135
139,173
191,639
198,522
242,918
21.3%
22.1%
23.4%
21.0%
22.4%
Current assets
230,617
315,766
428,977
488,130
630,674
Fixed assets
62,671
78,871
102,033
121,425
122,778
Investments
5,746
9,683
22,753
1,692
2,265
Other assets
112,536
115,998
114,527
121,933
133,716
Total Assets
411,570
520,317
668,290
733,179
889,432
Current liabilities
103,870
117,616
155,428
201,322
218,623
Net worth
301,380
393,410
499,028
517,625
658,628
Loans
1,175
2,122
2,548
3,003
1,958
Other liabilities
5,146
7,169
11,287
11,229
10,224
Total liabilities
411,570
520,317
668,290
733,179
889,432
Sales

Net profit
FY16
Balance Sheet
Sensex 40,000
| 27
Market Data
2,556
2,769 / 2,119
NSE Symbol
TCS
BSE Code
532540
No. of shares (m)
1,970.4
Face value (Rs)
1.0
43.5
Free float (%)
26.6
Market cap (Rs m)
5,036,414
111,913,000
4.6
20.7
Annexure for TCS Ltd: Shareholding (%, Mar-16)

Category
(%)
Promoters
73.4
Banks, MFs and FIs
5.1
Other institutions
16.8
Indian public
4.1
Others
0.6
Total
Sensex 40,000
100.0
| 28
Stock # 3
HDFC Bank Ltd

Continues to Redefine Excellence
A well-developed banking system plays a vital role in the smooth functioning of the
economy.
In a country like India, demographic advantage and growth prospects could provide
banks with a huge opportunity to create wealth for shareholders. However, this
opportunity is fraught with risks primarily from digitization and technology, i.e. upsurge
of non-branch banking. These factors coupled with regulatory policy changes, allowed
more competition, both in setting up of small finance banks and payment banks. This
increased competition will make profitable growth particularly challenging for banks
which do not compromise on the core of the business - lending margins and asset
quality.
Banks typically have a natural advantage to ward off any impending competition i.e.
Switching costs. For any individual, the allure of cheaper cost of loans, high interest
rates on deposits might be temporarily enticing. But it is the switching costs which
ultimately results in a very low customer turnover. This sticky nature of the customer is
now potentially under threat with non-branch banking. This digital makeover of banking
will make it difficult for banks to protect their natural moat of switching. Thus banks will
have to adapt digitization in a big way to retain customers. And this trend is something
one of the leading players in the banking space is taking very seriously.
HDFC Bank, with its plain vanilla banking, has utilized this switching cost moat to its
maximum advantage. It has also displayed how plain vanilla banking can be a safe,
profitable and a value creating business model. Today, even the largest and century old
banks in India are no match for the barely two and half decade old bank.
In addition, the bank continues to find newer avenues for profitable growth. The bank
has realized that its ability to launch products in the digital space, stay ahead of the
competition and at the same time retain margins and asset quality matters the most. It
understands that latching on to the latest fads of the time, like the dotcom, realty,
Sensex 40,000
| 29
power and infrastructure sectors, will result in subpar results or worse adversely affect
its asset quality. This prudence has resulted in the bank being least affected by the
boom and bust in these sectors.
When it comes to servicing its retail customers, HDFC Bank has relied on the model of
wide franchise and low cost deposit base. This is reflected in the form of continued
pricing power and sustainability of above average NIMs (net interest margins). With its
consistency, conservatism with respect to margins, provisions have proved to be
extremely rewarding for the bank. The bank has reported more than 20% YoY profit
growth for over 40 quarters with its NPAs having never crossed 0.5% of loans is a
testimony to its outstanding performance.
The bank stands to benefit from the opportunities that would arise from the group
companies. However it holds long term potential just based on its standalone entity,
concentrating on the core banking potential.
At the same time, the bank has been able to sustain above average return on equity as
well as dividend payout closer to 19% over the past 10 years, thus immensely rewarded
its long term shareholders.
What is impressive is the bank is not resting on its past laurels and continues to invest
in products thus effectively competing with banks and non-banks in the digital banking
space. The banks proactive initiatives give us comfort to sustain higher double digit
growth in the long term.
Having such a stock in the portfolio can help investors not just protect their capital but
also take advantage when the economic growth truly revives. While it is almost certain
that HDFC Banks earnings growth will outperform that of most other bluechips in the
benchmark index, we would recommend investors to consider buying the stock based
on its estimated FY19 price to adjusted book value. We recommend investors to buy
the stock of HDFC Bank at Rs 1,100 or lower.
Sensex 40,000
| 30
Risk Analysis
In order to further improve our risk analysis of companies we have come out with a
revised Equitymaster Risk Matrix (ERMTM). The ERMTM is broken down in to 4 sub heads
namely industry risk, performance risk, management risk and balance sheet risk. (For
details please refer to the ERMTM at the end of the report).
Regulatory Risk: Some businesses are subject to regulations by external

