Crompton Greaves: Buy

Power equipment maker Crompton Greaves is beginning to reap the rewards of its restructuring strategy set in motion after the company reported losses in 2000 and 2001. The strategy has not only led to robust growth of its domestic operations but also expanded the product range and geographical reach. The company has also demonstrated its ability to turn around loss-making operations of acquired companies, housed in subsidiaries.

The sizeable business opportunities in the domestic market supplemented by increasing contribution from overseas subsidiaries lead to high-earnings visibility for the company. Investments can be considered in the stock with a three- to five-year perspective. With the stock market going through a volatile phase, investors can consider buying in lots taking advantage of market dips. At the current market price, the stock trades at 18 times its expected consolidated earnings for FY-09. This is at a discount to peers such as ABB and Siemens.
Valuation re-rating

Crompton Greaves could not command comparable valuations because of a limited product range, especially in the power systems segment. With the three acquisitions made over the past couple of years, the company has not only widened its product basket but has also qualified itself to become a fully integrated player in the power distribution and transmission business. Hence, a narrowing of the valuation gap between the company and its peers appears justified at this stage.
Well-structured turnaround

After substantial losses in 2000-01, Crompton Greaves undertook a series of restructuring measures, including cost-cutting and exiting unrelated businesses. Consequently, net profits grew at a compounded annual growth rate of 115 per cent between 2002 to 2007. The company has not only managed to capitalise on the surging order flows in the transformer business, but has also ramped up contribution from other segments. In 2006-07, industrial systems and the consumer products division have generated returns of 77 and 112 per cent respectively on the capital employed. These segments accounted for 40 per cent of the consolidated operating profits.
Acquisitions add muscle

The next phase of Crompton Greaves’ turnaround strategy was to gain a global presence by acquiring companies that had strong business expertise but were cash-starved. Acquisition of the Belgium-based Pauwels has brought with it business opportunities in the West European and North American markets. The Ganz acquisition widened the company’s product basket by adding high-end technology switch gears and other support services. While Pauwels has turned around to generate profits, Ganz is expected to register profits (from operations) by 2007-08. Profits (before interest and taxes) of both the companies put together have grown by over 50 per cent in 2006-07.

The recently-acquired Microsol Group provides automation services for new sub-stations and retrofitting services for existing ones and has operations in the UK, the US and Ireland.

While the first two acquisitions expanded the company’s geographic reach and product range, the third, though small in terms of revenue, appears to be a move up the value chain. However, once integrated with the other businesses, this is likely to convert the company from a mere power equipment-maker to a total solutions provider. That Crompton Greaves has managed to acquire the above companies mostly with its internal accruals provides comfort. The company continues to remain cash-rich and may possibly look for more acquisitions.
Strong core operations

Crompton Greaves has also witnessed strong organic growth and improvement in operating profit margins. Higher volumes led to an increase in the latter by 2 percentage points to 11.7 per cent for the quarter ended June 2007 for standalone operations.

The power segment is the key growth driver with huge order flows as a result of the Government’s spending in T&D (transmission and distribution) infrastructure.

The company’s entry into latest generation value-added products has elevated it to the league of players such as ABB and Areva T&D. The government’s ambitious plans to add latest generation sub-station capacity augurs well for Crompton Greaves as it has few competitors here. The company’s has already ramped up its capacity ahead of peers.

While standalone earnings visibility remains high, subsidiaries are likely to emerge as major contributors to the business in terms of technical knowhow and revenues. As of June 2007, Pauwels and Ganz accounted for 56 per cent of the total order book of Rs 4,870 crore. Further, with the products and services of the subsidiaries likely to complement standalone operations, consolidated operations may capture the big picture.

The key challenge for Crompton Greaves would be to successfully integrate the operations of all the acquired companies and turnaround their operations. While the initial signs appear encouraging, any slowdown/failure may subject the stock to some de-rating.

Steel and copper, which are the key raw materials, have witnessed volatility in prices. Considering that overseas orders do not have a price escalation clause any steep rise could dent margins.