India Enginerring Elecon Equity Research | Engineering and Capital Goods

Result Update

ELECON ENGINEERING
Expanding growth opportunities

INR 493

BUY

Elecon Engineering’s (Elecon’s) Q4FY07 results were in line with our expectations in terms of the topline. They were however marginally below our expectations on the operating margin front due to higher share of bought out components in the MHE division. Sales for the quarter grew 52% Y-o-Y to INR 2848 mn on the back of 61% and 40% growth in MHE and transmission divisions respectively. EBITDA and PAT grew 54% and 45% Y-o-Y to INR 384 mn and INR 185 mn respectively; EBITDA margins, at 13.5%, grew 20bps Y-o-Y. For the full year though, the margins increased 150bps to 15.1%, and we expect this trend to continue going forward. Full year highlights The key highlight for FY07 was the strong sales growth of 77% and EBIT margin improvement of 400bps in the MHE division. We expect this division to grow at a CAGR of 32% over FY07-09E on the back of strong demand from the thermal-based power plants, steel, and cement sectors. Performance of the transmission division has been steady with sales growing 42% Y-o-Y to INR 3135 mn and EBIT margins remaining constant at 20%. The capital employed during this quarter has increased by INR 650 mn to INR 2950 mn, representing investment on the wind mill gear manufacturing front. Elecon is on the verge of entering into collaboration with an European company for manufacturing wind mill gear boxes. Order book Elecon’s order book, as of now, is INR 8360 mn with INR 6150 mn in MHE and INR 2150 mn in transmission divisions. The execution period for MHE and transmission divisions is close to 12-15 months and 3-5 months respectively. This however does not include the INR 1000 mn sales expected from the wind mill division. We continue to maintain our ‘BUY’ recommendation on the stock on the back of robust outlook on the user industries namely coal-based thermal power plants, steel, and cement. We envisage a demand of ~INR 30 bn for material handling equipment on an annual basis for the next five years. Elecon is on the verge of entering into a collaboration for manufacturing wind mill gear boxes, an INR 20 bn market in India. At the outset, Elecon is looking at manufacturing 650 KV of wind mill transmissions and then scale up to 1.5 to 2.5 MW. If this comes through, then the company will have another feather in its cap, which could lead to its potential re-rating. At INR 493, the stock trades at a P/E of 18.8x and 13.1x FY08E and FY09E earnings of INR 26.3 and INR 37.6 respectively. We maintain our ‘BUY’ recommendation on the stock.
Share Holding Pattern (%) Promoters MFs, FIs & Banks FIIs Others : : : : 42.2 20.7 5.0 32.2 Market Data 52-week range (INR) Share in issue (mn) M cap (INR bn/USD mn) Avg. Daily Vol. BSE (‘000) : : : : 528 / 156 30.9 15.2 / 372.6 89.6 Reuters Bloomberg : : ELCN.BO ELCN IN Bhargav Buddhadev +91-22-4009 4360 bhargav.buddhadev@edelcap.com Harish Sharma +91-22-2286 4307 harish.sharma@edelcap.com June 18, 2007

Financials Year to March Revenue (INR mn) EBITDA (INR mn) Net profit (INR mn) Q4FY07 Q4FY06 Y-o-Y% 2,848 384 185 1,874 250 127 Q3FY07 Q-o-Q% 1,682 296 152 FY06 4,425 597 279 FY07 7,231 1,094 548 FY08E 9,727 1,625 822

EPS (INR)
P/E (x) EV/EBITDA (x) ROE (%)
1

5.9

4.5

52 54 45 32.7

1.7

69 30 21 242.4

8.9
57.2 26.7 31.7

17.5
29.1 16.2 38.7

26.3
19.4 11.4 39.0

Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.

