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Management Interaction Note April 23, 2010

Company Background Hyderabad Industries Limited (HIL) is a flagship company of the C.K.Birla group of companies, incorporated on 17 June 1946. HIL's key product range include Fibre Cement Roofing Sheets sold under the brand name CHARMINAR, Autoclaved Aerated Concrete Blocks and Panels called AEROCON, and Calcium Silicate Insulation Product (thermal insulation) called HYSIL. The company is one of the leading manufacturers of Fibre Cement Sheets in India with a market share of about 20.5%. After starting out as a roofing manufacturing company, HIL has evolved into a multi product, green building products organization. HIL owns a 15% stake in a property at New Delhi, which cost the company Rs. 8.46 cr and this property, is currently given on lease. Business The company's business consists of the following product groups:

Division Products Business Activity Brand Name Fiber Cement Roofing Sheets Charminar, Malabar

Building Products Division Aerocon Panels & AAC Blocks (Autoclaved aerated concrete blocks – Light weight bricks)

Manufacturing & Marketing Aerocon

Thermal Insulation Products Calcium Silicate Insulation Product Manufacturing & Marketing Hysil (Source: Company, HDFC Sec)

Building products division: This segment consists of Fibre Cement Corrugated Sheets, Flat Products, Autoclaved Aerated Concrete Blocks (Light Weight Bricks) and Aerocon Panels. (1) Fiber Cement Roofing Sheets Fibre Cement Sheet is the main product accounting for about 85% of company's sales. In FY10, HIL set up a new production line at Vijayawada with a capacity of 90,000 MT per annum taking the total capacity to 8,54,500 MT per annum. This capacity came on stream in July 2009. HIL has a 20.5% market share in this segment, followed by players like Visaka Industries (15% market share), Ramco Industries (13%) and Everest Industries (13%). Other players also include Swastik (9%), Utkal (9%) and Sahyadri Industries (5%). Key raw material is Chrysotile (Asbestos Fibre), which constitutes 45% to 50% of the total raw material costs and is 100% imported, followed by OPC (Ordinary Portland Cement), flyash and wood pulp. Overall, to make 100 kgs of fiber cement roofing sheet, 80 kgs of input are required (43 kg of cement, 8 kg of asbestos fibre, 28 kg of flyash and the balance is dry waste, pulp etc). The remaining is water weight gained during the manufacturing process. The roofing industry is largely a commoditized business. While this product started out as an industrial product, the rapid spread of players, increase in production and increase in the number of access points has made this into a retail product. There is limited brand value or premium in the roofing business. HIL is a leader in this segment and thus its brand Charminar commands a band premium of between 2-4%. 80% of the sales come from rural markets with the balance 20% coming from the industrial and other segments (warehouses, poultry, urban slums etc). Asbestos Cement Sheet FY07 FY08 FY09Installed Capacity (tonnes) 622000 674500 764500Production 594465 660180 668955Utilization 95.6% 97.9% 87.5%Sales quantity 544721 650330 698119Sales Value (Rs cr) 384.8 403.9 525.9Realization (Rs per tonne) 7064.2 6211.9 7533.2

(Source: Company, HDFC Sec) (2) Aerocon Panels (Green product) HIL also manufactures various boards and panels that find application in housing, partitioning, interiors etc. HIL also supplies these panels to the army. HIL is one the largest players in this segment and has developed a patented process to manufacture the same. The boards and panels contribute about 3% to HIL’s topline. Any product that replaces wood (in this case plywood) or saves on the consumption of energy (energy efficient) is termed as a ‘Green product.’ Thus, Aerocon panels fall into this category. HIL has a capacity to produce 4,60,000 numbers of these panels. The company is currently running at about 70% capacity utilization. The plants are located at Thimmapur (AP) and Faridabad (Haryana). The raw materials for this product includes flat cement sheets, fillers etc. In terms of competitors, Everest Industries Ltd is also present in the boards and panels segment. However, HIL is a market leader. While panels contribute a negligible amount to topline, HIL is quite excited about the prospects of the use of panels in the low cost housing market. HIL is working on project with the AP Government to make a house out of these panels that could cost less than Rs. 1 lakh. HIL is currently working on a 40-house project and any breakthrough on this front could be beneficial for the company. Currently, HIL is running 2 shifts and thus can increase capacity from the current 4,60,000 numbers by 33% by running a third shift, if need be.

Hyderabad Industries Ltd (HIL) CMP: Rs. 619.05

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Building Panels FY07 FY08 FY09Installed Capacity (Numbers) 460000 460000 460000Production (Tonnes) 15666 18450 15618Sales quantity (Tonnes) 15468 17140 17759Sales Value (Rs cr) 17.78 17.41 17.37Realization (Rs per tonne) 11494.7 10157.5 9781.0

(Source: Company, HDFC Sec) (3) Autoclaved Aerated Concrete Blocks (AAC) (Green Product) AAC blocks are lightweight, building material that provides structure, insulation, fire and mold resistance in a single material. AAC’s high resource efficiency gives it low environmental impact in all phases of its life cycle, from processing of raw materials to the disposal of AAC waste. AAC’s lightweight also saves energy in transportation. AAC’s excellent thermal efficiency makes a major contribution to environmental protection by sharply reducing the need for space heating and cooling in buildings. HIL currently has one AAC block manufacturing plant at Chennai with capacity of 1.5 lakh Cu M (expanded by 50,000 Cu M in FY10). This plant caters to the need of Southern and Western market. Currently, HIL commands 40% of market share in the South. The blocks contribute about 5.5% to HIL’s topline. To cater to the growing demand in Western region, the company is augmenting its manufacturing capacity from 1.5 lakh Cu M to 3.7 lakh Cu M by setting up a new plant of 2.2 lakh Cu M at Golan, Surat, Gujarat. The company has started trial runs at its new AAC Plant, and is expecting commercial production by the end of May 2010. This plant will cater to urban centers in Maharashtra and Gujarat. Raw materials for this product include lime, flyash, cement and some additives. Competitors in this segment include BILT and Siporex. AAC Block FY07 FY08 FY09Installed Capacity (Cu M) 100000 100000 100000Production 73135 81157 88051Utilization 73.1% 81.2% 88.1%Sales quantity 72514 79421 90328Sales Value (Rs cr) 19.55 26.09 34.37Realization (Rs per Cu M) 2696.0 3285.0 3805.0

