BGR Energy Systems IPO Analysis

BGR Energy Systems (BGR) was formerly known as GEA Energy Systems India. The company, promoted by B G Raghupathy and his family, is one of the leading engineering companies supplying balance of plant (BoP) equipment and systems to the power sector. It also caters to process industries such as oil and gas, refinery petrochemicals and the process industries.

Starting off with production and sale of on-line condenser tube leaning systems, debris filters and rubber cleaning balls used in thermal and nuclear power plants in joint venture (JV) with GEA Energietechnik GmbH of Germany, BGR set up its first manufacturing facility for energy products at Pannamgadu, Andhra Pradesh, in February 1987 and supplied these products in India and overseas between 1987 and 1993. In 1993, the promoter and members of his family became the sole shareholders of the company with the JV partner exiting the business of energy products globally. BGR then entered into a series of technical collaborations and sourcing arrangements with foreign licensors to expand its portfolio of products. These included GEA BTT (France) for design and manufacture of air-cooled heat exchangers, Crane Environmental Inc. (US) for design and manufacture of deareators; and Ariel Corporation (US) for selling of packaged gas compressors.

In 1997, BGR established its power projects business and, subsequently, pioneered the concept of BOP contracts for power projects. It won its first BOP contract in 2001 as a subcontractor to Bharat Heavy Electricals (Bhel) for a project offered by the Tamil Nadu Electricity Board. The company executed its first engineering, procurement, construction (EPC) contract for the 120-mega watt (MW) power plant (excluding one gas turbine) of Aban Power Company, a private independent power producer (IPP), in the year ending March 2006 (FY 2006). Since then, BGR has been able to secure BOP contracts of large value directly from state power-generating companies of Andhra Pradesh, Rajasthan and Maharahstra. Besides, it has started focusing on EPC contracts for captive power plants with a capacity up to 100 MW since 2006.

BGR is primarily into two business segments: turnkey EPC contracts for either BOP or entire power plants; and industrial products comprising supply of systems and equipment such as heat exchangers, pressure vessels, condensers, high frequency resistance welded finned tubes, deaerators, and pipeline equipment used in the power, oil and gas, refinery, petrochemicals, and process industries. The industrial products and turnkey contracts division accounted for 29.5% and 70.3% of revenue in FY 2007. The company has a manufacturing facility at Panjetty near Chennai for air-fin coolers; and production of heat exchangers, pressure vessels, reactors, columns, surface condensers and finned tubes manufactured by its subsidiary Progen Systems and Technologies (Progen).

End June 2007, BGR sold its energy products division as a business undertaking to GEA BGR Energy System India for Rs 25 crore. The energy product business sells on-line condenser tube cleaning systems, debris filters and sponge (rubber) cleaning balls to a range of EPCs, original equipment manufacturers and power plant companies. This business contributed about 8% to the standalone revenue of the company in FY 2007.

The air-fin cooler division sells finned tubes to GEA Cooling Tower Technologies (India) (GEAT) and procures cooling towers from the latter for its power and captive power contracts. Incidentally, the BGR owns only 1% stake in GEAT, while GEA, Germany, has a 51% stake and BGR’s promoters 48%.

BGR also owns 41% shares in Cuddalore Power Company. But the majority stake in this power company is with BGR’s promoter Raghupathy. It is an IPP developing a 2 x 660 coal-based power project, still in the development stage. The company signed a power purchase agreement with Tamil Nadu Electricity Board (TNEB) on 28 September 200, to sell all of its power on a take-or-pay basis.

To strengthen its position among competitors, BGR has entered into alliances for its different business segments. For instance, it has formed global marketing agreements with Samsung (air-fin coolers); Termomeccanica Ecologia, Italy, for environmental engineering; SK Engineering & Construction, Korea, to jointly explore opportunities in the domestic market for infrastructure projects; and Ariel Corporation for oil and gas equipment.

The objects of the issue are to augment long-term working capital requirement, expand the production capacity by establishing additional manufacturing facilities in the Mundra special economic zone in Gujarat, China and Bahrain in the Middle East, and to fund corporate expenditure. The plants to manufacture finned tubes in China and Bahrain will offer proximity to customers in that region.

Strengths

In the Indian power equipment space, BOP is the weakest link as there are limited players. Proven track record in project management backed by design and engineering capabilities augur well. Typically, the BOP package accounts for 40% of the power plant cost and power producer manufactures about 40% of the BOP equipment inhouse, giving BOP suppliers an edge. The extension of service to include EPC for the entire power plant and captive power plants has widened the canvas.

Has diverse complimentary products, services and project management capability. The only business group (including subsidiary Progen) in India capable of producing all three variation of finned tubes (extruded finned, embedded finned and welded finned tubes) for different applications. The welded finned tubes, however, are manufactured by Progen.

Consolidated order backlog was Rs. 3321.2 crore with about Rs 2507 crore of orders in the power sector and Rs 427 crore of orders in the oil & gas industry end September 2007. This offers revenue visibility.

Weaknesses

Alleging cartelisation to obtain a higher price, Bhel has banned business dealings for three years, as per its letter dated 1 March 2006.

Has relatively limited track record in the EPC segment for complete power plant, its thrust area going forward. Not backwardly integrated to manufacture critical boiler, turbine and generator (BTG) equipment. Hence, complex projects could pose a challenge.

Most of the products and services, largely catering to the power sector, are sold at a fixed price. There is no cushion of price variation available to insulate margin from the vagaries of fluctuation in metal and other input prices. About 89.80%, 79.10% and 94.05% of the total income in FY 2007 (18 months) and FY ended September 2005 and 2004 are fixed-price contracts.

Owns only 1% stake in technology-oriented GEAT, while promoter own a sizeable 48%. Both a vendor for and buyer from GEAT. Conflict of interest with promoters is, therefore, not ruled out. Though the Cuddalore Power Company has a lucrative take-or-pay clause with TNEB for power supply, there is just a minority stake in this company.

Valuation

BGR clocked consolidated net revenue of Rs 786.80 crore in FY 2007 (18 months), translating into an annualised growth of 77%. Net profit posted an annualised growth of 102% to Rs 40.81 crore. On post- issue equity of Rs 72 crore, EPS works out to Rs 3.70.

At the offer price band of Rs 425 – Rs 480 and on FY 2007 earning, P/E works out to 114.86 (on the lower band) and 129.73 (on the upper band). Sunil Hitech and Techno Electric are trading at P/E of around 36 times. However, BGR is relatively larger and has a more diversified profile. On the first quarter (ended June 2007) annualised EPS of Rs 9.7, BGR’s P/E stands at 43.8 and 49.5 times.