Elgi Equipments BUY C OMPANY R EPORT ENAM DIRECT

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1 ENAM DIRECT EQUITY RESEARCH Elgi Equipments For private circulation only C OMPANY R EPORT Proxy to Industrial capex Company Background Elgi is a leading manufacturer of compressors catering to industries like construction and mining, water well, railways, power, engineering, transport and textiles. It is also engaged in manufacturing of automobile service station equipments and provides manufacturing and engineering solutions for compressors and automotive equipments. Investment Argument An oligopoly industry with high industry barrier: The domestic industry is an oligopoly industry with only 4 players- Elgi, Kirloskar Pneumatic, Atlas Copco and Ingersoll-Rand. Furthermore, the industry has high entry barriers in the form of technology. Strong product portfolio coupled with steady domestic demand: Elgi manufactures a wide range of compressors catering to large number of industries thus insulating it from downturn in a single industry. Elgi is a key beneficiary of higher industrial capex. With domestic demand on an up-tick, we have estimated revenue and PAT (consol.) to increase at a CAGR of ~32% and ~36%, respectively, through FY1-FY12E. Increasing International presence: Elgi is focusing on increasing its international presence by the way of organic and inorganic route. It has presence in large number of countries and is further expanding. As a result, Elgi s exports have also got a fillip and management expects the international business to contribute meaningfully to its business, going ahead. Elgi has established subsidiary in China to produce large screw compressors and also acquired Belair (which has 3% market share in France). It has also established a company in Brazil to enter S.American market. An Asset light business model with improving ROCE: A virtually debt free company with steadily increasing revenue and profit. It has maintained average ROCE and ROE of 37% and 25% over the last four years. It has a strong balance sheet with cash of Rs.139 cr. as on Sep 1. It has been able to manage its working capital efficiently with working capital to sales reducing to 8.6% in FY1 from 22% in FY6. The business has high asset turn at nearly 4x. Factors to monitor Slowdown in industrial capex: Lack of fresh investments across all market segments could dampen the growth of the company. Valuation We believe that with India s GDP on a high growth trajectory, Elgi should continue its strong performance. Elgi has a scalable business model with strong balance sheet, stable ROCE and has generated FCF of Rs. 89 crores as on FY1. We initiate BUY on the company with a target price of Rs. 124 (based on 16x FY12E consol. EPS of Rs. 7.8). Financial summary (Consolidated) CMP (Rs) 84 Target price (Rs) 124 Potential upside 48% Stock data No. of shares (cr) 15.7 FV (Rs) 1 Market cap (Rs cr) 1,32 52 week high/low (Rs) 17/ 39 Avg. daily vol.* (shares) 11,338 BSE Code NSE Code Bloomberg code Reuters Code * BSE & NSE 6 monthly Shareholding (%) ELGIEQUIP ELEQ IN ELGE.BO Dec-1 QoQ Chg Promoter FIIs MFs / UTI Banks / FIs.15 (.1) Others (.73) Price performance BUY Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Jan-11 BSE_SENSEX Elgi Equipments Source: Cline, ENAM Direct Research Y/E March Sales Adj. PAT EPS* Change P/E RoE RoCE EV/EBITDA DPS (Rs cr) (Rs cr) (Rs.) (YoY %) (x) (%) (%) (x) (Rs) (12) E E 1, Source: * Adj. for bonus for FY9 & FY1; Company and ENAM estimates ENAM Securities Direct 17 th January 211