(Source: Company, HDFC Sec) Thermal Insulation Products (Green Product): This group of Calcium Silicate based insulating materials services industries such as cement, power, petrochemical, fertilizer plants etc. Due to their superior properties and high quality, the company's products have good acceptance over its substitutes. Calcium silicate is commonly used as a safe alternative to asbestos for high temperature insulation materials. Industrial grade piping and equipment insulation is often fabricated from calcium silicate. Its fabrication is a routine part of the curriculum for insulation apprentices. Efforts are being made for developing new applications to expand the market size. Raw materials for this product include lime, calcium silicate and used glass. Power and fuel costs play a major role in the production of this product. This is a high margin product in comparison to the building products division with PBIT margins in the range of 30% (building products division PBIT margins are between 15-20%). The company had increased the production capacity at its Dharuhera plant to 6,000 MT per annum, from 3,500 MT per annum in FY09. In FY10, HIL has increased the capacity by another 2,500 MT taking the total capacity to 8,500 MT as of 1 April 2010. This product contributes about 4.7% to revenue. HIL has a 76% all India market share in this product. Other players include Mega Insulation and Nuchem. However, HIL claims that its competitor’s products cannot withstand as high a temperature as Hysil. Thermal Insulation FY07 FY08 FY09Capacity (tonnes) 3500 3500 6000Production 3339 3884 4616Utilization 95.4% 111.0% 76.9%Sales quantity 3577 3909 4728Sales Value (Rs cr) 20.49 22.55 29.09Realization (Rs per tonne) 57282.6 57687.4 61527.1

(Source: Company, HDFC Sec) In terms of operating margins, the aerocon panels have the highest margins (30% plus), followed by thermal insulation products (30% range), AAC blocks (~20% range) and then building products (13%-16% range). Products & Usage

Product Name Use Charminar AC Roofing Sheets Industrial sheds, Agricultural buildings, Warehouses, Poultry farms, Garage, Verandahs and Cinema halls Aerocon Panels Partition, Prefabricated House, Mezzanine flooring, Schools and Low cost housing Aerocon HQ Building Blocks Residential apartments, Commercial complex, Industrial complex, Multiplex and Shopping malls Aerocool Roof Block for Cool Indoors Residential Buildings, Commercial buildings and Industrial buildings Flex-O-Board Partitions, Paneling, Sign boards, Return air boxing, Air cooling ducts, Backing material for cupboards,

Table tops, Sandwich panels

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Calcium silicate blocks and Pipe coverings

Boilers, Blast furnace shaft, annealing furnaces, preheater cyclones, steam pipelines

(Source: Company, HDFC Sec) Location & Marketing Network The company presently has manufacturing facilities at Hyderabad, Faridabad (aerocon panels and roofing sheets), Jasidih, Dharuhera (thermal insulation products), Thimmapur (aerocon panels), Vijayawada, Chennai (AAC block), Thrissur, Wada, Sathariya and Balasore. HIL has recently set up a new unit at Golan in the State of Gujarat for manufacturing AAC Blocks. Trial runs are going on and the plant is expected to start commercial production by May end. The freight cost of roofing sheet manufacturers accounts for almost 7 -10% of the total sales and any oversight in this factor could lead to a significant shrinkage in the margins. In terms of transportation, both the transport of raw materials to factory and the transport of finished goods to the market are the critical factors for this industry. Companies are constantly striving to reduce the distance between raw material source - plant and plant - market for finished goods without compromising on other aspects of the business. The products travel around 400-500 kms on an average. HIL has an extensive presence across the country with 11 manufacturing facilities (now 12 with Golan), 52 sales depots and more than 5,000 sales points, thereby providing extensive product reach. The widespread presence has reduced the time and distance to market for HIL products and has also reduced the freight cost. HIL has been able to leverage on its distribution reach for its other building products as well. However, at the same time 5 of HIL’s plants are in the South (thus over concentration in the South) while HIL has a limited presence in the East (which is a fast growing market). However, the company is planning to increase its presence in the East by setting up another 90,000 MT plant for the manufacture of roofing sheets in FY11. Shareholding pattern Given below is the shareholding pattern of the company as of 31 December 2009 as well as a list of entities holding more than 1% in the company.

Shareholding Pattern % Funds holding more than 1% % Foreign 5.93 DSP Blackrock Micro Cap Fund 1.26 Institutions 4.48 ICICI Prudential Discovery Fund 1.12 Government Holding 4.10 Governor of Andhra Pradesh 4.09 Non Promoter Corp 9.87 Promoters 43.13 Public & Others 32.50 Total 100.00

(Source: Company, HDFC Sec)

