BGR Energy Systems: Invest at cut-off

Investors looking for a proxy to the energy sector can consider subscribing to the initial public offering of BGR Energy Systems with a two-three year perspective. The steep asking price may, however, not provide quick exit opportunities for short-term investors.

This solutions provider for the power and oil and gas sectors offers exposure to a business which has unique positioning, strong potential and dearth of quality EPC (engineering, procurement and construction) contractors.

BGR’s ability to serve as a one-stop-shop for the user industries in the oil and power solutions segment, appears to be the company’s unique selling proposition.

The offer price of Rs 425-480 values the company at about 20-23 times its expected earnings for FY-09 on the post-issue equity base. This does not factor in any earnings upside from the success in bids that the company is now attempting.

Though not strictly comparable, BGR’s valuation, at offer price, is at a marginal discount to large listed power equipment players.
offer details

BGR’s operations can be broadly classified into two segments — supply of systems and equipment and undertaking turnkey engineering project contracts.

The company’s clients are from the power, infrastructure and oil and gas sectors and industries, which require environment engineering solutions and captive power plants.

The offer consists of fresh issue of shares and an offer for sale by the promoters; the proceeds of the latter will not accrue to the company. At the offer price band, Rs 184-207 crore would be raised through the fresh issue. The company seeks to deploy the same for working-capital requirements and expand manufacturing facilities in India as well as establish units in China and West Asia. The company’s market cap at the offer price would be Rs 3,000-3,500 crore.
Complementary

The business segments of BGR are complementary in nature, enabling it to offer a basket of wide-ranging solutions to sectors mentioned by us earlier. For instance, in the case of a power plant, the company started with offering balance of plant (BOP) solutions, which usually accounts for about 50 per cent of the total plant cost. This involves providing a range of facilities (electrical, mechanical, control, instrumentation systems and civil buildings) other than the core equipment of boiler, turbine and generators.

BOP does not only involve providing services but also supplying materials. Of the products required to execute a BOP, BGR typically manufactures 40-50 per cent in-house and sources the rest from suppliers. The company’s manufacturing facilities, therefore, support the services division. This in-house production also provides cost advantages.

In a BOP project, direct bids to power generation companies offer better returns than subcontracts with EPC players. The company, therefore, does only direct bidding to maintain its margins.

The four BOP projects that it is now handling in the power space involve dealing directly with the generation company.

Apart from capability to undertake contracts for projects that use different types of fuels (such as coal or gas), BGR has moved to servicing higher MW power plants as well.

Three of the four BOP contracts are in the 500 MW range and a recent letter of intent is for a gas-based power project of 820 MW. This is a positive, as future projects of power plants are expected to be larger.
Going the EPC way

The BOP experience has provided a platform for BGR to move to EPC contracts for power plants, which essentially involves completely building the power plant including supply of power equipment. The company has executed its first 120 MW gas based plant on EPC basis for Aban Power.

As BGR does not manufacture the key components such as boilers and turbines, it has tied up with international power equipment suppliers for EPC projects.

Such tie-ups may enable the company to bid competitively for EPC contracts as international equipment players, particularly the Chinese, are known to adopt aggressive pricing.
Oil and gas equipment

BGR has also established itself in providing products (such as separators, gathering and metering systems, storage tanks and pipeline equipment) and solutions ranging from transporting the oil/gas from the wellhead to the end user.

This involves manufacture of various components and offering services to industries focused on oil and gas fields, cross-country pipelines, refineries and petrochemicals. Its business is, thus, much more extensive than that of companies offering pipeline EPC services.

The manufacturing activity for this division is carried out through a subsidiary. The company is well-entrenched in the local market and in West Asia in this segment, retaining an edge to capitalise on the oil and gas boom.

That it has managed to compete with international players such as the Kar Group from Kurdistan, also provides confidence as to its ability to bid internationally.

While this division accounts for only 13 per cent of the current order back log, we expect it to improve margins, given that the segment is more lucrative.

Present projects are titled towards foreign orders, which are likely to offer good returns.
Rough roads

BGR has not had a pleasant experience in the road infrastructure space as two projects in Kochi and Tuticorin have faced hurdles, leading to their termination. The company has now taken a decision to avoid cash contracts and instead focus on BOT projects and technology-intensive projects such as tunnelling, multi-level cark parking and such other urban infrastructure projects.

It may not be difficult for the company to foray into these areas with the technology and project management skills that it possesses. Success in these could provide a significant boost to earnings. However, given the working capital-intensive nature of the current projects, funding these new segments with internal accruals could pose a challenge.
Financials

BGR’s sales and net profits have grown at 43 per cent annually over the last four years. We expect the profit growth to accelerate now, given the company’s transition to a high-end solutions provider and its proposed low-cost facilities in China and Bahrain to cater to the East and West Asian demand.

BGR’s current order-book of Rs 3,300 crore is about six times its annualised 12-month revenues (March 2007 was an 18-month period due to change in accounting year) of Rs 525 crore.

The company’s ability to manage its working-capital requirements is of concern, given that a good number of its clients are public sector/state companies, where delays in payment are not uncommon.

The company is a key beneficiary of the expected ramp up in activity in the E&P space; any slowdown in these sectors could affect revenue flow. However, its divisions of air fin coolers, electrical projects and environment engineering have steady clients and may provide some cushion against any slowdown in projects in the power/oil and gas divisions. The offer is open from December 5-12. SBI Capital Markets, Kotak Mahindra Capital, UBS and CLSA are the lead managers.