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Friday, June 29, 2007

Prabhudas Lilladher - AIA Engineering


Prabhudas Lilladher report on AIA Engineering:

AIA Engineering is a niche player in high-chrome metallurgy products catering to the cement, power and mining segments. It enjoys a 90% market share in the domestic market and 20% in the global market. AIA is increasing its capacity manifold from 65,000 tpa to 265,000 tpa within a span of two years and is poised for substantial growth in the years to come.

For the period FY07-09E, we expect a net profit CAGR of 40.2% on the back of a revenue CAGR of 46.5%. At the ruling price of Rs 1,752, the stock trades at 24.2x and 17.8x FY08E and FY09E earnings of Rs 72.3 and Rs 98.6 respectively. On an EV/EBIDTA basis, the stock is available at 16.4x and 11.4x FY08 and FY09 estimates respectively. We arrive at a DCF based target price of Rs 1,974 per share which discounts FY09 earnings by 20.0x.

Investment Argument

Niche player in a high-growth segment

AIAE is a niche player in the value-added high-chrome metallurgy segment catering to the cement, mining and thermal power industries in grinding and crushing operations. The grinding mill is of utmost importance to the user industries, as reduced efficiency has a significant impact on output. In case of a thermal power plant, lower output of ground coal would lead to reduced heat generation and eventually reduction in electricity produced. In case of a cement plant, lower output leads to substantial increase in power and maintenance cost.

The size of the market for mill internals in cement plants is expected to be around 275, 000 tonnes including China. Demand from the Chinese market stands at about 100,000 tonnes. The company does not have any presence in China. Thus, the total market available stands at 175,000 tonnes.

Industry capex cycle driving growth

Companies in cement, power and mining have announced huge expansion plans. AIA stands to benefit from this expansion, as the grinding mills manufactured by it are critical components in these plants. Industrial capex is expected to have a CAGR of 22% from FY06 to FY10.

AIAE has a market share of 90% in the domestic market for grinding mills and is thus expected to garner a major chunk of the emerging opportunities in related sectors. Most of AIA’s revenue now arises from replacement demand. However, ahead, as new capacities in the sectors start coming up, we could see this proportion changing.

Expanding capacities to cater to huge market

The biggest constraint the company faces in increasing market share is capacity, which is being fully utilized. It aims to increase its global market share to 50% within a span of three years. Currently, almost 55-60% of the global market is controlled by Magotteaux, which has a capacity of 300,000 tonnes. Magotteaux’s global market share has come down from 80% two years ago.

AIA Engineering currently has capacity of 115,000 tpa, which it plans to increase to 165,000 tpa by October 2007 and subsequently to 265,000 tpa by October 2008.

Robust order book

The company has a current order book of Rs 4.2bn, which includes orders only on the current facility. It has not booked any orders for the new facilities that are under commissioning, though it has been receiving a number of queries for the same.

Investment Concerns

Raw material price volatility

The main raw material utilized by the company is chromium. Chromium prices have peaked in the past few months; however, they now have come off their highs and are expected to be stable in the near term. Any increase in the price of chromium would adversely affect the margins of the company, thus hindering the bottom line.

Delay in execution of projects

The company is undertaking huge expansion projects. It plans to increase its capacity over four-fold to 265,000 tpa from 65,000 tpa. The capacities would come up in various phases till October 2008. Any delays in execution of plans might hinder growth of the company and thus have a negative effect on the estimates.

Downturn in industrial capex

Any downturn in the planned industrial capex might affect the growth prospects of the company. However, AIA supplies grinding media to three industries namely cement, mining and thermal power, thereby de-risking its business model from an industrial downturn in any sector. Also, the company generates almost 80% of its revenue from replacement demand, thus reducing its dependence on new capacities. hinder future growth

Financial Overview

Bottom line growing stronger than top line

We expect a bottom-line CAGR of 40.2% and a top-line CAGR of 46.5%. The bottom line is expected to grow faster than the top line due to improved margins from higher volumes, leading to operating leverage.

Q4 FY07 result update

AIA Engineering (AIAE) reported flat revenue for the quarter at Rs 1.7bn, due to capacity constraint. However, the new capacity has now come up and the company has started taking orders on the new facility. The EBIDTA margin improved by 30bp yoy to 23.1%. Net profit increased by 15% yoy to Rs 307m. The order book as on 1st April 2007 stands at Rs 4.2bn, which does not include any orders booked on the new facility.

Valuation

At the CMP of Rs 1,752, the stock is available at 24.2x and 17.8x FY08E and FY09E earnings of Rs 72.3 and Rs 98.6 respectively. The stock trades at an EV/EBIDTA of 16.4x and 11.4x FY08 and FY09 estimates. Considering the company’s monopoly position in the country, and the fact that it is poised for substantial growth in the next few years, we beleive that it should be valued at higher multiples. We rate the stock an ‘Outperformer’ valuing it using a DCF approach and arrive at a per share value of Rs 1,974. Our target price discounts FY08E and FY09E earnings by 27.3x and 20.0x respectively.