Triggers A Strong Brand Equity (Enabling Pricing stability, Brand extension and Volume Strength) HIL sells its Cement Fibre Sheet under the brand ‘Charminar’ which it has established over the past 6 decades. The strong Brand Equity enables the company not only to command a premium over its peers but also to capitalize on any growth in demand. Being a part of the CK Birla Group, HIL is a beneficiary from the Birla Brand giving it an instant recognition. The company has also been able to leverage on the brand supremacy for its new allied products like AAC Blocks, building panels and boards, which are rapidly gaining acceptance as a substitute for plywood and other traditional material use for building constructions. Thrust on Rural Housing to drive growth for Fiber Cement Roofing Sheets A shelter, being the most basic requirement only after food and clothing, is still a distant reality for the rural poor. Rural India accounts for ~70% of total population and with ~ 50% of Rural India living in Katcha & Semi Pucca homes thereby providing a vast opportunity for Pucca houses. Thatched roof need regular replacement and tiled roof need continued maintenance. Therefore, whenever the economic conditions improve the first choice of the rural poor to replace the roof over their head with an affordable and relatively durable product - asbestos cement sheets. As per NABARD, the housing shortage in Rural India is 14.6 mn units (11.4 mn on account of replacement and additional 3.2 mn of new units). The propensity to consume for the rural poor (~42% of the rural population and includes section like small and marginal farmers with land holding below 2 hectares and agricultural laborers), for shelter is very high and is only next to the food security. The implementation of the UIN Programme is expected to further boost income for the rural poor. Thus, there is increased potential (huge market) for usage of asbestos cement sheets in rural areas. The Government of India with an aim to provide adequate shelter to the rural poor has introduced programmes like Indira Awas Yojna (63% higher allocation in FY11 compared to last year), Golden Jubilee Rural Housing Finance Scheme, Pradhan Mantri Adarsh Gram Yojana, Productive Housing in Rural Area and Rural Housing Fund. With the drought situation in the past adversely impacting Rural India (especially the rural poor), their propensity to spend on housing has also been adversely impacted with food security emerging as the major issue. However, various government initiatives like NREGA (144% y-o-y rise in allocation), rise in MSP prices of crops over the past few years, farm loan waiver etc have managed to expand the rural pocket size. This has either lead to direct provision of housing or increased the amount of money in the hands of the rural consumer (enabling him to invest in housing). In addition, the situation is expected to improve post the harvesting of the Rabi crop and demand could remain strong going ahead.

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The increasing dependency of the poverty stricken rural population on non-farming activities, massive shortage of rural housing along with the high propensity of the rural poor to spend on shelter (after food) and the aggressive target (12 mn rural houses by 2012) set by the Government for rural housing would enable a consistent growth in rural housing and reduce the impact of drought and flood like adversities. Various State Governments (Govt. of AP, Bihar, Himachal Pradesh, Maharashtra, and Rajasthan) have done exceptionally in execution of the Indira Awas Yojana. Lastly, there is a strong correlation between the demand for roofing and GDP growth. The demand for roofing grows at about 1.3-1.5x GDP growth. Hence, with the Indian economy expected to report GDP growth upwards of 8% in FY11 as per the RBI’s estimates, we can expect the demand for roofing to grow in the 10.5-12% range. Thus, overall, a favorable monsoon in FY11, continued spending by the Government on various schemes / programmes and a strong GDP growth in FY11 is expected to translate into healthy demand for roofing sheets. Return of good times for the Roofing Industry The Indian Roofing Industry has a size of 4 mn tons. There exists a situation of an Oligopoly in this industry with the four largest players amassing ~60% of the market share collectively (HIL, Visaka, Everest and Ramco as indicated earlier). The industry has recently recovered from a turbulent phase in FY08, which was on account of an oversupply situation due to a rampant addition in the capacities in the past (FY05 and FY06). This is demonstrated by the operating and net profit margins of HIL as shown in the chart below. After reporting net margins in the 3% range in FY07 and FY08, HIL slowly saw its margins improve as the excess supply was absorbed. The recovery was on account of coordinated efforts amongst the players to restore demand supply equilibrium. With the robust demand in the future from Rural India on account of projects like NREGA & UIN leading to higher disposable income in the hands of the rural population, the industry expects a double digit growth (in the range of 10%) along with better margins going forward.

Trend in EBIDTA% & NPM

8.1 7.3

21.1 19.8

14.5

7.12.93.2

12.411.3

6.0

9.0

12.0

15.0

18.0

21.0

FY07 FY08 FY09 FY10 (E) FY11 (E)-2.0

1.0

4.0

7.0

10.0

13.0

16.0

EBIDTA % NPM %

(Source: Company, HDFC Sec) Increased capacity in Roofing segment to add to topline growth in FY11; Strong capex plans on the cards HIL is the largest producer of Asbestos cement sheets in India. HIL set-up a new 90,000 tonne cement sheet plant at Balasore, Orrisa which started commercial production in Q3FY09. The company also augmented its cement sheet capacity at Vijayawada plant by 90,000 tonne (commercial production started in Q2FY10) taking total capacity to 8.5 lakh tonnes. The full benefit of the Vijaywada capacity should be seen in FY11. In FY11, the company plans to put up two plants (of 90,000 MT each), one in Bihar and the other at an existing location in Sathariya (UP). The capex for the Bihar plant is expected to be about Rs. 40 cr and for the additional line at Sathariya about Rs. 25 cr. The plants are expected to come on stream by end FY11. With these plants, HIL intends to strengthen its presence in the East of India. Next, HIL’s unit located at Wada, Maharastra was shut down due to some labor issues for about 4 months in FY10 and has recommenced operations with effect from November 09. Due to enhanced capacity (Vijaywada and full impact of production at Wada) and off take together with better realizations, revenue from this division is expected to clock double-digit growth in FY11. Diversification into other products to make business model robust HIL is the largest producer of Asbestos cement sheets in India. However, the company has gradually diversified from a one-product company into other areas such as Autoclaved Aerated Concrete (AAC) blocks, thermal insulation products and other products like Prefabricated building panels, Hysil powder, Spares and accessories etc. With the “Green Building” concept gaining importance and growing acceptability for cement boards and panels as a substitute for plywood, HIL’s strategy to diversify into allied products like cement blocks, boards, panels etc should gain acceptance and market share going ahead. HIL is trying to evolve from being a Roofing company to a Building Solutions Player and is making special efforts like marketing of these products to architects, interior decorators etc. Due to ongoing expansion, we believe the revenue mix to tilt more in favour of AAC block business. HIL has increased its AAC block capacity from 1.5 lakh Cu M to 3.7 lakh Cu M, the full impact of which should be seen by Q2FY11. The change in revenue mix will be beneficial to HIL, as it decreases the risk of dependence on its flagship product for topline growth. Moreover, demand for AAC block comes from industrial segment and hence sole dependence on cyclicality of housing segment (through cement sheet sales) is de-risked

