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Engineering: A review - Views on News from Equitymaster
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  • Dec 28, 2002

    Engineering: A review

    While most of us would remember 2002 as a year that brought economic hardships for India Inc., one sector might view it as a dream year. The sector being referred to here is engineering. After being in doldrums in FY01, engineering companies kept their head down, restructured their operations, cut flab and emerged more competitive.

    To get a glimpse of what happened, we analysed India Inc.’ 3 listed leading engineering companies viz. ABB, BHEL and Thermax. What we saw may not be exhaustive for the sector as a whole but it did offer an insight to the trend that the sector has witnessed and is likely to see going forward.

    A look at the consolidated numbers of the 3 companies during April-Sep ’02 indicates that while the turnover fell marginally, operating margins nearly doubled to 5.5%. Consequently, the sample finished the 6-month period with 117% growth in net profits. Lower interest burden was a result of the financial restructuring in light of falling interest rates.

    (Rs m) Apr-Sep'01 Apr-Sep'02 Change
    Net Sales 29,861 29,713 -0.5%
    Other Income 1,129 1,023 -9.4%
    Expenditure 28,990 28,087 -3.1%
    Operating Profit (EBDIT) 871 1,626 86.8%
    Operating Profit Margin (%) 2.9% 5.5%  
    Interest 439 244 -44.5%
    Depreciation 976 1,044 7.0%
    Profit before Tax 584 1,361 133.2%
    Tax 7 289 -
    Extraordinary items -28 115 -
    Profit after Tax/(Loss) 548 1,188 116.7%
    Net profit margin (%) 1.8% 4.0%  
    No. of Shares (eoy) (m) 309.4 311.0  
    Diluted Earnings per share* 3.5 7.6  
    Current P/e ratio   23.3  

    These companies saw their orderbooks burgeoning largely on account of investments in the power sector. ABB witnessed a 24% growth in orders to Rs 9.3 bn during January – September 2002. Its order backlog at the end of Sep ’02 stood at Rs 8.9 bn, which equals almost 80% of the turnover it reported in FY02. India’s No.1 engineering company, Bharat Heavy Electricals Limited (BHEL) order backlog at the end of Sep quarter stood at a record Rs 135 bn plus. This is almost twice the size of its reported turnover in FY02. Mind you, this order flow is still rising. Thermax too, shunned in FY00 blues and made a profitable turnaround in FY02 through restructuring and cost cutting. Its order backlog of Rs 2.1 bn in June 2002, was almost 50% of its FY02 turnover.

    Rs bn Orders as ratio of
    FY02 turnover
    ABB 8.9 0.8x
    Bhel 135.0 2.0x
    Siemens 6.2 0.5x
    Thermax 2.1 0.5x

    All the aforesaid companies have put themselves neck deep in restructuring when the times were not so good. While BHEL reduced its employee base by nearly 23% to 48,000 in the last 4 years, Thermax too, has rationalised its employees by over 16% in recent times. Though we did not include Siemens in this sample, it is worthwhile to note that even this company rationalised its employee size by 7% in the last one year.

    Apart from employee rationalisation, these companies have also been taking a hard look at their product folio’s and aligned them to fit consumer needs. While ABB signed up with the parent as a potential global sourcing base for equipment, BHEL started to outsource small manufacturing to spend more time on research and development of high end products, and Thermax restructured its entire management team filling its board with independent directors thus improving management credibility.

    Consequently, valuations of all leading engineering companies have improved in the last one-year. Most companies are trading near their 52-week highs.

    Valuation snaphot…
      CMP (Rs) 52wk h/l P/E*
    ABB 244 292 / 199 12.8
    Bhel 170 196 / 131 7.3
    Cummins 48 64 / 45 10.7
    Siemens 297 344 / 185 11.4**
    Thermax 146 162 / 62 9.0
    *P/E based FY03 estimates
    **based on actual Sep'02 annual earnings

    Despite an encouraging FY03 so far, there are some concerns for the industry. The core sector (comprising steel, cement, electricity, petroleum products, crude production and coal) grew by 6.4% in April-Nov ’02, as against 1.3% in the previous year. But if we take only November figures then this growth stood at 3.4% as compared to 4% in November 2001. This may be a sign that the lag affect is wearing off and one may tougher times ahead. Already CMIE’s staid forecast of 3% GDP growth is worrying India Inc.

    But notwithstanding these concerns, India is taking strides towards infrastructure development. Power, roads, irrigation and railways continue to be some areas of focus for the current government. Though we agree that the pace of reforms is slow, but the path to progress is irreversible. In this context, 2003 and beyond will give the engineering sector to prove its potential.



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