Investors can retain their exposure to the stock of AIA Engineering Ltd (AIAEL), a manufacturer of impact, abrasion and corrosion-resistant high chrome parts — which find application in the crushing and grinding operations in cement, coal-based power generation and mining industries. At current market price, the stock trades at about 38 times its FY-07 expected per share earnings on a fully diluted basis. Though the growth prospects of the company are robust, the valuations appear pricey. Moreover, given that the benefits due to the enhanced capacities and the proposed backward integration would effectively accrue from FY-09, short-term investors can consider booking partial profits and re-entering the stock at lower levels. However, the medium-to-long-term investors can remain invested.
Investment Rationale
Encouraged by increasing demand, AIAEL is expanding capacity over the next two-three years. Its recent addition of about 50,000 tonnes is likely to contribute to the revenues from the current quarter (January-March). The facility, being an export-oriented unit, could enjoy tax benefits. Further, about 50,000 tonnes of new capacity installation is expected by October 2007. With a robust demand outlook, AIAEL is planning a further addition of 1,00,000 tonnes of capacity. This, however, is likely to contribute to the revenues from FY-09 only. The capex plan, if executed on time, would result in the total installed capacity to 2,65,000 tonnes in FY-09.
Exports form a significant part of the company's revenues (roughly about 48 per cent of its total consolidated sales in FY-06). It has presence in the US, the UK and West Asia through its subsidiaries. Furthermore, it enjoys a decent visibility in the overseas market — Holcim, Lafarge and Cemex are among its clients.The company's focus on the export market is likely to drive revenues in the future, given the higher realisation from them.
Cement continues to be the highest revenue contributor for the company. For the second quarter FY-07, cement, utilities and mining contributed about 62 per cent, 26 per cent and 13 per cent respectively of the total domestic revenues.
However, in the overseas market, cement contributed to 100 per cent of the revenues. As a result of this, AIAEL plans to expand focus on global mining and the utility segment. Though the decision is a positive, it could take a couple of years before significant contribution starts pouring in from the segment.
Strategies
More than 70 per cent of the total revenues of AIAEL comes from replacements, which rules out the possibility of any significant drop in demand during times of recession in the capital spending cycle. Further, AIAEL's value-add services that improve its client's productivity and product quality have also helped it create a niche market. To get a better grip over its raw material cost, it is considering the possibility of backward integration (either by acquisition or setting up a new plant) for sourcing Ferro chrome, an important raw material.
Additionally, its strategy of building in an escalation clause into most of its contracts is likely to reduce the risk of any increase in raw material prices. It also plans to set up a 30 MW plant for captive consumption, which could result in significant cost cuts.
However, we have not taken into account any savings that might arise due to the proposed power plant.
Delay in expansion plans, lower than expected capacity utilisation and an extreme rise in raw material cost are principal risks to our recommendation.