2 COMPANY BACKGROUND Elgi is a leading manufacturer of air compressors and automobile service station equipment. ELGI's products are used in a wide range of applications in areas ranging from mining, transport, pharmaceuticals, power, oil, railways, chemicals, textiles, printing to ship building, paper, electronics, telecommunications, medical, food & beverages and plastics. No sector contributes more than 1% to the topline of the company thereby hedging it from downturn in a single industry. Hence, it is a play on India s GDP growth which would in-turn fuel the growth in industrial capex. Compressor Technology can be classified as reciprocating compressors, screw compressors, centrifugal compressors and oil-free compressors. Elgi is largely into rotary screw and reciprocating compressors. The Automotive Service Equipment Division manufactures lubrication equipment, two-wheeler and four-wheeler hoists, paint booths, AC recovery units, crash repair systems, wheel balancers etc. Elgi has a vision of becoming a $1 bn. company in terms of topline by 215 by resorting to organic and inorganic growth routes. Product profile Source: Company, ENAM Research. 17 th January 211 ENAM Securities Direct 2

3 Company Structure Elgi includes Elgi equipment Standalone Company and its subsidiaries. ATS Elgi, is yet, in the growth phase as auto sales have picked up over the last few years and are growing strong. This, inturn, is leading to investment in new and existing garages. The compressor subsidiaries are still in their nascent stage of growth. However, they hold an area of promise since the management s vision is to touch $1 bn topline which would entail increasing international exposure through the subsidiaries- organically or inorganically. Subsidiaries Holding as on Mar-1 Total Assets (Rs cr) FY1 Revenue (Rs cr) FY1 PAT (Rs cr) ATS ELGI Limited 1% Adisons Precision Instruments Manufacturing Company Limited 1% ELGI GULF (FZE) 1% Elgi Equipments (ZHEJIANG) Limited 1% (3.8) Elgi Compressor Trading (Shangai) Ltd. 1% (.5) SA Belair-France* 1% ; the revenue and PAT nos.are only for one month as Elgi acquired Belair in Mar 21 Business Mix Compressors contribute lion s share of revenue (86%) which stands at Rs. 582 cr. for FY1. It accounts for 92% of EBIT of the company. Automobile Equipments contribute 13% to revenue at Rs. 89 cr. It accounts for 1% of EBIT. Revenue Break-up EBIT Break-up 13% 1% %. (2.) (2.1) Compressors Automotive Equipments Others Compressors Automotive Equipments Others ; All nos. are on consolidated basis 17 th January 211 ENAM Securities Direct 3

4 BUSINESS OVERVIEW Compressor Segment Elgi is Asia's largest manufacturer of air compressors. Elgi has a strong product portfolio. It manufactures a wide range of rotary and reciprocating compressors which cater to large number of industries like mining, transport, pharmaceuticals, power, oil, railways, chemicals, textiles etc. This diversifies its customer base and protects it from downturn in a single industry. Spares and services business accounts for nearly 2% of the compressor business. Elgi has a huge nationwide network of over 114 dealers with service team of over 25 engineers and technicians. Elgi manufactures airends in-house. It caters to large no. of esteemed customers. Rotary Compressor Customers Reciprocating Compressor Customers The size of domestic industry is around Rs. 3, cr. Furthermore, the domestic industry is an oligopoly industry with only 4 players- Elgi, Kirloskar Pneumatic, Atlas Copco and Ingersoll-Rand. The industry has huge entry barriers in the form of technology. Compressor Technology can be classified as reciprocating compressors, screw compressors, centrifugal compressors and oil-free compressors. Amongst these, Kirloskar is mainly into gas based compressors. Demand for spares constitutes for a large part of demand for compressors. This ensures a minimum level of demand even in downturn. 17 th January 211 ENAM Securities Direct 4