Elecon Enginerring

Result Highlights Sales for the quarter grew 52% Y-o-Y to INR 2848 mn and for the full year by 58% to INR 7232 mn. MHE division and transmission division accounted for 67% and 33% of sales, respectively, on a quarterly basis. Annually, the contribution was 62% and 38% from the MHE and transmission divisions respectively. On a segmental basis, sales in the MHE division grew 61% Y-o-Y, whereas growth in the transmission division was 41%. On a full year basis, the Y-o-Y growth in MHE and transmission divisions was 98% and 35% respectively. EBITDA for the quarter grew 54% Y-o-Y to INR 384 mn. EBITDA margin improved by 20bps from 13.3% in Q4FY06 to 13.5% in Q4FY07. However, on a sequential basis, there was a decline 400bps, primarily because of the following reasons: The proportion of bought out components in the MHE division was higher at INR 520 mn in Q4FY07 as against INR 330 mn in Q3FY07. We however do not expect this trend to continue, going forward, as it is a one off aberration and an inconsistent phenomenon. Other expenses, as a percentage of sales, stood at 14% of sales as against 12.2% in Q3FY07, which was abnormal considering the full year trend of 14%. As a result, there was a direct hit of 200bps on the operating margin front. For the full year, EBITDA grew 83% to INR 1094 mn. EBITDA margins increased 150bps to 15% on the back of 310bps improvement in the EBIT margins of the MHE and stable margins for transmission division. We expect this trend to continue going forward on the back of improved demand scenario from the user industries and operating leverage kicking in. Other income for the quarter increased 18% Y-o-Y to INR 23 mn in Q4FY07. For the full year though there was a decline of 21% Y-o-Y to INR 66 mn. PAT for the quarter grew 45% Y-o-Y to INR 185 mn in Q4FY07. For the full year, the same grew 96% to INR 548 mn. Net profit margin for the quarter declined marginally by 30bps to 6.5% in Q4FY07. For the full year though, margins improved 130bps to 7.6%. Other details Venture into manufacturing of large-size windmill gear boxes Elecon is venturing into the manufacture of large-size windmill gear boxes (between 1 and 2 MW). It will also be selling entire windmills on a turnkey basis for turbine sizes of up to 600 KW and has recently signed an agreement with Centre for Wind Energy Technology for certification of 600 KW windmills. For higher turbine sizes, it is looking at tying up with global windmill companies for their gear box sourcing requirements. It is setting up a separate plant for this purpose, entailing a capital expenditure of INR 800 mn. Though Elecon is targeting revenues of ~INR 1 bn in FY09E, we have factored in sales of INR 500 mn in FY09E from this segment. We have adopted a conservative approach because we would prefer waiting for the company to get a few orders, given the complexity of this business and presence of established players in the turnkey market.

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Elecon Enginerring

Capex plan of INR 1500 mn over the next two years We estimate a capex of INR 1.5 bn for Elecon over FY08-09E. The break-up of the same is as follows: Table 1: Expansion plan
Particulars Wind mill transmission Wind mill MHE Transmission Total
Source: Company, Edelweiss research

Amount (INR mn) 800 100 300 300 1,500

The company is likely to finance 30% of this capex through internal accruals and balance by way of term loans. We expect Elecon’s strong earnings to keep its debt-to-equity ratio at the current levels, going forward. Bonus and dividend Elecon declared bonus of 2 shares for every one held and a dividend of 75%. Post the record date we shall be incorporating the impact of bonus shares in our model.

Financials snapshot Year to March Net sales Raw materials Raw material consumed Stock adjustment Employee expenses Other expenditure Total expenditure EBITDA Other income Depreciation Interest PBT Provision for taxation - current PAT Tax rate (%) Equity capital (FV INR 10) No. of shares (mn) Adj EPS (INR) P/E (x) Margins (%) R.M. (% of sales) Emp exp (% of sales) Other exp (% of sales) OPM (%) NPM (%) 69.7 2.9 14.0 13.5 6.5 69.3 2.6 14.7 13.3 6.8 Q4FY07 2,848 1,984 1,750 234 82 398 2,464 384 23 34 58 315 130 185 41 63 31 6 Q4FY06 1,874 1,299 1,151 148 50 276 1,624 250 13 25 35 203 76 127 37 57 29 4

(INR mn)

Y-o-Y % 52.0

Q3FY07 1,682 1,113 1,214 (101) 67 206 1,386

Q-o-Q % 69.3

FY06 4,425 3,086

FY07 7,231 4,872

FY08E 9,727 6,880

191 552

271 993 6,137 1,094 66 122 194 843 295 548 35 63 31 18 29 67.4 3.8 13.7 15.1 7.6

325 897 8,102 1,625 23 169 251 1,227 405 822 33 63 31 26 19 70.7 3.3 9.2 16.7 8.5

53.6

296 15 33 54

77.7 29.7

3,828 597 83 94 140

55.1 45.3

225 72 152 32 63 31 5

40.1 21.3

410 131 279 32 57 29 9 57

0.5 8.8 (5.0) 1.1
87.1

66.2 4.0 12.2 17.6 9.1

5.3 (27.8) 14.1 (23.4)
30.8

69.7 4.3 12.5 13.5 6.3

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Elecon Enginerring

Q4FY07 Segment revenue (INR mn) Material handling equipment (INR mn) Transmission equipment (INR mn) Less: Intersegment (INR mn) PBIT (INR mn) Material handling equipment (INR mn) Transmission equipment (INR mn) Profitability (%) Material handling equipment (%) Transmission equipment (%) 2,849 1,913 1,104 168 451 223 228 15.8 11.7 20.7

