Kirloskar Electric Company : The Multibagger Call

-Sharper focus on core operations to lead to revenue CAGR of 37.5% over FY07-09E
-Government and private sector capex to provide huge growth opportunities
-Improved realizations and tighter control on costs to expand OPM by 60bps by FY09E
-We recommend BUY with a one-year price target of Rs361, an upside of 38%

Sharper focus should result in revenues growing at 37.5% CAGR over FY07-09E: Restructuring, through transfer of certain assets and liabilities to a subsidiary and relocation of manufacturing facility, helped Kirloskar Electric Company (KECL) turnaround in FY06. The company’s new transformer unit in Mysore will help capitalize on robust demand expected over the next five years. We expect KECL to witness a strong CAGR of 37.5% between FY07-09E.

Government and private sector capex to provide huge growth opportunities: With the government announcing huge investments for the power sector, we believe there will be strong demand for power equipments, i.e. electric motors, transformers and switchgears. Coupled with this, huge capex plans have been announced by players from the metals, cement, oil and gas, and other sectors. KECL’s presence in most of these segments makes it one of the key beneficiaries of this oncoming demand.

Strong demand and improved realizations to expand operating margin to 13.4%: Strong demand arising out of government and private sector capex should improve KECL’s realizations. Average realizations for transformers and motors divisions, which contribute majority of the revenues, witnessed an improvement of 45.6% and 32% respectively in FY07. We believe robust demand will further improve average realizations for both these divisions.
Bottom line expected to witness 53.3% CAGR over FY07-09E, BUY: Demand arising out of investments planned by government and corporates over the next five years, should reap benefits for the company. Improving realizations leading to margin expansion should help bottom line witness 53.3% CAGR over FY07-09E. At the current price the stock trades at around 15x and 11x FY08E and FY09E EPS of Rs 18 and Rs 24.1 respectively. We recommend BUY with a one-year price target of Rs 361.

Investment rationale

Restructuring should enable revenues to witness 37.5% CAGR over FY07-09E: KECL has widened its product profile to meet varied and increasing demand. In the past, the company incurred losses during FY99-05 but restructured operations and turned around at both, operational and net levels in FY06. It transferred some of the assets and liabilities to its subsidiary and relocated its manufacturing facility. KECL also upgraded and integrated all its manufacturing facilities to enhance its operational efficiencies. Its new transformer unit in Mysore will help it capitalize on robust demand for transformers. The restructuring effort should enable it witness revenue CAGR of 37.5% over FY07-09E.

Electric motors and transformers division to be major drivers: KECL receives 96.2% of its revenues from electric motors (64.4%), transformers (19.8%), circuit breakers (7.2%), controls for generator sets (3%) and DG sets ( 1.8%). With an improved industrial scenario, we believe electric motor, transformers and switchgear division will be major drivers for the company. Motors and transformer divisions will together register 39.3% CAGR and switchgear division will witness 30% CAGR over FY07-09E.

Electric motors division: Electric motors find application in the power, cement, sugar, steel, telecom, paper industries. Capex announced by various players in these industries provides the division an opportunity to experience strong growth going forward. Initially it was in collaboration with Brush Electric UK for technical support and other technical collaborations with NEI Peebles Electrical Machines, Scotland and AEG, Germany. These tie ups enabled it to develop high capacity motors. KECL’s industrial motors gamut range from 0.12kW to 20,000kW in 63 – 1,250 frames.

Transformers division: We expect 41,320MW to be added over the XIth Five Year Plan against the target of
78,869MW, triggering a strong demand of 110,000MVA over the same period. The timely expansion at its Mysore unit, which manufactures a wide range of power and distribution transformers, is expected to augur well for the company. These transformers are supplemented by other variants i.e. flame proof, dry type, furnace and earthing transformers. In the past it had technical tie-ups with Brush Electric, UK; MWB, Germany; Rolls Royce, UK; and May & Christe, Germany.

Electronics and switchgears division: This division offers process industries customized packages in motors and drives. This helps the user industries to improve productivity, save energy and reduce lead time. Major consultants such as Engineers India Ltd., M. N. Dastur & Co., Avant Garde and Entech Consultancy have approved the company’s products. The product range includes DC drives in collaboration with Thorn EMI, UK, in a range
from 2.7kW to 2.5MW. The 2.2kW–160kW AC drives are consumed by plastic and textiles industries. Both these products are exported to Vietnam, Nepal, Bangladesh, Pakistan, Thailand, Lebanon, Indonesia, Malaysia,  Philippines, South Africa and other African countries.

The switchgears division manufactures high voltage switchgears in the range of 3.3kV – 36kV. It caters to the requirements of state electricity boards, utilities, power generation, mining, defense applications and industrial clients from cement, steel, paper, textiles, chemicals and other process utilities.

Government capex over the next five years will boost demand: The government targets to add 78,869MW over the XIth Five Year Plan. However, we believe it will be able to achieve 41,320MW over the plan period. Despite lower addition there will be strong demand for motors, transformers and switchgears. The government’s focus on accomplishing “Power for all by 2012” mission and rural electrification during the plan period will fuel growth for all divisions of the company. Under Rajiv Gandhi Grameen Vidyutikaran Yojana it intends to electrify
all households in the country. It will also focus on the creation of a national grid in a phased manner by adding a transmission network of over 60,000ckm by 2012.

These programs will fuel demand for transformers and switchgears going forward. Better realizations and control on costs to expand OPM to 13.4%. Strong demand for all products – motors, transformers and switchgears – will help improve these divisions’ realizations. With copper expected to hover around US$7,500 per ton, we believe margins for the motors division will improve going forward. The company is expected to witness an improvement in margins due to huge demand coming from state electricity boards and industrial capex announced
over the next three–five years.

KECL is one of India’s leading electrical and power equipment manufacturers. Established in 1946, it manufactures AC motors, AC generators, DC machines, traction equipment, electronics, switchgears and transformers. The company also undertakes turnkey electrical projects. KECL has five manufacturing facilities, one each in Bangalore, Hubli, Tumkur, Govenahalli and Mysore. It also has a well-spread marketing network with 25 offices acro
ss India.

Concerns
-Growth dependent on reforms in the sector: Order flows are dependent on the pace of reforms undertaken by the government. Since this is a politicallysensitive issue delays in implementation are likely resulting in subdued
performance.
-Rising raw material prices: Rising prices of key raw materials could lead to contracting margins if the company is unable to pass on rising costs to the consumers.
-Economic slowdown: A slowdown in the economy will postpone various industries capex plans, which in turn will lead to a deferment in demand for KECL’s products.
-Competition from imports: Huge capex lined up by the government and private sector players will result in high demand for the company’s products. With this scenario in place, threat of foreign players and new  entrants entering the market is high, which will lead to higher competition and pressure on margins.