5 Elgi is focusing on increasing its international presence by the way of organic and inorganic route. ELGI has a presence in all the major markets across the world including Europe, North America, Latin America, Africa, Australia, Middle East, South East Asia, West Asia and the Far East. It has more than 5 dealers overseas. As a result Elgi s exports have also got a fillip and management expects the international business to contribute more than 5% to its business, going ahead. Elgi s major focus is on European and Chinese market. The Chinese market is more than double the size of Indian market. Elgi has established subsidiary in China to produce large screw compressors which faces little competition from domestic Chinese market. It is also looking at multiple acquisitions in China to capture small size rotary screw compressor market. In March 21, Elgi acquired Belair of France. Belair is a leading supplier of industrial compressors with 3% market share in France. It has also established a company in Brazil to enter S.American market. The compressor business contributes 86% to the total consol. revenue. The compressor segment revenue (consol.) has increased at a CAGR of 25% over FY6-1. The EBIT margin has averaged 16% over the last five years. The segment ROCE has averaged over 5% during the last five years. We have estimated revenue in compressor segment to increase at 35% CAGR over FY1-12E. Compressor segment Revenue and EBIT Margin Compressor segment ROCE (%) % 6% 4% 2% % FY6 FY7 FY8 FY9 FY1 FY6 FY7 FY8 FY9 FY1 Compressors Revenue EBIT(%) ROCE(%) ; All nos. are on consolidated basis 17 th January 211 ENAM Securities Direct 5

6 ATS- Elgi The Automotive Equipment Division manufactures lubrication equipment, two-wheeler and four-wheeler hoists, paint booths, AC recovery units, crash repair systems, wheel balancers etc. This segment is expected to perform in line with auto sales and investment in new and existing garages. It accounts for 13% of sales (consol.) and 1% of the profits of the company. Key Customers ATS- Elgi, is yet, in the growth phase as auto sales have picked up over the last few years and are growing strong. This, inturn, is leading to investment in new and existing garages. We have estimated revenue to increase at 21% CAGR for FY1-12E. Automotive Equipment Revenue and EBIT Margin ATS segment ROCE (%) 1 2% 6% 5% FY6 FY7 FY8 FY9 FY1 15% 1% 5% % 4% 3% 2% 1% % FY6 FY7 FY8 FY9 FY1 Automotive Equipment Revenue EBIT(%) ROCE(%) 17 th January 211 ENAM Securities Direct 6

7 INVESTMENT ARGUMENT Strong product portfolio coupled with steady demand domestically: Elgi manufactures a wide range of air compressors of both rotary and reciprocating technology in various powers and capacity. It caters to large number of industries like construction, mining, railways, power etc. This insulates it from downturn in a single industry as no industry contributes more than 1% to its sales. Elgi is a key beneficiary of higher domestic industrial capex. The size of domestic industry is around Rs. 3, cr. Furthermore, the domestic industry is an oligopoly industry with only 4 players- Elgi, Kirloskar Pneumatic, Atlas Copco and Ingersoll-Rand. Additionally, the industry has huge entry barriers in the form of technology. Demonstrated growth in sales and EBITDA margin: Elgi has been able to increase sales at a CAGR of 21% over FY6-1. In the same period EBITDA has grown from Rs. 39 cr. in FY6 to Rs. 18cr. in FY1 (CAGR of 29%). Ebitda margin has improved largely due to favourable product mix. We have estimated revenue to increase at a CAGR of 32% and PAT to increase at CAGR of 36% over FY1-12E. Increasing Net Sales and sustainable EBITDA margin FY26 FY27 FY28 FY29 FY21 FY211E FY212E 4% 35% 3% 25% 2% 15% 1% 5% % Net sales EBITDA Margin 17 th January 211 ENAM Securities Direct 7

8 A virtually debt free company with improving ROCE and ROE in the compressor business: A debt free company which has maintained average ROE of 25% and ROCE of 37% over the last four years. Cash flow from operation (CFO) has increased at a CAGR of 51% between FY7-FY1 (CFO increasing to Rs. 15 cr. in FY1 from Rs.31 cr. in FY7). Improving ROCE and ROE profile Multifold increase in Cash flow from operations 6% 12 5% 1 CAGR = 51% 4% 8 3% 2% 6 4 1% % FY26 FY27 FY28 FY29 FY21 FY211E FY212E 2 FY27 FY28 FY29 FY21 ROCE ROE CFO Working capital- A cash generator : Elgi has consistently been able to decrease its working requirement. Elgi has been able to reduce its working capital as percent of sales from 22% in FY6 to 9% in FY1. Working capital requirement falling with increasing sales 25% 14 2% 15% 1% 5% % FY26 FY27 FY28 FY29 FY21 FY211E FY212E Sales Working Capital -to-net sales % 17 th January 211 ENAM Securities Direct 8

