Indo Tech Transformers

Indo Tech Transformers is one of the small-cap stocks that witnessed steep declines during the recent sell-off by foreign institutional investors. With strong fundamentals in place, the correction has provided an attractive entry point into the stock.

However, given the volatility seen in the broad markets, investors can consider buying in small lots and use price dips, if any, to accumulate the stock.

Invest with a perspective of two-three years. At the current market price of Rs 515, the stock trades at 9.7 times its expected per share earnings for FY-2009 and 12.5 times its present trailing 12 months earnings. Capacity additions that have gone on stream in February 2008 can be expected to reflect fully in revenues from FY-2009.

While the company has enjoyed price-earnings multiple of over 20 in the past, we believe such valuations were driven more by market momentum than fundamentals.

While the company’s business potential is likely to drive healthy growth, investors may have to temper their expectations on the returns front.
Steady demand

Indo Tech Transformers makes a range of power and distribution transformers. The company has fully utilised the proceeds of the IPO (March 2006) towards its plans and has rapidly added capacities. For companies such as Indo Tech, timely expansion moves may be key to capturing orders in a demand-driven market such as the present one. Indo Tech has been doing well on this front with the recent capacity augmentation from 3450 MVA to 7450 MVA.

While the company has not made any significant foray into overseas markets because of capacity constraints, recent capacity additions have opened up opportunities to diversify.

The company has already received orders from the African markets. As these are at present booked in the euro, the risks arising from currency fluctuations may not be as high as with dealing in dollars. Enhanced spending in transmission and distribution segment in these countries has led to higher demand. As a result, Indo Tech’s orders from these countries now carry relatively high profit margins.

While Indo Tech may not significantly ramp up contribution from the export market, the 15 per cent contribution that it hopes to achieve by FY-2009 may be sufficient to strengthen overall profit margins.
SEB dependent

Indo Tech’s order-book of Rs 180 crore is likely to convert into revenues in the next 6-7 months. While state electricity boards (SEBs) of Tamil Nadu and Andhra Pradesh account for about 70 per cent of this, Indo Tech has been expanding its list of corporate clients as a de-risking strategy. Interestingly, the company has managed to recover its receivables more quickly than even bigger players such as Emco, despite having SEBs as its biggest clients.

The company has also managed to enter into price escalation clauses with these SEBs. While it has had a smooth sail dealing with SEBs, the risk of delayed payments arising from the cash-strapped and loss-making SEBs does remains a risk factor.

However, on the positive side, the spending warranted by SEBs would ensure that Indo Tech (being a regular supplier) would secure new as well as replacement orders, thus providing a steady stream of projects.

While the order-book has remained healthy for Indo Tech, inflows in the current quarter (ended March) may see some slowdown associated with the delays in tendering process normally seen towards the financial year-end.
Superior margins

Indo Tech has always enjoyed higher operating profit margins compared to peers. The company’s raw material as a percentage of sales has been lower than peers, indicating better management of sourcing cost.

For the quarter ended December 2007, OPMs surged to 34 per cent from the 25-28 per cent range. While a better client mix could have contributed to this improvement, the company may also have enjoyed the benefits of lower prices of copper in that quarter.

However, even if copper prices remain sluggish (as suggested by forward contracts now, the company may not always be able to retain the cost benefits. Hence, sustainable OPMs of 28-30 per cent appear more realistic.