Investors with a one-two-year perspective can consider exposure to the stock of domestic textile machinery leader, Lakshmi Machine Works (LMW). Robust growth in textile exports and consequent expansion by organised players, renewal of Technology Upgradation Fund scheme (TUFS) and significant increase in capacity utilisation of spinning mills since 2009-10 augur well for higher demand for textile machinery.

LMW is already reaping the benefit by way of strong order inflows. A major market share, sound pricing policies and debt-free status support the buy recommendation for this stock, at a time when interest rate hikes and inflationary conditions threaten many manufacturers.

At the current market price of Rs 2042, the stock discounts its expected per share earnings for FY-12 by 11.5 times, a good discount to its historic valuations of over 16 times. Strong earnings growth in recent quarters has led to attractive valuations. However, given the poor volumes traded on the bourses, investors should also avoid large exposure to the stock.

Also, given that the industry is prone to sharp downcycles, investors can refrain from a holding period of more two years.

Post sluggish performance for two years ending FY-10, the tide has once again turned in LMW's favour in the just ended fiscal. The company received fresh orders of Rs 3,082 crore in FY-11 andended the fiscal with a closing order balance of Rs 4,603 crore. A rather huge business risk in the textile machinery sector is that customers often place orders and defer delivery indefinitely, thus locking working capital and resources for the supplier.

Strategies to reduce risks

LMW has significantly mitigated this risk by adopting a three-pronged strategy. One, the company, after receiving an advance against an order which are typically non-cancellable; has a policy of ensuring that large orders are backed by finance options from the client's bank to reducerisk of default.

Two, the company has an agreement with customers of enforcing the prices ruling at the time of delivery (and not the price at the time of placing orders). This would mean that the company does not have to lose margins as a result of any significant cost increases between the time of ordering and delivery.

Also, the company does not sit on finished inventory; it instead goes ahead with the execution only after receiving the go-ahead for delivery from the clients. Three, the company's executable work is often tilted in favour of project orders than unitary/replacement orders; the latter sometimes posing risk of postponement of delivery by clients.

Orders from the likes of National Textiles Corporation, which are for expansion or upgradation, do not generally suffer from inordinate postponement of deliveries. Currently, over 75 per cent of the company's orders are project orders. We believe that these strategies significantly help reduce risks involved in order- to-revenue conversion.

Despite a robust 68-70 per cent market share, an over 85 per cent capacity utilisation and six million spindleage orders (as against 3.5 million spindleage capacity), LMW has chosen to keep its current capacities intact at present. This too, in our view, is a prudent policy decision, given that the cost of unused/excess capacities in a downturn later can be very high.

LMW's strong customer base abroad would also, to some extent, help hedge any slowdown locally. Besides a unit in China, it has orders from Indonesia, Thailand, Vietnam, Bangladesh and Turkey. Renewal of the TUFS up to March 2012, besides high capacity utilisation (of over 90 per cent) by spinning mills, are all demand drivers at least for the next one year.

Nil-debt status

LMW had a good fiscal 2011 that helped it clock a 56 per cent expansion in sales to Rs 1773 crore. Net profits grew by 59 per cent to Rs 166 crore. Lacklustre demand until a year ago did not provide room for the company to hike prices. This, together with wage revisions and profit sharing with employees, strained EBITDA margins which declined by over a percentage point to 15.3 per cent.

The company had in April hiked priced across-the-board by 3-7.5 per cent. This would, hopefully, bring back margins to over 16 per cent. However, the company cannot be expected to entirely pass on commodity hikes, despite its pricing policies. This could, therefore, keep margins from expanding further.

The key positive for the company though is its nil debt status. This would ensure that net margins, unlike most other manufacturers. are not threatened by interest costs.

LMW's long-term joint-venture partner, Rieter, which has now set up its own subsidiary may be a serious competitor to contend with in the long term. In the last year or so, however, robust demand has ensured that LMW has not lost market share.

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