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LMW: Can it get past these testing times?
Jul 23, 2009

We recently had a research meeting with the management of Lakshmi Machines Works (LMW) to get its perspective on the macro environment, the challenges the textile industry is facing and what it plans to do to counter the slowdown. What is the company's business?
LMW is India's largest textile spinning machinery manufacturer. The company's business is organised into two main business segments - textile machinery comprising spinning preparatory machinery, yarn-making machinery, accessories and parts, and others comprising metal cutting, including grinding machines and castings. In the first segment, the company manufactures the entire textile spinning machinery range - from blowroom to ring spinning. In the machine tools business, the company manufactures computer numerical control (CNC) lathes and machining centers for automobile companies, auto-component manufacturers as well as tier II and III manufacturers of the component conversion industry. The company also has a foundry division, where it manufactures ductile iron and grey iron castings to cater to its captive requirements (66% of the division's production) as also to the demand coming out of global companies manufacturing large generators and win energy turbines.

Key takeaways from the research meeting

Business environment: As per the management, the textile industry is in doldrums currently. It is quite understandable considering that consumption (globally) has declined considerably. While capacity utilisation levels of domestic textile majors are doing fine, other factors such as power shortages (especially in the state of Tamil Nadu) are adding to the woes. The management also added that on one hand, banks are reluctant to lend and on the other, mills are not looking to expand capacities as they are simply unclear about the future.

Keeping all these macro factors in mind, LMW has also reduced its capacity utilisation. To put things in perspective, the company has reduced its utilisation from 3 shifts to 1 shift (textile machinery business). The management added that the quantity of new orders that it is receiving are not sufficient to feed the factories, thereby forcing it to work only in a single shift.

As for its foundry division, the company has been going through a tough time as well. The company has 3 foundry units - 2 for captive usage and 1 for external parties. However, only the latter is functioning at the moment. The reason for the same is slowdown in captive demand.

As regards LMW's third business segment of machine tools, where the company manufactures computer numerical control (CNC) lathes and machining centers and caters to the automotive sector, the management was not so upbeat about the same. Stating that the scenario is improving slowly, it believes that demand has not yet reached the desired levels.

On competition: LMW's management believes that the competitive scenario has gotten more intense as new players have emerged in recent times. Established international companies like Reiter and ATE Enterprise have set up bases in India. LMW may be in a position to overcome these players due to its strong history and foothold in India. However, in terms of competition, its major concern is the entry of Chinese players that are offering equally good products at highly competitive prices.

Responding to why Chinese products are so competitive, the management indicated that the productivity level in China is higher by 25% to 30% as compared to India. What this basically means is that a similar amount of work can be done at a faster pace in China. A key reason for the same is discipline amongst the work force. Also the fact that cost of labour and the ability of companies to source raw material at competitive prices cannot be ignored. These are the key reasons as to why Chinese goods are available for cheap.

On FY09 performance: LMW's financial performance during FY09 is one that it would like to forget. While the company's topline was down by about 39% YoY, its profits were lower by 56% YoY. This was mainly due to a poor operating performance, as operating margins fell to 13.5% from 18.1% in the previous fiscal. More so during 4QFY09, the company's topline and bottomline were lower by 70% YoY and 87% YoY. In fact, the company reported a loss at the operating level itself.

LMW currently has an order backlog of about Rs 34 bn, as against order backlog of Rs 45 bn at the end of FY08. Now, considering that it was about 2 times its FY07 revenues, it did give a good amount of revenue visibility as it was executable over a period of 15 months. But due to the economic slowdown, and the company's visibility estimates went for a toss. Order delays, deferments, cancelations, customers not willing to go ahead with plans, banks not willing to lend, are just some of the reasons that led to the company to perform in such a manner during FY09.

Capex plans: In anticipation of a strong order inflow during the fast growth phase, LMW went in for a capacity expansion during FY08. It increased its spinning preparatory machinery capacity by 19% to 5,000 units during the fiscal. Another major reason for the same would be the fact that the company operated at an utilisation rate of about 91% in FY07 and FY08 as compared to an average utilisation of 44% in the period between FY02 to FY06. With the company building up capacity significantly, it is obvious that it will not go in for any major investments in the next few years. However, the management did add that it plans to invest some amounts towards automation.

Management's guidance for FY10: Unsure about when the scenario is likely to improve, the management is simply unclear about LMW's future numbers. However, it does believe that the company has a good foothold in the domestic markets and as such will be in a position to emerge through the slowdown.

What to expect?
At the current price of Rs 880, the stock is trading at a multiple of 10.2 times its FY09 earnings, and 1.2 times book value per share. The visibility with respect to LMW's business has deteriorated sharply over the past few quarters, and the management sees no respite coming in the next few quarters. Given this, it has become very difficult for us to project any reliable forward estimates for the company. For investors in the stock, LMW's strong cash balance of around Rs 540 per share (based on last year's numbers) might give some comfort. But as far as the core business is concerned, it's really cloudy out there. The stock is trading around 56% lower than our last recommended price. Given the drastic and sharp changes that have impacted the company since then, we now have a cautious view on the stock. While the company can sharply turn around on the back of its financial strength if the industry were to revive, it is still a big 'if'.

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