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to a certain extent. AAC block business also commands much better EBITDA margins of around 20%+ as compared to cement sheets, where margins hover at 13-15% depending on cyclicality. Long-term EBITDA margins could increase due to change in revenue mix. However, in the short term, margins could dip as HIL aims to achieve optimum capacity utilization / volume growth and thus could forego some margins (in order to make AAC blocks competitive with clay / concrete blocks). Similarly, HIL’s thermal insulation products should continue to grow at a healthy rate. HIL manufactures calcium silicate based insulating materials and services industries such as cement, power, petrochemicals, fertilizer plants etc. The insulating material manufactured by HIL is of a special variety, which is use for specific high heat applications only. The company commands ~75% market share in this special variety of insulation product. In FY09, HIL had increased its thermal insulation capacity from 3,000 MT to 6,000 MT. In FY10, the company has utilized about 90% of its capacity. The demand was so robust, that HIL further increased its capacity in FY10 by another 2,500 MT taking the total capacity to 8,500 by 1 April 2010. As per the management, this enhanced capacity is fully booked for 6 months. Depending on the demand and economic scenario going ahead, HIL is also contemplating putting up another 3,000 MT plant in FY11 for a capex of about Rs. 25-30 cr. HIL’s insulation material could receive a good uptick in demand as all the industry segments (to which it caters to) are in expansion mode and have aggressive industrial capex lined up during next 2-3 years. Thus, the share of thermal insulation products in also slated to increase in the overall revenue mix from the current 4.7% and it is expected to grow at a rapid clip, albeit on a small base. In 9MFY10, this division has reported revenue growth of 24.9% y-o-y to Rs. 24.45 cr while PBIT margins are at 32.2%, up from 27.5% in 9MFY09. As a result, the contribution of roofing sheets is expected to fall from about 85% in FY09 and FY10 to about 76% in FY11. In terms of operating margins, the aerocon panels have the highest margins (30% plus), followed by thermal insulation products (30% range), AAC blocks (~20% range) and then building products (13%-15% range). We believe that this is a good move on part of the company as it helps HIL de-risk its business model, diversify its revenue stream and it could also result in the stock getting a higher rating as the company reduces its dependency on asbestos sheets (commoditized product) and moves into more value added (green) products. AAC blocks to slowly gain acceptance and market share as a building material AAC blocks are lightweight, building material that provides structure, insulation, fire and mold resistance in a single material. AAC’s high resource efficiency gives it low environmental impact in all phases of its life cycle, from processing of raw materials to the disposal of AAC waste. AAC’s lightweight also saves energy in transportation. AAC’s excellent thermal efficiency makes a major contribution to environmental protection by sharply reducing the need for space heating and cooling in buildings. Given below is a summary of some of the differences between ACC blocks and Conventional bricks. Saving in cost of structure - AAC blocks are one third lighter than conventional clay bricks, thereby reducing the dead weight of the structure drastically. Lightweight structure decreases construction cost due to reducing steel, Cement and Excavation. Reduction in steel is 15% and reduction in cement is 10%. Savings in Mortar - AAC blocks are 7 times bigger than the size of the conventional bricks. Bigger size means less number of joints. Less joints results in lesser quantity of mortar for building. There is overall 60% reduction in use of Mortar. Savings in Plaster - AAC blocks have uniforms shape and texture, which gives even surfaced to the walls. There is overall 35% reduction in the cost of plastering. Reduction in wasting due to less breakages - Unlike conventional clay brick which are prone to breakages, AAC blocks have almost nil breakages. There is over all 65% reduction in cost due to practically no wastages the input cost. Reduction in HVAC Load - AAC blocks are resistant to thermal variations. It reduces total load of refrigeration and air conditioning. Though initial installation cost may remain same but AAC blocks reduces operation and maintenance cost drastically. There is over all 25% saving in operation cost. Savings in power infrastructure - Due to lesser HVAC load, cost of power infrastructure i.e. lesser capacity of transformer, DG set, and Cable etc. also reduces considerably which in form results in savings in electricity charges. However, AAC blocks are more expensive than the conventional red clay bricks or concrete blocks. HIL has a presence in the South and West in AAC blocks. In the South, about 48% of the market still uses clay brick, 34% use concrete brick and only about 3% use AAC. Thus, the market penetration of AAC is low and the market size is vast. However, it could time for builders to shift from one form of material to another, especially when at first the impression is that AAC is much more expensive. The correct marketing strategy and spread of awareness / education of end users about the advantages of AAC could lead to deeper market penetration. Currently, HIL commands 40% of market share in the South. Other players in the south include BILT with a market share of about 6% and Siporex with a market share of about 7%. Grasim is expected to enter this space in FY11 and could gain a market share of about 7%. HIL currently has one AAC block manufacturing plant at Chennai with capacity of 1.5 lakh Cu M (expanded by 50,000 Cu M in FY10). This plant caters to the need of Southern and Western market. Currently, HIL commands 40% of market share in the South. The blocks contribute about 5.5% to HIL’s topline. To cater to the growing demand in Western region, the company is augmenting its manufacturing capacity from 1.5 lakh Cu M to 3.7 lakh Cu M by setting up a new plant of 2.2 lakh Cu M at Golan, Surat, Gujarat. The company has started trial runs at its new AAC Plant, and is expecting commercial production by the end of May. This plant will cater to urban centers in Maharashtra and Gujarat. Raw materials for this product include lime, flyash, cement and some additives. In FY11,

