Titagarh Wagons

Investments with a two-three year perspective can be considered in Titagarh Wagons (TWL), a leading private sector wagon manufacturer.

Our investment argument stems from the relatively stable business opportunities available in the rail sector arising from setting up of dedicated freight corridors, sustained capex by leading container rail logistics companies and introduction of wagon leasing scheme.

All these factors hold considerable merit in today’s scenario as many mid and small-sized manufacturing companies are already facing a slowdown in demand. On that note, TWL’s revenues appear comparatively cushioned.

Not only is the demand for wagons stable, the fact that TWL has a long-standing relationship with both the Indian Railways (IR) and private players also lends considerable credence to its growth potential.

Valuations

From a long-term perspective, the recent meltdown in the broad markets has rendered the company’s valuations quite attractive.

At the current market price of Rs 399, the stock now trades at about 10 times its likely FY09 per share earnings, down significantly from the PE multiple (of 17 times) it enjoyed at the time of its initial public offering in March this year. That there has been no significant mark down in capex, by either the IR or leading container rail logistics players such as Concor and Gateway Distriparks (GDL) in the interim period, suggests that there may be sufficient room for expansion in its price-earnings multiple from the current levels.
Wagon demand buoyant

The demand for wagons is largely driven by the capital expenditure incurred by the Indian Railways. That IR has moved to positive earnings territory over the last couple of years and given that railway spending has little linkage to the global economic slowdown (in recent times, the passenger traffic using railways has increased significantly) suggests that its budgetary spending on revamping its infrastructure and adding to its wagon fleet in the coming years may well continue.

This bodes well for TWL since IR had intended to procure an all-time high of about 20,000 wagons in the coming years. Another factor that adds up favourably for TWL is the high replacement demand from IR. To increase its share of the freight traffic, IR plans to substitute its older wagons with ones that have a higher axle load design and are made of stainless steel and aluminium.

The entry of new private players in container rail logistics is also a positive. While it may take a while for the demand from private players to ramp up, this space offers a huge business potential for wagon manufacturers (industry estimates peg it at about Rs 2000 crore).

The growing consensus that interest rates may have peaked and will begin to taper from hereon may also support demand. On that note, the wagon investment scheme, which seeks to provide 10 per cent rebate on normal freight charges to wagon owners and guaranteed supply of rakes every month, may also sustain demand.

Besides this, introduction of wagon-leasing scheme, which allows third-parties to invest in wagons and lease them, may also help.

In addition to all this, TWL has recently started the manufacture of Electric Multiple Units (EMUs), which are widely used for the passenger transport by the Railways. While only a nascent business presently, it holds the potential to become a significant revenue spinner for TWL in the coming years.
High barriers to entry

Given the high entry barrier in this business, private wagon manufacturers are likely to reap the benefits arising from near term opportunities. This is because IR’s procurement policy stipulates that three-fourth of its orders should be placed with players on the basis of their past five years’ track record. That straightway eliminates the threat of TWL losing any significant market share to newer players.

On the other hand, TWL may well procure incremental business from the Railways in the coming years since it is presently investing in doubling its wagon manufacturing capacity. That the capacity expansion will be funded through the IPO money raised by the company also does away with concerns regarding any high reliance on debt for expansion. The only bottleneck in this business is the limited availability of axle and wheel sets given the supply constraints of the domestic railways-approved wheel set manufacturers.

sThis, the company plans to circumvent by setting its own axle machining and wheel set assembling plant.
Financials

On a compounded annual basis, TWL has in the last four years grown its revenues and profits at 76 per cent and 97 per cent respectively.

Operating profit margins, during this period, have expanded by over 2.6 percentage points to 15.5 per cent.

Though TWL has presence in HEMM (heavy earth moving and mining equipment) and steel castings (captive consumption) businesses, we expect a bulk of its revenue growth to come from the wagon manufacturing division.

To that extent, it leaves little scope for expansion in margins and realisations as IR fixes the price of wagons on the basis of the lowest bid (L1) it receives.