Action Construction Equipment: Buy

Investors with a high risk appetite can consider exposure, with a two-three year perspective, in the stock of Action Construction Equipment (ACE). ACE has an expanding product portfolio, uses competitive pricing and well-established distribution network, which could help it capitalise on the ongoing infrastructure boom, over the next two-three years.

ACE’s capacity expansion and presence in Europe, through its recent acquisition of a Romanian company, also bolster its growth prospects. At the current market price of Rs 335, the stock trades at about 18 times its likely FY09 per share earnings. This valuation is not inexpensive; but the historical earnings growth managed by ACE and its business plans suggest that it is well-placed to take advantage of the boom phase in the construction segment. .

Investment argument

The demand environment for construction equipment companies appears bright, given the government’s increasing focus on infrastructure and construction. While this augurs well for all companies in this space, it has also intensified competition. In the hydraulic cranes segment, which contributes about 90 per cent of total revenues, ACE is likely to continue enjoying a higher visibility in the market for two reasons– one, its market share of about 50 per cent and two, its pricing strategy. ACE prices its cranes at a significant discount to other playersTo reduce its dependence on the cranes segment, ACE has forayed into the forklift and backhoe loaders segment. The company expects to break through the backhoe loaders market, which is mainly dominated by JCB , on the basis of its aggressive pricing strategy.

, It could well succeed in garnering business given the robust demand scenario. The company has capacity to manufacture 50 backhoe loaders per month.

In the forklift segment, however, the company has planned its entry strategy differently. It plans to import the forklift trucks in CKD (completely-knocked down) condition from a Chinese company. In this segment again, while competition from Godrej and Voltas, which have about 90-95 per cent market share, cannot be ignored, the management expects the pricing strategy and distribution network to help it gain market share. Interestingly, in the forklifts segment, ACE has positioned its products, claimed to be superior in technology, at price points that are comparable to products offered by the existing players.

While such an aggressive pricing strategy means lower margins, it is also likely to build volumes, thus helping ACE sell its new products.

Inorganic growth

ACE’s acquisition of 74 per cent stake of a Romanian company is likely to give it access to the European market. ACE plans to ship its products in semi-knocked down condition to its Romanian facility and import engines and other spare parts from other countries. This could contribute significantly to its bottomline, given that margins are likely to be on the high side.

For the quarter ended June 2007, ACE reported a 91 per cent growth in earnings backed by 67 per cent increase in revenues. Operating margins, owing to higher steel price, dipped to about 10.7 per cent. ACE’s discount pricing strategy means that margins may not witness significant expansion but margin pressure will likely ease with the change in revenue mix from FY 09.

Concerns

Any unprecedented hike in steel prices could exert pressure on ACE’s margins, especially given that its strategy relies heavily on competitive pricing.

The possibility of other large players in the market also following suit on pricing exists and this could impact ACE’s competitive advantage. This apart, the stock’s valuation isfairly high and any slowdown in earnings performance could cause a slide in the price.