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AAC’s contribution to net revenue is expected to rise to 11.7% from the current 5.5% of revenue. AAC block business also commands much better EBITDA margins of around 20%+ as compared to cement sheets, where margins hover at 13-15% depending on cyclicality. Long-term EBITDA margins could increase due to change in revenue mix. However, in the short term, margins could dip as HIL aims to achieve optimum capacity utilization / volume growth and thus could forego some margins (in order to make it seem competitive with clay / concrete blocks). Financial Performance & Outlook Despite the economic downturn in FY09, HIL and other players in the asbestos roofing industry continued to do well. After suffering from over capacity in FY06 and FY07, the roofing industry saw demand return in a big way, thanks to various measures taken by the Government, favorable monsoon and increase in MSP prices for crops. HIL saw its topline grow by 28.2% y-o-y to Rs. 618.8 cr, operating margins expanded by 720 bps to 14.5% and bottomline grew by 213.1% to Rs. 44.1 cr. Both segments, building products (roofing sheets, aerocon panels and AAC blocks) and thermal insulation products reported growth of about 28% each in topline in FY10. PBIT margins in the building product segment stood at 14.2% as against 5.9% in FY08. Margins in thermal insulation were at 31.1% as against 41% in FY08. HIL has taken a number of initiatives to reduce costs. These include increase in fuel efficiency, manpower rationalization, more automation of processes, reduction in fixed costs etc. In 9MFY10, HIL has reported a topline of Rs. 497.2 cr, up 14.3% y-o-y. Operating margins expanded to 21.6% from 15.3% in 9MFY09. Interest costs declined by 29.7% to Rs. 4.5 cr and depreciation increased by 16.7% to Rs. 10.4 cr in line with the company’s capex. HIL reported a PAT of Rs. 63.4 cr, up 78% y-o-y driven by volume growth and margin expansion. The building product segment reported growth of 13.9% to Rs. 473.49 cr and PBIT margins of 22.3% (15.3% in 9MFY09). Thermal insulation products reported growth of 24.9% to Rs. 24.45 cr and PBIT margins of 32.2% as against 27.5% in the corresponding period last year. In 9MFY10, HIL has done an EPS of Rs. 84.7. Overall, we expect HIL to report topline growth of 11.5% and 23.2% to Rs. 690.2 cr and Rs. 850.2 cr in FY10 and FY11 respectively. In FY11, the growth will mainly come from a number of factors, namely: (1) increased sale of roofing sheets due to full benefit of Vijaywada plant (90,000 MT) and Wada plant (labor issues resolved) (2) increase in volume and sale of AAC blocks due to 2.2 lakh Cu M of capacity going into commercial production by end May 2010 (3) increase in sale of thermal insulation products as capacity has been increased from 6,000 MT to 8,500 MT by 1 April 2010 (4) expectations of the roofing industry to grow at 10-12% (5) a good Rabi crop and expectations of a good monsoon which should translate into better purchasing power for the rural population and lastly (6) a recovery in the GDP growth which should be beneficial for the real estate and construction sectors as well. HIL could close FY10 with operating margins of about 21.1% due top strong demand and lower raw material prices. However, in FY11 margins could come off their peak in FY10 and stabilize in the 20% range (focus on volume growth / capacity utilization incase of AAC blocks and increase in raw material costs could impact margins). Depreciation is expected to increase sharply in FY11 on account of the Rs 80 cr capex carried out by the company in FY10 (funded via internal accruals). In FY11, HIL plans to incur a capex of about Rs. 100 cr, which will be funded partly by debt and the rest from internal accruals. HIL could report a PAT of Rs. 85.7 cr and Rs. 96 cr in FY10 and FY11 respectively, registering a growth of 94.3% and 12.1%. Concerns Ban/restriction on use of asbestos may force industry to look for other alternative - In the past, in Western countries, due to uncontrolled usage of asbestos, there were cases of people suffering from diseases like Asbestosis, Lung cancer and Mesothelioma. These health issues recorded in the Western countries in the past and which are being highlighted and debated by the anti-asbestos lobbies relate to extensive and uncontrolled usage of the Blue and Brown varieties of Asbestos fibre. In India, there is ban on the usage of Blue and Brown varieties of asbestos. Any government initiative (based some NGO protests) to completely ban or restrict the use of asbestos will force industry to look for alternative and may increase its overall cost. However, with government thrust on affordable housing projects, there seems to be remote chances of complete ban on usage of asbestos. The increased use and presence of Chrysotile fibre sheets in developing countries like Brazil, China, Russia, India and Indonesia etc., and constraints in the availability of Fibre have resulted in significant increase in prices of raw Chrysotile. Further, fewer shipping lines accepting this cargo has resulted in considerable increase in ocean freight and high inventory built up in the company. Asbestos sheets face competition from GI (galvanized iron) sheets and incase of adverse regulatory developments and / or a fall in metal prices, competition from this segment could increase. Increase in raw material costs and forex fluctuation - Chrysotile (Asbestos Fibre) is the vital raw material, which constitutes 45% to 50% of the total raw material costs. It is 100% imported. The roofing industry is thriving on the import of about 350,000 tonnes of chrysotile asbestos a year from Canada, Brazil, Russia, Zimbabwe and Kazakhstan for production of sheets and pipes. There are a limited number of suppliers and there exists some coordination amongst them, if not collusion. The cost of Chrysotile thus depends on the suppliers and the parity between USD and INR. OPC (Ordinary Portland Cement) constitutes 35% to 40% of raw material cost and has witnessed huge price escalations in the previous 2 fiscals. Thus, HIL faces risk from volatile raw material prices. In order to hedge its currency exposure, HIL enters into forward contracts for about 50% of its exposure if rates are favorable. Appreciation of the Rupee vs the USD is beneficial for HIL as its imports 45-50% of its raw materials. Increase in the cost of fly-ash - Fly-ash which was procured from the thermal power stations free or at low cost earlier is now being sold by some of the power plants through the tender mechanism, resulting in increased cost for the company.

