Transformers & Rectifiers

Investors with a one-two-year perspective can consider buying the stock of Transformers & Rectifiers (TRIL). Turnaround in performance ahead of peers, the ability to keep debt at bay and less dependence on industrial clients make the stock a superior option to peers such as Emco and Voltamp Transformers.

The massive capacity addition in power and consequent investment in transmission provide ample business opportunities for transformers manufactured by mid-sized players such as TRIL.

At the current market price of Rs 392, the stock would trade at 9.8 times its estimated per share earnings for FY-11.

Investor can consider buying the stock in small lots on declines linked to broad market indices, given the sharp volatility witnessed in the market in recent times.

Slow to turnaround

A good number of stocks in the capital goods sector have witnessed sharp rallies since March 2009, on expectations of a quick revival in capital expenditure. While the third quarter earnings do suggest improvement, not all sectors have been quick to turn around.

The transformer industry, for instance, is yet to shrug off its woes of slowdown in volumes as well as depressed pricing power. Rightly perceiving the prolonged slowdown, markets have refused to award higher valuations to stocks in this sector. In the December quarter earnings too, most of the companies — Emco, Bharat Bijlee, Indo Tech Transformers and Voltamp Transformers — witnessed a decline either in their revenues or earnings. Pressure on pricing as well as lower off take from industrial clients were key reasons for the slowdown.

Higher copper prices have also ensured depressed profits for players with fixed price clauses. Given this scenario, TRIL's strong revenue growth of 30 per cent and earnings growth of 20 per cent in the December 2009 quarter, could well be termed as an exception; the company is, perhaps, also an early bird in the turnaround expected in the sector.

TRIL primarily makes power transformers, which account for 85 per cent of its current order book. At about Rs 400 crore, its order-book would be executed over the next nine-12 months. Much of the orders are in the 120KV and 220 KV capacities — typically used in the current capex by Power Grid Corporation and State electricity boards.

TRIL also has an edge over peers of similar size, in its capability to manufacture higher voltage 400KV transformers. It recently delivered transformer of this capacity to a private power player, thus creating a good reference point for future orders.

Business and prospects

Over 70 per cent of TRIL's orders come from Central and State Utilities. This has held the company in good stead as it has been fairly protected from the slowdown in orders from industrial clients and less hurt by raw material cost hikes.

Note that while public sector orders carry price escalation clauses, orders from private players are seldom attached to such a clause, given the short duration of execution.

This factor is also likely to provide the company some support, given the hike in price of raw materials such as copper in 2009.

Copper and Cold Rolled Grain Oriented Steel (CRGO) each account for close to 30-35 per cent of the raw material cost of a transformer.

TRIL is nevertheless not so immune to the depressed pricing power of transformer players, thanks to the increase in capacities. TRIL alone has more than tripled its production capacity to 23,200 MVA per annum over the last couple of years.

While the capacity addition in this industry was needed to cater to the impending demand arising from power capacity additions in the Eleventh and Twelfth Plans, it did, for a short time, over 2006 and 2007, create a supply shortage situation, resulting in transformer companies enjoying superior pricing power.

This may no longer be the case with the sector. In the December quarter, TRIL's operating profit margins fell by 3.5 percentage points to 12.6 per cent. Decline in export orders in the present quarter was also partly a reason for the dip in OPMs.

TRIL's realisation for transformers at Rs 4.4 lakh/MVA is down close to 15 per cent compared to a year ago.

Going forward, higher volumes but at less lucrative prices could be the trend. Volumes, though, can be expected to drive earnings growth.

via BL