Elecon Engineering

Investments with a two-three year perspective can be considered in the stock of Elecon Engineering, a leading manufacturer of bulk material-handling equipment and industrial gears.

At current market price of Rs 222, the stock trades at about 18 times its likely FY-09 per share earnings on a fully diluted basis. This appears reasonable, given Elecon’s expanding order-book, healthy return ratios and foray into the high-end windmill gearbox business. Elecon’s higher reliance on the domestic capex cycle also offers comfort in the midst of a possible global slowdown.

While the stock price has declined significantly after a disappointing third-quarter performance, we feel this slowdown in Elecon’s revenue growth may only be an aberration, given its strong order-book and good execution skills. Investors can use dips in the share price to accumulate the stock.

Presence in high-growth sectors

With a presence straddling high capex sectors such as power, mining and cement, Elecon appears well-positioned to reap the benefits of the increasing infrastructure spends in the country. The company’s order-book is nowtilted towards the power sector.

Segment-wise, while power (59 per cent) and mining (18 per cent) industries made a significant revenue contribution to the material-handling division, revenue inflows in the industrial gears division was relatively fragmented leaning towards industries such as material handling, cement and sugar.

Going forward, Elecon plans to extend its presence across industries such as steel and ports also. This holds potential given the investment planned in these industries.

The company’s strong mooring in the domestic capex cycle also merits attention. Elecon’s limited exposure to overseas market (about 4 per cent of revenues in FY-07) may make its revenue stream relatively resilient to the global economic uncertainties.

While the company does plan to increase focus on exports over the long term, the domestic focus reduces the impact of any global slowdown on the company’s order flows or revenue growth.
Rising order-book position

Driven by investments in the infrastructure sector, the company’s order-book has also seen significant growth over the years. It stands at Rs 1,091 crore (about 1.5 times its FY-07 revenues).

On a year-on-year basis, the company’s order-book has grown by 57 per cent, with about 80 per cent contributed by the material-handling division and the rest by the industrial gears division. For nine-months ended December 2007, the order intake for the material-handling division grew by a whopping 157 per cent as opposed to a negative 8 per cent in the industrial gears division.
New initiatives

Elecon’s foray into manufacturing windmill gearboxes holds potential, given the supply constraints for gearboxes. Addressing a target market of over Rs 2,000 crore, the management expects to achieve an asset turnover of up to three-four times in the long run, once the facility begins commercial production in April 2008.

Regarding technological know-how for the manufacture of gearboxes, the management has indicated that it is in the negotiation stage to acquire the necessary technology for high-class gearboxes of between 1-2 MW.

However, since the company is yet to forge a formal tie-up, it may fall short of its guidance of Rs 110-120 crore revenues (for this business) in FY-09. The windmill business too may suffer from the delay. However, these delays may only result in slowdown over the short term, even as medium-term prospects continue to be bright.
Capex plans

The company plans to invest about Rs 100-120 crore to fund its expansion drive. Out of this, about Rs 80 crore will be for its windmill gearbox business and Rs 8-10 crore for the windmill business. The remaining would be distributed evenly between its two divisions — material-handling and industrial gears. This would be funded through a mixture of debt and internal accruals. While 25-30 per cent of the capex spend will come from Elecon’s internal accruals, the rest would be through term loans.
Future growth drivers

Elecon’s dominance in the material-handling space on the back of high investments in infrastructure development is the key growth driver for the company. While the tilt in the order-book towards this division augurs well for revenues, on the earnings front, however, the higher-margin industrial gears division may drive growth.

With the share of customised gears expected to gain prominence as opposed to the standard ones, earnings contribution from this division may scale up. Elecon’s technical collaborations with Germany-based RenkAG and Haisung Industrial Systems Company Ltd of South Korea for technology for manufacturing vertical roller mill gearbox (used in cement and coal mills) and high capacity gearbox (to be used in lift/elevators) respectively, also hold potential.
Financial performance

The company’s performance for the quarter ended December 2007, however was disappointing. Despite a promising order-book position, Elecon’s revenue grew by only about 10 per cent as compared to last year. This was due to lower invoicing of the material handling division’s orders, which grew by only about 6 per cent.

The industrial gears division also disappointed on the revenue front with almost flat numbers. Despite the perceptible lag in the execution of orders this quarter, the company’s swelling order position suggests a likely acceleration in growth.

The quarter, however, saw Elecon expand its operating margins by 1.7 percentage points to 18.8 per cent. Margins may see further expansion given the company’s foray into high-margin businesses. Growth in earnings however may not be commensurate given the company’s higher dependence on debt.

Any slowdown or delay in the capex plans of user industries or delays in the roll out of windmill and gearbox businesses may affect Elecon negatively.