Fresh investments with a one to two-year perspective can be considered in the stock of Shanthi Gears, a leading manufacturer of industrial gears. Buoyant demand trends from user industries, improving product and revenue mix combined with a significant expansion in margins suggest strong growth prospects for the company.
At current market price, the stock trades at about 11 times estimated FY09 per share earnings, assuming full conversion of its foreign currency convertible bonds into equity.
The positive demand environment for industrial gears is driven by rising capital spending across Shanthi’s user industries such as steel, compressors and cement. In this context, Shanthi’s timely expansion in capacity and upgradation of technology lend confidence on its ability to meet the rising demand.
The management’s guidance towards a capital expenditure of about Rs 20-25 crore over each of the next two years also appears favourable. Revenues could also get a lift from the company’s increased focus on exports.
Shanthi, apart from being the global supplier to Atlas Copco’s Belgium unit, may also soon start supplying to Atlas’ branches in China and Thailand. For the quarter ended September 2007, the company recorded a 52 per cent increase in earnings on the back of a 26 per cent growth in revenues.
Operating margins expanded by a significant 2 percentage points to about 40 per cent.
While the company has traditionally enjoyed higher margins owing to its fully integrated facility (notably all processes are done in-house), this 2-percentage points expansion could be credited to the change in product mix during the quarter.
Given Shanthi’s evolving product mix, which favours custom-built products over the low-margin standard ones (60:40), margins are likely to sustain at higher levels.
Any unprecedented rise in raw material prices could impact the company’s earnings negatively.
However, given the shorter delivery schedule of orders (3-4 months), Shanthi appears better positioned to build volatility in input prices, into its contracts while pricing them.
Besides, the price escalation clause in most of its contracts also offer insulation in this regard. Slowdown in the capex across user industries remains the primary risk.