Edelweiss - McNally Bharat

Edelweiss Research report on McNally Bharat Engineering:

McNally Bharat Engineering’s (McNally’s) Q4FY07 results were below our expectations both on the revenue and the operating margin front on account of higher share of low margin orders being booked in the current quarter. Sales increased by 25% Y-o-Y to Rs 1.71 billion while profits increased by 216% to Rs 64 million. However if we adjust for the other income which was on account of sale of investments then the profits de grew 30% to Rs 14 million. We do not expect this trend to continue going forward as most of its low price orders have already been executed last quarter. In fact we expect the operating margins to increase by 200 bps and 300 bps respectively over FY07 on the back of higher contribution margins in the Steel and the mineral processing sector.

McNally’s order book as on 31.5.2007 was at Rs 10.5 billion. Interestingly, the share of mineral processing and steel (which has the highest margins among its various segments) has increased to 63% compared with 10% in the same quarter last year. The company is L1 bidder in Rs 20 billion worth of orders (steel sector application) which it expects to get allotted in a months time. Including this, the order book would increase to Rs 30 billion which is a growth of 200% order book as on 31.3.2007. This gives a serious visibility over the coming three years and hence we recommend investors to invest from a long term horizon.

We are down grading our revenues, operating profits and PAT for FY08E by 1.5%, 25% and 30% respectively on account of change in our assumptions of EBITDA margin from earlier estimate of 10.2% to 7.8% in FY08E. We expect our earlier EBITDA margin estimates to be now met in FY09E as the revenues from the steel and the mineral processing sector starts contributing in a substantial way. Management has also been guiding for a double digit margin in two years time frame. SAIL; which is the main customer for Mc nally is incurring a capex of Rs 420 billion over the next five years in its RINL, IISCO, Bokaro and Durgapur division which are in the radius of approximately 45 Kms from Mc nally Bokaro factory. The addressable market from this segment alone is Rs 200 billion for the company. Thus, we feel very confident of EBITDA margins improving from hereon.

We are also introducing our FY09 estimates. We expect revenues and PAT CAGR of 43%, and 93% respectively over FY07-09E on the back of improvement in EBITDA margins from 5.6% in FY07 to 10.5% in FY09E. We expect a lack luster price performance in the near term; on the back of below than expected results. But we expect the company to exhibit robust performance in FY09 and hence continue to maintain our positive stance on the company with a long term perspective. At Rs 180, the stock trades at a PE of 16.5x and 8.7x on our EPS estimates of Rs 10.9 and 20.8 respectively. We continue to maintain our ‘BUY’ recommendation.