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Elecon Engineering: ‘Gearing’ up
Jun 19, 2007

Performance summary
Elecon Engineering, a leading player in the material handling equipment business, had recently announced results for the fourth quarter and year ended March 2007. For FY07, while revenues have grown by 63% YoY, net profits have almost doubled, largely led by expansion in operating margins. Operating margins have benefited from lower raw material and staff costs (both as percentage of sales). The board has recommended a dividend of Rs 1.5 per share (dividend yield of 0.3%) and issue of bonus shares in the ratio of 2:1 (2 bonus shares for every 1 share held as on the record date).

Performance snapshot
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Sales 1,874 2,848 52.0% 4,425 7,231 63.4%
Expenditure 1,624 2,459 51.4% 3,828 6,114 59.7%
Operating profit (EBDITA) 250 389 55.8% 597 1,117 87.3%
Operating profit margin (%) 13.3% 13.7%   13.5% 15.5%  
Other income 13 23 82.8% 83 66 -21.0%
Interest 35 58 66.5% 140 194 38.5%
Depreciation 25 34 36.6% 94 122 29.6%
Profit before tax 203 321 58.0% 445 867 94.7%
Extraordinary income/(expense) (18) (6)   (36) (23)  
Tax 76 130 71.0% 131 295 125.3%
Profit after tax/(loss) 110 186 69.3% 279 549 96.9%
Net profit margin (%) 5.8% 6.5%   6.3% 7.6%  
No. of shares         30.9  
Diluted earnings per share (Rs)         17.8  
P/E ratio (x)         27.4  

What is the company’s business?
Elecon, which was established in 1951, was one of the pioneers in the manufacture of material handling equipment in India. During the past five decades of its existence, and from a modest start of design and manufacture of elevators and conveyors, Elecon has grown to be known as a pioneer of bulk material handling equipments in India. Its product range includes design, engineering, manufacture, supply, erection and commission of wagon tipplers, fertilizer reclaiming scrapers, limestone blending plants, stationary and moveable conveying systems for lignite mines, integrated coal handling plants for power stations and underground mining conveyors. The company is also foraying into shipbuilding fabrication and manufacture of windmill gearboxes. Elecon’s broader business segments of Material Handling Equipment (MHE) and Transmission Equipment (TE) formed 59% and 41% respectively of the company’s FY07 sales.

What has driven performance in FY07?
Segment-wise performance
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Material Handling Equipment (MHE)
Revenue 1,187 1,913 61.2% 2,260 4,484 98.5%
% share 60.2% 63.4% 49.4% 58.9%
PBIT margin 10.8% 11.6% 9.2% 12.3%
Transmission Equipment (TE)
Revenue 784 1,104 40.8% 2,319 3,135 35.2%
% share 39.8% 36.6% 50.6% 41.1%
PBIT margin 18.5% 20.6% 20.0% 20.6%
Total
Revenue 1,971 3,016 53.1% 4,578 7,619 66.4%
PBIT margin 13.9% 14.9% 14.7% 15.7%
* Excluding inter-segment adjustments
MHE leads topline growth: Elecon’s MHE business, which accounted for 59% of the company’s total sales, almost doubled its turnover during FY07, thus contributing a large part to the company’s overall sales growth of 63% YoY during the fiscal. The TE business also recorded a strong growth, with its sales rising by 35% YoY during FY07. Strong investments in core sectors like power, coal and cement has kept the order flow strong for Elecon in the MHE segment, where it is a major player in the industry. Power sector is the largest contributor to Elecon’s MHE business, as it provides the company with nearly 70% of its orders. During FY07, the company garnered some key project sin this space from industry leaders like NTPC and Reliance Energy. We have gathered from the company’s management that almost 10% to 12% of total cost of setting up a power project is expended towards material handling equipments. Considering the size of investments planned in the sector, the opportunity for Elecon seems huge. As such, we expect the MHE division to be the growth driver for Elecon in the future as well. Also, with large-scale expansions in mining planned in the company’s export markets of South Africa and Australia, the growth process is likely to get a further boost.

As for the TE business, Elecon’s growth has been driven by strong upsurge in industrial capex, with strong expansion activity in cement, steel and sugar industries. Further, with average capacity utilisations running at high levels in these industries, the buoyancy in capex cycle is expected to continue over the next 2-3 years. This shall provide a strong impetus for the gears division of Elecon. The management has also indicated its intentions of focusing more aggressively on the wind power business. Towards this, the company has already set up the manufacturing infrastructure in Gujarat and is now trying to tie up with a customer that can give it business on a sustainable basis. The management has indicated of a sales target of Rs 10 bn in FY08 (38% YoY growth), which we expect it to meet. As far as FY07 is concerned, the company’s actual revenues are higher than our estimates by a marginal 2%.

Cost efficiencies aid margin expansion: Elecon has recorded lower raw material and staff expenses (both as percentage of sales) during FY07, which has helped it expand its operating margins by 200 basis points (2%) to 15.5%. Based on segments, while PBIT margins of MHE division recorded a strong expansion from 9.2% in FY06 to 12.3% in FY07, those of the TE division remained almost stable at 20%.

Margin expansion aids bottomline: Elecon almost doubled its net profits during FY07, chiefly due to the expansion in its operating margins. But for the decline in other income and higher tax and interest outgo, the bottomline picture would have been even better.

What to expect?
At the current price of Rs 486, the stock is trading at a multiple of 13.1 times our estimated FY09 earnings. The company has maintained a strong growth momentum in the MHE business and we expect the going to remain strong, simply on the basis of large core sector (power, steel and coal) investments that are expected to flow in over the next few years. The company’s venture into windmill gearbox is also likely to add to profitability, as indicated by the management. Overall, we maintain our positive recommendation on the stock from a 2-3 years perspective.

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