Investors with a medium-term perspective and a high-risk appetite can consider retaining the stock of Elecon Engineering, a major player in the manufacture of bulk material handling equipment and industrial gears. With an established set-up, Elecon Engineering would be among the key beneficiaries of the increased investment in sectors such as power, coal and steel, which contribute significantly to its bottomline. Further, the changes in the product mix, entry into the wind energy segment, coupled with a healthy order-book, lend greater confidence to its earnings visibility. At the current market price, the stock trades at 17 times the expected per-share earnings for FY-08. However, one can use stock price weakness or market corrections to take fresh exposure.
Investment Rationale
Elecon operates in two business segments — material-handling equipment (MHE) and industrial gears. The company enjoys a dominant presence in the former segment and will stand to benefit from the increased government allocation and spending on power and infrastructure. This apart, the shift in Elecon's product profile, with an increased thrust on the MHE segment, is likely to drive its revenue growth.
The 125 per cent increase in segment revenue from MHE for the quarter-ended December 2006 compared to the corresponding previous period reinforces our optimism.
In the industrial gear segment, Elecon's conscious effort to shift its revenue mix has augured well for the division's profitability. The increased focus on the manufacture of customised gears, which enjoy better realisations than the standard ones, has added stability to the segment's overall margins. In addition, the increased sales in the MHE division will also rub off positively, since MHE involve the use of industrial gears.
Elecon also plans to sell windmill gearboxes and has entered into a technical collaboration with the Belgium-based Turbowinds for the same. However, it is likely to face stiff competition from Shanthi Gears in the gear segment.
New opportunities
To diversify its business, Elecon has decided to make and sell windmills, for which it has lined up a capex of Rs 40-50 crore.
However, most of the components for the windmills are likely to be imported while turbines are to be procured from domestic manufacturers.
The gearboxes for these windmills will, however, be made in-house. Nonetheless, given the nature of this business, we believe the margins are likely to be low. Elecon has also planned to set up a ship fabrication facility and has signed an MoU with Pipavav Shipyards.
While the latter would be responsible for designing ships, the former will fabricate ship blocks. Elecon has planned a capex of about Rs 15-20 crore to set up facility for the same. However, revenues from this business depend on orders received by Pipavav Shipyards.
For the quarter-ended December 2006, Elecon posted an 80 per cent increase in earnings compared to the corresponding previous quarter. In the same period, contribution of revenues from the MHE segment rose to 56 per cent, and the industrial gears division chipped in with the rest. On the operating margin front, the MHE division saw a margin expansion by about 560 basis points to 13 per cent year-on-year. Margins in the industrial gears division, however, remained stable at 21.2 per cent.
Concerns
Growth in both the segments of the company hinge directly on the capex plans across its user industries. Any slowdown or delay in the capex plans of these industries will have a negative impact on Elecon's earnings.
Any sharp rise in raw material cost such as that of steel, nickel or chrome may also affect operating margins and earnings growth.