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Players are increasing capacity in the roofing segment - A number of players are increasing capacity in the roofing segment. In case rural demand falls, this could lead to over capacity, pressure on realizations and profitability. Further, there are about 18 players in the industry with the top 4 occupying a market share of about 60%. Thus, competition is stiff and during times of over-capacity, competition can become fierce with players resorting to under-cutting. Rural spending and monsoon effect – A poor monsoon impacts the demand for roofing in rural India. As per the management, HIL has felt some impact of the poor monsoon on roofing offtake for the past few months. However, it expects H2FY10 to be better as the Rabi crop is expected to be better. Other than that, HIL is also dependent on Government spending on schemes like NREGA, Indira Awas Yojna etc. Any decrease in spending on these schemes could reduce the purchasing power of HIL’s customers in the roofing segment. Seasonality – Since HIL’s building product business is largely driven by sales in rural India it is seasonal in nature (impacted by Kharif and Rabi crop cycles) and hence the March and June quarters are generally better than the rest of the year. However, entry into other building products and thermal insulation should help to smoothen sales to a certain extent. Operating margins could come under pressure - Increased spend on advertising of new products, educating builders about the advantages of green products and spreading awareness of its products could impact HIL’s operating margins. Further, in the short run the company may forego some part of its operating margins in order to push volumes. Aggressive capex plans – HIL has steadily been investing in its gross block over the past few years. In FY10, HIL has incurred a capex of Rs. 80 cr and in FY11 this number is expected to rise to Rs. 100 cr. Thus, while HIL’s strategy to diversify into other revenue streams is prudent, the timing of cash flows from these investments and the success of the new products is uncertain. Given below is a chart depicting the trend in gross block addition and the return on capital employed

Trend in Gross Block & RoCE

050

100150200250300350400450500

FY07 FY08 FY09 FY10 (E) FY11 (E)0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

%Gross Block ROCE

(Source: Company, HDFC Sec)

Conclusion From a roof manufacturing company, HIL has evolved into a multi product, green building products organization. HIL is the market leader (Capacity – 8,54,500 tonnes) with a share of ~20.5% in the Roofing industry (Asbestos Cement Fibre Sheet) with an experience of over six decades. Large capacity, brand superiority of “Charminar” and strong distribution network places HIL in a leadership position. HIL has also been able to capitalize on the strong thrust of Government on Rural Housing. Moreover, the company has gradually diversified from a one-product company into other areas such as Autoclaved Aerated Concrete (AAC) blocks, thermal insulation products and other products like Prefabricated building panels, Hysil powder, Spares and accessories etc. With the “Green Building” concept gaining importance and growing acceptability for cement boards and panels as a substitute for plywood, HIL’s strategy to diversify into allied products like cement blocks, boards, panels etc should gain acceptance and market share going ahead. We believe that this is a good move on part of the company as it helps HIL de-risk its business model, diversify its revenue stream and it could also result in the stock getting a higher rating as the company reduces its dependency on asbestos sheets (commoditized product) and moves into more value added (green) products. In 9MFY10, HIL has reported a topline of Rs. 497.2 cr, up 14.3% y-o-y. Operating margins expanded to 21.6% from 15.3% in 9MFY09. Interest costs declined by 29.7% to Rs. 4.5 cr and depreciation increased by 16.7% to Rs. 10.4 cr in line with the company’s capex. HIL reported a PAT of Rs. 63.4 cr, up 78% y-o-y driven by volume growth and margin expansion. The building product segment reported growth of 13.9% to Rs. 473.49 cr and PBIT margins of 22.3% (15.3% in 9MFY09). Thermal insulation products reported growth of 24.9% to Rs. 24.45 cr and PBIT margins of 32.2% as against 27.5% in the corresponding period last year. In 9MFY10, HIL has done an EPS of Rs. 84.7. Overall, we expect HIL to report topline growth of 11.5% and 23.2% to Rs. 690.2 cr and Rs. 850.2 cr in FY10 and FY11 respectively. In FY11, the growth will mainly come from a number of factors, namely: (1) increased sale of roofing sheets due to full benefit of Vijaywada plant (90,000 MT) and Wada plant (labor issues resolved) (2) increase in volume and sale of AAC blocks due to 2.2 lakh Cu

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M of capacity going into commercial production by end May 2010 (3) increase in sale of thermal insulation products as capacity has been increased from 6,000 MT to 8,500 MT by 1 April 2010 (4) expectations of the roofing industry to grow at 10-12% (5) a good Rabi crop and expectations of a good monsoon which should translate into better purchasing power for the rural population and lastly (6) a recovery in the GDP growth which should be beneficial for the real estate and construction sectors as well. HIL could close FY10 with operating margins of about 21.1% due top strong demand and lower raw material prices. However, in FY11 margins could come off their peak in FY10 and stabilize in the 20% range (focus on volume growth / capacity utilization incase of AAC blocks and increase in raw material costs could impact margins). Depreciation is expected to increase sharply in FY11 on account of the Rs 80 cr capex carried out by the company in FY10. In FY11, HIL plans to incur a capex of about Rs. 100 cr, which will be funded partly by debt and the rest from internal accruals. HIL could report a PAT of Rs. 85.7 cr and Rs. 96 cr in FY10 and FY11 respectively, registering a growth of 94.3% and 12.1%. FY09 9MFY10

