SIEM: Margins likely to come under pressure  HSBC Research,

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SIEM: Margins likely to
come under pressure
 Margins are likely to decline to 9-10% in FY12 in the face of
competition, limiting moderate earnings growth
 A further increase in the parent’s stake remains unlikely; hence, we
believe the stock warrants a discount to historical average multiple
 We have trimmed our FY12-13 EPS estimates by c4-5%; this
reduces our TP to INR940 from INR985; remain Neutral


Investment thesis
With strong growth in revenues (c33%) and
earnings (c17%) in the first 9 months of FY11,
Siemens is likely to record robust earnings growth
for the full year. However, we note its profit
margin has now started to be eroded by increasing
competition, as being evident in the last quarter
when the EBITDA margin contracted to 9.0% in
3Q from 14.5% in 1H. While the decline in
margins was much more severe in the power
generation, and oil and gas businesses, the bigger
impact came from margin erosion in the power
transmission business, which contributed c44% to
overall profit. The margins in the power
transmission business came down to 12-13% from
18-20% in previous quarters.
Consequently, we believe that while Siemens can
continue to deliver strong revenue growth over the
next couple of years, earnings growth may remain
modest. We currently expect the group’s overall
EBITDA margins to contract to 12.4% in FY11e
and 11.9% in FY12e from 13.7% in FY10. This
would limit EPS growth to within 10-12% during
FY12. We currently forecast EPS growth of 9.2%
for FY12.
Driven by our cautious view on margins, we
have lowered our FY12-13 EPS estimates by
c4-5%, which trims our target price to INR940
from INR985.
Based on our revised numbers, the stock trades at a
28.2x FY12e PE compared to a historical average
12m forward PE of 31x for the past 5 years.
We strongly believe that Siemens AG is unlikely
to increase its stake in Siemens India beyond the
current 75% holding as the company wants to
position itself as a domestic player (rather than
just a subsidiary of a foreign company).
Therefore, we think the stock no longer warrants
the takeover premium which it has historically
enjoyed and believe the current valuation discount
to historical average is justified. Therefore, we
expect the stock to remain range-bound and
reiterate our Neutral rating.
Our new target price of INR940 is derived from
our preferred EVA valuation methodology and

implies that 12 months from now, the stock
should trade at a 12m forward PE of 27x on 24m
forward EPS of INR35.
We highlight the key bull and bear factors related
to SIEM below.
Bull factors
 Relatively strong order book of c1.3x
FY11 sales
 One of the technology leaders, with a strong
presence on the power grid
 Balance sheet remain under-levered providing
enough room for acquisitions or investments
in green-field projects
 One of the best performing firms in the sector
in our view in terms of fundamental
measures, such as returns, working capital
management and coverage ratios
Bear factors
 Failing to win a lot of orders in the 765kV
segment, which is expected to witness
significant order inflow going forward
 Low visibility on likely margin erosion
 Valuation not attractive at the moment


Valuation
Our target price of INR940 is derived from our
preferred EVA valuation methodology, assuming
target sales growth of c9%, through-cycle
operating return margin of c12% and WACC of
c11.3%. Our target price implies that 12 months
from now, the stock should be trading at a 12-
month forward PE of 27x on 24 month forward
EPS of INR35.
Under HSBC’s research model, for stocks without
a volatility indicator, the Neutral rating band is
5ppt above and below the hurdle rate for India
stocks of 11%. This translates into a Neutral
rating band of 6% to 16% around the current share
price. Our 12-month target price of INR940
suggests a potential return of c12% (excluding
dividends), which is within the Neutral rating
band; hence, we reiterate our Neutral rating.
Risks
We highlight the key risks related to our
investment case for SIEM below:
Upside risks
 Significant order wins
 Better-than-expected improvement in margins
Downside risks
 Delay/cancellation of domestic transmission
projects
 Excessive pricing pressure

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