Elecon Engineering: Buy

Together with its newly-acquired British gear systems and gearbox player, Elecon's earnings growth prospects appear bright.



Even as the index for industrial production continues to oscillate, the pick-up in performance of six core industries bodes well for companies such as Elecon Engineering. Deriving its business from core sectors such as power, steel, cement and mining, material handling equipment and industrial gears maker Elecon has seen a steady pick-up in order flows in recent times. Together with its newly acquired British gear systems and gearbox player, Elecon's earnings growth prospects appear bright.

Investors with a two-year perspective can consider buying the stock of Elecon. At the current market price of Rs 76, the stock trades at 8.6 times its expected per share earnings for FY-12 (including earnings from the new acquisition). This is at a marginal discount to its slightly larger peer McNally Bharat Engineering.

Order pick-up

Elecon is among the top few players in the material handling equipment space and is the largest domestic player (25 per cent market share) in the industrial gear box business. Being dependent on some of the core sectors for growth, the company took a hit in profits during the slowdown although it managed to expand revenues. Tepid order inflows, post-downturn, kept the stock price depressed. Inflows, though, picked up pace from the first half of FY-11 and have since improved. Currently the Rs 1,513 crore of order book lends visibility for well over a year. Inflows have gained traction from the beginning of this fiscal, with the company announcing at least three orders in the power, cement and iron ore sectors.

Key driver

Material handling systems account for close to 80 per cent of the current order book, driven by orders from the power and steel sector as also cement. The prospect for this segment remains high on account of the following: one, the management has indicated live enquiries of about Rs 5,000 crore from the core sectors discussed above, which suggests that capex plans of industries are reviving. Even if 20-25 per cent of this converts into orders for the company — a feat not too difficult given that it is among the larger players — order flows are bound to see a healthy surge.

Two, there appears to be a visible improvement in the company's pricing strategy, given that EBITDA margins have seen a marked improvement. For the December quarter EBITDA margin at 16.5 per cent is 2 percentage points higher than the September quarter. Pricing policy that includes in-built escalation clauses in orders from government agencies and public sector players such as NTPC may well help cushion raw material hikes. Nevertheless, sharp commodity hikes may hurt non-government orders with a lead time of over one year; such time often taken in the material handling division.

Gearing up

Elecon's industrial gears and gear box systems (called the transmission systems segment) division is known to be less prone to cyclical downturns as it caters to various industries. However, the segment did see a dip in profits during the downturn, given that capex activity across industries was put on hold. This segment has shown improvement, albeit slowly, with order inflows for the nine months ending December higher by 11 per cent over a year ago. The company's acquisition (through a subsidiary) of gear supplier, UK-based Radicon Benzlers in October 2010 could fast-track the growth of this division.

With presence in the UK, Sweden and Thailand as well as network in the US, the acquired company would not only add muscle (about Rs 175 crore sales per annum) to the group's revenues but also provide channels for distributing Elecon's products. Elecon plans to commence exports to Europe from this fiscal through the foreign subsidiary's distribution channels. Windmill gear box for 1-2 MW capacity is also another area that may provide some volumes, given the increasing interest in the renewable energy space. The company is said to have tied up with a couple of wind energy players for the same.

Elecon's revenue for FY-10 was Rs 1,067 crore while net profits stood at Rs 66 crore. Current debt equity ratio of 1.5 times provides sufficient room for capex plans of Rs 75-100 crore in FY-12.

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