Peer Comparison Sales OPM % PAT Equity FV Sales OPM % PAT EPSD/E

FY09 Latest

BV Price P/E P/BVVisaka Industries 580.7 14.5% 38.5 15.9 10.0 435.1 19.1% 43.8 27.6 0.9 118.23 177.7 4.8 1.5Ramco Industries 501.6 21.3% 42.8 4.3 1.0 363.7 21.8% 42.8 9.9 0.9 35.2 62.1 4.7 1.8Everest Industries 530.4 9.4% 14.5 14.8 10.0 467.5 9.9% 18.8 12.7 1.2 102.1 232.0 13.7 2.3HIL 620.7 14.6% 44.8 7.5 10.0 499.0 21.8% 63.5 84.7 0.4 242.2 619.1 5.5 2.6

(Source: Capitaline, HDFC Sec, P/E is based on annualized 9 month EPS) As can be seen from the peer comparison given above, HIL has amongst the highest operating margins in comparison to its peers. Further, it is the largest in terms of size and has the lowest debt equity ratio. HIL’s debt to equity ratio is further slated to go down as it has repaid part of its debt in 9MFY10 (and funded its capex in FY10 with internal accruals) and could close FY10 with a D/E of 0.24. Part of this can also be attributed to tighter working capital management. Inventory days are at about 62-65 days while debtor days are about 30. Everest Industries is quoting at a significant premium in comparison to its peers due to its MNC parentage (though now owned by Indians) and entry into the pre-engineered building space. Ramco and Visaka get subdued valuations due to their presence in other segments - Ramco is into cotton yarn and cement in addition to building products, while Visaka is also into synthetic yarns. Also, Ramco’s investment book value (based on CMP) is more than its market capitalization and is hence not directly comparable. Given HIL’s entry into ‘green products’ and the success of its thermal insulation product, we expect, HIL to get re-rated. Asbestos sheets as a % of sales is expected to fall from 85% in FY09 and FY10 to about 76% in FY11. This diversification into advanced building products and thermal insulation products will lead to a de-risking of the business model from the cyclicality of the roofing business and could lead to HIL getting better valuations. At the current market price of Rs. 619.05, the stock trades 4.8x FY11 (E) earnings of Rs.128.2. We recommend a buy on the stock with the sequential price targets of Rs. 705 and Rs. 769 at which it discounts its FY11E earnings by 5.5x-6x. On dips, investors can add the stock in the Rs. 565-582 band. Financials

Quarterly Results

(Rs cr) Q3FY10 Q3FY09 % Chg y-o-y Q2FY10 % Chg q-o-q 9MFY10 9MFY09 % Chg y-o-yNet Sales 146.0 129.6 12.6% 143.4 1.8% 497.2 435.1 14.3%Other Income 1.3 0.9 54.0% 1.1 27.6% 3.9 3.2 19.8%Total Income 147.4 130.5 12.9% 144.5 2.0% 501.1 438.3 14.3%Total Expenditure 119.9 113.9 5.3% 113.4 5.8% 390.0 368.5 5.8%Raw Material costs 68.9 66.9 3.0% 56.9 21.2% 231.1 220.9 4.6%Employee costs 14.5 12.3 17.8% 13.8 5.2% 42.0 35.7 17.7%Other Expenditure 36.5 34.7 5.2% 42.7 -14.5% 116.9 111.9 4.5%EBIDTA 27.4 16.6 65.4% 31.1 -11.8% 111.1 69.8 59.1%Interest 1.4 2.6 -45.0% 1.3 11.8% 4.5 6.4 -29.7%PBDT 26.0 14.0 85.8% 29.8 -12.8% 106.6 63.4 68.1%Depreciation 3.9 3.8 1.8% 3.6 9.0% 10.4 8.9 16.7%PBT 22.1 10.2 117.3% 26.3 -15.8% 96.2 54.5 76.5%Tax 7.6 3.6 111.5% 8.8 -13.7% 32.7 18.9 73.4%PAT 14.6 6.6 120.5% 17.5 -16.9% 63.4 35.6 78.0%EPS 19.4 8.8 120.5% 23.4 -16.9% 84.7 47.6 78.0%Equity 7.5 7.5 7.5 7.5 7.5Face Value 10.0 10.0 10.0 10.0 10.0OPM % 17.9% 12.1% 21.0% 21.6% 15.3%NPM % 9.9% 5.1% 12.1% 12.7% 8.1%

(Source: Company, HDFC Sec)

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Segmental Q3FY10 Q3FY09 % Chg y-o-y Q2FY10 % Chg q-o-q 9MFY10 9MFY09 % Chg y-o-yBuilding Products 137.56 120.53 14.1% 134.98 1.9% 473.49 415.75 13.9%Heavy Engineering 0.00 0.23 NA 0.00 NA 0.00 0.42 NAOthers 0.00 0.00 NA 0.00 NA 0.00 0.00 NAThermal 8.78 9.02 -2.7% 8.45 3.9% 24.45 19.58 24.9%Total 146.34 129.78 12.8% 143.43 2.0% 497.94 435.75 14.3%PBIT Building Products 24.09 12.88 87.0% 29.63 -18.7% 105.55 63.80 65.4%Thermal 2.95 2.51 17.5% 2.39 23.4% 7.87 5.39 46.0%Total 27.04 15.36 76.0% 32.02 -15.6% 113.42 69.16 64.0%PBIT Margin Building Products 17.5% 10.7% 22.0% 22.3% 15.3%Thermal 33.6% 27.8% 28.3% 32.2% 27.5%Total 18.5% 11.8% 22.3% 22.8% 15.9%Capital employed Building Products 336.17 298.10 12.8% 325.79 3.2% 336.17 298.10 12.8%Heavy Engineering 0.00 1.55 NA 0.00 NA 0.00 1.55 NAOthers 0.00 0.46 NA 0.00 NA 0.00 0.46 NAThermal 17.72 12.22 45.0% 15.10 17.4% 17.72 12.22 45.0%Unallocated Net Assets/Liabilities -109.61 -125.83 12.9% -105.89 3.5% -109.61 -125.83 12.9%Total Capital Employed 244.28 186.50 31.0% 235.00 3.9% 244.28 186.50 31.0%

