Gujarat Apollo Industries: Hold

Investors with a long-term perspective can retain their holdings in the stock of Gujarat Apollo Industries (GAI), a manufacturer of road construction equipment. Increased investments towards the development of road infrastructure combined with GAI’s timely capacity expansion suggest good earnings prospects.

At the current market price of Rs 364, the stock is valued at about 15 times its likely FY-09 per share earnings on a fully diluted basis. While this does not appear very cheap, the valuations are underpinned by strong prospects and the healthy return ratios of the company. Investors can utilise broad market corrections, if any, to take fresh exposure to the stock.
Road to success

The various road development initiatives undertaken by the government are likely to have a positive impact on GAI’s revenues. The Eleventh Plan, entailing an investment of about Rs 2,09,400 crore in road infrastructure projects points to strong order flows. Road construction equipment contributes about 21-23 per cent of the total project cost in road projects, indicating the growth potential of the road equipment sector.

GAI could, thus, emerge as one of the leading beneficiaries of such a positive investment climate. The company’s market share of about 30 per cent in the asphalt road construction equipment segment should help it capitalise on the growth in this segment. Besides this, GAI’s increasing exposure to the overseas market also suggests more diversified revenues and healthy future prospects.

With its established clientele spread across countries such as Saudi Arabia, Australia and African countries, the company could benefit significantly from the increased overseas demand for road construction equipment.

An increased exposure to such markets may improve margins as margins tend to be superior in such projects; it also reduces the company’s vulnerability to any blips in domestic activity.

Gujarat Apollo’s strategy of adding to its product portfolio, to expand its addressable market is also promising. It has recently concluded a technical know-how and licensing agreement with a European Company for manufacturing of two models of soil compactors and three models of tandem vibratory compactors.

The management expects this range of products to start contributing to revenues from the first quarter of FY-09. Besides this, the recently added range of crusher and mining equipment also strengthen GAI’s product offerings.

Addition of rollers and crusher holds potential given their larger addressable market size. Further, the company has embarked on a capacity expansion drive and plans to almost double its capacity from the current levels.

The management plans to use the proceeds from the recent disinvestment of a 49 per cent stake in subsidiary — Johnson Screens (India) (pegged at about Rs 25.8 crore) to fund its expansion plans.
Robust earnings growth

For the quarter ended September 2007, the company recorded an earnings growth of about 65 per cent on the back of 39 per cent increase in revenues. Operating margins for the quarter have expanded by 3.2 percentage points to about 22 per cent. This could be attributed to lower raw material cost and improving efficiency. On a long-term basis, the company has recorded a compounded earnings growth of about 32 per cent over the last four years.

Exports have also risen significantly to the current levels of about 40 per cent of revenues. Going forward, margins may expand further on the back of better realisations supported by a firm demand scenario. GAI’s focus on increasing exports may also help.
Concerns

Slowdown or delays in spending on road development and a rise in interest rates remain key risks to GAI’s business. The entry of MNC players with better product offerings or with attractive price points may also affect GAI negatively. For investors, liquidity constraints could also pose a challenge since GAI is a small-cap stock.