Areva T&D: Buy

Investors with a two-three year perspective can consider adding the Areva T&D India (Areva) stock to their portfolio, as the company is likely to emerge as one of the key beneficiaries from the continued investments in the power sector. Strong support from its French parent and expansion plans are factors that will enable the company to capitalise on imminent opportunities.

At the current price, the stock trades at 26 times its expected earnings for calendar year 2008 (CY 2008). With very few local competitors in the segment in which it operates, and the high growth visibility that the power equipment sector offers, the company is likely to sustain premium valuations. Investors can make use of any declines in the stock price linked to the broad markets to accumulate the stock.

Areva has started its expansion process with the setting up of two greenfield projects consisting of high voltage power and instrument transformers. It also has plans to further expand its product range and double its current capacity over the next couple of years. The proposed projects may not only help the company capture domestic orders, but also secure orders from its parent and other Asian companies. Areva, at present, contributes to about 10 per cent of its parent’s order intake. The interest evinced by the parent in the Indian arm is in line with the trend seen in companies such as ABB and Siemens. In this backdrop, we expect Areva to gain more business through its parent, given the cost advantage that the Indian unit enjoys.

Areva is in the process of merging three group companies. This is likely to result in more integrated operations, as all the T&D businesses would come under one roof. The merger is likely to be earnings accretive, with marginal equity dilution. Areva’s stronger thrust on the T&D business has been evident since its exit from non-core businesses last year. The benefits of this in terms of profitability are clearly visible as the operating profit margins for the quarter-ended June 2007 increased by 300 basis points to about 15.5 per cent. Net profits also surged by 55 per cent.

Any business opportunities in India arising from the parent’s strength in nuclear power projects, could provide additional upside, though they have not been factored in, pending clearance of India’s civilian nuclear deal by International agencies. Any business from the same would accelerate earnings growth. A sharp slump in order book levels and hike in raw material costs remain principal risks.