government agencies. These companies are subject to regulatory risk since
the regulation, higher is the risk for any business. The banking sector is subject
to various regulations imposed by the Reserve Bank of India in terms of capital
adequacy, lending norms, provisioning requirements etc. Based on these
parameters, we assign a risk rating of 4 to the stock.
Cyclicality Risk: An industry cycle is characterized by an upturn as well as

upturn and vice versa. On the other hand, there are some businesses based on
consumption stories that are non-cyclical. These businesses are immune to
industry cycle changes and have less risk. In short, if the business is cyclical
higher is the risk. The banking sector is extremely cyclical and is in fact a
reflection of the macro economy. The sector typically witnesses average credit
growth at 1.5 times GDP growth. Based on this, we assign a score of 4.

competition risk. Low barriers mean more players can enter into the industry
thereby intensifying competition. Low product differentiation also intensifies
competition risk. The banking sector is already very fragmented and
competitive with newer banks having fetched licenses already and more in
pipeline.
Sensex 40,000
| 31
As explained earlier competition in the banking sector is expected to become

extremely stiff in coming years. Despite HDFC Banks strong positioning on the
private sector, we assign a score of 5 to the stock on this parameter.
Income growth: Over the eight year period (actual history of past 5 years and
explicit forecast for the next 3 years) HDFC Bank's income CAGR is 24%. We
assign a rating of 7 to the stock on this parameter.
Net Profit Growth: Over the eight year period (actual history of past 5 years
and explicit forecast for the next 3 years) we expect net profit CAGR of 25%. We
assign a risk rating of 7 to the stock on this parameter.
Net interest margin: Net interest margin (NIM) is a measurement of the

spread that the financial entity makes on its average earning assets (typically
loans, investments and balance with other banks). Banks that are able to fetch
sufficient low cost funds and lend them with a good spread or invest in high
yielding assets have steady NIMs. The higher the NIM, the easier it is for
financial entities to tide over volatility in interest rates. The average NIM for
HDFC Bank over the 8 year period (actual history of past 5 years and forecast
for the next 3 years) stands at 4.2%, which is higher than industry average. We
assign a score of 7.
Net Margins: Net profit margin is a measurement of what proportion of a

at 19.5%. We assign a score of 6.

Sensex 40,000
| 32
of past 5 years and explicit forecast for the next 3 years) stands at 19.4%. We
Cost to income ratio: This ratio helps assess the operating cost efficiency of a
financial entity. It primarily takes into account the operating cost for the
company vis-a-vis income by way of net interest earned and other income.
Financial entities that are lean in terms of cost to income ratio manage to retain
a healthy profit margin across cycles. The average cost to income ratio for HDFC
Bank over the 8 year period (actual history of past 5 years and forecast for the
next 3 years) stands at 46.3%. We assign a score of 6.

