Transformers and Rectifiers

Investors with a long-term perspective can consider buying the stock of Transformers and Rectifiers (T&R). Robust growth in revenue backed by stable margins, healthy growth in order backlog and the likely commissioning of new capacities by the end of the current quarter add visibility to the company’s growth prospects.

At the current market price of Rs 303, the stock trades at a reasonable valuation of about 10 times and 7 times its likely FY-09 and FY-10 per share earnings. Investors can, however, consider buying the stock in lots given the present turbulence in the stock market.
Strong revenue growth

The first quarter numbers of T&R belie fears of any significant slowdown in the T&D space, given that there were concerns regarding execution slippages in power projects. In the quarter-ended June 2008,

T&R has more than doubled its profits on the back of a 53 per cent growth in sales. Margins, however, came under slight pressure because of increase in raw material price; EBITDA margins dipped by 90 basis points to 14.4 per cent. Net profit margins improved by 3 percentage points to 11.3 per cent helped by a higher ‘other income’ and lower interest cost in the quarter.

The management has guided towards maintaining EBITDA margins at about 18-19 per cent.

This may well be achievable since over 74 per cent of its current outstanding order book has price escalation clauses, whereas for the balance 26 per cent (primarily short-term orders), T&R has already secured raw material supplies, thus locking into current prices.

There could, however, be some pressure on the realisation front, given the increasing levels of competition.

Average realisation per MVA of the transformers sold in the first quarter has dipped to Rs 4.9 lakh from Rs 5.3 lakh last year. Increasing competition apart, drop in realisation may also have been due to varying sales mix during the quarter. This variation is a result of SEBs’ requirement of higher range equipment vis-À-vis the industrial buyers but with similar price points.

That said, the management expects realisation to remain stable from hereon with slight moderation next year, when its new capacities are likely to become fully operational (16,000 MVA).
Order book

Pegged at about 1.3 times its FY-08 net sales, the company’s order backlog of about Rs 384 crore (executable in the current financial year) also reiterates its growth potential.

In terms of segmental break-up, over 82 per cent of the outstanding order-book is constituted by the power and distribution transformers, while furnace and rectifiers, and exports make up 14 per cent and 5 per cent respectively.

With newer capacities likely to become operational by September end, the contribution from the power and distribution segment may rise further as T&R proposes to manufacture higher voltage transformers (220kV and later 400kV) in its new facility. Once fully operational, T&R’s installed capacity will increase to 23,200 MVA (one of the largest in the industry).
Concerns

The company derives a chunk of its revenues from the SEBs, whose payment cycles are longer than the industrial consumers.

While so far the company has been able to recover its dues from the SEBs on time, there has also been a commensurate increase in working-capital requirements. That T&R now has a healthy cash balance (post-IPO) may provide some respite to its working-capital requirements.

Any delay in power generation capacity-additions, however, will remain a primary risk to the company’s earnings.