Transformers and Rectifiers: Invest at cut-off

Investors with a high-risk appetite and a two-three year perspective can consider subscribing to the initial public offer of Transformers and Rectifiers (T&R). Established in the business of manufacturing transformers, T&R appears well-placed to benefit from the expanding business opportunities in the power transmission and distribution (T&D) space. Robust growth in sales and bottomline, diverse revenue mix and the proposed entry into the high voltage transformer segment suggest good prospects.

In the price band of Rs 425-465, the offer is priced at about 22-24 times annualised per-share earnings for the current year, on a diluted equity base. The valuations, while at a marginal premium to its peer, Indo Tech Transformers, appears attractive considering the healthy order-book and a likely move up the T&D value chain.
Investment argument

The demand for transformers is likely to remain buoyant given the increased government spending on power infrastructure. Government initiatives such as APDRP (Accelerated Power Development and Reforms Program) and RGGVY (Rajiv Gandhi Gramin Vidyuthikaran Yojna) also point to improving prospects for companies in the power T&D space.

With such structural growth drivers in place, fortunes of companies could hinge on their execution capabilities and ability to move up the value chain. T&R scores positively on both these aspects. T&R witnessed a compounded earnings growth of about 96 per cent annually during the last four years. Besides, the company’s order book pegged at about Rs 360 crore (1.7 times its FY07 consolidated sales) also lends visibility to revenues.

Further, T&R’s proposed move up the T&D value chain with the manufacture of high voltage transformers holds potential to expand margins and reduce competitive pressures, as this segment has fewer players.

Profit margins may also get a boost from T&R’s proposed expansion in product portfolio and optimisation of its existing plant capacities. Backward integration by way of the recent acquisitions of two companies may also help control costs.
Business and revenue model

T&R makes a wide range of transformers, including power generation transformers, T&D transformers, industrial transformers and speciality transformers.

The company’s product portfolio is set to expand further with the setting up of a greenfield facility in Moraiya (near Ahmedabad). This facility is expected to initially manufacture transformers of 220 KV and 400 KV, with the ability to move up to 765 KV. Part of the proceeds from the issue will be used for setting up this plant. The facility, likely to be commissioned in FY09, will increase T&R’s installed capacity to 23,200 MVA (one of the largest in the industry).

T&R’s presence in the furnace transformers, while not significant now (about 13 per cent of FY07 revenues), could gain importance given the increasing capex in the steel industry and preference for the EAF (electric arc furnace) route. Notably, the company is one of largest manufacturers of furnace transformers in the country.

On the revenue front, T&R has a good mix between SEBs (State electricity boards) and corporates as clients. For the financial year 2007, utilities contributed to about 51 per cent of the revenues with the industrial segment making up for the rest. T&R has also forayed abroad, supplying to countries such as England, Canada, South Africa and UAE.
Concerns

Concerns on T&R’s dependence on SEBs cannot be ignored, though the company’s ability to recover dues on time in the past infuses confidence. Further, the exposure to SEBs also makes T&R’s earnings susceptible to any change in policy by power utilities and possible lengthening of the receivables cycle.

The company has reported negative cash flows in recent years. However, with part of the proceeds proposed to part-finance incremental working-capital requirements, this pressure on cash flows may be alleviated to some extent. Moreover, T&R’s move up the value chain and the resultant expansion in client base may also help it reduce its dependence on SEBs.
Offer details

The offer is open from December 7 to December 12. Enam Securities is the book running lead manager.