holders be it the customers, suppliers, distributors or shareholders. The easiest
way to gauge the same is checking the level of disclosures in the company's
quarterly financial updates and communication with minority shareholders.
Most importantly, the management's willingness to explain its stance if there is
a negative development in the company or stock shows its forthrightness.
Transparent managements would get a higher rating. The management of
HDFC Bank has been a very transparent in its operations. Also it is very
forthcoming with information about the key risks to the business. We thus we
assign a rating of 9.
important in assessing management quality. By capital allocation we mean how
the management chooses to deploy capital in the business or across
low rating. The management of HDFC Bank has always displayed prudence in
capital allocation. We assign a score of 9 to HDFC Bank on this parameter.

to when all other sources of external liquidity dry out. The risk with this strategy
Sensex 40,000
| 33
arises when share price falls. This triggers margin calls. If management is
unable to provide some sort of a collateral to the lending party from whom the
money is borrowed that party may sell the shares to recover its money. This
accentuates the share price fall. Hence, higher the promoter pledging higher is
the risk. With none of the promoters' equity being pledged we assign rating of
10.
Net NPA to advances: A good asset quality is the hallmark of good lending
practice of a financial entity. Financial entities that tend to have high nonperforming assets (NPAs) during periods of economic stress deserve a lower
rating. Ones that have average net NPA ratio in excess of 1.5% are particularly
risky. The average net NPA to advances ratio for HDFC Bank over the 8 year
period (actual history of past 5 years and forecast for the next 3 years) stands
at 0.2%, which is the best in the industry. We assign a score of 9 on this
parameter.
Capital adequacy ratio (CAR): This is one of the most important factors that
are used to judge the soundness and sustainability of a financial institution's
business over the longer term. It shows the ratio of capital to assets financed.
The RBI has stipulated a minimum CAR of 9% for banks as per Basel III. Since
HDFC Bank's CAR at the end of March 2016 stood at 15.5%, we assign HDFC
Bank a score of 6.
It may be noted that quality of loan book, return generating capability, earnings
quality and management risk get the highest weight in our matrix. Hence,
scores assigned to these factors influence the overall score.
Considering the above analysis, the total ranking assigned to the bank is 95 that,
on a weighted basis, stands at 7.2. This makes the stock a low-risk investment
from a long-term perspective. However, apart from the risk score investors must
take into account the latest valuations before investing in the stock.
Sensex 40,000
| 34
ERMTM
Riskiness (A)
High - Medium - Low
Points
1 2
Industry risk
9 10
Regulatory risk $
5.0%
0.2
Cyclicality risk $
5.0%
0.2
Competition risk $
5.0%
0.3
5.0%
0.4
5.0%
0.4
5.0%
0.4
5.0%
0.3
10.0%
0.6
10.0%
0.6
10.0%
0.9
10.0%
0.9
Promoter pledging $
Balance Sheet risk
10
10.0%
1.0
Net NPA to advances
10.0%
0.9
Capital adequacy
Final Rating#
5.0%
0.3
Performance risk
Income growth
Net profit growth*
Net interest margins
Net profit margin
RoNW
Cost / Income ratio
Management risk
Transparency $
95
7.2
Sensex 40,000
| 35
Consolidated (Rs m)
FY12
FY13
FY14
FY15
FY16 UA
Interest income
276,054
358,609
425,550
484,697
602,214
151,060
196,954
234,454
260,741
326,299
124,994
54,536
88,071
161,655
71,329
115,519
191,096
82,975
124,696
223,956
89,963
139,875
275,915
107,517
169,796
15,264
76,195
23,461
16,770
100,695
31,693
15,880
133,495
45,849
23,398
150,646
48,487
27,256
186,380
63,417
52,734
69,002
87,646
102,159
122,963
19.1%
2,346.7
19.2%
2,379.4
20.6%
2,399.0
21.1%
2,506.5
20.4%
2,528.2
20.9
27.3
34.7
40.4
48.6
Interest expense
Net interest income
Other income
Other expenses
Provisions and contingencies
Profit before tax
Tax
Profit after tax/(Loss)
No of shares (m)
Diluted earnings per share (Rs)
Adjusted book value (Rs)
125.3
151.9
170.5
241.1
279.6
Balance Sheet
Advances
Investments
Fixed assets
Cash and balance with RBI
Balance with other banks
Other assets
Total assets
Net worth
Subordinate and perpetual debt
Deposits
Borrowings
Other liabilities
Total liabilities
Sensex 40,000
1,988,374
2,472,451
3,154,188
3,654,950
4,645,940
967,942
1,104,572
1,186,493
1,664,599
1,638,858
23,779
149,916
61,835
24,968
146,308
129,003
26,216
253,572
145,562
31,217
275,104
88,210
33,432
300,583
88,605
218,693
3,410,539
196,824
4,074,125
177,141
4,943,173
190,949
5,905,029
381,038
7,088,456
305,159
69,471
368,640
69,471
443,879
69,471
622,307
69,471
726,778
69,471
2,465,396
2,960,916
3,670,802
4,507,935
5,464,242
192,645
377,869
159,055
516,043
257,756
501,265
382,664
322,652
530,185
297,780
3,410,539
4,074,125
4,943,173
5,905,029
7,088,456
| 36
Market Data
1,160