Q4FY06 1,874 1,187 784 97 274 129 145 14.6 10.8 18.5

Y-o-Y% 52.1 61.2 40.9 73.6 64.7 73.5 56.9

Q3FY07 1,682 999 790 107 297 130 166 17.6 13.0 21.1

Q-o-Q% 69.3 91.4 39.8 57.7 52.1 71.1 37.2

FY07 7,232 4,485 3,135 388 1,196 551 645 16.5 12.3 20.6

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Elecon Enginerring

Company Description
Elecon Engineering (Elecon) was incorporated in 1951 and has supplied equipment to major core sectors such as steel, fertilizers, cement, coal, lignite and iron ore mines, power stations, and port mechanisation in India and abroad. It used to be a two-product company (elevators and conveyors), but now it operates in two broad business segments- MHE and industrial transmission equipment

Investment Theme
With 42, 625 MW of capacity addition expected over FY07-12, we expect a total capital expenditure of Rs.112.5 bn on the material handling equipment front over the period of six years. Elecon being one of the bulk material handling equipment players is expected to benefit from the same. Elecon is the largest manufacturer of transmission equipment in India. Order book for the transmission division is driven by the corporate capex plans that have increased from a low of 23% of GDP to 26% in 2004. With average capacity utilisations running at higher levels currently, India is on buoyant corporate capex cycle for the next three years, which will provide growth for the transmission business.

Key Risk
Any slowdown in the capex plans of the user industries, namely coal-based power plants, steel, and cement, could be a major threat to the company’s expansion plans.

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Elecon Enginerring

Financial Statements
Income statement Year to March Income from operations Direct costs Employee costs Other expenses Total operating expenses EBITDA Depreciation and amortisation EBIT Interest expenses Other income Profit before tax Provision for tax Extraordinary items Reported profit Adjusted net profit Shares outstanding Dividend per share Dividend payout (%) Common size metrics- as % of net revenues Year to March Operating expenses Depreciation Interest expenditure EBITDA margins Net profit margins Growth metrics (%) Year to March Revenues EBITDA PBT Net profit EPS FY05 71.2 138.3 731.0 375.2 375.2 FY06 62.2 87.0 155.0 176.3 176.3 FY07E 63.4 83.4 89.2 96.4 96.4 FY08E 34.5 48.5 45.7 50.2 50.2 FY09E 29.7 38.4 43.0 43.0 43.0 FY05 88.3 3.0 3.4 11.7 3.7 FY06 86.5 2.1 3.2 13.5 6.3 FY07E 84.9 1.7 2.7 15.1 7.6 FY08E 83.3 1.7 2.6 16.7 8.5 FY09E 82.2 1.6 2.5 17.8 9.3 101 101 28 0.6 15.9 FY05 2,728 1,915 157 337 2,409 319 82 237 93 31 175 74 FY06 4,425 3,086 191 552 3,828 597 94 502 140 83 445 131 36 279 279 29 1.1 11.0 FY07E 7,230 4,872 271 993 6,136 1,094 123 971 194 66 843 295 548 548 31 1.5 8.6 FY08E 9,727 6,880 325 897 8,102 1,625 169 1,455 251 23 1,227 405 822 822 31 6.6 25.0 (INR mn) FY09E 12,614 8,927 407 1,032 10,365 2,249 196 2,053 318 20 1,755 579 1,176 1,176 31 9.4 25.0

Cash flow statement Year to March Net profit Add: Depreciation Add: Misc expenses written off Add: Deferred tax Gross cash flow Less: Dividends Less: Changes in W. C. Operating cash flow Less: Change in investments Less: Capex Free cash flow FY05 101 82 32 24 239 16 188 34 (1) 229 (193) FY06 314 94 27 (2) 434 31 914 (511) 13 401 (926) 694 47 657 (10) 700 (710) FY07E 548 123 23 FY08E 822 169 992 206 887 (101) 700 (801)

(INR mn) FY09E 1,176 196 1,372 294 819 260 1,000 (740)