9 Quarterly sales trend is encouraging- Sales have been rising consistently from Mar 9 onwards. In the last three quarters the company has posted an average revenue growth of over 5% YoY. Consistently rising quarterly sales Growth of over 5% YoY over the last three quarters 3 7% 25 6% 5% 2 4% 3% 15 2% 1 1% % 5-1% -2% Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Net Sales Sales Growth Y-o-Y RISKS TO VALUATION Slowdown in industrial capex: Lack of fresh investments across all market segments could dampen the growth of the company. Hence, if GDP growth slows down for a sustained period of time it can hamper Elgi s growth. Adverse exchange rate movements- Around 15% of company s revenue (st.) comes from export, rupee appreciation could have a negative impact on revenue. Recovery of global economy- Elgi has exposure to international markets some of which are still under recessionary trends especially Europe. Recovery of Europe will be key to Elgi s growth. Rise in input costs- Sharp rise in commodity prices such as steel and copper and company s inability to pass on the increase in prices could hamper the margin of the company. 17 th January 211 ENAM Securities Direct 9

10 VALUATION Revenue growth of ~32% CAGR during FY1-FY12E EPS growth at ~36% CAGR over next two years Scalable business model and stable earnings growth Strong Corporate governance Asset light business with virtually no debt Our 1-yr. target price of Rs. 124 is based on 16x consol. EPS of Rs th January 211 ENAM Securities Direct 1

11 FINANCIALS Income statement Y/E March (Consol.) E 212E Net sales ,185 Other operating income Total income ,188 Material Cost Employee Cost Other Manufacturing Cost Contribution (%) Advt/Sales/Distrn O/H Operating Profit Other income PBIDT Depreciation Interest Other pretax Pre-tax profit Tax provision (-) Minority Interests Associates Adjusted PAT E/o income / (Expense) 3 (8) () Reported PAT Balance sheet (Rs. Cr) Y/E March (Consol.) E 212E Total assets Gross block Net fixed assets CWIP 1 2 Investments Wkg. cap. (excl cash) Cash / Bank balance Others/Def tax assets Capital employed Equity capital Reserves Borrowings Others th January 211 ENAM Securities Direct 11

12 Key ratios (%) Y/E March (Consol.) E 212E Sales growth OPM Oper. profit growth COGS / Net sales Overheads/Net sales Depreciation / G. block Effective interest rate n.a. n.a. n.a. n.a. Net wkg.cap / Net sales (x) Net sales / Gr block (x) RoCE Debt / equity (x).... Effective tax rate RoE Payout ratio (Div/NP) EPS (Rs.)* EPS Growth (11.6) CEPS (Rs.) DPS (Rs.) * EPS adjusted for bonus in FY9 & FY1 Cash flow Y/E March (Consol.) E 212E Sources Cash profit (-) Dividends Retained earnings Issue of equity 23 Borrowings 3 1 Others 9 (5) Applications Capital expenditure Investments () Net current assets 24 (36) 26 3 Change in cash th January 211 ENAM Securities Direct 12

13 CONFLICT OF INTEREST DISCLOSURE We, at ENAM, are committed to providing the most honest and transparent advice to our clients. However, given the nature of the capital markets, from time to time we are faced with situations that could give rise to potential conflict of interest. In order to provide complete transparency to our clients, before we make any recommendations, we are committed to making a disclosure of our interest and any potential conflict IN ADVANCE so that the interests of our clients are safe- guarded at all times. In light of this policy, we have instituted what we believe to be the most comprehensive disclosure policy among leading investment banks/brokerages in the world so that our clients may make an informed judgment about our recommendations. The following disclosures are intended to keep you informed before you make any decision- in addition, we will be happy to provide information in response to specific queries that our clients may seek from us. 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