1,195 / 928
NSE Symbol
HDFCBANK
BSE Code
500180
No. of shares (m)
2,528.1
2
Face value (Rs)
9.5
78.57
Free float (%)
2,956,107
Market cap (Rs m)
890,250

23.9
Price to Book value* (times)
4.1
Annexure for HDFC Bank : Shareholding (%, Mar-16)
Category
(%)
Promoters
21.4
Mutual Funds
8.4
Banks and FIs
2.8
FIIs
32.2
Public
8.7
ADR holders
18.6
Others
7.9
Total
Sensex 40,000
100.0
| 37
Stock # 4
Larsen & Toubro Ltd

A Company Thats Tamed the Beast that is Indias Capital Goods Industry
The capital goods industry in India has grown tremendously over the years. But that
growth has also been marked by extreme volatility. True to its cyclical nature, big
swings from year-to-year have been the norm.
Take a look at the chart below. It shows the year-on-year growth of the capital goods
component of the index of industrial production in India:
Capital goods sector growth has seen large swings
Capital Goods Component of IIP, % YoY growth
50
35
20
5
-10
FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16
Data Source: CMIE
Over the last nine years, the sector has seen numbers ranging from an output growth
of 48% YoY in one year, to a contraction of 6% YoY in another. Yes, this is an industry
that thrives on large investments by corporate India. And corporate India has large
mood swings as far as its investment-plans are concerned.
Not surprisingly, companies in this industry have a hard time conducting business in
such an environment. Their numbers and profitability suffer and often end up seeing
similar ups-and-downs.
Sensex 40,000
| 38
All but one company, that is. Which one?

Its a company that hardly needs an introduction: Larsen & Toubro (L&T) - the largest
engineering company in India. Its business spreads through the length and breadth of
the Indian capital goods sector. And through all of the ups-and-downs that the
industry has seen, have a look at the companys operating margins:
Calm Amidst the Storm
L&T's EBIDTA margins over the last 8 years,
15
14
13
12
11
FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16
Source: Company, Equitymaster Research
India's is currently well in the middle of an investment slowdown. It is precisely in times

