McNally Bharat Engineering Ltd

Investors can consider accumulating the stock of turnkey engineering solutions provider McNally Bharat Engineering. The stock is among the mid-caps that have fallen steeply as a result of broad market volatility. The correction offers a good opportunity to add the stock. At the current market price of Rs 204, the stock trades at 10 times its expected consolidated per share earnings for FY-12. As the rights issue proposed last year has not shown any signs of taking off, shareholders can use the current weakness to accumulate the stock.



Power game

McNally had a good half-year ended September 2010. While sales expanded 22 per cent, net profits jumped 66 per cent during this period. Restructuring its business to focus more on project implementation, and hiving off its products division to a subsidiary has helped the company.

While the material and non-ferrous metals division continues to be the major contributor in terms of sales, this proportion is set to change with the company's order book of Rs 4006 crore now tilted in favour of power division which accounts for 37 per cent of the orders.

Orders for coal handling plant from NTPC, SAIL and balance of plant works from Ideal Power are some of the major projects bagged in FY-10.The material and non-ferrous metals division comes second at 30 per cent of order book while the rest is accounted for by the infrastructure, steel and port segments.

The power and material divisions are likely to remain key drivers of revenue as the company is well-integrated to offer complete solutions for projects in these areas. For instance, in power Balance of Plant projects, the company can supply its own coal and ash handling systems. Similarly, its German subsidiary is well-equipped with technology relating to ash handling and mineral processing.

Separately, the company's German subsidiary and McNally Sayaji have orders totalling Rs 500 crore in their kitty. The local subsidiary, McNally Sayaji, however, reported sedate performance in the latest quarter, as a result of restructuring.

The company plans to customise manufacture of products to suit the design needs of customers. For instance, its Asanol plant near Calcutta is equipped to do plate rolling, boring and machining of various diameters. While this may mean longer order-to-revenue conversion time, the margins of this subsidiary could well improve.

Tapping opportunities

McNally has moved on to a few other related businesses. The company is now an EPC contractor in water management and is in collaboration with Hyflux of Singapore for setting up of desalination plants. It can and is already executing two Balance of Plant projects in this sector.

While this division is unlikely to make any significant contribution to the top line in the near term given the limited number of orders at present, the vast potential in the water treatment space and limited local players provide good opportunity to scale up this business.

The company is also exploring opportunities in the nuclear space, in non-nuclear pockets such as Balance of Plant. Similarly, it has a tie-up with a foreign company for turnkey contracts for setting up cement plant.

Bidding for mechanical and civil packages in the oil and gas space is also on the anvil, given that the company has established presence in South-east Asia, West Asia and Africa through its international division. These businesses could be drivers of revenue over a five-year period. That these new opportunities also hold lucrative margins at present is enough reason for the company to evince interest. It is noteworthy that none of these lines of businesses is entirely alien to McNally, given execution capability in the engineering space and its tie-ups for technology and products. Is there a risk of the company diverting too much resource into new businesses? This may not arise as the technology and product tie-up may ensure that the company is left only with execution of projects instead of incurring huge capital expenditure.

Financials

The present debt-equity of about 1.2 times provides some room for gearing. The company can revive its equity-raising plans if it has any major capex lined up for its new ventures.

The company's sales expanded at a compounded annual rate of 76 per cent while profits grew 60 per cent over the last three years. McNally's business has traditionally earned low operating profit margins of 6-7 per cent as a result of being predominantly a product supplier.

However, over the next few years, if the company is able to sustain its growth in its projects business, there could be a steady rise in margins. In the near term, raw material costs, which provided relief in the latest ended quarter, could once again depress profit margins if materials such as steel see any significant price increases.