Elgi Equipments

Investors with at least a two-three year perspective can consider buying the stock of Elgi Equipments, a manufacturer of air compressors and automobile service station equipment.

Revival in capex in the domestic market, manufacturing /trading presence in high potential developing markets such as China and Brazil and a strong cash position that allows scouting for acquisitions in new markets are factors that favour earnings growth for the company over the medium term.

At the current market price of Rs 80, Elgi's stock trades at 8.5 times its per share earnings for FY-11.

The stock is currently at a steep discount to its bigger peer Ingersoll-Rand; the latter not yet fully out of the slowdown.

Long-term play

We do not expect any significant ramp-up in revenues in the next few quarters, owing to peaking of demand (according to the management) for air compressors used for water wells and the continuing sluggishness in overseas market.

However, given that the industrial business segment has also been contributing actively to revenues and emerging markets such as Brazil and China are likely to buttress sales growth over the long term, Elgi may have to be a buy and hold candidate in one's portfolio.

The stock, at this point, could be a dark horse play; investors can consider buying it in small lots and accumulate on declines linked to broad markets.

Business

Elgi is the market leader in air compressors (over 10 per cent) as well as automobile service station equipment and is also among the larger players in Asia.

Elgi has a very wide customer base, given the diverse application of its products in sectors such as mining, transport, power, railways, oil, textiles, shipbuilding, plastics and electronics, to name a few. It also has all major automobile manufacturers as its customers.

The extent of diversification has allowed Elgi to keep up growth momentum. Even as the capex slowdown hurt capital goods companies in FY-09 resulting in decline in sales/profits, Elgi managed to grow revenues, albeit marginally even as profits remained flat.

However, strong focus on global markets resulted in a slow recovery for the company in the current fiscal. The December quarter results though, have shown the first signs of a revival with all its segments reporting growth. Revenues for this period expanded by 30 per cent, even as profits jumped 70 per cent over a year ago, thanks to a low base and lower raw material costs. Interestingly competitors such as Ingersoll-Rand and Kirloskar Pneumatic are yet to demonstrate similar decisive revival signs. However, not all is well , since the company has admitted that its demand for air compressors in the water wells segment has peaked out, which effectively means that there could be some dent in revenues.

However, pick-up in auto equipment as dealers ramp up their capex, on improved auto sales could make up for the dip in the water wells compressor demand.

Reaching out

Besides, Elgi has utilised the slowdown period to test grounds and ramp up presence in the Brazilian and Chinese markets. In Brazil, where the company's products have for long had takers, the company has set up a wholly-owned subsidiary as a trading unit.

In China, it owns a manufacturing unit and also has trading presence; the company though, may take a longer time to ramp up demand in this market, as it has to compete with local players. Nevertheless, the scope of application for Elgi's products in China, given the latter's massive manufacturing activity, combined with superior technology, is tremendous. This market could, however, take a couple of years, before it contributes significantly to the bottom line, even as revenue flow may kick in early. Elgi products' application in the oil sector has also given it a market in West Asia.

The company has a presence in UAE. This market too, in the near term is likely to remain sluggish. Elgi is in the process of acquiring a European company, which makes compressors. This move too is intended to expand geographically rather than acquire new products, as Elgi's product range, thanks to its joint ventures with many overseas players, is fairly comprehensive.

We suspect this acquisition could come at attractive valuations, given the slowdown in the region. The company has stated that it will not go for any fresh debt, suggesting that internal accruals should meet the acquisition cost. Elgi has traditionally been a debt-free company has also has a lucrative investment book.

Elgi' sales grew at 20 per cent compounded annually (to Rs 595 crore in FY-09) over the last three years, while profits expanded by 25 per cent over this period. Operating profit margins, though healthy at 12 per cent levels, could come under pressure as a result of hike in cost of steel and copper.

While any excise duty hikes in its end product is unlikely to impact margins (as its products, mostly used as inputs by clients for their business enjoy cenvat credit), as they are passed on, whether its own raw material cost hikes will hurt margins, remains to be seen.