(Source: Company, HDFC Sec) Profit & Loss A/c

(Rs cr) FY07 FY08 FY09 FY10 (E) FY11 (E)Net Sales 439.7 482.7 618.8 690.2 850.2Other income 4.1 4.7 3.9 5.3 5.0Total Income 443.8 487.4 622.7 695.5 855.2Total Operating Expenditure 404.2 447.3 529.1 544.5 681.8EBITDA with OI 39.6 40.0 93.6 151.0 173.4Interest 4.4 7.3 9.1 6.3 8.8Depreciation & Non cash charges 9.6 11.1 14.0 15.0 20.1PBT 25.6 21.6 70.5 129.7 144.5Exceptional items 3.3 -0.3 1.1 0.0 0.0Taxation 8.4 7.8 25.3 44.0 48.5Net Profit 14.0 14.1 44.1 85.7 96.0

(Source: Company, HDFC Sec)

Balance Sheet

(Rs cr) FY07 FY08 FY09 FY10 (E) FY11 (E)Capital 7.5 7.5 7.5 7.5 7.5Reserves & Surplus 134.3 143.5 178.7 253.9 339.4Shareholders’ Funds 141.8 151.0 186.2 261.4 346.9Secured Loans 54.2 70.3 46.8 40.7 65.7Unsecured Loans 21.2 21.5 33.5 22.5 26.8Total Loans 75.3 91.8 80.3 63.2 92.5Net Deferred Tax 13.5 16.3 18.7 18.7 18.7Total 230.6 259.1 285.2 343.3 458.0Net Block 129.4 129.2 159.8 191.3 273.6Capital WIP 2.6 23.0 36.5 52.4 49.8Investments: 9.6 9.5 9.3 9.3 9.3Net Current Assets 89.0 97.4 79.5 90.2 125.3Total 230.6 259.1 285.2 343.3 458.1

(Source: Company, HDFC Sec) Cash Flow Statement

(Rs cr) FY07 FY08 FY09 FY10 (E) FY11 (E)Profit Before Tax 22.3 21.9 69.4 129.7 144.5Net Operating Cash Flow -8.6 33.2 76.7 94.1 99.8Net Cash from Investing Activity 1.4 -28.7 -57.7 -62.4 -99.8Net Cash from Financing Activity 7.0 5.3 -24.8 -33.9 10.0Cash & Cash Equivalents (includes FD and C/A) 6.5 16.3 10.5 8.2 18.2Net Inc / (Dec) in Cash -0.2 9.8 -5.8 -2.3 10.0

(Source: Company, HDFC Sec)

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Ratio Analysis

FY07 FY08 FY09 FY10 (E) FY11 (E)Profitability Ratios (%) EBITDA 8.1 7.3 14.5 21.1 19.8Net profit 3.2 2.9 7.1 12.4 11.3RoCE 8.8 7.5 18.7 28.6 25.4RoA 6.1 5.8 16.2 27.3 24.0RoE 9.9 9.3 23.7 32.8 27.7Growth Ratios (%) Net sales 9.8 28.2 11.5 23.2EBITDA 1.2 133.7 61.3 14.9PBT -15.7 226.5 83.9 11.4PAT 0.8 213.1 94.3 12.1EPS 0.8 213.1 94.3 12.1Valuation Ratios (X) PE 33.2 32.9 10.5 5.4 4.8CPE 19.7 18.4 8.0 4.6 4.0Price/BV 3.3 3.1 2.5 1.8 1.3EV/EBITDA 4.3 4.3 1.6 3.1 3.0EV/Sales 0.4 0.4 0.2 0.7 0.6EV/Mcap 1.5 1.6 1.7 1.1 1.1D/E (Total) 0.5 0.6 0.4 0.2 0.3Per share data (Rs) Earnings 18.7 18.8 58.9 114.4 128.2Cash Earnings 31.4 33.7 77.5 134.4 155.0Book Value 189.3 201.6 248.6 348.9 463.1Turnover Ratios Fixed Assets 3.3 3.2 3.2 2.8 2.6Inventory 3.8 4.2 5.5 5.9 6.2Debtors 11.3 11.1 12.6 12.5 12.3Payable 4.9 5.2 5.6 5.4 6.0Working Capital 4.9 5.0 7.8 7.7 6.8Inventory (days) 95.6 86.4 66.4 62.1 59.1Debtors (days) 32.3 32.8 29.0 29.2 29.6Creditors (days) 73.8 70.8 65.3 67.5 61.2

(Source: Company, HDFC Sec) RETAIL RESEARCH Fax: (022) 30753435 Corporate Office HDFC Securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Website: www.hdfcsec.com Email: hdfcsecretailresearch@hdfcsec.com Disclaimer: This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. Thisdocument is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buyany security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not berelied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to timesolicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for Retail Clientsonly and not for any other category of clients, including, but not limited to, Institutional Clients