such as these that it becomes so reassuring to know that L&T's operating margins have
stuck in such a tight range of 12% to 15% through good times and bad. A testament to
just how well-entrenched L&T is in the industry. Its reputation, extensive technical
prowess, and large skilled workforce have enabled L&T to command a certain premium
from customers and vendors alike, providing a cushion to its profitability through thick
and thin.
Being well-diversified within the engineering space has also helped. The company
conducts business in infrastructure, power, defense, metallurgical, material handling,
heavy engineering, hydrocarbons, automation, and the list goes on. It has also come to
derive about 15% of its business from IT and financial services.
Things are not all rosy though. For example, it can easily be pointed out that the
company has been over-ambitious on diversification and has perhaps spread itself too
Sensex 40,000
| 39
thin. In recent times, it has also put a large amount of capital in the developmental
projects business. Higher debt levels have followed.
On balance though, the companys strength in its core business remains extremely
solid. The capex slowdown of the last few years have not been favorable for the
company. Yet, it has weathered the slowdown quite well relative to many of its peers.
We believe that the long-term fundamentals of the company remain strong. The
companys ability to capitalise on a turn in the capex cycle is as strong as ever. It is no
wonder that we expect the company to grow both its revenues as well as its profits at
the brisk pace of over 15% CAGR during the three years to financial year 2019 (FY19).
Given all these positives, we believe that L&T should form part of an investors portfolio.
At the same time, we believe that the current valuations of the stock do not offer the
requisite margin of safety. And hence, we recommend investors to buy the stock at Rs
1,175 or lower (correction of around 21% from the current price levels).
Sensex 40,000
| 40
Risk Analysis
The ERMTM is broken down in to 4 sub heads namely industry risk, performance risk,
management risk and balance sheet risk. (For details please refer to the ERMTM at the
end of the report).
Regulatory risk: Some businesses are subject to regulations by external

government agencies. These businesses are subject to regulatory risk since
the regulation, higher is the risk of volatility in profit and growth for any
business.
The regulatory framework in India is very conducive for Engineering and
Infrastructure companies. In fact, there is always an emphasis for the
development of the manufacturing and engineering sector. Therefore,
companies such as L&T do not face high regulatory risk. As a result, we have
assigned a rating of 8 to the stock.
Cyclicality Risk: An industry cycle is characterized by an upturn as well as

upturn and vice versa. On the other hand, there are some businesses that are
not very cyclical. These businesses are more immune to changes in industry
cycles in the sector and have less risk. In short, if the business is cyclical higher
is the risk. Engineering and Infrastructure sectors are highly cyclical businesses
as they are sensitive to the economic progress of a country. Thus, we assign a
high risk score of 4 to the company on this parameter.

competition risk. Despite intensive capital requirement and reasonable entry
barriers, many domestic and international players have invaded the
Engineering and Infrastructure sector in the recent past. Though companies
Sensex 40,000
| 41
like L&T on account of its strong brand has been able to avert the competition
to a certain extent. We assign a rating of 4 to the company on this parameter.
Sales Growth: Over the eight year period (actual history of past 5 years and
explicit forecast for the next 3 years) we expect sales CAGR of 15%. We assign
a risk rating of 5 to the stock on this parameter.
Net Profit Growth: Over the eight year period (actual history of past 5 years
and explicit forecast for the next 3 years) we expect net profit CAGR of 7%. We
assign a risk rating of 2 to the stock on this parameter.
Operating Margins: Operating margin is a measurement of what proportion

of a company's revenue is left over after paying for variable costs of production
such as raw materials, wages, and sales and marketing costs. A healthy
operating margin is required for a company to be able to pay for its fixed costs,
such as interest on debt. The higher the margin, the better it is for the company
as it indicates its operating efficiency. The average operating margins over the
8 year period (actual history of past 5 years and explicit forecast for the next 3
years) stand at 12.6%. We assign a score of 4.
Net Margins: Net margin is a measurement of what proportion of a company's

revenue is left over after paying for all the variable and fixed costs inclusive of
interest and depreciation charges. Net margin is the final measure of
profitability. It reflects the total profits the company takes home. Higher the
at around 5.6%. We assign a score of 2.

Sensex 40,000
| 42
of past 5 years and explicit forecast for the next 3 years) stands at 13.2%. We
Earnings Quality: This measure helps us assess the quality of earnings

reported by the company. For instance, some companies may follow aggressive
accounting practices and recognize revenues earlier than warranted. Earlier
recognition of revenues boosts profits. However, at the same time they do not
generate sufficient operating cash flow (OCF). This signifies debtors are not
liquidated on time as sales were booked in advance. Such companies face
working capital issues and their quality of earnings is poor. We assess earnings
quality by dividing operating cash flow to net profits. Higher the ratio better is
the quality of earnings. The average OCF/net profit ratio over the 8 year period
(actual history of past 5 years and explicit forecast for the next 3 years) stands
at 0.39. We assign a score of 6.