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Elecon Enginerring

Balance sheet As on 31st March Equity capital Reserves & surplus Shareholders funds Secured loans Unsecured loans Borrowings Sources of funds Gross block Depreciation Net block Capital work in progress Total fixed assets Investments Inventories Sundry debtors Cash and equivalents Loans and advances Total current assets Sundry creditors and others Provisions Total CL & provisions Net current assets Net deferred tax Others Uses of funds Book value per share (BV) (INR) Ratios Year to March ROE (%) ROCE (%) Current ratio Debtors (days) Fixed assets t/o (x) Debt/Equity Valuations parameters Year to March EPS (INR) FY05 3.2 FY06 8.9 FY07E 17.5 FY08E 26.3 FY05 14.6 17.6 1.7 152 5.1 1.3 FY06 31.7 23.0 2.0 177 5.6 2.0 FY07E 38.7 28.9 1.7 150 5.8 1.3 FY08E 39.0 31.1 1.7 150 5.4 1.2 FY05 57 677 733 670 292 962 1,695 1,725 1,112 613 7 621 50 1,200 1,140 92 251 2,682 1,539 45 1,584 1,097 (123) 50 1,695 26 FY06 57 970 1,027 1,506 551 2,057 3,084 2,027 1,182 846 107 952 63 1,639 2,142 247 306 4,334 2,122 45 2,167 2,167 (121) 23 3,084 36 FY07E 63 1,738 1,800 1,706 589 2,295 4,095 2,727 1,305 1,423 107 1,529 63 3,010 2,975 48 383 6,415 3,502 289 3,790 2,624 (121) 0 4,095 58 FY08E 63 2,354 2,417 2,206 789 2,995 5,412 3,427 1,474 1,953 107 2,060 63 3,663 4,002 (53) 478 8,090 4,268 412 4,680 3,410 (121) 0 5,412 77

(INR mn) FY09E 63 3,236 3,299 2,706 989 3,695 6,994 4,427 1,670 2,757 107 2,864 63 4,754 5,011 (94) 560 10,231 5,454 588 6,042 4,189 (121) 0 6,994 106

FY09E 41.1 33.4 1.7 145 5.1 1.1

FY09E 37.6

Y-o-Y growth (%)
CEPS (INR) P/E (x) Price/BV(x) EV/Sales (x) EV/EBITDA (x)

375.2
32.4 153.0 19.0 5.4 46.5

176.3
65.4 55.4 13.7 3.6 26.7

96.4
107.3 28.2 8.6 2.4 16.2

50.2
158.6 18.8 6.4 1.9 11.4

43.0
219.5 13.1 4.7 1.5 8.6

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Elecon Enginerring Edelweiss Securities 14 Floor, Express Towers, Nariman Point, Mumbai – 400 021 Board: (91-22) 2286 4400 Email: research@edelcap.com Naresh Kothari – 2286 4246 Vikas Khemani – 2286 4206 INDIA RESEARCH Shriram Iyer Gautam Roy Ashutosh Goel Vishal Goyal, CFA Revathi Myneni Harish Sharma Priyanko Panja Parul Inamdar Priyank Singhal Prakash Kapadia Niraj Mansingka Manika Premsingh Sunil Jain Yogesh Radke 2286 4256 2286 4305 2286 4287 2286 4370 2286 4413 2286 4307 2286 4300 2286 4355 2286 4302 4097 9843 2286 4304 4019 4847 2286 4308 2286 4328 SECTOR Head – Research Airlines, Textile Automobiles, Auto Components Banking & Finance Balakumar V Cement Ashish Agrawal Infrastructure, Auto Components, Mid Caps Infrastructure, Engineering, Telecom Information Technology Media, Retail, FMCG Mid Caps Tushar Mahajan Oil & Gas, Petrochemicals Harsh Biyani Economist Alternative & Quantitative Alternative & Quantitative Nirmal Ajmera Ankit Doshi Dipesh Shah 2286 4419 2286 4258 2286 4671 2286 4434 2286 4439 Nikhil Garg Swati Khemani Neha Shahra Priya Ramchandran Anubhav Kanodia 2286 4301 2286 4282 2286 4266 2286 4276 2286 4389 2286 4361 (044) 4263 8283 Co-Head, Institutional Equities Co-Head, Institutional Equities INSTITUTIONAL SALES Nischal Maheshwari Rajesh Makharia Vikrant Oak Abhijit Chakraborty 2286 4205 2286 4202 4019 4712 4019 4823
th

Email addresses: firstname.lastname@edelcap.com

e.g. naresh.kothari@edelcap.com RATING INTERPRETATION

unless otherwise specified

Buy Accumulate

Expected to appreciate more than 20% over a 12-month period Expected to appreciate up to 20% over a 12-month period

Reduce Sell

Expected to depreciate up to 10% over a 12-month period Expected to depreciate more than 10% over a 12-month period

Trading Buy Expected to appreciate more than 10% over a 45-day period

Trading Sell Expected to depreciate more than 10% over a 45-day period

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