Everest Kanto Cylinders

Long-term investments can be retained in the stock of Everest Kanto Cylinders (EKC), which makes high-pressure CNG (compressed natural gas) and industrial cylinders. Though the stock is up 77 per cent from our earlier ‘Buy’ recommendation in March at Rs 102, shareholders can remain invested in the stock, given the uptick in the company’s order enquiries in the quarter just ended.

Though EKC’s recent quarterly numbers were far from impressive, the addition of Maruti Suzuki to its OEM client list and the possibility of improving margins in the coming quarters helped by lower material cost promises upside potential in future. At the current market price of Rs 181, the stock trades at about 13 times its likely FY10 per share earnings.

This appears reasonable, given that EKC holds the lion’s share of the cylinder market in India (80 per cent share) and operates on capacities far superior to its peers.
Growth story intact

While in the last two quarters, the company’s growth was capped due to the slowdown in auto sales, the management has indicated at improving demand undercurrents in the coming quarters. Led by the overall improvement in the macro-economic scenario, EKC has seen an upturn in order enquiries and demand for its cylinders from both the retrofit and OEM segments in the last quarter.

That EKC added Maruti Suzuki as its OEM client last quarter may also help drive growth, given the carmaker’s wide popularity and distribution reach in the country. Besides, it merits attention that Maruti Suzuki has recently launched the CNG version of its highest selling small car, Alto.

While this new CNG variant of the car would initially be available only in Delhi and the National Capital Region (NCR), the company after gauging the response to the Alto CNG plans to launch CNG versions of all its models by the first quarter of next year.

EKC may see a ripple effect from Maruti’s demand for CNG variants, as it may prompt other OEMs (such as Bajaj Auto, Tata Motors, Ashok Leyland, Swaraj Mazda and Hindustan Motors, which are EKC’s clients) to press ahead with similar models. The lack of proper CNG distribution infrastructure in the country, however, can impede growth.

The company’s high-margin jumbo cylinders too are likely to enjoy better demand. Driven by export orders (to begin supply from end of the current quarter), the jumbo cylinder segment is likely to better its performance by the second half of the current fiscal.

And if the management’s indication of a possibility of export orders becoming repeat orders fructifies, it would lend further strength to its growth prospects. These cylinders, used specifically in the transportation of large quantities of gases, may also come in much demand with the availability of surplus gas supply for transportation from the KG Basin; EKC though is yet to strike a formal deal.

Over the long-term, the setting up of city gas distribution (CGD) networks in many cities may also help the demand for CNG cylinders. The Petroleum & Natural Gas Regulatory Board expects the city gas distribution network to spread to 100 cities by the end of the Eleventh Five-Year Plan (2012). Besides, industry estimates expect the CGD sector in India’s consumption of gas to quadruple, from the 5-6 per cent of the total available gas, in a few years.
Results disappoint

Led by lower sales, high raw material cost and depreciation, EKC’s earnings numbers for the June quarter were below expectations.

The company reported 19 per cent fall in overall sales, while profits declined by 52 per cent. For the quarter, while its India and Dubai sales fell by 28 per cent and 47 per cent respectively; it China sales grew by seven times (albeit on a low base) and that of US improved by 55 per cent.

While bulk of the fall in revenue was driven by drop in volumes, the quarter also witnessed a decline in blended realisations per cylinder (due to higher mix of low-priced industrial cylinder sales). This, in addition to the high cost of inventory, led to a margin slippage of over 12 percentage points to 21.7 per cent.

Sale of low-value cylinders by its US subsidiary, CP Industries also led to the margin contraction. The coming quarters however may witness an improvement in margins as the company reaps the benefit of low raw material cost on the new purchases made at current price levels.
Triggers to watch

While political uncertainties in Iran and delay in dispatch of consignment led to the poor performance of the company’s Dubai unit, improvement in the political climate will help better sales. But in the event of continued uncertainty on the political front, EKC may be forced to look for newer markets.

Besides, developments in the form of EKC’s entry into city gas distribution in Kolkata by way of a joint venture with a local company which holds gas distribution rights, though presents a perfect synergy to its existing line of business, may need to be monitored.

via BL