holders be it the customers, suppliers, distributors or shareholders. The easiest
way to gauge the same is checking the level of disclosures in the company's
quarterly financial updates and communication with minority shareholders.
Most importantly, the management's willingness to explain its stance if there is
a negative development in the company or stock shows its forthrightness.
Transparent managements would get a higher rating. We have assigned a score
of 8 to the company on this parameter.
important in assessing management quality. By capital allocation we mean how
the management chooses to deploy capital in the business or across
low rating. While the company has decent return ratios, one hopes that the
management does a better job of sticking to its core asset-light engineering
business. Hence, we assign a score of 4 to L&T on this parameter.
Sensex 40,000
| 43

to when all other sources of external liquidity dry out. The risk with this strategy
arises when share price falls. This triggers margin calls. If management is
unable to provide some sort of a collateral to the lending party from whom the
money is borrowed that party may sell the shares to recover its money. This
accentuates the share price fall. Hence, higher the promoter pledging higher is
the risk. L&T is a professionally managed company. There is no promoter
equity. We assign a lowest risk rating of 10 to L&T.
Debt To Equity Ratio: A highly leveraged business is the first to get hit during
greater than 1 is a high-risk proposition. The average D/E ratio for L&T over the
8 year period (actual history of past 3 years and explicit forecast for the next 5
years) stands at 2.1x. Therefore, we assign a score of 3.
Interest Coverage Ratio: It is used to determine how comfortably a company is

placed in terms of payment of interest on outstanding debt. The interest
coverage ratio is calculated by dividing a company's earnings before interest
and taxes (EBIT) by its interest expense for a given period. The lower the ratio,
the greater are the risks. On the basis of these parameters we assign a score of
4 to L&T.
It may be noted that leverage, return generating capability, earnings quality and
management risk get the highest weight in our matrix. Hence, scores assigned
to these factors influence the overall score.
Considering the above analysis, the total ranking assigned to the company is 68.
On a weighted basis, it stands at 5.2. This makes the stock a medium-risk
Sensex 40,000
| 44
ERMTM
Riskiness (A)
High - Medium - Low
Points
1 2
Industry risk
9 10
Regulatory risk $
5.0%
0.4
Cyclicality risk $
5.0%
0.2
Competition risk $
5.0%
0.2
Sales growth
5.0%
0.3
Net profit growth
5.0%
0.1
Operating margins
5.0%
0.2
Net margins
5.0%
0.1
RoIC / RoNW
10.0%
0.4
10.0%
0.6
10.0%
0.8
10.0%
0.4
Promoter pledging $
10
10.0%
1.0
10.0%
0.3
5.0%
0.2
Final Rating#
68
Performance risk
Management risk
Transparency $
Balance Sheet risk
5.2
Sensex 40,000
| 45
Consolidated (Rs m)
FY12
FY13
FY14
FY15
643,131
744,980
851,284
920,045
1,026,317
Sales growth (%)
23.5%
15.8%
14.3%
8.1%
11.6%
Operating profit
88,839
98,592
107,543
113,355
123,427
13.8%
13.2%
12.6%
12.3%
12.0%
Net profit
46,937
52,057
49,020
47,647
50,905
7.3%
7.0%
5.8%
5.2%
5.0%
Current assets
571,819
681,887
794,411
870,245
993,776
Fixed assets
332,626
396,203
250,208
242,420
229,860
Investments
72,246
75,046
66,762
79,653
79,653
Other assets
216,422
277,915
588,847
749,523
807,678
Total Assets
1,193,113
1,431,051
1,700,227
1,941,841
2,110,968
Current liabilities
461,956
538,753
687,540
777,072
855,216
Net worth
293,868
338,597
377,116
409,091
439,702
Loans
419,755
527,172
603,780
705,692
761,615
Other liabilities
17,535
26,529
31,792
49,986
54,436
Total liabilities
1,193,113
1,431,051
1,700,227
1,941,841
2,110,968
Sales
FY16UA
Balance Sheet
Sensex 40,000
| 46
Market Data
1,485
1886/ 1016.60
LT
NSE Symbol
500510
BSE Code
943.6
No. of shares (m)
2.0
Face value (Rs)

18.25
Free float (%)
100.0
1,400,854
Market cap (Rs m)

1.4
27.5
Annexure for L&T: Shareholding (%, Mar-16)

Category
(%)
Promoters
0.0
Banks, MFs and FIs
38.9
FIIs
16.6
Indian public
35.7
Others
8.8
Total
Sensex 40,000
100.0
| 47
DISCLOSURES UNDER SEBI (RESEARCH ANALYSTS)

REGULATIONS, 2014
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DISCLOSURE WITH REGARDS TO OWNERSHIP AND MATERIAL CONFLICTS OF

INTEREST:
a.
'subject company' is a company on which a buy/sell/hold view or target price is

given/changed in this Research Report.
Sensex 40,000
| 48
b.
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Bank Limited
c.
Equitymaster's investment in the subject company is as per the guidelines

prescribed by the Board of Directors of the Company. The investment is however
made solely for building track record of its services.
d.
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Limited and HDFC Bank Limited.
e.
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HDFC Bank Limited and a buy at lower view on Bharat Forge.
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Sensex 40,000
| 49
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Sensex 40,000
| 50
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TABLE OF CONTENTS

Bharat Forge Ltd

HDFC Bank Ltd

Larsen & Toubro Ltd

Disclosures under SEBI (Research Analysts) Regulations

More importantly, the opportunities to bet big on a reversal in valuations could be

Avg YoY Profit growth 17.7%

Source: Ace Equity

Long term price to earnings multiple of the best Indian business

Source: Ace Equity

Yet another way to look at it is to think of it as the contribution of corporate

Capacity utilization (%)

3 year Earnings CAGR

The earnings wave is not restricted to the 30 Sensex companies alone!

An EPS of Rs 100 three years hence would be........

3 year Earnings CAGR

How will you benefit from Sensex 40,000?

Impact of Earnings growth on Shareholder Wealth

Sensex EPS (LHS)

Sensex Mkt cap (Rs billion)

Of course, you need to act now.

Bharat Forge Ltd

Regulatory risk: Some businesses are subject to regulations by external

Cyclicality risk: An industry cycle is characterized by an upturn as well as

Competition risk: Every industry is characterized by competition. However,

4 to the stock on this parameter.

Operating margins: Operating margin is a measurement of what proportion

Net margins: Net margin is a measurement of what proportion of a

Return on net worth (RoNW): RoNW is an important tool to assess a

is on the lower side. We assign a score of 6.

Earnings quality: This measure helps us assess the quality of earnings

Transparency: Transparency is the key to any business. Transparency can be

Promoter pledging: Promoters typically pledge their shares to take a loan

Interest coverage ratio: It is used to determine how comfortably a company

Company Specific Parameters

High - Medium - Low

Weightage (B) Weighted (A*B)

Net profit growth

Earnings Quality (OCF/PAT)

Interest coverage ratio

Balance Sheet risk

Sales growth (%)

Operating profit margin (%)

Net profit margin (%)

Price on 16th June 2016 (Rs)

52-week High/Low (Rs)

No. of shares (m)

FY16 dividend/share (Rs)

Free float (%)

Market cap (Rs m)

Avg. 52-week liquidity (No. of shares) (BSE+NSE combined)

Price to sales* (times)

Price to earnings* (times)

*Based on trailing 12-month numbers

Annexure for Bharat Forge Ltd: Shareholding (%, Mar-16)

Banks, MFs and FIs

Regulatory Risk: Some businesses are subject to regulations by external

Cyclicality Risk: A business cycle is characterized by an upturn as well as

Competition Risk: Every industry is characterized by competition. However,

Operating Margins: Operating margin is a measurement of what proportion

Net Margins: Net margin is a measurement of what proportion of a

Return on Net Worth (RoNW): RoNW is an important tool to assess a

Earnings Quality: This measure helps us assess